Zynga offers lesson in why fledgling companies might not be a great bet

You might have heard about the shellacking that the online gaming company took in the second quarter. Sales were lower than expected, in large part because users on Facebook - Zynga's primary platform - aren't spending that much money on games. To anyone who is remotely familiar with the company's business model, this should not come as a surprise. I laid it out late last year in Los Angeles magazine:

Last summer San Francisco-based Zynga, which created FarmVille and other casual games for use on Facebook, began preparing a public offering that valued the company at up to $20 billion--an insanely high number for a business that's only four years old. Then came a sharp drop in earnings, followed by the stock market tumble, and by October the number being thrown around was closer to $10 billion. With the IPO being finalized, reality is setting in. Since Zynga's games don't cost anything to play, the company makes its money through the sale of add-on virtual goods like imaginary chickens or skyscrapers--and only 5 percent of the 150 million unique monthly users spend money on those items. In addition, Facebook takes a 30 percent cut of whatever Zynga collects. True, the games are relatively cheap to develop, but when so few players are paying customers, it's bound to raise questions. Recognizing the vulnerabilities, Zynga has announced plans to start its own social network, though it will continue to offer games on Facebook. Denis Dyack, president of Canadian video game developer Silicon Knights and an outspoken critic of casual gaming, told a trade publication earlier this year that when the business crashes, "it's going to crash very hard. I don't see there's an economy there."

All right, so the business has been underwhelming. Happens to the best of them. But what about a company whose insiders dump 43 million shares right before the stock tanks? That's another story. From Henry Blodget:

Zynga's April stock offering was managed by Morgan Stanley, Goldman Sachs, Bank of America, and other premiere Wall Street underwriters. All of the stock sold in the offering was sold by Zynga insiders. None of the cash raised in the offering went to the company. The Zynga underwriters were paid ~$15 million of fees to arrange this cash-out. Zynga, the company, also paid $1 million in expenses to facilitate the cash-out (legal fees, private jet rental, etc.) And, thanks to the offering, the Zynga insiders took $516 million off the table just before the stock crashed.

The lucky investors sold out when the stock was at $12 a share. It's now at $3.10. Oh, and they were led by CEO Marc Pincus, who sold 16.5 million shares for $200 million.