Zynga Inc. (ZNGA) Management Presents at Morgan Stanley Technology, Media and Telecom Conference (Transcript)

Zynga Inc. (ZNGA) Morgan Stanley Technology, Media and Telecom Conference March 3, 2021 12:30 PM ET

Company Participants

Frank Gibeau - CEO

Conference Call Participants

Matt Cost - Morgan Stanley

Matt Cost

Hello, everyone. Welcome to the afternoon of Day 3 of the Morgan Stanley TMT Conference. Thanks so much for being with us. My name is Matt Cost from the U.S. Internet Team. I'd like to welcome you to a conversation with Frank Gibeau, CEO of Zynga.

Let me just run through the disclosures. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Frank, you've been at Zynga since 2016. Before that you were at EA for 25 years and a number of senior leadership roles over there. Thank you so much for joining us.

Frank Gibeau

It's a pleasure to be here. I'm looking forward to your conversation.

Matt Cost

Great. So I guess just kind of starting out big picture. So 2020 was an extraordinary year for Zynga and the whole game industry, but a lot of new players came into your entertainment format and some really strong growth for you guys, but what we can tell, it seems like the first quarter is actually comparing pretty favorably to the fourth quarter, even sequentially. So maybe we can start out with your thoughts on what changed last year, what didn't and what you're seeing so far in 2021?

Frank Gibeau

Look, I think, 2020 was a year unlike any other for the interactive entertainment industry. It was a transformational year on multiple levels. And first and foremost, and I think most importantly, I think millions if not tens of millions of people found interactive games and appreciate them in new ways, whether it was on mobile or PC or console, just in general the art form and the entertainment form has really hit a new level of appeal, interest.

And that momentum is carrying forward even as the world is starting to think about returning to what it looked like before the pandemic, you're still seeing people play games, keeping the games with them, just because they found communities, they found friends, they found social opportunities. They found a lot of fun. They can play it on their phones. They can play it in a lot of different formats.

So I think it was a real coming out year for games that is going to set to just to drive growth for us in the coming years for sure. In addition to that kind of appeal expansion and audience expansion, you saw a lot of profound new investments hit the market. You saw companies going public and get teed up for going public, a lot of new entrance into the category. Obviously, the availability of capital and the vibrancy of the markets for IPOs right now is really driving a lot of that. But you've seen this kind of - with the industry traditionally have been defined as kind of the incumbents.

Do you want to do invest in the industry, you invested in EA, Activision, Take-Two. And now you have a whole - investors have a wide range now of companies to invest in the public markets, which I think is exciting and the definition of what a game company is starting to change. Now that all the platforms are starting to talk to each other in their cross-platform play, you're starting to see some really interesting companies emerge that might have started out as ad networks and have acquired game assets and they become something new and unique in the category.

And so as you think about what's going to happen next, there is a lot of profound change happening in industry. There is a lot of exciting appeal and expansion happening in the industry, especially internationally, but you've got a lot of core technologies that are rolling out that will be drivers of great entertainment, development, 5G. You've got a lot of new handsets coming out. You've got new consoles. The PC is constantly upgrading its processing environment.

You're getting new ways of distribution through streaming and hyper-casual games. New markets are opening up and anything for even further out, you have technologies like AR, VR, blockchain that have even really emerged yet as opportunities. So I profoundly believe in this category obviously because I've spent a lot of time in it, but when I think about the next 10 years, I think it's going to be a tremendous time for investors and for consumers and for the companies themselves.

Matt Cost

And sign me up for all that. I mean, there's a bunch of things I want to go into there, but before we touched on some of those really exciting new opportunities, I do want to zoom in for a second on the core of your business, non-live services, because everything we can tell, your life services portfolio today, the core of what you guys do. It's at - the strongest point, it's really been in the company's history. And specifically I think of like Harry Potter: Puzzles & Spells that game seems to be off to a great start.

It's not actually even the first new game that you guys have put out in recent years, but it does feel like it cements the idea that even in a low hit rate industry, like free to play mobile games. Zynga has some pretty exciting live services capabilities and pipeline to look forward to. So maybe just looking back at the first six months of that game, what has exceeded your hopes? What are potential areas of improvement? What do you think it says about Zynga's core live services?

