Zynga's New Venture Is A Major Gamble

By Tim Parker | Updated May 03, 2013 AAA

In a move that pleased investors, Zynga (Nasdaq: ZNGA) announced the launch of two real money gambling games in the U.K. "ZyngaPlusPoker" and "ZyngaPlusCasino" were launched in partnership with Bwin.party Digital Entertainment, one of the U.K.’s largest online casino companies.

It’s no longer farm animals and words with friends. Zynga is entering “sin stock” territory with the new venture and while investors might have shown their excitement by bidding the stock up more than 15 percent intraday April 2, it only represents a relatively small investment for a company that is struggling to make up for lost revenue from its once popular games that are now old news.

The UK is a Small Market
In a research note, Jefferies points out that only 6 to 9 percent of Zynga’s total revenue comes from the UK. Of that, Zynga Poker, the company’s second most popular game, generates about $15-22 million annually. Assuming that the real money games will take some of the revenue from Zynga Poker, this won’t be a large revenue driver for Zynga in the short term especially after the company splits some of the profits with Bwin.party.

SEE: Are Big Budget Video Games Dead?

But the Online Gambling Market is Huge
Only three states allow online gambling: Nevada, Delaware, and New Jersey. However, that hasn’t stopped Americans from participating in what is already legal in many other countries. It’s estimated that online casinos off the shores of the United States already produce $4 to $6 billion annually.

The size of the gambling industry in the United States is massive. In 2012, the top 20 grossing casinos in the country brought in more than $25 billion in gross revenue. If online gambling is legalized, this $25 billion market is expected to grow as people who don’t live near casinos would now have the ability to gamble.

Since Zynga games are already producing $243 million in revenue for the company, investors can believe that there is a sizable market for what Zynga has to offer. 81 million people play social games at least once a day with 49 million playing multiple times daily. That’s 9.5 hours every week.

$42.7 billion is already spent purchasing online currency with U.S. based gamers purchasing $600 million in virtual goods. Zynga alone has more than 223 million active users.

SEE: What Are Social Media Sites Really Worth?

Legislative Gridlock
It’s no wonder that Zynga is willing to bet a significant portion of its future on this market, but it’s currently forced to learn the market outside of The United States. According to the Jefferies research note, the company is not likely to enter the U.S. market until legislation at the Federal level legalizes online gambling.

Navigating the relatively small market that the few states would offer is too much work for too little reward, according to the report.

And don’t expect any sweeping Federal reform any time soon. Several other states are considering legalizing online gambling. Nevada is allowing only online poker but New Jersey said yes to all types of online gambling. As more states legalize it, it becomes more difficult for a Federal law to gain traction in Congress since individual states will want to uphold their own gambling laws.

Second, with Obamacare, the lack of a budget, and the myriad of economic matters facing lawmakers, online gambling barely gets a second look. According to lobbyists, no member of Congress is actively pursuing the issue and - unless a bill gains momentum by June or July - there is virtually no chance anything will change this year.

It’s Up to the States Now
For now, states are moving ahead with the debate but it’s a hard fight. Illinois is attempting to pass legislation for a third time. Illinois Governor Pat Quinn is open to the idea, but he recently told reporters that “we're not going to be doing gambling expansion before we do our pension reform. Pension reform comes first -- that's imperative.”

California and Iowa are among other states studying the adoption of online gambling but headway is slow with most bills stalled or dead.

SEE: Government Regulations: Do They Help Businesses?

Take Action
What does that mean for an investor? Expect for the big casinos like Caesars Entertainment (Nasdaq:CZR), Las Vegas Sands (NYSE:LVS), MGM Resorts International (NYSE:MGM), and Wynn Resorts (Nasdaq:WYNN) to continue lobbying Congress to make it legal across the country. If legislation legalizing online gambling is enacted, these stocks will see large upside gains but a long position based on that thesis might be premature.

As for Zynga, pardon the pun but the company is taking a large gamble. With legislation stalled in the United States and the European market already full of companies that are capturing large-scale market share, Zynga could be in the unprofitable middle ground.

Investors are wise not to consider online gambling as a viable revenue source for the company until it provides evidence that it’s gaining market share.

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