Wall Street has turned on Zynga — with a vengeance. One day after Apple delivered a disappointing earnings report, online game-maker Zynga detailed its own bad news: a quarterly loss of $23 million, despite revenue of $332 million. The disclosure sent the company’s shares down a slack-jaw-inducing 40%. It’s a bad omen for social networking titan Facebook, which derives substantial revenue from Zynga and reports earnings results for the first time as a public company on Thursday.
There’s a scary feeling in the tech equities market right now. Zynga’s dismal report rattled investors who had been bracing for bad news from the tech sector after bellwether Intel last week reduced its forecast for the rest of the year. On Wednesday, streaming video pioneer Netflix plunged 25% after analysts cut their estimates for the company, following a disappointing earnings report of its own. The bottom line: With global macro-economic conditions worsening, tech companies have little margin for error — or basis for market support — in this weak environment. Facebook shares fell 8% ahead of Thursday’s crucial call.
(More: Intel’s Earnings Warning is an Ominous Sign for the Tech Sector)
Zynga, the online gaming company known for titles such as Farmville, Cityville and Mafia Wars, failed to meet Wall Street‘s already low expectations. The company reported a loss of $22.8 million, or 3 cents per share. (Excluding stock-based compensation, that translates to a profit of one penny per share, well below the 5 cents per share that analysts were expecting.) Here’s a round-up of Wall Street analyst reaction:
- “Zynga’s second quarter results and outlook for 2012 were extremely disappointing across the board,” JPMorgan tech analyst Doug Anmuth wrote flatly in a note to clients.
- Respected tech analyst Ben Schachter at Macquarie offered: “Zynga’s shocking results and guidance (EBITDA [earnings before interest, taxes, depreciation, and amortization] guidance for FY’12 down by ~50%) raise our worst fears about the stability of the company’s business model and competitive positioning.”
- Scott Devitt of Morgan Stanley sounded chastened, as he downgraded Zynga stock. “We were wrong about the current state of Zynga’s business,” he wrote this morning. “The severity of the guidance cut signifies the bear case is playing out and Zynga faces significant headwinds from its reliance on Facebook and transition to mobile.”
- BTIG analyst Rich Greenfield, who absolutely grilled Zynga executives on the post-earnings conference call, published a note Thursday entitled: “Downgrading Zynga to Neutral: We Are Sorry and Embarrassed by Our Mistake.”
Like Intel, Zynga reduced its forecast for the entire year, in a worrying sign for the tech sector. The company attributed the lowered outlook to “delays in launching new games, a faster decline in existing web games due in part to a more challenging environment on the Facebook web platform, and reduced expectations for Draw Something.” (In March, Zynga bought OMGPOP, the New York-based studio that created Draw Something, for a reported $200 million.)
(More: Zynga Shares Jump On Facebook IPO Connection)
For most of its short life, Zynga has been heavily reliant on Facebook. Zynga pays Facebook fees in exchange for being hosted on the gargantuan 900-million-member-strong social network. Facebook receives a 30% cut of Zynga’s virtual goods sales. Last year, those fees amounted to a whopping $480 million to Facebook. If Zynga’s games lose popularity, it’s going to affect Facebook.
But “it’s complicated” — and Facebook has been moving to distance itself from its erstwhile “friend.” (In the first quarter of 2012, 15% of Facebook’s revenue came from Zynga, but that’s down from 19% one year earlier.) Here’s Mike Isaac of AllThingsD getting down to the point of why Zynga has Wall Street spooked:
Essentially, Facebook’s platform tweaks favor new games over Zynga’s long-established titles. The social gaming giant once had a stranglehold on Facebook’s application ecosystem, but Facebook changed tack this year, tweaking its News Feed algorithm and opening App Center, a central location for Facebook users to discover new third-party applications.
Zynga discussed the importance of Facebook to its business in the “Risk Factors” section of its IPO prospectus:
Facebook is the primary distribution, marketing, promotion and payment platform for our games. We generate substantially all of our revenue and players through the Facebook platform and expect to continue to do so for the foreseeable future. Any deterioration in our relationship with Facebook would harm our business and adversely affect the value of our Class A common stock. [Emphasis added.]
Zynga faces a number of headwinds into the back half—some structural, some more execution-based. But the biggest factor impacting current performance appears to be the way Facebook is surfacing gaming content on its platform. Given what we believe could be multi-quarter impact from Facebook and lack of near-term operational catalysts, we’re downgrading Zynga shares to Neutral. [Emphasis added.]
Zynga was founded in 2007 by Silicon Valley entrepreneur Mark Pincus. Last December, the company raised $1 billion in a high-profile initial public offering that valued the company at $10 billion. The company’s shares opened at $11 — 10% above the $10 offering price, and rose above $14 amid the hype-fueled run-up to Facebook’s IPO in May. Late Wednesday, Zynga shares were trading at $3.18.