Zynga's Stock Pop Makes No Sense

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

U.S. stocks posted another day of losses on Friday, capping the worst month for the stock market since May 2012. The benchmark S&P 500 index fell 0.6% on the day, while the narrower Dow Jones Industrial Average (DJINDICES: ^DJI  ) lost 0.9%. However, the social networking sector bucked the trend, including social games company Zynga (NASDAQ: ZNGA  ) . Shares of Zynga vaulted higher by 23.6% on the news of a major acquisition.

Yesterday afternoon, Zynga announced its fourth-quarter results a week ahead of its scheduled reporting date. The beleaguered social game developer managed to exceed Wall Street's expectations by $0.01, with a $0.03 loss; however, revenue of $176.4 million was shy of the $183.3 million consensus estimate. Furthermore, the company's guidance for the current quarter – a net loss of $0.06 to $0.07 per share on revenue of $155 million to $165 million – also fell short of analysts' estimates at the time of the announcement. Finally, the number of daily active users fell 12% from the previous quarter.

In that (grim) context, I'm forced to conclude that the reason investors bid the stock up today was the concurrent announcement of the largest acquisition in the company's history – that of privately held U.K. mobile game developer NaturalMotion, for $527 million (of which $391 million was in cash). Launched on the iOS in July 2012, NaturalMotion's hit, CSR Racing, was said to be grossing more than $12 million per month, but it was developed by gaming studio Boss Alien, which NaturalMotion acquired in August 2012. NaturalMotion has also had successes with American football game Backbreaker, and the free Clumsy Ninja for iOS.

However, to get an idea of the half-life of these games, compare the $12 million per month figure mentioned above in regard to CSR Racing to the $70 million to $80 million of total bookings Zynga expects NaturalMotion to add to its results for the whole of this year. Furthermore, Zynga is looking for an EBITDA (earnings before interest, taxes, depreciation, and amortization – a crude measure of cash flow) contribution of $15 million to $25 million. Compare that to NaturalMotion's $527 million price tag for NaturalMotion, and you have what looks like a very pricey acquisition.

And speaking of pricey, after the pop in today's shares, Zynga is now valued at nearly six times this year's forecasted revenue. Sure, the company has $1.1 billion of cash on hand ($1.42 per share), but given that analysts don't expect Zynga to be profitable this year or the next, that is but little comfort. Given the price paid, Zynga's ability to recoup its investment in NaturalMotion looks highly uncertain -- and the same is true for Zynga's shares. Today's pop looks like the triumph of hope over experience.

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Comments from our Foolish Readers

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  • Report this Comment On February 01, 2014, at 12:48 AM, Johnnyo26 wrote:

    Perhaps there is more coming.

  • Report this Comment On February 01, 2014, at 9:13 AM, giggy wrote:

    The company said it will be profitable this year and you are saying it won't this year or next year because one bashing anal said no out of many others? Remember the one who got totally wrong on the earnings and caused PPs drop 12%?

    The company bought NaturalMotion for its brilliant engine not for the current lucrative games. Study HARD what a "game engine" is. It will create virtually infinite number of the same brilliant games.

    I will tell you MF has kept bashing ZNGA in a row but it went up 20% meanwhile with record volume.

    Now give up!

  • Report this Comment On February 01, 2014, at 6:58 PM, TMFAleph1 wrote:


    Thanks for your comment.

    I was not referring to one "bashing anal[yst]" -- according analysts' *consensus* estimate, Zynga will not be profitable this year (you can see this here:

    However, it appears I may have been wrong concerning the consensus estimate for 2015.

    I understand that NaturalMotion's Euphoria engine renders graphics beautifully, but it's not clear to me that that's worth half-a-billion dollars.


    Alex Dumortier

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Alex Dumortier

Alex Dumortier covers daily market activity from a contrarian, value-oriented perspective. He has been writing for the Motley Fool since 2006.

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