Perfect World’s Weak Performance And The Outlook for 2013

Quick Take 
• Perfect World’s stock price has shed over 5% since its latest earnings were released on March 11, 2013.
• The company posted weak performance in 2012 as its revenues fell by 7% annually in the year and its operating margin dropped to 18% in 2012. as compared to 34% in the prior year.
• Its aggregate average concurrent users (ACU) for games operated in China also decreased throughout 2012 on account of its anti-cheating initiatives and rising competition in the market.
• Perfect World plans to launch various games in 2013 including Neverwinter, Dota-2, Swordsman Online and Saint Seiya Online and the success of these games will be critical for its future growth.
• Moreover, Perfect World continues to launch its games internationally through overseas subsidiaries and licensing partners, and we expect its international revenues to grow over our forecast horizon.

Top Line Declined In 2012

While the Chinese gaming industry witnessed a strong annual growth rate of 35% in 2012, Perfect World posted revenue decline throughout the period. ^[1] Rising competition and a declining active user base were two of the main factors that contributed to Perfect World’s weak performance in 2012.

Though Perfect World was one of the earliest entrants into the Chinese gaming market, the competition has intensified within the industry. Tencent, NetEase, Shanda Games, ChangYou and Giant Interactive Group are some of Perfect World’s biggest competitors. It’s market share in China dropped from 7.8% in Q1 2010, to 6.7% in Q1 2012. ^{[2] [3]} Apart from Chinese companies, Perfect World also faces competition from international MMORG developers such as Activision Blizzard. Rising popularity of casual online games have further added to Perfect World’s problems.

For Q1 2013, Perfect World expects revenues in the range of Remnibi (RMB) 592-619 million ($95-99 million). Going forward, we think revenues in 2013 will be dependent on the success of the new games to be launched in the year.

Margins Under Pressure

Perfect World’s profitability also came under pressure throughout 2012. Its operating margin in Q4 2012 came in at a mere 2% on account of goodwill impairment related to its subsidiary in Japan as well as higher R&D expenses. The company’s efforts to develop and market new games have contributed to the rise in operating expenses.

Since Perfect World continues to invest in game development and a number of games are expected to be launched in 2013, we think these factors could weigh on its profitability in 2013.

Declining User Base

The aggregate average concurrent users (ACU) for games under operation in China declined in 2012, as compared to the prior year. Anti-cheating efforts initiated by the company as well as rising competition in the Chinese gaming market contributed to the decrease in user numbers.

Going forward, we think success of new games that will be launched in 2013 will be a key factor that will determine Perfect World’s user base in the year.

Upcoming Pipeline Of Games Could Drive Growth In 2013

Perfect World expects to launch a diverse pipeline of games in 2013. MMORGPs including ‘Swordsman Online’ and ‘Saint Seiya Online’ are in the final stage of development and will be launched later this year. Neverwinter, a highly anticipated game being developed by Perfect World’s subsidiary Cryptic Studios, is expected to be released in North America soon. Moreover, the company has gained exclusive rights to operate Dota -2, a world-famous title with a unique mix of action, RTS and RPG gameplay in China.

Along with MMORGPs, Perfect World is also developing web games and mobile games to counter the threat from rising popularity of casual games. We think this upcoming portfolio of games could curb the decline in user numbers in the future.

International Expansion Remains A Key Strategy For Perfect World

Facing intense competition in the Chinese market, Perfect World is focusing on expanding its overseas presence to grow its business. As part of this strategy, it is growing its network of overseas subsidiaries and licensing partners. Over the past few months, Perfect World launched MMORPG games such as Zhu Xian and Chi Bi in Southeast Asia and Battle of the Immortals in Korea through its overseas subsidiaries. In November 2012, it launched the German, Polish and Russian versions of Torchlight 2. Also in January 2013, it licensed Forsaken World to an online game operator in Vietnam. ^[4]

Perfect World recently also undertook certain organizational changes that further strengthened its focus on overseas markets. Mr. Qi Zhu and Mr. Alan Chen were appointed as Chief Publishing Officer (Asia) and Chief Publishing Officer (U.S. & Europe) respectively, to look after the operations in those markets. We think Perfect World’s revenues from international markets could continue to increase over our forecast period.