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Sweet - Candy Crush Creator King undervalued at $24

This piece was updated to respond to the New Yorker article “What’s Candy Crush Really Worth?” by James Surowiecki

New Yorker staff writer and business columnist par excellence James Surowiecki posted a thoughtful response to my argument over on his blog. But I’m still right. King is already demonstrating its prowess at sustaining its Candy Crush revenue stream and developing new ones. It’s not remotely a Beanie Baby situation, an analogy Surowiecki doesn’t choose to defend.

As Candy Crush play appeared to be peaking in December, King added a whole new side expansion called Dreamworld. That certainly worked on my wife, who had (only temporarily it now seems) stopped playing but got sucked right back in. And King credits the expansion with renewing growth --  97 million people played the game daily in February up from 93 million in December.

Also, there are plenty of video game franchises of all kinds that don’t depend on any kind of “natural upgrade cycle.” Think Angry Birds, Need for Speed, Pokemon and all those zillions of simple Mario Bros. games we loved way back when among many others.

They often do require big marketing investments but King already does that and plans to continue (to the tune of $100 million per quarter and counting, they say). A combination of small targeted ads, big brand ads and links in other games got 20 million people playing King’s new Farm Heroes Saga in two months. And, excluding Candy Crush, King has two of its newer games in the top 10 grossing games on both iOS and Android. Those tend to build over time.


King Digital Entertainment, owner of the world’s most addictive video game, slapped a price range on its initial public offering Wednesday, and the bottom line was a lot lower than expected.

The owner of Candy Crush Saga said it planned to sell 25.5 million shares at up to $24 each. With 315 million shares outstanding after the offering, that values the company at $7.6 billion.

Wow, crazy, insane, nuts – right?

Hardly. Mainly on the strength of Candy Crush, King brought in $1.9 billion of revenue and $568 million of profits last year. That’s $1.80 per share in profit, or a trailing price-to-earnings ratio of a whopping 13.3.

This is nothing in comparison to high-flying, bubble-icious tech stocks. Facebook’s (FB) P/E is 115 and Netflix (NFLX) sits at 235. It’s also nothing like beleaguered game maker Zynga (ZNGA), valued at $5 billion with a cool $600 million of losses in the past three years.

King’s ratio is more like unloved, out-of-favor tech stocks with declining franchises, such as IBM (IBM), with its P/E of 12.3, or Hewlett-Packard (HPQ), at 10.9.

The question of sustainability

Of course, the real question is the sustainability of King’s profits. Well, sort of. An investor buying the shares is really getting a stake in the future cash flow from the company’s current hits, plus an option on all the future games King may or may not develop to similar stratospheric levels of addictiveness and popularity.

Candy Crush Saga may be the company’s one hit, but it’s a biggie. And though it may be fading somewhat, it’s not dropping off the face of the earth. In its latest filing, King said that, in total, people played its games 1.4 billion times a day in February, up from 1 billion times a day in December. That came from 144 million daily active players, up from 128 million in December.

Most of the activity came from Candy Crush, but its play increased over the two months, rising to 97 million daily active users in February from 93 million in December. And while most other games showed flat activity rates, King’s newest game, Farm Heroes Saga, jumped to 20 million daily active users in February from 5 million just two months earlier.

There’s also the distinct possibility of future cash dividends, a rarity for tech IPOs.

King paid out two huge dividends, totaling over $500 million, to its existing owners over the past six months. That’s not uncommon in cases like this, where a private equity firm owns part of the company. But there are actually indications in King’s securities filing to suggest it wants to keep paying dividends as a public company. Based in Ireland, King said it has petitioned the Irish High Court for permission to pay future dividends from cash designated as “distributable reserves” under Irish law. That move, along with other considerable detail about dividend tax issues in the filing, suggests King is aiming to pay dividends soon.

A continuing dividend yield of 2% at the $24 share price would consume just $152 million. A 3% dividend requires $227 million. Cash flow may decrease if Candy Crush trails off without a replacement, but with just over $700 million coming in from operations last year, the company has a substantial cushion.

A tougher question

The tougher question is the value of the option piece.

Some people argue somewhat convincingly – lately James Surowiecki in the New Yorker, for example – that the nature of mobile gaming popularity is all randomness and happenstance. And I, too, wasn't impressed with the results in King's initial IPO filing.

“King is part of a venerable tradition: the one-hit wonder," writes Surowiecki. "Like Coleco, with Cabbage Patch Kids, or Ty, Inc., with Beanie Babies, King’s business is dependent on its one star product; although the company has more than a hundred titles, almost eighty per cent of its revenue comes from Candy Crush. King has done a great job of making money from the game, and of keeping it fresh, but Candy Crush is still a fad, and, like all fads, it will fade.”

That certainly could be. And Zynga’s experience with Farmville is an obvious warning sign.

But the comparison isn’t completely apt. Candy Crush Saga is nothing like a Beanie Baby. It’s a video game. It's an experience, an upgradable one at that, not a static toy. There are many successful video game franchises, despite a few examples of failures Surowiecki mentions. And he may not appreciate how long King will be able to milk Candy Crush just with upgrades and additions to the original app. That seems evident from the December to February stats King just provided.

King's mobile games also have some of the characteristics – by design – of another lucrative and sustainable gaming industry: slot machines. The crazy, flashy colors, frequent small rewards and low-priced, in-game payments, among other features, are designed to create the same kind of addictive game play. And, by the way, Zynga's Farmville is not built on that model. The trick here isn't actually about inventing some totally new and brilliant mobile game. (Take a good look at  Farm Heroes Saga if you don’t believe me). Rather, it’s about keeping an addicted audience tuned to your particular brand of addictive payoff.

Slot machine owners have to build vast casinos and give away free beer to keep people playing. The question is whether King can build something of a mobile casino model to go with its slot machine-like hit games. Promoting one game inside another is one option. Large-scale brand and image marketing could also work.

It’s not a sure thing, but it’s also much less of a risk than some seem to think. And that could give investors a reason to buy.