A Perfect Opportunity for Growth in a Perfect World (PWRD)

A Perfect Opportunity for Growth in a Perfect World (PWRD)

            The coverage for Perfect World was suppose to be on June 1^st 2012, however I decided to break this company down earlier since the company will be reporting Q1 2012 numbers on May 21^st. This company has a lot of potential and I wanted to cover this stock earlier because this stock seems too good to miss before earnings.

            Not many people know what this company is, therefore here are the basics broken down of the company:

·         Chinese Gaming Company located in Beijing

·         Fairly new company, founded in 2004 and went public in mid 2007

·         Makes many of the most popular MMORPG (massively multiplayer online role playing games) in China including Empire of the Immortals

·         Is operating in other countries such as Russia, Japan, Europe and United States

·         Expanding in social media to enhance their online casual games. So far only one has been launched “Hot Dance Party” that came out in March 2009

When looking into this company’s fundamentals, it is safe to say that although this company is fairly new, is company has solid numbers on the table and this allows room for growth.

Key numbers to look at:

·         Book value of $13.58, this stock currently trades just around this price

·         Price/Book is 0.96, meaning that this stock has been trading around its book value

·         Profitability is pretty solid with profit margin and operating margin at 32% and 34% respectively

·         Positive cash flow, with $363M in cash (or $7.86) and $89M in debt

·         Volume is relatively low for the past year with volume around 1.5 M

Because there is relatively low information about insider buying and institutional buying, looking at the analyst coverage is pretty important for an international company.

            Currently, 9 analysts cover Perfect World (PWRD) .

           

            From looking at the ratings, it seems that generally there is positive potential for Perfect World. Also Zack.com puts this stock has #1 on Strong Buy as well.

When looking at a company like Perfect World (PWRD) that has competition, we have to look to competitors and the advantages/disadvantages with competition.

Some of the main competitors may include:

- NetEase.com (NTES)

- Giant Interactive Group (GA)

- The9 Limited (NCTY)

- Sohu.com (SOHU)

- Shanda Games (GAME)

            From the companies that are mentioned from above, we can see that Perfect World does have a lot of competition for the gaming and social media market in China. Personally, I believe that the biggest competition is with NetEase.com (NTES) as it does have $2B in cash and no debt which is nothing to compare with Perfect World (PWRD) currently. However, I believe that Perfect World (PWRD) can mirror Netease.com’s (NTES) success with the current management team and continued growth. As for the other competitors, I do not see it as the same level of value as Perfect World because of the continued growth that Perfect World has shown that most of the other companies still have not proven.

The biggest concern however is looking to see if Perfect World (PWRD) can sustain its growth for upcoming years. In the past 3 quarters, we have seen great numbers reported and as beat estimates on average of 50%! As you might expect, the stock has rallied on average of 15% in the past 3 quarters every time they have reported. The most recent quarter that was reported in March had growth increase $11 million up to $124 million in revenue. The Street’s estimates are pretty conservative on Perfect World (PWRD) and every time Perfect World (PWRD) has exceeded these expectations. Also, the forward earnings for 2013 is as low as 0.60. These numbers can be easily be beat and make this stock jump. We also see a 25% revenue growth in 2011 and this is a good indicator to what we may see this year.

As always, when investing we have to draw out the pros/cons.

Pros	Cons
Great previous quarters, blowing estimates	Little info on institution/ inside ownership
High growth potential still and profitability returns are better than ever	Chinese economy slowdown could affect business
Diversified in international market; not just China	Sustainable profitability and growth
Value play, below book value	Competitive Market
Great analyst coverage	A bit volatile with beta around 2.00
Good cash flow, cash positive/ no debt	Continued innovation with new products
Good management/experience	Expansion can overwhelm expenses
Revenue continues to grow
Low projections by Street on forward P/E

From looking at the past performance and future projections, Perfect World definitely has some momentum going into the future and as long as the management can sustain a fairly consistent growth; this stock is a great growth play for any portfolio.

Disclosure: I am long PWRD. I have a price target of $25 by the beginning of 2013.

Going Back to Looking at Nokia – Don’t count it out yet

On April 11^th, I made a video on why I believed that Nokia had a lot of work to do after it forecasted lower profits. This was also the day that Nokia touched below book value. During that point, I decided that Nokia had a lot of problems and it was going to take a while for it to fix. That is why I put a conservative rating of Hold. Watch the video here:

As Nokia reported their Q1 results, everyone pretty much knew that the numbers were not pretty. Nokia had forewarned this several days ago and shares already tumbled more than -15% beforehand. When Nokia reported in on April 19^th, Stephen Elop, the CEO of Nokia, made it clear that there was a problem on their hands. He stated that the results were “clearly disappointing”. Also the Lumia 900 sales, which were the newest phone that they launched with Windows, had “mixed results”. Most of the mixed results came with bug glitch that was found out about the phone and giving people the phone essentially free to everyone up to April 21^st. (Had a $100 mail in rebate, the price of the phone). But I wanted to look back at the numbers again as I have received some feedback on that video that I was being too conservative and not taking on a greater risk.

