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A Tech IPO Bellwether: What to Watch as Zynga Stock Starts Trading

By , Associate Editor, Money Morning •

Social-gaming giant Zynga Inc. starts trading today (Friday), capping off a rocky year for tech initial public offerings (IPOs). A strong performance from Zynga stock today and into the New Year would shed the "bubble" reputation surrounding the sector in 2011.

Here's what you need to know about this latest tech IPO:

  • Zynga will set the tone for 2012: The tech IPO market this year has fizzled, and could use a spark. Zynga could provide one. Scott Sweet of IPO Boutique told clients in an e-mail Wednesday morning there was more investor interest in Zynga than available shares. A strong debut for Zynga stock would be a good lead-in for Facebook Inc., which is expected to debut in the second quarter of 2012. It might also help Yelp! Inc., the business review site that filed for an IPO on Nov. 17. Finally, it might even subdue talk that tech is doomed for a second dot-com bubble.
  • It's Facebook-dependent: Zynga's growth is tied directly to Facebook. It generates a whopping 95% of its revenue through the social networking site, and that's not going to change anytime soon. While the relationship is an incredible revenue boost for Zynga, it's also a huge investor concern. If the business relationship soured, Zynga's revenue stream would dry up immediately.

    Still, this dependence could give Zynga stock a boost, in that investors eager to profit from Facebook's growth can do so with the social gamer.

    Zynga's contract with Facebook isn't up for review until 2015, giving Zynga three years to develop new revenue sources and decrease its Facebook dependence - if it proves detrimental. The company plans to push its product toward high-growth Asian markets.

  • It could mark the end of drastic tech-IPO overpricing: Zynga has drastically scaled back its initial pricing by more than 50% since July, when it was valued at $20 billion. Tech IPOs priced earlier in the year received a barrage of criticism for overpricing, but there's been much less of the same talk surrounding Zynga's adjusted range.

    BTIG analyst Richard Greenfield recommended participating in the IPO in the $8.50 to $10 range, and said even at the higher end he thinks it could yield up to a 50% return for investors within a year. Greenfield said the lower IPO price range favors investors and expects the company's revenue to grow by about 45% over the next two years.

  • It needs to get creative for revenue growth: Right now the majority of Zynga's revenue comes from selling virtual goods - items like tractors, weapons or clothing used in their games - but only about 3% of users actually buy them. It also gets revenue from advertisers like Starbucks Corp. (Nasdaq: SBUX) who pay for visibility in the settings where Zynga's games are played, like a coffeehouse in CityVille.

    Doug Creutz, a video game analyst with Cowen and Co. (Nasdaq: COWN), said Zynga is "in an excellent position in gaming on an important platform, but they're at the point where there has to be a realization that, with what has worked for them so far, they've sort of hit the wall on that." Its future profitability depends on innovation, keeping existing users and increasing non-Facebook related revenue.2011 Tech IPOS

  • Zynga stock might kick the sector's downward trading pattern: Not all tech stocks that came to market this year are now trading below their IPO price, but they have slipped significantly from their first-day closing price. LinkedIn Corp. (NYSE: LNKD) soared 109% from its IPO price in the first day. Its shares are still trading about 50% higher than the initial offer price, but have sunk 30% from their first-day close.

    Then there's Pandora Media Inc. (NYSE: P), which closed only 8.9% higher than its initial price in the first day of trading. Pandora is now down about 37% from its IPO price and 40% from its first-day close.

    U.S. tech stock Jive Software Inc. (Nasdaq: JIVE), which went public Tuesday, gained 25% in first-day trading, and is so far about even with its first-day $15.05 closing price.

    If Zynga stock can post a strong first day and continue that performance well into 2012, look for growing investor interest in next year's tech IPOs.

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