Zynga Might or Might Not Turn Around, so You Should Consider Alternatives

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When I think of Zynga (NASDAQ: ZNGA), I think of the Allstate slogan, “You’re in good hands.” Mark Pincus (CEO of Zynga) got demoted in favor of a top level entertainment executive from Microsoft. The man that’s going to be replacing Mark Pincus as CEO is Don Mattrick.

Can Zynga be turned around?

This is going to be the toughest challenge for Don Mattrick in his executive career. Let’s start with a basic look at the annual financial statement to get a first-hand look at how bad things are.

<img alt="" height="325" src="http://g.fool.com/editorial/images/55160/7-2-13-znga-pic-1_large.png" width="746" />

Source: Zynga

The company saw exponential growth in revenue between 2008 and 2012. However, the biggest challenge for the company has been finding a break-even point. Currently, the company has lost money in almost every fiscal year with the exception of 2010.

<img alt="" height="474" src="http://g.fool.com/editorial/images/55160/7-2-13-znga-pic-2_large.jpg" width="733" />

Source: Statista

The company went from reporting exponential growth in sales to now declining sales. The Farmville gaming platform has gone through every stage of the product life-cycle (growth, maturity, and decline). The company’s video games will have gone through the product life cycle in just three years. This isn’t very long for a gaming franchise. For example, Electronic Arts' Madden NFL is on its 25th iteration. The company has been able to milk the franchise since 1988. So if anything, the problem with Zynga right now is the lack of staying power for its video games.

How the business may change

Don Mattrick worked as a top executive at both Electronic Arts and Microsoft's gaming segment. The new CEO has had a track record of creating gaming franchises that have staying power, examples include The Sims, Halo, and Madden NFL. In other words, it is possible that the CEO will focus on higher quality paid for content in the mobile space rather than the freemium model that Zynga currently uses.

Chances are high that the number of games that are currently in development will be reduced. Instead, it is likely that Don Mattrick will focus on creating an exclusive gaming franchise for mobile devices. The game has to be refined, and must be a game that can attract mainstream appeal without being reminiscent of a typical Zynga video game.

A reasonable goal would be 5 million downloads or more. I come up with the 5 million figure because Take-Two Interactive (video game studio) tends to measure success in a video gaming franchise based on whether or not it can sell 5 million copies.

Gartner projects that smartphone shipments will grow to 1.2 billion in 2016. Gartner also estimates that the tablet market with grow to 375 million shipments by 2016. In total, Zynga’s addressable market is 1.6 billion people by 2016. Assuming that is the case, then it is highly probable that Mattrick's first job will be to capture the mainstream appeal of hundreds of millions of gamers, and generate a higher amount of revenue per user. Currently, the company generates $0.05 in revenue per user per day.

How to position

There is no way to know whether or not Zynga can turn around. There is no guarantee that Don Mattrick can turn around Zynga, and until we get solid data that indicates the company could be on the right track, we should consider other investment opportunities. The two businesses I have in mind are Facebook (NASDAQ: FB) and Netflix (NASDAQ: NFLX).

The two companies don't have anything to do with gaming, but have working business models in both the mobility and internet space that offer better upside.

Netflix is on the rise

Netflix has a lot of growth potential. The company’s partnership with DreamWorksWalt Disney, and Time Warner will give it the movie collection it needs in order to expand its international streaming segment. The company’s collection of both foreign and domestic films is far superior to any other competitor in the marketplace currently. Netflix has further growth potential as Microsoft predicts that there will be at least 4 billion internet users by 2020. This means that Netflix’s total addressable market will grow to 4 billion people. The company’s $8/month price point is cheap enough for both emerging and developed markets.

Analysts remain pretty optimistic about the company. The company’s contribution margin has gone up consistently over the past several quarters, which will contribute to the company’s earnings growth significantly. The company is projected to grow its earnings by 375% in the current fiscal year, and 121.7% in the year following that.

Facebook a safer bet

Going forward, I believe that Facebook (NASDAQ: FB) may eventually launch some successful products going forward. Recently, the company’s launch of Instagram Video lowered activity on Vine (which is owned by Twitter). Facebook also launched hash-tagging, which is keeping the company competitive in the social space. Some have argued that the company’s strategy of adding on features to its pre-existing social network is gimmicky. But let’s be honest. It’s nice having a place to be able to e-mail, share blog posts, pictures, and videos seamlessly within a single location on the web.

<img alt="" height="420" src="http://g.fool.com/editorial/images/55160/7-2-13-znga-pic-2_large.png" width="728" />

Source: Facebook

The company frequently adds features. This helps keep users engaged, and has resulted in an up-trend in the average revenue per user. The company was able to grow average revenue per user from $1.21 in the first quarter of 2012 to $1.35 in the first quarter of 2013.

The company’s business model works. Analysts back this assumption by forecasting the company to grow earnings by 28.26% per year over the next five years.

Conclusion

Zynga may be able to turn around under the guidance of Don Mattrick; however, a lot would have to go right for this company’s turnaround to materialize. That being the case, investors should consider investing in alternative likes Netflix and Facebook. Both companies are likely to grow based on the product strategy, and underpinning economics of digital media and social networking.

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Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Facebook and Netflix. The Motley Fool owns shares of Facebook and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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