The Contrarian Blog

Zynga Needs to Put on its Game Face

by Terri Stridsberg 6/26/2012 10:17 AM
Stocks quoted in this article:
Publication: "Market Watch"
Publication title: "Zynga to 'Unleash' Games on Cloudy Outlook"
Publication Date: 6/25/2012
Brief Summary:

Although this article somewhat hastily mentions some of the technical troubles plaguing Internet game developer Zynga Inc (NASDAQ:ZNGA) -- namely minimal growth of its monthly active users and a decline in its daily active users over the past few weeks -- it packs plenty of positive sentiment from the mouths of Wall Street. Today's "Zynga Unleashed" event in San Francisco will offer a sneak peek at some of the company's upcoming game releases, as well as a look at what's on the horizon for the company in general. The author notes that ZNGA, producer of free games such as FarmVille and Words with Friends, is still heavily reliant on Facebook (NASDAQ:FB) in terms of revenue. However, several analysts weren't shy about touting their belief in the company's ability to claw its way out of the red -- provided that it changes, well, pretty much everything about its current business model.

As one analyst commented, the online game guru needs to venture outside the box and offer more challenging options. Meanwhile, another analyst explained that the games with the most users are not always ZNGA's breadwinners. "They need to get a lot of people trying the game in order to get a core group that plays for a long time, and that core group is where they will make their money," he said. (Interestingly, both have still deemed the stock worthy of an "outperform" endorsement.) A third analyst -- who maintains a lofty price target of $13 for the equity -- pointed out that the recent lackluster usage data doesn't necessarily send up any red flags in terms of a possible second-quarter earnings miss, nor does it include the company's flourishing mobile gaming segment. The article also reaffirms that ZNGA still holds the title as the largest game publisher on Facebook, and ranks well above King.com and Electronic Arts (NASDAQ:EA) in terms of daily active users.

Contrarian Takeaway:

From a technical standpoint, ZNGA has indeed been quite the underperformer lately, swallowing a loss of more than 33% year-to-date, and lagging the broader S&P 500 Index (SPX) by nearly 51% over the past three months. On the charts, the stock continues to trade beneath its 10-week moving average, a trendline that has not been surmounted since early April.

As with Wall Street, however, there is plenty of positivity surrounding the stock in the options pits. According to the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), ZNGA sports a 50-day call/put volume ratio of 3.87, confirming that calls bought to open have nearly quadrupled puts during the past few months. From a shorter-term perspective, the equity's 10-day call/put ratio checks in at 3.22, signaling that traders have bought to open calls over puts by a margin of more than three to one over the last 10 sessions.

In a similarly optimistic vein, the Schaeffer's put/call open interest ratio (SOIR) sits at 0.58, indicating that calls almost double puts among options slated to expire in the next three months. In fact, a closer look at the data shows that the front three-months' series of options is home to a glut of call open interest. Specifically, the September 7 strike holds peak call open interest of more than 12,600 contracts. Moving forward, this area could translate into a layer of options-related resistance.

Turning back to the Street, Thomson Reuters pegs ZNGA's average 12-month price target at a lofty $12 -- in tandem with the upbeat brokerage outlooks presented in the article. However, this figure also reflects a staggering premium of 97.3% to Monday's closing price of $6.07. These potentially overzealous expectations leave the door wide open for future price-target cuts, which could push the stock lower -- and possibly prompt a downgrade or two in the process.

Despite the glowing endorsements from the aforementioned brokerage firms, ZNGA has a long way to go before it can truly be considered worthy of such bullish attention. In the meantime, analysts and gaming enthusiasts alike will wait with bated breath to see what's in store for the entertainment giant over the next several months.


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