China's Giant Interactive Should Buy Rival 9you

Today (July 31), all major Chinese internet media outlets are reporting that Giant Interactive (GA) will likely pay half a billion dollars to buy Shanghai-based online game company Nineyou International Limited (9you). Rumors indicate negotiations have entered the 'detail' phase.

GA and 9you both deny these reports. 9you published a formal announcement that it has no plans whatsoever to merge with another company. GA closed at $9.00 Wednesday, down 10%, while the Dow Jones Industrial Average gained 1.63% and the NASDAQ rose 0.44%. $9.00$ is the all-time closing low for GA.

Apparently, GA's stock price was punched by the rumor. The rumor could be either true or false, however, if it is true, is the quoted price of half billion dollars a bargain or not?

Analysys International ranks 9you as China's No.1 casual game operator. Revenue in 2007 was about $100M. Four months before, Singapore's Temasek Holdings invested $100M in 9you. I think 9you's operating margin is around 50% and year-on-year sales growth should be at least 30% (China online game industry average) in the next few years. What's more, 9you has at least $100M cash in hand. If I am right on all these estimates, GA will be buying 9you at a P/E of 8 and a PEG of less than 0.3. I think this represents a fair valuation for 9you.

Since GA is now trading for only $9, its 2009 forward PE is just above 8 itself. In a market climate like this, 9you has few chances to offer an IPO on its own. Even if 9you manages to IPO, the ensuing market value will not be above half a billion dollars. If I was an investor in 9you, I'd be happy to receive GA's current offer price.

From GA's point of view, taking $500M to buy 9you will not hurt its intrinsic value. Maybe Wall Street thinks it's safer to keep cash on hand when the economy is so shaky and has therefore punished GA. But the truth is China's online gaming sector is full of cash. Taking the chance to acquire a valuable business when capital markets are so miserable is a brave strategy that could truly pay off down the road. I regard this action as classic "buy low sell high."

If GA does not buy 9you soon, its stock price should recover. If it does decide to take the plunge, it should have itself a good investment, which will also serve to send shares higher long term.

Disclosure: Long GA

Comments

[big-papa:]

i think the author needs to study more about the chinese market. 9you is having problem dealing with the chinese government. The game 9you is operating attacts too many teenagers and the government thinks it promote too much sex contents.

2008 Jul 31 09:10 AM

[James Shaw:]

I agree with big-papa.

The Wall Street's worry has its rationale. GA just invested 51.com and Shi should learn from the failure of his own aggressive over expansion he made in 1990s when his software product was a big success.

Often it is the case one may most likely to repeat the mistakes. If he feels very good on himself it may be the time to fail.

Of course I bought big yesterday before close at $9.00 and I am expecting small bounce today. But I will be very careful on GA's long term strategy.

2008 Jul 31 01:28 PM

[Louis Liu:]

I know 9you is surrounded by negative news, lawsuit and even government punishment. But these factors also made the chance to merge. Without them, 9you should have been listed on Osaka exchange for one year.

2008 Jul 31 09:32 PM

[Sangeeta La...:]

I'd like to please know if 9you is now planning to list on the Hong Kong stock exchange, after failing to list on the Osaka stock exchange an year back? Are there plans for an IPO by the company? If yes, then could you please suggest me the status of the IPO & the timeline? Thank you. Please reply to my query on: [e-mail]

2008 Aug 01 04:53 AM