Zynga, Rovio And The IPO Issue

You don't have to be a wizard of Wall Street to know the market sucks these days. While the Dow Jones Industrial average is slightly higher than it was at the start of the year, persistent fears of a double-dip recession – or worse – are preventing both individual and institutional investors from jumping into the market with any gusto. That's starting to affect the valuations of companies with looming public offerings, including a high profile one in the gaming world. And it should be a lesson to other game companies thinking about an IPO. Zynga, of course, is the company that's most in the crosshairs these days. It's moving forward with its plans to list on the Nasdaq market, likely before the end of the year. But the excitement level surrounding the social games maker, which was stratospheric when it made its initial S-1 filing with the Securities and Exchange Commission in July, has slipped with each of the company's four revisions to that prospectus. Revenues are up, which certainly isn't bad, but net income is down as marketing and hosting costs increase. And while it wasn't that long ago that Zynga's public offering was expected to make it the largest publicly traded game company, with a valuation of $15 to $20 billion, that's looking far less likely now. Earlier this week, analyst Sam Hamadeh of PrivCo, which examines privately held companies, said he puts the expected public value at closer to $5.5 billion. While that likely upsets the venture capitalists looking to cash out of Zynga, realists are probably pretty happy. If you'll recall, the earnings multiple (a nerdy moneyspeak term that lets bean counters more accurately compare the value of companies) on a $20 billion Zynga valuation in July was a whopping 46X. (Read a plain English explanation of that terminology and the math behind it here.) It was, to many, the definition of a bubble about to explode. Of course, it's ultimately the market that decides what a company is worth, and with all the shuffling going on at Zynga, investors are nervous. The most recent SEC filings indicate company founder Mark Pincus will retain a vast majority of the company even after the IPO, thanks to the creation of a third class of stock. Pincus would hold all of those shares, with each having 70 votes at shareholder meetings. (VC investors would get seven votes per share in their stock class, while plebes who buy stock as part of the IPO will get just one vote per share. Welcome to steerage class.) You would think Angry Birds maker Rovio, which has been crowing about its own plans for an IPO, would be paying close attention to this, but it's hard to see any evidence of that. "Mighty Eagle" (and chief marketing officer) Peter Vesterbacka told Bloomberg Television last week that the company is eyeing a 2012 public offering and believes the $1.2 billion valuation that has been attached to the company for a while now is a bit low. I've made my thoughts on that valuation pretty clear before. Simply put, though, the company's dependence on a single franchise, even one like Angry Brids that has plenty of offshoot revenue streams, is the sort of investment that might sound good in theory, but that investors tend to flee from – especially in rocky markets. Meanwhile, the ongoing economic uncertainty worldwide is prompting some companies to think about withdrawing from the market. Chinese MMO operator Shanda Interactive is hoping to do just that, in fact. Other game-related companies, like Gamefly, have been remarkably quiet about their own IPO plans, indicating they've put them in deep freeze for the time being. Neither Zynga nor Rovio seem to be following that path. But as the financial media and Wall St. analysts sound warning bells about Zynga and its valuation, you have to wonder… are these companies moving forward with the IPOs out of hubris, to cash in while there's still a degree of optimism about their market or in an honest belief that investors will see substantial returns?