By Scott McDonald
Zynga (ZYNG) is the creator of such ridiculously addictive social media games as Farmville, Cityville, Castleville, Mafia Wars and Words with Friends and is the most highly anticipated IPO since Groupon (GRPN). The IPO is expected in early December. The first week of December is gone and Zynga is receiving a big boost in publicity due to Alec Baldwin’s recent ejections from an American Airlines (AMR) flight after he refused to stop playing Words with Friends and turn off his iPAD. The smart money is on the IPO happening early next week but should a position in ZYNG (the expected ticker) be on your Christmas list this year?
Zynga is undoubtedly going to be a high volume stock on the day of its IPO and that will result in a significant first day pop. Doubters should look no further than the recent Groupon (GRPN) or Linkedin (LNKD) IPOs as evidence. Zynga also benefits from its relationship with Facebook, which is also expected to IPO in the not too distant future. This stock will be off-the-charts popular because until Facebook does IPO Zynga will be a surrogate, the next best thing. People itching to buy into Facebook will be all over this one. This offers great opportunity and danger because the first day gains will likely be too good for many investors to avoid the allure of the “pump and dump.” There is potential for a 50% or more gain on day one and who would blame them for cashing out and causing a second day slide.
For investors not interested in simply riding the hype there are a couple concerns. Zynga has only recently turned profitable, posting just over $90 million in net income in 2010 opposed to the $58 million loss in 2009. A single year of profitability is not a trend. While social media games as a business proposition have certainly proved resilient, the popularity of individual game titles is far more volatile. What if Zynga’s titles fall out of favor?
Facebook accounted for nearly all of Zynga’s first-quarter earnings in 2011. While Zynga does have apps on many different platforms like the Apple’s (AAPL) iOS and Google’s (GOOG) Android, Facebook is where it makes its money. Until additional revenue streams become viable and consistent contributors Facebook has far too much power over Zynga. Who knows how that relationship will change when Facebook goes public?
The secondary exchange, SharePost, Inc has valued Zynga at $15.4 billion, which beats the $14 billion valuation of Blizzard Activision (ATVI), developer of such highly regarded video game titles as "Diablo," "Starcraft," "Call of Duty" and "World of Warcraft." Zynga will likely become the largest video game company on the planet when it IPOs but comparing Zynga with Activision or Electronic Arts (ERTS) is difficult.
Zynga’s model is vastly different from the traditional console and PC game developers and as such can’t really be compared with them. It more closely resembles the “freemium” model that software as a service (SAS) companies like Skype, a subsidiary of Microsoft (MSFT) use. The application is free to use but there are additional features or in Zynga’s case, virtual goods, that are for sale. Whether this model is sustainable is still questionable. Skype hasn’t had a lot of success maintaining profitability but it also did not have Facebook in its corner.
Recognizing that these risks are real is a matter of staying informed and in my opinion should not ward an investor off of buying into Zynga. The company has too much going for it right now. However, this information should temper enthusiasm to buy on the day of the IPO. This stock will skyrocket; that is not a question. There is simply too much hype and anticipation. The question is how far it will fall back to earth when it is no longer the next hot internet IPO. My recommendation is to put a limit buy order for a position in ZYNG on the day of the IPO for 120% of the IPO price. If you are one of the millions of orders that does not get filled, wait a week and try again when the stock is old news. By that time reality may have set in and the market may have corrected itself.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
