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					                                                                              MORGAN                STANLEY                RESEARCH
                                                                              ASIA/PACIFIC


                                                                              Morgan Stanley Asia Limited+             Richard W Ji
                                                                                                                       Richard.Ji@morganstanley.com
                                                                                                                       +852 2848 6926

                                                                                                                       Gillian Chung
                                                                                                                       Gillian.Chung@morganstanley.com
                                                                                                                       +852 2848 5456

                                                                                                                       Jenny Wu, CFA
                August 17, 2010                                                                                        Jenny.Wu@morganstanley.com

                                                                                                                       Philip Wan, CFA
Stock Rating    Perfect World                                                                                          Philip.Wan@morganstanley.com

                                                                                                                       Timothy Chan, CFA
Overweight

Industry View
                Valuation Attractive yet                                                                               Timothy.Yh.Chan@morganstanley.com



Attractive
                Catalysts still Pending                                       Key Ratios and Statistics
                                                                              Reuters: PWRD.O Bloomberg: PWRD US
                                                                              China Internet
                What's Changed                                                Shr price, close (Aug 16, 2010)                                           US$24.81
                ModelWare EPS 10-12e                       down 9% to 21%     Mkt cap, curr (mn)                                                        US$1,314
                                                                              52-Week Range                                                        US$50.49-20.75
                                                                              EV, curr (mn)                                                             US$1,057
                Earnings shy: Sales of Rmb594mn declined 5% QoQ               Net debt/cap (12/07) (%)                                                    1,415.9
                but rose 14% YoY, largely in line with our estimates.         Sh out, dil, curr (mn)                                                           53
                                                                              S'hldr eqty (12/07) (mn)                                                    US$190
                Diluted EPADS of Rmb3.71 dropped 35% QoQ and 25%
                                                                              Avg daily trading value (mn)                                                 US$35
                YoY, 22% below our forecasts on higher costs.
                                                                              Fiscal Year ending                            12/09      12/10e       12/11e       12/12e
                What we liked: 1) Overseas revenues (~9% of total
                                                                              ModelWare EPS (Rmb)                           19.48       17.43        21.90        26.10
                sales) grew 3% QoQ and 19% YoY, aided by the                  Prior ModelWare EPS (Rmb)                         -       22.01        25.39        28.54
                successful launch of Pocketpet Journey West in Korea,         EPS (Rmb)**                                    19.5        17.4         21.9         26.1
                Battle of Immortals in Vietnam, and Zhu Xian in Korea         Prior EPS (Rmb)**                                 -        22.0         25.4         28.5
                and Russia. 2) PWRD expects 3Q sales to stabilize and         Revenue, net (US$ mn)                          314         368          459          564
                likely recover (+0-5% QoQ), helped by favorable               ModelWare net inc (US$ mn)                     152         136          171          206
                seasonality. 3) The company is considering a share            P/E                                            13.8         9.7          7.7          6.5
                buyback, pending the board approval.                          P/BV                                            5.8         2.6          1.9          1.5
                                                                              EV/EBITDA                                      11.0         6.0          3.8          2.2
                What concerned us: Online game sales shrank 5%                Div yld (%)                                     5.5         0.0          0.0          0.0
                                                                              Unless otherwise noted, all metrics are based on Morgan Stanley ModelWare
                QoQ and rose only 14% YoY. Its active paying customer         framework (please see explanation later in this note).
                                                                              ** = Based on consensus methodology
                volume declined 14% QoQ and 24% YoY, while online             e = Morgan Stanley Research estimates
                game ARPU dipped 5% QoQ but advanced 23% YoY.
                Such sequential declines were largely due to the
                deceleration of the in-game promotions and
                monetization activities, tighter anti-cheating initiatives,
                and underperformance of Fantasy Zhuxian.

                Attractively valued but awaiting a catalyst: We
                highlight that: 1) despite its near-term weakness, PWRD
                has an industry-leading “hit ratio” of turning its new
                games into blockbusters. It owns one of the strongest
                game pipelines with differentiated new titles in all 2D,      Morgan Stanley does and seeks to do business with
                2.5D, and 3D categories. 2) It is the online game export      companies covered in Morgan Stanley Research. As
                leader in China, with ~40% China’s online game export         a result, investors should be aware that the firm may
                market share in 2009, we estimate. 3) It trades at 7x our     have a conflict of interest that could affect the
                2011e earnings and we forecast that its profit may rise       objectivity of Morgan Stanley Research. Investors
                                                                              should consider Morgan Stanley Research as only a
                20-25% annually for the next 3 years. We are closely          single factor in making their investment decision.
                monitoring the debut of Forsaken World (3D), Dragon
                                                                              For analyst certification and other important
                Excalibur (2D), and XiaoAoJiangHu, which may turn into        disclosures, refer to the Disclosure Section,
                new catalysts for the company.                                located at the end of this report.
                                                                              += Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be
                                                                              associated persons of the member and may not be subject to NASD/NYSE restrictions on
                                                                              communications with a subject company, public appearances and trading securities held by a
                                                                              research analyst account.
                                                                                         MORGAN             STANLEY              RESEARCH

                                                                                         August 17, 2010
                                                                                         Perfect World




