Chinese online gaming company Perfect World (NASDAQ:PWRD) announced its Q2 2012 results early last week. The company’s stock declined after the earnings release that posted 6% and 34% sequential declines in revenues and operating profits, respectively. (Read: Perfect World Needs New Games & Expansion Packs To Revive Revenue Growth)
While the overall Chinese online gaming market has grown in terms of users, Perfect World’s market share has dropped over the years due to increasing competition in the online gaming space from players such as NetEase, Tencent, Shanda Interactive, Giant Interactive, and ChangYou. While the company has been eying the international gaming arena by focusing on increasing its presence through subsidiaries and licensing its games to game publishers outside of China, the Chinese gaming market continues to contribute a higher proportion (30%) to Perfect World’s valuation, according to our estimate. China is still dominant in terms of sales, cash still makes up for almost half of our valuation for Perfect World.
We believe that robust growth in international markets will be the primary growth driver for Perfect World and accounts for just over 20% of its value. However, at the same time, with a number of expansion packs, content enhancements and new games in the pipeline, the company could see growth back home, which will augur well for its valuation.
Check out our complete analysis of Perfect World
Stability in Active Paying Customers in China
The average concurrent users (ACU) for games under operation in China declined from 890K in Q2 2011 to 804K in Q1 2012, and further dropped to 739K in Q2 2012. The decline was on account of Perfect World’s increased efforts toward anti-cheating measures as well as the expected seasonal decline.
Perfect World’s Chinese user base has shrunk over the last couple of years, dragging down its overall revenue growth. 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 company has not had a big title launch in China in the past two years. Additionally, the rise of casual gaming in the country has contributed to a slowdown in growth of the overall MMORPG user base.
However, according to Perfect World, MMORPGs continue to capture the largest market share (over 60%) in China and are expected to continue doing so for the next few years. Perfect World plans to launch a new game – Return of the Condor Heroes – by the end of the current quarter and has a few other games – Swordsman online and Neverwinter – in its pipeline for next year as well.
Additionally, the company plans to launch one or two web games later this year. The first 2-D based web game launched by the company was not really successful. However, since the 2-D gaming market in China is declining, the company hopes to leverage its 2-D game resources to set up 3-D based web games, which it expects will be better received in the market.
Hence we believe that though Perfect World’s active paying customers might drop down significantly this year, the rate of decline will slow down and stabilize by the end of our forecast period.
Marginal Increase in Revenue Per Paying User
The average revenue per ACU for the company increased marginally, by 2%, in Q2 2012. As Perfect World continues to introduce expansion packs and enhance the content of its current games, we forecast a marginal increase in revenue per user by the end of our forecast period.
We have revised our price estimate for Perfect World to $17.68, which is at a premium of over 50% to the current market price.
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