Giant Interactive and Perfect World Follow NetEase Lower

Three of China's publicly traded online gaming companies have reported quarterly results over the past few days. NetEase (NASDAQ: NTES  )  kicked things off last week, falling short of Wall Street expectations on weak World of Warcraft trends. Giant Interactive  (UNKNOWN: GA.DL  )  and Perfect World  (NASDAQ: PWRD  )  are reporting this week.

Giant Interactive didn't live up to expectations either when it reported last night. It saw revenue clock in nearly unchanged at $92.5 million. Analysts were expecting Giant's revenue to top $100 million. Active paying accounts inched higher both sequentially and year-over-year, but the average player is spending less across Giant's several diversions. Giant's profit of $0.22 a share also missed the $0.24 a share that the pros were projecting. 

Earlier this week it was Perfect World bucking the trend, but the good vibe didn't last. Revenue soared 44% to $143.3 million. Net income grew even faster, shooting 54% higher to $0.64 a share. Analysts were only targeting $0.53 a share on the bottom line. 

Perfect World's performance wasn't applause worthy to Mr. Market. Four analysts tracking the stock lowered their price targets after the report, with some also talking down their near-term profit targets. A dip in gross margins as the company expands into lower margin mobile games and a sharp sequential drop in average concurrent players as it initiated anti-cheating measures spooked Wall Street. The stock tumbled 9% on Tuesday after Monday night's report.

Clearly this wasn't the kind of quarter that China's online gaming companies were expecting. Seasonality could explain the sequential dips at all three companies, but Wall Street estimates take all of that into account when they bake up their forecasts.  

The sector is still cheap. All three stocks are trading for less than 12 times next year's projected earnings. Wait. It gets better. NetEase, Giant, and Perfect World all have ample cash balances, and that's enough to price all three stocks at single-digit forward earnings multiples on an enterprise value basis. 

The risks are real. China regulators have been critical about the online gaming industry. They don't want China's youth to get addicted to these virtual experiences. However, online gaming is a global phenomenon that can't be ignored. All of these companies have been trading for years -- and in NetEase's case, more than a decade -- proving over time that they can continue to remain relevant and popular, with pipelines of new games and expansion packs for popular franchises. It was a bad quarter all around, but the future's still bright for those still willing to play along.

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