Can Zynga Be Saved?

To say the last two weeks have been unkind to Zyngais a bit of an understatement. The company's stock has plunged roughly 45 percent. It reported an earnings shortfall. Guidance was reduced. And it found itself on the receiving end of a lawsuit from one of the videogame industry's biggest publishers.

Getty Images

The hits just keep on coming for a company that not long ago was the poster child for the next big thing in gaming. More bad news for Zynga could be on the way.

One Aug. 16, the lock-up period on 150 million employee stock options will expire — and while the stock is hardly the windfall many workers were hoping for, some money is better than none.

Zynga used stock options as a major recruitment tool in its pre-IPO days. Developers were lured from the traditional console industry not so much because they believed in the company's future (though that was certainly part of the appeal), but because of the temptation of sudden wealth when the company went public.

At the time, a Zynga stock explosion seemed a sure thing. Things change, though. And employees considering another career shift could be waiting for that lock-up period to expire before departing.

This will be the fourth lock-up expiration for the company since its IPO, which is dramatically expanding its float. When Zynga went public, there were only 100 million shares available. Between a secondary stock offering and the expiration of previous lock-up periods since then, the number has jumped to over 600 million. Next week's expiration will bring the float to nearly 800 million shares.

Meanwhile, last week's copyright infringement lawsuit by Electronic Arts was the latest in an escalating series of legal woes against the company. Earlier in the week, a California law firm accused Zynga of failing to disclose key data. It hopes to make that a class action suit.

It's the EA dispute that most concerns investors and analysts, though. Competitors have often complained of the similarities between Zynga games to their own, but none has had the resources to mount a sustained legal challenge. EA has the bankroll to see the case through to the end, something analysts believe it will do. And that's something that could hang over the stock for a long time.

"We are convinced that EA will press on with this lawsuit until it receives a jury verdict," says Michael Pachter of Wedbush Securities. "It is our opinion that the two companies will remain adversaries for the next several years over this case, and we do not expect the case to be resolved for several years."

Further complicating things was Zynga's decision to shuffle its top management, removing game oversight responsibilities from chief operating officer John Schappert, a videogame industry veteran who has held executive roles at both EA and Microsoft.

Some have criticized the move, noting that Schappert shouldn't be held responsible for overall declines in the social gaming space. But Mike Hickey of National Alliance Capital Markets notes the de facto demotion could signal the problems won't be over soon.

"It probably is suggestive of more than a single quarter miss," he said. "You probably have a multi-quarter trend. [Zynga CEO Mark Pincus is] kind of giving you a heads up here. … Is it fair [to Schappert]? I don't know. That's not for me to judge. But if you're the owner of a company and you lose 40 percent of your value overnight, someone has to be accountable."

While Zynga still has a strong market cap (at $2.2 billion), the stock performance has made it a "show me" story for investors, much like THQ and EA. Analysts say the thing to watch for is whether the development talent the company hired from traditional game companies sticks around and how smoothly the company transitions to a force in the mobile market. (While its 'With Friends' games are generally doing well, its $180 million acquisition of OMGPOP earlier this year — and the subsequent underperformance that company's game "Draw Something" — has raised concerns.)

They're also likely to keep an eye on the build out of Zynga's web portal, which will lessen its dependence onFacebook. (The company was actively recruiting partners at this year's E3 trade show.)

All of those are long-term events, though, and investors are looking for a near-term catalyst. And while not everyone is convinced, some investors see that hesitation as an opportunity for patient investors to make money.

"Looking forward, they have a performance opportunity," says Hickey. "At the moment, the market sentiment is decidedly negative because we're at the crossroad of another cycle, so I think this is a great time to find value."