Why You Should Sell This Web 2.0 Stock

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

Zynga (NASDAQ: ZNGA) has witnessed a steep decline in its share prices in the last 8 months- down to $2.31 (Oct. 12) from $14.69 (Mar. 12).  Zynga’s recent announcement of 3Q 2012 results were in line with its negative outlook. Seeing the maturing legacy of titles like FarmVille, CityVille, CastleVille, Poker, and the lack of sufficient new products in the pipeline, its business prospects don’t look appealing.

Its 3Q 2012 earnings show declines in almost every matrix. Let’s have a quick look at some of these:

  • Decline in the average Daily Active User (DAU): 60 million, from 72 million in 2Q12
  • Decline in Average Mobile Update Players (MUP): 3.0 million vs. 4.1 million in 2Q12
  • Decline in Online Game Bookings: $225 million vs. $260 million in 2Q12

Due to declines in its user base, the average billing per user (ABPU) has been reduced to $0.047 in 3Q 2012, compared to $0.058 in 3Q 2011. Zynga reported total revenue of $255.6 million this quarter, a decline of 11% year over year & 15% quarter over quarter. 

Even though the company has announced that it will begin a share buyback to the tune of $200 million and has started a cost reduction program, which is expected to save about 17 million in Q4, I still feel that the benefit of these steps will not help it in the long term, because of its struggling business models.

  • Zynga’s business model, which totally depends on Facebook (NASDAQ: FB), is not looking promising, given the fact that Facebook has seen a continuous decline in online gaming on its platform. Additionally, it does not even have its own distribution platform and it is still working on its 2 year old “Project Z,” which allows users to play games and chat with their Facebook friends without logging on to Facebook.
  • Although Farmville 2 has gained initial traction, DAU is not expected to improve in the near term, as its new titles The Ville, Bubble Safari, and ChefVille have shown DAU declines of 43%, 21% and 32%, respectively, month over month in October.
  • Its acquisition of OMGPOP (for $180 million) has not provided the expected gains, as a sudden drop in engagement of “Draw Something” resulted in DAU decline. This explains the changing mobile player trend and limited network effect. On the Mobile front, I think consumers have more options in the form of other interactive apps, which may lead to shorter gaming time in the long term.  
  • Zynga has not been successful in monetizing its games to their maximum potential. It has focused more on generating revenue from selling virtual goods and has not used the traditional form of online advertising. This model is very risky, given the fact that Zynga's revenue is generated by a very small number of its users. Between 4% and 5% of its user base contributes to its virtual goods transaction revenue. So even if its new games (like Farmville 2) attract more users, this will not necessarily translate into revenue growth

The leading console gaming companies are also increasing their presence on web based/mobile gaming. Electronic Arts (NASDAQ: EA) has already planned to launch its mobile franchises, and also went for the acquisition route (with the recent acquisition of ESN) for growth in online gaming. Activision may also look for acquisitions and launch new games for a bigger online presence.

With its struggling business, combined with low entry barriers in social gaming industry, the competition is still going to intensify. Hence I would rate Zynga a sell.

ShwetaDubey has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Electronic Arts and Facebook. 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.

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