Zynga Earnings Preview: A Difficult Transition Lies Ahead

by Trefis Team
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Quick Take

  • Zynga is likely to report lower revenues and monthly active users when it releases its Q2 2013 earnings results on July 25.
  • The company closed some underperforming games and its existing titles aren’t doing too well, except Farmville 2 and Texas Holdem Poker.
  • The workforce reduction may help offset the lower earnings.
  • We’ll look for any color that Zynga provides on the initial traction of its real money games in the U.K.
  • The company is going through a difficult transition, and its financial performance will fluctuate as it reorganizes its core business.

Zynga (NASDAQ:ZNGA) will release its Q2 2013 earnings on July 25, and we expect the company to post a decline in revenues and monthly active users. It is quite likely that the weakness in several gaming titles that was apparent in the first quarter might have carried on into Q2 as well. In addition, the company closed several underperforming games that will further impact results.

In early June, Zynga had announced that it would cut around 18% of its workforce, or approximately 520 people, for an estimated $70-$80 million in pre-tax savings for the company. The move will lower Zynga’s headcount below what it had at the time of its IPO. This suggests that the kind of explosive growth that the company was expecting when it went public doesn’t exist anymore. It will be interesting to see how this move impacts its Q2 profits. Zynga is going through a rough patch, and its financial performance is likely to fluctuate as it reorganizes its core business and invests in new growth avenues.

Check out our complete analysis of Zynga

Weak Performance From Existing Games

We expect Zynga’s revenues as well as monthly active users (MAU) to decline due to weak performance from some of its existing games and the closure of The Ville, Empires & Allies, Dream Zoo and Zynga City on Tencent in the second quarter. In Q1 2013, the company saw its revenues slump by 18% compared to the the first quarter of 2012 due to a lower number of monthly active users (MAU) and a decline in monetization. Social gaming is a volatile industry and Zynga needs to come up with innovative games continously to keep users engaged.

However, Farmville 2 did well in the first quarter and user statistics from appdata.com suggest that the game continues to do well. For now, it averages close to 26 million MAU, which is higher than our estimate for 2012. In addition, we expect some support from the success of Zynga’s own gaming platform which hosts third-party games besides its own titles. The company’s long term strategy of creating its own gaming ecosystem will protect it against the inherent volatility of individual social gaming titles.

Update On Real Money Gaming Success

Last quarter Zynga rolled out real-money games ZyngaPlusPoker and ZyngaPlusCasino in the U.K. We’ll look for any color that the company provides on the initial traction received by these games. Zynga recently stated that it will bring real money gaming to Facebook, which can give it an edge over traditional online gambling companies. The company has also acquired Spooky Cool Labs, which is involved in building social and online gambling games. Its motive behind this acquisition is to strengthen the team with veterans from real-money gaming who are currently a part of Spooky Cool Labs‘ team. Although the market opportunity is big, Zynga will face competition from the existing players.

According to the management of Betable, a gambling platform, the online gambling market outside the U.S. is worth more than $32 billion. [1] Gambling research group H2 Gambling Capital estimates that the global online gambling market stood at 21.73 billion euros or 19 billion pounds in 2012. [2] The research firm further expects this market to grow by 30% over the next three years. While Zynga has already launched in Europe, it may want to expand to China later on. China’s online gambling market is expected to grow close to $12 billion in 2013. This may not be surprising as Macau, which is a special administrative region of China, is already the biggest casino market in the world.

Due to the lack of federal legislation, gambling is being introduced state-by-state in the U.S., and Zynga has already applied for operator license in Nevada. [3] The U.S. online gambling market could reach $7.4 billion in the next 4 to 5 years, and Zynga will strive to be one of the leading operators driving this growth. [4] However, the company will have to compete against popular gaming providers and casino operators who have significant mind share with gamers.

Zynga can make a big difference to its business if it can tap this market successfully. It appears that the global online gambling market could reach $40-45 billion in the next five years, and even if Zynga can grab 1-2% share of this market, it could add additional $400-$900 million in revenues. This translates into an upside of about 20-30% to our price estimate. However, the company will have to deal with competition from gaming incumbents such as Caesars Entertainment, which already operates online gambling services in Europe and has bought social and mobile game maker Playtika.

Our price estimate for Zynga stands at around $3.50, implying a premium of 5-10% to the market price.

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Notes:
  1. Big Fish Casino Raises The Stakes On iPhone With Real-Money Gambling, TechCrunch, Aug 16 2012 []
  2. Probability looks at U.S. alliances as online gambling gathers steam, Reuters, Apr 18 2013 []
  3. Zynga’s Online Gaming Push Faces Hurdles From Casinos, Bloomberg, Apr 2 2013 []
  4. ref:4 []
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