What Gives With Zynga?

If you read the mainstream media on Wednesday, you would have thought that Zynga (ZNGA) was destined for bankruptcy court.

"Zynga shares in free fall," said one media outlet.

There was some truth to that as shares of Zynga initially traded down 15%. But yesterday shares rebounded to levels they had been trading at around 2 p.m. on Wednesday. Zynga shares are up another 8%, back to above where they were at the close of business Wednesday prior to the earnings report release.

This is a lesson in how dangerous to draw conclusions from initial market reactions to earnings news. It also shows how the dominant narrative that most want to still believe about Zynga is a negative one.

The initial drop in shares reflected early investors focusing on the numbers. Daily active users, monthly active users and average bookings per users were all down.  Those became the headline numbers that drove the immediate narrative: "another bad quarter for Zynga ... where is the bottom?"

And, yet, almost as soon as the earnings call started on Wednesday, the stock kept coming back up from the immediate down 15% reaction. It got stronger as the market opened yesterday and then again today.

What gives?

I think there are a few things going on, but basically I think many investors took a step back and concluded that this was a trough quarter for Zynga. They axed a few new releases in the quarter, so their slate was rather light. This had a direct effect on active users and revenues. 

The slate for Q2 and the second half of this year looks much healthier. Immediately after the earnings call, Zynga released Draw Something 2 in the U.S. (it had already been released in Canada). The initial reviews have been strong for it and there are plans to heavily cross promote it with the help of celebrities and TV. Some investors seem inclined to buy in here at these levels on the assumption that it will be a hit game for Zynga and propel the stock upwards as its growth trajectory continues.

There was another interesting fact that came out in the details of the call on Wednesday. Zynga has done really well recently with a mid-core game called Ayakashi. This has monetized much better for Zynga compared to several of their other games and game categories.

So, not surprisingly, Zynga is planning on investing more in this mid-core product category. They have a game called Battlezone coming out in a few weeks that will also be mid-core and they're also hoping monetizes well.

Of course Zynga doesn't want to hype it, but there were clearly signs in COO David Ko's comments. If true, it suggests now is a great entry point for Zynga, assuming they are able to roll out a good suite of games over the course of the rest of the year with good cadence.

We'll see. I'm staying long with their backstop of cash and real estate assets.

At the time of publication, the author was long ZNGA.