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:ZNGA   00:00AM GMT
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Why Zynga is Getting Crushed but Hope Remains



Zynga is a video game creator which puts it both in a strong growing segment of mobile games and a rather competitive one. I authored an article Why Electronic Arts (EA) May Be the Greatest Comeback In All of Technology, and much of what I wrote about EA is the opposite of ZNGA, right now.

I remind all readers that a report just like this one is available for any company for free on Yes, literally for free. No e-mail. No login. Free. Forever. Period.

Here's the bullish thesis for ZNGA: The company has upwards of $1 billion in cash which gives it staying power for the future and to capitalize on future winning products without "running out of time." With a $2.4 billion market cap, subtracting cash (which leaves $1.5 billion), the company trades at about 2x revenue which is hardly frothy. The company has seen new hits spark its brand like the "Hit it Rich!" slots app and "Looney Tunes Dash!." When that product launched, ZNGA saw 30 million downloads and a breathtaking 26 million new users (Source: Investor'sPlace). According to a report from New Zoo in November of 2104, "The mobile gaming market is set to surpass that of the traditional console to become the largest gaming segment by revenues next year," with revenues topping $40 billion by 2017.

The bearish thesis is pretty harsh. Although we find ourselves in an aging bull market where thousands of companies are making new highs in revenue, ZNGA's revenue (TTM) is down from a year ago ($778 million), and from two-years ago ($1.2 billion). The company's CEO resigned in April and his prior gig was the president of Microsoft's interactive entertainment division. He had $40 million in options to vest over three-years.

Worse yet, the company has growing losses and pays about $1.25 in expenses for every $1 in revenue it generates. Other game competitors like Glu Mobile (GLUU) and Electronic Arts (EA) are seeing revenues explode to all-time highs. ZNGA is being out maneuvered , out developed and is getting crushed because of it in terms of growth. While it lives in a booming segment, revenues are actually shrinking. Incredibly, the stock is down 60% from its highs in March of 2014. In that same time period GLUU is up 17% and EA is up over 140%. Yikes.

Technicals   |   Support: 2.24   |   Resistance: 2.75   

Swing Death Cross Alert: The short-term 10 day MA is now below the 50 day MA.

ZNGA has a one bull (lowest rated) technical rating because it's trading below the 10-day (short-term), 50-day (medium-term) and 200-day (long-term) moving averages.

Here are the consensus estimates for next quarter. Note that last quarter's actual result is included at the far right.
Earnings Date EPS Revenue (Mean) Revenue (Median) Last Quarter (Actual)
2015-08-06 $-0.06 $157 million $156 million $183 million M Provided by ZACKS

Let's look at the core elements that drive the company's fundamental rating.

Fundamentals Rating Summary

Revenue (TTM US$ Millions) 706 778 1,224 FALLING

Operating Margin (QTR) 0.816 0.71 0.98 RISING

Net Income (TTM US$ Millions) -211 -102 -120 FALLING

Levered Free Cash Flow (TTM US$ Millions) 102 -4 70 RISING

Research and Development (US$ Millions) 98 98 129 RISING

Research and Development Expense/Revenue 0.535 0.581 0.490 FALLING

Stock Returns and Chart

ZNGA is up +4.0% over the last three months and down -4.0% over the last six months. The stock has returned -13.8% over the last year.

Before we dig into the fundamental trends that drive the rating, let's look at a two-year stock chart with regression channel and 10-day momentum (on the bottom).
Click here to interact with this stock chart

Now let's examine the visualizations of the critical financial measures.

Revenue (TTM US$ Millions) 7067781,224FALLING

Revenue over the trailing twelve months (TTM) for ZNGA is down 9% and down a staggering 42% from two-years ago. At its peak, the company say annual revenue of nearly $1.3 billion. in the trailing-twelve-months (TTM) it has realized revenue of $706 million.

What do all these numbers mean?
ZNGA's fundamental rating was hit hard by these results:
1. The one-year change was negative.
2. The two-year change was negative.

