Game time: Why China's online community is big business

Published: 1 March 2010

World's No. 1 internet market creates opportunities for investors

It is being called the next growth wave in China's telecommunications boom. First, there was the massive growth in subscribers between 2003 and 2008 as mobile phone use swept the country. Next came huge waves of capital expenditure over 2007-2009 on broadband and 3G infrastructure. Now it's computer games.

Tucker Grinnan, HSBC's senior telecom analyst in Asia, outlined the position: "The internet services-based companies in the online gaming, advertising, and e-commerce segments represent the new phase of growth".

"Now that China has built a world-class series of broadband networks, the primary value creation will be in the content services that flow over these networks."

"This growth will be driven by a sharp increase in internet and broadband penetration, structural growth in per capita spending on media entertainment, and an economic policy shift towards domestic consumption. We forecast 30 per cent revenue CAGR for the online games market over 2009-2012 versus 7-10 per cent for companies that make telecom equipment."

As usual when it comes to China, the numbers are jaw-dropping. There are now 360 million internet users in China – according to data from the China Internet Network Information Center, it overtook the United States as the world's largest online community in the first half of 2009 – with some 200,000 people joining the online club every day. In addition, China is now spending USD40bn-50bn a year on telecom capital expenditure, representing 50 per cent of the global total.

HSBC thinks the rapid expansion in China's internet penetration is strong enough to create world-class companies in this sector, emulating China Mobile's success in the telecom world (it now has the most subscribers in the world). Two of the leading companies are Tencent and Perfect World. Tencent has grown into China's largest and most used internet service and 50 per cent of its revenues come from gaming, while Perfect World has the best portfolio of online games, the highest spending on research and development and focus on domestically developed content. They are HSBC's top picks in the sector (see box).

The China online gaming market has seen revenue CAGR of 56 per cent over the past two years and demand continues to grow. HSBC believes this market will become the largest of its kind in the world in the next few years.

"We project that the number of people paying to play online games in China will increase from 30 million (10 per cent of total internet users) today to 58 million in 2012 (12 per cent). This is still far below Korea (50 per cent)," said Mr. Grinnan. "It's a booming growth market."

"Online gaming is still in its early stages of growth in terms of participation levels but it is, quite simply, already the most important form of entertainment for young people in the country. It's cheap, accessible and allows people to build online communities, something that was impossible only a few years ago."

China is now the world's second-largest online gaming market. It's worth about USD3 billion a year and accounts for 27 per cent of the global market. The US is No. 1 at USD3.2 billion and Korea No. 3 at USD2.3 billion. HSBC believes that China will become the global leader in the next few years.

Based on data from consultant IDC, 30 million people pay to play online games in China, representing nine per cent of the country's internet users. These numbers are still lower than the US and Korea and are expected to grow rapidly over the next five years.

Significantly, the internet penetration rate in China is still only 22.6 per cent, so the growth story has a long way to go. There are parallels here with the mobile industry. In only 2.5 years (2005 to mid-2007) China's mobile penetration rate increased to 45 per cent from 25 per cent, helping to create the world's largest mobile operator, China Mobile.

The demographics look good too. Based on surveys by 17173, an online gaming portal in China, in the past five years the age of online gamers has broadened. While young players (19-25) still dominate, those over 30 have increased from 7 per cent to 20 per cent and players below 16 rose from 5.8 per cent in 2006 to 9 per cent in 2008.

Playing games online also offers good value for money. It costs RMB30-50 to watch a movie, to buy a KFC meal or play snooker for two hours, while gaming offers hours of entertainment as well as the fun of being part of a huge online community. We expect online gaming to become one of China's top three pastimes, along with TV and movies (like Korea).

Today's online games are designed to attract as many users as possible. Anyone can play but once you reach a certain level you have to buy items such as extra weapons if you want to progress. According to IDC, revenues from these 'item-based' games reached USD2.1 billion and accounted for 76.2 per cent of China's total online game revenues in 2008. This trend is expected to continue, with revenues forecast to reach USD5.3 billion, or 91.4 per cent of total online game revenues, in 2013.

The interactive nature of online games also creates a strong community effect and allows players to have an interactive experience that can be customised to suit the player. Some participants invest huge amounts of time in these games and the related social networks. The leading games require high levels of skill and strategy which take a long time to develop. Also, the time invested in building a character and moving up the status ladder while connecting to a number of virtual communities which provides opportunities to interact with friends or make new ones.