Frank Gibeau

Well, I think one of the key elements in the success of Harry Potter so far has been the quality of the game team that built it. This was a team that didn't have success on their first outing. They had worked through a couple of different games at Zynga and learned from some of the mistakes that we made on earlier launches and really perfected that game play loop and we always saw for long-term engagement, making sure that a player that comes into our game could be playing it for years.

And so, they really - what's really critical about how we build games is we like to iterate. We like to keep teams together. We like to learn from what we've done before. And in the case of Harry Potter that was a big element of it. One of the things that we learn was we needed an intellectual property in a world that was appealing to a much larger audience and a much more global audience, so that a lot of the cool game play features that we had could reach a bigger audience. So we combined a new IP with some proven mechanics that we'd been messing around with. And then we tested it for a very long period of time and test markets. That's really the structural difference between mobile and console. And [00:05:58] constantly, you can't really put out code and test it for very long periods of time and then take it live.

In mobile, you can really test market something to remove a lot of the introduction risk. And so with Harry Potter that was something that we did as we went into whether it was Australia or Canada, we were testing very specific elements of what makes for a successful game. Does it retain? Does it engage? What's the conversion rates? Does the UA scale against what the cost of acquisition is? And so, we thoroughly put Harry Potter through its test marketing phases. And what we're really excited about was first and foremost the reception from fans was phenomenal.

We saw - the ratings were very strong. The Harry Potter fans were raving about it. It went really viral. We did some fun stuff with Zayn Malik. And it really had really a lot of nice momentum out of the launch. But then when it started to hit weeks 14, 30 and beyond, all the testing that we had done about what were the retention rates engagements, we were exceeding them. So it was actually really positive to see that the test marketing worked and that was a critical part of the success here. We're very much a product management data science company combined with the art of game making, it's art and science, not one or the other. And so, we liked that playoff of art and science as were test marketing to get the right blend, so that when we do go worldwide, we've removed as many unknowns as possible.

Now that's not to say that the market might not like something [indiscernible] [00:07:21] test market, that's always - failure is always possible and it keeps us very humble, but at the same time, if we can really maximize that part of it, it gives us a better than average chance of releasing new games, which as you called out is extraordinarily hard in the video game business in general and in mobile in particular. So that's one of the reasons why we - when we look at our business overall, the vast majority of the revenue that we make comes from our live services portfolio, which are games that are knowns. They're out. They're successful. And we can really give our - by building and growing that business continuously, it gives us the flexibility to not have to rush a new game to market.

We don't have to make a quarter for financial reasons. We don't have to rush it out for an ad at Walmart or something like that. We can really keep progressing. I know it's frustrating at times when we say, yes, it's in test marketing. When it's ready, it will come out. That - we're actually saying the truth, right? We're not going to rush it through some external reason if we don't have to. And for the most part, because our live business is successful, it gives us that flexibility to be able to attack new game development in a very patient and methodical way.

Matt Cost

Yes, I think that goes really naturally into another thing I wanted to touch on here, which was the fact that you're targeting two new game releases for the first half of this year. So you've got Puzzle Combat and FarmVille 3 targeting the first half. That's a pretty action packed release window and a lot to look forward to. So, I want to know what are your expectations for those two titles right now based on what you're seeing in test marketing and test launches. And how do you think they'll stack up in the portfolio?

Frank Gibeau

Well, there are two very different experiences. So there is not - they're going to feel and look different in terms of how they roll out. The team at Small Giant, which created Empires & Puzzles, their philosophy is to get the games out into market test, understand how they settle in and then grow them from there. So they typically don't load up a lot of marketing day one, week one to drive a lot of installs because they want to see the game settle in with a natural organic set of customers to understand how the game is performing, where it's good, where it's bad, where it needs to be improved, and then scale it up over time.

It's actually a very patient and methodical approach and it worked very well for them on Empires & Puzzles. So as we think about releasing Puzzle Combat in the first half, I wouldn't necessarily set the expectations that this is a theatrical movie model where it's - a Marvel movie that comes out at summer and it's got this huge spike. That's not at all the model here, right. We're in this for the long-term. This is a marathon, not a sprint. And so, we're going to be releasing the game, see how it settles in and then very methodically start acquiring based on what we're seeing in the dynamics and the metrics.

