Cabot Wealth Advisory 4/14/07  -  Easy To Begin, Impossible To Finish Featuring Lutts' Logic:

France vs. China

Entrepreneurship, Chinese-Style

Making Money from World of Warcraft

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It's time for a little more coverage of China.  Why?  Because that's where
the action is!  Those Chinese stocks just won't quit!  And neither will my
brain, which is still weighing the sights and sounds I experienced on my
recent trip there with other experiences, and occasionally coming up with
surprising comparisons.

For example:

My daughter who is now studying in China as a college junior spent her
freshman year studying at the American University of Paris.   
Among the first orders of business, once she arrived in Paris, was
acquiring a mobile phone, and to do this, she needed to have a local bank
account.  So she walked into a bank one day, and asked to open an account.
 The response?  "Come back tomorrow - we're too busy."(!!)

To me, it was a perfect illustration of the French attitude: that the job
of the worker is more important than the needs of the customer.   
I don't believe this could happen in America, though as time goes on I
know it becomes more possible.  But I know with absolute certainty that it
wouldn't happen in China!

A few weeks back, in fact, I wrote about the issue of Excess Human Capital
in China, a reality that provides a willing worker - often two or three -
for any task that needs to be done.

More recently, my daughter wrote in a similar vein, and I think you'll
find her comments interesting.

"The Chinese people are the most overwhelmingly enthusiastic entrepreneurs
I've ever seen. Their eagerness to seize every opportunity to sell things
is obvious. Besides fruit, street vendors have everything from DVDs to
beer, from nail clippers to hot sweet potatoes, from bicycle seat covers
to new soles for your shoes. And that's just in the back alley behind my
school!

Their determination to sell you stuff translates into huge benefits for
the customer. Not only does it mean low prices, great variety and
convenience - the service is also incomparable. I went to buy a laptop
with my friend Amanda on Monday, and it was unlike any experience you'd
have in the States. We started out browsing on the ground floor of one of
the electronics malls in Zhongguancun, where the salespeople swarming the
floor shout, compliment and sometimes even grab to get your attention
focused on their product.

Once we'd expressed interest, they all kept trying to convince us to come
to their stores on the upper floors, explaining that the ground floor was
closing in ten minutes. It turned out to be true, and Amanda found a
couple laptops she liked, so we allowed three of the salespeople to escort
us to the 12th floor, which they did in extremely courteous fashion. 
Their store on the 12th floor was packed with helpful salespeople,
computers and large blue couches. We sat on a couch and they gave us paper
cups of water, then brought over several laptops and set them on the
coffee table in front of us to try out. The manager of the store, who
spoke English, sat down on the couch across from us and explained the
features of each computer and told us the prices, which he could lower a
bit . . . just for us, of course.

After Amanda chose a laptop - small, light, and an inexpensive Chinese
brand - one of the salespeople installed Windows, Microsoft Office and an
internal wireless card for her, right there at the table. Then he gave her
a free computer bag to carry it away in, and we were escorted out of the
building by another salesperson (a girl who was very impressed by our pale
skin, Amanda's curly red hair, and my height), who carried the computer
out for us.

The overall feeling is that you're doing them a favor by buying the
computer from them, which, given that there are at least four buildings in
Zhongguancun filled with people selling laptops, you kind of are.

The origins of this entrepreneurial spirit are complicated, and I won't
pretend to be an expert yet. But I think a lot of it comes from the
newness of this type of opportunity . . . as recently as the 1980s there
was no private property in China; all businesses were state-owned.

We're only at the mid-1950s in my history class right now, but I have
studied the economic reforms some in Sociology and some in Chinese, in
which our current lesson is called "Self-Employed Cucumber Seller and
Money Chasing" (not kidding).

Although tight control was and is maintained, the reforms allowed private
business and private property and gave the Chinese people a whole new
range of choices. The Chinese word for entering the private sector we just
learned in our cucumber seller lesson literally translates into "jumping
into the sea."

It's a big deal in a country where state-owned enterprises composed the
entirety of the economy less than a lifetime ago. The money chasing part
of the lesson describes entrepreneurs who will sacrifice everything to
earn money - including abandoning ethical business practices.

