Summary
SUMMARYYou should read the following summary together with the entire prospectus, including the more detailed information regarding us, the ADSs being sold in this offering, and our financial statements and related notes appearing elsewhere in this prospectus.
We are a leading online game developer and operator in China as measured by the popularity of our game Tian Long Ba Bu, or TLBB. TLBB, which was launched in May 2007, was ranked by International Data Corporation, or IDC, for 2007 as the third most popular online game overall in China and the second most popular online game in China among locally-developed online games. We engage in the development, operation and licensing of our massively multi-player online role-playing games, or MMORPGs, which are interactive online games that may be played simultaneously by hundreds of thousands of game players. We currently operate two MMORPGs, TLBB, which we developed in-house, and Blade Online, or BO, which we licensed from a third party. For the three months ended December 31, 2008, we had approximately 1.8 million active paying accounts, which refers to the number of accounts from which game points are utilized for the purchase of virtual items at least once during a given period, for TLBB and approximately 159,000 active paying accounts for BO.
TLBB is a martial arts game with 2.5D graphics. In May 2007, the month of its launch, TLBB’s peak concurrent users surpassed 400,000, and its quarterly peak concurrent users for the fourth quarter of 2008 was approximately 738,000. In March 2009, its peak concurrent users exceeded 800,000. TLBB is adapted from the popular Chinese martial arts novel “Tian Long Ba Bu,” which means “Novel of Eight Demigods,” written by the famous writer Louis Cha. Millions of copies of his novels have been sold in numerous languages, and they have been adapted into various movies and television series. To leverage the success of TLBB, we licensed the game to third-party operators to operate the game in Taiwan, Hong Kong, Vietnam, Malaysia and Singapore.
We have three new MMORPGs in the pipeline, including the Duke of Mount Deer, or DMD, Immortal Faith, or IF, and the Legend of the Ancient World, or LAW. DMD, which we are developing in-house, is also based on a popular martial arts novel written by Louis Cha. We have licensed IF and LAW from third parties. We expect to begin open beta testing of IF and DMD in the second and fourth quarters of 2009, respectively, and of LAW in early 2010.
Sohu.com Inc., our controlling shareholder, has operated a leading Chinese Internet portal, Sohu.com, since 1998. Sohu had more than 250 million registered accounts as of December 31, 2008. We have benefited from Sohu’s strong brand recognition in China, large user base and pre-launch game review services. Sohu’s trusted brand name in China provides us with a broad marketing reach. By marketing across Sohu’s web domains and taking advantage of the Sohu Group’s single-user ID system that provides easy access to our games, we believe we have been able to tap into Sohu’s large user base to drive new users to our games. Sohu’s experienced game editors review and critique our games prior to launch, thereby improving the quality of our games. We intend to continue to leverage our relationships with Sohu in the development, marketing and operation of our games.
We operate our current games under the item-based revenue model, meaning game players can play our games for free, but may choose to pay for virtual items, which are non-physical items that game players can purchase and use within an MMORPG, such as gems, pets, fashion items, magic medicine, riding animals, hierograms, skill books and fireworks, to enhance the game-playing experience. Game players purchase prepaid game cards or game points, which are used to purchase virtual items. Most of our virtual items are priced between less than $0.01 and $2.20. However, unit prices of certain virtual items can be as high as approximately $180. We sell our prepaid game cards to approximately 100 regional distributors throughout China, who in turn sub-distribute them to numerous retail outlets, including Internet cafes and various websites, news stands, software stores, book stores and retail stores.
We continually collect feedback from our game players through multiple channels. Our product development team and our game operations team work closely together, allowing us to translate game player feedback into game updates and expansion packs in a timely manner. We typically release expansion packs, which are software packages that contain significant upgrades and improvements to a game based on the existing game’s framework, every few months. These upgrades may include new game content such as storylines, characters, tasks, maps and virtual items. We also update TLBB on a weekly basis with interim enhancements. We believe that such expansion packs and regular updates improve the game-playing experience and help to maintain the interest level of TLBB’s players, thereby helping us to extend the lifespan of the game.
Our revenues grew from $42.1 million for the year ended December 31, 2007 to $201.8 million for the year ended December 31, 2008, and our net income grew from $5.3 million to $108.0 million during the same period. For the year ended December 31, 2008, 93.6% of our total revenues was attributable to TLBB.
According to the China Internet Network Information Center, or CNNIC, in June 2008 China surpassed the United States as the largest Internet market in the world. Within the Chinese Internet market, online games have been a fast growing segment and one of the most popular activities for Internet users.
