A lot of people seem to be missing the fact that they plan to sell the building and then rent it back, turning an already paid CapEx into an OpEx.
Zynga seems to be really good at the CapEx/OpEx game. Back before they went public, they did everything on Amazon, so it was all OpEx. Then they built the ZCloud, which converted OpEx to CapEx, which investors liked.
What a lot of people don't realize is that they have been slowing dismantling ZCloud and going back to AWS (converting previous CapEx to current OpEx).
Beyond CapEx and OpEx considerations, the ability to extract cash to offshore (via loans from offshore companies to entities offshore) allows both tax avoidance (legally) and transfer of wealth to executives (legally, since ownership of the various companies is diluted with other executive "co-conspirators"). I know this because I worked at companies where they kept reselling and reselling the skyscrapers over and over again - so they could keep maximizing their ability to make themselves richer while avoiding taxes.
Companies are rated on equity to liability ratios for creditworthiness.
Assets = Liability + Equity
Let's say my company has:
50 million in non-real estate assets (cash, IP, etc)
25 million in liabilities (loans, accounts payable, etc)
25 million in equity
50 million in a building paid by a loan (both an asset and a liability)
If I own the building:
Assets (100) = Liabilities (75) + Equity (25)
Equity/Liabilities = 1/3
If I sell it, pay the loan, and lease it back to myself:
Assets (50) = Liabilities (25) + Equity (25)
Equity/Liabilities = 1
I appear much more credit-worthy.
This sounds like a bug - a business is not clearly safer or less safe a credit risk doing the movement described. Perhaps a business opportunity there.
There are lots of accounting bugs like this. The challenge is Accounting isn't as cut and dry as people think.
For example - how long do you depreciate (write down the value of) an asset that you buy? If you depreciate it too slowly, it might make it seem like you're more profitable than you really are.
Another example - If you buy a financial product to hedge a risk vs to speculate, the accounting treatment is different. (In the latter you need to mark it to market more frequently)
One more... If you're a bank, and you make a loan which you intend to hold until maturity, the accounting treatment (mark to market) is different than if you intend to sell the loan.
Accounting is more than just consistent rules followed by the green eyeshades. :-)
There are two immediate existing business opportunities:
1) Accounting companies (E&Y, Deloitte, etc) help execs understand all these rules. Their advisory (what can you do?) work is more profitable per partner than their audit (what did you do?) work.
2) Investment funds do detailed analysis of accounting statements to make "Apples to Apples" comparisons of companies, then analyze their equity and debt valuations to see if they are properly priced. Sometimes this goes by the name of "Relative value" or "Long/short".
People think accounting is just sums -- it's not. It's the interpretation of sums. Balance sheets and P&L statements don't follow some law of nature; they are careful crafts that try to convey specific concepts about how a company views itself and how it thinks other people should view it. Like all things written by humans, these documents can lie, misdirect, and bend the truth to an agenda. It takes skills to craft them and to decipher them.
Accounting is "just sums" in the same way being a playwright is "just writing". It's a shame that formal education seems to fail at communicating this to the general public; Western society is based on capital but few people understand where and how this capital actually is.
The failure you speak of is by design, I think. Discovering that there aren't hard and fast standards for how to declare everything and that balance sheets can be made to lie is rather shocking to most people.
Hard and fast standards would just re-incentivize gaming the system on the operations side. Accounting is very, very difficult. The best answers often include subjective decision making.
Consider; your project managers claim to be done with 80% of a project. You've billed and been paid for 50%. One lone ranger claims the project is only 30% done. At completion, the project will require a an expensive piece of hardware from you to launch. You have three of these pieces of hardware in stock; the first two you bought cost $50k. The last one cost $150k. The market value is $100k, and the customer will pay $100k at launch.
There is no one answer as to how to book this. You have three choices for the inventory booking (FIFO, LIFO, AVCO) -- the first one will at launch book you a net profit of $50k, the second a loss of $50k, and the last one a profit $17k or so. And, you may decide to book the expense of the hardware now, depending on the contract, so it might look like an expense until you actually launch.
If you are accrual basis, you have at least two ways to book your current revenue; 80% or 30%. Depending on your internal personnel costs, that may yield a profit or a loss. Of course, if some of the project time has been spent on things that could yield benefit to the company later, you may move some of it over to an R&D budget,...
