The rational Candy Crush IPO

By Felix Salmon
March 10, 2014

Jim Surowiecki is absolutely right about the IPO of King Digital Entertainment, the makers of Candy Crush Saga. The point of an IPO is to raise permanent capital for a company which intends to exist in perpetuity, while King will realistically last only as long as the Candy Crush fad. King will probably never again make the kind of money ($568 million) it made last year, and yet it issued options in January at a crazy $9.4 billion valuation.

Surowiecki writes:

It’s easy to see why King’s founders want to go public: money. But the money isn’t worth the hassle. As a public company, King will have to show shareholders consistent results and ever-growing profits. Such expectations are, frankly, silly in crazily competitive, hit-driven industries, and trying to meet them is a recipe for frustration. If King stayed private, it could milk its cash cow and build games without having to worry overmuch about hatching a new cultural juggernaut. We expect companies to constantly be in search of the next big thing. But, for one-hit wonders, the smartest strategy might be to just enjoy it while it lasts.

There are two different pieces of advice here. The first is entirely sensible: if you have a business throwing off massive amounts of cash, and you have no real assurance that you can build a similar business or replicate your past success, then probably the best thing to do is to just pocket the cash, rather than trying to reinvest it. After all, Candy Crush Saga itself was not the product of hundreds of millions of dollars of investment: it was the product of good luck, basically.

The second piece of advice is that if you’re just going to cash checks from Candy Crush, you’re better off doing that as a private company, rather than having to deal with public shareholders. This is probably also true. Public companies are bad at managing decline: they always want to show growth. The result is all manner of attempts at “pivots”, or at investing cashflow into longshot attempts to build a new business from scratch (for a prime example, see the way that AOL took the hundreds of millions of dollars flowing from its dialup service and poured them into Patch). Which, needless to say, rarely works.

But here’s the problem: all companies have a valuation, and right now the market is placing a valuation on King which is somewhere in the $10 billion range. If the present value of Candy Crush Saga’s cashflows is less than $10 billion (which it almost certainly is), then it is entirely rational for anybody who might be inclined to live on those cashflows to instead sell the company to people who think it’s worth more than that.

And there’s another great reason to go public: it gives King’s current shareholders — employees and VCs — the ability to cash out easily, rather than just waiting for a ever-diminishing series of dividend checks. Like it or not, this is the way of the current technology world: you start up a company, you sell it, you get rich. Even if going public sucks.

The main reason to go public, however, could just be that the IPO market is so frothy right now that companies have to have the credible threat of an IPO in order to get the best possible price from a strategic acquirer. Right until the day before the IPO, King is going to retain the option to simply sell itself to some company which wants proven expertise at making enormous profits in the world of mobile-native apps. By moving towards an IPO, King is forcing those companies to get serious about making an offer — both in terms of timing (they’d better do it quick) and in terms of valuation (they’d better meet the likely IPO share price). Because buying King after it’s gone public is going to be a lot more difficult.

Sometimes, capital markets are inefficient at allocating capital. When debt markets are frothy you see a lot of debt issuance; when equity markets are frothy, you see a lot of IPOs. We’re seeing a lot of IPOs right now, including some pretty crazy ones. And if you sell into a frothy market, you’re being rational, not stupid. Let the buyers of King shares worry about where their return is going to come from: no one is twisting their arm. So long as there are people out there willing to buy at a $10 billion valuation, markets demand that the current owners should be able to sell.

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This is just another in a series of examples of why I stopped investing in equities some time ago Felix. Plug Power is another very recent example.

I know, I know, let the buyer beware…..When I contemplate making money that way it just doesn’t feel very good. It feels like cheating. Like ripping off people who aren’t that smart.

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