Zynga Inc (Z) Has Miles To Go Before It Succeeds

Zynga Inc (Z) Has Miles To Go Before It Succeeds

Zynga Inc (NASDAQ:ZNGA) went public in 2011, but it has not been able to register any profits since then. The profit margins of the company have been falling, and this has led to a cut in the revenue outlook by the company for 2014. The company procured a low score of 9 on the StarMine Earnings Quality (EQ) model, and this low score is an indication of not having sustainable income sources for earnings. A report from Seeking Alpha by Alpha Now notes other sources that are indicators of poor earnings quality.

Falling margins, revenues

The operating margins of Zynga have been falling continuously for the last three-quarters.  “After turning positive in 2012, during the release of FarmVille 2, trailing 4Q operating margins have continued to slide and reached -16% in the most recent quarter,” notes the report. The reason behind this decline is that the number of customers/players spending money on games has declined substantially. An important point to be noted is that the margins are flat for the rest of the industry, and hence, falling margins of Zynga are not an issue of weakness across the industry, notes the report.

The revenue too has been falling at a fast pace, down almost to half the level achieved in 2012. Revenues for the last quarter have been noted at $153 million. The company has resorted to massive cost-cutting measures, but even then the cost of SG&A and R&D has been noted at $168 million.

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Underutilized assets for Zynga

According to the report, the game maker has not been able to utilize its assets to their full potential. The same is reflected in the return on net operation assets, which has been declined sharply in the last three-quarters. The metric is a key measure and is below the industry median by large. The main reason for this, according to the report, is that Zynga is making disappointing releases one after another, and investments made in R&D are not bearing expected fruits. The company is making efforts to bring about improvement in its products, and for the same five releases scheduled for the end of 2014 have been postponed to 2015.

If a company’s earnings are different than that of GAAP earnings on a consistent basis, it reflects a sign of poor earnings quality, notes the report. In the last two-quarters, the GAAP earnings trailed pro forma earnings by six and seven cents per share for Zynga.

The StarMine models also reflect that Zynga is overvalued considering the valuation models. In the end, the report notes that until the game maker’s “delayed launches come out, there remain very few catalysts to lift earnings at Zynga.”

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