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Analyst Rates Zynga ‘Sell’ Before IPO

In a rare break from Wall Street protocol, a Sterne Agee analyst has placed a "sell" rating on social network game maker Zynga before the IPO, before the stock ever begins trading.

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The Farmville-creator — whose initial public offering is set for Thursday evening — faces slowing revenue growth and has too much dependency on Facebook, according to Arvind Bhatia.

“Farmville, the company’s flagship title which helped generate hyper-growth in the past, has peaked and the other titles are coming on line at a much slower pace,” the analyst wrote in a note to clients Tuesday.

“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.”

Zynga is scheduled to offer 100 million shares at a price between $8.50 and $10 apiece, giving it a market value of $7 billion if it prices at the high end of the range. Zynga’s underwriters include Morgan Stanley , Goldman Sachs , Bank of America, Barclays, JPMorgan and Allen & Co.

Following the research scandals during the tech bubble, rules were put in place by regulators to stop the research arms of these underwriters from issuing research reports until 15 days after the expiration of a stock’s lock-up period.

Since Sterne Agee is not an underwriter, the firm is free to publish when it wishes. But it is unusual for any firm to issue research on a stock that hasn’t priced yet.

“Why wait when you can get a sell rating out on an internet IPO today?” said Michael Murphy, CEO of hedge fund Rosecliff Capital. “I agree with this call 100 percent. Traders are not going to give the benefit of the doubt to new issues right now. It will be below the offering price in less than six weeks.”

IPOs are down 11 percent this year, according to Renaissance Capital, led by declines in the business social network Linked-In and Pandora , an interactive music service.

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Cityville, currently Zynga’s best title in terms of traffic, is tracking, by our estimates, 50 percent below Farmville at the same point in its history,” wrote Bhatia.

Zynga gets 94 percent of its revenue from Facebook, Bhatia points out, making it vulnerable to competitors on the social network, which has low barriers to entry.

The stock will begin trading Friday under ticker ZNGA … not that it matters to Bhatia.

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