Special Report – Zynga: The Untold Story

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Technology sector is getting hotter and hotter with each IPO filing. In this line of sweltering IPO’s comes the maker of the Ville games.

Zynga Inc., a company that sells imaginary tractors and other make-believe goods in online games, plans to raise some very real money from public investors.

After weeks of speculation the San Francisco start up which makes ?FarmVille? and ?Mafia Wars? and other popular games decided filed for an initial public offering in a deal that could value it as high as $20 billion, said people familiar with the matter.

It is expected to be Silicon Valley?s biggest grossing IPO since Google’s in 2004.

Hunger

Zynga is not alone in its venture to exploit the appetite of public investors for fast growing IT Internet brand names. Other include LinkedIn Corp., Pandora Media Inc., and soon to go public Groupon Inc.

?Zynga is taking advantage of the hysteria right now around social networking,? said Michael Yoshikami, chief investment strategist at YCMNet Advisors, which manages $1.1 billion in Walnut Creek, California. ?The valuation of $15 to $20 billion is extremely generous and they?re going to have to execute spectacularly in order to justify that valuation.?

 

The IPO will be managed by Morgan Stanley, Goldman Sachs Group Inc. , Bank of America Corp., Barclays Plc, JP Morgan Chase & Co. and Allen & Co., according to the filing. The company didn?t say how many shares it would sell or at what price.

 

Growth

It has been seen in the past that many companies which have grown at a rapid rate had bled red as they continued to spend to grow. However the highly anticipated filling from four year old Zyna showed that its mining money.

The growth rate has been amazing. In a letter to potential shareholders, Chief Executive Mark Pincus wrote that the 4-year-old company now has users in 166 countries.

Zynga increased revenues almost 400 percent between 2009 and 2010, when it booked $598 million in business. The company reported net income before dividends and other payments of $90.6 million for last year. “Their rate of growth is amazing,” said Michael Pachter, an analyst at Wedbush Securities, whose firm isn’t involved in the IPO.

During the first quarter of 2011, 94% of Zynga’s $235 million in revenue came from virtual goods, while the remainder was generated by advertising, according to the company’s IPO filing.? And the growth has remained steady, with a 133 percent revenue increase last quarter compared

In a letter to potential shareholders, Chief Executive Mark Pincus wrote that the 4-year-old company now has users in 166 countries. It also claimed it has 232 million users each month, a figure that drew whistles of appreciation from observers.

Importance of play

In a letter to prospective investors, Zynga founder and CEO Mark Pincus said gaming was rapidly becoming a core function of the Internet and connected devices.

“Play is one of life’s big macros – it’s an activity people love to do and do often,” he said. “Zynga was founded on a deeply held passion for games that family and friends play together – connecting, collaborating, gifting, bragging, nurturing, admiring and sometimes just doing silly stuff together.”

That “silly stuff” has created serious profits for the 4-year-old company, whose popular games run primarily on Facebook’s platform.

People are increasingly willing to take the discretionary money they would have spent on a movie or going out for ice cream and use them to buy virtual goods and play with each other. Zynga makes most of its revenue by selling digital food, tools, livestock and homes to users who pay with real dollars to build their online worlds.

Revelations

The filling has revealed the inner workings at Zynga.

It has been revealed that the revenues comes almost entirely from the sale of virtual goods within its otherwise free games, a business that?s largely alien to U.S. investors but is common among games companies in China and South Korea.

Zynga games are free to play, with the company making money from selling virtual items within apps, such as a townhouse in ?CityVille? or a shipyard in ?Empires & Allies.?

The worldwide virtual-goods market will more than double to $20.3 billion in 2014, from $9.28 billion last year, according to ThinkEquity LLC, a San Francisco-based research firm.

Zynga’s filing also shows how it accounts differently for its revenue, depending on the type of virtual goods sold. Revenue from “consumable” virtual goods like energy is recognized by the company immediately after a player’s game avatar consumes it.

In contrast, revenue from “durable” virtual goods like tractors, which can be used over and over again, is recognized over the estimated average playing period of players for particular Zynga games, a period that ranges between 10 and 25 months, Zynga said in its filing.

Zynga is valued at $15.4 billion on secondary exchange SharesPost Inc., topping Activision Blizzard Inc. and Electronic Arts Inc., which are worth $13.5 billion and $8 billion, respectively, on the Nasdaq Stock Market. Public market investors may balk at that price, said Ken Smith, a money manager at Munder Capital Management in Birmingham, Michigan.

Achilles heel

Zynga’s dependence on Facebook one hand seems to be a benefit as investors are piling into social media but it may also be the company?s Achilles heel.

While Zynga has developed games for Apple Inc. iPhone and iPad, Google Inc.?s Android phones and Yahoo! Inc.?s game site, it has struggled to make money outside Facebook. The company warned that it generates nearly all of its revenue and players through the world’s No. 1 social networking site.

“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.”

