Giant Interactive Group (GA) is an online game developer and operator in China. Specifically, Giant specializes in Massively Multiplayer Online Role Playing Games (MMORPGs). The basic idea of MMORPGs is that a large number of players inhabit a shared world and interact with each other and kill imaginary goblins. To do this, they pay the operator a monthly fee. The most famous MMORPG is probably Activision Blizzard's (ATVI) World of Warcraft. Blizzard's 2012 revenues (from WoW and a number of other popular games) were $4.76 billion.
I used the word imaginary in the previous sentence, but my tongue was firmly in my cheek. The fact is that virtual goods have real value. We're not just talking a few bucks for Farmville unicorns either - an Echoing Fury (a legendary mace for those of you not familiar with Diablo III) sold in December for about $16,000. Yes that's $16,000 United States dollars of real world money. Whether or not you think MMORPG players are nerds or not (and speaking as someone who knows a lot of players, you'd probably be right assuming most of us are) this is a serious industry. So, let's talk about Giant Interactive.
Giant is a leading MMORPG game developer in the Chinese market. Their in-house games include the ZT Online family of games (ancient Chinese martial arts themed), World of Xianxia (Chinese mythology theme), and Glorious Mission (a military themed game that is supported by the Chinese military). Giant's games tend to operate on a freemium model like Zynga (ZNGA) that means the game is "free" to play, but there are a lot of opportunities to spend money for virtual products and services.
Giant currently yields about 6.6% with a payout ratio of about 60% and a P/E ratio of 9.6. These are some pretty healthy numbers so let's dig into the numbers a little more.
Gross Profit Margin - Giant managed an impressive 86% GPM in 2012. This is good but isn't too surprising, since they are selling a product that does not cost much to produce. By comparison, Activision (the 500lb gorilla of MMORPGs) managed a 76% GPM for 2012.
Selling, General & Administrative Expenses - Giant spent just 15.8% on SG&A expenses in 2012 - this is up slightly from 2011's 14.7% due to share-based compensation. Marketing expenses actually declined over the period. Activision spent 30.8% in 2012 on SG&A expenses, so Giant compares favorably here too.
Research and Development - Software is a very competitive business. If you're not improving your product you're going backwards. Giant spent 17.6% of income on R&D - an increase on the previous years (they hired an extra 20 developers for new games and gave existing staff a bonus) but still below Blizzard's three-year average of 21.5%
Net Margin - Giant winds up delivering an impressive 46.2% of income to its bottom line. This is a very good number (Blizzard managed about 23% over the last two years) and definitely suggests they have a strong commercial position.
Cash - As you might expect from a highly profitable business that has no long-term debt, Giant is sitting on a pile of cash (28% of market cap). August last year they paid a special dividend of $3 per share. Now I obviously can't guarantee they will do this again, but it is a good sign that management are willing to return cash to shareholders if they don't need it and that they have the cash generating power to be able to do so.
Debt - Giant has no long-term debt and Total Liabilities of <50% of Shareholder Equity. This is a very strong balance sheet.
So, the numbers look good, but what about the business itself? The main income producing asset Giant have is their player base so I have inserted the relevant slide from the Q4 earnings call.
Active Paying Accounts - How many players actually paid money to play the game? Free users are necessary to give the game a player base and play for free is a powerful acquisition tool but until they put their hand in their pocket they aren't helping me get rich. We see a steady Q on Q uptrend here, which is exactly what we want.
Average Concurrent Users - The ACU tells us the average number of users online at the same time. Increases in this number can reflect either existing players playing longer, or new players joining the game. Both of these are good things. Giant is showing a nice steady uptrend in ACU, which should mean a similar growth in revenue.
Peak Concurrent Users - The PCU tells us the highest number of users online at the same time. It is potentially an issue if the business doesn't have the servers to support it (see the Sim City launch for an example of how a company can ruin things by underestimating PCU). I am quite happy to see a relatively flat PCU
Average Revenue per User - ARPU is a key metric for any subscription / repeat custom business. Giant shows a good history of growing ARPU. We will have to see if the most recent flat quarter is an anomaly or the start of a new trend. I am not too worried as ARPU in freemium games tends to drop with new acquisitions or new games (as players tend to start playing for free).
Macro / Other Factors
Expansion - in 2013, Giant is looking to expand into Web-games and Mobile games. This is potentially a risky endeavor as the skills / products required are somewhat different. However, they have plenty of cash to fund the attempt, and management seemed aware of the challenges in the recent earnings call. The upside seems like it will be higher than the downside and this diversification will help the company longer term.
China - For some, it's a land of opportunity full of bargain shares that are all about to double and for others it's the Wild Wild East full of balance sheets that make Enron look honest. The truth is obviously somewhere in the middle. I think the positives outweigh the negatives - China is a growing market (especially for Internet businesses) and cash doesn't lie. Giant has been able to pay out a lot of money to shareholders. Another positive sign is that management recently wrote down an investment in 51.com - they are willing and able to admit failures because the core business is strong.
Overall, I think Giant Interactive is a very good company and that the shares are currently available at a good price. That seems like a recipe for success although nothing is certain and you should do your own research.