King (NYSE:KING) shares trade at a modest 5x EV/EBITDA, suggesting that its bookings, EBITDA, and cash-flow will decline. The company has had remarkable success generating bookings and profits from its Candy Crush game, and investors appear to believe that Candy Crush is destined to decline precipitously going forward.
To the contrary, we expect King’s bookings to stabilize in Q2 and Q3, and to begin to grow once again in Q4. We think that contribution from King’s other games will fully offset expected declines in Candy Crush bookings, and we believe that the company has sufficient control over its cost structure to allow it to stabilize EBITDA and cash-flow contribution. We expect a ramp in bookings in late Q3, when some contribution from Candy Crush in China will be recognized and the company has a full quarter of contribution from the recently-released Bubble Witch Saga 2. Candy Crush will launch in China in summer, and bookings are recognized a quarter later, so only modest bookings will be recognized in Q3. Bubble Witch Saga 2 launched in June, so it is likely to contribute only minimal bookings during the current quarter.
In Q4, we expect meaningful contribution from Candy Crush Soda Saga, a brand extension of Candy Crush Saga that is sufficiently different from the first game to be considered a separate game, but sufficiently similar to draw the interest of the vast Candy Crush audience. We expect the release of Candy Crush Soda to allow King to grow its overall bookings level sequentially, and expect the ramp in bookings, EBITDA and cash-flow to drive King shares significantly higher later this year.
In our view, investors genuinely misunderstand the drivers of free-to-play spending, and genuinely believe that King’s success is transitory. In this note, we explain why we think King is built to last. The free-to-play market is large ($12 billion annually) and growing by 25 percent – 30 percent annually. We expect King to maintain its very large market share going forward.
We are maintaining our OUTPERFORM rating and a 12-month price target of $25. Our target is based upon assigning a roughly 9x multiple to our $2.80 estimate for King’s EPS in 2015. This reflects a discount to the market multiple to account for the risks associated with a hit-driven business, and to reflect King’s large concentration of revenues from its biggest game, Candy Crush Saga.
Michael Pachter is an analyst at Wedbush Securities.
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