Seeking Alpha
Long/short equity, contrarian, short-term horizon, dividend investing
Profile| Send Message|
( followers)  

Summary

  • A break-even quarter is as lackluster as you get, but options are pricing in a big move.
  • The potential for a buyout offer or further expansion into real money poker is the real value.
  • Zynga has tons of cash - investors can consider the stock as options without expiration.

Background: Zynga Inc. (NASDAQ:ZNGA) develops, markets and operates online social games as live services on the Internet, social networking sites and mobile platforms.

Strong second quarter earnings growth is expected by Wall Street after the market closes on August 7, 2014. The consensus mean is a break-even a share, edging a slight improvement over the loss of 1 cent during the corresponding quarter last year.

Losing 1 cent is the lowest analyst estimate I have examined, and they reach up to a profit of 1 cent per share. The whisper numbers I've read range from breaking even to a high of 3 cents. So the market isn't pricing in much for Zynga.

Compared to Zynga's 49.1 forward price-to-earnings ratio, Facebook (NASDAQ:FB) has a P/E of 36.78. The P/E ratio is the number of years of earnings the company needs to pay for one share of stock. Historically, above 20 P/Es underperform the market in the long run, while under 20 outperform.

But P/Es don't tell the whole story with Zynga, and I've become an un-remorseful Zynga bull in the last six months. Also, while I'm writing an earnings preview, I don't think the upcoming earnings are very significant, and especially not the primary factor in developing a bull thesis.

I'm bullish because Zynga's cash position by default means it has many options available and can exploit opportunities as readily as any other company in the space can.

But I'm also bullish because it hosts the largest play-money poker site in the world. As soon as Zynga expands its real-money poker operation beyond the U.K., and I believe it will, all bets are off (cheesy pun, I know) for as high as the stock may fly. Zynga needs to do this sooner rather than later if it hopes to maintain its lead.

I also think the stock is becoming an attractive takeover target for domestic and Chinese mobile content companies. A little known fact is that the average Chinese smartphone mobile user spends more than the average American user on content.

There's a real content shortage that Zynga can fill in Asia as companies compete for content producers to acquire.

With its Beta of 2.76, this stock is relatively wild and subject to extreme price changes at times. You don't need a roll cage, but expect a strong move after it reports earnings.

Beta is a measurement of volatility, with 1 representing the market average. Above 1 means the stock on average has been relatively more volatile, and below 1 demonstrates greater stability than the average.

Analyst opinion is mixed with this company. Most of the analysts surveyed don't believe a buy or a sell is currently warranted. I think they're missing the potential and focusing on freemium game revenue. Right now, Zynga has two buy recommendations out of 22 analysts covering the company, 17 holds, and three recommend selling.

The stock is for the most part flat at a 0.3% gain in the last year, and the average analyst target price for Zynga is $4.55. Zynga has an average analyst target price of $4.55. While I believe Zynga's downside is linear, the above reasons give Zynga's upside potential a distinctive binary feel to it.

Shareholders and other market participants can get an edge by examining the amount of premium paid and demanded for the stock's options. The most important expiration date to look at is the one immediately after the earnings release. The premium of various strikes and especially at-the-money strikes for both calls and puts indicates what others are thinking. Higher premium means greater expected volatility.

Based on current option premium, investors and traders are wagering on a 15%, or about a 46 cent move in the next 10 days.

You want to plan on the shares trading from $2.56, or as high as $3.48, while remaining within a single standard deviation percentage.

After last quarter's results, the shares decreased a modest 4.6%, or 21 cents from the close before the earnings release to the closing after. The final price preceding the report was $4.56, and concluded at $4.35 the next trading session.

The current proportion sold short based on the float is 6.8%, and I find this much interest by short sellers worth looking at in more depth. As I've stated many times, short sellers are the smart money on Wall Street, but they don't always get it right. I remain doubtful this earnings can squeeze shorts, and if you're betting on it, I think you'll be sadly disappointed.

However, it's the headline risk that shorts are likely discounting too much that could land them in trouble. That's what I'm betting on and why I will remain long into and past this earnings release.

Source: Why Zynga's Earnings Are A Non-Event