ReadWriteWeb DeathWatch: Zynga

Zynga’s Mafia Wars, Farmville and Bubble Safari are enormously popular pastimes that helped define social/casual gaming. But faced with a changing market and an unpopular leader, can Zynga innovate its way out of the hole it keeps digging for itself?

The Basics

Zynga’s climb to the top of social gaming didn’t take long. In 2007, Mark Pincus launched the Texas Hold'Em Poker app (now Zynga Poker) on Facebook. Within a year, he had acquired nearly $40 million of venture capital. A year later, Zynga reached 40 million active users on the back of Farmville, and an empire was born. Zynga went public in late 2011, and its stock took off, bolstered by strong performances from games like CityVille, Bubble Safari and Words With Friends. Since it peaked in March 2012 at nearly $15 per share, scandals and missed numbers have driven Zynga’s stock down to just over $3 per share. The company is now fighting to gain back the valuation, reputation and dominance it enjoyed just a few months ago.

The Problems

Zynga’s biggest problems break down into four buckets. Some of them are Zynga’s fault, and others aren’t:

1. The Brand Problem Mafia Wars has a loyal following. So do Words With Friends, Hidden Chronicles and Pioneer Trail. They’re all Zynga games, but Zynga itself does not command any loyalty. Social gamers are interested in individual game, not the companies producing them. That’s how something like OMGPOP’s Draw Something could come out of nowhere in a matter of days. Draw Something scared Zynga enough to prompt it to buy the company for $180 million. You can only do that so many times before the well runs dry, and hot apps can die as fast as they grow. The only way to stay on top is to keep churning out new hit games. That’s a tough business to maintain and scale.

2. The ‘Book Problem Zynga and Facebook are tied together in a very unequal partnership. Sure, Zynga still dominates Facebook’s gaming channel, but there are plenty of other options for gamers, and Facebook is willing to test the waters. When Facebook made non-Zynga games easier to discover, Zynga’s business – and its stock – took a dive.

On a recent earnings call, Mark Pincus acknowledged Zynga’s Facebook problem, noting that “getting beyond the Facebook Web footprint through mobile is going to give us more growth opportunities.” In the long run, that may be the case, though monetizing mobile traffic has been notoriously difficult for everyone. In the short term, Zynga has to hang on to as big a piece of the pie as Facebook will let them eat.

3. The Bubble Problem Zynga isn’t the only social gaming company that’s disappointed. Electronic Arts' PopCap acquisition is also starting to look like a bust. Social gaming is here to stay, but it seems tremendously overvalued. Zynga was funded in a bubble, built its expectations in a bubble and now has to meet bubble-sized expectations in a world that’s made a market correction.

4. The Boss Problem Speaking of management, the former wunderkind at the top of the org chart hasn’t made a lot of friends. Despite all his talk about everyone being a CEO, Mark Pincus has always been known as a bit of a control freak. When he was on top of his game, everyone let it slide. Then it got ugly, and so did the public.

In late 2010, we heard rumors of stock option clawbacks where Pincus allegedly demanded that certain employees return their options or be fired. Then, when Zynga executives cashed out before the stock tanked (and while everyday employees remained locked up), Pincus became the target of a class-action lawsuit alleging insider trading.

Pincus doesn’t seem to care about the common employee, and when you make video games for a living, your employees are your only real asset. That helps competitors to swipe your best talent and makes it really easy to mock you in videos like this one from Kixeye (language not suitable for work):

 

The Players

Mark Pincus, CEO: Mark Pincus is a smart guy, and he gets social media, having founded the push news service Freeloader and the social network Tribe Networks. He’s also not afraid of bending the rules to make a buck. In addition to the stock clawback, Pincus admits to dumping spyware on his users' computers to turn a profit:

I knew that I wanted to control my destiny, so I knew I needed revenues, right, f*cking, now. Like, I needed revenues now. So I funded the company myself but I did every horrible thing in the book to, just to get revenues right away. I mean we gave our users poker chips if they downloaded this Zwinky toolbar which was like, I don't know, I downloaded it once and couldn't get rid of it. *laughs* We did anything possible just to just get revenues so that we could grow and be a real business…So control your destiny. So that was a big lesson, controlling your business. So by the time we raised money we were profitable.

Pincus got the company this far by being ahead of the curve. His challenge now is coming up with a way to stay there as the industry becomes more commoditized.

The Prognosis

Zynga’s stock will not return to its peak for years, if ever. Its current franchises will likely hold onto a good deal of their market share, and the titles in the pipeline should perform well enough, but competition will eat into the company’s dominance. Within a few years, Zynga may still be the biggest social game publisher, but own a far smaller portion of a market valued far more conservatively than it is today. Unless it hits a major home run with one of its new initiatives (see below), there’s really no reason for anyone to acquire Zynga, so the company’s value will continue to float down to a point justified by its actual profit.

Can This Company Be Saved?

Zynga should continue to produce relevant, popular games, but to remain a power player in the social world, Pincus needs to win big with two moves.

First is his push toward becoming an infrastructure provider. This will be an uphill climb, and there’s no good way to lock in developers who become successful on the Zynga platform.

Second, and much riskier, is a jump into online gambling, a recurring theme that Pincus resurrected in July. Given the recent domestic troubles online gambling has faced, Zynga will likely be relying on years of Farmville sequels before gambling becomes a major revenue source.

The Deathwatch So Far

Research In Motion: Amid Massive losses - more than 11 times worse than expected - the company has reportedly started pitching its long-delayed Blackberry 10 devices to carriers. And rumors are swirling that the company may do a licensing deal - or even a sale - with Samsung.

HP: The company reported disappointing earnings last week, with declines in computer and printing revenues - and an $8.9 billion loss on a $10.8 billion writedown. Reports that HP is creating a new division to take another plunge into the consumer tablet market did not reassure anyone.

Nokia: The mobile phone giant’s quarterly revenue and earnings exceeded expectations and it has reduced its cash burn rate, but the company lost money yet again and saw its debt ratings cut to junk status. And it still hasn’t cracked the U.S. smartphone market as it halves the retail price of its flagship Lumia 900 to $49.99.

38 Studios: No change

Barnes & Noble: No change

Sony: No change

Groupon: Groupon’s stock price continues to hit all-time lows as growth slows. T-Mobile USA: The company’s troubles continue to mount, reporting second quarter losses of 557,000 high-value contract customers, and a net loss of 205,000 customers. 

NetflixNo change

Electronic Arts: No change

Best Buy: After rejecting Richard Schulze’s takeover bid over the weekend, Best Buy hired Hubert Joly as its CEO. Joly is a turnaround mercenary who’s done good work in the past with companies like EDS, but whose primary experience is in the hospitality industry. Best Buy’s stock dropped 7% in an initial response.

Motorola Mobility: no change