Perfect World Update: Stock Recovers Following Rumors of Regulators’ Investigation

Shares of Perfect World (NASDAQ:PWRD), a Chinese online gaming company crashed almost 30% on December 9, following rumors that an investigation had been initiated against the company and its CEO by the SEC and Chinese authorities, over allegations of undeclared related party transactions and securities fraud. ^[1] Tuesday morning the shares recovered around 10% though a short sale restriction is in place and it’s a thinly traded stock. The company has also responded to these allegations vigorously defending itself.

A blog on the Tianya website reported that its CEO used his position for personal profit at the expense of Perfect World’s shareholders, and acquired a 20% stake in Chi Chu Network without the approval of the board. It also asserted that Perfect World’s CEO used the help of Chinese organized crime gangs and illegal underground banks for illegal currency conversions and tax evasion.

Perfect World  is one of the top online gaming companies in China where it competes with the likes of NetEase (NASDAQ:NTES), Tencent, Shanda Interactive, Giant Interactive, and ChangYou. It also operates localized versions of its games in international markets like Europe, North America and Japan, and licenses its games to publishers in other markets where its offerings compete with games like World of Warcraft by Activision Blizzard (NASDAQ:ATVI), and Warhammer Online by Electronic Arts (NASDAQ:EA).

Check out our complete analysis of Perfect World

We currently have a $21 Trefis price estimate for Perfect World, which implies a 140% upside to the current stock price following the crash.

Perfect World hasn’t yet made an official comment on the report, which has now been taken down by Tianya. The timing of this announcement follows a string of allegations regarding US listed Chinese companies’ disclosure practices regarding transactions involving company directors or companies that are affiliated with directors of the companies. Focus Media was the most recent stock to take a pounding after research firm Muddy Water issues a scathing report about its failure to disclose relevant material transactions regarding the company’s founder as well as challenged its accounting practices.

If the report turns out to be false for Perfect World, there could be a significant rebound in the short term. However, given the seriousness of these charges we would wait until the company makes a formal announcement as well as keep an eye on if there is any merit to the US and Chinese authorities’ investigations.

Notwithstanding the current allegations of fraud or the SEC investigation, here’s why we think that Perfect World’s a value pick for 2012, with a fair value of $21.

We may revise our Trefis price estimate for Perfect World soon, in light of the recent events.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Not So Perfect: Perfect World Slammed On Investigation News, Benzinga [↩]