Is Zynga a Prime Short Candidate?
Eric is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The studio OMGPop struggled before it gained a major success with its Draw Something app, but this app soon became so popular that it convinced Zynga (NASDAQ: ZNGA) to buy OMGPop for $200 million. In Forbes, Paul Tassi reports that Draw Something lost almost a third of its audience in April, illustrating a major flaw in Zynga's business model.
Zynga's main strength is game monetization, not game design. Originally, Zynga grew rapidly because its business model allowed it to cut out some major game development expenses, as it simply released games that were very similar to games that its competitors produced. When Zynga started catching too much heat for making close copies of other Facebook apps, it had enough cash on hand to start buying smaller studios, such as OMGPop, instead.
Zynga can still afford to make a few more purchases like the OMGPop acquisition, as Yahoo Finance states that the company has $1.06 billion in cash and no debt. Although a large cash reserve and no debt is often a sign of a healthy company, Zynga seems like it might need to buy other companies just to maintain its current performance. The OMGPop acquisition suggests that Zynga has changed its focus to buying out its competitors, instead of copying them.
Zynga's monetization plan for Draw Something, which was mentioned in the Forbes article, could create another major business risk. Zynga basically planned to rely on product placement to fund the game, adding major brands to the words that the game selected for its players. Product placement might convince many former Draw Something players to stay away. Most ad supported Facebook apps haven't gone as far as adding prominent chain franchises and well known consumer brands to the actual story lines of their games.
Facebook allows many developers to create apps for its platform, so the Facebook platform doesn't give Zynga a moat. Zynga's website launch has created a platform that gives Zynga more control over the games it offers, more independence from Facebook, and a way to sell in-game items without Facebook collecting a major share of the proceeds. The main problem with an independent platform for Zynga is that Zynga still relies on Facebook to attract gamers, so it has a long way to go before it becomes truly independent.
One breakup between two former business partners recently made the headlines when Target (NYSE: TGT) decided that it didn't want to serve as a showroom for Amazon.com (NASDAQ: AMZN) any longer. Although Amazon's Kindle was a popular product at Target stores, Target decided to give up the revenue from the Kindle to prevent Amazon from using Target to advertise its own business. If Zynga truly became independent from Facebook, Facebook could easily decide to retaliate against Zynga just like Target retaliated against its former partner.
Zynga's compensation decisions have also attracted negative attention. Zynga explained that it developed a plan to take back shares from early employees because these employees didn't meet the company's expectations, reported David Louie at ABC 7. This decision could easily have reduced the morale of Zynga's workforce, as employees lost out on compensation they expected to receive, and hindered the company's recruitment efforts going forward.
Zynga shows the importance of looking beyond the financial statements to evaluate a company's investment potential. The CEO's decisions are critical, and innovation and ethics are very important factors that an investor should consider. Even with a large cash balance and no debt, I still think that Zynga is a sell.
enovinson has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com. Motley Fool newsletter services recommend Amazon.com. 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. If you have questions about this post or the Fool’s blog network, click here for information.