Analyst Calls Zynga a "Sell"...Before You Can Buy It

Joel Anderson  |

It's usually not a good sign if your stock gets given a "sell" rating  before it's even available to the public or been priced, but that's precisely what appears to be happening to gaming company Zynga ahead of Friday's IPO. Arvind Bhatia of Sterne Agee started the company out as an "underperform" with a target price of $7, joining the debate over whether the company will ultimately prove a profitable investment.

At the core of the debate over Zynga is whether or not the company's prepared to make money in the long term. Bhatia, for his part, is bearish about the stock's potential. “While we believe in the potential for social games, we think Zynga’s growth is slowing even faster than what is obvious at first, its margins are under pressure, and free cash flow has been declining recently; thus we believe the implied valuation in the IPO is not justified,” he wrote.

He voiced concerns about the decline of Farmville, the company's most popular game, and the failure to get new titles out with enough speed. “Cityville, currently Zynga’s best title in terms of traffic, is tracking, by our estimates, 50% below Farmville at the same point in its history,” he writes. “Castleville (released 11/15), the new title in the “Ville” series, is averaging DAUs [daily average users] 50% below Cityville at the same point. The picture with Mafia Wars 2 (released in early October this year) appears quite dismal with DAUs having already declined to less than 1 million from 28 million reached 2 weeks after launch. This also implies, perhaps, that sequels in social gaming are not a guaranteed success. Zynga Poker, the company’s oldest title, seems relatively stable but is also past its peak.” Bhatia said that he anticipates decreasing revenues and growth to slow to 20 percent in 2012 and 17 percent in 2013 after a 16 percent spike in 2010.

However, Bhatia's opinion is not the consensus by any means. BTIG analyst Rich Greenfield differed, claiming that Zynga is a sound investment at the $8.50 to $10 range it's been projected for. "While it may be viewed as the next big Internet IPO with comparisons being made to other social-networking driven companies, such as LinkedIn or Groupon, Zynga is really a media company focused on taking a greater share of your time and money spent on entertainment," Greenfield said. He also pointed to the global adoption of smart phones and tablets, superior data analytics, and a first mover advantage as some reasons of many to be bullish on Zynga's chances in the open market.

Zynga is offering 100 million shares, an 11.1 percent stake in the company, which would give the company a market cap of between $7.65 billion and $9 billion depending on the initial pricing. Whether or not Zynga is actually worth that much is open for speculation. Zynga had $12.5 million in its third quarter this year, down 54% from its $27 million profit in last year's Q3. However, the company did manage an 80 percent increase in sales to $307 million. However, Zynga has to pay Facebook (whose IPO next year looks to be something of a big deal) 30 percent of its publisher revenues, Facebook's standard cut.

Some investors may be thinking that IPO should stand for "Incredibly Predictable Operation" as tech IPOs this year have followed a fairly similar trajectory over their first few months. Overall, it's been a rough year for technology sector IPOs as a number of prominent online companies went public only to see their share prices bail after the first month. Groupon (GRPN) had its IPO in November with an initial offering price of $20 a share. The stock spiked on its first day, reaching prices as high as $31 a share. However, prices leveled off and then, in late Novemeber, plunged, dropping under $15 a share on November 28th before regaining some value to trade at $21 a share. Similarly, LinkedIn (LNKD) offered at $45 a share in May, closed its first day up over 100 percent at $94.25, and plummeted under $65 a share in July before recovering and declining again in November to a 52-week low of close to $55 a share. According to Renaissance Capital, the tech sector has had 41 I.P.O.’s this year, also including Pandora (P) and Yandex (YNDX), with an average first-day jump of 20.3 percent. Year-to-date, though, the same companies have lost about 13 percent in value.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:

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