Changyou.com Ltd (NASDAQ:CYOU), the video games subsidiary of Sohu.com Inc. (NASDAQ:SOHU), will report Q2 2014 earnings on July 28 before market opens. In this article, I provide my estimates of the company's financial metrics, and discuss the key things for investors to watch when reading Changyou's earnings release and listening to its conference call.
Forecasts for Changyou's 2Q '14 results.
I expect Changyou's total revenues to grow 4.5% quarter-over-quarter to $189 million in 2Q '14, primarily driven by flagship game TLBB's expansion pack that was launched in April. This forecast is based on the fact that historically TLBB's expansion pack has been effective in driving short-term revenue growth. To forecast the company's net profits, I take into consideration company management's comment during the 1Q '14 call that Changyou will continue to invest aggressively in the platform business for the rest of the year. I forecast operating expenses to stay at the 1Q '14 level as Changyou continued to invest in promoting its game platform. As a result, I expect Changyou to report a net loss of $23.6 million and EPS of -$0.45 in 2Q '14, recording the second consecutive loss-making quarter.
Key things to watch
Changyou's game platform should be investors' focus when the company reports 2Q '14 results. The company's game platform includes game information website 17173.com and several mobile and PC applications that provide services to video gamers. Here is why game platform should be investors' top priority: Since 4Q '13, Changyou has been spending the cash flow from its traditional online game business to acquire new users for this game platform. The platform's average monthly active accounts have more than doubled to 239 million in 1Q '14 from 99 million in 3Q '13. However, during the same period, surging marketing expenses have hurt Changyou's net profits, which dropped to -$19.5 million in 1Q '14 from $72.8 million in 3Q '13. Changyou's stock price has fallen more than 25% since the company announced this large-scale marketing campaign on October 28, 2013. On the 2Q '14 conference call, investors should look for management's specific plans on monetizing its game platform's surging user base. A clear plan to significantly increase game-platform-related revenues will help alleviate investors' concerns over surging marketing expenses.
Flagship game TLBB is the second most important topic in Changyou's 2Q '14 report. The reason for the game's importance is that it has been the primary source of cash flows for Changyou since it went public. As the company increased marketing expenses significantly to promote its game platform, TLBB becomes even more important because without this stable source of cash flow, Changyou's game-platform-related investment cannot continue. On the Q1 '14 earnings call, Changyou disclosed that TLBB's number of users in Q1 were flat quarter-over-quarter, while revenues dropped because gamers delayed their spending as they waited for TLBB's latest expansion pack that was launched in April. In the past, TLBB's expansion packs have been very effective in generating quarter-over-quarter revenue increases for Changyou. When the company reports 2Q '14 results, investors should look for management's comments on TLBB's revenue and usage trends. Increases in revenue and the number of active users for TLBB in 2Q '14 will prove that TLBB is still a stable source of cash flow that enables Changyou to make investments in new businesses such as the game platform and mobile games.
Browser-based games are the third most important topic in Changyou's 2Q '14 report. This business line is important because it is Changyou's second biggest source of cash flows following TLBB. Within this business line, DDTank and Wartune are the two biggest revenue contributors in Changyou's browser-based game portfolio. On the 2Q '14 call, investors should pay attention to management's comments on these two games' recently launched new versions, DDTank 3 and Wartune 2. For DDTank, the key is whether DDTank 3 is effective in boosting gamers' spending on this mature game. For Wartune, the key is whether updates in Q2 have stabilized its declining user base and revenue. In addition, fast-growing new game Shadow Sword has been launched on 29 social networking sites and game portals. It will be a positive sign for Changyou's browser-based games business if this number continues to go up.
Mobile games are the fourth most important topic in Changyou's 2Q '14 report. This business line currently does not generate significant revenues for Changyou, but its operating metrics will indicate the status of the company's ambitious expansion into mobile games. On the 1Q '14 call, Changyou announced its plan to launch 10 to 15 mobile games during the remainder of 2014, and disclosed that it had set up R&D centers in five major cities, and hired nearly 1,000 mobile game engineers. On the upcoming 2Q '14 call, investors should look for updates on this ambitious expansion into mobile games. Specifically, if 3-5 games have been launched during the quarter, then the implication is that Changyou is doing well in executing its business plan for mobile games.
Conclusion. While the rapidly expanding user base of Changyou's game platform is impressive, I suggest investors wait on the sidelines ahead of the company's 2Q '14 earnings report. The reason is that without a clear plan to monetize this surging user base, the faster the game platform expands, the more financial losses Changyou will incur. A clear revenue-generation plan will help investors look past near-term losses and become more confident in the company's long-term outlook.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.