Perfect World (NASDAQ:PWRD) is one of the top online gaming companies in China where it competes with the likes of NetEase (NASDAQ:NTES), Tencent, Shanda Interactive, Giant Interactive, and ChangYou. It also operates localized versions of its games in international markets like Europe, North America and Japan, and licenses its games to publishers in other markets where its offerings compete with games like World of Warcraft by Activision Blizzard (NASDAQ:ATVI), and Warhammer Online by Electronic Arts (NASDAQ:EA).
We have a $24 Trefis price estimate for Perfect World, which implies around 90% upside from the current market price. Games in China account for around 34% of its value while International Games account for 20%.
We believe that the market is grossly undervaluing Perfect World.
Absurdly low P/E & enterprise value less than net profit in 2011
Perfect World has an absurdly low price-to-earnings ratio, compared to its Chinese peers like Netease, Giant Interactive, Shanda, as well as its American competitors like Electronic Arts or Activision Blizzard.
It currently has a market cap of around $550 million, while its cash balance comprising cash equivalents, restricted cash, short-term investments and time deposits, net of short-term debt added up to $430 million as of December 31, 2011. This implies that the market values Perfect World’s entire business at only $120 million, which is ridiculously low, considering that it made a net profit of more than $155 million in 2011 which will possibly increase going forward, as its international gaming operations gain traction.
Decline in Chinese user base to slow down
Perfect World was one of the first MMORPG developers in China. It has been losing market share in the past couple of years, primarily because of increasing competition in the online gaming space due to the entry of giants like NetEase, Tencent, Shanda Interactive, Giant Interactive, and ChangYou. Part of the decline in its user base was because of a delay in launching new games, most of which failed to gain much traction. The rise of casual gaming in China has also contributed to a slowdown in the growth of the overall MMORPG user base.
However, we expect the decline in user numbers to slow down considerably going forward as Perfect World launches expansion packs for its existing games like Forsaken World as well as new games. Perfect World has been able to generate much higher ARPU (average revenue per user) than any other MMORPG developer in China in the past. We expect it to increase its ARPU by a minimum of 2-3% throughout the forecast period, which is a very modest estimate, considering that it managed to increase its ARPU by more than 25% in each of the last two years.
International gaming revenue expected to increase slowly
Perfect World also generates a substantial amount of revenue from its international gaming operations in markets like Europe, North America and Japan. It has been focused on launching its games internationally, and recently launched Blacklight: Retribution, Forsaken World and other games in various international markets. We expect its international gaming revenue to increase at a CAGR of less than 10%, which is a pretty conservative forecast considering that its estimated international revenue increased 5x in the last two years.
Despite the increasing competition in the global online gaming market, and the rise of casual games, we expect Perfect World to show a net increase in its international user base, as it continues to launch localized versions of its popular Chinese games in other markets that have seen huge demand for its games in the past. We expect its international gaming business outside of China to drive most of its earnings growth going forward.