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Zynga: The worst may be yet to come
Zynga: The worst may be yet to come Exclusive
August 1, 2012 | By Chris Morris

Last week was an ugly one for Zynga. An earnings shortfall and reduced guidance for the coming fiscal year resulted in a 40 percent drop in the company's stock, which brought out the doomsayers.

Those corporate obituaries are premature, but the company is likely to face some even rockier times before there's much chance of things getting better.

Zynga is facing a tremendous series of hurdles as it struggles to course correct. The social gaming space is slowing down -- and player numbers for the company's flagship games are declining. Investors know this, and they're rightfully worried, but the most looming hurdle is the coming expiration of a new round of employee stock options.

On August 16, the lock-up period on 150 million shares will expire, meaning employees will be able to exercise their shares. While the stock is hardly a windfall for anyone these days, some money is better than none. And it's a safe bet some employees will cash out.

Zynga used stock options as a major recruitment tool in its pre-IPO days. Developers were lured from the traditional console industry not so much because they believed in the company's future (though that was certainly part of the appeal), but because of the temptation of sudden wealth when the company went public.

At the time, a Zynga stock explosion seemed a sure thing. Things change, though. And employees who are thinking about another career shift are likely waiting for the chance to cash out some of those options before they go.

Complicating things is Zynga's float -- and forgive me a little finance gobbledygook here. A stock's float is the number of shares that are available for trading. When Zynga went public, there were only 100 million shares available. Between a secondary stock offering and the expiration of three lock-up periods since then, the number has jumped to over 600 million. When the latest lock-up period expires in August, that will bring the float to nearly 800 million shares.

Larger floats tend to make a company less volatile in general, but at Zynga, it's starting to look like the supply for company shares is outstripping demand, and that could batter the stock price even further.

And make no mistake, the stock is being hammered. Alarmists point out that Zynga shares are now trading at a price that's nearly half of THQ's stock. That's an unfair comparison, though, since THQ just completed a 10-for-1 reverse stock split. But Zynga is getting very close to the territory of Majesco, which hasn't topped $4 per share in over five years. (By mid-day Tuesday, the stock was trading at $1.83 per share, versus Zynga's $2.92.)

Beyond the new options about to hit the market, the poor results are bringing about the usual lawsuits. A California firm is seeking class action status in its accusations that the company failed to disclose the decline in users and revenue. These suits rarely go anywhere, but they're a distraction and tend to weigh down the stock.

And Tuesday's baffling decision by the company to yank game oversight from chief operating officer (and EA/Microsoft vet) John Schappert may be the company's most bone-headed move in years -- and could cause even more stock turbulence. Investors may want a scapegoat, but Schappert is one of the most game-savvy executives the company has. Mark Pincus, who will now oversee game development, doesn't have the experience, and should things slip further, it will further undermine confidence in his leadership abilities.

Zynga's tailspin isn't entirely its fault. The company was dragged down by Facebook's IPO (which pretty much put a halt to all public offerings after the social network landed with a thud). And until Zynga finds a way to become less dependent on its biggest partner, the stock will suffer. It's in the process of building up and is actively recruiting development partners for the site, but it's going to take a while for that to bear fruit.

The mobile market is another source of revenue, but Zynga hasn't quite learned the trick of mastering it. And after the bloated acquisition of OMGPOP earlier this year (and the subsequent underperformance of Draw Something), investors are going to be skeptical of any buyouts in that space.

Zynga is a company in transition, one it didn't expect to go through quite this quickly. (And investors certainly weren't planning on having to weather this so soon after the IPO.) Assuming it doesn't suffer a major talent drain and it's able to course correct, especially in the mobile space, it could once again be the powerhouse it was a short while ago. But until then, investors -- including those developers who hope to see their options bring them a windfall -- are likely to be in for a bumpy ride.

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Fernando Fernandes
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Bye bye, Zynga. Take Farmville with you.

Chris Rigopulos
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What is the deal with the THQ comparison? Comparing share prices of two companies tells you almost nothing. Zynga market cap is still over $2B. THQ is at $35M. What am I missing?

Kris Graft
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Hi Chris,

You're right, it's absolutely not apples to oranges (as Chris Morris points out). On top of your point, THQ just did a 10-for-1 reverse stock split, making peoples' comparisons even sillier.

Nathan Zufelt
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Comment deleted.

Kris Graft
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Chris (Morris) was referring to the very people who have been comparing THQ and Zynga shares. He's in agreement with you...