Financial Summary
Fiscal year ends December 31
Income Statement, 2008-12E                                                               Cash Flow Statement, 2008-12E
(RmbMM)                                     2008      2009    2010E    2011E    2012E    (RmbMM)                                      2008    2009E    2010E    2011E     2012E
Online game operation                      1,251     1,880    2,278    2,850    3,493    Net income                                   646     1,038      925    1,166     1,403
Overseas licensing                           186       215      217      276      343    Ajustments for:
Total revenues                             1,437     2,144    2,503    3,126    3,836      Share-based compensation                    50       78        61       82       102
  % change Y/Y                             109%       49%      17%      25%      23%       Depreciation and amortization expenses      22       44        72      100       133
                                                                                         Changes in:
Gross profits                              1,262     1,845    2,115    2,640    3,219
                                                                                           Accounts receivables                       (22)     (44)      (63)     (85)     (112)
Gross margin (%)                            88%       86%      85%      84%      84%
                                                                                           Prepayments and other assets               (29)     (64)     (100)    (140)     (184)
  % change Y/Y                             121%       46%      15%      25%      22%
                                                                                           Deferred tax liabilities                    26       13         6       11        13
Sales and marketing                         (254)     (336)    (478)    (564)    (615)     Accounts payables                           (1)      29        47       56        68
General and administrative                  (102)     (154)    (254)    (305)    (374)     Advance from customers                      29       22        14       35        47
Research and development                    (228)     (270)    (361)    (437)    (532)     Salary and welfare payable                  31       40         0       36        43
Operating profits                           677      1,084    1,022    1,334    1,698      Taxes payable                                7       20        24       31        52
Operating margin (%)                        47%       51%      41%      43%      44%       Accrued liabilities                          9       15        21       25        30
  % change Y/Y                              93%       60%       -6%     31%      27%       Deferred revenue                           113      123       126      152       173
Interest income / (expense)                   35        15       23       33       47    Cash from operations                         972     1,315    1,134    1,468     1,768
Others                                       (13)        6        2        3        3    Purchase of fixed assets, software          (760)    (152)     (127)    (190)     (194)
Pretax profits                               700     1,106    1,047    1,369    1,748    Purchase of copyrights                        (1)     (41)      (43)     (45)      (46)
Income tax                                   (53)      (68)    (122)    (204)    (345)   Cash paid for the assets acquired           (103)    (150)     (111)    (111)     (111)
Net profits                                 646      1,038      925    1,166    1,403    Cash held in escrow a/c for InterServ       (150)     150         0        0         0
Net profit margin (%)                       45%       48%      37%      37%      37%     Purchase of short-term investment            (50)      10         0        0         0
   % change Y/Y                             79%       61%     -11%      26%      20%     Cash paid for equity investment              (24)      (1)     (200)       0         0
                                                                                         Cash from investing                        (1,088)   (185)     (480)    (345)     (351)
Net earnings per share, basic (Rmb)         2.30      4.11     3.71     4.65     5.58
Net earnings per share, dilute (Rmb)        2.18      3.89     3.49     4.38     5.22    Repurchase of company shares                   (5)   (743)        0        0         0
Net earnings per ADS, basic (Rmb)          11.50     20.56    18.54    23.25    27.90    Cash from financing                            (1)   (743)        0        0         0
Net earnings per ADS, dilute (Rmb)         10.91     19.46    17.44    21.92    26.12    Change in cash                              (163)      388      654    1,123     1,417
                                                                                         Cash at beginning of year                  1,496     1,333    1,721    2,375     3,497
                                                                                         Cash at end of year                        1,333     1,721    2,375    3,497     4,915
Balance Sheet, 2008-12E
                                                                                         *Foreign exchange rate is 7.29 Rmb/US$ for 2007, 6.79 Rmb/US$ for 2008, 6.75 Rmb/US for
(RmbMM)                                     2008      2009    2010E    2011E    2012E    2009 and 6.53 from 2010 onward. Source: Company reports; Morgan Stanley Research. E =
Cash and cash equivalent                   1,333     1,721    2,375    3,497    4,915    Morgan Stanley Research estimates.
short-term investment                         50        40       40       40       40
Accounts receivables                          39        82      146      231      344
Prepayments                                   36       100      200      340      524
Total current assets                       1,610     1,946    2,764    4,114    5,828
Equity investment                             23        37      237      237      237
Property and equipment                       169       302    1,121    1,242    1,343
Construction in progress                     714       742        0        0        0
Intengible assets                             26        54       75       89       95
Goodwill                                       0       111      221      332      442
Long term deposit                             19        19       19       19       19
Total assets                               2,562     3,212    4,438    6,032    7,964        Company Description
                                                                                             Perfect World (PW) is the leading 3D online game developer
Accounts payables                             14       41       79      125      180
                                                                                             and operator in China. It operates four self-developed 3D
Advance from customers                        78      100      114      149      196
Salary and welfare payable                    62      102      102      138      181         massive multiplayer online role-playing games, namely: Perfect
Taxes payable                                 21       41       66       96      148         World, Legend of Martial Arts, Perfect World II, and Zhuxian. It
Accrued liabilities                           25       40       60       85      115         has licensed Perfect World II and Legend of Martial Arts to over
Deferred revenue                             223      331      448      586      743
                                                                                             10 countries and regions, including Korea, Japan, and Taiwan.
Share repurchase liabilities                 387        0        0        0        0
Deferred Tax liabilities                      26       39       45       57       69
                                                                                             PW was founded in 2004 and listed on the Nasdaq in July 2007.
Total current liabilities                    836      695      917     1,239    1,637        China Internet
Total liabilities                            897      773     1,012    1,359    1,786
                                                                                             Industry View: Attractive
Additional paid-in capital                 1,178     1,256    1,317    1,400    1,502
                                                                                             We believe the internet industry, while in its early stages and
Treasury stock                              (391)        0        0        0        0
Statutory reserves                            95       194      278      378      491
                                                                                             risky, is among the fastest-growing industries in China and may
Accumulated deficit /                        849     1,040    1,881    2,948    4,238        offer investors one of the better ways to benefit from China’s
Accumulated other comprehensive loss         (66)      (66)     (66)     (66)     (66)       strong consumer market growth.
Total equity                               1,666     2,438    3,425    4,673    6,178
Total liabilities and equity               2,562     3,212    4,438    6,032    7,964
Source: FactSet, Morgan Stanley Research estimates




                                                                                                                                                                             2
                                                                                                        MORGAN                           STANLEY        RESEARCH

                                                                                                        August 17, 2010
                                                                                                        Perfect World




Risk-Reward Snapshot: Perfect World (PWRD.O, US$24.81, OW)
Risk-Reward View: Substantial Upside Potential Vs. Modest Downside                                                                                 Investment Thesis
                                                                                                                                                   • PWRD is emerging as an innovative
      $80


           70                                                                                                                                        leader for 3D online game and
                                                                                                             $68.7 (+177%)
                                                                                                                                                     entertainment content, largely thanks
           60
                                                                                                           $57.3 (+131%)
                                                                                                                                                     to its cutting-edge game development
                                                                                                                                                     platform and its skilful adoption of local
           50
                                                                                                                                                     cultural hot spots.
           40                                                                                                                                      • It sets itself apart from its rivals by
                                                                                                                                                     focusing on higher-margin in-house
           30                                                                        $ 24.81                                                         development, the faster-growing 3D
           20
                                                                                                                                                     game market, and overseas
                                                                                                              $19.6 (-21%)
                                                                                                                                                     expansion.
           10
                                                                                                                                                   Key Value Drivers
           0
           Aug-08                Feb-09        Aug-09              Feb-10            Aug-10         Feb-11                     Aug-11
                                                                                                                                                   • We estimate PWRD’s online gamer
                     Base Case (Aug-11)              Historical Stock Performance              Current Stock Price
                                                                                                                 WARNINGDONOTEDIT_RRS4RL~PWRD.O~
                                                                                                                                                     volume (ACU) will soar at a 10-year
                                                                                                                                                     CAGR of 13% to 2.7mn in 2020.
 Price Target: NA                                                                                                                                  • Upswing of average spending per
                                                                                                                                                     gamer with monthly ARPU per ACU
 Bull                       18x Bull        Better-than-expected sales growth: We assume PWRD’s
                                                                                                                                                     estimated to rise at a 10-year CAGR of
 Case                       Case 11e        long-term user market share at 4%, 10-year CAGR of ARPU per
 US$68.7                    EPS*            ACU at 4%, and 10-year CAGR of overseas revenues at 14%.                                                 3% to Rmb316 in 2020.
                                                                                                                                                   • Expansion of overseas licensing with
 Base                       16x Base        Sustained growth: We assume PWRD’s long-term user market                                                 sales climbing at a 10-year CAGR of
 Case                       Case 11e        share at 3%, 10-year CAGR of ARPU per ACU to be 3%, and                                                  13% to an estimated Rmb0.7bn in
 US$57.3                    EPS*            10-year CAGR of overseas revenues at 13%.
                                                                                                                                                     2020.
 Bear                       8x Bear         Capped growth due to competition: We assume PWRD’s
                                                                                                                                                   Potential Catalysts
 Case                       Case 11e        long-term user market share at 3%, 10-year CAGR of ARPU per
 US$19.6                    EPS*            ACU to be -7%, and 10-year CAGR of overseas revenues at 3%.                                            • Existing games, including Zhuxian and
                                                                                                                                                     Perfect World 2, Battle of Immortal,
* P/E multiples based on each case’s value and 2011e EPS in respective scenario.
                                                                                                                                                     Fantasy Zhuxian become more
                                                                                                                                                     popular.
Bear to Bull: Market Share Gains Driving Valuation
                                                                                                                                                   • New games, such as Forsaken World,
           100                                                                                                                                       Dragon Excalibur, Xiao Ao Jiang Hu,
                                                                                                                                                     turn out to be hits.
                80
                                                                                       5.4
                                                                                                 5.5           0.5
                                                                                                                                                   • Margins improve due to better
                                              31.4           2.7
                60                                                                                                                     68.7          monetization and economies of scale.
   (US$)




                                                                            57.3
                40                                                                                                                                 Key Risks
                                      3.6
                20                                                                                                                                 • Competition in online gaming eroding
                          19.6                                                                                                                       PWRD’s market share
                0
                                                                                                                                                   • Governmental regulation of the online
                         Bear        User    10-year  10-year            Base          User    10-year  10-year                      Bull
                         Case       market CAGR of CAGR of               Case         market   CAGR of CAGR of                       Case            game industry
                                  share ~3% ARPU ~3% overseas                       share ~4% ARPU ~4% overseas                                    • Product cycle risks, causing sales
                                                     sales 13%                                         sales 14%                                     volatility
Source: FactSet, Morgan Stanley Research estimates




                                                                                                                                                                                            3
                                                                 MORGAN              STANLEY         RESEARCH

                                                                 August 17, 2010
                                                                 Perfect World




