Seeking Alpha

Zynga Likely to Benefit From Facebook-Google+ Competition

Includes: GOOG, ZNGA
by: Zack Bockmier

I wrote several weeks ago about how I thought Googles (NASDAQ:GOOG) new social-networking service, Google+, would indirectly lead to the demise of LinkedIn (LNKD).

Now lets to look at how Google+ will affect another company belonging to theInternet Bubble 2.0”: Zynga (ZYNG). With roughly 270 million monthly active users and 2010 revenue of $850 million, it is one of the few internet companies planning an IPO that has created a substantial revenue stream and a pretty successful business model. Zynga generates most of its revenue via selling in-game items to users, who can exchange real money for Zyngas virtual currency.

A common trend among companies using this system is for much of the revenue to come from a small, core group of userssomething which purportedly applies to Zynga as well. Four of its games (CityVille, FarmVille, Zynga Poker, and FrontierVille) are the top four most used game applications on Facebook, with CityVille having approximately 20 million users daily.

Zynga has been able to achieve this success through its partnership with Facebook, the massive social-networking site with hundreds of millions of members. The two companies came to an agreement in 2010, wherein the main point of focus was that Zynga pledged to keep any game with Facebook integration exclusive for five years. Facebook agreed to share ad revenue while also taking around 30% of revenue generated by the games. Zynga is looking to raise $1B in its IPO and has been given valuations in the range of $15-20B.

This competition for social-networking dominance between Facebook and Google+ could be equally beneficial or catastrophic for Zynga. Other than maintaining the status quo, I see two potential outcomes for the young gaming company: 1) They leverage the competition between Facebook and Google+ and are able to negotiate a more favorable revenue-sharing deal, or 2) they try the previous strategy and end up being left with their hands out, neither service wanting to work with them.

As it stands, Zynga needs Facebook, plain and simple. Their games would not have an iota of the current success without exposure to Facebooks gigantic membership via nearly seamless integration. The main draw for Zyngas games is the combination of convenience, simplicity, and the ability to play with friends. Take Facebook out of the equation, and all thats left is simplicitysomething that can be found in a bevy of places on the internet. Make no mistake - the popularity of Facebook brings users to Zynga, not the other way around.

When you add Google+ into the mix, Facebooks negotiating power becomes substantially diminished. Google can potentially provide everything that Facebook does, meaning that Zynga has a classic negotiating bargaining chip: the threat of going to the competitor. If Facebook grants any credibility to the threat, and wants to keep Zynga around for the easy revenue and dedicated group of users, they will be willing to talk. Every percentage point that Facebook cuts from that initial 30% becomes instant profitundoubtedly something investors will rejoice over.

Zyngas best case scenario: Google decides that it wants to bring Zyngas portfolio of titles to its Google+ users, creating a sort of bidding war for Zynga. While this is probably rather unlikely, it is not outside the realm of possibility. However, the same is true of the worst case scenario: Zynga tries to play the two giants off each other, only to be rebuked by both and left without a platform. This would be absolutely disastrous, once again eliminating the convenience and social aspects that Zynga has built its success upon. This puts Zynga in a precarious position; they will have the opportunity to put pressure on Facebook for a better arrangement, but will have to place the well-being of the company at substantial risk to do so.

This also puts investors into a precarious position: there will undoubtedly be a high demand for ZYNGs initial offering, but the stock could quickly decrease to near-worthlessness if Zynga does not have a platform through Facebook or Google. There are obviously several variables that could come into play for affecting the situation, but I foresee a generally favorable outcome for Zynga.

With increasing competition from Google, I cannot imagine Facebook cutting ties with a service that a very large portion of its users seem to enjoy, especially if there is any chance Google could then pick up that service. In all likelihood, Zynga and Facebook should be able to come to terms that result in considerable gains for Zynga, with a relatively small loss for Facebook. This would drive Zyngas stock through the roofanyone who got in around the initial offering price would be jumping for joy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.