Exclusive: Pachter Examines Zynga’s Flailing, Sees Wii U Failing

Moments before our interview at [a]list Summit Seattle, Wedbush analyst Michael Pachter looked down at his phone and started walking.

“Something’s happened with Zynga,” he called back and disappeared around the corner.

Zynga had just revealed that it expected a net loss of about $100 million for the third quarter despite beating revenue forecasts. It blamed costs of up to $95 million related to its acquisition of Draw Something maker OMGPOP.

Zynga purchased OMGPOP for $180 million in late March of this year. Notoriously, the company’s biggest hit Draw Something began bleeding users from its peak almost immediately afterward. In the month following the acquisition, the game’s daily active users (DAU) fell by more than a third. The write down on the deal represented yet another open wound in Zynga, a company that seems to be punctured head to toe as it deals with plummeting share price, shrinking market cap and its now legendary senior management exodus.

Just last February, Pachter had delivered the keynote at [a]list Summit San Francisco where he countered the notion that Zynga’s earlier success could represent a social game bubble.

We warned him we would be asking for currency on his take on the company. We never imagined something else in Zynga would pop before our interview. Being the unflinching and always accessible pundit who he is, Pachter agreed to the interview anyway. Besides Zynga, we also got him talking on the upcoming launch of the Wii-U.

[a]list: Do you stand by your earlier take on Zynga or do you now think there’s something fundamentally wrong with their business?

Michael Pachter: I think the problem with Zynga is they’ve given us way too much choice, way too much quality and satisfaction, and less of a reason to spend money. So where I was wrong was, I thought they would continue to monetize and hook people. Their strategy backfired. They’ve given us so much choice we don’t have to spend money.

[a]list: Can they turn it around?

Michael Pachter: I think that Zynga’s biggest problem is they started out as a free to play company, and so as they grow users they don’t necessarily grow revenues. They have to figure out how to monetize every user. The simple way to do that is advertise. Make this commercial supported gaming. If you don’t spend money you have to sit through ads and if you spend money you don’t. So the Words with Friends model, where you can pay three bucks and opt out of ads, I think that’s fine.

I have to say, I actually think the right model for them would be if you pay a dollar, and the dollar goes as a credit in the game so you can spend it on in-game items if you want to, but if you deposit a dollar each quarter, no ads for three months. If you got four dollars a year out of each of their 311 million actives, that’s more revenue than they’re making now. That alone I think would solve their problems, and then the whales would still spend — you know, two percent of them would still spend $100 each. I don’t know why they don’t do that. I think that’s the fix. I think the reason it hasn’t been fixed is, nobody wants to be first to do that.

If the alternative to spend a dollar is watch a dollar’s worth of ads over 90 days, I mean again, if you deliver the ads with the frequency — call it a penny per ad impression — which really is something they could do, that’s one ad per day. If it’s a tenth of a cent per ad impression, it’s ten ads a day. If you’re going to play the games as often as most people do, that’s just not that hard to sit through.

The crazy thing, I play Words with Friends and the ads come after I play my word. Well after I play my word, I’m done. The only reason I need to sit around is I might want to move to the next game, because I might have multiple games going. I don’t get why there’s not an ad when I load the game. To me, that’s just lame. Make me sit through the ad before I play my word because I’m there, you know? I’m going to play my word. If I want to play one game, I can close it out. And if I load it up again I can play the next game. I’m not sure they’re particularly thoughtful about ad delivery, but I think that’s the big opportunity.

[a]list: Nexon has done well for itself in free to play social and mobile games, and they’re experiencing continuous growth in the category while Zynga’s headed in the other direction. What would you define as the core difference between these two companies and why one’s thrived while the other is struggling to find its business model?

Michael Pachter: I think Nexon probably derives 85 percent of its revenues in Asia, and Zynga probably derives five percent of its revenues in Asia. That’s the primary difference. Nexon is significantly less successful in North America and Europe than Zynga is. I think Nexon has a great Asian model that I think they’re doing a very effective job of exporting to the West. But they started with the Asian model, and they designed their games for Asian markets, so they’re far more effective and they’re set up differently. There’s room for both. Zynga doesn’t have any games that are like Nexon games. Nothing. They’re different models.

[a]list: The Wii U is priced and ready to ship. We know you have strong opinions on the console and Nintendo’s hardware strategy. We’d be remiss not to ask you for final thoughts with their next launch on the horizon.

Michael Pachter: I’m not a fan of the console. Essentially I look at the GamePad and the television, the two screens, and I see a DS that’s disaggregated. It’s very similar to playing a DS game. The difference is, with the DS your line of sight is on both screens. It’s easy to toggle back and forth. With the GamePad on the Wii U you have to look back and forth, and that’s not natural.

I understand the console is going to be way more powerful than the DS. It’s entirely possible you’ll get great experiences that are console-like but take advantage of the touch screen. But I think most developers look at the GamePad as either a gimmick or very DS like, and they don’t want to incorporate the touchscreen features because the games aren’t any better for them.

Nintendo will pioneer, they’ll do a far better job than anybody of exploiting the console and the control scheme, and I think others will learn from them. I’m afraid we’re going to have a repeat of the Wii cycle from the publishers’ perspective and the developers’ perspective, where very few people will support it. Then if it’s successful they’ll come in, and they’ll fail. When they fail, they’ll go away again. The reason I think they’ll fail is, I can’t think of a third-party publisher that did well on the DS. I mean, Scribblenauts, so there are a handful games and you can count them. Nobody did very well on the DS, and I don’t think anybody’s going to do very well on the Wii U.

So my advice is, it will sell out until the hardcore Nintendo fan base has all their consoles, and I don’t know what that number is. They sold 90 million Wii’s, it’s certainly less than 90 million hardcore fans. I would guess it’s between seven and ten million, and it could be 20 million but they don’t all have $350. When the hardcore fans are satisfied, I think sales are going to drop precipitously because I don’t think the thing is priced competitively with what most people think is a comparable console, Xbox 360 or PS3. I think that this thing, rather than launching and being the cheapest of the three consoles, which the Wii was, and very novel because no one had ever seen motion control before, this console is launching and it’s the most expensive of the three consoles and it’s not novel because it’s very much like the DS.

The final complicating factor is, if you’re a gift giver, you have a choice of giving somebody a Kindle Fire in HD for $199 and standard def for $169, or perhaps an iPad mini which I’m guessing would be $299 but probably not more than the $349 price of the Wii-U, or a smartphone which is a couple hundred bucks if that. I think there’s a lot of competition at that price point for gift givers so I’m not sure this is the best solution for most people. I don’t think it’s going to succeed after its first six months or so, I think once it’s done selling out it’ll really surprise people and its price will have to come down.

[a]list: Thanks, Michael.