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Chinese online game developers: game changer or game over?

China Mobile Games and Entertaintment_230px
By Rev Hui
11 Mar 2014

Skyrocketing share prices combined with huge upside potential are making Chinese online game developers one of the hottest tickets in the equity market right now. But while the rewards of banking the next Candy Crush are certainly worth drooling over, the sector is beginning to look overheated.

The investment story behind Chinese online game developers is pretty easy to understand. China boasts one of the largest online communities in the world, with 591m internet users as of late June last year.

Yet despite the size of the market, those numbers only translate into a relatively modest internet penetration rate of 44.1%, according to China internet Network Information Center.

That means there is plenty of room for growth — and investors are certainly buying into the story. Boyaa Interactive International, the developer of a popular Texas Hold ’Em poker game, raised HK$1.6bn ($206m) last September, pricing its IPO at HK$5.35. It was trading at HK$12.60 early Tuesday afternoon, a rise of 135.5%.

A second company, Nasdaq-listed China Mobile Games and Entertainment Group (CMGE), saw its stock soar 709% in 2013 to its Monday close of $32.22. Now it is looking to take advantage of its buoyant stock price by raising $115m from a placement of new shares.

The huge returns have not gone unnoticed and more names are piling in. Locojoy, Ourgame International and Suzhou Snail Digital Technology are all preparing for IPOs. 

But the business strategy is far from foolproof. The general approach of Chinese game developers is simple — churn out tonnes of new games every month and keep their fingers crossed that one of them will become a hit.

Until Locojoy’s 2012 smash-hit Epic Heroes, which has around 23m registered users, none of the company’s previous titles had managed to surpass the $100,000 mark in yearly revenues. Now the company is estimated to be raking in around Rmb50m ($8m) a month.

CMGE is another example of the volume model, having published more than 700 games since it was founded in 2008. It plans to release another 80 by 2014.

The problem is that even if a company does manage to create a money-spinner, it does not mean it will continue to be a sure-fire win for investors. More than 91.3% of Boyaa’s revenues in 2012 came from its Texas Hold’Em game. A shift in gamers’ preferences will see the firm’s primary income stream evaporate.

The good and the bad

There are typically two choices for Chinese game developers looking to list — the US (CMGE) or Hong Kong (Boyaa, Locojoy, Ourgame, Suzhou Snail). Both markets offer the twin benefits of investor familiarity with the sector and liquidity.

What sets the two regions apart, however, is that the US does not require companies to be in the black before listing. Those wanting to IPO in Hong Kong need to have a three year track record of profit — the theory being that a company cannot therefore rely on a short-term fluke.

For the time being, banks are happy to bring more game developers to both markets. And who can blame them, since investors seem to have an insatiable appetite for such names while more traditional sectors such as property are failing to excite?

The worry, as so often, is of a bubble, and already some ECM bankers are whispering the B word. Investors should beware, even if the pickings elsewhere are less than compelling. Unlike the obsessive players of the games these companies churn out, the investment losers can’t reboot when it’s game over.

By Rev Hui
11 Mar 2014