Hi all, I’d like to bring Zynga (ZNGA) up for discussion. It’s been growing at 40% for the past 5 quarters and I think it has the potential to do better going forward. I don’t think the market is giving it enough credit for its 40% growth and huge FCF generating ability. I currently own shares in the company.
10/13/2020 Closing share price = $9.54. Market Cap = $10.26b.
Zynga has come a long way since its Farmville heydays on FB. It languished for years thereafter until some good hires were made in 2015. Since then the business has turned around to pretty good success.
The company focuses on social games that are mostly free-to-play, casual and hyper-casual. The majority of players are women who are not looking to spend 45min-1hr playing a game in one sitting. Revenue comes from selling in-game items (growing) and advertising (less so).
The company has 8 Forever Franchises (games that can entertain for > 5yrs and generate > $100m annual bookings) such as CSR Racing, Empires & Puzzles and Zynga Poker. It recently added 2 games, Toon Blast and Toy Blast, to its Forever Franchises. New games line-up for 2020 includes Puzzle Combat, Farmville 3 and Harry Potter. The company is also working on new publishing routes via Snapchat and Amazon Prime (announced April 2020).
Other than creating its own games, Zynga also adopts a roll-up model where it acquires smaller local gaming companies, improves their studio operations, and distributes the acquired games in other markets. Acquisitions have been a large driver of their growth. With their strong cash generation, I think this is a viable strategy for growth going forward.
In 2018, ZNGA acquired Gram Games and Small Giant Games for just over $1bn. These kick-started the growth in 2019. It just made another 2 acquisitions in 2020, which I believe can push the company to 50% growth levels.
Founder Mark Pincus started the company with phenomenal success in Farmville. These days he is the non-executive Chairman. He owns 6.8% of the company.
I believe the transformation started when Pincus brought in Frank Gibeau as CEO in 2015. Since then he’s brought more people from Electronic Arts and other gaming companies. He owns about 9m shares or a shade less than 1% of the company. Not a huge percentage share, but a sizeable amount nonetheless.
(All dollar values in USD)
Year Q1 Q2 Q3 Q4 FY 2017 194.3 209.2 224.6 233.3 861.4 2018 208.2 217.0 233.2 248.7 907.2 2019 265.4 306.5 345.3 404.5 1321.7 2020 403.8 451.7
Year Q1 Q2 Q3 Q4 FY 2017 4% 15% 23% 22% 16% 2018 7% 4% 4% 7% 5% 2019 27% 41% 48% 63% 46% 2020 52% 47%
As can be seen, rev growth picked up in Q1 2019 following the 2 acquisitions.
The company closed the acquisition of Istanbul-based Peak Games on July 1st 2020 ($600m in revenue for each of the past two years). It also closed the acquisition of Istanbul-based Rollic Games on Oct 1st 2020 ($100m revenue run rate). The company has guided that the acquired revenue will show up in deferred revenue post-acquisition. I expect these deferred revenues to show up on the Income Statement in the subsequent 2-4 quarters after acquisition close. This is consistent with how the 2018 acquisitions panned out.
While the company expects some of its revenue growth from existing games to taper, adding another $125m per quarter in revenue from the two acquisitions should bring it into 50% growth territory (or greater).
Non-GAAP Gross Profit Margin
Year Q1 Q2 Q3 Q4 FY 2017 66.9% 69.5% 70.8% 72.7% 70.2% 2018 67.1% 66.1% 66.4% 66.8% 66.6% 2019 54.3% 58.4% 61.4% 65.1% 60.5% 2020 63.9% 60.4%
Non-GAAP Net Profit Margin
Year Q1 Q2 Q3 Q4 FY 2017 4.2% 11.2% 15.8% 18.1% 12.7% 2018 9.9% 8.7% 13.3% 9.6% 10.4% 2019 -12.8% -3.8% -0.6% 11.8% 0% 2020 9.0% 5.4%
Margins have generally been consistent other than in Q1-Q3 2019. This was because the revenues acquired in 2018 initially showed up as deferred revenue in 1H 2019 while acquired expenses went straight to the Income Statement. Margins improved over 4 quarters after the 2018 acquisitions. We can expect a similar trend after the 2020 acquisitions of Peak and Rollic.
Free Cash flow ($M)
Year Q1 Q2 Q3 Q4 FY 2017 -7.0 35.9 32.4 23.3 84.7 2018 -5.3 38.9 37.3 86.0 156.8 2019 -3.5 93.8 59.8 89.3 239.3 2020 -43.7 142.2
Year Q1 Q2 Q3 Q4 FY 2017 -3.6% 17.2% 14.4% 10.0% 9.8% 2018 -2.6% 17.9% 16.0% 34.6% 17.3% 2019 -1.3% 30.6% 17.3% 22.1% 18.1% 2020 -10.8% 31.5%
This is where the company shines. The strong FCF generation will allow it to continue its roll-up strategy.
Average daily bookings per mobile DAU ($) has been growing steadily.
Year Q1 Q2 Q3 Q4 2017 0.107 0.109 0.113 0.113 2018 0.096 0.110 0.122 0.130 2019 0.170 0.188 0.202 0.223 2020 0.216 0.248
The company has executed well in the past 2 years, with acquisitions and self-developed games contributing 40% growth rate and generating strong FCF. Going forward, its 2 latest acquisitions should bring rev growth to 50%, or at the very least, maintain its 40% trajectory. Margins will likely decline in the next 2 quarters but should recover after that.
I don’t believe the company is getting much credit from the market currently at 6.4x ttm sales. Going forward, I believe that the company will at least benefit from the re-rating of the acquired revenues (Peak was purchased at less than 3x rev while Rollic was purchased at 2.25x rev.)
Ideally, the market recognizes the success of its turnaround and gives it a valuation in line with its 40% growth and FCF generation. Here is my ball-park valuation of the company:
TTM Rev = $1,605m. Using an undemanding 30% rev growth pa over the next 3 years and applying a 20% FCF margin, FCF in 3 years’ time is expected to be $705m. Applying a 30x multiple on FCF gives $21.15b value. Current market cap = $10.26b.
- Integration of acquisitions don’t work out
- Demand for their games fall off a cliff after Covid.