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Electronic Arts Inc. (EA), Zynga Inc (ZNGA): Beware This Sweet Gaming IPO

King, the maker of Candy Crush Saga, is reportedly eyeing an initial public offering. While this single game is hot today, Zynga Inc (NASDAQ:ZNGA)’s fall from grace should be ample warning to investors. Most would be better off sticking to giant video game maker Electronic Arts Inc. (NASDAQ:EA).

Electronic Arts Inc. (NASDAQ:EA)

Casual Games

While it may be hard to believe today, there was once no such thing as a casual video game. Sure, games like Sim City and Tetris captivated a wide audience, but that demand was still focused on computer users at a time when computers weren’t mainstream. Other games, meanwhile, were mostly geared towards kids.

The start of the casual market really came about with Nintendo’s Wii game console. That game machine’s motion-sensing controller radically altered the game experience. With a focus on family-friendly fare, sales at Nintendo rocketed from $500 million in 2003 to $1.8 billion in 2008.

That’s been the high water mark, however, as sales have fallen every year since then and are now about a third of that peak. Making matters worse, the company brought out an updated version, Wii U, and sales have continued to fall. Clearly, the company lost its mojo in the game market.

With Sony Corporation (ADR) (NYSE:SNE) and Microsoft Corporation (NASDAQ:MSFT) slated to bring out new game consoles at the end of the year, investors should avoid Nintendo.

Hardcore vs Casual

Hardcore gamers tend to be very loyal to both game systems and games. These players will spend huge sums on the best equipment (like an Xbox or PlayStation), spend hours building up their skill at a game, and then happily buy additional installments of a game to continue the experience. Casual game players aren’t asked to invest as much in simple, often free, casual games and thus move on to the next big thing as soon as they get board.

That’s been the experience of Zynga Inc (NASDAQ:ZNGA). The company came public amid huge expectations that it would dominate the casual game market by giving away free games and charging customers for in-game purchases. However, there were big problems with the company’s model from the start.

A Social Issue

For example, it relied almost exclusively on Facebook Inc (NASDAQ:FB) for customers. While Zynga Inc (NASDAQ:ZNGA) has broadened out, it hasn’t been able to find a ready customer base to offset its reliance on the most-used social network. That’s a huge business risk, particularly since the social network model is relatively new and still changing rapidly.

Second, there are few barriers to entry in the casual game market. Facebook Inc (NASDAQ:FB) has no loyalty to Zynga Inc (NASDAQ:ZNGA), it’s happy to collect revenues from anyone who makes a popular game. And, since there’s no switching costs, customers have very little loyalty either. If Nintendo can’t keep customers who have paid hundreds of dollars for a game console, Zynga shouldn’t have expected to be able to keep customers who paid nothing.

Zynga Inc (NASDAQ:ZNGA) is losing money, restructuring its business, closing facilities, and just hired a new CEO. After quickly running up more than 40% after the IPO, shares are now trading around 80% below their $14 high reached in early 2012. Investors should avoid the stock, but keep the lesson in mind as King moves toward its own IPO, backed primarily by the brand recognition of a currently hot game.

Better Option

Instead of following the next hot game into a risky IPO, investors should take a look at Electronic Arts Inc. (NASDAQ:EA). The company has struggled of late, with sales declining year-over-year in each of the last four quarters. Still, it has a solid lineup of games and has been strategically pushing into the casual game market.

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