King Digital Entertainment (KING, Financial) may appear one of the most undervalued stocks on the market, but the company’s future prospects do not look bright. Activison Blizzard (ATVI, Financial) recently announced that it will be acquiring King Digital in a deal worth $5.9 billion. As a result, King’s shares surged 30% since the time the acquisition was announced.
Despite the massive uptick, King is still trading at 10x trailing earnings, and the stock appears cheap on paper, but it is a value trap that investors should ignore. Activison has overpaid for the acquisition, and it will be nearly impossible for the company to break even.
The mobile gaming industry is a booming market, but it also has no entry barrier. Although analysts expect it to be a $40 billion-plus industry in the coming years, I don’t think any company will be able to dominate the sector due to the extremely high competition.
Anyone with a few months of experience can become a game developer and publish games on iOS and Android. Due to the lack of entry barriers, the mobile gaming industry is extremely fragmented, and it will be difficult for any company to sustain multibillion-dollar valuation in the market.
Historically, every mobile gaming company has risen to the top due to the success of a few hit titles. But when the popularity of those games starts declining, the companies find it difficult to replace it with new games. It is very difficult to predict what kind of mobile game will go viral next, which is why the likes of once-high-flying stocks like Zynga (ZNGA, Financial) and Glu Mobile (GLUU, Financial) are struggling in today’s market.
The game that put King Digital on top was Candy Crush. The company is still milking the success of this cash cow as it reported gross bookings of $502 million in the latest reported quarter. Although the bookings are impressive, investors should be cautious about King as the popularity of Candy Crush is waning. Gross booking were down 8% year-over-year, and users declined all across the board, however. Monthly active users, or MAUs, fell to 474 million from a year-ago 495 million, and daily active users (DAUs) plunged to 133 million from 137 million.
The popularity of King’s Candy Crush has been declining ever since the company went public. Mobile gaming companies try to stop this trend by launching new versions of their successful titles; however, that strategy doesn’t work in the long term as users get bored playing the same game over and over again.
Conclusion
The mobile gaming industry is extremely fragmented and unpredictable. No publicly listed company has been able to sustain its multibillion-dollar valuation, and King Digital will suffer the same fate. The company may seem fundamentally strong, but its future still looks bleak.
King has managed to report good earnings thanks to the success of Candy Crush. However, once the fad of Candy Crush dies, King Digital will fall considerably. With the popularity of Candy Crush declining, it is impossible for the company to sustain its current market cap of over $5.6 billion. For these reasons, King Digital Entertainment is a value trap that investors should avoid.
