Zynga (ZNGA) has been quiet for a while. There seems to be no significant development in the user statistics for the current games (except Farmville 2), and there aren’t any newly launched games that may have the potential of becoming big franchises. Zynga is no longer the king of social gaming on Facebook (FB) and has registered a steep fall in its web bookings in the recent quarters. This has encouraged the company to shut down some of its underperforming games, which has further exacerbated the revenue decline. This is not a surprise given the fickle nature of social gaming user base and the necessity of continuous innovation and upgrades.
We believe that Zynga can stem these losses and make its business more stable and predictable. It needs to divert some of its focus from progression-based games to skill-based games along the lines of Poker. One of the classic example from core gaming industry is Counter Strike. The game was simple and was launched as a free side-package to Half Life. It was surprising how it gained global popularity owing to its simple design, competitive spirit and the fact that the progression was not in terms of the game levels, but in the form of player skills. Similar games developed in the context of social interaction can attract mid-core gamers and reduce the company’s dependence on Farmville franchise and fickle user base.
The recent weakness in Texas Holdem Poker is a matter of concern. The game has been the major supporting pillar for Zynga and accounts for roughly 20% of its value according to our estimates. If we exclude the net cash, which accounts for half of Zynga’s value, we conclude that the Poker constitutes roughly 40% of the company’s enterprise value. A lot of this is based on our expectation that the game will be able to grow its user base over the next few years. Zynga should do everything to ensure that Poker sheds off the recent weakness and gets back on growth track. If the game’s user base continues to decline, our price estimate could fall by more than 10%.
Given the company’s decision of not pursuing real money gaming in the U.S., we believe that most of the incremental growth in the near term is likely to come from mid-core games and hosting third party games. The strategy of gradually building the user base rather than relying on explosive and unsustainable growth will pay off. The company has launched some mid-core games on mobile, including War of the Fallen, Battlestone and Solstice Arena. Such games have a different growth trajectory and tend to build an audience over longer periods of time. In addition, the company’s long-term strategy of creating its own gaming ecosystem will protect it against the inherent volatility of individual social gaming titles. What Zynga needs is better games, innovation, more sustainable ways of monetizing games as well as higher focus on core gamers.
Our price estimate for Zynga stands at $3.40, implying a premium of about 20% to the market price.