China's No. 3 Online Game Maker To Play U.S. Market

Shanghai, China

(86-21) 6451-5001

Lead underwriters:

Merrill Lynch and UBS Investment Bank

Offering price: $12-$14

Expected date: Nov. 1

Ticker: GA

THE BUZZ

Just how much risk are investors willing to take on to get into the Chinese video game market?

Going by the performance of Perfect World , quite a bit. After it priced at 16 on July 26, the firm topped 34 by October. Perfect World had only five quarters of operations on the books -- just one of them profitable.

That IPO must have looked like a blazing green light to Giant Interactive . Giant is only three years old and has just one game on the market, but it still pulled four times Perfect World's revenue last year. It is now the third-largest video game maker in China, with a 15% market share.

In a preview note for Pali Research, analyst Tian Hou says that in China, Chief Executive Yuzhu Shi "is considered a genius in marketing and sales." She expects him to deploy this talent to sell the new games in Giant's pipeline and believes the stock price could reach 20.

Still, investors will need a bit of sang-froid to buy into Giant. Shi may be a genius, but he's also the defendant in several lawsuits stemming from his previous business ventures. And the current valuation puts Giant's market cap at a heady $3.4 billion, which Tom Taulli, author of "Investing in IPOs," finds too rich for his blood.

"The valuations for these Chinese IPOs are just off the charts," he said. "It's enough to make me want to stand on the sidelines."

THE COMPANY

The company was originally formed in 2004 as Shanghai Zhengtu Network Technology. Zhengtu gave its name to the first game, "ZT Online," which launched in January 2006.

"ZT" is a massive multiplayer online game set in ancient China. According to IDC, it was the most popular online game in China last year. In 2007 it has continued to grow, with an average of 481,054 concurrent users in the most recent quarter. Users buy prepaid game cards with which they can play indefinitely.

In July 2006, Zhengtu reorganized in order to offshore itself, creating the current Giant Interactive Group as a holding company. The name change also signals its next game, "Giant Online," which it plans to release some time before the end of the year.

"Giant Online" is rather different from "ZT," as it's set in a modern military environment. At around the same time as that release, the firm will launch a pay-to-play version of "ZT Online."

Giant also acquired another game, called "King of Kings III," from Taiwan Lager Network Technology. It plans to launch this game, which has a medieval European setting, next year in China.

RISKS/CHALLENGES

Giant is basically a one-hit wonder at this point, with a short operating history. No one knows if it can repeat its "ZT" success with its upcoming games, and analyst Hou thinks the popularity of "ZT" has already peaked.

The young company has also already been tainted by scandal. Founder and CEO Shi has started up several other companies, one of which, Zhuhai Giant, went under when a real-estate deal went bad. That brought lawsuits against Shi, a few of which are still in the courts.

Another Shi-related company, Giant Investments, has also been subject to claims relating to allegations of false advertising.

Giant Interactive itself got some bad publicity last year when it turned out that a contest offering prizes was not, in fact, awarding any. Giant axed the employees involved, but its prospectus says the incident got considerable press coverage in China.

Like most young Chinese firms, Giant audited its finances before its IPO and found that internal controls weren't up to snuff. This was not unusual, but one more dramatic consequence was that the lawyers found that its part-ownership of Taiwan Lager was null under Taiwanese law. Giant unwound its ties with Lager, though the two firms still have a licensing deal relating to "King of Kings."

THE RESULTS

Revenue reached $90.3 million in the first half of this year, already surpassing the $53.7 million haul in all of 2006.

Profit in the first half totaled 34 cents a share, almost 10 times year-ago earnings.

USE OF PROCEEDS

Giant expects to raise $657 million from the offering of 57.2 million shares, but it has no specific plans for the money.

The company says it will invest it in "general corporate purposes, including capital expenditures and funding possible future acquisitions."

THE MANAGEMENT

Yuzhu Shi

Chairman and chief executive

Founded several other companies, and sits on the board of China Minsheng Banking, Giant Investment, Ready Finance Limited and Shanghai Youyuan Gardening. He holds a B.S. in mathematics from Zhejiang University.

Wei Liu

President and director

Became Giant Interactive director in October 2006 and president in September. Previously she was general manager at Shanghai Golden Partner Biotech, Shanghai Jiante Bio-Technology and Zhuhai Selan Yidai. She holds an MBA from China Europe International Business School.

Lu Zhang

Chief operating officer and director

Joined in October 2006. Previously he held managerial positions at Shanghai Jiante Bio-Technology and Zhuhai Giant Group. In the 1980s, he spent six years as an engineer for Nanjing Electronic Technology Development Institution. He holds a B.S. in computer science from Hangzhou Electronic Industry Institute.