China's Volatile Gaming Industry

Shaun Rein's article Investing In China's Online Gaming Sector brings up some good points. Having been actively involved in the Chinese games industry, I would like to add some further comments:

1. In addition to the major players the author mentions, other publicly listed companies that deserve a mention are Tencent, the leader in the casual games space with its QQ Game platform, and CDC Games, who have been quite successful operating "Yulgang" through their 17game subsidiary. They also recently announced that they have licensed the MMOG, "Lord of the Rings" [LOTR], which should launch in China later in 2007 or early 2008.

2. One of the reasons why the western publishers such as Electronic Arts (ERTS) struggle in China is that due to regulatory issues they can't directly publish online games so they need to work with a local partner. Korean companies such as NC Soft who have licensed numerous games to Chinese companies are worth looking at. The game consoles (ie: Microsoft's (MSFT) Xbox, Sony's (SNE) PS3 etc) has too many issues at this point (regulatory, piracy, business model) so the market will continue to be PC-game dominated for the foreseeable future.

3. A big issue for the Chinese games industry is the shortage of quality game developers, especially game designers, and low level of game developer education. While Netease (NTES) has been successful at developing their own 2D/ 2.5D titles no Chinese company has managed to develop a quality 3D title. Imitation still rules over innovation with many copycat games being developed.

4. I would expect all of the Chinese game companies, including Netease, to license foreign titles in the future. This is partly due to the poor state of the local game development industry as mentioned above, and also because WoW has shown that a lot of money can be made from licensing a blockbuster title even if royalties have to be paid out to a foreign party. Due to the risk averse nature of many of these companies they will try to secure western titles that have reached open beta testing or have already launched in the west, or are being developed by famous developers who already have a track record. While this lowers their risk it also means that they will likely have to pay higher licensing and royalties for these titles.

5. Expect to see more games operated on a "play for free, pay for items" model compared to the traditional subscription model. The Korean games industry has already moved in this direction and Shanda (SNDA) and CDC Games/ 17game have shown that it is a viable model in China.

As the author mentions, it is likely that all of these stocks will remain volatile due to the nature of the games business. Netease has some strong positives including their management team and past success at game development, however a big test for them will be whether their upcoming 3D title, Tianxia II, is a commercial success. If not then they don't have much else in the pipeline and licensing will become a priority.

The9 (NCTY) has had a good run with WoW and has licensed numerous upcoming titles but it is not obvious to me how a company that has essentially been operating one game could expect to be successfully operating up to six games within the next 18-24 months. I suspect that their strategy has more to do with "locking up" as many of these titles as possible - Granada Espada was originally meant to launch at the end of 2004 but still hasn't - by paying a small upfront fee and then only paying the bulk of the licensing fees when/ if they actually launch the game. While this may suit The9 it isn't good for their licensing partners and so I don't see them being the "Chinese partner of choice" for foreign companies as some have stated.

Shanda will likely remain very volatile. Their strategy of licensing 2nd tier titles and using their core competencies e.g. card distribution and marketing ability to promote them aggressively, has not been successful recently. Their in-house game development efforts have been poor and it is doubtful whether Dungeons & Dragons will even launch commercially as initial feedback has not been good and the game, in my opinion, is not well suited for Chinese gamers. However if they license some good titles and abandon their misguided "Shanda box" strategy then they could perform well. By the way, the game the author mentioned is called "Archlord," not "Overlord Land."

Disclosure: Author doesn't own any of these stocks but does have business dealings with some of these companies.

Comments

[Stephen Ngai:]

Do you guys really know and understand Game industry in China?

I doubt it. Stephen Ngai

Disclosure: I am holding SNDA shares.

2007 Jan 05 07:10 PM

[Paul Meyer:]

You are right. The game industry is much huger and competitive then these guys talk. Companies will find away and growth will happen big time.

2007 Jan 06 10:15 AM

[David Oliver:]

Stephen,

I have been involved in the Chinese games industry for a number of years and talk regularly to senior executives from many of these companies, including Shanda.

Paul,

I agree that overall the games market in China will continue to grow quickly. The point is that the fortunes of the early leaders - Shanda, Netease and The9 - will remain volatile as new competitors and new games enter the market, and games based on the "play for free, pay for items" model gain traction.

2007 Jan 06 09:23 PM

[Chimin Sang:]

Agree with David Oliver. His point is that these companies are going to be volatile, which they are and will be.

China game companies are now highly speculative, and the gaming topic alone is not worth long term investing. Short term I am bearish on shanda, neutral on ncty, bullish on netease. Netease is not without severe problem either. If they cannot succeed in search business, they are not worth investing.

2007 Jan 07 12:44 AM

[Stephen Ngai:]

Question to David Oliver:

What standards are you using in classifying & to define the followings:
1. First Tier?
2. 2nd Tier?
3. Other Tiers?

In Chinese Game Industry, there is no official business practices of defining and classifying the games into each tier.

You bashed Shanda of licensing second tier games. You are misleading the readers here.

My question: Who define which tier based on industrial standard?

If this is only your opinion, your analysis is not objective. Keep on shorting SNDA PLEASSSSSEEEEE!

2007 Jan 07 07:34 PM

[Warrick Buc...:]

I came across this old article the other day and found it and the comments interesting. Especially since I have been in China researching the industry from the consumer and developer perspective the past 5 months.

My background is the UK computer games industry for over 8 years with many published titles. I had the option to look at setting a company up in the UK or finding a better place to do it.

Now I find myself in the interesting position of having a few titles I am looking to release online in the Chinese market assuming I can sort out the needed licences(!) and they are not quite the cloned titles the market is used to - indeed my plan involves experienced western professionals being brought over here.

Just from some of the things you guys have been saying I would be interested to talk to you and hear your thoughts.

Thanks

warrick 'at' graffiti-games.com

2007 Nov 13 04:17 AM