2Q10: Valuation Attractive but Awaiting a Catalyst …
2Q10 Financials                                                  Exhibit 1

In 2Q10, Perfect World’s net sales declined 5% QoQ but           Perfect World: Performance Analysis
advanced 14% YoY to Rmb594mn, 2% below our estimates.                                                 2Q09       3Q09   4Q09   1Q10   2Q10
                                                                     Revenue split
•   Net sales from the online game operation (90% of total       Domestic                              91%       82%    89%    91%    90%
    sales) dipped 6% QoQ but rose 12% YoY to Rmb533mn,           Overseas                               9%       10%    10%     9%     9%
    4% below our estimates. Average concurrent users (ACU)       Others                                           8%     1%     0%     1%
    for 1Q10 dipped 11% QoQ to 886k. Average revenue per         Total Revenue                       100%        100%   100%   100%   100%
    user (ARPU) for games under the item-based revenue
    model declined 5% QoQ to 292Rmb. Active paying                   Margin analysis
    customers (APC) for games under the item-based model         Gross margin                          87%       84%    87%    86%    84%
    dropped 14% QoQ to 1.4mn.                                    Operating margin                      54%       50%    45%    52%    37%
                                                                 Net margin                            50%       49%    45%    49%    33%
•   Net sales from overseas licensing grew 3% QoQ and 19%
    YoY to Rmb55mn, accounting for 9% of total revenues (vs.
                                                                     Growth rates QoQ
    9% in 1Q10 and 9% in 2Q09).
                                                                 Domestic                              26%        2%    12%     5%     -6%
                                                                 Oversea                               -4%       27%     5%    -13%    3%
Operating profit dropped 31% QoQ and 21% YoY to
                                                                 Total Revenue                         23%       13%     3%     3%     -5%
Rmb221mn, with an operating margin of 37% (vs. 52% in 1Q10
                                                                 Gross profits                         23%        9%     6%     2%     -8%
and 54% in 2Q09). Excluding share-based compensation
                                                                 Operating profits                     21%        6%     -7%   17%    -31%
(SBC) of Rmb25mn, operating profit was down 29% QoQ and          Pretax profits                        20%        6%     -4%   16%    -32%
18% YoY to Rmb247mn, with an operating margin of 41% (vs.        Net profits                           22%       10%     -6%   13%    -36%
55% in 1Q10 and 58% in 2Q09).                                    Source: Company data, Morgan Stanley Research


Net profit was Rmb197mn, down 36% QoQ and 25% YoY, with
a net profit margin of 33% (vs. 49% in 1Q10 and 50% in 2Q09).    Please refer to the following reports for more of our views:
Excluding SBC, net profit dropped 32% QoQ and 22% YoY to
Rmb222mn with a net margin of 37% vs. 52% in 1Q10 and            •      Softer Guidance, New Game Launches Skewed to 2H10,
                                                                        May 18, 2010
54% in 2Q09.
                                                                 •      4Q09: Stronger at Home Market, More Upside Abroad,
Fully diluted earnings per ADS were Rmb3.71, compared to                March 2, 2010
Rmb5.75 in 1Q10 and Rmb4.94 in 2Q09. Excluding SBC, fully
                                                                 •      3Q09: Owning a Well Rounded Portfolio, November 17,
diluted earnings per ADS were Rmb4.19 (vs. Rmb6.16 in 1Q10              2009
and Rmb5.32 in 2Q09).
                                                                 •      2Q09: Strategic Fine-tuning Bears Fruit, August 11, 2009
For 3Q10, the company guided that total sales to be in a range   •      Raising Estimates on New Guidance, June 24, 2009
of Rmb594-624mn, implying 0%-5% QoQ and up 1-6% YoY.
                                                                 •      1Q09: BI and Zhuxian Franchise May Fuel Growth, May
Due to the company’s deceleration of in-game promotions and             19, 2009
monetization activities, we have trimmed our forecast. We        •      4Q08: Weak in the Near Term, yet Deep in Value, March
modeled net sales of Rmb2.5bn (down 5% vs. our prior                    3, 2009
estimate) for 2010, Rmb3.1bn (down 5%) for 2011, and
                                                                 •      3Q08: Pocketpet Journey West – Another Hit Game,
Rmb3.8bn (down 5%) for 2012. We have also modified our                  November 11, 2008
earnings per diluted ADS estimate to Rmb17.44 (down 20%)
for 2010, Rmb21.92 (down 14%) for 2011, and Rmb26.12             •      2Q08: Staying on Track in a Choppy Market, August 19,
(down 9%) for 2012, due to the company’s lower operating                2008
margin.                                                          •      Lifting 2Q Guidance on Better Game Performance,
                                                                        June 16, 2008




                                                                                                                                        4
                                                                                        MORGAN        STANLEY               RESEARCH

                                                                                        August 17, 2010
                                                                                        Perfect World



Exhibit 2
Perfect World: Highlights of Quarterly Income Statements
(RmbMM)                                2Q09     3Q09    4Q09    1Q10    2Q10 2Q10E      QoQ    YoY    vs. Est Comments
Online game operation                  475      486     542     570     533     553      -6%    12%       -4%   ACU was 886k (down 11% QoQ), APC was 1.4mn (down 14% QoQ) and ARPU was Rmb292 (down 5% QoQ)
Overseas licensing                       46      59      62      53      55      51      3%     19%       9%
Movie                                            45        4      2        6       0
Net revenues                           521      590     608     625     594     604      -5%    14%       -2%
  % change Q/Q                         23%      13%      3%      3%     -5%     -3%


Cost of services                        (67)     (95)    (82)    (87)    (98)    (93)    12%    46%       4%
Gross profits                          455      495     526     538     497     510      -8%    9%        -3%
  Gross margin (%)                     87%      84%     87%     86%     84%     85%
  % change Q/Q                         23%       9%      6%      2%     -8%     -5%


                                                                                                                 due to consolidation of C&C Media, launch of large expansion packs for "Zhu Xian" and Fantasy Zhu Xian and expenses
Sales and marketing                     (73)     (88)   (125)    (82)   (121)   (103)    47%    66%    17%      related to attending a nationwide industrial exhibition in U.S.
General and administrative              (37)     (38)    (48)    (55)    (63)    (59)    16%    71%       8%    due to consolidation of C&C Media, partially offset by decrease in professional service expenses.
                                                                                                                due to hiring more R&D talents and consolidation of Runic Games. Partially offset by Rmb11mn capitalization of
Research and development                (65)     (72)    (77)    (78)    (91)    (81)    17%    40%    12%      development costs for two games under testing.
Operating profits                      280      298     277     323     221     266     -31%   -21%   -17%      Ex-SBC, operating profit was Rmb247mn, down 29% QoQ and 18% YoY
  Operating margin (%)                 54%      50%     45%     52%     37%     44%                             Ex-SBC, operating margin was 41%, vs. 55% in 1Q10 and 58% in 2Q09
  % change Q/Q                         21%       6%     -7%     17%     -31%    -18%


Interest income / (expense)               4        3       5       5       6       6     12%    63%       5%
Others                                   (1)      (1)      7       5      (1)      5
Pretax profits                         282      300     288     334     226     278     -32%   -20%   -19%


Income tax                              (20)     (11)    (18)    (29)    (30)    (23)    3%     50%       30%
Net profits                            262      289     271     305     197     255     -36%   -25%   -23%      Ex-SBC, net profit was Rmb222mn, down 32% QoQ and 22% YoY
  Net profit margin (%)                50%      49%     45%     49%     33%     42%                             Ex-SBC, net margin was 37%, vs. 52% in 1Q10 and 54% in 2Q09
  % change Q/Q                         22%      10%     -6%     13%     -36%    -16%


Minority Interest                         0       (1)     (0)      0       0       0
Net income to ordinary shareholders    263      288     271     305     197     255     -36%   -25%   -23%


