Some years back, I was asking my prof at Rutgers what to look for in a short? He said simply the death of its business model. My reaction was how in the world to run a stock screen on that? Today I might have just that stock.
The9Limited (NASDAQ: NCTY) is a computer game company. It held the license to run to the world's most popular online Massive Multi-player Online Role Playing Game (MMORPG) - the World of Warcraft (WoW) by Blizzard Entertainment - in China. In April 2009, the company announced that Blizzard will not be renewing its license and has awarded it to another company. WoW accounts for 91% of NCTY's 2008 revenue (from 2008 20-F, pg 29). The license was terminated on June 7, 2009. NCTY's other game franchises include Hellgate: London, Soul of the Ultimate Nation, EA Sports FIFA Online and Granado Espada. None of which approach the size of WoW.
It will be hard for NCTY to replace the revenue because MMORPG's are subject to the network effect. Simply put, the more people in any given network, the greater the ability to draw new people into the network. Other examples are mobile phone networks. What makes MMORPGs so fun is that you get to explore a large online world with your friends, go on quests and campaigns with them or challenge them to fights online. WoW is the largest MMORPG (11.5M subscribers as of Dec 23, 2008). It is really difficult to create a new MMORPG from scratch, reach the critical mass/ level of popularity such that young people will pay for it. These MMORPGs are notoriously complex and hard to create because they aim to create whole new worlds online. Furthermore, it is hard for the game to gain enough acceptance to reach that critical mass.
The company has in the past (2007 20-F) run into accounting issues, specifically inadequate financial controls in its financial reporting, leading its auditor, PWC Shanghai, to explicitly state in NCTY's 2007 20-F. This is really unusual. Normally, the auditor's letter in the 20-F or 10-K will give the company a clean bill of health. Any deviation/ failings from the standard norms should be rectified before it comes to the auditor reporting it in the 20-F. All in all, this does not reflect well on the management.
The stock is down around 40% to 50% from the first announcement in April 2008. Currently, it is trading at $8.45 as of last Friday's close. The price rallied to $12 in June. So there might be opportunities for profit on the short end of this trade. I'd recommend to wait for a rally, then short the stock.
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