Zynga: Don't Be Shaken Out

Zynga investors should be prepared for a bumpy ride over the next couple of quarters until Mattrick gets the social gamer turned around.

Jan 31, 2014 at 2:00PM

The recent downgrade by Sterne Agee on Zynga (NASDAQ:ZNGA) apparently shook out many investors, considering that the company's stock plunged roughly 12% that day. The interesting news about the analyst report is that it provided virtually nothing in the way of news to investors who were paying attention.

Zynga continues to be a leading social gaming platform that is struggling to complete a turnaround under new CEO Don Mattrick. While Mattrick came to Zynga from Microsoft (NASDAQ:MSFT) with a ton of promise, he has yet to place his stamp on the company. Zynga has coffers stuffed with $1.5 billion in cash and a strong lineup of game franchises, yet it hasn't done much to innovate in the last year. The company has recently made some moves, including agreeing to accept Bitcoins and releasing an interesting slots game, but investors expect much bigger things out of a heavy hitter like Mattrick.

On the opposite side of the spectrum, Electronic Arts (NASDAQ:EA) made a splash last week based on a return to console game success. This was partly due to the success of the Xbox One console developed by Mattrick before leaving Microsoft.

Sterne Agee downgrade
Analyst Arvind Bhatia of Sterne Agee issued commentary that fourth-quarter estimates were too high and the company would likely guide first-quarter expectations lower. While Bhatia lowered first-quarter bookings and EBITDA to $116 million and minus $17.2 million, respectively, he did make some interesting points about the first quarter being the bottom of the cycle. The analyst actually didn't adjust the full-year 2014 estimates.

At this point, it isn't clear whether Bhatia is correct, but his commentary is actually bullish. With the lack of a mega hit closing in on a month into the first quarter, Zynga would have a major victory if the first quarter were the trough of bookings. Besides, if the high expectations for Mattrick are accurate, the timing is right for a major product release.

Electronic Arts boosted by console and game sales
Ironically, with the shift to digital gaming, Electronic Arts got a major boost recently due to expectations related to the new Titanfall game, scheduled for a March release on the Xbox 360 console and personal computers. The company's stock also got a boost from market research showing that three games made December's top-ten sales list. Electronic Arts' Battlefield 4, Madden NFL, and FIFA 14 made the list and represented 30% market share among games available on Xbox One and 40% on PlayStation 4.

Digital sales strong
Market research firm Super Data reported that overall digital sales increased 11% to $11.8 billion in 2013, compared to $10.6 billion in 2012. Reportedly, revenue from social games declined 22% to $1.8 billion. Part of the decline might be the shift in classification of social games on mobile devices. Mobile gaming revenue jumped to $2.1 billion. More importantly for Zynga, free-to-play game revenue surged 45% year-over-year to $2.9 billion.

Prepackaged video game sales still surpassed digital sales for the year at nearly $13 billion. With the new consoles that were released at the end of last year, Microsoft and Sony should see solid years, followed by Electronic Arts with a strong franchise in the casual game segment.

Bottom line
With the downgrade of Zynga, Sterne Agee only repeated what most investors should already know. The lack of new hit games places a lid on the revenue potential for the social gamer and returns most investors to the "wait and see" category. For a long-term investor, though, this analyst should not have made any difference. The major assets of the company, including the new CEO, cash, and solid game franchises, are all still in place. Those are the three strong reasons to continue investing in this turnaround story. Don't be shaken out by the daily focus on short-term financial targets. Rome wasn't built in a day, and Mattrick won't turn around the slumping gamer in such a short time.

Industry data continues to suggest that Zynga is on track by continuing to focus on the spending shift to digital games. Electronic Arts and Microsoft might obtain short-term blips from the new consoles, but the future of gaming is very clear. Ultimately, investors must stick to their convictions, except for those who dumped the stock for a profit prior to the analyst downgrade. Typically, it's too late after a major move.

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Mark Holder and Stone Fox Capital clients own shares of ZYNGA INC. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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