Zynga Inc (ZNGA): Transform Something

While Wall Street estimates can be, on the whole, a negative force in the world of investing, they benefited mobile-gaming firm Zynga Inc (NASDAQ:ZNGA) last week. And, not to give all credit to expectations, the company also posted some encouraging numbers in the midst of its massive overhaul. Of course, it wouldn’t be a Zynga Inc (NASDAQ:ZNGA) earnings release without some heart-wrenching financials, as well. Revenue was down 18% year over year, while bookings took a 30% hit. Yet, with the U.K. real money gambling business on its maiden voyage, there remains significant potential for the company. Is this the inflection point for Zynga Inc (NASDAQ:ZNGA)?

Earnings with friends
For Zynga Inc (NASDAQ:ZNGA) bulls, who have been energized this year with the launch of real money gambling services and a more than 35% run up in stock price, the recent earnings release was a mixed bag. For headline numbers, the company was able to post a $0.01 EPS — in line with the previous quarter’s number, and far ahead of analysts’ estimate of a $0.04 loss. Year-overyear EBITDA growth was an impressive 66%, due to continued success in the company’s franchise titles. Free cash flow is coming in nicely — $23 million in the past quarter alone. Zynga Inc (NASDAQ:ZNGA)’s sequel to Draw Something just launched, along with new “-ville” titles. Of course, the most compelling remains the gambling segment, which we will touch on in a minute.

Though there was some cause for celebration, the stock did not respond favorably; the reason was that many underlying numbers were not as exciting.

Earning with enemies
Revenue fell nearly 20%, though investors should keep in mind that the company has shut down many of its studios and properties that were not carrying their weight. More troubling is the fact that revenue from daily users is falling — down 11% last quarter. And though the profitability is certainly encouraging for a business recently deep in the weeds, management guided down for the coming quarter — expecting a $0.03-$0.05 per share loss.

So what are investors to do in light of recent information?

Transform something
The company is still deep in its shift from high-cost, mediocre-reward to something more sustainable. As the U.K. gambling launches on Facebook Inc (NASDAQ:FB), it will be very interesting to see the percentage of fake money users switching over to the real side.

I do not have much faith, long term, in the mobile gaming business as a whole. Users seem incredibly flakey when it comes to these products — using them obsessively for two months and then never again. Given the high cost of development, it just doesn’t seem like a great investment. More concerning is that the newer games seem to be monetizing users less, or at least more slowly than the older games.

The hope for the company still lies in gambling. At this point, we just don’t know how successful it will be.

Investors should expect costs to remain high, and profitability limited or nonexistent. The stock should be looked at as speculative with high reward if the story plays out.

The article Is Zynga Out of the Dog House? originally appeared on Fool.com and is written by Michael Lewis.

Fool contributor Michael Lewis has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook.

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