If I were to tell you that for just $250 you could be an NFL owner, you’d probably call me nuts. But for the first time in over ten years, you can make your dream of becoming an NFL Franchise owner a reality. Earlier in the month, the Super Bowl Champion Green Bay Packers (which is the only team owned in its entirety by common folk like you and I), offered on its website the chance for any individual to purchase a “share” in the company at the price of $250 with a limit of 200 shares. The offering of 250,000 shares is the first one made available to the public since March of 1998. The Packers will use the more than $60 million in proceeds to renovate the stadium. But before you get all giddy and start dabbing into your rent money to get in on the action, let us consider first if this is a worthy investment.
With the recent news of Zynga (ZYNG) soon to be trading on the block, much has to be said about 2011’s attack of the Internet IPOs. From Linked In’s (LNKD) offering in May to the debut of Groupon (GRPN) and Angie’s List (ANGI) last month, the online social media onslaught has been in full effect. While the recent IPO run has been quite the roller-coaster ride for both bulls and bears alike, investors should be extra weary and tread carefully before buying into the Zynga hype.
Zynga is a social network game developer that publishes free online games accessible to hundreds of millions worldwide. It generates revenue by selling virtual items to be used in the games. As of the close of the first quarter 2011, the company boasted of having 236 million active monthly users (coined “MAUs”) and 62 million daily active users (“DAUs”). Unlike the Internet IPOs that have preceded it, Zynga has recorded net profits for fiscal year 2010 through the first quarter of 2011, $90.5 million and $11.8 million respectively.
According to their SEC S-1 filing, Zynga plans to sell a little over 11% of its diluted shares, or 100 million shares, between $8.50 and $10.00 each. Using a midpoint range of $9.25, Zynga is valuating itself at around 9 billion dollars, quite the hefty price tag. The IPO offering would be the largest by an Internet company since the behemoth Google (GOOG) raised $1.7 billion in 2004. While the company sports an impeccable reputation among its users and a history of actually turning a profit, there are significant pitfalls that lie in the wake.
Only one will be mentioned in this article and that one may be enough to cause serious concern – Facebook. Facebook is no doubt Zynga’s closest ally. Facebook is the primary, if not the exclusive, platform for which users play Zynga games. Through this platform, Facebook also shares critical personal user data with Zynga. Zynga in turns processes, stores, and uses this valuable information to target potential new users within the social network.
Financially, more than 93% of Zynga’s gross revenues come from Facebook. While the games are free, players purchase virtual items from Zynga to enhance their gaming experience. However, to do so, the players must use a form of virtual currency called “Facebook credits.” Facebook keeps 30% of this revenue and delivers the remaining 70% to Zynga.
Without doubt, Zynga would not be where it is today without Facebook. But for those very same reasons, Facebook may soon become Zynga’s worst enemy. In it’s S-1 filing with the SEC, Zynga admits that one of the risks associated with its business is if it is “unable to maintain a good relationship with Facebook.” That is quite the understatement. Facebook controls the platform that nearly all gaming occurs on, the provision of users and information required to expand the business, and the payment scheme to which Zynga is able to stay afloat.
Facebook also has broad discretion to change the terms of service with Zynga at any time. It can terminate any and all contracts in place or change the terms thereof. An example of such occurred in 2010, when Facebook initiated a proprietary policy requiring all applications on its network to accept only its virtual currency, Facebook Credits, as payments from its users. By doing so, Zynga’s profits took a sizeable hit, because it now had to share a much greater percentage (30%) of its proceeds with Facebook than before. Another example of Facebook’s influence on Zynga occurred in the early part of 2010. Facebook instituted a number of policy changes for application developers like Zynga that inhibited communication channels among users. Zynga noted that because user interaction was integral to the games they offered, the number of users on Facebook declined.
Zynga’s only defense to Facebook’s enormous influence would be to divorce itself from the Facebook platform. While Zynga has planned to create an alternative gaming platform dubbed “Project Z,” it is restricted under a five-year contract from releasing any game integrated with Facebook on another platform. Zynga generates the vast majority of its income on just a handful of games, all of which are played on the Facebook platform.
In summary, Facebook has Zynga by its jugular. It could single handedly put Zynga out of business by altering or discontinuing access to its platform. Before you say that is extreme or unlikely, consider this. It is pretty much a given that Facebook will inevitably come out with an IPO sometime in 2012. Zynga admits that there is very little to no barrier to competition in the online gaming sphere.
