ZNGA

Zynga (ZNGA) is a maker of casual social games played principally on Facebook.  The most famous of them is FarmVille.

The company follows in the footsteps of the Korean smash hit Kart Rider, which showed how immensely profitable “free” casual online games can be if they charge money for items players need to succeed (microtransactions).

going public

ZNGA went public in mid-December 2011–before GRPN shares began to give up the ghost–at $10 a share.

Shareholders weren’t as lucky on day one as GRPN IPO participants, however.  The stock opened at $11 and rose to $11.50.  It then faded back to $9, before closing the day at $9.50–below the IPO price, despite presumably the best efforts of the underwriters to “stabilize” the price at $10.

The stock did have a brief renaissance in February, when it reached almost $16 a share, before beginning its downward journey to the current $2.78.

 ZNGA as a “greater fool” stock

two investment variables

To my mind, the most important investment issues surrounding ZNGA were/are:

–whether it could follow the success of Farmville with other, hopefully bigger, games, and

–its relationship with Facebook.

on the first count,

It’s pretty easy conceptually to figure how much a given game is worth.  Games have a lifecycle that’s a function of:

–how many users it has

–how often, and for how long in each session, they play

–how long the game remains at/near peak popularity before players become interested in something else and fade away.

The detailed data may be difficult to come, but this is a straightforward discounted cash flow problem.  Figure out the value of a game–let’s say $3 a share–and that tells you how many successful games are already being presupposed in a given stock price.

Long before the IPO, industry sources were indicating that ZNGA was having trouble finding a follow-up success to Farmville.  Its subsequent games were attracting fewer players–who were playing them less intensely than Farmville, and losing interest more quickly.  Therefore, on all DCF counts, they were (much) less profitable.

To my eyes, ZNGA had all the earmarks of a one-trick pony.  Yet, to me the $10 IPO price presumed a parade of new hits.

on the second point,

experience, common sense and basic microeconomics all suggest that symbiosis can be a fragile thing in the business world.

From FB’s perspective, the fact the ZNGA games were a significant source of its revenue had to start it looking for other game makers to feature.  That would hedge against the possibility that ZNGA was a flash in the pan.  And it would diminish the leverage ZNGA would otherwise be gaining over FB if the hits kept on coming.

From ZNGA’s perspective, the fastest way for it to grow would be to tap non-FB gamers by establishing a platform separate from FB.  That, of course, would be potentially bad for FB.

The issue has two facets:

1.  Was ZNGA successful because FB steered traffic to it?; or was FB successful, at least in part, because it had preferred access to ZNGA games?  The more important partner should get the lion’s share of any profits from the partnership.

2.  The FB/ZNGA relationship had become profitable enough that the question of the respective profit shares came up.

Here again, the issue was settled pretty decisively over a year before the IPO.  ZNGA is successful because of  FB, not the other way around.

why subscribe to this IPO?

What must the subscribers to the IPO have been thinking?    …all I can see is the thought that “greater fool” had worked once with GRPN, so it would likely work again.

And, if you flipped the stock into the early strength on the first trading day, it did.

Tomorrow:  what were the underwriters thinking?