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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.

Conclusion

  • 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.

NCTY chart.

Ncty617

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Source: Pacific Growth starts The9 (NCTY) with an "overweight" rating