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King Crushed as Growth Slows

August 14, 2014 | About:

King Digital, maker of popular mobile game Candy Crush, announced disappointing Q2 2014 results, which have resulted in a decline greater than 20% in stock price. King missed top line estimates by 2% as the company posted $593.5M in revenue (compared to the expected $606M. The bottom line expectations, however, were met with EPS $0.59.

King a One Trick Pony?

As seen below, both the gross booking and revenue growth of King has slowed (even declined) since it peaked at Q3 2013. This is primarily due to the slowing pace of megahit Candy Crush. The decline of Candy Crush has been inevitable as none of these mobile games have proven to be sustaining in the long term. However, for King’s top line, of which 59% is composed of Candy Crush, this is a huge risk moving forward.

king gross bookings

According to CEO Zacconi, 2014 will be a year of transition as company moves towards more diverse revenue through new game introductions. The worry though is that this transition may not be smooth for King, which has set high expectations with Candy Crush and unless they make another megahit, earnings will disappoint.

New games, like Farm Heroes Saga and Bubble Witch 2 Saga, have seen a 19% increase QoQ in bookings, however they still make up a minority of King’s overall top line at 40%.

Disappointing Guidance Indicates Further Slow Down

Much of King’s drop in price can be attributed to the weak guidance that the company projected for the remainder of 2014.

  • Q3 2014 Gross Bookings: $500 million to $525 million
  • Fiscal Year 2014 Gross Bookings: $2.25 billion to $2.35 billion

The decline of Candy Crush is expected to continue as seen by the two projections above. Year over year, Q3 will decline approximately 20%. For the full year, 2014 will still have a 20% increase in booking over 2013, however most of this is due to the success experienced in 1H 2014.

Enough Resources to Fuel Growth

With $832M in (or nearly one fifth of company value) cash balance, King has all the necessary resources to fuel growth that could minimize the effects of Candy Crush decline and replace the megahit’s financials.

king cash position

One way of recuperating losses would be through acquisitions. King acquired NonStop Games to expand beyond general games with new titles expected to be launched in 2015. Like Zynga in prior years, King is quickly realizing that the company will need consistent revenue streams from a broad portfolio of games, rather than reliance on one hit. Due to this, I expect more acquisitions in King’s future. The pressure will be on King’s human capital to integrate and develop new games that could continue the top line expansion. The resources are already there.

Special Dividend: A Band-Aid Fix

Along with a disappointing earnings release, King announced a $150M special dividend (about $0.47/share). As discussed above, King needs to utilize its resources to create sustainable revenue streams rather than appease investors through special dividends. There’s a saying that a dividend is paid when management has nothing better to do with the capital. In King’s case, there’s plenty more to do (acquisitions, R&D) considering the mobile developer is a “growth” company.

The recipients of the special dividend will be early shareholders of King, which consist of executives and founders. This small concentrated group hold roughly 80% of King shares. With the original lock up period dated for Sept 22, King was on the verge of plummeting, similar to Twitter. King incentivized shareholders to extend the lockup period after Q4 with the $150M special dividend. However, what’s to say these same shareholders don’t sell shares by the end of 2014? Due to this, I see the special dividend as a short term “fix” and therefore a waste of resources.

Conclusion

King is facing a dilemma with the decline of Candy Crush. This downward trend in Candy Crush revenue will continue so it will be up to King’s upcoming games to recover the losses. With more than $800M in cash, King has the necessary resources to develop organically and acquire growth. However, the company’s first move was a rather pointless $150M short term fix to prevent insiders from selling. Until King starts making moves for the long term, I do not see the same upside as with other gaming stocks like Glu Mobile.

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