Zynga In Facebook’s Pocket?

Zynga did not disappoint analysts, who were expecting it to file for an IPO earlier this summer. With IPO documents filed in July of this year, Zynga plans to raise $1 billion at a valuation of $15 billion to $20 billion. Researcher eMarketer has projected online gaming revenues in the U.S. to grow to $1.1 billion this year from $0.86 billion last year. Surely Zynga is hoping to cash in on this growth.

Zynga’s Financials
According to their IPO filing, Zynga reported revenues of $235.4 million in the first quarter this year with earnings of $11.8 million. The company claims to have more than 60 million active daily users who together spend more than 2 billion minutes each day playing the company’s games. Revenues last year were $597.5 million and had grown significantly over 2009 revenues of $121.5 million. Zynga ended last year with earnings of $90.6 million.

Zynga’s Facebook Dependence
While there is no doubt about Zynga’s supremacy within the social gaming segment, the market is rightfully concerned about their complete dependence on Facebook. Some have even gone to the extent of saying that “Facebook basically owns Zynga.”

In their IPO filing documents, Zynga admits that Facebook is the primary distribution, marketing, promotion, and payment platform for their games and that Facebook helps to generate “substantially all” of their revenue and user base. Zynga doesn’t expect this degree of reliance to change in the near future and admits that any deterioration in their relationship with Facebook will significantly impact operations.

The current contract with Facebook is valid until 2015. Accoring to this contract, Zynga pays Facebook a 30% share of revenues earned through the sale of virtual goods on their games. In addition, games built by Zynga that involve Facebook integration or use of Facebook data remain exclusive to Facebook for the duration of the contract. Further, Facebook expects Zynga to tell them about the new games they plan to launch at least a week in advance, and Zynga cannot launch games on any rival social networks. While Facebook may be the biggest social networking player in the world, Zynga’s heavy dependence on Facebook and the highly restrictive contract conditions don’t make analysts very happy.

Zynga’s Paying Customers
Worse still, the pool of customers who pay to play on Zynga is rather small.  The company’s historical data claims that a mere 5% of their players have converted from free players to paying players. That is not a number that inspires confidence. It is this low percentage that points me toward companies like SocialVibe that have figured out alternate ways of monetizing free traffic. SocialVibe’s tools ensure that marketing campaigns reach an engaged user. As their CEO Jay Samit explained in a recent interview, a user will be able to continue to play their game free in exchange for willingness to watch an advertisement.

Another interesting advertising-based revenue model is followed by the 1M/1M player Pontiflex wherein advertisers pay only when someone signs up for ads. According to Forrester, digital advertising is projected to grow to $55 billion in 2014 from from $22.7 billion in 2009 and will account for 21% of U.S. ad spending.

Zynga has also been focusing on the immersive advertising model in their games. However, at present, advertising contributes a mere 4% of overall revenues. Last year, Zynga earned $22.8 million from advertising on a total revenue base of $597.5 million. In the first quarter this year, they reported advertising revenues of $13.0 million, translating to 5.8% revenue contribution for the quarter.

Zynga’s Games
Analysts have also lashed out on Zynga for churning out games that are rather similar. According to an article on Forbes, most of Zynga’s players are “Average Joes and Average Janes” who are happy with playing simple games and do not tire of repetitive experiences. For Zynga to feel secure in the gaming market, they should be looking to cater to dedicated game players as well. Zynga seems to be addressing that issue. The company reportedly hired Mark Turmell, formerly at Electronics Arts. Turmell is known as the creator of successful arcade games, NBA Jam, NFL Blitz, and Smash TV.

Meanwhile, with market conditions being what they are, when Zynga’s IPO will finally hit the stock exchange still remains uncertain.