Despite Negative Press, Zynga Has Long-Term Potential

| About: Zynga (ZNGA)
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Zynga stock continues to suffer from bad publicity and a skepticism towards mobile game companies, despite signs of a turnaround.

They've successfully pivoted their focus from Facebook to mobile, and are laying the groundwork for long-term franchise titles.

In Q3 mobile bookings made up 55% of total bookings, and 48% of revenue.

Despite these positive signs, their valuation remains extremely low with a high upside potential.

Zynga (NASDAQ:ZNGA) can't seem to catch a break. Although its recent Q3 earnings showed promise of a long-awaited turnaround - and their stock was upgraded to a buy by Jefferies - they immediately fell back into bull territory over a stock sale lawsuit against their founder and former CEO Mark Pincus. The stock is currently trading around $2.50, down from a 52 week high of $5.82.

Regardless of whether the lawsuit has merit (clearly the Delaware Court of Chancery thinks it does), it's more negative press for a company that few seem willing to bet on anymore. Which is surprising given Zynga's improving metrics, and recent inroads into mobile gaming. When assessing the upside of Zynga, investors shouldn't be distracted by the string of drama surrounding their founder and general skepticism of mobile gaming. Powered by a growing industry, their recent acquisition of NaturalMotion, and a clear marketing strategy, Zynga is looking like a viable publisher.

Growth Industry

As Zynga's CFO pointed out at the recent UBS Global conference, mobile gaming is a good market to be in. The industry is predicted to be worth approximately $35 billion by 2017. Those numbers should be taken with a grain of salt (they're from a mobile game marketing firm), but the market is certainly expanding. Being in a growth industry doesn't guarantee success (just look at Zynga's past), but it does allow for second chances. There's no set template yet for successful mobile publishers, and the market doesn't seem to be a zero-sum affair. That's good for Zynga, because it allows them to focus on establishing franchises instead of directly competing. As the industry grows, there's room for multiple strategies.

Establishing the Zynga Brand

Game companies, more so than many businesses, are vulnerable to swings in customer attention. For mobile publishers, this has been even more true. Games that have rapidly risen to popularity, including Zynga's own Farmville, have experienced just as rapid declines. Even seeming franchises such as Angry Birds are not immune to shifting tastes. Because the titles are often bigger than the publishers, and mobile games don't yet attract the kind of dedicated audiences that console and PC games have, fans rarely move on to other titles by the same publisher after they tire of an app.

Zynga finally seems to be realizing this, and has been working to position itself has a dedicated mobile publisher, and recognized brand.

Their recent acquisition of NaturalMotion fits into this. Unlike their acquisition of Draw Something, where they purchased a one-hit wonder that almost immediately tanked, NaturalMotion has produced a succession of solid hits including CSR Racing and the recent Clumsy Ninja. Both titles hit number one in multiple app categories and have maintained steady downloads. A roster of consistent games that draw solid engagement will give Zynga a network in which to advertise its own titles (for free), and provide a less erratic income steam from in-game ads and purchases.

Their new sports ventures - including a licensed NFL game and a forthcoming Tiger Woods golf title - should help them break into the sports arena. Even if they aren't immediate successes (NFL Showdown, despite positive press, has seen lackluster downloads), they gives Zynga long-term brands to build on. People will forget the name of the latest viral app in less than a year - sports franchises have proven, dedicated bases that extend to gaming.

In their most recent Q3 results, there are signs this strategy is working. Mobile bookings represented 55% of their total bookings, up from approximately 30% in Q3 2013. Meanwhile, only 41% of Zynga's bookings came from Facebook, down from 65% year-over-year. Moving way from Facebook and establishing a mobile presence has been the number one priority for Zynga, and it seems to be paying off. These numbers also exclude mobile bookings from NaturalMotion, which should eventually account for a significant portion.

In terms of revenue, 48% came from mobile, up from 23% last year. Their cost of revenue also decreased, along with their general and administrative costs, providing some evidence that their cost control methods are working. Meanwhile, their "sales and marketing" expenses rose to ~25% of revenue, which seems about in line with their need to reposition their brand and their recent publicity efforts (they've partnered with Apple, for instance, for a Red campaign). Their R&D budget is also up for the quarter, suggesting an expanded pipeline of titles for 2015.

The most worrying number in their Q3 report is their daily active user count, which fell by approximately 13%. Part of this could be from their rapid and ongoing shift to a mobile-first business, and their corresponding loss of legacy users from Facebook. However, given their slate of upcoming games, acquisition of NaturalMotion, and positive long-term position in the mobile game market, they should be able to stabilize and grow this number in 2015. With a lineup of solid, long-term titles and a leaner mindset, Zynga appears to be (finally) poised for actual growth. For many investors, it might be time to give this stock a second look.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.