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those Zynga games must be launched on Facebook as well. In addition, if Zynga acquires any social game available on Zynga but not Facebook prior to the game’s acquisition, it must be made available through the Facebook website after the acquisition has closed.
Although Zynga investors have reacted negatively to Thursday’s announcements so far, we view them as a longterm positive for both companies. Zynga now has an incentive to expand the reach of its most popular social games beyond Facebook and Zynga.com and be able to offer additional payment options, likely resulting in additional payers who are not Facebook users. In addition, Zynga will be better-positioned to compete against games from other developers (such as Kixeye) that migrated from third-party websites to Facebook at less expensive terms. While Zynga’s popularity arose in part from Facebook’s expansion, it was at the mercy of Facebook during negotiations, resulting in the costly Developer Addendums. We believe that Facebook benefits from healthy partners, and believe that encouraging partners to create valuable content will ultimately result in a healthier ecosystem. So long as Facebook protects its user base from cannibalization, we think that the agreement overall is neutral to positive for the company.
Maintaining our Facebook and Zynga estimates, as although the agreements appear to be mutually beneficial, the near-term financial impact will likely be somewhat muted. We note that Zynga reaffirmed its FY:12 guidance just over two weeks ago.
Maintaining our OUTPERFORM rating and our 12-month price target of $4. Our price target reflects 2x cash and real estate of $2/share. Despite the cost cuts recently outlined by the company and a new share repurchase program, we expect Zynga shares to remain somewhat constrained over the next few quarters until management and investors can judge the success of its turnaround plan.
Risks to the attainment of our share price target include changes to game release timing, decreasing interest in Facebook and other social networks among the general public, changes to the terms or economics of its Facebook agreements, the inability to create popular mobile games, increased competition from other social gaming companies and the traditional video game publishers, greater-than-expected consumer demand for video game hardware and single purchase software, and changing macroeconomic factors.
Michael Pachter is an analyst at Wedbush Securities.
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