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King's IPO is no Royal Flush

King's IPO is no Royal Flush

Fri 21 Feb 2014 8:00am GMT / 3:00am EST / 12:00am PST
Financial

Investors beware - the Candy Crush Saga publisher is just Zynga 2.0

Over 90 million people play Candy Crush Saga every day. Say whatever you like about London- based social game developer King, but its headline game is an unquestionable success. Like many games (most games, perhaps) it iterates upon previously existing formulae rather than being a breakthrough, unseen innovation. Like many games, the real DNA of its success can only be analysed honestly if we first admit that one of the dominant genes involved was luck. Still; 90 million players. About 1.3 per cent of the entire population of the planet try to clear candies and jellies at least once a day. Whether you consider that to be a depressing reflection of the state of humanity or not is entirely subjective; whether you consider it to be a remarkable business success is not. King's got a touch of magic in its sweet jar.

Now King wants to convert that magic into cold, hard cash, so it's going to float on the New York Stock Exchange. It's proposing an initial public offering valued at $500 million, but given that its net income last year was $568 million (on revenues of $1.9 billion), everyone involved will clearly be hoping to make a killing off an early spike in share value.

"About 1.3 per cent of the entire population of the planet try to clear candies and jellies at least once a day"

When any company announces an IPO, it's reasonable to ask why it's happening. There are two ways for an entrepreneur to "exit", cashing in his or her chips on the company that's been built. One is by being acquired by a bigger firm (like the recent purchase of a major stake in Supercell by Puzzle & Dragons publisher GungHo). The other is an IPO. In both cases, there are two clear reasons for cashing in - the first one, which everyone always claims to be pursuing, is to raise more money to facilitate further growth and make your company bigger and better. The second is shadier but not uncommon. You reckon you've taken the business as far as you can - organic growth is looking rocky from here, maybe you sense a change in the market or an oncoming headwind, and you want to grab as much cash as you can while the going is good, before your valuation starts to heavily decline.

"Take the money and run" isn't an uncommon reason for a sale or an IPO, although none of the parties involved would ever be so gauche as to admit to such a thing. Still, the logic underwriting such a thing is cold and undeniable. If you can sense that your company is facing rocky ground and its valuation has likely peaked, you want to make sure you get as much of a return on your holdings as possible before they become devalued. Laws and rules force lots of disclosure of financial data, of course, so you can't hide a decline that's already started - but if your instinct says next year won't be as good as last year, now's the right time to sell, and "instinct" doesn't appear on SEC-mandated documents.

Is King taking the money and running? Yes, I think they are. I think this IPO is actually a little late - it's going to occur just as King is on a downslope - but it's far better timed than the easiest comparison, Zynga. Zynga launched on the stock exchange far too late, after it had already become obvious that the company was completely hobbled by the rapid transition from Facebook to smartphones in social gaming. Its IPO was a flop from an investor's perspective, although plenty of people still made a lot of money from it - it certainly made more money than it would have if they'd waited around until the depths of the company's troubles became apparent. On its current timeline, King will be IPOing while it's still within touching distance of Candy Crush Saga's peak.

"Is King taking the money and running? Yes, I think they are"

I foresee two problems, both of which ought to ring huge alarm bells for investors interested in the company. The first is that Candy Crush Saga's peak is just that - a monolithic, dramatic peak climbing up out of a landscape of foothills and gentle valleys. There are no other peaks in sight. King's other games do "okay", but nearly 80% of its revenue comes from Candy Crush Saga, whose 90 million daily users figure is six times greater than the daily users figure for the firm's second-place game, Pet Rescue Saga. There is nothing on the horizon which might replace Candy Crush Saga; once you start descending from that peak, the danger is that you end up back in the foothills with no more peaks to ascend. There's simply no evidence, let alone proof, that King is capable of recreating the lightning-strike success of Candy Crush Saga. Bluntly, I don't think King believes it can manage that either - because if the firm and its investors genuinely believed that they could repeat the success of Candy Crush, they would IPO after doing so, knowing that a company with a proven ability to turn out enormous hits is vastly, vastly more valuable than a company with one lucky strike and a string of also-rans to its name.

