It’s one of the oldest – and most reliable – Wall Street adages: Sell when others are buying, and buy when others are selling. And sometimes a stock glows like lightning with all the selling and misplaced hatred.
It sure does with the most hated IPO of the year, Candy Crush Saga owner King Digital Entertainment (KING). One week after the stock debuted on the NYSE, it's trading at $19.50, about 14% below its IPO price of $22.50; the highest it's traded since then has been $20.15. But, going against the general sentiment regarding King, I actually have faith in the company's fundamentals. And, to put my money where my mouth is, I waded in last week and bought 300 King shares in a retirement account. Purchase price: $18.85. I’m willing to sit tight until investors discover the value of this much-hated stock – and to take a hit if they never do.
Last year, when King was just a rumored IPO, I was one of the haters. Candy Crush looked like a one-hit wonder in a business where the next big thing could come from anywhere. And who could forget Zynga (ZNGA), the disastrous IPO of two years ago? They made games similar to Candy Crush, didn’t they? That’s pretty much the conventional wisdom on King to this day.
But in my house, we have a bunch of Candy Crush players. In solidarity, I played myself for a while. And there’s clearly a lot more going on with the game than just random processes. It works to keep you playing. In that sense, it’s far different than Farmville and the sort of long-running role-playing games that are Zynga’s stock in trade; Candy Crush is much simpler and yet much more compelling to many players.
So I dug into King’s IPO filings. And the company is a cash-generation machine, racking up $2 billion in revenue and profits – actual GAAP profits – of almost $600 million. But it all happened so quickly. Is it sustainable? Is it repeatable?
And thus the question – is mobile gaming a market that can be cracked? Zynga didn’t do it, but the 20 search engines before Google didn’t prove Web search couldn’t be cracked. And how many Hollywood studios issued 14 hits in a row before Pixar?
First off, as I’ve discussed before, the research people cite to argue hit games arise randomly is pretty weak: an eight-year-old study, done before the iPhone existed and before Facebook and Twitter hit it big, looking at kids downloading songs under highly controlled conditions. Songs aren’t like games, and mobile phones are different than PCs.
Games can be programmed to react to individual players’ preferences. Games can not only lead to sequels, games can actually pitch other games by inserting advertising or even links to other apps. Most important of all, games can, again, be very addictive (Civilization, I’m looking at you), especially when you've got that phone with you everywhere.
The more I looked into it, the more Candy Crush seemed to be operating similarly to slot machines in a casino, relying on many of the same psychological tricks. There’s an awful lot of big-data crunching and science behind the scenes in Las Vegas – thank you very much, Gary Loveman.
King, too, is using a lot of data crunching, small experiments and frequent failures to hone its games. Psychologists have even noted the game appeals to some of our most deeply rooted desires. And King is using Candy Crush to uncover the minority of players, about 10%, who really like to play that style of game and are willing to pay to progress. That’s a valuable group to know, like the “whales” who populate casinos from Vegas to Macau.
King has already used Candy Crush Saga to launch several newer games that are proving just as popular in the early going. Farm Heroes Saga gained 20 million daily users in just a few months and already ranks as the 6th-highest grossing app in the U.S. iTunes store. If I am correct, the market will eventually recognize what’s going on and the stock will take off.
Of course, Candy Crush won’t remain popular forever. Game play already suffered a slight downturn in the fourth quarter relative to the prior quarter, although activity appeared to pick up again in 2014. And no investor is infallible, certainly not I. Anyone remember typewriter maker Smith Corona? Sirius Radio? I’ve had my share of busts over the years and will likely have more.
The key is to stay wary by frequently reassessing the investment thesis. And that adds another appealing aspect to the King trade: The top-grossing app charts for Apple and Android live and breathe in real time, 24/7. If it turns out I’m wrong and King is a one-hit wonder, there will be creeping evidence for those paying attention.
So if you see King's Farm Heroes Saga slipping its way down the app charts, you may be reading my mea culpa next.