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Zynga Gears Up to Turn Publisher

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After reporting lackluster fourth quarter results, hurt by higher game development costs, social game maker Zynga Inc. (ZNGA) is gearing up to turn publisher, much akin to its closest competitor Electronic Arts Inc (EA).

According to a recent report from Bloomberg, Zynga is expected to launch a new publishing program in March this year that will allow third party developers to showcase their games as well as advertise on the company’s platform.

The publishing program is somewhat similar to Zynga’s direct-to-customer platform “Zynga Live” or Project Z, which was unveiled in October last year. Zynga Live allows customers to play games from anywhere (web or mobile) without accessing through Facebook or any other social networking site.

Zynga primarily generates revenue through the in-game sale of virtual goods in exchange of Facebook credits, which is a form of virtual currency. Much of Zynga’s success is attributed to the massive popularity of Facebook, which generates more than 90% of Zynga’s gross revenue.

However, Facebook charges a hefty 30% of this revenue, which has been a bone of contention for many developers such as Zynga over the last couple of years. It is rumored that in light of such a scenario, Zynga launched its standalone portal Farmville.com in an attempt to distance itself from Facebook.

We believe that the idea of foraying into the publishing arena will not only reduce Zynga’s dependence on Facebook but also diversify its revenue base going forward. As per details of the program available from Bloomberg, third party developers will still have to pay a fee to Facebook (since most of the developers use Facebook Credit), but Zynga will also get a percentage of sales for its services, which is expected to drive its advertising revenue going forward.

We also believe that, through the publishing program, Zynga will be able to further expand its existing game portfolio, without incurring significant in-house game development costs. However, we believe that publishing is an uncharted area for Zynga and the company will face stiff competition from EA, which is already a dominant player in the publishing business.

In a bid to further diversify its revenue stream, Zynga also entered into a partnership with toy maker Hasbro. Under the terms of the agreement, Hasbro will develop toys and games based on Zynga’s most popular titles like FarmVille, CityVille and Mafia Wars and will pay a licensing fee based on sales. We believe that this new source of revenue will further boost Zynga’s top line going forward.

We remain Neutral over the long term (6-12 months). Currently, Zynga has a Zacks #2 Rank, which implies a Buy rating over the near term (1-3 months).

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