Sometimes you lose by winning the game. Online game publisher The9
It has been able to take its strength with Blizzard's World of Warcraft to launch an expansion pack, flesh out its pipeline with new titles, and win an investment from Electronic Arts
The company closed out the period with 27.6 million registered users, with as many as 985,000 gamers playing The9's Web-based multiplayer fantasy games at the same time. It's a healthy sequential advance from the 22.4 million users during this year's second quarter, when usage peaked at 930,000 concurrent die-hard players.
So where's the problem? Well, earnings of $0.17 a share fell well short of the $0.35 a share that The9 earned a year earlier, as well as the $0.21-per-share profit that Wall Street was expecting.
It's not the first time the company has broken hearts. It came up short three months ago, too. It's a pity, because The9 had crushed analyst net income targets in each of the six quarters before that.
How can earnings disintegrate so quickly despite heady top-line growth? You won't find the culprit on the gross margins line. The9 held its own there. Things get messy after that, anchored by operating expenses that nearly doubled during the quarter.
A lot is baked into that spike. Higher costs related to marketing the World of Warcraft: The Burning Crusade expansion pack and an uptick in both executive salaries and stock-based compensation expenses squeezed profits.
Just a few quarters ago, The9 was the growth darling in this sector. Market leader NetEase.com
This doesn't mean that The9 investors should bolt. The stock was only trading at 15 times next year's earnings estimates, and that was before the market's negative reaction to last night's report drove the multiple lower. Sure, analysts are bound to trim their profit targets now, but the company's pipeline is rich now. If it can catch lightning in a bottle again -- and find a way to hack away at its bulky operating expenses -- The9 can learn how to win by winning.
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.