In an attempt to restore the market’s confidence in the company, Zynga Inc (NASDAQ:ZNGA) recently confirmed the layoff of 18% of its workforce, or about 520 employees. The company says that this will result in $70 million to $80 million in annualized pre-tax savings. That’s good news for investors who had witnessed their shares drop 68% from the IPO price level.
Despite those savings, its guidance for second-quarter earnings calls for a loss between $39 million and $28.5 million. Zynga is a video-game creator that launched in 2007 and went public in 2011. If you’ve ever played Words with Friends or Farmville, you’ve used Zynga Inc (NASDAQ:ZNGA)’s products.
Zynga’s challenges
These virtual games can be really addictive. People love playing them. In fact, data-tracking website comScore reports more users play Zynga’s mobile games than the next five mobile game developers combined. But Zynga Inc (NASDAQ:ZNGA) has two great challenges. The first challenge is the company’s over-dependecy on Facebook Inc (NASDAQ:FB), the mighty social media platform. The slightest hint that Facebook might begin to develop its own mobile games is enough to send Zynga’s shares out of the window.
And there’s another challenge — you can play for free. You never actually have to spend a penny to play Zynga Inc (NASDAQ:ZNGA)’s games. Only 5% of Zynga users pay to play its games. It has 63 million daily active users but it still can’t turn in a profit. The company generated $1.3 billion in revenue and still hasn’t made a penny of profit. That’s a huge inherent risk with the company’s business model.
What’s working and what isn’t
One can learn a lot by looking at the social media frenzy that surrounded us back in 2011. Zynga wasn’t the only company that filed for an IPO back then. Pandora Media Inc (NYSE:P) is a free Internet radio website that also went public in 2011. Pandora Media Inc (NYSE:P) also shares the same business model challenge with Zynga Inc (NASDAQ:ZNGA). Pandora Media Inc (NYSE:P) lets you design your own radio station based on the music you like. The site has 175 million registered users. About 140 million have accessed it through phones and tablets. According to radio industry service provider Triton Digital, Pandora has a 70% market share of Internet radio.
Advertising makes up about 87% of Pandora’s sales. The rest comes through premium Pandora One subscriptions. Pandora One is Pandora with no ads and better sound quality, and it costs $4 per month. But it has plenty of competition in Spotify, Grooveshark, Sirius XM Radio, and even iTunes. And again… you can use its products for free without ever having to cough up a penny. I love music, and I want to love Pandora. I could see some users becoming addicted to it, the way you might to a favorite radio station or TV show or computer game. But if it’s not making money now – with 175 million registered users – will it ever?
Pandora generated $138 million in revenue last year, but like Zynga Inc (NASDAQ:ZNGA) and many of the other social media companies, it failed to turn a profit
On the other side of the fence stands Facebook Inc (NASDAQ:FB) with over 1 billion monthly active users all over the world. Facebook’s public filings suggest that’s half the Internet users in the world. So far, Facebook Inc (NASDAQ:FB)’s massive web traffic has been good for $1.7 billion in total profit. That’s a great start. If the company’s market cap was 15 or 16 times annual earnings (instead of around 45 times today), I would buy the shares. But, this stock trades at an exorbitant valuation of around 12 times price-to-sales and around 45 times earnings. This pricing implies an estimated annual growth of approximately 25% year-over-year. That’s simply unrealistic.
The Fool thinks social media
The social media space has become crowded with companies that generate lots of internet traffic…but very few profits. Facebook, on the other hand, is much more promising in that sense. Wait for its stock to become cheaper and invest accordingly.
The article Zynga Is Zapped: Look at This Company Instead originally appeared on Fool.com and is written by Shmulik Karpf.
Shmulik Karpf has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. Shmulik is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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