Does High Unemployment Mean More Profits for Changyou (CYOU)?

Last April, an IPO for the online gaming subsidiary of internet portal Sohu.com, Changyou, prompted analysts to speculate about the possibility of a launch of the multiplayer games by the Chinese company from a US location.

Here’s an interesting comment about the IPO from PC World:

“Online games, a relatively cheap form of entertainment, have outperformed other industries in recent months as rising unemployment leaves players in and outside of China with more free time, analysts say.”

Is this the upside of unemployment we’ve all been waiting for? But seriously, even if you agree that unemployment causes more online gaming, will unemployment inspire gamers to spend money on virtual goods in online games, the source of Changyou’s revenues?

The results are in. CYOU reported second-quarter earnings today, so let’s take a closer look at the situation one year later.

Changyou.com Limited (NASDAQ: CYOU)

CYOU beat expectations by $.02 with $0.79 per ADS on a 7.8 percent increase in revenues over the prior quarter and 17 percent for the year-ago period. Both revenues from game operations and licensing revenues increased substantially. Net income grew by 6 percent quarter-over-quarter and 22 percent year-over-year.

The company reported aggregate active paying accounts grew 17 percent quarter-over-quarter and 17 percent year-over-year to about 2.79 million accounts.

Sales gains were offset by an increase in operating expenses at $24 million, up 12 percent from the prior quarter and 3 percent over the year-ago period.

Aggregate revenues per active paying account (ARPU) for the company’s games declined 8 percent and 1 percent year-over-year.

Commensurate with the Chinese preoccupation with ‘saving face,” the company said the results were “consistent with the Company’s intention to have ARPU within a range that keeps the Company’s games affordable for the majority of Chinese game players.” In other words, the company reduced prices.

Mr. Alex Ho, Changyou’s chief financial officer, summarized the results this way: “We set quarterly record in revenues and net income in the second quarter as our games continue to capture new audiences. We expect that our highly profitable model, healthy balance sheet, and rich cash flows will allow us to further boost the popularity of our existing games while we invest in our pipeline and position ourselves for the many opportunities in our industry.”

Comments: CYOU is profitable indeed with gross margins consistently in the 90s and operating margins averaging over 60 percent within the last year.

The company is expanding rapidly, increasing its user base and with it, paying accounts, but revenue per paying user has dropped. But the expansion of paying user accounts has more than offset the drop in user revenue. The company is sitting on mounds of cash, ready to invest in future products and releases, as well as to expand into new markets.

The company estimates total revenues for the third quarter to be between $80 and $83 million. And at a P/E of 4.67, the stock is trading at a discount to its peers.

CYOU gapped up about 7 percent at the open after the earnings report to $29. The IPO was priced at $16 last April. Still the stock price is down about 34 percent since the start of the year. It reached a 52.-week high of 48.37

From here, it looks like the stock will outperform for the near future and has serious upside potential.

Note: After the IPO, SOHU retained about 70 percent ownership in the CYOU. SOHU also reported earnings today and rose over 4 percent before falling to its current price increase of over 2 percent.

Sohu.Com Inc (NASDAQ: SOHU)