Zynga (ZNGA) is a game developer known primarily for creating popular casual games designed for social media platforms such as Facebook (FB). The company's market capitalization currently sits at a cool $5.20B as of last close. I believe that this company is significantly overvalued at current prices and it should be avoided.
Why? Well, first of all it's helpful to understand just what Zynga does. The games they create are not particularly difficult to write compared to the high budget, triple-A games that come from the larger publishers such as EA Games (EA) and Activision-Blizzard (ATVI). In fact, their games are sometimes even shameless clones of games that have already been available.
Don't believe me? Zynga's recent release, Dream Heights, is actually a clone of a game called "Tiny Tower" (that was developed by a team of three developers, no less). Their other games? "Words With Friends" is just Scrabble. And the rest of the games they put out, like "FarmVille" and "CafeWorld", are incredibly simplistic and have the mass appeal that they do because they're fairly addictive and easy to play.
So, okay, they make unoriginal, easy to play games with mass appeal. Yes, there's absolutely a market for these games, and a good amount of ad revenue can be generated because advertisers know that a huge number of folks are playing these games. However, the valuation is just too high, especially compared to its peers. Let's examine this further.
EA's market cap sits at $4.88B; less than Zynga's! EA, if you're unfamiliar with them, makes a wide variety of very popular games that people actually pay to play across many platforms, including the PC, Microsoft's (MSFT) Xbox 360, Sony's (SNE) Playstation 3, and mobile devices such as smartphones, tablets, and handheld gaming systems. They develop and publish many popular sports games such as "NBA Live" and "Madden NFL", first person shooter games such as "Crysis 2" and "Battlefield 3", real time strategy games such as "Command & Conquer", and casual games such as "The Sims". Let's not forget that they're expanding to try to capture market share in the very lucrative MMORPG segment with "Star Wars: The Old Republic".
With a very rich and diverse portfolio of high quality intellectual property and games that are selling extremely well, it's baffling to see EA worth less than Zynga, a company that makes easy to replicate games that rely mainly on ad revenue.
In order for Zynga to be worth what it's currently trading at, it needs to have some very significant growth prospects. Sure, they can keep creating these simple addictive games to keep the current user base interested, but that's not going to drive massive revenue or EPS growth. The traditional game publishers such as EA and Activision-Blizzard could very easily muscle in and produce games with similar mass appeal for any and all of the platforms they currently develop on. And while stealing the casual business away from Zynga with relatively minimal investment, they will continue to generate significant revenue and profits from their core games.
I wouldn't be so sure about Zynga ever encroaching on the big boys' turf. It's a whole heck of a lot easier to write a flash game than it is to write a sophisticated 3D game. In fact, most of Zynga's games would probably qualify as solid efforts for a college software engineering course. A game like "Mass Effect 3" takes years of the best and brightest artist, software engineers, musicians, and game designers to create.
If you want to buy Facebook, buy Facebook. If you want to buy the games industry, buy EA or Activision-Blizzard. In no case should you buy Zynga.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.