Zynga Stock Is a Play on Smartphones and Popular Games Like Words with Friends

The largest in the U.S., by far, is

Zynga

(ticker: ZNGA). Despite huge growth, the stock plays second fiddle to those of larger game publishers

Activision Blizzard

(ATVI),

Electronic Arts

(EA), and

Take-Two Interactive

Software (TTWO). That creates an opportunity for investors. Zynga shares could have significant upside in the year to come.

For years, Zynga was essentially an offshoot of

Facebook

(FB). Its hit FarmVille game relied on the giant social network, which complicated life for the game maker and weighed on profitability. Since taking over in 2016, CEO Frank Gibeau, a 20-year veteran of Electronic Arts, has widened Zynga’s circle of friends.

The company now counts eight games with at least $100 million worth of sales, according to Jefferies analyst Alex Giaimo.

“At their base, [our mobile games] are about being social with other people, and they are meant to be entertaining people 24/7, 365,” Gibeau says. “Every quarter, we want to come out with some big new feature or some big new content for each game.”

Wall Street forecasts Zynga sales to grow 42% this year, easily outpacing the larger game makers, to $2.23 billion. While the big videogame makers generally rely on big hits and new consoles to drive sales, Zynga has a steady stream of sales, which now generate significant profits, as well.

In 2020, analysts expect record net income of $377 million, or 35 cents a share, excluding certain costs like acquisitions and stock-option expenses. That’s up 45% from a year ago.

Investors are largely still stuck in a FarmVille state of mind, and they don’t give Zynga full credit for the growth. Zynga shares trades at less than four times sales estimates for the coming year, versus an average of 6.3 times for Activision, EA, and Take-Two. At 23 times forward earnings, Zynga also trades below the peer price-to-earnings average of 25, despite a more-reliable and generally faster-growing earnings stream.

While the console market dominated by Zynga’s peers can be lucrative, the roughly 210 million consoles is a small market compared with the billions of people who play mobile games, according to Giaimo’s research. While there’s more competition on phones, mobile games also come with far lower development costs.

“Not only is mobile the fastest-growing segment, but also it is the most competitive and is the cheapest category to create a game, so it makes the barrier to entry a bit lower,” says Giaimo.

That creates a challenge for upstart videogame developers, but Zynga’s scale allows it to stand out. The company’s portfolio includes Words with Friends and Zynga Poker, along with Harry Potter– and Star Wars–licensed games.

After going public at $10 in 2011, Zynga stock spent much of the following decade mired in the low-single digits.

The stock, which closed Friday just below $9, fell as low as $2 in 2016, giving the company a value less than its assets, which included a lavish San Francisco headquarters that has since been sold.

The turnaround has roughly coincided with Gibeau’s arrival four years ago. “We started building fewer games,” the CEO says. “We started focusing on making the games we had much bigger.”

In the second quarter, the company had 22 million daily active users and 70 million users that tuned in at least once a month.

In comparison,

Nintendo

(7974.Japan) has sold 61 million units of its popular Switch console since its release in 2017. Its top-selling Switch game, Mario Kart 8 Deluxe, has sold 27 million copies.

The broad reach of Zynga’s games helps to maximize profits by spreading development costs across a larger base. Zynga’s operating profit margin has more than doubled since Gibeau arrived.

Now, Zynga is using the success to scale up more. The company bought Turkish game developers Peak for $1.8 billion in July and Rollic for $168 million in October.

Peak’s games are similar to some of Zynga’s current mobile offerings, including a popular one called Toon Blast. Rollic adds so-called hypercasual games—simple games that are cheap to make and have a relatively short shelf life—to the company’s portfolio. Together, the acquisitions will bring millions of new users that Zynga may be able to attract to its existing franchises.

While Zynga has managed to free itself from Facebook, the company still relies on

Apple

(AAPL) and

Alphabet’s

(GOOGL) Google. The companies’ app stores are Zynga’s primary source of distribution.

That has been a worry for some investors, particularly as Apple weighs changes to advertising technology in its iOS mobile operating system that could limit Zynga’s ability to track ads and recruit new users.

Gibeau says that the game maker has a plan to mitigate any potential damage to its advertising revenue—which was 20% of total revenue last year—and to its ability to attract fresh players to its titles.

“It’ll require us to build some new tools,” he says, and “to change some of the processes in terms of how we acquire users.”

The good news is there are billions of people to choose from.

Write to Max A. Cherney at max.cherney@barrons.com