CashVille: Zynga prices at a high $10 a share

After months of delay, social game maker Zynga is finally about to go public. The company priced its stock moments ago at $10 a share, the upper-end of the price range.

The maker of games like FarmVille and CityVille now has enough cash to buy many of the hardcore game companies that openly scoffed as Zynga came of age.

Founder Mark Pincus is now a multibillionaire on paper, as the majority shareholder in a company that has staged one of the largest initial public offerings of the year — bigger than Groupon’s $700 million raise and the biggest tech IPO since Google went public in 2004. Trading begins on Friday on the Nasdaq under the stock symbol ZNGA.

At the $10 price, Zynga will raise as much as $1.15 billion for its coffers and will be valued at the opening bell at $8.9 billion — the upper end of its range. That $8.9 billion value includes outstanding stock options. When Zynga first announced it planned to go public in June, the rumored valuation was about $15 billion to $20 billion. Since that time, the stock market has cooled and Zynga’s growth has slowed.

Zynga’s IPO will go down as one of the biggest events in gaming history. Through the IPO, the company hopes to meet the ambitious goal of investing more “in play than any company in history.”

The pricing could generate interesting reactions. A similar company, online gaming firm Nexon, saw its shares fall after its IPO on the Tokyo Stock Exchange on Tuesday (Pacific time). Nexon raised $1.2 billion. It makes about the same in revenues as Zynga, but focuses on hardcore gamers who play online games, which users play for free but pay real money to purchase virtual goods. Nexon has profits of $260 million this year, while Zynga’s profits are at $30 million year-to-date.

Analysts are also mixed about whether Zynga is a good investment at its $8.9 billion valuation.

As we chronicled in our 25,000-word history of the company, Zynga has come a long way since Pincus founded the company as Presidio Media on April 19, 2007. At the time, Pincus wanted to jump on the Facebook bandwagon as that company took its shot at beating rival network MySpace by inviting third parties to make applications to run on the Facebook platform.

By July, Pincus’s small team of web veterans had created Texas Hold ‘Em Poker, a simple card game that would see its growth skyrocket into the millions of users as Facebook’s own popularity soared. Zynga then launched its Mafia Wars role-playing game, blatantly copying a rival, and figured out how to make money from the free games.

It did so by adopting the free-to-play business model, which was pioneered in Asian online games that tried to skirt rampant piracy. In those games, users played for free and paid real money for virtual goods in small transactions. While only a few percent of users paid, those users spent enough money to make up for all the freeloaders and make the games profitable. And since free was a pretty good price, Zynga was able to grow its users by the millions upon millions.

Traditional game companies tried to compete, but Zynga left them in the dust. It did so in part by heavily marketing and advertising its games so they quickly became dominant. It also cross-promoted new games among its existing users. While rivals had to launch games and build an audience from scratch, Zynga simply had to expand into new genres with its familiar cartoon style and get its existing users to adopt the new games. The rapid spread of games from friend to friend on Facebook helped Zynga games spread faster than any other games had done in the 50-year history of video games.

That enabled the company to climb to the top of the heap, and Zynga games have been No. 1 on Facebook for two years running now. But that doesn’t mean the company has it made. The firm has to expand beyond Facebook, grow its overseas business, establish leadership on new platforms, and grab market share in mobile. At the same time, low barriers to entry on Facebook make Zynga’s user base vulnerable to attack, as rival Electronic Arts demonstrated this summer with the launch of The Sims Social, which rose to No. 2 on Facebook, second only to Zynga’s CityVille. The intense competition will make it hard for Zynga to hit its goals.

The company reported net income of $12.5 million in the third quarter ended Sept. 30, down 54 percent from $27 million a year ago, according to an updated S1 filing with the Securities and Exchange Commission. The performance isn’t stellar, but it’s not so bad as to suggest Zynga’s planned initial public offering is in trouble.

Revenue was $307 million in the quarter, up 80 percent from $170.6 million a year ago. In other words, Zynga is working harder for the profits it gets by generating a lot more revenue compared to the past.

In the second quarter, Zynga reported only $1.4 million in profits on $280 million in revenue, so the third quarter report is an improvement on a quarter-to-quarter basis.

Critics are plentiful. Analysts at PrivCo.com say that Zynga is only profitable because of a change in its accounting, where it amortizes virtual goods revenue over a shorter time, which helps generate revenue faster than otherwise might happen.

Arvind Bhatia, an analyst at Sterne Agee, published a report on Tuesday initiating coverage of Zynga with an “underperform” rating that put Zynga’s price at about $7 a share.

That price is equivalent to about 11 times 2012 estimated EBITDA (earnings before income tax, depreciation and amortization). That gives Zynga a 30 percent price premium relative to its peer group, meaning it is viewed as one of the leaders of its pack.

A similar social gaming company, Nexon, went public on the Tokyo Stock Exchange with a pre-trading market capitalization of $7 billion, although it closed the day down about 3 percent off its IPO price. The Asian online gaming giant raised $1.2 billion and it made net income of $260.1 million, up 14 percent, on revenue of $853.5 million, up 26.5 percent, for the nine months ended Sept. 30.

But Andrew Cleland, a partner at Comcast Ventures, by contrast, has looked at the same fundamentals and come up with a different analysis. He noted that investors should not expect growth in the near future as Zynga invests heavily in the next stage of social gaming. Those who buy Zynga’s stock, he says, should understand that they are betting on Zynga’s long-term platform vision, not its 2012 cashflow.

BTIG also wrote a report on Zynga on Wednesday morning that said investors should participate in the Zynga IPO within the $8.50 to 410 a share price range. The research firm’s analysts Richard Greenfield and Brandon Ross wrote that they believe Zynga’s social games are  cure for boredom, much like TV, and can be played anywhere. They said that Zynga is a “media company” focused on taking a greater share of your time and money spent on entertainment. They said Zynga’s growth will be driven by launches across more game platforms, with a powerful network effect. They see continued growth of social networking beyond 1 billion users, with both Zynga and Facebook benefiting.

Investor’s Mosaic, a research firm for investors, said in its analysis that favorable trends for Zynga include its powerful business model, market leadership in social games, and strong social gaming growth. The negative is the dependence on Facebook, and Investor’s Mosaic is neutral on the valuation. The company believes that a fair valuation is about $9.25 a share, but it foresees risks for Zynga in the next 12 to 18 months as it tries to reduce its dependence on Facebook.

Zynga says it has 230 million monthly active users, down from 232 million when it first filed for an IPO in June. It has 58 million daily active users in 175 countries. Those users play 2 billion minutes a day and engage in 4 billion in-game user-to-user connections a day.

Zynga said that, according to AppData, its games are played by more daily active players than the next 14 social game developers combined. It also said it has four of the top five social games on Facebook, based on daily active users.

Cumulative revenue to date is $1.5 billion since 2007. Zynga now has 2,789 employees, compared to 2,543 at the end of June.

By comparison, Google raised $1.7 billion and its valuation after it went public in 2004 was $27 billion. Hilariously, Zynga updated its IPO papers this morning after Google chairman Eric Schmidt called Pincus a “fearsome negotiator.”

“Pincus is critical to our vision, strategic direction, culture, products and technology,” Zynga said in today’s updated prospectus statement, echoing previous filings. “The loss of our founder and chief executive officer, even temporarily, or any other member of senior management would harm our business.”