Perfect World’s Results Helped By New Game Launches

Perfect World (NASDAQ:PWRD), a Chinese online gaming company, posted 13.5% sequential and 4.7% annual revenue growth in Q2 2013 to $115.4 million, exceeding its initial guidance of 5%-10% sequential revenue growth. The recent launch of new games such as Saint Seiya Online and Neverwinter were the key growth drivers. It also gave encouraging outlook for its revenue growth in the third quarter. We believe that Perfect World’s top line growth will continue to accelerate over the next few quarters driven by launch of new games, a strong upcoming pipeline of games and international expansion.

However, Perfect World’s profitability came under pressure during the second quarter, in line with our expectations. Its gross margin declined to 75.5% as compared to 76.5% in Q1 2013 and 81.3% in Q2 2012 due to rise in employee cost, royalty cost, sales-related taxes and data center expenses. The operating margin declined sharply to 9.5% in comparison to 21.3% in Q1 2013 and 22.9% in Q2 2012, as sales and marketing expenses and R&D costs surged by 102% and 10% sequentially, respectively. The rise in sales and marketing expenses was mainly caused by promotional activities associated with new game launches. We believe the company’s profitability will  stay under pressure during the rest of the year as these expenses will continue to be high.

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Recent Launch Of New Games And Expansion Packs

The recent launch of new games such as Saint Seiya Online, Neverwinter and Swordsman Online has accelerated Perfect World’s revenue growth. Moreover, the company continued to release expansion packs for its existing games to strengthen their life cycle. A number of expansions were released during the second quarter, such as Mounted Might (for Return of the Condor Hero), World Contest (for Zhu Xian) and Rise of Warriors (for Empire of Immortals). In addition, expansion packs including The Night Patrol (for Legend of Martial Arts), Storm Army Attacks (for Forsaken World) and Divine Archer (for Battle of Immortals) were also recently launched. ^[1]

Perfect World is also strengthening its gaming portfolio with mobile and web games to leverage their rising popularity. During the second quarter, web games including Legend of Chu and Han and Gourmet Adventurer, and mobile games such as Rise of the King and Return of the Condor Hero were launched. ^[1]

Due to the growing popularity of new games, Perfect World saw an increase in its user base during the second quarter. The aggregate average concurrent users (ACU) for games operated in China rose to 742,000 as compared to 554,000 in Q1 2013, and 739,000 in Q2 2012. The recent increase in user base is encouraging and we believe this trend could continue in the short-term.

Upcoming Pipeline Of Games

Perfect World has a healthy pipeline of upcoming games. In addition to new MMORPGs such as Dota 2, Holy King and Legend of the Condor Heroes, the company is developing a spate of mobile and web games. Moreover, Neverwinter which was recently launched in North America and Europe is being modified for release in China.

International Expansion Continues To Add Upside To The Company’s Outlook

Perfect World is leveraging its overseas network of subsidiaries and licensing partners to expand its international business. During the second quarter, several localized versions of Torchlight 2 were launched in Asia. The company also released Forsaken World in Korea, the Empire of Immortals in Asia, and regional versions of Neverwinter in Italy, Poland, and Turkey. ^[1]

Accounting for more than 25% of total revenues, we believe Perfect World’s international revenue will continue to rise over our forecast horizon.

Guidance For Q3 2013

– Total revenue in the range of RMB779 million and RMB815 million, representing a q-o-q growth of 10% to 15%.

We are in the process of updating our price estimate for Perfect World’s stock.

1. Perfect World’s CEO Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, August 20, 2013 [↩] [↩] [↩]