Giant Interactive (GA) - Giant Opportunity
Fan has been clueing me in on chinese gaming stocks, namely MMORPGs, so I decided to take a look at them. I think it's basically a given that the industry in China will do well - the real question is which company will triumph. However, despite the market being as competitive and overcrowded as they come, many of these stocks have fallen so far that it almost doesn't even matter which one will win. In any event, I think we've come to the agreement that Giant Interactive looks to be the most attractive of these.
Here's a list of the major publicly-traded players:
There are many more, but these are essentially the main players. This is a fascinating industry, characterized by high growth and insane margins. The9 is an interesting little company as it has the license to operate the highly popular World of Warcraft game in China. Unfortunately, that's also just about all it does, so I'm avoiding that one for now. I've ruled out the first 3, because they simply don't look as attractive when compared to Giant Interactive.
This is an interesting article giving a nice background of the company and some of the things that set GA apart. GA's strategy is to target the middle market. GA's key title ZhengTu Online is geared toward mass adoption as it is free to play and requires only a 10Kb connection to play. Similar to how Wal-Mart grew its business by staying away from major metropolitan areas, the company has concentrated its 2,500 person marketing force on medium and smaller sized cities in China. The goal is for players to become addicted to the game and fork over real money to purchase upgrades like weapons, gear, or clothes for their in-game characters. The company evidently has become really good at executing on this plan as it now has 2.1 million peak concurrent users (2nd most in China) and the highest ARPU (~300RMB per quarter) in the industry.
The MMORPG model is attractive because once a game reaches a certain critical mass, it essentially becomes a self-contained money machine. It basically takes virtual goods and converts it to real hard cash. The only expenses are the R&D to create it and the marketing expenses to spread the word.
Here are some other interesting findings gleaned from the 2007 annual report, IPO prospectus, the Q2 08 earnings call transcript, and the company's investor relations site:
Decision:
I'd have to think that the downside to this stock is limited. At under $8, this is a $1.9 billion market cap stock with an enterprise value at about $1.1B. With the share repurchase plan, the company can afford to buy back almost 20M shares. This is over 15% of the 114M share float according to Yahoo Finance. The company certainly has the cash balance and cash flow generating ability to to buy back more shares.
The operating margins are sure to come down though. Operating expenses was close to 33% of revenue in Q2, with the bulk of that coming from marketing. Taxes will also play a larger role going forward. However, even factoring those in, this is still likely a conservative 40% to 50% net margin business with very limited capital requirements. The company only has one hit game for now, but they do have a few in the works with new game Giant Online reaching 344k peak concurrent users. Even if you disregard the other games, ZT Online can be a cash cow for GA for quite a number of years given its track record and critical mass, and it is still growing. It seems highly probable that GA can generate at least $150M in free cash flow annually over the next few years just off of ZT Online. Any additional value from new games or from newly acquired businesses would just be gravy.
I don't see this stock dropping below $1.2 billion in market cap, which is basically its cash balance plus two years of free cash flow. That translates to a bottom of about $5 per share, or a loss of less than $3 per share from these levels. However, the upside here can be quite substantial. If we assume the company reaches $300M in free cash flow in 3 years (CY 2011) and the market values the FCF conservatively between 9-12x EV/FCF, that translates to a market cap range of $3.5B to $4.5B, or $14 to $18. Even a return to its IPO price of $15.50 would yield a 100% return. When this sector and company return to the market's favor, the limited float and high margin/high growth characteristics of the business could potentially justify a multiples expansion and yield a return several times higher than that. The risk/return proposition appears very favorable, and I'll be looking to build a fairly substantial position here.
Here's a list of the major publicly-traded players:
There are many more, but these are essentially the main players. This is a fascinating industry, characterized by high growth and insane margins. The9 is an interesting little company as it has the license to operate the highly popular World of Warcraft game in China. Unfortunately, that's also just about all it does, so I'm avoiding that one for now. I've ruled out the first 3, because they simply don't look as attractive when compared to Giant Interactive.
