Broader Growth Helps Perfect World Beat Expectations

Perfect World (NASDAQ:PWRD) is a Chinese online gaming company that specializes in developing 3D MMORPGs (massively multiplayer online role playing games). A MMORPG is a type of video game in which a number of players interact with each other in a virtual world setting by assuming the role of a character. Perfect World posted $151 million in revenues in the recently reported fourth quarter of fiscal year 2013, up by 11% sequentially and 34% annually. The strong showing was better than expected considering that the company had provided guidance for sequential top line growth in the range of 2%–7%. The success of Perfect World’s flagship game Zhu Xian and its first mobile game Return of the Condor Heroes were the key contributors behind the remarkable performance. With more games in the pipeline, including the expected launch of the popular DOTA2 and Neverwinter in China, we believe that Perfect World’s top line will continue to grow strongly in the future. ^[1]

We are in the process of updating our $17.14 price estimate for Perfect World’s stock, based on the recently announced results.

User Activity Increased Due To Rising Popularity Of New Games

After remaining depressed for many quarters, the number of average concurrent users (ACU) for Perfect World’s Chinese operations started to grow fervently in 2013. It increased from 554,000 during Q1 2013 to 803,000 during Q4 2013, mainly due to the strong performance of new and existing games, and due to the initial commercialization of the world famous game DOTA2. ^[1] We believe that the rise in user activity is suggestive of good user engagement by Perfect World’s games.  We expect this trend to continue since DOTA2 is nearing its large scale launch in China. DOTA2 has won several awards and accolades such as ‘Best PC Strategy & Tactics Game’ and ‘Best PC Multiplayer Game’ of 2013, by Imagine Games Network. Other games in the pipeline will also help expand the user base.

The following table summarizes the data for Perfect World’s ACU in the last six quarters:

Licensing Business Accelerated Due to Overseas Growth

Perfect World is trying to strengthen its overseas network by licensing games to partners and by operating games through some of its own subsidiaries. The company registered more than 20% sequential growth in licensing revenues as new commercial launches in international markets helped it earn higher initial license fees. Usage-based royalty fees also rose due to strong overseas growth. ^[1] We estimate that licensing revenues will continue to increase in the future as Perfect World forges more partnerships to expand internationally. However, the company is also increasingly operating games in overseas markets through its subsidiaries which could result in cannibalization of licensing revenues.

Gross Margins Declined Due To Growing Share Of Mobile

Mobile revenues are recorded by Perfect World on a gross basis. This means that the distribution channel’s share is recognized as cost of revenues, leading to thinner gross margins for mobile as compared to PC. Mobile’s contribution to Perfect World’s revenues increased as the year 2013 progressed. As a result, gross margins declined to approximately 75% in Q4, from 78% in the preceding quarter. ^[1]

Perfect World earned just under 10% of its revenues from mobile in Q4. We estimate the percentage to rise further in the coming quarters due to the introduction of more mobile games. The company recently launched its first 3D RPG mobile game Fantasy of the Immortals and intends to bring another game Forsaken World to the mobile gaming market. ^[1] A greater proportion of revenues from mobile will lower overall gross margins.

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1. Perfect World’s CEO Discusses Q4 2013 Results – Earnings Call Transcript, Seeking Alpha, March 11, 2014 [↩] [↩] [↩] [↩] [↩]