Zynga’s stock fail was sadly predictable, and the company is left with few prospects for the future
Zynga stock is selling for $3.17 a share as of this writing, down from the $10 opening price and all-time high of $15.91. The company's free fall has been a popular story in both the gaming and the business press, but what's fascinating about the story is the fact that it's a story at all. Zynga has always been a company that seemed to resist innovation, chasing a simplistic formula that is beginning to look increasingly outdated in a world where even Facebook is having trouble keeping its value up. Zynga's IPO was volatile when it launched, and things are only getting worse.
What was wrong with the IPO?
Zynga seems to be a company with a broad slate of projects and impressive revenue, but the reality of their business was laid bare in its filings with the Security and Exchange Commission before the launch of the company's 2011 IPO. The risks were many, and obvious. “We rely on a small percentage of our players for nearly all of our revenue,” the filing stated, while also noting that “a small number of games have generated a majority of our revenue, and we must continue to launch and enhance games that attract and retain a significant number of paying players in order to grow our revenue and sustain our competitive position.” Those two things should have sent giant red flags going off for investors; Zynga counted on a small number of players in a small number of games to make up the majority of its revenue. The massive amount of people who played Zynga games don't matter, what matters are the people who pay for items in the game, and if even a small number of those people leave, relative to the size of the overall user base, the company will collapse. It's important to remember that Zynga came to prominence in the gaming industry with games like Farmville and Mafia Wars, which were based on concepts honed in earlier games by other companies. Zynga has a long history of appearing to “borrow” from successful games, and then leveraging the size of its audience to make their versions of these games a success. “I don't fucking want innovation,” an ex-employee remembers CEO Mark Pincus saying. “You're not smarter than your competitor. Just copy what they do and do it until you get their numbers.” A later memo described that strategy in softer terms was leaked to Forbes. “We don’t need to be first to market. We need to be the best in market,” Pincus wrote. “There are genres that we’re going to enter because we know our players are interested in them and because we want and need to be where players are. We evolve genres by making games free, social, accessible and highest quality.” Cashing in the design work of others isn't a lasting strategy, but the purchase of OMGPOP provided more evidence that Zynga was headed for a crash. The estimated $180 million acquisition, with $30 million more used to retain employees, came together on the strength of one game: the monstrously popular Draw Something. The problem is that any attempts at monetizing the game would prove to be annoying to consumers, and have the effect of pushing them to other similar products. The game's active users were only topically impressive; there wasn't anything of long term value in OMGPOP's stable of products, and little evidence of talent that could provide innovation for future products. There was nothing proprietary or special about Draw Something, as the game was merely a simplistic take on Pictionary. The only thing Zynga bought for that money was users, who promptly fled the game, leaving Zynga with a $210 million acquisition of developers who likely didn't understand why Draw Something was a hit in the first place. It's not quite as bad as lighting money on fire, but it's the next worst thing. Today Draw Something has 3.4 million daily active users, according to AppData, down from an average of 14.5 million daily active users in April. Zynga has yet to create a single hit that isn't based on the DNA of existing games. The company simply threw money at a developer whose only asset was a fluke hit with users that had no reason to begin paying for the product, much less stick around. Those are bad things, but the worst part of Zynga's business is an utter reliance on Facebook, and Facebook is beginning to realize that diversification is in its own best interest.
The Facebook problem
“If we are unable to maintain a good relationship with Facebook, our business will suffer,” Zynga's filing stated. The filing had a long list of ways Facebook could hurt its business, including if “Facebook discontinues or limits access to its platform by us and other game developers,” “Facebook modifies its terms of service or other policies, including fees charged to, or other restrictions on, us or other application developers, or Facebook changes how the personal information of its users is made available to application developers on the Facebook platform or shared by users,” “Facebook establishes more favorable relationships with one or more of our competitors,” and lastly, if “Facebook develops its own competitive offerings.” Let that sink in for a moment: Zynga exists at the pleasure of Facebook. We're beginning to see these dangers come into play as Facebook adjusts how game data is shared across its network. “Essentially, Facebook’s platform tweaks favor new games over Zynga’s long-established titles,” AllThingsD reported. “The social gaming giant once had a stranglehold on Facebook’s application ecosystem, but Facebook changed tack this year, tweaking its News Feed algorithm and opening App Center, a central location for Facebook users to discover new third-party applications.” This shift also caused newer Zynga games to get more exposure, but Zynga has proven that amount of players isn't nearly as important as the number of paying customers. Without launching new games that consumers are willing to pay for, the lowered emphasis on Zynga's existing properties could be fatal. Just in case this feels like a case of hindsight being 20/20, these are the dangers I wrote about back in July of last year when I first covered the IPO for Ars Technica. It looked like a bad investment from the start. Zynga's fortunes are tied to Facebook, but Facebook has more to gain by emphasizing a wider variety of games from many different vendors. This could force Zynga to look for success on other platforms, where the company has little experience, and what's likely to be a smaller appetite for acquisitions after the disastrous purchase of OMGPOP.
It's okay though, the big names have already dumped their stock
The stock's plummeting value wasn't hard to predict, but the 43 million shares dumped by company insiders for $12 a share in April is galling. This is the same stock that is now selling for slightly over $3 a share. “In other words, Zynga insiders cashed out at exactly the right time,” Yahoo Finance reported. “In fact, they cashed out in the same quarter in which Zynga imploded.” That same article points out that all the stock sold in this “secondary stock offering” belonged to company insiders, and none of the cash went to the company. The company that paid, according to Yahoo finance, $1 million for “legal fees and private jet rental” to make the sale happen. Not a bad deal. Marc Pincus himself sold 16.5 million shares of stock, for $200 million. If he had held onto those stocks until today, they would be worth approximately $52.3 million. He still owns a large number of shares, but that single sale may have been the best business decision he made since Zynga's IPO. It's a shame no one else could benefit from his prodigious foresight. This sale is now under investigation. Zynga is a company that became successful when a small number of people began paying for items in a small number of seemingly cloned social games. That success was always contingent on Facebook keeping Zynga in its good graces. Now the company is forced to rethink its business model without any easy targets to clone or buy, with expertise in a style of game that may prove to be little more than a fad. This is the challenge of our new gaming economy: it doesn't matter how many people are playing, it only matters how many are paying. These days, Zynga gamers are keeping their wallets in their collective pockets.