Why Churchill Downs Can Succeed with Big Fish Where King Digital and Zynga Failed

TAGs: big fish games, Churchill Downs, Editorial, king digital entertainment, Rafi Farber, social casino, Zynga

As the social casino market continues to coalesce through acquisitions, the biggest question for investors in this industry is not whether it will grow, but whether growth will come from consistent sources and market leaders, or whether it will come haphazardly from surprising one-shot-wonders like tall weeds making a manicured lawn look like a jungle.

Why Churchill Downs Can Succeed with Big Fish Where King Digital and Zynga FailedGranted the social casino market will grow. Even bankrupt Caesars (CZR) social casino division Caesars Interactive Entertainment is growing to the justified anger of its creditors who have been stripped of that asset in a company gutting operation. Recent estimates for the social casino market are $2.7B for this year. But for the market to be investible, you have to be able to predict or at least roughly estimate the likely patterns of that growth. Otherwise your capital will be in the wrong place in the right industry. Since the social casino market is so new and evolving at such a fast pace, it will be especially difficult to invest in, with pitfalls all over the place.

Right now the big news is Churchill Downs’ (CHDN) acquisition of Big Fish Games for $885M. Too much? Good deal? Hard to tell, but I can try to give one possible rule of thumb for making judgment calls. There are two kinds of social gaming companies. The first is the one-hit wonders that have one or two very popular games that go viral, make a big name for themselves, go public, cash in on a bunch of equity, whose founders become instant billionaires, and then never find that viral hit again. The games that make it big are clearly fads that people will lose interest in eventually. The second kind of social gaming company is the one with a larger base of popular games coupled with a good footing in the actual casino market.

Casino games, as opposed to original games where you can win cash on the side, are more dependent on brand loyalty and customer service than the latest version of Fairway Solitaire. There is nothing original about poker, black jack, roulette or any other table game, so what makes companies that offer these games succeed is trustworthiness, customer service, basically something reproducible on a consistent basis. Once they have a customer base, there is a higher chance of that base being maintained and steadily growing through simple competent service. On the other hand, if a company like Big Fish comes out with a successful game like Fairway Solitaire, it is only a success because it is original, interesting, or otherwise unique. In order for Big Fish to maintain that customer base, it will have to keep churning out original, interesting, or otherwise unique and fun games. The chances of doing that are much smaller than simply keeping online poker, black jack, or roulette players happy.

Churchill Downs’ acquisition of Big Fish Games is not, however, a clear bungle like King Digital Entertainment (KING) or Zynga (ZNGA) and its disastrous acquisition of OMGPOP for $200M. Big Fish does have a real casino it relies on for revenue, and though we don’t know the numbers yet and how top-heavy the Big Fish revenue structure is, we will know soon enough.

Restated simply, if Big Fish maintains itself as a well-rounded social casino with a some blockbuster viral games on the side but does not rely on the latter for its main source of revenue, it will be a success and Churchill Downs will have succeeded in this acquisition. If, however, Big Fish focuses on viral games and fails to develop the casino side sufficiently, the chances of it being a flop will increase.

Another thing this acquisition has going for it is that Churchill Downs is not some hotheaded newbie on the scene that’s trying to flash money around by buying a bunch of stuff in order to make headlines. That was the case with Zynga when it got all drunk on Farmville, and with King when it went all crazy on Candy Crush trying to trademark the world “Candy”. Churchill Downs has been around since 1875 and is a little bit more sober in this regard, more trustworthy in its acquisitions and more reliable. Though I would not recommend buying Churchill now simply because it is right at its highs, that doesn’t mean this acquisition can’t work. It can.

So though I am not a fan of investing in the social gaming sphere, follow the rule of thumb described here and you should be able to avoid most of the pitfalls. Though on the other hand, when you do find one of those drunk noobs in this industry, it’s an easy short. We made a short call here on KING at the end of March at $18.19 and covered at $13.40. KING now trades at $15.85.

As for Zynga, we made no explicit calls on its stock, but since first bashing it together with King in that same call in March, ZNGA is down 36%. If you did short Zynga back then, covering now is advisable.


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