Now, Puzzle Combat is not in an intellectual property. That’s widely known like Harry Potter or like FarmVille, for example, that has a lot of latent demand. It has a lot of expectations that are already pre-built about what the game is, what it could be. So from that standpoint, we can be a little bit more patient and a little bit more methodical there. When it comes to FarmVille 3, this is going to be an interesting launch from our perspective, because this is one of the brands that really made the company back when it was founded.

And, there’s a lot of fans that have tens of millions, if not hundreds of millions of people had played FarmVille over the years. And when we think about all of those fans and what their expectations are and how to bring them into a new experience, we’ve doing a lot of testing. We’re also running a bunch of FarmVille games right now, whether it’s Country Escape or Tropic Escape, which has a very big fan bases and they love the game.

And so it’s a little bit more complicated to navigate some of the pre-set expectations, but what we’ve done is really build out a terrific new experience and experience that is unlike LA. It has things that are familiar to people that have played FarmVille in the past, but it’s got a lot of unique new elements to it, and a new look and feel that feels very modern and very cutting edge for what we believe mobile games really are these days.

So we’re very excited about it. We’re in the final stages of testing on both games, and really looking at different attributes and different ones to see how the metrics are and what the audience responses. And then when it’s ready to go, then we’ll launch that rocket. And so it’s exciting that the first half we’re thinking about those two games, and as you know, a couple of weeks ago, we announced our Star Wars Hunters product at an intender event. And that’s a title that’s staged for the later half of this year that we’re also very excited about.

So, we never build our forecast or our guidance around a lot of contribution from new. And we recently do that is to de-risk them from the standpoint of us not being forced into decision-making that we don’t need to be, and because the live business is growing strong, the market is good. It gives us again to my point in the first question, a lot of flexibility to be able to make the right decisions for the game and for the player, because ultimately that’s what matters long-term.

Matt Cost

Yeah. So I guess kind of feeding out of your comments on Star Wars. So, I mean, this morning, you actually made an announcement that you’ve acquired a cross-platform studio, extra games that seems to feed right into some of the commentary you’ve been making recently about sort of make it, trying to bring titles and investing to bring titles to PC and console, in addition to mobile. So, we now know that one of those titles is going to be Star Wars Hunters, but before we touch on that specific game and I’ll come back to it. Yeah. I did want to ask you about cross-platform at a high level for you guys. What should we be envisioning when we think about the types of experiences that Zynga might bring cross-platform? Why is now the right time to do this? And maybe then you can tell us a little bit more about Echtra, and what we have to look forward to from them?

Frank Gibeau

Yeah. I think if you take a step back and look at the industry overall, some of the largest franchises in the world right now are cross-platform, and they’re free to play in many cases with seasons passes and things like Fortnite, Pub G, Engine Impact, a lot of people have been talking about how the console developers getting into mobiles the thing. Well, I think that door swings both ways. I think mobile developers can actually step into the cross-platform mega franchise part of the market, because of a few reasons.

First and foremost, the tools are the best they’ve ever been, with Unity, with Unreal, with AWS, with 5G infrastructure, that’s really starting to fill in for some of the performance gaps on the bandwidth side. You’ve never had a better set of tools to be able to build a game that could work across platforms right out of the box. The amount of custom code that you need to do is at an all-time low. So the marginal cost to complete a new game for a new platform is the lowest it’s ever been in my 30 years in the industry.

The second piece of it is for mobile now, because the devices have so high performance, we’re building the assets in 4K. So when you’re building a car or a lightsaber or a blaster or the Millennium Falcon it’s in for - its core graphics resolution and such that you don’t have to redo it all to make it work on console from a mobile device or vice versa. You can actually, there’s a lot more flexibility in terms of how to use those assets. So the idea that we have to spend lots of additional R&D to actually get the games to run is no longer true.

