Does Zynga Need More Money Already?

Social game maker Zynga (Nasdaq: ZNGA  ) is approaching its three-month anniversary of going public back in December. Bloomberg reported yesterday that the company is now planning an additional secondary offering of shares to the public. Does Zynga need more money already?

Look before you leap (or sell)
Not so fast, my Foolish friend. While secondary offerings can typically involve issuing more shares and diluting equity while raising cash for the company, this offering is of a different flavor altogether. IPOs typically have a "lock-up period" during which early large shareholders aren't able to immediately unload shares once they are publicly traded.

Lock-up periods start at 90 days and can go up from there, but it's a range you need to watch because once they expire shares can see some major selling pressure as early investors celebrate their newfound freedom to exit their positions. For example, Tesla Motors (Nasdaq: TSLA  ) saw a mean selloff of over 15% on its fateful day in December 2010. Fusion-io (NYSE: FIO  ) lost about 9% of its value when its lock-up expired just a few months ago.

This is precisely what Zynga is trying to manage -- and avoid -- with this offering. The company is not receiving any of the proceeds from this and it's being set up primarily as a way for large shareholders to orderly unload their shares instead of just dumping them into the market and driving down the price.

SodaStream (Nasdaq: SODA  ) partially used this tactic last year with a 5-million-share secondary offering, with 3.8 million of those shares coming from existing shareholders. SodaStream did issue 1.2 million new dilutive shares, so that one was a mixed bag.

In Zynga's case, it doesn't need additional capital, as it's sitting on roughly $1.9 billion in cash and investments and generated $389.2 million in cash flow from operations last year. According to its S-1 filing for the offering, existing shareholders are looking to sell about $400 million in shares.

Pincus rules
Zynga has Class A, B, and C shares which carry 1, 7, and 70 votes, respectively. Early shareholders are selling Class B shares, which, importantly, convert to single-vote Class A shares for mere mortals. This means that after the conversion, remaining B and C share classes will carry even more proportional voting privileges, while CEO Mark Pincus is still the sole owner of those magical supervoting C shares. Yeah, he's hanging on to all 20.5 million of those. Wouldn't you?

There are still a lot of blanks to be filled in on its S-1, notably how much voting power each share class and Pincus will control after the offering. Prior to the offering, class B and C shareholders collectively held roughly 97.8% of the voting power of all outstanding capital stock, with Pincus alone holding on to 36% of all voting power thanks to those C shares.

This offering has a chance to tilt the voting scales further in insiders' and executives' favor, as if individual investors didn't already have effectively no say in things. This is one of the more glaring corporate governance risk factors with Zynga, and one I've had issues with since day one.

Pincus rules Zynga with a cartoonishly disproportionate iron fist.

What's next?
Using an offering as an organized way to sell a bulk of shares is better than having large shareholders dump them en masse and thus disrupt the market. It's certainly better than a secondary offering, in which the company dilutes existing investors in order to raise capital.

Now all Zynga needs to do is address its shrinking revenue pipeline and overdependence on Facebook. I guess launching its own platform is as good a place to start as any.

Until then, Zynga is still a Faker Breaker. Faker Breakers don't have good odds of scoring multibagger returns -- Rule Breakers do. If you really want to discover the next rule-breaking multibagger, don't miss our new special free report that names a company that's been recommended multiple times. While Zynga has five out of six signs of a Faker Breaker, this company has all six signs of a Rule Breaker, and I own it in my personal portfolio. Get the free report now.

Fool contributor Evan Niu owns shares of Tesla Motors, but he holds no other position in any company mentioned. Click here to see his holdings and a short bio. Motley Fool newsletter services have recommended buying shares of SodaStream International and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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