Zynga Earnings Preview: Looking For Growth Catalysts

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Zynga (NASDAQ:ZNGA) will report its Q1 2013 earnings on April 24. Given the company’s previous guidance, we expect lower bookings during the quarter, mainly due to slower new releases as Zynga tries to control its game portfolio. We further expect the company to report losses. However, there are some trends that indicate that Zynga is making strategic and tactical moves to secure its long term growth. These include reducing reliance on Facebook (NASDAQ:FB) and promoting its own platform, investing in mid-core games and expanding into casino gaming. Let’s take a look at some of the trends that can govern Zynga’s first quarter earnings and its long term outlook.

Check out our complete analysis of Zynga

Reduced Reliance On Facebook Can Act As Short Term Dampener

The relationship between Zynga and Facebook can be described as complicated at best. In a recent move, Zynga removed the requirement of Facebook login in order to access games on its own website. The move comes a year after the company launched its own platform for third-party game developers. Given Facebook’s reach and user engagement, the straining relations can affect user activity on Zynga’s games in short term. However, from a long term perspective, there is a value in less of a reliance on Facebook, which is getting crowded by a host of game developers.

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Approximately 45% of Zynga’s value comes from its cash pool with another 30% coming from new and smaller games (other than FarmVille, CityVille, CastleVille, Empires & Allies and Texas HoldEm Poker), according to our estimates. In other words, a significant portion of our price estimate relies on the expectation that Zynga will continue to launch successful games. One way to ensure this is by marketing third-party games, which is what the company has been doing for a while.

Zynga’s gaming platform could potentially become the default cloud gaming platform, thanks to the scalability and immense marketing reach it offers. In a recent conference, Zynga stated that one of its third-party games, Village Life, has reached 1 million daily active users. A lot of times smaller game developers may have a compelling product, but not near enough marketing muscle. This is where Zynga can add value.

New Games May Help

Zynga has something to cheer about regarding its mobile gaming initiative as Draw Something hit 100 million downloads in February 2013. As Zynga tries to gain share in the mobile gaming market in 2013, we can expect the company to relaunch and push its popular titles. Zynga is still the largest social gaming company in the world with about 30o million monthly active users, out of which, nearly 72 million users are purely on mobile.

In addition to Draw Something, Zynga also launched Elite Slots in January 2013, which is its most polished slots game yet. It can almost be called a role playing game as the slot spins can lead to character progression, thus forming a story. This adds a new dimension to the game, which also includes a social element as players can interact with each other. While it is too early to comment on the game’s success, it forms a part of Zynga’s broader strategy to expand into online casino gaming.

Future Growth Opportunities

Zynga has a substantial growth opportunity in mid-core games and online casino gaming.

The company expects its mid-core games to keep users engaged for longer periods of time. A mid-core game tries to combine the engagement level of a core game with the learning curve of a casual game to provide an engaging gaming experience to a larger user base. This can potentially allow for retention of a large user base while promoting in-game purchases as the games are designed to be more engaging and users are likely to pay to upgrade rather than drop off, once the free-play scenarios are completed.

While investing in mid-core games might help, Zynga has much larger opportunity in real money gaming. The company recently rolled out real-money games ZyngaPlusPoker and ZyngaPlusCasino in the U.K. [1] The online gambling market outside the U.S. is worth more than $32 billion and Zynga can make a big difference to its business if it can tap this market successfully. [2] However, the company will have to deal with the 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.

Due to 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 can 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. [3] However, the company will have to compete against popular gaming providers and casino operators, who have significant mind share with gamers.

Our price estimate for Zynga stands at around $3, implying a discount of 5% against the market price.

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Notes:
  1. Zynga Rises on Real-Money Gambling in U.K.: San Francisco Mover, Bloomberg, Apr 3 2012 []
  2. Big Fish Casino Raises The Stakes On iPhone With Real-Money Gambling, TechCrunch, Aug 16 2012 []
  3. Zynga’s Online Gaming Push Faces Hurdles From Casinos, Bloomberg, Apr 2 2013 [] []