3 Huge Risks For Zynga Inc. Investors

The 'Farmville' publisher is in a tough spot. Can Zynga beat these three risks and orchestrate a comeback?

Jun 20, 2014 at 11:02AM

Social games maker Zynga (NASDAQ:ZNGA) has fallen from grace and is battling to reclaim pieces of its former glory. The transition from browser based social games to mobile platforms rendered the publisher's business model archaic in record time, somewhat amusing considering one of the company's goals was to eat into the dedicated console market.

The Farmville publisher's IPO debuted in December 2011 at a share price of $10.00 . The company's valuation hit a highpoint in March of 2012, with shares climbing all the way to $14.69. Today, shares of the Zynga trade in the $3 range, and its market cap sits at approximately $2.7 billion. Despite efforts to turn the business around, there are still serious issues threatening the company's viability. These three risk factors have the potential to further damage Zynga and depress its comeback effort.

Zynga's key games could continue to lose popularity at a rapid rate
As the owner of properties such as Zynga Poker, Farmville, and Words with Friends, Zynga controls some of the most lucrative browser and mobile games. December 31, 2013, saw the company with three of the top 10 games on Facebook (NASDAQ:FB) by measure of daily active users. The company's model revolves around having a select number of high volume, high engagement titles, with 54% of Zynga's 2013 revenue coming from just three titles.

Screen Shot

Source: Zynga.com

Unfortunately, the company has also witnessed significant decline from its marquee games. 2013 saw games-related earnings decline 38% from 2012. As of December 31, 2013, Zynga had lost approximately 63% of its active player count in a two year span. The social games space is also particularly subject to knock-offs, meaning that successful titles spawn frequent imitators which can damage brand and staying power.

Zynga's new properties and acquisitions might be duds
For a company so dependent upon the performance of a few key titles, failing to introduce new power-earners as the old ones wane is a recipe for disaster. Additionally, Zynga's acquisitions carry substantial risk and may not integrate well with the company. 2012 saw the purchase of developer OMGpop for $200 million. Shortly afterwards, user engagement for the studio's premier title dropped precipitously.

February 2014 saw Zynga acquire Natural Motion for $527 million in cash and company shares. Natural Motion created the mobile hits CSR Racing and Clumsy Ninja, and also developed the Euphoria physics engine used in recent installments of the Grand Theft Auto series and other games. These assets make Zynga more diverse, but there's little indication that Natural Motion's games will be more than the typical flash in the pan, or that the Euphoria engine will be much of a boon to the publisher's typically low-budget games.

Zynga is heavily reliant on its relationship with Facebook
In 2013, 75% of Zynga's revenue was came from its games on Facebook. What's more, many of the players who took up Zynga's games outside of the Facebook portal had their first introduction to the software through the social media site. The two companies have a contractual partnership until 2015, but they are considerably less cozy than they were even a couple years ago thanks to a 2012 reworking of terms.

Put simply, Facebook controls Zynga's future because the social games publisher has not made enough of an impact in mobile. Should Facebook seek to limit Zynga's access to its platform or do away with the partnership entirely, the results for the Farmville company will be disastrous. Similarly, Facebook aligning more closely with one of Zynga's competitors could also be damaging to the publisher's business. The social networking giant could also hurt Zynga by increasing its own development efforts and prioritizing its products on its platform.

Foolish takeaway
Zynga has received a considerable amount of buzz thanks to better-than-expected performance in the last fiscal year. The positivity mostly ignores that the company achieved this feat by drastically reducing its number of employees and slashing its research and development budget. R&D expenditures for 2013 stood at $413 million, down from $645.6 million in 2012 and $727 million in 2011. As an interesting point of comparison, President Don Mattrick's compensation plan will have the executive earning approximately $58 million this year.

Zynga's sagging valuation may give the company explosive potential, but there are too many problems with the publisher's business to make it a recommendable investment. 

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Keith Noonan has no position in any stocks mentioned. The Motley Fool recommends Apple and Facebook. The Motley Fool owns shares of Apple and Facebook. 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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