Can Zynga Recover From a 40 Percent Plunge?

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Zynga

Zynga slashed its 2012 earnings outlook after posting second-quarter earnings that fell well below estimates. The stock fell nearly 40 percent on the report. With $1.6 billion of cash on hand, can the social gaming company make a comeback?

“No…well, yes,” is what Evan Wilson, Pacific Crest Securities analyst, told CNBC’s “Squawk on the Street.”“We have not been positive on this name, but the thing that they have is cash.”

With $1.6 billion in cash, Wilson said Zynga can acquire new developers and new assets in order to release new games.

But money cannot necessarily buy popularity. “The problem is the traditional games like the Farmvilles and the Cityvilles — they’re basically declining,” Wilson said. Not only are these games declining, but Wilson said it is not clear that Zynga has games in their portfolio that will allow them to grow in the future.

“This is basically a no growth company with declining margins going into this year and next,” Wilson said.

With development costs up 79 percent, Zynga’s search for the next hit game will become more costly. Wilson predicted that Zynga will generate a small amount of cash in 2012, but he is anticipating the operating cash flow to start to drag in 2013.

“They are going to go out and start acquiring more assets,” Wilson said citing Zynga’s recent $180 million acquisition of OMGPopas an example of their growth strategy. He explained that the company will continue to chip away at their $1.6 billion cash pile and become more of a value trap.

Wilson warned investors that buying the stock because it’s cheap may not be the best idea. “The cash balance and the operating cash flow might go negative and it might be a value trap,” he said.

Zynga went public in December 2011. Some investors question why the company went public in the first place.

If history can serve as a guide, Zynga may look like a riskier investment. Wilson explained that there have been several game companies in the past that have gone public with only one or two popular games. “As those games start to decline, they show that it is very tough to create hits,” he said.

In 2011, 11 percent of Facebook’s revenue came from Zynga. Facebook was down 7 percent in early morning trade and this may be attributed to Zynga’s poor earnings report.

Zynga claimed that some of its second-quarter losses came from changes in the way Facebook operates. It accused Facebook of favoring other game makers and putting Zynga at a disadvantage.

“Zynga said that Facebook is incentivizing people to go toward new games from old games,” Wilson said. “That transition is going from very high paying games to very low paying games.”

This transition is a sign that the payments revenue opportunity may be shrinking.

Zynga is the biggest chunk of Facebook’s payments revenue. Wilson said the Street had this business line growing over 50 percent in 2012. “Clearly that growth rate is too high,” Wilson said adding that it will likely be seen inFacebook’s earnings release.

Wilson cited concern in Europe, the transition from desktop to mobile, and the situation with the payments line as headwinds that will likely impact Facebook’s earnings report after the bell Thursday.

—By CNBC.com’s Madeline Laskoski

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Disclosures:

Facebook is an investment banking client of Pacific Crest Securities. PCS makes a market in the shares of Facebook and Zynga.

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