The decisions go on. They are neither trivial nor are they unlinked from reality -- answering the questions like 'did we make money on this project?' and 'how much should we sell the hardware for?' are basic questions that yield 'it depends' type answers.
So, yes, people lie on balance sheets, all the time. But, truth is often hard to achieve for even a very solid financial officer and good management team.
It is by design but there is no way to come up with a truly 100% objective system. There are real reasons to have judgment involved. (Hard and fast rules in any subject always create strange exceptions)
>For example - how long do you depreciate (write down the value of) an asset that you buy? If you depreciate it too slowly, it might make it seem like you're more profitable than you really are.
It isn't supposed to be ambiguous, though it sometimes is (and that's a problem). At least in Canada, we have relatively straight-forward rules to follow for allowable capital depreciation rates, as seen here:
Bit of a tangent, but this makes me think about how personal credit scores are calculated. I find infuriating the exact formula isn't public knowledge.
> a business is not clearly safer or less safe a credit risk doing the movement described
Yes they are? The reason you're thinking of the building as completely safe wrt to credit risk is that, if the company finds it can't pay the loan on the building, it can sell it and hope to pay the loan that way. But that might not work! In the second scenario, that's already been done, which eliminates the risk of being unable to sell the building for an amount that will cover the loan.
Sort of, but another way to look at it is Zynga is not a real estate company and shouldn't be valued based on its real estate. Decoupling the real estate and the Real Business lets investors properly value both (when bankers say this they mean the two parts will be worth more than they are now as one).
In a sense it's a question of vertical versus horizontal integration. (Figuratively and literally) Do you want to concentrate just on what you're good at, or the whole stack? There's not a right and wrong answer, but it's best not to have too much value tied up in something that you're not focusing on.
That's a common thought on Wall Street. Activist investors frequently push companies to separate from real estate holdings (and frequently succeed).
This particular deal makes a lot of sense, the type of investor who wants real estate is not usually the same type that is interested in a struggling tech company.
But it may be way more profitable. Because profitability is not the amount of dollars earned, but the ratio of earned dollars per invested dollar.
Also, it makes sense for most healthy companies to borrow money and pay out a stock dividend at the same time. You need to pay interest on the borrowed money. But that interest can be deduced from the taxes you'd have to pay otherwise. The trick is to find the correct ratio.
The earnings to invest ratio goes up and everyone is happy.
Whilst what you say is true, it should, however, be noted that this is done mostly for liquidity considerations rather than beefing up any accounting ratios. Obviously it’s impossible to tell without seeing the actual legal documents, but the upcoming guidance on lease accounting will most likely require that this type of sale and leaseback transaction to be shown on the balance sheet. So any benefit of turning this into an off-balance sheet lease would only be for the next few years.
True - if not on the balance sheet, definitely in the footnotes.
I think there is something to be said for extracting the value of the illiquid asset. Retailers like Sears and Target were valued primarily based on their real estate until real estate went South and all that was lost.
I didn't word it well, but basically instead of buying more servers (increasing CapEx) you spend more OpEx instead, but not all at once. So it's better on the balance sheet because less is being spend up front (Even though it's more overall).
If you mean the building, it's because they can take advantage of the gains and add that to their balance sheet and then slowly spend it back down.
>So it's better on the balance sheet because less is being spend up front (Even though it's more overall).
A balance sheet balances, so every asset matches a liability. A sale like this doesn't alter the sheet, they are merely swapping one asset (a building) for another (cash).
Actually, I think the balance sheet is affected because they're realizing a profit on the sale.
The profits probably haven't been accrued in past P&L's have they?
So the amount of profit will be a credit to equity and a debit to cash, improving the leverage of the balance sheet.
But that's beside the point, any good analyst would have already adjusted their balance sheet to take account of the value of real estate.
My best guess is that they are planning a round of lay-offs and will use progressively less space in the building. I'd wager that they plan to move headcount to lower cost areas. They also view the real estate market as peaking and want to get out at the top instead o ending up with a depreciating asset. These are just my wild guesses though, no analysis to back it up.
The asset should be worth it's market value in the balance sheet, so when they realize that asset that just get the value in the balance sheet, less any loan against the building.