"Alarmists point out that Zynga shares are now trading at a price that's nearly half of THQ's stock. That's an unfair comparison, though, since THQ just completed a 10-for-1 reverse stock split."

Mathieu MarquisBolduc
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Chris Rigopulos is right. Any price-to-price comparison of stock price is pretty meaningless, since the number of shares are different.

Chris (Morris) goes on to say that "Zynga is getting very close to the territory of Majesco, which hasn't topped $4 per share in over five years"

Zynga's shares are is still worth over 2 billion total, and Majesco 70 million. Im not defending Zynga but it is completely false to say that Zynga and Majesco are in the same range.

Zynga is halfway between Take-Two and EA, as far as "stock value" (market capitalization) goes.

Alan Rimkeit
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Class-action lawsuit details alleged insider trading at Zynga

BOOM. Law suit. Insider Trading. Prison.

E McNeill
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"These suits rarely go anywhere"

Freek Hoekstra
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but in the case of selling 200 million worth of shares just before terrible news will come out with a very much to be expected (and significant drop) in the price of shares, this one just might...

OT: i never believed in the inflated value of Facebook and Zynga (and everything alike)
this second internet bubble is starting to burst at a rapid rate, and on one side I am happy as valuation might finally return to slightly normal values, on the other side this might be a really bad sign for a triple dip in this industry...

Lex Allen
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This news doesn't look good for the social game that I'm making. Good thing there's a single-player option!

Kenneth Blaney
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Zynga's failures do not reflect on the social game genre. There are still plenty of good things to do within social games. So this situation isn't likely to have a huge effect on your title unless you are working for Zynga or where planning to be bought by them.

Ramin Shokrizade
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When 2K Games asked me over a year ago if Zynga was a threat, I explained that they were not in a 13 page "Zynga Analysis":

This analysis explained why various systemic weaknesses in the Zynga business model were already creating a downward trend that was not visible to conventional analysts. I have to disagree with the OP when he says that Zynga is a company in transition that may rebound, as none of those systemic weaknesses described in my analysis have been successfully addressed, or even acknowledged, by company executives. This gives me the impression that they are oblivious to their own circumstances and will remain incapable of executing remedial action.

Ian Uniacke
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How do we know the majority of investors weren't ma and pa? "Oh I hear that farming cityvillage is quite popular with the kids these days".

Ramin Shokrizade
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I don't see some investors as "good" and some as "bad". All investors create jobs in our space and when they lose, we lose. This is what is so scary about 57% of all interactive media investment having gone into the social gaming space last year. If those products are mostly Zynga clones, or at least monetized in a similar way, then we could be in for one huge bubble. While this may help AAA studios recover, in the meantime unemployment will spike and there is always the risk that domestic companies in trouble will get acquired.

Curtis Turner - IceIYIaN
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Work a year or two at a company... Longer... Then suddenly have a bonus check worth a crapton... Yeah, every single one of you would take it. Or would you like to go back to the farm?

Brad Borne
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That's sure assuming a lot the readers here, leaving the option 'make some good games and make good money on them without selling our souls to Zynga' off the table :P

Michael Rooney
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J EdG: why do you assume that all Zynga employees want to make a quick buck by flooding the market with crap and hurting people? That's at least as shallow an opinion as the one you criticize.

I don't agree with Zynga's business model, but they have 3,000 employees. I doubt they're all out to ruin the world.

steve roger
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Serves the policy makers at the top right. PC after PC was "infected" with unwanted==and uninstallable Zynga. I can understand a small annoying company or start up preying on the PC owning public as way to worm their way onto the desktop--but a giant social gaming company? Their strategy of forcing there red dog insigna down our throats doesn't lend itself to a sustainable presence in our lives. In fact, we all vowed to never play any of their products.

I do have a heart for the regular rank and file employees though and am sorry that they will probably suffer some job loss.

Ivan Pozo-illas
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Hi There,

It doesn't help the company valuation much when the CEO, CFO, COO, and assorted investors cash out of the company totaling around $516 million dollars.

Zynga CEO Marcus Pincus sold 16.5 million shares for $200 million
Zynga investor Google sold 4 million shares for $48 million
Zynga CFO David Wehner sold 386,000 shares for $4.6 million
Zynga COO John Schappert sold 322,000 shares for $3.9 million

Alex Nichiporchik
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It's at 2.81 at the writing of this comment...

Questioning the freemium social games business model

Michael Rooney
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I don't think the fremium business model was the problem with Zynga.

