At one time in my life, I was bullish on Zynga (ZNGA). I believed that the company would be able to further monetize its strong network of games through advertisements while potentially expanding into the online gaming industry by leveraging its popular titles like Zynga Poker. After a drop in price of about 76 percent since its initial public offering, I admit that I was wrong. In this article, I go over the events that triggered Zynga's decline and provide insight on how to trade Zynga shares in the future.
Zynga's acquisitions strategy, with emphasis on its acquisition of OMGPOP, has really hurt the company. At a time where tech darlings were still trading at very high valuations, Zynga bought OMGPOP for $180 million. In its most recent quarter, the company wrote off $95.5 million of that acquisition, which caused shares to drop and put Zynga in the red for a fourth straight quarter. One of the positive aspects of Zynga during its IPO was that it was profitable and had plenty of opportunity to further monetize its games.
Most of its revenue at the time was generated from premium purchases and special offers rather than traditional advertisements. Instead, Zynga put itself at risk by acquiring OMGPOP, Wild Needle, and Buzz Monkey Software, when it could have spent that money growing organically and developing its gaming platform to maximize revenue per active user.
A lot of Zynga's problems stemmed from its strategy to become more independent as a company by establishing its own network and move away from its heavily dependent relationships on Facebook (FB), Apple's App Store, and Google Play. The project, known as "Project Z", is a collaborative environment where users can play Zynga games and interact with their Facebook friends, without actually being on Facebook. Being dependent on other platforms was a major point of caution for investors, but a path to independence may not have been the right choice for Zynga at the moment.
The plan was announced in October 2011, but Zynga is still heavily dependent on other platforms for their games and almost all Zynga gamers still play games through Facebook or download apps on their smartphones. The money spent on Project Z, which was two years in the making when it was announced, would have been better spent on other projects that focus on innovation and new game development.
Bad Job Defining Social Gaming
Successful companies are able to create new markets and then constantly redefine and innovate in those markets to maintain a lead on the competition. Zynga didn't do that. The company did a great job creating a large social gaming industry that didn't previously exist with titles like Mafia Wars and Farmville. Then the company pushed the envelope on interactive gaming on smartphones with titles like Words with Friends. After that, Zynga simply did more of the same. Many of their newer titles like Cityville and Farmville 2 have very little deviation from their earlier titles. Zynga kept putting new names on the same idea when they should have been exploring new ways of pushing the social gaming experience even further.
Bad Monetization Strategy
Zynga's inability to monetize their games to their maximum potential stems from several factors. The company has not really exploited the classic forms of online advertising, like banner ads, product placement, and video ads, to their fullest extents. Instead, Zynga has focused more on getting users to purchase more digital goods with their freemium model. The company also tried to promote their game through constant spam and convincing users to download malware.
Take this quote from CEO Mark Pincus as an example:
So I funded [Zynga] myself but I did every horrible thing in the book to, just to get revenues right away. I mean we gave our users poker chips if they downloaded this Zwinky toolbar which was like, I don't know, I downloaded it once and couldn't get rid of it. *laughs* We did anything possible just to just get revenues so that we could grow and be a real business.
These strategies led to significant losses to the company and allowed big competitors to take more ground in the social media world.
Zynga's decline ultimately stemmed from a healthy combination of bad ideas before and after the initial public offering. Its bad acquisitions, bad strategy, lack of innovation, and inability to successfully monetize its games all led to what I believe to be an irreparable decline in its stock price.
Going forward, I put a sell recommendation on Zynga shares. Shorting Zynga can prove to be very expensive, so I recommend staying away from shares completely. At its current pace of bad decisions, expect Zynga to no longer exist as a publicly traded company within the next 5 years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.