First-day pops in initial public offerings are almost axiomatic today. After all, IPOs are engineered that way: You build buzz in a company in a hot sector, then sell only a small fraction of the shares, thus creating artificial scarcity. Presto: The stock jumps.
So what happened today with the IPO of social gaming company Zynga, whose shares are up a massive, um, 2 cents as of this writing? (Whoops, now they’re actually down 30 cents, or 3%.)Update: Make that down 5%. Apparently the only reason it didn’t drop more was a “stabilizing bid” by Zynga’s underwriters. Seriously? They can do that?
After weeks of anticipation and buzz, social game maker Zynga's initial public offering quickly soured Friday, with shares dropping into negative territory. Rex Crum reports on digits. Photo: Getty Images.
For one thing, it’s apparent that in this economy, investor appetite even for the most promising and successful IPOs isn’t bottomless. I’m not sure that any one company can set the sentiment for coming IPOs–least of all for Facebook, which will be a one-of-a-kind IPO when it presumably happens next year. And with Jive Software popping a respectable 30% earlier this week, it’s clear some IPOs will do just fine. But Zynga’s tepid performance casts a pall on many other IPOs in the pipeline.
It’s a little puzzling that Zynga–which is profitable and fast-growing, with few of the uncertainties of, say, two earlier IPOs, Groupon and Pandora–didn’t do better out of the gate. It priced at a relatively low $10 a share, and its $7 billion valuation ended up being about half of the amount some had speculated.
One reason besides the economy may be that investors realize Zynga is as much an entertainment business as a tech company, maybe more so. While Zynga has some network effects to leverage, the fact remains that it must keep coming up with compelling new games or it can quickly lose ground to rivals or the next big time-suck to catch consumers’ fancy.
So at some level, investors may sense that Zynga could be more vulnerable to competition than more traditional tech companies–a sense bolstered by the fact that Zynga’s profits fell 50% in the most recent quarter thanks to higher expenses. Some analysts certainly understand this, and have pegged Zynga’s fair value at only $6 to $7 a share.
What’s more, most of Zynga’s revenues depend not on sales of ads or physical products but on sales of virtual goods, such as trees and tractors in its signature game FarmVille. These items, which countless news stories misleadingly tout as “imaginary,” are no more imaginary than the 4,000 songs in your iTunes. But a lot of investors may be uncertain how long people will want to buy them–not to mention that a very small percentage of Zynga gamers account for the vast majority of virtual goods sales.
Finally, Zynga is almost completely dependent on Facebook, where its games are largely played. In the past, Facebook has changed the rules in ways that hurt Zynga, and given how rapidly the social network changes its service, that could easily happen again.
Yet another reason for the lack of a pop is that Zynga actually sold a somewhat larger percentage of its shares, about 14%, than some recent IPOs such as LinkedIn’s, which sold less than 10%. That’s still below the 24% average for tech offerings in the past year, however. What’s more, its offering price of $10 a share was at the high end of the proposed range–but under its most recent private offering. That means a little less of that artificial scarcity to drive shares up quickly.
Mark Pincus and wife Ali after he rang Friday's opening bell for Nasdaq trading to begin from Zynga's corporate headquarters in San Francisco. ZNGA stock went to $11.50 then pooped instead of popped ending at $9.50
Now, a reality check: Let’s not forget that Zynga’s IPO is the biggest since Google‘s in 2004, and that it raised $1 billion for the company. That’s a huge cushion and moat against the competition. If Zynga CEO Mark Pincus can keep his company on track, a disappointing IPO pop will mean precisely nothing in the long term.
COMMENTARY: The Zynga IPO had to be a huge disappointment for the underwriters who some analysts expected a 30% pop, but it just never happened for the reasons given above.
Here are few of the peaks and valleys during its first day of trading.
- ZNGA shares went to $11.00 right after the bell rang at 9:30 a.m. EST.
- ZNGA shares dropped from $11.08 to $9.50 between 11:06 a.m. and 11:16 a.m. EST,
- ZNGA shares rallied to $10.08 by 11:22 a.m., but that was the highest the shares would go, before experiencing a slow decline to $9.02 at 1:54 p.m. EST.
- ZNGA shares climbed back to $9.64 at 3:08 p.m. EST, but the shares went up and down and ended the trading day at $9.50.
It's obvious that the "Facebook Halo Effect," did not help Zynga very much at the end of the day. Instead, the market views Zynga's dependency on Facebook as a negative, rather than a positive. Zynga pays Facebook 30% right off the top for all virtual goods purchased by gameplayers. This should send a strong signal for other social networks if they are thinking about an IPO.
Zynga is a hit-driven business, and it has been able to create games that became hits the last two years, but has also incurred very high costs in the process, and this has negatively impacted its earnings as noted above, even though the company has increased revenues significantly on a nine-month basis between September 2010 and September 2011. That's not a good thing.
Zynga's revenue model has also been brought into question. 96.7% of its users are freeriders. Only 3.3% or 7.7 million users out of 227 million total monthly active users pay to play. Sophisticated investors would undoubtedly question how long you can continue maintain steady growth in revenues when only 3 out of 100 people are actually paying to play Zynga games.
What really cnaws at me the most is that 30% of virtual goods sales that Zynga pays Facebook for the privelege of using their social platform. If you review Zynga's prospectus dated December 2, 2011, without that 30%, Zynga would've generated operating income of $308 million and $316 million for the year ending December 31, 2010 and Nine months ending September 30, 2011 respectively.
That is the nexus of the problem facing Zynga, and investors saw right through that . The sooner that Zynga can get off Facebook and setup its own game site, something they are already planning on doing, the more profitable the company will be, in order to justify its P/E multile of 228.
Courtesy of an article dated December 16, 2011 appearing in Forbes
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