Why I Will Buy Changyou.com

| About: Changyou.com Limited (CYOU)

Perhaps now is not really the time to talk about buying some company making online games. After all, Zynga's (NASDAQ:ZNGA) share collapse is still fresh in everyone's mind. Perhaps it's also not the time to speak about buying a Chinese stock, after all if the shares won't implode because of the company being a fraud, then they will implode because China's economy is going to hell in a handbasket.

So, knowing this, what will I do? Well, I'll tell you about this Chinese online gaming company, Changyou.com (NASDAQ:CYOU), which I am thinking of buying shares on. I am obviously motivated by its growth—revenues have been growing in the 30% range, though that's expected to slow down to 12% and 19% for 2012 and 2013, respectively. I am also motivated by its valuation, with CYOU trading at a forward 2012 P/E of 3.7 times, an EV/EBITDA of 1.6 times (due to a large $520 million cash hoard) and a price/book of 1.6 times.

But how do I put aside the fears? Let's see.

The stock being a fraud

With every Chinese stock, you always have to wonder. CYOU, though, is a subsidiary to Sohu.com (NASDAQ:SOHU), which has been in the market for longer without ever being accused of being fraudulent.

And then there's another detail that comes from comparing CYOU to a truly alleged fraud, Qihoo (NYSE:QIHU). You see, QIHU acts in one of the segments where CYOU is also present, yet claims its 129000 generate an ARPU (Average Revenue Per User) that's as much as 10 times CYOU's! What this tells us is that QIHU's claims are false, and those of CYOU's have a much higher likelihood of actually being true! (For more detail on this, check Matt Berry's excellent "Qihoo's ARPU: Playing Games With Investors").

The Chinese slowdown

Here, my thesis is somewhat different. I've already talked about this some time ago, in my article "There's More To China's Slowdown": Basically China's slowdown has more to do with a transition from an investment-led economy, to one that's more based on consumption. That's pretty hard for things such as basic materials, but online gaming is not investment. It's consumption.

So, although I expect a China slowdown, I don't think it will be all that hard on consumption, and by extension, on online gaming. Sure, it might produce slower growth rates, but I don't expect it to produce a contracting online gaming sector. For that, we'd have more to worry from competition in the field than from the economy itself.


Putting aside those fears, it's impossible not to be attracted to a growing company gaining from China's increased consumer affluence and trading at an incredibly low valuation. So yes, I will have to buy stock on CYOU.

As a small aside, SOHU itself suffers from about the same fears and is equally cheap. Also important, the trends on both these equities are strongly negative, and so buying them might mean spending some time underwater.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CYOU over the next 72 hours.

Additional disclosure: I am short QIHU in a pair trade with RENN.