In addition to that, you have the prevalence of free to play as a business model coming to this - coming to consoles in a major way. And certainly on PC, that’s always been there on mobile, and that’s something that we’re very experienced in. And we also are very experienced in running live operations with a lot of update. So when you take live operations free to play, combine it with really good tools like Unity, Unreal, AWS, and 5G infrastructure. If you’ve got the right IP and you’ve got the right game design, you can complete the circuit and have something could work there very easily. And that’s how we thought about the business when we look forward from how we’re finishing up 2020, and we thought, Hey, what do we need to change in our growth strategy here to potentially double the company or more?

And it wasn’t just about doing more live services and more new games and expanding margins. We’re going to do all that. But we thought about, what are the new growth drivers out there in the marketplace that really are set up for us to succeed in. And cross-platform, Hyper Casual and then building out an ad networks and a platform. I think we’re going to talk about in a few minutes, those are kind of three key growth drivers that we started to lean into in the second half of last year that put us into position for being able to grow the company in the next five years, in a way that, it wasn’t like the last five and would really create an opportunity for investors to see a great return.

I think the last point I’d make on cross-platform is that. We’re just getting started in this. So the acquisition of Echtra is really a key one for us, because ultimately game quality is a function of game team talent and leadership. And when you look at these guys, they’ve worked on RPGs for up their whole careers. They’ve worked on Diablo, they helped to create Torchlight, which is a fantastic IP and the action RPG category. They’ve actually published games cross-platform. It’s a team less than 50 in San Francisco right near our shop.

And so it really kind of came together as an opportunity for us in these last few months. And in terms of what they’re going to work on, we haven’t announced that yet, but they’re definitely going to be getting us into the action RPG category, combined with all the things I talked about in terms of tools, they’ll be part of the natural motion, a group of studios, and they’ll be working alongside the guys on Hunters and on CSR. And as we plot out what cross-platform looks for Zynga over these next two, three, four years, you’re going to see more of that, that type of activity from us.

Matt Cost

So I think one thing that’s great, the purposes of discussing cross-platform is that, we mentioned a couple of times already Star Wars Hunters. We know that game is coming. So I definitely want to ask about that. So you announced it two weeks ago, it’s a free to play shooter coming to mobile and to switch. This is obviously a big milestone, because it is the first game that you guys are doing in the cross-platform arena. So what should investors expect to be different about this game in terms of how you launch it, market, operate it, and then maybe you can tell us about why you chose the partners that you did with Lucas and Nintendo kind of on the IP and the platform side for this game.

Frank Gibeau

Sure. Well, in my career, I’ve worked a lot with Disney and Lucas on the Star Wars business. And I’ve seen the power of that brand, when it hits the market with a high quality game. You get a high quality game with the Star Wars brand and it can be a tremendous success driver and you can create really wonderful experiences. So when we thought about how do you get into the shooter category, which I felt and the team felt was going to be an emerging thing several years ago. For mobile, we thought about, well, if you come in with an original IP. Do you come in with a partner IP? Is there something out there that people haven’t seen before on the platform? And well and behold, we kind of - we’re able to put together a deal with Lucas that brought Star Wars to life in this category and do it in a way that we felt like really leveraged a lot of the really cool innovation that we were seeing from Overwatch, from Pub G from Fortnite.

We don’t want to copy them. We want to be our own kind of game, but the PDP free to play arena battler with lots of new ways to play and a season pass. That's a really compelling part of the market right now. Fans really like that formula and to give them new experiences in the Star Wars Universe really felt like the right idea. So, that was a bit of how we thought about going into the category and why we pick the partners that we did.

In addition to that, we looked at Nintendo as a mobile device. We looked at the switches being mobile and I’m sure you can put on a display. But when we think about bringing those two experiences together, day one, that was where we kind of focused. And then with then we’re going to start to think about other platforms more long-term across the overall strategy that we have here. So it will be PC. It will be console and it will be mobile, all interconnected. It will be kind of the types of games that we make. We don’t think we’ll just do console games without mobile. That’s not our mission. Our mission is mobile plus all these other platforms coming together. And I think when you look at what’s possible and action strategy, what’s possible in action RPG, as well as Shooters and driving. I think the cross-platform future for some of our intellectual properties is quite bright.