When I took a closer look back at Nokia, I found some interesting information that I did not consider as much. Nokia has decided to pay a $0.26 dividend back to shareholders in early May. This is something that is controversial due to the fact that Nokia has already blown a lot of cash. By Nokia paying out this dividend, which yields around 6-7%, this is something that needs to be ended. I believe that if Nokia reinvests that money back, which is nearly $1 Billion, into their products that they will be much better off in the future. Also when looking back at the stock, I did not consider some of their intangible assets, such as patents that had not considered back. Nokia’s patents are something that are also something to consider, these patents can make other competitors attracted to them and possibly can get some more cash by selling these patents. These patents may seem silly, such as the Vibrating Tattoo, however it may prove to be one of the biggest catalysts for Nokia. Nokia in total has about 11,000 patents according to a study by Chetan Sharma. To put that into perspective, Apple has less than 1/10 of that at nearly 1,000 patents. Although these patents may not seem to provide any true value, it could raise more cash for Nokia adding to their $14 Billion that they already have. Also when I looked back to see how analysts think of this stock, I was truly surprised to see that even though analysts have been cutting their price target for this stock and yet they are actually BULLISH on it, the price target is still well beyond what the currently market price is at. The most recent example is by Northland Securities that cut its target from $10 to $8 and had a “OUTPERFORM” rating on the stock. However we can not only look at only one research firm, I decided to look for other takes on this stock. One of the most interesting takes was by Benchmark Co. that put a “hold” rating to a “buy” rating on April 19^th. They have a $45.00 price target. YES, I said $45! This is insane and it seems like there are still people who believe in this stock. If you look at the Nasdaq analyst coverage, there are currently 18 ratings that are a hold or higher out of 23 analyst firms. But we have too look for more than just what the analysts think.

I then decided to go back to the basics, and look at truly how bad is the phone business for Nokia. I wanted to see how much market share Nokia actually has in this market. Nokia currently is not doing well in the smart phone industry w/ the Symbian, which was discontinued after it produced disappointing results and only received a low market share of the smart phone industry. One of the biggest moves was to decide to go to Microsoft for help. This was one of the biggest catalysts to why I’m changing my rating from Nokia from “Hold” to “Strong Buy”.  During that video, I had not known about this Microsoft – Nokia deal that was done. But this can prove that Nokia will benefit either way from Microsoft. By using their operating system, they can worry less about spending money to build an OS to deal with AND have money provided by Microsoft. (Exactly cash value is not really clear in the partnership). And to me the most obviously way is Microsoft may have a chance to buyout the company. Although like what I said in the video, don’t count on it there is a greater chance that this may happen in the future. Nokia has a great advantage in basic phones even though the basic phones market is declining in the US, Elop clearly mentioned that international countries “are still using basic phones”, and it proves that this market isn’t dead either. Countries in the Middle East and Europe do have a much bigger market for basic phones than the United States.
Here is a market share of the smartphone business at the beginning of 2012:

As for the management, I do believe that the management needs to allow Elop to stay in until at least the end of the year. If Elop can’t prove himself by the end of the year, I believe that it would be time for the board to find someone else. Elop in case you don’t know, actually worked at Microsoft for 2 years before he joined Nokia in late 2010. To be fair, I believe that Elop does have the experience in business however not enough in the actual industry that he is working for, which is the tech industry. Elop is much more of a business person and does not have as much sense of the industry. It is time for Nokia, to cut workers that are unnecessary and find more people that are innovative and can put something on the table. Elop’s salary was $1.4 million, and a signing bonus of $6 million for 2011.

Let me end by saying this, Nokia is not for the weak and it may be a while until the company can prove itself once again. However, I do believe that Nokia does have potential for a huge comeback like Apple in the 90s, with better innovation and management. There is a lot of talks saying Nokia is worth next to nothing, however that has not been proven to be the case after my research. I believe strongly that anything below $3.50, would be a huge discount and if it goes to $3 it would be a steal.

Like what Yogi Bera said before, “It’s not over ‘til it’s over.”

Alex Xu is the founder & CEO of Investary. 

Disclosure: I am long NOK

Additional Disclosure: I am bullish on MSFT, however I do not plan on initiating an position in the near future.

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