Zynga: A Strong Buy At Current Price Levels

| About: Zynga (ZNGA)

Social media investments quite often offer little but an abundance of unnecessary risk. Last year showed example after example of this concern with wild swings and plummets during the first week of trading. The hype over companies like Zynga (NASDAQ:ZNGA) and Groupon (NASDAQ:GRPN) hit investors hard as revenue growth slowed much faster than anticipated. In addition, the Facebook (NASDAQ:FB) IPO debacle showed that even underwriters didn't know how to value these stocks.

However, with some time to settle, it would seem some of these stocks are beginning to reflect a more reasonable valuation while positioning themselves with a high degree of growth potential. I predict that Zynga in particular will see a significant increase based on its aggressive strategy and innovative leadership.

The Pattern

As with any investment, one must look at the whole pattern in order to anticipate appropriate timing for investing. For instance, Facebook shares hit a 52-week high of $45.00 per share shortly after going public at $38.00 per share, then plunged to a paltry $17.55 for a 52-week low, in the final months of 2012. This year the stock has slowly, yet steadily, been rebounding, ranging between $26.00-30.00 in recent weeks.

This seems par for the course as stocks "find their footing." It could also be proof that other stocks in this sector are next to rally. As stated before, I see a strong possibility for Zynga's growth for several reasons.

Why Zynga?

On its first trading day, Zynga's stock closed just below the estimated $10.00 IPO price. After gaining almost 14 percent trading around $13.00 per share, it now hovers just over $3.00. This is the price investors would want to get in on, especially because of what is coming.

The launch of Zynga.com last year, its own gaming site independent of Facebook, allowed for stand-alone games and application widgets on other social networking sites. This was not a complete separation from Facebook. Players on the new site are still able to log in with their Facebook IDs and play games with existing Facebook friends. In addition, Facebook credits are still the "currency" for all Zynga.com players.

Next, Zynga has done an outstanding job building its foundation. With assets of about $1.32 billion in cash and only around $100 million in debt, the company is not only securing its viability, but also setting investors up for big gains. Its cash-on-hand is equivalent to about $1.69 per share. That is considerable since the stock is now trading around $3.00. This indicates that the patents, game portfolio, brand name, and other assets are only being valued at just over a dollar per share. The smart investor can understand that these factors translate into a very cheap price for the stock.

Finally, Zynga is getting into an extremely profitable new business: online real-money gambling. According to a report from KQED, Public Media For Northern California:

In a partnership with Bwin, the world's largest publicly traded online gambling company, Zynga plans to release 180 real money games in Europe during the first half of 2013. Meanwhile, it is lobbying hard to legalize online gambling in the United States, where some analysts predict they could make a killing.

The company applied for a gaming license in Nevada earlier this year. It also recently launched two gaming websites called Zynga Plus Poker and Zynga Plus Casino for players in the United Kingdom. This is a smart strategy for the company, to get established outside the US and then use that experience to step into a leading position once online gaming becomes legal in the United States. Investors who buy into Zynga now might be getting a shot at investing in the next leader in online gambling.

It is interesting to look at how these two strategies are interdependent. With Zynga's new independent platform, it can capitalize on changes in gambling laws, whereas, if it were still tied to Facebook, the battle could linger. Facebook is a social site and has already taken the stand of protecting young users. The legalization of online gambling would be slow to be allowed into this "safe" environment, and even then only after a battle that would most likely cost both companies.

One also cannot boast Zynga without commenting on its foresight to "buy vs. build." This strategy alone allows it to be more profitable than other companies focusing on generating hardware/software in house. The company currently claims 240 million active users. With a new platform, this could easily double. Scaling to those heights would be costly for those companies who follow the DIY approach. Zynga's zCloud, however, is built upon cloud computing software by Cloud.com (now part of Citrix (NASDAQ:CTXS)), its analytics platform is primarily a Vertica database (now part of HP (NYSE:HPQ)), and its application servers run the Couchbase NoSQL database. This outsourcing strategy gives Zynga the leg up it needs to compete against companies with high operating costs.

A perfect example of this competition involves Activision Blizzard (NASDAQ:ATVI), the creator of games like Warcraft, Starcraft and the Diablo series. Blizzard released its first installment of Warcraft in 1994 and has continued to release expansion packs that greatly improve the game's length and depth of play. These expansion packs operate on the company's own platform and boasts more than 10 million active users.

The expansions are inherently inexpensive to produce, as they are built on the same platform as the original titles and also relatively easy to advertise, as the captive customer base is already aware of and anticipating the next release. Even so, Blizzard relies on the creation and operation of these in house, increasing operation costs to a level far above Zynga.

Based on its financials and growth factors, Zynga looks attractive. Its calculated and measured strategy toward independence will be the foundation of its success. It is also prepared for consistent profitability over time by continuing to expand a customer base through expanded platforms and increasing revenue through advertising and new legislation with online gaming.

Disclosure: I am long ZNGA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.