I am back in the swing of writing 500 words a day, and since I am a bit behind on that, I wanted to do some extra posts today as there is a lot going on.
A few months back, I took a look at King Digital’s IPO Prospectus filing. King Digital is the maker of hit iPhone game Candy Crush Saga. KING went public today. Their shares opened at $20.50 and closed at $19, well below the IPO price of $22.50.
In that earlier post I compared KING to Zynga. King had much better financials than its older peer Zynga, triple the revenue and users, more than double the profitability. King is now trading at a market cap of $5.9 billion, to Zynga’s $4.0 billion. However, if you compare the trading multiples of the two Zynga is actually trading at a premium. King is trading at 6.8x 2013 trailing EV/Adj. EBITDA while Zynga is trading at 11.9x. (I have to use trailing multiples as there are no published forecasts for KING yet.)
The market is saying that Zynga is twice as valuable as King. This despite the fact that the average King user is many times more profitable than the average Zynga user.
The market seems to think that KING’s business is going to decline in coming quarters. Let me quantify that. Using the multiples above, the market is saying that King’s $824 million in adjusted EBITDA in 2013 is likely to fall by almost half to $470 million. At those levels, the two peer companies would trade at the same multiple.
There seem to be two big concerns about King. First is that their key game, Candy Crush, seems to be slowing down in user growth. The last quarter saw declines in usage numbers. This is the same red flag that investors saw in Twitter’s last earnings call. (Note: I own 100 shares of Twitter.) Slowing user growth is a concern. However, the second problem investors have with KING is that they are almost entirely dependent on that single game, with Candy Crush contributing 78% of revenue last year. So the investment thesis seems to be that KING is dependent on Candy Crush, and Candy Crush appears to be slowing if not declining. To make matters worse, Candy Crush is not really a game that appeals to the investor demographic, with its blinking lights and super basic game mechanics. So it is easy for investors to assume the worst.
That being said, could the sell-off in KING be overdone? While a $6 billion market cap for a game maker seems like a lot of money, a trading multiple at less than 7x EBITDA is not outrageous. I would argue that the company probably made some smart moves in how they priced their IPO and communicated their model forecast to the Street. This is the right way to do an IPO. Underpromise at the IPO and then steadily beat expectations. If the company did that, then we may see some positive earnings surprises when the company reports results next month.
Despite the similarities between King and Zynga, the two represent very different investment stories. Zynga went public on the expectation that it could keep growing by adding new game titles and leveraging its user base to move those users to new games. That did not happen, and the company’s user base quickly shrank as newer games could not reproduce the popularity of older titles. King is very openly dependent on a single title. They have proven adept at building a user base for the game, and arguably holding on to that user base. People continue to play Candy Crush and spend money there. So the question boils down to can King hold on to existing users and keep them spending. I would argue that other, similar games, like Clash of Clans from SuperCell, have proven that they can do this. It is getting very hard (and expensive) to launch a new title in mobile app stores. Consequently, the longevity of existing titles is improving somewhat. This speaks to the way in which the App Store model has some serious flaws, but does provide something of a moat protecting Candy Crush.
Now I am not recommending you go out and buy the stock. That is not what I do on this site, and I the only work I have done of this stock is to read its financial filings and check out its position on the iTunes Store, where Candy Crush remains one of the highest grossing games. But I do think it merits more work.