Chimin Sang's  Instablog

Giant Interactive (GA), a Chinese online game company, announced its preliminary results for Q3 this morning. It sees its quarterly sales between $40 million and $43 million, which is lower than its guidance of $45 to $50 million issued on August 18th. 

This result is very disappointing given that the previous guidance was a disappointment to begin with when the Street was expecting $58 million before the last earning report. Merely 40 days later, Giant found that it was at least 10% below the forecast. If we assume that Giant management was telling the truth on August 18th and Giant was on track to make its forecasted revenue at that time, then its running rate after August 18th further deteriorated to probably 20% below what was expected.

In the conference call this morning, the management claimed that compared to the Q2, ARPU declined teen digits percent wise, APC (Average Paying Customer) declined single digit, PCU (Peak Concurrent User) lowered teen digits, and ACU (Average Concurrent User) lowered high single digits. 

One big reason for the decline is that Giant stopped selling "Lottery Box" in the games due to the government regulation. According to the management, the impact of the discontinuing selling "Lottery Box" rippled into the playability of the games, and thus caused higher revenue reduction than expected. 

Looking forward, Giant has four games coming out in the fourth quarter, and Giant is likely to see the revenue decline continue into Q4 since none of them will contribute materially to the revenue but incur marketing cost. Out of the four games, the CEO believes that ZT online Green, a variation of its flagship product, ZT online, is the most promising product. 

The net cash position of Giant is roughly $3.30, half of the close price today. I expect that EPS for Q3 come in at 10 cents, with a lower guidance of Q4. 

Giant looks a good candidate to short due to the following several reasons:

1. It is heavily dependent on ZT and its derived game series. This is a typical case of one trick pony. 
2. While the reduced ARPU is a welcome signal, the user number reduction is rather alarming. It is not a trend Giant can easily reverse. The high base number for ZT makes compensation from newer games very difficult.
3. Giant has no proven new games even though it has games in its pipeline. These days which game company does not have several games in its pipeline?

Giant's stock price dropped 12.5% today, and it looks like its downward channel is just opening up. 

Disclosure: Short GA