Will King Digital Entertainment PLC Get Crushed?

After a disappointing IPO, shares of King Digital have begun recovering nicely, which brings into question if the company will go the way of Zynga and Electronic Arts into mediocrity or if it has the potential thrive like Activision Blizzard.

Daniel Jones
Daniel Jones
Apr 3, 2014 at 9:00PM
Technology and Telecom

Source: candycrushsaga.com.

After falling 20% from its IPO price of $22.50, shares of King Digital (UNKNOWN:KING.DL), the maker of Candy Crush Saga, partially redeemed itself on April 1. Despite fears from investors that the company may go the way of rival Zynga (NASDAQ:ZNGA), Mr. Market pushed the company's shares 9% higher to end out the day. This was followed by a modest 2.5% pullback on April 2, but the general picture is starting to look good for the company's share price. 

Now, however, the big question is how King Digital will perform moving forward. Will it follow in the footsteps of Zynga and Electronic Arts (NASDAQ:EA) toward mediocrity, or does the business have what it takes to bask in the glory of success like Activision Blizzard (NASDAQ:ATVI)?

King Digital looks like a different creature entirely!
Over the past three years, King Digital has had an amazing run. Between 2011 and 2013, the company saw its revenue rise nearly 2,900% from $63.9 million to $1.88 billion. In its prospectus, the company attributed its rise in revenue to a drastic increase in its gross bookings over time. This was, primarily, attributable to the company's three most popular games, which comprised 95% of gross bookings by the end of its 2013 fiscal year.

While this kind of growth is reminiscent of Zynga's early success, there is a key difference between the two. Unlike Zynga, King Digital has been able to book a profit for two of the past three years. In 2012, the company reported a net gain of $7.8 million, up from the $1.3 million loss incurred in 2011. Then, something amazing happened. In 2013, the company's bottom line jumped to a whopping $567.6 million because of its tremendous revenue growth and modest research and development expenses.

Source: Wikimedia Commons.

In juxtaposition, both Zynga and Electronic Arts have had difficulty turning a profit. Between 2011 and 2013, Zynga reported an aggregate net loss of $650.7 million, while Electronic Arts saw its cumulative loss come in at $102 million. Both businesses have reported a drop in sales over this timeframe, but cost-cutting initiatives imposed by management has improved their profitability to some extent. While Zynga reported a net loss of only $37 million during 2013, Electronic Arts saw a gain of $98 million.

King Digital looks a lot more like Activision Blizzard!
Although their business models differ, King Digital's performance looks closer to Activision Blizzard's than it does Zynga or Electronic Arts. In 2013, King Digital sported a net profit margin of 30%, compared to Activision Blizzard's 22%. On top of high margins, Activision Blizzard has proven to be a true growth machine.

Source: Wikimedia Commons.

Excluding the company's 2013 fiscal year, when sales dropped 6% (largely due to fewer subscribers playing its World of Warcraft franchise), the company has increased its revenue at a nice clip. Between 2005 and 2012, for instance, the company's revenue improved every year, growing at about 17% per annum.

Foolish takeaway
Based on the evidence provided, it's clear that King Digital is a fast-growing enterprise that still has room to run, but unlike rivals like Zynga, the business behaves like a strong, mature participant. Moving forward, it will be interesting to see if management can continue innovating and pumping out cash cows like Candy Crush Saga.

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If it can, there's no telling how high the business can fly. But any sign that its customer base is heading out the door, could cause the company, (and its shareholders), to be crushed.