Perfect World Is Worth A Whole Lot More Than The Market Thinks

Perfect World (NASDAQ:PWRD) announced its earnings for Q1 2012 recently with its revenue growing to $114 million for the first quarter, implying a year-over-year revenue growth of nearly 4%. While its gross margins have taken a slight hit, it managed to keep its SG&A expenses under control. However, its R&D spend rose as it continues to invest increasing amounts of money to develop new games, and this concern along with overall weak sentiment for China Internet stocks has pushed the stock lower. On the plus side, it continued to launch new games in international markets as well as in China, its home market. It is also working on a series of new titles customized for new markets, as it continues to grow its international operations. ^[1]

Check out our complete analysis of Perfect World

New games and upgrades to drive growth

Perfect World not only customizes its existing games for international markets, but is also working on several new games to expand its user base and revenue. In the coming months, it will launch two new martial arts MMORPGs — Heaven Sword and Dragon Saber, and the Return of the Condor Heroes — which could significantly boost revenue growth if they turn out to be hits.

It is also working on other games like Swordsman Online and Saint Seiya Online and a series of casual web-based games. We expect its international gaming revenue to contribute to most of its revenue growth, going forward, as its market share in the Chinese gaming space continues to decline, with the number of active concurrent users declining nearly 10% in the last quarter.

Operating expenses continue to increase

The company’s operating expenses continued to rise, with its R&D spend jumping nearly 30% due to investments in new games and its platform. While it has mostly clamped down on SG&A spending, we expect its R&D spend to continue to increase going forward, as it will be forced to invest more in R&D to remain competitive in the international gaming scene.

However, even after projecting an increase in operating expenses, a slowdown in revenue growth in China, and a modest boost in international gaming revenue, we arrive at an intrinsic Trefis value estimate of around $23 for Perfect World, which is much higher than its current market price.

Perfect World 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).

1. Perfect World Co.’s CEO Discusses Q1 2012 Results – Earnings Call Transcript, SeekingAlpha [↩]