December 16, 2011

Zynga falters in debut, sheds doubt on IPO market

Online games developer Zynga Inc scored badly as it went public on Friday, dashing hopes for the year's hottest tech IPO, as investors frowned on its over-reliance on Facebook, dimming growth prospects, and outsized control by CEO Mark Pincus.

Zynga's stock fell 5 percent below its $10 initial public offering price to close at $9.50 on Nasdaq on Friday, dealing losses to IPO buyers used to racking up gains on a stock's first day of trading.

Investors had eagerly awaited the IPO as a way to get a slice of Facebook's growth before the leading social networking website goes public, possibly in 2012. Zynga makes money on Facebook by selling virtual items such as jewelry and poker chips in its games such as “FarmVille” and “CityVille.”

At least one analyst said on Friday that some investors may have been turned off by Chief Executive Mark Pincus' large voting stake and control over the company. He has a special class of shares that grants him 37 percent voting power even though his equity stake is much lower, and public shareholders will have less than 2 percent of votes.

“We believe that having a CEO/owner-controlled board is particularly dangerous for investors in young companies,” said Cowen and Co analyst Doug Creutz.

Creutz, who has a neutral rating on the stock, added that history is full of examples of CEOs who have built young companies but cannot manage them when they mature.

Asked about his voting shares, Pincus told Reuters he decided to retain such huge control over Zynga because he believed from the start that he was the best person to lead the company.

“Investors who want to see the company deliver long-term value are going to be better served by the fact that I can continue to ensure the company keeps its focus on the long term

and we don't let short-term swings and opportunities reduce that,” he said in an interview.

Based on Friday's closing share price, the value of Pincus' holdings fell to $1.05 billion from $1.1 billion at the IPO price.

Friday's flop stunned investors who had expected a strong showing because the company is profitable, unlike other recent high profile Internet IPOs such as Groupon (GRPN.O) and Pandora (P.N).

“I was stunned when I saw this. This is a disaster for them. The way you're supposed to price deals is to give investors a 15 percent IPO discount to compensate them for the risk of backing a relatively new company,” said Dan Niles, chief investment officer of AlphaOne Capital Partners, who did not buy shares.

“It makes me wonder about the underlying health of the market. IPOs like this can change the whole tenor of the market,” he added.

Investors said Zynga's stock performance could hurt other private companies in the pipeline such as Yelp and even Facebook. Some investors regard Zynga's IPO as a proxy for Facebook, because 95 percent of its $828 million in revenue in the past nine months comes from Mark Zuckerberg's social network.

“Now we have an exciting IPO and people don't want it and that's a big concern for when Facebook comes out,” said Jeff Sica, president and chief investment officer of SICA Wealth Management.

The cooling off in the IPO markets could hurt Facebook's estimated $100 billion valuation, BGC analyst Colin Gillis said.

Zynga's reliance on the platform was supposed to attract investors looking to bet on Facebook's growth. With Facebook's IPO expected to be at least several months away, Zynga is one of the few indirect ways to bet on the website's future.

Facebook takes a 30 percent cut of the revenue Zynga derives from the social network, which features more than 222 million monthly active Zynga users.

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