Why Zynga's Recent Results Don't Matter

| About: Zynga (ZNGA)

Zynga's (NASDAQ:ZNGA) recent Q1 2013 results were actually quite bad. In fact they were much worse than I anticipated. Revenue for Q1 2013 was $263.6 million, down 18% compared to Q1 of 2012 and a 15% sequential decrease compared to Q4 of 2012.

Online gaming revenue was $229.6 million, a decrease of 22% compared to Q1of 2012 and a decrease of 16% compared to Q4of 2012. Advertising revenue for Q1 of 2013 was $34.0 million, an increase of 21% compared to Q1 of 2012 and a decrease of 8% compared to Q4 of 2012. Bookings were $229.8 million for Q1 of 2013, a decrease of 30% compared to Q1 of 2012 and a decrease of 12% compared to Q4 of 2012.

On the positive side, net income for Q1 2013 was $4.1 million compared to a net loss of $85.4 million for Q1 of 2012.

Another positive note was the cash equivalents and marketable securities reached $1.67 billion, compared to $1.65 billion as of December 31, 2012. Cash flow however was much lower and came in at $26.4 million for Q1 of 2013, compared to $78.8 million for Q1 of 2012.

Also positive was that as of April 2013, Zynga repaid all long-term debt (about $100 million) and currently has no long-term debt outstanding.

The outlook was dismal, with revenue for Q2 2013 projected to come in at $225 - $235 with a projected loss of about $26.5 - $36.5 million.

On April 25, the very next trading day these results were published, the stock closed down by about 7%. The very next day however, Friday April 26, Zynga recovered what it lost the previous day.

The question is why was the stock up, if the company's quarter was bad? The answer is because these results don't matter that much. Let me explain.

Zynga's social gaming business at the moment is not doing that good. On the one hand there is more competition in the space and on the other Zynga is in restructuring mode.

Zynga is reorganizing activities, closing down games that don't make money and focusing on games that have a better chance to make money, while on the same time concentrating on mobile that is growing faster than desktop games. This reorganization will take time. If management however turns the company around remains to be seen.

But despite all this, Zynga is holding its own. The company will continue to be there and it will continue to be the leader in the social gaming space for the foreseeable future, even it never makes a dime in the process. There is the possibility that social games will go out of style and people will stop playing with their friends on Facebook (NASDAQ:FB), but I doubt it.

I have said in the past that the social gaming business is not something that is of particular interest to me. While I do not rule out the possibility that Zynga will come up with some new revolutionary social game and take the world by storm -- and make a lot of money in the process -- I would not bet on it either.

There are two issues that current shareholders should keep in mind about the future of the company and nothing else.

The first has to do with the company itself. No so much if it will grow and if the social gaming business will make money or not, but if the company as a whole can stay intact, even assuming that the social gaming business continues from bad to worst.

Given that Zynga's balance sheet has stayed intact, I think the social gaming business can continue to deteriorate for the foreseeable future, without impacting Zynga negatively a whole lot. On a non-GAAP basis the company will continue to hold its own and not deteriorate to such a state, that warrants the thought if it will go bankrupt or not.

The second question is if the company can stay afloat to give it enough time to enter the online gambling business. Please note, the issue at hand (for the time being) is not if the company will be successful or not, but if the company's balance sheet will give it enough time to get a chance to make in the on-line gambling space.

I for one say the answer is yes. The company has more than enough cash on hand to weather the storm, and with no long term debt on its balance sheet, it really does not have many things to worry about.

Whether the company will be successful in its real money gaming activities remains to be seen. But this is exactly what the market will be playing for the next two years or so. Again let me explain.

If the company manages to make it big time in the gambling space, then the stock has very big upside potential. However since we don't know if it will be successful, we cannot bid up the stock for the time being.

The market however will stay on top of this stock because of the potential and place a bid under the stock for the time being. The market is waiting to see -- and will play out -- the gambling potential.

So on the one hand the market will not bid up the stock too much, but on the other it will also buy the stock when it corrects. That's what I think happened on the 25th and the 26th of last month.

So how will the stock play from now on?

This is what I think will happen. As time goes by and as Zynga gets deeper and deeper in the gambling business, irrespective if the company is making money yet, the market will give the company the benefit of the doubt and will be bidding up the stock.

So as time goes by, the stock will be making higher highs and higher lows. Currently I think the bottom range of this channel might be around the $3 range. I think the market will buy the stock when it reaches that level and will sell it at higher levels and buy it back again, but at higher levels the next around and so on.

For the time being the chart below is what I think investors should be looking at. I think the gray area below is the current buying zone.

Click to enlarge
(Click to enlarge)

Please note that anything can happen and I could be wrong and the stock might tank even below the $2.80 level. However for the time being -- and unless the stock trades below the $2.80 level -- I think investors should be buying the dips and selling at higher highs for the next 18 months or so, or until we get some positive news on the company's gambling activities and reassess our thoughts on the stock once again.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.