Dec. 5, 2011 – Zynga announced last week the price range for its IPO will be $8.50-$10.00, valuing the company at just over $9 billion. This is down over 50% from the original target of $20 billion (or an initial asking price of around $24/share).

As PrivCo predicted months ago, Zynga’s sky high $20 billion valuation was not feasible. The information provided since Zynga’s original S-1 filing in July has raised questions about the company’s operations and financials. PrivCo has run analysis on Zynga’s deteriorating market position and have found the 5 main strikes against Zynga’s valuation, namely:

Strike 1: Zynga and Facebook

Zynga was essentially forced by prospective investors to disclose the nature of their 5 year contract extension with Facebook in the first amendment to their original S-1 Filing. In a nutshell, the contract is terribly one-sided against Zynga in favor of Facebook. The contract effectively ties Zynga's future for the next 5 years to Facebook by transferring the names of its best-selling games to Facebook, imposing the now infamous 30% tax on Zynga revenues by requiring Facebook Credits payments for all Zynga games, and imposing Facebook-exclusivity windows for new Zynga games.

"Upon reading the Zynga-Facebook contract, it was pretty apparent why Zynga at first chose to simply refer vaguely in its first S-1 instead of attaching the full contract and hope to get away with it," says Sam Hamadeh, CEO of PrivCo.com, the financial data provider on privately-held companies. In such a young and fast paced industry, 5 years is a very long time. Such a contract will not only stunt the growth that Zynga is looking for, but also stifle the innovation required to maintain and expand Zynga’s early market lead in the social gaming market, where established industry veterans such as EA are quickly catching up on.

Strike 2: Zynga’s 2^nd Quarter Financials

The September filing showed the first strong sign that Zynga’s business had peaked in the near term and was starting to deteriorate. Key Metrics like Daily Active Users (DAUs) showed their first ever decline since the release of CityVille in December 2010. Zynga’s DAUs dropped from 62 million in 1Q 2011 to 59 in the second quarter. DAUs were actually as high as 67 million in the second quarter of 2010, so the drop is actually worse, from 67 million DAUs for 1st quarter 2010 to just 59 in the most recent quarter. (Note that MAUs are also below where they were in the first quarter of 2010, from 236 then to 228 now).

Strike 3: Zynga’s Onerous Stock Structure

In late September, Zynga officially filed its amended certificate of incorporation changing its stock ownership structure so public investors in the IPO would receive an awful third-rate security: Mark Pincus' stock gets 70-to-1 voting power per share, VCs get 7-to-1 voting power per share, and public buying in the IPO. Mark Pincus has effectively turned Zynga into a plane where Mark Pincus got the sole first class seat, a few VCs sit in coach, and Zynga's asking the general public to pay up big to sit in steerage with their suitcases. The 3-class voting structure is unheard of and shareholders are essentially asked to ride in the back while Mark Pincus steers for the indefinite future. It is noted that Mark Pincus’ management style and business tactics have raised eyebrows in the past. Most recently, Mark Pincus had an unprecedented employee stock clawback in November (read full story here: http://www.privco.com/press/zyngas-forced-stock-clawback)

Strike 4: Zynga’s 3^rd Quarter Financials

Filed just last week, the SEC document showed further declines in Zynga’s business. DAUs fell again, now for the 2nd quarter in a row to just 54 million.  Another 10% of users disappeared in 1 quarter, 20% in just 2 quarters since the start of 2011. That's not exactly a compelling growth story.  The third quarter numbers also showed total "bookings" (advanced sales of virtual goods) actually fell for the first time ever.

"Zynga's sequential drop in bookings is so troubling for a 'hot IPO' that it just put the final nail in the coffin of the company's valuation," says PrivCo.com CEO Sam Hamadeh.

Strike 5: Zynga’s Change in Accounting Practices

Zynga’s change in accounting principles to accelerate revenue recognition (see full report for more information) to make the claim of profitability in 2011 where Zynga is actually closer to breaking even if not operating at a loss. The change was shown on Zynga’s second quarter filings with the SEC, stating Zynga changed the duration it recognizes revenue from sale of virtual goods: shortening the period from 18 months to 15 months, which added just enough revenue to show a tiny profit.  Without the accounting gimmick, Zynga was actually LOSING money.

Changing accounting assumption to increase revenue is something that should frankly be saved for a rainy day and is a tactic you might expect from a large corporation that's slow growing and stretching hard to hit its quarterly number. It is not something one would expect to see from a 4 year old "hot, fast growing" startup and should be a very worrisome indicator for investors

Conclusion

As PrivCo expected, the hoped-for $20 billion valuation has 5 very real and pressing strikes again it since the original IPO filing.  The series of bad news, deteriorating financial situation, and increasingly shaky corporate position of the company has dropped the valuation over half of what was expected in late summer. PrivCo analysis of comparable companies shows that although the $8 billion to $10 billion valuation is feasible, it is still above where industry comparables such as Electronic Arts and Activision-Blizzard trade at using similar revenue multiples.