Can Zynga's bet on action games spark revival?

Real money in virtual games?
Real money in virtual games?   

Three years ago this week, Zynga was the hot new kid on the stock-market block. Fresh off its initial public offering, the social game developer was valued at $11 billion on the strength of "FarmVille" and other smash hit applications on Facebook.

Shortly thereafter, consumers began rapidly moving to smartphones, leaving Zynga in the dust. The San Francisco-based company lost 87 percent of its value over the next eight months and has yet to recover, despite overhauling the executive suite and pouring its balance sheet into mobile game development. The current stock market value: $2.2 billion.

Whether the one-time Internet star can recapture its glory largely depends on the success of action-packed games like "Dawn of Titans," which Zynga is showing off on Thursday for the first time ahead of its upcoming launch. Created by NaturalMotion, the studio Zynga acquired last year for over $500 million, "Dawn of Titans" is the company's most aggressive effort yet to lure hardcore gamers, rather than just the casual and social type.

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The reason that market is so critical for Zynga comes down to economics. Four of the top 10 grossing games in Google's Play store and three in Apple's app store are action battle games, according to App Annie. On both platforms, the number one game is Supercell's "Clash of Clans," followed by Machine Zone's "Game of War: Fire Age."

Zynga doesn't have any games on iOS or Android that rank better than 19th.

"That's an important category because of the profit pools in it," said Clive Downie, Zynga's chief operating officer and a former vice president at Electronic Arts. "The top 10 grossing charts are generally reflective of mainstream consumer tastes."

Zynga's absence from the charts explains the company's 46 percent decline in revenue over the past two years to $690 million and the plunge in its stock price from a high of $15.91 in March 2012 to $2.39 as of Wednesday's close.

Zynga launches fully mobile game
Zynga launches fully mobile game   

But the company has ambitious plans to right the ship. Chief Executive Officer Don Mattrick, former president of Microsoft's interactive business, took over the company from founder Mark Pincus in 2013, and told investors to expect six to 10 new games this year.

"Dawn of Titans" is among three announced so far. The other two are "Empires & Allies," another action game, and "FarmVille: Harvest Swap," a puzzle matching game along the lines of "Candy Crush Saga."

With "Dawn of Titans," Zynga is going after the gamer that likes player-versus-player battle scenes. The game is free to play and will charge for users to level up or gain some sort of advantage that would otherwise require more time. The game will roll out for testing in certain locations in the coming weeks and launch globally later this year.

Michael Pachter, an analyst at Wedbush Securities, said that Zynga must show it can create a winner in the space before investors will get excited, because there's a tricky formula for success. Just creating a highly engaging game, even with Zynga's large marketing budget to back it up, doesn't assure financial returns.

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"There's no question they're going to make a game that works and no question they'll get a lot of people to play it," said Pachter, who has an "outperform" rating on the stock and a $6 price target. "The question is—will they get the economy so balanced that people who don't spend money feel like their time is worthwhile and the people that do feel the money they spend is worthwhile."

Mastering that balance is largely in the hands of NaturalMotion CEO Torsten Reil and his team of U.K.-based developers. NaturalMotion represents Zynga's biggest ever acquisition and recognition that the types of games that work on mobile are very different than the social games like "FarmVille" and "CityVille" that exploded on Facebook four to five years ago.

"Dawn of Titans" is a fantasy battle game that lets users develop their own kingdoms and then build armies to defend their turf and attack others, while also joining up with friends. Reil throws around the term "epic battles" to describe the thousands of troops fighting all at once in a highly immersive environment, all controllable from a mobile phone or tablet.

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NaturalMotion spent the past 14 years developing sophisticated game technology, and is excited to showcase it with this title and others in the near future. Experts said it's a big challenge to make sure a game not only works on smartphones without draining battery life and clogging up the device, but that it also adapts to the way people play.

Reil calls it the "Starbucks line test." Can a battle be started and completed all while waiting in line for a macchiato?

Torsten Reil, CEO of NaturalMotion
Source: Zynga
Torsten Reil, CEO of NaturalMotion

"Even though we want it to look epic, it needs to be resolved very quickly," said Reil, while walking through a demo of the game in a theater at Zynga's headquarters. "If a game doesn't fit that then it doesn't work well on mobile."

Like the rest of Zynga's game catalogue, "Dawn of Titans" will have the ability to make money from free users by showing them ads. Reil said that interstitial and video ads, among other formats, are likely to come, but the team will do plenty of testing to determine when and how to effectively show them before they go live.

Overall, advertising is actually a booming business for Zynga, with sales surging 139 percent in the fourth quarter to $58 million, accounting for 30 percent of total revenue. Building out the ad team was a big focus over the past six to eight months, said Downie.

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As strong as Zynga's advertising has become, none of it much matters if the company doesn't have hot new games and enthusiastic players. Downie calls Zynga a "show-me story," and analysts covering the stock agree.

Among analysts tracked by FactSet, Pachter is the only one to have a price target higher than $4.50, with the mean prediction at $3.11.

"At this point we still feel that visibility in '15 is low," wrote Piper Jaffray analyst Michael Olson, in a Feb. 13 report. He has a "neutral" rating and a $2.50 price target. "We expect most on the Street will also take a wait-and-see approach to the ability of those games to reach the top 20 rankings."

Correction: An earlier version of this story had a typo in the game title "FarmVille: Harvest Swap."