Zynga takes axe to outlook, spooks Facebook investors

26 Jul, 2012

Game provider Zynga Inc slashed its 2012 outlook and quarterly results badly missed Wall Street targets, sending its stock plunging 35 per cent and casting a chill over Facebook Inc on the eve of the social network's inaugural results.

Investors now fear a larger-than-expected hit to Facebook's earnings, which relies on the "FarmVille" creators for about 15 per cent of its revenue. Shares in the No. 1 social network, which has yet to regain investor confidence since its botched May IPO, slid more than 7 per cent to a new low of $27 in after-hours trading.

Blaming its poor performance on a steep drop-off in players for its core Facebook money-makers, Zynga took an axe to its earnings forecasts, predicting 4 to 9 cents a share, down from a previous 23 to 29 cents. Zynga shares tumbled to a record low of $3.00 after the bell.


That dim outlook highlights how dramatically the fortunes of consumer Internet stocks have turned in the past year.

Zynga was among a bevy of hot tech prospects going public in 2011 on the back of a renewed dot-com mania gripping Wall Street. But since its December IPO at $10 a share, Zynga has shed almost 70 per cent of its value while peers like Groupon Inc and Facebook are down 65 per cent and 29 per cent, respectively.

"The quarter is a disaster," said Sterne Agee analyst Arvind Bhatia.


"It's looking more and more like this was a fad because they've introduced so many new games, yet EBITDA continues to come down," he said, referring to earnings before interest, taxes, depreciation and amortization.

The number of monthly paying players, which rose to 4.1 million from 3.5 million, would in fact have declined were it not for an infusion of new players to "Draw Something", a game Zynga purchased in March and which Zynga executives now admit has not lived up to expectations.

FarmVille, which represented 29 per cent of Zynga's second-quarter revenues, has shrunk to just 20 million users this month from a high of about 80 million in March, according to Appdata.com, a Facebook tracking service.


"The company has been saying for some time that declining traffic doesn't matter and clearly it does," Bhatia said.

OMG, what a miss

The company on Wednesday reported a quarterly net loss of $22.8 million, or 3 cents a share, compared with a profit of $1.4 million a year ago. Excluding certain items, it reported a profit of 1 cent a share, below the 5 cents that Wall Street had expected.


Admitting that mobile titles failed to pick up the slack, it logged revenues of $332.4 million, below the average analyst estimate of $344.12 million, according to Thomson Reuters I/B/E/S.

The company said CEO Mark Pincus had taken control of the company on or around Wednesday, with a rise in his voting stake to around 50.15 per cent.

The increase in his stake follows a $500 million-plus payday via a choreographed private stock sale at $12 a share in April for Pincus, a small circle of top Zynga executives and investors but which many employees were excluded from.


That deal, explained as an effort to stagger the timing of when stockholders may cash out to avert a simultaneous sell-off at the expiration of a post-IPO lock-up period, now seems especially well-timed.

The increase in Pincus' voting power to over 50 per cent was due to sales or transfers by other holders of Class B shares.

Zynga said daily active users rose by 23 per cent to 72 million in the second quarter, but the company earned less revenue per subscriber. Average daily bookings per user dwindled to 4.6 cents in the quarter, down about 10 per cent.


Pincus said a recent change to Facebook's algorithm spurred users toward new games, rather than repeatedly playing existing Zynga offerings.

Last month, Zynga unveiled zynga.com, an independent game-publishing platform, specifically to lessen its dependence on Facebook. But that service remains in beta after a multi-year development process, and executives declined to break out revenue for the platform when asked by analysts.

Executives grilled

For the first time, Zynga executives acknowledged its acquisition for Draw Something developer, OMGPOP -- its costliest purchase at $183 million -- has not unfolded ideally. The gaming sensation fizzled out almost as soon as it was acquired.

"Draw Something under-performed versus our early expectations," Pincus said.

The results jolted analysts including BTIG's Richard Greenfield, who pointedly asked Zynga's leadership to explain comments made in recent weeks by top executives that the company's performance will pick up in the second half of the year.

Chief Financial Officer Dave Wehner said the company's policy was to only revise its forecasts during quarterly earnings calls.

In an interview, Chief Operating Officer John Schappert told Reuters that the company's financial picture came into focus only late in the quarter.

"You see some data but it takes a while to collate that data together and paint the whole picture," he said.

In a lone bright spot, Pincus said the company expects to launch its first, real-money gambling products in international markets in 2013. But Zynga will not likely pursue cash gambling in the United States, where gambling regulation remains an obstacle.

Zynga's results surprised investors especially because many analysts anticipated a bounce in its stock after expectations had been set low following a mediocre first quarter report.

"Everyone's going to reset their growth expectations to a far lower level," said Mike Hickey, an analyst at National Alliance Capital Markets.

Shares in Zynga plummeted 35 per cent to as low as $3.00 in after-hours trade, from a close of $5.08 on Nasdaq. Stock in Facebook slid almost 7 per cent to $27.33, from a close on Nasdaq of $29.34.