Last week we saw shares of Glu Mobile (GLUU) take a sympathy dive with Zynga (ZNGA), as Zynga lowered its 2012 guidance for the second time this year. There are several reasons why I think Glu Mobile will be successful regardless of the performance of Zynga:
- The Numbers
Zynga is struggling to generate revenues from its social gaming business model, as shown by its second reduction in 2012 outlook (bookings for the full year of 2012 projected to be in the range of $1.085 billion to $1.100 billion, down from previous estimates of $1.15 billion to $1.225 billion). Mark Pincus, Zynga's CEO, said this about the lowered guidance for Q3:
"We are lowering our outlook to reflect delays in launching new games, a faster decline in existing web games due in part to a more challenging environment on the Facebook web platform, and reduced expectations for Draw Something."
These weaknesses had already begun to show when Q2 results were released:
- Average daily bookings per average Daily Active User (ABPU) decreased from $0.051 in the second quarter of 2011 to $0.046 in the second quarter of 2012, down 10% year-over-year.
This means Zynga is making 10% less money per user than it was a year ago. It implies that Zynga's margins have been squeezed by increased competition in the social gaming space and/or that Zynga has not figured out how to encourage users to purchase their in-game products.
- Bookings were $301.6 million for the second quarter of 2012, a decrease of 8% compared to the first quarter of 2012.
That statistic is particularly frightening given that bookings are the primary source of revenue for Zynga. Even more worrying is the outlook for bookings in Q3, which Zynga expects to be between $250-255M. This decline in bookings coincides with Zynga projecting lower revenues for Q3 ($300M-305M) than it has posted since going public.
Furthermore, analysts project revenues of $1.17B for 2012 and $1.19B for 2013, showing an extraordinarily sluggish YoY growth rate of 1.1% and 1.7%, respectively.
Glu, on the other hand, has increased revenue projections for 2012 and shows strong growth potential that Zynga lacks. Non-GAAP revenue for 2012 was first estimated to be between $79.5M and $85.5M when Glu announced results for FY11 but has since raised non-GAAP revenue expectations to $94.4M-96.4M. This would mean YoY sales growth for Glu would be 32%, much more impressive than Zynga's 1.1%.
Glu also shows more promise than Zynga when it comes to EPS.
- Analyst EPS estimates range from ($0.07) to $0.25 with the average being $0.08. Even at Zynga's beaten-down price (down 74% since IPO), this gives Zynga a forward P/E of slightly over 30, which is quite high considering Zynga's stagnating growth.
- Analyst EPS estimates range from $0.12 to $0.28 with the average being $0.18. This gives Glu a forward P/E of about 22.6, which seems fairly low for a company showing the growth that Glu has projected.
To make things even more uncertain for Zynga, it must be noted that Zynga has posted an average surprise percent over analyst EPS estimates of only 3.4% since going public, with the most recent quarter coming in 83.3% under analyst estimates. Comparatively, over the past four quarters, Glu has posted an average surprise percent of 87.7% with the most recent quarter coming in 100% higher than analysts expected.
Zynga's management has been an area of concern since its IPO. There has been a noticeable outflow of top managers since going public, many of whom developed or managed their most popular games. The most recent losses have been the developers behind "Words With Friends" and the general manager of "Zynga Poker." This is alarming because software companies need to keep and attract top talent if they hope to stay competitive in the long run, especially as Zynga's primary business model (still heavily reliant on Facebook (FB)) is falling out from beneath them as mobile gaming takes over. Another thing that is noteworthy was the mass of insider selling following the IPO from executives (including CEO Mark Pincus), suggesting that management was not optimistic about the valuation or future prospects of the company after the IPO.
Those are not the only, nor the smallest, problems that can be brought up regarding Zynga's management. The biggest red flag in my opinion was the acquisition of OMGPop, in which Zynga acquired one flavor-of-the-month game (Draw Something) for about $180M. The valuation for this deal left investors scratching their heads at the time and has not done Zynga any favors since. The subsequent and meteoric fall in the popularity of Draw Something has already resulted in Zynga saying they would have to write off $85M-95M in IP related to the acquisition in Q3. This may be just one flub but a bone-headed move of this caliber is at least enough to shake investor confidence, and it has already negatively affected the stock price.
In contrast, Glu management has been a stable team working together to identify and expand into new markets. Another SA article which included an interview with Glu CFO Eric Ludwig recently gave some insight as to how Glu is currently expanding into international markets, many of which are poised or are already showing explosive growth. Glu has also shown that it is capable of identifying smart acquisitions and getting them at good prices. In the interview with Eric Ludwig, he explains how they acquired GameSpy Technology for next to nothing and the ways it will benefit Glu's business prospects going forward.
Furthermore, while Zynga has been flirting with the idea of mobile gambling for some time now, Glu has very recently partnered with a company called Probability PLC. Probability PLC is a publicly traded company focused entirely on mobile gambling. Probability PLC has agreed to take on all regulatory responsibilities and will work with Glu to create gambling games based off of Glu's current IP portfolio. This is just another example of how Glu management is capable of identifying new markets and allows Glu to be a frontrunner in the mobile gambling space.
Even more proof of Glu's ability to maneuver into new markets can be seen with Glu's shift from making games for feature phones to smart phones. Glu began to shift its focus to smart phones beginning in 2010 and has been extremely successful in doing so. As of Q2, 2012, revenues from smart phones comprised 84% of Glu's total GAAP revenues, and smart phone revenue showed 111% YoY growth from Q2 of 2011. To further illustrate this point, smart phone revenues for 2012 are expected to total between $81.9M-83.9M or about 87% of total revenue. This is especially impressive when compared to 2011, when non-GAAP smart phone revenue totaled $41.9M on total non-GAAP revenues of $72.9M.
While both Glu Mobile and Zynga are in the closely related mobile/social gaming spheres, it is Zynga's mistakes that have been punishing the stock prices of both companies. This sympathetic fall in the price of Glu shares has been frustrating for owners of GLUU, but may present a good entry point or a chance to accumulate more shares at a lower price if you feel confident in the future of Glu Mobile. I do not believe that the drop in GLUU's share price has been justified nor do I believe that Zynga's mistakes will impact the future of Glu Mobile. I also do not think Zynga will be out of the picture any time soon with well over $1B in cash on hand, but I do see a bumpy road ahead of it if it continues to disappoint shareholders.
Disclosure: I am long GLUU.