China Gaming: Shanda's Back in the Action

The online-game producer is in the black again as its free-entry model, and sale of avatar accessories, clicks with young Chinese gamers

Back in late 2005, Chinese online game purveyor Shanda Interactive (SNDA) made a huge strategic gamble when it made several of its most hugely popular, subscription-based, online role-playing games free. Shanda's founder and billionaire chairman Tianqiao Chen analyzed China's vast universe of youthful gamers and decided this crowd wanted more—much more—from its gaming experience.

So Shanda experimented with free admission to its games, hoping to reap revenues from the sale of virtual goods. In other words, users could alter a character's appearance and prowess by purchasing clothes or, say, high-powered weaponry. What's more, Chen anticipated the now-current rage among China's most avid gamers to adopt virtual personas, or avatars, and give them a unique identity online.

Still, the shift has been a painful transition, not unlike wending one's way through increasingly more life-threatening challenges in an online adventure game. Shanda pretty much pioneered the market for multi-player, online, role-playing games with the commercial launch of The Legend of Mir II back in 2001, but it's now No. 2 in the field behind (NTES) for leadership in China's roughly $1 billion market.

Rounding a Corner

One of the most closely-watched Chinese Net-play stocks in the U.S., Shanda lost money on a net basis in the fourth quarter of 2005. And the Nasdaq-listed company's shares fell 51% to a 52-week low of $12.36 per share last April, just five months after the remake of its business model.

Now it looks as if Shanda has turned a corner. On Feb. 13 the company reported better-than-expected fourth quarter earnings and 2006 results. Shanda earned $22.2 million in the October to December period last year (compared to a fourth quarter loss in 2005 of $69 million), excluding the proceeds from the sale of part of its equity stake in Chinese Net portal Sina (SINA). Shanda still owns 3.9% of Sina.

For the full year, the company raked in $67.8 million, vs. $21.3 million in 2005, on $211 million in revenues. Shanda's shares rose about 2.5% on Nasdaq to $22.30 before the earnings announcement and are trading near a 52-week high. "Today we are more confident than ever," says Shanda president Jun Tang, who joined the company in 2004 after serving as president of Microsoft China.

Upgrade From Analysts

Tang says the decision to adopt free-to-play models for some of its most popular games such as Mir II, Magical Land, and The World of Legend, is paying off. Consumers enjoy altering their online gaming experience by purchasing virtual goods such as ammunition, weapons, and costumes with prepaid cards. Tang expects Shanda to deliver revenue growth of about 6% to 9% during the first quarter of 2007.

Analysts generally agree that Shanda is making strides. Deutsche Bank analyst William Bao Bean wrote in a recent research note to clients that the company is doing a good job of switching existing games to the new format of free entry and paid-for virtual goods while rolling out well-received new games such as ArchLord, an adventure game in which users embark on a quest to search for ancient relics. He also upgraded Shanda's stock to a "buy" rating in August.

Coming later this year likely will be the commercial roll-out of a new Shanda game called Kung-Fu Masters, a martial arts adventure designed by Beijing game developer JoyChina. The game features a cast of well-known characters from Chinese folklore and history including the Monkey King and Mulan, each with its own unique fighting style.

Growth Wave Ahead

Shanda thinks China's gaming community will continue to prefer its gaming approach, and that the company has a huge lead over industry rivals such as NetEase. "You really need to redesign and restructure your games" to entice young Chinese gamers, says Tang. "We have accumulated 12 months of experience doing this."

Another plus for Shanda, and for other companies that compete in this segment such as The9 (NCTY) and Tencent (TCEHF), is the huge growth wave ahead for the online gaming industry in China. This rosy outlook owes much to the expansion of high-speed broadband service throughout the mainland and China's nearly 140 million Internet users, a consumer base second only to the U.S. And an estimated 70% of those Netizens are under the age of 30 in China, according to Morgan Stanley.

China's online game market is expected to hit $2.1 billion by the end of the decade, figures research firm IDC. And the mainland is expected to surpass tech-happy South Korea next year as Asia's biggest gaming market.

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