(Reuters) - Zynga Inc (ZNGA.O) shares fell 7 percent in premarket trade, suggesting investors were wary of the social game maker's weak bookings outlook and expensive valuations, and at least three brokerages downgraded the stock.
A lackluster fourth-quarter showing -- Zynga's first as a publicly traded company -- and expectations of sequentially slowing bookings in the first half of 2012, may rattle bullish industry watchers who have driven up the company's valuations.
Bookings is the metric Zynga uses to measure the cash it gets upfront when people spend money on virtual items in its games such as tractors, houses or poker chips.
Evercore Partners said the company's stock -- trading at 31 times the brokerage's 2013 estimate for earnings before interest taxes depreciation and amortization (EBITDA) -- bears risk, and downgraded it to "under weight" from "equal weight."
The company, which went public in December, trades nearly 67 times forward earnings, compared with the sector average of 12, according to Thomson Reuters data.
"Core game monetization is slowing more rapidly than expected," Macquaries Equities Research said in research note.
Zynga said its games are designed to gain popularity and make money in the longer term, adding that it still has the six-most played games on Facebook.
The owner of the popular Farmville and Cityville games does not disclose the number of its unique payers on Facebook, making it difficult to gauge any possible deceleration trends.
The company's Words with Friends, a Scrabble-like game, was recently in news after actor Alec Baldwin got kicked off an American Airlines flight for playing the game on his iPhone while the plane was parked at the gate.
While filing its IPO last year, Zynga said it gets almost all its revenue from Facebook. Investors are closely watching its strategy to diversify and make money from games on smartphones and tablets.
Analysts, however, remain convinced that Zynga is well positioned for longer-term growth.
"Zynga was one of the key developers that turned Facebook from a relatively passive communications medium to a more active and engaged social platform," Robert W. Baird & Co wrote in a research note, and downgraded the stock.
"While growth has slowed for both Facebook and Zynga, long-term secular shifts in content consumption, along with significant growth opportunities on smart devices from Apple (AAPL.O) and Google (GOOG.O) are too compelling to ignore."
The gamemaker's shares, were trading at $13.42 in trading before the bell. The stock, which has jumped more than 30 percent since its December 16 debut, closed at $14.35 Tuesday on theNasdaq.
COMMENTARY: In a blog post dated December 15, 2011, I commented on an article by Lou Basenese appearing in Seeking Alpha in which he gave seven reasons to ignore all the hype surrounding Zynga prior to their IPO.
In a blog post dated December 18, 2011, I commented that Zynga's IPO was a flop, that investors expected a pop, but all they got was poop. It appears that Mr. Basenese's warnings about Zynga were dead on. Zynga's IPO stock price was $10.00 per share, but it ended its first day of trading at $9.50 or 5% below the issuing price. This was not a very good performance for a startup that many analysts thought would become an instant hit with investors. Here's what I said in my post:
"It's obvious that the "Facebook Halo Effect," did not help Zynga very much at the end of the day. Instead, the market views Zynga's dependency on Facebook as a negative, rather than a positive. Zynga pays Facebook 30% right off the top for all virtual goods purchased by gameplayers. This should send a strong signal for other social networks if they are thinking about an IPO."
"Zynga is a hit-driven business, and it has been able to create games that became hits the last two years, but has also incurred very high costs in the process, and this has negatively impacted its earnings as noted above, even though the company has increased revenues significantly on a nine-month basis between September 2010 and September 2011. That's not a good thing."
"Zynga's revenue model has also been brought into question. 96.7% of its users are freeriders. Only 3.3% or 7.7 million users out of 227 million total monthly active users pay to play. Sophisticated investors would undoubtedly question how long you can continue maintain steady growth in revenues when only 3 out of 100 people are actually paying to play Zynga games."
The Facebook Halo Effect Boosts Zynga Stock
On February 1, 2012, after the markets had closed, Facebook filed its S-1 Registration Statement for its IPO with the SEC. On February 2, 2012, several social media stocks received an immediate pop from the news of Facebook's IPO filing. Zynga's stock went from $10.60 on February 1, 2012 to $12.385 on February 2, 2012--an increase of 1.785 or 16.84% solely on the news of Facebook's IPO filing, something that I often refer to as the "Facebook Halo Effect."
The Facebook Halo Effect and "investor fever" over Zynga increased its stock price to an incredible $14.352 at the close of trading on Tuesday, February 14, 2012--an increase of 3.752 or 35.4%. All of this happened prior to Zynga's earnings call, which did not come until after trading closed.
