Strong Server Stats Predict Strong Earnings
We have been tracking the utilization levels of the WOW servers since October 2005. Our methodology allows us to estimate the number of gamers playing the game, the daily average concurrent user [ACU] and peak concurrent user [PCU].
Based on this analysis, we predict a substantial quarter over quarter increase in revenues, and number of WOW users. Our ACU estimate is 380,000 a 35% increase over the 280,000 ACU recorded during the previous quarter. PCU is predicted to increase by a more modest 15% to 686,000 from 595,000 in the previous quarter. The main driver for this impressive growth is the opening of a new server area and the launch of the cross-server battlegrounds upgrade in early October. The upgrade drove gamers back to World of Warcraft and made existing gamers play longer hours.
A longer average playing time is also responsible for the ACU growing faster than the PCU during the quarter.
Furthermore, the server stats also paint a favorable picture on The9's operational capabilities; the unscheduled server downtime was minimal during the fourth quarter.
Our previous earnings preview report for The9 was reasonably accurate, and generated strong interest from research analysts and investors. It's worth noting that in preparation for the release of the cross-server battlegrounds feature, The9 had made changes to the server infrastructure, merging low usage servers, dedicating servers to battlegrounds and adjusting the server user caps. In our present analysis we were forced to deal with these changes and to make assumptions that add to the uncertainty of the ACU and PCU estimates for this quarter. We are anxiously waiting for the earning report to re-calibrate our data.
The9 recognizes revenue based upon the actual usage of the prepaid game cards. For this reason, the revenue generated by WOW, which is responsible for 99% of The9's revenues, can be easily calculated knowing the game ACU and the ARPU (average revenue per hour).
If our ACU and ARPU estimates are correct, the net revenues for the fourth quarter should stand at $38 million, a 29% increase over the revenues posted during the third quarter.
For this analysis we assume an ARPU of 0.37 RMB/hr, lower than the 0.39 RMB/hr reported for the third quarter. A lower ARPU is expected this time, due to the renewal of the free WOW trial accounts with the opening of the 7th server site in late September.
Our EPS estimate for Q4 is 47 cents, significantly higher that the 37 cents analyst consensus estimate. Although The9 is entitled to a reimbursement of local taxes for 2006, the above estimates do not include any extraordinary items. A possible tax reimbursement of $1.5 million could add an additional 6 cents to the EPS figure.
We believe that The9 is still a good value, trading at a forward P/E of about 20. For 2007, analysts conservatively expect The9 to earn $1.89 per share, 32% more than for 2006.
We believe that the potential earnings growth following the release of the Burning Crusade expansion, SUN and Guild Wars is not yet fully built into the 2007 estimates and that the stock price could benefit from increasing analyst earnings projections following the release of these games.
Disclosure: the author owns stock in The9 since 2005. He does not own stock in any other Chinese gaming company.
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