Walter Hutchens’ Blog

Giant Interactive, a Chinese online gaming company that had its IPO earlier this month, will report its first quarterly results post-IPO in a conference call tomorrow (also available here).

A Reuters preview of the numbers is here. Some highlights:

Net revenue for the third quarter of 2007 was RMB405.2 million (US$54.1 million), an increase of 164.2% over the third quarter of 2006 and 9.5% over the second quarter of 2007.

Gross profit for the third quarter of 2007 was RMB359.8million (US$48.0million), an increase of 152.8% over the third quarter of 2006 and 8.5% over the second quarter of 2007. Gross profit margin for the third quarter of 2007 was 88.8%.

Astounding year-to-year growth (modest growth month-to-month). Also, great profit margins. So far GA has created rather than licensed games (some firms pay the World of Warcraft creators or Korean game companies heavy licensing fees, then localize the game for China), so GA has enjoyed tremendous margins.

GA listed in a tough climate. US markets have been in general decline. These results are coming out on a day when the Dow is down more than 200 points.

Plus, besides this general market risk, people fear the Chinese bubble is near a popping point, and that kind of analysis may not discriminate between A-shares, H-shares, PetroChina and Giant Interactive. I keep hearing Jim Cramer tell people on his CNBC show to stay away from Chinese stocks except Bidu and “China Tel.” It’s hard to imagine he really means to recommend the land-line carrier, not China Mobile (and even if he does mean China Tel, he’s clearly not terribly well informed about distinctions among Chinese issuers and so is saying avoid the “sector” rather than specific companies).

Third, I think many investors in the US just don’t “get” online gaming. To the extent most people my age and older think about gaming at all, we think of our kids playing Microsoft’s XBox, Sony’s PlayStation 3 or Nintendo’s Wii (or the PSP and DS handsets). But the console market is less important than the online market in China. Chinese gamers can go to internet cafes (which are very nice now) and play for a few kuai, whereas buying a console is big capital outlay even if they use pirated games, which they will, which means those console businesses are less promising in China, too.

GA’s CEO Shi Yuzhu is the guy behind Nao Bai Jin (脑白金), a medicinal/nutritional supplement advertised so ubiquitously in China that anybody who’s lived in China in recent years knows the jingle. Shi wears track suits and may not look like an insurance company exec, but I think he’s a major plus factor for GA.

I’m still bullish (and long) GA. I previously wrote about the company here.

Came across this jewel on an investment site:

I’m also partial to the iShares Taiwan Index Fund (EWT). After all, the Republic of China known as Taiwan has the stability of a long-standing, nimble Democracy for 50+ years. And still, it scores emerging market-like growth, particularly in the tech space.

Um, impressive economic growth yes, 50+ years of democracy no. Taiwan was a Leninist state until recently. They were “our” Leninists unlike the mainland communists, but they were Leninists nonetheless. The government controlled the press, suppressed dissent and didn’t have free elections. Martial law was in force from 1948-1987. The first opposition candidate elected president came into office in 2000.

Taiwan does now have a vibrant democracy (with occasional slugfests in the legislative yuan), and they have some great companies that should benefit from continued growth in China and the tech sector globally. But the prospects of those firms have nothing to do with 50+ years of democracy in Taiwan.

On a different site, I found someone bullish (like me) on Giant Interactive (GA) because, inter alia:

Giant Interactive raked in the largest amount of money of any IPO this year (over $86 million)

That’s the kind of typo I’m prone to. Actually, they raised about USD 800 million in their IPO. The official report is here. The typo aside, I agree with much of the commentator’s analysis, though after-hours trading in GA (post earnings release) is making both of us look bad right now.

Here Business Week rounds up some of the China-listed companies that have reached dizzying valuations. Here Barron’s echoes the theme and provides some analysis of the causes of these sky-high valuations. They mention the inability of Chinese citizens to invest abroad and the small percentage of shares available for public trading in many PRC listcos.

I would add to that list 1) China’s excessive savings 2) China’s lack of alternative ways to invest (and thereby allocate risks and capital more diversely and efficiently), 3) investors’ belief in some implicit government backing of these firms or the markets generally, 4) not clearly irrational exuberance that many of these firms have vast potential and will continue to grow rapidly and 5) yes, a herd effect as people see the returns and want some of that for themselves—a classic bubble.

I was bearish on China’s stock markets long before the current bull market began (suggesting I’d better stick with teaching rather than day trading), but in reacting to this “China stocks are a bubble” meme, it’s important to distinguish among markets. Chinese stocks are traded both inside and outside of mainland China. Domestically-listed Chinese companies (meaning those listed in Shenzhen and Shanghai) do seem excessively valued. But foreign investors, as a rule, cannot directly buy shares in mainland-listed companies anyway (except through the narrow qualified foreign institutional investor or QFII scheme and some of its derivatives). However, many Chinese companies are listed outside the mainland, often in Hong Kong or the U.S. (and sometimes both). Prices of shares in many of those companies have increased dramatically, too, but still they are often below the utterly frightening levels of the mainland-listed firms. Seeing that a mainland-listed Chinese stock is overvalued doesn’t mean that a US-listed Chinese stock is, too. The Great Currency Wall of China keeps these markets separate. For example, a bubble in the share prices for Chinese companies listed outside of China can’t arise because investors have limited investment choices (yes, limited China concept choices, but their investment choices are not limited to China concepts—a US investor can buy Google or Bidu, whereas a Shanghai investor cannot buy Shenhua or Peabody with equal ease).

