Zynga (NASDAQ:ZNGA), a global leader in mobile gaming, will soon become part of Take-Two Interactive (NASDAQ: TTWO), a video game juggernaut. And I don’t think ZNGA stock is worth buying ahead of that tie-up.
This announcement caused a sudden spike in ZNGA stock, which closed at $6 on Jan. 7 and at $8.44 the next trading day. Gaining nearly 40% in one trading session doing nothing is the definition of getting lucky for ZNGA shareholders at the time. But I do not like ZNGA stock now for several reasons.
Until the combined company is finalized, investors have limited choices if they want to invest in ZNGA stock. And I already think Take-Two Interactive overpaid significantly to acquire Zynga, which is not an ideal business decision. It may be great news for investors who owned its shares on Jan. 7, as the agreement landed on a price of $9.86 per share for Zynga. But that doesn’t make it a good decision.
The detail of Take-Two issuing stock to finance part of this deal was also not good news, and now ZYNGA stock is trading at a tight price range.
Why Did Take-Two Pay a Premium for ZNGA Stock?
Sure, there are synergies here, and Zynga brings with it intellectual properties and a proven leadership position in mobile entertainment. But do those things justify the premium paid to acquire Zynga? As I said before, I don’t think so.
Reason number one is that until Jan. 7, 2022, Zynga stock has been in a long-term state of decline lasting almost a year. Take-Two Interactive could likely have been more patient and waited for Zynga stock to decline further, at which point it could have paid even less for the deal. When a stock price declines consistently for over half a year there is a strong reason. This reason was, as you may assume, the financial performance of ZNGA stock.
If the only criterion considered for acquiring Zynga was its revenue growth history, then Take-Two most probably did well. The annual revenue growth of Zynga for 2019-2021 was consistently above 40%. But I am certain that revenue growth was not the only reason TTWO went after ZNGA. What other positive factors did Take-Two notice?
Zynga’s gross margin has been in long-term decline, losing an average of -2.6% per year. That’s not inspiring.
Zynga has a debt/equity ratio of 0.47 as per the latest quarter, which is not either bad or good.
Zynga for the fiscal year 2021 reported higher long-term debt, lower short-term debt and lower cash.
The tricky question to ask is whether Take-Two knew in advance about the fourth-quarter 2021 results announced by Zynga after the news of the acquisition released. This is material information, and chances are that the management of Take-Two most probably had the opportunity to evaluate the financial results before they got made public.
In 2021, the operating margin for Zynga turned positive to 4.4% versus -18.7% in 2020, net margin narrowed to -3.72% from – 21.74% in 2020 and free cash flow declined 41.2% to $241.3 million.
Bottom Line on ZNGA Stock
Overall, a look at its profitability does not build a case to pay that large a premium. The valuation of Zynga stock does not support the premium paid either. In almost all key metrics Zynga has a significant premium over the Communication Services Sector median values.
I believe that Take-Two decided to build the leader in global interactive entertainment and paid a very elevated price to get this piece. Zynga stock should continue to trade in a tight range until the deal is officially materialized. That makes investing in ZNGA stock now indifferent. The future is in the newly combined company, which should take a few quarters to evaluate synergies, benefits and any weaknesses.
On the date of publication, Stavros Georgiadis, CFA, did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.