Net earnings per share, basic          1.04     1.17    1.09    1.22    0.79    1.01    -36%   -25%   -22%
Net earnings per share, diluted        0.99     1.10    1.02    1.15    0.74    0.96    -35%   -25%   -22%
Net earnings per ADS, basic            5.21     5.83    5.44    6.12    3.93    5.05    -36%   -25%   -22%
Net earnings per ADS, diluted          4.94     5.50    5.09    5.75    3.71    4.78    -35%   -25%   -22%      Ex-SBC, EPADS was Rmb4.19, vs. Rmb6.16 in 1Q10 and Rmb5.32 in 2Q09
E = Morgan Stanley Research estimates
Source: Company data, Morgan Stanley Research




                                                                                                                                                                                   5
                                                                                                        MORGAN             STANLEY              RESEARCH

                                                                                                        August 17, 2010
                                                                                                        Perfect World




What We Liked? Overseas Upside + 3Q Sales Stabilization                                                          Notably, 1) it self-operates four games in the US, which is
                                                                                                                 the world’s second largest Internet country by online
No. 1 – Overseas revenues grew 3% QoQ and 19% YoY, aided
                                                                                                                 population. 2) The company acquired the Japan-based
by the successful launch of Pocketpet Journey West in Korea,
                                                                                                                 C&C Media in April. Via C&C Media, it previously
Battle of Immortals in Vietnam, and Zhu Xian in Korea and
                                                                                                                 out-licensed four games to Japan, the third largest Internet
Russia. We highlight that:
                                                                                                                 market in the world with ~127mn online users in 2009
                                                                                                                 (Internet World Stats). 3) Perfect World also opened its
•      Perfect World tops peers in online game export. It owned
                                                                                                                 European office in 1Q, by leveraging its operating
       ~40% of China’s online game export market share last
                                                                                                                 know-how gained from the US market.
       year and may enlarge its market share to 50-60% this
       year.
                                                                                                        •        The top overseas market by revenue contribution include
                                                                                                                 the US (5-10% of sales contribution now, on our
•      To date, the company has out-licensed 8 games to
                                                                                                                 estimates), Japan (100% self-operated), Taiwan, and
       overseas distributors in 50+ countries and regions.
                                                                                                                 Russia.



Exhibit 3
Perfect World: Top Online Game Exporter from China
    Game               Country / Region                    Licensee                  Time                   Game               Country / Region                    Licensee                 Time

    PW II              Taiwan, Hong Kong, Macau            Soft-World                Dec-06                 Chibi              Taiwan                              TIC                      Sep-08
                       Vietnam                             Quang Minh DEC            Feb-07                                    Hong Kong and Macau                 Gamania                  Sep-08
                       Malaysia and Singapore              Cubinet Interactive       Mar-07                                    Malaysia and Singapore              Cubinet Interactive      3Q08
                       Japan                               C&C Media                 Apr-07                                    Thailand and Vietnam                Cubinet Interactive      4Q09
                       Philippines                         Level Up!                 Jul-07                                    Japan                               C&C Media                Jun-09
                       Korea                               CJ Internet               Oct-07                                    Korea                               KTHitel                  Dec-09
                       Thailand                            Cubinet Interactive       Jan-08
                       Brazil                              Level Up!                 May-08                 HDP                Malaysia and Singapore              Cubinet Interactive      Apr-09
                       Russia                              Astrum Nival              Jun-08                                    Thailand                            Cubinet Interactive      Jul-09
                       Indonesia                           LYTO                      Aug-08                                    Taiwan                              TIC                      3Q09
                       ~40 European countries              Games-Masters             2H08                                      Hong Kong and Macau                 Gamania                  3Q09
                       US                                  Self-operation            2H08                                      Russia                              Astrum Nival             2H10e


    LMA                Taiwan, Hong Kong, Macau            Soft-World                Nov-07                 PJW                US                                  Self-operation           1Q09
                       Japan                               C&C Media                 Feb-08                                    Korea                               Synopex Greentech        2Q09
                       Malaysia and Singapore              Cubinet Interactive       Mar-08                                    Taiwan                              TIC                      3Q09
                       Thailand and Vietnam                Cubinet Interactive       4Q08                                      Hong Kong, Macau                    Gamania                  3Q09
                       Korea                               EYA Interactive           Jun-09
                                                                                                            BI                 Taiwan, Hong Kong, Macau            Game Flier               Sep-09
    Zhu Xian           Taiwan, Hong Kong, Macau            Soft-World                Jun-08                                    Korea                               NDOORS                   Jan-10
                       Japan                               C&C Media                 Nov-08                                    Vietnam                             Vina Group               May-10
                       Philippines                         IP E-Game                 Dec-08                                    Russia                              Astrum Nival             2H10e
                       Malaysia and Singapore              Cubinet Interactive       2H08
                       Thailand and Vietnam                Cubinet Interactive       1Q09                   FZX                Taiwan                              TIC                      2H10e
                       US                                  Self-operation            Jun-09
                       Taiwan (Zhu Xian 2)                 Soft-World                4Q09
                       Russia                              Astrum Nival              May-10
                       Korea                               CJ Internet               Jun-10


No. of regions          50+
Note: PW II refers to Perfect World II, LMA refers to Legend of Martial Arts, HDP refers to Hot Dance Party, PJW refers to Pocketpet Journey West, BI refers to Battle of the Immortals and FZX refers
to Fantasy Zhuxian; e = Company estimates; Source: Company data, Morgan Stanley Research




                                                                                                                                                                                                   6
                                                                     MORGAN        STANLEY       RESEARCH

                                                                     August 17, 2010
                                                                     Perfect World




•   Overseas market contributed ~9% of the company’s total                game in China. In comparison, the industry’s “hit ratio”
    sales, flattish QoQ and YoY, and ~20% of its net profits.             averages at only ~5%, on our estimates.
    On our observation, out-licensing often carries higher
    profit margin, as: 1) licensors generally collect upfront fees   •    Perfect World owns a portfolio with differentiated games in
    and share 20-30% revenues from licensees. 2) Licensors                all of the 3D, 2.5D and 2D game categories, while it had
    incur minimal incremental costs, mainly for providing                 only 3D games at its IPO three years ago. The compay
    technical supports. 3) We estimate the net margin for                 plans to launch Forsaken World (3D) and Dragon
    online game export should exceed 80%-90%, twice as                    Excalibur (2D) in 3Q and 4Q, respectively. It aims to debut
    high as the level for self-operation in China.                        its highly anticipated Xiao Ao Jiang Hu in 2Q-3Q next year.
                                                                          Notably, 1) these game launches may serve as catalysts
No. 2 – Perfect World expects 3Q sales to stabilize and likely            for Perfect World’s sales expansion. 2) The company has
recover (+0-5% QoQ):                                                      prolonged the testing period for new games to 6-9 months
                                                                          (vs. 1-2 months previous) to strengthen game content and
•   Such guidance implies 1-6% of sales growth YoY.                       optimize player experience. 3) We conservatively budget
                                                                          in only 2% of 2010e sales.
•   Historically, 3Q is often the peak season for online game
    activities, helped by summer school holidays.                    No. 4 – We consider Perfect World undervalued, as:

•   The company started to re-focus on its in-game                   •    It trades at 9x our 2010e earnings and 7x 2011e. On our
    promotions and monetization – 1) It released four                     estimates, 1) the company may deliver 20-25% YoY
    expansion packs in 2Q, including Drum Your Heart Out for              earnings growth for the next three years. As a result, it has
    Hot Dance Party, The Rookie and the General for Chi Bi,               a low PEG ratio of 0.6 based on our projected three-year
    Rise of the Dragons for Fantasy Zhuxian and The New                   operating profit CAGR. 2) It is priced at a 20-50% discount
    World for Zhuxian. 2) On July 14, the company launched                to its peers, such as NetEase and Shanda. 3) Based on
    an expansion pack for Pocketpet Journey West, A Cool                  our analysis, the current share price conservatively implies
    Summer, which features new costumes, tools and                        Perfect World’s sales may only grow 5-10% p.a. over the
    creatures.                                                            next five years, vs. 20-30% for overall online game market
                                                                          in China, on our estimates.
No. 3 – Despite its near-term challenges, Perfect World has
been a leading online game innovator, with one of the                •    According to the company, it is considering a share
strongest game pipeline in China. Notably,                                buyback, subject to board approval. Notably, 1) Perfect
                                                                          World owned US$254mn net cash at the end of 2Q,
•   As a leader for in-house development, the company                     accounting for ~20% of its market value, on our estimates.
    self-produced all eight of its games in operation. On our             2) Share repurchase, which suggests management
    observation, relative to the game licensing companies,                consider the stock undervalued, tends to be a leading
    game developers often enjoy higher margins as they do                 indicator for share price outperformance, on our
    not need to pay licensing royalties, which typically range            observation.
    around 20-30% of online game sales.

