Video game stocks are a hot commodity this year amid all the shelter-in-place orders, but Zynga (ZNGA) is leading the pack with a 60% gain so far in 2020.
The game producer kicked off the new decade in grand style with the successful launch of a handful of new titles, and though parts of its business may struggle because of the pandemic, the core business is stronger than ever.
This leader in mobile entertainment has made a number of other moves in recent months to build on its recent momentum. Investing in times of duress may feel like the wrong course of action, but history says fortune favors the bold.
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Expanding the global audience
Zynga's revenue in the first quarter of 2020 surged 52% to $404 million, driven by the success of Empires & Puzzles, Merge Magic!, Merge Dragons!, and Game of Thrones Slots Casino. Zynga has been working on adding to its forever franchises: primary mobile video game names like Words With Friends, Zynga Poker, CSR Racing, and FarmVille that make up the bulk of income. But to complement new games, part of the growth strategy over the last few years has been emphasizing live events within those forever franchises. Live events keep players coming back and add a social element popular among mobile gamers.
Monetizing the user base has increased in large part thanks to the emphasis on live events. At the end of 2018, average bookings per daily user were $0.13, a metric that had risen to $0.216 in the first quarter of 2020. However, daily average users (DAUs) have been mostly stagnant over that same stretch of time. DAUs were 21 million at the end of 2018, compared with 20 million at the end of 2019 and 21 million in the first quarter of 2020. Infusing the portfolio with some new titles is clearly needed.
Zynga didn't disappoint. It announced in early June it was purchasing Peak, creators of Toon Blast and Toy Blast, for $1.85 billion. A few years ago, Zynga purchased Peak's online card game business to bolster its own offering, and completing the tie-up for the rest of the company will be quite meaningful. Peak will add 12 million more daily users to the equation, many of them outside the U.S. where Zynga still has a small presence. The deal was funded with equal parts cash (more on the balance sheet in a minute) and issuance of new stock.
Additionally, Zynga has been investing in new game formats, specifically on Facebook Instant Games (with Words With Friends and Draw Something) and Snap's game platform (Tiny Royale). Shortly after the Peak announcement, Zynga announced it was launching another game on Snapchat, Bumped Out. And along the way, the management team at Zynga sees the opportunity to make more acquisitions to continue building up the video game portfolio.
Managing the cash situation
Even after shelling out over $900 million in cash to pay for Peak, Zynga's financial situation remains solid. The company had $1.26 billion in cash and equivalents at the end of March, plus an additional $173 million in long-term investments and $577 million in convertible debt. That would imply there is over $500 million in liquid assets remaining after taking over the Toon Blast parent.
The addition of all those new games, paired with the extra time at home many people have had the last few months, should lead to a big increase in results. An update is pending post-tie up with Peak, but the outlook for 2020 provided during the first quarter report was for revenue to increase 25% to $1.65 billion. Shares currently trade for 6.4 times expected 2020 sales and 48 times trailing 12-month free cash flow. For a growth company about to get a big bump via acquisition, it's not an unreasonable price tag.
Zynga's second-quarter update on Aug. 5 will no doubt be full of details, but I expect its results during the pandemic will be good. Add in a couple of new popular global games and the company's success in promoting live events, this is my top video game stock pick right now.
