King Digital (BATS:KING) shares got crushed earlier this week when its Q2 results missed Wall Street expectations. Some of the key indicators of the report are as follows:
- EPS of $0.59 misses expectations by $0.01.
- Revenue of $593.56 million (+30.3% Y/Y) misses estimate of $606 million.
- Bookings totaled $611.1 million, down 5% since the previous quarter.
- Daily active users down 3% to 138 million, while monthly active users increased 1% to 485 million.
- Guidance on Q3 is even more bleak, with management projecting Q3 bookings of $500-$525 million and $2.25-$2.35 billion for fiscal 2014. That's much worse than analyst estimates of $615 million for Q3 and $2.47 billion for the year.
It seems that the disappointing quarter comes from a combination of a continual decline in popularity for Candy Crush and no other game to take its place. The consequences put KING in a difficult position. Does it try to pump out more and more games to find another diamond in the rough? Or does management try to keep milking its cash cow dry?
Reaching out to Asia
It seems as if management is content with doing the latter. In April, King Digital teamed up with China's Tencent (OTCPK:TCEHY), the fourth-largest internet company in the world, to release a Chinese version of Candy Crush. With a market of 500 million mobile gamers and reports showing that China will account for 82% of global game growth in 2014, it makes sense for KING to focus on that market. The launch of Candy Crush Saga on Tencent's popular WeChat and Mobile QQ platforms is slated for the second half of 2014.
During the quarter, KING also acquired Singapore-based game developer Nonstop Games for $6 million in cash upfront and $74 million scattered over four years depending on its success in reaching revenue targets.
Over-dependence on Candy Crush Saga
While other games KING has released have seen success (three of its games remain in the top ten grossing games on Google's Play Store and the Apple Store for the second quarter in a row), none of them have come close to generating the same kind of cash that Candy Crush has. For Q2, Candy Crush made up 59% of total bookings, which is down from 78% at the time of the IPO, but it still shows a problem with diversification.
The release of a Chinese version of Candy Crush through Tencent could certainly have a positive impact on bookings and user growth, but history has shown that it's harder than it looks for Western social and gaming companies to make it over there. Zynga (NASDAQ:ZNGA), for example, teamed up with Tencent and never really got a good foothold in the country, and other Western gaming companies make up only a small percentage of the market. Currently, the top ten grossing mobile games in China are all from local companies.
The need to diversify
So while some investors may be banking on success in China, it certainly isn't going to be an automatic thing. Of course, history isn't always the best predictor of the future. And who knows, maybe Candy Crush will find new life. But management should be careful to avoid the urge to put all of its eggs back into that basket. The only way to provide investors with sustainable growth comes from diversifying its platform. Despite the success of games like Bubble Witch Saga 2 and Farm Heroes Saga, none of them have come anywhere close to Candy Crush, and that's the biggest worry. Because even if China proves to be fertile ground for the Tencent partnership, Candy Crush won't live on forever. If KING wants to avoid Zynga's fate, it needs to continue to diversify to build a moat around its castle. The current one simply won't do.
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