Ignore the Financials; This Was Zynga's Best Quarter Ever

Revenue improved slightly while users dropped. But Zynga's new acquisition made the fourth quarter report one to remember.

Feb 5, 2014 at 1:15PM

Social gaming company Zynga (NASDAQ:ZNGA) surprised investors last Thursday by releasing its fourth quarter and full-year results a week ahead of schedule. Shares were up over 20% aftermarket as the market responded to some surprisingly good news. What brought on this boost of optimism?  

It wasn't the financials. Zynga reported revenue of $176 million for the quarter, which fell a bit short of the $186 million consensus estimate from analysts but marked the first quarter-on-quarter revenue since mid-2012. The company did beat analyst expectations of a $0.04 loss per share by one cent.  

But the financial metrics weren't the real story in the fourth quarter report. 

Zynga Logo

Mobile gaming acquisition
Zynga announced an agreement to acquire mobile gaming company NaturalMotion for $527 million in cash and equity. NaturalMotion currently has the top mobile titles CSR Racing and Clumsy Ninja. CSR Racing made $12 million in the first month following its 2012 release and remains a top racing app for iOS.

But the big news in this deal is the technology that comes with the acquisition. 

NaturalMotion owns the Euphoria game animation engine, which was used in the development in Clumsy Ninja but also has a strengthening presence in console games. Euphoria has been used in Grand Theft Auto IV, Red Dead Redemption, and reportedly in the record-breaking fall release Grand Theft Auto V.  Those games all come from Take Two Interactive (NASDAQ:TTWO) subsidiary Rockstar Games and are some of the biggest titles in recent years.

The purchase doesn't mean Zynga's going to leap straight into console games. But the Euphoria engine will help distinguish the look of future Zynga titles from the often flatly cartoony look of the company's freemium games from its competitors. 

Zynga expects the NaturalMotion acquisition to add $70 million to $80 million in bookings and adjusted EBITDA of $15 million to $25 million this year. But this was an incredibly smart buy that should payoff in interesting ways in the future. 

Why does Zynga need a big change?
The company isn't doing the best job with player retention. Zynga reported 27 million daily active users, or DAUs, in the fourth quarter, which was down 52% compared the previous year's quarter and down 12% from the third quarter. The silver lining is that mobile DAUs made up almost half of that number. Why does that matter? Mobile monetization is a difficult task that was hard for even Facebook to manage. A slow growing mobile segment for Zynga at least shows that the company can attract players in that format.  Monthly active users fell 62% year over year and 17% from the previous quarter. 

Average daily bookings per DAU, or ABPU, were up 19% year over year and 10% from the prior quarter. I've written at length about how this is Zynga's key metric because it shows how well the company is monetizing its games. But the caveat is that ABPU can drive up because DAUs drop, which was what happened here. 

The majority of online game revenue still comes from only three titles: Farmville 2, Zynga Poker, and FarmVille.  And it's worth mentioning again that Zynga Poker will soon turn seven years old.

What's next for Zynga?
Keep an eye out for any announcement about how Zynga's utilizing NaturalMotion. This technology could reinvent Zynga's development style and push the company back to the top of the casual games market. And standing out in the crowded field could help with user attention and drive the ABPU to organic growths.  

Zynga has relied too heavily on sequels or near replicas of existing games. And that strategy has obvious limits or so few games wouldn't account for so much revenue. But the NaturalMotion acquisition could push Zynga toward being a legitimate content innovator. And that would prove a total game-changer. 

Foolish final thoughts
The fourth quarter report wasn't phenomenal from a numbers standpoint, but the NaturalMotion acquisition is one of the smartest moves Zynga has made in...possibly the entire company history. 

Brandy Betz has no position in any stocks mentioned. The Motley Fool recommends Take-Two Interactive. 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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