Crushed Candy: Can Analysts, Earnings and Valuation Rekindle King Digital?

King Digital Entertainment PLC (NYSE: KING) had a rather poor week. In a week that saw the DJIA and S&P 500 end basically flat, post-IPO investors might have been hoping for more but did not get it. The news on King Digital, the maker of the Candy Crush saga, was good on the surface — but the reaction came with a bit of a surprise. The shares ended the week down 7.2%.

One cannot help but to wonder if the same woes of Zynga Inc. (NASDAQ: ZNGA) are surfacing at King Digital. 24/7 Wall St. has to ask: Is this an opportunity or a reason to be concerned?

When King released first-quarter 2014 results on Wednesday morning, the mobile game maker reported earnings per share of $0.61 on revenues of $606.7 million, up from $0.20 in earnings and revenues of $205.9 million a year earlier. Keep in mind that this was also King Digital’s first earnings reports since its late March initial public offering.

Analysts have ignored the drop in King’s share price. The stock’s post-IPO history was one where the shares closed on its first day of trading down 15.5% from its IPO price of $22.50. On Monday, just two days before earnings, the analysts in the underwriting group were freed up from their so called IPO quiet period to finally issue their analyst coverage. The group of ratings was very positive, with the lowest price target was $19 and the highest at $30:

• Started as Buy with a $23 price target by Bank of America Merrill Lynch;
• Started as Buy and with a $27 price target at Deutsche Bank;
• Started as Buy and a $22 target price at Stifel Nicolaus;
• Started as Overweight and with a $30 price target at J.P. Morgan;
• Started as Overweight with a $23 price target at Barclays;
• Started as Outperform with a $25 price target at BMO Capital Markets;
• Started as Outperform with a $28 price target at Credit Suisse;
• Started as Outperform and with a $21 price target at Pacific Crest;
• Started as Outperform and a $24 price target at RBC Capital Markets;
• Started as Outperform with a $25 price target at Wedbush;
• and Started as Neutral and a $19 target price at Piper Jaffray.

Where things may remain a concern is that 75% of King’s first-quarter gross bookings were derived from its mobile audience. Still, the increase in gross bookings and in revenue was primarily due to the launch of its Farm Heroes Saga game in January. Candy Crush Saga, meanwhile, accounted for 67% of gross bookings in the quarter, down from 78% in the prior quarter.

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One of the big questions about the company is whether it could produce a follow-on to the enormously popular Candy Crush Saga. The jury may still be out on that, but the preliminary reading certainly seems positive. Yet the stock says something different — perhaps drastically different.

The closing price on May 2, ahead of the analyst calls, was $17.56; the close after the analysts piped in was $19.05. Shares even hit a high of $19.46 on the day of earnings, but that was short-lived. Shares closed at $16.25 on Wednesday and managed to only close up $16.53 on the following day. The shares ended the week at $16.30.

Again, the history of Zynga has to be of concern. Zynga had a great set of games. After a while, however, no one cared. Then the launch of a video game console refresh cycle and an improving economy meant that consumers could pay $49 and $59 for new hit games again – rather than paying nothing or a couple bucks here and there for “freemium” games.

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Zynga’s IPO price was $10 in late 2011, and shares briefly went higher only to close at $9.50 on the debut. Shares eventually popped above $15 in early 2012, but by the end of 2012 the stock had fallen to less than $3. Now, the stock’s 52-week range is $2.50 to $5.89 and its market cap is about $3.1 billion. Does it matter that Zynga trades at only 1.5 times book value? Maybe, maybe not.

King’s market cap is $5.1 billion, but was valued at $7.1 billion around the time of the IPO.

It is too soon to infer any technical analysis in King Digital shares, even if the shares are showing a very ugly pattern and direction. The verdict remains out by our take. That being said, it looks like King shares will either stage a large bounce or will settle far lower.