Jim Wilson/The New York TimesMark Pincus, Zynga’s founder and chief executive.
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With a real-world profit and an inexhaustible supply of virtual cows, Zynga on Friday filed for what is expected to be one of the biggest Internet stock offerings ever, a debut whose fate is tied largely to that of Facebook’s.
Zynga, the online gaming company behind the Facebook hits FarmVille and CityVille, said on Friday that it expected to raise about $1 billion in an initial public offering, a figure used to calculate the registration fee. But Zynga’s ambitions may be significantly higher. The company is expected to ultimately offer up to 10 percent of its shares at a valuation near or above $20 billion, people briefed on the matter said.
For some of the biggest Web start-ups, there is a growing sense of urgency to capitalize on the booming investor interest in new Internet stocks — as evidenced by the blockbuster debut of the professional social network LinkedIn in May.
Groupon, the giant daily deals site, filed last month for its offering. Its rival LivingSocial is said to be speaking with bankers about an offering. And the juggernaut of the group, Facebook, is expected to file this year at a valuation above $100 billion, according to two people close to the matter.
Some clues to Facebook’s business model may be found in Zynga’s performance. As the largest game developer on Facebook, Zynga accounts for many of its page views and more important, the sale of virtual items.
Zynga’s filing shows how a business built on virtual goods, like animated sheep and Tuscan villas, can be so lucrative. The company offers its games free but makes the bulk of its revenue from a small percentage of users who spend money on virtual goods to enhance their stature in its games. Online ads account for a sliver of revenue.
Its colorful, cartoonish games, most of which are played through Facebook, attract 148 million unique visitors a month across 166 countries.
Although Zynga started with a poker game in 2007, it has become best known for creating virtual world games that attract a broad base of users. Many of its top offerings encourage players to build, manipulate and share their virtual worlds with friends. Its reliance on Facebook is no accident. Early in Zynga’s history, Mark Pincus, the company’s 45-year-old founder and chief executive, focused on Facebook and quickly learned how to leverage the platform and its sharing functions to maximize the viral nature of Zynga’s games.
“Mark saw that this was going to be a land grab,” said Lou Kerner, a Wedbush Securities analyst. “Now they can advertise their new games to this giant base and that gives them a huge marketing advantage.”
The model has become a powerful cash machine. While many players never pay a dime, Zynga sells about 38,000 virtual items every second. The company swung to a profit last year, $90.6 million. Revenue, meanwhile, roughly quadrupled to $597.5 million. As of the end of March, Zynga had $995.6 million in cash on hand.
And while Zynga has competitors in online gaming, including stalwarts like Electronic Arts, so far no rival has been able to shake its dominance on Facebook. Of the social network’s top five games, four are Zynga’s. CityVille is most popular with 88 million active users. The No. 2 game, Empires and Allies, has more than 45 million monthly active users and it was introduced just a month ago.
And yet its success on Facebook also underscores its vulnerabilities.
While Zynga has prospered, its dependence on Facebook represents one of the greatest threats to the game maker. The vast majority of Zynga’s revenue courses through the Facebook pipeline. In the risk factors section of its filing, Zynga warns investors that “if we are unable to maintain a good relationship with Facebook, our business will suffer.”
At times, the relationship has been challenged by disputes over Facebook Credits, the site’s virtual currency system, and changes to the site’s notification system. Tensions flared last year over Facebook Credits, which effectively take a 30 percent “tax” from virtual good purchases, but the companies reached a five-year agreement in May to keep the marriage intact. (Notably, the company’s revenue figures are net of Facebook’s cut.)
“I think that’s the major risk in the story,” said Mr. Kerner of Wedbush Securities. “They do exist at the whim of Facebook, but it’s certainly in Facebook’s own self-interest to have a vibrant gaming ecosystem.”
Over the last year, Zynga has signaled to the markets that it is trying to become more independent. The company has signed partnerships with other portals like Yahoo and it has poured more resources into gaming on mobile devices.
According to the filing, proceeds of the offering will mainly be used for general expenses, including the development of games and marketing. In an investor letter, Mr. Pincus specified that he planned to continue to make big investments “in servers, data centers and other infrastructure.” And in a sign that Zynga will continue to be active in acquisitions — the company has made more than a dozen deals in the last year— Mr. Pincus said he planned “to fund the best teams around the world to build the most accessible, social and fun games.”
The growing war chest will come in handy as expenses mount. As Zynga expands beyond Facebook and grapples with the natural evolution of social games — which are becoming more complicated, as user tastes change — the company will be forced to spend more money on development, according to analysts.
Over the last year, the company, which is based in San Francisco, has hired hundreds of developers, and now has a staff of more than 2,000 people. According to the filing, its cost of research and development roughly tripled to $149.5 million last year.
When Zynga finally does go public, top executives and its venture capital investors will see their fortunes surge. Mr. Pincus, whose stake will be worth several billion dollars and represent the largest voting block, will also keep a firm grip on the company he founded.
In its filing, Zynga outlined a three-class stock structure that favors Mr. Pincus’s voting rights. Public shareholders will receive class A shares, with one vote per share. Meanwhile, Zynga’s current owners, the holders of class B and C shares, will carry stock with several votes per share. Mr. Pincus, who owns all of the class C shares, will see his voting power increase over time as class B shareholders sell their shares, according to two people close to the company, who were familiar with the matter.
The filing revealed that Mr. Pincus, who sold stock worth nearly $110 million earlier this year, still owns some 91 million shares of Zynga’s class B stock, or 16 percent of that class. Kleiner Perkins is the next largest shareholder, with 11 percent of class B stock, and five other venture capital firms own at least 5 percent. In total, the filing showed, Zynga’s employees and directors own 33.6 percent of the company’s class B stock. It is not known how many of those shares will be sold during the offering.
The filing also disclosed executives’ compensation, as well as one quirky add-on. Reginald D. Davis, senior vice president and general counsel, received $615,000 in cash bonuses and a paid trip to an out-of-town concert, which the company said it gave to Mr. Davis “in recognition of his dedication and long hours worked in 2009 and 2010.”
Kevin Roose and Michael J. de la Merced contributed reporting.
Article source: http://dealbook.nytimes.com/2011/07/01/zynga-files-for-1-billion-i-p-o/?partner=rss&emc=rss