King Digital Entertainment Plc: Social Gaming Steal or Falling Knife?


Investing in any IPO is always a tricky process, especially in today's market.

After its "challenged" secondary market debut Wednesday social-gaming maker King Digital Entertainment can certainly attest to just how hard it can be to strike a balance between what investors will willingly pay and how much capital it could siphon from the investing public.

Unfortunately for King yesterday, the scarred memories from Zynga's public market debut in December 2011 and its eventual cratering undoubtedly loomed large in investors' collective psyche. Part of this is for good reason. Like it or not, Zynga and King share some undeniable similarities. However, key differences also exist that only make this comp fit only to a certain degree.

So as we sift through the aftermath of King's less-than-stellar IPO, let's once again put King Digital Entertainment under the microscope to see just how fairly its Zynga comparison really is and what that could imply for King's now-public future.

Source: King

King vs. Zynga
In sizing King up, it's worth noting Zynga comparison is both a good and bad thing at the same time. Let's start with the bad news.

I'll be the first to admit that history is only so helpful in understanding what the future could hold for King. History is also where the Zynga analogy should make investors shudder. Zynga hit the public markets with its revenue absolutely exploding, just as King is experiencing today. In the two years from 2009 to its IPO year 2011, Zynga's top line mushroomed nearly 1000%. Similarly, King's sales have surged over 1000% year-over-year.

Alas, Zynga couldn't hold on to its IPO era success as its been snakebitten by declining revenues over the last year or so, which have fallen some 23% since its IPO. King shares this same high growth, high reliance on hits model. And as we've seen play out time and again, social games homeruns like King's Candy Crush, to which I'm admittedly addict, tend to have limited shelf-lives. As we saw with Zynga, the sad reality in the social gaming space is if you live by the hit you also die by the hit. And no one lives forever.

However, there's also a silver lining that also shines through when comparing Zynga and King. Going from their most recently reported figures, it appears King is significantly more efficiently managed than Zynga as well. Particularly worth noting here are the differences in company spending habits between King and Zynga. Just take a look:












Source: S&P CapIQ; figures reflect LTM reported figures for each

Hopefully the general point should be plainly clear - Zynga spends a lot more of its revenue on funding and investing in its operations than King. It's a meaningful part of why King is actually a surprisingly profitable company, while Zynga remains stuck flirting with break-even over 2 years since its IPO.

What's harder to tell is which company in on the right path in terms of spending, especially when it comes to R&D spending. It's certainly possible that Zynga understands that you have to spend money to make money in a big way in social gaming, although its track record would suggest otherwise. One the other hand, King could have ratcheted back on R&D spending to goose profits heading into its IPO at the risk of underinvesting in its future.

However, as the company producing actual financial results (ie, profits), it's clear King

Source: King

has created a version of a social gaming business model that's superior today to Zynga's bloated bottom line, and that should be scored as a point for King for those of you scoring at home.

At the end of the day
Even after accounting to King's superior economics to Zynga, I'm still not a huge fan of this business as a whole.

More broadly, we know that users of social games tend to have somewhat limited attention spans, which makes getting over King's reliance on Candy Crush basically insurmountable in my mind. Even if a company's conservatively valued today, the possible, or even likely, revenue cliff King could face if Candy Crush hits the skids makes King seem like a possible value trip hiding in plain sight.

So even if the company grows meaningfully cheaper in the months ahead, I'll sleep better keeping my relationship with King as a Candy Crush player, but not an investors.

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