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Zynga Tumbles as Game Development Costs Crimp Profit

(Corrects percent and year of sales projection in 17th paragraph of story published on Feb. 15.)

Zynga Inc. (ZNGA), the biggest developer of games on Facebook Inc. (FB), fell the most since its initial public offering after an earnings report yesterday showed product- development costs weighed on profit in the fourth quarter.

Zynga tumbled 18 percent to $11.80 at the close, the biggest drop since it began trading Dec. 16. Before today, the stock had gained 44 percent since its initial public offering.

Earnings before interest, taxes, depreciation and amortization fell 34 percent to $67.8 million in the fourth quarter from a year earlier as expenses climbed, the San Francisco-based company said yesterday in a statement.

Zynga, which raised $1 billion in its initial public offering, is trying to maintain its grip on social-networking gamers by creating new titles and features. Research and development costs jumped more than eightfold to $444.7 million last quarter, the company said. Sales and marketing expenses almost tripled to $112.2 million.

“The fact that R&D went up more than we expected is not a good sign,” said Benjamin Schachter, an analyst at Macquarie Capital in New York who has a “neutral” rating on Zynga. “They are continuing to spend more money to create games.”

Zynga invested in a new technology infrastructure called “Cloud Z” and hired experts in areas such as mobile gaming, Chief Operating Officer John Schappert said in an interview.

“Our expenses and costs are in line with our growth plans,” Schappert said. “We’re investing for growth in our business.”

Sales Gain

Zynga makes money by selling virtual goods within its games -- say, a gun in “Mafia Wars” or a tractor in “FarmVille.” Sales rose 59 percent to $311.2 million in the fourth quarter. Analysts had predicted $301.1 million on average, according to a Bloomberg survey. Excluding some costs, profit was 5 cents a share, higher than the 3-cent estimate.

The company posted a net loss attributable to common shareholders of $435 million, or $1.22 a share, compared with a profit of $16.1 million, or 5 cents, a year earlier. The results included $510 million of compensation expenses for stock issued to employees, which weren’t recognized until the IPO.

Bookings, or the total value of virtual goods sold in the quarter, were $306.5 million, up 26 percent from the fourth quarter of 2010. The company expects 2012 bookings of $1.35 billion to $1.45 billion. Zynga’s reported revenue includes virtual items sold prior to the quarter and amortized over their expected life.

Friend of Facebook

The shares got a bump earlier this month when Facebook filed for its own IPO. Facebook, the world’s biggest social network, said in its S-1 filing that it relies on Zynga for 12 percent of its revenue, reassuring investors in the gaming company. Facebook takes a 30 percent cut from purchases of virtual goods within Zynga games.

Zynga’s rally raised expectations for the earnings report, making it harder for the company to impress investors, said Arvind Bhatia, an analyst at Sterne, Agee & Leach Inc. in Dallas.

“The Wall Street expectations had become way too high and there was too much optimism that had been built into the stock price, particularly since the filing of Facebook’s S-1,” Bhatia said.

The company did get a boost last quarter from newer games, which helped the company make 6.1 cents from the average daily user, up from 5.5 cents a year earlier, said Atul Bagga, an analyst at Lazard Capital Markets in San Francisco.

More Engaging?

“That is basically telling you that the newer games they are launching are more engaging and better, and its users are going to spend more money than they would in the past,” said Bagga, who recommends buying Zynga’s stock.

“Hidden Chronicles,” released last month, has become Zynga’s third most popular game, with 30.2 million monthly users, according to research firm AppData. It ranks behind two more established games, “CityVille” and “Texas HoldEm Poker.”

Social games will generate $5.33 billion this year, an increase of 39 percent since last year, according to Lazard. By 2015, the market could grow to $8.98 billion. Zynga operates six out of the seven top games on Facebook, according to AppData.

Electronic Arts Inc. (EA) has been Zynga’s chief rival in social games, with its “Sims Social” game attracting 20.9 million monthly users. Rovio Entertainment Oy emerged as a competitor this week, when it released a version of its popular “Angry Birds” game for Facebook.

Zynga’s “growth will be weighted towards the back half of the year,” the company said in the statement. That suggests that its most significant new products won’t be released until the summer, said Colin Sebastian, analyst at Robert W. Baird & Co. in San Francisco.

“It’s good that they are trying to constrain expectations here, given the run-up in the stock and some uncertainty about how new games will perform,” Sebastian said.

To contact the reporter on this story: Douglas MacMillan in New York at dmacmillan3@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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