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Zynga has filed for an initial public offering, a highly-anticipated event for many investors. Rash Menaria recently wrote about Zynga and compared the valuations for it against other companies. While Zynga has impressive growth and the IPO will certainly get a lot of attention, I think that unless you already have shares or can buy at the IPO price, it will be challenging to make money as an investor, especially if you buy at what ends up being the top of the price range for these shares.
I prefer to focus on companies that may not be as exciting (for now) but that are likely to perform well over time, and have much lower valuations and no hype. One recent article talks about the sky high valuation for Zynga, which might be valued around $20 billion. By contrast, Shanda Games (NASDAQ:GAME) has revenues of about $714 million (vs. Zynga at about $597 million for 2010), and yet the market value for Shanda is only about $2 billion, around 1/10th of what the market value might be for Zynga. Is it worth paying that kind of premium for Zynga? I don't think so, and here's why.
According to its IPO filing, Zynga has about $597 million in GAAP revenue for 2010. Under "Risk Factors," Zynga states:

Facebook is the primary distribution, marketing, promotion and payment platform for our games. We generate substantially all of our revenue and players through the Facebook platform and expect to continue to do so for the foreseeable future. Any deterioration in our relationship with Facebook would harm our business and adversely affect the value of our Class A common stock.

This reliance on Facebook creates too much risk for me to be interested in Zynga as an investment -- and the high valuation will keep me away as well. If Facebook decides to negotiate tougher terms with Zynga or starts to develop its own social games as alternatives to Zynga, it could be very difficult for investors.
Also, while the growth rate at Zynga has been very impressive, it will be harder and harder to keep up that growth due to the law of large numbers. It's much easier to grow 50% in a year if your revenues are $100 million or less, but it is much more challenging when you are approaching nearly $1 billion in revenues and many new competitors are coming into the field so that they can be the next $20 billion IPO. You have to give credit to Zynga management for being one of the first social gaming companies, and I think it's also masterfully planning the timing to go public while the market valuation is what some might call absurdly rich.
Below I have detailed some of the game stocks that might be worth investing in as an alternative to Zynga. Just about every China-related stock has plunged recently. There is no doubt that with the huge population in China, and continued population growth, the opportunities for some of these companies are enormous. These companies have very strong balance sheets and have been in business for awhile.
GAME is trading at $6.60. GAME is one of the leading online gaming companies in China. The 52-week high is $7.70. The 50-day moving average is $6.82 and the 200-day moving average is $6.39. GAME has earnings estimates of about 73 cents per share for 2011 and 80 cents for 2012. This puts the PE ratio at about 9. According to Yahoo Finance, GAME has about $714 million in annual revenue and over $380 million in cash.
Giant Interactive (NYSE:GA) is trading at $7.45. Giant Interactive is one of the leading online gaming companies in China. These shares have a 52-week trading range of $6.03 and $9.45. The 50-day moving average is $8.06 and the 200-day moving average is $7.26. GA earnings estimates were about 65 cents per share in 2011 and 73 cents for 2012. This puts the PE ratio at about 11, which is low for one of the leading online gaming companies. According to Yahoo Finance, GA has about $221 million in annual revenue and over $900 million in cash, which gives it plenty of money to invest in the development of new games and Internet sites. The balance sheet is extremely strong, with about $4.17 per share in cash. This stock was trading near new highs just recently of about $9.45 and have dropped to current levels. Looks like a good time to buy cheap again, especially on any dips to about $7.17, which appears to be a strong support level for this stock.
Perfect World Co., Ltd. (NASDAQ:PWRD) is trading at about $19. PWRD is one of the leading online gaming companies in China. These shares have fallen from a 52-week high of $34.40. The 50-day moving average is $22.77 and the 200-day moving average is $24.05. PWRD earnings estimates are about $2.63 per share in 2011. According to Yahoo Finance, PWRD has about $397 million in annual revenue; the balance sheet is extremely strong, with almost $5 per share in cash. The substantial amount of cash it has on the balance sheet will allow it to invest in future high growth opportunities.
Disclosure: I am long PWRD.
Additional disclosure: I may buy shares of GA and GAME soon.
Source: Forget Zynga; Consider These Game Stocks Instead