Zynga Takes a Hit

By now everyone that follows the market in tech IPOs has seen the shellacking that Zynga has taken since its earnings disappointment on Feb. 14.  Not only has the stock been pistol-whipped like a Mafia Wars stoolie, now down about 14% since its pre-announcement peak, but the analyst community has heaped manure on it, Farmville-style,  even going so far as to issue that rarest of Wall Street opinions, an outright sell (from Evercore). It wasn’t just this first quarterly report that raised the skepticism of analysts and traders; issued at $10 by lead underwriter Goldman Sachs on Dec.16, the stock, rather than exhibiting the customary upside explosion associated with hot tech IPOs, actually sunk to a low of $7.97 before earnings speculators bid it up to $14.55 in anticipation of a nice report. Instead they got ambushed. Granted, part of the revenue miss was connected to the costs associated with the end of the lock-up period, and even though stockholders got drubbed, Zynga founders and early employees got to cash out and get rich. Other elements of the report that set the hairs standing on investor’s necks was the slower-than expected growth in Daily Active Users, and the big jump in R&D costs, which suggest to some analysts an undisciplined development environment.

Just to twist the knife, a self-proclaimed ex-developer went public on Reddit to amplify some of these concerns. According to "mercenary-games", Zynga is intentionally re-jiggering their games to make them addictive, and their development teams are overrun with “brogrammers”, defined as “Silicon Valley/Harvard type douchebags who got into programming ... YCombinator drop outs with…no idea how to setup a build system  nor work in native code.” This sort of “disgruntled ex-contractor” stuff is usually self-debunking, but in this case it reinforces some of the concerns that have been pointed out by respected analysts like Ben Schachter of Macquarie, who said the numbers still were "not enough to make the stock work.” In a lovely understatement, Schachter said “The fact that R&D went up more than we expected is not a good sign.” In fact, R&D increased eight-fold, a jaw-dropping metric.


So we’ve got a company that relies on one partner, Facebook, for 90% of its revenue, and that partner skims 30% of Zynga's take for the privilege of that dependency. If the worst is believed, Zynga is having challenges managing its development environment, and is not experiencing anything like  the growth numbers required to meet expectations or justify its valuation. To veterans of the first internet bubble, these issues sound hauntingly familiar. And they have major implications for the mega-IPO everyone’s chattering about, Facebook. As Dan Lyons notes in his Daily Beast commentary, the $100 billion valuation that’s being posited for Facebook values it at about half of Google’s current $188B valuation, without much clarity on its eventual business model or revenue-generation capabilities, which are now around $1B to $1.5B. I find it fascinating that investors are not showing anything like the tolerance for “investing in growth” or “collecting eyeballs before monetization” that they demonstrated in the first ‘net bubble.  Will investors, who probably will have to sell their families and debase themselves to their brokers just to get on the list that gets you on the list to get an allocation of Facebook, have the tolerance for a $100B company that’s seven years old and still doesn’t really know what it does for a living? I guess we’re about to find out.