When was the last time a video game company earned crazy growth? It seems that people disfavor investment in games these years. Perfect World (NASDAQ:PWRD) has the lowest P/E ratio (A P/E ratio of 3 according to 2013's projected earnings) in the whole gaming industry. So is this company really that bad? Or is this a great asset which is greatly undervalued?
The Chinese gaming industry had explosive growth before 2009. The burst of the Internet users led to crazy gamer growth that lasted for a few years, and now as the overall Internet user growth is stalling, the growth in the gaming industry seems to be stopped. In addition, mobile games are creating a new thriving place for investors to cheer. It's true that things look bad for PC games.
However, Activision Blizzard's (NASDAQ:ATVI) Diablo 3 gave those people who announced the death of PC games a loud slap in the face. Diablo 3 is now the fastest selling game in history. Its new auction house feature is a good try to make MMORPG games more profitable and sustainable. The auction house feature encourages gamers to actively trade virtual items in which the company will take part of the virtual item transaction fee. This in-game auction house feature first appeared in Asia MMORPG games. Giant Interactive (NYSE:GA)'s Zheng Tu 2 has this auction house feature built in game and it has been a successful example so far. Mobile games are surely growing fast, but they cannot provide the same overwhelming gaming experience that PC games deliver. It's not just the game plays and qualities that limit the users' experience. It's the size of the screen that makes the difference.
Now, back to Perfect World, its flagship game Zhu Xian generated about 30% of the total revenue for the company in 2011. Perfect World and other Chinese gaming companies like CYOU, GAME, and NCTY are all facing the same problem as they highly rely on a few titles to drive revenues. The Chinese users now demand better quality games in terms of gameplay, graphics, and amusing stories. They want to play better quality games and these companies realized that they couldn't just reproduce games like factories making pop sodas. So they have been burning cash in their R&D departments since 2008. This is partly the reason why we don't see new titles releasing for Perfect World. Perfect World has a few titles that have been under development over 3 years now, and these titles are expected to release starting the end of 2012.
There are other titles releasing this year and next year, but these three titles are expected to show significant revenue driving power. Torchlight 2 is unlikely to drive the revenue a lot. However, it will make a great model for the future MMORPG version of similar games. GAME's Dragon Nest is running well in China and all three titles I have listed above are the same genre as Dragon Nest. PC games nowadays are more like games on the XBOX and PS3 and they still carry their MMORPG traits, which make them highly profitable.
Perfect World is cheap indeed. It hasn't proved that its new games will drive the revenues forward. With a P/E this low, even if the new games performed somewhat "OK", the share price could be worth a lot more than the recent price. Furthermore, the company acquired a few international studios that own amazing titles. With the new games releasing ahead, I have faith in Perfect World that they will show people a perfect comeback soon.
Disclosure: I am long PWRD.