Valuation of Zynga

📝 Abstract

On December 16, Zynga, the well-known social game developing company went public. This event is following other recent IPOs in the world of social networking companies, such as Groupon, Linkedin or Pandora to cite a few. With a valuation close to 7 billion USD at the time when it went public, Zynga has become the biggest web IPO since Google. This recent enthusiasm for social networking companies, and in particular Zynga, brings up the question whether or not they are overvalued. The common denominator of all these IPOs is that a lot of estimates about their valuation have been circulating, without any specifics given about the methodology or assumptions used to obtain those numbers. To bring more substance to the debate, we propose a two-tiered approach. First, we introduce a new model to forecast the global user base of Zynga, based on the analysis of the individual dynamics of its major games. Next, we model the revenues per user using a logistic growth function, a standard model for growth in competition. This leads to bracket the valuation of Zynga using three different scenarios (base one, optimistic and very optimistic): 4.17 billion USD in the base case, 5.16 billion in the high growth and 7.02 billion in the extreme growth scenario respectively. Thus, only the unlikely extreme growth scenario could potentially justify today’s 6.6 billion USD valuation of Zynga. This suggests that Zynga at its IPO has been overpriced.

💡 Analysis

On December 16, Zynga, the well-known social game developing company went public. This event is following other recent IPOs in the world of social networking companies, such as Groupon, Linkedin or Pandora to cite a few. With a valuation close to 7 billion USD at the time when it went public, Zynga has become the biggest web IPO since Google. This recent enthusiasm for social networking companies, and in particular Zynga, brings up the question whether or not they are overvalued. The common denominator of all these IPOs is that a lot of estimates about their valuation have been circulating, without any specifics given about the methodology or assumptions used to obtain those numbers. To bring more substance to the debate, we propose a two-tiered approach. First, we introduce a new model to forecast the global user base of Zynga, based on the analysis of the individual dynamics of its major games. Next, we model the revenues per user using a logistic growth function, a standard model for growth in competition. This leads to bracket the valuation of Zynga using three different scenarios (base one, optimistic and very optimistic): 4.17 billion USD in the base case, 5.16 billion in the high growth and 7.02 billion in the extreme growth scenario respectively. Thus, only the unlikely extreme growth scenario could potentially justify today’s 6.6 billion USD valuation of Zynga. This suggests that Zynga at its IPO has been overpriced.

📄 Content

arXiv:1112.6024v1 [q-fin.GN] 27 Dec 2011 Valuation of Zynga Zal´an Forr´o, Peter Cauwels and Didier Sornette August 4, 2018 1 Introduction After the recent initial public offerings (IPOs) of some of the major social networking com- panies such as Groupon, Linkedin or Pandora, Zynga went public on December 16. The estimated value of this social network game developing company was as high as 14 billion USD in November 2011 ([4]). However, after the poor performances of the other IPOs earlier this year, this number was scaled down. Indeed, 100 million shares of Class A common stock were sold at 10$ per share, the top end of the indicative 8.5 $−10$ range. Having a total of 699 million shares outstanding ([3]), the value of the company at IPO was of 6.9 billion USD. As of December 23, its market capitalization was of 6.6 billion USD ([5]). In no case, to our knowledge, were specifics given about the methodology used to obtain these estimates, and one could wonder about the economic justification for such a change in value in only a few months period. In this paper, we extend to Zynga the methodology proposed by Cauwels and Sornette in 2011 ([1]) for the valuation of Facebook and Groupon, by introducing a semi-bootsrap approach to forecast Zynga’s user base. This paper is organized as follows. Section 2 gives a brief summary of the methodology used to value Zynga. Section 3 describes the dynamics of the number of daily active users (DAU) of Zynga. Section 4 analyzes the financial informations relevant to the valuation of the company. Section 5 gives its estimated market capitalization and section 6 concludes. 2 Valuation methodology The major part of the revenues of a social networking company is inherently linked to its user base. The more users it has, the more income it can generate through advertising. The basic idea of the method, proposed by Cauwels and Sornette in 2011 ([1]), is to separate the problem into 3 parts:

1. A part based on what we consider as hard data: this part uses the known historic daily active users (DAU) metric that quantifies the frequentation of Zynga. Based on this figure, we develop a methodology to forecast the future evolution of Zynga’s user base. 1 2 VALUATION METHODOLOGY Other metrics exist such as the number of registered users (U) in the case of Facebook. To understand the reason why the DAU instead of the U are used for Zynga, we need to explain how this company is organized. Zynga uses Facebook as a platform for its games. One does not need to register in order to get access to Zynga’s games; it is enough to have a Facebook account. Therefore, the number of registered users is not even well defined for Zynga. The choice of the DAU metric has consequences: being a more dynamical measure than U it can decrease significantly from one day to another. This is not true for the number of registered users: in practice, it takes an effort in order to unregister from Facebook. Because U are monotonically increasing, the logistic model (equation 1) could be used by Cauwels and Sornette ([1]) to model the growth dynamic. dU dt = rU(1 −U K ) (1) Here r is the constant growth rate and K the carrying capacity (biggest possible number of users). For Zynga however, a different approach had to be worked out. Another specificity of Zynga, justifying the need for a new approach, resides in the fact that it is a heteroge- neous entity: it is the aggregate of all the games it developed. Therefore, to understand the dynamics of Zynga’s user base, we had to examine the dynamics of the DAU of the individual games it developed (figure 1). Jul−09 Oct−09 Jan−10 Apr−10 Jul−10 Oct−10 Jan−11 Apr−11 Jul−11 Oct−11 0 2 3 4 5 6 7 8x 10 7 Time DAU DAU for Zynga, Cityville and Farmville over time

Zynga Cityville
Farmville s(t) Figure 1: Number of DAU in time for Zynga and its 2 most popular games (Cityville and Far- mville; only these 2 games are reported for clarity). A typical feature of the games can be seen in Cityville and Farmville: after an initial rapid raise, the DAU of the games enters a decay phase. The black vertical lines illustrate the notion that the DAU of Zynga depends on the performance of its individual games. Source of the data: http://www.appdata.com/devs/10- zynga In order to reproduce the DAU of Zynga, only the top 20 games (out of 63) were 2 3 HARD DATA considered; these account for more than 97% of the total number of Zynga users. The specifics about the dynamics of Zynga and its individual games will be further elaborated in section 3. 2. Another part of the methodology is based on what we consider as soft data: this part uses the financial data available in the S1 form of filings to the SEC ([3]). The data are used to give us an estimate of how much revenues are generated per daily active user over time. It also gives us information about the profitability of the company. Due to the limited amount of published financial information, we also have to rely on our intuition and good-sense to

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