Did Zynga Just Issue Splunk Investors a Stern Warning?
Thomas J is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Last month I took considerable heat from readers on an article I wrote stressing the weakness of Zynga’s (NASDAQ: ZNGA) business. Admittedly so, my analysis was a very high level and academic one; I filtered the online and mobile game maker through Michael Porter’s 5 Forces Model. Assessing the core business story should be the first step an investor takes in deciding where to put his money. For me, Zynga’s business case does not make sense. On the other hand, Splunk (NASDAQ: SPLK) has a business story that is very compelling, but there is an eerie similarity between these two companies that has me sweating my Splunk investment.
As good as it feels to say I told you so on Zynga, I will try my hardest to refrain. The numbers were worse than anyone could have guessed and the 40% adjustment to the shares emphasizes that fact. As has been the case of late, Zynga has been handcuffed to Facebook (NASDAQ: FB) and after the bell Zuck's company reported similarly troubling earnings. Zynga lowered its “bookings” forecast, which is the company’s internal metric for sales of virtual goods, by more than $200MM for the remainder of the year. The market also stressed worries of social gaming fatigue as the company said that the acquisition of the hit mobile game Draw Something has had less of an impact than expected. Facebook's CFO called the company's inability to monetize mobile users both "a challenge and an opportunity." Zynga investors cringed as they watch their investment get cut nearly in half, while simultaneously being reminded by media outlets that the company’s management had cashed in at the precise moment to secure a payday to the tune of $512MM.
In April, Zynga CEO Mark Pincus, with a host of other C-level executives and major investors, dumped portions of his holdings in what is being called a “secondary offering” of 43 million shares. All of the shares came from employees meaning that none of the proceeds of the second offering were used to raise capital for the company. It is important to note that Pincus is not necessarily popping champagne this afternoon; all of the parties involved in the secondary offering are still shareholders. Whether or not the value of these holdings matters to Pincus after personally netting $200MM is your call to make.
So why should Splunk investors care about any of this? Because on July 19 Splunk made the exact same kind of public offering. The company announced that they would offer more than 11 million shares in a secondary offering at $28.25 and that all of the shares would be supplied by current employees, meaning again that no money would be raised for the company. Splunk gave some reasoning for the offering: to increase float and to limit the negative effect of employees exercising their stock options. Both are fair points -- the secondary offering will almost double the amount of shares outstanding and will limit the market speculation on insiders exercising their options. That would all be gravy had Zynga not issued the exact same reasoning for their secondary offering. It is also interesting that in a gangbusters market yesterday, Splunk is trading flat right around the valuation of the secondary offering.
Splunk is due to release earnings on Aug. 31 and as a shareholder I am extremely concerned about what this secondary offering means in the wake of the Zynga disaster. The most important thing to remember is that Splunk’s business case is compelling. The company is becoming a major player in the exploding Big Data market that is expected to grow from $5BB to $52BB in the next 5 years. They operate in 12 industries and serve both public and private sector clients. Is it possible that this offering was simply to double the float and to smooth the effect of employees selling their shares? Sure. Nonetheless, I am going to watch this stock like a hawk in the time leading up to the Aug. 31 earnings call and if there is any indication of a repeat of Zynga’s earnings today I am going to get out.
Tom Lavan owns shares in Splunk. The Motley Fool owns shares of Facebook. Motley Fool newsletter services recommend Facebook. 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. If you have questions about this post or the Fool’s blog network, click here for information.