Hop on the Next Hot Chinese IPO

Growth-stock investors starved for an IPO can call off the hunger strike.

Sohu.com (Nasdaq: SOHU  ) is taking its online gaming subsidiary public as a stand-alone company. Underwriters hope to price 7.5 million ADSs of Changyou.com between $14 and $16 apiece. Half of the shares will come from Sohu, raising roughly $50 million for the new media giant. The balance will be freshly minted certificates. The offering will eventually trade under the ticker symbol CYOU.

Sohu will own nearly 71% of Changyou -- and an even larger voting stake -- after the IPO. It presently has an 84% stake in the gaming unit; in other words, Sohu will continue to benefit from Changyou's success, and should see an uptick in its own stock if Changyou's IPO goes well.

Tian Long Ba Bu is Changyou's flagship title. It's a Web-based role-playing game that blends martial arts fighting with sticky community-building elements. It's quite popular in China. Earlier this month there were more than 800,000 players on at the same time. The game accounted for nearly 94% of Changyou's revenue last year.

Changyou is on a growth tear. Revenue grew nearly fivefold last year to $201.8 million. Earnings grew even faster to $108 million. Yes, you're reading that right. Net margins clocked in at a whopping 53.5% last year. A high-margin product in a country with light taxation can work wonders in milking a lot of profitability out of the top line.

If there is any caveat here, it's that investors have been reluctant to attach high multiples to China's fast-growing online gaming companies.

Company

2009 P/E

2010 P/E

NetEase.com (Nasdaq: NTES  )

12.1

10.6

Shanda Interactive (Nasdaq: SNDA  )

12.4

11.1

Perfect World (Nasdaq: PWRD  )

6.2

5.1

Giant Interactive (NYSE: GA  )

12.3

10.6

The9 (Nasdaq: NCTY  )

8.7

8.6

Source: Yahoo! Finance.

The five publicly traded online gaming specialists are trading at forward earnings multiples in the pre-teens or lower. Did you catch how all five companies have even lower multiples when you look out to 2010? That means that analysts expect all companies to grow their bottom lines next year.

It's hard to get a handle on investor apprehension. Yes, investing in Chinese growth stocks is risky on many different levels. However, it's been more than two years since the industry was rocked by China's move to crack down on Internet cafe growth. The sector clearly found a way to get over that.

Despite its recent gains and stellar quarterly report, even Sohu is trading for less than 10 times next year's projected earnings.

So lick those lips, investors. A torrid growth stock in a value-priced industry wrapper is in the IPO pipeline.

Other games to play:

Sohu.com, NetEase.com, and Shanda have all been recommended to Motley Fool Rule Breakers premium research newsletter subscribers. Find out how to play the growth stock game with a 30-day trial subscription offer today.

Longtime Fool contributor Rick Munarriz has been a fan of China's high-margin gaming stocks for a long time. He is also 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.


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