Zynga (ZYNG) is expecting to raise $1 billion on Thursday with its IPO. At an expected $10 IPO price, the company will be valued around $7 billion.
This number sounds ludicrous to most investors since Zynga, a company whose biggest revenue source is virtual barnyard animals, is valued around the same price as Electronic Arts (ERTS), a company that is on the cutting edge of today’s video game technology. Despite Zynga being overvalued, in my opinion, I still believe that it will trade much higher than its IPO price for the first few days of trading. In this article, I provide my readers with three reasons why Zynga shares could be trading over $15 from day one.
Zynga is, believe it or not, a profitable company. In fact, it had a net profit margin of OVER 10%. Profit margins are down in 2011 due to research and development costs, but profitability still exists. Groupon (NASDAQ:GRPN), LinkedIn (NYSE:LNKD), Pandora (NYSE:P), Angie’s List (NASDAQ:ANGI) and Zillow (NASDAQ:Z) were still in the red at the time of their IPOs and future profitability was a long ways away for each company. Not even its competitor EA Sports is profitable despite cash cows like the Madden franchise. Having some form of earnings to predict future trends will really help Zynga out.
2. Multiples Analysis
I know this is a very ineffective way to value stocks, but when valuing Zynga with revenue multiple analysis using Groupon (8.9), LinkedIn (13.4), Pandora (5.8), Angie’s List (10.2) and Zillow (10.1), Zynga is about a $13 billion company using a lot of rounding and estimating. I’m not saying Zynga SHOULD be worth $13 billion, I am just saying that the market could potentially spit out that valuation if current trends continue. Investors who are bullish in tech darlings will take note of this, which will cause very bullish activity on the stock.
3. Revenue Potential
Zynga games have 227 million monthly users. With the company having $92.1 million per month in revenue, that comes out to about 41 cents in revenue per monthly user. The vast majority of Zynga’s revenue is derived from selling virtual goods, not by selling advertising. If Zynga started advertising more through games or started producing games specifically for large companies, there is a lot more revenue to be made. In this respect, Zynga is very similar to Google during its infancy. There is a lot of revenue potential that has not been exercised yet.
Zynga has delayed its IPO several times now and I am very surprised that the IPO price is about half of what was expected to be earlier this year. Pretty much every tech darling IPO strongly exceeded expectations, and Zynga should do the same.
I think Zynga will hold its value until at least the Facebook IPO and it will be a safe stock to hold for now. A good stock play would be to buy Zynga shares and short Groupon or buy Groupon puts. This way, if tech darlings as a whole fall off the table, you have some protection. But if Zynga proves to be a more valuable company than Groupon, you can generate a very nice return. Tech darlings are still very unpredictable and are hard to value by most standards, so I don’t suggest putting all of your eggs in one basket. But I think this strategy could be a fun little gamble.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.