•   It enjoys an industry-leading “hit ratio” – most of its
    self-developed MMO games turned into blockbusters (with
    peak concurrent users of 100,000+). In particular, Zhuxian
    has probably turned into the most popular domestic 3D




                                                                                                                                     7
                                                                 MORGAN        STANLEY      RESEARCH

                                                                 August 17, 2010
                                                                 Perfect World




What Concerned Us? Softer 2Q Sales + Lower Margin                No. 2 – Operating margin shrank 14ppts QoQ and 16ppts YoY
                                                                 to 37%, near its lowest point since its IPO.
No. 1 – Online game sales shrank 5% QoQ and rose only
14% YoY.
                                                                 •    Gross margin dipped 2.5% QoQ and 3.6% YoY to 83.6%,
                                                                      largely due to softer sales performance.
•   Its top 3 games by revenue contribution included Zhu Xian,
    Perfect World 2, and The Battle of Immortals.
                                                                 •    Operating costs rose by 28% QoQ and 57% YoY in 2Q, as:
                                                                      1) the company incurred heavier costs due to the
•   Its active paying customer (APC) volume declined 14%
                                                                      consolidation of the Japan-based C&C Media, higher
    QoQ and 24% YoY to 1,433,000. Its ACU for games in
                                                                      marketing/promotion costs related to the debut of large
    mainland China approximated 886,000, down 11% QoQ
                                                                      expansion packs for Zhu Xian and Fantasy Zhu Xian, and
    but up 16% YoY.
                                                                      the expense associated with attending a nationwide
                                                                      industrial exhibition in the US. 2) Perfect World has more
•   Online game ARPU dipped 5% QoQ but advanced
                                                                      than doubled its R&D staff YoY to 1,800 nowadays.
    23% YoY to Rmb292.
                                                                 •    The company expects its margin to still be under pressure
•   Such sequential declines were largely due to the
                                                                      in 3Q due to heavier promotions for the launch of Forsaken
    deceleration of the in-game promotions and monetization
                                                                      World and the marketing activities at ChinaJoy. Yet its
    activities, tighter anti-cheating initiatives, and
                                                                      margin should improve in 4Q, helped by accelerating new
    underperformance of its newly launched Fantasy
                                                                      game sales.
    Zhu Xian.




                                                                                                                              8
                                                                    MORGAN                           STANLEY   RESEARCH

                                                                    August 17, 2010
                                                                    Perfect World




Valuation and Rating                                                At today’s trading price of ~US$25, Perfect World is trading at
                                                                    7.4x our 2010 earnings forecast, implying a P/E vs. growth ratio
We reiterate our Overweight rating on Perfect World.                (or PEG ratio) of 0.6 based on our projected three-year
Discounted cash flow (DCF) valuation is our preferred               operating profit CAGR of ~16% from 2010-12.
methodology for valuing the company, as it incorporates our
long-term view about the company’s operations. For our DCF          Downside risks to our valuation include: 1) competition in the
valuation, we assume a discount rate of 15% (vs. previously         online gaming industry, which may erode Perfect World’s
15%) and a free cash flow exit multiple of 8x (vs. previously 9x)   market share; 2) government regulation of the online gaming
at a terminal growth rate of 3% (vs. 4% previously as the           industry; and 3) product cycle risk, which may cause sale
company intends to decelerate its in-game monetization              volatility.
activities.)
                                                                    Exhibit 7: Perfect World: P/E Band
•   Our base-case DCF valuation yields a fair value of
    US$57.3 for the stock, as we assume Perfect World’s                                     60
    long-term user (ACU) market share at ~3% (vs. previous
    assumption of ~2%), 10-year CAGR of ARPU per ACU to                                     50
    be 3% (previously 7%) and 10-year CAGR of overseas
                                                                                                                               15x
    revenue at low-10% (no change).                                   Share Price (US$)
                                                                                            40

•   Our bull-case DCF valuation produces a value of US$68.7
    for the stock, implying 20% upside potential relative to our                            30                                 10x

    base-case value. Our bull case assumes Perfect World’s
    long-term user market share at ~4% (previously 2%),                                     20
    10-year CAGR of ARPU per ACU at ~3% (previously ~8%),                                                                      5x
    and 10-year CAGR of overseas revenues at mid-10% (no                                    10
    change).
                                                                                             0
•   Our bear-case DCF valuation generates a value of
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    our base-case value. In our bear case, we assume Perfect
    World’s long-term user market share at ~3% (previously          * P/E is based on our estimated 12-month forward EPS
    0.8%), 10-year CAGR of ARPU per ACU to be -7%                   Source: FactSet, company data, Morgan Stanley Research

    (previously 2%), and 10-year CAGR of overseas revenue
    at 3% (previously 2%).




                                                                                                                                    9
                                                                                                    MORGAN        STANLEY         RESEARCH

                                                                                                    August 17, 2010
                                                                                                    Perfect World




Exhibit 8
Perfect World: Discounted Cash Flow Valuation for Base Case
Discounted cash flow
(RmbMM)                                   2008             2009       2010E       2011E    2012E       2013E    2014E    2015E    2016E    2017E    2018E     2019E     2020E
Revenue                                  1,437           2,144        2,503       3,126    3,836       4,648    5,519    6,443    7,385    8,338    9,227    10,150    11,108
   % revenue growth                      109%               49%         17%         25%      23%         21%      19%      17%      15%      13%      11%       10%        9%
EBIT                                       677            1,084       1,022       1,334    1,698       2,064    2,471    2,874    3,235    3,580    3,850     4,147     4,460
+ Other income                             (13)               6           2           3        3           4        5        5        6        7        8         8         9
- Tax                                      (51)             (67)       (119)       (199)    (336)       (455)    (594)    (720)    (810)    (897)    (964)   (1,039)   (1,117)
+ Depreciation & Amortization               22               44          72         100      133         161      191      223      258      287      314       342       371
+ Share-based compensation                  50               78          61          82      102         125      152      184      220      262      311       366       430
- Change of working capital                161              155          75         120      130         136      146      151      146      136      118        95       104
- Capex                                   (761)            (194)       (170)       (235)    (240)       (247)    (250)    (340)    (336)    (347)    (347)     (452)     (459)
Free cash flow                              86           1,107          944       1,205    1,490       1,788    2,120    2,378    2,720    3,028    3,288     3,467     3,798
 % change                                 -78%           1183%         -15%         28%      24%         20%      19%      12%      14%      11%       9%        5%       10%
Exit value                                                                                                                                                             31,262
Present value                                                                     1,044    1,119       1,163    1,196    1,162    1,152    1,111    1,045      955      8,370
Sum                                                                  18,317
Net cash                                                              1,725
Implied net value                                                    20,042
in US$                                                                3,037

Per ADS value (US$)                                                    57.3

Discount rate                                                           15%
  Exit growth rate                                                       3%
  Exit FCF multiple                                                       8

DCF sensitivity analysis
 Per FD ADR value (US$)                         Exit multiple (x) Discount rate
                                                             57         13%         14%      15%         16%      17%
                                                        6              57.0        54.1     51.4        48.8     46.5
                                                        7              60.5        57.3     54.4        51.6     49.1
                                                        8              64.0        60.6     57.3        54.4     51.6
                                                        9              67.5        63.8     60.3        57.1     54.2
                                                        10             71.0        67.0     63.3        59.9     56.8


E = Morgan Stanley Research estimates
Source: Company data, Morgan Stanley Research




