The Terrible Irony Surrounding Zynga's $527 Million Acquisition

Zynga just announced that it will acquire mobile-game developer NaturalMotion. Here's why investors should tread lightly.

Feb 2, 2014 at 4:00PM

On Friday, Zynga (NASDAQ:ZNGA) shareholders rejoiced after their company not only released better-than-expected quarterly results, but also announced cost-cutting efforts and a massive acquisition. When all was said and done, Zynga stock had skyrocketed nearly 24%.

But you know what? After carefully considering the repercussions of everything the social-gaming specialist revealed, I'm still not impressed.

These numbers sound good ...
Now before you recoil in disbelief, hear me out: I know Zynga achieved a $0.03-per-share adjusted net loss on revenue of $176.4 million, which handily beat analysts' expectations for a $0.04-per-share loss on sales of just $138.42 million.

And though fourth-quarter bookings -- Zynga's key measure for in-game virtual goods purchases -- still trailed GAAP revenue after falling 44% to $147 million, Zynga told investors to expect full-year 2014 bookings to increase to a range of $760 million to $810 million, representing 6% to 13% growth over 2013.

That's where Zynga's $527 million acquisition of mobile game developer NaturalMotion comes in.

Specifically, Zynga says the purchase is expected to be accretive to non-GAAP earnings this year and should generate 2014 bookings of $70 million to $80 million. To be sure, I can't blame investors for being excited for the mobile play considering Zynga's Q4 mobile bookings fell 5.6% to $51 million over the same year-ago period -- an especially troubling statistic when we remember research firm SuperData recently reported the mobile gaming market grew 28% last year.

... but there's more than meets the eye
However, this acquisition is terribly ironic in more ways than one.

First, it seems as though the market doesn't remember just how badly Zynga's early 2012 acquisition of Draw Something creator OMGPOP turned out. You know, when Zynga forked out $180 million for OMGPOP, only to close its doors and suffer a $95.5 million impairment charge less than a year later.

And this time the stakes are much higher; Zynga is financing its latest purchase with a combination of $391 million in cash (or 25% of its $1.54 billion stockpile) and diluting investors further by issuing another 39.8 million shares of Zynga common stock. That's a steep price to pay for a company which is only expected to contribute $15 million to $25 million in adjusted EBITDA in 2014.

Worse yet, investors applauded Zynga's cost-cutting efforts, which namely involve generating pre-tax annual savings of roughly $34 million by eliminating 314 employees, or 15% of its workforce.

But keep in mind that NaturalMotion already has around 260 employees, which means Zynga is effectively reducing its workforce by only 54 people and spending almost $500 million more for the privilege. In short, those NaturalMotion workers had better be worth it.

To their credit, while NaturalMotion arguably has only two big hits in Clumsy Ninja and CSR Racing, I fully understand it also owns some slick gaming-development tools and simulation technologies. As a result, there's a decent chance Zynga will be able to take advantage of its newly acquired tech to pump out additional wildly popular, visually appealing titles going forward. In fact, I'd count on it.

But that still doesn't change the fact Zynga's business suffers from poor economics, anyway. After all, if it weren't already hard enough turning a consistent profit in the low-cost and free game segment in the first place, it's even more difficult continuously churning out titles to keep consumers' attention for any meaningful period of time.

In the end, that's why I still simply can't bring myself to get excited about Zynga as a long-term investment.

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4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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