Zynga Is Toast Without Real Money Gaming

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

Zynga’s (NASDAQ: ZNGA) change of heart may cost it its life. The company announced that it will no longer seek a real money gaming platform in the United States, choosing to focus on casual games to drive future performance.

So what does this mean for Zynga?

Why Zynga needs real money gaming

I’ve been a critic of Zynga’s plans for real money gaming, but not because it is an unprofitable venture. Rather, I feared that Zynga was making a move that would destroy shareholder value. I proposed that Zynga should “sell” its members to another casino operator to enter gaming with an asset-light business model that would provide instantaneous profitability. Why do all the work necessary to open an online casino when you can ride the coattails of an already established player?

Online casinos pay hundreds of dollars to partners to recruit a single player. Zynga could simply cash in its millions of fake money players to collect upfront payments and royalties on their real money gaming at another online casino. No risk, huge rewards.

Unfortunately, recent statements shed zero light on the strategy Zynga plans to follow. If Zynga intends to work as a partner and refer its members to another casino operator, the company would be a definite buy. Based on my numbers from an earlier article, Zynga is valued at roughly $35 for every fake money poker player.

That’s pretty low, especially when one considers that a casino will pay $200 or more for a real money player, and that Zynga has other profitable games that could be left to “run off” and pay millions per year to the company until the cash flows eventually go to zero.

Assuming a 10% conversion and $200 payment per player, Zynga would nearly cover its entire market valuation in a single year and grab very valuable cash it could use to invest to find new, free-money players. Zynga needs to be the “farm team” for existing casinos.

Did Candy Crush lure Zynga back to casual games?

I see little reason for Zynga to spend more to build out its casual gaming business. The company finds little success in this hyper-competitive business where the average customer sticks around for only a few months.

In just the past year, a new studio claimed the title as the number one Facebook (NASDAQ: FB) game publisher. A hit game by competitor King.com, Candy Crush, popped on the scene, and its success is met with an estimated $200 million of annual sales. If nation-wide cable advertising is any indication, Candy Crush is making a mint from players on all platforms.

Zynga only wishes it had a game like Candy Crush in its roster.

In the latest quarter, Zynga reported second quarter revenue of $230.7 million, besting expectations of $183 million. However, higher sales didn’t lead to profitability. Once again, Zynga recorded a quarterly loss of $15.8 million in net income.

Bookings, a measure of future quarterly revenue, fell 38% year-over-year to $188 million.

Facebook squeezes Zynga’s bottom-line

Facebook may be the biggest threat to Zynga. The social network demands 30% of all spending on games on the platform, which means that each $1 of revenue adds only $.70 to Zynga’s top-line. Facebook gets the better end of the business model, earning a royalty on apps it doesn’t have to pay for. Zynga wants to ditch the Facebook platform, but doing so is easier said than done. Facebook offers access to more than a billion global users – marketing that is tough to pass up.

Zynga’s casual games won’t keep the company afloat. It needs real money gaming, and it needs it now.

Quarter over quarter, monthly active users have plummeted to 197 million from 253 million. Every single game Zynga owns is slowly providing less and less to the top-line, as you can see from a chart in the investor relations presentation:

Now is no time to run from real money gaming. Zynga should be heavily investing in its free poker app, Zynga Poker, which maintains leadership in its category. The company needs to continue to drive free players to the app – an asset it can tap for millions of dollars in advertising and royalty revenue when real money gaming comes back to American shores.

Zynga should slash its workforce to a level necessary to maintain its existing non-Poker games and invest every dime it has into collecting as many free money poker players as it can. If real money poker comes back in the U.S., Zynga would be the biggest takeover target on Wall Street for any big casino operator. 

I’m astonished by Zynga’s cut and run strategy, especially since a new CEO, Don Mattick, took the helm to lead the struggling enterprise. Zynga investors who sent the company’s shares up more than 10% on the announcement of his hiring are naturally reflecting their disdain for the company’s new direction by sending shares down more than 13%.

Without Poker, Zynga is just another struggling technology company fighting in a much too competitive market where excess profits are difficult to find. Now that Zynga has completely thrown away the idea of real money gaming, investors should throw this stock out of their portfolio, too.

It's incredible to think just how much of our digital and technological lives are almost entirely shaped and molded by just a handful of companies. Find out "Who Will Win the War Between the 5 Biggest Tech Stocks?" in The Motley Fool's latest free report, which details the knock-down, drag-out battle being waged by the five kings of tech. Click here to keep reading.

 


Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure