With social gaming giant Zynga's IPO to begin trading later this week, analyst group Sterne Agee has initiated coverage of the company with an "Underperform" rating.
Sterne Agee's Arvind Bhatia noted that, while the potential for social games is definitely present, Zynga's growth has slowed down rapidly in recent months. The company revealed in September that its profits and userbase both declined during its June fiscal quarter.
"We are initiating coverage with an Underperform rating," he explained. "We think Zynga's growth is slowing even faster than what is obvious at first, its margins are under pressure, and free cash flow has been declining recently; thus we believe the implied valuation in the IPO is not justified."
He cited Farmville and Cityville as titles from Zynga that have now peaked, and noted that Castleville, the latest release in the Ville series, is only averaging DAUs 50 percent below what CityVille achieved during the same timeframe.
Finally, Bhatia explained that Zynga's overreliance on Facebook is a concern. Zynga currently sees 94 percent of its revenue generated from Facebook, and Bhatia argued that any disruption to Facebook or policy changes to the service could impact negatively on Zynga.
Overall, he suggested that the company will see growth of 20 percent in 2012 and 17 percent in 2013, compared to growth of 156 percent in 2010 and 37 percent in 2011.