Please ensure Javascript is enabled for purposes of website accessibility

Zynga's Stock Pop Makes No Sense

By Alex Dumortier, CFA - Jan 31, 2014 at 11:06PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Zynga's acquisition of NaturalMotion looks expensive and it's no game-changer

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

U.S. stocks posted another day of losses on Friday, capping the worst month for the stock market since May 2012. The benchmark S&P 500 index fell 0.6% on the day, while the narrower Dow Jones Industrial Average (^DJI 0.00%) lost 0.9%. However, the social networking sector bucked the trend, including social games company Zynga (ZNGA). Shares of Zynga vaulted higher by 23.6% on the news of a major acquisition.

Yesterday afternoon, Zynga announced its fourth-quarter results a week ahead of its scheduled reporting date. The beleaguered social game developer managed to exceed Wall Street's expectations by $0.01, with a $0.03 loss; however, revenue of $176.4 million was shy of the $183.3 million consensus estimate. Furthermore, the company's guidance for the current quarter – a net loss of $0.06 to $0.07 per share on revenue of $155 million to $165 million – also fell short of analysts' estimates at the time of the announcement. Finally, the number of daily active users fell 12% from the previous quarter.

In that (grim) context, I'm forced to conclude that the reason investors bid the stock up today was the concurrent announcement of the largest acquisition in the company's history – that of privately held U.K. mobile game developer NaturalMotion, for $527 million (of which $391 million was in cash). Launched on the iOS in July 2012, NaturalMotion's hit, CSR Racing, was said to be grossing more than $12 million per month, but it was developed by gaming studio Boss Alien, which NaturalMotion acquired in August 2012. NaturalMotion has also had successes with American football game Backbreaker, and the free Clumsy Ninja for iOS.

However, to get an idea of the half-life of these games, compare the $12 million per month figure mentioned above in regard to CSR Racing to the $70 million to $80 million of total bookings Zynga expects NaturalMotion to add to its results for the whole of this year. Furthermore, Zynga is looking for an EBITDA (earnings before interest, taxes, depreciation, and amortization – a crude measure of cash flow) contribution of $15 million to $25 million. Compare that to NaturalMotion's $527 million price tag for NaturalMotion, and you have what looks like a very pricey acquisition.

And speaking of pricey, after the pop in today's shares, Zynga is now valued at nearly six times this year's forecasted revenue. Sure, the company has $1.1 billion of cash on hand ($1.42 per share), but given that analysts don't expect Zynga to be profitable this year or the next, that is but little comfort. Given the price paid, Zynga's ability to recoup its investment in NaturalMotion looks highly uncertain -- and the same is true for Zynga's shares. Today's pop looks like the triumph of hope over experience.

Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool has no position in any of the stocks mentioned. 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.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$34,152.01 (0.00%) $0.00
Zynga Inc. Stock Quote
Zynga Inc.
ZNGA

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
402%
 
S&P 500 Returns
129%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/18/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.