The Stock That Has Lost its ZYNG!
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From making every gaming gambler into a millionaire (“Poker”) and turning farming into a cool profession (“Farmville”), online game maker’s Zynga (Nasdaq: ZNGA) have seen a quick change in fortunes. Zynga has been dictating majority of the social gaming network by launching games such as Mafia Wars, Poker, and Farmville among others in collaboration with Facebook(Nasdaq: FB) turning the concept of “playing with friends” into a revenue generating proposition for both these companies.
For a company that went public in December 2011 at an opening price of $10 to being shot up to an all time high of $14.50, the slash to mere $2 bracket comes too soon even if it was anticipated.
It is just a game!
The company generates the majority of its revenue through in-game sale of virtual goods and advertising which has taken a major hit in the recent quarters. This explains why Zynga cut down its booking expectations from a $1.09 billion to $1.1 billion range to a $1.15 billion to $1.23 billion range. Bookings are a reflection of the in-game purchases of virtual goods on a quarterly basis.
The major chunk of profit for the company comes from games like "FarmVille," "FrontierVille," "Zynga Poker," "Mafia Wars," and "CityVille," which accounted for 83% of the company’s total revenue last year. However, these games have since struggled with low average users. Even the launch of new games such as FarmVille 2, The Ville, and ChefVille has not brought the company consistent growth, and all three games trailed off of the 7 million-users mark in their first month.
Zynga’s stock has been slashed by nearly 18% to a new low of about $2, after the company announced weak Q3 revenues along with a cut down of the full year estimates. The company expects revenue in the third quarter of 2012 in the range of $300 million, losses amounting to about $100 million, non-GAAP net loss between $2 million and $5 million and adjusted EBITDA between $10 million and $15 million. For year 2012, Adjusted EBITDA is estimated to be in the range of $147 million to $162 million.
The Why’s behind the Downfall
The lead up to this fateful scenario could be attributed to a number of likely reasons. Firstly, the decrease in users due to migration to games on Smartphones and tablets. Although Zynga has been long trying to move into the mobile business, the investment hasn’t yet resulted in margins to make up for its losses from the Facebook gaming segment.
Secondly, the acquisition of New York-based social game developer OMGPOP, makers of the cultural hit mobile game, “Draw Something” for a whopping 183 million in March also turned out to be a downer. The inability of the acquisition to replicate the success of its former game coupled with an impairment charge of about $85-95mn related to OMGPOP being slashed on ZNGA’s way have only added to its financial burden.
Tryst with Facebook
The days just got gloomier for folks at Facebook. For a company already trading at a treacherously low share price, a further hit in its valuation couldn’t have come at a worse time. In 2011, Zynga accounted for 11% of Facebook’s total revenues and still affects the overall health of the Facebook gaming segment. In light of the social gaming firm’s outlook change, Facebook, where most of Zynga’s games are played, also saw its shares drop about 5% to close at around $20. J.P. Morgan also, cut its revenue target for Facebook’s Payments quoting similar reasons.
Facebook has been struggling with marginal growth in user base and stagnation of revenue for a few quarters in a row. Even Zuckerberg’s announcement of 1 billion users could not save the day for Facebook stock which further lowered 9% then, and 15% from its September stock price.
With a market cap of roughly $42,000 million and a consistent earnings growth in the last 5 years, Facebook may not be dislodged from its market position immediately. However, Facebook’s negative EPS growth and a P/E of 109.64, only adds to the company’s woes.
Brokerage firms are cautioning investors before investing in Facebook. Recently, BTIG media, downgraded Facebook stock to “sell” after slashing down its price target for Facebook stock to a surprising low of $16. Analysts at Credit Suisse Group AG also, reduced their Facebook stock price targets to $24 from $34 retaining their “neutral” stand for the social networking company.
With users losing interest, (a dip of 20% in desktop usage was recently reported) and investors losing faith, Zynga only adds to the list of liabilities for the company. There is no doubt about the fact that this partnership bore fruit for both the companies but with Zynga losing its zing, it is time for Facebook to turn to greener pastures.
One of the saving factors for Zynga could be its huge cash reserve roughly amounting to $1.6 billion which will discount any doubts regarding bankruptcy. Although valuation could go lower as the company uses up some cash to meet working capital needs, the market cap now stands at $3million.
Another factor that could prove to be a turning point is the legalization of online gambling. If such an event were to occur then Zynga could leverage its large user base in the game “Zynga Poker” which raked in 18 percent of Zynga's $332.4 million revenue last quarter. Currently, the business is illegal but endeavours are being made to legalize it
Wait and watch
Zynga might be shrouded in the cloud of uncertainty at the moment, but writing it off completely is something I am not in favour of. Its cons might be in excess of it pros currently but given some time, I think it has the potential to bounce back right into the game. Armed with a considerable cash pool and brighter plans for the future, I would like to put my bets on this company.
Gargi27 has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend 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.