Zynga Spurning Sale Strands Owners at Worst Web Value

Zynga Inc.’s operations are getting the least credit in public markets among Internet media companies, and management’s refusal to consider a sale as growth slows is blocking an avenue for shareholders to recoup losses.

With the stock plunging 70 percent following Zynga’s December initial public offering, cash and investments represent 73 percent of the company’s market value, the highest proportion among peers trading for more than $1 billion, according to data compiled by Bloomberg. Zynga shares are priced at 1.03 times sales, the worst valuation in the industry, after posting the third-biggest slump in the Russell 1000 Index this year.

While Chief Executive Officer Mark Pincus, who controls

50.15 percent of the voting rights for Zynga shares, said in July that he’ll never consider a sale, Ironfire Capital LLC says the biggest developer of games for Facebook Inc.’s social network may draw the attention of activist shareholders pushing for changes. The $2.26 billion company, which has dropped to $2.97 a share following second-quarter earnings that missed analysts’ projections last month, might fetch $7.30 a share in a takeover, according to Falcon Point Capital LLC. Needham & Co. says Pincus probably wouldn’t consider an offer below the IPO price of $10.

“If they have an offer on the table, shareholders who have lost so much would welcome it,” Arvind Bhatia, an analyst at Sterne Agee & Leach Inc. in Dallas, said in a telephone interview. He has the equivalent of a hold rating on the stock, along with at least 17 other analysts, data compiled by Bloomberg show. Only six recommend buying.

Losses Accelerate

“We remain focused on this sector to deliver an engaging social experience to our players, and to develop and create the best social gaming products in the industry,” Dani Dudeck, a spokeswoman for San Francisco-based Zynga, said when asked if the company would consider a sale.

Today, Zynga shares rose 9.8 percent to $3.26 for the biggest advance since June 15.

Losses in Zynga shares accelerated in July when the company reported lower second-quarter profit than analysts forecast, saying changes to Facebook’s site made it harder for users to find its games. Compared with the first three months of 2012, three of its top games -- “FarmVille,” “CityVille” and “CastleVille” -- lost at least 20 percent of players, according to Bhatia, who cited AppData figures.

Zynga also cut its 2012 projection for bookings, a measure of sales of virtual goods. The company said earnings excluding some items will total 4 cents to 9 cents a share this year, down from a prior range of 23 cents to 29 cents.

COO Resigns

A week after the quarterly report, people familiar with the matter said Chief Operating Officer John Schappert was stripped of his role overseeing game development amid a reorganization aimed at reviving growth and making more money from mobile services. Zynga announced his resignation on Aug. 8.

“Given the reputation that management has garnered in only a short time as a public company, shareholders would likely have more near-term faith in the business if a change in control were to occur,” Evan Wilson, an analyst at Pacific Crest Securities Inc. in Portland, Oregon, said in a phone interview.

Zynga is suffering along with Facebook, which has tumbled 50 percent since its IPO in May. A renewed emphasis on mobile with games may help Zynga reduce its reliance on Menlo Park, California-based Facebook, which accounts for about 80 percent of quarterly bookings, or the total value of goods sold in its games.

Takeover Value

The slump in Zynga’s stock means its operations represent a relatively low proportion of its market capitalization. The company had $1.64 billion in cash as well as short- and long-term investments on June 30. That’s 73 percent of Zynga’s market value of $2.26 billion at yesterday’s close, the highest among 34 Internet media companies worldwide trading for more than $1 billion, according to data compiled by Bloomberg.

Still, Zynga may be worth between $4.75 and $7.30 a share to a buyer, based on the valuation investors are giving game developers Activision Blizzard Inc. and Electronic Arts Inc. relative to their sales, said Michael Mahoney, a senior managing director at Falcon Point in San Francisco. That implies a premium of 60 percent to 146 percent from yesterday’s closing level. Tom Taulli, who analyzes acquisitions and public offerings for Los Angeles-based IPOPlaybook.com, said he could see Zynga fetching $6 a share.

Zynga’s ownership structure would be a hurdle to getting a deal done. Pincus owned shares giving him 50.15 percent voting rights as of July 23, up from the 36 percent level reported in the company’s annual report in February. Its equity is split up into Class A, Class B and Class C shares, with the publicly traded Class A stock conveying the weakest voting rights.

‘Natural Causes’

Pincus, who founded the company in 2007, said at a PandoDaily event in July that he’s told investors and employees that he plans to keep Zynga independent.

“I was upfront with everybody,” he said. “I said, ‘We’re never going to sell the company. There is no exit.’ I’ve said, ‘My only exit is by natural causes.’” When Pincus, 46, was asked if he plans to be Zynga’s CEO for the rest of his career, he said, “That’s what I aspire for.”

Despite the concentration of ownership in the hands of Pincus and other insiders, activist investors may push for changes at the company, according to Eric Jackson, the founder of Ironfire Capital.

“It wouldn’t surprise me if people started to do that at Zynga because it’s getting close to the value of cash,” Jackson said in a phone interview.

Value Questions

Potential buyers may be deterred by the slowdown in Zynga’s business, Macquarie Group Ltd.’s Benjamin Schachter said.

“I don’t think people will approach them right now,” Schachter, an analyst at Macquarie in New York, said in a phone interview. “People are questioning the value of the user base and the business model. People are trying to figure out how broken the story is.”

The company may still prove alluring to Activision Blizzard, Electronic Arts, Google Inc., Microsoft Corp. and Sony Corp., Sean McGowan, an analyst at Needham, said in an interview. Asian companies such as Gree Inc., Nexon Co., Sina Corp. or Tencent Holdings Ltd. may also be interested in Zynga, according to Mike Hickey, a senior analyst at National Alliance Securities Corp.

Representatives for Electronic Arts, Google and Microsoft declined to comment on whether their companies are interested in Zynga. Activision, Gree, Nexon, Sina, Sony and Tencent didn’t immediately return requests for comment.

Initial Gains

Zynga has an “excellent library of games, great developers and a good brand in the marketplace,” Paul Sweeney, an analyst at Bloomberg Industries, said in an interview. “That would make them attractive to anyone looking to get into the games business.”

The company’s stock initially rose following the December IPO, climbing 47 percent to $14.69 as of March 2. Zynga is now struggling to convince investors that it can maintain growth.

“I thought even before the IPO, $6 would have been cheap,” Needham’s McGowan said. “Now, the prospects have changed. I’ve not seen a story change this quickly -- in 100 days. That’s a very rapid change.”

“I don’t rule out the possibility of somebody being interested in them, but let’s not forget that Mark Pincus controls the company,” he said.