According to IDC, China’s online game players reached 40.2 million in 2007, and generated revenues of $1.4 billion, representing a 61.5% increase over those in 2006. Online game revenues are expected to continue to grow to $3.4 billion in 2012 at a compound annual growth rate, or CAGR, of 19.9%. MMORPGs represent a dominant online game type in China, revenues from which accounted for 76.0% of China’s total online game revenues in 2007. Most of the revenues from online games are generated under the item-based revenue model as compared to the time-based revenue model.
In addition, China’s online games industry has other key characteristics, including:
We believe that the following competitive strengths enable us to compete effectively and to capitalize on the rapid growth in the online game market:
Notwithstanding our competitive strengths, we expect to face various challenges, including those presented by:
Our objective is to establish one of the most powerful online game brands in China. We intend to achieve this objective by pursuing the following strategies:
Our MMORPG business began operations as a business unit within the Sohu Group in 2003. In June 2003, the Sohu Group launched its first MMORPG, Knight Online, or KO, which was licensed from a Korean developer. KO had limited acceptance in the Chinese market, and its operation was discontinued in November 2006 when the license expired. In October 2004, the Sohu Group launched BO, its second MMORPG, which was licensed from a Beijing-based studio. In May 2007, the Sohu Group launched TLBB, its first in-house developed MMORPG.
In 2007, the Sohu Group reorganized its MMORPG business. As part of the reorganization, Changyou.com Limited, or Changyou, a Cayman Islands company and an indirect, wholly-owned subsidiary of Sohu.com Inc., was established in August 2007 to hold the MMORPG business of the Sohu Group. Subsequently,
Gamease is jointly owned by Tao Wang, our Chief Executive Officer, and a Changyou employee, but is controlled by AmazGame through a series of contractual arrangements, and therefore its financial results are consolidated with ours. We operate all of our MMORPG operations through Gamease, our VIE, rather than a subsidiary, in order to comply with PRC laws and regulations restricting foreign ownership in the online game business in China. See “Our History and Corporate Structure” for a detailed discussion of our contractual arrangements with Gamease.
After the establishment of the above entities, Changyou, AmazGame and Gamease entered into various agreements with Sohu. Pursuant to these agreements, Sohu transferred to us, effective December 1, 2007, all of its assets and operations relating to its MMORPG business unit, and we assumed all the liabilities associated with the MMORPG business unit and paid net consideration of $9.9 million to Sohu.
In January 2009, we incorporated AmazGame Entertainment (US), Inc., through which we intend to operate our planned MMORPG business in the United States.
The following diagram illustrates our corporate structure as of the date of this prospectus(1):
We were a business unit within the Sohu Group prior to our reorganization as a separate, indirect subsidiary of Sohu.com Inc. The Sohu Group began reporting results of its MMORPG operations as a separate business segment for the three months ended June 30, 2007. References in this prospectus to the operations of our business, financial condition, and results of operations with respect to periods prior to December 1, 2007 are to the Sohu Group’s MMORPG business unit. Prior to this offering, Sohu had provided us with tax, accounting, treasury, legal and human resources services, and had also provided us with the services of a number of its executives and employees. All of our current executive officers and most of our current employees formerly were employees of Sohu.
Upon the completion of this offering, Sohu will continue to be our controlling shareholder, with an indirect shareholding of 70.7% of the combined total of our outstanding Class A and Class B ordinary shares, and control of 81.5% of the voting power of the combined total of our outstanding Class A and Class B ordinary shares, assuming the underwriters’ over-allotment option is not exercised.
We have entered into agreements with Sohu with respect to various interim and ongoing relationships between us, including a Master Transaction Agreement, a Non-Competition Agreement, and a Marketing Services Agreement. These agreements contain provisions, among others, relating to the transfer of assets and assumption of liabilities of the MMORPG business, provide cross-indemnification of liabilities arising from each other’s business, mutually limit Sohu and us from competing in each other’s business, and also include a number of ongoing commercial relationships. See “Our Relationship with Sohu.”
We believe that we will realize benefits from our carve-out from Sohu, including:
Our principal executive offices are located at East Tower, Jing Yan Building, No. 29 Shijingshan Road, Shijingshan District, Beijing 100043, People’s Republic of China. Our telephone number at this address is (8610) 6272-7777. Our registered office in the Cayman Islands is located at Scotia Centre, 4th Floor, P.O. Box 2804, George Town, Grand Cayman, Cayman Islands, KY1-1112.
