A Fresh Look At Perfect World As Growth Catalysts Fuel The Stock

The stock price of Perfect World (NASDAQ:PWRD), a Chinese online gaming company, has increased by around 40% in the last three months. The main factors that have led to this change include an improved outlook due to the launch of highly anticipated games such as Saint Seiya Online and Neverwinter and the launch of web games and mobile games have also strengthened Perfect World’s play against competitors. Revenue growth is expected to accelerate in the future owing to this improved outlook. A strong pipeline of upcoming games further supports strength in Perfect World’s business.

While the recent stock price movement is encouraging, we think investors need to consider certain risks before investing in Perfect World’s stock at current prices. A rise in sales and marketing expenses as well as R&D costs could impact profitability in the future. Perfect World’s user base is declining and with the slowdown in monetization activities for old games, this could impact the overall top-line growth rate in the future. High competition in the gaming industry will continue to pose a threat to the company’s business. While the risk from Chinese accounting concerns is low, any negative finding on such issue could cause a large movement in the company’s stock price.

Check out our complete analysis of Perfect World

Here Are The Key Reasons Why Perfect World’s Stock Price Has Increased Recently :-

Launch of new MMORPG games, web games, mobile games and expansion packs:

Perfect World has recently released various MMORPG (massively multiplayer online role playing) games as well as mobile and web games. Expansion packs for existing games have also been released to enhance their life cycle.

• Open beta testing for highly anticipated MMORPG games – Saint Seiya Online and Neverwinter was launched on May 16 and April-end respectively.
• Web games including Adventure in a Free Kingdom, Touch, Legend of Chu and Han and Gourmet Adventure were released in Q1 and Q2 2013. ^[1]
• Mobile games including Legend of Chu and Han and Return of the Condor Heroes have been launched in the recent past. ^[1]
• Expansion packs such as Return of the Crouching Dragon (for Chi Bi), Mountain Might (for Return of the Condor Heroes) and World Conquest (for Zhu Xian) have also been released. ^[1]
• Another highly anticipated MMORPG Swordsman Online will be launched for open beta testing on June 28, 2013.

Revenue outlook for Q2 2013 is encouraging

The launch of new games is expected to result in the acceleration of revenue growth in Q2 2013 and beyond. Revenue in Q2 2013 is forecast in the range of RMB 656 – 687 million ($105.9 – 110.9 million) representing an increase of 5%-10% on a q-o-q basis. While Perfect World has seen y-o-y decline in revenue since the past four quarters, we could see a change in this trend in Q2 2013.

Upcoming pipeline of games

A number of new games are in the pipeline. Dota-2 is in closed-beta testing and will be launched in China in the near future. Holy King (a new MMORPG) is also under development. In addition, Perfect World is also focusing on web games and mobile games and several such games are expected to be launched in the future.

Strong Cash Position and Real Estate

Cash (net of debt) accounts for about $8.90 per Perfect World’s share and hence this presents significant downside protection. In addition, Perfect World owns about 62,200 square meters of office space in Beijing. Since these buildings were acquired in 2007 and 2008, when real estate prices were much lower as compared to present prices, the fair value of these buildings are much higher than the value recorded on the balance sheet. ^[2]

Here Are The Key Risks To Consider Before Investing In Perfect World’s Stock At Current Levels :-

Margins could decline: We believe the margins could face some pressure in the future due to higher sales and marketing expenses as well as R&D expenses. The sales and marketing expenses will be high in Q2 2013 due to a launch of new games. The development of new web games and mobile games in addition to MMORPG’s will impact the R&D costs.

Decline in user base and slowing monetization for current games: The aggregate average concurrent users (ACU) declined to around 554,000 in Q1 2013, as compared to 620,000 in Q4 2012 and 804,000 in Q1 2012. The decline in the user base could be reflective of the declining popularity of existing Perfect World’s games. While the new games are expected to bring in incremental revenues, slowing monetization of existing games to increase their life cycle could impact the overall revenue growth rate in the future.

Chinese accounting concerns: While Perfect World has not faced any accounting problems in the past, certain investors worry about accounting issues with Chinese companies. With more than 50% of the company’s valuation tied to net cash reserves, the risk related to accounting issues is high. However, since Perfect World returned a dividend of $2 and $0.45 per ADS in 2011 and 2012 respectively, and expects to distribute dividends annually, this allays some of the fears related to accounting issues.

High competition in the online gaming industry: Perfect World faces high competition from Chinese companies as well as international MMORPG developers. There are over 100 online game operators in China and since the barriers to entry are low in the gaming industry, the competition could further intensify in the market. Tencent, NetEase, Shanda Games, ChangYou and Giant Interactive Group represent some of the leading competitors to Perfect World. In addition, the rising popularity of casual games could further limit the growth potential of MMORPGs. Owing to high competition, Perfect World will continuously need to invest significant resources in R&D and marketing to stay ahead of the competition.

Our $15.8 price estimate for Perfect World’s stock, represents near 5% premium to the current market price.

1. Perfect World’s CEO Discusses Q1 2013 Results – Earnings Call Transcript, Seeking Alpha, May 29, 2013 [↩] [↩] [↩]
2. Perfect World A Perfect Buy, Seeking Alpha, February 13, 2013 [↩]