                                                                                                                                                                         10
                                                                                                                 MORGAN               STANLEY                RESEARCH

                                                                                                                 August 17, 2010
                                                                                                                 Perfect World




Exhibit 9
Morgan Stanley’s Valuation Comparison for Internet and Media Companies
Company                                  MS                                Market Cap        EV             P/E           P/E Ex-cash      PEG      EV/EBITDA                    EV/Sales          52 week price
                                                        1
Name                       Ticker       Rating Currency            Price    (US$MM)       (US$MM)       2010E 2011E        2010E 2011E 2010E 2011E 2010E 2011E                 2010E 2011E        High       Low
China Internet
Alibaba                    1688.HK         O         HK$            15.2         9,912          8,762    48.0     34.2       41.6    29.6     1.1     0.9      28.8     20.8      10.8     8.3        22.5        12.5
Baidu                      BIDU.O          E         US$            84.4        29,461         28,589    63.1     40.4       62.2    39.9     0.9     1.0      47.4     29.1      27.0    17.5        88.3        31.6
Changyou                   CYOU.O          E         US$            27.1         1,438          1,211     8.4      7.4        7.2     6.3     0.5     0.4       5.8      4.9       3.8     3.0        42.8        24.9
Ctrip                      CTRP.O          O         US$            41.3         6,267          5,863    46.2     34.5       41.9    31.5     1.2     1.1      37.7     27.1      14.0    10.4        47.0        23.4
51job                      JOBS.O          O         US$            29.8           829            634    26.6     19.0       21.9    15.6     0.6     0.8      16.1     11.7       4.3     3.6        29.9        12.0
Giant                      GA.N            O         US$             6.2         1,403            682    10.7     10.5        6.3     5.8     1.0     0.9       4.7      4.1       3.2     2.7         8.3         6.1
NetEase                    NTES.O          O         US$            37.2         4,845          3,513    14.4     11.6       10.3     8.3     0.6     0.6       8.8      7.0       4.5     3.6        48.5        26.2
Perfect World              PWRD.O          O         US$            23.8         1,261          1,007     9.0      6.7        7.2     5.4     0.6     0.3       5.9      4.5       2.7     2.2        50.5        20.8
Shanda Interactive         SNDA.O          O         US$            43.3         2,974          1,210    20.5     18.4        8.5     7.6      —      1.1       4.7      4.0       1.5     1.3        60.4        36.3
Shanda Games               GAME.O          O         US$             6.6         1,904          1,528     9.0      7.7        7.4     6.3     1.5     0.6       5.7      5.0       2.1     1.8        13.0         5.0
Sina                       SINA.O          O         US$            42.7         2,591          2,257    31.1     24.2       29.1    23.4     0.6     0.9      24.9     20.3       5.7     4.5        48.0        28.9
Sohu                       SOHU.O          O         US$            47.0         1,800          1,173    13.0     10.4        6.4     5.3     0.9     0.6       5.0      4.0       2.0     1.6        72.3        40.1
Tencent                    0700.HK         O         HK$           146.9        35,135         33,251    29.2     21.7       28.2    21.1     0.8     0.8      22.3     16.8      11.8     8.9       176.5       111.0

China Media
AirMedia                   AMCN.O          O         US$             4.0           263            162    38.4     5.6        23.1     3.5      —       —        4.7      1.8       0.7     0.5         9.3         2.8
China Digital TV           STV.N           O         US$             6.4           375            139    16.8    14.0         7.9     6.6     1.0     0.7       5.3      4.4       2.4     1.9         8.2         5.2
Clear Media                0100.HK         O         HK$             4.7           314            260    13.3    14.1        11.2    11.9     0.2     1.3       3.9      3.8       1.6     1.4         5.3         2.8
Focus Media                FMCN.O          O         US$            17.9         2,673          2,019    44.9    15.4        39.0    12.2      —      0.3      15.0      8.2       3.3     2.8        19.3         8.4
Gehua                      600037.SS       E         CNY            14.5         2,264          2,025    45.8    33.9         —       —        —       —       15.0     11.0       7.7     5.9        19.2        10.2
Hunan TV                   000917.SZ       U         CNY            19.2         1,146          1,349   120.5   118.1         —       —        —       —        9.0      8.1       1.7     1.4        24.6        14.1
Oriental Pearl Group       600832.SS       U         CNY             9.7         4,555          4,079    34.8    26.6         —       —        —       —       33.8     25.0      10.9     8.5        14.8         7.6
B-ray Media                600880.SS       O         CNY            19.1         1,689          1,571    29.1    26.8         —       —        —       —       21.9     18.5       9.3     7.8        21.5        10.7
Phoenix Satellite          2008.HK         O         HK$             2.2         1,383          1,300    28.0    21.0        21.2    16.7     0.7     0.7      16.9     12.7       5.0     4.2         2.2         1.4
Television Broadcasting    0511.HK         E         HK$            36.9         2,080          1,816    15.3    12.9        13.4    12.5     1.4     1.3       8.1      7.3       3.4     3.1        40.9        31.5
SinoMedia                  0623.HK         O         HK$             2.3           166            118     9.4     7.9         6.9     5.7     0.4     0.5       4.5      3.7       0.6     0.5         2.8         1.3
VisionChina Media          VISN.O          O         US$             3.9           312            301     —      11.1         —      11.9      —       —        —        7.6       2.1     1.5        12.3         2.5

Adv Agency
JCDecaux                   JCDX.PA         E         EUR              19         5,499          6,103    27.5     21.5        —       —        —      —         9.5      8.5       2.1     2.0         23          14
Lamar                      LAMR.O          E         USD              30         2,730          5,397     —        —          —       —        —      —        11.8     10.9       4.9     4.7         39          20
China Telecommunications
China Mobile (HK)          0941.HK         E         HK$            84.1       222,051       185,305     12.8     12.3        —       —        —      —         5.3      5.2       2.6     2.4        86.5        69.0
China Telecom              0728.HK         E         HK$             3.8        34,727        40,658     18.2     19.3        —       —        —      —         3.7      3.9       1.3     1.2         4.2         3.1
China Unicom               0762.HK         O         HK$            10.5        32,441        37,468     91.7     84.4        —       —        —      —         4.4      4.0       1.5     1.4        11.9         8.1

Asia Internet
NCsoft                     036570.KS       U         KRW        203,000          3,747          3,295    20.3     20.1        —       —        —      —        12.6     13.0       6.0     5.7   218,000     111,500
Rakuten                    4755.Q          E         JPY         63,500          9,720         11,701    18.9     14.4        —       —        —      —        11.3      8.8       2.9     2.6    74,300      55,200
Softbank Corp              9984.T          E         JPY          2,413         31,885         49,538    18.0     16.6        —       —        —      —         5.0      4.6       1.4     1.4     2,629       1,890

US Internet
Amazon.com                    AMZN.O           O         US$          128.9         58,631         53,626    52.4   36.1        —       —        —       —        26.6    19.4       1.6    1.3     151.1          77.5
eBay                          EBAY.O           O         US$           22.4         29,686         22,960    18.2   15.2        —       —        —       —         8.2     7.5       2.6    2.3      28.4          19.1
Google                        GOOG.O           O         US$          490.5        158,186        127,750    19.9   18.1        —       —        —       —        10.9     9.9       6.0    5.4     629.5         433.6
IACI/InterActive              IACI.O          NC         US$           23.9          2,198            560    29.6   19.1        —       —        —       —         2.2     2.0      0.3     0.3      25.7          18.2
Yahoo!                        YHOO.O           O         US$           13.9         19,669         12,268    23.1   18.9        —       —        —       —         8.7     7.2       2.7    2.5      19.1          13.5
Currency is for the stock price. Estimates for non-covered companies (NC) are based on the mean of FactSet consensus estimates.
E= Morgan Stanley Research estimates, except where noted.
We use the No. of diluted shares as of the latest quarter to calculated related ratios for companies under our coverage, which might be different from the No. of basic shares used by ModelWare. As a result, the
ratios in this table might be different from the corresponding ones listed in the databox on the front page.
Source: Company data, FactSet, Morgan Stanley Research (Prices as of Aug 17, 2010)




