The upcoming initial public offering (IPO) of Zynga (ZNGA) has been one of the most debated topics of 2011. Founded in 2007 and headquartered in San Francisco, California Zynga is a leading social game developer with average monthly users of approximately 232 million across 166 countries. Currently valued at $6.5 billion, Zynga is expected to garner approximately $925.0 million through the IPO.
In their filing notice to the SEC, Zynga said that they intend to use the money for building working capital, marketing spending and, most importantly, in developing new games. According to the filing, Zynga's profits took a gigantic leap from $4.5 million in 2008 to $392.7 million in 2010.
The much-awaited IPO has managed to attract significant attention owing to the success that Zynga has achieved over the last four years and the staggering growth outlook for the social gaming sector over the next couple of years.
According to market research firm eMarketer, the U.S. social gaming market is expected to be worth $2.18 billion in 2012. Most of the social games are free to play and generate revenue primarily through the in-game sale of virtual goods.
eMarketer expects revenues from virtual goods to drive the biggest share of dollars through 2012. Advertising spending is expected to grow more quickly in 2012, and concurrently eMarketer forecasts an increase of 41% in advertising spending in 2012 compared with 2010.
According to market intelligence firm In-Stat, the worldwide market for virtual goods was $7.3 billion in 2010 and is expected to more than double by 2014. Analysts believe that an increase in the number of social gamers will further boost spending on virtual goods, lead-generation offerings and advertising over the long term.
Analysts believe that the social gaming market will double from its current level by 2014. We believe that this trend will boost Zynga's growth over the long term.
Facebook and Zynga
Most of the phenomenal growth in the social gaming market has been credited to Zynga. The company's June 2009 release, FarmVille , has been touted as one of the most successful social games ever developed, similar to PopCap's Bejeweled Blitz and followed by another Zynga super-hit Mafia Wars . Zynga has launched a few of the most successful social games in the industry over the last three years and generated more than $1.5 billion in cumulative bookings since 2007.
Much of Zynga's success is attributed to the huge popularity of the social networking site Facebook. Facebook contributes more than 94% of Zynga's gross revenues. Zynga primarily generates revenue through the in-game sale of virtual goods in exchange of Facebook credits, which is a form of virtual currency.
Facebook keeps 30% of this revenue and delivers the remaining 70% to Zynga. Zynga earned $575.0 million from virtual goods sales in fiscal 2010. Advertising is also an important source of revenue for Zynga.
Is Zynga More Valuable Than Traditional Gamers?
Currently, this is possibly the biggest question in the minds of investors. If we take a closer look, Zynga is a smaller company compared to both Electronic Arts Inc. ( ERTS ) (market capitalization $7.19 billion) and Activision Blizzard Inc. ( ATVI ) (market capitalization $13.87 billion).
Revenue wise, Zynga expects to hit the $1.0 billion mark in 2011, up 43.0% on a year-over-year basis, while we expect Activision's revenue to decline approximately 4.0% on a year-over-year basis to $4.3 billion for 2011. Electronic Arts has already reported lower revenue growth in fiscal 2011.
The declining top-line growth of these two stalwarts reflects a change in industry dynamics that are increasingly favouring the digital, mobile and social segment over the packaged segment. Zynga's dominance in these markets enabled it to emerge as a potential challenger to the two most established players in the market.
Although both Electronic Arts (better known as EA) and Activision boasts solid product portfolios and loyal customer base, Zynga's popularity has pushed them on the backfoot in recent times.
Activision is yet to jump on the social gaming band wagon and is launching digital versions of its popular titles which should drive its top-line growth going forward. However, EA has emerged as the primary competitor for Zynga.
Zynga's popularity has forced EA to reconsider its strategy with respect to online, mobile and social games. In a bid to counter Zynga's threat, EA has allied with Facebook and also acquired Playfish to gain traction in the digital gaming market.
To further strengthen its position in the social gaming sector, EA acquired Zynga's direct competitor PopCap Games in July this year for $1.3 billion. EA also launched its popular casual game Sims Social on Facebook, and by the end of September 2011, it emerged as the second most popular game on Facebook behind CityVille , with over 8 million daily active users and 40 million monthly users. Most recently, EA acquired KlickNation to strengthen its portfolio and further drive market share in the social gaming arena.
Meanwhile, Zynga continued expansion through accretive acquisitions. According to the IPO filing, Zynga completed seven acquisitions in 2010 with the most notable being Newtoy for approximately $101.6 million ($35.2 million in stock and $66.4 million in cash). Zynga is also expanding its presence in the mobile gaming sector and has acquired a number of companies including Five Mobile in 2011.
Although mobile accounts for only 7.0% of Zynga's total revenue, the company expects it to play a big part going forward. In July 2011, the company launched a mobile version of CityVille for Apple Inc.'s ( AAPL ) iOS platform. Additionally, Zynga entered into a marketing deal with AT&T Inc. ( T ) to bring customized games and content to the carrier's customers. These partnerships and accretive acquisitions are expected to boost Zynga's top-line growth going forward.
We expect the social-gaming market to remain a duopoly with increasing competition between EA and Zynga in the near term. We note that it is extremely difficult to point a winner right now as both the companies boast significant market share, talented development teams and significant product pipelines.
We believe that Zynga holds a slight edge due to its strong presence in the social-gaming market. On the other hand, EA's major market (packaged good) is more saturated due to overcrowding and this will hurt its growth going forward.
However, Zynga's dependence on Facebook, low paid user base and significant cannibalization effect on its earlier games as users quickly move on to the newest title in the "Ville" series may hurt its growth going forward. We also note that barriers to entry are low in the social gaming market, which will attract new entrants, thereby further increasing competition for Zynga over the long term.
We remain Neutral on both EA and Activision. Currently, EA has a Zacks #3 Rank, which implies a Hold rating on a short-term basis. On the other hand, Activision has a Zacks #2 Rank, which implies a Buy rating over the short term.
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