Zynga (ZNGA) poised for immense future growth

Zynga (NASDAQ: ZNGA) is a leading mobile game developer well-known for developing many social games such as Farmville, Words with Friends 2, and Zynga Poker. This game developer focuses heavily on creating games hosted on mobile platforms rather than console and PC platforms, and they differ from other leading gaming developers such as Activision and Ubisoft by targeting the social, bonding components of gaming. Therefore, accessibility and interactivity are two major features they aim to achieve through the development of their games. Since their 2011 IPO, Zynga has shown immense potential to grow into a behemoth in the mobile gaming industry, and they have shown time-and-time again to be a significantly undervalued stock with extremely high future potential. The 2020 fiscal year proved to be their most successful yet, achieving their highest revenue and user pay performances in Zynga’s history in Q3, up 46% YoY and 55% YoY respectively. These achievements were marked by the strong impact of COVID-19, causing many people to turn to at-home hobbies such as gaming in order to pass the time during lockdown. Zynga’s current business model of free-to-play games with built-in microtransactions is extremely accessible to the general public compared to its console and PC competitors, and during the 2020 fiscal year, the company has adopted many emerging strategies poised for growth within the gaming industry, such as social gaming (being able to interact with your friends through games), live services (live-streaming, which has seen a spike in popularity and was cited as the secret key to Zynga’s growth by the company’s chief executive), and mobile gaming. From a macro standpoint, mobile gaming rests as a key growth industry as society continues to move towards an increasingly interconnected landscape, and with 2/5 of the global population now owning smartphones, mobile gaming is projected to register a compound annual growth rate (CAGR) of 14% in the next 5 years with high economic resilience. An important note is that Zynga has adopted a unique growth strategy that not many other mobile developers have taken on in the past. The developer has focused on carrying out an aggressive M&A strategy aimed to achieve long-term growth prospects, and much of their shareholder’s equity has been invested into bigger and bigger game developer acquisitions. Since 2010, they have completed over 25 acquisitions of mobile gaming developers around the world, where they are slowly but steadily building up a strong and active player base and game inventory from these acquisitions. Chris Petrovic, Head of Corporate Strategy at Zynga, states that their M&A strategy is focused on the long-term relationship with the companies they acquire and increasing Zynga’s game inventory, which will propel them to increased future profitability with the acquisition of bigger and bigger player bases. Acquired 80% of Small Giant Games for $560M (2018) Acquired Gram Games for $250M (2018) Acquired NaturalMotion for $527M (2014) Acquired Peak for $1.8B (2020 - biggest acquisition) Acquired Rollic for $180M (2020) Bears argue that the cash-poor position of Zynga as a result of these acquisitions dampens the future prospective growth of the company, and Zynga will not be significantly appreciating in price anytime soon. The stock has been trading sideways since the beginning of the summer in 2020, likely due to the effect of smaller operating margins as a result of this aggressive acquisition strategy. We can see that Zynga’s Current EV / Free Cash Flow (Annual) ratio is 110.15, compared to competitor EA’s ratio of 12.32 and ATVI’s ratio of 41.72. The higher this ratio is, the more slowly a company is able to pay back the costs of acquisitions, as well as its ability to generate cash to reinvest into its business. In its current state, Zynga's reinvestment of its resources back into the business is relatively slow, considering the hefty price tags that are attached to each acquisition. As well, looking at Zynga’s 10-Q filing for 2020Q3, their biggest cash outflow during this quarter were business acquisitions (outflow of $791M), and this was before they had acquired Peak for $1.8B. Despite this, they generated positive operating cashflow of $113M in 2020Q3, which is their best Q3 performance and was up 65% YoY. This M&A strategy should be thought of like an investment into Zynga’s future. During their Q2 earnings, with their plans to acquire Peak, their goal of increasing monetization with their games and player base proved to be extremely successful. Throughout 2020, every single quarter has seen higher and higher revenue generation because of Zynga’s new acquisitions, as well as record revenue and bookings generation with the new games they acquire with each successive quarter. This shows that while Zynga might not be experiencing drastic growth in the short-term, the company is carefully utilizing its resources to invest into companies poised for high future growth. As well, Zynga is currently trading at an Annual P/E of 248.84, compared to its industry, which is hovering at around a ratio of 30x. This is appropriate considering that Zynga is still a young and growing company, and with such a high valuation compared to some of its more established competitors such as Electronic Arts (NASDAQ: EA) or Activision Blizzard (NASDAQ: ATVI), Zynga is shown to have high future growth in its current position. This is because the higher the P/E, the higher expected revenue growth by the company in the future. With their upcoming Q4 release on February 10, investors are looking for continued increases in their Daily Active User (DAU) base, as well as the successful integration of the acquired games within the developer's inventory. Investors should take into account Zynga’s current cash-poor position, because this will not be a stock you want to buy if you’re looking to sell it in the short-run. Overall, their share prices will definitely rise and dip in the near future, but taking into account Zynga’s massive future potential growth, the stock is valued at a very cheap at $10.71USD currently. For any value investor looking to pick up a long-term buy and hold stock, Zynga shows high promise within the next few years as they slowly churn out increases in their DAU base and slowly increase monetization from their growing inventory of games from each acquisition. Sources / Documents used: https://investor.zynga.com/static-files/574774cc-b366-4a6c-85d4-2051fbe81ff1 https://investor.zynga.com/static-files/3781c001-7e1f-42e8-a3f3-981352462da9 https://www.reuters.com/companies/ZNGA.OQ/profile https://www.businesswire.com/news/home/20201201005996/en/Global-Mobile-Gaming-Market-Growth-Trends-and-Forecasts-2020-2025-Free-to-play-Pricing-Model-Offers-Potential-Growth---ResearchAndMarkets.comhttps://www.reuters.com/article/esports-business-gaming-revenues-idUSFLM8jkJMl

