The Number 1 Reason To Avoid Zynga

| About: Zynga (ZNGA)

The most frightening detail that I have ever heard about Zynga (NASDAQ:ZNGA) was revealed recently on Reddit by someone claiming (and providing fairly convincing proof) to be an ex-employee of the social gaming company. The full topic is available here and certainly worth reading for anyone who's long or short Zynga shares, or just for anyone curious about how Zynga's business (supposedly) works.

However, there's one particularly important fact exposed that is worth focusing on, as I believe that it shows how Zynga's business model is fragile at best, and evil at worst. The ex-employee states that Zynga carefully tracks and targets users who have spent over $10,000 on game purchases. Zynga apparently even has a name for these users - they're called Zynga Black.

It's baffling that anyone would spend $10,000 on virtual tractors, tower upgrades, and not-for-profit poker, but it's even crazier that Zynga is building its business around maintaining those users. Maybe Zynga knows something that I don't know, such as that those users have nearly infinite money and don't mind blowing it on internet games. But I would think that rationality supports the fact that those users are a tiny, and almost certainly shrinking, pool - who can waste that much money regularly, and not hate himself for doing so? And is it really fair to pray on someone who may be seriously addicted to online gaming?

There is additional discussion in the responses to that statement about what percent of players spend sums that significant. The ex-employee claims that it's 5%, but that is quickly debunked by a responder extrapolating that percentage to $50 billion in revenue for Zynga, which is about 50 times too high. However, the ex-employee goes on to elaborate that Zynga's strategy is to create and implement features that convince big spenders to spend more, solidifying his point that Zynga's focus is on milking many dollars out of a small percentage of users. He also states that when Zynga creates and modifies games, it isn't adding features that make gameplay more fun; it adds features that get heavy spenders to spend more.

So why is this a bad thing for Zynga shareholders? To me, it just seems as though such behavior cannot be sustained by the playing individuals nor cultivated by Zynga over the long term. Maybe the Redditor wasn't telling the full story; surely, Zynga must also focus on the users who are spending small sums of money, in an effort to keep them interested and gradually boost revenue per user. But to me, this seems like a near-sighted strategy meant to boost short-term results that sacrifices the ethics of the company and the quality of its games.

There are many other often-cited problems with Zynga. It is notorious for copying other companies' games; the most recent and high-profile example is Tiny Tower. While other companies have been successful by competing very aggressively [such as Microsoft (NASDAQ:MSFT) in its earlier days], Zynga just seems to do it more brazenly and shamelessly than others. Again, this strategy may work well in the short term, as it can keep its large user base happy with clones of popular games, but a company that cannot innovate (especially in industries like smartphone apps and internet games) seems likely to not last long.

I have no position in Zynga, but after its recent Facebook IPO-induced run-up, now seems like it might be a time for bulls to take a breather and for bears to consider shorting.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: I can not independently verify the facts about Zynga; I am relying on the accuracy of supposed ex-employee "mercenary-games" published into a public record.

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