Why Changyou's Shares Crashed

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Chinese online gaming portal Changyou.com fell throughout the day, finishing with a 10% loss as Wall Street digested the news that the company's earnings for the upcoming quarter might be weaker than expected because of higher operating costs.

So what: The raw numbers all look good. Changyou beat the fourth-quarter revenue consensus of $168.7 million with a $173.5 million top line, and its earnings per share of $1.42 came in $0.09 better than analyst forecasts. Looking ahead, Changyou expects revenue in the $168 million to $174 million range, ahead of the Street's consensus, and $1.38 to $1.44 in EPS, against the $1.38 consensus.

However, part of Changyou's slide can be blamed on Sohu.com , which offered weak guidance for the upcoming quarter, and which indicated that shrinking margins would crimp Changyou's profitability in the future. The other part of this slide can be pinned on rising operating costs, which were up 20% sequentially and 17% on a year-over-year basis. Much of this was due to a 35% spike in year-over-year product development costs and a big 59% spike in year-over-year product development costs.

Now what: Sohu provided a worse forecast than Changyou, yet it declined by only half as much today. Changyou's gross margin on both a GAAP and an adjusted basis, at 84% for both, was actually higher than the prior quarter, and roughly in line with the year-ago quarter's 85% margin. Changyou's operating and net margins also remained stable despite the large increase in costs. There's nothing wrong with spending more to lure in new gamers, especially with such a long runway remaining in China. Today's drop brings Changyou back to even for the past 52 months, but at a 5.5 P/E, it seems like there's more upside than downside for this well-positioned Chinese game purveyor.

Want more news and updates? Add Changyou.com to your Watchlist now.

The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in our brand-new free report: "The Motley Fool's Top Stock for 2013." I invite you to take a copy, free for a limited time. Just click here to access the report and find out the name of this under-the-radar company.

The article Why Changyou's Shares Crashed originally appeared on Fool.com.

Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter, @TMFBiggles, for more news and insights.The Motley Fool recommends Sohu.com. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Can't get enough business news?

Sign up for Finance Report by AOL and get everything from retailer news to the latest IPOs delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.