The Motley Fool has been making successful stock picks for many years, but we don't always agree on what a great stock looks like. That's what makes us "motley", and it's one of our core values. We can disagree respectfully, as we often do. Investors do better when they share their knowledge.

In that spirit, we three Fools have banded together to find the market's best and worst stocks, which we'll rate on The Motley Fool's CAPS system as outperformers or underperformers. We'll be accountable for every pick based on the sum of our knowledge and the balance of our decisions. Today, we'll discuss Zynga (NAS: ZNGA) , the online social-gaming company.

Zynga by the numbers
Zynga is still a relatively new company on the public market, completing its IPO this past December. Here's a quick snapshot of the company's most important numbers.


Result (Most Recent Available)

Revenue $1,140 million
Net Income ($404.3 million)
2011 Stock Based Compensation $600.2 million
Market Cap $9.2 billion
Key Titles Farmville, Zynga Poker, Words With Friends, Draw Something
Users 240 million monthly active users
Key Competitors Electronic Arts (NAS: EA)
Activision Blizzard (NAS: ATVI)
Glu Mobile

Source: Zynga 2011 annual report.

Here's what we each think of the company's business model and prospects.

Travis' take
I must admit that the amount of revenue Zynga has been able to generate and the rate it has grown are both impressive. The company has also been able to continuously invent new games that keep users engaged. I just wonder how long it can last, since Zynga doesn't actually sell anything tangible and its competitive advantage is as fleeting as the whims of virtual gamers.

So far, Zynga hasn't faced a lot of competition from big players in the industry because they've been slow to react to the social-gaming scene. Electronic Arts, Activision, and Microsoft (NAS: MSFT) have maintained focus on their big-ticket console games, but with Zynga's success, I doubt that will continue. Microsoft has Xbox Live on the iPad, opening gaming possibilities, and Electronic Arts is growing its presence in mobile games. Small developers may pose the biggest threat, as OMGPOP proved before Zynga wisely snapped up the company.

If you want a good reason to avoid Zynga, all you have to do is look at the company's SEC 10-k filing and check out the "Risk Factors" section, which is lengthy. One of the headings says, "There are low barriers to entry in the social game industry, and competition is intense." That means that two of the five forces in Porter's Five Forces are extremely weak for Zynga -- not a position I like my investments to be in.

I think Zynga will underperform the market, and a long Activision/short Zynga trade may be a good way to play the industry. A trade like this puts investors long a profitable, established company in the industry versus a young hot shot whose bubble may be about to burst.

Alex's take
Is Zynga a top stock? No. No, it is not. It is not an OK stock, either. It is a stock I would stay far, far away from.

I wanted to like it at first. I even played Empires and Allies on Facebook for a while. I had a lovely island full of crops and factories, with many complete strangers willing to click on my crops and factories to help them along. It was fun, for about a week. Then I maxed out, most of my loyal clickers got bored and stopped clicking, and I was left with a ton of wilted crops and idled factories. The few remaining loyal clickers whined plaintively about being blocked from spamming my Facebook wall with requests for fish or howitzers or something. I had to eliminate all traces of it.

This turns out to be a rather appropriate microcosm of Zynga as a company. It seems that much of the company's user growth happened very early in its existence. According to these graphs, the number of Zynga's daily and monthly active users have been flat to declining for almost two years, despite having taken less than three years to reach that peak. Compare that with Activision Blizzard's World of Warcraft, which and took a full four years to reach its highest subscriber count.

Zynga has launched several high-profile games in the past two years. Where are the new users? It seems likely that Zynga relies on those loyal clickers to keep its user base stable. Since so few of them actually buy anything, it becomes a bit like trying to squeeze oil out of a tapped well. In time, there won't be enough left to click on Zynga's crops. Profits may wilt! That may be why CEO Mark Pincus is already looking for an exit, filing to sell 15% of his shares less than half a year after going public.

Don't count on mobile gaming to save Zynga, either. Glu Mobile has never been profitable despite a stable of more than 50 mobile games -- offered "freemium," the same format Zynga prefers. Zynga's OMGPOP acquisition reeks of desperation to me, as that studio had no real success before Draw Something, and that game's already been displaced from its perch atop the App Store leaderboard. Is a one-hit wonder worth $200 million?

No, and I don't think Zynga's worth your money, either.

Sean's take
Zynga is social-media time bomb just waiting to go off, and, like the bomb squad, I'm running in the opposite direction. Despite rapid sales growth and the popularity of its Facebook-based games, Farmville and Mafia Wars, there are far too many weaknesses that could topple Zynga.