The second problem is Zynga itself. The stock market has already had one market-leading social game company perform absolutely dismally after flotation. Investors now know that this sector, while it's exciting and interesting and extremely profitable, is also insanely volatile, completely hit- driven and largely subject to the rapidly changing whims of technology. On the surface, the F2P model is far more investor-friendly than the old-fashioned boxed game model, since you actually get a steady revenue stream from your products rather than a single burst of revenue after a couple of years of expensive development. In practice, though, you still need to keep turning out hit titles in order to ensure revenue growth (which is all the stock market gives a damn about). Few studios have shown any capacity for doing that - there are laudable exceptions like Supercell and Nimblebit, but most mobile gaming studios are still dining out on single successes. King has Candy Crush Saga; Rovio has Angry Birds; GungHo has Puzzle & Dragons. None of these companies have managed to create another game as popular as the one that made them famous - lacking a track record, each of them can fairly be considered a one-hit wonder until proven otherwise.

What about recent controversies around King? The company's aggressive approach to trademarks, its reputed cloning of games and so on have done nothing to endear it to the gaming world and cultivated an atmosphere of negativity around the company. I would caution against reading too much into the likely impact of such stories on an IPO, though. Investors, bluntly, don't really care if a company stands accused of not being terribly innovative, as long as the results are good. They certainly couldn't care less about trademark spats with independent developers, I fear. Such issues are important and relevant to those directly involved, but of no consequence to the IPO prospects of a company like King.

"I suspect that investors burned by Zynga will be quick to note the parallels between the sort of behaviour of which King stands accused, and the sort of behaviour in which Zynga engaged"

What they do, however, is set mood music around the firm. Being seen as a bit ruthless is no bad thing, but I suspect that investors burned by Zynga will be quick to note the parallels between the sort of behaviour of which King stands accused, and the sort of behaviour in which Zynga engaged. The two companies are, in my mind, very similar both in culture and in approach. Neither was founded out of any attachment to games as a medium, a culture or an artform; both are simply entrepreneurial vehicles to exploit a potential market, and as such, it's to be expected that both would struggle to adapt and succeed at points where they encounter obstacles that can only be surmounted by creativity rather than by management bullet points or business model refinement.

That's not entirely a criticism, by the way; in a capitalist economy, there's no sin to creating a business just to exploit a gap in the market. If the market in question happens to be a creative medium, one has to expect significant blowback to this approach. Moreover, there's a limited lifespan to such a strategy - a company in a creative sector which is not founded on creative principles cannot expect to significantly outlive the market conditions it was originally designed to exploit.

In summary, I find it hard to view King's IPO as anything more than Zynga 2.0. It is better-timed, certainly, but the companies involved are similar enterprises facing similar challenges - and thus far, demonstrating a similar lack of capacity to overcome them. Zynga is much, much further down the slope from its peak than King, so of course there remains a reasonable possibility that King can surprise us all with a second title on the scale of Candy Crush - and by doing so, establish itself as a genuine leading light of this new market. For all the negativity poured upon the company of late, I honestly hope King can make lightning strike twice for itself. I don't like Candy Crush Saga personally, but that's a subjective view - objectively, I cannot find a trace of the supposed immorality, grasping and nastiness of which the game regularly stands accused, and can't help but recall all the awful stuff of which Flappy Bird also stood wrongly accused when it dared to be a break-out mobile gaming success. King faces problems down the line and I question whether it represents a good investment opportunity for anyone - but should it overcome those issues and prove itself capable of the creativity required to replicate its Candy Crush success, it would be churlish to call that anything other than a fresh triumph for UK game development. Fingers crossed that it happens.

18 Comments

Paul Johnson Managing Director / Lead code monkey, Rubicon Development

959 1,759 1.8
Popular Comment
I hope they don't make another title. It might have a word I'm using in it.

Posted:9 months ago

#1

Neil Young Programmer, Rebellion Developments

312 412 1.3
As I mentioned on the article about their floatation, I'm sure they said they were delaying the IPO until they could demonstrate that CCS wasn't a one off. Either I'm misremembering, or they've changed their minds.

Posted:9 months ago

#2

Dan Tubb Investment manager, Edge

32 165 5.2
Popular Comment
“It's proposing an initial public offering valued at $500 million, but given that its net income last year was $568 million (on revenues of $1.9 billion), everyone involved will clearly be hoping to make a killing off an early spike in share value”

With the greatest of respect Rob this is just not correct. The valuation in IPO’s is rarely set from the outset, but is determined by the reaction the corporate financiers get from key investors as they set about building their book. The valuation is likely to be between 6 and 9 times EBITDA (profit). It certainly won’t be less than 1. I believe the $500m number is the value of the new shares they are creating to be sold as part of the floatation, NOT the value of the whole entity as determined by the offer.

