Perfect World launches Nasdaq IPO

The Chinese online game developer launches its offshore listing at a discount to its peers as it seeks to overcome a short trading history.
Chinese online game company Perfect World yesterday kicked off the roadshow for an initial public offering that aims to raise between $141.6 million and $165.2 million. The offering will see Perfect World join its Mainland peers Shanda Interactive Entertainment, and The9 Limited on the Nasdaq board.

The listing comes at a time when investors are getting more comfortable about the growth in ChinaÆs online game industry and less concerned about the regulatory environment, which has helped the share prices of Shanda and The9 more than double over the past eight months.

International Data Corporation projects that online game revenues in China will increase from $816 million in 2006 to $3 billion by 2011. This represents a compound annual growth rate of 30.2%, which compares with 9.5% in Korea and 10.1% in Taiwan that are the second and third largest online game markets in Asia in terms of revenue.

At the same time, Perfect World is a new player in the industry with a short track record that has yet to report its first full-year profit. The companyÆs first three games have done well, but investors will be asking themselves whether these games will be able to grow to critical mass and whether the company will be able to replicate this success in subsequent games.

ôThey really have only one real hit so far,ö says one industry specialist, referring to the companyÆs self-branded Perfect World game, which as a stand-alone title is one of the most successful games in China. ôThe biggest risk about investing into a company like Perfect World is that it is a young company and one hit doesnÆt necessarily beget other hits.ö

Perfect World specialises in three dimensional so called massively multiplayer online role playing games (MMORPGs), where players adopt a specific character through which they interact with other players within a virtual world. The Internet-based games, which can be played by thousands of people at the same time, typically have no endings, but feature multiple stories with unlimited scenarios and game situations depending on the actions of each player.

Aside from the use of 3D in all its games, what makes Perfect World stand out from the already listed players, sources say, is the fact that it develops all its games itself, using a proprietary 3D game engine and a module-based game platform. This, according to its listing document, allows the company to create ôsuperior 3D graphics with impressive visual effectsö and also means it is able to maintain higher margins and doesnÆt need to pay license fees û which can account for as much as 30%-40% of revenues - to other developers. The module-based platform also allows it to shorten the development time for new games to about six months.

The9 almost exclusively licenses popular foreign games, which it then markets and distributes in China, while Shanda provides both licensed and self-developed games. Netease, which has historically been regarded as the best online game developer in China, still uses 2D technology on most of its self-developed games.

Among Perfect WorldÆs current four games, one is a second version of Perfect World based on a different revenue model, while the fourth is still relatively untested since it was launched only at the end of May. Perfect World was the winner of the Best 3D Online Games award at last yearÆs China Digital Entertainment Exposition and Conference, while its second game, Legend of Martial Arts, won the Best Self-Developed Online Games award at the same event.

The companyÆs first three games had approximately 237,000 average concurrent users in China in the first quarter 2007.

As part of its expansion, the company is planning to launch two additional 3D MMORPGs in 2007 and also one casual game by early 2008. Casual games are easier and take less time to play than the intricate roll-playing games and include sports games like basketball or car racing, and card games such as poker and blackjack

The company is offering 11.8 million American Depositary Shares (ADS), or 21.1% of the company, at a price of $12 to $14 apiece. Of the total, 9 million ADSs are backed by primary shares, while the remaining 2.8 million are sold by China-based venture capital firm Prosperous World that was an early investor into the company.

The 15% greenshoe, which could increase the maximum deal size to $190 million, is backed by existing shares that will be sold by SB Asia Investment Fund II, a fund backed SAIF Partners that counts Cisco and Softbank as strategic investors, and by a company controlled by Perfect WorldÆs founding chairman and CEO, Michael Yufeng Chi.

The chairmanÆs stake will fall to 26.02% from 31.02% as a result of the IPO, or to 23.8% if the Greenshoe is exercised in full. SAIF, which was also an early investor in Shanda, will hold 30.08% at the time of listing, or 29.13% post-shoe, while Prosperous World will hold 13.9%. All existing shareholders, as well as the company directors and executive officers have agreed not to sell any more shares in the first six months after listing.

Each ADS is equal to 5 Class B ordinary shares, which have one voting right each. The company also has Class A shares with 10 voting rights each. Credit Suisse and Morgan Stanley are joint bookrunners for the offering, while CIBC World Markets and Susquehanna Financial Group are also helping to sell the shares.

The price range is pitching Perfect World at a discount to its more established peers. According to sources, the syndicate consensus profit forecasts translate into a 2008 price-to-earnings multiple of about 11 to 13 times, which looks particularly cheap versus Shanda and The9 which are approaching 20 times next yearÆs earnings. Based on WednesdayÆs closing price Shanda was quoted at 19 times after a 119% gain in its share price since November last year, while The9 was at 19.2 times, having rallied 105% in the same period, Bloomberg data show.

Netease, which aside from its online games also provides Internet portals and wireless value-added services, have struggled in recent months as some of its new games havenÆt done as well as expected and is currently trading at 15 times. The stock fell 23% from a high of $21.82 in late February to $16.80 on June 26, but has since stage an impressive rebound. On Wednesday it closed at $19.01.

Perfect World, which was founded in 2004 and launched its first game in the first quarter of 2006, posted a loss of Rmb27.9 million ($3.6 million) last year, but reported a profit of $5.2 million in the first quarter this year.

Its first quarter revenues amounted to $87.2 million, just 12% below the top-line income received in 2006 as a whole. Some 86.5% of the first quarter revenues was generated through an item-based model which is increasingly replacing the time-based model where players are charged based on how long they play. In an item-based revenue model, itÆs free to play the game, but players are charged for in-game purchases of things like performance-enhancing items, clothing or accessories.

Shanda, Netease and The9 stirred up a lot of attention when they came to market three years ago, but then they hit a patch where people became less certain about where the industry was going. There was also concern about regulatory issues as the government was worried about addiction and the industry became associated with a lot of cheating and violation of intellectual property rights.

Such concerns have largely faded away as the companies have continued to do extremely well, however, and now the industry is seeing the second wave of Chinese online game players being in a position to come to market. Like Perfect World these younger companies typically develop their games themselves and because they are big promoters of intellectual property rights they are also receiving a lot of government support, sources say.

Another key attraction of Perfect World, according to the industry specialist, is that the architecture of its games are built specifically for emerging markets, which makes them less dependent on good broadband Internet connections than most Korean-developed games or the US blockbuster World of War Craft, which are very data traffic intensive.

ôWe have heard from publishers of games in emerging markets such as India that people like Perfect World because it works,ö the industry specialist says.

As a result, Perfect World has been able to license its games to several other emerging markets. At present, Perfect World II is available in 11 countries and Legend of Martial Arts in seven.

The final price is expected to be set on July 25 with the shares due to start trading the following day.
¬ Haymarket Media Limited. All rights reserved.
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