A sad day in FarmVille - Zynga stock collapses on earnings.

Today was truly a sad day in FarmVille. Zynga, once considered a modern darling of the tech industry, has taken a massive stock hit after an abysmal earnings call. In late trading today, the stock was down over 40%, just a penny under $3.00. For a stock that had traded as high as $15.91 and had been sold by its CEO, Mark Pincus, for $12 a share shortly after its IPO, selling at $2.99 is a slap to the face. What caused this? A combination of factors led to this market reaction including bad earnings and a worse outlook. Zynga dropped its 2012 earnings outlook to 4 to 9 cents per share - 1/3 to 1/6 of Wall St. expectations. 2nd quarter earnings were non-existent; an actual loss of 3 cents per share.

Zynga, who partially blamed Facebook for its problems, also dragged Facebook's stock down over 7.5%. “Facebook made a number of changes in the quarter,” said John Schappert, Chief Operating Officer. “These changes favored new games. Our users did not remain as engaged and did not come back as often.” It will be interesting to see what Facebook's earnings look like tomorrow, the first for the company since its fiasco of an IPO. The stock has yet to come close to its IPO value of $38, and there are serious concerns about viable mobile revenue going forward. Zynga is also one of Facebook's largest revenue streams outside of advertisements. I would assume that Facebook is going to meet with Zynga and try to rapidly address the 'issues' before both companies take an even larger revenue loss in Q3.

A shrinking user base for its existing games like FarmVille and dwindling revenue from in-game purchases were probably the largest contributor to this bad quarter. The real question is whether this pattern is a blip on the radar or the beginning of a long term trend of less interest in these simplistic online games. As any CFO knows, however, revenues are only one side of the coin. The other is expenses. The recent acquisition of OMGpop, makers of Draw Something, brought new users to Zynga's platform, but at what cost?

It is no secret that when FarmVille started to gain popularity, Zynga could not meet the infrastructure growth demands within its existing data centers. It turned to Amazon's Elastic Compute Cloud to meet demand and scale as needed. Then, an interesting thing happened. Zynga, who is in the business of games (software) decided that they could build a better Cloud than Amazon and do it within their own data centers. CTO Allan Leinwand noted "Moving 80 percent of our players off a public cloud onto private Z Cloud — that means we built capacity, data centers, infrastructure, storage, servers to handle the dramatic shift of workload." And therein lies the rub. Zynga chose not only to deviate from its core competency (developing games), but also to turn from a utility billing model to a model loaded with millions of dollars in capital expenditure. All of that built out capacity cost millions and will sit mostly idle until demand peaks. This is why the Amazon Public Cloud model makes so much sense for internet-based businesses like Zynga. With Amazon, you only pay for the capacity you need, and when demand falls, you simply shut down spare capacity, decreasing your costs. For Zynga, the expense side of the house has to be eating them alive right now. This most definitely contributed to the plunge in Zynga's financials.

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