Matt Cost

So, I guess kind of dialling it back to something that looks a lot more like games you’ve made in the past, but is actually kind of a departure in it. And something innovative in and of itself. It’s a Hyper Casual space. And that’s something you’ve been talking about for a year or two now, but I wanted to check back in on it, because you made the Rollic acquisition in 4Q. It seems like you’re really actually seeing some results there with the success of high heels and then some of the other titles on the Hyper Casual front. So tell us more about how that fits into the portfolio and why that’s an important business.

Frank Gibeau

Yeah, I think five years ago when I joined Zynga Hyper Casual is just starting to emerging and there is a lot of discussion around how it was a fad and it wasn’t going to last and that’s that it lo and behold the category evolved every year to get into something new and something better. And I think what it’s done is it’s created a new way of playing games on mobile. These are instantly on games. They’re high concepts. You don’t have to think particularly hard about going over an obstacle course and high heels. There’s not a big storyline there. Right. And you see it and it’s immediately playable and it’s fun and it’s highly accessible. And if you look at the number of games that are coming out in Hyper Casual the quality has really been going up over time.

Now it’s a short experience. It’s not a long-term engaging experience necessarily, but what, when you think about what Rollic has done in this period of time that they’ve been at Zynga, it’s really remarkable about how fast they’ve been accelerating. We’ve been learning a tremendous amount from these guys about how to use advertising in games? How to test games? They test 400 games a month, and then whittle it down and optimize. And so the number of game ideas that we’re seeing and then choosing from is unbelievable. And a lot of those ended up being features in our other games, not maybe they’re not full Hyper Casual games, but they end up just looking at a ton of stuff and working with a lot of great developers, small teams. A lot of them are in Turkey and Eastern Europe and in regions where they don’t get as much access to the overall global marketplace re-publisher and they have great STK that a lot of these developers can quickly implement and be part of the network.

So we’ve learned a lot about speed, testing, nimbleness, the instant on nature and appeal there. And on a consumer level, we’re really excited to learn was that a lot of Hyper Casual gamers that’s the first time they’ve ever played a game on a mobile device. This will be a Hyper Casual game and they come in organically. They don’t usually come in through a paid ad. And then guess what a little bit of time goes by, they’re playing six, seven, eight different Hyper Casual games, and they’re playing mainline mobile games. So what you find is that Hyper Casual games are part of their choices of things that they like to do in addition to playing a Harry Potter or playing Clash of Clans or something else. In addition to that. So these are legitimately they’re younger players, they’re more global players, and their consumption rates are very high.

And so as we looked at them as a top of the funnel if you will, of players coming into the Zynga networks, Rollic is a tremendous asset for us from that standpoint, because it’s constantly refreshing, our players are coming in organically. And if we are using paid acquisition to get them, they’re coming in for pennies. And so it proves to be a very efficient way to bring people into the promise of what mobile gaming can be, introduce new ideas to them. Also more importantly, just entertain them with fun stuff. High Heels, Blob Runner 3D are Rollic’s recent releases in January. I think they’re number one or number two in China right now. They’ve been the top of the charts that are viral on in Tik-Tok. And so we like this category and I think it operates in a very complimentary way to our core life services portfolio, and also our new game pipeline.

Matt Cost

So I think that Rollic and kind of that big expansion in users and that ad based business kind of DuckTales into another one of the growth drivers that you talked about at earnings, which is kind of on the ad tech side. Obviously, Zynga plays multiple roles in the audio ecosystem today. On the usual acquisition front and you’re an advertiser, you generate revenue by selling ads within your games. What new roles if you think Zinga could play going forward? What will it take to get there? And is the main goal about recapturing economics that you currently pay to partners? Or is it a revenue opportunity as well?

Frank Gibeau

Well, I think what’s great about this opportunity is it’, multi-dimensional and terms of the value that it can create. First and foremost, mid-point the last year, we started looking at the fact that we were one of the premier advertisers in gaming. All of our games are enabled for IAP and IAA. But between the time that they saw an ad and they ended up in our game, we had it was kind of opaque, right. We worked with other parties – other third particles or use other third-parties like, Iron Source or Unity app loving Google, Facebook, and they were handling the third-parties were handling a lot of the information and a lot of the acquisition. And then we looked at our first party data asset, which is the data that we were generating around what a player was doing inside of our games.

