Is Zynga Inc Stock Worth The Risk?

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Zynga stock - Is Zynga Inc Stock Worth The Risk?

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Zynga Inc (NASDAQ:ZNGA) stock tricky for me. One of my cardinal rules of thumb in investing is to stay away from stocks trading under $5. After all, most stocks don’t go public at under $5 per share, so there’s a reason a stock is languishing below $5, and its not a good one.

But every rule has exceptions. For example, I’m a big fan of pharmacy operator Rite Aid Corporation (NYSE:RAD) because I believe the stock has been unnecessarily tortured following a botched takeover attempt from Walgreens Boots Alliance Inc (NASDAQ:WBA). Indeed, Rite Aid stock is up about 50% since mid-November.

In other words, exceptions do exist. Certain stocks under $5 can be big winners. But is mobile gaming focused Zynga one of them?

Maybe. I’m not wholly convinced there is a bunch of upside in this name. But Zynga is doing all the right things to ensure long-term success, revenue growth is back, margins are expanding, profitability is improving, and the stock appears slightly undervalued.

Can it be winner? Again, maybe. I don’t love Zynga stock (I loved and still love Rite Aid stock), but I’m cautiously optimistic that this stock can head higher.

Why Zynga Stock May Not Be Worth It

The biggest knock against Zynga stock is that this is a going-nowhere company in a going nowhere-space with a going-nowhere stock.

I see the merits to this argument. Zynga stock is a pure-play on the mobile gaming space. Nearly 90% of the company’s revenues are from its mobile product portfolio, which includes Words With FriendsFarmVilleZyngaPokerCSR Racing, and Clumsy Ninja.

But I’m not convinced this is a growth space that investors need exposure to.

Yes, mobile engagement is rising, especially on a global basis. But a majority of that incremental engagement is going towards social media, not gaming. Plus, the advertising model in mobile gaming is tough. Consumers just don’t pay attention to mobile gaming ads. That is why Zynga’s ad revenue continues to fall off.

Moreover, Zynga stock hasn’t really done anything notable for a really long time. Back in 2012, it dropped from $14 to $2. Since then, Zynga stock has just been range bound between $2 and $5. Its a sideways stock.

Why Zynga Stock May Be Worth The Risk

But despite this going-nowhere behavior the stock has exhibited in the past, I do think times are changing for this struggling mobile gaming company.

The story of Zynga is one of pivots and transitions. Zynga used to be a mega-popular browser game company with tons of users. But then the company overreached by branching into games that had heavy overlap with the traditional video game market, like sports titles. That didn’t work. Eventually, the company lost users, and the company spiraled downward.

So Zynga pivoted. They transitioned from web to mobile while narrowing their gaming title focus to specific categories that were social and didn’t have overlap with traditional titles. This pivot was supposed to streamline operations, cut costs and improve profitability. It was also supposed to drive growth by focusing investment on growth areas, like augmented reality and chat platforms.

This transition has played out smoothly.

After a down year last year, revenue growth is back (up 23% last quarter). User growth is strong and ramping (up 19% last quarter). Margins are tracking higher, and profitability is dramatically improving (net income of $18.1 million last quarter versus a $41.7 million loss one year ago).

This big improvement isn’t sustainable, but it does imply that the ship is headed in the right direction.

Overall, I largely agree with analysts that this is a 10% revenue growth story over the next several years. Margins have been tracking higher, and will continue to do so, but at a lesser rate as the company needs to invest in its games in order to drive healthy growth. Overall, that 10% revenue growth should translate into something like 20% earnings growth.

The balance sheet is clean (a ton of cash, no debt), so Zynga stock easily deserves a big premium for that 20% growth. The S&P 500 is trading at a 75% growth premium (21.2-times this year’s earnings for 12% growth prospects). Zynga, given its really strong balance sheet, easily deserves a 100% premium.

That implies a 40-times multiple on this year’s earnings estimate of $0.10, which gets you to a “fair” value of $4.

Bottom Line on Zynga Stock

I’m not in love with the name.

But I do think Zynga stock could head higher in the near and long term as the the company’s turnaround plans materialize into long-term profitability improvements.

As of this writing, Luke Lango was long RAD.  


Article printed from InvestorPlace Media, https://investorplace.com/2018/01/zynga-inc-stock-worth-risk/.

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