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Will Gambling Save Zynga?

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Over the past year, Zynga (NASDAQ: ZNGA  ) has been methodically losing at its own game. Shareholders as of Dec. 16, 2011, have watched 73% of their investment go down the virtual tubes. One of the few bull arguments remaining for the gaming company is its interest in gambling. Time will tell if this is the path to profitability for the beleaguered company, but this past week gave some renewed hope as the company officially applied for a gaming license with the Nevada Gaming Control Board. After a year of investor lawsuits, wonky management decisions, and general deterioration, is this a signal of an improving Zynga?

As the year ends, we all tend to become retrospectors, looking back at the past 365 days to see what it tells about the next round. People at Zynga, and its investors, are probably trying to avoid this as much as possible.

Besides the slide in stock price, the company had a troubling first-year run on the public markets. After the company released its dismal second-quarter earnings report, an investor filed to open a class action lawsuit against the company for misleading investors regarding lower user counts, delayed game releases, and the subsequent declining revenues. The company's deep-seated relationship with Facebook (NASDAQ: FB  ) gave Zynga a guilty-by-association stigma shortly after the 'Book's IPO debacle. A yearlong talent drain saw some of the company's top brass head over to competitors' offices. And of course, probably the worst event of the year was the company's mindless $180 million purchase of OMGPOP, a good portion of which has now been written down off Zynga's balance sheet.

To me, the hope for the company lies in its push into gambling.

When CEO Mark Pincus announced that the company had applied for a license from the Nevada Gaming Control Board, investors started hitting the buy button -- sending the stock up 7% last Thursday.

With Zynga's large user base, the company does have the potential to make an impact in the online gambling space, which was effectively shut down in the U.S. last year (though many say this will be reversed in the coming years). As one analyst notes, Zynga's first game was Zynga Poker, and it is to this day the most widely used online poker game (not using real money). So the company has a platform for the project, and the people to populate it.

There are a couple of concerns, though, and let's not forget that those who seek salvation in gambling historically get left out in the cold.

Nevada, unsurprisingly, has an online gambling system in place. Nevada's Sen. Harry Reid has been lobbying for adoption on a federal level, and there is plenty of reason for the country as a whole to put a regulated online gaming system in place (and most of those reasons start with dollar signs). Still, though, at this moment, online gambling in the United States is a muddy, red-tapey mess, after last year saw the government crack down on companies such as PokerStars and FullTilt, which was a Ponzi scheme. Entering into this business will be costly for Zynga in the legal department, with no 100% guarantee that their efforts will pay off.

Ultimately, I don't see this as being too much of an issue for the company, but it serves to remind investors that this new venture won't yield an immediate turnaround in Zynga's business.

A more interesting conflict for Zynga will be in who else populates the space once it is again a legal enterprise. PokerStars, similar to Zynga, has a large user base that is typically very loyal to one platform or another. Zynga will have to find a way to get those former paying PokerStars users to switch over to their own platform.

Other competition could come in the form of the traditional gaming companies, such as MGM Resorts (NYSE: MGM  ) or Wynn   (NASDAQ: WYNN  ) , which have both applied to the same Nevada Gaming Board for online poker licenses. Bally   (UNKNOWN: BYI.DL  ) already has a license. What these companies have over Zynga is obvious -- pure gaming experience. They certainly aren't tech companies, and the jury will be out to see if they can provide a platform that is comparable to that of Zynga's (which is, admittedly, nice). But navigating the murky waters of gambling is what these guys do every day, and have been doing for a long time. It is a less tangible but very important advantage.

In the past, I've been one of the legions of people who thought Zynga was another IPO disaster with tyrannical management and lousy business models. For the most part, that still stands, but there is certainly opportunity down the road for an improvement.

This is not an insta-fix, nor is it in any way a guaranteed venture, so investors need to use caution if they're looking to take a position in light of the recent developments. Though this company is not as horribly untouchable as it once was, I would advise staying away until a more lucid, predictable flight path emerges.

More Zynga-talk from The Motley Fool
Zynga's post-IPO performance has been dreadful, and investors are beginning to wonder if it's "game over" for this newly public company. Being so closely tied to the world's largest social network can be a blessing and a curse. You can learn everything you need to know about Zynga and whether it's a buy or a sell in our new premium research report. Don't even think about picking up shares before you read what our top analysts have to say about Zynga. Click here to access your copy.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 17, 2012, at 7:06 PM, TheRealRacc wrote:

    The article makes a vague reference to FullTil and Pokerstars. To clarify: FullTilt was a Ponzi scheme. PokerStars is a 100% legitimate business.

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