Facebook Cuts The Zynga Cord

| About: Zynga (ZNGA)

Zynga (NASDAQ:ZNGA) and Facebook (NASDAQ:FB) recently amended the terms of their two year old agreement. According to the renewed agreement, Facebook will no longer have exclusive rights to support Zynga games while the social networking giant can develop its own titles beginning in March, 2013. Facebook however, has clearly stated that it's not a game developer and does not wish to venture in this arena, which begs the question why did they negotiate for this in the first place.

Zynga will also no be longer required to show Facebook ads and support Facebook credits. Facebook's relationship with Zynga from here onwards will be similar that which it has with other developers. However, with a few exceptions, Zynga will be required to publish any of its games on Facebook that are playable on its own or other third party platforms.

Through the end of its third fiscal quarter of 2012, Zynga earned 84% of its revenues from Facebook, down from 93% in the same quarter last year. Similarly, Zynga has added more to Facebook's earnings than any other game developer; roughly 15% of the latter's total revenues come from in-game Zynga purchases. For example, Facebook takes a 30% cut of all Farmville revenues. Investor sentiment surrounding Zynga is bearish, but this is a good long term move, if one believes that Zynga has a long-term future.

When Zynga launched its own online gaming platform Zynga.com and Facebook started to attract more and more game developers -- such as KixEye and Electronic Arts (NASDAQ:EA)--it became apparent that the two companies would reduce their interdependence. Moreover, Mark Zuckerberg indicated in October that Zynga has become less attractive to Facebook now. Facebook's Zynga quarterly revenues were down 20% from last year while Facebook's monthly revenues from all other parts of their ecosystem went up by 40%.

Zynga now has to prove that its success does not depend on Facebook. This would give Zynga an opportunity to explore more payment options and attract other gamers who are not on Facebook. As I identified two months ago, Zynga was making a serious move into the $30 billion online gambling industry. By early this month they had moved those plans forward as the company has made a preliminary application for a gaming license in Nevada. Its popular title "Zynga Poker" could make a switch from in-game currency to real money betting with little fanfare. The licensing process is expected to take more than a year.

Although both Facebook and EA have been struggling, their problems are nothing compared to Zynga's. Four consecutive quarterly losses are the result of dwindling popularity of its games. Moving into real-world gambling is a desperation move due to their having a fad-based business model. For companies like Zynga, you are only as good as your last title. Rovio will find this out once they push the Angry Birds franchise too far. At some point ennui will set in and the market will move onto something else.

Zynga has cut its annual guidance twice as its board approved a $200 million share repurchase program to support the stock price. Again, this is a desperation move meant to stave off further fund liquidation. Meanwhile, the company is implementing a cost cutting program that could result in pre-tax savings of $15 -$20 million at a cost of $8 million - $12 million. It has closed its Boston studio and plans are underway for the closure of the Japan and UK units as well.

While Zynga has laid off hundreds of employees, it has also lost several of its high profile executives. Some, like Wilson Kriegel who came to Zynga following its misguided acquisition of OMGPOP, have joined other startups. Add in the company's legal troubles with Electronic Arts for copyright infringement-- which caused Zynga's COO John Schappert's departure-- and it sums up to Zynga being a big pass even for speculative investors. There are many better turnaround stories in the tech sector at similar prices than Zynga. Nokia (NYSE: NOK) springs immediately to mind, for at least they are producing a product in a high growth sector that is forward looking, the Lumia 920, that people acutally want to buy.




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Some of Zynga's problem can be attributed to its strategy to focus on desktop gaming when the world was shifting away from PC games, but that only tells part of the story. The MMORPG and MOBA space are doing very well, just ask Tencent and its acquisition of Riot Games the 33 million people playing League of Legends, or the 10 million people still playing World of Warcraft. Zynga's biggest problem is that the days of using Facebook on the desktop for hours a day are ending and integrating a few minutes of Farmville into your daily chatting with friends isn't a natural outgrowth of one's Facebook time for many people anymore.

So the company responds, possibly too little too late, by cutting costs and attempting to find the next Angry Birds. There is no way for investors to plan for that to happen. Fads are not something one predicts. Fads occur. To buy into Zynga's mobile strategy versus anyone else's is simply a bet rational investors should avoid making while the move into gambling is a growth strategy it is at least 18 months from being accretive.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.