King Digital Entertainment (UNKNOWN:KING.DL) suffered one of the worst initial public offerings this year, with the stock plummeting more than 16% on March 26, its first day as a publicly traded company. The immediate decline was surprising considering the company priced its IPO at $22.50 or in the middle of its $21 to $24 range. Nonetheless, shares continued to slide following its stock market debut -- slipping a whopping 20% by the end of the week. Today, the mobile game maker's stock is trading around $15 a share. For those keeping score at home that's a decline of more than 31% from its IPO price.
Investing in this botched IPO has taught me two important lessons.
1. Don't trade into the hype.
2. One-hit wonders make terrible IPO candidates.
Investing in IPOs is risky. There tends to be a lot of hype surrounding companies ahead of their initial public offerings. After all, it's the job of the underwriters and the business in question to drum up excitement ahead of a company's debut on the stock market. Unfortunately, this can distract investors from potential red flags.
Wild enthusiasm about the burgeoning social gaming space underscored King Digital's ballooning valuation in the days leading up to its public inauguration. The company looked great on the surface. King was not only profitable at the time of its IPO, but it's free-to-play gaming model also pulled in revenue of $1.88 billion in 2013. The underwriter's made sure to promote this fact ahead of the company's offering.
Yet, in hindsight, investors (myself included) should have put more thought into why the company wanted to go public in the first place. It certainly wasn't to raise money to fund its businesss (it had $409 in cash on the books at the end of 2013). Nor was it going public to repay debt obligations (King Digital didn't have any debt). A closer look revealed that the company was using this IPO, at least in part, as an exit strategy for existing investors.
To be clear, King wasn't hiding this. A quick look at the prospectus would tell investors all they needed to know. The problem was, for many investors, it was easier to trade into the hype. The fact that the company's Candy Crush Saga game accounted for 78% of sales and 70% of its average daily users was another red flag that many investors chose to ignore. This meant that those who chose to invest in the IPO were making a big bet on the ongoing success of a single game. The casual gaming business is highly competitive and users are fickle.
There were dozens of one-hit wonders that came before Candy Crush including Angry Birds and Zynga's (NASDAQ:ZNGA) FarmVille franchise. Yet, these too eventually fizzled out as players moved on to newer social games. Candy Crush has been bleeding players since its stock market debut and currently ranks 49th on Apple's App Store and 24th on Google's Play Store. The takeaway here is that social games like Candy Crush can only remain on top for so long because of the nature of the free-to-play model. Ultimately, King needs to introduce new hits that resonate with casual gamers if it hopes to see a turnaround in bookings.
Ultimately, the most important thing I've learned is to invest in the company, not the IPO.
Tamara Rutter owns shares of King Digital and ZYNGA INC. The Motley Fool has no position in any of the stocks mentioned. 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.