The New Game Plan for Zynga: Will it Work?

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

Avid social gamers may know Zynga (NASDAQ: ZNGA) for its smash hit games such as Farmville and Mafia Wars, but investors will always remember it as the company that set the recent trend for underperforming Internet IPOs. The company's stock has been on the run lately and gained over 45% in the year so far. Let’s not forget, however, that the stock is still down 50% from its 52-week high of $6.79. Apart from the obvious fatigue surrounding its games, the company has also been stung by its partner-in-crime Facebook as it broke the exclusivity clause in its contract. Now Zynga is on its own and looking to establish itself on its own terms. Let’s have a look at the future roadmap for the company.

Online gambling, anyone?

Zynga had already been making money with the sale of virtual goods, so it is about time for the company to dabble in new endeavors to generate more real-life cash. The company recently launched an online gambling portal in the UK. While online gambling is still illegal in the United States, Zynga has set the ball rolling with its UK launch. The limited release will also enable the company to measure the feasibility of a larger scope for the project.

The UK online gambling scene is awash with competition, however, and Zynga has not come up with any compelling selling point. The company’s online gambling portfolio includes online poker, blackjack, slot machines and other games. It will be expanding the portfolio to Facebook in the UK later this year.

The company's US plans are still under a cloud, however. Various states such Nevada, New Jersey and Delaware are close to legalizing online gambling, but the time line for this is still hazy and Zynga needs it to happen sooner rather than later. Even if the company is able to start its US operations this year itself, it will take a minimum of two more years for the new venture to have any positive impact on the company’s bottom line.

The road is not smooth, even after the regulatory hurdles are cleared. Zynga will have to compete with real-life big players such as Wynn Resorts (NASDAQ: WYNN) and Caesars Entertainment. Wynn Resorts is rumored to be in talks with Zynga for a possible collaboration when online gambling is legalized. Despite its enviable standing in social gaming sector, Zynga lacks the infrastructure required for online gambling operations. While Wynn Resorts can help Zynga with its existing operations, the Nevada-based company can draw synergies from Zynga's massive user base at the same time. Wynn is currently witnessing a decline in its domestic business while its Macau operations pick up traction. The company recently reported its quarterly numbers, beating consensus estimates.  

Once online gambling is legalized, however, expect the ring to be packed with other players, including Boyd Gaming and MGM Resorts International. Among such heavyweight movers and shakers, Zynga is going to have a tough time carving out a niche.

Mass exodus of talent and users

While the company’s future hinges on the shaky ground of online gambling, Zynga is getting deserted by not only its employees but also by its users. In the last couple of months, the company saw the departure of a number of its top executives. But the more worrisome news was announced last month, as the company reported a 21% decline in its daily user activity in the previous quarter. Its revenue dipped 18% on year-over-year basis.

The company launched sequels to some of its successful titles to plug the outflow of users. It is now planning to ramp up its game launch cycle. About a month back, Zynga released second the iteration of its runaway success "Draw Something." It also launched "Running with Friends," trying to capitalize on the buzz created by "Temple Run." So far, these two titles have generated only minimal attention. "Draw Something 2" topped out at no. 2 in the Apple App Store, and then faced a constant decline. While both the games are likely to add to Zynga’s bottom line, their lukewarm performance cast a shadow of doubt over the robustness of the gaming company’s upcoming titles.

Silver lining in the cloud

Despite all of its shortcomings, Zynga does have a couple of trump cards. Its poor performance in the stock market aside, the company is flushed with funds. Zynga’s balance sheet is also debt free, further boosting its capacity to weather the storm. Its cash pile of $1.67 billion does generate confidence.

It also received some institutional backing as Jana Partners revealed its $86 million worth of stake in the company. While institutional investment is generally a good sign for a stock, the point to be noted here is that Jana is managed by activist investor Barry Rosenstein. Since Zynga has been underperforming for quite a while, Jana may resort to pressurizing management to change their business track. It may also try to force sale of the company as Zynga is fast becoming an attractive takeover target.

Zynga has long been speculated to be on Yahoo!’s (NASDAQ: YHOO) shopping list. Yahoo! is currently on an acquisition spree and has made a number of high-profile purchases, including the acquisition of the Tumblr blogging platform. Yahoo! is virtually absent in the mobile and social gaming arena, and this is exactly where a Zynga acquisition could help it. Zynga's current valuation makes it an expensive proposition, however, and Yahoo! is likely to shy away from such commitment after spending more than a billion dollars on Tumblr. Yahoo! is in the process of reinventing its business and has recently revamped some of its services, including Yahoo! Mail and Flickr.

Facebook too seems like all too natural of a partner for the struggling gaming company, and Google may also want to augment its interest in the company. Zynga’s takeover potential has been fueled by various research firms including Wunderlich Securities.

Investment takeaway

Zynga is currently hanging on to the hopes of developing a lucrative online gambling business. While the company will certainly add a new revenue stream this way, the competition is going to be tough and there is no clear indication as to when online gambling will be allowed in the US. Overall, Zynga does not hold much appeal as a good investment target.

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Jag Mitra has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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