Sohu's Changyou: It's a Perfect World for Chinese Internet Gaming

As I’m sure most of you have heard, online gaming is a huge market in China. In the past couple of years, new companies and products have been rolling out the door on a fairly consistent basis. The latest news is that Sohu.com (SOHU) is taking its online gaming subsidiary, Changyou (proposed ticker: CYOU), public as a stand-alone company.

For those of you that are not familiar with Sohu.com, they are a internet portal in the Peoples' Republic of China and are often referred to as “The Yahoo" (YHOO) of China.” Last year, Changyou’s revenue was $201.8 million, which is more than four times what it was the year before. Profits for that same year clocked in at a staggering $108 million, giving them a profit margin of over 50%.

After the IPO, Sohu.com will still own 71% of Changyou, which means that as long as the IPO goes well, Sohu.com’s stock should see an uptick in price along with Changyou. Although I like Sohu.com as a company, I am reluctant to take a position in them unless it should happen that they fall below $38 a share. Currently, Sohu.com is trading at a forward price to earnings ratio of 8.9.

As I hold no position in Sohu.com, and Sohu.com isn’t really an online gaming play, I get my exposure through Perfect World (PWRD). Perfect World is consistently releasing new games, as well as open betas for new games. Estimates over the past 90 days have remained somewhat steady at $2.53 a share 90 days ago to the current estimate of $2.43. These estimates are for the next fiscal year, 2010, and leave Perfect World trading at a forward price to earnings ratio of 5.2.

I, however, must admit that Shanda Interactive (SNDA) is currently the industry leader. Estimates for 2010 have drastically increased over the past 90 days from $2.75 to the current estimate of $3.23. Although earnings estimates have increased over the past 90 days, Shanda Interactive’s stock price is up nearly 100% from its low of $19.75 nearly 4 months ago, and since Wall Street is reluctant to put high multiples on this industry, I choose to stick to Perfect World and may buy more if the timing is right. I plan to reevaluate when Perfect World hits around $19 a share. Other key players in the industry that investors should take note of for research purposes are Netease.com (NTES), Giant Interactive (GA), and The9 (NCTY).

Disclosure: I am long PWRD, do not hold a position in SNDA, SOHU, NTES, NCTY, GA, and obviously not the yet to begin trading CYOU.

Comments

[Alphameister:]

PWRD is my choice also as offering by far the best growth relative to price-earnings ratio. I likewise will probably be selling some around 19 though the stock would still be an appealing GARP choice at that level. I suggest you also take a look at Linktone (LTON) which I've just started to accumulate this week: powerful growth, no debt, great chart and priced below book value.

Mar 19 08:53 AM

[Max Petrisek:]

GIGM has a smaller footprint in China's gaming world. It is a buy in the $5s.

Mar 21 01:04 PM

[Zoltan L. K...:]

Sohu is making the IPO to fund more R&D for gaming. It is a very interesting perspective. Now Sohu is at the lower end of its trading range, seems you were right about waiting.

Mar 25 02:36 AM

[Dan Heil:]

thanks for the tip on linktone(lton), i did my research and began accumulating yesterday. I know some may see china as risky right now, but during a global recession, when China almost clears growth for the year in double digits, I'm bullish. I also discovered another Chinese company China Green Agriculture (CGA) micrap fertilizer, which is trading at a forward p/e of less than 4, analysts see revenue of 31.74 million this year and profit of .63 a share, and next year year revenue 41.98 million and profit of .90 a share. That country is beefing up thats for sure.


On Mar 19 08:53 AM Alphameister wrote:

> PWRD is my choice also as offering by far the best growth relative
> to price-earnings ratio. I likewise will probably be selling some
> around 19 though the stock would still be an appealing GARP choice
> at that level. I suggest you also take a look at Linktone (seekingalpha.com/symbo...)
> which I've just started to accumulate this week: powerful growth,
> no debt, great chart and priced below book value.

Mar 25 10:56 AM