Sell This Weakening Chinese Online Game Developer

Robert Hsu, October 21, 2009

The online gaming industry was one of the hottest trends in China -- and we took full advantage of the trend by investing in a company with the next blockbuster game.

Changyou.com (NASDAQ: CYOU), as the leading online game developer and operator in China, also provided us with a great opportunity to take advantage of the new IPOs in China. The company was a spin-off from Sohu's gaming division in 2007, and its shares were listed on the NASDAQ in early April. So I recommended that my Asia Edge readers snatch up shares in CYOU just after its initial public offering. In fact, over the summer I even took my family to a Chinese amusement park themed after the company's hit online game -- here's a picture of my family and I standing outside the gates.

However, Changyou's shares declined after management announced disappointing second-quarter earnings. I was expecting a much higher growth rate than the company reported -- so it was time to take our gains and move on to the next trade.

While the company continues to garner a strong market share in China's online gaming industry, and even has a substantial pipeline of popular games, the company's growth rate wasn't able to catch back up with what I want for our investments. Considering that shares remained unlikely to gain much ground, I recommended selling CYOU -- and my Asia Edge readers locked in a 34% gain in just over four months.

Since then, CYOU has dropped about 16% and remains on a downward trend. And I'm not expecting the company to turn around any time soon, especially with the uncertainty about online gaming in China.

New regulation by China's press and copyright authorities has banned foreign investors from operating online games -- "in any form." This has me concerned about China's domestic online gaming business since even online game operators aren't sure how, or even if, the rules will be enforced.

The rules ban foreign businesses from investing in China's online game operations, even through joint ventures and cooperatives. Additionally, no organization is allowed to run an online game without permits from China's General Administration of Press and Publication (GAPP). Especially important is that this also includes upgrades to existing games -- each upgrade will require the company to go through the likely time-consuming approval process again.

Knowing the way the Chinese government operates, the new rules will probably not be carried out in its entirety -- and indeed are likely more of a power struggle between two divisions of the Chinese government than an attempt to shut down foreign investment in Chinese gaming companies entirely. However, it is nevertheless a negative for online gaming companies, even domestic gaming companies, at least in the near future.

For my insight into short-term trading throughout all of Asia, join Asia Edge today.

Sponsored Links

What's happening in the world's major foreign markets right now? Will current events affect the stocks in your portfolio? Read InvestorPlace Asia's Top Stories to find out everything you need to know in order to stay on top of global economic news.

more...

Every country has its own special customs and traditions. Being familiar with a country's culture can often make a difference in whether you gain or lose from investing in its stock market. Check out our culture section to learn more about the societies of the world's fastest-growing emerging economies.

more...

There's a lot happening around the world today, and it's important to know how it's affecting your investments. Watch the latest videos covering important Asia topics!

more...