On Tuesday, Zynga (ZNGA) reported its first earnings as a publicly traded company. The earnings exceeded analysts' expectations, but the stock traded down as much as 9% in after-hours trading on the cautionary outlook the company provided for 2012. ZNGA fourth-quarter results were as follows:
- 2011 net loss of $435.0 million or $1.22 on revenue of $311.2 million (up 59% from last year)
- Non-GAAP net income was $37.2 million in the quarter (down 41%)
- EBITDA in the fourth quarter 2011 was $67.8 million, which is down 34% year-over-year
- Total revenue of $1.14 billion (up 89% from last year)
Though these numbers may be impressive, what should be frightening for investors is the fact that the company sees 2012 growth being "weighed down" in the first part of the fiscal year. Investors are hoping the company can keep up with its past performance of developing and distributing as many as 12 games per-year, several of which being hits. Due to the company's incredibly high valuation (with a trailing price/earnings ratio of nearly 200), ZNGA is not expecting the results for 2012 that would support the elevation of its stock price. Investors should be wary of a company that is in an ever-changing industry where the barrier to entry is low and the expectation is perfection, time and time again.
Why Zynga stockholders could be in for a realization and the chart (above) could look drastically different in the future:
Where is the revenue coming from?
In the IPO filing of Facebook (FB), it was revealed that ZNGA made up 12% of Facebook's total revenue. This gave ZNGA a tremendous boost from investors seeing that this company represents such a portion of Facebook, potentially worth over $100 billion. Barbara Ortutay of US Today reports, "[ZNGA] relies on Facebook games for nearly all of its revenue, Zynga is working on expanding to other areas, notably mobile devices." The problem with ZNGA relying almost entirely on Facebook for revenue is that many believe Facebook, with over 800 million users, is not in a position to grow user counts dramatically in the coming years. This marks an opportunity both for ZNGA to have the same viewership it currently does now and for other companies in the same gaming vein to come in and diminish the gaming monopoly that ZNGA currently has. This creates potential for serious issues to arise for ZNGA where the company would not be able to reach a greater audience and at the same time would have its gaming monopoly removed by other large companies. On these prospects, one must think twice of the valuation the company currently has.
2012 Growth & Beyond:
ZNGA CEO Mark Pincus stated in the fourth-quarter earnings release, "We expect that growth will be weighted towards the back-half of the year with slower sequential growth in the first half of the year." These results are not worthy of the current multiples the company is currently trading. Forbes highlighted the 2012 growth prospects of ZNGA:
- Bookings are projected to be in the range of $1.35 billion to $1.45 billion.
- Adjusted EBITDA is projected to be in the range of $390 million to $440 million.
- Stock-based compensation expense is projected to be in the range of $400 million to $425 million excluding the impact of equity awards granted in connection with potential future acquisitions.
- Capital expenditures are projected to be in the range of $140 million to $160 million. Our effective tax rate for non-GAAP net income is projected to be in the range of 20% to 25%.
- We project non-GAAP weighted-average diluted shares outstanding to be approximately 865 million shares in Q1 2012 and approximately 890 million shares in Q4 2012. Full year 2012 non-GAAP EPS is projected to be in the range of $0.24 to $0.28.
The problem lies in the fact that these results are rooted within the expectation that ZNGA will be able to break into the mobile environment and gain other sources of revenue outside of Facebook. Though it is not unreasonable to think that ZNGA cannot build other sources of income, it is not something an investor should bank on. With a strong history of servicing social media, the company will likely not lose much ground in that area, but the prospects of expanding beyond this market are not certain at this point. The long-term growth prospects are largely up in the air because this industry can be broken into without the barriers to entry companies like Google (GOOG) or Amazon (AMZN) have with extensive infrastructures. Investors should wait to see proof of the long-term strategy the company is putting forth. Without more data, an investor is banking on predictions that are not rooted in facts. This decade could easily be the bubble of internet startups like Groupon (GRPN), Pandora (P) and Linkedin (LNKD). With ZNGA trading at an astronomical valuation, the risk of missing perfection is too high .
Market Cap: $10.04 billion - this proves to be extremely high being that the company has revenue of roughly $1 billion and operating profits of roughly $35 million. Though investors are not buying the current earnings/profit, until improvements occur in either earnings or a more realistic valuation, the stock is one to stay away from.
Trailing price/earnings: 193.95, this is an incredible figure and is amongst the highest in all of technology and internet stocks. For this to be justified, true growth would need to commence.
Forward price/earnings ratio: 65.24, in the same vein as above, this forward PE ratio is extremely high.
- PEG Ratio: 3.01, this is the most accurate way to measure a company's valuation and it is clear that a PEG of over 3 is not healthy. Even with earnings increasing by the five year projection (above), the PEG ratio will not decrease to a level near its pears. As aforementioned, the stock will either need to trade at a more realistic valuation or growth will have to be elevated.
EV/EBIDA: 44.32, this is a valuation multiple used to measure the value of a company and a healthy company usually has an EV/EBIDA of below 10. Even a company like Amazon (AMZN) trading at nearly 100 times earnings has a EV/EBIDA value of 20.62.
R&D Spend 2011: $590 million. This amount of spend in a fiscal year represents the expense in creating the games that ZNGA does. With earnings and cash flow as they currently sit, the company's spend is unsustainable. This speaks to the idea that ZNGA must perform at near perfection to avoid further losses.
Conclusion: As Dennis Gartman of The Gartman Letter states, "This is not a business of buying low and selling high. It is, however, a business of buying high and selling higher." In the case of ZNGA this can read, do not bet on market capitalization by a tech company, rather wait for strength that is tangible. For ZNGA, the current valuation is unrealistic unless the company can continue to build incremental sales in multiple areas of its business (which do not currently exist). With a direct tie to Facebook and little competition, the landscape for ZNGA is bound to become more difficult. In buying this company an investor is betting that ZNGA can do everything perfectly in the coming years. This is not a risk I am willing to take now. Be wary of ZNGA until tangible growth is demonstrated over a longer duration of time.