Zynga Earnings Preview: Update On Strategic Initiatives Is More Important Than The Financial Numbers This Q3

by Trefis Team
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Investors will be keen to know of Zynga’s (NASDAQ:ZNGA) revival strategy as the company releases its Q3 2013 earnings on October 24. Last quarter was disappointing as the social gaming giant’s web bookings fell by 44% as compared to the same period a year ago. [1] The figure came down significantly compared to the first quarter as well, due to the closure of certain under-performing games and surprising weakness in Texas Holdem Poker, which has been one of the key game franchises for the company. The decline is likely to continue in the third quarter as well, but that’s widely expected and not so important this time. The appointment of the new CEO with a strong background in gaming has rekindled the hope among investors who are expecting him to reveal a promising roadmap for the future.

Zynga has struggled primarily due to its inability to manage fickle social gaming customers and the lack of innovation and originality. To manage profits, the company started laying off its employees with the expectation of saving an estimated $70-$80 million in pre-tax income. That’s certainly not the solution to its woes. Zynga needs better social games and better ways to monetize its gaming platform and assets. Our price estimate for Zynga stands at $3.34, implying a discount of about 10% to the marker price.

Check out our complete analysis of Zynga

Revenue Decline To Continue

Zynga heavily relies on three games that together constitute half of its revenues. Texas HoldEm Poker, Farmville and Farmville 2 account for roughly 20%, 16% and 15% of Zynga’s online gaming revenues respectively, with no other game bringing in more than 10%. [1] Farmville 2 has done reasonably well and may continue to do so in the near term due to Appaloosa River expansion (read Zynga To Launch Biggest Game Update For Farmville). Zynga stated that Farmville and Farmville 2 grew their combined bookings by 29% in Q2 2013, compared to the same period a year ago. [1]

However, the weakness in Zynga’s Poker franchise isn’t a good sign and played a major role in the company’s revenue decline in the second quarter. The situation was further worsened by the closure of The Ville, Empires & Allies, Dream Zoo and Zynga City on Tencent. Zynga mentioned that poker bookings fell due to illegitimate card activity on the Internet, a user shift to mobile platform and to more casual casino activities such as slots. This demonstrates the volatile nature of social gaming where a strong game like poker is also struggling to hold on to users. Clearly, Zynga needs a fundamental shift in its core business and the third quarter may not be meaningfully different.

Investors Will Need A Plan From Zynga’s Management

Given the company’s failures in recent quarters investors are looking for a promising plan forward from management. In Q1 2013, Zynga rolled out real-money games ZyngaPlusPoker and ZyngaPlusCasino in the U.K., and was looking at getting a license in the U.S. for the same. The second quarter was disappointing on this front as the company did not give material insight into the initial traction of these games in the U.K. and announced that it will not purse the license for online gambling in the U.S. In addition to this, it stated that its recent acquisition of Spooky Cool Labs, which is involved in building social and online gambling games, was motivated by its intention to leverage Spooky Cool Labs‘ assets and capabilities to promote social slots, not real money gaming. If not real money gaming, then what? That’s the big question that the company needs to answer.

We believe that Zynga will continue to focus on expanding mid-core games and will adopt a steady approach of building up its user base rather than relying on explosive and unsustainable growth as it has seen in the past. The company launched some mid-core games on mobile in the second quarter including War of the Fallen, Battlestone and Solstice‬ Arena. Such games have a different growth trajectory and tend to build audience over longer periods of time. In addition, the company’s long term strategy of creating its own gaming ecosystem will protect it against the inherent volatility of individual social gaming titles. What Zynga needs is better games, innovation, more sustainable ways of monetizing games as well as higher focus on core gamers. New CEO Don Mattrick can leverage his vast experience in building sustainable customer base for Xbox Live to offer fresh perspective and help the company in managing its costs better.

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Notes:
  1. Zynga’s Q2 2013 Earnings Transcript [] [] []
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