King Digital (KING): Valuation Matters

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When King Digital (KING) went public back in March, I was a skeptic. I find it difficult to get enthusiastic about any company in the online game business. It is not that “Candy Crush Saga” hasn't been a tremendous success. Obviously it has, but the success of such games is generally fleeting and difficult to reproduce. Simple logic warns me to steer clear. As King gets ready to report earnings on Wednesday, however, I cannot escape the thought that the stock is worth buying.

If nothing else, as the quiet period following that IPO comes to an end and the banks involved in that offering are allowed to initiate coverage, a whole rash of “buy” recommendations look to be on the cards. Already this morning, Stifel and Pacific Crest have initiated coverage with positive recommendations and price targets of $22 and $21 respectively. More of the same can be expected over the coming days and weeks if Wednesday’s results are average or better.

Wednesday’s announcement obviously poses some short term risk, but, given the performance of the stock since the IPO, it looks like any bad news is already priced in. The stock has never traded above the $22.50 initial price.

The basic reason I am bullish on KING, though is a very simple one. It is, in fact, the most basic of reasons to buy anything... it's cheap. In these days where tech companies' P/Es are measured in the hundreds, it is hard to pass up a young company with a trailing P/E of around 10 that has an established record of positive cash flow.

Of course, trailing P/E could be deceptive here, Candy Crush Saga is past its prime popularity, and with bookings representing around 82% of 2013 totals, potential investors are worried by declines in that game. King, however is not a one trick pony. They have used the ”saga” brand to good effect, with “Farm Heroes Saga,” “Pet Rescue Saga” and “Bubblewitch Saga” all achieving success. King is the leading supplier of Apps on Facebook (FB), but the focus of the company is on mobile. Growth in mobile gaming is rapid and King is the number 1 grossing publisher on both Apple’s App Store and Google Play during the last quarter.

The mobile gaming app industry as a whole is booming, and nowhere more than in China. King are working on a Chinese version of Candy Crush and if the game’s popularity can be even partially reproduced in that massive, virtual product friendly market there may be a few new tricks left in the old dog yet. Revenue from advertising looks set to grow as well.

King currently derives almost all of their revenue from virtual goods, but at some point in the future, leveraging their games popularity for advertising revenue must be on the cards. As technology for advertising delivery improves, the ability of companies with successful titles to monetize their products should go with it.

There are, then, plenty of opportunities for positive news in the announcement on Wednesday. With KING’s price remaining well below the initial pricing, anything positive could have a rapid effect, while a so-so or slightly disappointing result looks to be factored in.

To an old fuddy-duddy with tightwad tendencies like me, a business model based on people paying to upgrade an otherwise free game is a strange one. I learned a long time ago, however, that the one time not to trust my instincts was when they were contradicted by numbers, and that is the case with King Digital. They have been enormously successful at generating revenue and profit from their games and there is no reason to suspect that that will end any time soon. I am still not certain that KING is a stock I want to hold for 5 or 10 years, but with the short term catalysts of earnings and coverage initiations coming up the stock certainly looks like a decent short term bet.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , Technology

Referenced Stocks: KING , FB

Martin Tillier


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