King Digital's King-Size Tumble

 | Mar 28, 2014 | 9:30 AM EDT  | Comments
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King Digital (KING) shares took a huge dive on Wednesday, and the move continued Thursday. The critics are calling it a failure and claiming that it's destined to follow the path of Zynga (ZNGA).

Here's my take.

Gaming stocks strike fear in the hearts of investors because of the whole Zynga debacle after that stock's IPO.

Zynga has almost become a word loaded with negative connotations now. On Wednesday, over and over, you heard pundits saying that King might be "another Zynga."

Taking that with the fact that it is clear that Candy Crush is on the other side of the mountain in terms of its growth, investors decided to sell from the get-go of post-IPO trading, even though King discounted its valuation compared with its peers to try and compensate for this.

However, here a few things that are worth pointing out about King and about the gaming sector in general.

A recent report said that in February, more than 90% of the app revenue generated on Google (GOOG) Play's store was for games. For the AppStore on iOS, it's estimated to be at least 70%. This suggests that games are not some fringe activity done in people's basements by a select few who understand them. Gaming has gone mainstream, first with the explosion of Zynga on Facebook (FB) and more recently with the shift to mobile.

So, if gaming is now a mainstream activity, why is it any different from television, film or music, in the sense that they are all "hits-driven" businesses? There is no real need for gaming to be required to take a discount compared with those other content businesses. They all require professional management, which needs to weed out the hits from the non-hits. They need to control costs. They need to oversee a "professional" process that ensures the greatest likelihood that the hits keep getting churned out.

Zynga had a belly-flop after its IPO, but this had to do with it being poorly positioned internally to develop mobile games that were well suited to the new mobile world.

King was a PC-based gaming company, but then it did successfully transition to become a mobile gaming company. It also helped to develop one of the more dominant mobile games recently, Candy Crush.

Yet that success is now being looked at askance by investors. Investors say that King's success has to be discounted because there are no guarantees that it will be able to develop another game as popular as Candy Crush. They are taking a "show me" attitude.

That's fine.

King management is solid. It has been able to build some other popular games. I'm convinced that it will be able to do so again. But investors will likely have to wait until it does before the stock will start to move again.

King primarily IPO'd in order to give liquidity to some of their early investors. That did happen, even though the stock fell. Management likely cares very little about these price movements of the first few days. It is likely focused on where the stock will be heading six months from now.

I suspect that that's the time frame that will make sense to start looking at building a position in King.

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