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Zynga Inc (NASDAQ:$ZNGA), is acquiring ‘A Bit Lucky Inc.’, a game developer that is known for its relatively complex games such as ‘Lucky Train’. The details of the deal weren’t disclosed but the estimates are between $20 and $25 million.  Its 20+ employees will join Zynga’s San Francisco team. The new deal came hours after Zynga hired the famed game designer and “Mortal Kombat” co-creator John Tobias. 

Zynga has long been associated with popular Facebook (NASDAQ:$FB) titles such as ‘FarmVille’ and ‘Words with Friends’, but its recent moves suggest a strategic shift towards attracting serious gamers with mid-core titles rather than just focusing on simplistic games that attract casual gamers.

Zynga has relied primarily on FarmVille, and, because of its declining popularity, analysts have questioned whether its casual gaming focus is sustainable in the long-run or even the end of the year.  Gamers are fickle and once something is no longer habitual for them they leave it behind without a second thought.  Social games played with friends are very susceptible to this phenomenon.

Luck Running Out?

The company is already facing a copyright infringement lawsuit from Electronic Arts (NASDAQ:$EA) who claims that Zynga’s games have copied elements from their title ‘The Sims’. Zynga has not only denied those allegations but this week, they filed their own lawsuit against EA claiming that the company’s CEO John Riccitiello fearful that Zynga was attracting EA employees with better compensation packages and was seeking a “no hire” agreement that would stop any EA employees from quitting EA and joining Zynga. Clearly the battle between Zynga and EA is now much bigger than just stealing copyrights.

With the A Bit Lucky takeover, it is rumored that Zynga is planning to launch Solstice Arena, a much more complex game which can be played on computers as well as tablets and smartphones. Earlier this year, Zynga acquired OMGPop for $180 million at the height of the popularity of the company’s smartphone app ‘Draw Something.’  Investors hated the deal and between that and poor earnings reports this year have abandoned the stock in droves.  However, the much smaller ‘A Bit Lucky’ has been looked on more favorably. 

But the real drain has been Zynga itself.  A miserable 2nd quarter earnings report has been followed by a number of high profile defections.  In August alone, at least eight managers have departed including COO John Schappert and the Chief Creative Officer Mike Verdu, who left to start a mobile gaming company. Chief marketing officer Jeff Karp has also resigned. Most recently, on September 18th, OMGPop’s chief revenue officer Wilson Kriegel, who joined Zynga after the takeover, has also left the company.

Last week, Facebook’s founder and Zynga’s ally Mark Zuckerberg said that although the company has had “a rough few quarters” but it is “basically a strong company,” He further reminded that there is a lot of money for game developers to be made on his website, “We have 200 million people playing games monthly. That’s real.” The comment seems to have helped Zynga’s shares which are up 10.2% since 12th September.

The main reason for the decline was simply the poor financial performance but it was also partly due to the expiry of lock up period which ended in May when the company’s CEO Mark Pincus also sold $200 million worth of shares. This isn’t unique to Zynga as many other firms such as Linkedin Corp (NYSE:$LNKD) and Pandora also witnessed a slump in share prices following the lock up period.  But, unlike Zynga, LinkedIn not only has a disruptive element to its business model it is also monetizing that comparative advantage.  It is one of the few internet stocks today that can justify a growth company valuation because of what it is doing to HR services.

Facebook is facing a huge increase in supply over the course of the next two months as two more tranches of shares become unlocked by late November.  With the gaming industry itself having to deal with recession worries for 2013 and the utter fiasco that Facebook’s IPO has been it is no wonder that investors have bailed on Zynga at this point. 

Future Imperfect

The future for Zynga depends heavily on its pushing into mobile and smartphone gaming, an area where it is relatively inexperienced. Its primary gaming platform, Facebook, is itself witnessing falling numbers of daily active users which have dropped 16% year-on-year.  It currently has about 20 games in its pipeline for iPhone and 10 games for Windows phones. With new graphically rich and challenging titles from A Bit Lucky, Zynga is hoping to catch a higher class of gamer that will be willing to pay more per game. 

Along with mobile Zynga will move into online gambling games and an app market that also involves real money wagering.  Zynga hired a top online gambling executive Maytal Olsha, the former VP of the world’s leading online gambling firm 888 Holdings Plc. It is planning to enter the $30 billion online gambling market by the first half of 2013. If changes in US regulations allowing Americans to gamble online again would help it to tap into the domestic gambling market but currently it can only compete online in other countries where online gambling is legal.  Of course, Asians love to gamble which is why Macau has been allowed to exist as it produced a ton of revenue for the Chinese government but does so in a confined location. 

In early September, Zynga announced its new gambling title with RocketPlay, ‘Sports Casino’ where players can place virtual bets while watching sports on TV. However, players cannot withdraw their winnings and this might not be a major breakthrough for Zynga. However, it will give it exposure and experience to a market where it wants to dig deeper and an opportunity to work alongside an experienced online gambling firm RocketPlay.

At this point Zynga is a pure speculative bet.  Facebook social gaming is too casual to be anything other than a fad, and not something to build a multi-billion market cap off of.  The barrier to entry is too low for anyone to come in and steal your customers on a whim.  Is there room for another Angry Birds?  I’m sure there is.  The question is whether you think Zynga is the company to develop it.  Tapping into the mobile betting market is a smart move and the online betting games may bring them cash flow enough to give them the time to develop it. 

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Peter Pham is a capital market specialist and entrepreneur.  With expertise as a Head of Institutional Sales and Trading he closely watches the market and probes for investment opportunities utilizing a unique blend of quantitative trading experience and macro trend analysis… (read more)

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