Outlook: Is Zynga Taking a Leaf Out of Amazon’s Book?

Source: http://www.flickr.com/photos/marketingfacts/

Source: http://www.flickr.com/photos/marketingfacts/

We have observed several parallels between Zynga (NASDAQ:ZNGA) and Amazon (NASDAQ:AMZN) at a similar point in the latter’s history. Like Amazon, Zynga has a CEO focused on a large and growing marked who is determined to position the company to capture market share by focusing on the customer.

Zynga appears determined to address the “play anywhere” free-to-play market by leading with mobile games and ensuring that its games are available cross-platform. The company recently updated its Words with Friends and Zynga Poker games on mobile, and has entered limited beta testing of its FarmVille mobile version. Ultimately, we expect Zynga to lead with a mobile-first strategy, and to ensure that all of its games are playable on mobile, tablet, and PC.

Zynga CEO Don Mattrick is focused on hiring the best personnel available. His first key hire was mobile veteran Clive Downie as COO. Mr. Downie formerly headed up DeNA’s western operations and prior to that, was a senior executive with ngmoco and EA. We believe that Mr. Downie’s mission is to focus Zynga on its customer, and as Zynga rebuilds its customer base, we expect the company to see monetization of its products begin again to grow.

We think that Zynga’s current staffing levels imply that a significant number of new products are on the horizon. The company has approximately 2000 employees, including 260 hired as part of the NaturalMotion acquisition. This figure is down from 3400 employees at its peak, and reflects approximately 1000 employees working on existing franchise and the balance working on new projects.

We expect Zynga to profitably grow its business. Management sounds confident that Zynga can hit its bookings and profitability goals, and we expect to see regular increases in guidance as the company continues to execute on its strategy. We do not expect Zynga to deliver meaningful profit growth for several quarters, as we believe the company intends to reinvest in revenue growth to gain market share. However, we believe 30 percent contribution margins are achievable over the long run, as Zynga sees revenues grow beyond the $1 billion level again.

We are maintaining OUTPERFORM rating, but raising our 12-month price target to $7 from $6. Our PT reflects an EV/bookings multiple of 6x our 2014 bookings estimate. We believe the higher multiple is warranted, as the risk of negative earnings or cash flow has been mitigated and bookings have begun to grow.

Michael Pachter is an analyst at Wedbush Securities.