These Two Scenarios Can Impact Zynga’s Stock Price

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Zynga

Social gaming company Zynga’s (NASDAQ:ZNGA) share price has slumped by about 40% over the past year owing to various challenges in its business model. Though our $2.30 price estimate for the company represents near-5% downside to the market, we believe there are certain plausible scenarios that can move the stock considerably over the coming years. Specifically, the possibility of more-than-expected recovery in player base and continued increase in expenses are plausible scenarios that could influence stock price changes for better or worse.

See our complete analysis for Zynga

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Zynga’s Monthly Active User Base For Games (Excluding Poker) Rises To 125 Million (+15%):

Zynga’s average monthly active user base has fallen drastically from 302 million in 2012 to 118 million in 2014, owing to reduced popularity of older games, failure to launch new hit games, and problems with Facebook business. Notwithstanding these challenges, we expect Zynga to show some recovery in the coming years with new game launches and strength on the mobile platform. The company’s substantial cash reserves and technical strength represent competitive advantages that can be leveraged for new game launches. Zynga’s upcoming game pipeline consists of six to ten games in gaming categories, such as match-three puzzles, action-strategy and sports. Titles such as FarmVille Harvest Swap, Empires & Allies and NaturalMotion’s Dawn of Titans are expected to be launched later in 2015. We think some of these new games could help curb the fall in Zynga’s player base — as a result, we forecast Zynga’s monthly active users for games (excluding Poker) to stabilize at around 90 million in our $2.30 price estimate.

In a scenario where this monthly active user base (for games excluding Poker) expands to more than 120 million by the end of our forecast period, it would represent a 15% increase in our price estimate to $2.65. Some of the factors that make this scenario plausible include — 1) more-than-expected success with new game launches, 2) stabilization in the web games business, and 3) acquisition of other game publishers. Zynga’s access to proprietary tools and technology, coupled with Natural Motion’s simulation capabilities could help the company launch new hit games.

Challenges In Business Model Continue To Cause Low Profitability (-10%):

Zynga’s adjusted EBITDA margin dropped from 26.2% in 2012 to -4.7% in 2014 (according to our estimates), in line with the challenges in the business and since the company spent heavily on R&D and marketing to launch new games. Though we expect profitability to stay grim over the short-term, we believe EBITDA margins could normalize to over 20% in the long-run in our valuation model; this is as a recovery in revenue could result in operating leverage gain in the future, in our view.

In a scenario where Zynga’s business continues to struggle and its EBITDA margin increases to only 15% by the end of our forecast period, it would reduce our price estimate by more than 10% to $1.95. This could happen if Zynga’s new games fail to gain traction in the market. The intense competition in the mobile gaming market coupled with its low barriers to entry makes this scenario plausible. In such a situation, the company will most likely invest heavily on product development and marketing to come up with new hits. A slowdown in top-line coupled with high growth in R&D expenses could add pressure on margins.

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