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Paulo Santos, Think Finance (377 clicks)
Long/short equity, arbitrage, event-driven, research analyst
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First of all, I must say I'm aware of all the troubles Zynga (ZNGA) has been going through, including the seemingly ill-advised, perhaps euphoric, acquisition of "Draw Something". The troubles also include deep slashes to yearly revenue estimates, and obviously the company is producing losses (except on a pro-forma basis).

The thesis

But here's the thesis why I bought Zynga:

  • Zynga is cash flow positive (although all of it comes from paying employees with shares);
  • Zynga paid and recognized paying to employees using ZSUs (Zynga Stock Units) vested at an average of $11.67. That would have been the same as paying employees with stock sold at $11.67, so for anyone buying today Zynga really was cash flow positive in spite of paying employees with shares (the P&L overstated the value of the vested shares);
  • Zynga has a lot of cash on its balance sheet. People sometimes quote $1.1 -1.2 billion, but in truth it's more like $1.53 billion (excluding $100 million in debt), because the $426 million in long-term marketable securities can also be considered cash. So at $2.84, 74% of the market capitalization is cash. The entire gaming business is thus worth just $531 million. That doesn't seem much for a >$1 billion/year social gaming business with potentially high margins if well managed.

In short, right now there's a potentially large and profitable social gaming business available for just 0.5 times sales. This should be very attractive to other players in the space, such as Electronic Arts (EA) or even Facebook (FB) itself. These could certainly make a move for Zynga if they recognize all that cash on the balance sheet makes the acquisition of the whole company very, very cheap.

The risks

  • Zynga can continue to underdeliver and eventually destroy the franchise.
  • Facebook can continue plunging and pull Zynga shares with it.

Conclusion

Pondering my long thesis and the risks involved, I decided to pull the trigger and buy at $2.84. I bought a small position because I don't like buying against the trends in place, and those surely are negative at this point.

Source: Why I Bought Zynga