The Pros and Cons of the Zynga IPO (ZNGA)

Zynga is one of the most anticipated IPO’s of the year and with the collapse of other social media elite such as Groupon(GRPN) and Linkedin (LNKD) it is worth some review.

The social gaming company Zynga is planning to begin its IPO road show this coming Monday.  The company’s bankers began telling clients about the road show this morning, which also means we may soon get an amended S-1 filing with details about how many shares the company plans to list and at what price. Zynga originally filed for the offering back in July with plans to raise $1 billion, with reports that it could be seeking a valuation of between $15 billion and $20 billion.

Company founder and CEO Mark Pincus will be among those pitching to prospective investors on the road show. Other participating Zynga execs will include chief operating officer John Schappert and chief financial officer David Wehner.

The offering will be closely watched in Silicon Valley, particularly given that recent issuers like Groupon (GRPN) and Angie’s List (ANGI) already have begun trading at or below their IPO offering prices. A successful Zynga IPO could make those dips look company-specific rather than industry-endemic. If Zynga struggles, however, it could make the road to listing much rockier for those who hope to follow in the FarmVille creator’s footsteps.

Zynga plans to trade on the Nasdaq under ticker symbol ZNGA, with Morgan Stanley (MS) and Goldman Sachs (GS) leading a group of six underwriters. The San Francisco-based company reports around $30 million in net income for the first nine months of 2011 on $828 million in revenue.

Argument Against Zynga

• Video game revenues are driven by consumer taste, which can be fickle.  There is no guarantee of future success in forthcoming titles
• There is serious partnership risk with Zynga, who is solely dependent on Facebook.  It doesn’t have titles on other platforms like computers or game consoles (Xbox, PS3, Wii) – so, no other revenue streams.  Also, Facebook now mandates that developers use ‘facebook credits’ for customers to purchase items in-game, this takes 30% of the revenues away from Zynga (a five year deal was recently stuck between Zynga and Facebook).
• Only $13 million of $235.4 million of Zynga’s first quarter revenue was derived from online advertising and $222.4 million came from online gaming revenue.
• Dependence on few.  While Zynga has 230 Monthly Average Users (MAU’s), it only has 6.7 million unique payers.  The company generates the majority of its money from these few paying customers that buy in-game items.
• P/E ratio is very high.  It’s estimated that the starting price of $15-20 would be a P/E ratio of 195 trailing earnings or 105x expected 2011 figures.
•   Social Media may be overvalued.  Groupon opened its IPO ~$26, its now around ~$16 per share.  LinkedIn went up to ~$110 but is now back all the way down to ~$66 per share.
• Revenue growth appears to be declining. While revenue for Q3 2011 was up 80% from last year’s Q3 2010 and at $306M, they only grew 10% from this year’s Q2 2011. In fact Q2 revenue only grew 15% from this year’s Q1 revenue. While still good numbers it would seem to indicate a saturating of their core markets.
• Net Income for 9-month (2011) is $30.7 million.  A decrease of 35.5%, from 2010’s 9-month Net Income of $47.6 million.
• The adoption of Facebook Credits as their primary in-game payment method beginning in the third quarter of 2010 negatively impacted online game revenue in the nine months ended September 30, 2011.

Argument in Favor of Zynga

Crazy good customer usage stats:

• 230 million monthly active users (MAU) across 175 countries
• More MAU’s than the next 8 social game developers combined.
• 58 million daily active users, 2 billion minutes of play per day
• Zynga is profitable and growing revenues.  It reported $90 million in profits in 2010 and grew YOY profits in Q1 of 2011 by 84 percent.
• 9-month revenues in 2011 were $829 million, representing YOY growth of +106%, (2010’s 9-month revenue: $402 million)
• Social Networks are growing.  Market estimates are that there will be approximately 1.1 billion users of social networks globally, including over 800 million active users on Facebook, in 2011.  Globally this will grow to 1.6 billion by 2014.  (IDC Marketing)
• In game revenues are growing. the worldwide market for the sale of virtual goods was $7.3 billion in 2010 and is expected to more than double by 2014
• Company is decreasing its dependence on its top three games.  Zynga’s top three games accounted for 93%, 83%, 78% and 59% of online game revenue in 2008, 2009, 2010 and for the nine months ended September 30, 2011, respectively.

Guest Blogged with Simon Leach