1 Social Stock Frozen In Time Warp
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Groupon and Zynga, in my view, face very different future growth stories. While I believe one can rebuild its business to be sustainable--and is already doing so--I see the other one as stuck in a perpetual time warp. Social media moves fast, so either one is vulnerable to getting caught behind the competition. However, investments by one of these companies have helped reduce that risk…
Groupon (NASDAQ: GRPN)
Despite my typical aversion to social media stocks, I have quick to be bullish on Groupon--a sentiment that was supported by the stock nearly doubling from the low (the point at which I recommended it). There are several reasons why I am bullish on the company. First, I like the acquisitions that it has made. From CommerceInterface to Glassmap, the company is making a legitimate attempt at the eCommerce space that combines the social networking aspects of real-time deals in real-time travel. Second, partnerships with major media groups, like the MLB, represent a step forward in terms of sustainability. With a leading position in mobile deals, Groupon has established itself as the go-to source for mobile deal support. This is likely to change irrespective of deals from small local businesses at this point.
The third reason I like Groupon is mostly secular. With consumers now more price conscious, they are looking for deals; and this is becoming increasingly true with smartphone penetration recently eclipsing 50% in the United States and catching up European exposure. Perhaps this is why Sterne Agree recently expressed that it has "greater conviction in the company's ability to evolve beyond its current business".
And, if nothing else, the current business isn't exactly bad. The stock only trades reasonably at 24.8x forward earnings for an expected growth rate of 27.1% over the next 5 years. Meanwhile, free cash flow is generously at a yield of 7.5% and unburdened by the absence of long-term debt.
Zynga (NASDAQ: ZNGA)
I am considerably more concerned about Zynga, the social video game developer. It is making a foray--in my view, an increasingly desperate one--in online gambling business in the UK this quarter. They’re also readying paperwork to launch a gambling business in Nevada and 3 free gambling games on Facebook have already been launched Elite Slots, Zynga Slots, and Zynga Poker. While I have expressed optimism about the gambling initiative in the past, my intent is on providing both sides of the story--unfortunately, I am closer to the bear's take for now.
It is humorous then that Electronic Arts (NASDAQ: EA) recently settled its dispute with Zynga over copyright infringement relating to The Ville copying The Sims Social. The outcome wasn't entirely important; what is important, however, is that it came at a time when, ironically, AppData reported that The Ville and The Sims Social are not particularly popular on Facebook. That these two would squabble over weak titles is a testament to just how far behind the curve they have come.
And if you thought gambling was wacky, consider that Zynga recently hired media executives to produce 30-minute animated episodes of FarmVille. What scares me about Zynga is that it appears to be stuck into a perpetual time warp. What may have been popular 5 years ago, especially on the Internet, is not necessarily popular today. And just like you can't unscramble scrambled eggs, you can't "reinvent" a broken product.
Conclusion & Stock Fundamentals
Groupon and Zynga are both incredibly risky stocks to play. Making money on them is as much, if not more, a function of playing off of market emotions as it is a function of properly valuing the business. At any rate, Groupon is reasonably priced at 17.7x forward earnings and a free cash flow yield of 4.8%. It is still forecasted for growth rates north of 20%, which more than justifies a forward multiple above 20x at a discount rate of 10%. By contrast, it will take some time for Zynga to churn a profit--over the twelve trailing months, it burned $136 million worth of free cash low. Electronic Arts, which has generated more than $250 million worth of free cash flow over the twelve trailing months, is more ideal for social media game exposure. It is already well diversified in several different platforms ranging from consoles to online gaming, and it trades reasonably at 16.6x forward earnings for double-digit growth forecasts. It is at a 52-week high after rallying more than 70% from the lows. If nothing else, it hedges against the uncertainty of a Zynga investment while providing exposure to a similar industry.
David Gould has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. This article was written by the staff of TakeoverAnalyst, which does not intend on opening a long position in the next 48 hours.