ZNGA is a company at the crossroads of a massive change in the gaming sector from the more traditional console, multi-player, or desktop format to an fast growing mobile-centric platform that has its share of profitability pitfalls.
Last week the company reported Q1 earnings that beat seemingly low expectations, Barron’s review here:
Revenue in the three months ended in March rose to $321 million, yielding EPS of $6 cents, slightly ahead of the consensus $317.3 million and 5 cents a share.
Monthly active users rose to 292 million from 236 million a year earlier, the company said, while daily active users rose slightly to 65 million from 62 million a year earlier.
For this year, the company projectsbookings in a range of $1.43 billion to $1.5 billion, it said, and Ebtida, on an adjusted basis, of $400 million to $450 million, up from a prior $390 to $440 million estimate.
Adjusted EPS is expected in a range of 23 cents to 29 cents, which is a penny below the 27-cent average estimate.
Since ZNGA’s mid Dec IPO of 100m shares at $10 by a “who’s who” of investment banks (MS, GS, BAC, JPM to name a few) the company has been doing their best to manage the deluge of intended insider and investor lock up selling. In late March, the underwriters sold an additional 49.41 million shares at $12 which included founders/insiders and pre-ipo investors. Barron’s did a nice job describing the events leading to the secondary here, but what was also clear that there was additional insider shares unlocked on or after April 30th, which is likely the result of the selling pressure on Monday that saw the stock reach new all time lows before bouncing.
What We Are Looking At:
Without debating their business model and the prospects for the company in quickly changing mobile/social media/gaming world, I want to focus on sentiment and supply/demand characteristics in the near term as we head into next week’s Facebook pre-ipo roadshow, with the IPO tentatively set for May 18th.
On April 23rd, FB amended their S-1 filing for their IPO and offered some fairly instructive facts about ZNGA and FB’s co-dependence and the potential for ZNGA’s decreasing importance to FB. In Q1 FB said that ZNGA was directly responsible for about 15% of total revenue, which is down from 19% a year ago. This all comes at a time when ZNGA is launching it’s own website for gamers and trying to increase their games usage out side of the FB network. Answers to this question are not likely to be resolved soon but the fact that ZNGA’s costs are going up, and their earnings have swung to a loss, and insiders are selling at levels below the IPO price is obviously spooking investors.
Since ZNGA is such a new stock there isn’t alot of history in the options to go by. Near term options trade at higher vols than farther out months. But since the stock is low dollar, with wild recent moves, looking at options in any manner other than their dollar value and chance of more big moves is probably useless. Try to make sense of this skew chart and you’ll see what I mean:[caption id="attachment_11187" align="aligncenter" width="497" caption="ZNGA monthly skew from LiveVol Pro"][/caption]
MY VIEW INTO FB IPO: While many of you know that normally I would be pre-disposed to short a stock like this, and if they can’t grow users outside of FB and figure out ways to better monetize mobile users this company maybe challenged in the long term. For now, though comparisons to companies like EA which has a market cap of about $5.1b, with about $1.2b in net cash, and trailing 12 month sales of about $4.17b will be tough when you consider ZNGA’s $6.4B market cap, $1.5b in cash and trailing 12 month sales of about $1.14b. Obviously ZNGA’s expected earnings and revenue growth of 13% and 27% respectively this year will justify the almost ridiculous valuation.
On the flip side, the company isn’t exactly admired for the overly ethical way in which they get people to spend money on their products, something they’ve made attempts at addressing. But a few wrong moves on this front could mean quick damage to the company. It also could be a a difficult summer for the stock as more lock-ups end from now until August.
SO my quick take, long term lots of things have to go right or ZNGA will quickly trade at a valuation better suited for names like EA that only grow sales in the single digits % annually. But the Facebook IPO could drag alot of these stocks higher into the event, as we saw with the announcement that FB was going public.
POTENTIAL SHORT TERM TRADE??:
IF YOU THOUGHT THAT FB’S IPO, EXPECTED TO PRICE MAY 18TH, WILL LIFT MOST SOCIAL MEDIA NAMES WITH IT, ZNGA SHOULD BE A PRIMARY BENEFICIARY OF THIS PRICE ACTION.
BUT THIS IS A BIG IF, IN THE FACE OF INCREASED INSIDER SELLING, I WOULD HAVE TO GUESS THAT ZNGA’S INSIDERS WHO CONTINUE TO SELL WOULD HAVE A BETTER READ ON THIS THAN ME AND YOU.
Stock still has fairly high short interest at about 20% of the float and could on any decent news be susceptible to a short squeeze. This would not be a trade that you would want to bet the “farmville” on (sorry i couldn’t help myself), but may be worth a little premium.
After taking a hard look at the options, there are few if any trades that make sense, they are expensive on a Vol basis, they are expensive on a Dollar basis as there is a ton of bid ask as the options trade in nickels rather than pennies. For example the May19th 9 calls are .45 at .55 (stock ref 8.74). So to break-even you would need a 9% move just to break-even in 2.5 weeks. Call spreads don’t look that attractive either, for instance the May19th 9/11 call spread is offered at .50, ugh and the 11 call is only .05 bid which seems silly to sell.
SO AFTER TAKING A CLOSE LOOK AT THE STOCK WE ARRIVE AT THE CONCLUSION THAT THE ONLY WAY TO PLAY FOR A BOUNCE IS TO BUY THE STOCK, BUT WITH THE STOCK UP FROM $8 THIS WEEK WE WOULD RATHER WAIT TO SEE IT COME IN BACK TOWARDS THE LOWS PLAY FOR A QUICK BOUNCE INTO THE FB IPO AND SELL. STAY TUNED.