Candy Crush IPO – a risky investment?

Great entertainment but subscribing to its share issue may be a dangerous game to play…

By Wouter De Maeseneire, Professor of Corporate Finance at Vlerick Business School

Many observers agree that King (Entertainment) comes to the market at stunning valuation levels, and I would back that up. Most of all, I will also admit that this is a rather high risk investment. The entertainment industry in general and the gaming sector in specific is scattered with one hit wonders – companies who experience huge success with a single product but were not capable of repeating the success. People who invest in such companies bet their money on the genius of a few creative people – who can easily be snatched away by competitors.  The high level of risk is also clear from the huge list of risk factors reported in the prospectus – it spans about 25 pages. King currently obtains 78% of its revenues from one single game, Candy Crush Saga.

Is it really overpriced?

Although many claim that King’s IPO valuation is astronomically high, there are some arguments which could suggest that is reasonably priced. King’s peers such as Activision Blizzard (Call of Duty, Warcraft) or Electronic Arts (The Sims, Battlefield, Fifa) respectively have a market cap of $14.85 bio and $9.2 bio, and are valued at roughly 2-3 times sales. In that respect, one could state that King with its astonishing track record is just valued at 3.5-4 times sales and that this is justifiable. But the companies mentioned above are more mature and established firms. Activision for instance for the last 3 years generated a growing sales number exceeding $4.4 bio, and managed to generate strong margins leading to operating profits of $1.3 bio and $1.4 bio in 2011 and 2012, which justifies its rather high P/S ratio.

Compared to the valuation ratios at which Zynga went public in December 2011 one might even have the guts to declare that the King IPO is an absolute bargain. Zynga went public at a $7bio valuation, corresponding to about 12 times 2010 sales and more than 6 times 2011 sales. It went public at 78 times 2010 earnings, yet sales growth basically stalled after its IPO and the company has been loss making ever since (more than $400 mio in 2011).

King’s operating performance is unambiguously mind blowing: sales increased from $64 mio in 2011 to $164 mio in 2012, and exploded to $1.88 bio in 2013. Net after tax earnings display an even more amazing evolution, from $1.3 mio loss in 2011, to $7.8 mio in 2012 and $568 in 2013 – and that with a workforce of 665. In that respect, one could say that the suggested IPO price is just 11-13 times current earnings, peanuts for a rapidly growing business.      

King has a 324 mio user base – measured by monthly users, corresponding to a valuation of about $20-25 per user. This seems fairly low compared to the 40$ per user paid by Facebook in its $19 bio WhatsApp deal. It also compares favourably to the $90-150 per user at which social media firms like Twitter, LinkedIn and Facebook are trading.  Nevertheless, recently disclosed figures exhibit that the number of people playing Candy Crush started to decline…

Obviously – based upon the above observations one cannot safely conclude that for sure the company is enormously overvalued at the time of the IPO, but clearly it is not priced cheaply and its valuation levels imply a future growth level and margins which are very hard to generate – yet only time will tell whether the company indeed succeeds at displaying that level of performance.

Where do I see the company’s stock price within 5 years from now? Obviously, it is just impossible to predict that but I can safely say that there is limited room for significant further increase in King’s share price, and that the stock will more likely stabilize or decrease rather than rise – the implicit valuation levels reflected in the suggested offer price leave no room whatsoever for disappointing investors and require the company to sustainably meet the markets’ very ambitious expectations about the company’s future performance, in terms of competitive positioning, sales growth and profit generation.

In summary, returns for King’s IPO investors may be positive but those buying the stock at IPO better be ready for potentially a bumpy ride…

Read the full opinion article: "Candy Crush - great entertainment but subscribing to its share issue may be a dangerous game to play…"


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