Zynga's Story Poses Problems Like Other Recent Tech Filings

When social gaming company Zynga filed on Friday for a $1 bn IPO, the company’s financial performance stood out from some other tech S-1 filings and IPOs. There wasn’t any immediate negative surprise, unlike a number of recent tech IPOs. So does Zynga get to fly clear by comparison? Not a chance.

Some recent tech IPO filings presented obvious, if potential, problems. Pandora faces upcoming increases in royalty rates, which could bite profits. Demand Media claimed years of profitability that suddenly appeared as losses, and its business model was heavily dependent on the kindness of the Google search engine.

LinkedIn also confessed losses in years it had previously claimed as profitable, but had a bigger issue in how few of its members regularly used the site. Groupon, which has filed but not yet had its IPO, spun profit from its numbers with creative accounting that ignored significant marketing expenses.

By comparison, Zynga seems relatively clean. Although it, too, has a numbers issue – deferred revenues made results look smaller than many had expected – the company nevertheless made real money. But Zynga still has a pivotal issue going forward.

Zynga is completely dependent on a few critical factors for success. For example, Facebook ‘is the primary distribution, marketing, promotion and payment platform’ for Zynga. Just a few players are responsible for nearly all the company’s revenue, while a small number of games have been responsible for a majority of that revenue. A single vendor – Amazon, which has had some major service outages – hosts a ‘significant majority’ of the game traffic.

A company is always safer when risk is spread out in such a way that no one problem can endanger the whole company. But, like many technology companies with leveraged business models or forms of operation, Zynga has some very big individual risks. And although its past performance will be an enormous asset, the IR team will have to explain why the potentially crippling issues are unlikely ever to happen.

[Article by Erik Sherman, IR magazine]

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