Shares of social gaming company Zynga Inc (NASDAQ:ZNGA) plunged recently, after the company reported that it would cut 520 jobs, or roughly 20% of its workforce, in an effort to reduce expenses. It also warned of weak bookings (in-game virtual product sales) in its current quarter, which doesn’t bode well for a company that has lost nearly 50% of its market cap over the past twelve months.
Zynga Inc (NASDAQ:ZNGA) was once considered a speculative growth stock, but even now the speculators have turned bearish on the company’s growth prospects. An increasingly frayed relationship with Facebook Inc (NASDAQ:FB), a decline in total users, a paradigm shift from desktop to mobile gaming, and a desperate investment in online gambling all suggest that it may be time to give up on the maker of Farmville and Words With Friends.
First quarter fumble
During its first quarter, Zynga Inc (NASDAQ:ZNGA)’s revenue slid 18% year-on-year to $264 million. It managed to squeeze out an adjusted profit of a penny per share, or $9.1 million, a dramatic plunge from the 6 cents per share, or $47 million, it reported in the prior year quarter. Despite the decline from last year, its top and bottom lines still topped analyst estimates.
What really prompted Zynga Inc (NASDAQ:ZNGA)’s initial sell-off, however, was its drop in active users. Its daily active users, which generate the majority of Zynga’s revenue, dropped 20% to 52 million users. Monthly active users also fell 13% to 253 million. In other words, the writing is on the wall – double-digit user declines lead to double-digit revenue reductions.
In comparison, Electronic Arts Inc. (NASDAQ:EA) first entered the social games arena with its $300 million purchase of Playfish, which it closed down in April, and its $1.3 billion purchase of PopCap Games. Since then, EA has released several successful social games, such as The Sims Social, Sim City Social and Pet Society. However, Electronic Arts Inc. (NASDAQ:EA) has discontinued all three of these social titles as the company shifts its focus towards mobile games. That quick change has helped Electronic Arts Inc. (NASDAQ:EA), which recently reported a 21% year-on-year gain in non-GAAP mobile revenues.
Zynga CFO attempted to appease investors during the post-earnings conference call, stating, “It’s not about keeping score of the quarter. It’s about the long game.”
The long (losing) game
If the “long game” is to wither slowly into unprofitability, then Zynga is winning. However, if the goal is to actually steal market share away from smaller competitors, such as Angry Birds maker Rovio Entertainment, then Zynga is failing miserably.
Zynga Inc (NASDAQ:ZNGA) CEO Mark Pincus’ current strategy is to close studios, discontinue older games, and lay off employees. Pincus’ long-term goal is to streamline the company’s resources to focus more on mobile games, rather than desktop social ones. The company’s recent round of job cuts, which brings its workforce down to 2,300, will also eliminate its New York, Los Angeles and Dallas studios. Zynga claims the cuts will reduce expenses by $70 million to $80 million.
While reducing its expenses to balance its costs with revenue is a step in the right direction, Zynga still doesn’t produce enough mobile games to remain competitive. Some of Zynga’s more popular mobile offerings include Draw Something, Words With Friends and Farmville 2.
By comparison, EA is developing 15 new mobile titles for fiscal 2014, such as Plants vs Zombies 2, a new Bejeweled game, and more EA Sports games. Last quarter, EA enjoyed massive mobile gains from The Simpsons: Tapped Out, which generated $10 million in digital revenue last quarter, hitting a cumulative total of $50 million since its launch last August. That’s a tough lineup for Zynga to defend against, especially considering Zynga Inc (NASDAQ:ZNGA)’s open admission that it often resorts to copying other more successful franchises.
EA CFO Blake Jorgensen has echoed Pincus’ strategy, stating, “We are placing greater emphasis on mobile and less on social games.” The only difference is that EA is pulling it off with ease, fueled by the second largest video game publishing operations in the world, while Zynga is shrinking rapidly into a dark corner.
Worse times ahead
What’s worse, Zynga lowered its expectations for its second-quarter bookings, which are now projected to come in at the lower end of its prior guidance of $180 million to $190 million. This indicates that even the most die-hard fans of Zynga games, who sometimes spend thousands of dollars on virtual cows and power ups, are losing interest. Bookings comprise the majority of Zynga’s top line, the rest of which is generated by advertising revenue.
As a result, Zynga Inc (NASDAQ:ZNGA) anticipates a second quarter loss between $28.5 million to $39 million, steeper than its previous forecast for a loss between $26.5 million to $36.5 million. Zynga’s fundamentals tell a similarly bleak tale.
| Forward P/E | Price to Sales (ttm) | Price to Book | Debt to Equity | Profit Margin | Qty. Revenue Growth (y-o-y) | Qty. EPS Growth (y-o-y) | |
| Zynga | N/A | 1.94 | 1.27 | 5.37 | -9.80% | -17.90% | N/A |
| Electronic Arts | 16.16 | 1.83 | 3.06 | 24.66 | 2.58% | -11.60% | -19.20% |
| Advantage | Electronic Arts | Electronic Arts | Zynga | Zynga | Electronic Arts | Electronic Arts | Electronic Arts |
Source: Yahoo Finance, 6/5/2013
Although Electronic Arts is not a fundamental winner by any means, it is still a better bet on the rise of mobile games. Electronic Arts has a large selection of well-known games (such as the recently acquired Star Wars) it can base games on. It also has more cash – $1.7 billion compared to Zynga’s $1.2 billion – to heavily market its products.
That brings us to another major problem with Zynga – why hasn’t the company used that cash hoard to invest in a smaller competitor, such as Cut the Rope creator ZeptoLab or Candy Crush maker King.com?
A final desperate gamble
While investing in ZeptoLab or King.com would make sense, Zynga has opted for the bizarre path of online gambling. Zynga recently introduced real-money games ZyngaPlusPoker and ZyngaPlusCasino in the U.K., which the company intends to expand into the rest of Europe. Some analysts have speculated that Zynga could even expand into China later this year, but that is highly unlikely, since online gambling is prohibited in the country. Brick-and-mortar casino gambling, on the other hand, is only allowed in the special administrative region of Macau.
Back at home, Zynga has already applied for an online gambling operator license in Nevada. The bulls claim that the global online gambling market could reach $40 billion to $45 billion in the next five years, and if Zynga can claim just 1% of that market, it could add $400 million to $450 million to its annual top line. But that’s if Zynga can actually still survive for another five years.
The Foolish Bottom Line
While Zynga Inc (NASDAQ:ZNGA)’s online gambling business is an interesting side venture, I don’t think it will do much to offset its declining top and bottom line growth, poor retention of users, and steady loss of market share to smaller rivals and Electronic Arts. I don’t expect Zynga to be able to stand back up by itself. Instead, I think Zynga could be taken over by a larger rival, get swarmed by activist investors, or simply fade away. In other words, this is a volatile company that individual investors should avoid at all costs.
Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Leo is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Is This the End for Zynga? originally appeared on Fool.com and is written by Leo Sun.
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