Don't Gamble With This Gaming Company

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

With its new plans to continue pushing into the real-money gambling space, social gamer Zynga (NASDAQ: ZNGA) provided some much-needed hope to investors during its third quarter earnings release Wednesday. While ZNGA shares responded by popping as much as 17% Thursday, I remain unconvinced this house of cards can stand much longer.

True, Zynga has a huge pile of cash with nearly $1.6 billion in the bank.  For context, note that's nearly 90% of the company's overall market cap!  In addition, ZNGA is currently trading at a measly $2.30 per share, down 77% from its December IPO and 85% from its 52 week high.  It's no mystery, then, why people are wondering whether shares have bottomed.

Early investors surely wish they would have sold along with CEO Mark Pincus when he dumped $200 million in stock in April.  To make matters worse, Pincus certainly wasn't alone in his lack of commitment to the company; other insiders, including Zynga's CFO, COO, and General Counsel, dumped another $316 million in the secondary offering.  After the stock imploded three months later and insider trading lawsuits followed, Zynga faced a mass exodus of engineering talent and key executives.  Apart from employees leaving on their own accord, the company also announced a 5% workforce reduction on Tuesday amid reduced bookings (or the amount users have spent on virtual game goods) for the year.

With regard to Zynga's mountain of cash, investors are underestimating just how quickly a growth-hungry, unprofitable company like Zynga is capable of burning money.  Between this weeks' ill-advised $200 million buyback announcement, the promise of additional overpriced acquisitions, legal expenses in defense of its copycat ways, and plain old fashioned wasteful spending, Zynga seems bent on using cash for anything but building an innovative, sustainable business.  When the coffers run dry, you can bet Zynga will have no qualms diluting existing shareholders to stay afloat.

Investing is not Gambling

With Zynga off the table, where should we put our hard earned poker money?  Luckily, the stock market offers plenty of options to stack the odds squarely in our favor.

Why not consider long term Motley Fool Stock Advisor recommendation and World of Warcraft creator  Activision Blizzard (NASDAQ: ATVI)?  A perennial powerhouse in the gaming world, Activision has its own cash hoard of nearly $3 billion with no debt.  Additionally, ATVI is trading near 52 week lows with a reasonable P/E of 15 and a price to free cash flow ratio of just 8.6.  To sweeten the pot while you wait for the price to catch up with the value (as it nearly always does), ATVI will pay you for your troubles with a 1.6% dividend.

If you're not stuck on finding a gaming stock, consider branching out and buying shares of Facebook (NASDAQ: FB).  After all, Facebook is arguably the reason Zynga exists in the first place and, after its encouraging third quarter earnings report, investors are starting to see it in a whole new light.  While investors have been busy underestimating how fast Zynga is capable of burning through cash, the world has been busy underestimating Facebook's ability to make it.  That's okay, though; CEO Mark Zuckerberg actually prefers it that way.

In the end, while I may look a little crazy for opening my "Underperform" CAPScall on ZNGA just a few weeks ago, I remain convinced the company has no future in its current form.  Until Zynga proves it can change its unimaginative, self-serving, money-wasting ways, it has nowhere to go but down.

Now, if you'll excuse me, I need to log on to Facebook to ignore another FarmVille request...

Steve Symington has no positions in the stocks mentioned above. 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 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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