Market Punishes Perfect World for Earthquake; Buying the Dip

Perfect World (PWRD) reported very good numbers, but due to 'disappointing earnings' (some of it due to 3 day shutdown in China due to mourning period for the earthquake) the stock is down over 9%. Sort of silly, so I added more here in the low to mid $28 range, which coincides nicely with some key support around $28.00. Growth metrics this quarter look very nice; revenue grew 18% sequentially and 248% year over year. Gross margin expanded 2.5%! sequentially and nearly 10% year over year! (wow). Net income up 8.3% sequentially and 296% year over year.

• Total revenues were RMB303.2 million (USD43.2 million) in 1Q08, an increase of 17.3%, or RMB44.8 million, from RMB258.4 million in 4Q07 and an increase of 247.8%, or RMB216.0 million, from RMB87.2 million in 1Q07.
• Online game operation revenues were RMB264.5 million (USD37.7 million) in 1Q08, an increase of 14.9%, or RMB34.3 million, from RMB230.2 million in 4Q07 and an increase of 245.4%, or RMB187.9 million, from RMB76.6 million in 1Q07. The sequential increase in online game operation revenues primarily resulted from the successful launch of Chi Bi, expansion packs for the Company's existing MMORPGs and the successful implementation of the "Perfect Festival" marketing campaign.
• Gross profit was RMB265.6 million (USD37.9 million) in 1Q08, an increase of 20.9%, or RMB45.8 million, from RMB219.8 million in 4Q07, and an increase of 290.9%, or RMB197.6 million, from RMB68.0 million in 1Q07. Gross margin was 87.6% in 1Q08, which increased from 85.1% in 4Q07 and 78.0% in 1Q07. The sequential improvement in gross margin was mainly due to a higher level of economies of scale generated from rapid revenue growth, a reduction in IDC costs and an increase in overseas licensing revenues, which have a higher gross margin.
• Net income was RMB158.4 million (USD22.6 million) in 1Q08, an increase of 8.3%, or RMB12.2 million, from RMB146.2 million in 4Q07, and an increase of 295.8%, or RMB118.4 million, from RMB40.0 million in 1Q07. Basic and diluted earnings per ADS were RMB2.83 (USD0.40) and RMB2.67 (USD0.38), respectively, in 1Q08, as compared to basic and diluted earnings per ADS of RMB2.62 and RMB2.48, respectively, in 4Q07, and basic and diluted earnings per ADS of RMB1.27 and RMB0.82, respectively, in 1Q07.

Guidance

• Based on the Company's current operations, total revenues for the second quarter of 2008 are expected to be between RMB303 million and RMB318 million. This represents an increase of 0% - 5% on a sequential basis and reflects the impact of suspending game services in response to the three-day national mourning for earthquake victims and the earthquake's impact on the Company's operation in Sichuan. In addition, the Company has incurred and expects to continue to incur additional operating expenses in the second quarter of 2008, including increase in R&D expenses in connection with Beijing and Shanghai operations and other operating expenses in connection with the new U.S. Subsidiary, which will reduce operating margin and net margin for the second quarter.

US Subsidy? Hmmm

• In April, 2008, the Company established Perfect World Entertainment Inc, or PW USA, a Delaware corporation and its wholly owned subsidiary, to capture potential business opportunities in North America. PW USA is expected to primarily focus on solidifying the Company's international expansion strategy.

So I guess I see this one different than the market; much like Ctrip.com (CTRP); there is not much a company can do about earthquakes or 3 days of national mourning. If a company is supposed to lose 10% of its value since it is losing 3 days (out of 365), I guess that is market logic for you. I took the opposite tact and now have pushed Perfect World up to 2.3% stake from 2.0%. Perhaps next quarter gains will be muted, but things continue to look rosy for the year(s) ahead, and this quarter's beat of 3 cents should offset any shortfall next quarter and the full year number should remain beatable. A forward PE of 17 is not unreasonable considering the metrics they are putting up.

Disclosure: Long Perfect World, Ctrip.com in fund; long Perfect World in fund

Comments

[Joseph Ramelli:]

The reason for the stock sell-off is not the Revenue Guidance, it is because the company said margins are going to come under pressure because of increased spending. Increased spending has nothing at all to do with the earthquake. In my opinion it was pretty bad that the company said that they are going to have lower margins with out quantifying how much lower. I think the stock breaks lower again today.

2008 May 20 08:59 AM

[User 195441:]

if you dont mind me asking, did u buy any stocks for PWRD


On May 20 08:59 AM User 128183 wrote:

> The reason for the stock sell-off is not the Revenue Guidance, it
> is because the company said margins are going to come under pressure
> because of increased spending. Increased spending has nothing at
> all to do with the earthquake. In my opinion it was pretty bad that
> the company said that they are going to have lower margins with out
> quantifying how much lower. I think the stock breaks lower again
> today.

2008 May 20 09:47 AM

[weng ho teng:]

This company is a great long term hold.

The best inexpensive online stock in the China space at this time however is MYST.OB.

They are partners with Google and China Netcom on the new Subaye English global B2B site.

MYST.OB is a big moneymaker in 2008 and 2009.

2008 May 20 03:40 PM

[aadil ayob:]

hi all, am very interested in investing in the china stock market,
as i am a south african living in dubai, how do u start a trading account for stocks or investing in china stocks, i am of the opinion that we cannot invest in china stock market,
any views or information will be greatly appreciated
please do email me at [e-mail]

2008 May 24 08:57 AM