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Perfect World (PWRD), a Chinese online gaming company, is expected to announce its Q4 2012 results on March 11, 2013. Owing to intense competition in the online gaming space, its revenue growth has slowed down over the last few quarters. In Q3 2012, its revenues registered a 3% sequential increase; however, its sales were marginally lower (2%) compared to the prior year. Its operating margin declined from 23% in Q2 to 16% in Q3 of 2012 on account of higher R&D and sales and marketing expenses.

As revenues in Q3 2012 included a substantial one-time contribution associated with the release of English version of "Torchlight 2," we expect this factor to negatively weigh on Perfect World's sequential earnings growth in Q4 2012. Going forward, we believe that expanding international presence as well as a rich pipeline of upcoming games and expansion packs will drive growth for Perfect World.

Diverse Pipeline of New Games and Expansion Packs to Curb Decline in User Traffic

Perfect World has a rich pipeline of games expected to be launched in 2013. Some of the new MMORG games under development include "Swordsman Online," "Saint Seiya Online" and "Legend of the Condor Heroes." Moreover, the company is also developing a number of web games. Along with its subsidiary Cryptic Studios, it is developing "Neverwinter," which is expected to be launched in early 2013. Moreover, in Q3 2012, Perfect World obtained exclusive rights to operate "Dota 2," the world-famous title with a unique mix of action, RTS and RPG gameplay in China.

The company released expansion packs in Q3 2012 to maintain a healthy life cycle for its existing portfolio of games. The expansion packs included "Legend of Yellow Emperor" for "Dragon Excalibur," "Heavenly Scripture" for "Fantasy Zhu Xian," the "Wolf for Forsaken World" and "Call of Heaven for Perfect World." Perfect World witnessed a sharp decline in its average number of concurrent users (ACU) in the third quarter on account of its anti-cheating measures and adverse seasonality factors. Going forward, we expect the upcoming portfolio of games and expansion packs to curb the decline in user numbers.

Higher International Revenues to Drive Growth

While Perfect World has witnessed a decline in its Chinese user base over the last couple of years, it has been focusing on expanding its international operations through overseas subsidiaries as well as by licensing its games to other game publishers in countries, including Indonesia, Brazil, Turkey, and Azerbaijan. Perfect World's international gaming revenue recorded more than 100% annual growth in 2011, according to our estimates. In Q3 2012, Perfect World introduced Dark Blood and RaiderZ in international markets through its overseas subsidiaries in Japan and the U.S., respectively.

Partnering with Cryptic Studios and other such specialized R&D studios has bolstered Perfect World's global R&D capabilities. Going forward, we expect Perfect World's international revenues to continue to increase over our forecast horizon.

Disclosure: No positions.

Source: Perfect World Earnings Preview: New Games And International Operations In Focus