Zynga Post-Earnings: A Contrarian Analysis

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

Zynga (NASDAQ:ZNGA) announced Q3 in-line with their preannouncement.  Total revenue was $317 million, compared with our estimate of $305 million, the pre-announced range of $300 – 305 million, and the consensus estimate of $261 million.  Non-GAAP EPS was $0.00 (excluding $0.07/share of net charges), compared with our estimate of $0.00, the preannounced range of $(0.01) – 0.00, and consensus of $(0.00).

Guidance consistent with expectations. Zynga revised FY:12 guidance for bookings to $1.09 – 1.1 billion from $1.085 – 1.100 billion, for adjusted EBITDA to $152 – 162 million from $147 – 162 million, and for non-GAAP EPS to $0.02 – 0.03 from $0.04 – 0.09. Zynga had not updated EPS guidance previously.

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We believe Zynga has sufficient expense control to allow it to  return to profitability after a steadily deteriorating performance in 2012. Zynga will likely generate a loss in Q4 after earning $0.06 over the first three quarters. As part of its cost control, the company will sunset 13 games and reduce headcount by ≈ 5%, lowering costs by $15 – 20 million in Q4. We have modeled breakeven results in FY:13; Zynga should easily achieve this through better expense management.

The Board of Directors has authorized a $200 million share repurchase program. At  its current share price, we believe a fully executed program could result in accretion approaching 10%.

Real money gaming (“RMG”) presents a new bookings growth opportunity. The company announced a partnership with bwin.party, an international RMG operator in the UK. The first games will be released in 1H:13.   Zynga does not currently plan to release RMG domestically, as U.S. law prohibits online gambling.

The majority of Zynga’s players continue to be non-payers. Zynga ended the quarter with only 3.0 million monthly unique payers (2% of monthly unique users), down from 4.1 million a quarter earlier. We believe Zynga can increase the number payers in a number of ways, but sustained success has been elusive.

Maintaining our OUTPERFORM rating and our 12-month price target of $4. Our price target reflects 2x cash and real estate of $2/share. Despite the cost cuts outlined over the past two days and the new share repurchase program, we expect Zynga shares to remain somewhat constrained over the next few quarters until management and investors can judge the success of the turnaround plan.

Michael Pachter is an analyst at Wedbush Securities.

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