                                                                                                                                                                                                                  11
                                                                                                MORGAN            STANLEY             RESEARCH

                                                                                                August 17, 2010
                                                                                                Perfect World




Exhibit 10
Perfect World: Income Statement, 2004-12E
(RmbMM)                                                                2004          2005         2006         2007         2008         2009         2010E     2011E    2012E

Online game operation                                                                   0           98         616         1,251        1,880         2,278     2,850    3,493
Overseas licensing                                                                      0            1          73           186          215           217       276      343
Movie revenues                                                                                                                             50             8
Total revenues                                                                          0           99         689         1,437        2,144         2,503     3,126    3,836
   % change Y/Y                                                                                               593%         109%          49%           17%       25%      23%

Server and bandwidth leasing                                                                       (15)         (73)         (81)         (95)          (91)     (106)    (123)
Salary and benefits                                                                                 (4)         (14)         (17)         (21)          (25)      (30)     (36)
Depreciation and amortization                                                                       (1)          (8)         (22)         (44)          (72)     (100)    (133)
Business tax                                                                                        (3)         (26)         (53)         (80)         (113)     (141)    (173)
Cost of services                                                                        0          (25)        (119)        (175)        (300)         (388)     (486)    (617)
Gross profits                                                                           0           75          570        1,262        1,845         2,115     2,640    3,219
   Gross margin (%)                                                                               75%          83%          88%          86%           85%       84%      84%
   % change Y/Y                                                                                               662%         121%          46%           15%       25%      22%

Sales and marketing                                                       (0)         (13)         (37)        (130)        (254)        (336)         (478)     (564)    (615)
General and administrative                                                (1)          (2)         (46)         (36)        (102)        (154)         (254)     (305)    (374)
Research and development                                                  (6)         (15)         (19)         (54)        (228)        (270)         (361)     (437)    (532)
Operating profits                                                         (7)         (30)         (27)         350          677        1,084         1,022     1,334    1,698
   Operating margin (%)                                                                          -28%          51%          47%          51%          40.8%     42.7%    44.3%
   % change Y/Y                                                                                                             93%          60%            -6%       31%      27%

Interest income / (expense)                                                0            0            0          25            35           15            23        33       47
Others                                                                    (0)           0           (1)         (2)          (13)           6             2         3        3
Pretax profits                                                            (7)         (29)         (28)        374           700        1,106         1,047     1,369    1,748

Income tax                                                                              0           (0)        (12)          (53)         (68)          (122)    (204)    (345)
Net profits                                                               (7)         (29)         (28)        362          646        1,038             925    1,166    1,403
   Net profit margin (%)                                                                         -28%        52.5%        45.0%        48.4%          37.0%     37.3%    36.6%
   % change Y/Y                                                                                                             79%          61%           -11%       26%      20%

Net income / (loss) attributable to ordinary shareholders                 (7)         (29)         (31)        360           646        1,037           925     1,166    1,403
  Excl. Share based compensation                                                                     7         369           696        1,115         1,013     1,248    1,505

Net earnings per share, basic (Rmb)                                   (0.05)        (0.20)          (0)        1.73         2.30         4.11          3.71      4.65     5.58
Net earnings per share, dilute (Rmb)                                  (0.05)        (0.20)          (0)        1.35         2.18         3.89          3.49      4.38     5.22
Net earnings per ADS, basic (Rmb)                                                                              8.63        11.50        20.56         18.54     23.25    27.90
Net earnings per ADS, dilute (Rmb)                                                                             6.74        10.91        19.46         17.44     21.92    26.12
Note: Foreign exchange rate is 7.81 Rmb/US$ for 2006, 7.29 Rmb/US$ for 2007, 6.79 Rmb/US$ for 2008, 6.75 Rmb/US for 2009 and 6.53 from 2010 onward.
E = Morgan Stanley Research estimates
Source: Company data, Morgan Stanley Research




                                                                                                                                                                            12
                                                                   MORGAN         STANLEY     RESEARCH

                                                                   August 17, 2010
                                                                   Perfect World




Exhibit 11
Perfect World: Balance Sheet, 2004-12E
(RmbMM)                                            2004   2005   2006     2007        2008     2009    2010E    2011E    2012E
Cash and cash equivalent                                    4    101     1,496       1,333    1,721    2,375    3,497    4,915
Restricted cash                                                                        150        0        0        0        0
short-term investment                                                                   50       40       40       40       40
Accounts receivables                                        0      6        17          39       82      146      231      344
Prepayments                                                 1      7        22          36      100      200      340      524
Deferred tax assets                                  0      0      0         1           2        3        4        5        6
Total current assets                                 0      6    114     1,536       1,610    1,946    2,764    4,114    5,828
Equity investment                                                                       23       37      237      237      237
Property and equipment                                      3     11       107         169      302    1,121    1,242    1,343
Construction in progress                                                               714      742        0        0        0
Intengible assets                                                  3         2          26       54       75       89       95
Goodwill                                                                                        111      221      332      442
Long term deposit                                                  0        20          19       19       19       19       19
Deferred tax assets                                                          1           1        1        1        1        1
Total assets                                         0      8    128     1,666       2,562    3,212    4,438    6,032    7,964

Shareholders' loan                                         12      0         0          0        0        0        0        0
Accounts payables                                           2      7        23         14       41       79      125      180
Advance from customers                                      7     20        50         78      100      114      149      196
Salary and welfare payable                                  4     10        31         62      102      102      138      181
Taxes payable                                               0      5        13         21       41       66       96      148
Accrued liabilities                                         3      7        14         25       40       60       85      115
Due to related parties                                      2      0         0          0        0        0        0        0
Deferred revenue                                                  33       123        223      331      448      586      743
Deferred government grants                                         1         1          1        1        2        3        4
Share repurchase liabilities                                                          387        0        0        0        0
Deferred Tax liabilities                                                               26       39       45       57       69

Total current liabilities                            0     30     84       256        836      695      917     1,239    1,637

Deferred revenue                                                            19         33       49        57       71       87
Other Long-term payable                                                                28       30        39       49       62
Long-term liabilities                                0      0      0        19         61       79        95      119      149
Total liabilities                                    0     30     84       275        897      773     1,012    1,359    1,786

Convertible preferred shares                                      62         0           0        0        0        0        0
Ordinary shares                                                    0         0           0        0        0        0        0
Additional paid-in capital                                 15     46     1,124       1,178    1,256    1,317    1,400    1,502
Treasury stock                                                                        (391)       0        0        0        0
Receivables from shareholders                                     (0)        0           0        0        0        0        0
Statutory reserves                                                 0        30          95      194      278      378      491
Accumulated deficit / other comprehensive income          (36)   (64)      268         849    1,040    1,881    2,948    4,238
Accumulated other comprehensive loss                                       (32)        (66)     (66)     (66)     (66)     (66)
Minority Interest                                                                                14       14       14       13
Total equity                                         0    (21)    43     1,390       1,666    2,438    3,425    4,673    6,178
Total liabilities and equity                         0      8    128     1,666       2,562    3,212    4,438    6,032    7,964
E = Morgan Stanley Research estimates
Source: Company data, Morgan Stanley Research




                                                                                                                           13
                                                                       MORGAN        STANLEY               RESEARCH

                                                                       August 17, 2010
                                                                       Perfect World




