The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
According to Bloomberg TV, Zynga (NASDAQ:ZNGA) Chief Operating Office John Schappert has been stripped of responsibility for product oversight. Bloomberg reported that Mr. Schappert will continue in his role overseeing Zynga’s operations, but that mobile executive David Ko and Executive Vice President of Games Steve Chiang will now report directly to CEO Mark Pincus, rather than to Mr. Schappert.
The shift in responsibility is intended to increase Zynga’s mobile software focus, according to Bloomberg. Zynga mentioned on last week’s earnings conference call that it was focused on expanding its presence on mobile phones. We believe that this makes eminent sense, particularly as Facebook users increase access via mobile devices.
We question whether the move is related to Mr. Schappert’s performance, or reflects Mr. Pincus’s desire to be more involved in day-to-day aspects of the business. We believe that Zynga’s lowered outlook was primarily attributable to loss of traction from some of its older games, which launched prior to Mr. Schappert’s tenure. In our view, Zynga games such as CityVille and FarmVille are not evergreen titles, and as revenues from these games began their inevitable decline, Zynga’s new games were not launching fast enough to allow the company to meet its prior growth expectations. It is not clear to us that Mr. Schappert bore responsibility for the decline in revenues from legacy games, although it is certainly fair to assign blame for underperformance or delays for games developed since he started in April 2011.
We have previously complimented Mr. Pincus for surrounding himself with capable games industry professionals. In addition to quality hires such as Messrs. Ko, Chiang and Schappert, Zynga has hired Barry Cottle, Travis Boatman and Jeff Karp from EA and Rob Dyer from Sony, all extremely capable and experienced game industry veterans. We believe that a stable of capable and talented executives such as these positions Zynga to dominate the social games landscape, but we think that it is important that these executives are led by someone that understands their contributions and can add value when working with them. We were confident that Mr. Schappert had the industry knowledge and experience to supervise this group, but we are less confident that Mr. Pincus has sufficient knowledge and experience.
Notwithstanding the shift in responsibility, we continue to believe that Zynga shares have upside. The company has $1.8 billion in cash and real estate, or $2 per fully diluted share, making its enterprise value under $1 billion. It is profitable and has tremendous brand equity, suggesting that there is upside to the share price. We think that Zynga has sufficient management strength to weather a disruption at the top, and are confident that the team will execute n Zynga’s business plan going forward.
Maintaining our OUTPERFORM rating and $7 price target. Our price target reflects a 25x multiple on our FY:13 EPS estimate of $0.20 plus cash and real estate of $2/share. A 25x forward multiple is in line with Zynga’s long-term growth rate.
Risks to the attainment of our share price target include changes to game release timing, decreasing interest in Facebook and other social networks among the general public, changes to the terms or economics of its Facebook agreements, the inability to create popular mobile games, increased competition from other social gaming companies and the traditional video game publishers, greater-than-expected consumer demand for video game hardware and single purchase software, and changing macroeconomic factors.
Michael Pachter is an analyst at Wedbush Securities.