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Zynga Inc Stock Could Be a Big Winner, But It’s Still Risky

ZNGA stock is a classic case of high-risk, high-reward that could ultimately prove to be a winner

By Luke Lango, InvestorPlace Contributor


Source: Brownpau via Flickr (Modified)

Despite reporting what were pretty good fourth-quarter numbers, mobile gaming company Zynga Inc (NASDAQ:ZNGA) saw its stock drop healthily after the results.

Part of the weakness in Zynga stock isn’t the company’s fault. The broader markets are selling off, thanks to concern over higher interest rates. After a brief dip, the 10-year treasury yield is soaring once again. That is putting pressure on stocks, which continue to broadly sell-off.

In this sense, Zynga stock is victim to broad market turmoil.

But there is another part to the story which is specific to ZNGA. The guide wasn’t great. Although revenues are expected to continue to grow at a healthy rate, the margin expansion narrative that has been so hot recently looks like it’s starting to cool off. Robust revenue growth but slowing margin expansion isn’t a winning combination against the backdrop of markets deep in the red.

So what’s the move? I do see Zynga stock potentially getting to and above $5. But it’s a stretch. And this stock is risky at current levels. All in all, ZNGA stock is a speculative investment, not a sound investment.

ZNGA Is High Risk and High Reward

Zynga is a story of pivots, and its most recent pivot into mobile is perhaps its most promising pivot yet.

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. They couldn’t compete in that market. Eventually, the over-extension sparked user churn, and ZNGA spiraled downward.

Zynga proceeded to pivot, transitioning its business model from web-focused to mobile-first while narrowing its gaming title focus. This pivot was supposed to streamline operations, re-invigorate top-line growth, cut costs and improve profitability.

Indeed, it has. Zynga just recorded total company revenue growth of 22%, its best since the first quarter of 2013. Mobile daily actives hit 20 million in the quarter, up 24% year-over-year and the highest daily active number in four years. Margins are exploding higher. The company turned a huge $100 million-plus loss last year into a $26 million profit this year.

Hestitations With ZNGA

All appears well. But my hesitations with this company are that this is still a narrowly profitable business in a really tough market that I don’t see growing by much. Yes, mobile engagement is rising, especially on a global basis. But a majority of that incremental engagement is going towards social media, not gaming.

Granted, the mobile gaming market is growing globally, but most of that growth is happening in China, thanks to smartphone usage proliferation.

In that market, mobile gaming is dominated by Tencent Holdings Ltd (OTCMKTS:TCEHY) and NetEase Inc (ADR) (NASDAQ:NTES). On the domestic front, where Zynga rules, there are signs that the mobile gaming market may have already reached its zenith.

For those reasons, I’m hesitant on Zynga stock. But if things go right for this company, this stock could easily zoom past $5.

Under bullish assumptions, it’s reasonable to project 10% revenue growth per year over the next five years into $1.4 billion in revenues in 2022. EBITDA margins are supposed to break into the 20% range this year, and build into perpetuity thereafter. Consequently, 25% EBITDA margins in 2022 seem reasonable, putting EBITDA in five years at just under $350 million. That would represent roughly 20% EBITDA growth per year over the next five years.

The growth premium for the S&P 500 is currently 30%. That implies a fair forward EBITDA multiple for Zynga stock of 26 (30% premium on 20% growth). I think EBITDA will be roughly $166 million this year (18% margins on $920 million in revenue). A 26 multiple on $166 million implies a market cap of $4.3 billion, or about $5 per share.

Bottom Line on ZNGA Stock

This stock could roar to $5 if the company can grow its international presence, continue its margin ramp, and maintain domestic market dominance.

Those are big “ifs,” so I’m not terribly bullish on the stock here. But I do see it as a potentially big winner over the next 12-24 months.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.  

Article printed from InvestorPlace Media, https://investorplace.com/2018/02/zynga-inc-znga-stock-big-winner-still-risky/.

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