Perfect World Could See Its Growth Accelerate In The Second Quarter

Perfect World (NASDAQ:PWRD), a Chinese online gaming company, is scheduled to report its Q2 2013 results on August 19, 2013. The company’s stock price has risen by more than 70% in the last three months supported by an improvement in its future outlook. This has come on the launch of highly anticipated games such as Saint Seiya Online, Neverwinter and Swordsman Online as well as the launch of new web and mobile games. We believe the company’s revenue growth will accelerate in Q2 and beyond owing to the improved outlook. In addition, a strong pipeline of upcoming games and the international expansion strategy provide additional confidence in the company’s business.

However, we expect Perfect World’s margins to stay under pressure during the year. We believe its sales and marketing and R&D expenses will rise in the short term.

Check out our complete analysis of Perfect World

Recap of Q1 2013 results

Perfect World’s revenue declined by 8% sequentially and 13% annually to $100.6 million in Q1 2013. This was attributed to a slowdown in in-gaming monetization activities as well as the lack of new major game launches during the quarter.

Gross margins were recorded at 76.5% in Q1 2013 compared to 76.9% in Q4 2012 and 82.3% in Q1 2012. Operating margin improved sequentially from 1.8% in Q4 2012 to 21.3% in Q1 2013. This was caused by a sequential decrease in sales and marketing expenses, R&D expenses, goodwill impairment and general and administrative expenses. However, on an annual basis, operating margin declined from 32.7% in Q1 2012.

Profitability could be under pressure in Q2 2013

We expect Perfect World to post lower margins in the second quarter due to an increase in sales and marketing and R&D expenses. Promotion associated with new game launches will result in higher sales and marketing expenses, and the development of mobile games and web games, in conjunction with MMORPGs will impact R&D costs.

Revenue growth is expected to accelerate in Q2 2013 and beyond

We expect Perfect World’s revenue growth to accelerate in Q2 2013 and beyond with the launch of new games such as Saint Seiya Online, Neverwinter and Swordsman Online. Moreover, the recent launch of various web games (including Adventure in a Free Kingdom, Touch, Legend of Chu and Han and Gourmet Adventure) and mobile games (including Legend of Chu and Han and Return of the Condor Heroes) will enhance revenue growth during the year. While the company has witnessed a y-o-y drop in revenue since the past four quarters, we believe there could be a reversal in this trend in Q2 2013.

Upcoming pipeline of games and international expansion bode well for future outlook

Perfect World’s upcoming pipeline of games and international expansion will further drive its growth. A number of new MMORPG games such as Dota 2 and Holy King are in the development pipeline. In addition, the company is also developing various mobile and web games to strengthen its gaming portfolio.

We believe Perfect World’s international revenue will rise over our forecast horizon as the company is expanding its international operations by leveraging its network of overseas subsidiaries and licensing partners. A number of games such as Battle of the Immortals, Blacklight Retribution, Forsaken World and Torchlight 2 were launched in the international markets in 2013.

We will update our price estimate for Perfect World’s stock after the earnings release.