Zynga's Stock Pop Makes No Sense

Zynga's acquisition of NaturalMotion looks expensive and it's no game-changer

Jan 31, 2014 at 11:06PM

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.

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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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Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool has no position in any of the stocks mentioned. 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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