Internet Soft & Services
Games with winners and losers
Online gaming has so far proven recession-proof in a difficult economy and we
expect it to continue to deliver high growth and high returns. Thus, we
Overweight China online gaming. Within the sector, we focus on the four big
names and would avoid companies losing market share.
PER-based valuation
Company Ticker Ratings
Current
price
Target
price Upside Target
Implied
ex-cash
Forward
PEG
/Downside FY09 PER FY09 PER ratio
Perfect World PWRD.US Buy US$13 US$24 85% 10x 7.6x 0.7x
NetEase NTES.US Buy US$24 US$27 12% 13x 9.4x 1.0x
Shanda SNDA.US Sell US$36 US$30 -17% 10x 7.1x 1.4x
Giant GA.US Hold US$7.2 US$6.8 -5% 10x 4.0x 5.0x
Source: Company data, ABN AMRO forecasts
China has one-fifth of world population, one-quarter of world online gaming revenue
In 2008, China’s online gaming market generated US$2.7bn in revenue, accounting for 25%
of global online gaming revenue of US$11bn. The active gamer population involved 49m of
China’s 1.3bn citizens, according to IDC. As such, one-fifth of the world’s population is
contributing one-quarter of global online gaming revenues. The number of paying gamers in
China was 30m at end-2008, and we forecast it to reach 53m in 2012. US and Korean
games only accounted for 31% and 23% of Chinese online gaming revenue in 2007. We
forecast China’s online gaming revenue will see 29% CAGR over the next three years, and
will contribute one-third of the global industry revenue by 2011.
Overweight for being recession-proof plus attractive valuation
A general market convention holds that the online gaming industry is recession-proof, and
60% revenue growth in 2008 and strong 1Q09 guidance by the companies in our coverage
universe would appear to back that up. With stock market conditions as they are, revenue
growth has not translated into increased investor value. China’s online gaming stocks are
trading at a 30% discount to Korean peers based on Bloomberg consensus estimates.
China’s online game market still has great potential whereas Korea and the Western market
are already saturated, in our view. We think the Chinese gaming sector deserves a valuation
premium for its higher growth potential, higher ROE and stronger recurring cash flows, on
our estimates.
Initiating coverage on the Big Four; our top-pick is Perfect World
We compared the performance of 10 public game companies in China. The four on which we
initiate coverage in this report all possess key qualities that we see as critical to sustain their
long-term leadership. These traits include strong R&D, a large user base, operational
expertise and an extensive distribution network. We suggest investors focus on these bluechip
names and avoid market share losers, despite their high cash balances. Our order of
preference is: Perfect World, NetEase, Giant and Shanda.
Contents
Picking the winners 3
We expect China online gaming to continue to deliver high growth and high returns
in a difficult economy and, so, Overweight the sector. We cherry-pick four ‘bluechip’
names to start our coverage. Our order of preference is: Perfect World,
NetEase, Giant and Shanda.
3
Initiate coverage with an Overweight on the sector 3
Sector valuation 8
We have used PER together DCF to value these high-growth, high-risk online
gaming stocks. We also value the sector in relation to its global peers.
8
Methodology and peer analysis 8
Our conclusion: Perfect World has significant upside potential but expectations
for Shanda’s AION look too high
8
11
One-year price performance comparison 11
Current PE one-year discount comparison 12
Market overview 13
Driven by increasingly broad penetration and an expanding number of gamers, the
Chinese online gaming industry enjoys high growth compared with its global peers.
Among all online genres, MMORPG possesses the highest stickness and
monetisation.
13
Rising from the East 13
A glimpse into China 15
MMORPG remains the easiest genre to monetise 16
Reaching the casual gamer 19
Value chain structure 27
Risk analysis 29
Chinese online gaming faces title risk, regulation risk and management risk, in our
view. Competition risk in domestic and overseas markets is also rising.
29
Appendix 30
Massively multiplayer online games (MMOGs) 30
Company profiles 32
Perfect World 33
NetEase.com 50
Shanda 68
Giant Interactive Group 86