King Digital Entertainment (KING +0.00%) and Zynga (ZNGA +0.00%) both performed abysmally over the past year, due to top and bottom line declines and murky plans for the future. However, bottom-fishing contrarian investors might be wondering if either stock could bounce back next year.
King Digital Entertainment went public on March 26th. Source: YCharts.
Let's compare King and Zynga's growth, business models, and future opportunities to see if either social gaming stock is worth considering for 2015.
Top line and subscriber growth
King and Zynga often refer to "bookings," or total purchases on virtual products, instead of revenue. These virtual purchases are first reported as deferred revenue, then recognized as bookings over the estimated time that it takes to consume that product.
By that measure, King is faring worse than Zynga. Last quarter, King's gross bookings fell 16% year over year to $543.9 million, while Zynga's rose 15% to $175.5 million. However, both companies posted disappointing declines in reported revenue last quarter: King's fell 17% to $514.4 million while Zynga's dropped 13%. That raises the question of whether Zynga's deferred revenue impact of $50.5 million distorted bookings more than they should have.
Regardless of that discrepancy, King still easily bests Zynga in terms of user growth. Last quarter, King's monthly active users (MAUs) rose 37% year-over-year to 495 million on the launch of more non-Candy Crush games, which accounted for nearly half of total gross bookings. Zynga's MAUs fell 16% to 112 million last quarter due to a lack of hit titles.
Lack of diversification and dependence on whales
Both King and Zynga have top-heavy business models -- 51% of King's gross bookings last quarter still came from Candy Crush Saga and Candy Crush Soda Saga. Three fading games -- Farmville 2, Zynga Poker, and Hit It Rich -- generated 61% of Zynga's revenue last quarter.
Candy Crush Soda Saga. Source: King
To exacerbate the problem, both companies are heavily dependent on so-called "whales" who spend hundreds to thousands of dollars per month on virtual purchases. In February, app testing service, Swrve, estimated that just 0.15% of all active players accounted for half of the in-app purchases made in free-to-play games. Many of Zynga's whales are Facebook users, who accounted for 41% of its gross bookings versus 55% from mobile platforms.
Unless both companies can diversify their game portfolios and rely more on advertising revenue than high-rolling whales, they will remain top-heavy investments.
Bottom line blues
King and Zynga's bottom lines are both declining due to rising expenses. Last quarter, King's adjusted profit fell 22.6% year-over-year to $177.4 million, while Zynga's net loss widened from $68,000 to $57.1 million.
During the third quarter, King spent less on sales and marketing but incurred higher research and development expenses for new games. Zynga dramatically increased expenses in both categories.
|
Sales and marketing expense / year-over-year change |
Research and development expense / year-over-year change | |
|
King |
$100.7 million / (8.5%) |
$42.3 million / 283% |
|
Zynga |
$44 million / 107.9% |
$100.1 milion / 23.6% |
Source: King and Zynga quarterly reports.
Glimmers of hope
Zynga's operating expenses will likely rise over the next few quarters due to licensing fees from its new Looney Tunes, Tiger Woods, and NFL games. However, New Words of Friends -- a new Zynga title that depends heavily on ad revenue -- recently debuted at No. 1 in the iOS App Store.
Zynga's ad revenue, which accounted for 21% of its top line, rose 32% year-over-year last quarter, indicating that the company is getting better at monetizing its free user base. By comparison, King no longer generates ad revenues after it removed in-game ads last June.
King's ability to diversify its top line away from the Candy Crush Saga franchise with games like Diamond Digger Saga is encouraging, but make no mistake: King's future still depends heavily on gamers crushing candy.
The verdict
It's tough to pick between two losers, but I marginally prefer King to Zynga for several reasons.
First, King is profitable while Zynga's losses are widening -- its active user base is growing as Zynga's is shrinking. King is also slightly cheaper than Zynga on a price-to-sales basis, with a trailing 12-month ratio of 2.2 versus Zynga's 3.3.
Moreover, King's ability to generate more revenue off a smaller portfolio of games (eight versus Zynga's whopping 37) indicates that it has a clearer idea of what gamers want. Four of King's games were in the top 15 highest grossing games on Apple's iOS App Store and Google Play (U.S.) during the third quarter.
But before I consider King a solid investment, it must further reduce the weight of Candy Crush on its top line and possibly bring back ads in some games to generate steady revenue from completely free offerings. Until that happens, both stocks remain risky, top-heavy plays with a notoriously fickle customer base.
