Analyst: Zynga Is Right to Cut Costs

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

Before market close on Monday, Zynga (NASDAQ:ZNGA) announced cost-reduction initiatives following reports of such actions that surfaced earlier in the day. Trading in Zynga shares was briefly halted as the company issued a press release. By August 2013, Zynga will eliminate approximately 520 positions, or 18 percent of its global workforce, following 155 layoffs (roughly 5 percent of its workforce) in Q4:12. It will also close various unspecified office locations (AllThingsD reported that Zynga would close its Dallas, Los Angeles, and New York offices).

The initiatives are expected to result in significant cost savings. Pre-tax annualized cash expense savings are expected to be in the range of $70-80 million; however, the company will record pre-tax restructuring charges of approximately $24-26 million in Q2, and $2-5 million in Q3. The Q2 expenses will be partially offset by an estimated $15 million reversal of stock-based expense.

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Zynga made a slight change to Q2:13 guidance, and reaffirmed FY:13 adjusted EBITDA margin guidance. For Q2, it expects bookings in the lower half of the previously provided range of $180-190 million, and a net loss $39-28.5 million, down from $36.5-26.5 million previously. It disclosed that the FarmVille franchise is performing well, but other games are underperforming.

It reaffirmed Q2 guidance for revenue ($225-235 million), EPS (a loss of $0.05-0.03), adjusted EBITDA (negative $10 million to breakeven), and non -GAAP EPS (a loss of $0.04-0.03). It reaffirmed FY:13 adjusted EBITDA margin of flat to positive 10 percent.

Lowering estimates to reflect bookings softness. We are lowering our Q2 estimates for bookings to $180 million from $190 million, for revenue to $225 million from $235 million, and for EPS to $(0.02) from $(0.01); we are lowering our FY:13 EPS estimates to $0.00 from $0.03, and for FY:14 to $0.11 from $0.15.

We believe management is correct in focusing on cutting costs. We think this is the right move given the uncertainty of potential monetization on social networks, mobile, and from RMG; however, Monday’s announcement is likely to increase investor skepticism that Zynga’s bookings growth can ever rebound.

Maintaining our OUTPERFORM rating and our 12-month price target of $4.25. Our PT reflects roughly 20x our FY:14 EPS estimate of $0.11 plus$2/share in cash and investments. We believe the headcount reductions and flexibility inherent in Zynga’s business model make a return to profitability possible as early as 2014.

Michael Pachter is an analyst at Wedbush Securities.

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