A year or two ago, I was waiting inside the library of a premier academic institution to meet a client. As I was waiting, I noticed an elderly lady, at least in her fifties, sitting in front of a public computer playing the game that we all have either played or scoffed at, Farmville. At the time, I recall thinking how silly, immature, and disrespectful it was for this lady to be playing some ludicrous game with corn and pigs at an academic institution of this caliber while there were students waiting to use the machines for intellectual edification. But now I realize that encounter was irrefutable evidence of just how pervasive, addicting, and successful these online games that Zynga (ZNGA) has developed were. The games were so enticing that a mature, full grown lady was willing to play at the expense of her social and professional reputation. When a consumer product becomes this enthralling, it is only logical for us to examine whether this is the time to wonder if ZNGA is going to last.
On February 5th, 2013. ZNGA CFO Mark Vranesh reported a Q4 revenue of $311 million, but a net income loss of ($48.5 million). However displeasing those numbers may appear to be, the Q4 FY2012 net income is actually quite a positive number for ZNGA as the same quarter a year ago, the company reported losses of ($435 million). Also, Vranesh reported a quarter-over-quarter EBITDA growth of 179% but down 34% from a year ago and a $30 million free cash increase in Q4, with $119 million generated for 2012. CapEx, however, was down 88% year over year to $6 million. According to Vranesh, "We ended Q4 in a strong position, with cash and marketable securities of approximately $1.65 billion, up $4 million from Q3." For the future, the Q1 2013 projections are between $255 million and $265 million in revenue (which is lower than Q4) and a net income loss of between ($32 million) and ($12 million).
Despite the income loss the previous quarter, Vranesh states that Zynga is in a strong position because they are steadily reducing operating costs quarter-over-quarter, and that trend will continue as indicated by their next quarter predictions. The elimination of inefficiencies and then investing in profitable venues is going to lead to positive earnings in the coming quarters. Furthermore, the $119 million in free cash generated in 2012 and $1.65 billion in equities demonstrates that Zynga has potential to invest in big ideas that I will mention later in this article, such as online gambling and an enhanced mobile platform for gaming.
My major concern is that if Zynga does not return positive operating margins in the next few quarters, I reckon investor sentiment would become too disconcerting, eventually to the point of no return. Currently, the consensus of the 20 analysts covering Zynga reports a -.03/share for Q1 FY2013 earnings, but hopefully there could be a positive surprise. Additionally, I am mildly concerned over the news that CapEx was 88% down year-to-year, as I fear that signifies that Zynga has not invested thoroughly for the launch of new real money online gambling games. Hopefully it has saved the capital for CapEx in this quarter…
For 5 trading days, shares have risen from $2.75 to $3.75, a greater than 36% increase, but then starting from the 12th, the shares have plummeted.
At first, I thought the drop in price was merely a correction for such a bullish uptrend, but when the decline persisted for a few days and has dropped by 16%, there clearly must have been more than just a correction causing this sell-off. In my opinion, this sell-off may be attributed to investors nervous about Zynga's future after its planned departure from Facebook (FB) starting March 31, 2013, which I estimate to be just short of the Q1 earnings reporting date. This is a reasonable fear as Vranesh stated that Facebook related bookings for Q4 bookings accounted for 79% of the pie, and the rest of the bookings were essentially on mobile platforms. This may seem scary at first glance, but after looking at some more numbers, I think investors may be convinced that this is just a temporary speed bump that is quickly being overcome. In Q4 FY2012, mobile bookings also grew from 8% in Q4 FY2011 to 21%, a 262.5% increase. Also from a year-over-year basis, Monthly Active Users or MAU's grew 24% to $298 million, and $72 million of those users originated from mobile, meaning that 24% of MAUs are on mobile. During that same time period, DAU's (Daily Active Users) grew 3% to $56 million, and $20 million of the DAUs were from mobile, signifying 35.7% of all DAU's are mobile.
Now, what does that all signify for investors? Well, as I mentioned, I think the recent precipitous drop in ZNGA shares can be attributed to the news that Facebook would no longer partner with ZNGA starting March 31, and that news is doubly scary considering that currently 79% of bookings (aka source of revenue) are from Facebook. However, the numbers that I showed you demonstrate that ZNGA investors should not worry too much about that because the mobile base for ZNGA is quickly growing, and I would bet that by the time the next quarter rolls around, the percentage of MAUs on mobile will cross 40% and the percentage of DAUs will be well beyond 50% for sure. The trend has already started to form as the mobile bookings have increased to represent 21% of all bookings in the past quarter and I bet Zynga is working on more mobile games to develop as we speak. So yes, the loss of the Facebook partnership is temporarily hazardous for Zynga, but at the same time, the mobile base is steadily growing and that, my fellow investors, is great indication of a positive and winning future (pun is intended). Furthermore, revenue in advertisement has increased year-over-year by 35% to $37 million dollars and with increased mobile activity, the revenue stream will continue to increase.
Facebook is not the only online social media site that Zynga partners with as Zynga also has games on Google+ (GOOG), and QQ (a Chinese social media site). Furthermore, the popular game "Words with Friends" is owned by Zynga, and during the earnings report, Zynga reported that it will focus on re-designing "Words with Friends" so that it allows for friends to more easily find each other. Currently, many users play with random players using a feature they have that allows them to play with a random player across the world. With the new design of facilitating friend searches, Zynga encourages a form of "social networking" and we have seen how popular a social media company can be if it begins "networking" friends with friends. Do I even need to mention Facebook and Twitter? With more popularity = more revenue stream from advertisement.
The hopes for 2013:
Let's not forget that Zynga's COO David Ko has said this during the last Q4 earnings call:
"We remain on track to deliver our first real money gaming products in the U.K. in the first half of 2013. Together with bwin.party, we'll offer poker and casino games under the Zynga Plus Casino and Zynga Plus Poker brands, and we'll be rolling out these products in multiple phases across a range of platforms in the U.K., namely via web, download, Facebook, and if we choose, mobile."
As investors or glorified gamblers alike, we all know how much human nature loves to gamble and to put down money hoping to win big. Even if we lose, we continue to gamble because we hope to win even bigger next time. The people that truly bring in the revenue for casinos and online gambling games are people who are addicted to the thrill, and will always be there weekend after weekend. So, as a prudent and rational investor, we must realize that we have the opportunity to profit from the irrationality of human nature. Also, if they carry forth and do what David mentions in the end of that statement - bringing gambling to the mobile platform, I can only imagine the profit that Zynga could generate from Androids alone. Lastly, news that some U.S. states may legalize online gambling offers an additional venue for Zynga's online gambling platform.
Zynga has the potential to be in for the long haul as it is re-adjusting its focus away from Facebook and into the realm of real money gambling and the mobile platform. Gambling has always been a hot source for revenue and it is never too late to jump in, and the mobile industry has never been stronger. Also, additionally crucial is whether or not Zynga can cut unneeded operating costs to generate positive operating margins and to wisely use CapEx to finance the launch of its new games, both on mobile and in the online real money gambling arena. If Zynga can establish its mobile platform to time Facebook's exit, and develop a strong crowd for its online gambling games, there is a sure future for the old Farmville maker. Maybe I will see that old lady again sometime, but this time clenching her wallet.