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The hot topic of today is likely to be the IPO of Zynga (NASDAQ:ZNGA). The company’s initial public offering raised $1 billion for the social gaming company. Around 14% of the company’s outstanding shares will be publicly traded while the rest of the company will be owned by CEO Mark Pincus (16%), employees, and a variety of other early investors. Chief executive officer Mark Pincus is not selling any of his ownership of Zynga during the offering and neither is the second largest owner KPCB Holdings, who own 11% of shares. There will be a ninety day lockup period before owners can sell shares of the newly public company. Shares were priced at $10 per share to the lucky people who gained entry during the IPO. They will hit the open market and likely rocket out of the gate

Zynga was founded in 2007 with the simple goal of “connecting the world through games”. Over the last four years the company has learned to monetize this connection through the sale of virtual goods. Zynga has looked at its company as, “A series of sprints that make up a marathon.” This might explain why they did not go public in the last few years. The company’s ability to release a series of games spread out along with several small acquisitions has helped them increase their cash flow and attractiveness to investors.

There are numerous articles on Seeking Alpha and other investment sites that pick why or why not to buy shares in Zynga. I have read through the S-1 filed by Zynga and numerous articles. I believe I have found the positives and negatives of the company and have presented them here for you to view and decide on an investment for yourself.

Positives

  • Users Activity – Users of Zynga’s social games spend over two billion minutes per day playing games like Cityville, Farmville, Zynga Poker, Empires and Allies, Mafia Wars, and Words with Friends. Playing games online is now the second most popular activity online, as it surpassed email during 2010. The majority of new users are gained through unpaid channels and word of mouth. Companies like Sirius (NASDAQ:SIRI) and Netflix (NASDAQ:NFLX) spend large amounts of money on attempting to acquire new users who will then pay monthly subscription fees.
  • Growing Revenue – Unlike other recent internet IPOS, Zynga is profitable and has been for several years. The revenue has grown substantially over the last three years.

2008-$19 million

2009-$121 million

2010-$597 million

The revenue is reached from two sources: advertising and the sale of virtual goods. Zynga has also recently entered in partnerships with companies like 7-11, Coca-Cola (NYSE:KO), and Farmers Insurance to help promote its products and increase its revenue.

  • Number One Position – As far as competition goes in social games on Facebook, Zynga seems to be doing fine. Zynga has more active monthly users on Facebook than the next fifteen gaming companies combined. Since the beginning of 2009, a Zynga game has been the most popular on Facebook each month.
  • Acquisitions – Other than a tax expense that is being paid with the proceeds of the initial public offering, hundreds of millions of dollars will go into working capital that could be used for acquisitions. While Zynga has grown primarily on its own created games, its acquisition of Words With Friends was one of the company’s best decisions. The company could put some of the money to good use and expand into new segments. Rovio, maker of Angry Birds, was a rumored buyout target of Zynga’s for between $1 and $2 billion.
  • Addictive Easy to Play Games – Part of the reason Zynga users play games every day or several times a week is the addictiveness. The games are built on users functioning with them daily whether it is creating a word on Words With Friends, or watering a plant on Farmville. Zynga has created games that are easy to play and enjoyed by users of all ages, which is something many competitors can not say.

Negatives

  • Facebook Credits – The introduction of Facebook Credits has been one of the publicly discussed negatives of an investment in Zynga. In 2010, Facebook made all gaming companies begin to use Facebook Credits as currency to pay for virtual goods. Due to this change Zynga went from paying an average of 2-10% fees on virtual goods sold to the now 30% Facebook collects on the credits. Facebook Credits are available for purchase through Facebook, directly in the games, or as gift cards at retail outlets.
  • Reliance on Facebook – While reading through the S-1 it is possible to see just how important Facebook has been and is to the future of Zynga as a company, Zynga threatened to walk away from Facebook recently but eventually caved and signed a five year exclusive agreement to offer its games on Facebook.
  • Minimal Paying Users – Around two to three percent of monthly users purchase virtual goods inside social games offered by Zynga. The virtual goods may be a new plant on Farmville, or the ability to refill health and energy on Mafia Wars. The percent of paying users is quite small. CEO Mark Pincus recently said he thinks the number of paying users could double. The announcement came just days ago and could be an attempt to pump up shares or it could be an actual goal by Zynga. If Zynga could grow its paying base to 5% it would represent an additional 7 to 10 million paying users based on current monthly user information.
  • Competition – While Zynga maintains the number one position in social games, it does not escape from competition. Electronic Arts (ERTS) has been buying out social gaming companies at an aggressive pace and could be the biggest threat to Zynga. The company launched The Sims Social and it is one of the few games to enter the top ten in monthly users on Facebook apart from Zynga games. Along with Electronic Arts and its subsidiaries like Playfish, Zynga also faces competition from Disney’s Playdom unit, Crowdstar, PopGames, Vostu, Wooga, Gluu Mobile (NASDAQ:GLUU), Rovio, and Gree.
  • High Valuation - The hype on Zynga shares is at its highest. Shares could prove too high of a price for investors to see any return for years on their initial investment. The company priced with a valuation of $10 billion but by the end of the day could be worth more than Activision and Electronic Arts combined.

Conclusion

As a small time investor, I did not get in at the IPO price of $10 yesterday. Shares will likely shoot up to $18-$20 in the morning hours. The important question is whether they will continue to rise over time or will fall back down to earth like recent IPOs Angie’s List (NASDAQ:ANGI) and Groupon (NASDAQ:GRPN) have. Shares of Zynga will also be added to newly traded exchange traded fund SOCL, which holds social media companies. I think shares of Zynga are a long term buy. The problem I have is they may be too expensive for several days. I think that if I can acquire shares at $15 I would strongly consider investing money in the company. As Cramer and other investors advise traders to sell the stock on the first day, I could get my entry point today as well.

Another option to invest in Zynga is publicly traded GSVC. The company has investments in non-public internet companies and offers a valuable investment option to small investors. Large stakes in Facebook, Twitter, and Zynga gives investors an opportunity to own private companies. The Zynga stake was purchased by GSVC at a valuation of $4 billion. The company will have a market capitalization of $10-20 billion depending on where it ends tomorrow. GSVC’s investment will double from the Zynga IPO.

Disclosure: I am long ATVI.

Additional disclosure: I own shares of Activision. I own no shares of Zynga but will purchase if they are traded within the right range during the next 72 hours.

Source: 5 Positives And 5 Negatives In An Investment In Zynga