Morgan Stanley recently downgraded Zynga (ZNGA) to underweight with a price target of $2.60 from $3.00. The main reason for the downgrade has to do that the company's transition to mobile, which will take longer and cut deeper than anticipated according to Morgan Stanley. Analyst Scott Devitt also thinks Zynga is being surpassed by competitors in web gaming.
Estimates compiled by AppData conclude that Zynga has been passed by competitors in web gaming, and its key titles are diminishing among the top Facebook (FB) games. One other reason for the downgrade is that Morgan Stanley thinks Zynga might not see the benefits of real money gaming until 2014 or 2015.
"We believe RMG is potentially a very large global opportunity for Zynga, as discussed in our November 2012 MS Blue Paper, Social Gambling: Click Here to Play. However, we do not think RMG can move the needle for Zynga until 2014 / 2015 since it only operates in one country and may not receive attractive economics until it obtains its own operator licenses."
Well, I could not agree more. In fact both points that Morgan Stanley raises have been my thesis for Zynga also, if you have followed my articles on the company. That is the reason I have recommended selling Zynga into rallies up to the $3.60 level.
I have also said I would be a buyer of the stock around the $3 level for short term trading purposes. In addition, I have specified $2.80 as a major stop loss. If it breaks that, technically the chances that the stock will see lower levels are increased.
On a pure technical note, now that Zynga is trading below $2.80, there is a possibility that the stock might correct all the way to $2.30. If this were to happen, I think it would have more to do with overall market sentiment and the fact that markets can correct much more than with Zynga itself. Please read my take on what the Hindenburg Omen might mean.
The question is, why would someone be a buyer of the stock if its social games are not doing that good and if its gambling endeavors will not yield much revenue or profits until 2015?
Despite the fact that Zynga has been laying off people, it is also hiring people. More importantly, it is hiring where it counts. Zynga recently announced that it has acquired Spooky Cool Labs, a game studio staffed with talented social and real money gaming veterans focused on developing cutting edge, high quality social slots games.
So the company is pressing with it plans to get a foothold in the online gambling space when and if U.S. legislation permits. This will probably happen before 2015.
However, only the companies that are positioned for online gambling have a good chance to get a big piece of this business in the future. And if those who are positioned succeed, they will make a lot of money in the process. Zynga is getting positioned.
So buying Zynga at these prices gives you a long term option on the potential for such profits. One the one hand this option will never expire and on the other, the company's social assets are not exactly worth zero. Zynga has $1.4 billion in current assets on its balance sheet, with a market cap of about $2.15 billion as of Friday. So you are not exactly buying hot air when you buy Zynga at current prices.
At these prices, the entry point for getting a long term option that will never expire in the gambling space is worth the current price of Zynga's stock. Even with the volatility and even if you experience short term losses, if the company gets a foothold in the space, investors buying at current prices will probably make a killing.