Social media stocks have been all the buzz in 2011. As the year draws to a close, Zynga is one of the most talked about of the 11 remaining IPOs scheduled for the year. Let's take a look at what investors will be buying into and how they might fare.
Zynga's Selling Points
Founded in 2007, Zynga is a social network game developer. Its games include "Farmville," "Words with Friends," "Castleville," "Zynga Poker," "Mafia Wars," "CityVille," "Pioneer Trail," "Empires and Allies" and others. The games are free, but some of the virtual goods used within the games cost money. The company does most of its business through Facebook.
Zynga will trade on the Nasdaq under the symbol ZNGA. According to the company's IPO road show presentation to investors, it will offer 100 million shares with a possible 15% overallotment. An overallotment would allow the company to raise additional capital if demand is high and the shares are trading above the offering price.
The overarching theme of the road show presentation is "Zynga = play." The company envisions itself as a leader in its field, on par with Google, Amazon and Facebook. Its most popular game, and in fact the most popular social game in the western world, is "CityVille." The company has created nine of the 10 biggest social games ever, the only exception being EA's "The Sims Social," which edges in at number three. Zynga alone has more daily average users for its games than its next 14 competitors combined. In the company's S-1, an SEC document a company must file before going public, it states, "games have become the second most popular Internet activity based on time spent, and have even surpassed email."
The company earns 95% of its income from its $969 million in sales of virtual goods that allow users to do things like play longer, give virtual gifts to friends playing the same game, buy VIP access and accelerate game progress. Five percent of the company's revenue, or $55 million, comes from advertising. Year-over-year growth for advertising revenue is 162%; for virtual goods, it's 122%.
Zynga says its model is better than the traditional game model because its development cycle takes months, not years. Its revenue model is not based on a single game purchase, but on free play with ongoing revenue from virtual goods. It engages players for years, not days or months, it gets continuous feedback from data and analytics, and it has network virality, rather than traditional retail distribution.
The company sees opportunity in the growth of social networks, the emergence of the "app economy," and the rapid growth of free-to-play games. Its strategy includes enhancing existing games, launching new ones, continuing mobile growth, gaining more international users and increasing the monetization of its games through advertising, sales of branded virtual goods and sponsorships, in addition to its existing sales of virtual goods.
It has 11 recently launched or new games to add to its existing 11 games. Its older games doubled in size last year and have continued to grow this year.
In its S-1 the company describes some of its risks. These risks include its heavy reliance on Facebook, operating a new business model for a short time in a new and rapidly changing industry, and reliance on a small percentage of players and a small number of games for most of its revenue.
Will Zynga's IPO Be a Success?
Even though this year's other new social media stocks have been unexciting after their first day of trading, some experts think the Zynga IPO could be a success.
"There is a premium to being one of the first companies like this to IPO, just like there is a premium to being one of the first companies to come to market with a particular product," says Mark S. Fellhauer, president & CEO of St. Louis-based Arch City Capital, which provides financial analysis and management consulting.
"This, and given that rumors are starting to fly about the Facebook IPO, could provide for some increased interest in this particular IPO, all of which would bode well for the overall performance of this particular issue," he adds.
Michael Ryan, chairman of San Francisco's Executive Impact Group, a global advisory company specializing in startup solutions, is also bullish on Zynga. He thinks Zynga could be one of the most profitable companies the U.S. has seen recently, given its high revenues and low overhead.
"My observation is it will be a very successful IPO," he says.
However, as Zynga transitions to a public company, Ryan says that CEO and founder Mark Pincus and his management team will need to adapt to increased public scrutiny and diversify their platform dependency on Facebook and head toward mobile games.
"Overall, Zynga should be one of the winners in social media and would seem to be a good long-term investment. My assessment is Zynga will grow with Facebook fortunes," says Ryan.
The Bottom Line
Looking back over 2011, the only safe bet when it comes to social media stocks seems to be the potential to make a profit buying and selling on day one. If your pile of investment money allows for room to play, go ahead and take a chance on Zynga or whichever social media stock strikes your fancy. If not, look for safer bets. If Zynga follows the pattern of companies like Groupon, investors who buy on the first day of trading will get hammered when the stock drops significantly in the following days. On the other hand, Zynga has some significant differences from already-public social media companies, such as its profitability, that could make its stock a significantly better performer.
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