Zynga: Institutional Investors Now Own More Than 82%

Summary

• Zynga develops, markets, and distributes social games played on mobile platforms. Players may play for free; the company earns revenue by selling virtual currency to the players and by exposing.
• The company lost money in 2020 and expects another loss this year, although not so deep. It has grown revenue, but its net margins are low.
• At the end of 2020, it was owned by 555 institutional investors, who held the lion’s share of outstanding shares. Several insiders also continue to own significant stakes as well.

The shares of Zynga, Inc. (ZNGA), a company that's all about playing games, have been swallowed up by serious, professional investors.

Institutional investors, the professionals who buy and sell on behalf of pension funds, mutual funds, and the like, developed new-found enthusiasm for Zynga in the third quarter of 2019:

Source: GuruFocus

According to GuruFocus, institutional investors owned just 47.13% at the beginning of the third quarter and then jumped right in, driving their share of ownership to 82.44%. The Vanguard Group alone owns than a billion dollars' worth of shares.

As this 5-year chart shows, Zynga's share price rose more than five-fold between 2016 and 2021, from $2.15 to more than $11.00.

Why this increasing interest, and why do these professional investors continue to hold a company that is posting losses rather than earnings?

What is Zynga?

Source: Q4-2020 Financial Results Presentation

It described itself this way in the introduction to its 10-K for 2020,

"a leading provider of social game services. We develop, market and operate social games as live services played on mobile platforms, such as Apple's iOS and Google's Android, social networking platforms, such as Facebook and Snapchat, Personal Computers, consoles, such as Nintendo's Switch game console, and other platforms. Generally, all of our games are free to play, and we generate substantially all of our revenue through the sale of in-game virtual items ("online game revenue") and advertising services ("advertising revenue")."

More specifically, revenue comes from:

• Virtual Items: This, the company's main revenue source, comes from the sale of in-game virtual currency; players use this currency to buy virtual goods (they can also earn virtual currency by gameplay or accepting promotional offers from advertisers).
• Advertising: Players may play for free, but in doing so they must watch advertisements. Responsible for about 16% of revenue in 2020.

Zynga made two major acquisitions in 2020:

• July: Peak Oyun Yazılım ve Pazarlama Anonim Şirketi ("Peak").
• October: A controlling interest in Rollic Games Oyun Yazılım ve Pazarlama Anonim Şirketi ("Rollic").

Those acquisitions helped the company post record revenue for the fourth quarter and full-year 2020.

Risks

There are several fronts on which investors should be concerned about Zynga.

• The company notes in its 10-K for 2020 that it depends on a small number of games to generate the majority of its revenue. At the same time, there are few barriers to entry, new games appear constantly; should one or more of them displace Zynga's top games, the company's revenue could be depressed.
• It depends heavily on several other companies for its infrastructure: For example, the Apple (AAPL) App Store and the Google (GOOG) Play Store to distribute its apps, on Amazon Web Services (AMZN) for its hosting, and on social media platforms such as Facebook (FB).
• And it points out it depends heavily on a relatively small group of players, "We rely on a small portion of our total players for a substantial amount of our revenue and if we fail to grow our player base, or if player engagement declines, revenue, bookings and operating results will be harmed."

Competition

The gaming industry is highly competitive and rapidly evolving, according to the company.

It names the following as major sources of competition: Activision Blizzard (ATVI), AppLovin, Aristocrat (OTCPK:ARLUF), DoubleU (South Korea), Electronic Arts (EA), Epic Games, Glu Mobile (recently purchased by Electronic Arts), and numerous others.

That list of 'others' includes Tencent Holdings Limited (OTCPK:TCEHY) which is rumored to be interested in acquiring Zynga. According to Seeking Alpha's Jason Aycock, the deal would have advantages for both firms. For Zynga, it would mean a power backer and more rapid expansion in Asia, while Tencent would expand its international market.

