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King Digital Entertainment plc (KING - Snapshot Report) reported second quarter fiscal 2014 earnings of 52 cents per share, which managed to beat the Zacks Consensus Estimate of 50 cents. Earnings surged 29.6% from 40 cents per share reported in the year-ago quarter.

Shares of King Digital declined 20.8% ($3.79) in after-hours trading following the release due to weak revenue growth and lackluster guidance for fiscal 2014.

Quarter Details

Revenue (after adjusting for deferred revenue) for the quarter increased 28.7% year over year to $593.5 million but missed the Zacks Consensus Estimate of $618 million.

Monthly unique users (MUUs) surged 77.8% on a year over year basis to 345 million while monthly active users (MAUs) jumped 83% from the year ago quarter to 485 million in the reported quarter.

Daily active users (DAUs) were up 81.6% on a year-over-year basis to 138 million in the second quarter. Monthly gross average bookings per paying user (MGABPPU) were $19.54 in the reported quarter versus $15.51 reported in the year-ago quarter.

Gross bookings were $611.1 million in the reported quarter, up 27.1% from the year-ago quarter. However, gross bookings declined 5% on a sequential basis.

During the quarter, King Digital launched eight new games on royalgames.com. The second quarter also witnessed the launch of Pyramid Solitaire Saga, its first card game for mobile. In the quarter, King Digital completed the initial rollout of a localized version of Candy Crush Saga for the Chinese market in collaboration with Tencent’s mobile communications and social network platforms Mobile QQ and Weixin.

Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) surged 34.7% to $248.2 million in the reported quarter from $184.2 million in the prior-year period. Adjusted EBITDA margins improved 20 basis points to 42% due to productivity improvements.

Total cost and expenses were up 25.8% from the year-ago quarter to $377.8 million in the reported quarter. This rise in expenses was primarily attributable to a year-over-year increase in research & development expense (up 60 bps) and general & administrative expense (up 270 bps).

Adjusted net profit was $165.4 million compared with $130.6 million reported in the prior- year quarter. Net margin of 27.9% declined 40 basis points (bps) on a year-over-year basis from 28.3% reported in the year-ago period.

During the quarter, King Digital acquired Singapore-based game developer, Nonstop Games for $6 million in cash upfront and $74 million scattered over a period of four years, provided it succeeded in reaching certain revenue targets.

    
Balance Sheet and Cash Flow

Cash and cash equivalents at quarter end were $832.2 million. The company generated operating cash flow of $161.7 million during the quarter.

During the quarter, the company announced a special dividend amounting to $150 million payable to shareholders of record as of Sep 30, 2014.

Outlook

Management expects gross bookings to range between $500 and $525 million in the third quarter of 2014. The company expects bookings to register a sequential decline in the third quarter followed by an increase in the fourth quarter.

For the fiscal year ending Dec 31, 2014, the company expects gross bookings to be between $2.25 billion and $2.35 billion (down from the prior guidance of $2.55 billion to $2.65 billion).

Our Take

With the rapid adoption of smartphones and tablets, we expect the demand for King Digital’s mobile-based games to increase considerably. The company derives approximately 74% of its revenues from mobile platforms. The company’s innovative product pipeline is a positive.

In April, King Digital launched Diamond Digger Saga on Facebook (FB - Analyst Report). Most recently, the company launched Bubble Witch Saga 2, which will further boost its top line in 2014. Moreover, gamers’ growing preference for free-to-play games bodes well for King Digital’s future prospects.    

However, strong sales of new consoles from Microsoft (MSFT - Analyst Report) and Sony are expected to intensify competition for King Digital in 2014. Moreover, competition from Zynga (ZNGA - Snapshot Report), Glu Mobile and other established players with a more visible business model like Electronic Arts, Activision Blizzard and Take-Two Interactive cannot be ignored.

Moreover, overdependence on Candy Crush Saga for its revenues may cost King Digital heavily going forward. In the second quarter, Candy Crush Saga accounted for about 60% of the gross bookings. The fact that Candy Crush Saga is losing players on a regular basis poses a major concern for the company.

Under such circumstances, we believe that the company needs to develop other franchises capable of delivering strong growth consistently. However, so far, it has failed to find any replacement, which remains a headwind for the rest of 2014.

Currently, King Digital has a Zacks Rank # 3 (Hold).
 

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