This is an interesting article giving a nice background of the company and some of the things that set GA apart. GA's strategy is to target the middle market. GA's key title ZhengTu Online is geared toward mass adoption as it is free to play and requires only a 10Kb connection to play. Similar to how Wal-Mart grew its business by staying away from major metropolitan areas, the company has concentrated its 2,500 person marketing force on medium and smaller sized cities in China. The goal is for players to become addicted to the game and fork over real money to purchase upgrades like weapons, gear, or clothes for their in-game characters. The company evidently has become really good at executing on this plan as it now has 2.1 million peak concurrent users (2nd most in China) and the highest ARPU (~300RMB per quarter) in the industry.
The MMORPG model is attractive because once a game reaches a certain critical mass, it essentially becomes a self-contained money machine. It basically takes virtual goods and converts it to real hard cash. The only expenses are the R&D to create it and the marketing expenses to spread the word.
Here are some other interesting findings gleaned from the 2007 annual report, IPO prospectus, the Q2 08 earnings call transcript, and the company's investor relations site:
- The company went public in November 2007 at a price of $15.50, raising net proceeds of $780M. The stock is now roughly half that level despite delivering stellar returns.
- The CEO/founder Shi Yuzhu owns 49% of the company, and principal shareholders and entities own 70% of the company.
- $835M in cash and equivalents as of June 2008
- Announced $150M share buyback in August
- The company is planning to launch ZTOnline in Vietnam - perhaps the first of many such launches. The game's minimal tech requirements are conducive for this type of expansion.
- Active Paying Accounts: 1.76 million, 41% growth YoY. However, slightly decreasing ARPUs. The company recently changed its revenue model to grow paying accounts at the expense of ARPU, part of the reason the stock's been hammered.
- Net margins of 70% - but this will likely come down
- Operating Cash Flow of $203M, free cash flow of $188M in 2007
- No taxes paid in 2007. Their 2007 annual report says that they have a 50% tax holiday from 2008-2010, or 7.5% effective tax rate in those years.
- The last quarter's results were also tempered by the Sichuan earthquake as well as the Olympics distracting people from playing games.
- GA is the only Chinese gaming stock (and one of the few Chinese stocks) to trade on the New York Stock Exchange rather than NASDAQ. I thought that was interesting as NYSE tends to be less volatile and more expensive than NASDAQ, while NASDAQ is more often associated with technology stocks. Here's a breakdown of the differences between NYSE and NASDAQ.
Decision:
I'd have to think that the downside to this stock is limited. At under $8, this is a $1.9 billion market cap stock with an enterprise value at about $1.1B. With the share repurchase plan, the company can afford to buy back almost 20M shares. This is over 15% of the 114M share float according to Yahoo Finance. The company certainly has the cash balance and cash flow generating ability to to buy back more shares.
The operating margins are sure to come down though. Operating expenses was close to 33% of revenue in Q2, with the bulk of that coming from marketing. Taxes will also play a larger role going forward. However, even factoring those in, this is still likely a conservative 40% to 50% net margin business with very limited capital requirements. The company only has one hit game for now, but they do have a few in the works with new game Giant Online reaching 344k peak concurrent users. Even if you disregard the other games, ZT Online can be a cash cow for GA for quite a number of years given its track record and critical mass, and it is still growing. It seems highly probable that GA can generate at least $150M in free cash flow annually over the next few years just off of ZT Online. Any additional value from new games or from newly acquired businesses would just be gravy.
I don't see this stock dropping below $1.2 billion in market cap, which is basically its cash balance plus two years of free cash flow. That translates to a bottom of about $5 per share, or a loss of less than $3 per share from these levels. However, the upside here can be quite substantial. If we assume the company reaches $300M in free cash flow in 3 years (CY 2011) and the market values the FCF conservatively between 9-12x EV/FCF, that translates to a market cap range of $3.5B to $4.5B, or $14 to $18. Even a return to its IPO price of $15.50 would yield a 100% return. When this sector and company return to the market's favor, the limited float and high margin/high growth characteristics of the business could potentially justify a multiples expansion and yield a return several times higher than that. The risk/return proposition appears very favorable, and I'll be looking to build a fairly substantial position here.
posted by Henry at
1:55 AM
0 Comments:
Post a Comment
<< Home