Ramin Shokrizade
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I would say that the *way* Zynga uses freemium is large the problem, but this is a very cynical Chinese/Las Vegas hybrid model that is coercive and not at all designed for long term sustainability. The way the Zynga C-level execs cashed out promptly indicates to me that they are well aware of this and just "forgot" to tell investors this.

Brent Gulanowski
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Investment bubbles are disturbing. But I think they point to a much deeper, more disturbing, problem in society. When everyone is looking for a quick way to make a buck, they all seem to resort to trying to outsmart one another. It's a losing strategy for most, because only the few smartest and luckiest will manage to outsmart everyone else.

The more people who resort to these get-rich-quick scams, the more capital (and when I say capital, I mean human effort and goods, not just fairy-tale money) disappears and never comes back. The get-rich-quick mentality says bad things about people's priorities, their long term expectations, and their fundamental beliefs and priorities about how society is (or should be) organized. It means that a large amount of human effort is being spent of trying to grift someone else, instead of building things that will last.

The stoic view is that these events are just cyclic patterns in history. Unless you're someone like Mark Pincus, the best bet is to just wait it out and not get caught up in the mania. Better yet, start working to get the next socio-historic stage--with a focus on long-term wealth creation--started earlier.

Brent Gulanowski
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@Daniel Steckly

Actually, I've read a lot of good research that belies that, and other assumptions of standard economic theory. People are not simple, rational maximizers. People have values, beliefs and morals. They have quite deeply ingrained ideas about fairness and justice. In different societies, however, these norms can vary greatly.

Check out the book The Origin of Wealth, which is a great introduction to complexity economics, which is solving some of the problems of classical economic theory.

Ramin Shokrizade
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I warned against the formation of an IGE-like company in April of 2000 on the front page of the Los Angeles Times, I warned Nexon in 2001 that their models would lead to "pay to win", and I felt concerned enough that someone would make a "Zynga-like" company back in 2005 that I started the field of applied virtual economics. Our whole industry has been playing "follow the fad" for a very long time. Creating alternatives is a tedious process and generally not particularly lucrative. Investors chase big money, as you can see in all these cases, not good ideas. This would have discouraged me many times in the last 12 years if I didn't have a vision of myself doing this for the next 50 years.

Daye Williams
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"You are not smarter than your competitor.."

jin choung
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the conclusion of this article is ridiculously rosy.

zynga getting in a position to go without facebook's teat is a massive and unlikely undertaking.

the decline is social gaming is not something zynga itself has any control over.

important employees who were lured in with stock are likely to be very very very disgruntled by now.

to see this as something other than a death seems ludicrously optimistic.

Joshua Hawkins
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In 2009 I talked w/ a few Zynga reps at GDC. They each gave me the same impression of Zynga. Zynga's sole motivation was profit. Now I'm not some naive dreamer that games are funded by rainbows and good ideas, but this was a giant red flag for me. In any industry if your sole goal is making money you're heading for failure. Yes making money is vital to any company, but it's not everything. For a second imagine that corporations are people. Now imagine a person who's only goal in life is to make money. That person probably doesn't seem like a very good person on any level despite their success.

Dustin Clingman
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A couple of points here.

- Zynga has oodles of cash on hand. Despite the loss on paper, they have plenty of money to reinvest in /acquire new products that will reinvigorate the player base.

- Players may be fatigued of the current generation of Zynga's games, but that does not mean there's any reason to read that players don't want to game on Facebook as a platform

- Zynga's acquisitions have been strategic in looking forward towards this change in player behavior. They bought Floodgate (formed by the folks from Looking Glass (System Shock, Thief, Ultima Underworld) as well as Buzz Monkey and Area/Code. Main point being that they have a great deal of core and casual game devs working on new products in the pipe.

I don't have any great love for them, but declaring them dead is ridiculously premature.

Brent Gulanowski
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If EA wins their suit, what do you think will happen to Zynga? What about when all the other companies that Zynga has cloned see that they have a good chance of winning? Will Zynga be able to continue with their current business model of cloning, when they're likely to get sued? If they have start taking risks and innovating at least a little bit? That's not in their "DNA".

William Anderson
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Gaming trends have always come and go, its the developers who are flexible that survive. Another thing is that I see developers moving their products off to standalone sites and away from Facebook. Facebook now suffers from the same thing that Apples App Store does, there are just so many products now that yours just gets lost in the noise, unless you have a huge advertising budget.