DEEP ANALYSIS: Is This the BOTTOM for Zynga?

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Zynga (NASDAQ: ZNGA) shares should continue to rebound from recent lows. We believe shares may have hit a bottom on concerns over recent declines in monthly active users (MAUs), and expect launches of new games to drive sustained user growth. We expect strong 2H:12 financial performance, driven by increased spending on key older franchises and maturity of 2011 releases. Zynga shares should benefit as investors gain better understanding about the key drivers of the company’s financial performance (which reflect a lag between game launches and spending), as opposed to a focus on daily usage statistics alone.

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Expect improving monetization in 2H:12. When Zynga releases a new highprofile game, we believe that the number of paying users grows steadily for at least a year following launch. As a result, we expect steady payments growth, coming from a slew of releases beginning in June 2011, including Bubble Safari, Empires & Allies, Adventure World, CastleVille,  Draw Something,  Hidden Chronicles, Zynga Bingo and Zynga Slingo.

Misperception that monthly active user (MAU) growth and revenue growth are immediately correlated.  Zynga shares have been negatively impacted by MAU declines as investors become concerned that fewer users result in lower total revenue. We disagree, and believe that the majority of gamers who discontinue playing Zynga titles are likely to be non-payers, with payers spending more as they make a greater investment of time in each game.

Zynga shares have been negatively impacted by Facebook weakness  and comScore data. The decline in the value of Facebook shares led to a decline in Zynga shares. We remain focused on Zynga’s Facebook penetration (market share), its usage statistics, and most importantly, its monetization trends.

Dominance of social games market continues. Zynga still has the largest player audience on Facebook, with roughly five times as many MAUs (≈ 255 million as of June 15 according to AppData) as its next closest competitor.

Maintaining our OUTPERFORM rating and our 12-month price target of $17. Our price target reflects an EV/EBITDA multiple of ≈ 19x our estimate for 2013 adjusted EBITDA, or an EV/EPS multiple of ≈ 33x our 2013 EPS estimate. We think that the company’s market dominance and rapid recent user growth will allow it to continue robust growth for the foreseeable future.

Michael Pachter is an analyst at Wedbush Morgan.

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