Zynga Stock: Can You Play the Long Poker Odds?

Investing is a little like prospecting for gold. There are billions of dollars to be found somewhere in corporate filings at any given time. It just requires digging. Lots and lots of digging.

In light of Zynga’s (ZNGA) rapid descent from its IPO (the stock trades at a 48% discount to its IPO price), this company may have a unique diamond in the rough.

Zynga Stock

 

The Social Gaming Business Model

Unlike other social media and gaming companies, Zynga derives revenues from sales to users. This is unique in the space – Facebook, LinkedIN and others earn revenues primarily from advertising. Zynga actually sells something.

But what it sells is virtual. And that means awesome free cash flows. It costs Zynga practically nothing to add credits or extra tractors to a FarmVille players’ account. Each marginal dollar of revenue goes directly to the bottom line.

And that makes Zynga exciting. In 2011, some 2.9 million people (1 out of 60 social gamers) purchased virtual goods and services. Some spend only a few dollars, a handful spend as much as $10,000 or more. BusinessWeek broke the story about Zynga’s hunt for “whales,” people who spend thousands of dollars to best their friends on online social games.

 

Diamonds in the Rough

The true value with Zynga isn’t in what it has right now. On Tuesday, an analyst broke the news that Zynga’s users are spending less time on its very popular gaming platforms. That’s never good for in-game spending or advertising revenues, which are paramount to Zynga’s ability to generate free cash.

Where Zynga has tremendous untapped potential is in poker. Zynga Poker was a first mover, and it has some 30 million active users to show for it. Except there’s only one problem: Zynga can charge customers to play the game (you can purchase chips to add to your account), but the chips cannot be withdrawn.

If you could cash out your chips, Zynga Poker would evolve from a fun online game to pure online gambling. Online gambling, despite being a massive $28 billion business by one 2008 estimate, is entirely illegal.

Forbes published an article on PokerStars, one of the leading online poker companies. The article says the company took in some $1.4 billion in revenues and $500 million in profits in 2009. Keep in mind that Zynga Poker has 10 million more users than PokerStars, which is estimated to have 20 million active users.

 

Can Zynga Thrive on Poker?

Poker might not be what you think of when you think about Zynga, a company that is best known for family friendly titles like FarmVille and online social games. But it is in poker that Zynga could ultimately generate its largest haul.

Consider the following:

    1. Zynga attracts a unique crowd – Zynga users are not your typical poker players. It draws people from all walks of life; people who likely thought they would never ever pay for a single online game, yet millions do each month.
    2. Zynga has the power of a network – Zynga is the king of producing titles for social gaming platforms. When you want a game that you know your friends will have, you naturally pick the Zynga title. The power of the network effect is a very strong economic moat.
    3. Disconnect from spending psychology – It’s way too easy to spend money on a mobile device. Imagine millions of “hooked” part-time mobile poker players charging another stack of chips to their AT&T or Verizon bill each month.
    4. Zynga has the lowest cost marketing – Zynga cross promotes new games to existing users, meaning that it can grab new gamblers at a much lower cost than other poker stalwarts. The company can push its Zynga Poker game to its millions of users with a few lines of code. No casino, online or offline, has that same power.
    5. Poker has durability – Poker has been around in the current community card poker variety since the 1920s, and one would expect it to be around for centuries longer. Poker isn’t Draw Something, and it certainly isn’t FarmVille – it’s more like checkers…a classic. It may have bubbled during the later 2000s, but its popularity is still holding strong.

There is little doubt that Zynga has the infrastructure and user base to turn online poker into serious profits. It’s all a matter of a small change in government policy.

 

Legalized Online Poker is a Longshot

Let’s not lose sight of reality: the possibility for legalized online gambling is a longshot. Luckily for Zynga, 46% of Americans are willing to accept legalized online gambling provided it is regulated by the government.

Forty-six percent of people are not a majority, but it is close. And over time, support for legalized online gambling has only grown stronger. I would venture to guess that online gambling will only become more popular as the government seeks new sources for revenues.

Zynga is investing heavily in lobbying, something many suspect to be related to a goal to move Zynga Poker from a fun game to an online gambling center. Zynga recently hired two new lobbying firms presumably to push forward with a message that online gambling is good for government, and good for would-be gamblers.

Even if Zynga’s members are only 20% of the cash cows that PokerStars members are, Zynga could add as much as $150 million per year in extra free cash flow. That would more than double Zynga’s current free cash flow of $136 million in the last 12 months. It would certainly help justify Zynga’s lofty $3.3 billion valuation.

So, are you willing to take a wager to double down on Zynga Poker?

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  • http://worksavelive.com Jason @ WSL

    Interesting – they would certainly be a huge play if online poker was legal. I think online poker will eventually be legalized though. It’s has huge revenue potential for the government and that can’t be overlooked.

    It’s pretty crazy what happened at Full Tilt awhile back and that just goes to show there does need to be some oversight.

    • http://thecollegeinvestor.com Robert

      I think online poker will be legalized as well, but when? Probably not for several years at the earliest.

  • http://www.financialsamurai.com Financial Samurai

    I wonder when FB buys them.

    Bought 7,000 shares at an average price of $4.88 6/12 and old 6,000 the next day at $5.16. Couldn’t resist. Will let the 1,000 shares ride and kick myself when it pops up to $6.

    US will never legalize online gambling! Don’t need it for a 20% pop.

    • http://thecollegeinvestor.com Robert

      With playing cards legal in so many places, even in California, you don’t think that online poker will make a return anytime soon?

    • http://moneymamba.com JT

      Odds on that buyout seem so low. Facebook already gets like 30% of Zynga’s revenue without any capital commitment.

  • http://www.iheartbudgets.net Jacob @ iHeartBudgets

    Mostly, I hate Farmville. I could never invest in Zynga soley for this purpose.

    Also, investing in them on the basis the online gambling “might” become legal seems like a bad idea. This company will die before online gambling is legalized because the government m…o…v..e…s v…e..r…y s…l..o…w..l…y ;)

    My $.02

    • http://thecollegeinvestor.com Robert

      I hate Farmville as well, but millions of people are paying to play. The hardest part of a game company, though, is to keep reinventing yourself with new products, and I think Zynga has stalled a bit on that front.

    • http://moneymamba.com JT

      Yes, definitely on the basis it might be legal. But they have a few good titles and somewhat of a decent economic moat. I don’t own Zynga, and wouldn’t buy unless it was substantially cheaper, but its an interesting play nonetheless.

  • http://tightfistedmiser.com Andy Hough

    I will pass on Zynga for now. They might prosper if online poker is legalized but they would have to make some major software changes. The way it is setup now it is pretty easy to cheat.

  • http://howimakemoneyblogging.com/ Charlotte @ HIMMB

    I haven’t gotten into the Facebook thing. I can’t understand all the fascination with telling your friends everything you do. As for Farmville, please. I would rather find something to do outside or with family and friends in person.

  • http://thirtysixmonths.com Marissa @ Thirty Six Months

    Farmville caused me to hate everything Zynga. I don’t think Facebook is going to buy them out anytime soon. 1)FB has issues right now. 2)They are getting a chunk of their revenue already.

    • http://thecollegeinvestor.com Robert

      Why did Farmville cause you to hate Zynga?

  • http://Economicallyhumble.com PB @ EconomicallyHumble.com

    I’m still not convinced but in a year I may be kicking myself!

  • http://barbarafriedbergpersonalfinance.com Barbara Friedberg

    Interesting thoughts and analysis, let us know how it works out. I’d certainly consider this a speculative shot. Good luck.