Chinese Gamer Going Gangbusters

Investors are selling off shares of Chinese gaming company The9 (Nasdaq: NCTY  ) , probably because the company missed analysts' revenue and earnings estimates. But before giving up on the stock -- it was down 13.1% at its lowest point on Friday -- investors should take a closer look at the underlying strength this company offers.

How's this for results? Revenue was up 232% over last quarter and up 2,096% over the comparable quarter last year. To be fair, The9 is a tiny company with just $22.8 million in sales this quarter. Still, that was $100,000 less than analysts had projected.

Net income swung from a loss of $2.8 million last quarter to a profit of $4.7 million. Still, the $0.19 per share in earnings missed the average analyst estimate by $0.08.

The growth engine at The9 is an online multiplayer game called World of Warcraft, which contributed $22.3 million, or close to 98% of the company's sales. In the latest quarter, peak online usage hit 467,000 users; average concurrent usage was 240,000. That's a strong following for a commercial operation just launched in June 2005. By the same token, its long-term potential has yet to be established, and the game is still being rolled out within China.

Some investors might balk at the relative concentration of World of Warcraft revenue and make them wonder whether the game will prove to be a fad. It's possible that it will be, but I wouldn't discount the strength of the game's network -- it has a powerful cult following. Really, a walk around Fool HQ tells a captivating story to that effect.

Another potential concern for investors is that activated accounts stood at 2.5 million this quarter, up nicely from the 2 million at the end of last quarter. So where's the problem? Well, when you get 1.5 million accounts during your first month of operations, expectations are high that growth within the world's most populous country will continue at stratospheric rates.

It's also worrisome that Chinese game companies have been slammed as they've announced increasing competition. Rule Breakers recommendations Shanda (Nasdaq: SNDA  ) and NetEase (Nasdaq: NTES  ) have slumped this week after reporting their earnings.

What investors need to decide is whether analysts are right that The9 can compound earnings at a 150% annual rate for the next five years. If so, the stock is bargain priced, even if the company falls short of the $0.47 this year and $1.72 next year that analysts expected before today's report.

Still, this is a fledgling company. And although it has seen, and continues to see, explosive growth, it still needs to prove it is a capable of producing long-term returns. Furthermore, there's a certain expectation that Chinese consumers will continue to acquire PCs, and build disposable income, at a rate comparable with current conditions. And don't forget the emerging competition from the likes of Shanda and NetEase, which might crimp growth rates a bit more than analysts like.

But if the current trend of fast earnings growth at a decelerating rate continues, I wouldn't be surprised if Chinese gaming companies emerged as value plays in a matter of quarters.

Fool contributor W.D. Crotty does not own any shares in the companies mentioned. Clickhereto see The Motley Fool's disclosure policy.


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