How Bright Is Zynga’s Future?

Zynga, unlike any other company, has been able to create a game I obsess over. Actively, I have to force myself to stop wasting time on Farmville. I’ve created a farming community that would make even the biggest potato growers proud.

The online gaming company responsible for Farmville recently filed its S-1 prospectus with plans of raising at least $1 billion on the open market. Despite the whopping debuts of LinkedIn, Pandora, and Renren, this is a lot of money for a relatively unproven company; however, the valuation may not be too wild after all. With nearly 300-million monthly active users in Facebook games alone, Zynga has the potential to become a driving force in online gaming and, more importantly, a great investment, too.

A powerful gamer finally making money
Unlike many of the recent tech IPOs, Zynga’s balance sheet is not splattered with red ink. The company became profitable in 2010 with a net income of $27,895 after posting a loss of $52,822 the previous year. After several years of unprofitability, Zynga has finally figured out a way to translate high-powered revenue growth down to the bottom line.

The way Zynga makes money is primarily through advertising and users paying real money for virtual goods; it brought in about $597.5 million and $121.5 million in 2010 and 2009, respectively. Although R&D costs haven’t necessarily kept up with revenue growth, what’s impressive is the amount of capital invested in their technology. Zynga has designed a model to analyze the 15 terabytes (that’s a lot) of data per day generated by user activity on their games. With this information the company can release new products tailored specifically to its audience. Also, Zynga progressively has built proprietary technology to support its growing business, which now includes players in over 165 countries.

The shortcomings of a new company
Though the potential is there, Zynga will need to jump over some hurdles before becoming a leading player in the social-gaming sphere. The main issue is its dependency on Facebook. If players want to buy virtual goods, then they must buy Facebook credits first. From these transactions, the social network giant gets 30% of the purchase. Zynga depends on Facebook for the distribution, marketing, and promotion of the bulk of their products.

Zynga must expand to other platforms to reduce the risk of its dependency. This shouldn’t be too hard considering there has been talk about Google’s (Nasdaq: GOOG  ) Google Games, a possible new venture that could debut after its new social networking platform. Google also invested a hefty amount in Zynga in 2010, so the integration may not be as wild as it seems. Zynga already is focusing on future expansion by looking into new mobile platforms, including Google’s Android and Apple’s (Nasdaq: AAPL  ) iOS.

Though Zynga holds the lead on the majority of games played on social-networking sites, it still faces stiff competition. Major players in the industry already have made moves to enter this niche. Electronic Arts (Nasdaq: ERTS  ) recently bought PopCap games, creators of Bejeweled and Plants vs. Zombies, while Majesco Entertainment (Nasdaq: COOL  ) acquired QuickHit, a developer of sport-oriented online games. Both of these companies have the power and funding to invest in the burgeoning online games market.

Finally, the last problem that may be weighing down Zynga is having fully accessible free games. Don’t get me wrong, I love freebies, but I don’t believe in giving all of your hard work away at no cost. Zynga admits one of its biggest risks is that its revenue comes from a small percentage of its users. This means that it has to direct more resources into creating games that will retain players, yet also entice them to purchase virtual goods, or eventually upgrade to the paid version. Zynga might want to take a card from Rovio’s playbook; it charges for upgrades. With a rising app market, the opportunity to charge a low price on games is very, very possible.

Don’t jump in too fast
Whenever a new company debuts on the market, it’s tough to see quite how it will fit in or how successful it will become. Zynga certainly has its work cut out for it – it’s operating in a competitive environment and will have to innovate continually to stay alive. However, with the capital to be raised in the upcoming IPO, it should have the funds available to invest more in the market in which it already seems to be a leading contender.

So what company do you think is best suited to take the social-gaming world by storm? Let us know what you think and participate in the poll below!

Michelle Zayed does not own any shares of companies mentioned in this article. The Motley Fool owns shares of Google and Apple. Motley Fool newsletter services have recommended buying shares of Google and Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On December 08, 2011, at 10:13 AM, Tomohawk52 wrote:

    My wife likes Zynga games, though she would never pay money to play them. I find them mostly derivative of each other and ultimately quite boring in that they are very repetitive. I don't see this company having any sort of moat.

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