Perfect World Co., Ltd (PWRD) is one of the pioneers in China's booming online video game industry. Its MMORPG games such as "Zhuxian" and "Perfect World" are among the most popular online video games in China. However, its stock is not doing well lately, mainly because of disappointing Q2 and Q3 earnings results.
At a market cap of about $550 million, PWRD is worth more dead than alive. Its cash on book plus the value of the office buildings it owns are more than its market cap. I believe this offers investors a great low-risk, high-reward opportunity. The following are my investment theories:
Extremely Attractive Valuation
At $11.50 per share, PWRD is valued at a trailing P/E ratio of 5 and a P/B ratio of 0.9. This valuation is absurd given the fact that the company is still making good money and has a ROE of 19%.
The Industry is Still Growing
In 2012, China's total video game sales reached RMB60.3 billion, with a growth rate of 35%. This growth is expected to continue, albeit at a slower rate. Total video game sales are forecast to grow more than 12% per year in the next five years and hit RMB130 billion by 2017.
Strong Game Pipeline
I think investors are overly concerned about PWRD's business. Yes, it's true that its main flagship games are aging and struggling. But the life of these popular MMORPG games can be lengthened to more than 10 years by launching expansion packs periodically. Moreover, PWRD has a strong game pipeline. It will launch Dota2, Neverwinter, Saintya and many other new games in 2013. These new game launches should not only offset the decline in existing games, but bring new growth to the company.
Real Estate Play
Investors seem to overlook the treasure in PWRD's book: The office buildings it owns. At the end of 2011, PWRD owned a total of 62,200 square meters of office space in Beijing. These office buildings were bought in 2007 and 2008 when the price was very low. For example, PWRD paid only RMB700 million for 55,000 square meters of office space located in Chaoyang District, a trendy business district in Beijing. That translated to about RMB12,000 per square meter purchase price. The market price has since more than tripled to about RMB36,000. The value of PWRD's office space now is worth RMB2.2 billion, or $361 million.
PWRD paid a special dividend of $2 per ADR in 2011. That's about a 17% dividend yield based on the current price of $1.50 per share. Management has indicated PWRD will pay dividends annually going forward. I don't expect a double-digit dividend yield going forward, but a yield of 5% or 6% should be enough to draw in some investors looking for decent dividend yields.
According to the latest SEC filings, Fosun International Limited has recently increased its stake in PWRD from 8.31% to 9.39%. Fosun has proven to be an extremely shrewd investor that has good eyes for bargains. Its latest stake increase should boost investor confidence and possibly bring in new institutional investors.
In summary, PWRD is a bargain at $11.50 per share. Its net cash on book plus the value of the real estate it owns is more than its current market cap. In my opinion, this offers investors a wide margin of safety. Furthermore, the industry PWRD is in, is still a blue sea and is still growing. Finally, PWRD's strong game pipeline should bring growth to the company.
Disclosure: I am long PWRD.