The point is, even by the standards of non-communist countries, the
"marketplace" in China is huge, thriving, flexible and growing. And of
course it's not all because of the entrepreneurial spirit; there's the
population, the reinforcing effects of raising the standard of living, the
growing middle class, and probably some cultural influences too. What it
means for me is I can buy everything I need within a 5 minute walk from my
dorm - and it's cheap too!"

Note: This intelligent young woman (of course I'm biased), who's majoring
in journalism and international relations, is available for summer
employment opportunities in the Boston area.

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Back in Salem, which in pre-clipper ship days boasted America's greatest
China trade - my current view of China is centered on the charts of the
Chinese stocks that climb up my computer monitor.  And I've got to tell
you - they're strong!

I thought we'd have some kind of pause in the Chinese market, particularly
after Cabot China & Emerging Markets Report was ranked the #1 advisory
letter in the business, based on its 75% return last year.  After you're
#1, there's no place to go but down.

But I was wrong.  While we had a quick 10% plunge in the Shanghai Index a
few weeks ago - just enough to shake out the weak holders - Chinese stocks
have roared back and are hitting new highs again!

How to explain it?  Fast growth continues, and the world's money continues
to pour into China.  At the most basic level, demand exceeds supply; there
simply aren't enough Chinese stocks to go around.  Editor Paul Goodwin
works hard to keep an eye on every one of them, and he tells me there are
about 100 Chinese stocks that trade in the form of ADRs on American
exchanges.

When I look at the list, I see a lot of strong stocks, but I also see
something else, some very big holes.  For example, there is no major
Chinese retailer.  Where we have dozens, from Gap to Target to Federated
Stores, they have none.  There is no national restaurant chain.  Where we
have McDonalds, Wendy's, Krispy Kreme and Starbucks, they have none. 
There are no national food processors.  We have Dean Foods, Kraft,
Con-Agra, Tyson and Smithfield.  They have none.

And medical investments?  Forget it.  No hospital chains.  No assisted
living chains.  No biotechnology stocks.  Just a few traditional medicine
sellers, medical device manufacturers and one Western-style clinic.

Public stock exchanges?  No.

Online brokers?  No.

Insurance companies?  Just one.

You get the picture.  In time, these sectors will develop, and as they do,
there will more places for all this foreign capital to go.   
Until then, it goes where it can.  And it pushes stocks up.

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My favorite investment sector, in both the U.S. and China, is the solar
power (photovoltaic) sector.  It's not for the faint of heart; what goes
up can come down fast, too.  But most companies in the industry are
enjoying triple-digit growth of revenues.  Their manufacturing costs are
falling, as they grow volumes and develop more efficient methods.  And
their profit margins are fat! We've suggested several solar investments in
recent issues of the Advisory, and you don't need any more.

So today I want to share with you my favorite non-solar Chinese
investment.  The stock first appeared in the pages of Cabot China &
Emerging Markets Report, but I wrote it up as Stock of the Month in early
March, and what I wrote then still applies today.  Here it is:

"Let's get one thing clear here.  We're not talking about gambling; we're
talking about playing.  About games, in the original sense.   
But this isn't kid stuff.  The online game industry has grown up, and
absorbs billions of dollars from gamers all over the world.

The most exciting action right now is taking place in China, for reasons
that are not hard to understand.  GDP is growing about 10% per year.  But
of 1.3 billion people, only 137 million have Internet access, and just
three-quarters of those have broadband connection, a necessity for playing
most of today's modern games.  So there's a vast untapped market.  But the
industry is growing fast; last year the number of online players increased
20% to 31 million, and their spending on these games increased a whopping
75%, to $830 million!

The9 Limited is our favorite of the top-tier game providers in China,
mainly because it's the fastest-growing.  The name, admittedly awkward,
refers to the claim that game is the ninth art, after the traditional
eight, namely painting, sculpture, architecture, literature, music, dance,
drama and movies.

But the real name to remember here is World of Warcraft, because that's
the game that accounts for 99% of The9's revenues!  World of Warcraft,
hereafter know as WoW, was launched by an American company, Blizzard
Entertainment, in November 2004, and currently serves more than 8 million
players worldwide.  Two million of these players are in North America, 1.5
million are in Europe, and 3.5 million are in China.  And every one of
those Chinese players is a customer of The9, which holds the exclusive
Chinese license.

