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The Candy Crush IPO will be a bargain, not a bust

Shares of King Digital, makers of the popular Candy Crush Saga, were getting, well, crushed Wednesday morning, down on its first day of trading. Why is this hotly anticipated IPO doing so poorly? Matt Jarzemsky joins MoneyBeat.

It’s the greatest – or really worst – day ever for puns and other fancy wordplay in financial headlines after the ugly initial public offering of Candy Crush owner King Digital Entertainment (KING) on Wednesday.

Underwriters priced King’s shares at $22.50 Tuesday night, smack in the middle of the expected range. But demand has been tepid thanks to waves of less-than-brilliant consensus analysis that King is too dependent on Candy Crush. And so the shares opened down about 10%, leading to headlines such as:

“'Candy Crush' maker gets crushed in early trade”
Brother can you spare a life? 'Candy Crush' maker prices under IPO
“Sour market debut for Candy Crush maker King Digital”
"The Candy Crush IPO Is a Nasty Popcorn Jellybean"

The great irony, of course, is that King is more likely a long-term winner than almost all of this year’s previous tech IPOs, especially at its current stock market value of less than $6.5 billion. Valued at three times revenue and, sacre bleu, 11 times last year’s profits (the GAAP approved kind, not the hinky-jinky “adjusted” kind), there is much less risk buying shares of King than other recent IPOs, with their ballooning losses and intensely competitive market niches.

King has already proven it can develop one winner and milk it for tons of money. It may have been lucky at some point but it’s more science that fueled the growth. Even if Candy Crush is a fading classic, it’s still going to throw off tons of profits for the foreseeable future. While many stories have noted Candy Crush activity declined from the third quarter to the fourth, they failed to mention game play picked up in January and February, with daily active users rising 4% to 97 million over the two months, according to King’s most recent SEC filings.

What King appears to have actually accomplished is building a casual, mobile gaming empire, including Candy Crush and other titles, that attracts people who will pay to play. Plays per day across the whole network are still rising at a rapid clip – from 1.2 billion in December to 1.4 billion in February.

As discussed in previous weeks, King is already gaining large audiences for a couple of its newer games, like Farm Heroes Saga, using the same psychological techniques and mathematical analysis that built the highly addictive Candy Crush. These methods are also used in the casino gambling industry, where the "whales" pay all the bills and more as the "minnows" drink free beers and play slots.

Investors flocking to other IPOs are making a classic mistake, betting on exciting themes and that tiny companies will be the winners in gigantic, fast-growing markets. Yes, Castlight Health (CSLT), I’m thinking of you, carrying nearly half of King's valuation with $13 million in revenue and $68 million of losses last year. Investors may have made a mistake betting on another gaming play, Zynga (ZNGA), but the company's model was quite different from King's, with the games less addictive and the monetization too dependent on Facebook (FB). And there were never any profits.

Meanwhile, it must be a lot more work to evaluate what’s behind the empirical success of a proven profit maker such as King. Google (GOOG) was just an index of the Web that could be dethroned tomorrow, Amazon (AMZN) just another online retailer, eBay (EBAY) only a place to trade used baseball cards and Pez dispensers. But a lot of these tech winners are more like Coca Cola (KO), with its secret formula for soda, than commodity producers of the tech equivalent of corn feed or copper ingots.

Has King cracked the code to reliably monetize mobile gaming? There's more evidence that they have than that they have not.