Is it time to buy Zynga?
Zynga (ZNGA) has had quite the roller coaster ride in stock prices since its IPO in December of 2011. The share price surged to $15 in March of 2012 and has been on a long downward slide to below $2.50 since then but has now recovered to just over $3.50. The analysts following the stock are quite bearish on Zynga according to Fidelity.com. Not that I always follow the advice of analysts. I reviewed the most recent 10-K report in order to try to understand where Zynga is heading as a company and to decide if I want to jump on this roller coaster and invest.
Zynga currently has a market capitalization of $2.79 billion and as of December 31, 2012, had $1.652 billion in cash and cash equivalents. Last year Zynga produced almost $200 million in operating cash flows so unless Zynga has acquired another company in the 1st quarter we can expect that cash position to be getting close to $1.7 billion. Zynga's balance sheet is strong and the share price seems low with a little less than half of its value coming from the cash hoard it has.
Moving to revenue we see that Zynga grew revenue from in-app purchases by a little more than 7% growing to $1.144 billion in 2012. While advertising revenue has been historically low compared to the in-app purchases it grew by 84% to $137 million. I would like to see revenue growing faster for the in-app purchases but the massive uptick in advertising revenue is a good sign. Zynga is generating more value for its advertisers and this revenue accounts for almost 12% of total revenue. The other positive I saw was the decrease in expenses. Cost of revenue grew by a little more than 6.5% while research and development expenses were down by almost 12%. Sales and marketing as well as the general and administrative expenses categories were both down by more than 20%. Between the increase in revenue of $142 million and the containment of costs Zynga was able to shrink the net loss by over 50%.
Zynga has been recently making changes to become less reliant on Facebook (FB) but still derives 86% of its revenue through Facebook. Zynga recently launched its new website to connect both mobile and PC users during game play adding additional value to the games by increasing the social aspect of them. We are also seeing a diversification of the revenue stream as well. The top three games in 2010 accounted for 78% of the revenue but in 2012 that percentage had fallen to 55%. This seems like a positive sign as the company is seeing success in additional games garnering solid revenue. The company is also growing more internationally and now derives 41% of its revenues outside of the U.S. But let's go back again and look at the revenue growth of Zynga when compared to the growth of the social gaming market and see how successful the company was at building market share.
According to the Casual Games Association the world wide social gaming market grew by 25.5% in 2012 but Zynga only grew its revenues by 7%. The competitive landscape must be catching up with Zynga and the proliferation of casual game titles are limiting Zynga's success in adding revenue. This does not bode well for Zynga's success in the future. The social gaming market is predicted to be slowing its growth now with 20% growth in 2013 and 15% in 2014. Zynga is being successful in containing the costs, which will produce more profit from the same revenue but it needs to find new avenues for continued revenue growth. The Real Money Gambling [RMG] market is one of those avenues the market has been excited about recently. I researched this market a little bit and according to H2 Gambling Capital the RMG U.S. market could reach $7.4 billion by 2017. The current worldwide market is estimated at $30 billion with 54% of that market concentrated in the UK and Europe. Zynga is entering into the UK RMG market with its ZyngaPlusPoker and ZyngaPlusCasino games in partnership with bwin.party. This is a good expansion for Zynga since the RMG market is already four-times bigger than the social gaming market but it is also just as crowded. Competition will be fierce in RMG too and Zynga will have to pay some of its profit to its partner lowering its margins in this market. This is still a great avenue for more growth for Zynga. I just want to temper the enthusiasm a little.
Zynga's management indicates it is interested in expanding its offerings into different genres of games like 3D action games. It is using its third-party publishing platform to bring developers into its network and launch new titles to grow revenues from this market as well. I read an article on Newzoo that defined the "mid-core" market at approximately $2 billion in the U.S. and Europe and growth in the double digits. "Mid-core" is combining the deep experience of the hard-core games with the casual gameplay allowing you to sneak some time in when you can and not require a five-hour block to play the game. Naturally utilizing a publishing platform will provide lower profit margins for Zynga but will also lower the risk of establishing new titles since another group is completing the initial development. Zynga is also borrowing developers that specialize in creating games in this genre, which should also increase the success rate of the titles since this is a new market for Zynga.
Zynga appears to be successful with its game development with five out of 10 of the top Facebook games being developed by Zynga. Revenue growth has been a little slower than I like but still positive overall. The possibility of earning revenue from real money gambling and the entering into the "mid-core" market provides Zynga with significant opportunity for additional revenues though it will put downward pressure on margins.
Almost half of the value of Zynga is tied to its cash position and it has half of the top 10 Facebook games with increasing revenues and good cost controls. It is expanding into the $30 billion RMG market in the UK this year and will expand into Europe in the near future. It is working through its publishing platform to enter into the $2 billion "mid-core" market as well. I think it might be time to purchase Zynga even with the recent 40% increase in share price. It will be announcing first-quarter results on April 25, and with a consensus of -$.04 earnings Zynga has the ability to earn an earnings surprise if it can continue to contain costs even as it expects lower revenues.