Zynga (ZNGA), a leading provider of social gaming services and probably best known for Farmville on Facebook, reported its first-ever quarterly results after going public in December. Though its results showed tremendous top-line expansion, we have long-term concerns with owning Zynga at these levels and view its near-term results as inconsequential to its intrinsic value.
First of all, we urge investors to keep their heads as the social-networking bubble heats up in the coming months, leading up to and following the well-publicized IPO of Facebook. We’ve already witnessed what we’d describe as “sympathy buying” of firms like Zynga and LinkedIn (LNKD) and think the best way to play the group is to stay as far away as possible or nibble at out-of-the-money put options when the time comes. While LinkedIn trades at a whopping 40 times next year’s EBITDA, Zynga’s projection to achieve adjusted EBITDA in the range of $390 million to $440 million puts its forward EV/EBITDA multiple at a full 19 times — and that’s if one excludes what the firm expects to pay out in stock based compensation for the year! Including what we’d consider to be a legitimate expense puts expected 2012 EBITDA very close to $0 (nothing).
Though the company is cash-rich, pulling in $137 million in free cash flow during 2011 and over $300 million in 2010, we have some long-term concerns. For starters, Zynga’s business model remains largely unproven and its customer concentration risk is severe (Facebook accounts for almost all of its revenue). And we can only expect the competitive environment for social gaming to heat up in coming years, pressuring margins through higher research and development costs. Considering these factors, we have trouble justifying the firm’s huge $10 billion+ market capitalization and think there are better risk-adjusted investments out there.