Playing Games in China

So now we know that The9 (Nasdaq: NCTY) is mortal after all. The Chinese online gaming specialist stumbled in its latest quarter, clocking in well below Wall Street expectations, as a new game wasn't enough to offset service outages of its popular version of Blizzard's World of Warcraft.

Net revenue inched 5% higher to $35.5 million, but earnings fell 40% to hit $0.25 per share. Analysts were expecting the company to generate a profit of $0.34 a share on $38.7 million in revenue.

The server downtime was necessary for game upgrades and Wall Street was already braced for a bottom-line dip. However, May's commercialization of Soul of the Ultimate Nation should have helped a little more than it did.

This is a disappointing quarter for a couple of reasons. Yes, the company missed its top- and bottom-line targets, but the report also comes just one day after rival Shanda (Nasdaq: SNDA) blew past analyst expectations.

It's the first time that The9 has missed Wall Street estimates after six straight market-thumping quarters. Finally, this comes during the same quarter in which The9 was going to show us all how it is no longer a one-trick pony. (Last quarter's conference call identified how The9 planned to diversify into a multigame operator.)

Sure, The9 has come a long way since it was little more than a lowly distributor of games in mainland China made by Korea's Webzen (Nasdaq: WZEN). Now it's right up there with Shanda and NetEase.com (Nasdaq: NTES) as the three online gaming companies that command a collective 60% stake of the promising Internet video game market in China. The9 closed out the quarter with 22.4 million registered users, with as many as 930,000 of them playing at the same time.

Despite the lackluster quarterly financials, The9 is encouraged by the initial reaction of consumers to Soul of the Ultimate Nation. It also has another two games in the pipeline.  

If you believe in the niche, the market's negative reaction to the company's report is a buying opportunity. Too much attention is being given to the government's crackdown on 100,000 Internet cafes and not enough to the improving economy that will make home-based connectivity more common in the years to come.

If you're going to get excited about more conventional video game publishers closer to home, like Activision (Nasdaq: ATVI), Take-Two (Nasdaq: TTWO), and THQ (Nasdaq: THQI), then betting on the market leaders in China's high-margin niche is more than reasonable.

Sure, The9 is mortal, but as its product catalog can now tell you, it also has Soul.

For related Foolishness:

• Review The9's last quarter.
• The9 teams up with electronic arts.
• The9 is one of seven stocks on sale.

NetEase and Shanda are Motley Fool Rule Breakers recommendations. Activision is a Motley Fool Stock Advisor pick. A free 30-day subscription is available for either newsletter service.

Longtime Fool contributor Rick Munarriz has been a fan of China's high-margin gaming stocks for a long time. He is part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. He does not own shares in any of the companies in this story. The Fool has a disclosure policy.