Is Zynga (ZNGA) A Buy?

| December 19, 2011 | 0 Comments

One of the most highly anticipated IPOs of the year happened late last week.  Shares of Zynga (ZNGA), the self-styled world leading social game developer, began trading publicly for the first time on Friday.

The company raked in a whopping $1 billion from the IPO.

They issued 100 million shares (14% of the company) at an IPO price of $10 per share.  Zynga plans on using the IPO proceeds to acquire additional start-up mobile game developers.

Now, whenever a company is able to raise a billion dollars through an IPO, it's a huge success.  But Zynga shares did not see any follow through once the shares opened for trading.  After briefly moving up to $11.50 a share, the stock plunged to a low of $9.00.

The stock ended up closing at $9.50, a surprising 5% below the IPO price.

Not the big first day pop many analysts and investors were expecting.

After the strong first-day showings from other web IPOs this year, many believed Zynga would follow suit.  You may remember LinkedIn (LNKD) more than doubled in price on their first day of trading.  And more recently, Groupon (GRPN) surged 31% in their opening debut.

Investors had been salivating over the prospective IPO for months.

You see, Zynga is the creator of some of the most popular and most successful video games available on Facebook.  So, the IPO has been viewed by many as the first opportunity to invest (albeit indirectly) in the social media juggernaut.

Of course, Facebook is currently valued at around $100 billion and rumored to be planning a $10 billion IPO for sometime in 2012.

If you use Facebook, you've probably seen, played, or heard about Zynga's games.  They're the masterminds behind incredibly popular titles like CityVille, FarmVille, Mafia Wars, Words With Friends, and Zynga Poker just to name a few.

How popular are Zynga's games?

According to the company's prospectus, Zynga has the largest player audience on Facebook with more monthly active users than the next eight social game developers combined.  They've launched the most successful social games in the industry in each of the last three years.  And the company has generated over $1.5 billion in cumulative revenue and over $2 billion in bookings since the company's founding in 2007.

That's a pretty solid track record of success.

Of course, the key to Zynga's early success is no doubt their dominating presence on Facebook.

Right now nearly all of the company's revenue is generated from players accessing Zynga's games through Facebook.  But that's no small thing. Remember, Facebook has over 800 million members worldwide.  And they're adding over eight million new members every month.

You don't have to look very far to find evidence of the company's success.  Just take a look at the company's performance over the first nine months of 2011.

Revenues have more than doubled over the prior year period to $829 million.  And the company's pulled in more than $30 million in net income so far this year.  That's right, unlike the other hot web IPOs this year, Zynga is already turning a profit.

And the outlook going forward is very bullish.

At least one market analyst is projecting huge growth ahead for Zynga. Gartner recently said they expect Zynga to generate revenues of over $11.4 billion… by 2014!  That's a projected eleven-fold increase in sales over just the next three years.

So, should you buy Zynga right now?

No question about it, the shares are carrying a lofty valuation at current prices.  With a market cap of $2.7 billion, ZNGA is trading at 2.7x sales. And they're carrying a hefty forward P/E ratio of 59x the 2012 estimate of $0.16 per share.

Both metrics are quite a bit higher than those of leading video game maker Electronic Arts (ERTS).

However, if Gartner's estimates turn out to be anywhere close to accurate, Zynga shares are dirt cheap.  Using Gartner's 2014 revenue projection of $11.4 billion, you get a projected price to sales ratio of just 0.23x.  That's quite a bit lower than ERTS' price to sales of 1.74x.

In fact, if we use ERTS' price to sales ratio as a guide, ZNGA could be worth more than $70 per share by 2014.

Based on this outlook, I'd suggest establishing a small position in ZNGA today.  Then wait and see what happens.  If the shares start to fall, look to add to your position at lower prices.  This will help lower your cost basis and set you up for bigger potential profits.

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Category: Stocks

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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