Why We Love Chinese Internet Stocks

by George Leong, B. Comm.

The People’s Republic of China has a population of about 1.3 billion people and a rapidly growing consumable-hungry middle class of about 300 million people. The global recession has impacted the country’s growth, but, in the long term, China should be a core foreign market for growth investors looking for above-average returns.

China’s GDP growth was in the double digits, but has slowed along with other global economies; yet the country is the world’s third largest economy after the United States and Japan. The country’s GDP estimate for 2010 is currently predicted somewhere in the eight-percent level, depending on the length and severity of the global slowdown. Investment bank Goldman Sachs predicts that China will become the largest economy by 2040.

An area that I continue to like is China’s Internet space, where I continue to see an upward trend and extremely good speculative opportunities. China has become the epicenter of the Internet world, with Internet demand growing at a staggering pace. The number of Internet users in China is tops in the world, with over 275 million on the Internet. According to BDA China Ltd., China’s Internet usage could grow at 18% annually and reach a staggering 490 million by 2012. In addition, about 30%, or about 84.5 million, of Internet users in China roam the Web via their cell phones, according to the Telecom Research Institute in China.

Within the Internet area, the market for online gamers in China is exploding, with the number of users jumping 23% to 40.17 million in 2007, according to the Publishers Association of China and IDC. Sales in the online games sector were US$1.5 billion in 2007, up 61.5% year-over-year. We expect the number of users to rise as Internet usage increases, especially among the country’s youth. For company’s youth-oriented target market, the metrics are positive. In China, about 70% of Internet users are under 30 years old, which bodes well for the gaming market We expect the number of online gamers to rise as Internet usage increases, especially amongst the country’s youth, who are technologically savvy. IDC predicts that China’s online game market will grow to over US$3.0 billion by 2011, up from the current US$1.5 billion.

In the online gaming area, a Chinese company that has loads of potential is Beijing-China-based Perfect World Co., Ltd. (NASDAQ/PWRD). Founded in 2004, Perfect World is rapidly becoming a major developer of high-quality three-dimensional (3D) online games in China. The company’s core 3D massively multiplayer online role-playing game (MMORPG) is the “Perfect World” game, a 3D online adventure game set in an imaginative fantasy world. For those outside of China, the company operates “Perfect World II,” also known as “Jade Dynasty” in North America.

The company’s games have received acclaim in China. At a major gaming conference in China, Perfect World won 11 awards across eight major categories. The awards won included “2007 Excellent Marketing Enterprise in Chinese Game Industry,” “2007 Top 10 Chinese Game Developers,” “2007 Top 10 Chinese Game Operators,” and “2007 Overseas Development Awards for Domestic Game Developers.”

Going forward, Perfect World has launched additional online games that could help drive revenues.

The balance sheet is without debt and has cash of about 138.5 million dollars. The financial strength allows the company the flexibility to expand and grow its business and revenue base.

Based on the optimistic estimated five-year annual earnings growth of 31.04%, the PEG ratio remains attractive at 0.50.

Perfect World is not widely known to investors, with only 11% institutional ownership, which has made the stock attractive for early buyers.

Please note this should not be construed as a recommendation to buy, but is merely for information purposes.