Zynga continues to be one of the most widely talked about companies driving the social media revolution, and while it isn’t yet public, there’s much speculation on what it would be valued at if it were public.
While it does trade in modest quantities in the illiquid world of private market exchanges at around $9 per share (a market cap of $2.8 Billion), if it were public, I’m confident that the public would value the shares at a market cap of $5 billion or more.
While I recognise that most people’s knee jerk reaction is to think it’s 1999 all over again, this value is based on Wall Street style fundamental research (and no, that’s not an oxymoron).
There’s a social media revolution going on, and it’s bigger than most people think. It’s not 1999, it’s closer to 1997, and Zynga is one of the companies leading the revolution. Our $5 billion value represents 75% upside to where the shares are trading today. As I was told that Business Insider readers appreciate brevity, I’ll make just three points to justify my bullish stance.
- Zynga’s reach is truly staggering and dominant. With over 237 million monthly active users (MAUs) according to developerAnalytics, Zynga already reaches 120 million people every month, as each person plays about two games per month on average on the Facebook platform. Zynga is almost 4.5X the 2nd largest game developer (EA), and EA’s reach is largely a result of their Playfish acquisition (for $400mm)!
- Zynga is in the embryonic stage of the monetization of their massive user base. Yet I believe that Zynga generated $300 million in revenue in 2009, largely off the sale of virtual goods, and project revenue will leap 70% to $525 million in 2010. The 2010 projection assumes revenue of just $2.25 per MAU, while people in China (yes China where per capita income is roughly 3% of the U.S.) are averaging $5 per MAU today on gaming sites like TenCent. An estimate of $2.25 per MAU does not feel 1999ish. In addition, social gaming generates very healthy margins, with the leading Chinese gaming companies generating EBITDA margins of 50%. Even with more muted expectations for Zynga’s margins due to high marketing costs and the expected rise in payment processing fees due to Facebook Credits, I expect margins to reach 30%+ in 2010, and grow to 40% by 2015, when Zynga revenues should pass $1.6 billion.
- Zynga has some major competitive advantages as the dominant provider of social games. Most notably, Zynga has the unique and significant ability to cross-market their games to their user base of 120 million players. In addition, Zynga has proven very adept at replicating games that are gaining popularity, and using their marketing clout to surpass the original game developer (e.g. Farmville and Farmtown). In addition, Zynga will continue to use its deep pockets and coveted shares to strategically acquire games and gaming studios. Jesus, Zynga even has their own debit cards available in stores like Target and BestBuy to facilitate more buying of virtual goods. Where’s EA’s debit card?
While I’m bullish on Zynga, I don’t live in a cave, and I recognise that Zynga is facing some daunting risks. First and foremost is Zynga’s high dependence on Facebook, where the vast majority of Zynga’s revenue comes from. Facebook is going to increasingly tax Zynga, and all game developers, in various ways, for leveraging the Facebook platform.
Tax #1 is a marketing tax, where once game developers used notifications as a major marketing tool, Facebook stopped that practice, forcing game developers to dramatically increase their marketing dollars to Facebook to get maintain their presence and get the word out.
Tax #2 is Facebook Credits, which is extraordinarily well positioned to emerge as the dominant payment platform on Facebook, and Facebook is taking a 30% tax, I mean fee, for processing the payments ofr virtual goods.
Concentration is also a risk as about 45% of Zynga’s revenue appear to be coming from Farmville. While it’s a monstrous hit, beyond anything that came before it, it appears to have already peaked in terms of its popularity.
We are also going to see an onslaught of competitors, as outsized profits like those being earned by Zynga and others are invariably going to attract massive amounts of capital invested in competitors (that called capitalism). There will undoubtedly be thousands of small competitors that provide niche games that eat away at Zynga’s market share (think of what niche cable channels did to the networks). There will also be massive well capitalised entrants like Microsoft, who will surely buy their way in to market share by putting to work some of the billions of dollars currently laying dormant on their balance sheets.
So where does the $5 billion valuation come from?
The valuation is based on a 15.3X multiple on our projection of Zynga’s 2015 EBITDA of $659 million. I’m the first to admit valuation is part art and part science. The leading Chinese gaming company TenCent, trades at a 21X multiple of EBITDA, valuing it at $40 billion (yes BILLION). Yet we think Zynga should trade at a discount to that number, as Tencent’s games are played on its own platform paid for with its own currency (QQ coins). The second tier of Chinese gaming competitors, comprised of three publicly traded companies, trade at an average of about a 9X multiple. So we use a number in the middle (that’s the art part). A reality check on the multiple can be done by looking at our projected 5 year compounded annual EBITDA growth rate, which at 16%, is above our multiple, given us some level of comfort.
The entire 7 page detailed report on Zynga can be can be found at SecondShares.com, where you’ll also see credit going to my co-authors Eli Halliwell and Jay Gould.
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