The Hidden Gems, and Risks, In Zynga's IPO Filing

Zynga Inc. has finally filed the preliminary paperwork for an initial public offering with the SEC.  The S-1 filing puts a sale of up to $1 billion in Class A common stock but no formal terms have been indicated.  The social gaming maker of FarmVille and CityVille and other social-networking games also has not even listed a proposed stock ticker nor has it determined whether it will list on the NYSE or the NASDAQ.

We have come up with some of those gritty details that are hidden inside SEC filings to give investors a more clear picture of this IPO.  There is some pause for concern, but this does still remain one of our Top 17 IPOs to Watch for 2011.

The preliminary group of underwriters includes Morgan Stanley, Goldman Sachs, BofA Merrill Lynch, Barclays, J.P.Morgan, and Allen & Company.  The company’s current lineup of games is CityVille, FarmVille, FrontierVille, Words with Friends and Zynga Poker.  It also noted, “in June 2011 we launched Empires & Allies, a strategy combat game. Within its first month, Empires & Allies became the second most played game on Facebook based on monthly active users.”

Because of Class A, Class B, and Class C shares being involved, we are going to hold off until the first or second amended S-1 before breaking down the capital structure.  There are just too many exclusions.  The company’s filing even noted specifically, “the three class structure of our common stock has the effect of concentrating voting control with those stockholders who held our stock prior to this offering, including our founder and Chief Executive Officer and our other executive officers, employees and directors and their affiliates; this will limit your ability to influence corporate matters.”

Sales in bookings in 2010 were $839 million with GAAP revenue of $597 million.  Those figures in 2009 were $328 million in bookings and $121 million in 2009.  In 2008 those were $36 million and $19 million, respectively.

Here are some basic current statistics:

• 166 countries
• 38,000 virtual items created every second
• 60,000,000 daily active users
• 232,000,000 monthly active users
• 2,000,000,000 minutes of play per day
• 4,000,000,000 neighbor connections

Here are some other stats which have previously not been formally disclosed until today’s S-1 filing:

• 2,000 employees
• 148 million monthly unique users in 166 countries, which comes to 232 million monthly active users
• over $1.5 billion in bookings since its 2007 founding

Here is another hidden gem on its management team… Not a single one of its executive officers and directors listed on page 92 is actually under 40 years old.

The company also noted that it has generated positive operating cash flow since the fall of 2007.  It has also raised hundreds of millions of dollars and it now processes 15 terabytes of game data every day.

Major shareholders (via affiliates and entities therein) are listed as follows, but these are in CLASS B shares:

• Mark Pincus and related entities with some 91,385,846 shares, about 16.0%
• KPCB Holdings, Inc. with some 64,159,896 shares, or about 11.0%
• Institutional Venture Partners with some 34,326,072 shares, about 6.1%
• Union Square Ventures with 30,738,892 shares, or about 5.5%
• Foundry Venture Capital with 34,560,060 shares, or about 6.1%
• Avalon Ventures with some 34,680,608 shares, or about 6.1%
• DST Global Limited with some 32,843,100 shares, or about 5.8%

Here are just some of the key risks associated with the filing, listed directly from Zynga:

• “if we are unable to maintain a good relationship with Facebook, our business will suffer”
• “a significant majority of our game traffic is hosted by a single vendor, and any failure or significant interruption in our network could impact our operations and harm our business”
• “we rely on a small percentage of our players for nearly all of our revenue”
• “a small number of games have generated a majority of our revenue, and we must continue to launch and enhance games that attract and retain a significant number of paying players in order to grow our revenue and sustain our competitive position”

As of March 31, 2011, Zynga listed its cash, short-term and marketable securities as $995.648 million.  Revenues in the first quarter of 2010 were listed as $100.927 million, and that first quarter in 2011 had revenues of $235.421 million.  Operating income was $6.315 and net income was $6.435 in the first quarter of 2010; those figures in the first quarter of 2011 were $28.733 million in income from operations with net income of $11.805 million.

What investors need to know is that this is going to be another “tail IPO” or “sliver IPO” where only a small portion of the company’s total and fully diluted shares are outstanding in the free float.  That will help support the artificial high market capitalization rate, but we are beginning to consider these sliver IPOs as being very close to the old “tracking stock” model that was so popular in the late-1990s.

The expected value here will likely be put around the $15 billion to $20 billion.  Would that hold up if the company was selling say 50% or 60% of its total diluted share count?

The full SEC IPO filing is here.

JON C. OGG