Sohu's New MMO in Beta

Sohu.com’s (SOHU - Analyst Report) online gaming subsidiary Changyou.com (CYOU - Snapshot Report) recently announced the open beta version of the upcoming new game Tao Yuan. Players will be able to access the game from May 24, 2012 onward.

Based on the legends of the Three Kingdom period, Tao Yuan is a turn-based massively multiplayer online role-playing game (MMORPG) developed by using the Unreal 3 game engine. In turn-based games fights between players take place in turns. Turn-based games are more strategic in nature as they allow players to choose their mode of attack and defense. However, turn-based games are much slower than action games.

In Tao Yuan, players are allowed to pick their positions in a 3X5 grid, where they place their characters. Unlike traditional turn-based games, the game features a time-keeping meter, which determines the turn of each character during the combat. Players are expected to keep pace with the time-meter to grab their opportunities to attack or defend.

Changyou expects this new variation in Tao Yuan to attract new players, thereby expanding its subscriber base going forward. Changyou has a dominant position in the Chinese online gaming industry (Changyou operates Tian Long Ba Bu, one of the most popular massively multi-player online games in China, and DDTank, one of the top-ranking web-based games in China), which will help the new game to solidify its position going forward.

Online gaming, which includes MMORPG’s, casual, social & web games grew 32% in 2011. Changyou ranked #4 in terms of revenue in the Chinese market and garnered approximately $485.0 million from online games. In a recent study from Pearl research, China's online gaming market is expected to exceed $9.2 billion by 2014 from $6.6 billion in 2011. We believe that Changyou will continue to benefit from the strong growth trends of online gaming in China over the long term.

Besides Tao Yuan, Changyou has three more MMO games scheduled to release this year and four web-based games. We believe that this strong product pipeline will drive Changyou’s as well as Sohu’s top-line growth going forward.

However, both Changyou and Sohu are facing significant competition from Tencent, Shanda Games (GAME - Snapshot Report) and Renren Inc. (RENN - Snapshot Report). This has compelled both the companies to increase spending on product development and promotional expenses, which is hurting profitability. Moreover, a slowing Chinese macro environment (declining auto sales and weakness in real estate) may hurt Sohu’s growth in the near term.

Thus we remain Neutral on Sohu and Changyou over the long term. Sohu has a Zacks #5 Rank, which implies a Sell rating in the near term. However, Changyou has a Zacks #3 Rank, which implies a Hold rating in the near term.