Zynga Updates Growth & Financials For IPO... Risks & Pitfalls

Zynga Inc. has updated its IPO paperwork with the SEC for its second amendment to its prospectus.  Many might be worried about market conditions due to the extreme volatility, but Zynga is still preparing to proceed with its IPO.  The financial terms are not yet set for shares or a price and there is still no ticker nor listing exchange selected.  The social gaming company is best known for its FarmVille, CityVille, Empires & Allies, and Hanging with Friends.  While Zynga has some real caveats, this was one of our own TOP 17 IPOs TO WATCH IN 2011.

The one issue we have is that there is still going to be a very complicated share class structure with A, B, and C shares in the company.  This implies that we have yet another IPO that will have a limited float and likely carry an artificially high market capitalization solely because of a small float.

The underwriting group is huge: Morgan Stanley; Goldman Sachs; Merrill Lynch; Barclays Capital; J.P. Morgan Securities; and Allen & Company.  Zynga’s stats are amazing when you consider that there is no true value other than the entertainment value (not to knock entertainment value, of course).  Zynga has customers in 166 nations, 60 million daily active users, 232 million monthly active users, 2 billion minutes of game play each day, and 4 billion “in-game user-to-user connections.

For the three months ended March 31, 2010 and 2011:

• revenue rose from $100.9 million to $242.9 million;
• bookings rose from $178.3 million to $286.6 million;
• net income rose from $6.4 million to $16.8 million;
• adjusted EBITDA rose from $93.6 million to $112.3 million.

From 2008 to 2010:

• revenue rose from $19.4 million to $597.5 million;
• bookings rose from $35.9 million to $838.9 million;
• net loss of -$22.1 million to net income of $90.6 million;
• adjusted EBITDA rose from $4.5 million to $392.7 million.

There is a warning in here on how many customers are free users that pay the company nothing:

• “Consistent with our “free-to-play” business model, historically less than 5% of our players have been paying players. Because the opportunity for social interactions increases as the number of players increases, we believe that maintaining and growing our overall number of players, including the number of players who may not purchase virtual goods, is important to the success of our business. As a result, we believe that the number of players who choose to purchase virtual goods will continue to constitute a small percentage of our overall players as our business grows.”

The risk section is also full of caveats that you might not see elsewhere in other online businesses.  The first and foremost risk is FACEBOOK: “if we are unable to maintain a good relationship with Facebook, our business will suffer.” Other business risks are as follows:

• “we operate in a new and rapidly changing industry, which makes it difficult to evaluate our business and prospects.”
• “we have a new business model and a short operating history, which makes it difficult to evaluate our prospects and future financial results and may increase the risk that we will not be successful.”
• “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.”
• “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.”
• “security breaches, computer viruses and computer hacking attacks could harm our business and results of operations.”
• “if we fail to effectively manage our growth, our business and operating results could be harmed.”
• “our growth prospects will suffer if we are unable to develop successful games for mobile platforms.”
• “expansion into international markets is important for our growth, and as we expand internationally, we face additional business, political, regulatory, operational, financial and economic risks, any of which could increase our costs and hinder such growth.”
• “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.”

So here is the deal in a nutshell: Zynga is a massive growth company.  You will be getting a sliver of the company and will never have any real voice as a shareholder no matter what. The company is almost entirely Facebook-dependent.

JON C. OGG