The Case For Taking Zynga Private By Leena Rao And Erin Grif

The case for taking Zynga private by Leena Rao and Erin Griffith

The case for taking Zynga private by Leena Rao and Erin Griffith July 31, 2015 This spring, Mark Pincus returned to Zynga, the gaming company he founded in 2007, to attempt the near-impossible: a turnaround of a consumer tech company. Pincus, you might remember, was ousted in 2013 after the company’s share price cratered from over $14 a share to under $3. Now he’s back to save the company. But Zynga’s cheap valuation, pile of cash, and real estate holdings has plenty of investors wondering, why is he doing it in the public market? Zynga, the argument goes, should be private.

It’s simple math: The company has $1.1 billion in cash on its balance sheet. It owns real estate worth at least $228 million. And brings in almost $700 million in revenue. But Zynga’s market cap is a paltry $2.26 billion. It hasn’t traded above $3 billion in over a year.

“There is no good reason why it’s still public,” says Richard Greenfield, managing director with BTIG. “They don’t need the public’s capital to run their business.” Indeed, at least four different groups of investors have plotted takeover bids for Zynga over the last year, according to people familiar with the situation. One group included former Facebook executive Chamath Palihapitiya in partnership with financial partners, and another was spearheaded by Los Angeles-based incubator Science Inc. Those bids fell apart when Pincus returned in April. Zynga declined to comment.

At least two of the plans involved a “cash extraction” strategy, where the company’s new owners strip all of the costs from the company by selling the real estate and sending labor overseas. Growth would come through acquisitions, rather than in-house development. That strategy is less exciting, but easier and more profitable, than trying to create the next hit game from scratch. The problem is that plan was a lot more promising four months ago, when Microsoft exec Don Mattrick was still running Zynga. He was supposed to transform the company from a primarily Facebook-based game network into a mobile games company, and he was failing.

Even as gaming soared on mobile devices, Zynga struggled to produce hits for smartphones. Competitors like King Digital Entertainment and Supercell leapfrogged it. According to IDG, the mobile games market generated $17.5 billion in revenues in 2014 and will hit $27 billion in the next five years. Under Mattrick, Zynga’s annual revenue shrank from $1.28 billion in 2012 to $690 million in 2014. Net losses widened from $209 million in 2012 to $225 million in 2014.

Costs increased as the company overpaid its executives and spent $100 million building its own data centers. Even as shares plummeted under Mattrick’s leadership, Zynga’s board approved a $57.8 million compensation package for him in 2014. But Zynga’s biggest drain on costs came from its bloated headcount. Zynga employs 2,000 workers to earn $690 million in revenue. Contrast that with Supercell, which employs 150 people and last year earned $1.7 billion with $565 million in profits.

Seeing these potential efficiencies, Palihapitiya and his consortium prepared a tender offer for Zynga. But they were too late. Pincus had already planned his return to replace Mattrick. In the last four months, Pincus has addressed some of the problems mentioned above. In May, Zynga shut down the data centers, moving its games to Amazon’s cloud computing platform.

Pincus also announced he would cut $100 million in costs, laying off 18% of the staff, or 364 people. But Zynga needs to do a lot more if it wants to compete with Supercell and revive its dismal stock price. Analysts have called for more job cuts. Beyond that, Zynga needs to somehow create new hit games. The question is whether it would be better off doing that as a private company.

Zynga has two options: There’s the Dell route of selling to a private investor to complete its turnaround behind closed doors, or there is the Electronic Arts route, where Zynga makes big financial bets on building potential mega-hits. That’s the direction Pincus appears to be taking now. “He doesn’t want to run a non-innovative tech company that just throws off money,” one observer says. “He wants to build new stuff.” That attitude may thwart any potential buyout. After all, no deal can happen without Pincus’ approval – he owns a majority of the voting power of Zynga’s stock.

Paper For Above instruction

Introduction

The debate over whether large technology and gaming companies like Zynga should remain publicly traded or convert to private ownership has garnered significant attention in recent years. Proponents of privatization argue that private companies enjoy greater strategic flexibility, reduced regulatory scrutiny, and the ability to focus on long-term growth without the pressures of quarterly earnings reports. The case for taking Zyngaprivate revolves around its undervalued assets, cash reserves, and potential for strategic turnaround behind closed doors. Mark Pincus’s return to the helm signifies a strategic pivot that could benefit from privatization, especially given the company's recent struggles and the evolving gaming industry landscape.

