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King Digital Entertainment (NASDAQ: KING) is as close to an overnight success story as you can get. Revenues jumped from just $164 million in 2012 to $1.8 billion in 2013. With its Candy Crush Saga game rising to the number one spot for top grossing mobile games.
However, King Digital is essentially flat since its IPO last week. At one point, shares were down as much as 10% during its debut.
Investors are a bit cautious of mobile gaming companies after being burned by Zynga (NASDAQ: ZNGA). Zynga shares are down over 50% since its 2011 IPO. By avoiding King Digital, investors are hoping to avoid seeing their investment cut in half again.
Part of that is because King Digital could just be a one hit wonder.
The gaming company is still relying heavily on Candy Crush Saga, which made up nearly 80% of company-wide bookings during the fourth quarter. But the fourth quarter bookings for Candy Crush Saga were down from the third quarter and are already 20% below their peak booking levels from mid-2013. It also recently lost its title as the top grossing mobile game.
The fact that the major mobile gaming companies rely heavily on just a few games frightens many investors. And rightfully so. King Digital’s revenue concentration is even greater than Zynga.
During 2013, Zynga’s top three revenue generating games only accounted for 54% of revenues. However, King Digital’s top three games accounted for 95% of total bookings during the fourth quarter. Besides Candy Crush Saga, Digital King’s other games include Pet Rescue Saga and Farm Heroes Saga.
But perhaps investors are being too cautious and missing a great investment opportunity with King Digital?
King Digital is looking to boost its workforce by 25% in an effort to build out its mobile game portfolio. The big question is whether King Digital can develop another top game in time to counter the decay in Candy Crush Saga revenues.
As a result, King Digital trades a slight discount to Zynga on a price-to-sales basis. King Digital is trading at a P/S ratio of 3.2, compared to Zynga’s 4.2. But King Digital and Zynga both trade above the major video game companies on a P/S basis, including Electronic Arts (NYSE: EA) and Activision Blizzard (NASDAQ: ATVI).
The King Digital and Zynga advantage is mobile. Their business model focuses on providing casual games on a variety of devices we use every day, from our laptops to mobile phones. It could be argued that King Digital has yet to fully tap mobile. The game maker is still heavily focused on Facebook (NYSE: FB). Where it has twice the number of games on Facebook than it does on mobile.
And thanks to the remarkable growth of Candy Crush Saga, King Digital’s margins are now above the other major gaming companies and major competitor, Zynga. King Digital’s operating margin is an impressive 38%. With that, King Digital actually trades at a cheaper valuation on an earnings before interest taxes depreciation and amortization-to-enterprise value basis than all its gaming peers. However, those margins will likely come down as King Digital is forced to increase spending to develop and market new games.
The King Digital IPO shouldn’t bring the entire IPO market into question, rather, it should bring into question companies that come to market with a heavily concentrated revenue stream.
Another heavily concentrated company, Groupon (NASDAQ: GRPN), is also down big since its 2011 IPO. Shares are down over 70%. While it can be argued that Facebook and Twitter (NASDAQ: TWTR) are just as concentrated, these two companies have very large user bases and plenty of opportunities for monetization.
So will King Digital go the way of Zynga? That remains to be seen, but it certainly has a lot of similarities.
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