It's a Perfect World for Chinese Gaming Developers

It’s a perfect world for Chinese developers of online games. That’s because the industry is growing at a robust pace with gamers spending significant amounts of time (and money) on entertainment. The online game sector in China is expected to grow at a 26% rate from 2006 to 2011, and the red hot sub-sector in this group is Massivly Multiplayer Online Role Playing Games (MMORPGs). These giant online games allow users to interact with thousands of concurrent players, basically living a “virtual life” within the game through the character they control.

Online game play is currently the #1 internet application in China in terms of time spent. The game playing appeals mostly to the 30 and under age group and is primarily a male phenomenon, although games are broadening their appeal in attempts to bring in the female players as well. China has long been criticized for its “one child” law and now many children and young adults have fewer potential playmates than in many other modern countries. At the same time, there are fewer national sports teams to follow, and censorship makes traditional TV less appealing so online gaming has filled the entertainment void for many young Chinese citizens.

The revenue model for the industry used to be based on time spent online playing. Gamers would buy time in blocks or be charged at the end of the period for the amount of time they had spent in the game. The model is now shifting to an item-based revenue platform where it is cheap (or free) to begin playing the game, but there are amenities that are purchased for real money as part of the game. This new revenue structure should allow more users initially drawing people who might not otherwise have spent the money to begin playing the game. These new entrants are now more likely to get hooked on the community and become involved to the point of buying items for their virtual character. Since developers are often able to continue to modify games, as long as particular games remain popular with users, there could be a very broad range of products that could be introduced into the games for users to purchase.

Currently Shanda Interactive (SNDA) is the leader with 29% of the online gaming market share. Other competitors include Netease.com Inc (NTES) and The9 (NCTY). At this point NTES has a fairly weak pipeline and is likely to try to defend its market share through strategic acquisitions.

At the same time, NCTY has had a tough quarter due to expenses related to their infrastructure build out, but is expected to release multiple games in the next year which should boost performance. Perfect World (PWRD) has only 5% of the total online gaming market but has developed leadership in the 3D MMPORPG market which is the fastest growing and most sustainable portion of the online gaming market.

Perfect World is known to have one of the most robust development engines for 3D games in the industry. This “engine” is a program that assists developers in creating the physics necessary with 3D game systems. Functions such as gravity, collision impact, and other artificial intelligence functions allow builders to create games that are very lifelike in much less time than it takes competitors to develop similar games.

The engine enables the games to be played on a variety of computer platforms and is able to take advantage of high performance systems and video cards while at the same time still being functional on lower quality computers.

In a “hit based” industry that requires massive acceptance of their product, being able to come to the market quickly with a quality product that outperforms competitors games is crucial. PWRD has a strong track record proving their ability to create such ground breaking games.

PWRD Notes

Full disclosure: Author has long position in PWRD

Comments

[Jim888]

The only thing not covered is that the stocks have a low volume and therefore are not particularly liquid. Additionally online gaming in China has another side - gambling. Any discussion of internet gaming in China should compare those stocks (GIGM for example) with the online gaming at large. Interesting though and something to monitor for future investments.

[yuan.zi]

Also what has been overlooked here is the political hostility against youths' obsession with online games in China. Any adverse policy could led to a sharp decline in the projected growth. Apart from that, I like this stock, and think it might be one of the gem among all the China concepts.