Market Overview

Inside The $1 Billion Zynga IPO

Online gaming company Zynga filed a $1 billion IPO today. The underwriters for the transaction will be Morgan Stanley (NYSE: MS), Goldman Sachs (NYSE: GS), Bank of America Merrill Lynch (NYSE: BAC), Barclays Capital (NYSE: BCS), J.P. Morgan (NYSE: JPM) and Allen & Co. In the filing documents, Zynga states that the company has online game players in 166 countries, and 60,000,000 daily active users accounting for 2,000,000,000 minutes of play per day. On a monthly basis, Zynga sees 232,000,000 active users.

The companies growth thus far has been phenomenal, with GAAP revenues going from $19 million in 2008 to $597 million in 2010. The company, which was founded in 2007, has grown to over 2,000 employees. In the company's letter to potential shareholders, they highlight the fact that games have become the second most popular internet activity based on time spent and have even surpassed email. Furthermore, games now represent the most popular category of apps on smartphones and account for nearly half of user time spent.

The company outlines its operating philosophies as such:

  • "Games should be accessible to everyone, anywhere, any time. From the beginning, we have strived to lower the barriers to play in people's lives. We want to build games to play with our parents, our children, our co-workers and our best friends."

  • "Games should be social. Every week our teams test new features to make our games more social. Historically, our players have created over 4 billion neighbor connections. And, currently, our 60 million daily active users interact with each other 416 million times a day.

  • "Games should be free. Free games are more social because they're more accessible to everyone. We've also found them to be more profitable. We have created a new kind of customer relationship with new economics—free first, high satisfaction, pay optional. This model aligns shareholder value with delivering the best player experience."

  • "Games should be data driven. Our culture combines the creative with the analytical. We develop and operate our games as live services with daily, metrics-based player feedback. This allows us to continually iterate, innovate and invest in the content our players love."

  • "Games should do good. We want to help the world while doing our day jobs. Through Zynga.org our players have purchased social goods, raising more than $10 million for those in need from tornado-stricken communities in Alabama to earthquake survivors in Haiti. With programs like our Sweet Seeds for Haiti, our players have touched people around the world."

Zynga lists its core values as:

  • Build games you and your friends love to play.
  • Surprise and delight our players.
  • Zynga is a meritocracy.
  • Be a CEO and own outcomes.
  • Move at Zynga speed.
  • Put Zynga first, decisions for the greater good.
  • Always innovate.

In the IPO prospectus where the company highlights potential risk factors to the business, Zynga discusses at length its relationship with Facebook and the risks that this relationship presents to the business.

The prospectus states that "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."

Potential risk factors would be if:

  • Facebook discontinues or limits access to its platform by us and other game developers;
  • Facebook terminates or does not renew our addendum;
  • Facebook modifies its terms of service or other policies, including fees charged to, or other restrictions on, us or other application developers, or Facebook changes how the personal information of its users is made available to application developers on the Facebook platform or shared by users;
  • Facebook establishes more favorable relationships with one or more of our competitors; or
  • Facebook develops its own competitive offerings.

Another very interesting, and potentially grave risk factor that Zynga highlights in the prospectus is that "we rely on a small percentage of our players for nearly all of our revenue."

Also, "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."

Despite the risks, Zynga's Key Financial Metrics section does provide a glimpse of the company's impressive growth. For example, EBITDA has grown from $17 million in Q1 2009 to $112 million in Q1 2011. One thing that investors will want to take note of, however, is that EBITDA growth has been slowing substantially in the last several quarters. In Q1 2010, EBITDA was $94 million. This implies y/y EBITDA growth of a little more than 19%, which is solid, but on par with Zynga's initial growth trajectory.

Expect this IPO to be hot, but there are many questions that remain about the long-term viability of Zynga as a leading social networking company.

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