Why Changyou's Shares Crashed

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Chinese online gaming portal Changyou.com (NASDAQ: CYOU  ) fell throughout the day, finishing with a 10% loss as Wall Street digested the news that the company's earnings for the upcoming quarter might be weaker than expected because of higher operating costs.

So what: The raw numbers all look good. Changyou beat the fourth-quarter revenue consensus of $168.7 million with a $173.5 million top line, and its earnings per share of $1.42 came in $0.09 better than analyst forecasts. Looking ahead, Changyou expects revenue in the $168 million to $174 million range, ahead of the Street's consensus, and $1.38 to $1.44 in EPS, against the $1.38 consensus.

However, part of Changyou's slide can be blamed on Sohu.com (NASDAQ: SOHU  ) , which offered weak guidance for the upcoming quarter, and which indicated that shrinking margins would crimp Changyou's profitability in the future. The other part of this slide can be pinned on rising operating costs, which were up 20% sequentially and 17% on a year-over-year basis. Much of this was due to a 35% spike in year-over-year product development costs and a big 59% spike in year-over-year product development costs.

Now what: Sohu provided a worse forecast than Changyou, yet it declined by only half as much today. Changyou's gross margin on both a GAAP and an adjusted basis, at 84% for both, was actually higher than the prior quarter, and roughly in line with the year-ago quarter's 85% margin. Changyou's operating and net margins also remained stable despite the large increase in costs. There's nothing wrong with spending more to lure in new gamers, especially with such a long runway remaining in China. Today's drop brings Changyou back to even for the past 52 months, but at a 5.5 P/E, it seems like there's more upside than downside for this well-positioned Chinese game purveyor.

Want more news and updates? Add Changyou.com to your Watchlist now.

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