Can Facebook and Zynga stop the bleeding?

Both companies report earnings next week and have left investors with little more than disappointment.

By TheStreet Staff Jul 19, 2012 11:09AM

By Robert Weinstein   

 

After the biggest initial public offering in history, Facebook (FB) has disappointed investors large and small. Zynga (ZNGA) Facebook's big driver in traffic, is performing more like a lead zeppelin than a Led Zeppelin.

 

Facebook is anticipated to report weak second-quarter earnings after the close on July 26. The consensus estimate is currently 9 cents a share. Based on $29 a share and 9 cents earnings for the quarter, the price-to-earnings multiple is over 80. I am not sure the International Space Station is at a much higher altitude. At the current level of profits, it will take over 80 years of earnings to pay for one share of stock.

 

Facebook trades an average of 13.3 million shares a day with a market cap of $65.7 billion.

 

Over half the analysts covering Facebook rate it as a buy or strong buy; 14 of the 27 analysts covering the company give a "buy" recommendation. 11 analysts rate it a "hold" and two recommend selling.

 

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Analysts are increasingly more bullish with Facebook; 12 out of 27 analysts now rate Facebook a "strong buy," up from six analysts a month ago. Compared to three months ago, even more analysts are rating this company as a "strong buy."

 

The average analyst target price for Facebook is $38.50. At a price of $38.50, it will take over 100 years of profits to pay for one share.

 

An investment in Facebook is an investment based on the company rapidly growing the bottom-line profits. I believe Facebook has room to grow revenue and profits, but expecting a fivefold increase is beyond my expectations. Facebook needs at least a fivefold increase to justify a price above $38.50.

 

TheStreet's Harry Schiller provides another viewpoint on Facebook. (You need a Real Money Pro account to read, but Schiller's analysis makes it worthwhile.)

 

Revenue year-over-year has increased to $1.97 billion last fiscal year compared to $777 million in the previous year. The bottom line has rising earnings year-over-year of $606.00 million last fiscal year compared to $229.00 million in the previous year.

 

Smart money is increasingly betting against Facebook. Despite glowing reports and expectations from analysts, short interest has almost doubled from the first reporting period until the most recent report at the end of June. Over 60 million shares are short, up from 35 million about a month ago. That's over 12% of the float short.

 

Zynga is like dog sitting a 120-lb beast that enjoys chewing your furniture and isn't housebroken. You can't wait for your soon-to-be former friend to pick up their dog so you can forget the mistake. Probably the same friend that recommended buying Zynga.

 

Zynga is the world's largest social game developer whose titles include CityVille, FarmVille, FrontierVille, Words With Friends, Mafia Wars, Zynga Poker, Cafe World, and Treasure Isle. Zynga trades an average of 20 million shares per day with a market cap of $3.6 Billion.

 

Wall Street is expecting Zynga to report weak second-quarter earnings after the market closes on July 25. The consensus estimate is currently a loss of four cents a share. Last quarter Zynga reported 6 cents. The last quarter of 2011 was worth 5 cents in earnings. Two quarters aren't enough to extrapolate a pattern, but Zynga did beat estimates in both.

 

If the short interest level in Facebook raised concerns, Zynga's short interest is frightful. More than one out of every five shares is shorted. Zynga has a 21% short interest level of the float. The positive aspect of a large short interest on a sub $5 stock is it sets the spring for a bounce higher.

 

Zynga is a prime candidate for a classic old fashion short squeeze. (See my Apple preview Apple Earnings Preview: Another Home Run?)

 

If Zynga blows the number away and puts 10 cents up on the board, the stock can easily double from here. Zynga will need to follow up with impressive guidance, but I have witnessed bigger surprises in my career. I don't believe the odds favor it, but it's a thought in the back of the minds of every short-seller right now.

 

Technically the chart pattern is bearish (not hard to figure out when the price moves from the top left to the bottom right), but also nearing an oversold status as shares move towards $4. A strong down day with heavy volume may signal a bottom.

 

Unless you're a short-term trader it doesn't mean much. Investors will want to focus on fundamentals and the earnings performance. Without a significant beat, don't look for this dog to hunt anytime soon.

 

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