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Analysis: Putting Zynga's IPO In Perspective
Analysis: Putting Zynga's IPO In Perspective
July 1, 2011 | By Chris Morris

If we've learned one thing from today's long-awaited Zynga IPO filing, it's this: Damn, would it be nice to be Mark Pincus.

The founder and CEO of the social games juggernaut stands to make an insane amount of money when trading of the company begins on Wall St. (likely 3-4 months from now). He's already bucks up from selling 7.8 million shares back to the company in March for $100 million – and he's still holding another 105 million shares in his portfolio. It's nothing short of a massive payoff for his four-year old company.

(Fun factoid sidebar: Pincus not only owns the company, but he's the landlord for their office, pocketing $28,000 per month in rent. Also, Zynga has given him $145,000 over the past two years to use his private plane.)

As investors lick their chops, though, the rest of the video game industry is busy reading tealeaves. If, as expected, the company increases its offering to $1.5 billion or $2 billion, that will catapult it to the top of the publishing pack, with a valuation of $15 billion-$20 billion – supplanting Activision-Blizzard as the king of the hill and shoving Electronic Arts a little further down.

But if that happens, Zynga's 'industry leader' status is going to come with an asterisk – and it has nothing to do with the types of games the company makes.

It's gonna get a little wonky here with the moneyspeak, so bear with me.

To determine a comparative value between Zynga and traditional game companies, there's a multiple known as EV/EBITDA – essentially a company's enterprise value divided by its EDITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). Financial nerds use it to look for attractive takeover candidates and to search for signs of a bubble.

At its core, if the multiple is low, there's a decent chance the company is undervalued. Depending on the industry, higher multiples can point to something that's overvalued – with the exception of companies in high-growth industries. Gaming, in and of itself, isn't high growth (just look at the NPD numbers), but social gaming is.

So what I'm about to show isn't an exact apples to apples comparison, but it's as close as you're going to find for a while.

Arvind Bhatia, an analyst with Sterne Agee, ran the numbers to let investors compare how the Zynga offering may compare to traditional game companies. Here's what he found:

Activision has a 6X multiple. Electronic Arts came in at 11X. Take-Two and Ubisoft both had 8X multiples.

Zynga, if it sticks with the $1 billion round, will have a $10 billion valuation, giving it a multiple of 19X – a pretty high figure, but nothing insane. If it bumps that to $2 billion, however (as many expect it to do), the valuation jumps to $20 billion and the multiple soars to 46X.

Decide for yourself if that constitutes a bubble. I'll be busy covering my ears.

Actually, Zynga's filing could benefit a traditional game publisher – EA.

EA's one of the few companies that has invested substantially in social network games, with its Playfish acquisition in late 2009. The company saw its shares spike earlier this week when talk of Zynga's imminent filing began to circulate – and they're up 2.5 percent today.

Disney, of course, is laser focused on social games these days, but because that company is divested in so many industries, this likely won't ping their stock.

Does a public Zynga mean the company's a bigger threat to traditional game publishers? Not really.

It'll have more money to woo developers over, which is the biggest concern. But analysts say when it comes to stealing customers, a lot of the worries have been overblown.

"We do not see Zynga’s business as cannibalizing the packaged goods business, at least for hard core games," says Michael Pachter of Wedbush Securities. "We think that Zynga has captured some of the Guitar Hero and Wii Fit crowd—primarily women—and expect the company to continue to grow the games category beyond the traditional 13 – 30 year-old male demographic. However, we do not think that Zynga’s success spells doom or failure for the traditional publishers, as we are confident that the hard core gamer is here to stay."

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Greg McClanahan
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An EV/EBITDA of 46 isn't totally ridiculous given Zynga's recent growth. The question is just whether they can maintain this growth rate. It bears emphasis that the stock market is all about growth, growth, growth. Evaluate Zynga by its future forecast, not its present.

I'm not sure where you're getting an 11 EV/EBITDA for EA. Yahoo Finance has it at 467 (!), but probably because EA fluctuates so wildly between profitability and unprofitability between quarters that it's just a question of which data you're using. Questions of profitability certainly don't exist for Zynga, which is another justification for a high multiple. Not to mention EA's comparatively flat growth rate.

You could alternatively buy shares of Majesco, which is currently trading at an EV/EBITDA of 8 -- they might represent a possible buyout target with Zynga's new cash, which might be why there's been so much speculative movement on the stock lately. Even without the buyout, though, Majesco is currently forecast to have a P/E of 6 by 2013 (very cheap relative to earnings).

I don't think anyone thinks Zynga's a threat to the old business model of traditional publishers, but they're certainly a threat in the sense that the big publishers need to enter the casual space given the relative flat growth elsewhere in the more traditional corners of the industry. There's a land grab going on and Zynga is winning -- that's why their proposed market cap for the IPO is so high.

David Serrano
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I wonder which house of cards will collapse first... Farmville or COD?

Brad Borne
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Gotta love how Patcher considers the bulk of Wii adopters to be customers without loyalty to Nintendo, but then suddenly expects this fickle bunch to have loyalty to Farmville when the next entertainment fad rolls around, be it Wii U or the next franchise like Guitar Hero or what have you?

Jamie Mann
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I find it interesting that people have these great expectations of Zynga when they themselves admit that the vast majority of their revenue comes from a very small subset of users - and when indications are that the major social-networking markets have reached saturation (and may even be starting to decline), which in turn implies that there's limited opportunities for the growth of "piggyback" services such as those offered by Zynga.


Tynan Sylvester
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Wow, not only are they floating a financial bubble, but their products are also part of a design bubble since they "consume" their players so fast (very few people will play Farmville sustainably over the long term. Naive people sign up, play a while, get it out of their system, leave).

It's a bubble in a bubble. Double bubble trouble.

Jay Moore
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Retention and Re-Engagement costs are key metrics along with cost of acquisition, virality (nearly gone in FB) and life-time value of a customer.

Zynga has lost a good portion of its players to itself, Farmville --> Frontierville --> Cityville --> Empires & Allies, while still holding onto some decent preforming audiences with Mafia Wars and Poker. Illustrated well by their having only 148 million players across all games accounting for overlap vs. App Data showing 280 million MUU.

The more intelligent question is can social graph games expand to engage more sophisticated audiences while staying sticky for the new players they have attracted.

alexis bonte
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@tynan, they leave farmville and then play Frontierville, then cityville, leave cityville and then play Empire & Allies and that has more longevity (plus it kills me to say this being a CIV fan boy but its much better than Civ world) then on to the new game and so on. A few become fully engaged in one of the games and stay on. So as ling as they keep delivering new games of the quality of E&A they will keep growing perhaps not so much in player numbers but certainly in revenues. Then there is mobile expansion, acquisitions etc.. I'd say they are looking pretty good

Frank Gilson
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Alexis has identified one of Zynga's key strategies.

Release 'new' titles on as regular a schedule as possible in order to retain players within Zynga, if not individual games. Studies of internal cross-promotion demonstrate it to be beneficial. Some players continue to play (and pay) in the 'old' game, rejecting the new game. Some players leave the old game to play (and pay) in the new game. A short few actually play (and pay) in both!

Looking at the data shows that this strategy does NOT cause added player churn out of the company's portfolio as a whole.