Zynga Bomb: Deep Stock Analysis of Horrific Announcement

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

Zynga (NASDAQ:ZNGA) negatively preannounced Q3 earnings. Zynga pre-announced revenue between $300 – 305 million, compared with our prior estimate of $354 million and consensus of $276 million. Zynga expects non-GAAP EPS of $(0.01) – 0.00, compared with our $0.01 estimate and consensus of $0.00. The company cited weakness in certain games within its Ville-style category, although FarmVille2 drove solid daily bookings, on par with CastleVille and mobile has remained strong. The company did not provide Q3 guidance.

Zynga lowered FY:12 guidance once again. The company lowered bookings to $1.085 – 1.100 billion from $1.150 – 1.225 billion and lowered FY:12 adjusted EBITDA guidance to $147 – 162 million from $180 – 250 million. Due to a largely fixed cost base, changes to bookings have a big impact on adjusted EBITDA.

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Management will detail planned cost reductions and its transition strategy on its Q3 call, scheduled for after market close on Wednesday, October 24. Zynga will reduce costs in Q4 and downsize its R&D pipeline as it transitions away from first-party online game development toward becoming a multiplatform game network, with a strong focus on mobile.

The company also intends to take a substantial impairment charge related to its OMGPop acquisition, completed earlier this year. Zynga acquired the Draw Something developer for $180 million, and will take an impairment charge for roughly half this amount.  The game was immensely successful in Q1 and Q2, but began showing weakness early in Q3. Notwithstanding the write-down, the company made clear its strategy to continue investing in its mobile business.

We are lowering our FY:12 estimates for revenue to  $1.2 billion from $1.4 billion and for EPS to $0.02 from $0.10. We are lowering our FY:13 estimates for revenue to $1.3 billion from $1.8 billion and for EPS to $0.00 from $0.20.

Maintaining our OUTPERFORM rating, but lowering our 12-month price target to $4 from $7. We revised our FY:13 EPS estimate to break-even, and believe that a $4 target is more realistic as the company transitions. Thus, our new price target reflects 2x cash and real estate of $2/share. While we would normally be inclined to downgrade the company’s shares due to a more difficult outlook, the stock traded close to cash in the after market, and we believe there is significant upside, so we concluded that only a price target revision is warranted.

Michael Pachter is an analyst at Wedbush Securities.

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