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Jan 25, 2021

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Change % Since Posting

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ZNGA

Zynga Inc - Class A

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Current Price

Zynga (ZNGA) poised for immense future growth

bullish

Zynga (NASDAQ: ZNGA) is a leading mobile game developer well-known for developing many social games such as Farmville, Words with Friends 2, and Zynga Poker. This game developer focuses heavily on creating games hosted on mobile platforms rather than console and PC platforms, and they differ from other leading gaming developers such as Activision and Ubisoft by targeting the social, bonding components of gaming. Therefore, accessibility and interactivity are two major features they aim to achieve through the development of their games.

Since their 2011 IPO, Zynga has shown immense potential to grow into a behemoth in the mobile gaming industry, and they have shown time-and-time again to be a significantly undervalued stock with extremely high future potential. The 2020 fiscal year proved to be their most successful yet, achieving their highest revenue and user pay performances in Zynga’s history in Q3, up 46% YoY and 55% YoY respectively. These achievements were marked by the strong impact of COVID-19, causing many people to turn to at-home hobbies such as gaming in order to pass the time during lockdown. Zynga’s current business model of free-to-play games with built-in microtransactions is extremely accessible to the general public compared to its console and PC competitors, and during the 2020 fiscal year, the company has adopted many emerging strategies poised for growth within the gaming industry, such as social gaming (being able to interact with your friends through games), live services (live-streaming, which has seen a spike in popularity and was cited as the secret key to Zynga’s growth by the company’s chief executive), and mobile gaming. From a macro standpoint, mobile gaming rests as a key growth industry as society continues to move towards an increasingly interconnected landscape, and with 2/5 of the global population now owning smartphones, mobile gaming is projected to register a compound annual growth rate (CAGR) of 14% in the next 5 years with high economic resilience.

An important note is that Zynga has adopted a unique growth strategy that not many other mobile developers have taken on in the past. The developer has focused on carrying out an aggressive M&A strategy aimed to achieve long-term growth prospects, and much of their shareholder’s equity has been invested into bigger and bigger game developer acquisitions. Since 2010, they have completed over 25 acquisitions of mobile gaming developers around the world, where they are slowly but steadily building up a strong and active player base and game inventory from these acquisitions. Chris Petrovic, Head of Corporate Strategy at Zynga, states that their M&A strategy is focused on the long-term relationship with the companies they acquire and increasing Zynga’s game inventory, which will propel them to increased future profitability with the acquisition of bigger and bigger player bases.

