Pacific Growth Equities analyst Jason Brueschke initiated coverage of The9 (ticker: NCTY) with an overweight rating and a price target between $40 - $50 per share. The stock is currently trading in the mid-20s. Here are the key points:
Initiating coverage of The9 with an overweight rating
- The9 is a leading online gaming company in China with the license to what could be the most successful Chinese online game in history -- World of Warcraft (WoW).
- The9 already has a successful Korean-developed game, MU which it has been operating in China for more than two years.
Investing in The9 is largely a bet on the success of World of Warcraft
- Tremendous growth potential for the next 2 years.
- Expect The9 to grow significantly faster than the overall Chinese online gaming market over the next few years.
- The9 generated $4.5 million in revenue in 2004 based primarily on one game, MU.
- With The9 set to launch 4+ games over the next 18 months including WoW, PacGrow forecasts revenue to grow at nearly 880% year-over-year to $44.8 million in 2005 and an additional 150% year-over-year to $110 million in 2006.
- PacGrow's model assumes that WoW will have a strong debut and staying power.
- To be conservative, PacGrow has modeled all the other games planned to be released as moderate successes.
Strong earnings leverage
- PacGrow expects The9 to grow earnings 202% year-over-year in 2005.
- Expects earnings growth of 408% year-over-year in 2006.
World of Warcraft set to be a blockbuster
- A hit in the US, Europe and Korea, WoW was commercially launched in China on June 7th.
- Open beta numbers -- 500,000+ peak concurrent users.
- An estimated 435,000 peak concurrent users in the first week of commercial launch.
Huge marketing budget behind WoW
- Estimates that The9 will spend as much as $4 - $5 million on marketing WoW in 2005.
- This could be a record amount for any Chinese online game marketing campaign.
- Expect much of this budget will be spent in Q2 and Q3.
- Note: The9 is contractually obligated to spend a minimum of $13 million over the next 4 years marketing WoW in China.
- Expect the marketing spend to help WoW become one of the top games in China.
Coca Cola (ticker: KO) marketing agreement
- The9 beat out competitor Shanda (ticker: SNDA) for a nationwide co-marketing campaign with Coca Cola.
- PacGrow believes Coke chose The9 largely due to the success that WoW has enjoyed in Europe, the US and Korea.
- Estimates that Coke will spend at least a similar amount to what The9 is planning to spend in Q2 and Q3.
Strong pipeline of additional games
- The9 broadened its product portfolio in 2004.
- The9 now has 5 games—including both propriety, in-house developed games and games licensed from third-parties—set to go live in a series of staggered launches in 2H 2005 and early FY 2006.
- PacGrow expects 2006 numbers to reflect full year contributions from these new games.
Why The9's WoW will be successful
- WoW has been successful in virtually every other market.
- The9 received 1+ million applications for its closed beta testing.
- Great peak concurrent user numbers.
- The9 and Coke are putting an extraordinary marketing budget behind the launch.
- PacGrow considers current share price a favorable entry point.
- Fair value is 20x – 25x its 2006E EPS, or a range of $40 to $50 per share.
- Initiating coverage with an over weight rating.
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