Is Zynga Back to Square One?

With shares of Zynga (NASDAQ:ZNGA) trading at around $3.05, is ZNGA an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

Let’s begin with the famous email CEO Marc Pincus sent to employees. This will give readers an excellent idea of what’s taking place at Zynga:

“To our Zynga Community,

Today is a hard day for Zynga and an emotional one for every employee of our company.  We are saying painful goodbyes to about 18 percent of our Zynga brothers and sisters.  The impact of these layoffs will be felt across every group in the company.

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None of us ever expected to face a day like today, especially when so much of our culture has been about growth. But I think we all know this is necessary to move forward. The scale that served us so well in building and delivering the leading social gaming service on the Web is now making it hard to successfully lead across mobile and multiplatform, which is where social games are going to be played.

These moves, while hard to face today, represent a proactive commitment to our mission of connecting the world through games.  Mobile and touch screens are revolutionizing gaming.  Our opportunity is to make mobile gaming truly social by offering people new, fun ways to meet, play and connect.  By reducing our cost structure today we will offer our teams the runway they need to take risks and develop these breakthrough new social experiences.

Because we’re making these moves proactively and from a position of financial strength, we can take care of laid off employees.  We’re offering generous severance packages that reflect our appreciation for all of their work and we hope this will provide a foundation as they pursue their next professional steps.

Although these are hard decisions, I’m confident that our strategy of building leading franchises and supporting them with the largest network is the right one for the long term. I’m encouraged by our recent progress.  Running With Friends is a great example of the quality player experience we can deliver, already receiving an average 4.5 app star rating from 22,700 players in less than one month after launching. Our FarmVille franchise teams continue to innovate and deliver ground breaking new social experiences like County Fair which, despite only being available on the web, is engaging 39 million monthly players.

I want to thank every one of you for the spirit, creativity and energy that you’ve invested in Zynga.  You’ve reintroduced a generation of people to gaming and through these games offered them new ways to connect with their families, make new friends and even sometimes find love.

Everyone will be affected by these changes and I’m sure there will be many follow up questions to this email.  If you have specific questions relating to your project or team, please talk to your manager.  For any other feedback or thoughts feel free to email me directly.

Mark”

Zynga is shedding 18 percent of its workforce, which is expected to save between $70 million and $80 million. This might help in the short term, but it’s not a long-term solution to Zynga’s problems. And Zynga has many problems.

One, Marc Pincus doesn’t seem to be the ideal leader. He might even be untrustworthy. When employees and investors lose trust in a company’s leader, it’s only a matter of time before it’s Game Over. Marc Pincus has dealt with unscrupulous advertisers, taken stock back from executives that he didn’t think was doing a good job, and more. As far as character goes, he seems to be the type of person that will take money from anyone regardless of the cost. According to Glassdoor.com, 54 percent of employees approve of Marc Pincus. This isn’t terrible, but it’s still on the low side. It should also be noted that “disorganized” was a common theme for employee reviews on Glassdoor.

According to Alexa.com, pageviews-per-user has declined 2.71 percent over the past three months, and time-on-site has declined 1.0 percent over the past three months. Once again, these aren’t terrible numbers, but they’re on the low side. Most visitors are 18-24 years old, and there are more female visitors than male visitors. Approximately 35 percent of visitors were on Facebook (NASDAQ:FB) prior to visiting Zynga, and approximately 39 percent of visitors went to Facebook after playing games on Zynga.

The chart below takes a look at some basic fundamentals for Zynga, and they’re not very impressive.

ZNGA
Trailing P/E N/A
Forward P/E N/A
Profit Margin -9.80%
ROE -6.59%
Operating Cash Flow 143.40M
Dividend Yield N/A
Short Position 3.80%

Let’s take a look at some more important numbers prior to forming an opinion on this stock.

T = Technicals Are Mixed

The numbers below can be deceiving. The only way someone made money investing in Zynga was by having impeccable timing. There is no doubt that those people are out there, but they’re the minority. Investing in Zynga has been a disaster for most people.

1 Month Year-To-Date 1 Year 3 Year
ZNGA -6.68% 27.33% -50.00% 0.47%

At $3.05, Zynga is trading below its 50-day SMA, but above its 200-day SMA.

50-Day SMA 3.29
200-Day SMA 3.01
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E = Equity to Debt Ratio Is Strong

The debt-to-equity ratio for Zynga is stronger than the industry average of 0.10.

Debt-To-Equity Cash Long-Term Debt
ZNGA 0.05 1.27B 100.00M

E = Earnings Have Weakened

Zynga has difficulty turning a profit. Cutting 18 percent of the workforce might help in this regard, but it’s only a temporary solution. As far as revenue goes, there has been growth on an annual basis, but the growth has slowed.

Fiscal Year 2008 2009 2010 2011 2012
Revenue ($) in millions 19 121 597 1,140 1,281
Diluted EPS ($) NA NA 0.11 -1.40 -0.28

Looking at the last quarter on a year-over-year basis, revenue declined and earnings improved. At least it was a breakeven quarter opposed to a loss. Revenue doesn’t look good on a sequential basis.

Quarter Mar. 31, 2012 Jun. 30, 2012 Sep. 30, 2012 Dec. 31, 2012 Mar. 31, 2013
Revenue ($) in millions 320.97 332.49 316.64 311.17 263.59
Diluted EPS ($) -0.12 -0.03 -0.07 -0.06 0.00

Now let’s take a look at the next page for the Conclusion. Is this stock an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY?

Conclusion

Zynga is no longer using its spam-blast approach to gain exposure. Therefore, the biggest growth days might be behind the company. In order to see renewed growth, Zynga must find a way to be successful in mobile, but this will require the company to start all over again. As far as momentum goes, it’s all to the downside. Another issue is an extremely low barrier to entry. In other words, another company can come along and become a fierce competitor in a short period of time.

The one big positive for Zynga is a strong balance sheet. However, that’s not enough to offset all the challenges in the paragraph above, nor is it enough to offset the impact of a potentially untrustworthy CEO. Let’s also remember that several employees have stated that the company is disorganized.

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Zynga’s concept is good, but the company simply isn’t playing the game correctly. It’s possible for Marc Pincus to improve his and his company’s reputation, but it would be a very long road.

For now, Zynga is a STAY AWAY.

Using a solid investing framework such as this can help improve your stock-picking skills. Don’t waste another minute — click here and get our CHEAT SHEET stock picks now.

All content posted should not be considered professional advice. Please do your own research and consult with a professional financial advisor before making any investment decisions. I don’t have any positions in this stock.

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