Zynga: Myths and Truths

By Eric Jackson 07/06/11 - 07:00 AM EDT

NEW YORK (TheStreet) -- A lot has been written about Zynga in the last week since it filed its S-1 last Friday, revealing more details about its financials and future IPO plans.

Overall, most in the press have described the company positively because it appears to be making money compared to Groupon.

The company does have a number of strengths but the general view of the business press is badly misinformed due to a lack of familiarity with the gaming sector.

Here are some myths on Zynga and some underlying truths:

Myth: The company is cheap relative to Facebook and LinkedIn(LNKD_).

Fact: Facebook and LinkedIn are going to be trading at 40 times their 2011 revenues this year, while Zynga is "only" going to trade at 20 times their revenues. Therefore, it's cheap. The reality is that there's a reason Zynga will trade at a discount: It's in a "hits" business where your valuation is only as high as your last hit game.

Myth: Its profitability in the future is assured.

Fact: Again and again in the IPO coverage, you get articles that refer to what Zynga did in net profits last year and in the first quarter of this year. The assumption is that you will see it continually build from there. Whatever its revenue and profit ramp has been so far, that trend will continue. This is the same basic math skills and unquestioned assumptions that caused us to drive the U.S. economy in a ditch because of housing.

Zynga is more vulnerable to a disruption in future profitability because it's a gaming company. Look at the quarterly earnings of any gaming company: it's lumpy over a three- to five-year period. Nobody's figured a way out of that one. And just because they sell their games on Facebook doesn't change that basic industry structure they operate in.

Myth: It is in a weak position because it relies on a few core gamers for most of its revenue and profit.

Fact: This was listed as one of its risk factors in its filing. (By the way, news flash to the media: All companies making filings with the SEC include risk factors. It's not a sign that the company is about to go belly up. Their lawyers write this section.) All gaming companies are in the same boat. Usually 80% to 90% of the users play the game for free. The real money is made off the small addicted users who play.

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