Exhibit 12
Perfect World: Cash Flow Statement, 2004-12E
(RmbMM)                                                      2004    2005    2006        2007      2008      2009    2010E    2011E    2012E
Net income                                                     (7)    (29)    (28)       362       646      1,038      925    1,166    1,403
Ajustments for:
  Share-based compensation                                                     38           8       50        78       61       82      102
  Depreciation and amortization expenses                       0       0        1           7       22        44       72      100      133
  Exchange loss                                                                 1           7       12
  In-process R&D acquired from Interserv                                                            78
  Investment loss                                                                                    1          1        0        0        0
  Loss from disposal of PPE and software                                                             0
Changes in:
  Accounts receivables                                                         (6)        (11)      (22)      (44)     (63)     (85)    (112)
  Prepayments and other assets                                 (0)     (1)     (5)        (15)      (29)      (64)    (100)    (140)    (184)
  Deferred tax assets                                                          (0)         (1)       (1)       (1)      (1)      (1)      (1)
  Deferred tax liabilities                                                                           26        13        6       11       13
  Due from/to related parties                                  (6)     8       (2)         (0)        0         0        0        0        0
  Long-term deposit                                                            (0)         (1)        0         0        0        0        0
  Accounts payables                                                     2       5           7        (1)       29       47       56       68
  Advance from customers                                                7      15          29        29        22       14       35       47
  Salary and welfare payable                                   1        3       6          21        31        40        0       36       43
  Taxes payable                                                0       (0)      5           8         7        20       24       31       52
  Accrued liabilities                                          1        2       3           7         9        15       21       25       30
  Deferred revenue                                                             33         110       113       123      126      152      173
  Deferred government grant                                                     1           0        (0)        1        1        1        1
Cash from operations                                         (11)      (8)     67         537       972     1,315    1,134    1,468    1,768
Purchase of fixed assets, software                            (1)      (3)     (9)       (112)     (760)     (152)    (127)    (190)    (194)
Purchase of copyrights                                                         (3)          0        (1)      (41)     (43)     (45)     (46)
Cash paid for the assets acquired from InterServ                                                   (103)     (150)    (111)    (111)    (111)
Cash held in escrow a/c for InterServ business acquisition                                         (150)      150        0        0        0
Purchase of short-term investment                                                                   (50)       10        0        0        0
Cash paid for equity investment                                                                     (24)       (1)    (200)       0        0
Cash from investing                                           (1)      (3)    (12)    (112)      (1,088)     (185)    (480)    (345)    (351)
Proceeds from issuance of common stock                        15                     1,008            0        (0)       0        0        0
Proceeds from redeemable and convertible preferred stock                       55        0            0         0        0        0        0
Receipt of shareholder loan                                           15        1        0            0         0        0        0        0
Repayment of shareholder loan                                         (3)     (13)       0            0
Dividend payout                                                                          0            0         0        0        0        0
Proceeds from exercises of share options                                                              4
Repurchase of company shares                                                                         (5)     (743)       0        0        0
Cash from financing                                           15      12       43    1,008           (1)     (743)       0        0        0
Effect of exchange rate changes on cash                                        (1)     (39)         (46)
Change in cash                                                 3       1       97    1,395         (163)      388      654    1,123    1,417
Cash at beginning of year                                              3        4      101        1,496     1,333    1,721    2,375    3,497
Cash at end of year                                            3       4      101    1,496        1,333     1,721    2,375    3,497    4,915
E = Morgan Stanley Research estimates
Source: Company data, Morgan Stanley Research




                                                                                                                                          14
                                                               MORGAN        STANLEY            RESEARCH

                                                               August 17, 2010
                                                               Perfect World




Exhibit 13
Perfect World: Quarterly Income Statement, 2009-2010E
                                                                       2009                                    2010
(RmbMM)                                                     1Q09    2Q09    3Q09         4Q09     1Q10     2Q10 3Q10E        4Q10E
Online game operation                                        377     475     486          542      570      533     556        619
Overseas licensing                                            48      46      59           62       53        55      53        55
Movie revenues                                                                45            4        2         6
Net revenues                                                425      521     590          608      625      594     610        674
  % change Q/Q                                               2%     23%     13%            3%       3%      -5%      3%       10%
Cost of services                                             (56)    (67)    (95)         (82)     (87)      (98)    (98)     (105)
Gross profits                                               369      455     495          526      538      497     512        569
  Gross margin (%)                                          87%     87%     84%          87%      86%      84%      84%       84%
  % change Q/Q                                               0%     23%       9%           6%       2%      -8%      3%       11%

Sales and marketing                                          (51)     (73)        (88)   (125)     (82)     (121)    (131)    (144)
General and administrative                                   (30)     (37)        (38)     (48)    (55)      (63)     (65)      (71)
Research and development                                     (57)     (65)        (72)     (77)    (78)      (91)     (93)      (99)
Operating profits                                           230      280         298      277     323        221      222      255
  Operating margin (%)                                      54%      54%         50%     45%      52%     37.3%     36.4%    37.8%
  % change Q/Q                                              54%      21%          6%      -7%     17%      -31%        0%      15%

Interest income / (expense)                                   3        4           3       5        5         6         6        6
Others                                                        2       (1)         (1)      7        5        (1)       (1)      (1)
Pretax profits                                              235      282         300     288      334       226       227      260

Income tax                                                   (20)     (20)        (11)    (18)     (29)      (30)     (30)     (34)
Net profits                                                 215      262         289     271      305       197      197      226
   Net profit margin (%)                                    51%      50%         49%     45%      49%       33%      32%      34%
   % change Q/Q                                             73%      22%         10%     -6%      13%      -36%       0%      14%
Minority Interest                                                     0.1        (0.7)   (0.1)     0.2       0.0      0.0      0.0
Net income / (loss) attributable to ordinary shareholders   215      263         288     271      305       197      198      226

Net earnings per share, basic                               0.83    1.04         1.17    1.09     1.22     0.79      0.79     0.90
Net earnings per share, dilute                              0.79    0.99         1.10    1.02     1.15     0.74      0.75     0.85
Net earnings per ADS, basic                                 4.14    5.21         5.83    5.44     6.12     3.93      3.95     4.52
Net earnings per ADS, dilute                                3.96    4.94         5.50    5.09     5.75     3.71      3.73     4.27
E = Morgan Stanley Research estimates
Source: Company data, Morgan Stanley Research




                                                                                                                                 15
                                                                                MORGAN         STANLEY         RESEARCH

                                                                                August 17, 2010
                                                                                Perfect World




                                                      Morgan Stanley ModelWare is a proprietary analytic framework that helps clients
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                                                      basis. ModelWare also emphasizes the separation of operating performance of a company
                                                      from its financing for a more complete view of how a company generates earnings.



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                                                                                                                                                    16
                                                                                              MORGAN            STANLEY           RESEARCH

                                                                                              August 17, 2010
                                                                                              Perfect World




                              Coverage Universe    Investment Banking Clients (IBC)
                                             % of                   % of % of Rating
Stock Rating Category            Count       Total     Count Total IBC Category
Overweight/Buy                   1095           42%            380         44%           35%
Equal-weight/Hold                1123           43%            388         45%           35%
Not-Rated/Hold                       14           1%              4          0%          29%
Underweight/Sell                   362          14%             93         11%           26%
Total                           2,594                          865

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                                                                                             August 17, 2010
                                                                                             Perfect World




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Industry Coverage:China Internet

Company (Ticker)                              Rating (as of) Price* (08/17/2010)


Richard W Ji
Alibaba.com Limited (1688.HK)                O (11/11/2009)               HK$15.24
Baidu.com, Inc. (BIDU.O)                     E (02/15/2007)               US$84.35
Ctrip.com (CTRP.O)                           O (09/12/2005)               US$40.34
Netease.com (NTES.O)                         O (09/12/2005)                 US$38
Perfect World (PWRD.O)                       O (09/05/2007)               US$24.81
Shanda Games (GAME.O)                        O (11/25/2009)                US$6.61
Shanda Interactive Entertainment             O (05/23/2007)               US$42.89
Limited (SNDA.O)
Sina Corporation (SINA.O)                    O (10/19/2009)                US$42.5
Tencent Holdings Ltd. (0700.HK)              O (09/12/2005)               HK$146.9
Jenny Wu, CFA
51job, Inc (JOBS.O)                          O (08/07/2009)               US$27.81
Changyou (CYOU.O)                            E (05/05/2009)               US$27.25
Giant Interactive (GA.N)                     O (05/29/2009)                US$6.19
Sohu.com Inc (SOHU.O)                        O (07/28/2009)               US$46.37

Stock Ratings are subject to change. Please see latest research for each company.
* Historical prices are not split adjusted.




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