Zynga: Too dependent on Facebook

Social games maker plans $1 billion public offering. What should investors expect?

Credit: Photo credit: Facebook

As people who didn't start their Fourth of July weekend early might know, social games maker Zynga filed its long-awaited initial public offering last Friday.

I touched on the basics in a post that day. Zynga, of course, makes wildly popular Facebook games such as FarmVille, CityVille and Mafia Wars.

(Also see: Zynga files for an IPO)

To recap the highlights:

* Zynga hopes to raise up to $1 billion in the offering

* The company hasn't settled on a ticker symbol or trading exchange.

* There's also no information yet about the share-price offer range or number of shares.

* Zynga is profitable. Net earnings i this year's Q1 weres $11.8 million, up from $6.4 million in the year-ago quarter, while net profit for last year was $90.6 million, versus a net loss of $52.8 million in 2009.

* Revenue is growing fast. In the first quarter of 2011, Zynga's revenue was $235 million, up from $101 million in the first quarter of 2010. For 2010, revenue was $597.5 million, nearly five times its 2009 revenue of $121.5 million.

All that sounds swell! But what should investors be cautious about? What are the "risk factors" for Zynga's business? Here's some of what the company writes in its S-1 filing:

* It's overly dependent on Facebook.

"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."

Or any deterioration in Facebook's popularity and user base:

"If Facebook loses its market position or otherwise falls out of favor with Internet users, we would need to identify alternative channels for marketing, promoting and distributing our games, which would consume substantial resources and may not be effective."

* It's overly dependent on a small percentage of users.

"A small percentage of our players account for nearly all of our revenue."

In other words, while Zynga claims 232 million monthly average users, and 62 million daily average users, those statistics essentially are meaningless. Only a small fraction of those users matter to Zynga's bottom line.

* It's overly dependent on a handful of its games.

"Historically we have depended on a small number of games for a majority of our revenue and we expect that this dependency will continue for the foreseeable future."

In other words, the vast majority of Zynga's games are failures.

* Zynga doesn't get mobile yet.

"Our growth prospects will suffer if we are unable to develop successful games for mobile platforms. We have limited experience developing games for mobile platforms." ...

"Our experience in developing social games for use primarily on Facebook may not be relevant for developing games for mobile platforms."

The rest of the risk factors are boiler-plate: It's competitive out there, the departure of the CEO (Mark Pincus) would hurt, etc.

But the biggest risk factor investors must take seriously is Zynga's dependence on Facebook. If you think Facebook has staying (and growing) power, then owning Zynga shares might seem quite appealing to you.

But if Facebook hits a wall, or if the social networking giant's relationship with Zynga deteriorates, then investing in Zynga will be a losing game. And those aren't fun to play.

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