Zynga Finally Files for IPO to Raise $1 Billion

Zynga, a four-year-old company which has made its riches off selling virtual goods in social games, has filed to raise $1 billion in an IPO.

The IPO may potentially rank among the largest of the year, especially among tech companies. For instance, Yandex, which is considered the Google of Russia, secured $1.4 billion last month.

Zynga said it will use the cash for general corporate purposes, including game development, marketing activities and capital expenditures. It also may continue to make acquisitions. In an interesting twist, it also said it will use a portion of the proceeds to contribute to charitable causes through Zynga.org.

The company’s underwriters include Morgan Stanley, Merrill Lynch, Barclay’s Capital, Allen & Co. and Goldman Sachs. (One item sadly missing from the filing — a list of investors.)

In particular, what’s interesting about Zynga’s offering is that it will represent the first publicly held company that makes its revenues mostly from the sale of virtual goods, like an energy boost or a virtual collectible garden gnome.

The company said it operates in 166 countries and sells 38,000 virtual items every second. It has 60 million daily active users and 232 million monthly active users. Astoundingly, people play two billion minutes of play a day and have four billion neighbor connections.

The San Francisco-based company, which was founded by Mark Pincus in 2007, was named after his late American Bulldog, Zinga. It got an early start from launching Texas Hold’em Poker on Facebook, and today dominates the four largest applications on the social network.

Some of its hit titles include CityVille, Empires & Allies, FarmVille and Mafia Wars.

The game-maker has grown extremely quickly, acquiring more than one company every month for the past year. Today, it has 2,000 employees (some of whom, as my colleague Arik Hesseldahl notes, are about to become very wealthy).

In 2010, the company’s revenues totaled $597.5 million, compared to $121.5 million in 2009. In the first three months of 2011, it’s revenues already totaled $235.4 million.

In 2010, profits totaled $27.9 million, reversing a 2009 loss of $52.8 million. In the first three months of the year, the company broke even.

That’s how the company accounts for its revenues by the law, but Zynga has come up with its own methods in dealing with its financials as one of the first virtual good companies to go public, a subject I’ve written a lot about.

From 2008 to 2010, it said so-called bookings increased from $35.9 million to $838.9 million, and that its adjusted EBITDA increased from $4.5 million to $392.7 million.

It says bookings is defined as the total amount of revenue from the sale of virtual goods during the same period the purchase was made by the player. Under GAAP accounting, it typically spreads revenues over a 12-month period, which it believes is the average life of a virtual good.

Much of its success has been tied to the ability to create games that are attractive to a large userbase. Many of its early players were women who were looking for a way to unplug after a long day of changing diapers, or while a young baby was napping. Zynga and other social game makers are largely credited with expanding the number of people who play games beyond the traditional gamers, who play on the Xbox or PlayStation.

However, because of this social element of playing games with friends, Zynga’s success so far has been closely tied to Facebook. Over the years, the two have shared a hot-and-cold relationship. A year ago, Zynga entered into a five-year partnership with the social network, in which it agreed to expand its use of Facebook Credits in games.

The benefit of Facebook Credits is that there is a common currency across all games, which makes it easier to conduct microtransactions. The downside is that Facebook takes a 30 percent cut, representing a big chunk of a company’s revenues.

In the filing, Zynga revealed a huge piece of its business comes from games on Facebook. As of December 31, 2010, and March 31, 2011, 69 percent and 82 percent of its accounts receivable were amounts owed to it by Facebook, respectively.

The company’s dependency on Facebook is just one of its risks. Revealed in the filing is that Zynga does not have any special terms with Facebook. In other words, it must share three cents of every 10-cent credit that is sold to a user, like every other game company.

Another risk is that Zynga also relies on a small percentage of its players for nearly all of its revenues, meaning that many players play for free and avoid having to ever buy any virtual goods. It did not disclose that percentage.

As for growth, one blemish on the company’s record is that the number of daily active users has fallen to 62 million in March from 67 million in the same period a year earlier.

However, many other companies have seen a drop in that same time period, and is likely correlated to Facebook’s crackdown on allowing game companies to post an unlimited number of messages to a users’ wall promoting a particular game.

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