Zynga

Social games maker Zynga (ZNGA) came public last December at $10 a share.  Its stock rose to an intraday high of almost $16 in early March, before beginning a swoon that has taken it down to less than a third of its initial offering price today.

What’s going on?

There are certainly Zynga-specific factors involved.  But it’s also important to note, I think, that the relative performance of ZNGA parallels almost exactly that of Groupon (GRPN), another flawed investment concept whose stock price has also cratered.

GRPN came public early last November at $20 a share.  It reached an intraday high on its debut day of a bit more than $31, but fell quickly to $15 late in the same month.  From there, GRPN rose again, to reach almost $26 in February before falling away to the current $6.50 or so.

The businesses of the two companies have almost nothing to do with each other.  Yes, both have weak competitive positions; both companies have eyebrow-raising management practices.  But one distributes discount coupons, the other makes games.  Yet, the stock market is treating them in identical fashion.  This suggests to me that the mood of the market has a lot to do with how the stocks have traded.

What’s surprising about them both, to my mind, is not their weak stock market performance itself.  Instead, it’s the fact that both initially got such a warm welcome from Wall Street.

ZNGA’s potentially wobbly foundation

Two potential issues with ZNGA were evident long before the IPO:

–the company’s almost total dependence on FB to distribute its offerings, and

–its reliance on a small number of games for its profits.  Even more worrying, reports I read before the IPO indicated that ZNGA’s newest games were attracting fewer users, and had shorter shelf lives–therefore, were making less money–than its existing hits.  So even maintaining operating profit might be a struggle.

ZNGA’s dilemma

It seemed to me to be basic microeconomics that if ZNGA tried to strengthen itself by developing distribution apart from FB, the move would bring a competitive response from FB that might be harmful.  This appears to be what has happened during the June quarter.  ZNGA established its own game portal and began to direct users to it;  FB responded by making it easier for its users to find new games instead of just playing ZNGA’s.  The result has been a sharp drop in ZNGA’s audience.

wide stock market effects

One slightly head-scratching consequence of the release of ZNGA’s weak June quarter financials has been a subsequent worldwide selloff in smaller consumer-oriented internet stocks, especially those with any social networking associations.  This makes no sense to me.  ZNGA’s problems are mostly unique to it, in my view.  FB appears to have been caught napping by the switch to mobile use in the US.  Its woes may well be temporary.

Anyway, the fallout on other internet stocks looks to me to be a case of throwing the baby out with the bath water–an emotional reaction that may mark as extreme a negative reaction as we are likely to get, and which may the the market equivalent of 4Q11’s buying frenzy.