A couple of weeks ago, I wrote a piece about Zynga (ZNGA), in which I concluded that the decision to close OMGPOP was another in a slew of warnings to potential investors. They are a company that, despite several popular games in the past, has failed to maintain profitability. Revenue generation is tough in the gaming business when your focus is on mobile and social platforms where many play only the free version of any game. Given this, ZNGA has done quite well, producing $150-$175 Million per Quarter in revenue, but profit remains elusive. The company’s decision to abandon their tentative attempt at the real money gaming market in the US seemed to remove one avenue of potential revenue and left many, myself included, skeptical as to the stock’s prospects.
As you can see, ZNGA obligingly fell from the 2.94 close on the day that article was published (August 12th), to just above $2.70, but has since rallied, even as the market as a whole has wobbled. The buyers of ZNGA seem to emerge on each dip in the stock, which made me curious; what was the bull case? I turned to a kind of crowd sourcing for the answer.
I posted a question on Stockr.com, asking if buying ZNGA was purely a play on a takeover, as it seemed to me that there was little other reason to buy the stock. Stockr, for those unfamiliar with the site is a market based social network; a Facebook (FB) for market geeks, if you will. I should say at this point that I have no interest, financial or otherwise in Stockr, I just find that the market types who hang out and contribute there can give me some insight and a different perspective on many issues.
So it was with ZNGA, where the main proponent of the bull case was Michael Pachter, Research Analyst at Wedbush Securities. He has an “Outperform” rating and $4.25 price target on the stock. He rightly pointed out that a takeover was extremely unlikely unless the stock appreciates considerably, but he remains bullish. His base case was that the new CEO, Don Mattrick, who joined from Microsoft (MSFT) in July, would turn them around. Job cuts had already been announced, and the case as presented seemed to be based on accelerating and enlarging those cuts to reduce costs, while expanding from a social based company into other gaming platforms. “My view on Zynga Inc. is that Don will get the staffing level right (meaning smaller) and will re-focus the company's efforts on producing social, puzzle/casual and mid-core/PvP games instead of social only.” said Pachter.
Some industry insight was bought by Paul Thelen, Founder and CEO of Bigfish games. His observation that ‘The bull case is they are one "candy crush saga" away from doubling their revenue and they will have many at bats in the coming years’ gave me pause for thought, but, as Thelen went on to say, this makes the stock more of an option gamble than an investment.
I have some sympathy with the basic case made by Mark Meadows and others that buying the stock now is a reasonable bet based on the ability and track record of Mattrick; I’m just not sure the situation won’t get worse before it gets better. When the new guy comes in wielding a big axe it may be what is needed, but morale counts, and big cuts don’t make for a happy team.
I have no doubt that, from a trading perspective, there will be opportunities in the coming weeks and months. If history is a guide, each new launch will be greeted with some optimism and buyers will emerge, but, as I pointed out in the original article, popularity of a game in the social media realm doesn’t always translate into profit. My view is more in line with that expressed by Balaji Viswanathan, that with a $2.3 Billion market cap and no consistent record of profit, the company still looks overvalued.
After all was said and done, the thread we created was illuminating and interesting, but my basic belief that ZNGA is not a stock to buy remained and was, in fact, probably strengthened. When the bull case for a stock is that large cuts in staffing and a change in direction is needed to turn things around, they may get lucky and have a hit, and they have a CEO who succeeded elsewhere, you don’t need much of a bear case. If you have a better reason for buying ZNGA, let me and others know in the comments below.
Of course, I could be completely wrong. That is the beauty of markets; we all look at the same information and reach differing conclusions. If we didn’t there would be no buyer and seller and therefore no trade. Vive La Difference!