The Zynga Turnaround Has Begun - Why It Is Time To Buy

Nov.14.13 | About: Zynga (ZNGA)

Zynga Inc. (NASDAQ:ZNGA) has become one of the most hated stocks on Wall Street over the last year. With the stock trading 70% under its IPO price it is not a surprise to me. However, as a long term investor looking for value plays I found myself taking a look at ZNGA after its most recent earnings report. After my research I find myself saying now is the time to buy. I will go over my reasons for that in this article.

The fall of ZNGA has been well documented in many articles. In July ZNGA made a big decision to right the ship, hiring Don A. Mattrick as its chief executive officer. Don was the man who took Microsoft's (NASDAQ:MSFT) Xbox from 10 million units to 80 million and grew its Xbox live service to 50 million subscribers. ZNGA was able to lure Mattrick from MSFT with a very stock heavy compensation package. The package worth $50m is loaded with stock grants. I like seeing executive compensation tied to the performance of the stock as it aligns the CEO's pay with those of investors like myself. Since his hiring Mattrick has been busy replacing executives at the company, narrowing the focus and looking to focus on core competencies. Restructurings such as this can take upwards of a year to unfold. One that comes to mind is Yahoo Inc. (NASDAQ:YHOO). In July of 2012 YHOO hired Marrissa Mayer, a long term Google Inc. (NASDAQ:GOOG) executive. The stock was $15 at the time. In the last year shares of YHOO have doubled under her leadership. This is a great roadmap for the potential for ZNGA under its new leadership.

Last month ZNGA reported its earnings and the stock gained 10%, trading over $4 initially on the results. A first glance the numbers were horrendous so when I saw the stock surging on the report it made me take a closer look to see what the interest was. This was the first quarter under the leadership of Mattrick. Revenue for the 3rd quarter was down 36% year over year to $203m. Net loss was much improved with only a $68,000 loss for a zero cent EPS. As I dug deeper into the earnings report things did not get much better. Daily active users declined 49% over the last year. Monthly active users declined 57%. The guidance for the next quarter was not that great either with ZNGA estimating a 15% drop in revenue and a projected loss of $21 to $31 million. For emphasis I broke out those numbers just so the negative aspects of the report would sink in:

  • Daily Active Users: 49% DECREASE
  • Monthly Active Users: 57% DECREASE
  • Bookings: 40% DECREASE

Now for the positive I see from the report. With a $68,000 loss ZNGA essentially traded at breakeven for the quarter. This included $7m in restructuring costs. Cash flow was a negative $6m. This left ZNGA with its enormous cash hoard of $1.52 billion, or $1.80 cash per share. 50% of ZNGA's market cap is held in CASH with zero debt. This is not a one off thing. Since its IPO ZNGA has essentially traded flat on a cash flow perspective looking at past cash flow statements. I find this very attractive from a investors prospective. A large cash balance with no debt and a breakeven cash flow per quarter during a difficult restructuring process is a sign of value in the stock. Even taking a pessimistic view of ZNGA's prospects the stable cash flow has to be viewed as a big positive.

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Despite the large revenue drop, restructuring and numerous other issues the cash flow for ZNGA is very strong. This stability during a major business transition is an excellent sign for when the company does turn around. Another positive in the most recent earnings report was average daily bookings. This number increased 17% over the same period last year. With the large drop in users ZNGA was still able to increase its revenue. Those that remain are the hard-core fans, the building block for the new ZNGA going forward. The push to fewer and higher quality and stronger revenue can already be seen in the last quarter's report. Although only one quarter into his ZNGA restructuring Mattrick is already seeing positive trends. The company will post a profit for the year. Mobile, where I believe ZNGA will makes its fortunes going forward, were flat. All other segments of ZNGA's business were down large but mobile has stabilized.

The positives I see for ZNGA far outweigh the perceived negatives. The new CEO is only one quarter into his turnaround. There have been similar turnarounds with YHOO and Groupon (NASDAQ:GRPN) that have seen their stock prices soar in the last year. ZNGA has a large cash hoard and no debt. The company is finally making a big push into mobile. Despite an horrendous quarter the market initially rewarded ZNGA with a stock price increase. The fact that ZNGA gained on this report is another strong indication to me that the stock is very close to, or has already made, its bottom. While those that invested at the IPO price are not happy, investors such as myself seeing ZNGA at this price, at this stage in its turnaround, should be giddy with anticipation for gains in the coming year. The turnaround at ZNGA has begun!

Disclosure: I am long ZNGA. 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.