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After losing 3.1mm Monthly Active Users (MAUs) across its vast Facebook gaming empire two week ago, Zynga’s MAU decline accelerated last week with the loss of 4.2mm more MAUs.

While Treasure Isle continued its growth, the growth curve flattened significantly, adding 1.6mm MAUs last week after gaining an average of 6.6mm the previous three weeks.  Every other major Zynga title lost users last week, with Farmville (-600k), Texas Hold ‘Em (-600k), CafeWorld (-700k), Mafia Wars (-300k) Fishville (-600k) and YoVille (-500k) combining to lose over 3.8mm MAUs.  On a positive note, the losses from the six losing major titles decelerated from the previous week, when they combined for a total loss of 6.5mm MAUs.  The weekly loss totaled 1.7% of Zynga’s total MAUs, which now stands at 244mm, still dwarfing its competitors, the next ten which combine to total only 215mm total MAUs.

The second straight week of MAU losses comes on the heels of reports that Zynga is readying for a major battle with Facebook given the rise of Facebook Credits and its 30% fee structure, as well as Facebook’s elimination of notifications and Facebook’s pending Gift Request changes.  While Facebook’s changes in communications cuts down on the noise in users newsfeed, the elimination of the free communications/advertising is forcing the gaming companies to increase their advertising to drive usage.  As a result of these changes, Zynga appears increasingly focused on lessening its dependence on the Facebook platform.

While Zynga MAU loss accelerated last week, every other major developer but Playdom (which added a modest 300k MAUs last week) also lost MAUs last week, and Zynga’s share of the total MAUs of the top 11 game developers actually increased last week from 53.1% to 53.2%.  So if Zynga’s players aren’t leaving Zynga for the other major gaming providers, where are they going?

The lost gamers are either doing other things than playing games on Facebook, like taking advantage of better weather in the seasonally slower spring and summer months for gaming, or playing the games of smaller developers.   Among the many risks we highlighted in our original Zynga report was the risk of “branded” games coming to Facebook that come with a built in audience given the strength of the brand.  Case in point is the recent rise of the Family Feud game introduced in to the Facebook ecosystem just two months ago.  Family Feud grew its MAUs base by 700k last week to pass 4mm total MAUs.   While Family Feud doesn’t appear poised to enter the pantheon of top 10 Facebook games, where 17mm MAUs is required, the deluge of new gaming companies introducing games on the Facebook platform, including those with branded games, are likely to be increasingly meaningful in the Facebook gaming ecosystem.  All that said, we always caution readers to not read too much in to the weekly gyrations of MAUs, but rather use them as context over longer periods to divine the trends that will be meaningful in the long run.

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While Zynga’s Treasure Isle continued its ascent last week, adding over 4.2mm Monthly Active Users (MAUs)  to pass 25mm total, and become the 4th biggest game on the Facebook platform (passing Mafia Wars and Petville) every other major Zynga title lost MAUs for the week.

Farmville had it largest weekly MAU decline, dropping 2.3mm users to finish with 78mm.  Farmville is now 18% below its peak Daily Active Users (DAUs) of 32.5mm, as the behemoths best days appear to be behind it.  Zynga’s Café World (-1.3mm MAUs) and Fishville (-1.0mm MAUs) also experienced big declines.  Interestingly, Treasure Isle was the only Top 10 game on the Facebook platform to increase its total MAUs last week, but even its growth slowed dramatically when compared to the 6.7mm MAUs Treasure Island added the week before.   As a result, Zynga’s total MAUs across all its properties declined by more then 3mm to finish the week at 248mm.  The only other major winner this week was EA’s Hotel City, which gained 1.8mm users (to 13mm MAUs total) to help EA eke out a gain of 0.1mm MAUs for the week (to 58.6mm MAUs) as EA’s other tow major titles, Restaurant City (-0.4mm MAUs) and Pet City (-0.8mm MAU;s) both suffered declines.   As we always point out in our weekly updates, we don’t put too much weight on what happens with MAUs in any one week, but it is always provides additional context.

The last few weeks have seen Zynga, and its CEO Mark Pincus, receive significant press, some good (e.g. Business Week and Details), some not so good (e.g. Valleywag), as Zynga ups its PR push.  But at the least, the company is keeping itself front and center as interest in the Facebook ecosystem explodes.

