I've been on the receiving end of what this, more than I care to remember and usually it spells the beginning of the end at that place of work for me. Here's what I've gathered from having it happen to me so many times.
If someone brings something like that to you as a manager, you have to realize that they are highly motivated about what they're doing and that you shouldn't get in the way of that unless its affecting other things that are a priority for you.
Its a very rare case where there is a valid reason to tell someone to completely stop working on something that they're doing, if there is, then outline it in simple terms and have a good discussion about it and how they feel about it, instead of just commanding them to stop.
The only valid reason these side projects are a problem is that they become a distraction for the employee. A skillful manager will know how to use this project as a carrot to let the employee perform better on the major projects that you want them to do. "If you can get me x by the 12th instead of the 15th then I'll give you 2 days to work on your side project on company time".
Its also the case that as a manager, you're overconfident about your abilities to foretell the usefulness of an idea to the firm. Only 1 out of about 5 side projects I've ever done for companies , I worked for, turned out to be total busts, all the others were pretty popular when I put them out but if I bet if I had asked my managers before I did them, they would have told me they wanted me to work on something else.
Overall, show interest in what they're trying to do ... talk through it with them, you'll learn a lot more about your employees by seeing what genuinely excites them than the stuff you just assign to them.