Perfect World

"Perfect World Co., Ltd." and its selling shareholders are offering 11,800,000 ADSs in price range of $12.00 and $14.00 per ADS. Company was incorporated under the laws of the Cayman Islands in June 2006.

Business

Company is a leading online game developer and operator with main operations in china. It primarily develop three-dimensional, or 3D, online games. Company offers three games in 2006 namely "Perfect World", "Legend of Martial Arts" and "Perfect World II". In the first quarter of 2007, these games recorded approximately 237,000 average concurrent users in China. In late May 2007 company introduce one more game named "Zhu Xian".

Company earns most of its revenues from online gaming operations (nearly 85%), some part of its revenue comes from overseas licensing of its gaming rights.

Company intend to use approximately US$12 million of the net proceeds from this offering to expand its research and development efforts and rest of the proceeds for other general corporate purposes, including capital expenditures and funding possible future acquisitions.

Financials  

Company's financial year ends on December 31.

*Quarter ended March 31

Since the company launch its first game in January 2006, FY 2005 and FY 2006 figures are not comparable.

Company launch its two more games in quarter ended Dec 31, 2006 effect of which can be seen in revenue rise from quarter to quarter and thereafter.

Launch of games has also resulted in rise in average concurrent users:

Business/Company Outlook

Online gaming business can be divided under two parts development and operations:

• Development includes planning and development of a online game/gaming software 

• Operation includes making game available to end users and to handle relative infrastructure.

Online gaming in the newest medium of entertainment and is gaining popularity rapidly due to its attractive features like 3-D and rich color graphics, real time interaction with other players, vast choice of games from single medium (computer and internet) other factors which contribute to its popularity includes increase penetration of internet and rising knowledge of computer among people. As per estimates online gaming industry in China is expected to grow @ CAGR of 30% till 2011.

Perfect world is developer as well as operator of online gaming software. Company is a holding company

Its wholly own Chinese subsidiary "PW Software Co., Ltd." develop gaming software and handle international business.

Its VIE (variable interest entity) "PW Network Technology Co., Ltd." handle's gaming operation and distribution network in China.

To compile with present Laws of PRC (China) company don't hold any equity in its VIE, but instead enter into series of agreements with PW network through its subsidiary, due to these contractual agreements company gain's almost 100% financial and operational control in PW Network (VIE) till 2024.

Currently company is a establish player in Chinese market and has a clear growth strategy for future which includes:

• To concentrate on item based revenue stream in which players can play the games for free, but they are charged for purchases of in-game items, such as performance-enhancing items, clothing, accessories and pets.

• To frequently introduce new games\new versions of older games.

• Expand globally.

• To enhance and further develop its proprietary game engine.

• To look for potential acquisition.

With the projected high growth of online gaming industry, established position of company in Chinese market, effective growth strategy, own game development capabilities,  in-depth knowledge of Chinese's market, establish distribution and operating network presents positive future outlook for company.

Valuation/Offer value ($ in million)

(Company may not be able to perform this well, chances of company performing this well is, four out of five)

Assume that company shows (assuming that, nothing negative happen with company and it perform just ok, although due to growth potential of  its business and strong development marketing and distribution capabilities, company has potential to grow exceptionally well and can perform better than these assumptions.)   

1. Company earns revenue of $45.12 million in FY 2007 and $58.66 million in FY 2008.

Assuming that company for whole FY 2007 perform inline with Q1FY 2007 (in absolute number terms.) and shows growth of 30% thereafter in line with industry.

2. Gross margins at 78% in FY 2007 and 79% in FY 2008.

3. Operating profit margins at 48% in FY 2007 and 50% in FY 2008.

This leave company with operating profit of $21.66 million and $29.33 million in FY 2007 and FY 2008 respectively and after detecting interest cost of nearly $0 and $0 and income tax @ 15%** this leave company with net profit of $18.41 million and $24.93 million, that is EPS of $ 0.066 and $ 0.09 for FY 07 and FY 08 respectively, that is earning per ADS $0.33 and $0.45 for FY 07 and FY 08 respectively.

This means if nothing negative happen with company and it perform just ok, at offer price of $13 company's ADS is available at one year forward (FY 2007) PE of nearly 39 and two year forward (FY 2008) PE of nearly 29.

** Under current PRC (China) rules and policies, an enterprise qualified both as a "software enterprise" and a "high and new technology enterprise" is entitled to a preferential income tax rate of 15%. (company may be eligible for certain tax rebate which are not considered in assumptions)

We rate this IPO 3+ on scale of "1 to 5" (5 for best)

Negatives

• Company's short operating history.

• Complex corporate structure.

• Revenues can fluctuate quarter on quarter.

• Most countries are implementing laws to avoid online game addiction among its users/online player any tough law can hit company hard.

• Currently high dependence on Chinese market.

Positives

• In-house game development, distribution and operational capabilities.

• In depth knowledge of Chinese market.

• High growth rate of company as well as industry.

• Any acquisition will accelerate this growth rate further.

• Healthy balance sheet. (after this offering).

• Funds raised from this offering will give company extra financial strength to lookout of acquisitions or partnerships.

• Expanding globally.

This article reflects personal view of the author about the company and one must read offer prospectus and consult its financial adviser before making any investment decision