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Is Zynga (Nasdaq: ZNGA) Doomed Without Facebook?

By , Money Morning •

Zynga Inc. (Nasdaq: ZNGA), creator of FarmVille and other popular social games, has lost its special relationship with Facebook.

Zynga and Facebook Inc. (Nasdaq: FB) have had a symbiotic relationship since 2010 by which Zynga was the only provider of social game software that was allowed to promote its games to Facebook's one billion users. In return, Zynga used Facebook's credit system to process payments even on its own Zynga.com games platform.

The close relationship between the two companies had made Zynga the single largest contributor to Facebook revenues outside of advertising. For its part, Zynga is thought to have received about 80% of its revenue from Facebook users.

"We have streamlined our terms with Zynga so that Zynga.com's use of Facebook Platform is governed by the same policies as the rest of the ecosystem," Facebook said in a statement. "We will continue to work with Zynga, just as we do with developers of all sizes."

The popularity of Zynga's games has declined in recent years as users are spending more time playing games on mobile devices. Zynga has had to revise down guidance twice so far this year and that has been reflected in the company's share price, which has fallen by 74% since its IPO in December 2011.

The revised agreement between Zynga and Facebook allows Zynga to market its games more widely.

According to Bloomberg News, once the new agreement goes into effect in March 2013, users will no longer use Facebook as the login for Zynga games. Zynga can use methods other than Facebook Payments to process purchases and will no longer have to display advertisements provided by Facebook.

Barry Cottle, Zynga's chief revenue officer, said in a statement, "Our amended agreement with Facebook continues our long and successful partnership while also allowing us the flexibility to ensure the universal availability of our products and services."

For its part, Facebook has been improving relationships with other game software providers. Facebook is also free to build its own social gaming platform although several reports say that the company has no plans to do so.

Zynga shares have been sold since the announcement of the revised relationship with Facebook was announced after the close on Thursday. In trading around noon on Friday, Zynga was down about 8% to $2.40.

Bad News for Zynga (Nasdaq: ZNGA)?

Zynga's status update with Facebook does not necessarily have to be a negative for the company if it means that it can expand the number of users and, more importantly, the number of paying customers.

Zynga games can be played on Facebook or on the company's game platform at no charge.

So how does Zynga make money? According to analysis by Business Insider, the company gets revenue by selling virtual goods to users who play their games and by selling advertising.

Currently, Zynga derives most of its revenue from the sale of virtual goods. These are virtual currency or points used in the game to allow the user to progress faster or to accomplish more in the game. Zynga builds a certain amount of tedium into its games.

For example, in FarmVille, it might take several hours of waiting for your crops to grow. But, for the impatient gamer, the growing season can be compressed into a few moment with the purchase-with real money-of points that allow the user to move on to the next stage of the game.

Also, since social games are played along with friends, there is an element of competition. A gamer might spend money to gain powers in a fighting game or to trick out his barn in FarmVille.

Zynga also gets paid for advertising. Most of the ads are simple banner ads at the top or the bottom of the game screen. But ads can also be in the form of a video, which plays while a new round of the game is loading or incentive-based advertising where users can earn credits that can be used to purchase virtual goods by watching an advertisement. Finally, advertisers can place their products into the game itself.

How the new, more distant relationship with Facebook will impact Zynga's ability to earn revenue from the sale of virtual goods-Facebook friends will no longer be updated on a user's progress in a game-and from advertising, since Zynga will no longer have privileged access to Facebook's one billion customers, remains to be seen.

Zynga (Nasdaq: ZNGA) is going to have to make more progress in attracting users to its own game platform and in attracting mobile users if it is going to overcome being unfriended by Facebook.

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