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Zynga's bet on midcore, real-money gaming could be a win

Profitable, but smaller, Zynga is aiming to turn its business around with new games, midcore, mobile, and real-money gaming

Zynga's first quarter results are in for 2013, and it's a mixed bag. The company showed a profit, but all of its major metrics were down. Zynga's executives put their best spin on the numbers, but the hard truth is that it was a tough quarter in a tough year. Still, while the current situation is rough, there is reason to be optimistic that things can improve.

Many analysts were expecting lower results from Zynga, though Michael Pachter had nailed it pretty closely. Zynga handily outperformed the consensus estimates of about $209 million in GAAP revenue; the company actually pulled in $263.6 million, mostly due to to a strong performance by FarmVille 2. Still, the company's stock fell nearly 10 percent in after-hours trading, as investors absorbed the news that next quarter isn't going to look very good and that Zynga expects a "significant" decline in bookings.

The difference between Zynga's GAAP results and the non-GAAP results are particularly striking. Typically, companies present non-GAAP earnings because they feel it represents a truer picture of the state of the business. When you look at Zynga's non-GAAP results compared to last year, the company's shrinkage is clear. Bookings for Q1 2012 were $329 million; for Q1 2013 they were $229 million. Non-GAAP net income was $47 million last year, and only $9 million this year.

It's at this point that you want to look at the overall metrics of the company's audience to see how it looks. Not good; all the key metrics are down. The daily active users (DAU) dropped from 65 million in Q1 2012 to 52 million in Q1 2013; monthly active users (MAU) dropped from 292 million to 253 million.

Critically, monthly unique payers (MUPs), the folks who actually give Zynga money, declined from 3.5 million to 2.5 million. Zynga's business has clearly shrunk significantly since last year.

"Zynga's business has clearly shrunk significantly since last year"

What's the good news? The company managed its reversal of fortune well over the last year, and demonstrated this by turning a $4 million GAAP profit versus the same quarter last year that had an $85 million GAAP loss. It's also significant to note that Zynga had only two minor new releases in Q1, which definitely hurt revenue. CEO Mark Pincus also noted that during Q1 the company killed two products in development because they didn't show sufficient promise.

COO David Ko said that Zynga would be "picking up the release cadence for the latter half of the year." In other words, more product releases, more on mobile and more midcore games. There are early signs from Zynga's midcore efforts of much higher monetization, and once a number of those games reach the market this may improve Zynga's revenue picture.

Zynga is also making progress on advertising, as ad bookings per DAU more than doubled. Several big accounts have renewed ad contracts, and Zynga will be looking for more. The other growth area of significance is real-money gaming (RMG), as Zynga has just launched RMG in the UK and is applying to launch in states like Nevada where legalization of online real-money gaming is making progress. The potential for revenue from people gambling on mobile devices is large indeed, but there are many competitors and problems to overcome.

The larger picture for Zynga is shifting its development into mobile and mobile/multiplatform games, "where the growth is" as Pincus puts it. The company has shrunk, but it's still putting money in the bank ($23 million added in Q1, for a total cash horde of $1.7 billion). Zynga's audience may have diminished, but it's still larger than any other social game company. That audience is crucial when it comes to promoting new games, as it neatly sidesteps the problem of increasing user acquisition costs. When you have a new game, cross-promote to your existing audience and you can get a sizable audience in days without spending anything on marketing. (In fact, Zynga's marketing expenses were down significantly.)

"Zynga is managing to turn a profit despite falling audience numbers, but investors are looking for a bigger audience and reasons to believe in growth"

Pincus stressed that 2013 will be "nonlinear" and difficult to predict. Aside from warning that Q2 won't be very good, Zynga is still projecting positive earnings for the full year. Reading between the lines, Zynga's got a number of games in the pipeline and many of them will be arriving in the second half of the year. While the company hopes these games will do well, it's wisely not getting too specific about any particular release or what it thinks that game might achieve.

Zynga has been ruthlessly pruning its game library (several more, including The Ville and Empires & Allies, are slated for removal) to focus on fewer, better-performing games. There's a strong emphasis on midcore titles, with Pincus admitting that there are more resources focused on midcore games than on any other genre the company produces. Many of the new titles will be mobile, or multiplatform. Zynga is also pushing some of the games from its partners that it feels can grab a big audience, like Village Life. Real-money gaming should start contributing to the bottom line this year, and become significant next year.

The bottom line for Zynga's year of transition: New games arrive in the second half of the year, and the company's turnaround depends on how well those new games perform. Zynga is managing to turn a profit despite falling audience numbers, but investors are looking for a bigger audience and reasons to believe in growth. New games, real-money gaming, mobile dominance and ad revenue all have potential to boost Zynga's growth, but Zynga has to start showing strong results in one or more of these directions before the stock price makes real progress.

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Steve Peterson

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Steve Peterson has been in the game business for 30 years now as a designer (co-designer of the Champions RPG among others), a marketer (for various software companies) and a lecturer. Follow him on Twitter @20thLevel.