Novice Investing - The9 Does Not Ace Earnings

Date: Monday 01st 2008f December 2008 04:17:18 PM

The9 Does Not Ace Earnings - 08/12/2006

By: Hari Wibowo

The9 Ltd.(NCTY) is the operator of online gaming in China. One of its big hit includes operating the World of Warcraft where it is widely popular worldwide. For the second quarter, The9 reported profit of $ 10.5 Million or $ 43 cents per share, versus 33 cents per share estimate. Analysts louded the result. Evan Wilson from Pacific Crest noted that "The9 continues to have the most robust pipeline of any Chinese online game operator". Further, Rick Aristotle Munarriz from the Motley Fool wrote a favorable piece regarding The9 second quarter performance. Revenue soars 363% to $ 32.2 Million during quarter. Who doesn't like that?

On the other hand, I beg to differ. This result shows how vulnerable The9 is. First of all, revenue per users is super low. Picture this. The company announced that it has 5 million paid accounts. Revenue is 'only' $ 32.2 Million, which is equivalent to $ 2.14 per user per month. What this means is that each gamers need to fork out $ 2.14 per month to play World of Warcraft online. That is low even with Chinese currency. In the US, users would have to pay around $ 15 per month to get going. Also, if you switched to Avatar-based model, I do think that avid gamers will pay a lot more than $ 2.14 per month to trade their avatars while playing the game for free!

The second disappointment is that 99.4% of its revenue is coming from World of Warcraft (WOW). While this demonstrates the success of WOW, the title has been released since November 23, 2004 or almost two full years. Game title will not be popular forever. As time progresses, The9 will not be able to earn $ 32 Million per quarter for that same title. Let's assume that this is the peak sales for WOW. At this stage, how much does The9 earn? A mere 10.5 Million or 43 cents per share.

Evan Wilson also noted that The9 has five games in the pipeline. Sure, it is good to know. But do you think that all five will be as big of hits as World of WarCraft? I highly doubt it. The best case scenario is that two will be star performers (with $ 25 Million quarterly revenue) and the rest will flop. Based on this, revenue might rise to $ 50 Million quarterly or $ 200 Million annually. At this point, profit will be around $ 60 Million annually or $ 2.46 per share. This is a reasonable guess since The9 has to pay 22% of royalty fee to Blizzard Entertainment, the creator of WOW, and $ 51.3 Million of non-refundable fee for four year period.

Contrast that with Shanda Interactive (SNDA). It switched to Avatar-based revenue model (sacrificing short-term revenue hit) and in my opinion, it has progressed well. Before the switch, revenue comes in at $ 61 Million per quarter or $ 244 Million annually. With the new avatar-based revenue model, revenue comes in at $ 42 Million quarterly. Compare this with The9's 'fabulous' second quarter result with revenue of $ 32 Million (*yawn*) and all this is because of one hit. Thus, if analysts feel that The9 second quarter result is fabulous, I don't see why. (Except, of course, by beating analysts' expectation)

Despite that, China online gaming still holds tremendous potential. The top three online game operator, Shanda (SNDA), NetEase (NTES) and The9 (NCTY) accounts for 50% of the share while the market is expected to grow from $ 760 Million this year to $ 1.7 Billion in 2010.

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding The9 Ltd. (NCTY) or any other securities.

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