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The venture capitalist angle on Zynga

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The tape on Zynga ZNGA -3.94% is about as ugly as you’ll ever see.  The almost 40% drop on the day means the stock is down about 67% in the last three months (and also that much since it came public). The Nasdaq’s COMP +1.37% circuit breakers got tripped, preventing any more short activity.   My contrarian spidey senses are picking up and I have to share some of the comments  I’ve read from analysts:

Arvind Bhatia, Sterne Agee: “While we have been bearish on the story since the beginning, these results and the current trends appear to be much worse than even we had anticipated.”

Evan Wilson, Pacific Crest, stops just short of accusing Mark Pincus of fraud: “While it is impossible to tell about Zynga, we have seen several examples of online game companies over-monetizing in the quarters leading up to an IPO or a follow-on offering, intentionally or unintentionally. Shortly after the fundraising, monetization decelerates or declines until it goes back to its normal level. This appears to have happened once again.” 

Ken Sena, Evercore Partners“Nevertheless, despite Zynga’s new valuation, we would caution investors to be wary as we don’t see these negative factors improving anytime soon.”

And my favorite one that has my alarm bells going off from Doug Creutz, Cowen & Co“ We Are Wary of Including Cash in Valuation. If erosion in Zynga’s Facebook business continues, we think they could be sorely tempted to chase potentially expensive acquisitions in the mobile space (i.e., OMGPOP) to jump start growth.”

Those of you who have been following my career know that I’ve successfully bought tech stocks that trade near or below their cash balances many times over the years.  And while Zynga ain’t no Apple, which is indeed a name I bought back when it was trading for less than cash back in March 2003, I’m taking a shot and getting long right here with the stock teetering around $3.  As I told my TradingWithCody.com subscribers this morning:

“At $3 a share, you’re essentially buying a “call option” with no expiration date.on the whole future of Zynga’s business. The company’s going to more than a billion dollars in sales this year, so you’re paying about a 1/3 sales ratio for this business now.”

Let’s be really clear about my reasoning and timeline.  I see a margin of safety in Zynga’s $1.6 billion in cash (plus some $200-odd-million in real estate, happy they took my advice and bought a home), but this isn’t a big position at all for me, it’s one that I’ll hold for a couple months, not a play on a long-term secular trend or it would go in the Marketwatch Revolution Investing Portfolio.  But the business will still generate about $1.2 billion in revenue this year, Facebook FB -11.16% will continue to expand, giving Zynga more potential customers, and that’s without any new killer titles.

Look at the list of the Zynga insiders who cashed out this quarter to the tune of $516 million, it’s chock full of A-list investors like Fred Wilson, Reid Hoffman and Silver Lake Partners.  So the narrative right now is “The insiders dumped that stock at the exact right time.” I want to flip that and say “The VC’s have sent you a term sheet for an investment.”  Consider the rationale for fiduciaries like Fred Wilson, who turned a $5 million investment in Zynga into almost $400 million.

When you hit an 80-times winner, you sell a little and send some money back to your limited partners, which has nothing to do with your belief in the company. Regulars investors like, who have never been involved with Zynga and haven’t lost or made money, are coming in with a clean track record to the name, that everyone loved at $12 and everyone hates at $3.  And here’s the term sheet the selling VC’s have just handed you:

Price: $3.10

Shares allotted: 736M

Implied valuation: $2.29B

Balance sheet: $1.6 billion

Q2 cash flow: $67 M

Q2 net loss: $22.8 M (including $95.5M stock-based expenses)

Q2 revenue: $332.5M (19% year-over-year growth)

Monthly-active-users: 306M (34% year-over-year growth)

I think it’s worth a shot for the next couple months starting from this $3 a share base.

Cody Willard writes Revolution Investing for MarketWatch and posts the trades from his personal account at TradingWithCody.com. At time of publication, Cody was net long Apple and Facebook. Follow Cody on twitter at http://twitter.com/codywillard.

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Cody Willard

Cody Willard

Founder, CEO & Chairman at Wall Street All-Stars, LLC
Cody Willard is the founder of Wall Street All-Stars and the principal of CL Willard Capital. Cody serves as an adjunct professor at Seton Hall University and writes TradingWithCody.com. He was an anchor on the Fox Business Network, where he was the co-host of the long-time #1-rated show on the network, Fox Business Happy Hour. He wrote a monthly investment column for The Financial Times as well as columns for TheStreet.com and was a regular guest on CNBC’s Kudlow & Company from 2004 to 2006. Cody’s stock picking ideas and economic outlooks have been featured on NBC’s The Tonight Show with Jay Leno, ABC’s 20/20, CBS Evening News, CNBC’s SquawkBox, Jon Stewart’s The Daily Show, as well as in the Financial Times, Wall Street Journal, New York Times, and many other outlets.
Cody Willard
Cody Willard

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