  • Acquired 80% of Small Giant Games for $560M (2018)
  • Acquired Gram Games for $250M (2018)
  • Acquired NaturalMotion for $527M (2014)
  • Acquired Peak for $1.8B (2020 - biggest acquisition)
  • Acquired Rollic for $180M (2020)

Bears argue that the cash-poor position of Zynga as a result of these acquisitions dampens the future prospective growth of the company, and Zynga will not be significantly appreciating in price anytime soon. The stock has been trading sideways since the beginning of the summer in 2020, likely due to the effect of smaller operating margins as a result of this aggressive acquisition strategy. We can see that Zynga’s Current EV / Free Cash Flow (Annual) ratio is 110.15, compared to competitor EA’s ratio of 12.32 and ATVI’s ratio of 41.72. The higher this ratio is, the more slowly a company is able to pay back the costs of acquisitions, as well as its ability to generate cash to reinvest into its business. In its current state, Zynga's reinvestment of its resources back into the business is relatively slow, considering the hefty price tags that are attached to each acquisition. As well, looking at Zynga’s 10-Q filing for 2020Q3, their biggest cash outflow during this quarter were business acquisitions (outflow of $791M), and this was before they had acquired Peak for $1.8B.

Despite this, they generated positive operating cashflow of $113M in 2020Q3, which is their best Q3 performance and was up 65% YoY. This M&A strategy should be thought of like an investment into Zynga’s future. During their Q2 earnings, with their plans to acquire Peak, their goal of increasing monetization with their games and player base proved to be extremely successful. Throughout 2020, every single quarter has seen higher and higher revenue generation because of Zynga’s new acquisitions, as well as record revenue and bookings generation with the new games they acquire with each successive quarter. This shows that while Zynga might not be experiencing drastic growth in the short-term, the company is carefully utilizing its resources to invest into companies poised for high future growth.

As well, Zynga is currently trading at an Annual P/E of 248.84, compared to its industry, which is hovering at around a ratio of 30x. This is appropriate considering that Zynga is still a young and growing company, and with such a high valuation compared to some of its more established competitors such as Electronic Arts (NASDAQ: EA) or Activision Blizzard (NASDAQ: ATVI), Zynga is shown to have high future growth in its current position. This is because the higher the P/E, the higher expected revenue growth by the company in the future.

With their upcoming Q4 release on February 10, investors are looking for continued increases in their Daily Active User (DAU) base, as well as the successful integration of the acquired games within the developer's inventory.

Investors should take into account Zynga’s current cash-poor position, because this will not be a stock you want to buy if you’re looking to sell it in the short-run. Overall, their share prices will definitely rise and dip in the near future, but taking into account Zynga’s massive future potential growth, the stock is valued at a very cheap at $10.71USD currently. For any value investor looking to pick up a long-term buy and hold stock, Zynga shows high promise within the next few years as they slowly churn out increases in their DAU base and slowly increase monetization from their growing inventory of games from each acquisition.

 

Sources / Documents used:

https://investor.zynga.com/static-files/574774cc-b366-4a6c-85d4-2051fbe81ff1

https://investor.zynga.com/static-files/3781c001-7e1f-42e8-a3f3-981352462da9

https://www.reuters.com/companies/ZNGA.OQ/profile

https://www.businesswire.com/news/home/20201201005996/en/Global-Mobile-Gaming-Market-Growth-Trends-and-Forecasts-2020-2025-Free-to-play-Pricing-Model-Offers-Potential-Growth---ResearchAndMarkets.comhttps://www.reuters.com/article/esports-business-gaming-revenues-idUSFLM8jkJMl

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5 min

11.78

Target Price

9/ 10

Confidence

1-3 Years

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