A Perfect World? In Name Only

Is there a Chinese company whose accounting can be trusted? Increasingly the answer is leaning toward no, as yet another Chinese name bit the dust yesterday on as-of-now unconfirmed allegations of wrongdoing by its CEO, Michael Chi.

Perfect World (Nasdaq: PWRD  ) came under heavy scrutiny yesterday stemming from allegations that its CEO purchased a 20% stake in 178.com without first disclosing it to the Securities and Exchange Commission. If that wasn't bad enough, it's alleged that 178.com purchased ads from Perfect World at above-market rates without disclosing the link between the two companies. There are claims that the U.S. judiciary department has launched an investigation against Perfect World.

As of now, Perfect World has denied the allegations as false, and if the past handful of fraud allegations are any clue, we can likely expect a rebuttal letter from the company within days. Shares of online gaming rivals SINA (Nasdaq: SINA  ) and Sohu.com (Nasdaq: SOHU  ) also felt the brunt of the accounting allegations against Perfect World and traded down slightly while the overall market indexes ticked higher. Like Perfect World, SINA and Sohu compete online for advertisers' dollars in China.

The problem is that whether these allegations are true or false, it's yet another step in confirming that Chinese accounting either cannot be trusted or will not be trusted until it conforms to the same standards we have in the United States. Even that wouldn't prevent fraud completely, but many would agree it's a step in the right direction.

What is clear is that these allegations have already done damage to a company that already guided earnings lower in September. Like many other Chinese names, Perfect World appears cheap on paper, and that was the main reason I chose the company as a Mid Cap to Rule Them All in July. Since that selection, however, the stock has been on a precipitous decline despite reporting a 22% revenue increase over the year-ago period in its latest quarter.

Without anything tangible to trust other than unaudited financial results, which have been anything but trustworthy from Chinese companies of late, I'm increasingly turning back to the States for possible ways to play the gaming industry. If you want a forward earnings similar to Perfect World but want to shop stateside, Take-Two Interactive (Nasdaq: TTWO  ) could be worth a look. Trading at a forward P/E of just 6 and less than a year away from its next big release, Grand Theft Auto V, it could provide the value and trust you're looking for in the gaming sector.

For now, we simply watch and wait for Perfect World's response and pray that we have not witnessed yet another case of blatant fraud. My fingers are crossed -- your move, Perfect World.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He learned long ago that honesty is always the best policy. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool owns shares of Take-Two Interactive. Motley Fool newsletter services have recommended buying shares of SINA, Sohu.com, and Take-Two Interactive. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that cannot tell a lie.


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