Most investors remain skeptical about the future of social gaming company Zynga (ZNGA). However, although Zynga's decreasing revenue is a well-known trend, they may be making a mistake. Zynga is planning a turnaround.
Source: YCharts
What went wrong
Not too long ago, Zynga was known in the valley for being one of the most innovative game makers. Thanks to the massive success of its Farmville series, Zynga became the star of Facebook's (META 1.54%) gaming platform, and one of the best positioned companies in the social gaming industry.
Nowadays, few people remember how important Zynga was for Facebook. In 2011, Zynga contributed to 12% of Facebook's total revenue. The picture is completely different this quarter. Fierce competition from King.com -- the developers behind Candy Crush -- and Asian gaming companies, combined with a shift to mobile devices, took the company's revenue from $332 million in the second quarter of 2012 to $231 million in the latest quarter. At the same time, the company keeps burning cash. It reported a net loss of $16 million last quarter.
Source: Zynga Investor Relations
However, the industry looks pretty healthy. By 2014, the market share of social gaming will be almost twice as large as it was in 2011. By 2015, the social gaming market in the U.S. alone is expected to reach $5 billion. And Facebook has more than 260 million users playing games. A huge market!
The best part is that this market is expected to grow considerably in the next years. Facebook has a 1.1 billion user base. Most of these users spend more time on Facebook than they do on any other site. And more than half of them are aged between 18 and 29 years old. In other words, this is a great population to sell games to.
Moreover, Facebook's mobile usage is growing at an amazing pace: 54% annually to more than 750 million users in the first quarter of 2013. With $656 million of mobile ads sold last quarter, Facebook is well aware of the fact that the future is mobile, and will continue promoting its mobile app by all means possible. This is great news for game developers with a mobile-focus. Unfortunately, this is both an opportunity and threat for Zynga, because until very recently the company gave too much priority to PC-oriented development.
Zynga has a plan
The good news is that Zynga has a long-term plan to save its business. The bad news is that the short-term effects of the plan's implementation could strengthen negative momentum. The company anticipates two to four quarters of volatility.
This plan basically started in early June, when the company laid off 18% of its staff and shuttered down New York, Dallas and LA offices. It also closed its Omgpop studio, which developed the Draw Something series, only one year after acquiring it for $200 million. In the next months, the company kept laying off people, and got a new CEO, Don Mattrick, former Electronic Arts (EA -0.54%) studio head.
Mattrick was a key figure behind the success of EA's FIFA series. This game is a genuine cash cow. In the latest quarter, FIFA 13 netted $70 million in digital revenue, roughly a third of Zynga's whole revenue. This figure shows that with Mattrick, Zynga can learn a lot from EA's success. One of EA's key success factors was to focus on a particular segment, the sports genre of the game industry, and be the best at it. This strong focus caused the company to account for nearly 50% of sports game sales.
Not surprisingly, Mattrick announced in the last earnings call a "back to basics" approach. Zynga now plans to focus on what it does best: free-to-play social games. As a result, it is not pursuing a license for real money gaming in the U.S. anymore. However, the company will continue producing games and keep a strong emphasis on mobile experience, with the hope of developing a new hit that could replace Farmville. In this context, the presence of Don Mattrick, who was responsible for game franchises like "Need for Speed" and "The Sims," brings a lot of know-how and valuable vision to the firm. After all, Mattrick was behind the success of Microsoft's Xbox, growing its installations from 10 to 80 million.
After reducing its cost base considerably and increasing its Xbox 360 revenue base by over 600%, the company hopes to minimize its loss per share this year, and manage a transition to mobile as successfully as possible. And with more than $1 billion in net cash and some valuable real estate, the company may be able to survive this difficult transition.
My Foolish takeaway
Short term, Zynga faces an incredibly difficult situation. However, management is confident that its transition plan will work out. If Zynga manages to survive, it will look very different from its current version. Its revenue will be more diversified. It will not carry out hasty acquisitions of expensive studios. It will develop the capacities needed to produce mobile social game hits not only once in a while, but on a constant basis. But in the meanwhile, the company has clearly forecasted two to four more quarters of volatility. This risk should not be ignored.
