Zynga: Margins On The Right Track, Users And Bookings Coming Next

| About: Zynga (ZNGA)


Solid Q2 bookings and EBITDA, but DAU and MAU disappoint.

With three major games launching in Q3 and Q4, the DAU issue could be fixed soon.

The earnings recovery potential is huge while the valuation is a no-brainer.

For the second quarter in a row, mobile video game developer Zynga (NASDAQ:ZNGA) delivered a solid set of results with both Q2 bookings and EBITDA exceeding guidance and consensus expectations ($175m and $12m, respectively vs. a guide of $160-170m and $0-5m, respectively).

As the EBITDA margin is now firmly in the black (650 bp margin gain year on year to 7% despite flattish bookings, after a 480 bp expansion to 6% in the previous quarter), we believe the company's turnaround is well on track. That said, Zynga's declining audience remains a source of concern (average daily active users fell 8% sequentially to 18m and average monthly active users dropped 11% to 61m) and probably explains the conservative Q3 guidance (bookings in a $180-190m range and EBITDA between $12m and $16m).

While the market seems disappointed by these DAU and MAU numbers, we believe that this issue could be fixed soon. As Zynga released in early Q3, "CSR2, a racing game which ranks among the top grossing apps on iOS and Google Play in the U.S., and will launch "Farmville: Tropic Escape" in late Q3 and "Dawn of Titans" in Q4, the user base is likely to stabilize in the coming quarters and to increase in FY17.

Hence, we stick to our view that the company's earnings are at an inflection point. Any uptick in bookings could give a major boost to EBITDA margins in light of the recent restructuring efforts, and we estimate that any 10% top-line upside would translate into at least 50% EBITDA growth or 500-600 bp margin expansion. Assuming new titles gain traction as we expect, Zynga could be a $1bn revenue business with 20-25% EBITDA margins by FY18 (vs. $700m bookings and 2% margin last year).

While the company's earnings recovery potential is a major catalyst, the stock's valuation is another major reason to own Zynga. Considering that the cash and real estate are worth $1.4bn (or $1.8 per share), Zynga's gaming assets are valued at only $1.1bn.

First, this suggests that the company would be an easy target to swallow for most predators out there. We believe that Zynga could attract the attention from players seeking to give fresh impetus to their mobile gaming ambitions (Electronic Arts (NASDAQ:EA), Japanese publishers?) at a time when the strategic value of mobile gaming assets is rising, as illustrated by the M&A frenzy in the industry (see the recent acquisition of Finnish developer Supercell by Chinese Internet giant Tencent (OTCPK:TCEHY)).

Second, Zynga's gaming assets multiples (EV/Sales of 1.1x for both 2015 and 2016) appear compelling when compared to those of French rival Gameloft (acquired by media conglomerate Vivendi (OTCPK:VIVHY) for 2.3x 2015 sales), not to mention Supercell (4.4x).

Any takeover offer for Zynga would come with a premium above 100% in our view, suggesting the risk/reward on the stock (we estimate the cash and real estate assets limit the downside risk to 35%) is highly attractive.

Disclosure: I am/we are long ZNGA, EA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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