Web gaming phenom Zynga, which is preparing to go public Friday, does not have a complicated business. People love to hang out on Facebook and share stuff with their friends. People also love to play online games. So it’s no surprise that people love to hang out on Facebook playing Zynga games with their friends. They love it so much, in fact, that in the first nine months of 2011 they spent nearly $800 million on virtual goods that enhance the gaming experience, such as extra “energy,” increased “power,” and various in-game objects like buildings and animals. (Zynga’s games are so addictive, apparently, they can get you kicked off flights.)
Zynga, which makes games such as Farmville, CityVille, and MafiaWars (as well as Alec Baldwin’s favorite, Words with Friends) boasts 54 million users who play every day and 227 million users who play at least once a month. The company’s sales are growing like wildfire, jumping 392% last year, when it achieved profitability for the first time, to the tune of $90 million.
The company, which was founded in 2007 by Mark Pincus, is expected to raise as much as $1 billion in its IPO, with an offering price of $10 per share. If the offering follows the pattern of previous Internet IPOs this year, the stock could jump soon after the market opens, propelling the company to a valuation greater than $10 billion.
After the expected first day share price “pop,” Zynga faces several challenges. First among them is to increase the number of people who actually spend money while playing its games. Zynga emphasizes its “play-for-free” model — the base games are free; players spend money to enhance their experience and buy virtual goods. But only 3% of Zynga’s players do so, and Pincus and his team will surely be aiming to increase that percentage.
More fundamentally, Zynga needs to find away to wean itself from its dependance on Facebook. The company discussed this dependance in its IPO registration statement it filed with the Securities and Exchange Commission. “Facebook is the primary distribution, marketing, promotion and payment platform for our games,” Zynga wrote. “We generate substantially all of our revenue and players through the Facebook platform and expect to continue to do so for the foreseeable future. Any deterioration in our relationship with Facebook would harm our business and adversely affect the value of our Class A common stock.”
It’s unhealthy for the fortunes of any company, let alone a public company worth billions, to be so overly dependent on another company, let alone a potential rival. (Zynga readily acknowledges that Facebook is a potential competitor.) Without Facebook, Zynga’s remarkable success would not have been possible. Now, the challenge for the company is to expand onto different platforms. Zynga knows this and recently announced a new social gaming platform, code-named “Project Z,” which will use the Facebook Connect identity service to link players up with their social circle. In this respect, Zynga hopes to leverage the “glue” of Facebook’s social graph on its own platform.
Finally, Zynga will have to demonstrate to investors that it has the stamina to avoid the post-IPO malaise that has afflicted several high-profile Internet IPOs this year. Both Groupon, the discount retail site, and Pandora, the web-radio service, have both seen their stock prices fall below their IPO levels. Judging by the company’s rapid sales growth and established profitability, it has a pretty good shot at avoiding that fate. But investors, and particularly Internet investors, are a fickle bunch. They’ll be closely scrutinizing the company’s first earnings report as a public company. A few missteps, and Zynga could face the outcome it wants to avoid above all else: Game Over.