Zynga A Short-Term Investment

Zynga (ZNGA) operates in an industry where the competition is quite intense and its users have a short interest period. Any new or interesting game would easily divert the attention of a player from an existing game either from competitors or the company. So the company needs to continuously come up with original and innovative games. Currently, the company is mostly dependent on its top three games that include Farmville 1, Farmville 2 and Zynga Poker that collectively generate more than 50% of the company's revenues. These games are around two to three years old and can easily be replaced with any new or original game from its competitors or by the company. Being dependent on a few games is quite a risky strategy.

Zynga's business has been continuously declining over the last few quarters and it seems there is no feasible solution in the near term that would help the company to turn around. However, the company's restructuring efforts (cost-cutting plan) and hiring of a new chief operations officer seem to be paying off as reflected in its third quarter earnings results. The company has lowered its losses to almost breakeven. The company reported net losses of $68,000 for the third quarter of 2013, an increase from a net loss of $53 million for the third quarter of 2012 and a net loss of $16 million for the second quarter of 2013. Diluted net loss per share was $0.00 for the third quarter of 2013 compared to $0.07 for the third quarter of 2012 and $0.02 for the second quarter of 2013. This is a big win for the company, at least for now.

But on the dark side, the company is losing its daily active users (DAUs), monthly active users (MAUs) and monthly unique users (MUUs) and these are the key operating matrices of the company.

The company's DAUs decreased from 60 million in the third quarter of 2012 to 30 million in the third quarter of 2013, down 49% year-over-year. On a consecutive quarter basis, DAUs were down 23% from 39 million in the second quarter of 2013. Web DAUs and Mobile DAUs were 16 million and 14 million in the third quarter of 2013, respectively. Similarly, MAUs decreased from 311 million in the third quarter of 2012 to 133 million in the third quarter of 2013, down 57% year-over-year. On a consecutive quarter basis, MAUs were down 29% from 187 million in the second quarter of 2013. Web MAUs and Mobile MAUs were 82 million and 51 million in the third quarter of 2013, respectively. MUUs decreased from 177 million in the third quarter of 2012 to 97 million in the third quarter of 2013, down 45% year-over-year. MUUs were down 21% from 123 million in the second quarter of 2013, on a consecutive quarter basis.

Another alarming sign for the company is that the users are also losing interest in its top revenue generating games. During the first nine months of 2013 the company's online game revenue decreased $262.7 million compared to the same period of the previous year. This decrease is primarily attributed to decreases in revenue from FarmVille, CityVille, FrontierVille, Zynga Poker and CastleVille in the amounts of $126.4 million, $92.1 million, $50.9 million, $32.2 million and $29.4 million, respectively. The decreases in online game revenue from these five games were the result of the overall decay rate in bookings and audience metrics in these games. These decreases were partially offset by higher revenues in FarmVille 2 and ChefVille, in the amounts of $89.6 million and $34.9 million respectively, which were the result of the launch of these games in September 2012 and August 2012, respectively. The other games accounted for the remaining net increase of $56.2 million.

Scenario Analysis

So far it seems that there will not be a come back for the company any time soon, in terms of positive earnings. In order to analyze how many daily active users or average revenue per DAUs the company would require to breakeven its business I developed two scenarios with some assumptions. First, based on company's fourth quarter expectations, I managed to project the company's fiscal year 2013 income statement. On the basis of that I calculated average DAUs and average revenue per DAUs of the company for the year 2013. Then for 2014 I kept the costs of the company constant.

The costs in the years 2013 and 2014 are constant for both scenarios. I also used the average DAUs and revenue per DAUs of 2013 to calculate the revenues that achieve breakeven for 2014. In the first scenario, I kept the revenue per DAUs constant. Based on the first scenario, the company would require 0.85 million more daily active users to achieve the breakeven that would generate an average revenue of $24.05 per user for the company. Similarly, in the second scenario, by fixing average DAUs, the company would require $1.31 per DAUs with an average DAUs of 36.5 million to breakeven.

I believe that this scenario might be achieved, but based on the company's current performance it seems that its revenue per DAU is increasing due to decreasing DAUs during the last few quarters. Another big concern, as mentioned earlier, is declining revenues from its top revenue generating games which would be the biggest hurdle for the company to improve its revenues and reduce its costs. The company's success is only dependent on the success of its recently launched games. If the company is able to attract enough DAUs or revenues per DAUs as mentioned above, the company's growth prospects appear positive over the next few quarters. Otherwise the company will follow the decreasing trend that it has been experiencing over the last few quarters. Currently, I would recommend a bullish stance on this stock for the short term.

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

Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article.

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