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Why Zynga's Drop Is a Buying Opportunity


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Following an investor presentation -- on the back of news of more executive departures -- Zynga shares plunged to lows not seen in nearly a year. While investors shouldn't attempt to time the market, they should take advantage of large moves in either direction to modify positions. As long as an investing thesis hasn't changed, investors can use their acquired knowledge of the company to take advantage of a large, outsized market move that happens too often these days.

Anybody following Zynga over the last year knows that the company is in the midst of finishing up a turnaround led by CEO Don Mattrick. The company has shown a promising reversal in user trends and monetization metrics and is now embarking on a path toward growth. In the midst of all these improvements, investors became overly cautious on the mobile and social gaming sector following the disappointing IPO of King Digital Entertainment .

Analyst disappointed about CEO body language
The Zynga CEO gave a presentation at the Bank of America Merrill Lynch conference and analysts were disappointed with the tone and body language of the presentation. Despite limited actual news, several data points were extrapolated as negative that weren't new for the company. Some of the excuses for the stock dropping more than 10% during the day were really a rehash of current concerns that existed prior to the conference: low EBITDA margins, an unknown game pipeline, and the decision to not pursue real-money gaming.

Considering the lack of any long-term changes in the business model, investors can probably conclude the stock is reaching a crescendo with the negativity. The stock has now collapsed nearly 50% after reaching a high of more than $5.75 back in March. In that time, Zynga has produced solid stabilization in financial metrics, but it won't match the incredible 41% EBITDA margins of King Digital.

The building of solid franchises with repeatable business probably sets the company up for more stable margins in line with the 18% operating profit margins at Electronic Arts . Zynga is currently struggling to get the EBITDA margins up to those levels, much less match the higher margins of King Digital.

Source: Zynga Q1 2014 Presentation

On the right path, but don't expect a miracle
As with any turnaround, the path to recovery is always rocky. Investors should never get too high or too low when a company is in the midst of executing on a plan. The key is that the company is showing stable-to-growing user play and the key market is growing.

In the latest quarter, Zynga saw a reversal in user trends after a couple years of consistently declining numbers. The most impressive change was the trend in daily average users that increased sequentially to 28.4 million in the first quarter, up from 26.6 million in the fourth quarter. The impressive shift came without the help of any major games and on the back of improvements in old games such as Zynga Poker that recently gained bookings for the first time in seven quarters.

Source: Zynga Q1 2014 Presentation

Bottom line
Investors should expect volatile stocks like Zynga to have dramatic moves including the recent decline. Instead of panicking, investors should take advantage of the dips that occur without any evidence of a change in the turnaround plan. Despite the noise from the Merrill Lynch conference, the lack of an announced development pipeline provides the company a first-mover advantage, and real-money gaming remains an opportunity when that market opens up in the future. Investors need to quit sweating every move of the CEO and focus on the long-term potential of the company. Based on the margins of Electronic Arts, where Mattrick worked previously, Zynga has plenty of upside going forward.

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The article Why Zynga's Drop Is a Buying Opportunity originally appeared on Fool.com.

Mark Holder and Stone Fox Capital clients own shares of ZYNGA INC. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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