The CapEx versus OpEx game doesn't make as much difference with depreciating assets because you balance the initial expense against the asset value you are depreciating and so you spread the cost in your P&L over the time it takes to depreciate the value down to 0. So the balance between OpEx and CapEx is more which is better value for the business.
Appreciating assets like building of course have a different affect on the P&L, but then so do the loans you take out to finance them.
The same building used to be the headquarters of Sega of America back during their heyday. (the level design of Sonic Adventure 2 was heavily influenced by San Francisco / Bay Area)
Not CNet, ZDNet (Ziff-Davis) and TechTV (Which started life as ZDTV). Worked there can attest ;-)
A lot of the Adobe Stuff including the Macromedia divisions when they were alive are still immediately next door or across the street. I think their use of 650 Townsend was mostly for overflow office space.
This also used to be the Macromedia headquarters (before we moved across the street to the Baker Hamilton building). Here are some pictures of it on the inside, from around 2000 - 2001.
Not really familiar with SF, except as a yearly visitor. The area around the building seemed pretty sketchy. Lots of overpasses and car repair shops. I definitely had my spidey sense up walking to their offices.
It's called the Design District for a reason: large furniture stores don't usually make for beautiful architecture. It felt pretty safe to me on several visits, and definitely up-and-coming a few years ago.
If you ignore the homeless problem (which is actually in busy areas like Tenderloin), there are no real "sketchy" areas in SF. You have to cross the bay for that.
Maybe my parameters are skewed. IMHO sketchy areas in London, Paris, Milan are more threatening than anything I've seen in SF peninsula, despite the obvious difference in guns per capita.
Can't speak to Milan but I've never felt unsafe in Paris, and only once felt unsafe in London (and that was at 3AM and I was dressed... interestingly), whereas in the space of a week in SF I had two scary encounters with ranting homeless guys.
They actually pushed many of the homeless away from Market St. to just west of the Zynga building on Division street under the Central Freeway. It is indeed pretty sketchy - tents lined up in rows, broken car windows, needles and feces on the sidewalk, people working on obviously-stolen bikes, etc.
Hehe, "design center" of san francisco, aka just basically a bunch of overpriced furniture stores or other 'life-style' chains such as Bang and Olufsen :P
Many of the big names in design have offices there such as Studio Becker which do high end kitchens and cabinets for remodels and new buildings. Design companies ended up clustered there in part because the zoning locked out so many others, so there is an ongoing political battle over whether design services are worth having within the city boundaries.
Anyone have an idea if this means anything other than trying to cash out an investment before real estate prices potentially decline? Does this make them a better/worse target as an acquisition? Or could this be generating cash so Z could acquire someone else?
It can help if it turns an illiquid real estate investment with a liquid software company attached to it into a software company with a lot of cash. There's not much they can do to unlock the real estate value other than borrow against it which is risky.
I suspect that once they have the cash in the banks, activists will push them to "enhance shareholder value" with it, which is more likely share buybacks than anything else. It could still lead to an acquisition.
Unlocking the cash is nominally better than holding onto the building from a buyout perspective in that it saves the buyer the dirty work. If the buyer wants to do an LBO, they can use the cash to finance it. (Strange how that works!)
> If the buyer wants to do an LBO, they can use the cash to finance it. (Strange how that works!)
Agreed. If you can't figure out what to do with your cash, someone else with less insider knowledge and experience will. AKA they'll rebalance your books, make the tough cuts that you can't, point you in a new direction, and exit at 5-10x their initial investment in a couple of years.
It's not turning out that way for Manchester United though. The Glazer takeover simply burdened the club with massive debt, did not change anything in terms of actually running the club, and nobody will ever pay 5-10x what the Glazers did. It just enabled them to siphon money out of the club (as well as using it as a financial dump for sketchy funds, but that's pretty common in the football world).
Leveraged takeovers are often simple cash grabs by plundering buccaneers.
If I borrow 900K to buy a million dollar business, I have only 100K invested in it. Let's say 2 years later I sell the business for 2 million... After paying back the 900K and perhaps 100k in interest I am left with 10x (1 million) of my 100k equity.
Of course if the debt kills the company, we all lose.
>I suspect that once they have the cash in the banks, activists will push them to "enhance shareholder value" with it, which is more likely share buybacks than anything else.
