3 Chinese Internet Companies Poised for Gains

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

There is a major demographic shift going on in China right now. What was once primarily an agrarian society is quickly becoming an urbanized country, with millions of citizens moving into cities and taking advantage of amenities that many in the developed world take for granted.
 
As part of this shift, the number of Chinese Internet users is increasing dramatically. As a giant portion of the population begins using computers, tablets and cell phones, companies that provide applications are experiencing an increase in business.
 
Today, I want to take a look at three Chinese Internet companies that are benefiting from the rising number of Chinese Internet users. These companies represent strong investment opportunities as revenue and profit increase.
 
Population shift drives Internet usage 
 
The Chinese economy has been in aggressive growth mode for quite a few years. As consumption increases in the developed world, China's exporting economy has been strengthened by strong international demand.
 
But as developed economies have stumbled in recent years, China has had to deal with a deceleration in demand growth. Policymakers have become concerned by increasing domestic consumption within China, in order to reduce the country's dependence on outside demand.
 
As part of this program, China has aggressively shifted its population from farms and rural homes to large cities. This New York Times piece exposes just how dramatically these policies have affected the culture and way of life for millions of Chinese citizens.
 
Naturally, as the population becomes more urbanized, the number of internet users continues to increase dramatically. The younger generation has widely embraced internet gaming as a past time. 
 
Businesses in this industries are certainly competing for market share. But since the number of users are growing, there's room for multiple companies to grow aggressively without harming competitors. These business models offers tremendous opportunities for growth.
 
An addicting business model

The business model that most Chinese online gaming companies use to grow their user base is very intriguing. To begin with, internet games are typically free to play, making the game accessible to a large body of potential customers. Keep in mind that most of these games are "massively multiplayer online role playing games" (MMORPGs), so users are playing with and against other gamers across the country.
 
In order to generate revenue, the gaming companies sell items within the games, such as premium weapons, special powers, clothing, trinkets etc. In some cases, these items are bought with game currency. This currency must initially be bought from the gaming company, but then acts as a real-life active currency within the game.
 
As more users join the game, a reliable portion of these gamers generate revenue. Considering the widespread popularity of these games, the business model can be quite lucrative.
 
Fun games, cheap stock

Shanda Games (NASDAQ: GAME) has been allocating resources to build out a mobile game business. In the first quarter, this new segment generated 10% of total revenues. The company recently launched a new game titled "Million Arthur" in Korea. The game was successful, and will now be introduced to Mainland China as well as Singapore this summer.
 
Shanda Games is also actively improving its traditional online games by adding new expansion packs. As game improvements are added, the company is able to extend the life of each game - keeping user's interest and continuing to collect revenue.
 
Analysts expect Shanda Games to earn $0.67 per share this year, and $0.68 per share in 2014. With the stock trading slightly above $4.00 per share, Shanda Games represents a tremendous value. If the company is able to continue to generate revenue and expand into additional countries, the stock price could increase dramatically.
 
Chinese innovator

Perfect World (NASDAQ: PWRD) is another profitable MMORPG operator. Several years ago, Perfect World created a revolutionary development platform that allows programmers to efficiently create games with top quality graphics. The platform also helps simulate physical properties such as gravity, to make the games much more realistic.
 
Over the past several quarters, Perfect World has reduced its investment in promotions, and has increased its investment in new game development. This summer, several games that have been in the development pipeline are being introduced to users. These games include "Swordsman Online" and "Dota 2," along with a 3D game "Holy King." 
 
As these new games are released, Perfect World should realize a significant profit boost. It is also worth noting that the company is expanding beyond its traditional Chinese customer base, and will be releasing its most popular game in English, French, and German this year.
 
The turnaround
 
Finally, Renren (NYSE: RENN) looks interesting as a turnaround opportunity. The company operates a social media platform that could be considered the "Facebook of China." 
 
The company has been allocating capital to expand functionality, offering a wider range of features available to users. The company has suffered losses as capital is allocated to these expansion opportunities. In particular, the company's online gaming business has picked up dramatically. In the last quarter, this division saw a 51% increase in revenues.
 
Renren represents a very speculative investment, but based on the strength of the Chinese gaming market, the expanding user base, and the demographic tailwinds, Renren could turn out to be a high-risk, high-return growth option for aggressive investors.
 
Foolish final word
 
The bottom line is that China's online community is growing dramatically. Companies who are able to profitably cater to new internet users have a large and growing pool of potential customers, and should be able to aggressively grow business over the next several years.
 

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Zachary Scheidt has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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