Should You Buy Zynga After Its 11% Drop?

A little over a month ago, I wondered if Zynga's (NASDAQ: ZNGA  ) terrible first-quarter results had marked the beginning of the end for the social-gaming specialist.

After all, the stock had plummeted 9% that day after the company said bookings -- their metric for tracking customers' in-game virtual goods purchases -- fell 30% year-over-year to just $229.8 million. What's more, total revenue had fallen 18% to $261.3 million, and net income came in at meager $0.01 per share.

Worse yet, Zynga not only issued weak second-quarter sales guidance between $225 million and $235 million, but also told investors to expect a Q2 net loss between $36.5 million and $26.5 million, or between $0.05 and $0.03 per share. In addition, Zynga also said second-quarter bookings would likely be in the disappointing range of $180 million to $190 million.

Still, Zynga had managed to remain cash-flow positive for the quarter, with operating cash flow of $26.4 million and free cash flow of $23.2 million, and it still had $1.67 billion in cash remaining with no debt at the end of March.

Here's why things just got worse
On Monday, Zynga issued a press release which caused the stock to drop 11% and investors to wonder whether anyone realizes just how bad things have gotten for the otherwise cash-rich company.

The release, which was awkwardly titled "Zynga Announces Substantial Cost Reductions," described how Zynga will close some of its various office locations and eliminate 520 employees -- or around 18% of its total workforce -- "across all functions" by August. As a result, though Zynga will incur restructuring charges of approximately $24 million to $26 million in the second quarter, the move should save the company between $70 and $80 million annually before taxes.

If that weren't bad enough, Zynga simultaneously lowered its Q2 guidance and now expects a net loss anywhere from $39 million to $28.5 million. Meanwhile, a strong showing from Zynga's FarmVille franchise wasn't enough to prop up bookings, which are now expected to be in the lower half of the previously supplied range.

Even so, Zynga reaffirmed all other guidance metrics including revenue, earnings per share, adjusted EBITDA, and non-GAAP earnings per share.

Don't touch this house of cards
While the bulls may still be hanging onto a sliver of hope from the company's foray into online gambling, I'm going to have to side with fellow Fool Michael Lewis, who pointed out last month plenty of hurdles still need to be overcome for Zynga to succeed in the space.

After all, even if additional states continue to pass legislation legalizing online gambling, you can bet Zynga will face intense competition from other well-funded competitors. Michael also noted there's a chance recent rumors of a Zynga partnership with Wynn Resorts (NASDAQ: WYNN  ) could turn out to be true.

Wynn, for its part, certainly wouldn't mind another source of revenue; while the company did find some growth last quarter thanks in part to its Cotai operations in Macau, that growth still didn't keep pace with Macau as a whole. As a result, Wynn's overall sales managed to rise just 4.9% from the same year-ago period.

Even still, unlike Zynga, Wynn remains solidly profitable and doesn't need to lean on an unproven online presence nearly as bad as Zynga needs a partner to share the risk. In addition, as Zynga's dissolving relationship with Facebook proves, there's still plenty of risk involved with Zynga relying too much on other companies to ensure its own survival. 

Foolish final thoughts
Finally, Zynga is no stranger to experiencing painful brain drains, and I suspect this latest round of layoffs will likely result in a fresh exodus of top talent to other gaming firms like Electronic Arts or the ridiculously profitable Activision Blizzard.

In the end, despite all its cash, I'm afraid Zynga is still too risky for my taste. Until its online gambing efforts bear some tangible fruit, these "substantial cost reductions" may only be delaying the inevitable as Zynga extends its vicious downward spiral.

More expert advice from The Motley Fool
Zynga's post-IPO performance has been dreadful, and investors are beginning to wonder if it's "game over" for this newly public company. Being so closely tied to the world's largest social network can be a blessing and a curse. You can learn everything you need to know about Zynga and whether it's a buy or a sell in our new premium research report. Don't even think about picking up shares before you read what our top analysts have to say about Zynga. Click here to access your copy.


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