Christopher D. Merwin, CFA and David Lee of Barclays on Zynga Inc (NASDAQ:ZNGA) earnings

Today after the close, Zynga Inc (NASDAQ: ZNGA) pre-announced 4Q13 results that came in ahead of our expectations, most notably on EBITDA, due to early progress with cost cutting measures. Zynga also announced the acquisition of NaturalMotion, a mobile game developer with approximately 260 employees and 2013 bookings of $62M, for $391M in cash and 39.8M shares of ZNGA stock. The acquisition is expected to add roughly $70-80M in bookings in 2014 and should be accretive to 2014 non-GAAP EPS by roughly $0.01. We are initially constructive on the acquisition, which could give ZNGA a much improved foothold in the mobile space through an expanded network of mobile users that will allow for cross-selling of games.

Zynga Inc ZNGA
Zynga Inc ZNGA

In In addition, Zynga communicated plans to implement a workforce reduction of 314 employees, roughly 15% of its employee base, to go along with an expanded cost savings plan that is expected to generate roughly $33 to $35M in pre-tax savings for 2014. The new management’s team commitment to profitability gives us more confidence in the future FCF generation of the business, as they look to build out a more robust product pipeline that we believe could eventually be the source of material upside to bookings and ultimately ZNGA shares.

Zynga Inc (NASDAQ:ZNGA) Is there still more cost cutting and M&A from here?

While ZNGA just announced a cost-cutting plan that will trim its headcount by 314 employees, we estimate that ZNGA will still have over 2,000 employees, when adding in the impact of the 260 workers at NaturalMotion. Compared to other mobile game developers, ZNGA still appears to be heavily staffed, so we are curious to hear if management views the employee base as optimal at its current levels. As ZNGA makes strides in improving its cost structure, we are curious to see if management has appetite for further M&A in a space that is highly fragmented, although we think further M&A could add execution risk.

Zynga Inc (NASDAQ:ZNGA) Update on product pipeline

Despite efforts to reduce the cost-structure, we have still yet to receive much of an update on the product pipeline for core ZNGA. While the NaturalMotion acquisition should no doubt expand Zynga’s library of content, we believe a revamped product pipeline—and ultimately a new hit game—are necessary for sustainable improvement in bookings. We hope to hear more about the pipeline on the upcoming call.