This Zynga Board Member Thinks It’s Not Game Over Yet

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) has been consistently declining. The stock is down 8% in the last month, 22% in the last three months, 73% in the last six months, and a whopping 76% from its IPO last December. Well, one Board member has had enough. Ellen Siminoff, formerly a Yahoo! executive and CEO of search advertising company Efficient Frontier, alongside her husband, purchased 250,000 shares of Zynga on Oct. 31 at an average price of $2.22 per share. This purchase, which came in accordance with a 10b5-1 plan that the Siminoffs adopted in late August, puts considerable capital behind the thesis that Zynga has adjusted for the decline in its business and might be fairly valued for the worth of its current operations. Insider purchases tend to be bullish signals, so we track these filings and noticed this big buy at Zynga.

However, we’re still skeptical of Zynga’s prospects. Its report for the third quarter of the year showed total revenue up 3% from the third quarter of 2011, with higher numbers in advertising revenue more than offsetting a slight decline in games. Higher costs- though these included a large impairment expense related to the Draw Something acquisition and a whopping 36% increase in R&D- flipped the $33 million in pretax earnings in Q3 2011 to a pretax loss of $96 million last quarter (pretax earnings were about flat if those two factors are ignored). For the year, Zynga has lost $0.22 per share as its large investments in R&D have yet to pay off in terms of higher revenues.

Wall Street analysts expect $0.02 per share in earnings in 2013, which of course gives Zynga a very high forward P/E. Exchange records show that 12% of the shares outstanding were held short as of mid-October; our database of hedge fund filings shows that no fund or other major investor that we track owned more than $15 million in stock- a fairly low level for what are often multi-billion dollar funds- at the end of June.

In terms of online activities, including games, Zynga can be compared to Facebook (NASDAQ: FB) and to Chinese online gaming company (NASDAQ: CYOU). In our most recent analysis of Facebook, we concluded that the social network’s pricing was still high even after the decline from its IPO price; for example, it trades at 32 times forward earnings estimates. Operating income was down despite a rise in revenue (though at Zynga, considerable investments were made in R&D). Read our discussion of Facebook. Changyou is very cheap when looking at its financial reports- the trailing P/E is only 5, and it has been experiencing growth in earnings- but as with many Chinese-based companies investors should take precautions and do considerable due diligence before buying (you don’t want to end up like John Paulson!).

Electronic Arts (NASDAQ: EA) and Activision Blizzard (NASDAQ: ATVI) are two additional peers for Zynga. Neither of these companies is having a good year: their stock prices are down by double-digit percentages since a year ago, with EA’s stock falling nearly 50%. Revenue at each company was down in their most recent quarter compared to the same period in the previous year. However, the net income here is real and both EA and Activision trade at 11 times consensus earnings for 2013. We’d have to see these businesses halt their decline before trusting the Street and buying, however (see our analysis of EA and other gaming companies).

An insider purchase of over half a million dollars is not something that Zynga watchers- especially short sellers- should ignore. However, we still don’t see the company delivering earnings and its R&D investments are starting to look a little more like spending. We’d still advise against buying the stock.

Dig Deeper

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.  

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 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.

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