PREPARED BY NON-US BROKER-DEALER(S): BNP PARIBAS SECURITIES (ASIA) LTD THIS MATERIAL HAS BEEN APPROVED FOR U.S DISTRIBUTION. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES CAN BE FOUND AT APPENDIX ON PAGE 18 Transition pains may last n Maturity of titles may accelerate decline in player accounts Changyou’s total average monthly active game accounts fell 34% y-y in 4Q13. We believe this was due to the maturity of all three of its key titles: TLBB, DDTank and Wartune, which have been in operation for seven, five and two years, respectively. n High earnings dependency on three key games We estimate the three key games together contribute over 80% of Changyou's online game revenues. In our view, it will be challenging for new PC and mobile games in the pipeline to compensate for the slowdown in revenue growth from these three. n Heavy investments offer low visibility on returns The magnitude and duration of Changyou's increased investments is unclear – they could potentially be prolonged. Building a platform will be challenging, especially against more established platforms in the market. Changyou’s core competency is in developing and operating online games, not managing platforms. n Initiate coverage at REDUCE with a target price of USD24.0 We value Changyou using a DCF methodology, assuming 15% WACC and 0% terminal growth. Our target price of USD24.0 implies a 2015E P/E of 9.1x (we forecast a net loss for 2014). Heavy investments in 2014E with low visibility on returns Sources: Changyou, BNP Paribas estimates (20)020406080100(100)100300500700900201220132014E2015E(USD m)(%)RevenueGross margin (RHS)EBIT margin (RHS) 11 MARCH 2014 INITIATION 18CHINA / INTERNET CHANGYOU.COM CYOU US REDUCE TARGET PRICE USD24.00 CLOSE USD31.01 UP/DOWNSIDE -22.6% USD % HOW WE DIFFER FROM CONSENSUS MARKET RECS TARGET PRICE (%) (13) POSITIVE 3 EPS 2014 (%) (329) NEUTRAL 11 EPS 2015 (%) 36 NEGATIVE 2 Vey-Sern Ling vey-sern.ling@asia.bnpparibas.com +852 2825 1802 Alen Lin alen.lin@asia.bnpparibas.com +852 2825 1801 Our research is available on Thomson One, Bloomberg, TheMarkets.com, Factset and on http://eqresearch.bnpparibas.com/index. Please contact your salesperson for authorisation. Please see the important notice on the back page. KEY STOCK DATA YE Dec (USD m) 2013A 2014E 2015E 2016E Revenue 738 682 660 647 Rec. net profit 269 (16) 140 156 Recurring EPS (USD) 5.06 (0.30) 2.64 2.93 EPS growth (%) (5.4) nm nm 11.2 Recurring P/E (x) 6.1 neg 11.8 10.6 Dividend yield (%) 0.0 0.0 0.0 0.0 EV/EBITDA (x) 3.4 38.7 5.3 4.3 Price/book (x) 1.8 1.9 1.6 1.4 Net debt/Equity (%) (61.9) (59.1) (63.1) (66.4) ROE (%) 35.7 (1.8) 14.7 14.1 Share price performance 1 Month 3 Month 12 Month Absolute (%) 16.0 3.6 3.4 Relative to country (%) 14.8 13.6 10.7 Next results May 2014 Mkt cap (USD m) 1,649 3m avg daily turnover (USD m) 10.6 Free float (%) 19 Major shareholder Sohu (67%) 12m high/low (USD) 41.07/26.15 3m historic vol. (%) 42.2 ADR ticker - ADR closing price (USD) - Issued shares (m) 53 Sources: Bloomberg consensus; BNP Paribas estimates (12)8284826313641Mar-13Jun-13Sep-13Dec-13Mar-14(%)(USD)Changyou.comRel to MSCI China Changyou.com CYOU US Vey-Sern Ling 2 BNP PARIBAS 11 MARCH 2014 Investment thesis Changyou is one of the leading online game developers and operators in China, with almost 90% of its revenues from online games. 1. We see a declining trend in the number of Changyou game players due to the maturity of all three of Changyou's key games: TLBB, DDTank and Wartune, which have been in operation for seven, five and two years, respectively. 2. We estimate the three key games together contribute over 80% of Changyou's online game revenues. It will be challenging for new PC and mobile games in the pipeline to compensate for the slowdown in revenue growth from these three games, in our view. 3. The magnitude and duration of Changyou's recent step-up in investments are unclear, and they could potentially be prolonged, with low visibility on returns. Catalyst Downside catalysts include: 1) accelerating player loss from key games; 2) significant fall-off in revenue growth; 3) prolonged investments with no near-term returns. The key upside catalyst would be a privatisation bid, in our view. Risks to our call Key risks to our REDUCE rating are: 1) Earlier-than-expected recovery in margins and profits as the company reduces discretionary investments; 2) successful launches of new PC and mobile games leading to significant revenue growth; 3) Successful implementation of platform strategy leading to strong uptake of new software applications and growth in user traffic on the 17173.com game portal; and 4) Potential privatisation bids due to depressed valuations and recent privatisation bids on peers. Company background Key assumptions Founded in 2007 as an indirect wholly-o