There are earnings misses, and then there are earnings disasters. With Zynga
I'm not surprised at Zynga's decline. In early June I advised, "don't buy [Zynga] at any price." However, I am surprised by the speed at which Zynga has fallen from grace. Let's take a look at what in Zynga's earnings spooked investors, and the broader long-term problems facing the company.
On the surface, Zynga's results don't seem so bad. Revenues were up sequentially and came in at $332 million. That's below analyst expectations of $343 million, but let's be real: A ton of companies have been missing this earnings season without seeing heavy losses.
However, the real pain comes not from what happened last quarter, but Zynga's future guidance. On the year, adjusted (you know, the overly rosy non-GAAP kind) earnings per share (EPS) are now expected to be in the $0.04 to $0.09 range. That's a pretty huge haircut from the $0.23 to $0.29 range offered just three months ago.
Oh, but it gets worse! Bookings, which is probably the strongest measure of Zynga's business direction, had previously been forecasted at a midpoint of $1.47 billion for the year. Now, with just half the year left, Zynga's guiding to $1.19 billion!
Generally, when companies are sold off in huge amounts after earnings, it's an overreaction. However, in the case of Zynga, investors are completely right to stampede over each other while rushing to the exits. Growth companies showing this level of deterioration are a bad bet, and the unsustainability of Zynga's business is starting to show.
The long-term worries
The problem with Zynga stock in the long term is pretty simple. It's almost entirely reliant on Facebook
The problem for Zynga is that the company has very little presence in the mobile space and has failed in its early attempts to get serious traction. We've seen Zynga attract fewer mobile users on its tent-pole games like Farmville on mobile devices, and after buying Draw Something creator OMGPOP, daily active users of the game immediately went into a tailspin.
Video games are by nature a hit-driven business. However, video games on mobile are a hit-driven business on steroids. Falling off top sales charts can mean a quick plummet in sales, and tastes change quickly. That's not bad news for total spending on mobile gaming, and it has brought a tremendous amount of games to market. However, what it also does is level the playing field between small teams of developers and big video-game companies.
Think about it for a minute. If you want to create a game for Microsoft's
That can still lead to huge success stories. We've seen Zynga come to dominate gaming on Facebook itself, and a company like Angry Birds creator Rovio has had reports of a valuation near $10 billion. Yet these success stories are proving far more fleeting. As I've noted before, while Mario was a dominant cultural figure and game seller for decades, it's unlikely Angry Birds will still rule the roost in 2032.
The end result of the shift to mobile is that the digital gaming market is exploding, but it's a highly diffuse market. That's great news for small developers, and awful news for investors of big gaming companies that relied on scale to dominate console areas or had first-mover advantages in platforms like Facebook.
The one bright spot today for Zynga investors actually came after earnings. On the post-earnings release conference call, Zynga tried to soothe investors' fears by announcing its intentions to enter the real-money gambling space. That's a move that's not wholly unexpected, and the belief that Zynga could see huge success in offshore gambling has been a key reason for Zynga bulls.
As was stated on Zynga's conference call:
"Finally, we are developing a new growth opportunity in real money gaming that builds on our strong casino presence with Zynga Poker, the world's largest free poker game and our new hits, Bingo and Slots. We expect to launch our first real money gaming products in international markets in the first half of 2013 subject to licensing approvals."
In the coming days, investors will have to weigh whether such a move could pay off for Zynga. Real-money gambling has largely been removed from America, so the growth areas will have to come from overseas. To me, this is Zynga's one real hope for enduring success. However, given speculating on overseas gambling success versus buying other great companies on sale right now, I'll choose the latter.
Long-term tech ideas
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Eric Bleeker owns shares of no companies listed above. The Motley Fool owns shares of Google, Apple, Facebook, and Microsoft. Motley Fool newsletter services have recommended buying shares of Apple, Google, and Microsoft and creating bull call spread positions in Microsoft and Apple. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.
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