Shares of mobile game publisher Zynga (ZNGA) are soaring on news of a buyout offer from fellow video game company Take-Two Interactive Software (TTWO 0.10%). Games formatted for a mobile device have emerged as the biggest revenue generator for the massive and still-growing video game market, which is homing in on $200 billion a year globally. As a result, other publishers have scooped up leading mobile game developers (like Electronic Arts' (EA -0.39%) takeover of Glu Mobile last summer), and now it's Take-Two's turn.
But as a Zynga shareholder, I'll be selling my shares rather than participate in Take-Two's transformation (Zynga owners will be offered a mix of cash and Take-Two stock in the buyout). Here's why.
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Take-Two is breaking away from the episodic revenue model
Zynga is a leader in mobile games, responsible for classics like Words With Friends, Zynga Poker, and FarmVille. After losing its way after its IPO in 2011, the company has been back in growth mode since hiring CEO Frank Gibeau (a former EA executive) in 2016. Since the pandemic began, Zynga has made a number of acquisitions of smaller mobile publishers and a mobile advertising platform to sustain its growing number of monthly users and monetize its games in new ways. This latest round of moves under Gibeau has only just begun to take shape.
And now, with Zynga stock selling off hard in the last year (due to lapping its boom from early in the pandemic during lockdowns), Take-Two is fishing for its own makeover.
Take-Two's results over the years have been respectable. Franchises like NBA 2K, Grand Theft Auto, and Red Dead Redemption have done well, but sales of PC and console games tend to be uneven and tied to the successful launch of a new blockbuster title -- a business model that has existed since the dawn of the modern video game publisher in the 1980s. This stands in stark contrast with the more steady growth from mobile games, which rely on in-game purchases and ad revenue rather than a one-time sale to players.
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In short, Zynga's growth is likely to get diluted when combined with Take-Two, barring any big jump in sales from coming game releases. For now, I'd rather see what Take-Two has planned post-Zynga tie-up and invest elsewhere in the video game industry.
A higher premium for slower growth
Getting its hands on Zynga's fast-and-steady revenue expansion will be a big deal for Take-Two given Zynga's size, and combining forces will no doubt boost profitability as well. But I was invested in Zynga for its growth at a reasonable value. I expect Take-Two's PC and console-centric games to grow at a slower rate than mobile over time, and its stock is valued at an even higher premium than Zynga's -- based both on trailing-12-month earnings and forward expectations.
Zynga was anticipating a rapid rise in its free cash flow in the next couple of years as it digested its own spending spree that started over the summer of 2020 (Zynga paid for its acquisitions by issuing new debt and stock). Now the potential benefit of those purchases will flow to Take-Two. I'd rather look for a faster-growing place to invest in the video game, esports, and virtual reality universe rather than bet on a successful union of these two companies.
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Granted, Zynga combining with Take-Two could pay off in a big way, especially for the newly combined company's bottom line. EA, for example, has been able to sustain its growth by getting into mobile gaming in the last decade. But that hasn't resulted in market- or industry-beating stock returns -- at least not yet. I'm therefore opting for a wait-and-see approach on Take-Two for now and cashing out on the rally in Zynga thanks to the offered takeover price.
