Is Zynga on the road to recovery?

Zynga has closed out 2012 with a stronger than expected performance of $311 million in revenue (according to GAAP) when analysts had expected $212 million. The publisher also outperformed on earnings, with a non-GAAP gain of 1 cent per share, where analysts had expected a loss of 3 cents. The market responded well to this news, with Zynga shares gaining over 7 per cent for the day and an additional 6.5 per cent in after-hours trading, closing in on $3 per share.

However, does this mean Zynga is out of the woods? Not yet - there are still hurdles to jump and pitfalls to avoid. Overall, though, it looks like Zynga is making progress in the right direction. As usual, the important clues are scattered throughout the executives' statements to analysts - let's take a look at what they said, and what it means.

Zynga CEO Mark Pincus started off the earnings call with some justifiable pride in the results delivered, mentioning some key numbers regarding Zynga's audience. "We have the largest total audience, with 298 million monthly average players, and specifically, 72 million on mobile alone."

That's a big number, but it's down from the high-point of over 310 million monthly average players that Zynga had at one point in 2012. Still, the erosion is not as severe as it could have been - companies like Digital Chocolate have seen their monthly players drop from 30 million down to 6 million. EA's social game audience also shrank significantly in 2012.

"We have the largest total audience, with 298 million monthly average players, and specifically, 72 million on mobile alone."

Mark Pincus

Social game companies have seen both sides of free-to-play games. While publishers can quickly attract large numbers of players to a free game, the downside is that people who haven't paid anything for your game have no qualms about dropping it the moment they aren't having fun; audiences can evaporate as quickly as they appeared if something isn't right with the game.

Pincus pointed out the company's strategy: "We realigned our studios around the four leading social game categories - which are invest and express, social casino, casual, and mid-core - and we promoted four proven product leaders to run them."

Notice that 'Ville style games are now called 'invest and express,' which gets to the core of the gameplay; you invest in creating something which you're usually creating something to show off to your friends. The interesting thing to note is that 'social casino' and 'mid-core' games are now of equal importance to the 'Ville games and casual games which have been Zynga's bread-and-butter. Zynga is diversifying in game styles, which is another way to reduce risk and perhaps find another big hit.

Pincus was also keen to highlight an oft-forgotten fact about Zynga's performance. "I'm proud that as a company, we've been operating cash flow positive since 2007," Pincus noted. He should be proud; few game companies can make that claim. All other factors aside, a company that can generate positive cash flow every quarter is not headed for extinction. Zynga's had its reverses, disappointing games and a variety of headline-grabbing problems (like executive departures), but it's continued to keep the cash coming in.

Overall, Pincus summed up the core of the company's strategy going forward: "The number-one focus for our company this year is to deliver the best social games on mobile." It's all about mobile, folks. Sure, Facebook is our friend, and still accounts for most of the revenue, but the big growth potential is all on mobile.

"CityVille 2 missed our expectations... And both the Frame Game and Party Place failed to achieve the mass-market appeal that Zynga franchises are known for."

David Ko

COO David Ko gave some blunt details of Zynga's hits and misses for the fourth quarter. "We launched four new mobile games: Ayakashi, Bubble Safari, Ruby Blast, and Party Place, as well as four new web games: CoasterVille, CityVille 2, the Frame Game, and Bubble Safari Ocean. While we successfully expanded our game portfolio, not every launch was a success. CityVille 2 missed our expectations, despite pushing the envelope on 3D gaming. And both the Frame Game and Party Place failed to achieve the mass-market appeal that Zynga franchises are known for. As a result, we are closing CityVille 2, the Frame Game, and Party Place."

No more letting a game limp along for months to see if it manages to find an audience - Zynga is ruthlessly putting these games out of their misery. This may be painful for the teams involved, but if the game isn't a success the company needs to shut it down and move forward quickly into something that does make money.

Ko put it in no uncertain terms: "The two biggest changes on our pipeline from last quarter are that one, you should expect to see the shift move more to mobile. And two, with our efforts to call the ball earlier on games and focus on franchises, we're doubling down on games with the biggest potential, and we'll probably ship less games overall."

More mobile games, fewer games overall, and cull the sickly more quickly. Ko sounds like he means business.

