Zynga Posts Solid Earnings In The Second Quarter, But User Base Decline Dissapoints

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The second quarter of 2015 turned out to be a mixed quarter for Zynga (NASDAQ:ZNGA), which reported results last week. With a few days’ reflection, we share the following thoughts. Although the overall top-line and bottom-line metrics surpassed expectations, its user base saw a significant decline during the period. In the near-term, we expect Zynga’s growth to be driven by increased monetization on mobile and core franchises, even while its user base could see continued challenges as new games are expected to be released only in the fourth quarter. However, in the longer-run, we expect Zynga’s business to turn-around on the back of new game launches and cost cutting measures. Its new games such as Empire & Allies and Farmville: Harvest are showing promising results and this could bolster top-line outlook in the coming quarters. Based on these results, we have changed our price estimate for Zynga’s stock from $3.04 to $3.27.

See our complete analysis for Zynga

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Bookings Increase Was Driven By Core Franchises (Especially Slots Franchise) And Mobile Platform

Zynga’s bookings came in at $174 million in the second quarter, which far surpassed its initial guidance of $145 to $160 million. Robust demand in the core franchise and mobile business caused this outperformance. Bookings in core franchises rose by 4% quarter-over-quarter, helped by 32% sequential rise in the ‘Slots’ franchise and by the launch of new games including Empires & Allies and FarmVille: Harvest Swap. In contrast to the continued challenges in the web business, mobile bookings grew by 30% annually to comprise for 66% of the overall bookings.

Going forward, we expect continued decline in the web business, owing to declining popularity and shut-down of several PC-based games. However, the increasing monetization rate on Zynga’s games, due to its entry into newer gaming categories (such as Action Strategy) and enhanced advertising efforts, represents a key positive in this earnings report. In the event, Zynga is also able to curb the fall in its user base, then its outlook could change significantly over the coming years.

Improvement In Profitability Was Seen During The Quarter

Zynga delivered adjusted EBITDA of $1 million during Q2 2015, which came in far above its initial guidance of $15 million loss (at the mid-point). We believe this recent improvement in profitability is encouraging, considering it comes on top of increasing investments for development and marketing of new games. This also indicates that the company is on track with its recent cost cutting initiatives, which are expected to result in annualized pre-tax savings of $100 million by Q3 2016 (according to management estimates). In another positive development, the restructuring plan is now expected to cost only $22 to $32 million, much lesser than the initial estimate of $80 to $90 million.

However, Falling User Base Remains A Cause Of Concern

User base metrics represented a dark spot in an otherwise encouraging earnings report. Zynga’s average monthly active users and daily active users fell by 32% and 23% annually, due to the planned sunset of several web and mobile games. Additionally, the reduced popularity of Words With Friends and Looney Tunes Dash also contributed to the decline in user base. We believe the user base could continue to decrease in the near-term as new games are expected to be launched only in the fourth quarter. Thereafter, we forecast the user base to stabilise on the back of softer year-over-year comparisons and increased demand for new mobile games.

Our $3.27 price estimate for Zynga, represents around 20% premium to the current market price.

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