Can This Stock Make a Comeback?

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

Zynga (NASDAQ: ZNGA) is the developer of some of the most popular games that you see on Facebook, like Farmville and Mafia Wars. Revenues have been declining for the company, and investors are worried about the upward trend in costs and Zynga’s free-to-play business model. However, Zynga is poised to make a comeback. Watch out for this company- there have been some recent developments which are going to make it a strong player in the internet gaming market.

Stock performance

Zynga witnessed a huge slide in 2012 and is now trading at around $3.21, lower than its 52-week high of $9 a share. This happened due to the internet gaming world taking a hit after the unsuccessful Facebook IPO. The reason for much of the erosion in the value of the stock was due to negative publicity and tax-loss selling. With a market cap of $2.55 billion, Zynga has not given a steady return to investors compared to market indices. However, in the recently quarterly results, Zynga reported a profit of $4 million after accumulating losses for the past few years. One good thing: The company witnessed strong Farmville 2 bookings and a 21% jump in advertising revenue.

Zynga looking undervalued

As I stated, Zynga is trading near $3.21 a share. For me, the stock looks undervalued due to certain reasons. The recent $200 million buyback announced in February gives a hint of the same. If I look at the short percentage of the total float of Zynga, it is around 17.50%. This suggests that huge short selling has taken place, which is bringing the stock price down. The low P/E and P/B also gives an indication of the undervaluation.

Online gambling business

With the launch of real money gambling in the United Kingdom, Zynga has entered the potentially strong online gaming business. It launched ZyngaPlusPoker and ZyngaPlusCasino in the UK not so long ago- and already has a huge market presence. Although just about 8–10% of Zynga’s revenue comes from UK, the business is set to grow higher. I believe more "fake" money users will switch over to the real gambling business. According to CEO and founder Mark Pincus, 2013 will be a transition year.

We have seen a 35% bull run in the stock price in light of the gambling business launch. In the US, apart from Nevada, no other state has legalized online gaming. If it gets legalized in the future, this could present a gamut of opportunities for Zynga.

Competitors

Electronic Arts (NASDAQ: EA) has a market cap of $5.3 billion and has a strong base compared to Zynga. Revenue streams are diversified with popular games releasing with their newest versions every year. The new edition of Sim City has seen a sale of 1.1 million copies. The stock has given a return of 19% in the past year. EA is not so dependent on Facebook, like Zynga is, and looking to focus on high margin digital content. With the release of the new PS4 and Xbox in the 2013 holiday season, the company has strong growth promises.

Activision Blizzard (NASDAQ: ATVI) is another strong competitor to Zynga and has some of the most popular games like Call of Duty, Diablo, and World of Warcraft in its armory. With a market cap of $16 billion, the stock has given a steady return and quarterly revenue growth stands at 26%. Not only in the last quarter; the company has been increasing revenue since 2008. The recent decrease in short selling activity shows that investors are growing more bullish on this tech giant.

Looking ahead

Zynga may not be as diversified in the digital content world as its peers; however it's growing quite fast as suggested by the record gaming activity claimed by Facebook in its recent quarterly results. It has been constantly adding new games to its offerings. The launch of Zynga with Friends last year hints at Zynga trying to venture into its own social gaming network. It recently launched a new game called Zynga slots which topped the list of the fastest growing Facebook games calculated by monthly average users. Moreover, Zynga has another big hit in the app store with the launch of the sequel to Draw Something.

The company is in a re-organization phase, closing down unpopular games and focusing more on high-growth areas like mobile gaming. The strong balance sheet suggests that even if the social gaming business slows down in the future, Zynga will remain intact and weather the storm with sufficient cash in hand. Zynga has a cash component of $1.28 billion which can be utilized in acquiring any upcoming Internet start-up. The acquisition of Game of Thrones is a sign of diversification of revenue streams and open minded management by the company.

Conclusion

If Zynga makes it big in the gambling business, it can trade much higher from current levels. I personally have faith in the fundamentals of the company which will deter it from any unwarranted outcome. The gaming industry is a hits-driven business and developers constantly need to test and release newer versions and betas of exciting games. And Zynga, with its technical expertise, can certainly provide that. I predict a strong upside potential in the company, which makes the stock a buy at current levels.

Zynga's post-IPO performance has been dreadful, and investors are beginning to wonder if it's "game over" for this newly public company. Being so closely tied to the world's largest social network can be a blessing and a curse. You can learn everything you need to know about Zynga and whether it's a buy or a sell in our new premium research report. Don't even think about picking up shares before you read what our top analysts have to say about Zynga. Click here to access your copy.


Tanya Kanodia has no position 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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