3 Risks Zynga Should Worry About

Danny is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Thanks to tech media buzz, no one has a good excuse to miss the low prices on Zynga (NASDAQ: ZNGA) if it takes off.  There is some shame, however, if you act or neglect without thinking beyond the low price.

To avoid the embarrassment, let’s examine Zynga's filings and ask: what are the top 3 risks from Zynga’s last 10-K and where do they stand today?

1. A Symbiotic Relationship

By the end of last year, Facebook (NASDAQ: FB) had made exclusive agreements with Zynga.  Prophetically, the filing notes that “Any deterioration in our relationship with Facebook would harm our business”. In 2012, deterioration ensued.

As a result, Facebook is experimenting with monetization that could wean itself off the 12% that Zynga contributes toward its total revenue.  Despite a dizzyingly fluctuating board of directors, Zynga seems set on a strategy for “real money gaming” to bring casino games into browsers.

To catch Zynga at a low price, watch for milestones that prove it can survive without Facebook’s platform, especially in the mobile space.  Next, watch for studio acquisitions or announcements about a diversity of games; Zynga isn’t a leading genius by bringing poker online.  Zynga’s huge Facebook name doesn't carry as much weight in those saturated markets unless they can smoothly transition customers onto the non-Facebook platforms.

2. Management of Whales

In the free-to-play business model, “whales” are the players that actually make purchases.  To an experienced software developer, it’s worrisome to see whales listed as a risk.  This “risk” should be a designers’ duty that is in line with a product manager’s vision for a title.

Of course, that comes from a familiarity with Activision Blizzard (NASDAQ: ATVI) and Riot Games (Private).  Blizzard smoothly monetizes off both a subscription and microtransaction model for its World of Warcraft title, while a real-money auction house lets players sell in-game goods for cash in Diablo 3.  Riot monetizes from optional features that players can purchase without impacting the game.

Those two companies deal with this “risk” with an asset Zynga hasn’t established: a connection to community.  Rival Electronic Arts (NASDAQ: EA) can be said to have just as disconnected a relationship, but this just shows the importance of platform independence.  Unlike Zynga, EA launches titles for multiple platforms, including consoles, Facebook, iOS, and Android.

You’ve a good eye if you’re beginning to see these risks are connected.  The unfortunate reality is that whales burn out if designers overwhelm players with monetization and repetitive gameplay. No matter what the design, though, this third risk will also do the trick.

3. Reckless Saturation of Games

The aforementioned mobile platforms from Apple and Google are mature enough to offer a clear message to developers: you are one of many.  The gold rush is over, and Zynga made much of their success on Facebook's rush.

The reason that platforms are so important is that Zynga has likely reached a threshold with regards to the behavior of whales on Facebook.   Without expanding to other platforms or genres, the hope is that whales hop from one game to another of your games; the numbers are no longer growing with new sources of revenue.

The filing notes that a majority of revenue comes from a small subset of Zynga games.  Not controlling your own saturation means your games and your teams compete against themselves.

Show Some Innovation, Zynga!

Because of the foray into real-money gaming, it's tempting to pick up Zynga as a long-term investment.  Unfortunately, they haven’t yet proven themselves as solid innovators in new platforms.

Until they announce something like a geography-based betting game that shows solid installations on Android or iOS, or a Nintendo Wii U title, Zynga looks as appealing as a game request in a Facebook notification.

Dig Deeper

Zynga's post-IPO performance has been dreadful, and investors are beginning to wonder if it's game-over for this newly public company. Being so closely related to the world's largest social network can be a blessing and a curse at the same time. You can learn everything you need to know about this company and whether they're a buy or a sell in The Motley Fool’s new premium research report. Don't even think about picking up shares before you read what the Fool’s top tech analyst has to say about Zynga. Click here to access your copy.  

dfavela owns shares of Activision Blizzard. The Motley Fool owns shares of Activision Blizzard and Facebook and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Activision Blizzard, Electronic Arts, and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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