The social video game developer Zynga (ZNGA) has been whacked hard over the last several months, plummeting from its mid-$14 highs to sub-$3 as of the time of writing. As I noted in my earlier article, "Zynga Looks Incredibly Overvalued", the company was simply trading at a sky high valuation, especially relative to its peers in the game industry. Did it really make sense that a company that develops ad-filled casual games was valued significantly more than well established game publishers with strong, differentiated intellectual property? No, it didn't and the market has begun to price the company appropriately.
But after this significant hit, is it now time for value investors to come in and pick up shares of this stock? On a fundamental level, I still wouldn't recommend it for the following reasons:
Insiders Are Bailing
It's hard to justify an investment in a company whose insiders don't seem to have a whole lot of faith in the venture. There has been very consistent selling each month since the IPO, and it's clear that they knew what they were doing. The CEO, Mark Pincus, sold 16,500,000 shares at a price of $11.64 per share in April, netting nearly $2M. Other insiders have been steadily selling as the stock has dropped, with the most recently reported sale by Jeffrey Karp of 165,971 shares at a price of $3.10 per share.
The fact that not a single share was purchased on the way down is telling.
Excessive Bloat And Potential Cash Burn
While the company has $1.22B in cash, or 58% of its market capitalization, I remain skeptical that the company will put this cash to particularly good use. It has a large, bloated staff of 2,846 working on a number of relatively simplistic social games. In comparison, EA Games (EA), which has a number of high profile developers under its wings, developing everything from the latest, cutting edge 3D games such as "Battlefield 3" to popular casual games such as "Plants v.s. Zombies". Further, traditional game publishers have clear ways to monetize their business without too many gimmicks.
Earnings Aren't Encouraging
Even given the points made above, the final nail in the coffin lies in the financial reports. Q2 revenues were $332 million and the company managed to lose $0.03 per share in the quarter on a GAAP basis. The loss is expected -- it's a new, growth stock, so losses are often expected and forgiven in the short term. But with bookings projected to be in the range of $1.15B to $1.225B, it was, at the $5 level, trading at nearly twice expected revenues. Now, if we back out the $1.22B in cash, we get a price/sales ratio of 0.86 at the current $2.70 level, which isn't unreasonable. However, Q2 revenues in the most recent quarter were up only 19% year-over-year, so I am unsure if the growth prospects justify a higher valuation. Also, as the cash gets burned, that ratio starts looking a lot less attractive.
The stock might be good for a bounce from these levels, but I would exercise extreme caution going long here. However, I would also not advise taking a short position given that the stock could very well bounce at these levels for a number of reasons, not the least of which would be the inevitable speculation that Facebook (FB) may want to buy the company. In short, I wouldn't touch it, but if you're going to, take extra care in managing risk. Out of the money calls would be a good way to play a potential buyout rumor.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.