Why Did This $73 Billion Hedge Fund Company Buy Zynga?

Might you find it a compelling buy, too?

Mar 11, 2014 at 5:47PM

The latest 13F season is here, when many money managers issue required reports on their holdings. It can be worthwhile to pay attention, as you might get an investment idea or two by seeing what some major investors have been buying and selling.

For example, consider D. E. Shaw & Co. Founded by David E. Shaw, the company has a reportable stock portfolio totaling $73.3 billion in value as of December 31, 2013. Shaw is known as a math wizard and a quantitative investing pioneer. His firm is extremely selective when hiring, reportedly accepting about one in 500 applicants -- Amazon.com CEO Jeff Bezos once made the cut.

D. E. Shaw's latest 13F report shows that it has boosted its position in video game maker Zynga (NASDAQ:ZNGA). That's interesting, as it's far from universally accepted that its stock is a strong portfolio candidate. It boasts widely successful games such as Zynga Poker, Words with Friends, and FarmVille, so why might some doubt its value, and why would a big hedge fund company buy it? Let's see.

What's the problem?
A key concern for many is how successfully Zynga can monetize its popular games. After all, many users play them for free (about 98% of them, per one estimate!), and Zynga hasn't been raking in huge advertising profits from them, either. Some might also worry about how concentrated the company's profits are on just a few games; in its fourth quarter, three titles generated more than 60% of online revenue. Zynga's reliance on Facebook has also been a concern.

Zynga has been trying to grow in part via acquisition, but those moves haven't always generated a lot of confidence, as it ended up shuttering its rival OMGPOP company about a year after buying it for $200 million. A more recent purchase is mobile game developer NaturalMotion (known for Clumsy Ninja and CSR Racing), which Zynga snagged for $527 million.

Zynga's challenges are not only in the minds of skeptics. The company itself has posted disappointing earnings reports: Its fourth quarter featured revenue down 43% over 2012 levels and a loss of $0.03 per share, though that loss has narrowed considerably from 2012's $0.06 loss. Early this year the company announced it would lay off 314 workers -- about 15% of its workforce. This is on top of hundreds of layoffs last year.

On the other hand...
Meanwhile, bulls still find plenty to be hopeful about, such as Zynga's relatively new CEO Don Mattrick, who hails from Microsoft's Xbox division. The company is pushing into the mobile arena more strongly, redesigning titles to optimize its presence there. Its purchase of NaturalMotion is expected to accelerate its mobile growth. To understand why this refocusing is so promising, consider that the global mobile games market has been estimated to grow by about 27% annually, reaching almost $24 billion by 2016 as the number of players, and their average spending, grows.

Another growth prospect is real-money gaming (read: online gambling). Zynga has not yet embraced that, but it remains a possibility.

More compelling game companies
It's worth remembering that if you're bullish on video games, you have many more options than Zynga. Here are a few companies to consider:

Take-Two Interactive Software's (NASDAQ:TTWO) Grand Theft Auto V game was 2013's best seller, and its NBA2K basketball game franchise is also a strong performer. It, too, is aiming for more growth within the mobile realm. With a forward P/E ratio near 11, Take-Two Interactive is appealingly priced, but its sales growth has been inconsistent, and bears worry, as they do with most game companies, whether it will be able to keep churning out megahits.

Activision Blizzard (NASDAQ: ATVI) is the country's largest video game company, having developed and published franchises such as Call of Duty, Skylanders, World of Warcraft, StarCraft, and Diablo III. Bulls are hoping that the releases of the new PlayStation 4 and Xbox One video game consoles will drive more sales of games. Activision Blizzard also has updates for many games in its pipeline, and hopes to have a new blockbuster on its hands as it releases Destiny later this year. It, too, would like to be a major player in mobile gaming, but mobile players are more fickle than console players, and success in one realm doesn't necessarily translate to the other.

Electronic Arts (NASDAQ:EA) has had a mixed past, being named the "Worst Company in America" (twice) by Consumerist in part for what critics have called recent shoddy software output. The company has just released its anticipated game Titanfall. With the World Cup taking place this summer, its FIFA soccer games are likely to get a boost. In its last quarter, the company beat earnings expectations but posted revenue that fell $9 million short.

Glu Mobile (NASDAQ:GLUU) has enjoyed the huge success of its Deer Hunter 2014 game and is a key Zynga rival with more experience in the mobile realm under its belt -- and actual profit, too. Its fourth quarter blew many away, with revenue surging 62%. (Note that Deer Hunter 2014 generated about half that, reflecting a lot of dependence on that one title.) Some speculate that Glu Mobile might be acquired.

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Selena Maranjianwhom you can follow on Twitter, owns shares of Activision Blizzard, Amazon.com, and Microsoft. The Motley Fool recommends Activision Blizzard, Amazon.com, Facebook, and Take-Two Interactive. The Motley Fool owns shares of Activision Blizzard, Amazon.com, Facebook, and 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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