Microsoft Corporation (MSFT), Electronic Arts Inc. (EA): Is Zynga Inc (ZNGA) Finished?

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Zynga Inc (NASDAQ:ZNGA) is a leading provider of social games, with 123 million monthly unique users spanning the globe. The company primarily collects money through the sale of virtual goods in its games, and is best known for the popular Farmville franchise. Zynga Inc (NASDAQ:ZNGA) is unfortunately goring through a difficult period, with ongoing concerns ranging from casual-user fatigue to competition and marketing constraints following a major shift in management, as well as the recent decision to lay off over 500 employees.

Zynga Inc (NASDAQ:ZNGA)

Next generation risk

The upcoming launch of  Microsoft Corporation (NASDAQ:MSFT)'s Xbox One may place pressure on Zynga Inc (NASDAQ:ZNGA)'s key metrics – especially if it steals any portion of the 2.5 million users that drive virtually all of the company's revenue. I believe that hardcore gamers play a mix of games, and their use of social-game platforms does not preclude them from playing traditional console games. If this were not the case, we would not see record-breaking sales of traditional games like Call of Duty: Modern Warfare (which raked in $1 billion in sales over 16 days).

According to analysts at Janney Capital, there is a substantial risk that 60% to 80% of Zynga's 2.5 million users are  likely to shift their time and spending to next-generation systems at the expense of casual games.

In Zynga's defense, according to former CEO Mark Pincus, the company sees its peak hours during work hours, where consoles are not able to compete. Unfortunately for Zynga Inc (NASDAQ:ZNGA), Microsoft Corporation (NASDAQ:MSFT) is also developing games for its Windows-based smartphones, and will also offer many of its popular games to iPhone and Android phones later this year. Windows 8 users can currently play games such as Halo: Spartan Assault using their usual Xbox Live gamer profile.

Gamers are migrating elsewhere

A lot of the growth expectations around social games are what I believe to be overly optimistic, which over a long enough term will dictate a shift to other gaming platforms. With Zynga failing to impress users with any new popular games, the company has seen declines in its user base. Monthly unique users (MUU) have declined for the past year, and engagement is down 22% over the past two years. Monthly unique payers have also declined from 2.5% of MUU in 1Q 2011 to only 1.5% today.

The success of Zynga Inc (NASDAQ:ZNGA)'s games makes it easier for the company to advertise its other games. However, this may increasingly be a vicious cycle, as a drop in MUU and lack of popular games makes it more difficult (and expensive) to market its titles and attract new customers.

Xbox isn't the only form of competition

There are relatively low barriers to entry in the casual-games business. Developers can create games for a fraction of the cost of traditional console and PC games, and can get mass distribution via online platforms and downloads on Apple's iTunes and Google's Playbook.

We are also seeing a number of well-capitalized companies enter the space, such as Kongegate, owned by the largest game retailer GameStop, and Disney's Disney Games. Zynga Inc (NASDAQ:ZNGA) is also threatened by traditional developers like King, which recently surpassed Zynga's once-coveted status as the largest platform on Facebook with roughly 160 MUU. As of March, King's (highly addictive) Candy Crush Saga surpassed FarmVille 2 as the most popular game on Facebook, with 46 million average monthly users.

What company is worthy of an investment?

Electronic Arts Inc. (NASDAQ:EA) is one of the largest independent publishers and distributors of interactive games for all platforms, including game consoles, PC's and handheld devices such as mobile phones and tablets. What impresses me most about this company is that it understands mobile and is able to monetize accordingly.

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