Monetizing Perfect World's Latest Update

| About: Perfect World (PWRD)

On July 12th, Cryptic Studios released its season six update to its multiplayer online video game, "Star Trek Online". Months in the making, the update had been largely welcomed by the micro transaction game's customer base which had grown increasingly agitated over a lottery system mechanic implemented late in 2011. The mechanic was installed across all of Cryptic Studio's properties by Perfect World Entertainment (PWRD) after the company was acquired by the Chinese based firm.

After the rumor of possible action by European authorities, prior to the update, Perfect World retooled its lottery system to provide "losing prizes" in the form of several virtual currencies to accompany the possibility of winning the grand prize. This retooling was accepted by enough of the customer community that complaints against the lottery-like system have regressed sufficiently, such that government intervention seems unlikely at this time. Additionally, one of the virtual currencies featured among the "losing prizes" are now a key ingredient in the online game's newest content upgrade.

At the heart of the update is the improved congealing of players into their own personally run factions or guilds, a system made popular by market leader Blizzard-Activision's (ATVI) "World of Warcraft". Consequently most major online games feature these factions in one form or another because of their potential sales generation. For "Star Trek Online", the official term used for these player managed groups is "fleet". Players can join fleets of their choosing and work together to build fleet bases for both in-game play benefits as well as bragging rights. Cryptic's developers have reported that the fleet base construction system will take at least seven months minimum to reach the biggest space castle currently available, meaning a consistently high revenue stream until at least early 2013.

While building space castles in the galactic sand sounds quaint, behind all of this is a very complex system which grinds up a massive amount of virtual currencies. Some of these are purchasable directly from the game's online store, others have to be earned by playing the game or acquired from other players. It would seem that after all the grief around its lottery system, Cryptic has decided to take the soft sale method in generating new revenue. It took an extended amount of time in-game to research and produce hard sales numbers related to the new fleet base system, in part because the game features both the equivalents of a Forex and NYSE and each have to be utilized in the building project.

So what is the bottom line? Calculations indicate that Cryptic should generate roughly $2.4M, or $.05 EPS, on sales directly attributable to the update over the next seven months. This number does assume several important factors: 1) that online players seek the greatest price efficiency during their castle construction, 2) players trade for some of the virtual currencies among one another rather than direct buy from the online store where they are higher priced, and 3) that all construction costs increase in a uniform pattern through each successive tier.

Sales were computed based off released construction costs for both the first and second tier castles, with projected costs calculated for the third through fifth tiers based on some limited release data. The assumption was also made that approximately 1,000 fleets would each seek top tier construction with an additional 25,000 small scale "personal" fleets likely achieving the first tier. While "Star Trek Online" does not disclose its total player numbers, approximately 138,000 recently "liked" the game on their Facebook (FB) page, the results of an online contest hosted by the game. Given that players will not be entirely efficient in construction and that more castles may be built than projected, sales will likely be higher than currently estimated.

Approximate tier construction costs were $35, $116, $233, $466, and $699 USD respectively for castles one through five (for detailed calculations see the comments section). Given that the last castle builds upon successive renditions, each top tier building is worth potentially $1,550 in sales for Cryptic. This value could rise further should virtual currencies become scarcer. Not bad for a "free to play" video game.

It should come as no surprise that the first tier castle is priced near $35 USD. Turbine Incorporated's (TWX) "Dungeons and Dragons Online," the current measuring stick of free-to-play games, released its most recent update late June priced at $30 as a digital-only download. Turbine and Cryptic will be duking it out later this year when Cryptic releases "Neverwinter" a multiplayer online video game which is also micro transaction driven and in direct competition to Turbine's product. Whether or not two free-to-play games utilizing the same source material can be supported by one fan community has yet to be seen.

Cryptic has announced that a seventh content upgrade to "Star Trek Online" is due by year's end.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.