The DeanBeat: What does Zynga’s big unveil event mean for its IPO?

EDITOR’S NOTE: Each week, I’m writing a column on business and technology called The DeanBeat, while executive editor Dylan Tweney is writing a column on business and technology called Dylan’s Desk. They are available to newsletter subscribers a whole day before they appear on the VentureBeat website.

Zynga’s announcement of 10 mobile and social game initiatives on Tuesday was a clear attempt to set the stage for the company’s initial public offering. Was it a good enough show to convince investors to buy?

The social gaming powerhouse has its detractors and admirers. Detractors say Zynga’s possible valuation at $20 billion is a sure sign of a bubble in social gaming, especially considering its rival, Electronic Arts, has four times as much revenue and is only valued at $7.7 billion. Admirers say Zynga is the clear market leader in the fastest-growing area of gaming: free-to-play Facebook games monetized through virtual goods sales. If Zynga can adequately diversify beyond Facebook, then it should assuage any fears it is too dependent on a volatile social network for its revenues.

“Cross-platform initiatives by Zynga will be well received by investors,” said Colin Sebastian, an analyst at Robert W. Baird & Co. “Even better would be some successful cross-platform games that the company can point to.”

Zynga’s event seemed orchestrated to address investor concerns. It was the biggest single announcement of products and services the company has had. It included nine new mobile and social games. It mentioned Zynga’s upcoming social game platform, Project Z, which is part of a larger effort called Zynga Direct, aimed at taking Zynga’s games straight to consumers. The catch is not all of the announced games are shipping right now.

The sheer volume of product activity was impressive. Zynga has more than 2,500 employees, many acquired in developer studio acquisitions over the past year at a pace of one a month. It seemed in the past Zynga was overloaded with employees, considering it might take a crew of 25 people six to nine months to create a social game. Zynga essentially had enough people to build 100 games a year, but it was only trickling out titles once every few months. What are all of those people working on? Well, now we know they have been busy expanding Zynga’s game efforts in all directions.

In the meantime, EA has seen a renaissance on Facebook with the launch of The Sims Social, which has 66 million monthly active users after just a couple of months. It is stealing gamers away from Zynga’s top game, CityVille, which has fallen from more than 100 million users to 76 million. Zynga’s most recent quarterly reported showed the company is thinly profitable.

To go public, Zynga has to be able to show consistent user, revenue and profit growth. (The company is narrowly profitable, perhaps only because of an accounting change; we’ll have more on that in another story). That’s why it needed to show off the 10 games, and it is why the company now needs to execute on those titles. Zynga also has to make headway in mobile games, which could become the biggest part of the social games market. Zynga announced five new mobile games, but not all of them are shipping. As for mobile, Zynga is making progress but it still has a long way to go to gain market share against rivals like EA.

There is room for doubt. Zynga hasn’t hyped unannounced products in the past, partly because it tests games to see if they will take off, and also because it worries competitors could copy pre-announced games in a short time. Now it is talking about a bunch of games that are not yet shipping. If those games are all ready to ship, it would be extremely impressive. But if they trickle out over a long period of time, then it isn’t impressive. In the most recent announcements, Zynga has shipped a game within a couple of weeks of announcing it.

“I would say that they nailed the investor concern that relates to growth,” said Peter Relan, chief executive of rival social gaming firm CrowdStar. “Growth depends on titles and they talk about a lot of them. As for their dependency on Facebook, the jury is out.”

Relan says Zynga’s titles are “stumble upon” games, meaning you stumble upon them while catching up with your friends on Facebook. They are not destination games, where a user seeks them out because they really want to play them, Relan said. The more Zynga makes higher quality destination games, the more it can move beyond Facebook. (Relan, by the way, competes with Zynga, but he wants them to go public because he thinks it will lift the whole social game industry).

Zynga tantalized the crowd with some interesting possibilities in that respect, but it didn’t telegraph exactly what it would do. As mentioned, Pincus said Zynga Direct will be the company’s way to reach consumers directly by giving them one destination where they can seamlessly connect with other players on Zynga’s mobile and social games. Underneath the umbrella of Zynga Direct is “Project Z,” a social game service enabled by Facebook Connect that will bring Zynga players together on Zynga’s own web site.

“These were necessary moves. Zynga has to build its own platform and raise the quality bar for its games if Mark Pincus and company truly aspire to become a leading games publisher with valuation close to that implied in the IPO filing,” said Billy Pidgeon, an analyst at M2 Research. “The event and announcements seem targeted to buoy potential investor interest and to counter concerns about recent revenue losses. It’s rather a bold and unsubstantiated claim to say Zynga Direct will be ‘the most connected social gaming site in the world.’” Pidgeon said Zynga lags in mobile social networks behind companies such as DeNA and Gree, which are based in Japan.

Pidgeon also noted, “The platform doesn’t give Zynga autonomy from Facebook. Being ‘the deepest integration with Facebook Connect’ strengthens Facebook to a greater extent than it strengthens Zynga. A social network focused on games is a compelling and powerful idea. All publishers should have one as part of their games platform. But the winning plays in this category will not be proprietary publishers and platforms, but rather independents like Steam and Raptr that connect across publishers and platforms.”

Becoming independent from Facebook is one thing, but creating a platform — which conceivably competes with Facebook on some levels — is another. If Zynga launches an independent game platform, that would constitute a major move to diversify beyond Facebook and set up a platform Zynga itself can control. It also sets Zynga up to become a publisher of games developed by third parties, but Zynga didn’t go so far as to say it would do that with either Project Z or Zynga Direct.

Zynga Direct and Project Z were rumored to be in the works more than a year ago, though Pincus said the company had been working on it for two years. But rumors of such diversification attempts dried up after Zynga patched up its disagreements with Facebook and signed on to use Facebook Credits in the spring of 2010. After that, Zynga stopped pressing so hard to move to other platforms. It has indeed diversified, but at a slower pace, and most of its revenues still come from Facebook.

Under the Facebook Credits deal, Zynga has to share 30 percent of the revenue it gets from virtual goods purchased with Facebook. But moving away from Facebook hasn’t yet paid off. When will that happen? It isn’t clear, even after this week’s event.

In summary, Zynga showed it hasn’t been sitting still while rivals attack its user base. But it still has a lot to prove in making its new games succeed. It has to expand to new territories, break into mobile, set up its own platform, keep the hits coming and rake in a lot of profits in order to stay ahead of big rivals like EA, Disney and others.

Lou Kerner, analyst at Wedbush Morgan Securities, summed it up as follows: “While the slate of new game titles and Project Z all sound impressive, investors are more focused on results than announcements.  A heavy reliance on Facebook and flat gamer growth will remain risks, until there are data points to prove otherwise.  The IPO remains ‘on track,’ unchanged by these announcements, subject to market conditions.”

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