Zynga Improves Results Predictabilty

The improved results for the franchises at Zynga suggest that future revenue can become more predictable without the major peaks and valleys that characterized the recent past with King Digital.

May 13, 2014 at 11:05AM

The biggest complaint with the recent IPO of King Digital Entertainment (NYSE:KING) was the inability to predict future revenue streams. In the case of King Digital, the big hit game of Candy Crush Saga fundamentally distorted future results. If the company and industry can't guarantee repeated success, then the market will have a difficult time providing high valuations to the mobile and social game developers.

In the case of Zynga (NASDAQ:ZNGA), new CEO Don Mattrick made the concept of sustainable franchises a cornerstone of his arrival at the large game developer. It mirrors his past experience at Electronic Arts (NASDAQ:EA), where the focus was on repeatable game franchises that brought in consistent revenue streams in the way of large console hits. The ability to predict mobile and social success is very difficult with the diluted playing field and relatively easy entry.

Zynga probably has the best set of franchises in the mobile and social gaming world with Zynga Poker, Words With Friends, and Farmville, along with the potential additions of CSR Racing and Clumsy Ninja obtained from NaturalMotion. In the past, a mobile or social franchise typically meant a declining revenue base, but the recent results at Zynga suggest the concept can be grown and sustained going forward.

Mobile market
A major difference in the mobile and social gaming segment and the historical console market is the vast difference in costs and distribution to reach market. The console market was categorized by high distribution costs and limited shelf space providing the industry giants with the ability to better predict gaming hits based on the limited competition to reach the shelves of major retailers.

The mobile market is categorized by lower costs and easy distribution to millions of customers via Apple and Google ecosystems. In this scenario, the vast majority of games get lost in the shuffle allowing for a few games to rise to the top and reach exceptional results.

In the case of King Digital, the well-known Candy Crush Saga generated over $1 billion in revenue for the company in 2013. Unfortunately, the game is now showing declining user engagement, suggesting the prospects for the company has peaked. For the first quarter of 2014, revenue and booking only increased 1% sequentially while adjusted EBITDA declined 9%. Now without the likelihood for an equally successful game in 2014 and beyond, investors aren't willing to pay premium values for the recent IPO.

Franchise improvements 
The first-quarter results for Zynga provide hints that franchise games can have meaningful staying power. The major franchises of Zynga Poker and Words With Friends saw a turnaround of downtrends with mobile user engagement gaining sequentially. The encouraging news was the improvements prior to the release of new mobile games for all three franchises. The recently released Farmville 2: Country Escape has already cracked the top of both the download and grossing charts.

Zynga Poker saw a 19% increase in its mobile audience to help the franchise achieve the first sequential growth in bookings in seven quarters. Words With Friends saw bookings surge 43% year over year on the back of a 9% quarter over quarter gain in daily active users.

In the case of Electronic Arts, the console game leader still generates a substantial amount of revenue from Madden NFL and EA Sports franchises that in some cases have been around for more than 20 years. In total, the console games still contributed over 50% of GAAP revenue for the last quarter.

Bottom line
The recent rebound of the franchises at Zynga provides comfort that Mattrick can achieve a similar level of repeatable success in the mobile and social markets. With the mobile market becoming more and more cluttered with thousands of games, Zynga hopes that the brand name and franchise hits will more readily drive games to the top of the charts to improve the chance of success.

Companies like King will continue to create major hits virtually out of nowhere, but investors will be comfortable placing money with a repeatable franchise producer like Zynga.

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4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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