Shares of Zynga (NASDAQ:ZNGA) got rather bubbly after the company went public, eventually hitting a market capitalization that, at its peak, exceeded those of gaming giants such as Electronic Arts (NASDAQ:EA). Interestingly enough, as shares of game publishers, in particular EA's, have been on the rise (especially as it has been on a roll with hit releases such as Titanfall), social media has gone out of favor. With Zynga technically qualifying as both, and with the shares trading well off of its 52-week highs, it's worth taking a look to see if the shares are a bargain or simply a trap.
The underlying business is down year on year, but there's hope
While Zynga makes games, its business profile is very much social media, with audience metrics strongly influencing business performance. That said, if you look at the company's revenue trends as well as its audience metrics, you'll see some interesting trends.
First, notice that daily active users and monthly active users -- DAU and MAU -- had been on a downward spiral since peaking in Q1 '13. However, in the Q1 '14 results, we saw a quarter-over-quarter bounce in all of these key metrics.
Moving on to Zynga's bookings, we see that the numbers there largely reflect the audience metrics. In this case, it is much more useful to look at bookings rather than revenues. As explained very nicely over at Business Insider, bookings represent the actual money spent by users on virtual products during the quarter, and revenues simply refer to the sales of the virtual goods amortized over the expected life of those goods.
In addition to the fact that Q1 '14 is looking nicely up, the guidance for Q2 '14 bookings is expected to be in the range of $175 million to $195 million, which would suggest a continued upswing in the company's underlying business.
Is the stock worth buying here?
Zynga's business seems to be improving while the stock price remains stuck near 52-week lows. Intuitively, improving business prospects for such a hated stock should mean that the shares trend upward. However, the question is just how much of that "recovery" is baked in and what kind of risks investors will see to continued performance.
The company has about $0.88 a share in cash and no debt, and -- if you believe current sell-side consensus -- is on track to earn about $0.02 a share this year and then $0.06 a share next year as revenues grow 12.2% and 20.20%, respectively. At 40 times next year's earnings, ex-cash, Zynga isn't exactly cheap, and that number does bake in some pretty serious growth assumptions. However if Zynga can keep revenues growing at a double-digit clip while keeping costs under control, there could be some pretty nice leverage that drives pretty nice longer-term growth in earnings per share.
Zynga operates in a business where both visibility is limited and games live and die by a whole host of subjective factors. The good news is that the business appears to have bottomed and is headed in the right direction. So for investors looking to take capitalize on a potential turnaround, it may be worth considering a small speculative position. However, this isn't a stock to "load up the truck" with, particularly given the inherently risky nature of the business.
Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.