INTERNET: Giant Eyes Big Valuation as Game Operators Struggle

Bottom line: China’s gaming market remains stubbornly fragmented and unprofitable despite its huge potential, with no clear signs of much-needed consolidation coming anytime soon.

Gamers continue to struggle

As much of China bakes under a summer heatwave, a major trade show this week in Shanghai is casting a different spotlight on the overheated state of the nation’s gaming industry. One report is saying that only 2 percent of companies in the emerging mobile gaming space can generate big profits, and the situation may not improve anytime soon due to a stubborn state of fragmentation.

The problem has led many of China’s US-listed gaming companies to launch privatization drives over the last 2 years, including Giant Interactive, a large but decidedly second-tier player that de-listed a year ago. Giant’s talkative chief Shi Yuzhu is blaming US investors for failing to appreciate his company, with the latest reports saying he thinks Chinese stock buyers will value his firm at more than 5 times what it was worth when it de-listed from New York.

Personally speaking, I do think there is room for 2 or 3 more highly profitable companies in China’s huge gaming market. Right now the only 2 names that really qualify in that category are Tencent (HKEx: 700) and NetEase (Nasdaq: NTES). The former has found success by leveraging its hugely popular QQ and WeChat social networking (SNS) platforms. The latter has found fans through its strategy of developing its own games with Chinese themes, rather than relying on licensing games from third-party developers.

But after that pair, names like Giant, Perfect World (Nasdaq: PWRD) and Shanda Games (Nasdaq: GAME) are all hard to differentiate and have had difficulty maintaining strong profit growth due to their reliance on licensed games. Giant de-listed last year, Perfect World said this week it has finalized its own de-listing deal (previous post), and Shanda signed a similar deal in April.

Against all that backdrop, it’s not too surprising to read the latest report saying a scant 2 percent of mobile gaming companies can generate big profits in the current climate. (Chinese article) That estimate comes from Lin Yongsong, a top gaming executive at e-commerce giant Alibaba (NYSE: BABA), who says that only a tiny fraction of the 1,000 to 2,000 companies on his gaming platform are currently earning such big profits.

Worsening Situation

Lin added the situation is only getting worse as more game developers and operators enter the market. The situation certainly doesn’t look good for many of the mobile game developers that are still listed. Those include US-listed Sungy Mobile (Nasdaq: GOMO) and iDreamSky (Nasdaq: DSKY), which both recently announced privatization plans (previous post), as well as Hong Kong-listed Forgame (HKEx: 484) and Linekong (HKEx: 8267).

But all the gloom doesn’t seem to be affecting Giant Interactive. The company’s chief Shi Yuzhu was using the annual ChinaJoy gaming show in Shanghai as a platform to say he thinks his company will be valued at 100 billion yuan ($16 billion) or more if it completes its plan to re-list in China. That would be a huge increase over the $3 billion that Giant was worth when it de-listed from New York a year ago. (previous post)

While many Chinese firms have de-listed or announced plans to de-list from New York in search of better valuations in China, only one, Focus Media, has come close to achieving that goal just yet. It does seem like less sophisticated Chinese investors are likely to give Giant a better valuation if it can re-list on a domestic stock market, though I would expect that perhaps it could get up to double at best.

Giant is typical of the slow growth and fierce competition facing the broader sector, reporting just 6 percent revenue growth and a 42 percent profit decline in 2013, its last full reporting year before it privatized. At the end of the day, consolidation is still what’s really needed to create some more exciting companies in this space. Perhaps Giant will become one of those consolidators, though it hasn’t done anything yet to show it has such potential.

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