An Overview Of Perfect World’s Businesses

Perfect World (NASDAQ:PWRD) is a Chinese online gaming company. It specializes in developing 3D MMORPGs (massively multiplayer online role playing games). A MMORPG is a type of video game in which a number of players interact with each other in a virtual world setting by assuming the role of a character.

Perfect World earns revenues from its games in China, as well as the international markets, either through its subsidiaries in various countries, or by licensing its games to other international publishers. The company earned $445 million in revenues in 2012, more than double the amount in 2010, helped by strong growth in the international markets.

Our price estimate of $17 for Perfect World’s stock is almost in line with its current market price. In this article we provide an overview of its businesses with a quick snapshot of how Perfect World makes money.

Check out our complete analysis of Perfect World

How does Perfect World make money? What are the key markets/segments for the company?

Perfect World charges players for its games either on a time-based revenue model or an item-based revenue model. Under the time-based revenue model, players pay based on the amount of time they spend playing the game. In an item-based revenue model, players can play the basic functions of a game for free, but pay when they purchase in-game items such as performance enhancing items, clothing, accessories and pets. Perfect World generates the majority of its revenue from the item-based model, which we believe will continue to be the case in the future.

Our model divides Perfect World’s business into three main operating segments:

1. Chinese Operations: A key business despite declining revenues

According to a report published by Techweb, the Chinese gaming industry witnessed year-over-year growth of 35.1% in 2012, and is currently sized at $9.7 billion. Online games currently account for more than 90% of the Chinese gaming market and dominate the video gaming industry in China as video consoles (such as XBox and Playstation) have been banned in the country since 2000. ^[1]

Despite these facts, Perfect World’s revenue from China fell from $297 million in 2011 to $235 million in 2012, as its active paying user base shrunk from 1.3 million to 1.1 million during the same period. THis decline resulted from: 1) the tailure to achieve the desired level of popularity for certain games; 2) a slow pace in launching new games; 3) increased competition in the market; and, 4) the company’s anti-cheating efforts.

Although the contribution of China to Perfect World’s revenues has come down from 84% in 2008 to 53% in 2012, Chinese operations remain an important driver for Perfect World’s valuation. Perfect World has a robust pipeline of game launches, including the launch of Dota 2 and Legend of the Condor Heroes. We believe the portfolio of upcoming games and introduction of expansion packs for its existing games will stabilize the decline in its Chinese user base.

While Perfect World’s active paying user base has been declining in China, its average revenue per user has increased over the years. We believe that new expansion packs and content enhancements will lead to a potential increase in average revenue per user in the future. However, rising competition in the online gaming space could adversely impact the fee charged by the company to its users.

2. International operations: Will help decrease dependence on China

The revenue contribution of international operations has gone up from 17% in 2010 to 37% in 2012. Growing revenue from international markets has helped Perfect World to reduce its dependence on China. The company has strengthened its R&D capabilities by acquiring Cryptic Studios and other similarly specialized R&D studios. Going forward, we estimate the percentage contribution of international markets to increase as the company continues to attract additional international gamers by designing new games and expansion packs.

Unlike the Chinese market, video gaming consoles are not banned in most international regions. We expect the company to incur increased costs on R&D and SG&A in the future in order to remain competitive in international markets.

3. Game Licensing and Other

Perfect World licenses its games to other game publishers around the world for which it receives an initial licensing fee or ongoing royalties. The company earned about 10% of its revenues in 2012 by licensing its games. We forecast licensing revenue to continue increasing with the company’s focus on overseas licensing.

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1. Chinese games industry hits $9.7 billion in 2012, GamesIndustry International, Jan 2013 [↩]