Zynga IPO Goes SplatVille. What Went Wrong?

First-day pops in initial public offerings are almost axiomatic today. After all, IPOs are engineered that way: You build buzz in a company in a hot sector, then sell only a small fraction of the shares, thus creating artificial scarcity. Presto: The stock jumps.

So what happened today with the IPO of social gaming company Zynga, whose shares are up a massive, um, 2 cents as of this writing? (Whoops, now they're actually down 30 cents, or 3%.) Update: Make that down 5% on the day. Apparently the only reason it didn't drop more was a "stabilizing bid" by Zynga's underwriters. Seriously? They can do that?

For one thing, it's apparent that in this economy, investor appetite even for the most promising and successful IPOs isn't bottomless. I'm not sure that any one company can set the sentiment for coming IPOs--least of all for Facebook, which will be a one-of-a-kind IPO when it presumably happens next year. And with Jive Software popping a respectable 30% earlier this week, it's clear some IPOs will do just fine. But Zynga's tepid performance casts a pall on many other IPOs in the pipeline.

It's a little puzzling that Zynga--which is profitable and fast-growing, with few of the uncertainties of, say, two earlier IPOs, Groupon and Pandora--didn't do better out of the gate. It priced at a relatively low $10 a share, and its $7 billion valuation ended up being about half of the amount some had speculated.

One reason besides the economy may be that investors realize Zynga is as much an entertainment business as a tech company, maybe more so. While Zynga has some network effects to leverage, the fact remains that it must keep coming up with compelling new games or it can quickly lose ground to rivals or the next big time-suck to catch consumers' fancy.

So at some level, investors may sense that Zynga could be more vulnerable to competition than more traditional tech companies--a sense bolstered by the fact that Zynga's profits fell 50% in the most recent quarter thanks to higher expenses. Some analysts certainly understand this, and have pegged Zynga's fair value at only $6 to $7 a share.

What's more, most of Zynga's revenues depend not on sales of ads or physical products but on sales of virtual goods, such as trees and tractors in its signature game FarmVille. These items, which countless news stories misleadingly tout as "imaginary," are no more imaginary than the 4,000 songs in your iTunes. But a lot of investors may be uncertain how long people will want to buy them--not to mention that a very small percentage of Zynga gamers account for the vast majority of virtual goods sales.

Finally, Zynga is almost completely dependent on Facebook, where its games are largely played. In the past, Facebook has changed the rules in ways that hurt Zynga, and given how rapidly the social network changes its service, that could easily happen again.

Yet another reason for the lack of a pop is that Zynga actually sold a somewhat larger percentage of its shares, about 14%, than some recent IPOs such as LinkedIn's, which sold less than 10%. That's still below the 24% average for tech offerings in the past year, however. What's more, its offering price of $10 a share was at the high end of the proposed range--but under its most recent private offering. That means a little less of that artificial scarcity to drive shares up quickly.

Now, a reality check: Let's not forget that Zynga's IPO is the biggest since Google's in 2004, and that it raised $1 billion for the company. That's a huge cushion and moat against the competition. If Zynga CEO Mark Pincus can keep his company on track, a disappointing IPO pop will mean precisely nothing in the long term.

