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In-Line Earnings for This China Play

This company has announced its results; here's a look at the details.
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Giant Interactive (GA) is trading 5% lower at $9.10 this morning after reporting earnings, and we wanted to update readers. We aren't taking any action in this Alert.

On Wednesday night, Giant Interactive reported second-quarter earnings of 20 cents per share on revenue of $73.6 million. Earnings were in line with consensus estimates while revenue came in slightly ahead of expectations. The company did not offer guidance for the third quarter due to a change in online game "ZT Online's" revenue model, which management said "will impact revenue in the near term, but will help add players and increase paying accounts over time."

Looking at the details, operating margins declined by 300 basis points to 65% and gross margins fell by 0.6% to 88.6%. Because Giant Interactive boasts one of the largest margins in the industry, declines were expected heading into the quarter. Also, average revenue per user (ARPU) declined 3.2% from the last comparable quarter, but active paying accounts (APA) jumped 41% to 1.76 million.

As expected, the lack of guidance was not taken well by analysts during the conference call and lead to a downgrade from Roth Capital Partners to neutral from buy, given the uncertainty going forward. However, there are plenty of catalysts that could send this stock sharply higher from current levels over the next nine to 12 months.

First, the company has not bought back any shares under its $150 million buyback program that was announced two weeks ago. Second, Giant Interactive's pipeline is solid, with games "Empire of Sports" and "King of Kings III" scheduled for release in early 2009. Finally, Giant Interactive's signature "ZT Online" game -- which accounts for most of the company's revenue -- continues to see robust demand and is being launched in Vietnam next month.

While there is some uncertainty going forward, we maintain our One rating on Giant Interactive as most of the risks are already priced in at current levels. We will look to build up this small model portfolio position in the short term.

Frank Curzio is a research associate at TheStreet.com.

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