For a brief period the social game service Zynga (NASDAQ:ZNGA) was riding high. Like an old school gamer reaching a high score in an arcade a huddled mass began to grow around the company as the excitement and share price climbed. When they rang the bell at the New York Stock Exchange on the morning of December 16, 2011 investors jumped in. Just three short months later on March 2, 2012 the shares had scored an impressive 54% increase. Leading up to the peak Gamasutra.com reported "after a year of platform, infrastructure and game development in 2011, we believe that 2012 could shape up to be a harvest year for Zynga."
However, lately things look different for the company. The stock is trading at 78% off its high at just $3.19 a share. It seems 78 is an unlucky number because this same percentage represents the amount of the vote rival game company Electronic Arts (NASDAQ:EA) received in the annual Consumerist poll on "Worst Company In America." What's notable about this is that even a hated company like EA wants to divest itself of some of their social network game products including SimCity Social. Even more interesting is Zynga's decision to do the same, a surprising move for a company seemingly raised by the masses on Facebook (NASDAQ:FB). Early in the year the company announced their plan to shut down Petville, Mafia Wars 2, Treasure Isle and 6 others. This move along with a plan to cut 5% of the full-time Zynga workforce was largely regarded as a cost cutting measure.
The decision to reduce online presence is not the only thing the EA and Zynga have in common. Nearly nine months ago EA sued Zynga claiming their game "The Ville" was a clone of The Sims Social. This accusation of questionable business practices was underscored by a SF Weekly article by Peter Jamison, who spoke with anonymous employees who reported that founder and CEO Mark Pincus dictated that, "you're not smarter than your competitor. Just copy what they do and do it until you get their numbers."
Jamison goes on to explain, "the former employee, who requested anonymity in order to speak candidly about his experience at Zynga, said this wasn't just bluster. Indeed, interviews conducted by SF Weekly with several former Zynga workers indicate that the practice of stealing other companies' game ideas - and then using Zynga's market clout to crowd out the games' originators - was business as usual." EA and Zynga later decided to settle the suit on undisclosed terms.
The struggles of the company have been attributed to more than just the above reasons. Seeking Alpha writer Ed Liston explains, "the first hit to Zynga was its $183 million purchase of OMGPOP, the maker of the hit game Draw Something. The game, similar to Pictionary, went viral and sold over $250,000 per day. However, almost immediately after the purchase, the popularity stopped growing and eventually fell off." Furthermore, the user experience on Facebook changed thereby altering the dynamics of Zynga's business model. As TechCrunch reports, "Back in Zynga's heyday, most Facebook usage was on the desktop where its games were. But the shift to mobile was quick. It seemed to take Facebook by surprise, and it hit Zynga, too." Without question the company is built around social networking and given their relatively short history one might question if the decision to launch an IPO when they did, or at all, was wise. Remember, the company was formed as recently as 2007.
A deeper analysis into the stock only reveals more questions. With a company like Zynga one cannot easily make sense of basic financial metrics. Take for example the P/E ratio (NYSE:TTM) of -11.4 versus the industry average of 27. For many investors the number at this low of a factor is largely meaningless. However, other values speak volumes on the challenges facing the company. For most of its short existence Zynga has been working with a negative operating income and a negative net income. As a result investors have reaped no dividends and the negative capital spending has increased. The company has not reached profitability and has a consistently negative ROA.
With such a vast universe of poor financials it is not unreasonable to make comparisons to the early days of the dot com bubble as hysteria and hype drove stock prices up, not firm financials. Based on these numbers it becomes increasingly clear that the IPO for the company is, at least for now, solely a means to finance their operations and not a way to generate returns or real value for shareholders. The victories Zynga experienced early in their development are linked to the special relationship they formed with Facebook, which agreed on a 5-year partnership where Zynga uses Facebook credits. This is also changing; in 2012 Forbes reported. "Facebook's dependence on revenue from Zynga appears to be decreasing. Meanwhile, Zynga's revenue sent to Facebook in the first six months of the year was essentially flat from last year." This will put more pressure on Zynga's ability to create their own platform and leverage it as a means to consistent revenue generation. While some could argue that Zynga is merely a game company learning to behave as a business the truth is that even their ability to develop original titles has been questionable, based on the copyright lawsuits mentioned earlier in this article.
For now investors eager to advance to the next level of a fresh, exciting start-up would be wise to turn their analysis towards a company that has a longer track record and more sound financials. Facebook has experienced similar growing pains but they remain a giant next to Zynga.
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Business relationship disclosure: This article was written by an analyst at Catalyst Investments.