What's so great about this game?  In a phrase, the fact that it's easy to
begin, but impossible to finish.  Despite the title, it's more than a war
game.  It's more of a quest game, in which you (via your onscreen
character) strive to complete quests.  In the early levels, these quests
are easy to complete alone.  But as you gain in experience, and the quests
become more complex, cooperation with other players - in real time -
becomes necessary.

So alliances are built up.  Experience builds.  Assets (gold, weapons,
clothing) accumulate, are used, and are accumulated again ... or are
bought and sold from other players, just as in the real world.  And the
amazing thing is that the vast majority of these other players, who are
cooperating in real time on screen, have never met in real life.  The
shorthand for games like this is MMORPG, for massively multiplayer online
role-playing game.

But on the screen, they form a society . . . and it's a big one.  In
China, the maximum number of payers online at one time in the fourth
quarter was 680,000, while the average number of players online at any
time is 340,000.  And it's beautiful society, visually, in an epic way. 
There are mountains, oceans, forests, towns and cities.   
Pets, beasts and monsters.  Good guys and bad guys.  And the virtual world
is ever-evolving.  On January 1, for example, fireworks went off at
midnight.  On February 18, it happened again, to celebrate the lunar
festival (Chinese New Year).

And sometimes, you've got to buy more software to keep up.  Back on
January 9, for example, the Dark Portal in Blasted Lands opened and demons
poured out.  But this content was only available to purchasers of the
Burning Crusade expansion pack.

In the U.S. you can buy WoW on Amazon for $20, and the expansion pack for
$40.  In China, prices are lower.  But the real money is in the monthly
fees!  In the U.S. it costs about fifty cents per day to play the game; in
China, it's about six cents per day.  And that's gravy for The9.

In the fourth quarter, revenues grew 38% from the year before to $36.2
million, while earnings jumped 66% to $0.53 per share.  Equally important,
profit margins swelled to a fat 36.1%.

So what's in the future?  More WoW, of course.  The end of this game's
life is nowhere in sight.  Nevertheless, the company is bringing out a
slew of new games that will broaden its revenue stream.  These include
Guild Wars and Soul of The Ultimate Nation, which have been developed
in-house, and three games that have been licensed from their makers:
Ragnarok Online 2 and Emil Chronicle Online, two cartoon-style MMORPGs,
and Huxley, a highly-rated MMORP first-person shooter game.

Looking further down the road, there's the inevitable advent of the gaming
consoles.  Today, you see, all gaming in China is done on computers. 
Dedicated gaming machines like the Microsoft Xbox 360, Sony PlayStation 3
and Nintendo Wii are not allowed.  But when they are (analysts say
Microsoft has already partnered with The9) you can bet The9 will be there
to serve the online market.

The stock . . . broke out to new price and RP peaks just last month and
ran up to 40 before pulling back into a consolidation phase.  As we write,
it's pulled back to below 35 to kiss its uptrending 50-day moving average,
and we think this presents a decent entry point."

Today, that buy looks pretty good; the stock has climbed back to 40, and
found decent support there, in part because of a published report that
U.S. giant Electronic Arts would pay $200 million for a 19% stake in NCTY.
 Electronics Arts denied this, but it's no secret the companies are
working closely on getting Electronic Arts' games distributed the Chinese
market.  And the action of the stock confirms that belief.

I think aggressive investors can buy a little now, or on any pullback
toward 37.

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Editor's note,

To receive regular updates on The9 Ltd. - including advice on when to
sell, consider a no-risk trial subscription to the Cabot Stock of the
Month.  Featuring my favorite stock from all Cabot's advisory services,
it's a great choice for you if you're confused about which Cabot product
is right for you.  To get started, simply click the link below.

http://cabotmail.net/t/156805/13148861/86/0/

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Yours in pursuit of wisdom and wealth,

Timothy Lutts
Publisher
Cabot Wealth Advisory

Tim Lutts is also the Editor of the Cabot Market Letter, our flagship
publication. Now in its 37th year of publication, the Cabot Market Letter
provides all you need to be a successful investor: market timing, stock
selection, education and specific, buy, sell, hold advice. To get started,
simply click the link below.

http://cabotmail.net/t/156805/13148861/78/0/

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