Perfect World (NASDAQ:PWRD) is a Chinese online gaming company that specializes in developing 3D MMORPGs (massively multiplayer online role playing games). Its active paying customers (those who purchased an in-game item at least once in a particular period) peaked at 1.8 million in 2009. We estimate the figure to have declined to 1.1 million in 2012, as some of the new games launched during the period did not achieve the same level of popularity as previous games. Additionally, the anti-cheating efforts undertaken by the company led to a further decline in its user base in the last few quarters.
We believe that the decline in Perfect World’s active paying customers will stabilize in the future as the company has a rich pipeline of new games as well as expansion packs to maintain a healthy life cycle for its existing games. Additionally, the online gaming market in China is growing rapidly and we believe Perfect World will benefit from this growth.
However, certain factors such as the intense competition in the gaming market, hacking activities and adverse government policies may accelerate the rate of decline in Perfect World’s user base.
Factors That Can Lead To An Increase In The Number of Active Paying Customers
Strong Growth In The Chinese Online Gaming Market
According to Techweb, the Chinese gaming industry grew by 35.1% to reach $9.7 billion in 2012. Due to rising internet penetration in the country, the Chinese gaming market is estimated to be worth $21.7 billion by the end of 2017 according to the same report.  Online games constitute over 90% of the Chinese gaming market as video consoles (including XBox and Playstation) are banned in China. As Perfect World has a full pipeline of upcoming games and continues to release various expansion packs for its existing games, we feel it is in a strong position to leverage this growth in the industry.
Rich Pipeline of Upcoming Games and Expansion Packs
Perfect World has a diverse portfolio of games that are expected to be launched in 2013. Some of the new MMORGs under development include - Swordsman Online, Saint Seiya Online and Legend of the Condor Heroes. The company is also developing a number of web games. Moreover, in Q3 2012, Perfect World obtained exclusive rights to operate “Dota 2″, a world-famous title with a unique mix of action, RTS and RPG gameplay, in China.
Its partnership with Cryptic Studios and other such specialized R&D studios has strengthened Perfect World’s global R&D capabilities. Along with Cryptic Studios, the company is working towards the development of a much-anticipated game ‘Neverwinter’ which is expected to be released within the next few months.
In order to maintain a healthy life cycle for its games, Perfect World has released various expansion packs including Legend of Yellow Emperor for Dragon Excalibur, Heavenly Scripture for Fantasy Zhu Xian, the Wolf for Forsaken World and Call of Heaven for Perfect World.
Since MMORG’s are inherently sticky and enjoy a loyal user base, we feel this rich pipeline of upcoming games and expansion packs will help stem of the decline in Perfect World’s user base.
Risks That Could Lead To A Further Decline In Active Paying Customers
Hacking and Cheating Activities
Perfect World has faced various problems related to hacking and cheating activities wherein certain users gained unfair advantage by installing cheating software. Anti-cheating initiatives undertaken by the company has previously caused a significant decline in its active user base. Its anti-cheating initiatives in Q3 2012 contributed to the decline in average concurrent users (ACU) from 739,000 in Q2 2012 to 601,000 in Q3 2012. We feel these cheating activities will continue to pose a threat to Perfect World as the continued usage of such activities can lead to an unfair gaming environment, which can cause a decline in user’s interest to play as well as buy in-game items.
Intense Competition In The Industry
Though Perfect World was one of the earliest entrants in the online gaming industry in China, it is currently witnessing increased competition from other players in the market. There are more than 100 online game operators in China, and we feel this figure will continue to grow due to low barriers to entry. Tencent, NetEase, Shanda Games, ChangYou and Giant Interactive Group are some of Perfect World’s biggest competitors. While Perfect World accounted for 7.8% market share in Q1 2010, its share decreased to 6.7% in Q1 2012. However, Tencent, the biggest player in the industry, saw its market share improve from 25.3% to 33.7% during the same period.  ((Tencent’s Online Gaming Dominance Grows as Market Expands to $1.78 Billion, TECH IN ASIA, May 25, 2012))
While Chinese companies pose a threat to Perfect World, it also faces competition from international MMORG developers such as Activision Blizzard. Moreover, rising popularity of casual online games pose an additional risk to Perfect World. While the MMORG market in China was estimated to grow by 22% and 18% in 2011 and 2012 respectively, the Chinese casual and social gaming market registered an increase of 33% and 30% in the same period.