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Monday, February 25, 2013

Zynga's Valuation Amid Changing Online Gambling Markets - Seeking Alpha

Zynga's Valuation Amid Changing Online Gambling Markets - Seeking Alpha

Disclosure: I am long ZNGA(More...)
I published an article last week on Zynga (ZNGA) that focused on the progression of online gambling legislation. After receiving feedback asking what ZNGA has already done in preparing for online gambling and wondering which states had legislation on track to be passed, I decided to get the information and links together and answer questions regarding all aspects of ZNGA and its journey to the online gambling market.
Federal Gambling Laws and Limitations
On Oct. 13, 2006, President George Bush signed the Unlawful Internet Gambling Enforcement Act into law. This law banned internet gambling and created a task force to stop and punish violators of the law. For instance, BWIN Party Digital Entertainment -- which recently teamed up with ZNGA -- had its poker platform shut down in the U.S. in 2006, causing its stock to trade 60% lower.
The excitement to get back in the game has been halted, however, as federal as well as state legislation pending approval prohibits former sites from operating for five years minimum. This leaves new faces like ZNGA, previously an online social gaming site partnered with Facebook (FB), to point their future efforts toward Internet gambling in an effort to snatch up the available U.S. online gambling market.
Zynga Gambling U.K. Partnership
The U.K. is currently the largest online gambling market in the world. At the forefront of this market is BWIN Party Digital Entertainment, which is a company consisting of a BWIN and Party Gaming ( owner) merger. It teamed up with ZNGA to further pursue online gambling in the U.K. In 2012, online gambling in the U.K. raked in $2.5 billion andgambling in Europe overall is predicted to reach $42 billion in 2015. This, however, is not even the most staggering statistic. In 2010, there was a 30% growth in online users from the 2009 numbers (which was already 5.6% of the adult population). If this growth trend continues across Europe, the market could size could double in the next five years.
ZNGA, while pursuing everything from real money poker and blackjack to virtual slot machines, has seen a future that has a vast market for growth and innovation. On this subject, Mark Pincus said in January that the "amount of innovation you're going to see around gambling as an entertainment mechanic is going to be mind blowing."
The foundation for this innovation is an exploding gambling market. When poker was legal in the U.S. from 2001-05, revenue grew from $82.7 million to $2.4 billion. Internationally, online gambling generated $117.6 billion in 2011 and is predicted to grow annually at 9% to reach $182 billion in 2015. According to MSN Money, online poker alone could generate $6 billion to $8 billion a year.
State Gambling Legislation
Legal gambling in New Jersey and Pennsilvania was $3.05 and $3.16 billion, respectively, and they are just No. 2 and No. 3 on the U.S. gambling list. No. 1 last year was Nevada, making a whopping $10.8 billion. Nevada believed gambling was moving to an online venue in the future and wanted to ensure its place in the emerging market. Below are states considering legislation concerning online gambling and a timetable for completion of the legislation:
  • California -- Reintroduced a bill, and expected to vote between March and April.
  • Deleware -- Fully passed Online Gambling Bill and are currently putting infrastructure into place to get it up and running by September.
  • Florida -- Considering a bill, but could be next year before approval. They estimate online gambling will produce $10 million in tax revenue starting out.
  • Hawaii -- Proposed a bill, but are still waiting for support and have no real timetable, but would like to move quickly as they see possible revenue from Asian markets as well.
  • Illinois -- State Rep. Bobby Moak, D-Bogue Chitto, is rolling the dice again in the 2013 legislative session on online gaming legislation that could have a profound impact on the future of legal gaming in the state. The bill would have a 5% tax and limit licenses to companies already with land licenses in the state.
  • Iowa -- Are looking to move quickly on a gambling bill as they estimate 150,000 people in their state already illegally online gamble on offshore sites.
  • Maine -- Having been discussed for over a year now and not gone anywhere, it does not seem important on the agenda even though the idea is frequently thrown around in committee.
  • Massachusettes -- Proposed by State Treasurer, would allow online Social card games, fantasy sports, and the lottery.
  • Mississippi -- Failed to get bill out of committee so far.
  • Native American Tribes -- Have proposed and discussed bills, but need federal legislation to allow population to gamble on a Native American land-based gaming server.
  • Nevada -- Signed into law a bill that legalizes online gambling and sets up framework for interstate online gambling.
  • Pennsilvania -- Will introduce their online gambling bill this week and is expected to pass within the week.
  • Texas -- Proposed Poker Gambling Act of 2013 but does not have a timetable and has considerable resistance.
  • Washington -- Proposed bill legalizing in home online gambling, has yet to be voted on. Should be resolved in the next few weeks.
Why Zynga Has an Advantage in Future Markets
According to The New York Timesonline gambling from mobile devices will be $100 billion by 2017. Coincidentally, ZNGA has set its primary focus in social gaming at increasing its mobile usage in an effort to transition its 300 million monthly users away from PCs and toward mobile applications (a transition that was 25% complete according to Q4 2012 data released in February).
Currently there are many online poker sites internationally that will compete with ZNGA in current markets and future markets if the U.S. continues to open up to online gambling. What sets ZNGA apart from other gambling sites is its connection to the growth of social media sites such as Facebook, LinkedIn (LNKD), and Twitter (which is yet to go public). If the market continues moving in this direction, then ZNGA, which is the No. 1 social gaming site in the world, will be poised to take a dominate roll in the future of online gambling. Its 89 patents -- mostly from Walker Digital -- based on online social gaming will create a new unique platform that is protected by its patent portfolio. In addition, the legalization of online poker in the U.S. according to a Goldman Sachs could create $12 billion in revenue alone, an estimate nearly twice as much as previously thought possible.
According to a research report by KPMP titled "Online Gaming: A Gamble Or A Sure Bet?," one of the four key drivers that will shape the industry over the coming years is:
Combining online gaming and social networking: social networking will be a key driver of activity and growth in the online gaming world, as it represents a natural extension to users of digital and mobile technology. Social networking's role in driving online gaming is especially significant because of its high levels and ease of remote access.
ZNGA has been priced as a terminal company until recently. Its share price reflected only a 50-cent above cash valuation that was due to many analysts believing ZNGA would never become profitable and soon fail. With its partnership with BWIN Party Digital Entertainment and its hire of key executives, ZNGA has made a determined effort to become a serious player in the international and U.S. real money gambling market. With the move from traditional web-based gambling to interactive social media style gambling inevitable, ZNGA appears to be at the right place at the right time to become a dominant force in the near future. If ZNGA can even manage to take 1/1000th of the current global online gambling market, it would generate enough revenue from gambling alone to justify its current market price.
If you can see ZNGA gaining any more than 1/1000th share of the global gambling market, or having any profit from its current games, then it seems imperative that the stock valuation will be increased. As ridiculous as this scenario seems, the downplay of the importance of its move to real money gambling has been worse. Starting with the Morgan Stanley Conference that ZNGA is presenting at on Monday, I think that there will be a huge course correction by institutions raising price targets to between $7 and $11, which I believe is still a conservative valuation.

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