Perfect World

Perfect World: Perfection is Hard to Beat
posted on: February 27, 2008 | about stocks: PWRD Font Size: PrintEmail As markets begin to show the first sustainable signs of life this year, it is time to begin to nibble on long positions in hopes that the rally will last long enough to book some profits. While risk management and damage control are still key ingredients to any investment program, the environment is becoming a bit more amenable to putting some capital to work. In light of the recent strength, there are some “perfect” opportunities to swing the bat.

Perfect World (PWRD) was mentioned by ZachStocks in November after pulling back in conjunction with a very difficult market environment. While the stock sold off in sympathy with the overall Chinese indices, the value continued to build as PWRD continued to operate profitably and develop a deeper more loyal client base. The pent up value finally began to be recognized this week after the company reported an exceptional fourth quarter. The numbers blew out analysts expectations with revenues coming in at $35.4m (all dollar figures are expected equivalents to reported RMB amounts) which is a 20.8% increase sequentially but a 325.2% increase compared to last year. And PWRD is not the type of company growing sales at a healthy clip while bleeding cash. Instead, the company reported earnings equal to $20 million or $0.36 per ADS.

To give readers a quick overview, the company operates several online games in China (and increasingly in other parts of the world) whereby gamers are usually allowed to play for free, but then spend money to purchase particular items in the game itself. The company derives its revenues primarily from users purchasing habits within the game, but also has developed additional revenue by licensing its games to additional vendors in other countries such as Vietnam, Thailand, Malaysia and Singapore.

While companies often show a pattern of guiding conservatively and then outperforming a synthetically low standard, management impressed investors by setting the bar high into 2008. With launches of expansion packs for existing games, and new games being tested, growth is expected to be robust into 2008 and beyond. Management stated that while there are currently four games in various stages of development, it has set the goal of launching seven new titles within the next year. This aggressive roll out will undoubtedly increase the company’s distribution of customers and diversify its current revenue stream. The company has a proprietary game building engine of sorts that allows developers to more quickly and efficiently roll a concept into a fully operating game without sacrificing graphical quality. This engine is even able to calculate physics that come into play within the course of the game to make movement much more lifelike. Due to this technology, PWRD is expected to perform much more as a manufacturer of quality products instead of as a “one hit wonder” which many competitors have turned out to be.

One concern with the multiple titles is that the company risks cannibalizing on its current users who are interacting with its flagship games. While new launches may detract from some existing titles, the additional revenue from these players building up new characters within the new game will likely more than make up for any disappointment. Analysts note that the company has plenty of room to grow both by pulling in new customers at a very attractive rate, as well as by increasing average revenue per user [ARPU] simply by sponsoring game events which will encourage new purchases. This growth appears to be well managed so that it will be sustainable over the long run instead of spiking quickly higher and then succumbing to disappointment.

International expansion is one of the key strategies when looking into 2008. Management is excited about the new office opened in the United States as they attempt to learn more about the economic drivers within their business and attract qualified talent to develop a product for use in the US. While expansion into new languages and new markets will undoubtedly take significant investment, the company has an ample warchest with $205 million available in cash. There are no rumors of acquisitions at this time, but it may make sense for PWRD to make a small bolt on acquisition of a graphics or small gaming company in the US to better enable them to get their foot in the door.

While the price is quickly up 20% from its level a week ago, the valuation still appears very attractive. The company earned roughly 84 cents per ADS in 2007 and is expected to top out around $1.50 this year and possibly over $2.00 next year. With the stock less than $30, it appears investors are not fully confident that these growth projections are accurate. Still the company is putting out good numbers and as more investors become aware of the story, the multiple is likely to expand. One of the catalysts that may propel the stock would be for the research arms of a few brokerages to pick up coverage. This would open the stock up to a completely new investor demographic that is currently not being presented with the story. Also, as new games are successfully launched, press releases will be issued and will also have a positive effect on the stock. While the name is volatile, the growth prospects are intact and it would appear the stock has a long climb ahead.