Second, not all mainland Chinese companies listed abroad are priced with obvious irrational exuberance. The Barron’s piece compares Exxon to PetroChina and the coal companies Peabody and Shenhua. It suggests in both cases that the Chinese firm is comparatively overpriced. The point may be compelling for some Chinese companies listed abroad but not true for others. For instance, China Mobile—with its 300+ million customers, prospects for many more, and forthcoming new stream (tsunami?) of revenue once 3G services finally roll out—may be quite a different story. Even at its current price, I think China Mobile compares favorably to Verizon and AT&T whose prospects seem much less enchanting.

In other words, when the bubble pops on mainland China’s domestic exchanges, the deflation that will likely follow in the prices of US-listed Chinese stocks, particularly those with solid value propositions like China Mobile and CTrip, may constitute a buying opportunity (full disclosure, I own a little CTrip and China Mobile, but also some AT&T . . . and I sold my Bidu for a small profit but more than a hundred dollars per share below its current price, so this analysis may be worth the nothing you’re paying for it).

This promotional piece rounds up Chinese nicknames for some NBA players. The person writing the chart clearly doesn’t know Chinese—some of the explanations aren’t spot on (failing to note how some of the nicknames have both meaning and sound dimensions) and there are multiple errors in the romanization, but it’s a neat read.

Yesterday the Chinese online gaming company Giant Interactive listed on the New York Stock Exchange. It will trade under the ticker symbol GA.

GA’s online game Zheng Tu (translated as ZT Online) is extremely popular in China. Sometimes more than a million people are simultaneously online playing it.

GA competes with Shanda, Netcom and Perfect World, all of which are also listed in the US. Perfect World just listed in July, and already its shares have appreciated 65%.

It’s interesting that GA listed on the NYSE rather than Nasdaq which is more typical for high-tech companies. Also, it’s interesting that they listed in America at all. Many PRC IPOs, including the recent jumbo ones like Bank of China, have listed only in Hong Kong, avoiding the US exchanges entirely. Conventional wisdom has been that Sarbanes Oxley has deterred many foreign issuers from listing in the U.S. In contrast, GA’s colorful founder Shi Yuzhu said he wants to show that his company (and he still owns most of it) can comply with the world’s most rigorous listing standards.

There are scores of Chinese companies listed on the NYSE and Nasdaq. Most of these stocks have been top performers this year. In fact the exchange traded Chinese index fund that trades under the ticker symbol FXI has risen more than 120% in the last 12 months. Here’s what the 6-month chart alone looks like:

GA didn’t have a dramatic first day pop. It debuted on a day when the market was generally down, and I imagine lots of investors don’t yet understand the 1) online game businesses generally and 2) status of GA’s Zheng Tu in particular. To the extent some investors think of gaming at all, they may just understand the console business—that an XBox, PlayStation 3 or Nintendo Wii generates sales for the console maker, game writer and the retailer who sells both the game machine and the software that makes it worthwhile.

For most of us older folks online gaming is just not within our sphere of experience. I grew up in the Atari age, with the graphically-starved Pong for goodness sake, so I can see the problem of recognizing the potential here, particularly when investors don’t have children who play these games and the model of online gaming itself is less familiar (outside of the World of Warcraft subculture).

However, in China online gaming is compelling for several reasons. For one, it takes less capital to go play a game in an internet cafe for a few hours than to buy an expensive console. That’s a big advantage in a developing economy. China’s internet cafes are now often quite posh and inviting. They are filled with fast computers, big widescreen LCD monitors and customers wearing headphones so they don’t disturb other patrons as they engage in combat. Plus there are just massive numbers of existing and potential customers in China.

This opportunity to sell lots of game access is happening 1) in China 2) in Chinese and 3) online, all of which helps explain why some investors just don’t get it yet.

By contrast, lots of US investors do understand that 1) China is big, 2) growing fast, 3) search is important, so they have bid up Bidu’s shares dramatically in recent months.

I am a Bidu skeptic for various reasons. Leninist political controls and the “national champion” state-planning model don’t strike me as particularly compatible with the Internet ethos over the long term. I’m not aware of anything innovative Bidu has done (quite unlike Google), and finally I don’t understand why Bidu is spending any money in Japan when their own potential market is so vast. But even if I’m eveutally right, I may be wrong for a long time—many people may continue to make lots of money investing Bidu shares for the foreseeable future. Plus, I may just be flat wrong; Bidu may eventually be the Google of what will one day be the world’s largest and most lucrative internet market, and they may not need to innovate but rather can simply prosper using a copy-to-China model under the umbrella of some kind of government beneficence.

In any event, I am bullish on GA. Given 1) their success so far in China and 2) that they now have about 800 million dollars to spend on further development and acquisitions, I expect GA’s stock to appreciate over time.

I picked up a few shares yesterday; we’ll see if the hypothesis proves right.

Giant’s name in Chinese is 巨人网罗, romanized as Juren wangluo.