What the Heck Happened to Zynga This Quarter?

By Erin Griffith , written on July 25, 2012

From The News Desk

Zynga might have a few good excuses for missing its earnings estimates this quarter, but investors do not seem to care. After the company's third consecutive quarterly loss -- and a wide one at that -- blood is in the water.

The company's stock traded shockingly low, dipping at one point below $2 per share in after hours trading. (For reference: Zynga went public in December $10 a share and peaked at $14.69 in March.) The tough Zynga news also hurt Facebook shares, which traded down over 8 percent.

Last week, Zynga's CEO Mark Pincus told our PandoMonthly audience that Zynga intends to become a 100-year company. To achieve that goal after a quarter like the one it just had, the company needs to do some major convincing. Mark Pincus kicked the quarterly earnings call off with a string of reasons that boil down to this: Facebook is screwing us, we launched The Ville later than planned, and Draw Something was a bust.

Below, a closer look at those explanations:

1. Facebook tweaked its algorithms, which hurt engagement.

In users' news feeds, Facebook now emphasizes new game use over existing games. As a result, engagement with Zynga's games declined 15 percent overall. New games were emphasized, including Bubble Safari, which became the number one arcade game on Facebook. Likewise, Zynga's much-anticipated launch of The Ville saw 4.5 million installs on its first day. But engagement for existing games -- the requests, bookmarks, etc that remind people to water their virtual crops -- don't show up in users' news feeds.

Analysts weren't totally convinced of this reason. Facebook's changes weren't put in place until June, which is relatively late in the quarter, one pointed out. Zynga's executives clarified that the impact was "in part" related to Facebook's changes, but not the only reason. Zynga's existing games were already underperforming, and the Facebook changes exacerbated that.

All of that means the pressure for Zynga to get off Facebook is higher than ever. The relationship has been tumultuous: Pincus said at PandoMonthly last week that at one point, both sides were ready to walk away. "At the end of the day, we just had to say that we trusted each other," Pincus said of Mark Zuckerberg.

Still, Zynga, which was responsible for something like 12 percent of Facebook's annual revenue last year, has one foot out the door. The company began work on its own gaming platform at earlier this year. Its efforts to bring more of games to mobile are just as robust (perhaps responsible for Zynga's 39 percent increase in expenses and 79 percent increase in R&D). Zynga has 22 million daily active users on mobile -- the goal is to get higher monetizing games onto mobile. "We have found that mobile looks fine on monetization, with many of the same players we saw previously on the Web switching over, but we need to drive significant scale of distribution to get to the audience sizes we want," CFO David Wehner said.

2. The company delayed its release of the Ville. 

Zynga was hoping for that big launch to have more of an impact on its earnings this quarter. It didn't roll out as quickly as planned. Simple enough.

3. Draw Something was a big disappointment. 

Zynga bought Draw Something parent company OMGPop for $183 million in March. The app's popularity has waned since then. When asked if that experience tainted Zynga's appetite for acquisitions (analysts surely hope so, the market responded to the deal by trading Zynga's stock down), Pincus responded with a yes, basically: "Our M&A strategy has always been much more focused on adding entire development teams rather than whole product lines, so ... the OMGPop acquisition we saw as a rare instance for us." The company is working on ways to revive Draw Something's growth and earnings. But we all know how consumer internet revivals go.

So that's what Zynga has to say for itself. When asked about the possibility of a stock buyback, Pincus said it's a continual topic of conversation with Zynga's board. Right now the company has cash on hand worth almost half of its market cap. At one point an analyst asked outright, "Why should people buy your stock at $3 a share?"

Pincus' answer was long but simple. Paraphrased, he said: If you believe in social gaming, we're the biggest and best. There's no denying social gaming is big, and that Zynga dominates the category. Whether anyone believes it's a big business is Zynga's challenge.

Watch Pincus respond to a question on his company's stock price and the company's  biggest criticisms from PandoMonthly last week: