Why Zynga's (ZNGA) Decision to Close OMGPOP Is a Lesson

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Around 17 months ago, gaming company Zynga’s acquisition of OMGPOP was greeted with mixed reviews. Many maintained that purchasing the company responsible for the then immensely popular Draw Something was a smart move. The game, based on the always popular Pictionary format, seemed like it would never die. It was the hit at the time, the “Candy Crush” of 2012, or, more accurately, the “Candy Crush” of the first quarter of 2012. The game’s popularity collapsed in the second half of that year. In that context, ZNGA’s decision to shutter OMGPOP and close the division is not surprising.

When ZNGA announced a couple of weeks ago that they were abandoning real money gaming (RMG), however, many, myself included, were mystified.

The recovery in the stock from a low just above $2 at the end of last year was driven largely by expectations of revenue from ZNGA entering the US online gambling business, once a license was granted. The decision not to pursue that license and to give up the potential revenues from poker and other gambling in the US only really makes sense if you believe that the company knew or felt that they were unlikely to be granted a license.

Whatever the reason, that news was the catalyst for heavy selling, pushing the stock back below $3. RMG provided a hope of revenue for ZNGA, but without it prospects look bleak to me. It is hard to see how a company can make consistent profits from games for mobile and social platforms in the current environment. The story of OMGPOP and Draw Something should be seen as cautionary tales. Popularity, whether of a game or site, can be very short lived in the video gaming industry, and therein lays the problem, not just for OMGPOP, but for ZNGA itself going forward.

Just think back over the last couple of years. As well as “Draw Something” being hailed as the next big thing, we have seen “Words with Friends”, “Angry Birds” and now “Candy Crush”, not to mention “Fruit Ninja” and “Temple Run”.  Of these, only Words with Friends is by Zynga. The window of popularity for a game that takes off can be only a matter of a few months, which severely limits the possibilities for spin-off marketing.

Given that, it is hard to see an avenue for revenue generation for ZNGA without real money gaming. In a crowded field where most games are available for free, at least in a basic form, it is hard, if not impossible, to gain or maintain market share, so pricing power is unlikely to evolve over time.

This is even less likely when the industry has seemingly no barriers to entry. My 11 year old son was offered a camp this year based around developing games for mobile platforms. It would seem that anybody with an idea has a chance of producing the next trendy game.

To summarize, then, we have an industry that has virtually no barriers to entry, and where the most popular products are offered for free. Seriously, if it were anything less trendy, would you see any company in that field as an investment opportunity? I know I wouldn’t.

 

Friday’s pop back up to the $3 level, and certainly any subsequent strength, would seem to present a great opportunity to short the stock. With a resistance level firmly established just over $3.50, losses can be limited by a simple stop loss, but if the next earnings report disappoints even after downward revisions, as I suspect it will, the bottom could well fall out of the stock, with a challenge of previous lows around $2 coming quickly.

It would seem to me that ZNGA’s purchase of OMGPOP last year was based on confusing popularity with profitability, or rather the possibility of profitability. Buyers of the stock, without the prospect of any alternative revenue source for the company, are making the same mistake. When Zynga realized their mistake, they acted quickly and decisively to close OMGPOP. Traders and investors should learn from that, and act quickly and decisively to sell the stock.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: News Headlines , Technology , Stocks , Travel and Lifestyle

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Martin Tillier


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