Zynga - A Better Option in the Cruel Social Media Sector
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Gaming giant Zynga (NASDAQ: ZNGA) shares dropped 20% after the social gaming company’s guidance for future sales disappointed the market. The popularity of titles like Farmville and Draw Something couldn’t save Zynga. “The challenge for Zynga is to deliver a steady stream of hit games,” said Paul Sweeney, a business analyst at Bloomberg Industries. Facebook (NASDAQ: FB) shares also fell by 2.7% on this news based on its symbiotic relationship with Zynga.
Though Zynga stock is cheaper than it was in the past, its gaming peers in the console space offer better valuations and growth prospects.
Web 2.0 Valuations Challenged
Thankfully the web 2.0 bubble is deflating. Facebook’s IPO was a flop. Zynga, which makes games for the Facebook platform, has seen a dramatic price decline. At present Zynga is starting to look like a defensible speculative bet at this point, though this was not always the case.
Until recently, financial markets were buying the Web 2.0 as a megatrend story. In The next wave of digital growth is here Todd Harrison wrote that web portal usage is down 24% while social has grown 52%. He cited these changes to demonstrate how the economy of the net is fundamentally changing. New developments in the “hypernet” threaten to undercut television and web search.
Though these changes are substantial, investors should wait for Web 2.0 ventures to demonstrate an ability to generate earnings and for them to trade at attractive valuations before riding “the next wave.”
Technological Progress Can Be Overpriced
If equity investors care about returns, then they must pay attention to valuation. Valuation always matters regardless of how often pundits say that growth will justify any price.
Unfortunately, many new ventures run losses as they ramp up, and so price-to-earnings ratios are less useful. Price-to-book ratios are also difficult to use for comparing tech companies because internal research and development is not capitalized, which often understates the accounting value of assets and equity. However, very low price-to-book ratios can be used to gauge that a company is cheap since they are gross underestimations for these firms.
For technology stocks the price-to-sales ratio is extremely useful since it allows some form of comparison between companies which might have off-balance sheet assets or are currently running losses. An eye for actual earnings is also appropriate, since the promise is that these companies will one day earn a return for investors.
Zynga shares did not generate profits over the last year, so it does not have a calculable price-to-earnings multiple. Now that it trades near $2.50 per share the stock has a 1.48 price-to-sales ratio and a 1.01 price-to-book multiple. This price-to-book multiple is much cheaper than the 2.05 S&P 500 average. Investors should consider this an upper limit because the price-to-book ratio fails to account for internally-developed intellectual property including patents, brands, and trademarks. If the economic value of these assets were even partially recorded the price-to-book value of the stock would be much lower.
Zynga is much cheaper than its social media peers which, as a group, are overpriced. Consider Facebook which currently trades at $20 per share. Equity in this this company is rich on a price-to-sales basis since shares trade at a 9.64 multiple, eight times the 1.29 the S&P 500 average and ten times the price multiple of Zynga. FB shares are trading at an indefensibly high 108.2 price-to-earnings ratio.
Social media is not the only growth story in gaming. Console gaming companies may see growth from multiple platform releases this holiday season.
The Nintendo’s latest Wii U video game console is selling out even though units won’t ship until November. Pre-orders for the console have started catching speed as retailers declared that they are “sold out” already. Nintendo’s shortage of consoles could mean that the Wii U will be a huge hit just like its predecessor.
Not to be outdone, Sony (SNE) is also releasing a new console. Its new PS3 consoles will sell for $249, have more memory, and are tinier and lighter than older models. The release of the new PS3 comes during a regime change at Sony. Kazu Hirai became the CEO, so Sony will be highly motivated to work with game developers to help promote the platform and validate his leadership with a successful roll out.
Console Gaming Valuations
Zynga is not that cheap when compared to other game developers. Console gaming stocks may Electronic Arts (NASDAQ: EA) stock trades around $14 per share. At a value of 1.09, this stock trades at a fraction of the S&P price-to-sales average multiple. EA shares are trading at a high 73.58 price-to-earnings ratio. The price-to-book multiple of this stock is 1.74, cheaper than the 2.05 S&P 500 average. As was the case with Activision Blizzard, the price-to-book ratio is low even without accounting for internally-developed intellectual property including patents, brands, and trademarks. Overall, EA shares are a better value than Zynga shares based on established long-term profitability and attractive valuations.
Shares of Konami (NYSE: KNM) are also valued more conservatively at prices near $23 per share. At a value of 0.95, this stock trades at a fraction of the S&P price-to-sales average multiple. Konami shares are trading at an attractive 10.56 price-to-earnings ratio, lower than the 14.1 average of the S&P 500 index. The price-to-book multiple of this stock is 1.14, cheaper than the 2.05 S&P 500 average even without internally-developed intellectual property. These compelling valuations make Konami shares more compelling than Electronic Arts or Zynga shares.
On the other hand, Zynga is cheaper than Activision Blizzard (NASDAQ: ATVI) at prices near $11 per share. Investors can buy more revenues per dollar from the S&P 500 or from Zynga since Activision Blizzard trades at a much higher 2.85 price-to-sales ratio. Activision Blizzard shares are trading at a fair 15.92 price-to-earnings ratio, in line with the S&P 500 average. The price-to-book multiple of this stock is 1.19, cheaper than the 2.05 S&P 500 average, but not as cheap as Zynga.
The Future was Yesterday
Zynga is trading at valuations that are appropriate, but not compelling, for a firm with no earnings. Investors who are determined to buy social media stocks should consider Zynga as their least-worst option when compared to wildly overvalued stocks like Facebook. Investors who are willing to consider console gaming stocks can find deeper discounts in Konami and Electronic Arts.
Interested in Learning More?
Zynga's post-IPO performance has been dreadful, and investors are beginning to wonder if it's game-over for this newly public company. Being so closely related to the world's largest social network can be a blessing and a curse at the same time. You can learn everything you need to know about this company and whether they're a buy or a sell in The Motley Fool’s new premium research report. Don't even think about picking up shares before you read what the Fool’s top tech analyst has to say about Zynga. Click here to access your copy.
BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard and Facebook and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Activision Blizzard, Electronic Arts, and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.