Fundamentals

Institutional investors won't be buying Zynga shares on the basis of its financial strength. It has a significant amount of debt, and a cash-to-debt ratio of 1-to-1, meaning it has about the same amount of cash and cash instruments as debt. But that's weak compared to the Interactive Media industry median of 4.32.

It also has no interest coverage ratio because it has no positive operating income.

The Piotroski F-Score is weak, with a score of only 2-out-of-9. It failed on the measures of return on assets (negative), change in return on assets, change in leverage, change in liquidity, change in shares issued, change in gross margin, and change in asset turnover.

Profitability

Although Zynga has very good gross margins, its operating margins have been low, and dropped again last year, as shown in this 5-year chart:

Data by YCharts

On the positive side, revenue has been on an upward trajectory since 2019, well before the COVID-19 troubles began:

Data by YCharts

However, EBITDA growth turned negative in 2020:

Data by YCharts

Earnings per share also fell in 2020, but are expected to improve in 2021 and 2022:

Data by YCharts

Outlook

The company expects to do better in 2021 than in 2020

According to guidance provided in the Q4-2020 full-year report, it expects revenue to increase by 32% this year, to $625 million.

Some of that will make it through to the bottom line. For 2021 it expects a net loss of $150 million, compared with a net loss of $429.4 million in 2020. In 2019, it had positive earnings of $41.9 million.

The guidance was based on conditions in February 2021, and Zynga provided this caveat: "Given the level of continued volatility and uncertainty around the COVID-19 pandemic, there is the potential for a wider range of outcomes - both positive and negative - as it relates to our ultimate business results."

Dividends and Share Repurchases

Zynga does not pay a dividend, which is not surprising for a young company trying to expand its market and market share.

And, it has been issuing far more shares than it has repurchased:

Data by YCharts

Investors should beware of dilutions.

Valuation

As this excerpt from a Seeking Alpha table shows, this is no bargain stock:

Essentially, Zynga is a loss-making company with a rising share price:

Data by YCharts

It has also been handily beating the Nasdaq Composite and the S&P 500 averages over the past two years.

Because it has not had positive earnings, many of the usual metrics, including the P/E ratio are not available to us. Generally, though, we might say that investors should expect to pay a premium for what have been, and are expected to be, above-average capital gains.

Institutional Owners

According to Nasdaq.com, 555 institutional investors held Zynga shares at the end of the year. The three largest of the holdings were those of:

• Vanguard Group, with 93,421,512 shares, a reduction of 1.318% since the end of the third quarter. The total value of the position was $1.079 billion.
• Artisan Partners Limited Partnership, which increased its stake by 14.617% to 80,334,536 shares, worth $928.667 million.
• T Rowe Price Associates. Boosted its position by 20.473% to finish the fourth quarter with 72,558,078 shares worth $838.771 million.

Insiders

The company's insiders continue to own significant stakes in Zynga:

• Mark Pincus, the founder and former CEO, owns 3,462,944 shares.
• William B. Gordon, formerly Chief Creative Officer at Electronic Arts and now a venture capitalist, owned 1,231,745 shares
• Matthew S. Bromberg, Zynga's Chief Operating Officer, owned 911,662 shares.

Conclusion

No one knows which of today's smaller companies may explode and become another Amazon or Facebook. Perhaps none will. Nevertheless, institutional investors need to try, to meet or exceed their benchmarks. Zynga is one of the stocks that they are hoping will deliver above-average or even spectacular results in the next five to ten years.

Over the past five years, the company has set itself up for those kinds of expectations, with the share price rising more than five-fold from $2.15 in 2016 to well over $11 in 2021. That has meant significant capital gains for the companies that bought early and held on.

Given its profile and valuation metrics, this is a company for growth investors only. And those growth investors who are interested should familiarize themselves with not just the opportunities but also with the challenges. Value and income investors should pass Zynga by since it pays no dividend and is far from providing a margin of safety.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ZNGA over the next 72 hours. 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.