Perfect World (NASDAQ:PWRD), a Chinese online gaming company, is scheduled to report its Q3 2013 earnings results on November 25. Its stock price has run up by around 70% in 2013, due to the launch of highly anticipated games such as Saint Seiya Online, Neverwinter, Swordsman Online and Holy King. These games have resulted in the acceleration of revenue growth for the company. Perfect World’s topline was forecast by the company’s management to rise by around 10% to 15% sequentially in Q3. We believe it will record revenue growth at the high-end of this guided range due to the rising popularity of newly-launched games. However, we expect the profitability to decline on a y-o-y basis in Q3, owing to rise in sales and marketing, and R&D expenses.
Recently, the company has entered into agreements to acquire stakes in two gaming portals. It has purchased 100% stake in Wuhu Huitian for RMB 255 million, and a minority interest in Beijing Shouyou Daqu for around RMB 40 million. We expect these investments to boost the company’s gaming business due to various synergies, and more information around these transactions is awaited from the earnings call. 
Recap Of Q2 2013 Results
Perfect World’s revenue rose by 13.5% sequentially and 4.7% annually in Q2 2013 to $115.4 million, exceeding its initial forecast. The topline growth was driven by the launch of new games such as Saint Seiya Online and Neverwinter.
However, the company’s profitability fell during the second quarter. Gross margin decreased to 75.5% as compared to 81.3% in Q2 2012. In addition, the operating margin dropped significantly to 9.5%, as compared to 21.3% in Q1 2013 and 22.9% in Q2 2012. Sales and marketing expenses, and R&D costs increased by 102% and 10% sequentially, respectively.
Profitability To Remain Under Pressure
We expect profitability to stay under pressure throughout 2013, as promotion expenses associated with new game launches could result in increased sales and marketing costs. In addition, the development of mobile and web games, coupled with MMORPGs (massively multiplayer online role playing games) will keep the R&D costs high.
Upcoming Pipeline Of Games And International Expansion Represent Key Growth Drivers
Perfect World has a strong pipeline of upcoming games which strengthens its future outlook. In addition to new MMORPGs such as Dota 2 (currently in closed beta testing) and Legend of the Condor Heroes, several mobile and web games are also in the pipeline. Moreover, Neverwinter which was earlier released in North America and Europe is being modified for launch in China.
The company has set up a network of international subsidiaries and licensing partners to boost its revenues from markets outside China. During the last quarter, localized versions of Torchlight 2 were released in several markets of Asia. Various regional versions of Forsaken World, Empire of Immortals and Neverwinter were also launched. While international revenues contribute for over 25% of Perfect World’s revenue, we expect it to increase over our forecast period.
Our $17.14 price estimate for Perfect World’s stock, is around 5% below the current market price.Notes:
- Perfect World Announces Agreements to Invest in Two Gaming Portals, Perfect World, November 12, 2013 [↩]