And that was tremendously valuable, but we were missing that piece of it. And so when we looked at it, we said, wait a second. If we do a couple of things here, we can capture the 15% to 30% we’re paying partners right now, just to manage the exchanges. We would get more information about what’s hot, and what’s not at the top of the funnel in terms of what’s appealing? What’s not appealing? What companies or products are doing better and why? We would be able to creatively optimize our products better. We ended in a post IDFA world that would all become first party data. The big issue with privacy is what is one party exchanging to another party about an individual, right? But if you enter one network and you have a good exchange of what your permissions are, you carry through that whole process in a high fidelity way from a data standpoint.

And so when we looked at it from multiple directions, we're like, wow, we can margin expand, we can pick up more efficiency in our UA dollars and in our advertising business. We could grow our advertising business faster and we could generate potentially a competitive advantage and information superiority, just knowing more about the players coming into our walled garden or into our platform than the next guy.

We felt like this was something that we could go after. We went through a very diligent process of breaking down what these look like. And we found that some of these components we could build, some of these components we need to partner on and in addition to that in ad tech, there's a lot of - there's really a lot of vibrant companies and opportunities out there to potentially partner as you've seen from recent development.

So when we think about where we were as a company, we were a mobile pure play developer and publisher and we felt that that is a really valuable company, but we thought that we could become an even more valuable company by building out our platform by starting to grow our total addressable market by getting into consoles and PCs, and then leveraging this unique asset and hyper casual to really supercharge the platform as well as get us into a place where we're seeing more information coming into the top of the funnel and then converting them into players and ultimately payers.

We felt that there was a unique combination of elements there that would go after. Now, this isn't going to happen two o'clock next Tuesday. This is a course in speed that we've now entered on and then we're going to grow into and start to build out over time. And we think that it's a forward-looking strategy for how the gaming, especially the mobile ecosystem is evolving, if you think of it is owning your own distribution, right. We're going to be able to have much more control and insight into how we're acquiring and shepherding players through our ecosystem and our systems than ever before. And that should enhance our ability to predictably launch games successfully, optimize our businesses, expand our margins, and serve our players better, frankly.

Matt Cost

We covered. There was a lot of great stuff in there. And I think that you touched on almost all of kind of the growth drivers that you guys laid out on the call. I guess kind of zooming out as we get into the last couple of minutes here, as we think about each of those growth drivers, how do they fit into your - into your latest guidance for this year and next year, your medium to long-term growth and your margin expansion potential.

Frank Gibeau

The guidance for 2021 incorporates a few things. The majority of it is based on live operations. It's got a little bit in there for new games, but not all of the potential of the games hit their marks. We don't really - we have Rollic in there at a number that we've talked about, but it doesn't really incorporate into the other stuff, honestly, in terms of a big scale. We like to base our guidance on live services, the knowns. And then, if these other elements start to hit and take off that's where we can start to see trajectory changes and performance. In addition to that, as you know, we raised a convert in late Q4. So, we have a pretty healthy balance sheet right now.

And we're taking out a very patient look at what's possible from in an inorganic way, but our 2021 guidance is all organic. It's largely delivered on live and a little bit of new. And we'll see how these other events unfold over time, thinking very long-term in the multi-year four or five-year timeframe. We think they're going to be profound growth drivers for us. And I think it positions Zynga into where the industry is going and puts us in a position to be able to tap into some growth drivers that - if we hadn't or don't start to make those investments, we could find ourselves how to position on.

Matt Cost

Definitely I think you've referenced some of the developments in industry. I think they make some of those new initiatives and vertical integration efforts you're talking about, they make - it obvious how valuable they can be. So, I mean, we're right at the top of the hour here, so that's probably a good moment to call it there. Thank you so much for being with us today. This is great. Thank you everyone watching for tuning in. I'm sure we'll all be in touch soon.

Frank Gibeau

Thanks very much, Matt.

Question-and-Answer Session

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