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China Plays For Keeps Online


For most Chinese dot-com entrepreneurs, launching an Internet company means emulating American powerhouses such as Amazon.com (AMZN), Yahoo! (YHOO), or Google (GOOG), and adjusting their business plans to China. Chen Tianqiao didn't have that luxury. The Shanghai native is the CEO and founder of Shanda Interactive Entertainment Ltd. (SNDA), China's No. 1 operator of online games. "Online gaming is not popular in the U.S., so we didn't have a model to learn from," says Chen. "We have had to explore a totally new business."

Even without a teacher, Chen has learned well. Shanghai-based Shanda controls 35% of the Chinese market for online games, with eight offerings ranging from simple, single-player contests to elaborate affairs that allow thousands of people to simultaneously enter a fantasy world where they can take on the personas of warriors, magicians, and dragon slayers who form armies, fight enemies, collect treasures, celebrate holidays, or even marry their online alter ego to another player's virtual double. For instance, Zhao Li, a 23-year-old who works for a Beijing real estate company, spends three to four hours a day killing monsters and exploring virtual worlds. At any given moment, some 1.2 million Chinese such as Zhao are playing Shanda's games, each paying about 3 cents an hour.

WINNING WAYS

Those pennies add up. Shanda has been profitable almost from its launch in 2001, and this year is likely to earn $55 million on sales of $147 million, estimates brokerage UBS (UBS). Next year, UBS figures Shanda will see profits of $89 million on sales of $224 million. In May the company listed its shares on NASDAQ, raising $100 million, and since then the stock has nearly tripled. That gives Shanda a market capitalization of $2.2 billion, and makes 31-year-old Chen -- who still holds a 60% share -- one of China's richest men. While rivals are hot in pursuit, analysts are impressed with the way Chen and his team have added new titles. "Shanda has been out-executing its competitors," says Eric Wen, an analyst with UBS in Shanghai. "They have more types of games and more types of players."

Chen, though, will have to play smart if he hopes to keep his lead. New rivals are popping up faster than enemy soldiers in one of Shanda's offerings, attracted by the potential of China's online gaming market, which is expected to more than quadruple in size by 2008, to $1.3 billion. A year ago, Chinese players had a choice of 57 games from 38 companies. Today, 77 operators offer a total of 136 games. And some of the newcomers are heavy-hitters. Sina Corp. (SINA), for instance, is working with Korea's NCsoft Corp. to develop games. Portal operator NetEase.com Inc. (NTES) is making a major push into the business. And The9, another Shanghai-based gaming company, is planning an initial public offering of its own to catch up to Shanda. "There's a huge amount of entrepreneurial activity and investment going into the sector right now," says Ted Dean, managing director of BDA China Ltd., a Beijing consulting group. The newcomers have a healthy respect for Shanda's rapid growth and huge customer base. "They were the first ones in the history of online games to reach that scale," says Hurst Lin, Sina's chief operating officer. But he adds that Sina this fall will introduce Lineage II, a 3-D version of a popular NCsoft game, which he says is creating a lot of buzz among gamers.

To stay ahead, Chen is looking to hook China's couch potatoes on his games. The goal is to allow Shanda users to play not just on PCs in Internet cafés -- as most do today -- but also on TVs at home. To make that happen, he's working with Intel Corp. (INTC), graphics chip designer ATI Technologies (ATYT), and Taiwanese manufacturer Inventec Appliances Corp. to develop a set-top box that could turn China's 300 million TVs into online-gaming consoles. That's smart, because China has seven times as many TVs as it does computers.

The scheme would help Chen move beyond his current demographic of twentysomethings hooked on blood-and-guts games. He wants to sign up more middle-aged customers who would prefer to play a quiet round of electronic chess or mah-jongg at home. Even better, Chen says the new system will allow Shanda to sell movies, music, and other content online. "We want to be an entertainment company, not only a gaming company," says Chen. It's a risky plan. Without broadband -- available in relatively few Chinese homes -- neither the games nor the other services will work well. And it remains to be seen whether older Chinese will cotton to games on TV.

At the same time, Chen is teaming up with other Chinese Net companies. In mid-October, Shanda announced it was forming a "strategic relationship" with EachNet (EBAY), eBay Inc.'s (EBAY) Chinese subsidiary. Shanda's subscribers often swap virtual accessories such as clothing, weapons, and jewelry that they win during games. The EachNet tie-up will give them a place to buy and sell those trinkets. "We are going to create a system to verify that these are real, authenticated items from Shanda," says James Zheng, CFO of EachNet. In return, EachNet has agreed to buy ads on Shanda's site. Shanda has also bought four local dot-coms, including a literature site (which it hopes will provide source material for future games) and a developer of games for cell phones.

LAWSUITS IN GAMELAND

Shanda faces some obstacles on its journey to Net stardom. Chief among them is a legal dispute with Wemade Entertainment Co., the Korean developer of Shanda's The Legend of Mir II. Wemade says a game Shanda created in-house, The World of Legend, infringes on its intellectual property and has sued Shanda in a Beijing court. Chen denies any wrongdoing and calls Wemade's charges "unfair." Like one of his subscribers adding extra powers while pursuing a dragon, though, Chen may have a solution up his sleeve: Industry insiders in Seoul say Shanda is negotiating to buy a controlling interest in ActozSoft, which owns 40% of Wemade. That could zap the dispute into oblivion, though Shanda calls talk of such a deal just a "rumor."

The company has had some technical problems with its growth, too. Shanda early on licensed games from Korea and then tweaked them to suit the Chinese market. For instance, most Korean games are run from servers in one location. That works in a small country like Korea, but China's long distances and iffy networks would have rendered games run from a central server almost unplayable because of long delay times. So Shanda spread its servers out nationwide, which makes the games run faster -- but offers malicious hackers more inviting targets. One attack early on destroyed Shanda's user database. "I was, frankly speaking, almost desperate," recalls Chen. He learned his lesson, and today engineers constantly monitor Shanda's network and back up the company's 11,000 servers daily.

Can Shanda become the entertainment giant Chen hopes? The company is certainly getting attention. For instance, Softbank Asia Infrastructure Fund, controlled by Japan's Softbank and router maker Cisco Systems Inc. (CSCO), owns 15% of Shanda. China's online gaming market "will be a new frontier for Hollywood," says Andrew Y. Yan, the fund's manager. "They will have to follow this." If they do pursue that game plan, you can bet that Chen Tianqiao will be ready to play.

By Bruce Einhorn in Shanghai, with Moon Ihlwan in Seoul


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