Is Candy Crush Saga Developer King the Next Zynga?
The IPO filing of King Digital Entertainment, the company behind the wildly popular mobile game Candy Crush Saga, comes at a time of overwhelming success. The company's games have been installed on mobile devices more than 500 million times, with 128 million daily users racking up 1.2 billion daily plays. King's revenue and profits soared in 2013, and the company is expected to achieve an initial valuation of $7 billion.
But we've seen this story before, with fellow social gaming company Zynga going public back in 2011 near the peak popularity of many of its games. Zynga has since seen its revenue, profit, and stock price collapse, and King now faces many of the same challenges that led to Zynga's fall from grace. With competition from upstarts, as well as traditional game companies like Electronic Arts , is King just Zynga 2.0, or can the company survive and thrive?
The growth of King has been nothing short of stunning. Revenue in 2013 was $1.9 billion, more than 10 times the previous year, and net profit for the year was $567 million, up from just $8 million in 2012.
This growth has been largely driven by the success of Candy Crush Saga, a game which has 93 million daily active users and more than 1 billion daily plays. King has other successful games, like Pet Rescue Saga and Farm Heroes Saga, but Candy Crush is responsible for 78% of the total gross bookings, with the top three games responsible for 95%.
The big risk
This lack of diversification poses a significant threat to the company. The free-to-play mobile game market is incredibly fickle, evidenced by the recent Flappy Bird phenomenon, and one viral hit says nothing about a company's ability to stage a repeat. None of King's games released since Candy Crush have come close to its level of popularity, and if the company can't come up with a new viral hit before Candy Crush starts to fade, then the current levels of revenue and profits won't be sustainable.
It seems that this may already be happening. In the fourth quarter of 2013, both revenue and profit, while rising significantly year over year, declined compared to the previous quarter. This decline is attributed to a decrease in Candy Crush bookings, and while other games partially made up for it, King's main cash cow may be beginning to dry up.
No barrier to entry
Unlike the PC or console game markets, where budgets are often measured in the tens of millions of dollars, the free-to-play mobile game market has essentially no barrier to entry. Flappy Bird showed that one man with only a few days of work can make a mobile game that can rise to the top of app stores and overtake games with giant teams behind them. It takes very little money to develop the next viral hit, and there's absolutely no reason to believe that King will be the company behind it.
From single-person studios to small teams to big companies like Zynga and Electronic Arts, the free-to-play mobile game landscape is outrageously competitive. Viral hits come and go, and right now King is nothing more than a one-hit wonder.
Zynga is one big competitor, with its focus now squarely on the mobile market. The company recently paid more than $500 million for U.K.-based Natural Motion, a studio responsible for a couple of mobile hits, and it's possible that King will use some of the money raised from its IPO to finance similar deals. It's clear that King badly needs to diversify its revenue sources, and acquisitions are one way to do it.
The risk with this strategy is that the company overpays, much like Zynga has a history of doing. Zynga bought OMGPOP, maker of popular game Draw Something, a few years back, only to eventually shutter the studio and lay off most of its staff. The $500 million acquisition of Natural Motion may very well end the same way, with Zynga desperately trying to find a business model that works.
Traditional gaming companies like Electronic Arts are increasingly embracing the free-to-play mobile market, as well. EA has seen some success with games like Real Racing and The Simpson: Tapped Out. The company recorded $125 million in revenue from mobile games in the fourth quarter alone. Some controversy has recently erupted over EA's restrictive micro-transactions in the recently released Dungeon Keeper Mobile, but the company remains a force to be reckoned with in the mobile free-to-play market.
Left holding the bag
King has more than $400 million in cash on its balance sheet, so one may wonder why the company needs the $500 million it expects to raise from its IPO. In the IPO filing with the SEC, King states that going public "...will give us flexibility to act on strategic opportunities if they arise in the future."
This vague reasoning should worry anyone considering buying into the IPO, because all of the signs seem to point toward King being at its peak. Current investors are likely looking to cash out while Candy Crush Saga remains wildly popular, leaving the probable Zynga-like decline to those foolhardy enough to buy into the IPO.
The bottom line
Investing in IPOs is generally a bad idea, but King's IPO looks particularly awful. The problem is that the company's current profits are almost certainly not sustainable, with Candy Crush Saga already declining in popularity. A valuation of $7 billion doesn't seem unreasonable, based on 2013 profits. But I don't see how the company can maintain, let alone grow, its profits from here. King's IPO comes as its hit game has reached peak popularity, and there's nowhere to go but down from here.
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The article Is Candy Crush Saga Developer King the Next Zynga? originally appeared on Fool.com.Timothy Green has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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