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Zynga Reports Disappointing 4Q

Zacks Equity Research

Zynga’s (ZNGA) much-hyped fourth quarter results (first after the initial public offering) failed to excite investors as the social gaming company reported a loss of 56 cents per share (including stock-based compensation expense), which were miles short of the Zacks Consensus earnings estimate of 3 cents per share. Shares also declined 17.8% to close at $11.80 on February 15, 2012.

Earnings (excluding stock-based compensation) declined 44.4% year over year to 5 cents per share in the reported quarter. The year-over-year decline was primarily on account of higher operating expenses, which fully offset a healthy growth in the top line during the quarter.

Quarter Details

Revenue increased 59.0% year over year to $311.2 million, primarily driven by strong growth in advertising and online gaming revenue. Advertising (8.8% of the total revenue) surged 229% year over year to $27.3 million, while online game (91.2% of total revenue) shot up 51.4% from the year-ago quarter to $283.9 million. International revenue grew at a faster rate than domestic revenue, accounting for 37.0% of the total revenue compared with 33.0% in the year-ago quarter.

Bookings increased 25.9% year over year to $306.5 million in the reported quarter. Daily Active Users (:DAU), Monthly Active Users (:MAU) and Average daily bookings per average DAU (:ABPU) increased 13.0%, 38.0% and 11.0% respectively on a year-over-year basis. Zynga launched 12 games during full year 2011. As of December 31, 2011, Zynga had the five most played games on Facebook.

Operating expenses were $797.7 million as compared with $124.3 million reported in the year-ago quarter. This was attributed to higher general & administrative expense, research & development expense and sales & marketing in the reported quarter. Research & development surged 763.5% year over year to $444.7 million, while sales & marketing spiked up 193.0% year over year to $112.2 million in the quarter. Stock based compensation was $530.0 million as against $10.2 million in the year-ago quarter.

Adjusted EBITDA decreased 34.0% year over year to $67.8 million in the quarter. Zynga reported an operating loss of $486.6 million versus an operating income of $71.5 million in the fourth quarter of 2010. Net loss was $433.8 million in the quarter compared with net income of $58.0 million a year ago.

At the end of December 31, 2011, Zynga had cash and cash equivalents (including marketable securities) of $1.92 billion. Zynga generated cash flow from operating activities of $164.0 million and free cash flow of $113.6 million in the reported quarter. The balance sheet remained debt free at the end of quarter.


For full year 2012, Zynga expects earnings in the range of 24 cents to 28 cents per share. Stock-based compensation expense is projected to be in the range of $400 million to $425 million for the year. Currently, the Zacks Consensus Estimate stands at 22 cents (including stock-based compensation).

Bookings are projected in the range of $1.35 billion to $1.45 billion. Adjusted EBITDA is estimated in the range of $390 million to $440 million for the full year. Capital expenditures are projected in the range of $140 million to $160 million for full year 2012.

Our Take

We believe that Zynga is well positioned to grow over the long term due to the staggering growth outlook for the social gaming sector over the next couple of years. According to market research firm eMarketer, social gaming is expected to reach approximately 62 million US internet users by the end of this year (one-fourth of total online users). By 2013, eMarketer predicts this figure to reach 73 million.

Most of the social games are free to play and generate revenue primarily through the in-game sale of virtual goods. According to market intelligence firm In-Stat, the worldwide market for virtual goods was worth $9.0 billion in 2011 and is expected to reach $15.0 billion by 2014. Zynga is also expected to gain from the strong outlook for mobile gaming with the number of US mobile gamers set to rise 43.0% from 74 million in 2011 to 105 million in 2015.

We believe that an increase in the number of social gamers will further boost spending on virtual goods, lead-generation offerings and advertising over the long term. These trends will likely boost Zynga’s growth over the long term. Moreover, the upcoming IPO of Facebook also bodes well for Zynga. Much of Zynga’s success is attributed to the huge popularity of Facebook, which contributes a major portion of Zynga’s gross revenues.

However, higher spending on research and development, technology and game development are expected to hurt profitability going forward. Further, Zynga’s overexposure to Facebook, low paid user base and significant cannibalization effect on its earlier games as users quickly move on to the newest title in the “Ville” series may hurt its growth going forward.

Moreover, Zynga faces signficant competition from other established players such as Electronic Arts Inc (EA). We also note that barriers to entry are low in the social gaming market, and this will attract new entrants, thereby further increasing competition for Zynga over the long term.

Thus, we remain Neutral over long term (6-12 months). Despite a lacklustre fourth quarter and management’s cautious tone on a sequential decline in bookings, we believe that Zynga is poised to grow due to its strong product pipeline in the near term. Currently, Zynga has a Zacks #2 Rank, which implies a Buy rating over the short term (1-3 months).

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