In a relatively rare move in Street coverage, Sterne Agee’s video game analyst Arvind Bhatia today initiated coverage of online games operator Zynga ahead of the company’s IPO, which is expected this week.
Bhatia assigns a Sell rating and a $7 target, below the $8.50 to $10 range at which the stock is expected to price. Zynga is expected to assume the ticker “ZNGA.”
In sum, the business trends are not favorable, writes Bhatia.
While we believe in the potential for social games, we think Zynga�s growth is slowing even faster than what is obvious at first, its margins are under pressure, and free cash flow has been declining recently; thus we believe the implied valuation in the IPO is not justified.
“Farmville,” the company’s flagship game has peaked, insists Bhatia, with “daily active users,” or DAUs, having declined from 29 million in Q1 of 2010 to just 7 million in the period from October 1st through December 7th.
And the trend for “Mafia Wars,” he writes, is “dismal,” with DAUs down from 7 million in Q4 of 2009 to just 1 million in the most recent period.
Moreover, “CityVille,” which is currently the most successful title, with DAUs of 12 million, is “tracking 50% below FarmVille at the same point in its history,” he calculates.
In terms of the income statement, Bhatia sees Zynga having difficulty holding onto profit margin as the business has increased. Its Ebitda margin is down from 51% in 2009 to just 28% in the nine months ended in September, he writes.
Lastly, 94% of the company’s revenue derives from Facebook, making the company vulnerable, he believes.
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