Perfect World Earnings – Behind the Headlines
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Perfect World (NASDAQ: PWRD) can't seem to put two impressive quarters together no matter how hard they try. The proof is in the last four quarters -- the company has missed and then beaten estimates every other quarter.
The good news for investors is, over the last four quarters the company still has beaten estimates on average by over 19%. It seems the gaming industry perplexes analysts in general as competitor NetEase (NASDAQ: NTES) has beaten estimates in all four of the company's most recent quarters. The point is, online gaming is evolving and you can't measure the value of a company based on one quarter's performance. Keeping this in mind, let's see what Perfect World's most recent earnings report can tell us.
Many investors might say, well if NetEase is consistently beating earnings, why not just buy their stock? In short my answer would be, do you prefer growth and no dividend, or growth and a potentially huge dividend? NetEase is expected to grow EPS by over 16% in the next few years. Perfect World is expected to grow EPS by 8.70%. The Perfect World dividend, you'll have to read to the end of this post to find out about that one. Let's just say that it has the potential to change why you would prefer one company over the other.
Now that we know Perfect World could stack up well compared to one of their main competitors, let's move on to the company's financial results and a few other items I noticed.
Earnings & Guidance:
The challenge with online games is that interest in these games comes and goes. A company in this field has to constantly be on the hunt for hits to acquire or develop. Perfect World is pretty good at developing games, and they have recently stepped up their acquisition activity. The current quarter doesn't look that good -- the company reported flat revenues, gross profit was down 3.1% and EPS missed estimates by 5.8%. This would be a horrible quarter for most companies, but Perfect World has missed estimates before by greater than 30% in September 2011, only to crush estimates with a 60% beat in December 2011.
What contributed to the recent sell-off was the company's guidance. In the second quarter, the company said it expects revenues in the $647 mil. to $683 mil. RMB range. This implies a miss of revenues somewhere between 4% and 9%. The stock's reaction was a nearly 11% haircut in the value of the shares.
There are a few things I noticed beyond some of these headline numbers. First, the company now gets about 25% of its revenues outside of China. This is one of the company's key strengths, licensing its games outside of China. The company mentioned that “Blacklight Retribution,” which was developed by Zombie Studios, was recently released in North America, France, and Germany. This is a first person shooter and sort of a mix between Crysis 2 and Halo. Star Trek Online is being launched in France and Germany as well. The newly acquired Cryptic Studios, is working on the highly anticipated “Neverwinter,” which is part of the famous Dungeons & Dragons line of games.
Upcoming Chinese Games:
The company has two watershed launches coming up: “Heaven Sword and Drago Saber” and “Return of the Condor Heroes.” These two games are based on novels by the famous Chinese writer Louis Cha. The company is betting that these two games, as well as others, will drive stronger results in the second half of the year.
Balance Sheet & Financials:
Even though the company missed on EPS, there are several positives I found in the financial statements. First, about half of the company's operating profit decline was due to $30 mil. RMB in additional R&D expenses. I don't mind if a gaming company misses on profits by pouring money into R&D. Gaming companies have to invest in future title development, and this will pay off in the long-run. The company also decided to exit some equity investments, as they recorded a $4.6 mil. RMB in loss on equities. However, interest income was more than double last year. This shows that the company moved some of their cash into safer investments and generated more interest income. The most important number on the balance sheet I noticed was cash, investments, and restricted cash stood at nearly $500 mil. USD. This is after the company's annual dividend of $98 mil. USD. Last but not least, the company shows that they want to reward shareholders, as their diluted share count decreased by 9.23% from last year.
The Secret Dividend & Conclusion:
The market just doesn't understand the watershed the company's $98 million dividend represented. I've written this before, the company said, “we intend to distribute dividends annually in the future”. This was not a one-time event. Management intends to look once a year at their financials and decide what to pay out.
Analysts expect Perfect World to report relatively flat revenue growth this year, and then for growth to pick up next year. Even if Perfect World generates the same amount of cash in 2012 as they did in 2011, in theory the company should be able to afford the same $98 million USD dividend. With about 47.95 million ADS shares outstanding, this would represent about a $2 payment. With the stock price at $10.20 today, a $2 dividend would be equivalent to a 19.61% yield! With already almost $500 mil. USD on the balance sheet, the likelihood of a dividend next year seems pretty good.
Even if the stock goes nowhere from here, the potential for this huge dividend is enough of a reason to be patient and wait. Even if the company only paid half of last year's dividend, investors would still get a yield of nearly 10%. Either way, it sounds like a pretty perfect stock to me.
MHenage owns shares of Perfect World. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend NetEase.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.