Shanda: A Compelling Play in Chinese Web Games

S&P has a "strong buy" ranking on the American depositary receipts of the company, which operates MMORPGs, citing their attractive valuation

by Scott Kessler From Standard & Poor's Equity Research

We believe Shanda Interactive Entertainment (SNDA); recent price, $27), an interactive entertainment media company, is a diversified leader in a large and growing market. China is the world's largest online gaming market, and Shanda generates more revenues from online gaming than any other company. Shanda offers many different games in different categories, owns PC and mobile gaming platforms, is building an in-game advertising business, and is home to China's most popular original literature portal. The company's past success has provided it with notable resources to bolster its game pipeline and build out other operations, by our analysis.

In addition, we believe the upcoming Beijing Olympic Games could very well be a positive catalyst for the company and its American depositary receipts (ADRs). Initially, the eyes of the world will be on China, and we think that people will come to learn more about what we consider its compelling national growth prospects and perhaps seek out related U.S-traded investment opportunities. We also believe Shanda could benefit from government-mandated actions restricting business operations and driving that could increase consumption of the company's offerings in homes and local Internet cafés.

We think Shanda trades at a compelling valuation. The ADRs carry Standard & Poor's highest investment recommendation of 5 STARS (strong buy).

COMPANY PROFILE

A pioneer and leader in the Chinese online games segment, Shanda provides a variety of Internet games, and increasingly, other digital content. Its offerings consist primarily of online games that it develops in-house or licenses from third parties. Almost all of the company's revenues are generated from online games, including so-called massively multiplayer online role-playing games (MMORPGs) and casual games. In 2007, these two categories accounted for 96% of revenues.

The company's MMORPGs are largely action/adventure-based, and often draw upon martial arts and combat themes. Each MMORPG constitutes a virtual world in which players interact with one another. Typically, users assume ongoing roles with different attributes, and each character can gain experience and collect certain benefits (such as weapons or points) that increase his/her game abilities and/or status. In addition, groups of players often form alliances and teams to fulfill certain game objectives. As of yearend 2007, Shanda offered 11 MMORPGs, seven of which the company owned.

Importantly, in our opinion, in November 2005, Shanda announced that it would not charge users for playing some of its MMORPGs, and that it would charge only for certain in-game items or features. Previously the company had employed a "pay-to-play" model for all of its MMORPGs.

Shanda's casual online games generate revenues primarily from premium features (not from just game-play). We believe casual games are an important component of Shanda's growth strategy, as advertising is increasingly provided in free gaming experiences, and users become more accustomed to paying for certain features. Casual games also attract a broader range of users, as well as more home users, compared with MMORPGs.

As of December 2007, Shanda offered nine casual games, five of which were developed internally. These include battle games and fighting games, among others.

In July 2004, Shanda acquired Hangzhou Bianfeng Software, which offers a variety of casual games, including card games, board games, mah-jongg, and simple arcade games. In December 2005, Shanda purchased Gametea, a developer of chess and board games.

The company also provides original literature via three Chinese language portals, Qidian.com, Jjwxc.com, and Hongxiu.com. Through these offerings, Shanda publishes original works of independent writers. Users can access certain sections of these works for free, and pay membership fees to read complete works and access more content.

In addition, Shanda operates a PC computer game network where users can find and connect with other players of the games.