We had earlier advocated buying Zynga (ZNGA) because of its compelling valuation and adverse sentiment. The company reported good Q412 results which showed momentum in its mobile monetization strategy and a surprising success for the new version of its Farmville franchise. The guidance for Q113 was not great as the company is not expecting to release new titles during Q113 as it cuts its operating expenses to concentrate on existing franchise. The company is making a transition, where it is cutting its bonds with Facebook (FB) and looking to create a niche of its own. The current results have shown that the new strategy seems to be working for Zynga. The company reported that its mobile revenues have gone to 21% of overall bookings up from 8% last year. The management also revealed that Zynga has become the 5th most used website in the mobile internet space. The other good point to come out was that Farmville 2 succeeded much more than the company expected leading to a solid beat in bookings result this quarter.
Zynga Positives from the Call
- Successfully transitioning to mobile - One of the main concerns with Internet companies is how they transition themselves from the PC era to the smartphone era. Some companies like Baidu (BIDU) are facing headwinds in monetization of their mobile Internet traffic while others like Facebook are doing relatively well. Zynga seems to be on the successful side as it increased the number of monthly average players on mobile to 72 million. The company has managed to increase its mobile bookings to 21% in the current quarter up from 8% a year ago. The company launched 4 games each in mobile and web in the current quarter which reflects the importance they are giving to the mobile segment.
- Profits better than expected - Zynga exceeded their top line bookings forecast by $48 million, and adjusted EBITDA forecast by $51 million.Q4 bookings were much stronger than expected at $260 million which was driven mainly by the successful launch of Farmville 2. The company said it took 6 months to test and market Farmville 2 which contributed to its success
- Cost Reductions - Zynga is continuing to reduce its operating costs by shutting down nonviable games and reducing the number of game studios. The company plans to further reduce their costs by moving development to lower cost centers in India and China.
- Network Effect - Zynga said that its game network has become its strongest asset leading to 71% installs of its new games. The company is managing to use its large existing user base to try new games.
- Huge Cash Hoard and FCF positive - Zynga has a massive cash pile of ~$1.65 billion in cash with net cash of ~$1.2 billion. The company managed to generate $30 million in FCF in the past quarter and $119 million for the whole of 2012.
- Share Buyback - Zynga had announced a $200 million buyback in October 2012 and it has bought back $12 million in stock in the last quarter at an average price of $2.36 ( this means ~20% return)
Zynga Negatives from the Call
- Facebook still makes up 79% of the bookings - The change in the relationship between Facebook and Zynga has been a one of the main contributors to the steep fall in ZNGA stock. Facebook still accounts for 79% of the Zynga's booking in the quarter. However this dependence is reducing due to the transition to mobile.
- Average Daily Booking Per User falls - Zynga has seen its ABPU fall by 17% y/y to 5c/daily average user. This is due to the decline of the higher monetization older games. However, the ABPU was up 8% q/q due to better advertising. Online gaming revenues was down 3% y/y but advertising revenues showed a jump of 35% y/y.
- 2013 guidance is not great - The Company has given a wide range of adjusted EBITDA of 0-10% as the company has little visibility on how the platform transition will pan out over the course of the year.
Stock Price Performance
Zynga's stock has come a long way down from its peak value of ~$16 and is currently trading at ~$2.9 in afterhours trading. This means that the company still has a lot of room to go up as its mobile monetization strategy gains more traction. The stock is currently trading at up almost 12% when we advocated a buy call on Zynga. However, the company still is heavily undervalued at the current price. As the company matures and people start to have more faith in its ability to stand on its own without Facebook, the stock can go up much more. We would recommend that investors buy the stock given that the company is showing good signs of transitioning to the mobile era.
Zynga does not have a lot of optimism built in the stock as about 50% of the company's valuation is accounted by cash alone. The company's 2013 guidance and current results ($30 million in FCF) means that the company's is not going to lose its cash in a major way. The common stock at its current price represents a low cost call option in case the company is bought by a bigger technology player or its foray into real money poker succeeds.