4 Signs Zynga Will Outperform

I'm writing this at 8:30 am on Sunday and I've already been up for four-and-a-half hours. Not because of a sore throat, or a nightmare, or a wicked deadline, but because I had to know if my empire had been invaded by my French, German, Asian, and Scandinavian neighbors -- none of whom I've ever met face-to-face. Bizarre? Crazy? Call it the curse of Empires & Allies, a Facebook game from Zynga that has its hooks in me. Deep.

Ba-Zynga!
No, I haven't taken on a Red Bull habit to fuel all-night digital benders. I still shower and I don't skip work to play E&A -- to the contrary, I'm writing about it -- but I'd be lying if I told you the game hasn't had an impact. Just a few minutes ago, I set my iPhone's alarm to remind me to tend to my virtual crops when they mature. (Even digital empires have bills to pay.)

This sort of obssessiveness explains why venture capital investors had no compunction about buying into the social gamer at a $10 billion valuation. Well, that, and Groupon-like growth without the losses. Today, six months later, Zynga is expected to go public at $20 billion -- a 50% premium to Activision Blizzard (Nasdaq: ATVI  ) , owner of World of Warcraft, one of the most popular online games of all time.

Before you conclude that's crazy, consider this.:

  1. With 11.4 million reported subscribers, World of Warcraft is currently the world's most popular massive multiplayer online role playing game (MMORPG).
  2. Yet Zynga's FarmVille and CityVille each drew more than 40 million monthly active users within their first 100 days of release.

Looking at the asylum from an inmate's point of view
All told, Zynga accounts for roughly 30% of Facebook's active user base, or more than 200 million users at last count. By contrast, the Facebook page for Take-Two Interactive's (Nasdaq: TTWO  ) Grand Theft Auto -- a billion-dollar franchise, as far as I'm concerned -- shows less than 1 million fans as of this writing. Electronic Arts' (Nasdaq: ERTS  ) Madden NFL franchise had less than 700,000 Facebook "likes." The disparity should be at least a little startling.

What's causing it? For one thing, Zynga lives on Facebook. Social games will always draw a wider fan base on social networks, especially when said network is the world's largest by a substantial margin.

But there's also stickiness to consider. Remember, WoW may be popular worldwide, but Zynga's two major franchises dwarf its subscriber base. Even Empires & Allies -- barely a month old -- already shows 3.1 million fans at its Facebook page. This can't be accidental momentum.

Here are four reasons why I think users are adopting E&A and Zynga's other games so quickly:

1. Peer pressure
The smartest thing Google did in creating Google+ was to steal Facebook's notifications system. Like a moth to a flame, each system's "you've got stuff to read" signposts attract and keep my attention. The result? Deeper engagement. Zynga knows it, too. The social gamer uses notifications to tell me whenever there's E&A news -- such as when an ally wants something. The resulting peer pressure draws me in, making it ever more likely I'll spend real dollars on virtual goods.

2. Compelling offers
Zynga works with a wide variety of partners whose promotions are offered through its games in exchange for virtual power-ups. In E&A, they're called "empire points." Sign up for one of Discover Financial's (NYSE: DFS  ) credit cards, and you'll kick off a fee to Zynga, which it pays back in the form of virtual currency for purchasing in-game goods. (Sniffs deeply.) Smell that? That, Fool, is the sweet, powerful fragrance of large and growing margins.

3. Creative iteration
Console game developers love to sell special additions to core franchises. Zynga uses this same tactic, but thanks to Facebook, it also avoids the distribution costs and delays that come with selling through GameStop (NYSE: GME  ) . An Independence Day-themed expansion is still ongoing in E&A, inducing players to pay up in real currency for virtual power-ups available for a limited time.

4. Simplicity
Of all the things that drive value in Zynga's games, nothing is more important than ease. Getting started is easy, and playing is even easier. Every important action can be accomplished with just a click, a sharp contrast to the multiple-button-to-activate combinations so common to advanced PC and console games. Think of it as the Nintendo model, but with an even more elegant and addictive design.

The Foolish bottom line
For these reasons and more, I find Zynga one of 2011's most promising options for Rule Breaking investors. There's also opportunity for those who fancy themselves more bargain-hunter than rebel. Just consider taking a position in Adobe (Nasdaq: ADBE  ) , whose much-maligned Flash platform acts as the basis for a number of popular Zynga games.

Unfortunately for Adobe, its hegemony may not last. Facebook is apparently working on a system for creating and hosting games inside a fully Web-based HTML5 layer. Apple's (Nasdaq: AAPL  ) mobile Safari is expected to be Facebook's initial target for "Project Spartan," as it's called, but there's no limit to how far the social network could take this initiative. That's bad news for Adobe, since further commitment to HTML5 would result in less need for Flash.

So while Adobe's modest price-to-earnings multiple of 17 may look like the more attractive bet right now -- it's certainly a safer way to play Zynga over the short term -- I'll opt for the disruptor. Zynga's brand of social gaming is a sticky-sweet obsession I'm happy to suffer with. Now, if you'll excuse me, I have virtual crops to tend.

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The Motley Fool owns shares of GameStop, Apple, Activision Blizzard, and Take-Two Interactive Software.Motley Fool newsletter services have recommended buying shares of Nintendo, Activision Blizzard, Discover, Take-Two, Apple, and Adobe; creating a diagonal call position in Adobe, a synthetic long position in Activision, and a bull call spread position in Apple; and writing covered calls in GameStop. Try any of our Foolish newsletter servicesfree for 30 days.

Fool contributorTim Beyers is a member of theMotley Fool Rule Breakers stock-picking team. He owned shares of Apple at the time of publication. Check out Tim'sportfolio holdings andFoolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insightsdelivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.


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