Why Activision Must Renew The9's World of Warcraft Contract

Includes: ATVI, NCTY
by: Chuck Kasparov

With 92% of their 2007 revenues coming from operating World of Warcraft in China, The9 (NASDAQ:NCTY) must renew their WoW license or lose much of their earnings power. Their license is set to expire in June, 2009.

If they can renew this license, and simply maintain their current earnings level - they have a very attractive valuation. With a Market cap of $518M, $300M in cash, no net debt, and earnings of $16.8M last quarter, they are great deal, even ignoring the fact that they have a fabulous growth record.

On August 13, shares of The9 fell 20% on news that Netease (NASDAQ:NTES) had licensed various games from Activision Blizzard (NASDAQ:ATVI) (Starcraft II, Warcraft III: Reign of Chaos, Warcraft III: The Frozen Throne™, and Battle.net® platform) for the China market. (See here.)

While the Starcraft and Warcraft series of games are entirely different types of games from World of Warcraft (they are play once type of games with groups of up to 12 people vs. WoW being massive multiplayer games - or MMORPGs), it is easy to understand the concern investors have that Activision is working with Netease now and may not renew the the WoW license for The9.

So now the big question is - will Activision renew the license for The9? I believe they must.

First of all - if they give the license to someone else (for example, Netease), all of the million+ regular players will lose their WoW accounts with The9. These users have invested years of time in developing their characters and status in the game, and will have to start over from scratch. With significant competition from game operators competing for players, many customers will decide to go to a different game, rather than start from scratch with World of Warcraft. Since Activision gets a 22% cut of player revenues, they would take a huge loss on the reduction of players.

Now, there is no chance another operator will be able to take over The9's player base and generate the same per player revenues. But, if they are able to offer a significant upfront fee to the extent that Activision won't care about per-player license revenues, then Activision might consider the switch. But that would then send a really bad message to future licensors. It won't make sense for companies to fully commit to licensing from Activision with the fear that even if extremely successful Activision might backstab them in the end.

So I see Activision trying to diversify their China offerings a bit with the Netease licensing, and delaying their renewal with The9 for as long as possible to try and get a higher percentage of license revenues, but in the end, it makes sense for them to give in and renew the license with The9.

Disclosure: Author is long NCTY