Zynga Facebook Reliance Spooks Investors

July 02, 2011, 1:50 PM EDT By Ari Levy

July 2 (Bloomberg) -- Zynga Inc. has become the most valuable U.S. video-game company by relying on Facebook Inc. to reach users. Now it has to convince investors that its dependence on the social network won’t hinder growth.

Zynga, maker of social games such as “FarmVille” and “CityVille,” said yesterday it will raise $1 billion in an initial public offering, becoming the latest social-media company to announce plans for an IPO.

Founded by Mark Pincus in 2007, San Francisco-based Zynga is the biggest application developer on Facebook, with the four most popular games and eight times the number of users as its closest competitor. Facebook accounted for “substantially all” of Zynga’s $235.4 million in first-quarter sales, which may concern investors because so much of Zynga’s future is at the mercy of decisions made by Facebook.

“It’s a double-edged sword,” said Scott Rostan, a former banker and founder of Training the Street Inc., a New York-based firm that provides educational services for the finance industry. “You’re riding that wave of Facebook and its user base, but the danger would be if Facebook says, ‘Why can’t we capture more of that revenue ourselves?’”

Zynga said in its IPO filing yesterday that revenue surged almost fivefold in 2010 to $597.5 million, compared with 2009. The company also turned profitable last year, recording net income of $90.6 million, following a loss of $52.8 million.

Virtual Goods

Zynga games are free to play, with the company making money from selling virtual items within apps, such as a townhouse in “CityVille” or a shipyard in “Empires & Allies.” The worldwide virtual-goods market will more than double to $20.3 billion in 2014, from $9.28 billion last year, according to ThinkEquity LLC, a San Francisco-based research firm.

While Zynga has developed games for Apple Inc.’s iPhone and iPad, Google Inc.’s Android phones and Yahoo! Inc.’s game site, it has struggled to make money outside Facebook.

“Any deterioration in our relationship with Facebook would harm our business,” as well as stockholders, Zynga said in the risk factors section of its filing. Specific risks include: Facebook limiting the access of game developers, modification of terms of service, favorable treatment toward Zynga’s rivals and the possibility of Facebook building its own games.

Still, Zynga is valued at $15.4 billion on secondary exchange SharesPost Inc., topping Activision Blizzard Inc. and Electronic Arts Inc., which are worth $13.5 billion and $8 billion, respectively, on the Nasdaq Stock Market. Public market investors may balk at that price, said Ken Smith, a money manager at Munder Capital Management in Birmingham, Michigan.

Many Questions

“Expectations will be high, but I think there will be a lot of questions about the sustainability of the business model,” said Smith, whose firm manages about $15 billion. Dependence on Facebook “adds a large element of risk to the business that, I think, will hold back the valuation investors are willing to give it.”

Facebook currently gets 30 percent of all virtual-goods purchases made within games, through a payment system called Facebook Credits, which was rolled out across the social network last year. Facebook and Zynga forged a five-year agreement to use Credits exclusively in most games.

Zynga’s business model has yet to scare away some of the biggest mutual fund companies. T. Rowe Price Group Inc. and Fidelity Investments disclosed this year that they bought stakes in the company. The firms invested at a valuation of close to $10 billion, people familiar with the matter said in February.

‘Big Ecosystem’

“Facebook is going to build a big ecosystem for a range of applications and has proved there will be big, sustainable businesses on the platform,” said Rick Heitzmann, a managing director at FirstMark Capital LLC in New York, who invests in gaming startups. “I don’t think there will be a huge risk to Zynga.”

Pincus, 45, is Zynga’s chief executive officer and the biggest owner of stock, controlling 16 percent of Class B shares, according to the filing. Kleiner Perkins Caufield & Byers owns 11 percent and is the largest outside shareholder, followed by Institutional Venture Partners, Foundry Group and Avalon Ventures, which each own 6.1 percent.

Should Zynga raise $1 billion, it would be the largest IPO for a U.S. Internet company since Google Inc. in 2004. The offering follows the initial share sales of professional networking site LinkedIn Corp. in May and Web-music service Pandora Media Inc. in June. HomeAway Inc., the vacation-rental website operator, went public this week, and online coupon site Groupon Inc. filed for its IPO last month.

IPO ‘Hysteria’

Zynga’s IPO will be managed by Morgan Stanley, Goldman Sachs Group Inc., Bank of America Corp., Barclays Plc, JPMorgan Chase & Co. and Allen & Co., according to the filing. The company didn’t say how many shares it would sell or at what price.

Fifty-three Internet companies have filed for U.S. IPOs so far this year, the most since 164 companies in the industry announced plans for initial offerings in the U.S. during all of 2000, data compiled by Bloomberg show.

“Zynga is taking advantage of the hysteria right now around social networking,” said Michael Yoshikami, chief investment strategist at YCMNet Advisors, which manages $1.1 billion in Walnut Creek, California. “The valuation of $15 to $20 billion is extremely generous and they’re going to have to execute spectacularly in order to justify that valuation.”

--With assistance from Lee Spears and Devin Banerjee in New York, and Douglas MacMillan in San Francisco. Editors: Nick Turner, Donna Alvarado

To contact the reporter on this story: Ari Levy in San Francisco at alevy5@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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SAP Investors Want Proof $28 Billion Sales Target Can Be Met

May 25, 2011, 10:55 AM EDT By Ragnhild Kjetland and Aaron Ricadela

(Updates with investor comment in seventh paragraph.)