In other words: ‘if they fail, we fail. We have no other visible means of support’.

Not long ago both companies were at logger heads. Last year, for example, the gaming company came close to declaring war over a change in Facebook’s policy involving credits. Facebook wanted to take a 30 percent cut in transactions involving its credits — the currency Zynga players use to buy virtual goods.

Bing Gordon, a video game veteran, Zynga board member and partner at Kleiner Perkins Caufield & Buyers, described the standoff during the TechCrunch Disrupt conference in May as a Silicon Valley version of the Cuban Missile crisis where Zynga was at one point prepared to walk away from Facebook.

“Facebook would love to lessen its dependence on Zynga, but it’s not going to shoot Zynga,” said Wedbush’s Pachter. “Zynga is reason to come back to Facebook every day.”

Both the companies buried the hatchet by signing a five year contract. Things might change in the future.

More Capital

Zynga is a good corporate venture; it?s making profits, it?s a viable company and has got a vibe among everyone.? So while doing so well why does it need more money?

When we review document filled to SEC we get the feeling that this IPO is done just because they want to prove a point. Consider this, its raising money but it states in its filling document from page 28, “the three class structure of our common stock … will limit your ability to influence corporate matters.” Current management holds class B and C shares that get multiple votes per share and outweigh the A shares.

So it’s basically the company wants the money but opinions have to be kept to themselves.

From 16, “a small percentage of our players account for nearly all of our revenue?, people are addicted to their games and will not go anywhere. Their market is secured.

From page 36, “The principal purposes of this offering are to [blah blah blah], and create a public market for our Class A common stock.” Later in the paragraph, “We intend to contribute a portion of the net proceeds to charitable causes.”

Clearly proves money is not an objective.

Probable causes

Some experts say that the money will be used for branching into other platforms, such as smartphones and tablets. Indeed, in his notes to prospective shareholders, CEO Pincus wrote of being able to make his customers’ virtual worlds “available on all their devices in an instant.”

Another point which makes many people ponder is why is Zynga rushing to make the IPO, According to one source, the actual writing of the 150+ page S-1 document was one of the fastest documentation processes for an IPO of this size, only taking two to three weeks.

CEO Mark Pincus abruptly cancelled a planned appearance at the D9 conference at the beginning of June, adding to speculation that was when Zynga decided internally to go ahead with the IPO. The three-week period referenced above was the time between what is known as the first ?org meeting? with bankers and the final document filed ton Sunday.

Games

It could be the loot to build new games.

Of course, not all of those games are lucrative. “Historically we have depended on a small number of games for a majority of our revenue and we expect that this dependency will continue for the foreseeable future,” Zynga discloses in the filing.

“Our growth depends on our ability to consistently launch new games that achieve significant popularity. Each of our games requires significant engineering, marketing and other resources to develop, launch and sustain via regular upgrades and expansions, and such costs on average have increased.”

?Zynga should not just be viewed as a gaming company, but one that can engineer behaviour through a systematic process of gathering data and using that to refine its games. It?s not just about designing cute figures and a cute storyline,? says Ray Valdes, an analyst with Gartner research.

However, analysts fear producing formulaic games will wear thin. There has been some ?cannibalisation? as FarmVille users moved to CityVille, and ?churn? as users stopped playing Empires & Allies, perhaps turned off by the new combat element.

Own platform

Zyngas potential is not reached by its tie up with Facebook. Facebook does not have access to Chinese market, which has a huge interest in gaming.? Further 30% of Zyngas revenues are taken by Facebook.? Facebook limits the access of game developers. Thereby new games will be introduced slower leading to possible loss in market share.

Even though both companies have an agreement Facebook can easily turnaround and change its terms, which would leave Zynga out in the cold.? There is also the aspect of Facebook treating Zygna rivals more favorable.? And the final one what is stopping Facebook from building its own games.

So basing on all these factors it sure does make sense for Zynga to start their own platform, for which a lot of money is required.

Google interest

Well the biggest speculation regarding the IPO would be the internet giant Googles contribution. It is widely speculated that it is Google who would benefit from the IPO. This seems to be going off tangent for many.

Let’s get a better picture. Google invested more than $100 million in Zynga last year. The investment was designed to be part of a larger partnership, sources have told us. That partnership, we believe, will culminate with the launch of Google+ Games.

And you can bet that Google+ will prominently feature Zygna.

Arabiangazette published earlier that Google has not completely launched Google+ Games due to the insane demand. This shows that as most of Googles ventures its games platform would be a big hit.

Google believes in innovation and providing its users what it wants. All of this requires huge cash outlays.? The predicament that Google is in with the SEC probe and many other lawsuits which it is facing there may be some cash leaks.? One of the best ways to plug the leak is outside capital. If Google was to file for an IPO it would be an open target for more problems.

Thereby why not go through a venture which it already owns, silently!

Source: Wall Street Journal, CNN, BBC, Mashable, Daily Deal Press, San Francisco Chronicle

 

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