The Smart Play on Perfect World Earnings

Perfect World (PWRD) will release its quarterly report on Monday, and despite some economic concerns in the emerging-market nation, the stock has soared recently. Yet if Perfect World earnings don't show the growth that investors want to see, those share-price gains could prove short-lived. Can the company justify its much-higher valuation with its business fundamentals?

Perfect World is just one of many Chinese companies focusing on the lucrative online gaming market. With intense competition, one major source of speculation has been whether consolidation in the industry could lead to stronger combinations of existing players in the industry. Let's take an early look at what's been happening with Perfect World over the past quarter and what we're likely to see in its report.

Stats on Perfect World

Source: Yahoo! Finance.

Which way will Perfect World earnings move?
Analysts have had fairly optimistic views on Perfect World earnings in recent months, raising their June-quarter estimates by about 6% and their full-year 2014 projections by nearly 10%. The stock has soared in response, with gains of more than 70% since mid-May.

Perfect World came into the current quarter on a positive note, with its first-quarter earnings satisfying investors despite a 38% drop in earnings. Shareholders weren't disappointed with the results because the company didn't have any major new game releases planned, and so most investors focused instead on future revenue guidance, which was encouraging.

More importantly, new game releases recently should help bolster Perfect World's growth. One analyst pointed to 3-D games like Holy King and Saint Seiya as potentially helping the company round out its offerings of web-based and mobile games, but the game that arguably has the most blockbuster potential is Swordsman Online, which was released in open beta in late June. Investors are hoping that those releases help the company finally get sales growing again.

Yet one major problem facing Perfect World is just how much competition it faces. Giant Interactive (GA) has been able to grow both revenue and earnings at a much faster pace than Perfect World, with double-digit sales and net-income growth in its quarterly report just last week on the shoulders of the launch of beta testing for its World of Xianxia massively multiplayer online game. NetEase (NTES 0.11%) wowed investors last night with 20% revenue growth and a 25% jump in net income, with the company having strong hopes for its Legend of Tibet release planned for later this year.

The interesting question in the industry is whether consolidation will take hold and lead to strategic combinations. Late last month, Shanda Games (NASDAQ: GAME) announced it would spend more than $800 million to buy some related services companies from Shanda Interactive, but that move represents a reshuffling of assets across affiliate lines. Perfect World is small enough to be a potential target if larger players in the industry seek to widen their game pipelines by acquisition rather than organic development.

In the Perfect World earnings release, watch for the company to discuss its plans for game releases for the foreseeable future. With a big emphasis on translating existing online games to mobile environments, there's plenty of room for growth, but only if Perfect World can capitalize on the opportunity before its competitors saturate the market.

Click here to add Perfect World to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.