If it willed, Facebook could use the new funding raised to develop its own gaming system on its platform and exclude Zynga completely. Or if it decided not to take that route, they could just as easily enter a more financially equitable relationship with a Zynga competitor.
Ultimately, the question becomes what is the more prudent investment: buying shares in a Zynga IPO or a Facebook IPO? The latter seems to be the safer and sure-fire bet.
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Groupon (GRPN) has incurred a net loss annually since the company’s inception. As of the end of the first quarter of 2011, the local online advertiser faced an accumulated deficit of $522.1 million dollars. Groupon makes their money by keeping 50% of what the customer pays for the coupons it advertises on its website and mobile applications. While that sounds financially lucrative at first glance, a closer look at its business model exposes serious viability issues.
Groupon’s success is for the most part dependent upon two critical operating metrics: (1) Growth of subscribers who actually purchase vouchers, and (2) attracting new merchants to its already expansive list. As of March 31 this year, Groupon had more than 83 million subscribers while advertising the products and services of 56,781 merchants (the number of merchants featured in the first quarter 2011).
While Groupon has seen incredible growth since its infant days in 2008, it is highly unlikely to keep pace in the years to come. The primary reason for this is competition. When current CEO Andrew Mason thought of the idea for Groupon, there was little to no business entities in the arena. Now, there are more than 500 sites worldwide, with over 100 in the United States. Yes, Groupon has penetrated markets in South America, Europe, and the Middle East, but what have they done to distinguish themselves? What is unique about the service they provide? What do they offer that no other company can? The answer is – nothing.
The only way for Groupon to succeed in subscriber and merchant growth in the long term is to separate itself from the competition. High growth companies like Apple (AAPL) have been able to thrive because of their ability to innovate. There is nothing in Groupon’s business model that ensures it stays one step ahead of the competition. Big companies like Amazon (AMZN), through its investment backing of LivingSocial, have seized opportunities and enjoyed success. Google (GOOG), which once tried to acquire Groupon for approximately 6 billion dollars, has ventured into the field with its new Google Offers program. With close to a billion subscribers, Facebook will also inevitably become a dominant player in the game. Without that “it” factor, Groupon cannot continue to add subscribers anywhere near its historical rate.
The presence of other companies also provides plenty of options to merchants. Merchants may find better voucher percentage sharing programs with other companies or a faster reimbursement system (Groupon pays its merchants 60 days after the coupon has been redeemed). With more than one company providing a nearly identical advertising service, and the possibility of better financial arrangements, it will be difficult for Groupon to maintain growth in its merchant index.
Interestingly, the 2 components vital to Groupon’s success were also the two critical driving forces behind another popular company that has recently come under intense pressure – Netflix. Netflix (NFLX) was dependent on not only growing its subscriber base for its DVD and online streaming service, but also to retain and add to its content providers. Netflix succeeded in both areas for some time and saw it’s stock skyrocket as a result. However, the moment it suffered a retraction in the number of subscribers this past quarter, it’s stock took a swan dive (it is currently trading at just over 20% of its year-to-date high). The subscriber loss was largely attributed to an increase in monthly fees. Presumably, executives felt it necessary to raise fees to grow profits as opposed to concentrating on subscriber growth. If that is the case, it cannot bode well for Groupon, which already operates at a loss while reaping a hefty percentage (50%) of the profits with its merchants.
Coincidentally, Netflix shares a common enemy with Groupon, namely Amazon. Amazon has built a formidable library of streaming titles in its Amazon Prime service by striking deals with CBS and NBC Universal. In addition, Time Warner has expanded its streaming video service and Apple has slowly been adding video streaming to its iTunes service. Netflix’s loss in subscribers is one factor in their recent troubles. They have also struggled in maintaining content. It lost its contract with Starz and will not be able to have access to big name movies from the likes of Sony (SNE) and Disney (DIS) after February 2012. Ultimately, Netflix was a “growth stock” that stopped growing.
Groupon seems destined to follow the same path as Netflix. While it may have some success in the short term like Netflix, competition with deeper pockets will eventually catch up harming subscriber and merchant growth. As this happens, the current deficit will spiral out of control, quarterly losses will continue, and its stock will take a significant hit.
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