Here’s What Will Drive Zynga’s Future Earnings Growth

by Trefis Team
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We believe that the launch of new games, and controlled expenses will drive Zynga’s (NASDAQ:ZNGA) future earnings growth. While the company has seen moderate revenue growth in the recent past, we forecast the growth to accelerate over the next couple of years, primarily driven by the launches of new games, which will likely aid both Online Games and Advertising segments. We have created an interactive dashboard ~ What Will Drive Zynga’s Earnings Growth In The Coming Years ~ on the company’s expected performance in the coming years. You can adjust the revenue and margin drivers to see the impact on the company’s overall earnings, and price estimate. Below we discuss our forecasts in detail.

Expect Both Online Games And Advertising To See Strong Growth In The Coming Years

We forecast Zynga’s Online Games revenues to grow in low single digits to around $686 million in 2018, and grow in double digits thereafter to over $900 million by the end of 2020. This can primarily be attributed to the company’s new game launches in the second half of 2019. Zynga has entered into an agreement with HBO for rights to create two new Game of Thrones games. The company intends to launch a social mobile slot game slated for the second half of 2019. Also, the company announced a new licensing agreement with Warner Bros. Interactive Entertainment for a new Harry Potter Match-3 mobile game. Lastly, the company has also entered into a licensing agreement with Disney to create a new Star Wars mobile game slated for the second half of 2019. All of the above three franchises are very big, and will accelerate the revenue growth for Zynga in 2019 and 2020. Apart from new launches, the company’s forever franchises, such as Zynga Poker, and CSR 2, continue to do well, along with Words With Friends.

Looking at Advertising, we forecast the segment revenues to grow in double digits from $196 million in 2017 to $295 million by the end of 2020. This can be attributed to the trends in the company’s Online Games segment. With the launch of new games, and continued growth in forever franchises, as well as the impact from acquisitions, including Gram Games, will bode well for the Advertising growth.

Expect Margins To Remain Stable While R&D Expenses Could Decline

Zynga’s gross profit margin has averaged 70% over the last 5 years, and we forecast it to remains stable around the same mark in the coming years. The company’s mobile business is showing promising trends, and it now accounts for over 90% of the overall revenues. Even mobile advertising is seeing strong growth, and surged 45% in the previous quarter. This ongoing shift towards mobile will likely help the company sustain current margins. The decline in the company’s web-based games will lead to a decrease in hosting and data center costs, customer service expenses, and headcount related expenses. Note that the company expects the margins to be moderately impacted in 2019 due to the investments in new games. However, margins are expected to trend higher from 2020, which will reflect the benefits from the new game launches.

Looking at the company’s R&D Expenses As % of Revenue, it has declined from 38% in 2014 to 23% in 2017. We forecast it to decline further, albeit at slower pace to 21.6% by 2020. Note that while we forecast the R&D Expenses As % of Revenue to trend lower, the overall R&D expenses in dollar terms are expected to increase due to the company’s large slate for 2019. Zynga’s famous franchises have lost some ground in recent years and the company’s user base has been declining. The company’s efforts to launch new and innovative games in order to maintain its user base, as well as to attract new users, will result in higher R&D expenses.

Overall, we believe that the company’s future earnings growth can largely be linked to its new game launches. It makes more sense to look at the company’s earnings in the coming years, rather than 2018, which will likely see modest decline (y-o-y), in our view. We forecast the EPS to trend higher to around $0.20 in 2020. We currently have a $4.50 price estimate for Zynga, which is at a premium of over 20% to the current market price.

 

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