May 25 (Bloomberg) -- A week after wooing software customers with mobile and data-analysis programs at a U.S. conference, SAP AG’s co-chief executive officers need to win over investors by explaining how they will reach sales targets.

Shareholders gathering today in Mannheim, Germany, want Bill McDermott and Jim Hagemann Snabe to give details on how the largest business-management software maker can achieve its goal of making a quarter of 2015 sales -- projected at 20 billion euros ($28 billion) -- from mobile products, services and data analysis software such as the Hana technology.

The co-CEOs, ushered in by Chairman and co-founder Hasso Plattner 15 months ago, have gone on an offensive with new software. At the Sapphire conference in Orlando, Florida, SAP announced the release of mobile applications; it struck deals to store, deliver and develop software over the Internet with Amazon.com Inc and Microsoft Corp. Customers such as Colgate- Palmolive Co. and Lenovo Group Ltd. talked about their experiences with the Hana analytics technology.

“Many investors believe SAP’s product portfolio has potential, but we want to see proof and we probably won’t see that for another two years, three years,” said Thilo Mueller, a portfolio manager at MB Fund Advisory GmbH in Limburg, Germany, who helps manage 120 million euros including SAP shares. “I haven’t yet had the big ‘Aha!’ moment with the new management.”

Sybase Purchase

McDermott, 49, and Snabe, 45, replaced now-Hewlett-Packard Co. CEO Leo Apotheker in February 2010 amid employee and customer discontent, as well as delays in its Web-based software. “We didn’t have a real story,” Plattner said about SAP before the management change, in an interview last month at SAP’s California campus overlooking the Palo Alto hills. “What does SAP do next?”

Weeks before last year’s annual meeting SAP agreed to purchase mobile-computing software maker Sybase Inc. for $5.8 billion in the company’s second-largest takeover.

SAP needs to be “more precise about what the different innovations will contribute in terms of sales and profit,” Hans- Martin Buhlmann, president of Vereinigung Institutionelle Privatanleger, a Cologne, Germany-based shareholder proxy group, said at today’s meeting, which is attended by 3,300 shareholders. “We want to know how much money we’ll make when, from these innovations.”

‘Back Foot’

SAP fell 0.2 percent to 42.87 euros at 4:29 p.m. in Frankfurt. Before today, the stock had risen 29 percent since the co-CEOs took over. Rival Oracle Corp. increased 40 percent in the same period, and the Bloomberg World Software Index was up 19 percent.

Under Apotheker’s two-year leadership, SAP’s stock generated annualized returns of 5.7 percent, according to Bloomberg data.

“Last year they were still on the back foot” after giving in to customer pressure and delaying a price increase on enterprise support, said Rajeev Bahl, co-head of software and IT services research at London-based Matrix Corporate Capital LLP, who has a “buy” rating and a 50 euro price estimate for SAP.

“This year they are much more confident in their ability to grow beyond the core.”

In 2010, SAP’s software for enterprise resource planning, or ERP, used for tasks including financial planning, human resources and product development, accounted for 72 percent of sales. ERP customers include American Express Co., Canon Inc. and The Body Shop. SAP sales were 12.5 billion euros last year.

‘True North’

“In three years, ERP will have lots of mobile screens and will have a lot of in-memory-based” capabilities, Snabe said in an interview in Orlando. This is how mobile and in-memory will have a “huge influence on” the last 5 billion euros in SAP’s 20 billion-euro sales target. Such in-memory capabilities allow complex calculations to be performed instantly, and may help users to forecast how changes affect business.

In 2009, toward the end of Apotheker’s reign, the company had quarreled with some customers about maintenance prices. In January 2010, SAP caved in to customer pressure and froze planned fee hikes. The company also started offering clients a choice between a full range of tailor-made services and a lower- priced standard package with basic software backup.

“We’ve brought a certain humbleness, a certain intellectual curiosity, and patience for listening,” McDermott said about the relationship to customers after Apotheker’s departure. “You keep your promises, you do this one quarter, one year, at a time and you stay true north to your vision. And we’ll be there at 20 billion euros by 2015.”

Right Strategy?

During Apotheker’s departure, Plattner, who created SAP in 1972 with former colleagues from International Business Machines Corp., vowed to make SAP a “happy company again.” Plattner sought to remove management hierarchies and worked with Vishal Sikka, the executive board member in charge of technology, to speed up software development.

“Innovating doesn’t go through PowerPoint,” Plattner said in the interview. “I should have done this 20 years ago; it would have been a different company.”

Some investors are prepared to wait.

“In all likelihood it will be a couple of years at least before we can tell if it was the right strategy or not,” said Jella Benner-Heinacher, a representative of the DSW German shareholders association. “If you consider the Googles and Microsofts of this world, every day another company is being acquired in this industry that changes the make-up of the market and it will be interesting to see how SAP positions itself.”

--Editors: Kenneth Wong, Robert Valpuesta

To contact the reporters on this story: Ragnhild Kjetland in Frankfurt at rkjetland@bloomberg.net; Aaron Ricadela in San Francisco at aricadela@bloomberg.net

To contact the editors responsible for this story: Kenneth Wong in Berlin at kwong11@bloomberg.net; Tom Giles at tgiles@bloomberg.net.

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