For starters, to echo Travis, the barrier to entry into social gaming is incredibly low, while the research costs associated with new games is incredibly high. According to Electronic Arts vice president Jeff Brown, video-game development costs could rise 200% for the next-generation consoles (which, may I add, are right around the corner). Between the added competition on Facebook from EA and rising development costs, I don't see Zynga maintaining its torrid growth pace.

That leads me to my second key point: Zynga's slowing growth. If you look past the initial 91% pop in year-over-year revenue from 2010, you'd see a rapid decline in sequential revenue growth from 15% in Q1 leading to Q2, to 10% into Q3, and just a paltry 1.4% sequential growth in the fourth quarter. To me, it looks as if Zynga's days of high-growth are already gone.

Finally, we have Zynga's brutally lopsided revenue stream, which relies on Facebook for about 90% of its revenue and Google (NAS: GOOG) for another 5%, approximately. Facebook wields far too much control over Zynga's financial well-being for my liking. It also doesn't help that, of Zynga's 240 million gaming members, less than 3% of them are paying customers.

With numbers like these, I'm not quite sure how anyone would be excited to own Zynga. I'm almost tempted to call the bomb squad and give them advance warning of what I think is an impending disaster.

The final call
The group is unanimous (for once). None of us is a fan of Zynga, and we will add an underperform CAPScall on the stock on our YoungGuns CAPS page. Zynga may not be an analyst's top pick, but there is one stock that The Motley Fool has called its top stock of 2012. Find out what it is in the free report here.

At the time this article was published Fool contributors Travis Hoium, Alex Planes, and Sean Williams have no positions in any companies mentioned. You can follow Travis on Twitter at @FlushDrawFool, Sean at @TMFUltraLong, and Alex at @TMFBiggles.The Motley Fool owns shares of Activision Blizzard and Microsoft and has written calls on Activision Blizzard. Motley Fool newsletter serviceshave recommended buying shares of Microsoft and Activision Blizzard, creating a synthetic long position in Activision Blizzard, and creating a bull call spread position in Microsoft. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Increase your money and finance knowledge from home

Introduction to Economic Indicators

Measure the performance of the economy.

View Course »

Understanding Stock Market Indexes

What does it mean when people say "the market is up 2%"?

View Course »

Add a Comment

*0 / 3000 Character Maximum

1 Comment

Filter by:

These articles are becoming tiresome.

I remember when Google went public, how many 'stock pickers' and individuals that write blogs said it was a company without a future. A company with revenues that came from one thing - ADS. How they couldn't increase said revenues. Everyone said, "there is no way this company will make any money and will end up fizzling". Look at them now.

The one thing I see that gets repeated quite a bit is the comment regarding how their growth is slowing down. How long is a company that makes online games supposed to continue adding millions of new online players? How many people are NOT online, or even Facebook for that matter. After adding a few hundred million users, you would think 'analysts' would look at it and say, "you know what, they have quite a few customers for how long they've been in business", kudos, instead of repeating over and over and over that 'you think their growth is slowing'. What's comical to me is that eventually, they wont add any more customers. There is a finite supply of video gamers, a finite supply of people who use the internet and a finite supply of those with something as simple as access to the internet.

A few things that everyone casually forgets to mention.

1) They have the #1 rated online poker game in the world with approximately 43 million players. Regardless of what everyone wants to agree or disagree to, there is a LOT of talk about loosening gambling restrictions online. With states that have lopsided budgets, the added money from taxing online gambling revenues could be in the billions - closing any budget holes that might be there. Three states have already passed legislation allowing people to play against other players from their states. Now granted. If this never comes to fruition, it really does't matter. But if it DOES... Zynga is poised to be the leader in online gambling with revenues increasing into the billions.
2) Facebook gets 13% of their revenues from Zynga. That says a lot in and of itself. They have an agreement through 2015 which guarantees them everything they currently have. People say, "they need to be less reliant", so what did they do? Open Zynga.Com. Everytime the market indicates they think Zynga should do something - THEY DO IT.

I'm running out of characters so I'll finish this up.

Zynga is labeled as a company that will do anything to make a profit. Short of murdering, abusing, physically harming or just straight pilfering someones code - THAT IS THEIR JOB! No one cries foul when people die at Foxxconn making the Ipad you're viewing this on. Appe, Microsoft, Google, I could go on. They all were cut throat and profited off the backs of others.

Personally. I am glad they publically executed the one engineer at OMGPOP who said Zynga was evil. He's an idiot.

I am a shareholder. So are a lot of other people. We all want Pincus to do anything not-criminal to increase revenues to increase the PPS - it's the only reason we are even discussing this.

April 05 2012 at 6:38 PM Report abuse +1 rate up rate down Reply