- Zynga will likely report a slight surprise on bookings in Q1'16.
- User metrics will likely recover in the second half upon the release of 10 new game titles.
- Furthermore, the company is undervalued as there are a lot of tangible assets baked into the current enterprise value.
Zynga (NASDAQ:ZNGA) is expected to deliver earnings results after the close on May 4th 2016. The company is in the process of executing a turnaround, and with some promising franchises outside of Farmville, the company seems better positioned to return DAU/MAU metrics to growth by the end of 2017 or 2018.
The analyst consensus anticipates Zynga to report revenue of $162.13 million and EPS of $(0.01). I believe there’s a decent probability that Zynga will report a slight beat coming out of the earnings report.
Also read: Is Zynga A One Trick Pony
That being the case, the unit economics were the primary theme coming out of the prior earnings call, as Zynga is investing into mobile app installs to extend the life of current game franchises. For those who are not familiar, app installs are an ad unit that’s sold on the basis of installations of mobile applications. That being the case, Zynga believes there’s enough life time value per active user to justify spending on advertising. So, there’s at least a funnel to replenish active user churn, which makes the business model more predictable.
Over the past couple years, the investor base has misinterpreted or overstated the residual value of mobile active users for mobile game launches. There’s usually a sharp uptick in usage for popular mobile games followed by an abrupt decline. To sustain the life of a franchise just like any other game title, the mobile publisher has to produce additional sequels, i.e. create a miniature tent pole franchise.
However, for some soft core games like Candy Crush and Farmville, it’s difficult to sustain engagement through feature additions alone. After all, the game design is so basic or fundamental in nature that developing the gameplay any further results in diminishing returns. As such, Zynga has transitioned to a model of releasing new game franchises, similar to the broader gaming industry. However, game publishers for console and PC tend to generate revenue on the front-end through game licenses whereas Zynga has to monetize over the lifetime of usage. The unpredictability of life time value makes it difficult to anticipate the future cash flows or the duration of cash flows from current franchises.
However, Zynga has pivoted to some casino themed games like Poker and Slots. For the most part, these casino themed games are a little more predictable in terms of engagement. Therefore, there’s a stable source of revenue if all else fails. The company is also set to release CSR 2 (popular racing game), and Dawn of Titans in the second half of 2016.
Valuing the business is somewhat difficult, but with bookings recovering, the stock looks slightly more compelling. The company’s mobile bookings increased despite the drop-off in daily active users because the average booking per user grew to offset the decline in users. The user figures are expected to recover upon the launch of new games in 2H’16. ZNGA also trades at distressed levels despite $957 million in cash & investments and $270 million in property assets. The company has a market capitalization of $2 billion and an enterprise value of $1.067 billion. Therefore, it trades at a pretty heavy discount, which creates an opportunity to buy shares. However, many of the mobile game franchises like Glu Mobile and King Digital also trade at discount multiples, so anticipating multiple expansion without significant top line and bottom line improvements could be a stretch.
According to Wedbush Securities there could be upside to the stock:
We expect Zynga to guide to a modest q-o-q bookings increase in Q2:16, reflecting the ramping of its first half releases. We are modeling Q2 bookings of $180 million and breakeven profitability, although we do not think shares would be punished by a flat top-line guide, assuming that management remains committed to at least ten new game launches in 2016, with no further delays for the 2H releases CSR2 and Dawn of Titans. Maintaining our OUTPERFORM rating and our 12-month PT of $4.25. Zynga shares are on the Wedbush Securities Investment Committee’s Best Ideas List.
For the most part, I could see why there’s decent upside from these low price levels. However, I would need to see a meaningful acceleration in sales, and an inflection in DAUs to get even more aggressive. Notwithstanding, I anticipate that the combined efforts on marketing and game releases will result in an inflection point for active user retention and growth. Furthermore, the low valuation and the tangibles sitting on the balance sheet diminishes further downside risk.
As such, I’m initiating my Zynga coverage with a buy recommendation. It’s possible to argue both a value or growth investment case for the company. After the abrupt decline in Farmville revenue, the game studio has pivoted to a strategy of consistently launching successful game franchises and doubling down on less risky titles like Poker and Slots. Words with Friends is also carrying Zynga’s weight as it continues to grow at a 30% CAGR. When combined, the portfolio has some soft spots but the efforts to transition to mobile game apps has been somewhat successful. Further, efforts to solidify the portfolio and maintain a healthy growth rate will push the stock higher.
You can also see Amigobulls' Zynga stock analysis video for a quick look at the company's key financials.