China has 400 million Internet users, a quarter of them avid gamers, according to the China Internet Network Information Center. Despite that enormous market, a government campaign against online gaming is giving investors pause. Shares of Tencent, the Chinese market leader in Web-based games, has dropped 23 percent this year. Perfect World, another major operator, is off 47 percent, and Shanda Games (GAME) is down 42 percent.
With more Internet users in China than any other country, the Chinese game market seems ripe for growth. Two-thirds of Chinese have never been online and nearly half of China's Web surfers are under 25. "When I've had enough of one game I go on to the next," says Jiang Yuzhuo, a 21-year-old hairstylist who spends as many as four hours a day playing games in Internet cafés.
The Chinese government thinks that's excessive. The Ministry of Culture on June 22 announced regulations setting guidelines for the look and feel of games and requiring that social gamers register under their real names. The ministry also set limits on sales to minors of items using virtual currency, or points earned playing online. The news sent Tencent's Hong Kong-listed shares down 5 percent. "The new rules will be a challenge for operators," says Galant Ng, an analyst with Tai Fook Securities in Hong Kong. Tencent says the new rules will be good for the industry. Perfect World and Shanda didn't respond to requests for comment.
Gaming companies have other worries as well. While they see plenty of potential growth in poorer regions, it's getting harder to find players who aren't already online in Beijing, Shanghai, and other big cities. Parents are fretting about what they consider to be growing addiction to online games among young people. Though the industry's revenues are likely to grow 22 percent this year, to $4.5 billion, that's far below last year's 40 percent.
All that means the search for new hit games is urgent. This year, Chinese companies will launch 400 new titles, vs. 250 in 2009, says Samsung Securities analyst Paul Wuh. It's hard to stand out in the market because many operators have been churning out similarly themed medieval fantasies with titles such as Battle of Immortals and Dragon Power. "You end up with the same games in the same mythical worlds," Wuh says.
The new rules might inconvenience some players, but China's young gamers managed to evade earlier attempts at control, including a 2005 rule designed to cap how much time minors can play without taking a break (they signed on using older friends' IDs). Tencent and other companies are developing 3D games, which could help woo new players. The companies may also try to diversify into new businesses. Tencent began as an instant-messaging service before transforming into a top portal and game operator. With Google (GOOG) facing trouble in China, Tencent is stepping up its search business. "I am inclined to take them seriously in search," says Dave Carini, managing director of Maverick China Research in Beijing, "because they have successfully changed their focus so many times."
The bottom line: Investors are wary of Chinese gaming stocks as Beijing tightens the reins on Internet games and the industry's growth slows.