He also knows where Zynga is finding its players: "In Q4, our own network drove 71 per cent of all installs to new game launches during the first few weeks, and over the course of the entire quarter, drove a total of 92 million installs to all of our games." This seems to be true of most companies these days; nothing succeeds like success. If you have a large network, you can tell those players about new games. Of course, the majority of your new games have to be good ones, or eventually the whole concept falls apart.

"Q4 ad revenue was strong at $37 million, up 35 per cent year over year and 19 per cent quarter-over-quarter"

David Ko

One important opportunity for Zynga is advertising; with an audience of nearly 300 million you would think the potential for ad revenue is strong. Zynga has been slow to make that happen, but the tide seems to be turning. "Q4 ad revenue was strong at $37 million, up 35 per cent year over year and 19 per cent quarter-over-quarter," said Ko. "Our direct sales team onboarded new world-class brand advertisers like Progressive Insurance and LG Electronics while securing renewals from McDonalds, Honda, and NBC Universal, just to name a few."

Zynga has also made improvements on the cost side, as the freewheeling, freespending days seem to have departed. "On the cost side in Q4, we reduced our cash operating expense by $23 million quarter-over-quarter, exceeding the $15-20 million cost savings range we laid out in Q3," Ko said. We decreased spend in a number of areas, including marketing acquisition, data hosting, and outside services. We also closed several remote studios, reduced the size of our workforce, and rationalized our product pipeline."

It was left to CFO Mark Vranesh to mention the most important fact about Zynga's current situation: "Our Facebook related bookings represented 79 per cent of our bookings. Substantially, all of our non-Facebook bookings were on mobile platforms. Mobile bookings grew from 8 per cent of bookings a year ago to 21 per cent of bookings in the fourth quarter." This has been the key metric to watch. Zynga can talk about the importance of mobile, but the numbers show that the company is making good progress at shifting its revenue away from Facebook and onto mobile.

That's been the question: could Zynga keep revenues up, and profits coming in, while shifting from Facebook to mobile? It looks like the company is successfully walking that tightrope. A year ago Zynga was dependent on Facebook for 92 per cent of its revenue; that's down to 79 per cent, and you can bet it will continue to drop. Zynga needs to diversify its revenue sources so that it's not as vulnerable to any changes Facebook might make.

"A year ago Zynga was dependent on Facebook for 92 per cent of its revenue; that's down to 79 per cent."

Vranesh pointed out that the most important part of Zynga's audience, the ones who pay, are holding steady. "Monthly unique payers, or MUPs, were 2.9 million, down 1 per cent year over year and down 2 per cent quarter-over-quarter while payer conversions, or MUPs as a percentage of MUUs, was up 3.5 per cent to 1.7 per cent versus the prior quarter." A rise in the conversion ratio is a good thing to see, as it means Zynga is getting better at monetizing its vast audience. In fact, that audience can drop significantly and it won't matter to Zynga as long as the conversion ratio gets better. A reliance on a very tiny number of payers is also a dangerous thing, and clearly Zynga realizes this. Part of the reason to develop mid-core games is that they tend to have a much higher percentage of players who pay.

Vranesh also confirmed that Zynga has made progress in diversifying its cash cows, and that it's not overly dependent on one game. "Our top revenue generating games for the fourth quarter were Zynga Poker, FarmVille, and CastleVille, which comprised 20 per cent, 18 per cent, and 12 per cent of our online game revenue respectively. No other game generated more than 10 per cent of online game revenue in the quarter."

Pincus summed up Zynga's strategy thusly: "We are both bringing existing major franchises like FarmVille 2 to mobile and we're launching new potential franchises in new categories, so we hope to grow that traffic this year from new launches."

That has been a key question; when will Zynga bring its best titles (FarmVille, CityVille, CastleVille) to mobile? We understand the games were built in Flash, so going mobile is not trivial - but also not impossible. Certainly the Ville style of game works much better on a larger screen. Tablets should be a natural home for Ville games; smartphones are a much more difficult target given the screen size.

Zynga has managed to hold its revenues level during a tumultuous year, and made a number of important strategic shifts. These early numbers show that Zynga is making progress in the right directions of reduced reliance on Facebook, more and better mobile games, more advertising revenue, while expanding the scope of its game offerings. The company isn't projecting massive growth, but it is looking for steady progress in the upcoming quarter. Given these numbers, it looks like a good prospect.