Social Game Maker Zynga’s Market Valuation Tops $5.5B

A lot of people might not know Zynga’s name, but they sure know its games. “Farmville,” “Mafia Wars,” and “Café World” are some of the biggest titles on Facebook — and continue to draw hundreds of millions of players each month.

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That has led to massive growth at the social gaming company. And now SharePost, an exchange for shares of privately held companies, has put a valuation of $5.51 billion on Zynga. If accurate, that would make the company the second largest publisher in the video game industry — ahead of Electronic Arts and far ahead of Take-Two Interactive Software , but still less than industry leader Activision-Blizzard.

It’s a big bragging point for Zynga — but it’s also a reason for some concern. The social gaming space has been heating up considerably over the course of the past year, with a pair of high dollar buyouts. EA paid $325 million for PlayFish last November and Disney paid $563 million for Playdom in August. Zynga has long been thought the big fish, but with this valuation, it might have priced itself out of the pond.

“I think they’re too big to be acquired by a [game] publisher,” says Michael Pachter of Wedbush Securities.

"Zynga’s profits are bigger than Netflix." -Wedbush Securities, Michael Pachter

A mass media company like Time Warner or News Corp might have the war chest, but they’re not likely to follow Disney’s lead in jumping into this space. It’s one thing to bet half a billion dollars. It’s another thing entirely to risk 10 times that much.

If acquisition lies in Zynga’s future, say analysts, it will likely come from one of two places — a tech giant or an Asian game maker.

“Would someone like a Google or some larger online internet company take a look at them? It’s possible,” says Eric Handler of MKM Partners. “There’s also a lot of money in the Asian social networking video game companies. … They have cash on their books and this is a good way to get exposure in the U.S. gaming market.”

The other obvious exit strategy for its investors — which, it’s worth noting, include Google, which sunk between $100 million and $200 million into Zynga in August — is an IPO.

A $5.5 billion market cap for a company making Facebook games might seem high, and the growing bubble in the social gaming world is certainly contributing to that figure. But Zynga is immensely profitable, according to insiders. (The whisper number is revenues hover in the $400 to $500 million range.) And since the games are so inexpensive to make, margins are estimated at upwards to 50 percent.

It’s a steep valuation, but analysts say the market might actually support it, given the chance.

“The market is supporting a valuation of $9 billion for Netflix,” notes Pachter. “They’re essentially Blockbuster by mail. Zynga’s profits are bigger than Netflix.”

Zynga’s games are free to play, but users can pay real-world cash for upgrades. That — and ad revenue — fund the company. The NPD Group in August found that 10 percent of players have spent cash for small in-game transactions with these sorts of titles. Another 11 percent say they are likely to make a future purchase.

Before any sort of IPO can be considered, though, Zynga would have to clear up some outstanding legal issues, such as the class action suit filed against it this week, alleging the company illegally shared the user data of its customers with advertisers and other data brokers. Zynga says the suit is without merit.

Started just four years ago by Marc Pincus, Zynga has publicly downplayed talk of an IPO, but reportedly has heavily used stock options as a recruiting tool when luring talent from other gaming companies. Many fear if the company does go public, the talent drain could be tremendous as those employees cash in their shares and depart.

The audience seems to be staying put, though. Zynga boasts 235 million active players playing its games each month. That’s nearly 20 times the number of people who are currently in “World of Warcraft”.

And while the number of Facebook players might be declining due to a combination of user fatigue and changes to the social media site’s policies, the company is expected to have a notable presence on Google’s upcoming social network competitor and has recently branched out onto the iPhone and iPad. That should keep the virtual farms well-tended for years to come.

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