IPO Focus: No easy win for Changyou.com

Concern about ability to maintain growth will weigh on shares


By Lynn Cowan


The Wall Street Journal Asia

(c) 2009 Dow Jones & Company, Inc.
To see the edition in which this article appeared, click here http://awsj.com.hk/factiva-ns

Online videogame company Changyou.com Ltd. has a lot of positive attributes working in its favor for a successful IPO this week, but there is no certainty it will repeat Mead Johnson Nutrition Co.'s strong performance last month.

While Changyou.com has shown rapid revenue and earnings growth in the two years that it has been offering its 2-D martial-arts saga, Tian Long Ba Bu, to Chinese gamers, there is concern about its ability to continue at its current pace, particularly since about 94% of its revenue in 2008 was derived from that one online game.

"This is not a slam dunk, as far as I'm concerned," said Sal Morreale, who tracks initial public offerings for Cantor Fitzgerald LP.

Competition is keen among Chinese companies that develop large-scale online role-playing games, where hundreds of thousands of people can log in simultaneously to play from their personal computers.

In the past five years, about a half-dozen of these companies have launched IPOs in the U.S.; the last two, Perfect World Co. and Giant Interactive Group Inc., both made double-digit percentage gains on their first days of trading in 2007. So far in 2009, performance for the group is mixed; Perfect World is down for the year, while Giant is up.

Although Tian Long Ba Bu's audience appears to be growing -- it hit a peak in March of more than 800,000 players accessing the game simultaneously, double the level at its launch in May 2007 -- it could lose market share before the company is able to line up another hit from the three games it has in its pipeline, the first of which is due to begin beta testing some time this quarter, says Francis Gaskins, president of research site IPODesktop.com.

Another concern is that revenue growth is slowing as the company matures. Although revenue rose nearly fivefold last year from 2007 levels, those gains ebbed with every sequential quarter in 2008. Net income, which increased 20 times over 2007's level, also slowed after the second quarter of 2008.

"Right now, they are a one-trick pony, and their growth is leveling out. They want us to believe that they have a stable of horses that will help them grow more -- and they might. But they might not," Mr. Gaskins said.

Short term, there is enough pent-up demand for the small offering -- just 7.5 million shares are scheduled to debut under the symbol CYOU on the Nasdaq Stock Market on Thursday -- to drive the price higher in the first days of trading, believes Scott Sweet, managing director of Tampa research firm IPOBoutique.com. But if it can't sustain its gains after that, the stock could prove troublesome for longer-term investors given its risk profile and intense competition.

"I do think that it will likely play well in the short term. But I would be cautious if the stock broke through the offering price quickly, considering the outstanding numbers it's reported. If they can't hold it steady with those numbers, then the numbers and exponential growth do not matter," Mr. Sweet said. "It's potentially a deal that has tangible hazards."

Lynn Cowan
Dow Jones
301-270-0323