Zynga And Facebook: Pray They Don't Alter The Deal Any Further

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As Zynga Files For $1B IPO, LinkedIn And Pandora Stocks Pop

Minutes ago, social gaming giant Zynga filed its much-anticipated S1, beginning the path to an IPO in which it’s looking to raise $1 billion. We’re currently combing through the document, which lays out some of the company’s key statistics and financials for the first time. And there’s a clear trend: the word ‘Facebook’ appears in the document some 204 times (Google clocks in at 10).

The reasons for that should be obvious to anyone that’s tracked Zynga’s rise to success: the company is tied at the hip to Facebook Platform. It relies on Facebook’s viral channels, like News Feed and Notifications, to help its games grow. It’s reliant on Facebook’s Credits for monetization (Facebook now forces all games to use Credits). And it’s subject to whatever changes Facebook makes to its terms of service, or tweaks it makes to the way applications can interact with users. In other words, Zynga is warning investors that if Facebook changes the terms of their relationship, they’ll suffer.

But there’s one possible catch: an addendum that is repeatedly referred to throughout the S-1 that guarantees a 70/30 split between Zynga and Facebook on items purchased using Facebook Credits. The fact that an agreement exists isn’t news — Zynga and Facebook announced that they’d forged one last year after Zynga threatened to leave the platform. But the terms of their deal have been a mystery. And it seems like they still are.

Here’s the section that goes into most detail about the financial terms of the agreement:

Facebook Credits is Facebook’s proprietary virtual currency that Facebook sells for use on the Facebook platform. Under the terms of our agreement, Facebook sets the price our players pay for Facebook Credits and collects the cash from the sale of Facebook Credits. Facebook’s current stated face value of a Facebook Credit is $0.10. For each Facebook Credit purchased by our players and redeemed in our games, Facebook remits to us $0.07, which is the amount we recognize as revenue. We recognize revenue net of the amounts retained by Facebook because we do not set the pricing of Facebook Credits sold to our players.

That’s pretty straightforward (all developers are currently offered the 70/30 cut), but the S-1 alludes to some other aspects of the deal that are not described in the S-1 — namely, that it operates under modified Terms and Conditions compared to other developers (emphasis mine).

In 2010, we entered into an addendum with Facebook that modified Facebook’s standard terms and conditions for game developers as they apply to us and that govern the promotion, distribution and operation of our games on Facebook. In July 2010, we began migrating to Facebook Credits, and by April 2011, we had migrated all of our games on Facebook to Facebook Credits.

Whatever those adjusted terms are, they clearly don’t negate Zynga’s current reliance on Facebook.

All of the S-1’s financials are reported after first subtracting Facebook’s 30% cut whenever relevant, but it doesn’t look like Zynga breaks out just how much of their revenue is generated through Facebook, which is almost certainly a vast majority. I’m sure investors will be curious about that — and I’d also be eager to know just what kind of advantages the addendum gives Zynga over its competitors. Because on Facebook, even features that sound minor, like access to certain notification channels, can make all the difference in helping a game rise to massive popularity.

Of course, Zynga isn’t exactly without leverage. The company’s games continue to be a huge draw for users, and Facebook would suffer greatly if Zynga left the platform (especially if its games were available on a rival service, like the newly-launched Google+). Zynga’s deal with Facebook runs through 2015 so that doesn’t seem likely, but, again, it’s not clear exactly what that deal guarantees for both parties.

Here’s one relevant passage outlining how Zynga views its relationship with Facebook:

We have benefited from Facebook’s strong brand recognition and large user base. If Facebook loses its market position or otherwise falls out of favor with Internet users, we would need to identify alternative channels for marketing, promoting and distributing our games, which would consume substantial resources and may not be effective. In addition, Facebook has broad discretion to change its terms of service and other policies with respect to us and other developers, and those changes may be unfavorable to us. For example, in 2010 Facebook adopted a policy requiring applications on Facebook accept only its virtual currency, Facebook Credits, as payment from users. As a result of this change, which we completed in April 2011, Facebook receives a greater share of payments made by our players than it did when other payment options were allowed. Facebook may also change its fee structure, add fees associated with access to and use of the Facebook platform, change how the personal information of its users is made available to application developers on the Facebook platform or restrict how Facebook users can share information with friends on their platform. Beginning in early 2010, Facebook changed its policies for application developers regarding use of its communication channels. These changes limited the level of communication among users about applications on the Facebook platform. As a result, the number of our players on Facebook declined. Any such changes in the future could significantly alter how players experience our games or interact within our games, which may harm our business.