Zynga Shows Off Strong Financials but Questions Remain Around Impact of Credits, Off-Facebook Revenue
It’s been a hectic four years since Zynga launched on the Facebook platform, and in most ways the business the company is now showing off to the public is extremely impressive. Revenue is on a run-rate towards $1 billion this year, following nearly $600 million last year, and the company’s games reach nearly 60 million people around the world every day. There’s a lot for investors to like once Zynga makes its initial public offering.
As you can see in the graphs we’ve made above and below using data from Zynga’s S-1 filing today, the company has grown its way to profitability, even as it faces an increasing set of costs associated with the business. Total revenue is climbing towards $250 million per quarter, and since last year it has been handily beating total costs.
Digging into the costs, you can see in the second graph that research and development has taken a bigger place at Zynga, which isn’t surprising given its push to improve its technology, build higher-quality games, and expand into new areas like mobile and a site it is reportedly working on called ZLive.
The weakness that many developers know well, and that the filing details in the risk section, is the company’s dependence on Facebook. It explicitly notes that communication channel changes and a variety of other factors that have and will affect the business, with Credits being the latest issue.
Zynga says that it completed its move to using Credits exclusively as of this past April, having begun in June of 10, shortly after Facebook required it to sign on to the virtual currency. In one section, it says that “[t]he increase in online game revenue in the three months ended March 31, 2011 was negatively impacted by our adoption of Facebook Credits as our primary in-game payment method beginning in the third quarter of 2010.”
By the start of this past year it had largely converted direct payment options to Credits across all significant titles. So one would expect revenue numbers to reflect this time frame, given that virtual goods are 95% of its business.
It’s more complicated because Zynga has obscured the exact difference because it only accounts for the 70% of Credits revenue that it is paid through the agreement. Before, it did account for payment processing fees directly, noting in the filing that those costs usually came in between 2% and 10%.
The revenue and bookings graph seem to show steadily growing revenue despite the additional Credits costs, which is a great sign for Zynga’s long-term health. Note that Bookings is a term Zynga uses internally that it defines as the “total amount of revenue from the sale of virtual goods in our online games and advertising that would have been recognized in a period if we recognized all revenue immediately at the time of the sale.” It says this the main top-line metric it looks at.
The Adjusted EBITDA graph (a metric commonly used by investors) shows slower growth in 2010 and early 2011. The numbers plateaued around the time that Facebook began changing viral channels, including removing notifications, altering the news feed default back to the algorithmic view, and altering the news feed to group multiple news feed stories into a single-story view. Zynga’s growth stopped over a similar period.
A wider variety of expenses also started to come in over 2010. The company hired the majority of its 2200 employees last year, paid for large volumes of increasingly expensive ads on Facebook, increased its focus on mobile development and greatly expanded its technical infrastructure to support new growth. A number of acquisitions, like NewToy, also upped the costs in more recent months.
Margins fell to 5% last quarter from 15% in 2010. Zynga says the cost of revenue increase in the past quarter was “primarily due to web-hosting costs associated with higher-than-expected player activity that required us to purchase additional, more expensive temporary capacity.”
There are other ambiguities around Zynga’s numbers. We don’t know how much of its revenue is coming from any of its off-Facebook properties, as well. FarmVille.com, for example, still includes the non-Credits payment options even though it relies on Facebook Connect to provide user identities. None of Zynga’s booming mobile properties use Credits, either. And for most of the past years, including 2010, Zynga was also running games on other social networks, like MySpace, and according to many accounts monetizing well.
Still, between how Zynga has presented the numbers, and what else we’ve heard about its efforts over the years, we can safely conclude that the vast majority of the revenue is coming through Facebook.
So it’s quite possible that Facebook will make more than $300 million in Credits revenue from Zynga alone this coming year, which added together with what Zynga and other social game developers spend on ads could make Facebook up to $1 billion this year.
Additional reporting by Kim-Mai Cutler.