What's Going to Save Zynga Now?

Gerelyn is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When Zynga (NASDAQ: ZNGA) ushered in former Microsoft executive Don Mattrick to take the helm and replace outgoing Chief Executive Mark Pincus, hopes ran high. There was new blood with Xbox running through his veins, and Zynga was looking ahead. After a botched partnership with social-media giant Facebook that left the free social-gaming company jilted, Zynga had a plan to turn things around and online casino gambling was part of that vision - until days ago.

In its second-quarter earnings report, Zynga dashed the hopes of a new revenue stream from real-money online gambling. It won't pursue an online casino license. The problem is that online gambling was supposed to be Zynga's chance at redemption. Without it, the future is even more bleak.

Where's the growth?

Now that Zynga has revealed that it won't pursue a future in the real-money gambling arena, where will growth stem from? Online gambling was looked to as a saving grace and a gateway to greater profits that would lift the stock out of the doldrums even as U.S. states begin opening the online markets to casinos and possibly other gaming businesses, like Zynga. But the online-gambling ship seems to have sailed, taking with it the promise of Zynga tapping into a market that's projected to generate hundreds of millions of dollars in revenue if not more each year. 

Meanwhile, Zynga isn't abandoning its real-money gambling business in the United Kingdom, and through its partnership with local gambling company Bwin.party, continues to explore the opportunities. Nonetheless, Zynga made it clear that its focus is on its core business, including free social casinos, which means that nothing much has changed. If anything, things have worsened.

The number of monthly average users fell by almost 40% in one year to 187 million. So without a future in the online-casino market and the number of users falling off a cliff, where's the catalyst? 

Meanwhile, sales in the forthcoming third quarter are expected to take a dip to a range of $175 million to $200 million, while on the bottom line Zynga is expected to report a net loss of between $43 million and $14 million. The value isn't there, at least right now, and it's not worth betting on for the time being. 

Tale of two gamers

Investors are betting on a future turnaround, one that chief executive Mattrick says will take hold over the next three months. Or perhaps, with a market cap of approximately $2.4 billion and an enterprise value of about $1.5 billion, Zynga could become a takeover candidate.

It wouldn't be that much of a stretch, considering that International Game Technology (NYSE: IGT) found value in social-gaming company Double Down Interactive and agreed to pay half-a-billion dollars for the company, and casino company Caesar's Entertainment acquired Playtika. But who would want Zynga with its user-base on the decline? Worse, International Game Technology's online poker game recently surpassed Zynga Poker as the top-grossing social casino game on Facebook, according to International Game Technology's recent earnings call.

Slot-machine maker International Game Technology wagered a lot of money but it seems to have made a good bet. In the third quarter, Double Down saw its daily active users climb 25% to 1.7 million coupled with a 60% increase in the revenue per user to $0.40 per day. What's more compelling is the explosive growth in mobile, where the number of mobile users increased by 40% over the previous quarter.

International Game Technology attributes 9% of its revenue increase, (to $579 million), to higher North American machine sales and social gaming. The company is benefiting from a replacement cycle, underway in the Canadian market, in addition to the heightened focus on casinos in light of the online-gambling renaissance. With a P/E of 16, and a recent 50% increase in its quarterly dividend, the stock seems to be a good deal at current levels. 

International Game Technology competitor Bally Technologies (NYSE: BYI), the maker of the Cash Wizard Tiki Magic and Pawn Star machines, is growing via acquisition as well. Weeks ago, it announced its plans to acquire industry peer SHFL Entertainment in a $1.3 billion deal that will expand its product portfolio and also strengthen its position in Australia and Asia.

Based on the equity portion of the deal, Bally is paying some 16 times EBITDA, which is about double the industry average, according to a Bloomberg report. The addition is expected to be accretive to diluted earnings per share and free cash flow in the first year following the close of the deal.

Bally reports its financial results in mid-August. In its fiscal third quarter, the company generated a 28% increase in earnings while Shuffle Master had a record-breaking quarter where profits climbed 22%. 

Next year, Bally expects to earn between $3.70 to $4.05 excluding the acquisition's impact. This compares to analyst estimates of about $3.84, according to Bloomberg.  Now might be a good time to get in Bally's stock, despite its higher than industry average earnings multiple of 22.5. The deal can add between $0.30 to $0.40 in earnings by 2015, according to Sterne Agee and Leach analyst David Bain. 

Conclusion  

The gaming industry is an industry that's changing before investors' eyes, and that makes it a potentially rewarding place to be. After all, not all industries are on the cusp of such dramatic growth given the change in online gaming as Internet gambling becomes regulated. Of the three stocks, Zynga is clearly struggling, but you'd be making a good bet with International Game Technology or Bally.

It's incredible to think just how much of our digital and technological lives are almost entirely shaped and molded by just a handful of companies. Find out "Who Will Win the War Between the 5 Biggest Tech Stocks?" in The Motley Fool's latest free report, which details the knock-down, drag-out battle being waged by the five kings of tech. Click here to keep reading.


Gerelyn Terzo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus