1 Stock to Buy, 1 to Short

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

The technology sector is highly unpredictable. Some of the most spectacular Wall Street success stories are from this sector. On the other hand, it also has companies which find themselves at the bottom only quarters after absolutely dominating competition. In this unpredictable space, the most volatile industry is the digital media industry.

It is extremely difficult to value companies relying on internet advertisement revenues. This is because the potential of the internet seems limitless, but ground realities are usually different. These businesses are more susceptible to factors such as changing consumer preferences, competition, technology upgrades etc. Investors have lost a lot of my money by investing in these overvalued speculative stocks and made even more. Groupon (NASDAQ: GRPN) and Zynga (NASDAQ: ZNGA) are some highly followed investments from this unpredictable space. Investors of these companies have been on a roller coaster ride due to rapidly evolving market perception of their "true value."

Game Changer

 The diminishing demand for social media gaming has placed an enormous strain on Zynga’s valuations. The company is still struggling to recover from the severing of ties from Facebook which is the largest source of revenue from Zynga. The increasing popularity of smartphone applications has eclipsed the popularity of its brand of social gaming. This has been a primary factor behind the decline in company’s value. The founder and CEO Mark Pincus could not anticipate this evolution and the best thing for the shareholders was a fresh perspective.

According to the company, it has hired Microsoft (NASDAQ: MSFT) Xbox chief, Don Mattrick, as the new CEO. He will be paid a signing bonus of $5 million along with stock awards of around $40 million. Don Mattrick has been instrumental in the rise of Xbox to the number one spot in the gaming console industry. In a short period, it has surpassed Play Station as the console leader due to superior hardware and better marketing. The Kinect gaming sensor has been another key factor behind the success of Xbox 360.It still is still too soon to assess the impact of this appointment on Microsoft’s valuations. An insignificant handheld share and stagnant Windows 8 sales have forced the software giant to rely heavily on its Xbox leadership. The Xbox market share can suffer if Don is not replaced by a worth successor.

Despite falling revenues, Zynga is finally on the right track. It is focusing on reducing operational expenses and making itself a game developer across multiple platforms. In a recent move, the company has laid of 18% of its workforce; saving itself around $80 million. The appointment of Don, as the new CEO, is a step in the right direction. He has already proven himself in the technology sector and with the right support from Mark Pincus; he can lead Zynga out of the woods.

No Deal

Groupon shares has been on a roll. They are trading at a 52-week high, doubling in the last two quarters. The market capitalization of Groupon has reached the magical $6 billion mark and all this without any significant fundamental improvements.

Since its IPO, critics have constantly raised fingers on the viability of the company’s business model. Some have even called it a Ponzi scheme. When $810 million out of $946 million of the IPO money goes to investors, including $398 million to the chairman, the ‘Ponzi Scheme’ title should not come as a surprise. The initial issues of misleading accounting practices (over stating revenues) might now be irrelevant, but the company is still spending the bulk of its revenues on marketing costs.

Groupon has recently adopted the ‘Pull’ strategy which is supposed be the ‘game changer’ for Groupon’s fortunes. It now plans to send customized (according to preferences) emails to prospective consumers. According to Deutsche’s analyst Ross Sandler, this strategy can increase billing by almost 20%. While this strategy might result in increased billing, the ultimate impact on the bottom-line is still doubtful.

During the last six months, Groupon has risen from $2.5 and is now trading above $9. The investors still expect the company to achieve that elusive ‘economies of scale’ and finally create some shareholder value. Moreover, there are no fundamental changes which can justify a rise from $2.5 to $9. The shares are now trading at a 52-week high and the market should expect some heavy insider and institutional selling. Insider selling of a company which is already overvalued can create a panic and induce a stock slide. These factors make Groupon an attractive "short sell."

Conclusion

Some industries are more volatile as compared to other but at the end of the day each investment should be judged on the viability of the company’s business model. The development capabilities of Zynga make it a buy. The appointment of Xbox’s chief as the new CEO will bring fresher perspective to Zynga and just might be the catalyst it needs to get out of this rut. On the other hand, Groupon has seen a consistent rise in revenues but little in profits. The magnificent rally in Groupon is not justified, and the company might be heading towards some massive insider and institutional selling. These factors make Groupon a viable short target. 

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Mohsin Saeed has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. 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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