Will Investors Chomp On 'Candy Crush' Game Maker IPO?

THE BUZZ

Every day around 144 million people play online games made by King Digital Entertainment, most of them navigating the colorful "Candy Crush Saga.

King Digital (KING) devotees play about 1.4 billion game episodes daily, mostly on smartphones but also the Web and Facebook (FB), with "Candy Crush" accounting for about a billion of those plays.

It's not a brainbuster game like chess. "Candy Crush Saga" is a simple online puzzle game where players progress through a dazzling display of candy. There are 500 levels, each offering a different challenge that gets progressively harder.

Each game session is designed to last a few minutes. People play them on buses, trains, planes, in airports, on coffee breaks and study breaks, while they're watching TV or waiting to meet a friend.

King Digital has been developing games since 2003, but it wasn't until the introduction of "Candy Crush Saga" on mobile in the first quarter of 2012 that it hit the jackpot. Like a hit song, "Candy Crush Saga" rose to No. 1 on the charts and remained king far longer than others. The company believes "Candy Crush Saga" is one of the largest interactive entertainment franchises of all time.

King Digital is shooting for another big score with an initial public offering that is expected to launch Wednesday. The company plans to raise $500 million by selling 22.2 million shares in a 21 to 24 range. That would give it a $7.6 billion market cap at the high end.

THE COMPANY

King Digital describes itself as a leading interactive entertainment company for the mobile world.

"Our mission is to provide highly engaging content to our audience to match their mobile lifestyles: anywhere, anytime and on any device," the company says in its IPO prospectus filing.

The 144 million people who play daily are up from 128 million in December. In Q4, King Digital had 408 million average monthly users, up from 361 million in Q3.

In addition to "Candy Crush Saga," other games include "Pet Rescue Saga," "Farm Heroes Saga," "Papa Pear Saga" and "Bubble Witch Saga." They are referred to as casual games, which typically include a puzzle element, are easy to learn and hard to master. They can be played in a few minutes on a wide range of devices. King Digital has a catalog of about 180 games, all of them free to play.

King Digital operates six game studios — in Stockholm and Malmo, Sweden; Barcelona, Bucharest and London.

The company generates revenue primarily through the sale of virtual items to users, which they buy to enhance and expand the game experience. These items, which are purchased online, include things like extra lives, boosters and additional game content.

Purchases are made on a micro-transaction model. A typical virtual item is priced at about $1. Almost all of King Digital's revenue in 2013 came from selling virtual items.

RISKS/CHALLENGES

The vast majority of company revenue traces to the popular games "Candy Crush Saga," "Pet Rescue Saga" and "Farm Heroes Saga." Those three accounted for 95% of total gross bookings. But King's top game, "Candy Crush Saga," accounted for 78% of total gross bookings in the fourth quarter.

Sam Hamadeh, CEO of research firm PrivCo, sees that as a red flag.

"This company is a one-trick pony and the pony is getting tired," Hamadeh said. "It's no secret popular games are fads with short life cycles.

By "tired," he was referring to the slowdown in "Candy Crush" revenue in Q4 2013 compared with Q3. Total company revenue of $601.7 million in Q4 was $19.5 million less than what was reported in Q3, attributed to a slowdown in "Candy Crush" popularity.

"Candy Crush Saga" was the top downloaded game throughout 2013 but began slipping at the start of this year, according to data from App Annie, a business intelligence firm focused on gaming apps.

Hamadeh made a comparison to Zynga (ZNGA), which came public at a time when its "FarmVille" franchise was wildly popular. Zynga came public in December 2011 priced at 10. The stock peaked near 16 three months later and then went into a sharp dive, as its newer games failed to catch on.

"King Digital feels like Zynga all over again," Hamadeh said.

The digital gaming industry is highly competitive. It includes Electronic Arts (EA), Activision Blizzard (ATVI), Zynga and numerous other companies. King Digital also competes with game developers in foreign countries, such as Tencent Holdings in Asia.

Other competitors include GungHo Online Entertainment, creator of "Puzzles & Dragons," Finland-based Supercell and Rovio Entertainment, creator of the "Angry Birds" franchise.

"King Digital is not the only one being extremely successful and monetizing at a great rate," said Marcos Sanchez, vice president of corporate communications at App Annie. "This is an extremely competitive market where a breakout hit can come from even the smallest company.

As King Digital said in its prospectus: "If we fail to offer popular virtual items, make unpopular changes to existing virtual items or offer games that do not attract purchases of virtual items, or if our distribution partners make it more difficult or expensive for players to purchase in-game virtual items, our business, financial condition and results of operations will be materially and adversely affected.

THE RESULTS

The huge success of "Candy Crush" in 2013 shows in the financial results. Total company revenue of $1.88 billion in '13 compares with $164.4 million in '12. Profit of $567.6 million in '13 compares with $7.8 million a year ago.

In the December quarter, revenue of $601.7 million was up 764% from the same quarter a year ago. The company reported a profit of $159.2 million, up from $6.1 million in the year-ago quarter. In Q2 and Q3, revenue growth was more than 1,300%.

But a small portion of King Digital's player network accounts for a large part of revenue. In December, about 4% of monthly unique users, or 12 million players, purchased virtual items from the company, accounting for most revenue.

PROCEEDS

King Digital expects to receive net proceeds of $326 million from the offering, based upon an assumed IPO price of 22.50 per share, the midpoint of its set price range. It intends to use net proceeds for working capital and other general corporate purposes.

MANAGEMENT

Riccardo Zacconi

Chief executive

Zacconi, 46, a company founder, has been CEO since 2003. He previously was vice president of European sales and marketing at uDate.com, until it was acquired by IAC/InterActiveCorp (IACI) in 2002. Zacconi holds a B.A. in economics from LUISS University, Italy.

John Sebastian Knutsson

Chief creative officer

Knutsson, 45, has served as chief creative officer since 2004. He was previously founder and chief creative officer of Fjord Network, a developer of IP-telephone services. He holds a B.A in cost analysis and finance from Stockholm School of Economics, Sweden.

Hope Cochran

Chief financial officer

Cochran, 42, has served as CFO since October 2013. She previously held several positions at Clearwire Corp., most recently as CFO, until it was acquired by Sprint Nextel (S) in 2013. Cochran holds a B.A. in economics and music from Stanford University.

King Digital Entertainment

Dublin, Ireland King.com Lead underwriters: JP Morgan, Credit Suisse, Bank of America Offering price: 21-24 Expected date: March 26 Ticker: KING