Zynga Announces New Network & Games

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Social and casual game developer Zynga Inc. (ZNGA) recently announced a bunch of new games and a whole new network aimed at boosting its user base and share price. However, the announcements did not help the stock, as the share price slid approximately 5.0% to close at $5.77 on June 26, 2012.

The significant fall in the share price reflects investor skepticism over the new network, “Zynga with Friends” which seems to be another attempt by Zynga to reduce reliance on Facebook (FB). The social networking company has been hailed as the primary driving factor behind Zynga’s success over the last five years. Currently, Facebook contributes 85.0% of Zynga”s traffic and 92.0% of its revenue.

The new network will bring all Zynga gamers, whether playing on personal computers, mobile phones or tablets on one platform, where they can play against each other and share game information. The network provides a host of new features such as player profiles, activity logs and chat facility that is hoped to make the platform attractive. Zynga said that gaming-related friendship will induce people to spend more time on games, which will boost the sale of virtual goods.

Zynga’s dependence on Facebook stems from an agreement between the two companies signed in May 2010. As per the agreement, Facebook helps Zynga in meeting active user targets and shares advertising revenue. In exchange, Zynga gamers are required to use their Facebook accounts to play Zynga games.

Facebook enjoys exclusivity not only in terms of the existing games on its platform but also on upcoming new games that include Facebook integration data for the duration of the agreement. Further, Zynga is committed to use Facebook credits as the exclusive virtual currency for the sale of in-house game items (micro-transactions).

Facebook charges 30% of this revenue for the services it renders. More importantly, Zynga is prohibited from launching games on rival social platforms.

These strict terms have been a major concern for Zynga lately, particularly after the much criticized initial public offering (:IPO) of Facebook which suffered due to the lack of visibility around monetization of mobile platforms.

Moreover, rising concerns over the effectiveness of Facebook ads as compared to Google’s (GOOG) AdSense also added to the concern. Zynga earns approximately 9.0% of its total revenue from advertising, most of which is contributed by Facebook. Most recently, Facebook began to show ads in Zynga games, played by approximately 290 million gamers.

In such a scenario, the new network is expected to be a major strategic booster for Zynga. However, we note that Zynga’s earlier attempts at creating its own platform (Farmville.com, Project Z) did not gain material success, which makes us more cautious about the new platform.

Zynga also announced that it will provide programming tools to third party developers to publish online mobile games. The company also announced partnerships with Majesco Entertainment (COOL) and Atari. Mobile is the only platform where Zynga is allowed to publish games without involving Facebook. We believe that mobile initiatives such as partnerships and acquisitions (OMGPOP in March 2012) will expand Zynga’s user base beyond Facebook over the long term.

Lately Zynga has been criticized over the lack of new and diversified gaming content which is failing to attract new users. Moreover, demand for social games is also seeing some deceleration particularly due to stiff competition from video gaming companies such as Electronic Arts (EA) which has a more diversified gaming (social, casual, action-based) portfolio.

In order to combat this threat, Zynga announced a number of new smartphone games including Matching with Friends along with a couple of new additions to the Ville platform and a sequel to Farmville. However, these games are yet to prove their monetization capability which keeps us on the sidelines for the time being.

We remain Neutral on Zynga over the long term (6-12 months). Currently, Zynga has a Zacks #3 Rank, which implies a Hold rating in the short-term (1-3 months).

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