Was Zynga's IPO good enough?

It's all a matter of perspective.

By Motley Fool Pick of the Day Jan 18, 2012 4:01PM

By Evan Niu

 

Last year saw many overhyped IPOs, and Zynga (ZNGA) probably takes the cake -- although it may have to compete for that title with Groupon (GRPN), which is trading slightly above its $20 offering price.

 

Still, the month since Zynga shares started changing public hands has been a pretty lackluster one. After the offering priced at $10, shares broke that threshold on just the first day and have remained in single-digit territory ever since. But in a recent interview with The Wall Street Journal, CEO Mark Pincus added some detail on why he considers the offering a success.

 

Pincus said that two of Zynga's primary goals were met through the IPO: raising $1 billion and gathering more long-term investors. But from that perspective, Pincus could have put check marks next to those items as soon as the offer was priced and before shares even began trading in the secondary market. From an investor's standpoint, Zynga's foray hasn't wowed anyone yet -- but it has only been one short month.

 

There was also some controversy over Pincus' involvement in renegotiating some of the stock compensation that a handful of early employees had received, a typical Silicon Valley tradition. Pincus framed those as "isolated incidents," saying that Zynga's tremendous growth meant that the company outgrew some early leaders and that the renegotiations were part of finding them longer-term roles.

 

Pincus sees a secular shift within the broader video-game industry, where upfront cost barriers are quickly being removed and the industry shifts away from ad-supported free games and toward "engagement" with virtual goods and product placement.

 

Zynga continues to try to wean itself from its dependence on Facebook, as it generates "substantially all of [its] revenue and players through the Facebook platform." The company expects that to remain true for the foreseeable future, although it's been pushing heavily into Apple iOS and Google Android.

 

I don't think Zynga will be a long-term winner for investors. As drool-worthy as the 106% revenue growth the first nine months of last year was, net income shrank by 36% since expenses jumped by 115%.

 

I've always been skeptical of the freemium monetization model, and although it's popular now, it's hard to imagine its sustainability. Fellow social mobile gamer Glu Mobile (GLUU) also uses the model, and its revenue growth has hardly been consistent. Glu put up top-line growth of a modest 9% last quarter, only partially recovering from the 21% shrinkage a year ago.

 

On top of that, Zynga has corporate-governance voting issues that I'm not comfortable with.

 

Traditional game makers like Activision Blizzard (ATVI) and Electronic Arts (EA) are much safer picks. Activision may finally be about to move, and EA has nearly unmatched brand recognition.

 

I'm giving Zynga an "underperform" CAPScall today, as there are better ways to invest in video games.

 

Fool contributor Evan Niu owns shares of Apple, but he holds no other position in any company mentioned. The Motley Fool owns shares of Apple, Google, and Activision Blizzard and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Activision Blizzard, Apple, and Google, creating a bull call spread position in Apple, and creating a synthetic long position in Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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