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Is Zynga A Value Trap?
Zynga Inc Class A (ZNGA) has been losing ground to competitors for quite some time now. Neither its stock or games are popular with the investors as the company failed to maintain its place as the largest social gaming company in terms of users to King Resources Inc (KING.PK). As per the company's SEC filings, a massive decline can be seen in its Daily Active Users "DAU", Monthly Active Users "MAU" and Monthly Unique Users "MUU". In addition, Zynga reported losses for the current quarter but its results were much better than the market projections. Therefore, an impartial attempt is under way to decipher whether Zynga's woes carry weight or would the company be able to overcome its current financial distress.
Historical Performance
Zynga primarily generates revenue from advertisement and online games. Its revenue growth mainly depends upon the ability to attract and retain players. However, Zynga has not been able to attract new players or retain old ones in the last few quarters in addition to its lost market leadership to King; thereby making it improbable for Zynga to post decent margins.
SOURCE: Company s Financials
Facebook being the prime source, the above pie chart shows that Zynga generates a revenue of 88% from online games and 12% from advertisement. In the second quarter of FY2013, revenue from online games and advertisement decreased by 30% and 33.06% respectively owing to the loosing popularity of Zynga's games. On the whole, the table below shows that the company's revenues in the second quarter dropped from $332 million to $231 million in FY2013, a decline of 30% as compared to the prior year quarterly performance.
In addition, the cost of revenue decreased as a percentage of sales by 2.21%. Therefore, Zynga's gross margin increased from 71.39% to 73.59% in the second quarter of FY2013, however despite this the company reported low operating margins because of high general &administration and R&D costs. Moreover, net margins did not change during the second quarter of FY2013.
SOURCE: morningstar.com
Zynga's performance with the industry shows that the company's revenue grew by a CAGR of 119.30% over the last three years with the largest revenue increase of approximately 400% seen in FY2010. Soon after, the revenues then increased at a declining rate as is evident from the increase of only 12% for FY2012. On the other side, as shown in the following graph, industry revenues inclined by a CAGR of 4.70% over the last three years.
(click to enlarge)
SOURCE: Morningstar Zynga Profile
Zynga reported a negative 8.40% operating margin in the trailing 12 months while industry operating margin was 15.70%, quite higher than the stock's margin. Moreover, the negative 10.10% net margin is well below the industry average of 11.30%. ROA and ROE of Zynga are also in the negative.
The company is currently trading at a P/S ratio of 2.60, which is slightly higher than the industry ratio of 2.50; but its P/Cash flow ratio is 38.8, well above the industry average. Zynga's five year expected PEG is negative 1.66. Furthermore, Zynga's earnings forecast until FY2016 is given below.
Source: nasdaq.com
It is clearly seen that Zynga's earnings are expected to be negative until FY2016.
Industry Outlook And Company's Growth Opportunities
According to Newszoo research report, the global game industry is expected to grow at a CAGR of 6.70% by FY2016. As highlighted in the following table, there will be a plenty of shift in the market share of different segments as tablets and smart phones will experience a CAGR of 18.80% and 47.60% respectively whilst Hand console and PC/Mac are predicted to lose their market share.
SOURCE: venturebeat.com
(click to enlarge)
The following projections for sale depict that the global game industry will generate $9.99 billion in tablets, whereas the TV/Console will remain the largest contributor with $27.90 billion. The two would account for 11.60% and 32.40% of the total sales respectively.
SOURCE: venturebeat.com
The industry might have a bright outlook in the future, however, Zynga will not be able to take advantage as it clearly stated in its FY2012 financial statements that it expects a decline in revenues and bookings for the current quarter along with a downward pressure on its operating margins as a result of the increasing competition in the market. It defines bookings as a sum of revenue recognized during the period along with the changes in deferred revenues. The company's revenue depends heavily upon popular games, but it is very difficult for the Zynga to introduce such games every quarter. As you can see in the following graph, hit games tend to decline quickly within a few quarters because there is high tendency among players to get bored with the passage of time.
(click to enlarge)
SOURCE: company.zynga.com
Furthermore, it predicts a loss of 5 cents a share during the third quarter. Consequently, Zynga is not contemplated to overcome the barriers given the intense competition that dominates the core market. Although, the company has not provided any forecasts about MAU, DAU and MUU, but there is sufficient evidence from the recent quarters as depicted by the graph that they are likely to foresee a further decline.
(click to enlarge)
SOURCE: company.zynga.com
Final Verdict
Although the global game industry has a decent outlook, it is highly speculative that Zynga with its decreasing popularity of online games would capitalize that growth in its financials.
Additionally, Zynga's recent performance is not up to mark. Its profit margins, largely dependent on the successful launch of hit games are well below the industry average, since Zynga despite the high research & development cost was not able to show the desired efficacy in recent quarters. Moreover, the company's management is also expecting a decline in its revenues and bookings in face of the heightened competition.
Lastly Zynga's five years expected PEG is also in the negative. It's declining margins and expected negative earnings over the next few years reinforce a bearish outlook for the stock thereby compelling a sell position for investors.
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