A Big Payday Is Coming Soon

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I'll never forget when Peter Lynch described being able to buy a stock for roughly the amount of cash on their balance sheet. He said anytime you can buy a stock for primarily the cash on the balance sheet, it's like getting the company's operations for free. Granted, investors have to be careful that the company they are buying isn't burning through cash and making this thesis a moot point. Investors have this very opportunity in shares of Perfect World (NASDAQ: PWRD).

3 Negative Forces At Work
Perfect World has three things working against the stock.

First, the company is based in China. Over the last few years, investors have become increasingly skeptical of Chinese companies because of issues of accounting fraud and deceptive or hard to understand business practices. However, just like with any opportunity, for every 10 bad companies, you have to assume there will be a few good solid investments.

The second issue facing Perfect World is that the company sort of hit a wall with its existing games and has been losing users because they weren't able to ramp up new games fast enough.

Third, the company isn't expected to show much growth in EPS in the next few years.

However, even with these three challenges, I believe Perfect World represents a good opportunity for investors who understand what is really going on.

Earnings Don't Really Tell The Story
Perfect World's last earnings report wouldn't exactly inspire confidence if you didn't know what the bigger picture looked like. The company saw revenue down 1.85%, net income dropped nearly 40%, and average concurrent users dropped again to a new low of 601,000. Considering the average users were over 800,000 last year, this looks like a big problem.

Perfect World's online multiplayer games are small potatoes compared to a company like Activision-Blizzard (NASDAQ: ATVI) and their over 10 million users of the World of Warcraft franchise. Perfect World also has to face challenges from companies like Electronic Arts (NASDAQ: EA) and their push toward digital and casual games. Maybe the most similar company to Perfect World in operations is Zynga (NASDAQ: ZNGA). However, where Zynga has problems, Perfect World shows strength.

Online Multiplayer Games And The Biggest Challenger
Activision has two of the most well-known online multiplayer games in World of Warcraft and Diablo III. The company is faced with releasing upgrades and expansions to keep gamers interested.

Perfect World essentially does the same thing. The company has 12 different online multiplayer games. In the meantime, Perfect World is working on some big upcoming titles to expand their user base. While Activision relies on two primary games to keep online players interested, Perfect World just released three different games in Torchlight 2, Dark Blood, and RaiderZ in the last few months. The company also anticipates releasing Swordsman Online, Saint Seiya Online, and Neverwinter in upcoming quarters.

With games based on famous Chinese novels and the always popular Dungeons & Dragons, Perfect World should have new hits to bring gamers online.

This Is No Zynga
Zynga has several hit titles in the casual gaming segment, but casual games are different than the pay-to-play games that Perfect World operates. Zynga must convince users to buy in-game upgrades and virtual goods to make money.Perfect World also sells these upgrades, but the company makes money from users who pay per hour to play.

Zynga's market cap. is made up of 82% cash and investments, versus Perfect World's 73% cash and investments. The difference is, Perfect World typically has generated positive net income and cash flow; the same cannot be said of Zynga.

It's Not “In The Game”, But Gamers Pay To Play
The same advantage that Perfect World holds over Zynga is even more pronounced when compared to Electronic Arts. EA has console games like Madden, the NCAA series, Crysis, and Battlefield that allow the company to release new updates and garner new sales.

The problem is, if the updated version isn't significantly different than the one last year, gamers may choose not to buy. Perfect World doesn't have this issue. This is why Perfect World's gross margin is over 81% versus EA's 37.41%.

A Big Payday Should Be Coming
Maybe the key argument for buying Perfect World shares is that the company changed its dividend policy last year. In 2012, Perfect World said that they expect to pay dividends annually in the future. Last year, this payout was set at $2 per share, but was widely mis-reported as a special dividend. The company's statement said this was an “annual” dividend, which is very different.

Perfect World currently has $423 million in cash and investments compared to last year's balance of $455 million. If last year a $2 per share dividend was possible, it seems reasonable to expect something similar this year. A $2 dividend would equate to a 16.75% yield at current prices.

The Best Relative Value? 
Based on this annual dividend, Perfect World could be the best value in the gaming industry. An over 16% yield would exceed the total expected return on Activision with a 1.6% yield and near 10% growth in earnings. This return would also beat EA, which pays no dividend and is expected to grow by 13.84%.

Investors might make a case for Zynga and its 23.57% expected growth rate, but at over 80 times earnings the stock seems priced for perfection. In the middle of last year, this annual dividend would seem like a mirage in the desert. However, as we move into the middle of the first quarter, this announcement should just be weeks away.

MHenage owns shares of Perfect World . The Motley Fool recommends Activision Blizzard. The Motley Fool owns shares of Activision Blizzard. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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