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This Cheap Gaming Stock May Not Remain Cheap for Long

By Harsh Chauhan - Dec 3, 2013 at 9:45PM

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Perfect World is increasingly looking like a great way to benefit from online gaming in China.

Perfect World (NASDAQ: PWRD) is now back in the game in the Chinese online gaming market. After suffering from consistent revenue declines till earlier this year, Perfect World has executed a terrific turnaround. The market has rewarded Perfect World handsomely for its efforts as the stock is already up more than 70% so far this year, outperforming the likes of Shanda Games (NASDAQ: GAME) and NetEase (NTES -1.28%). But is it still a good buy? Well, it might be.

A compelling performance
The success of Perfect World's recent games led to robust revenue and earnings growth in the recently reported third quarter. Revenue was up 23% from the year-ago period, a massive improvement considering that Perfect World was suffering from double-digit revenue declines at the end of the first quarter. Earnings per share came in at $0.39 per share, well ahead of the $0.25 consensus.

In addition, Perfect World's sunny outlook for the ongoing quarter rounded off a seemingly perfect quarterly report. Its recently launched titles such as Swordsman Online and Saint Seiya Online have been doing quite well and Perfect World has a strong pipeline to continue its impressive run. 

Smart moves
Perfect World has been following a tried-and-tested strategy of releasing expansion packs for existing games in order to keep gamers engaged. It released as many as 11 expansion packs in the previous quarter, including Galaxy Arena for Saint Seiya Online and The Storm Returns for Swordsman Online. This sets up Perfect World nicely to end the year on a high as it has rolled out new content, which should lead to increased gamer interest.

Such strategies are already bearing fruit as average concurrent users (ACU) increased to 778,000 in the previous quarter from 601,000 in the same quarter last year. 

A strong pipeline
Looking ahead, Perfect World has a number of gaming titles coming up. The likes of Dota 2 and Legend of the Condor Heroes are expected to be launched soon, further bolstering Perfect World's existing gaming line up. Also, the company had launched Holy King last quarter, which means that Perfect World is leaving no stone unturned in order to garner maximum interest from gamers.

Perfect World is also looking to bring Neverwinter -- a game that has been successful in North America and Europe -- to China. Localization of the game is already under way and the launch is expected next year. Apart from these, Perfect World has also been making progress in mobile and web games. It recently launched a mobile game known as Return of the Condor Heroes along with Touch, a web game, and both have clicked. 

Stiff challenges ahead, but Perfect World is prepared
But if Perfect World intends to succeed in mobile, it needs to overcome the challenge posed by Shanda and Glu Mobile. Glu is already well-known in the mobile gaming industry, but Shanda is aggressively moving into this space. Shanda's mobile segment is now 70 times bigger than what it was a year ago. Revenue from mobile games increase 50% sequentially in the recently reported third quarter. 

Shanda's success has been driven by the success of Million Arthur in China, which was among the top-grossing games on both Google Play and Apple's Chinese app store earlier this year. Shanda has lined up 36 mobile games for launch going forward as it is counting on mobile for its growth. Hence, Perfect World will need to come up with a sound mobile strategy to succeed in this segment. 

To maximize its reach, Perfect World will be investing in and, two important gaming portals in China. Perfect World also commands good presence in the international markets, with its footprint now covering over 100 countries. More than 25% of its revenue comes from international markets, a figure which might increase in the future as it strengthens its network further. 

All in all, Perfect World is making some good moves and its efforts so far have proved fruitful. It boasts of a big and diversified portfolio of games and has been increasing its reach across various markets. These strategies are very important in the Chinese gaming market where Perfect World is competing with bigger names such as NetEase and Shanda, both of which are aggressively churning out new games. 

NetEase has found success with recently released games such as Heroes of Three Kingdoms and Dragon Sword. It recorded a 21% jump in gaming revenue in the previous quarter, even though the declining subscriber base of Activision's World of Warcraft weighed on the results.

Now, NetEase is 10 times bigger than Perfect World in terms of market cap. But even then, it clocked an identical revenue growth rate in the previous quarter, indicating that its self-developed games are finding great traction.

Looking ahead, NetEase is planning to release expansion packs for a number of games, while the new game pipeline includes Crisis 2015 -- its first person shooter game -- and Revelations. Perfect World needs to be wary of NetEase's size and marketing machinery, along with even bigger players such as Tencent. This is where Perfect World's international exposure and a growing game portfolio could come in handy going forward. 

The bottom line
No doubt, there are certain challenges in front of Perfect World. But the company seems to have shifted into a higher gear and its games are finding success. Management's strategies look interesting and analysts are also hopeful of a good performance from it. Its revenue is expected to increase almost 20% next fiscal year, double of the current year's growth rate, and at just 13.5 times earnings, Perfect World looks like a value play.

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