King Digital Entertainment's fresh IPO registration will spark plenty of investor interest. The company's revenue growth is incredible, from less than $200 million in 2012 to $1.9 billion in 2013. It's been profitable for two years. And it has 12 million paying customers, on average, each month. There's one issue, though. It produces digital games focused on mobile devices. And that industry has had a bad rap ever since Zynga's (NASDAQ:ZNGA) decline.
But are all Zynga-like companies doomed for failure, or could King Digital demonstrate that, given the right strategy, such a business can sustainably prosper? And if so, could it help Zynga come back from its troubles?
Candy crushing it
King Digital's darling is, of course, Candy Crush Saga, with 93 million daily active users. Its next most popular title, Pet Rescue Saga, only claims 15 million. Given the runaway success of Candy Crush, investors must ask if it can reliably repeat creating such a game, and if such a game will stay popular. Based on past popular titles, the popularity of top games doesn't last long -- at least according to Google Trends:
However, King Digital realizes this impediment to success, and puts "long-term retention of [its] players at the heart of [its] business model." It also has a proving ground for new games at its website, royalgames.com, where it can "gather rapid feedback" from players and launch the most popular games onto mobile and Facebook (NASDAQ:FB) platforms. This type of development process could help avoid putting huge development resources behind dud games.
Too great expectations
Even with a streamlined process and the right focus, a game creator is a lot like a movie producer. Revenue will be choppy as the hits fade and new ones are released. This unpredictable behavior can mean wild swings in stock prices. And unlike with traditional game makers, like Electronic Arts (NASDAQ:EA) or Activision Blizzard (NASDAQ: ATVI), the mobile game market is made up of much more casual gamers with little allegiance to what they decide to entertain themselves with while waiting for the bus. This is exemplified in the fact that only 4% of King Digital's players end up paying for virtual items. Likewise, when Zynga went public, less than 3% of its users paid for digital goods. With these casual gamers, popularity of titles churns even faster than compared to console or PC games, where users have invested a bit more than a few clicks.
A yet unproven model
Developers can make billions on mobile games. However, it's yet to be seen whether one company can sustainably make billions. It could be that the mobile game business, with its flitting user bases and unpredictable hits like Flappy Bird, favors the single or small team developers, which can be just as nimble as their users. Because, when you begin adding in the infrastructure and overhead of a corporation, the cyclical nature of game popularity can hurt while a company scrambles to produce another hit.
These are the reasons Zynga's recent layoff of 15% of staff, mostly from "infrastructure" areas, makes sense. It needs to be more nimble while finding a new hit. And while its purchase of NaturalMotion adds 260 employees, it gives Zynga a different development process and culture, which just might be what it needs to find a more sustainable future. In the meantime, Zynga still has a little over $1 billion to live off of while it expects its current fiscal year to end with a loss between $49 million and $56 million.
If King Digital finds that it has the processes and management to be the one successful mobile game developer as a large company, then the rewards will come with taking that risk.
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Dan Newman has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard and Facebook. The Motley Fool owns shares of Activision Blizzard and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.