Zynga Earnings Preview: A MISPERCEPTION to Watch Closely

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

Zynga (NASDAQ:ZNGA) will report fiscal Q2:12 (ending June) results after market close on Wednesday, July 25, and hold a conference call at 2pm PT (dial-in: 800-537-0745, conference ID: 96638729, webcast: investor.zynga.com).

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Expecting slight beat and raise. We expect results slightly above our estimates for revenue of $354 million (vs. consensus of $345 million) and EPS of $0.06 (inline with consensus). The company did not provide Q2 guidance. We expect Zynga to deliver revenue upside from better monetization, including for CityVille, which we believe continues to monetize well, notwithstanding the recent drop off in MAUs. We expect Zynga to raise FY:12 guidance for bookings of $1.425 – 1.5 billion and non-GAAP EPS of $0.23 – 0.29 by the amount of upside in Q2.

Zynga Unleashed 2012 featured many key announcements but failed to spark a sustained rally for Zynga shares as user concerns remain. Highlights wereZynga With Friends — connect to a single network using Facebook (NASDAQ:FB), Zynga.com, and iOS or Android smartphones — a dedicated partner program for mobile, and Zynga API. New games unveiled included ChefVille, The Ville, and Zynga Elite Slots.

Misperception that monthly active user (MAU) growth and revenue growth are immediately correlated.  Zynga’s shares continue to be hurt by usage data from AppData, with MAUs having dropped from ≈ 285 million on March 31 to ≈ 250 million on June 30 to ≈ 232 million on July 19. Investors are concerned that fewer users will result in lower total revenue. We disagree, and believe that the majority of gamers who discontinue playing Zynga titles are  likely to be non-payers, with payers spending more as they make a greater investment of time in each game.

Expect improving monetization in 2H:12. When Zynga releases a new highprofile game, we believe that the number of paying users grows steadily for at least a year following launch. As a result, we expect steady payments growth coming from a slew of more recent releases, including  Bubble Safari,  Empires & Allies, CastleVille, Draw Something, Hidden Chronicles, and Zynga Slingo, among others.

Maintaining our OUTPERFORM rating and our 12-month price target of $17.Our price target reflects an EV/EBITDA multiple of  ≈ 19x our  2013 adjusted EBITDA estimate, or an EV/EPS multiple of ≈ 33x our 2013 EPS estimate. Market dominance and user growth should allow strong growth for the foreseeable future.

Michael Pachter is an analyst at Wedbush Securities.

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