Zynga Shows Grueling Trek of an Internet Turnaround

(Bloomberg) -- Broken internet companies would seem to have a leg up on other kinds of struggling firms. They don’t have the high fixed costs and stodgy culture of broken companies in conventional industries like General Electric. Being nimble and responsive to change is what internet companies do.

You know where this is going. It turns out it’s incredibly tough to nurse an internet company back to health. A classic example is Yahoo Inc., about which former CEO Marissa Mayer recently said, “All we really managed to do was offset the declines” of the Yahoo web hangouts that lost relevance with people and advertisers. 

The mobile video game company Zynga Inc. is about two years into the latest of many attempts at revival. Zynga has been showing marked improvements, but it’s happening slowly. Revenue is growing again, but it hasn’t been consistent. Even after multiple rounds of cost-cutting, Zynga’s costs remain high and its profit margins by any measure — and Zynga uses lots of them — are improving, but still fall far short of other companies that specialize in smartphone games.

Zynga’s experience offers a disheartening lesson for any internet company that stumbles: Declines happen suddenly; getting back up again takes far longer, if it happens at all. 

Zynga has a familiar story arc. The company, founded in 2007, came up with the perfect idea for the web habits of its time: relatively simple, free and immersive video games like FarmVille and the Scrabble-like Words With Friends that allowed anyone with an internet connection — and not just die-hards with expensive game consoles — to play. The popularity of Facebook enabled Zynga to spread by making game players draw in their friends. Zynga took just a few years to boom from minuscule revenue to more than $1 billion in annual sales. 

Then Zynga’s world was upended. Facebook made changes that limited Zynga’s ability to lure people to play its games on the social network, which at the time of the company’s 2011 IPO was the place where most people played Zynga games. The adoption of smartphones also changed people’s habits. Game makers had to adapt by coming up with fresh distractions regularly and finding new ways to draw in people and generate revenue.

Zynga couldn’t make the leap. The company made waves of executive changes — founder Mark Pincus came in and out of the CEO post twice — and did multiple restructurings seemingly every year. Zynga’s revenue and stock market value peaked soon after its initial public offering. 

Two years ago, Zynga hired a new CEO, and he pledged to dump unpromising parts of the business and focus on the company’s core games including Zynga Poker, Words With Friends and the car racing game CSR. The marching orders from the new boss, Frank Gibeau, was for Zynga to revive growth, including through acquisitions, and improve profits.

Both goals remain a work in progress. Revenue for the 12 months ended March 31 was $875 million, up about 14 percent from a year earlier. Quarterly growth in bookings — a sales measure that includes the change in deferred revenue related to digital goods such as virtual poker chips that people buy for Zynga games — has been bumpy, but it's clear that the overall trend line is up.

Costs and profit margins have even further to go. Zynga acknowledges it’s trying to close a big gap between its profit margins and those of other video game companies such as Electronic Arts Inc. and Activision Blizzard Inc., which make smartphone games such as Candy Crush. All three companies use a dizzying array of unconventional profit metrics, but a comparison of their plain vanilla earnings before interest, taxes, depreciation and amortization shows the contrast.

Electronic Arts and Activision posted Ebitda as a share of reported revenue of 30 percent and 36 percent, respectively, in the most recent 12 months. At Zynga, it was 8 percent. (Zynga’s adjusted Ebitda, which excludes stock compensation costs, restructuring expenses and costs related to acquisitions, was 17 percent of revenue in the last 12 months.)

Gibeau has also said Zynga is trying to plan for the future by experimenting with potentially fertile areas for future video games, including smartphone chat apps such as Facebook Messenger. (Zynga apparently isn’t worried about being burned badly again by Facebook’s changing whims.) And yet three of the biggest video game hits of recent years didn’t come from Zynga. Nintendo’s handheld video game console Switch, the smartphone game Pokemon Go and the suddenly popular monster-killing game Fortnite were the kinds of blockbusters that Zynga used to have in its heyday. 

Zynga is clearly on the right track again, finally. It helps that Pincus appears to be sidelined for good after agreeing last week to give up a special class of stock that gave him control of the company even though he owns just one-tenth of its shares. Zynga’s quick rise and fall showed how painful it can be when an internet star becomes a has-been. Finding its footing again is slow, painful and unglamorous. 

©2018 Bloomberg L.P.

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