24/7 Wall St.

CNBC got the ball rolling today on yet another bubbly internet social media IPO coming down the pipe via Zynga with an IPO filing as soon as Wednesday.  Now the WSJ is noting much of the same.  This should be no surprise as some hints of a summer of IPO have been out before.  Zynga was also one of our Top 17 IPOs to Watch in 2011.  Still, this matters to IPO and internet investors.

Zynga makes the social-networking games FarmVille and CityVille.  The big deal here is that the IPO is being touted as proceeds of up to $2 billion, but with a valuation of $15 billion to $20 billion.  Another high value from a low float.  We have previously heard that revenues are north of $800 million.

There is a very large difference between the social-gaming companies and the old mega-hit traditional video games in a field dominated by Activision Blizzard, Inc. (NASDAQ: ATVI) with a market value of $13 billion and by Electronic Arts Inc. (NASDAQ: ERTS) with a market cap of $7.5 billion.  GameStop Corp. (NYSE: GME), with a $3.7 billion market cap, already saw the writing on the wall and has gotten in on the digital distribution model with acquisitions of Spawn Labs, a deal with Jolt, and portal Kongregate.  The difference between the “freemium” games and the MMORPG or the large-format mega-hit console and PC games is that the latter has a substantial barrier to entry due to high development costs and due to longstanding relationships with the console makers.  There is no barrier to entry at all to making a “freemium” app game at all.  In fact, I could make one myself if I was a computer geek rather than a finance and stock geek.  Admittedly, these “freemium” app games come with massively higher margins if they are successful as the development and distribution costs are significantly lower than traditional games.

Our biggest concern is simple, beyond the concern about no competitive barriers to entry… These companies are forming a bubble in valuation and this is creating an inflated market that might not support too many companies.  The low-float and extremely high set of earnings and revenue multiples is not sustainable and in some form or fashion has some of the same characteristics as the old “tracking stocks” that were popular in the late 1990s.

As Tim Keating, who is launching a pre-IPO Fund under Keating Capital, said in an exclusive interview, this has to be followed by continued significant growth rates to be justified.  Just look at LinkedIn Corporation (NYSE: LNKD)….  Large market cap, but with a very low-float.  The second thing we are concerned about is the media hype behind these companies.  It is day in and day out that the financial press and the televised media talks up these new social-this and social-that operations.

Make no mistake, Zynga will be a popular IPO when it comes out.  Our only verdict is over the price and what the value would be if the whole float was freely traded rather than 10% or 15% of the float.  It creates an artificial demand premium to the shares.

JON C. OGG