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Analyst Sterne Agee Initiates Zynga Coverage With 'Underperform' Rating
Analyst Sterne Agee Initiates Zynga Coverage With 'Underperform' Rating
December 13, 2011 | By Mike Rose

With social gaming giant Zynga's IPO to begin trading later this week, analyst group Sterne Agee has initiated coverage of the company with an "Underperform" rating.

Sterne Agee's Arvind Bhatia noted that, while the potential for social games is definitely present, Zynga's growth has slowed down rapidly in recent months. The company revealed in September that its profits and userbase both declined during its June fiscal quarter.

Zynga has set the price range for the IPO at $8.50 to $10 per share. However, Bhatia noted that he will be initiating coverage of the company with a target price of $7 per share.

"We are initiating coverage with an Underperform rating," he explained. "We think Zynga's growth is slowing even faster than what is obvious at first, its margins are under pressure, and free cash flow has been declining recently; thus we believe the implied valuation in the IPO is not justified."

He cited Farmville and Cityville as titles from Zynga that have now peaked, and noted that Castleville, the latest release in the Ville series, is only averaging DAUs 50 percent below what CityVille achieved during the same timeframe.

Finally, Bhatia explained that Zynga's overreliance on Facebook is a concern. Zynga currently sees 94 percent of its revenue generated from Facebook, and Bhatia argued that any disruption to Facebook or policy changes to the service could impact negatively on Zynga.

Overall, he suggested that the company will see growth of 20 percent in 2012 and 17 percent in 2013, compared to growth of 156 percent in 2010 and 37 percent in 2011.

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Harry Fields
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Timothy Barton
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But I thought they undervalued it in order to drive confidence? Ahem...

Damir Slogar
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It doesn't seem you do. Here is the more detailed explanation:



The use of irony to mock or convey contempt.



Ardney Carter
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@John: Specifically, OP was referring to this earlier Gamasutra article

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Zynga may be overpriced, but really... that analysis lacks even a pretense of rigor.

Firstly, Facebook as an overdependency. Perhaps Mr. Bhatia would like to suggest another social gaming platform with 800million users Zynga should launch on. Or maybe he should be honest and admit he has no idea what he is talking about =D

Secondly, 20% growth is stonking. Don't kid yourself. Maybe we don't see over-100% numbers but we mustn't be so jaded to imagine that a growth rate that high is anything but steller.

Thirdly, so Cityville is underperforming. Current strike rate is 2/3, which is better than Apple. And Cityville is hardly underperforming, it's just not performing as well as the -top social game of all time-.

Fourthly, quick investigation reveals... Sterne Agee applied for Zynga pre-IPO stock but did not receive any allocation. This is sounding like sour grapes now.

However this does not mean I agree with the valuation of 8.5 to 10 bux a share. What we have to acknowledge is that -no one- has an effective model for predicting the value of these businesses. Take every valuation with a grain of salt. Perhaps the easiest way to think about it is as follows. A valuation of 10 billion means that of Zynga's roughly (29 + 12 + 7) 48 million DAUs (some of these are CERTAINLY the same person, so unique users is much less), at this point in time the company is expected to extract (10,000/48) 208 dollars from each user. The question to ask yourself is does this seem a plausible number, taking into account direct purchases, advertising revenue, future user growth etc etc. I am not providing an opinion, just trying to put in real terms what I feel the valuation of 10 billion actually means.

Timothy Barton
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I agree with all of your points except the first. I think the point he was trying to make is that Zynga as a company is at the mercy of Facebook popularity, stability and policy. The first two are pretty safe bets but who knows about the third. While it seem that Facebook recognizes the value and importance of its games segment, it would make me nervous to have 94% of my revenue tied up in an agreement I have little to no control over.