UBS analysts Eric J. Sheridan, Vishal J. Patel, and Timothy E. Chiodo upgrade Zynga Inc (NASDAQ:ZNGA) from Neutral to Buy on the gradual stability of its organization after a tumultuous year.
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Zynga bright future as core stabilizes and growth emerges

We are upgrading Zynga Inc (NASDAQ:ZNGA) to Buy from Neutral and raising our PT to $6 (from $4) to reflect our increased confidence that: a) Zynga Inc (NASDAQ:ZNGA)’s core operations have begun to realize stabilization under the new management team (led by CEO Don Mattrick), b) that core cost cutting announced with Q4 operating results will result in a bottom for Zynga’s EBITDA margins; and c) that the $527mm acquisition of NaturalMotion (a leading iOS gaming company) will result in a greater level of scale and innovation to the broader Zynga mobile game pipeline.

Why upgrade? still early in the revenue and EBITDA recovery

What leads us to upgrade now? 1) We believe that Q1 ’14 & FY ’14 guidance from the recent earnings call will turn out to be conservative due to stability at the core Zynga properties (monetization/usage); 2) NaturalMotion (while inorganic growth) is one of the leading iOS game developers & has seen tremendous success with its CSR Racing and Clumsy Ninja franchises – future growth could come from Android expansion, future pipeline titles & licensing their Euphoria animation tech; and 3) Zynga Inc (NASDAQ:ZNGA) EBITDA margins (& FCF generation) is likely to materially improve from trough levels (effect of 18 months of core cost cutting & the leverage from NaturalMotion bookings growth) as EBITDA margins return to the 20%+ level in 2015 and beyond.

Changes in estimates: expecting a revenue growth & margin expansion story

Our new Q1 2014 estimates for bookings, revenues and Adj. EBITDA are $149mm, $167mm and $5mm (from prior $133mm, $165mm & $7mm). We are now expecting FY 2014 bookings, revenues and Adj. EBITDA of $801mm, $879mm and $94mm (from prior $565mm, $647mm and $55mm). The estimates reflect the inclusion of NaturalMotion assuming a mid-February close (in accordance with Zynga Inc (NASDAQ:ZNGA)’s guidance).

Valuation: upgrade to buy; raising PT to $6.00

Our $6.00 PT (prior: $4.00) is based on our weighted avg. framework (EV/Sales, EV/EBITDA, EV/FCF). We view Zynga Inc (NASDAQ:ZNGA)’s net cash following the deal consideration (est. $1.2bn total) and land/asset (PPE of $349mm) as downside supportive.