Despite the better-than-expected third quarter earnings report that vaulted shares of Zynga (Nasdaq:ZNGA) 15% in premarket trading on October 25, all is not well at the social gaming startup that has seen shares fall more than 70% from its $10 IPO price. In late October, on the day that Apple (Nasdaq:AAPL) held a press event to announce the new iPad Mini, Zynga quietly announced that it was laying off 5% of its workforce. This amounts to about 140 of its 2,800 person staff. In addition, the company announced it was closing its Boston office and has plans to shut down offices in Japan and the United Kingdom. In the midst of a tumbling stock price and large-scale layoffs, what is next for the company?

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What Zynga Makes
How often do you receive game requests on Facebook (Nasdaq:FB)? If you are apt to say no to those invitations to build a farm or a city, you probably do not have a lot of contact with Zynga products. Zynga is in the social gaming business. FarmVille, Zynga's best-known game, launched after only five weeks and a development staff of 10. At one point, FarmVille had more than 40 million active users and more than 100 million installs. Zynga's other flagship game, CityVille, had more than 90 million users. The wildly popular early games in the Zynga arsenal propelled it to an IPO in December of 2011, but problems have developed since.

SEE: How An IPO Is Valued

The Zynga Challenge
According to one analyst, Zynga and Facebook are "connected at the revenue hip." To compare the stock charts of both companies, one sees that they frequently move in tandem. When bad news about Facebook enters the market, Zynga falls with it. With Facebook currently helping to write the book on an IPO gone bad, Zynga may need to decouple from Facebook in order to avoid closing all of its studio doors instead of just three. Zynga acknowledges the problem but has done little to find a revenue stream since announcing that it would take active steps to better diversify income.

Zynga has also failed to capitalize on the mobile market. Critics argue that its mobile games largely constitute rebranded versions of already popular games. Its high-cost acquisition of OMGPOP, makers of the game, Draw Something, which resembles "Pictionary" and Words with Friends, similar to "Scrabble," is a prime example. With competition in the mobile market fierce, investors are looking for a game that will draw the revenue of FarmVille and CityVille.

Finally, Zynga has transformed itself into a large-scale game maker with all the related organizational complexities and costs. While FarmVille only involved 10 people and five weeks, FarmVille 2 took more than a year and a development staff of 50. FarmVille 2 costs were higher and, although Zynga is excited by the success of the game, the numbers fall short of the original.

SEE: Could Zynga Exist Without Facebook?

All Is Not Lost
Although it announced layoffs, Zynga's third quarter results were encouraging. The company reported sales of $317 million, up 3% year over year and surpassed analyst estimates of $256 million by a significant amount. Zynga went on to report a net loss of $52 million but broke even when compensation costs were backed out.

CEO Mark Pincus said that FarmVille 2 "converted 500,000 unique buyers, and just this Sunday marked its first day exceeding $950,000 in player purchase volume, including the amount retained by Facebook." According to Business Insider, if Zynga can sustain the success of FarmVille 2, that represents a $300 million per year franchise.

Finally, Zynga announced a partnership with bwin.party, a worldwide gaming operator that would allow the game maker to offer games that deal in real money instead of so-called virtual transactions. In future Zynga games your credit card may get you poker chips instead of "farm coins."

SEE: How To Decode A Company's Earnings Reports

The Bottom Line
The jury is still out on Zynga. Layoffs and the lack of excitement for FarmVille and CityVille have investors worried, but third quarter results were encouraging. As Zynga works to move away from Facebook and explore the new partnership allowing real money instead of virtual currency, the company may find new life. As with every startup, the first years can be nail biters - especially if you are an investor.

At the time of writing, Tim Parker owned shares of AAPL since 2012.
Tickers in this Article: ZNGA, AAPL, FB

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