Giant Buyout: Paving Way For A Real Gaming Giant?

| About: Giant Interactive (GA)

The ongoing cleanup of neglected Chinese firms from U.S. stock exchanges continues, with word that online game developer Giant Interactive (NYSE: GA) has finalized its plan to go private. A report on the bid says that several other Chinese online game firms are also planning privatizations, as former industry leader Shanda Games (Nasdaq: GAME) is also in the midst of its own such bid. It's not hard to see why these companies are going private, as their shares have gone nowhere for years due to anemic growth. But what's interesting here is the prospect that some of the private equity firms funding this wave of buyouts could finally force a few of these companies to merge and create a more vibrant major new player with real growth potential.

I've followed China's online game sector for many years now, and have seen the industry go through many changes before Tencent (OTCPK:TCEHY, HKEx: 700) and NetEase (Nasdaq: NTES) emerged as its 2 current leaders. Each of those companies has risen for different reasons, but their domination of the sector has left little space for the many smaller players crying for attention. Those smaller names include Giant, as well as The9 (Nasdaq: NCTY), Perfect World (Nasdaq: PWRD), Shanda Games and Sohu's Changyou (Nasdaq: CYOU) division.

Like everything in China's online world, consolidation has been slow to come to gaming because most companies are led by strong-willed founders who are reluctant to yield control of their empires. But that could slowly be starting to change as these founders get older and perhaps tire of their old jobs. Giant founder Shi Yuzhu could be one such player looking to retire from the space as he looks to pursue other ventures (previous post), and Shanda founder Chen Tianqiao could be having similar thoughts (previous post).

That kind of change of heart could leave room for savvy private equity firms to come in and merge some of these companies to create a major new player with the potential to challenge Tencent and NetEase. In Giant's case, the list of private equity firms funding the buyout looks relatively impressive, led by Baring Private Equity and a banking consortium whose members include France's BNP Paribas and Switzerland's Credit Suisse (company announcement). Another report says that Hony Capital, one of China's top private equity tech investors, is also participating in the buyout.

The deal was first announced in November, and immediately attracted a flurry of lawsuits from investors who thought the original buyout price of $11.75 per American Depositary Share (ADS) was too low. The just-announced new offer has raised the buyout price slightly to $12 per ADS, and the latest share reaction has the stock trading not too far below that level, indicating that investors are likely to accept the new price.

Giant's latest quarterly results broadly reflect the greater state of stagnation for all of these second-tier online game companies. Its revenue grew just 5.8 percent in the fourth quarter of last year, similar to the single-digit growth seen at many other companies. Investors haven't found much to get excited about in those kinds of numbers, and Giant's shares before the buyout offer hadn't changed much from levels 5 years earlier.

All that brings me back to the big question of what's next for Giant, Shanda and some of the others that might choose to privatize. One report says that The9 and Perfect World are exploring similar privatization bids, and I wouldn't be surprised to see one or both launch official buyout bids later this year. I would hope and expect such privatizations could then be followed by some quiet behind-the-scenes mergers of 3 or 4 of these companies, assembling a solid third-largest new player to rival Tencent and NetEase and perhaps make a new listing bid in New York or Hong Kong.

Bottom line: A series of online game company privatizations could pave the way for behind the scenes mergers, creating a new third largest player to challenge Tencent and NetEase.

Disclosure: No positions.

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