Zynga: Looking a Lot Like Netflix

NEW YORK (TheStreet) -- Some of the best conversations start on Twitter (@Rocco_TheStreet) :

Active Tweeter and investor Conor Sen also told me that I'm beating a dead horse by hammering Zynga ( ZNGA). Self-reflective dude that I am, I tend to agree.

In 2011, more than one person told me that I was beating a dead horse on Netflix ( NFLX). We see how that turned out.

There's a big difference between NFLX criticism during 2011 and ZNGA criticism now.

I was bearish NFLX as the stock surged. Eventually, vindication came. WIth ZNGA, I was bullish on the way down; now I'm bearish after the carnage.

The peanut gallery yelps that I'm hammering ZNGA and its CEO Mark Pincus because I lost money on the stock. That's absurd.

I'm losing money on IBM ( IBM) right now, but I'm not ripping the company. There's little, if any, incompetence at IBM relative to Zynga.

Larger issues that companies such as Zynga and Netflix illustrate come into play here. And, ultimately, that's what investors should consider.

First, there are uncanny parallels between the two companies that, independent of Zynga and Netflix, deserve critical treatment.

Insider Selling, Stock Options and Stock Buybacks

Netflix spent a good portion of 2010 and 2011 buying back stock. It spent millions repurchasing shares at prices in excess of its post-implosion market price.

The whole buyback scheme was curious.

Netflix never said much about the practice; the company just claimed it was making best use of free cash flow.

Some folks question the sense of a growth company buying back stock. Others wondered if Netflix was repurchasing shares to offset the impact of dilution caused by the exercise of massive amounts of stock options. On his own, CEO Reed Hastings regularly cashed out around a $1.5 million in Netflix stock per pop, alongside aggressive selling by other insiders and the company's employee program.

Netflix provided the classic case of a company destroying shareholder value, when it fundraised $400 million toward the end of 2011.

However, Netflix deserves some credit.

When the business imploded and the stock crashed, it halted the repurchase program. And Hastings cut back his option exercising.

Zynga, another growth company (or at least that's the plan), announced Wednesday that its board authorized the repurchase of up to $200 million worth of stock, as posted on its Web site. On Wednesday's earnings conference call, the company's CFO noted he was uncertain if Zynga would end the year free cash flow positive.

You could argue that it makes sense to buy back shares with your stock so low. Plus, Zynga is flush with cash.

That argument doesn't wash.

Given its uncertain business and it's horrible history of acquisitions (it took a nearly $100 million charge this past quarter related to its purchase of OMGPOP), Zynga has the potential to burn cash quickly.

At day's end, Zynga needs another hit game. And then another. And then another. And then another.

Pincus needs to turn this company around. I've never questioned his ability as a visionary. If anybody can vision, it's him.

That said, he's not fit to be CEO.

Instead of buybacks and spewing talking points on conference calls (he sidestepped the million dollar Facebook ( FB) question), Pincus should focus on one thing for the time being -- making himself "Chief Strategy Officer" like Tim Westergren is at Pandora ( P) and naming a CEO who can handle the gig.

At the very least, he should do what Hastings should have done long ago -- bring in a strong COO. Somebody like Sheryl Sandberg who makes more than a token contribution at Facebook. She helps Zuckerberg run the show.

Counterintuitively, if you compare the three -- Zuck, Pincus and Hastings -- the youngest CEO appears to require the least assistance. Maybe the COO has something to do with that.

At the time of publication, the author was long FB and P.

Rocco Pendola is a private investor with nearly 20 years experience in various forms of media, ranging from radio to print. His work has appeared in academic journals as well as dozens of online and offline publications. He uses his broad experience to help inform his coverage of the stock market, primarily in the technology, Internet and new media spaces. He has taken a long-term approach to investing, focusing on dividend-paying stocks, since he opened his first account as a teenager. Pendola, 37, is based in Santa Monica, Calif., where he lives with his wife and child.

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