One of the early entrants in the Chinese online gaming market, Perfect World (NASDAQ:PWRD) announced its Q3 2012 earnings on November 19. With $110.7 million in revenues, it marked a 3% sequential increase, though the earnings were marginally lower (2%) compared to Q3 2011. Owing to higher R&D expenses and an increase in sales, general and administrative costs this quarter, Perfect World’s operating profit dropped to $17.4 million, registering a close to 30% decline compared to the last quarter.
Though Perfect World’s revenue and gross profit continue to rise, the growth rate has significantly slowed down over the years as the company faces intense competition in the online gaming space. While the new games did contribute to its revenue stream in Q3 2012, the same were insufficient to spur Perfect World’s growth rate. Additionally, the company claims that the performance of existing games was lower compared to Q2 2012.
Perfect World’s declining user base in the Chinese market and the high operating expenses incurred to fuel demand for its new games continue to suppress its growth rate. However, we believe that with an expanding presence in the international market and a rich pipeline of upcoming new games and expansion packs, the company could start registering significant revenue gains in the upcoming quarters.
Decline In User Traffic To Slow Down
Perfect World continued to witness a decline in its average number of concurrent users (ACU) in the third quarter as well. It had 601,000 ACUs in Mainland China in Q3 2012, a 19% q-o-q and a 27% y-o-y decline. Perfect World believes that its anti-cheating efforts, which were stepped up during late Q2 2012 to maintain a healthy and fun gaming environment, was partly responsible for the sharp decline. In addition, the adverse seasonality factors and the fact that certain expansion packs were released towards the end of the third quarter also affected Perfect World’s user traffic in Q3 2012.
However, going forward, we expect the decline in user numbers to slow down considerably as Perfect World launches additional expansion packs for its existing games. The company claims to have decelerated its in game- promotional activities as it focused on launching content enhancements for existing games. It released expansion packs for the flagship titles, ‘Zhu Xian’”and ‘Perfect World II, toward the end of the third quarter.
Deep & Diverse Pipeline Of New Games To Drive Revenue
Despite being one of the first MMORPG developers in China, Perfect World’s market share has declined over the years, primarily due to the entry of heavyweights such as NetEase, Tencent, Shanda Interactive, Giant Interactive, and ChangYou. Additionally, the rise of casual gaming in China has also contributed to a slowdown in the 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 has had no big title launch in the last two years. However, the company is focusing on developing a wide genre of new games to further expand its portfolio. Some of the new MMORPGs games currently under development include – Swordsman Online, Saint Seiya Online and ‘Legend of the Condor Heroes. It is also working on developing a number of web games as well. Additionally, in Q3 2012, Perfect World obtained the exclusive rights to operate “Dota 2″, world-famous title with a unique mix of action, RTS and RPG gameplay, in Mainland China.
We believe that the robust pipeline of new games can be the future growth drivers for Perfect World’s business.
Higher International Revenues To Drive Growth
While its Chinese user base has shrunk over the last couple of years, dragging down its overall revenue growth, Perfect World’s international gaming revenue nearly doubled in 2011, according to our estimates. The company has been focusing on expanding its presence in international markets such as Europe, America and Japan through its subsidiaries as well as by licensing its games to other game publishers in other countries such as Indonesia, Brazil, Turkey and Azerbaijan.
In Q3 2012, Perfect World launched Dark Blood and RaiderZ in the international markets, through its overseas subsidiaries in Japan and the U.S. resp. It also signed several new agreements to license its games to overseas operators. Post its acquisition of US-based Cryptic Studios, Perfect World is working towards developing the much-anticipated game Neverwinter and certain other projects up for launch in 2013.
Partnering with Cryptic Studios and other such specialized R&D studios has strengthened Perfect World’s global R&D capabilities. Going forward, we expect it to continue to attract additional international gamers with new games and expansion packs, resulting in steady revenue growth.
Outlook For Q4 2012
Perfect World estimates its total Q4 2012 revenue in the range of RMB661 million to RMB696 million, flat to slight decline from Q3 2012. Though it might receive additional revenues from some new games launched this quarter, the company feels that it will take time for the operations to ramp up gradually and thus expects the revenue contribution from the same to increase 2013 onwards.
We are in the process of updating our price estimate of $17.68 for Perfect World.