Last week, King Digital Entertainment (KING +0.00%) became a publicly traded company in a remarkably bad IPO. Some pundits in the financial media, including Bob Pisani on CNBC's FastMoney, seemed to downplay the issues with the company. But complacency in discussing the facts surrounding recent IPOs may pull in individual investors unaware of the risks.
There is the possibility of King's Candy Crush reaccelerating growth in its subscriber base or new King games providing additional revenue streams, but if you are considering investing in shares of King, you need to understand the risks.
Revenue declined in December
In the December quarter, the company recognized $602 million in revenue, which was down 3% from the $621 million it recognized in the September quarter. Making anywhere near $602 million for a company in existence less than two years is very impressive, but it's still slowing.
This wouldn't be an issue if there were high competitive barriers or switching costs, but there really aren't any. If a customer decides to stop buying add-ons for his or her games, the revenue just stops. Immediately.
Average monthly unique payers declined in December
The quarterly average for monthly unique payers declined in December. If this represents an inflection point, revenue and profits could fall off a cliff. The chart below shows a drop from the average of 13 million to 12.1 million, but we don't know if this is gradual, or if users peaked and are falling.
Source: F1 filed with the SEC
The rate of decline could be worse than the chart above indicates
The chart above shows what traders might consider a consolidation, but the monthly data could look very different. We don't know the shape of the curve, but the company offered some clarity in the F1:
We believe the movement is as a result of less payment activity among occasional payers in our earlier Saga games, such as Bubble Witch Saga and Candy Crush Saga, in North America where we have enjoyed a rapid proliferation of network and payer growth.
Since the shape of the curve can take different forms, we put a sample together of two different scenarios. Neither one looks good, but one -- the dotted line on the chart below -- is dramatically worse than the other.
Source: Author's estimates for monthly data and company provided averages for the quarter. Figures shown in thousands.
Source: Author's estimates. Figures shown in thousands.
We don't know which of these scenarios will play out. These are only estimates for display purposes. The trend could reverse itself in the coming quarter. But either of these two scenarios is a possibility.
King paid out more in the last five months than it raised
At the IPO price of $22.50, the deal raised $350 million for King and $150 million for early investors, such as private-equity firm Apax Partners. The company and its shareholders sold 22.2 million shares, plus the underwriter greenshoe of an additional 3.3 million shares. This leaves the company valued at $7.1 billion.
However, the early investors have already been raiding the company's cash hoard. In the last five months, King Digital paid $504 million in cash dividends to its shareholders, This came in not one, but two, dividends: $287 million in October 2013 and $217 million in February 2014. Why are the investors so eager to get their cash back?
If investors who may have visibility into the monthly trend of active payers pulled out the cash assets of the company before the IPO, should individual investors wait and see if that cash will be replaced?
Don't kid yourself, it is a "one-trick pony" right now
AppAnnie.com shows that King has three of the 10 top-grossing games on the iPhone platform. This doesn't directly translate into revenue, but it does give an indication that the company can produce multiple high-ranking games. However, King still needs to show that it can derive revenue from these other games.
Candy Crush had 97 million average daily users in January, according the revised F1. But it drops off precipitously after that. The other two games in the top 10 are Farm Heroes and Pet Rescue, which have 20 million and 15 million, respectively.
Know the risks if you're going to invest
When Tim Seymour asked Pisani if recent IPOs like A10 and King selling off was a sign of sanity in the markets, he was chastised with phrases like "[King is] not a one-trick pony," and, "This was a good representation of the IPO market -- well-known, big name." This is misleading, and it could be dangerous for investors who haven't read the filings.
Consider the following about King Digital:
- It has declining customer growth in the one product that accounts for more than 75% of its bookings.
- It has investors who felt the need to pull money out just one month before the company went public.
- It has a CFO who has been with the company for only six months.
- Financial media seem to be pumping up the importance of the company.
It may be worth waiting to see the next quarter's results.
