Zynga Inc (ZNGA), Electronic Arts Inc. (EA), Perfect World Co., Ltd. (ADR) (PWRD): What Will They Do?

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Some analysts suggested that Activision Blizzard, Inc. (NASDAQ:ATVI)’s stock rose recently because of their strong earnings, or because of perceived improvement in the gaming industry. However, I would argue that the company’s statement that they are considering, “substantial stock repurchases, dividends, acquisitions, licensing or other non-ordinary course transactions” is the real reason for investor enthusiasm around the stock. The big question now is, what will they do?

Zynga Inc (NASDAQ:ZNGA)Only One Of These Makes Sense
If Activision-Blizzard decides to make an acquisition, Electronic Arts Inc. (NASDAQ:EA) would be the big fish in the pond. The company has several great brands in the Madden, NCAA, Sims, Crysis, Assassin’s Creed games as well as over 250 mobile games. The problem is, their cash flow generation is wildly inconsistent. In two of the four quarters last year, the company actually reported negative operating cash flow. While $938 million of net cash looks good, compared to a market cap. of over $5 billion, this purchase would need to significantly add to earnings to make sense. The other challenge would be getting anti-trust clearance since Activision-Blizzard and Electronic Arts co-dominate the console industry.

Jumping both feet into the mobile and casual gaming business would mean an acquisition of Zynga Inc (NASDAQ:ZNGA). In the last few years, they have generated positive free cash flow. However, in the last four quarters, Zynga reported a net loss each time. The good news is, Zynga has attractive mobile titles like Cityville, Farmville, and Words With Friends, and $1.577 billion in net cash on the balance sheet. However, the company is expected to lose money the next two years. Even at half the market cap. of Electronic Arts Inc. (NASDAQ:EA), Zynga Inc (NASDAQ:ZNGA) doesn’t seem to bring nearly enough to the table.

One acquisition that could make sense is, online gaming specialist Perfect World Co., Ltd. (ADR) (NASDAQ:PWRD). The company has 12 online multiplayer games currently, just released 3 new games, and has 3 new games in development for 2013 and beyond. The company’s primary user base is in China, where Activision-Blizzard only gets about 9% of their revenue. In addition, the company generated about $154 million in positive free cash flow last year, and has $423 million in net cash on the balance sheet. The stock seems cheap at just 5.5 times projected earnings, and analysts are calling for 10% EPS growth in the next few years. Since Perfect World Co., Ltd. (ADR) (NASDAQ:PWRD) carries a $550 million market cap. and $423 million of that is cash and investments, Activision-Blizzard would get a lot of company for very little.

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