Not 'Crushing' On King Digital Entertainment IPO

Mar.24.14 | About: King Digital (KING)

Summary

Valuation is rich compared to social game and video game companies.

Heavy reliance on Candy Crush Saga: 78% of bookings, 73% of daily active users.

Fourth quarter bookings and daily users down on quarter-over-quarter basis.

Consider me one of the lucky ones, as I have never played the highly addictive "Candy Crush Saga" mobile game from King Digital Entertainment (BATS:KING). The popular game is the main reason King Digital is seeing such a high valuation and could end up being the source of the company's problems. King Digital looks like a one trick pony and should see intense pressure to keep up its high growth. For that reason, I will be sitting on the sidelines for this highly anticipated IPO (S-1).

In 2013, King saw revenue of $1.8 billion. Net income was $568 million. Gross bookings for 2013 were $1.98 billion. All of these numbers were significant increases from 2012. In fact, net income rose from $7.9 million to $568 million.

In the fourth quarter, 73% of the company's revenue came from mobile. This is the biggest positive for King, as rival Zynga (NASDAQ:ZNGA) has struggled to transition to mobile. However, a recent announcement that Farmville is coming to mobile could spell trouble for King and may make Zynga the better buy here.

The biggest flaw with King is its dependence on "Candy Crush Saga." While the game is a cash cow and a current source of growing profits, I question how long the growth will keep up. In the fourth quarter, "Candy Crush Saga" made up 78% of bookings and represented 73% of daily active users for King Digital Entertainment.

Growth from King is actually starting to wear off. Fourth quarter bookings increased 9x from the prior year, but were down from the third quarter. Monthly active users also fell in the fourth quarter, when compared to the third quarter.

From the company's filing, here is a look at its current games:

  • "Candy Crush Saga": 93 million daily users
  • "Pet Rescue Saga": 15 million daily users
  • "Farm Heroes Saga": 8 million daily users
  • "Papa Pear Saga": 5 million daily users
  • "Bubble Witch Saga": 3 million daily users

The fact that 93 million people play "Candy Crush" every day is astounding. King has more than 120 million daily active users and also sees 1.2 billion daily game plays across its five game lineup. Like many social game companies, King sees a small percentage of daily users pay for virtual goods. In King's case, as of December 31st, only 4% of users paid for virtual items.

The company's core strengths from its filing:

  • Game design capabilities, IP catalog and laboratory.
  • Unique, repeatable, scalable game development process.
  • Cross-platform architecture enhances player experience and economics.
  • Efficient engine to drive acquisition, engagement, and retention.
  • Massive player network and loyal customer base.

Key strategies going forward include:

  • Strengthen and broaden unique game development model.
  • Continue to provide highly engaging cross-platform content.
  • Grow network.
  • Expand to new platforms and geographies.
  • Foster process innovation through technology.

King Digital has announced a pricing of $21 to $24 for its shares. This will give the company an initial valuation of $6.7 billion to $7.6 billion. If shares rally on open, King will be valued similar to huge video game player Electronic Arts (NASDAQ:EA), which sports a valuation of $9.2 billion. The valuation of King is more than Zynga, Glu Mobile (NASDAQ:GLUU), and Take Two Interactive (NASDAQ:TTWO) combined. To me, I would rather invest in any one of these three companies as they have huge brands and are more diversified. It used to be that Zynga was a one trick pony, but King is making that original dig at Zynga look like nothing in comparison.

I think there will be strong demand for the King IPO based on the name recognition of "Candy Crush Saga" alone. Shares could price above range and will likely see a pop on their first day of trading. I think eventually shares will come down and believe investors should stay away from this company as an investment. The company is going to be scrutinized worse than Zynga ever was to keep up its tremendous growth and to diversify immediately.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.