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Zynga Plans to Tap Gambling Market

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Social game developer Zynga Inc. (ZNGA - Free Report) is gearing up to enter the U.S. gambling market. This Zacks #3 Rank (Hold) stock recently announced that it has filed an application with the Nevada Gaming Control Board for an online gambling license in the state. However, Zynga did not specify what it intends to do with the license.

If Zynga is granted the license, it will be able to offer online real money gambling games, similar to its upcoming offering in the United Kingdom. In October this year, Zynga entered into a partnership with Gibraltar-based online gambling operator to provide real money online poker and other casino games (approximately 180) in the United Kingdom in the first half of 2013.

Online gambling is illegal in the U.S. as per the regulations of the Unlawful Internet Gambling Enforcement Act (UIGEA) 2006. However, UIGEA, which was implemented in June 2010, does not define illegal online gaming. The Act also does not apply to online gaming conducted within the boundaries of a state or a tribe.

Similarly, the Interstate Wire Act of 1961 prohibits the operation of certain types of betting businesses in the U.S. However, in a December 2011 ruling, the Department of Justice (“DOJ”) clarified that only sports-related betting falls under the purview of this Act. The DOJ also said that Internet poker does not violate the Wire Act.

The DOJ’s ruling called for a federal framework to regulate Internet poker and other forms of Internet gambling. This is particularly important as state governments are looking for ways to boost their crumbling budgets. Granting licenses for online gambling was looked upon as an effective way to boost state coffers.

Nevada is one of the first states (Delaware being the other one) to legalize online gambling. Besides Nevada and Delaware, other states such as New Jersey are expected to legalize online gambling in the near future. We believe that this provides a huge growth opportunity to online game providers such as Zynga over the long term. 

According to data available from market research firm H2 Gambling Capital, as reported by Forbes, the global gambling industry’s total gross wins are expected to grow 5.6% to $417.0 billion of which 8.1% comes from online sources, which is expected to increase approximately 10% by 2015. Of the global gross wins, the U.S. generates approximately 25%, with only 3.3% of the coming from online sources.

Lately, Zynga has been looking for new avenues to boost its sagging revenues. The company recently lost its exclusivity to Facebook (FB - Free Report) , which is a huge setback. The company has been losing traffic on a regular basis, which had a negative impact on its top-line growth.

In such a scenario, we believe that Zynga’s entry into the online gambling industry will drive revenue growth, particularly due to its innovative product portfolio that comprises online poker and slot games. Moreover, this will help Zynga to reduce its dependence on Facebook going forward.

According to Zynga, the whole process will take approximately 12-18 months to complete. We believe that Zynga will utilize this time to build strategic partnerships with casino operators in the state. The company has a sizeable cash balance ($1.3 billion at the end of the third quarter) which will also help it to pursue acquisitions in the sector.

We believe that partnerships and acquisitions will help it to gain an immediate foothold in the online gambling market provided it wins the license. Moreover, these partnerships and acquisitions will help it to fight stiff competition from the established casino operators going forward.

Nonetheless, we believe that the whole process is a time consuming affair and the stock will likely be range bound until the license is won. Year-to-date, the stock is down approximately 74% and we believe that Zynga’s core business (social gaming) needs to perform in order to gain investor confidence in the near term.

Thus, we remain Neutral on Zynga over the long term (6-12 months).

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