Why Zynga Will Never Be Great Again

Facebook isn't the only multibillion-dollar business that was hatched just a handful of years ago. Zynga (ZNGA) named after CEO Mark Pincus' late yet loyal bulldog, is less than five years old.

When Zynga began, social gaming was just about to get off the ground, and the company proved to be a quick learner. Zynga may not be a household name yet, but with a growing portfolio of sticky games including FarmVille, Words With Friends, and Empires & Allies, this bulldog of a company has become the undisputed champ of casual games played on Facebook and smartphones.

Math with Friends

When Zynga went public at $10 two months ago, critics blasted the company's valuation. With more than 700 million shares outstanding -- and counting -- was Zynga really worth $7 billion? Electronic Arts (EA), the country's second-largest traditional video game company, only commanded a market cap of $6 billion.

Bears won the first round. The IPO opened at $11, but Zynga consistently closed in the single digits through the first six weeks of the social gaming leader's publicly traded life.

Facebook put Zynga on the map, and the social networking behemoth with a whopping 845 million active users bailed out Zynga investors when it filed to go public. Buried deep in Facebook's prospectus was the revelation that Zynga accounted for 12% of Facebook's revenue. If Facebook was worth the $100 billion that some optimists were targeting, surely Zynga could justify a price tag closer to $10 billion.

Zynga's shares began to climb, peaking at $14.55 on Tuesday just before its fourth-quarter report.

Fertilizing the Farm

Zynga's first quarter as a public company was strong, but it poses some problematic questions.

Bookings -- a more telling metric for Zynga's business than traditional revenue -- grew 26% to $306.5 million. Growth has been decelerating lately, and it's not going to get any better. Zynga expects $1.35 billion to $1.45 billion in bookings for all of 2012, a 16% to 25% spurt over 2011. Will Zynga's growth rate ever accelerate?

Don't worry about the loss that Zynga posted for the holiday quarter. It is largely the handiwork of one-time stock-based compensation expenses triggered by its move to go public. Adjusted earnings weighed in at $0.05 a share, well short of the prior year's $0.09-a-share showing. Zynga sees a profit of $0.24 a share to $0.28 a share in 2012, and that's not a whole lot better than the $0.24-a-share adjusted earnings it rang up in 2011. Where has this gone as an earnings growth story?

Zynga will have roughly 890 million fully diluted shares outstanding by the end of this year. Based on Tuesday's high, that translates into a $13 billion market cap. Zynga went public valued more than Electronic Arts. Is it really worth nearly as much as video game leader Activision Blizzard (ATVI) now?

Sticky Situation

No one can argue that Zynga isn't massive. There are 48 million daily active users, 13% ahead of where Zynga was a year earlier. There are now 240 million monthly active users, and that's a year-over-year advance of 23%.

These are big numbers, but what does it mean when monthly active users are growing faster than daily players? Is Zynga losing its stickiness?

It's a fair question. Pull up Zynga's prospectus and you'll be shocked to see that faithful daily players are moving on. There were 62 million daily active users throughout Zynga's network of games during last year's first quarter. Daily visitors slipped to 59 million during the second quarter, 54 million during the third quarter, and 48 million in its latest reporting period.

Zynga has been able to overcome the sequential slide by growing its monthly users and milking more revenue out of every player, but how will investors react next quarter when daily average users are showing a year-over-year decline?

Toying Around

Investors applauded when Zynga teamed up with Hasbro (HAS) earlier this month on a deal to make toys based on Zynga properties. Holiday shoppers made Mattel's (MAT) Angry Birds game one of last year's best-sellers; what can Hasbro do with CastleVille?

The pairing was ironic, as I tweeted at the time:

Seriously, though, this has all the makings of a "jump the shark" moment, where Zynga's on the brink of losing relevance.

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It won't be the first time. Zynga learned about the fickle nature of gamers last year when Mafia Wars 2 failed to retain the gamers who enjoyed the original Mafia Wars.

Isn't that the problem with all of these social gaming companies? Zynga scrambled to put out a dozen games last year. Some will stick. Some will not. However, the developer barrier is low. The playing field is surprisingly level. The same path that Zynga took to grow so quickly will be followed by the next company to land the next FarmVille.

Zynga's stock may inch higher in the future. If online gambling rules are eased, investors will rally around Zynga's fledgling social poker game. Just because Mafia Wars 2 was a flop doesn't mean that Mafia Wars 3 will be a dud. The rub for investors is that Zynga is already being priced as if it has a market cornered that clearly will fluctuate in the coming years.

It's been an amazing five years for Zynga. The next five won't be as easy.

Longtime Motley Fool contributor Rick Munarriz does not own shares in any stocks in this article. The Motley Fool owns shares of Activision Blizzard. The Fool owns shares of and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Hasbro, Mattel, and Activision Blizzard, as well as creating a synthetic long position in Activision Blizzard.