China's Online Gamers Find Growth In Social And Mobile Networks

by: Kevin Quon

The industry of online video gaming is quickly maturing and becoming more popular as the world's adoption of the Internet rapidly spreads into households around the globe. All forms of online gambling aside, the video game industry is expected to grow from $66 billion in 2010 to $81 billion in sales by 2016, a stable trend that capitalizes upon people's desire to escape from reality. Yet while the industry continues to expand with technology adoption around the world, the move towards online and more casual social gaming has proven to be the next evolution of the gaming experience.

Online video games are already beginning to serve as one of the largest drivers towards the adoption of growth in the telecommunications and IT services sectors. In a world where the majority of the population does not yet have access to broadband internet, the adopted growth rate is accelerating quickly. In China alone, it's predicted that 53% of the population will have access by the end of 2013, a count of 718 million people. This is up from the 35% of the population that had access by 2010, a count of 469 million users. As it stands, the country now has the largest online user base in the world.

As a result of this internet boom in China, online gaming has steadily been growing. Two-thirds of the country's online user base engage in some form of online gaming. This fact has only been further legitimized with a flurry of Chinese internet gaming-related IPO activity in recent years. Such companies have tapped the public markets for large quantities of capital. As such, they remain primed for strategic acquisitions and reinvestment that can turn the companies into market leaders. As a frame of reference, when Google (NASDAQ:GOOG) had its IPO in 2004, the company raised $1.67 Billion.

Company Name Year of IPO Amount Raised
Perfect World (NASDAQ:PWRD) 2007 $188 Million
Giant Interactive (NYSE:GA) 2007 $887 Million
Shanda Games (NASDAQ:GAME) 2009 $1.04 Billion (NASDAQ:CYOU) 2009 $120 Million
RenRen (NYSE:RENN) 2011 $743 Million

As these companies join the ranks of other public online gaming companies like Tencent (OTCPK:TCEHY), (NASDAQ:NTES), and The9 (NASDAQ:NCTY), the dynamics of these companies are important to note. Online gaming in China predominantly comes in the form of massively multiplayer online role-playing games (MMORPG), video games in which a very large number of players interact with one another in a virtual game world. With the exception of Tencent and Renren, pure game developers have predominantly focused on these kinds of games. Shanda Games for instance had 37 active games in operation as of the end of October 2011 with at least 28 of them being classified as MMORPGs. Likewise, Giant Interactive operates 11 games with at least 9 classified as MMORPGs.

In stark contrast to these large online gaming developers, the social network operators have proven to be a breeding ground for the other variety of online gaming in China. Online social and casual gaming offers the promise of ever increasing popularity as these companies grow in stature. With the public offering for RenRen , the investing world was given direct access to this type of online gaming in China. As an integrated social network with 137 million activated users as of September 2011, RenRen's framework offers the potential for increased social gaming especially as the public moves to more mobile-based platforms. The company already develops most of its games in-house and has used this as a means of retaining high interest in its social network. When compared to its private rival Kaixin001, Renren has outshined the gaming found at Kaixin001 in terms of both quality and quantity.

Yet one of the growing threats to RenRen's potential social gaming leadership appears to be coming from Tencent. The company operates as the most popular social communication tool claiming a following to over 500 million active user accounts for QZone and more importantly claiming 149 million active users of Pengyou as of September 30, 2011. Pengyou is Tencent's answer to the rising popularity of real name social networks.

As it stands, 3G penetration in China has barely scratched 10% of the population, a factor that will turn gaming access into a readily accessible tool for hundreds of millions of people one fully realized. With strengthening initiatives by all of China's competing social networks in the area of mobile-based communications, the opportunity for increased interconnectedness combined with a plethora of social gaming opportunities provides for a lucrative market to come. Ultimately, online casual social gaming remains a market yet to be fully explored in China.

Yet for now, the bulk of the profits in online gaming appears to be centered around MMORPGs, and there are many companies vying to take market share. Developers with the financial clout to extend their development pipelines stand to gain the most in light of the inherent need for fresh new games. Many of these game developers appear to be sorely undervalued in light of their earning power and book values. Part of the reason for this anomaly might be in part due to the general distrust surrounding Chinese investments at present. Nevertheless, barring corporate fraudulence, a cursory glance at the each company's ratios clearly illustrate viable investment opportunities that investors should consider following up for additional due diligence. All values were taken as of February 15, 2012.

Company Name Market Capitalization Cash On Hand Forward P/E Price/Book Ratio
Perfect World $538 Million $318 Milion 4.23 0.95
Giant Interactive $986 Million $304 Million 5.57 2.74
Shanda Games $1.09 Billion $542 Million 4.86 1.40 $1.36 Billion $348 Million 4.90 2.67 $6.63 Billion $1.89 Billion 11.71 3.28
The9 Limited $230 Million $214 Million N/A 0.82

Disclosure: I am long GAME, GA, PWRD.