Tongue-Tied At Social Gaming

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Zynga's (NASDAQ: ZNGA) trouble underlines the difficulties with social gaming. The publisher behind games like FarmVille and Words with Friends recently reported that its number of monthly active users was down 13% year-over-year to 253 million in the first quarter of 2013. These figures are the lowest since the third quarter of 2012, which stood at 331 million. Daily active users also fell 20% year-over-year to 52 million. Seeing the continuous decline in social gaming, Zynga’s future is questionable.

Nine of its top game franchises are losing monthly active users quarter-over-quarter. Its top two games, FarmVille2 and Zynga Poker, declined 9% and 8% over the quarter, respectively. This is a serious problem, as these two games are significant revenue generators for the company. Similarly, its other top seven games, which are Bubble Safari, ChefVille, Words with Friends, FarmVille, Zynga Slingo, Bubble Safari Ocean, and Castle Ville, also declined in this quarter.

Zynga is not the only company to face trouble in this segment. Its rival, Electronic Arts (NASDAQ: EA), is also facing problems in its social gaming segment. The company faced the SimCity debacle, since the game requires players to always be online, resulting in heavy traffic and jammed servers. As a consequence, the company had to face angry consumers. Seeing the declining interest in social games, Electronic Arts has announced the closure of three of its social games from Facebook: The Slim Social, SimCity Social, and Pet Society. This closure will surely negatively impact social game maker Playfish, which Electronic Arts bought in 2009.

In order to offset this loss, Electronic Arts is shifting toward next-generation video game consoles. It has shortlisted a handful of titles on Nintendo's new system: Wii U, which was launched in October 2012, and the company is excited about its investment in “gen-four consoles” from Sony and Microsoft. The new-generation consoles will help Electronic Arts with its library of dominant sports titles, more than most game makers. Battlefield 4 will be one of the company's flagship titles this year and will likely attract players to new-gen consoles.

Real-money gambling

In order to offset the losses from social games, Zynga is offering real-money gaming in the UK via Zynga Plus Poker and Zynga Plus Casino, in partnership with Bwin.Party. This is a major step in company’s broader efforts in online gaming. Zynga also indicated its keen interest in online gambling by hiring Maytal Ginzburg, a former executive of 888 Holdings, a company which operates online gaming websites. UK players of Zynga’s Farmville will be offered Farmville-branded real-money slots games. This deal seems to be a good step toward long-term growth. Zynga’s expertise in social gaming, coupled with the top international real-money gaming operator, will create the highest quality gaming experiences for UK players and will allow local players to have the real-money games they’ve been asking for.

Zynga has also applied for licensing in Nevada and New Jersey, where online gambling has been legalized. With its legalization, internet gambling in the U.S. will generate $7 billion, or more, annually within five years. Though this space has large potential in the U.S., how Zynga will perform is still unclear. Zynga will take around 24 months after its gaming launch before it can obtain any meaningful revenue. Also, U.S. laws on online gambling are written to favor land-based casino operators, which means Zynga will need a land-based casino partner to remain in this field. Moreover, outside the UK and a few U.S. states (Nevada, New Jersey, and Delaware), sin taxes and strict regulations reduce the overall attractiveness of the market opportunity. Therefore, the margin opportunity for Zynga in real-money is a question mark.

Additionally, the company will face tough competition from Caesars (NASDAQ: CZR), which already operates online gambling services in Europe and has bought social and mobile game maker, Playtika. Caesars is the owner of World Series of Poker, one of the most popular poker brands.

Just like Zynga, Caesars also took advantage of Nevada’s legalization of online gambling by acquiring Bingo Blitz. In its first-quarter earnings for 2013, management disclosed that Caesars is encouraged by the progress of online gaming in Nevada and New Jersey. Caesars is preparing to launch real-money online poker in Nevada under its WSOP brand by this year’s end. In New Jersey, the company has applied for an online gaming license. These steps will further boost the online gaming market.

Caesars will also get benefits from its new growth venture, Caesars Growth Partners, which will focus on investments from private equity firms Apollo Management and TPG Capital. This will help in the pursuit of long-term growth opportunities in real-money online gaming, social gaming, and international expansion. It could be seen as a big asset for the company. The new growth venture could also include investments in Macau and South Korea. Other Asian countries are also working on legalizing gambling, which could provide new investment prospects for Caesars Growth Partners.

Hold ‘em

Seeing the SimCity debacle, and the accelerating decline of active users towards social games, it is not the right time to invest in Zynga. However, Zynga’s foray into online gambling could be seen as a positive step, but as the company is new to it and has a strong competitor like Caesars, it is better to hold this stock for upcoming quarters.

Zynga's post-IPO performance has been dreadful, and investors are beginning to wonder if it's "game over" for this newly public company. Being so closely tied to the world's largest social network can be a blessing and a curse. You can learn everything you need to know about Zynga and whether it's a buy or a sell in our new premium research report. Don't even think about picking up shares before you read what our top analysts have to say about Zynga. Click here to access your copy.

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