King Digital: Get It Before It's Hot

King Digital (KING) has been an enigma to Wall Street ever since its IPO a little over a year ago. It’s established itself as a leader in a new industry that—to put it frankly—gives sophisticated investors the heebie-jeebies. Mobile gaming, while insanely popular, is still in its infancy and there are a lot of questions about how mobile game companies can offer consistent and sustainable value to their investors.

In fact, there was a Fortune article in August 2014 that argued that mobile gaming companies shouldn’t go public at all. Its premise—at the time—was actually King Digital itself. The company reported a decent quarter the previous day, beating the consensus estimate on revenue by $0.02 but missing on revenue by about $25 million. But the stock plunged 20% that day on what the Fortune article labeled “sluggish growth and tepid earnings for the previous quarter. The mobile gaming kingpin’s new titles apparently failed to generate sufficient cash to cover the “unexpectedly” steep drop in revenue from its maturing Candy Crush franchise.”

The author went on to say that King Digital—and the rest of the mobile gaming industry—are terrible investments because of a “fickle audience, rapidly changing technology and almost no barriers to entry.”

It’s hard to blame the author, or anyone else for that matter, for being bearish on King Digital and the mobile gaming industry. The first example we have of a shooting star in that industry is Zynga (ZNGA). At one point, the game maker had a market valuation of over $7 billion. Today, the market cap has shrunk to $2.25 billion. Why? Because it was never able to replicate the success of its flagship Farmville franchise. Shares of the company are down 74% from its IPO price. So why do I disagree? Here’s why.

The Industry

The mobile gaming industry is absolutely still in its infancy, but it’s growing. According to AppLift, the global mobile gaming industry will reach $40.8 billion in revenue in 2017, up from $17.5 billion in 2013. The Asia Pacific, including China, is driving the most growth and will continue to do so in the coming years, but the United States is also a big player in the market.

These estimates counter the claims that the mobile gaming market is becoming saturated. In fact, the recent spike in growth has some analysts estimating that mobile gaming revenue will overtake console gaming revenue sometime this year. The main reason for this is because console gaming typically appeals most to young males, while mobile gaming is ubiquitous across all demographics.

The Company

While the mobile gaming industry is quickly changing, with some games becoming more complicated and intense, King Digital still has a vise grip at the top. As of February 2015, three of its games—Candy Crush Saga, Candy Crush Soda Saga and Farm Heroes Saga—all held spots in the top 10 grossing games for iOS (iPhone and iPad), Google Play and Facebook. The fact that Candy Crush Saga is still up there shows that its sequel isn’t cannibalizing sales as much as the market expected.

On top of that, 2014 Q4 earnings beat consensus estimates on both revenue and earnings quite handily. The company also reached a milestone with more than half its revenue (55%) coming from non-Candy Crush titles, down from 80% a year ago. Not only does that prove that King Digital can no longer be considered a one-hit wonder, it’s just the opposite. It’s building a fortress and its moat is filling up nicely.

The company is also diversifying away from casual games. With its acquisition of Z2Live, maker of Battle Nations, it now has the resources and manpower to break into markets previously untouched by casual game makers. Unlike casual games, non-casual games have smaller target audiences. For example, Newzoo shows that Candy Crush appeals to a much wider range of demographics than Supercell’s Clash of Clans does. Additionally, Clash of Clans has about 20 million less users than Candy Crush. However, Clash of Clans holds the top spot for highest-grossing games for both iOS and Google Play—and it has for a while.

Conclusion

With the mobile gaming market starting to establish itself, there still remain one-hit wonders and rising stars that offer nothing but the game du jour (see Glu Mobile). However, King Digital has proven time and time again it’s not one of them.

Not only has the market matured enough to be taken seriously, King Digital has built a brand that won’t die out quickly. All the worries about the slow death of Candy Crush can be wiped away as the company diversifies its offering, not only in casual games, but beyond. With King Digital scheduled to report earnings once again in a couple of weeks, I expect to be impressed once again as Candy Crush Soda Saga has been seen its first full quarter (it was released in November 2014) and King’s China initiative with Tencent (TCEHY) in China comes full circle. As investors see these results and as King Digital continues to grow, Wall Street will warm up to it. If you don’t already own King Digital, it’s time to get it before it’s hot.