Why We Are Revising Our Price Estimate For Perfect World

by Trefis Team
-0.10%
Downside
20.17
Market
20.15
Trefis
PWRD
Perfect World
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Perfect World (NASDAQ:PWRD) is a Chinese online gaming company which specializes in developing 3D massively multiplayer online role playing games (MMORPGs). A MMORPG is a type of video game in which a large number of players assume the role of a character and interact with each other in a virtual game world setting. The games have a social team element and also allow the players to customize their characters and upgrade their experience/abilities over the course of the game. Perfect world’s list of best-selling games include Neverwinter, Forsaken World, Torchlight, Battle of the Immortals, Jade Dynasty, Fantasy Zhu Xian, Zhu Xian and Swordsman Online. The company recently announced that it has entered into an agreement and plan of merger with Perfect Peony Holding Company Limited and will be going private sometime in the second half of 2015. [1] We are increasing our price estimate for Perfect World to $20.15 based on the following analysis.

See our complete analysis of Perfect World here

New Launches Will Help Bolster Chinese Operations

Perfect World’s revenues have almost doubled from $314 million in 2009 to $619 million in 2014, fueled by the periodic introduction of new games as well as the constant re-invention of best-selling games. [2] After an initial lull at the start of 2014, Perfect World finished the year strongly by launching a number of new mobile games, including Forsaken World, CrossGate Mobile, Touch, Legend Of The Condor Heroes, Forever Mars, Dawn After Dark, Swordsman Mobile and Saint Seiya Mobile. [3] [4] [5] The company continued this trend in 2015 with the launches of Adorable Battlers and Mega Pudding. [6] Mobile games have generated widespread interest in the last few years, and Perfect World is capitalizing on this trend to boost its revenues. The company also managed to sustain player interest in its PC games by introducing a number of expansion packs for many of its best-selling games, including Swordsman Online, Saint Seiya Online, Zhu Xian, Forsaken World, Battle of the Immortals, Perfect World II, Legend of the Condor Heroes, Return of the Condor Heroes and Legend of Martial Arts. In an important development in the Chinese online gaming scene, the earlier-banned gaming consoles were allowed into the market. [7] In order to cater to console gaming enthusiasts, Perfect World released a console version of its popular game Neverwinter through the Microsoft Xbox One platform. [8] Such efforts at monetizing the console gaming ecosystem could also receive assistance from Alibaba (NYSE:BABA). Alibaba is developing a product to compete with foreign-made consoles such as the Sony PlayStation and Microsoft Xbox. [9] All these efforts have fueled growth in Average Revenue Per Paying User (ARPPU), which has grown from $15.10 in 2010 to $41.50 in 2014. Accordingly, we believe that ARPPU from Chinese operations will continue to grow and will be north of $80.00 by the end of the Trefis forecast period.

Increased Focus On Operations Outside Of China

The global online gaming market is expected to grow at an annual rate of 11.95% between 2014 and 2019. [10] Perfect World has taken strategic steps to cater to the increase in global demand for online gaming. As the online gaming market in China grows increasingly competitive, Perfect World has focused on launching localized versions of its popular games in other regions such as North America, Europe and Asia. Through 2014 and 2015, the company’s major international launches included –

  • Russian and Portuguese Versions of Neverwinter
  • English, French and German Versions of Swordsman Online in North America and Europe
  • A console version of Neverwinter on the Xbox One platform in North America, Europe and Russia
  • Swordsman Online in Singapore, Malaysia, Korea and Japan
  • Perfect World II in Singapore and Malaysia
  • Saint Seiya Online in Singapore, Malaysia and Thailand

The global games market is expanding and provides potential for future growth. Perfect World is expanding its overseas network of subsidiaries and licensing partners as part of its strategy to penetrate lucrative foreign markets. Additionally, MMORPGs have a relative advantage over other online games as they have a loyal user base with a good retention rate. Once users start playing a MMORPG, they tend to continue playing for extensive periods because of the time and money they have already invested in mastering the game play and upgrading their characters in the game. Accordingly, we believe that revenue from games outside of China will continue to grow throughout our forecast period and will cross $200 million by 2021.

Lower Weighted Average Cost Of Capital

We have revised our discount rate (or weighted average cost of capital) downwards for valuing Perfect World’s stock. This is the rate at which we discount the company’s future cash flows, and is the weighted average of its after-tax cost of debt and cost of equity. This figure is a measure of a company’s risk. Perfect World justifies this revision as the stock’s beta has come down in the past year. Beta is a measure of company’s stock volatility relative to broader market. Perfect World’s correlation to the broader market has improved, which means that the risk of fluctuations in its stock price has come down. The company has also been able to stabilize its business and increase its revenues without taking on substantial debt. Perfect World has actually managed to reduce its leverage and its total debt has gone down from $120 million in 2012 to $72 million by the end of 2014. [2] Perfect World’s total debt is also significantly less than the company’s enterprise value of $649 million as of June 10, 2015. [11] This reduces the risk in the company and warrants the revision.

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Notes:
  1. Perfect World Enters into Definitive Agreement for Going Private Transaction, April 26, 2015, Perfect World Press Release []
  2. Perfect World’s SEC Filings [] []
  3. Perfect World Announces Recent Business Developments, July 7, 2014, Perfect World Newsletter []
  4. Perfect World Announces Recent Business Developments, August 18, 2014, Perfect World Newsletter []
  5. Perfect World Announces Recent Business Developments, November 25, 2014, Perfect World Newsletter []
  6. Perfect World Announces Recent Business Developments, April 30, 2015, Perfect World Newsletter []
  7. China suspends ban on video game consoles after more than a decade, January 7, 2014, Reuters []
  8. Perfect World Q3 2014 Earnings Report []
  9. Predictions For China’s Gaming Industry In 2015 []
  10. Global Online Gaming Market 2015-2019, March 2015, Research and Markets []
  11. Perfect World Enterprise Value, YCHARTS []
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