Zynga IPO nosedives on debut

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Zynga CEO Mark Pincus ringing the opening bell on the NASDAQ with his wife Alison Pincus and other board and management executives. Photo - Forbes.com

If Zynga thought its success on the World Wide Web could be replicated on the Wall Street, it clearly did not happen. Shares of the online games maker fell 5% on their first day of trading.

The IPO price values the company at about $9bn. However, the bubble burst on the first day of trading. Stocks closed last Friday down 50 cents to $9.50, making it the first major web IPO this year to close lower on its initial trading day. Its flotation is the largest by an internet company since Google raised $1.9bn at its IPO in 2004.

The investors were stunned at the performance as they had expected a strong showing based on the profitability of the company and the hype created by other IPOs like Groupon and Pandora.

“This is a disaster for them. The way you’re supposed to price deals is to give investors a 15% IPO discount to compensate them for the risk of backing a relatively new company,” said Dan Niles, chief investment officer of AlphaOne Capital Partners.

Analysts say that it was evident from the beginning that the IPO would not make it. They have been saying for the past week that the companys initial announcement of an IPO price range of between US$8.50 and US$10 was too high. Sterne Agee analyst Arvind Bhatia said Zynga should have priced its shares at US$7. Morningstar analyst David Summer argued last week that Zynga was really worth only US$6 per share.

That Zynga’s stock didn’t fall further in its first day of trading was partly the result of a “stabilising bid” by its Wall Street underwriters, Wall Street Journal quotedone person familiar with the matter.

ZYNGA ZYNGA

Unlike other web companies, Zynga is actually generating profits.

Stephanie Chang, research analyst at Renaissance Capital, said: “It’s currently the leader in the social gaming space. It has 54 million daily active users, which is more than the next 14 game developers combined.”

She also pointed to the company’s exposure to an estimated 3% of Internet users, which gave it advertising potential of $1.5bn.

“That’s a source of growth they haven’t even tapped into yet,” she said.

It seems to be the perfect combination for success, so why did it fall flat on its face on the first day? What spooked the market?

Zynga decided to go public in July but since then it has seen its valuation plummet. Initially the company planned on raising $2 billion at a valuation of nearly $20 billion. Unfortunately, not going through with it during the summer seems to the biggest mistake. As it was asked to make its operations transparent, the companys culture and compensation practices attracted attention.

It was reported by the Wall Street Journal last month that Zynga Chief Executive Officer Mark Pincus told a small number of senior executives he wanted them to give back some of their equity or be fired. The company also reported lower profits in a recent regulatory filing.

The companys over-dependence on Facebook does not seem to impress some people. Unlike other games like Angry Birds which has adapted itself onto any platform, Zynga publishes four of the top five games played on Facebook, and 95% of its revenue is generated from the social network. Furthermore, Facebook receives 30% of the revenue earned. If Facebook’s user growth slows, Zynga’s growth is also likely to suffer.

FUTURE OF WEB IPOs

The tech bubble seems to be deflating. Zyngas weak debut speaks volumes about the market’s wariness when it comes to tech companies. Investors have increased their scrutiny of the web companies operations and practices. In recent weeks, the stock prices of LinkedIn and Groupon have tumbled, with Groupon at one point trading below its $20 IPO price while LinkedIn is down 30% from its first-day close.

Analysts say that the shift may have implications for the upcoming public offering of Facebook, which is the biggest in the recent fast growing Web companies. The Facebook IPO is expected to launch between April and June 2012, it is expected to raise as much as $10 billion at a valuation of more than $100 billion.

“A lot of investors feel like they’ve been burned by this space” with the recent losses on Internet stocks including Pandora Media Inc., Yandex NV and Renren Inc., said Max Wolff, a senior analyst at GreenCrest Capital Management LLC. He added that investors are starting to care more “about valuation and not just [getting] exposure” to the sector at any price.

SILVER LINING

Zyngas debut does not seem to ruffle many feathers. Rick Marini, CEO of BranchOut Inc. a professional network company which is also built on top of Facebook has other views. “There shouldn’t be any disappointment in the market when you can create a [nearly] $9 billion market cap company in the period of four years.”

On its closing on Friday, Zynga had a market capitalisation of $8.5 billion counting unexercised options, way above rival Electronic Arts Inc.

Sources: Wall Street Journal, BBC, The Independent, Bloomberg

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