There are many different reasons that investors buy stocks. Sometimes, you buy shares for growth and income. Other investors buy for superior growth, still others buy a company because it seems like it’s turning around. Maybe the easiest stocks to choose are the companies where the value of their assets is so valuable, that a buyout by a larger company seems like a certainty. The nice thing about buying asset rich stocks, is you know that there is a floor under the stock price based on the value of their hard assets. This is exactly the situation with Zynga Inc (NASDAQ:ZNGA).
Earnings Don’t Matter. Wait…What?
I know what you’re thinking, how can you say that earnings don’t matter? You are partially right, I’m overstating a bit to say they don’t matter at all, but honestly to know the value of Zynga Inc (NASDAQ:ZNGA) is to look at two figures, their cash, and their users.If you look at Zynga’s larger peers, you see companies like Activision Blizzard, Inc. (NASDAQ:ATVI) and their huge franchises like Call of Duty and World of Warcraft.
While Zynga Inc (NASDAQ:ZNGA) certainly doesn’t have the scale of Facebook, they estimate that Farmville 2 alone has about 40 million players. Granted these players don’t have to pay anything, but this still represents 239% more players than both Battlefield Premium and World of Warcraft combined!
While Zynga Inc (NASDAQ:ZNGA) has struggled with daily active users down 21% recently, the company estimates more than 200 million people play their games.
Yes I’m Suggesting Investors Consider Buying Zynga (as a buyout candidate)
I know that some would say I’m crazy for suggesting buying stock in a company that is losing players. I know that their revenue was down more than 18% in the last quarter, and net income plunged 80%. However, I also know that the remaining players represent a valuable commodity, and that is the potential for digital sales. Activision gets about 53% of its sales from digital channels, and Electronic Arts get nearly 60% of sales digitally. While 85% of Facebook’s revenue is advertising based, the company is always looking to diversify their revenue stream.
The truth is, any of these companies could do much more with Zynga, than Zynga can do alone.
One of the main things a larger company could do is, they could blend Zynga’s research and development spending into their own. In the current quarter, Zynga Inc (NASDAQ:ZNGA) spent 49% of their revenue on R&D. By comparison, Activision spent 9.44%, EA spent 23.74%, and Facebook spent 20.1%. There is little question that these larger companies could get Zynga’s R&D spending to a more reasonable level and be equally as effective.
The 1.67 billion Pound Elephant In The Room
Everything else that I’ve said about Zynga Inc (NASDAQ:ZNGA) is dwarfed by one simple fact, the company is cash flow positive, and has $1.67 billion in net cash and investments. Just to give you an idea of how large this cash pile is, Zynga’s current market capitalization is only $2.68 billion. This means an acquiring company could buy Zynga at today’s prices, and the company’s operations are only being valued at about $1 billion.
If Zynga had any debt, this would be a potential deal breaker, but they don’t. If Zynga Inc (NASDAQ:ZNGA) were burning through cash, I would say stay away. However, Zynga produced $23 million in free cash flow in the current quarter. The most logical suitor to me would be Activision-Blizzard. The company has $4.6 billion of cash on their balance sheet, and the company’s Blizzard division is the class of subscription gaming. Imagine if Blizzard had the ability to promote hit casual games like Farmville 2, Cityville, Words With Friends, and more along with Diablo III, World of Warcraft, and Starcraft.
That being said, EA might snatch Zynga away, but they would have to do either a stock and debt deal, as they only have $1.12 bil. in net cash. Facebook could use Zynga’s games to increase engagement and diversify their revenue. With over $9 billion in cash, Facebook could certainly afford an all cash deal. The bottom line is, Zynga Inc (NASDAQ:ZNGA)’s market cap. is primarily made up of cash. The company is cash flow positive and retiring shares. They may not be the perfect company, but it’s easy to see why a larger player would want to acquire the company. If you are an investor who likes risk arbitrage, I would put ZNGA on your Watchlist right now.
The article There Are 1.67 Billion Reasons This Company Is a Buy originally appeared on Fool.com and is written by Chad Henage.
Chad is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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