The interesting contrast with Zynga is just how significantly the expectation of value have moved. Let me explain. With Zynga it was valued at 6.8x revenue, not profit, but revenue. Here we are talking about King just a couple of years later, and we are expecting them to be value at more like 6.5x profits, say around $5.3bn. That a pretty huge step down in terms of expectation, and is valuing King closer to the sort of metrics we would see on a more mundane old economy businesses in established media. If King were getting valued the same way as Zynga was we would be looking at a Ł13bn figure.

Now I fully understand that a lot of you will be (maybe rightfully) dismissive of the King floatation given the history of Zynga, however, at the right price everything can be good value. Even if King never has another hit again there is a value attached to the stream of revenues it has yet to come from Candy Crush. And given just how significantly the valuation metrics may have lowered since 2011, means that this floatation can’t be dismissed too lightly at this stage. We should find out in the coming weeks what the actual valuation is likely to be.

Edited 3 times. Last edit by Dan Tubb on 21st February 2014 10:06am

Posted:9 months ago

#3

Andrew Watson Programmer

113 290 2.6
@Paul:
Unfortunately there was a huge front cover ad on the Metro for their next totally-not-a-bejeweled-clone game this morning

Edited 1 times. Last edit by Andrew Watson on 21st February 2014 10:30am

Posted:9 months ago

#4
@Dan
I agree that its valuation looks fair based on its previous year performance. The key questions, though, should be over the somewhat flash-in-the-pan quality of its earnings history and how sustainable its profit (and revenue) growth is. Has it peaked as Zynga did at IPO and, given the unpredictable hits-driven nature of the industry, could it actually start to decline at some point over the next few years, again like Zynga despite its drum beat of acquisitions. Will these risks be properly accounted for in the final offer price? It will be interesting to watch...

Posted:9 months ago

#5

Chris Thomas Account Director, CBS Interactive

1 0 0.0
Interesting perspective Dan, thanks for adding that.

Posted:9 months ago

#6

Dan Tubb Investment manager, Edge

32 165 5.2
If I were (still) a fund manager as opposed to a VC I think I would only be persuaded to buy King as a ‘value stock’ which is to say I would buy it for the dividend yield it currently produces, perhaps factoring in some decline. Then I would simply work out the valuation I was prepared to pay based on the general level of yield the market as a whole was offering. i.e. what my alternatives were to get that yield.

But as you know, management teams don’t like being thought of as ‘value stocks’, they all want to be ‘growth stocks’. Ultimately, (in theory) still based on the future dividend yield but with the expectation that the best is yet to come; that revenues, profits and dividends will grow.

The game being played as we speak will be J.P. Morgan/Credit Suisse/BofA Merrill Lynch going around to all the big fund management groups and pitching to them what an outstanding growth story King is. The net amount of fund manager credulity will then determine the price that King and its advisers settle on. They want it as high as possible, without the risk of being left with unsold stock requiring the underwriters to step in.

I agree with Nick, be very interesting to watch what happens.

Edited 2 times. Last edit by Dan Tubb on 21st February 2014 3:29pm

Posted:9 months ago

#7

Todd Weidner Founder, Big Daddy Game Studio

429 1,027 2.4
Popular Comment
I like this article but I would suggest that anyone who invests in this market, is a sucker, or muppet as it were. You trade this market ( not invest in it) and you simply hope there is always at least one person (or algo) dumber than you so you can unload to them when need be. Its all a con game, a big rigged casino. Investing has nothing to do with it anymore.

Edited 1 times. Last edit by Todd Weidner on 21st February 2014 4:31pm

Posted:9 months ago

#8

Leo Wakelin QA Tester, Zoonou

24 4 0.2
@Andrew:
That's quite an old game now in the grand scheme of things.

Posted:9 months ago

#9

Russ Cogman Senior Game Artist, Serious Games International

26 53 2.0
I'm sure some of their success can be put down to aggressive marketing. Even Cydia had adverts that you accidentally clicked to open the App Store on Candy Crush Saga.

I never downloaded it, but I was very, very aware of it.

Posted:9 months ago

#10
I am not sure what a good candy crush follow up will be...

Posted:9 months ago

#11

Rafa Ferrer Localisation Manager, Red Comet Media

68 131 1.9
The Legend of the Uncharted Candy Creed Scrolls: The Secret Fable of the Grand Theft Skittle Kart, The Final Candy Fantasy Quest: Answering the Call of Duty adorned in Unreal Halos and Sonic Rings while Counter-Striking the Resident Ninja Evil in Street Fights and on the Battlefield using various Crafts for Mass Effect while wearing Metal Gear, avoiding Pitfalls, and Monster Hunting to defend Civilization in Ace Combat against Hitman Candy Kart Raiders beneath the Harvest Moon
...of the Dead.