Let's look at Revenue (TTM US$ Millions) in the chart below.

Click Here to Interact With This Chart

Operating Revenues/Operating Expense 0.8160.710.98RISING

This ratio (which simply represents how much revenue is generated per one dollar of expense) must be at a minimum above 1.0 in order for a company to turn an operating profit. For the latest quarter ZNGA showed a ratio of 0.82. In English, for every $1 ZNGA spends on expenses, it receives $0.82 in revenue. That's awful. At its peak, this company saw an operating margin of over 1.25. The fact that this ratio is up from a year ago is one of only two phenomena keeping ZNGA from having the worst fundamental rating possible. Having said that, let's not trivialize that trend. Margins are improving. That is a fact and it is not disputed.

What do all these numbers mean?
A year ago Operating Revenues/Operating Expense was 0.71. In the last year we can see operating margins are increasing but are still less than 1.0 (the minimum level needed to turn an operating profit).

ZNGA's fundamental rating was affected from the operating margin numbers in the following ways:
1. The current value is below the critical 1.0 level (the firm generates an operating loss).
2. The one-year change was positive (raises the rating a little).

Let's look at Operating Revenues/Operating Expense in the chart below with the total assets in the orange line.

Click Here to Interact With This Chart

Net Income (TTM US$ Millions) -211-102-120FALLING

Net Income (after tax profit) over the trailing twelve months (TTM) for ZNGA is falling and is negative (aka losses). For the most recent trailing-twelve-months (TTM) the company reported net income of -$211 compared to a loss of $102 million a year ago. The last time net income over a trailing-twelve-month (TTM) period was positive, was all the way back in September of 2011.

In our next chart we plot Net Income (TTM US$ Millions) in the blue bars and the quarterly results in the gold line. Note the falling bars from a year ago (four quarters ago).

Click Here to Interact With This Chart

Levered Free Cash Flow (TTM US$ Millions) 102-470RISING

Levered Free Cash Flow (TTM US$ Millions) is a critical determinant of stock price since market cap is the present value of all future free cash flows. For ZNGA the metric is rising (it was $-4 million last year). For the most recent trailing-twelve-months the company reported Levered Free Cash Flow (TTM US$ Millions) of $102 million. This is important as it does alleviate the conern that ZNGA is somehow going out of busines any time soon. The company products positive FCF and has substantial cash in the bank.

For our next chart we plot Levered Free Cash Flow (TTM US$ Millions) in the blue bars through time. Note the rising bars from a year ago (four quarters ago).

Click Here to Interact With This Chart

Research and Development (US$ Millions) 9898129RISING

Research and Development (US$ Millions) in the most recent quarter for ZNGA was $98, essentially flat from a year ago and down a whopping 24% from two-years ago. But, technology companies have th eugliest habit of pushing stock compensation into R&D so that metric is totally whacky when a new firm is breaking new high sin stock price (as ZNGA was doing). i do note that ZNGA now spends $0.53 of every dollar in revenue on R&D. That's absurdly high. GLUU is at $0.26 and EA is closer to $0.24.

In our final time series chart we plot Research and Development (US$ Millions) in the blue bars and R&D per dollar of revenue in the orange line. Note the rising bars from one-year ago.

Click Here to Interact With This Chart

While ZNGA has a pile of cash and some recent winners along with a segment in general that is growing rapidly and to rather substantial size, the company's revenue is shrinking, losses are growing and the stock price is dropping. The company lost its CEO (Wall St. essentially asked for his head on a platter) and is now being run by its original founder. There is a hint of promise with new games and a nice entry into mobile that has attracted brand new ZNGA users, in general, the thesis remains fairly bearish unless the turnaround starts, and it starts soon.

I will re-iterate, the company does have the money to wait and see if any new games turn out to be hits -- it's not suffocating. Having said that, GLUU and EA both present a more clearly defined bullish thesis as of right now.