No Worries About Zynga
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Who would have thought that a game where you raise livestock and grow your own crops would gain such a following? FarmVille is just one of the games offered by Zynga (NASDAQ: ZNGA), a social network game development company whose browser-based games allow users to connect via websites such as Facebook, Google+ and MySpace.
The recent slide of the company’s stock is no indication of long term performance. I predict that this stock will not only regain but see a significant increase based on its aggressive strategy and innovative leadership.
What is Happening
It was reported yesterday that Zynga shares settled below last week's gains after a JPMorgan analyst downgraded the online game company. The analyst moved Zynga from "Overweight" to "Neutral" based on the recent stock price increase. It seems odd that an erroneous label could have such impact, especially when simple research proves the companies forward motion.
On its first trading day, Zynga's stock closed just below the estimated $10 IPO price. However, since December, the stock has gained almost 14 percent, trading now at around $13 per share.
Last week the company announced the launch of Zynga.com, its own gaming site independent of Facebook. The company is positioning itself to work both stand-alone and as application widgets on other social networking sites. With over 200 million monthly active users, the new features of Zynga.com game world will undoubtedly lure players away from Facebook to play. One such feature is that players can meet and connect with other players outside their restricted Facebook friends list.
This is not a complete separation from Facebook. Players on the new site will still be able to log in with their Facebook IDs and play games with existing Facebook friends. Even so, this is a definite step in the right direction to stand on its own and hopefully reap the rewards of other newly offered tech sites.
This has been a not-so-secret dream for Zynga since 2011 when it revealed its intention to build its own gaming platform. It subtly introduced its infrastructure tool, zCloud, which enables game studios to scale their games. Some of these games by third-party developers include Mob Science, Row Sham Bow and Sava Transmedia.
Even with this attempt to set out on its own, Facebook is not going to suffer too greatly. It still gains from the move because Facebook credits will still be the ‘currency’ for all Zynga.com players. In addition, it also includes some free advertising, as non-Facebook users will be exposed to social games via their Facebook friends and gaming opponents.
What Will Happen and Why
Zynga leadership deserves respect for its thoughtful and planned approach to ‘loosen the ties’ with Facebook. The new platform on Zynga.com will look familiar to long-standing Zynga players who will migrate from Facebook. The company’s top games such as "CastleVille," "Words With Friends," and "Texas Hold ‘Em Poker" will be the main draws to the new site.
Not only will people get to play their favorite games, but will be able to play without having to appear ‘online’, put up Facebook wall posts, or participate in other distractions. For the serious gamer, this is a great attraction. Likewise, the company can now reach the non-Facebook market and those gamers who would rather enjoy the ‘less crowded – more focused’ world of Zynga than try to navigate the social universe of Facebook.
There’s more on the horizon that will make this move a success. Online gambling has been a battle, but the end is in sight and it looks to favor of those who want to spend their money as they choose. With Zynga’s new independent platform, it can capitalize on this win, whereas, if it were still tied to Facebook, the battle could linger. Facebook is a social site and has already taken the stand of protecting young users. The legalization of online gambling would be slow to be allowed into this ‘safe’ environment, and even then, after a battle that would most likely cost both companies.
Also, increased smartphone and tablet use and users' shift toward free games will be a huge win for Zynga. Two words could catapult Zynga beyond all expectations: iPad 3.
Finally, Zynga boasts a ‘buy vs. build’ strategy which allows it to be more profitable than other companies focusing on generating hardware/software in house. The company currently claims 240 million active users. With a new platform, this could easily double. Scaling to those heights would be costly for those companies who follow the DIY approach. The zCloud, however, is built upon cloud computing software by Cloud.com (now part of Citrix), its analytics platform is primarily a Vertica database (now part of HP) and its application servers run the Couchbase NoSQL database. This outsourcing strategy gives it the leg up it needs to compete against companies with high operating costs.
A perfect example of this competition involves Activision Blizzard (NASDAQ: ATVI), the creator of games like Warcraft, Starcraft, and Diablo series. Activision released its first installment of Warcraft in 1994 and has continued to release expansion packs that greatly improve the game’s length and depth of play. These expansion packs operate on the company’s own platform and boasts more than 10 million active users.
The expansions are inherently inexpensive to produce, as they are built on the same platform as the original titles and also relatively easy to advertise, as the captive customer base is already aware of and anticipating the next release. Even so, Activision relies on the creation and operation of these in house, increasing operation costs to a level far above Zynga.
A Look at the Numbers
Zynga’s latest financial results are a clear indication that the company must transition to a platform provider without restrictions of its social network partners. The company earned over a billion dollars in 2011, but ended up losing $405 million on the year. Roughly $445 million went to Facebook as the cost of doing business on its platform. With the augmentation of its own platform, this is money kept in house to solidify its position and continue growing.
Zynga.com has the potential to pull in hundreds of millions of users. On its own, it will have the ability to create a more balanced revenue stream. Currently, about 90% of the company’s revenue is with in-game purchases, leaving only about 10% revenue from advertising. It’s own platform can equalize this, allowing it to capitalize on the true life’s-blood of most web-platform companies: Advertising.
Similarly, Activision’s expansions continue to produce annuity-like revenue streams from paying customers through purchasing lengthened storylines, playable characters, and powers. Their advertising is also limited, however, and rely heavily on partnerships with retailers to sell their products.
Although Zynga and Activision cater to two different consumer types, both are efficiently prepared for consistent profitability over time by continuing to expand a customer base through expanded platforms and increasing revenue through advertising.
Zynga’s stock has ranged from $7.97 and $15.91 since its initial public offering. Its calculated and measured strategy toward independence will be the foundation of its success. I believe we will see the positive performance of Zynga’s stock in the coming weeks.
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