Posted:9 months ago

#12

Sandy Lobban , Noise Me Up

319 231 0.7
@ Todd. You are 100 percent right. Unsuspecting investors are going to get burned again, but then we probably need a few more cases of this before it becomes untenable and investors become more knowledgable on our sector and where the long term value lies. They will be able to make more informed choices in future, which is probably good news for everyone who wishes to create entertainment as opposed to developing their litigation strategies.

Investors, king and everyone else in between will see this as just another wave they are going to ride. Like Zynga they will be looking for other waves to ride when this one hits the beach, but thats when the challenge kicks in and they will then be tested on their motivation for the medium at that point.

Posted:9 months ago

#13

Alfonso Sexto Lead Tester, Ubisoft Germany

846 732 0.9
Indeed Candy Crush Saga is a great success. Nobody can say anything against that fact. There is not a problem there.

There is a problem in the fact that this is why mobile market games are self-stuck. Almost nobody is going to make a deep immersive game when the real beneficent comes from a simplistic time-killer.
But there is a bigger problem (much bigger, if you ask me) in the fact that this is a market that does not seem to learn from past mistakes. Now I'm not talking here about a console studio not remembering a game crash that happened 30 years ago. I'm talking about a company called King that doesn't remember nor seems to take not of the collapse of Zinga only one year and a half ago!

I try to give the mobile market more and more chances. But in their current state I can only see them as a step back to the early nineties; all is a "run for the money" and "copy this guy's idea before he notices. And each time you have one of their big supporters come to you all he talks is "activations", "Number of downloads", "Total income", "paying user" "numbers", "bigger market" and words like "experience" or "story" are nowhere to be found.

As I said, a "Run for the money" and a kick back into every single mistake done by the games industry during the 80's for the sake of the quick benefit and nothing else.

And those talented studios making something different in phones and tablets, with more elaborated game-play than the one present in lousy "Candy crash" or "Flappy Bird" copycats, struggling to survive. Do you think that is correct?

So they can keep making money and feed the non-gamers and casuals while they Kill time. that is perfectly legit and fine! But each time I compare "Outlast" (an "experience")with "Flappy <whatever>" (a "time killer") I can only gall "gaming" the former, the last one is just "waiting for the bus to arrive"

Sorry... need to say this from time to time.

Posted:9 months ago

#14

Alfonso Sexto Lead Tester, Ubisoft Germany

846 732 0.9
@Rafa
The Legend of the Uncharted Candy Creed Scrolls: The Secret Fable of the Grand Theft Skittle Kart, The Final Candy Fantasy Quest: Answering the Call of Duty adorned in Unreal Halos and Sonic Rings while Counter-Striking the Resident Ninja Evil in Street Fights and on the Battlefield using various Crafts for Mass Effect while wearing Metal Gear, avoiding Pitfalls, and Monster Hunting to defend Civilization in Ace Combat against Hitman Candy Kart Raiders beneath the Harvest Moon
...of the Dead.
...Champion Edition.

Edited 1 times. Last edit by Alfonso Sexto on 24th February 2014 8:15am

Posted:9 months ago

#15

Curt Sampson Sofware Developer

596 360 0.6
There is a problem in the fact that this is why mobile market games are self-stuck. Almost nobody is going to make a deep immersive game when the real beneficent comes from a simplistic time-killer.
I don't know that it's that big a problem. The mobile market is not about serious gamers, and that's fine. Just as there's a large but fickle market for books to read on an airplane (i.e., just to provide some sort of adequate entertainment for those who have some time to kill), we have the same market for games now that a large enough audience has a device on which to play them. Really, the competition here is video, radio, magazines and suchlike. Whatever happens to this market (and I would not be surprised to see it crash), I don't think it's going to affect the core gaming market at all, and that core gaming market is still a couple of hundred million people willing to shell out an average of a few hundred dollars a year each.

Posted:9 months ago

#16

Neil Young Programmer, Rebellion Developments

312 412 1.3
@Andreas - whilst that's going to be reassuring to their fans and staff, it doesn't sound like a great pitch for investment: investors want growth, and growth means either making more from CCS (merchandise?) or more hits on a similar scale.

Posted:9 months ago

#17
I wonder what will happen to the mobile market if King's IPO tanks?

Posted:9 months ago

#18

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