Background and Company Overview

Zynga, established in 2007 by Mark Pincus, became a dominant player in social gaming, primarily through Facebook. Its portfolio included numerous successful titles like FarmVille and Zynga Poker. However, rapid growth on social media platforms and the shift to mobile gaming posed challenges, as competitors like King Digital and Supercell began dominating the mobile space (IDG, 2014). From a peak revenue of $1.28 billion in 2012, Zynga's revenue sharply declined to $690 million in 2014, with mounting losses and an inefficient cost structure. Despite possessing $1.1 billion in cash and significant real estate assets worth approximately $228 million, its market capitalization languished at around $2.26 billion, illustrating a disconnect between intrinsic value and market perception.

Financial Position and Asset Valuation

Zynga's substantial cash holdings and real estate assets highlight its financial strength. With over a billion dollars in cash and real estate holdings, the company's tangible assets surpass its market valuation. This discrepancy signals an undervaluation and suggests that the market does not fully appreciate Zynga’s intrinsic asset value. The company’s liquidity provides a buffer and an opportunity to refinance, restructure, or invest strategically without immediate reliance on external capital. Moreover, the cash reserves could be deployed in acquisitions or innovation initiatives if the company were privately held, free from public market pressures.

Strategic Challenges and Industry Dynamics

The key challenges Zynga faces include declining revenues, high operational costs, and failure to produce mobile hits comparable to competitors. Under Don Mattrick's leadership, Zynga attempted to pivot towards mobile gaming, but results fell short, with shrinking revenues and widening losses (Curlin et al., 2007). The company’s bloated workforce, amounting to 2,000 employees, contrasts sharply with lean competitors like Supercell, which employs approximately 150 staff to generate comparable revenues and profits (IDG, 2014). Additionally, the company's hefty executive compensation and costly data centers contributed to its financial strain, highlighting inefficiencies in its cost structure.

The evolving gaming industry further complicates Zynga's prospects. Mobile gaming, now a $17.5 billion industry in 2014, is projected to grow to $27 billion over the next five years (IDG, 2014). While growth in the sector offers opportunities, Zynga’s failure to produce leading titles puts it at a strategic disadvantage. The company's efforts under Pincus to cut costs—such as layoffs and shutdown of data centers—are steps in the right direction, but more radical restructuring may be required to compete effectively.

Advantages of Privatization

Privatizing Zynga could provide several benefits. First, it would enable management to focus on long-term strategic initiatives without the pressure of stock price volatility and quarterly earnings reports (Greenfield, 2015). Second, the company’s undervaluation suggests that a buyout or private reorganization could unlock significant value for shareholders and stakeholders. Third, private ownership would allow Zynga to undertake radical restructuring, including layoffs, asset sales, or strategic shifts, without public scrutiny or investor pushback.

Fourth, with $1.1 billion in cash and real estate assets, Zynga could leverage its assets to fund innovation and development of new gaming titles, which is essential for growth in a highly competitive sector. Private ownership could also facilitate a “turnaround” approach, similar to Dell’s privatization, where the company refocuses on core competencies and optimizes its operational efficiencies.

Challenges and Considerations

Despite the potential advantages, privatization is not without challenges. Acquiring enough shareholders to facilitate a buyout requires significant capital investment. Mark Pincus’s substantial voting control could complicate negotiations if other stakeholders oppose going private. Furthermore, the industry’s fast-paced nature necessitates continuous innovation, which might require retaining certain public market advantages, such as access to capital markets for future funding.

Additionally, the valuation of Zynga’s assets, including its intangible properties such as intellectual property and brand reputation, complicates the valuation process for a buyout. The company must also consider the impacts on employee morale and the potential loss of investor confidence if privatization leads to uncertainty.

Case Studies and Industry Precedents

Looking at similar cases, Dell’s successful privatization in 2013 demonstrates how a company can benefit from going private, including reduced scrutiny and enhanced strategic flexibility (Greenfield, 2015). Another example is the shift of Electronic Arts towards a focus on blockbuster titles, highlighting how strategic reinvestment and innovation drive industry success. These precedents suggest that Zynga’s path to privatization could afford it the strategic room necessary to innovate and reposition in the competitive gaming landscape.

Conclusion

Given Zynga’s undervaluation, significant cash reserves, and the need for strategic repositioning, taking the company private appears to be a compelling proposition. It would provide management with the agility needed to restructure operations, develop hit games, and adapt to emerging industry trends without the constraints of public markets. While challenges to privatization exist, the potential for unlocking shareholder value, enhancing operational efficiency, and fostering innovation make privatization a strategic consideration worth exploring.

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