How Green Was My Farm

By Somnath Guha - October 6, 2012 | Tickers: ATVI, EA, ZNGA | 0 Comments

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The Zynga Inc (NASDAQ: ZNGA) website portrays Farmville as - Everything Grows Your Way. Your farm’s as wacky as you wanna be! Plant and harvest crops, or buy zebra unicorns and play match maker to polka dot livestock. Your farm, your way.

The farm, isn’t growing

The irony is nothing seems to be growing your way. It appears the games that helped cruise to one of the largest tech IPOs are helping lead to its downfall. Zynga’s 2012 riches to rags story continues apace as CEO Mark Pincus delivers a message to the social game studio’s staff and shareholders warning of even more troubled times coming along with its impending third quarter earnings report.

Zynga said it now sees full year bookings of $1.085 billion to $1.100 billion, down from a previously projected $1.150 billion to $1.225 billion. Full year adjusted EBITDA is now expected to be $147 million to $162 million, down from a previous range of $180 million to $250 million. Its stock is currently trading around $2.50 per share, down 84 percent from highs following its initial public offering. The market cap has crumpled from $20 billion before the IPO to around $1.7 billion today. The senior executives have abandoned the company in between. Its audience is dwindling. Its competitors are suing. Zynga is the portrait of a company on fire.

The company faces numerous challenges that have been evident for the last few months. Its core social game offerings such as “FarmVille” and “CityVille” and other similar titles have been under-performing relative to expectations, many new competitors are flooding into the space, and a raft of high level executives have left the firm – including at least four C-level positions since early August.

Your farm, their way

Zynga’s brands are valuable but it may not be easier for the company to turnaround. Since its value has diminished so greatly, Zynga is now a prime target for acquisition. Even if Zynga’s audience is turning away from FarmVille and its other time wasters, the company still commands an audience of 300 million. At a $1.7 billion market cap, a Zynga acquisition seems encouraging for anyone looking to pick up 300 million pair of eyeballs every month. The market analysts assume that Zynga may become a subsidiary of the social network that gave it life.

Games people play

In August, Zynga’s competitor, Electronic Arts Inc. (NASDAQ: EA) filed a copyright infringement suit against Zynga, alleging that its new social game, “The Ville,” infringes on EA’s copyrighted game, “Sims Social.” Zynga came back swinging, alleging that “EA did not invent the genre” of life simulation games. “Fifteen years before EA released its first life simulation console game, “The Sims,” Activision released “Little Computer People,” Zynga said in its answer to EA’s complaint. Another twist is the battle beneath the surface over employees stolen by Zynga from EA. Zynga’s answer confirmed that it had hired three former high-ranking EA executives.

In September, EA Mobile(TM), a division of Electronic Arts Inc. announced a partnership with PlayMG Corp to bring $10 worth of top titles preloaded and ready to play on the MG, a dedicated portable Wi-Fi gaming system for the Android market. Iconic EA franchise titles Need for Speed Hot Pursuit and NBA JAM were chosen for their high-end gaming experience and their broad appeal to the 62 million US kids ages 5 to 18 years-old and many of their parents who played these hit games growing up. 

At a $4.12 billion market cap, the current P/E of EA is high at 68.78, though the EPS is positive at $0.19. Again the debt/equity ratio is high at 21.32%.

Every spring, the other player, Activision Blizzard, Inc. (NASDAQ: ATVI) releases a new Call of Duty game. Typically, Activision makes some rather small changes to each new game by updating graphics slightly and adding a bit more content. Every other teenager buys the new game as it is important for them to play the most recent game with their friends. Activision is a renowned online and console game development company. It has leading positions across all categories of the video game industry. Activision Blizzard's portfolio includes popular video games such as Call of Duty and Tony Hawk, as well as Spider-Man, X-Men, Shrek, James Bond and TRANSFORMERS. The company has operations in the U.S., Canada, the United Kingdom, France, Germany, Ireland, Italy, Sweden, Spain, Norway, Denmark, the Netherlands, Australia, India, China, South Korea and Taiwan.

Historically, share prices have shown a positive correlation to earnings growth. Therefore, the current estimate trends indicate that they are headed upward. ATVI beat the Zacks Consensus Estimate by 63.6% in the second quarter of 2012, continuing its impressive record of outperforming expectations. In the past four quarters, this leading provider of online and console games surprised by nearly 218% on average. ATVI also raised its fiscal 2012 guidance.

In addition to the low P/B, the stock looks attractive with respect to a price-to-earnings (P/E) multiple of 12.9. A P/B less than 3.0 and a P/E below 15.0 generally suggest a value stock. Moreover, Activision’s PEG ratio of just 0.7 indicates that the stock is reasonably valued given the expected growth of 16.5%, which is higher than industry average of 14.6%.

Activision and EA were affected very little by the decline of the rhythm genre, as they had a plethora of other titles in other forms of gaming to derive revenues from. Zynga on the other hand remains completely reliant on social sector of gaming.

The robust financial position of competitors is putting Zynga under pressure. The company's operating margin of negative 35.35% is below its competitors, EA and ATVI.

Zynga might be onto this possible secular decline but its plans to focus more heavily on online gambling or onto a mobile platform can breathe new life into the beaten down stock. Despite having strong industry growth, considerably high franchise value, and large amounts of cash, the company has not been able to translate its business strategies into profits. Whatever may be the future plans, the turnaround would be really tough for this gaming company. As of now, it would be risky for anyone waiting to watch their farm grow.

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