Is Zynga a Good Stock to Buy Right Now?

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

Zynga (NASDAQ: ZNGA) announced its second quarter results on Wednesday and disappointed the market. Revenue and earnings both came in well under expectations, but worse news came when the company issued its guidance for the rest of the year; previous forecasts of about 26 cents per share of earnings were revised down to an average of about 6 cents. The stock opened on Thursday around $3, down from its $10 IPO price late last year and a high of over $14 in early March. $180 million of Draw Something has turned out to be a massive money loser rather than cash cow for the company, and recently released games have not matched the popularity of the older games in Zynga’s repertoire, meaning that growth is not going as well as investors had previously hoped. The poor business conditions were not entirely Zynga’s doing.  Facebook (NASDAQ: FB), which is responsible for the overwhelming majority of Zynga’s business, has apparently been reworking its system to broadcast more information about friends’ activities on newer games as opposed to older games. Since this is essentially advertising and Zynga has developed many of the older games on Facebook’s platform, Zynga’s games are losing publicity and users.

There is still hope that the company can recover. The social gaming business is highly hit-driven; just as Zynga gained off of a good run of popular games, and has cooled lately as its offerings have lost their luster, the next few months games Zynga has not even released yet could bring it large increases in revenue. Zynga has also drawn attention for its work on developing gambling games using real money, a potential company-saver but something that would obviously be illegal in the U.S. While Zynga could certainly launch any gambling programming outside the United States and still potentially make it a big business, the biggest gains would almost certainly have to come from pushing for changes in government regulations domestically.

As things stand now, however, the stock is down dramatically from its IPO price and has hurt investors small and large accordingly. As of the end of March, Partner Fund Management, which is managed by Christopher James, reported owning 4.2 million shares of ZNGA on its 13F filing, and valued those securities at $55.6 million. If Partner did not sell any of its shares, the losses on this position come out to about 3/4 of that value- over $40 million. Assuming that Partner charges its clients a 20% performance fee, the standard in the hedge fund industry, James and his partners would then have missed out on $8 million in potential income from gains on other investments. Of course Partner may have sold some of its shares before now; it may also have added to its position as the stock price fell, at least initially (find out how Partner's other stock picks have done).

Another pair of hedge fund managers who could be offsetting profits elsewhere with Zynga losses is Seymour Kaufman and Michael Stark of Crosslink Capital. Crosslink reported 2.1 million shares, half as many as Partner did, and therefore has lost $20 million of its investors’ money, assuming that it has not changed the number of shares in its portfolio (again, the number could have increased or decreased since the beginning of April). The potential decrease in carried interest due to this investment is half of Partner’s- $4 million- and to make matters worse, Crosslink reported that its largest 13F holding was Pandora Media (NYSE: P), which is down about 5% over the same period (See other stocks in Crosslink's portfolio).

Currently, analyst estimates imply a forward P/E of under 9 for Zynga (the company is unprofitable on a trailing basis), though we expect that those estimates will be revised down soon.  Facebook has a forward multiple of 42, and is already generating earnings.  The leading game company, Electronic Arts (NASDAQ: EA) now has a market capitalization slightly larger than Zynga’s; the latter company is down, but EA has fallen about 50% in the last year and also trades at about 9 times forward earnings estimates despite having a stronger market leadership position and valuable brands in sports video games.  The largest gaming company, Activision Blizzard (NASDAQ: ATVI), has a forward P/E of 11, but this reflects fairly modest growth estimates.  Activision Blizzard is slightly down on the year.  We think that either of these game companies are better value plays than Zynga, even after its massive decline, but would strongly advise against a Zynga short in case of a “dead cat bounce” or success in developing its gambling software.


This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article.The Motley Fool owns shares of Activision Blizzard and Facebook. Motley Fool newsletter services recommend Activision Blizzard 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.

blog comments powered by Disqus

Compare Brokers

Fool Disclosure