Zynga: All Fun, No Fight

| About: Zynga (ZNGA)

When you're spending hours a day on your smartphone playing Words with Friends or Farmville, do you ever consider there's a company trying to make money from those time-killing social media games?

In the case of those two aforementioned titles, that company is Zynga (NASDAQ:ZNGA). And until recently, the company seemed to be building a strong business based on people's need to play silly games.

Founded in 2007, Zynga Inc. is the world's leading provider of social game services with 253 million monthly active users playing its games, which include Zynga Poker, Words With Friends, Scramble With Friends, Gems With Friends, Draw Something, FarmVille 2, ChefVille, CityVille, Bubble Safari and Ruby Blast. Zynga's games are available on a number of global platforms, including Facebook, Zynga.com, Google+, Tencent, Apple iOS and Google Android. Zynga has its headquarters n San Francisco, California.

Tough Times for its Stock Price

Zynga stock traded as high as $9.54 a year ago, about the price it entered the market when it became listed on Nasdaq in February 2011. But since that recent high, the stock tumbled to a low of $2.09 in November. Shares had slightly rebounded to close to $4 in March, before falling to $3.01 following its earnings announcement.

Revenue was $263.6 million for the first quarter of 2013, down 18% compared to the first quarter of 2012. Online game revenue was $229.6 million, a decrease of 22% compared to the first quarter of 2012. The company did experience a 21% bump in advertising revenue from year-to-year. The company also reported net income of $4.1 million, compared with a loss of $85.4 million the first quarter of 2012.

Bookings, which are revenues from advertising and the virtual goods the company sells, were $229.8 million for the first quarter of 2013, a decrease of 30% compared to the first quarter of 2012 and a decrease of 12% compared to the fourth quarter of 2012.

Zynga's net operating cash flow has significantly decreased to $19.78 million, or 87.93%, when compared to the same quarter last year.

Fewer Users of its Game Brands

Activity on the company's games is trending downward. Consider:

  • Daily active users decreased from 65 million in the first quarter of 2012 to 52 million in the first quarter of 2013, down 21%.
  • Monthly active users decreased from 292 million in the first quarter of 2012 to 253 million in the first quarter of 2013, down 13%.
  • Monthly unique users fell from 182 million in the first quarter of 2012 to 150 million in the first quarter of 2013, an 18% drop.
  • Monthly Unique Payers (MUPs) decreased from 3.5 million in the first quarter of 2012 to 2.5 million in the first quarter of 2013, down 30% year-over-year.
  • Average daily bookings per average DAU (ABPU) decreased from $0.055 in the first quarter of 2012 to $0.049 in the first quarter of 2013, down 11% year-over-year. On a consecutive quarter basis, ABPU was down 2% from $0.051 in the fourth quarter of 2012.

Zynga exploded onto the social media gaming scene several years ago, but is now having to close down games to cut costs. One of its key competitors, Electronic Arts, has had to do the same. The big difference is that Electronic Arts can fall back on its popular sports games, such its Madden NFL series, for traditional gaming consoles. Zynga currently has no other fallback.

The company is forecasting a second-quarter loss of 3 cents to 4 cents a share on revenue of $225 million to $235 million. The Wall Street consensus target was a loss of a penny on revenue of $232.05 million, according to a Thomson Reuters survey.

Six Years after Founding, Already in 'Transition'

"2013 will continue to be a transition year as we face the challenging environment on the web and invest in developing the leading franchises and network across web and mobile platforms and offer our 253 million monthly players a connected experience that can follow them from work to school to home and anywhere in between," Mark Pincus, the CEO and founder Zynga, said in its earnings statement.

Perhaps the most telling, and concerning, part of that statement is the use of the word 'transition.' As an investor or potential investor in Zynga, one question you should ask yourself is: Should a six-year-old company already be in the midst of a transition?

Several analysts quoted shortly after the company's earnings release seem to have an answer:

"Zynga keeps hinting at meaningful changes to come ... profitably, on mobile, but we will need to see it before we can give them credit for it," Macquarie Equities Research analyst Ben Schachter said.

"Zynga is unlikely to ever dominate the mobile gaming market in the same way that it has the web-based gaming market for many years," Wedbush Securities analyst Michael Pachter said.

"Zynga's path toward renewed growth is uncertain and fraught with competitive and internal risks," Piper Jaffray analyst Michael Olson said in a research note to clients.

On a Positive Note

On the positive side, the company has managed its resources well. As of December 2012, it had stellar liquidity, as evidenced by a quick ratio and a current ratio that are both close to 3. In April 2013, the company repaid its long-term debt of $100 million and currently has no debt outstanding.

Zynga also recently launched its first suite of real money gaming [RMG], ZyngaPlusPoker and ZyngaPlusCasino, in the United Kingdom. These offerings are the first step toward realizing Zynga's long-term vision of bringing players the next generation of real money games on multiple platforms in regulated markets. However, because of the regulatory issues involved with casino style gaming, it may be a while before these offerings boost the company's long-term prospects.

But as long as the company can stay in business, it still makes popular games many people enjoy playing, even if it may not be a solid investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by an analyst at Catalyst Investments.

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