Zynga Rekindles Hope With Management Restructuring And Revived Strength In Key Franchises

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Zynga’s (NASDAQ:ZNGA) stock shot up as the company’s Q3 2013 results exceeded the higher end of its guidance. However, that does not cloud the fact that the business declined significantly compared to the third quarter of 2013 and the company is still not out of troubled waters. Management has not been specific about the ongoing strategic changes which was one of the updates that we were looking forward to. Nevertheless the organizational restructuring and the hiring of new chief operating officer is likely to improve Zynga’s efficiency and the quality of its games. The next two quarters are going to be critical as we expect the company to take advantage of the seasonal strength to launch new games and promote its strongest titles. Social gaming typically sees an uptick during the holiday season and the first quarter due to new device activations.

We also believe that 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. This is where the new leadership, including the new CEO and COO, will focus in the coming quarters. Our price estimate for Zynga stands at $3.33, implying a discount of about 10-15% to the market price.

Check out our complete analysis of Zynga

Key Franchises Doing Well, Strong Demand From Advertisers

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Zynga’s key gaming franchises Zynga Poker, Farmville and Farmville 2 continued their strength in the third quarter. These games account for roughly half of the company’s revenues and management plans to continue investing in them.

The weakness in Zynga’s Poker franchise played a major role in the company’s revenue decline in the second quarter of this year. This weakness eased off in the third quarter due to better execution under the new leadership. The company’s web bookings were better than expected as the new expansions for Farmville and Farmville 2 were well received by users. In fact, Farmville franchises’ bookings grew 45% over Q3 2012, which is a massive improvement. [1] This has rekindled hope that Zynga can potentially turn these franchises into evergreen games and sustained revenue sources.

The advertising business did well, driving revenues up due to new apps, improved technology and strong demand from advertisers. Ad revenue for daily active users (DAU) jumped 33% sequentially and 78% over the third quarter of 2012. That’s a huge jump, but should be taken with a pinch of salt because these figures are for daily active users. The situation doesn’t look that good as we see the bigger picture, as there has been a significant decline in the number of monthly active users and related revenues.

Focusing Away From Real Money Gaming, A Lot Relies On New Launches

Zynga has stated that under the new organizational structure, key product heads are closer to top level management which is likely to speed up the execution and improve the overall quality. At least for now it appears that the focus will not be real money gaming, which was being hailed as one of the potential saviors of the struggling social gaming giant. 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.

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 past few quarters have seen a significant divergence form the earlier strategy of launching a large number of games. With quality and innovation being the core focus, we can expect Zynga’s business to stabilize in the next few quarters. Castleville Legends was a high quality game launched in Q3 for tablets, garnering strong user interest. Although, Zynga also launched Ninja Kingdom, Fairy Tale Twist and Hit it Rich slots, the marketing was primarily focused around Castleville Legends indicating the company’s belief in the game’s potential.

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Notes:
  1. Zynga’s Q3 2013 Earnings Transcript []