Now That This Company Changed its Agreement With Facebook, Is It a Good Buy?

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In a surprising SEC filing released last week, Facebook (NASDAQ: FB) and Zynga (NASDAQ: ZNGA) made quite a few headlines. To give the short version of things, both companies "have agreed to substantially change an agreement the two companies struck two years ago," which had given "Zynga a privileged position on Facebook's platform."

The change now gives the social network the ability to develop games for its platform internally, effective March 31, 2013. While this is still months away, and we're even further away from seeing any Facebook-ready games on the platform itself, the markets have responded rather abruptly, pushing shares of ZNGA down more than 10% to the $2.25 range.

At the start of last week, shares of the troubled social gaming company had risen by more than 30 cents, though all of those gains are now erased. Facebook's stock, meanwhile, is up over 5% in the past week on the news.

Over the longer term, FB shares have worked hard to make it back to 'break-even,' so to speak, over the past six months. Though Facebook is still down since late May, the company still would've made a much better investment than - and one heck of a pairs trade with - Zynga. Since the start of the summer, Zynga has lost over half of its market value as a management shakeup and slowing revenues have had investors running for the exits.

As Bloomberg mentions, the decision to amend its agreement with Facebook is undoubtedly a piece of its "reorganization aimed at reviving growth by cutting costs and focusing on mobile," which CRO Barry Cottle said would give his company "the flexibility to ensure the universal availability of our products and services."

Though the decision to increase its independence while lessening its reliance on Facebook may be better for Zynga in the long run, investors haven't had the chance to see exactly how Zynga plans to move forward on its own, thus the market's bearish reaction is understandable.

For investors willing to take a chance on Zynga’s restructuring efforts, now might be the right time to buy in. At their current market price, shares of ZNGA trade below 1.0 times their book value at a near-70% discount to the Internet content and information industry’s average. This book valuation is below the likes of Facebook (4.2X), and other peers like SINA Corp (NASDAQ: SINA) at 2.5X, LinkedIn (NYSE: LNKD) at 13.7X, and Yahoo! (NASDAQ: YHOO) at 1.4X.

Zynga is also attractive from a cash flow standpoint. Despite accumulating close to twice the amount of operating cash it held three years ago, the company trades at a mere 1.3 times the value of this cash hoard, which is below each of its aforementioned peers.

From a growth standpoint, sell-side analysts do expect solid 23-24% in annual EPS expansion from Zynga over the next five years, but it remains to be seen exactly how this will materialize. It is notable that this forecast is nearly on par with what’s expected of Facebook (26.7%), and above Yahoo! (11.7%). Now, LinkedIn (72.5%) and Sina (33.7%) are both predicted to have better EPS growth over the intermediate term, but both trade at PEG ratios of at least 2.0.

For those who believe in a Zynga turnaround, the valuation is low enough to suggest that an obvious value play is in order. For a longer look at the social gaming company, check out Zynga’s profile page on Insider Monkey.


This article is written by Jake Mann 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 Facebook and LinkedIn and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Facebook, LinkedIn, and SINA . 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!

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