Unless otherwise indicated, information in this prospectus assumes that the underwriters have not exercised their option to purchase additional ADSs to cover over-allotments and assumes that there has been no vesting of restricted share units granted to our executive officers and employees.
This prospectus contains translations of certain Renminbi, or RMB, the legal currency of China, amounts into U.S. dollars at the rate of RMB6.8225 to $1.00, the noon buying rate in effect on December 31, 2008, in New York City for cable transfers of Renminbi as certified for customs purposes by the Federal Reserve Bank of New York. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or can be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. On March 13, 2009, the noon buying rate was RMB6.8380 to $1.00.
As used in this prospectus,
Unless indicated otherwise, the information included in this prospectus regarding our outstanding ordinary shares gives effect to the following as if they all had occurred as of January 1, 2005:
The information included in this prospectus regarding our outstanding ordinary shares also includes as outstanding, as of their January 2, 2008 grant date, 7,000,000 Class B ordinary shares and 8,000,000 Class B restricted shares (the amount of such shares giving effect to the ten-for-one split referred to above) that were issued, out of ordinary shares held by Sohu.com (Game) Limited, on January 15, 2009 to Prominence Investments Ltd., a British Virgin Islands company beneficially owned by Tao Wang, our Chief Executive Officer.
ADSs offered:
To understand the terms of the ADSs, you should carefully read the section of this prospectus entitled “Description of American Depositary Shares.” We also encourage you to read the Deposit Agreement, which is an exhibit to the registration statement that includes this prospectus.
The primary purposes of this offering are to create a public market for our shares for the benefit of all shareholders, retain talented employees by providing them with equity incentives and obtain additional capital. We intend to use the net proceeds from this offering for general corporate purposes, including capital expenditures and funding possible future acquisitions.
We will not receive any of the proceeds from the sale of ADSs by the selling shareholder.
The following summary consolidated statements of operations and cash flow data for the years ended December 31, 2006, 2007 and 2008 and the summary consolidated balance sheet data as of December 31, 2006, 2007 and 2008 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. You should read the summary consolidated financial data in conjunction with those financial statements and the accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our consolidated financial statements are prepared and presented in accordance with United States generally accepted accounting principles, or U.S. GAAP.
Prior to Sohu’s transfer to our PRC subsidiary and VIE of all of the assets and operations of the Sohu Group’s MMORPG business unit effective December 1, 2007, the operations of our MMORPGs were carried out by various companies owned or controlled by Sohu.com Inc. For periods both before and after December 1, 2007, our consolidated financial statements include the assets, liabilities, revenues, expenses and changes in shareholders’ equity and cash flows that were directly attributable to our MMORPG business whether held or incurred by Sohu or by Changyou. In cases involving assets and liabilities not specifically identifiable to any particular operation of the Sohu Group, only those assets and liabilities transferred or expected to be transferred to Changyou are included in our consolidated balance sheets. With respect to costs of operations of the MMORPG business, an allocation of certain general corporate expenses of Sohu which were not directly related to the MMORPG operations and an allocation of certain advertising and other expenses provided by Sohu to Changyou were also included. These allocations are based on a variety of factors depending upon the nature of the expenses being allocated, including revenue, the number of employees and the number of servers. Our statements of operations also include the sales and marketing expenses and other costs charged from Sohu. The transactions are measured at the amount of consideration established and agreed to by the related parties.
Our consolidated financial statements have been prepared as if the current corporate structure had been in existence throughout the periods presented.
Our management believes that the assumptions underlying our financial statements and the above allocations are reasonable. Our financial statements, however, may not necessarily reflect our results of operations, financial position and cash flows as if we had operated as a separate, stand-alone company during the periods presented. You should not view our historical results as an indicator of our future performance.
As used in the tables below and elsewhere in this prospectus:
The average concurrent users of any of our games for a given period is determined as follows: we first determine the number of users logged on to the game at ten-minute intervals and average that data over the course of a day to derive the daily average; the daily average data are then averaged over the period to derive the average concurrent users over the period.
Active paying accounts for a given period refers to the number of accounts from which game points are utilized at least once during the period.
Average revenue per active paying account of any of our games for a given period is our online game operations revenues for a game during the period divided by the active paying accounts of the game during the period.
Our calculation of average concurrent users, active paying accounts and average revenue per active paying account may not be comparable to similarly-named measures presented by other online game companies.
The following table sets forth our game operations revenues from TLBB in China and the related operating data:
The following table sets forth our game operations revenues from BO in China and the related operating data: