Zynga’s Contract Change Will Help Its Real-Money Gaming Initiative

by Trefis Team
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Zynga (NASDAQ:ZNGA) renegotiating its contract with Facebook is certainly fraught with risk for the social game maker as it is no longer subject to exclusive treatment by Facebook and will be treated as any other developer. In the filing dated November 28, Zynga reported a revamped agreement between Facebook and itself which will simplify its relationship. It will no longer be an exclusive developer for Facebook, and it will also lose its ability to promote Zynga.com games via Facebook notifications. Following this change, the company’s stock plummeted 12.6% in after-hours trading to end at $2.30.

The biggest reason for the drop in the share price was the loss of the exclusive cross-platform promotional ability of Zynga in our view where it could promote Zynga.com on Facebook games in addition to the fact that Facebook can now develop its own games. This also means that other game developers on Facebook can now compete on an equal footing with Zynga, and the company may lose market share to other game makers. We think that it is very unlikely that Facebook will develop its own games as it is far more lucrative to be a platform for developing games and apps than being a game/app developer.

We examine the contract below and its implications on Zynga.  Zynga has user base of about 300 million users and generates most of its revenue from in-game virtual goods sales and advertising on multiple platforms like Facebook, Google+, iOS, Android and others.

Check out our complete analysis of Zynga

Important Features Of The Amendments Made To The Contract

a) Zynga is no longer obligated to display Facebook ads or implement Facebook credits for games outside Facebook, on platforms such as Zynga.com. The flip side to this is that the company can no longer use Facebook mail or notifications to promote non-Facebook games.

b)  Zynga is no longer an exclusive developer for Facebook and so it can launch games off Facebook on sites such as Zynga.com, but these are subject to certain restrictions.

i) Any game launched outside Facebook should be concurrently available on Facebook or shortly thereafter. This does not apply to mobile games, social games, third-party games and games launched in China or Japan

c) Contingent on “certain conditions” which weren’t made clear in the filing, Zynga will have to launch real-money gambling games on Facebook; if Facebook allows real money gambling games in countries where Zynga has real money gambling games.

(d) Zynga will now have to make acquired games available on Facebook, if it was acquired but not made available on the Facebook web site previously.

What Are The Risks And Implications Of This Change

The biggest risk faced by the company is that it will no longer be treated preferentially by Facebook and will be treated as any other developer, subject to the same terms and conditions regarding advertising and promotion. All of Zynga’s promotions on Facebook will now lead back to Facebook games and not Zynga.com or third party platforms. Facebook games account for nearly 80% Zyngas revenues and this is not a big issue in the short term, but it will become increasingly harder for the social game maker to promote its own website.

The biggest implication for Zynga is obviously the flexibility to build on its own Zynga.com platform, but the clause with the biggest potential implication on future revenue is the real money gambling clause. The previous contract had no mention of gambling or real money games and this is an area that Zynga is concentrating on for future growth. This will now enable Zynga to build a user base for real money and gambling games via Facebook in countries where Facebook allows it, while having the flexibility to promote these games on its own platform in other countries.

Zynga entered into an agreement last month, with bwin.party, to launch real-money gaming to its UK customers. It plans to launch a real-money version of Texas Hold’em Poker and FarmVille themed slots in UK. Facebook allows real-money games in the UK market, and this entire contract change may very likely be to provide real-money games in UK and other countries and this is why we think the market may have oversold Zyngas stock on news of the contract change.

Outlook For The Rest Of 2012

Raising its lower end of the estimates, Zynga guided that bookings will be in the range of $1.09 billion to $1.1 billion while adjusted EBITDA will be in the range of $152 million to $162 million for 2012. Full year non-GAAP EPS is expected to be in the range of $0.02 to $0.03 based on a full year share count of approximately 830 million shares. We expect that reducing costs and concentrating on its top games will help its results in the next few quarters.

We have a $ 3.19 Trefis price estimate for Zynga, which stands significantly above its market price. We expect Zynga’s new platform and gaming network and online gambling initiatives to account for much of its future earnings potential.

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