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Here's Why Investors Should Avoid Zynga, Inc.

Zynga  (NASDAQ: ZNGA  ) released first-quarter 2014 results earlier this week, and I'll admit they weren't terrible.

In fact, despite the market's decidedly "meh" response, with shares closing down around 1.6%, investors are rightly encouraged that Zynga managed to return to sequential growth in bookings, adjusted EBITDA, mobile bookings mix, and audience for the first time in two years.

But that still doesn't mean I'll be buying the stock anytime soon, and I think fellow investors should avoid the stock as well.

Zynga, King Digital battle for supremacy in the free-to-play space

Source: Zynga.

First, the numbers
Before we get to that, let's recap Zynga's most recent quarter. 
Revenue fell 36.3% year over year to $168 million, which translated to a net loss of $61.2 million, or $0.07 per share. On an adjusted basis, however -- which excludes things like acquisition expenses and stock-based compensation -- Zynga reported a net loss of just under $6.3 million, or roughly $0.01 per share. By comparison, analysts were looking for the same $0.01-per-share loss but on lower sales of $146.52 million.

Meanwhile, bookings -- which are Zynga's key measure for in-game virtual goods purchases -- came in at a respectable $161 million, and adjusted EBITDA were $14 million. Both figures are well above Zynga's previous guidance, which called for bookings in the range of $138 million to $148 million and adjusted EBITDA of $5 million to $10 million.

What's more, Zynga announced its much-maligned founder and former CEO Mark Pincus has decided to move on from his operational role as chief product officer. Instead, he'll focus on continuing to serve as chairman of Zynga's board of directors.

So why am I not biting?

Bad economics
First, I need to see more than a single quarter of sequential improvement to know Zynga's business is sustainable over the long term.

Zynga still overwhelmingly relies on the success of a few key titles like FarmVille and Words With Friends, and even with its shift toward more visually beautiful titles with the help of NaturalMotion -- which could negate the perceived importance of its remaining preacquisition employees (more on that below) -- it still needs to overcome the increasingly difficult challenge of continuously pumping out and monetizing free-to-play games.

That's not to mention ever-increasing competition in the space for consumers' already-limited attention, including the recently IPO'd King Digital Entertainment  (NYSE: KING  ) . Of course, King Digital also suffers from a terribly risky overreliance on its hugely addictive Candy Crush Saga, which it most recently announced will expand to Tencent's fast-growing WeChat messaging platform. We should know more about King's plans to diversify when it reports earnings two weeks from now, but it's clear Zynga is far from alone anymore.

Oh, the irony
But that's also why Zynga acquired NaturalMotion for $527 million last quarter, right? NaturalMotion's 260-person team already had a few hugely successful titles to its name, including Clumsy Ninja and CSR Racing. Its game-development tools and simulation tech are also world-class, so you can bet Zynga has something coming down the pipe to differentiate itself as competitors like King Digital arise.

However, even as the market applauded the move, I'm still having a hard time looking past the terrible irony in Zynga's purchase. Namely, I was appalled when it simultaneously announced a "cost reduction plan" primarily involving the elimination of 314 employees -- or approximately 15% of its workforce.

Zynga boasted the move would save around $33 million to $35 million before taxes in 2014, but that excludes the $13 million in related restructuring charges it had to take this quarter. This also completely ignores the risk associated with harder-to-quantify survivor guilt, which could be a massive drag on the productivity of Zynga's remaining core employees.

Don't get me wrong: Perhaps the layoffs were necessary given Zynga's faltering core business. But they were ill-timed, at best, and it's hard to remain confident that Zynga is doing the right thing given its checkered past of shareholder un-friendly actions and exodus of high-profile engineering talent.

Then again, if Zynga is moving in the right direction, it could reward investors handsomely for their willingness to take a calculated risk on its eventual sustained profitability.

For the reasons above, however, I still can't bring myself to buy its shares.

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Read/Post Comments (4) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 25, 2014, at 11:16 AM, StayhomeMom2 wrote:

    Why are you doing this???You should be considerate of others before you write/post your article. Many people are losing money because of negative articles as yours. For many of us Stay-home Moms this is our only source of income to make a profit on Zynga stock. Why are you making it so difficult for us to make a living???

  • Report this Comment On April 26, 2014, at 8:54 AM, z06forum wrote:

    Articles have never been more clear about Their Agendas than they have been today.

    To the readers out there, if you beleive the Number of Mobile devices will be in the Billions and if you Beleive Don and Team are the right guys to win their fair Share or more. Then do not listen or waste your time on the Media Noise. Steve Symington is a Pawn that was paid to write an article and put a negative twist on it as opposed to a possitive twist which is really how the ZNGA report reflected.

    Steves Opinions to stay away short term will keep a few poeple from making the money they could have for sure. Once ZNGA has bottomed out and his "friends" have covered they will soon be on the long side and Good cop will surface with another article saying this is a good time to get in ~ after they do of course. When you have self governed entitys and all it takes is a Nod with no paper trail this is the

    kind of stuff you have to deal with. In my opinion this is Great system because it has never been as transparent to see who is doing what based on these articles. For those with a keen eye to understand this and to be able Trade ahead of it is making me a pretty good living. So I have to Thank Steve personally for doing his small part of providing me a lower Entry point.

    To the Stayathome mom ~ Day trading is for the home gamer is like playing roulette. Buy as much ZNGA as you can afford to lock in for 2-3 years and you will get 5 Times your money. Good luck!

  • Report this Comment On April 27, 2014, at 3:00 PM, BimmyBoris wrote:

    What all the analysts don't understand is that Zynga is basically a 'cash cow' ripe for takeover. It has over $2 BILLION in liquid assets. About $2.70 a share. If you take over the company, and remove un-necessary expenses, Zynga would be producing about $0.10/share QUARTERLY net profit. Not bad. IMO, Pincus turned over the operating duties to Donnie M so an acquisition could be arranged.

  • Report this Comment On April 28, 2014, at 12:19 PM, StayhomeMom2 wrote:

    To z06forum, thank you for enlightening me. I just learn that this system favors the rich helping the rich to get richer while the poor gets poorer. Thus is a GREEDY system!

    I have no money to buy more ZNGA. I'm much poorer now than a month ago thanks to Steve the Pawn! I would like to know who is the King. Please let me know. I would like to ask him why he's doing this! He's caused may of us to lose lots of our money!

    To BimmyBoris, who would acquire Zynga if the rich are selfishly shorting it and Steve the pawn selfishly writing negative article both are making money over poor investors like myself?

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Steve Symington

Technology and consumer goods specialist for the Fool. Steve looks for responsible businesses which positively shape our lives. Then, he invests accordingly. Enjoy his work? Connect with him on Twitter & Facebook so you don't miss a thing.

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