Strong demand for Giant IPO

The online gaming operator raises $887 million in the largest US IPO by a Chinese private sector company.
Online gaming provider Giant Interactive priced its US initial public offering above the initial range at $15.50 for a total deal size of $887 million, pulling off the largest US listing by a private sector Chinese company ever. If the 15% greenshoe is exercised in full, the final size will cross the $1 billion mark.

The company didnÆt have the same spectacular first day gains as some of the other Chinese companies that have listed in the US recently û on Wednesday insurance agency CNinsure rallied 58% in its debut û although this can probably be explained at least in part by its much larger size. At the time of listing, the company had a market capitalisation of just over $4 billion and a free-float of 22%.

According to several market watchers, there are no signs that the recent strong appetite for Chinese growth companies among US investors is subsiding.

The stock rose 32% to a high of $20.46 in the first hour of trading, but then assumed a gradually declining trend for the rest of the session. It finished 17.6% above its IPO price at $18.23.

The deal attracted a lot of interest from investors who were perhaps taken in by the companyÆs high cash-flow and the quick build-up of both revenues and net profit since the launch of its first, and so far only massively multiplayer online (MMO) game in January 2006. A key reason for the rapid growth, observers say, has been the companyÆs strong focus on marketing and on making the game available at Internet cafes in second, third and fourth tier cities across China where the entertainment options are limited. It also has a nationwide distribution network for selling pre-paid game cards and game points that spans supermarkets, software stores, book stores, newspaper stands and convenience stores.

Clearly the brainchild of the companyÆs founder Shi Yuzhu, this strategy has contributed to its ZT Online game being ranked as the most popular online game in China last year, according to report by International Data Corporation that is cited in GiantÆs listing document. The number of quarterly peak concurrent users of ZT Online increased to 888,146 in the third quarter this year from 120,037 in the first quarter of 2006. In the same period, the number of quarterly average concurrent users increased to 481,054 from 51,202.

During the three months to September, ZT Online had 1.32 million active paying players. However, its average revenue per user (ARPU) declined to Rmb295 in the three months to June this year from Rmb320 in the three months to March, having initially climbed from Rmb84 per user in the first quarter 2006.

Shi is considered something of a consumption guru within China û one source referred to him as ôthe godfather of marketing" û based on the savvy marketing of certain health food products and the popularity of a video game that he developed in the early 1990s. The video game company subsequently collapsed under weighty debts incurred as a result of an ill-fated foray into property development, all according to Forbes, which included Shi in its rich list in as early as 1995.

According to sources, the Giant offering drew more than $16 billion worth of orders which suggests a subscription ratio of about 18 times. About 65% of the demand came from the US, while Asia accounted for 25% and Europe for close to 10%. One source noted that there was also good interest from a few Middle Eastern accounts. The order book comprised about 600 institutional investors, who appeared to have no objections to the fact that the final price valued Giant at a premium to most of the other Chinese online gaming companies.

The final price of $15.50 was fixed 10.7% above the top end of the initial range of $12 to $14 and pushed up the 2008 price-to-earnings multiple to about 22.5 times, based on the average syndicate earnings projections. Its US-listed comparables trade at an average 2008 P/E ratio of 19.9 times, according to Bloomberg data, although individual valuations range from 12.3 times to 29.9 times for Perfect World (the only one with a richer valuation than Giant).

Kingsoft, which raised $99 million in a Hong Kong IPO last month and has gained 39% since its debut amid a rally in the broader market, is currently trading at a 2008 P/E multiple of 30 times.

ôThis will be the largest (of the Chinese online gaming companies) and by far the most liquid. There is a benefit to that and I think a lot of people who looked at the company were interested for that reason and willing to pay a bit extra for that,ö one source says with regard to the valuation premium.

Liquidity, and the ability to get out of investment at short notice has been a key concern among investors ever since the sub-prime crisis hit the markets in August.

Giant sold 57.197 million American depositary receipts, which each accounts for one common share. Close to 92% of the offering was made up of new shares, with the remainder sold by one existing shareholder who is neither a director nor part of the management. Merrill Lynch and UBS acted as joint bookrunners.

As part of the offering, Standard Chartered bought $25 million worth of shares in the company.

Giant is planning to launch its second and third MMO games in the fourth quarter this year. The second game is essentially a pay-and-play version of ZT Online. The latter is free to play, but gets revenues as the players buy accessories for their characters in the game. The third game is called Giant Online and will be similar in style, but based around a more modern military theme.

It has also acquired the intellectual property rights to a free-to-play MMO game called King of Kings III from Taiwan Lager Network Technology, which it intends to launch commercially in China in 2008.

The company posted revenues of Rmb687.4 million ($90.3 million) in the first half of 2007, an increase from Rmb408.5 million for the full year 2006. The net income more than doubled in the same period to Rmb512.3 million from Rmb244.6 million.

According to IDC, revenues from ChinaÆs online gaming industry are projected to grow at a compound annual growth rate of 30.2% between 2006 and 2011 to reach $3 billion. Of that, two thirds is expected to be generated by MMO games.
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