Chinese online gaming company Perfect World (NASDAQ: PWRD) has lost its wheels after a seemingly perfect start to the year. After gaining around 20% in the first quarter of 2014, Perfect World has taken a solid beating. The stock lost almost 10% in a single day, despite solid first-quarter results after it revealed a drop in average concurrent PC users.
This doesn't come as a surprise, as the PC online gaming market has hit a wall, evidenced by a weak performance from peer NetEase (NASDAQ:NTES). However, the future of gaming is in mobile, and this is where Perfect World has been making rapid progress. This progress can be seen in the company's first-quarter results, where revenue grew almost 43%, year over year, to $143.3 million. Earnings per share jumped 63% to $0.70 per share.
Dropping despite an impressive performance
Perfect World's results were comprehensively ahead of consensus estimates. Wall Street was expecting the company to post earnings of $0.56 a share and revenue of $140.7 million for the quarter. It delivered handsomely on both counts. Moreover, the 18% sequential drop in average concurrent PC users to 662,000 can be attributed to anti-cheating efforts and the Chinese New Year, when most gamers are away from their PCs.
Perfect World has been trying to deliver a solid experience to gamers, which is why it is focusing on anti-cheating efforts. But then, the weakness in the online gaming market in China also seems to have affected the company.
According to Tian X. Hou, analyst at T.H. Capital, massively multiplayer online role-playing games, or MMORPGs, are seeing a decline in their popularity in China, conceding market share to mobile games. The number of MMORPG gamers in China went up less than 1% in 2013, to 338 million users. In comparison, mobile game users in China shot up an impressive 54%, year over year, to 215 million in 2013.
Making the mobile move
Perfect World is making an aggressive push into mobile gaming. Although this move is taking a toll on its gross margin -- down to 73.6% in the first quarter, from 77.8% last year -- it should help Perfect World benefit from the fast-growing mobile gaming market. The company has made solid progress on this front as its games such as Return of the Condor Heroes and Fantasy of the Immortals are gaining good traction.
Looking ahead, Perfect World has a number of mobile games in its pipeline that should help it sustain its terrific revenue and earnings growth. Titles such as Forsaken World, Touch, CrossGate Mobile, and Swordsman Mobile are lined up for release going forward.
Perfect World will see further deterioration in its gross margin as it aggressively promotes these games. The positive side is that the company is moving fast in this segment to capture more gamer attention. This is important, as mobile gaming is a hugely competitive space with established players such as Glu Mobile (NASDAQ:GLUU) in play.
Investing in mobile is the right move
Glu Mobile is a veteran in mobile gaming and has an enviable portfolio of titles. The company is further expanding its offerings by acquiring PlayFirst, the creator of popular games such as Diner Dash, Cooking Dash, Hotel Dash, and Wedding Dash. Also, Glu has entered into a partnership with EON Productions and MGM Interactive. Together, they will develop the first free-to-play mobile game in the history of the James Bond franchise.
Even NetEase is looking at mobile to ease the pain of a decline in subscribers to World of Warcraft, which it licenses from Activision Blizzard. NetEase is looking to tap the popularity of its online games in mobile. It has found some success with this initiative, as it has received positive user feedback for the mobile version of its Fantasy Westward Journey II title.
The company also launched Mini Westward Journey, which is a mobile card battle game, and it received positive feedback. Going forward, NetEase will continue launching more mobile games and bring enhancements such as allowing users to log in to mobile games using its YiChat messaging service.
In light of such developments, Perfect World is doing the right thing to promote its mobile games aggressively. Mobile games now contribute around 15% to Perfect World's overall revenue, up from 10% in the fourth quarter. Considering the games that the company has in its pipeline, it won't be surprising if this revenue share improves going forward.
Perfect World is making investments to grow its mobile gaming business, and this is the right thing to do. Investors should look beyond the short-term weakness that's plaguing the company. As a result of Perfect World's weak share-price performance, the stock has become quite cheap at less than 10 times trailing earnings.
A dividend yield of 2.60% is yet another reason why it is an enticing investment. The bottom line is that the company is moving in the right direction and it is a good idea to buy some shares on the pullback.