Shares of social gaming giant Zynga Inc (NASDAQ:ZNGA), the company behind hit Facebook Inc (NASDAQ:FB) titles like Farmville, slumped over 10% in the after-hours session the other day. Although the company’s earnings exceeded expectations, the number of active players on Zynga Inc (NASDAQ:ZNGA) games dropped dramatically, and the company’s guidance for the future was weak.
This comes just about a week after Electronic Arts Inc. (NASDAQ:EA) said it would shut down three of its own social games: The Sims Social, SimCity Social and Pet Society.
With social gaming experiencing such a tremendous — and rapid — decline, it might be time to pronounce the fad effectively dead. This could have repercussions for EA, Facebook Inc (NASDAQ:FB) and (quite obviously) Zynga Inc (NASDAQ:ZNGA).
Social gaming is inherently prone to fads
To some extent, all forms of entertainment are prone to fads, particularly video games. Over the last 20 years, both the types of games and the companies making them have undergone both rapid rises and dramatic falls.
The Guitar Hero series, for example, took the world by storm in 2005, leading to numerous high grossing sequels (Guitar Hero III is said to have grossed over $1 billion). But by 2011 — just six years later — Activision opted to shutter the series indefinitely.
This is why I recommend investors stay away from video game stocks over the long-term. The investing world is littered with the corpses of failed video game companies. That said, social gaming is even more fad-prone than traditional video gaming. The very term implies it.
On average, social games are significantly more shallow than their traditional console and PC counterparts. But, because they thrive on the power of social networks and reward players for recruiting new members to the game, the games can grow incredibly popular — at least for a time.
At some point, players get bored. And just as quickly as the game rose to prominence, so too can it fall into obscurity. To stay successful, social gaming companies must continue to produce hit game after hit game.
Zynga Inc (NASDAQ:ZNGA) bought rival OMGPOP early in 2012 for $180 million. The transaction was primarily facilitated on the popularity of the company’s hit title, Draw Something. But literally just a few months after buying it, Draw Something’s popularity completely collapsed.
EA has minor exposure to social gaming
Although it remains a video game giant with a number of diverse businesses and franchises, EA does have some exposure to social gaming. Unlike rival Activision, EA has pursued social gaming aggressively — perhaps more aggressively than any other traditional video game company.
On the company’s last earnings call, EA admitted that social hasn’t done well for the company and the overall sector is “softer.” Its exposure to social gaming isn’t going to take down the company, but it’s proven to be yet another poor investment.
With CEO John Riccitiello now gone, perhaps there’s hope that the company can clean up its act going forward. EA certainly has been poorly managed in recent years; its bet on social is just more evidence of that.
Facebook is partially reliant on social gaming
As the platform for most social games, Facebook Inc (NASDAQ:FB) is reliant on the popularity of these games for much of its income. In its S-1 IPO filing, the company identified the decline of social gaming as a negative risk factor.
We currently generate significant revenue as a result of our relationship with Zynga, and, if we are unable to successfully maintain this relationship, our financial results could be harmed…If the use of Zynga games on our Platform declines…our financial results may be adversely affected.
In its most recent earnings slides, Facebook Inc (NASDAQ:FB) notes that roughly 16% of its revenue came from “payments and other fees.” The company provides no breakdown for how much of this category is derived from social games, but reading the 10-K reveals that “substantially all of [Facebook’s] Payments revenue is from users’ purchases of virtual goods used in social games.”
There are, of course, many other companies that operate social games on Facebook Inc (NASDAQ:FB), and Zynga Inc (NASDAQ:ZNGA) has slowly weaned itself off of Facebook in recent months. But with both EA and Zynga struggling on the social gaming front, Facebook’s earnings could disappoint.
Investing in social gaming
Video game companies are lousy long-term investments. Social gaming companies are even worse. Given recent events, social gaming as a category looks to be imploding. New games could rejuvenate the sector, but investors shouldn’t bank on it.
The article The Social Gaming Fad Is Over originally appeared on Fool.com.
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