Electronic Arts | Market Pitch

It’s Game Over for Zynga: Time to Restart

June 10, 2013 Leave a comment

Image representing Zynga as depicted in CrunchBase

Image via CrunchBase

Every game must surely end at some point, but it is less sure whether the player will emerge as the winner or lose out. At a point where the player is defeated, he chooses to either restart or opt out completely. Unfortunately for Zynga (NASDAQ: ZNGA), the social gaming company seems to be losing the game. It finds itself in a situation where it must strategize carefully, to enhance its chances of surviving the next level. The competition is heating up, and the industry is taking a paradigm shift, from web-based games to mobile application games. This is shifting social media gaming to smartphones and tablets, and Zynga must work hard to get into the act.

ZNGA data by YCharts

Zynga has failed to breach the $4 mark since July 25 last year, which is quite a slump considering that it did trade north of $14 during Q1, 2012. At its current price of about $3 a share, the company is down 70% from its 2011 IPO price of $10. The most difficult part is that the company seems to be ever sliding, rather than offering investors something to believe in, a lease of life. However, the company has adopted a strategy of cutting costs, coupled with ambitious bets on Real Money Gaming, Mobile and revenue from its website (zynga.com). These bets present the faintest of hopes for a turnaround, while the slimming up seems seems set to help the company save on costs.

Game over

From 2010-2011, Zynga was at the peak of its business: the company reported billings of $839 million during fiscal year 2010. The following year was equally impressive as revenues increased to $1.14 billion, and then the company went public via an IPO. The year 2012 was the beginning of Zynga’s fall from grace, as the transition to smartphones and tablets reached top gear. People now prefer to undertake their computing tasks using mobile devices, which threaten rendering the PC industry obsolete. People are now playing games via mobile applications, hence shifting from Zynga’s stronghold, the Facebook (NASDAQ: FB) platform.

When Zynga was at its peak, Facebook, the social gaming company’s main platform for engaging players, was the benchmark of social gaming platforms. However, the shift to mobile gadgets has created a swing in taste, with gamers now preferring the mobile platforms. Unfortunately for Zynga, Facebook is yet to build a commanding ground similar to its web-based platform. Additionally, Facebook has also changed significantly the way games appear on its sponsored stories listing. Initially, it used to be the most popular, but now it is the most recent that appear first. This gives other companies like Electronic Arts (NASDAQ: EA) an opportunity to challenge Zynga’s Farmville, its most famous game on Facebook.

The Facebook platform has been Zynga’s sole breadwinner for the better part of its five year history. Approximately 90% of the social gaming company’s revenue came via the social media giant over the last three years, bar 2012. However, this has since changed, with revenues received via the platform diminishing subsequently, every quarter. Zynga has tried to up its game on the mobile platform gaming by acquiring a selection of small companies over the last year. In 2012 the company made a $200 million acquisition of OMGPOP, which operated in the mobile space. However, it seems this did not pay off, as witnessed with the closure of OMGPOP. The unit’s closure came consequently as part of the restructuring plan being implemented, which also saw more than 500 staff or 18% of the total workforce (2,800 employees) lose their jobs.

Starting again

The restructuring plan is part of Zynga’s attempts to get out of its current situation on the way back to profitability. Analysts are confident that the company still has the opportunity to turn things around and start earning profits. However, the time it will take to effectively do that is likely to be longer than expected. Reports suggest that in the next one year, the social gaming company could become profitable. Betting on this estimate relies on the company’s progress in mobile, real money gaming, and of course revenue from its website.

The company’s 500 staff layoff represents significant amounts of long-term savings. However, there are costs associated with laying off staff, which usually hit first, before any benefits are realized. The severance costs and benefits continuance are likely to affect Zynga’s upcoming quarter, which again might make the decision taken by the company seem insignificant in terms of benefits. However, the company seems to have done the right thing considering the fact that it will need to keep hold of a majority of its $1.27 billion worth of cash going forward.

The company will need huge amounts of cash in its bid to give another shot at penetrating mobile platforms. The real money gaming also offers an exemplary opportunity, although this is only limited to two U.S states and parts of Europe. If all states allowed it then Zynga could be set for a huge upside. Therefore, the pitfall to this is the addressable market irrespective of the other challenges.

Competition

Zynga faces competition from Caesars (NASDAQ: CZR) on its online gaming venture, which it entered in conjunction with Bwin. Ceasars is a veteran in the industry, and trumps Zynga’s attempts to lure the European market. The Las Vegas based company has established itself as a market leader in Europe, since the U.S offers limited opportunity. Only Nevada and New Jersey allow online gambling, and Zynga has already applied for licensing in each of the two states.

Social gaming is proving to be a tough challenge as well, as exhibited by Zynga’s rival Electronic Arts, which recently closed some of its Facebook-based social games. In a message to the affected players, the company wrote:

“Today we are informing players of the difficult decision to retire some of our Facebook games: The Sims Social, SimCity Social and Pet Society. For players who have enjoyed our games, we will be making a special offer to introduce you to a PopCap game. You’re a valued fan and we want to make sure you get a smooth transition to PopCap. More details about that offer will appear in-game soon.”

Furthermore, EA is not the only example with regard to risks associated with running social games. Activision Blizzard (NASDAQ: ATVI) also closed Diablo III. This begs the question whether Zynga is any different as it continues making losses from this core unit.

Interestingly, Zynga has the best gross margins against its competitors. The trailing 12-month gross margin stands at a massive 73%, compared to Electronic Arts’ 64%, and Activision Blizzard’s 66%. Ceasars’ gross margin is the lowest at 48%. However, contrary to Zynga, Electronic Arts and Activision Blizzard are profitable. The two giants’ profit margins stand at 2.58% and 24.38% respectively. Operating margins for the trailing 12-months are pegged at 3% and 31% respectively, as compared to Zynga’s 0%. Activision is the biggest of the four companies with a market cap of $15.98 billion and trades at a 13.30 P/E, while Electronic Arts’ market cap is pegged at $6.92 billion,and trades at 73.82x. On the other hand, Zynga’s market cap of $2.37 billion is only superior to Ceasars’ at $1.66 billion, and both companies are unprofitable.

The bottom line

Zynga appears to be at a crossroads, with the social gaming industry proving ever tougher as the mobile shift takes course while at the same time the company is attempting real money gaming, which according to Ceasars’ income statement leaves a lot to be desired. Additionally, the fact that Europe seems the most reliable source of income for real money gaming, taking into consideration that Ceasars has already built its nest in the region, poses a huge challenge to Zynga. However, the restructuring process will definitely allow the company to cut on spending, hence giving it the opportunity to take on the challenges as they emerge. The huge gross margin TTM coupled with a 0% operating margin signifies high operating costs against declining revenues, which justifies the layoff.

The bottom line is if Zynga is to negotiate a way out of the current situation, then it will have to reinvent itself by embracing the changes in social gaming. It is game over for Zynga, and it definitely has to start again.