2010 was a lackluster year for PWRD as margins and revenue both showed decline due to no major game launch. However the investment in 2010 resulted in 5 new games for 2011 launch and is expected to grow revenue and margins. PWRD is also a leader in China game-licensing business for exports and exports account for approximately 10% of revenue. ACU for games under operation in Mainland China was approximately 999,000 in 4Q '10, as compared to 733,000 in3Q '10 and 1,157,000 in 4Q '09.
Core games i.e. Perfect World II and Zhu Xian have traditionally accounted for majority revenue(no break-up available). No major breakthrough game was launched in 2010. However 2011 would account for full revenue from the 3 games already launched (Forsaken World, Empire of Immortals and Dragon Excalibur). Among these 3 games Forsaken World became a hit among gamers and was third revenue driver in December quarter. In addition there are three more games in pipeline (Heaven Sword & Dragon Saber, Swordsman Online and XAJH) and a single hit among them would be additional revenue driver.
R&D expense was significantly increased in 2010 to develop the above games and that reduced operating margin from high of 50% to below 25%. With revenue growth back in picture and stable R&D expense margin expansion would also add to bottom-line.
Considering above, NTM PE at 9x and Cash-adjusted PE at 7x, the stock price has no growth scenario built into it. With growth coming back and expansion in operating margins, a cash-adjusted 9x PE is easily possible and would bring the stock price above $30, implying a 25% upside.
Catalyst: Upcoming results on May23, 2011 would be an important catalyst to assess progress. However I would wait for earnings for investment timing.
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