New IPOs (initial public offerings)offer the promise of huge
upside as investors speculate on a young company's impressive
growth potential. Yet just as often, this potential is more hype
than reality, so you should only stand on the sidelines as
investors' enthusiasm obscures their ability see real
challenges.
For online gaming firm
Zynga (Nasdaq:
ZNGA
)
, I laid out the stark reality
in December 2011
, a few days before the company went public.
At first blush, I might have seemed too pessimistic.Shares moved
above the $10IPO price and into the low teens by the time
I revisited this stock
in February 2012.
In that look at the social media stocks, I concluded: "Zynga may
be the most dubious long-term
business model
. Not only does the company need to keep coming up with winning
games (as existing popular games can have a fairly short shelf
life), but the company is vulnerable to consumers deciding they
want to spend their time on other leisure pursuits than Facebook
games."
Well, this stock chart tells you what happened, as reality
finally set in.
Shares
now trade for just $5, or half the
IPO
price, and nearly two-thirds lower than levels seen at the end of
the first quarter. This makes Zynga one of the worst-performing
stocks of the second quarter.
Yet even as I'm not a huge fan of this type of business model, I
have to concede that $5 is just too cheap for this broken IPO.
The end of a fad?
A few quarters ago, I felt like the only person that wasn't
spending hours on
Facebook (Nasdaq:
FB
)
playing games. Gaming holds little appeal to me in light of all of
the books I still need to read and movies I need to watch. Yet for
millions of Americans, games are a part of life. Zynga's real
trouble stems from the fact people may have grown bored with
playing games on Facebook. A research report from Cowen & Co.
notes that Zynga's roster of daily users fell 8% sequentially in
May, perhaps due to a waning interest in Facebook itself.
But simply put, to declare Zynga as dead-on-arrival is quite
premature. Even if it's true that Facebook as a platform has
peaked, interest in gaming has not. And Zynga still has plenty of
resources to find new ways to capture the interest of
consumers.
This will always be a company in search of the next hot thing.
In 2011, that was Farmville, which was wildly popular and helped
shape interest for the late 2011 IPO. The number of people playing
Farmville on a daily basis has now fallen 70% from last summer.
Cityville, another popular Zynga title, has seen similar drops from
the peak. That's typical for many gaming titles, even those offered
by console- gaming companies like
Electronic Arts (NYSE:
EA
)
,
Take Two Interactive (Nasdaq:
TTWO
)
and
Activision (Nasdaq:
ATVI
)
.
Zynga is now banking on newer titles such as Hanging with
Friends, Scramble with Friends, Words with Friends and Draw
Something. There's a good chance that few or none of these titles
will be big hits. But this doesn'tmean the Zynga business model is
broken. Even with a recent slump in traffic, Zynga still is a major
player in this space. Analysts at Baird, who recently upgraded
shares to "outperform" with a $13
price target
, note, "Zynga generates more engagement than the next five social
game developers, combined."
Analysts now anticipate an aggressive launch of new games later
this summer and fall, perhaps in the company's planned "Zynga
Unleashed" event. (The date has not been set, but last year's event
took place on October 11.)
How far has this stock sold off? Consider that Zynga ended the
first quarter with $1.52 billion ($1.80 a share) in cash, which
equates to 40% of its entire
market value
. That's a lot of dough for the company's developers to use to
churn out new titles. Many of the company's new games won't make a
dent in the marketplace, but just a few successes would quickly
restore this stock's luster.
Risks to Consider:
Shares of Zynga have been heavily pressured by the "lock-up"
expiration, as insiders have been free to sell shares 180 days
after the Dec. 16, 2011, IPO. Roughly 115 million shares were freed
up in late April, another 330 million in late May, and another 200
million will be released in July and August. As a result, shares
could stay under pressure until then.
Action to Take -->
Despite the recent bungled IPO, obituaries for Facebook may be a
bit premature, and Zynga still stands as the pre-eminent games
provider on that platform. Indeed, Facebook is looking for ways to
make it easier for partners such as Zynga to
monetize
revenue and drive growth.
Though it's hard to get a clear read on how Zynga's sales growth
-- both on Facebook and mobile phone platforms -- will play out,
it's clear that the company's stock price plunge now heavily
discounts potential success. Though I think this stock will be
hard-pressed to move back into the teens this year, a relief rally
could easily bring it back to $7 or $8, good for as much a 60% gain
for investors willing to take a flyer on this stock.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.