Which is perfectly reasonable. The money belongs to the shareholders, after all. Shareholders are generally happy if their money is going toward new profitable ventures, but they don't normally tolerate big piles of money in the corporate kitty that aren't doing anything. In that case as an investor you'd rather have it disbursed somehow so you can invest it somewhere else.
It makes them a much better target. If I'm looking to buy Zynga it's because I want a software company, not a real estate holding company. I can expose myself to real estate through REITS or PE funds that specialize in real estate.
They could also use it to acquire someone else, although it seems a bad time to make an acquisition.
> San Francisco-based Zynga is putting its San Francisco headquarters office property on the market for sale, according to sources that track the sale of office buildings in San Francisco.
They're going to lose out on the fact that everyone stuck on 101 headed onto the Bay Bridge has to look at their billboard, sometimes for long periods of time. It's definitely prime property that they're giving up.
Any time I'm stuck in gridlock, I just feel really frustrated and mad, and associate negative affects with any ads I see. I can't help but think others are the same, though I guess they still like billboards people will see during such periods so maybe I'm different...
The story says they're exploring a sale and long term leaseback - they wouldn't be moving out, they would be selling the building to raise money then leasing it from whoever bought it.
Just as an FYI if you are going to cross the bay bridge you should not get on the freeway before the turn. You should drive down regular streets and get on the freeway on 2nd street. If you're coming from the peninsula there are exits before potero hill you could take. I shave off 30+ minutes from my commute this way.
Ugh, I hate that area with a passion. You get stuck in that mess even if you're not going to the Bay Bridge.
It blocks all lanes of traffic until the exit, because people try to skip ahead of the line by using the far left lane until the last second. And then they try to merge in which blocks the lane. Once you get past the bridge exit, then 101 is usually clear. So frustrating.
They're not really giving it up, though. They're planning to sell it and lease it back. So they'll still be there and any signage that annoys commuters will still be there.
Honest question: why does a technology company own a building anyways? Especially one that is equal to half of its market cap? Surely Zynga investors are not interested in half of their investment being in Zynga and the other half in SF Commercial RE?
Part of it is timing, part cost. If you can fill a building and plan to be there for a while, generally it pays to buy it rather than rent it. (The renter generally charges a premium to short term borrowers) For financial accounting/engineering purposes (not wanting to show liabilities) firms may do long term leases.
This is why it pays for companies like Apple to own their headquarters.
Overbuilding the HQ is a classic sign of hubris, similar to putting your name on a stadium. (Look to Lehman and Bear Stearns for the former, Enron and 3com for the latter)
Isn't that the same as "cloud vs physical"? If you plan to use a lot of resources consistently for several years, physical is cheaper; if your workload is more transient, you choose virtual.
(The main difference being that real estate can even increase in value, so it is an investment as much as a cost; whereas computers invariably depreciate to 0 in the end.)
Somewhat, though companies (say Netlfix) may use the cloud even when they can fully utilize machines.
A similar analogy is also around core competence - focus on what you are good at (software vs real estate). Bathe world is littered with monuments to companies that overbuilt or overpaid.
ZNGA's market cap was 10x in 2012, when they bought the location for the 340/sq foot mentioned in the article. They occupied 65% of the building, which is a good capacity to be at if you're planning on growing.
Regarding buy vs. rent, I think at the time it made sense, if they were planning on sticking around for 5+ years, given the price per square foot they paid and the fact that they would fill up the entire space.
Hard to argue today that is was a mistake to buy it in 2012. Zynga was flush with cash after the IPO and "well timed" secondary offering[1]. That building is probably worth over $500 million today. Given that the entire company is worth around 1.7 billion it is likely the best investment they ever made.
So from the article, Zynga was going to post a loss (if I read that correctly), but because of the sale, they'll post a hefty profit. Given the artificiality of this profit, are execs still expecting to be paid performance bonuses?
I work at Zynga... The office building is awesome. The amenities at Zynga are still some of the best in the Bay Area. Awesome gym, large basement arcade, and snacks everywhere.
Zynga seems to be really good at the CapEx/OpEx game. Back before they went public, they did everything on Amazon, so it was all OpEx. Then they built the ZCloud, which converted OpEx to CapEx, which investors liked.
What a lot of people don't realize is that they have been slowing dismantling ZCloud and going back to AWS (converting previous CapEx to current OpEx).