Effects of Drop in Zynga’s Valuation

I was not planning on writing a post this week (working on some big projects right now) but the news today that Zynga will price its IPO with a valuation between $5.9 and $7 billion (Zynga … IPO at a $5.9 to $7B Valuation) was just so important I felt I need to write something. First, I don’t want to disparage in anyway what Mark Pincus achieved. It is an unbelievable achievement to build a multi-billion company in about three years (it took me over 15 years to sell a company at a fraction of this value). Less than one percent of one percent (if that) ever comes close to achieving this type of success.

Why I wanted to blog today was that this valuation represents less than 50 percent what many people thought Zynga would be valued at only a few weeks ago. More importantly, as I blogged about a month ago (The Effects of the Imminent Zynga IPO), Zynga’s IPO will have a far reaching effect in the social games industry; and this change in valuation will now have a similar effect.

First, almost every other social game company has now seen its valuation drop fifty percent. As I said in the blog post, once Zynga is public it will be a measuring stick for all other social companies, either ones trying to go public also, those looking for a suitor or those raising capital. Investors, acquirers, etc., will base valuation on Zynga’s multiples. Given that Zynga’s growth, revenue and profitability has not changed dramatically in the last few weeks, the drop in valuation means that other social games companies will now face much different price-to-earnings and price-to-sales (or projected earnings or sales) ratios.

Second, Zynga’s IPO will probably have an even greater effect on the social gaming M&A environment because of the lower valuation. While I already expected Zynga to cut back on acquisition post-IPO, they will have less currency to make acquisitions now. For example, if they value a potential target at $100 million and want to acquire them for stock, they will now have to provide twice as much stock as before (or that they were probably even offering three months ago). Thus, Zynga will have to negotiate “better” deals or cut back on acquisitions to avoid diluting too much.

Third, this will have a significant impact on publicly traded companies that have social media efforts. For example, the value of EA’s social media operations was also effectively cut in half by the change in Zynga’s valuation (so my guess is there is no cheering in Redwood City). Analysts have built into EA’s stock price a valuation for the social gaming operations (Sims Social, Madden, etc) largely based on Zynga’s multiples, thus it should have a very significant weight on EA’s stock price.

Related to the above, publicly traded companies now will be much less enthusiastic (about half as enthusiastic) to add social gaming to their portfolio. It won’t have the same impact on their valuation. Thus, we’ll not only probably see less acquisitions (or ones at lower valuations) but even internal investment in social gaming will drop (thus lowering the demand for talent).

These are only a few of the effects from the drop in valuation but as I hope this post highlights it will be far-reaching across the social games industry. What an interesting time we live in.