Buying Zynga on Potential Catalysts

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Anybody that has invested in Zynga (NASDAQ: ZNGA) since the IPO back at the end of 2011 probably doesn’t see many potential catalysts in the stock. The company was a massive hit with social games such as Farmville and has a strong franchise with Zynga Poker. Yet as the excitement over social games dies down, the company now has several catalysts that could push the stock higher

The catalysts include the large cash hoard, the new CEO, and online gambling. Plenty of doubts exist as to whether any of these will be an actual catalyst.

The company faces massive competitive pressure from not only new upstarts, but also the old school gamers of Electronic Arts (NASDAQ: EA) and Activision Blizzard (NASDAQ: ATVI). These large gamers are quickly moving into mobile and social and will no doubt work towards an online gambling presence. And oh yeah, both companies have hoards of cash as well.

See chart below for the one-year returns:

<img alt="" src="http://media.ycharts.com/charts/59abaac6f3d6cf52b3ed1cd2cbf7f744.png" />

ZNGA Total Return Price data by YCharts

Cash hoard

Zynga has an astonishing cash hoard of over $1.5 billion, yet the company has been reticent to spend the cash on stock buybacks, and buying growth in this sector can be a losing proposition. The BOD only spent $2.5 million on buybacks during Q1, yet the company has $186 million authorized that wasn’t spent. Spending a quick $200 million would’ve been the best way to utilize that cash with the stock down at $2.5 and trading near cash value.

Unfortunately the company faces a sector where the top players are loaded with cash as well. Activision has an amazing cash balance of around $4.6 billion while Electronic Arts lists around $1.1 billion in net cash. More importantly both stocks have strong free cash flow providing each company with the ability to more freely spend cash that Zynga lacks with its weak results.

New CEO

Investors need to look no further than Groupon (NASDAQ: GRPN) to see what a new CEO can do for a stock. That stock surged both before and after the announcement that Andrew Mason had been forced out back in February. Whether the same will happen for Zynga is yet to be seen.

Back on July 1, the company announced that the Microsoft Xbox President had taken over as CEO for founder Mark Pincus. While Dave Mattrick has been hugely successful in turning Xbox into a leading gaming console, investors are quick to point out that he has limited experience in mobile and online gambling areas.

As the chart above shows, Groupon has gained significantly since the shift in the CEO position. At the end of 2012, the stock was performing worse than Zynga, but it has now rallied all the way to positive returns for the last year.

Online gambling

With a successful online poker franchise, investors naturally have hope that Zynga will be able to transition that success into online gambling. The company is partnering with bwin.party to launch online gambling overseas while waiting for clear regulation in the US. The partnership has already launched ZyngaPlusPoker and ZyngaPlusCasino in the UK.

Forbes columnist Nathan Vardi clearly isn’t a big fan of this move. He sees the hiring of Mattrick as a negative in this area and the fact that the majority of existing online poker players are under 18 and come from countries like Indonesia, as further negative signs.

With competition coming from casinos and bigger players in the gaming industry, is there any reason to expect Zynga to succeed in real-money gaming? The one benefit is that games such as poker can have a social impact that Zynga has already conquered, but whether that will transition to success with the big money players is yet to be seen.

Bottom line

Zynga has several catalysts that could push the stock higher though it faces an ever-increasing competitive landscape. Social gaming is more competitive while the user base is eroding. Online gambling is still a crapshoot that could die due to regulatory issues even before running into competitive pressures. With a cash hoard of over $1.5 billion, the company has the balance sheet and possibly the new leadership to usher it back into prominence. Investors should look into adding the stock on dips once this initial excitement over the new CEO wears off.

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Mark Holder and Stone Fox Capital Advisors, LLC have no positions in any stocks mentioned. The Motley Fool recommends Activision Blizzard. The Motley Fool owns shares of Activision Blizzard. 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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