Cartman: I am the mightiest dwarf in all of Azeroth!
Kyle: Wow! Look at all these people playing right now.
Cartman: Yeah, it's bullcrap! I bet half of these people are Koreans.
-- South Park, "Make Love, Not Warcraft"
With more than 100 million registered users in China alone, CDC Games, a division of CDC (NASDAQ:CHINA), might dispute Cartman's grasp of demographics. Yet the company's mind-boggling player base isn't the most interesting news to come from its latest quarterly earnings conference call. I'm more intrigued by CDC's compelling slate of newly released and upcoming games, which might catapult the company into the upper echelon of China's online gaming hosts, alongside Shanda Interactive (NASDAQ:SNDA), The9 (NASDAQ:NCTY), and NetEase.com (NASDAQ:NTES).
This edition of "Fool on Call" will focus on CDC Games' recent and upcoming developments of CDC Games, its parent company's plans to unlock the division's value, and what that all means for investors. (If you need it, here's a refresher on this past quarter's numbers.)
The staple
Until very recently, CDC Games' online lineup consisted of just one game, Yulgang. Launched more than two years ago in July 2005, it was the first Chinese MMORPG -- that's "massively multiplayer online role-playing game" -- to let users play free, earning revenue from those players' purchases of in-game accessories.
Yulgang is still going strong today, adding another 6 million users in Q2, bringing the total number of registered users to 54 million. Meanwhile, Q2 revenues from the game rose 17% to $9 million year over year.
Yulgang received a blow early in Q3, as unauthorized servers running the game sapped its revenue. The company first got wind of the piracy in late May and early June, but the bootleg servers haven't had a material effect on revenue until recently. The game also suffered a decline in players' interest, because of a "long lapse [in time] from the last major content update," explains Xiaowei Chen, president of CDC Games.
To attack both the piracy issue and players' waning enthusiasm, the company introduced a new content update called "version 180." In addition to luring players back, the update adds new features "designed to increase the average revenue per user." Version 180 appears to be a success, since player participation now exceeds pre-update levels.
CDC is also attacking the piracy problem by working with government agencies like the Chinese Public Security Bureau, sending legal notices to pirate server operators, and forming an alliance with other companies against pirate servers.
The surge
Interestingly, Optics, a key acquisition of CDC Games in Q3, has recently and successfully obtained convictions against a pirate server operator and a macro program operator. Chen indicated that these convictions were the first of their kind in China. In addition to the more than 40 million registered users CDC brought on board via its Optics acquisition, it also seems to have gained greater legal expertise in combating piracy.
Optics has three major titles running in China right now: SHAIYA, MIR III, and EVE Online. The acquisition also provides CDC Games with five new titles in the pipeline, due for launch in the "near future."
The shooter
The company also released a first-person shooter game, Special Force -- the first of its kind to enter the Chinese market -- to bring the company's total offerings to five games. Special Force has topped the charts in every market it's entered to date, including Taiwan, Korea, and Thailand.
The game's already garnered 4.5 million registered users. Chen explained in the Q&A portion of the call that first-person shooter games typically see a "faster and faster" increase in user rate than MMORGs. This effect, coupled with new items for sale within the game, hint at the possibility of rapid revenue acceleration in the coming months.
The sword
Optics's addition in the current quarter basically doubled CDC Games' offerings. Given its warm reception in other markets, Special Force could provide a triple for the company. And CDC Games may just round third and head for home plate with the upcoming release of Lord of the Rings Online.
LOTR Online is at the top of the PC charts in both Europe and the U.S., but can Western successes translate equally as well in China? Electronic Arts (NASDAQ:ERTS) certainly believes it's possible, and it's backed up that bet with the introduction of FIFA Online. If any franchise can garner global applause from the online world, LOTR Online can.
"We have very high hopes for Lord of the Rings to become a blockbuster in China, too," asserts Chen. The game's set for release in China within the next six months.
Unlocking value
Over the summer, CDC announced its intentions to spin off CDC Games through an initial public offering. CDC CEO Peter Yip hopes the deal will "unlock shareholder value." A year ago, then-acting CFO Verome Johnston asserted, "We continue to believe that the Company harbors additional value not currently reflected in our stock price." At that time, the underlying stock traded at $5 and change. CDC is trading about 40% higher today, but management's remarks in this call suggest to me that the sum of the company's individual parts remains much greater than the current whole.
Because of the pending IPOs of both CDC Games and CDC Software, company officials declined to offer any forward guidance. The leadership team will take more time in the next quarter's conference call to provide greater detail on CDC Games' operations, which should give us a much greater sense of its value as an independent enterprise.
Until very recently, CDC Games had just one breadwinner, Yulgang. With the acquisition of Optics, the release of Special Forces, and the upcoming launch of Lord of the Rings Online, it's adding three more potential or actual moneymakers to the fold. We'll have to wait and see how the potential acceleration of CDC Games' top and bottom lines compares to the valuation of upcoming IPO. Still, you have to like the sound of things.
As Cartman put it, "You can just hang outside in the sun all day tossing a ball around, or you can sit at your computer and do something that matters." CDC Games and its potential investors seem to have chosen the latter. Let the games begin.
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