Zynga Reports Disappointing Q4 2011 Earnings Call
Late Tuesday, February 14, 2012, Zynga reported its first earnings call as a public company for Q4 2011. Although Zynga Inc (ZNGA.O) reported better than expected Q4 2011 revenue, the social game developer of games like FarmVille and Mafia Wars failed to add new daily players compared with Q3 2011. Here are a few of the highlights, or if you prefer, lowlights of Zynga's Q4 2011 earnings call report:
- Q4 2011 Revenues: $311.2 million. Analysts, on average, had expected revenue of $301.08 million, according to Thomson Reuters.
- Q4 2011 Operating Loss: Net loss of $435 million, or $1.22 cents a share, compared with net income of $42 million, or 5 cents share, a year ago.
- Q4 2011 Earnings-Per-Share: Zynga's earnings per share of 5 cents beat analysts' average estimate of 3 cents per share.
- No of Daily Active Users: 54 million in the three months ended December 31, flat from the previous quarter. The fact that Zynga is not adding new players at a high click each quarter is a concern to investors, analysts said.
Zynga Stock Tumbles On Bad News
Yesterday's earnings call brought sanity to bullish and over-zealous Zynga investors who had been taken in by the Facebook Halo Effect and driven up Zynga's stop price. As of 9:30 a.m. PST, Zynga's stock price is $12.76 per share--a drop of 1.62 or 11.34% from Tuesday's closing price.
The above clearly illustrates that Zynga's stock price is not guided by any resemblance to sound business fundamentals or prudent investor judgement, but driven solely by investor hype, speculation and the Facebook Halo Effect, and nothing else. That's a dangerous combination.
Wall Street Turns Bearish On Zynga
Most stock analysts have now turned cold on Zynga, reducing the stocks ratings from "buy" or "hold" to "sell." Seeking Alpha flat-out said, "Stay away from Zynga."
Here's what 24/7 Wall Street just said about Zynga:
"Zynga Inc. (NASDAQ: ZNGA) is getting shelled after the social gaming company’s first earnings report as a public company. This sell-off is actually one that is deserved. We also wonder just how much the earnings and guidance would have had to be to generate another round of buying."
"At issues is that ad revenues basically tripled while its active users grew, but sales were barely up overall from the quarter before. The company made $37.1 million in adjusted earnings as sales grew 26% on a year-over-year basis to $307 million."
"The biggest issue is that the Facebook halo-effect was the key driver in the recent two weeks. Before word came out that Facebook was going to formally file for its IPO, this was a $9.50 or so stock and technically a busted IPO because it was under the $10 IPO price. Before today’s drop of 14% to $12.31, the stock had hit a new high of $14.55 and the market value was nearing the $10 billion mark."
"$10 billion? So what if ‘social gaming is becoming the new television’ as the company suggested? Will it have the same revenues from advertisers? What happens if and when consumers lose their interest in social gaming? What happens when one of the large game publishing houses overpowers Zynga with a cooler game? And what happens when investors realize that they effectively have no vote whatsoever with the multi-class share structure, even if the entire floated class is out in the market?"
Could Online Gambling Be Zynga's Savior?
Now we keep hearing that Zynga's savior will be online gambling. However, only Nevada currently allows online gambling, which is limited to poker. The state has yet to license a company to run such services.
On January 21, 2012, The Wall Street Journal reported that Zynga was exploring a potential entry into the Internet gambling business, possibly in partnership with another company. Zynga said demand for online gambling amongs its social game users had motivated it to explore a potential move in the business.
Zynga said in a statement to the media.
"We know from listening to our players that there's an interest in the real money gambling market. We're in active conversations with potential partners to better understand and explore this new opportunity."
Zynga's exploration of online gambling comes amid growing belief that individual states will allow some forms of Internet betting. Last month, the Justice Department said no federal law prevents states from creating their own regulations for online gambling.
Major casino companies, such as Caesars Entertainment Inc. and MGM Resorts International, are driving efforts to change federal laws that would create a national system for online poker. Other gambling interests, like Indian tribes and lotteries, are pushing the efforts at the state level
However, most of the changes under consideration would prevent non-gambling companies, like Zynga, from becoming primary license holders. They could, however, become a partner with a license holder under some bills being considered.
Zynga will be at the mercy of online gambling laws passed by each state, and this will take sometime. Zynga will also need a suitable licensed gambling partner. All of this will take time, since the online gambling laws need to be legislated. Consequently, I don't see Zynga generating much in the form of revenues from online gambling until at least 2013. Until then, Zynga must concentrate on creating new hit games, increasing paid game participation, increasing sales of virtual goods, and creating new hit games.
If you were one of the lucky investors who manged to make some money off of Zynga or were able to cut your losses, good for you, next time listen to Tommy.
Courtesy of an article dated February 15, 2012 appearing in Reuters
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