Zynga - A 40% Sell-Off Is Warranted By The Bad Underlying Results

| About: Zynga (ZNGA)

Shares of Zynga (ZNGA) the online social game producer fell up to 40% in after hours trading, after the company announced that it was forced to lower its full year outlook. Investors are panicking as the company published a very weak set of second quarter results.

Second Quarter Results

Zynga reported second quarter revenues of $332.5 million which is up 19% compared to last year. Revenues are only up 4% compared to the first quarter of 2011. Bookings, or promised revenues, for the second quarter came in at $302 million which is up 10% on the year. Bookings fell compared to $329 million in the first quarter, and fell short of analysts expectations of $344 million.

The company reported a net loss of $22.8 million or $0.03 per share. This compares to a small $1.4 million profit in the second quarter of 2011 and to a $85.3 million loss in the first quarter of 2012.

During the quarter Zynga launched the game Bubble Safari and The Ville. The advertising business grew strongly, while online game revenues unexpectedly fell on the quarter. The company now has over 300 million active monthly users. Some 33 million users use Zynga on their mobile networks every day.

Mark Pincus CEO and Founder,"We also faced new short-term challenges which led to a sequential decline in bookings. Despite this, we're optimistic about the long-term growth prospects on mobile where we have a window of opportunity to drive the same kind of social gaming revolution that we enabled on the web."

Segmental Information

A major disappointment in Wednesday's figures was the online game revenue of $291.5 million for the second quarter. While it was up 10% compared to last year it was actually down 0.5% compared to the first quarter. Advertising revenues rose 170% to $40.9 million which is up 45% compared to the first quarter.


Zynga is lowering its full year outlook on the back of these terrible results. It now expects bookings to come in between $1.15 billion and $1.225 billion for the full year of 2012. As recent as April of this year Zynga anticipated bookings between $1.43 billion and $1.5 billion.

Adjusted EBITDA will come in between $180 and $250 million. Capital expenditures will come in between $370-$380 million which includes the purchase of the corporate headquarters.

The company expects to earn between $0.04-$0.09 per share for the full year on a non-GAAP basis. This is based on the assumption of 845 million shares outstanding by year's end. At the moment Zynga has some 730 million shares outstanding. Back in April, Zynga anticipated full year earnings of $0.23-$0.29 per share.


Zynga ended the second quarter with roughly $1.6 billion in cash, equivalents and short and long term marketable securities. It operates with roughly $100 million in long term debt for a net cash position of $1.5 billion. Zynga ended the quarter with 730 million diluted shares outstanding, up 12 million compared to the first quarter. This values the firm at merely $2.2 billion based on a share price of $3 in after hours trading. At this valuation, the market values the firm's operating assets at merely $750 million.

Based on anticipated $1.2 billion in annual revenues the firm's operating assets are valued at merely 0.6 times annual revenues. This compares to a revenue multiple of 0.9 times for Electronic Arts (EA) and a 15 times annual revenue multiple for Facebook (FB), whose shares trade up to 8% lower in after hours trading.

Investment Thesis

Shares of Zynga fell up to 40% in after hours trading around $3 per share. As such shares have lost some 70% from their public offering price of $10 in December of 2011. Shares peaked around $14 in February of this year when the firm was really popular and the market was looking forward to the much anticipated public offering of Facebook. Ever since, shares have lost nearly 80% as the public offering of Facebook was a major disaster.

Around February/March all red flags were raised. CEO and Founder Pincus sold shares near the peak in March of this year. At the same time the company was acquiring the company behind the game "Draw Something" at the day the user base of the drawing game peaked. Then came the news reports about declining user growth at Facebook, which platform generated 92% of Zynga's revenues in the first quarter.

Wednesday's results show that user numbers at Zynga's games are fading quickly and successful games are not lasting very long. Add to that some runaway expenses, stock-based compensation and expensive acquisitions and you will find the perfect storm that Zynga is witnessing now. Fortunately the losses are under control and the company has a very strong balance sheet.

Finances are not the biggest problem, credibility and corporate governance is. The company needs a credible manager who does not engage in insider selling and puts a tighter lid on the firm's operations. Zynga is no longer a start up, and it could really use an outside experienced corporate manager.

Look out for signs of improved accountability or hiring of an outside CEO, or co-CEO. Only then will I possibly initiate a long position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.