Here’s Why We Have Valued Zynga’s Stock At $2.83

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Zynga’s (NASDAQ:ZNGA) business has under-performed during 2014, and this has caused its stock price to fall by more than 30% since the beginning of the year. However, the third quarterly results were better as revenue came in ahead market expectations, with notable strength in both bookings and the mobile business. Although the company’s revenue declined by 13% annually during Q3 2014, it increased by 15% sequentially.

We have a price target of $2.83 for Zynga’s stock, which represents around 10% premium to the current market price. In this article, we analyze the key positives and negatives for Zynga’s business that drive our valuation. We believe the growing mobile business, which now accounts for 55% of overall bookings, represents the key positive for the company. While the overall engagement levels are declining, the mobile side is picking up and is seeing higher monetization. Bookings came in above expectations in the third quarter, and the success of the New Words With Friends game could boost results in the coming quarters.

However, there are several challenges that the company must tackle to see a meaningful change in its stock price. The web business is declining swiftly and this caused monthly active users and monthly unique users to respectively decline by 16% and 21% year to year during the last quarter. In addition, the lack of profitability in the company’s business model is disappointing and we see no change in this metric in the near-term. Still, a series of new games is expected to be launched soon, and investors must watch out for their success as any new hit game could change the fortunes for Zynga.

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See our complete analysis for Zynga

Growing Mobile Franchise And Bookings Represent The Key Positives For The Stock

While Zynga’s web business is clearly stumbling due to the increasing popularity of mobile games and its evolving relationship with Facebook, the  mobile business is showing promising results. Bookings on mobile devices increased by 111% annually and 10% sequentially during the third quarter. In contrast, web bookings fell by 27% year over year and 10% quarter over quarter. [1] The share of mobile bookings in total bookings has steadily risen from around 30% a year ago to 50% in Q2 and 55% in Q3.

Even though overall monthly active users (MAUs) fell during the quarter, mobile MAUs grew by 45% annually. Expansion in the mobile business is important, due to the continued shift of consumers to smartphones and tablets for most of their computing and entertainment needs. We expect Zynga’s mobile business to see continued strength in the coming quarters, as the company is making huge investments to bolster its mobile offerings.

Overall, bookings rose by 15% annually and 0.2% sequentially in Q3 2014, representing a year-over-year increase in bookings for the first time in nine quarters. [2] This certainly gave the markets something to cheer about considering it came in at the high end of management’s guidance range.  It also indicates that monetization on mobile games is rising.

Additionally, Zynga’s recently re-launched New Words With Friends is gaining traction and could help the company improve its financials in the future. According to App Annie, a firm that specializes in compiling app data for iPhone and iPad users, this new game has been among the top six downloaded games on iPhones in the U.S.  since its launch in October. We will be tracking the success of Zynga’s new games as any new hit game could reignite interest among investors, taking the stock to higher levels.

Lack Of Profitability And Declining User Base Are The Key Negatives For The Stock

Lack of profitability has been a long-standing concern for the company’s stock. Its diluted net earnings (loss) per share were ($1.40), ($0.28) and ($0.05) in 2011, 2012 and 2013, respectively. In 2014, we expect Zynga’s GAAP and non-GAAP diluted EPS at ($0.26) and ($0.01) respectively. Similarly, its operating margins came in negative at -14% and -8% in 2012 and 2013, respectively. We expect the margin-related pressure to persist in the near future, as Zynga will continue to invest heavily in R&D efforts to develop the next hit-game. In addition, marketing expenses will rise with new game launches. However, in the long-run, the company will have to achieve sustainability in its business model to take its stock price to significantly higher levels.

Recently, Zynga launched several games including NFL Showdown and a new version of the Zynga Poker. It also introduced New Words With Friends and Looney Tunes Dash in certain markets and will release them in more geographies in the near-future. In addition, it has updated a series of its existing games. However, these new games have failed to attract and retain users — in Q3 2014, overall MAUs declined by 16% annually and 14% sequentially to 112 million. Similarly, monthly unique users (MUUs) also fell by 21% year over year and 13% quarter over quarter to 77 million. This is clearly alarming as it indicates that the company’s old games are becoming less popular. Hence, Zynga will have to find a new hit game soon to stem the decline in its user base.

Zynga formed partnership agreements earlier this year with famous franchises including NFL, Tiger Woods and Warner Brothers’ Looney Toons to use their brands to launch new games. A new marketing deal with the TV franchise ‘Real Housewives’ for its popular game Hit It Rich was also recently announced. While these games will certainly help  to expand its presence in the under-served sports genre of the mobile gaming market, we think the company has to launch more exciting and unique original content to fuel its growth outlook in the long-run. A number  of new mobile games, including those from NaturalMotion, are expected to be launched in 2015, and we will be looking for more information n these developments in coming quarters.

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Notes:
  1. Zynga (ZNGA) Q3 2014 Results – Earnings Call Transcript, Seeking Alpha, November 7, 2014 []
  2. Zynga’s Loss Widens as Company Struggles to Generate a New Hit, The Wall Street Journal, November 6, 2014 []