Most importantly, while a down MAU week, and some bad press is notable, potential changes to come on Facebook portend some additional tough days down the road for Zynga.  Everyone following Facebook is aware of the Facebook’s continued interest in cutting down on noise in the newsfeed and increasing revenue.  This played out in Facebook’s elimination of application notifications which took effect on March 1.   While many in social gaming feared the worst, the impact has proven to be pretty minimal to gaming companies (although dating sites which rey more on notifications were hurt).  However, when the notification announcement was made, Facebook stated that they were also going to change how requests function.   It appears now as though Facebook is going to make some major changes to the gift channels and how gift requests function.    Facebook perceives that the Facebook channel is polluted by gift requests.  While the pending changes aren’t exactly clear yet, the gift channels are a very major driver of traffic to social games.  In fact, many game players struggle to navigate to games outside of the gift channels.  So this change will likely force the game companies to spend an even greater percentage of revenue on advertising, which is of course is what Facebook wants.  On one hand, Zynga, as the largest company in the space, has the most resources to pour in to advertising.  On the other hand, companies like CrowdStar that have put more resources in to viral channels they control, like forums, may be better positioned to weather the change.

With the pending changes to requests, Zynga is likely going to advertise even more, and thus experience lower margins than the 40% long term margins we have modeled.   While this may ultimately have a negative impact on our $5 billion valuation of Zynga, we sense the company is tracking ahead of the $529 million in 2010 revenue we forecasted.   For the moment, we are maintaining our price target.  We further understand that since our initial Zynga research report was published  on April 6th, Zynga’s shares have risen about 50% in the private market, to a high of $14 in a meaningful transaction last week.    However, the rising share price may not be great news to Zynga employees as the company considers limiting employees ability to sell their shares.

On a last, positive note, Zynga filed papers in Delaware two weeks ago authorizing the issuance of an additional 1.9 millions shares of Series B-2 Preferred Stock, at an issue price of $12.87 per share, implying a value of about $4 billion for the company based on the estimated 320 million shares outstanding.  While no deal has been announced, the filing is typical of shares issued around a strategic partnership, with Softbank often mentioned as a good potential partner for Zynga in Japan.

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We couldn’t be more pleased with the thousands of articles written around the globe in response to our Zynga report two weeks ago which estimated that Zynga would trade at a market cap of $5 billion if it were public.   While a some bloggers agreed with our fundamental analysis, we note that many more people disagreed.  A poll at the bottom of a thoughtful GamesBeat posting about our report indicates that 72% of respondents (275 voters) believe  Zynga “is worth less” than our $5 billion valuation.  While we won’t know the answer until Zynga goes public, SecondShares is now committed to continuing to cover Zynga and report on its progress.  We’re pleased to report that Zynga’s progress since we published has been quite impressive.

In the two weeks since our report, Zynga’s MAU (monthly active users) growth has meaningfully accelerated, as Zynga added over 5mm new MAUs a week, an annualized growth rate exceeding 100% vs. our projection of 35% annualized growth.

Now we don’t expect this growth rate to be maintained, but we are impressed.  We also note that Zynga’s MAU market share of the Top 10 app developers rose to 53.8% from 53.1%.

In our risk section we noted that many of Zynga’s games had peaked, including its monster smash Farmville.  In the two weeks since, Farmville has dropped about 1.5mm MAUs (to 81.6mm).  Fishville has also continued its fall, losing 1.7 mm MAUs (to 20.4mm)  and is now off more than 50% from its peak.  But we knew games have a lifecycle, and the bigger question/risk, was Zynga’s ability to continue to bring new hits to the market.  Congratulations Zynga, and its shareholders, Zynga has produced yet another hit.  Treasure Island, which was nowhere when we wrote the report two weeks ago, has over 16.5mm players, is growing like a weed, and is poised to become one of the top 10 games on Facebook this week.  That is stupendously impressive.  The dramatic growth of Treasure Island more than offset the modest losses in Farmville and Fishville, and enabled Zynga to increase its MAUs by more than 10mm in just two weeks, to over 250mm.  Our year end projection of 300mm MAUs for Zynga is looking mighty conservative at the moment.  While 72% of GameBeater’s readers thought our price target was aggressive, we strived to be conservative, and look to be achieving that goal.

Interestingly, Zynga is not the only game developer enjoying success.  The number two player, EA, also had a great two weeks, growing its MAUs by 7mm to over 57mm on the back of their new hit Hotel City, which now has 9.5mm MAUs vs. just 1.7mm when we wrote our report two weeks ago.  EA grew its MAU share to 12.3% from 11.2% in the last two weeks ago.

Lastly, largely due to Zynga and EA, total Facebook MAUs derived from the Top 10 developers increased 14mm, to 465mm MAUs, a 75% annualized growth rate, indicating that the Facebook platform remains poised for continued growth of social gaming applications.

The last two weeks gives us even greater confidence that social gaming is the next big wave in gaming, bigger than almost anyone currently forecasts, including us.

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