Recent Cost Cutting Measures Could Lead Zynga To Profitability

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Zynga

With bookings of $167.4 million, Zynga (NASDAQ:ZNGA) surpassed market expectations during the first quarter of 2015. This was driven by robust performance on the mobile platform, where bookings and the monthly audience count rose by 84% and 29% year over year, respectively. The company’s core franchises, including FarmVille, Zynga Casino and Words With Friends, saw a 28% aggregate annual growth in bookings, even as the web business continued to face challenges owing to dwindling user base and shut-down of several Facebook-related games. The strong earnings, coupled with the recent announcement of cost cutting measures, have resulted in a greater than 15% rise in the company’s stock price.

In view of these results, we have raised our price estimate for Zynga from $2.30 to $3.04.  In our view, the recent steps towards operational simplicity and efficiency could drive the company’s EBITDA margin to over-30% in the long-run, instead of our previous estimate of over-20%. In addition, we expect Zynga’s business to recover in the future on the back of new game launches and solid growth on the mobile platform.

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See our complete analysis for Zynga

Cost Cutting Measures Will Drive Margins Higher

Zynga recently announced a new cost cutting initiative under which it will cut around 18% of its workforce (comprising 364 employees) and will reduce spending on outside and centralized services. While the annualized savings from the workforce reduction program is estimated at about $45 million, annualized savings from the cutback in centralized services is forecast to be higher at $55 million. The company plans to complete the workforce reduction program by the end of this year; however, the latter program could took longer and is slated for completion by Q3 2016.

We believe this restructuring initiative is encouraging, considering efficiency improvements will help bring back the company to profitability in the future. Zynga’s stock price has tumbled by over 60% since its IPO, as the company has struggled to come up with new hit games, even as losses have soared for the company.

Zynga Will Narrow Down Its Focus On Fewer Gaming Categories

A key reason why Zynga’s management was criticized in the recent past was that in order to come up with new hit games, the company intended to enter into multiple gaming categories, including into those in which it had limited experience. However, the recent change in Zynga’s leadership is expected to result in narrower focus on just five gaming categories, including Action Strategy, Social Casino, Invest & Express, Racing and Casual. The company will exit the Sports gaming genre and has halted further development of titles such as NFL Showdown and Tiger Woods Golf.

As a result, the company now plans to launch six to eight games during the year, as compared to its previous target of six to ten  games. Some of the titles that are expected to be released later this year include Dawn of Titans, CSR2 and FarmVille Harvest Swap. We believe this recent change in strategy will not only help save costs, but could also provide more product differentiation in Zynga’s gaming pipeline. This is essential as we think the company must come up with more unique and original games to enhance its future outlook.

Our $3.04 price estimate for Zynga, is marginally above the current market price.

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