Take Aim at Shanda Games

 | Jun 20, 2012 | 1:00 PM EDT
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The video game shoot-em-up business is suffering big time in the United States as mobile communications sucks away users, but oh man, in China they got game. And there it is still a great business.

At the front of the firing line is Shanda Games (GAME), a Shanghai-based developer, operato, and publisher. The company has a player-base of more than 20 million average monthly users, with nearly 5 million active and paying at any given time..

Shanda has more than 2,000 game research and development staffers working with more than 20,000 developers around the world, providing a diversified portfolio of more than 70 games, including role playing games, casual games, Web games, mobile and flash-integrated games.

The company has a multi-channel sourcing strategy that includes in-house game development, licensing, investment and acquisition of properties and co-development. Innovation has made it one of the best emerging-growth stories in the world.

Shanda was founded in 1999 by Chen Tianqiao and Chen Danian, but is now run by CEO Qunzhao Tan, who's been in charge since January 2010. Prior to taking this post, he was president of parent firm Shanda Interactive, which was just recently taken private by original founder, Chen Tianqiao.

The vast majority of Shanda's revenues are generated from what's called Massive Multiplayer Online Role Playing Games (MMORPGs). In a nutshell, these are games that exist within an online virtual game world where a large number of players can interact with each other through characters they have created or been assigned. 

They are largely played on PCs, but in recent years they have begun to penetrate game consoles from manufacturers Sony (Playstation 3), Microsoft (XBOX 360) and Nintendo (Wii). Revenues from these games can be generated from a multitude of sources, including the initial cost of the game, ongoing subscriptions and costs associated with in-game purchases and updates.

The company's top game franchise is the Mir II series, which most recently contributed 34% of total revenues, followed by Dragon Nest 18% and the Woool series at 16%. Shanda has been exceptionally adept at maximizing the longevity of its major franchises and Mir II is a great example. 

The game originally launched in 2001 and Shanda was able to turn the Chinese version of it into the highest-revenue-producing online game in the country by actually making it free to play in 2006. This resulted in tremendous growth of more than 50% just two years later.


Shanda Games (GAME)
Source: StockCharts.com


According to Morgan Stanley, Shanda has an industry-leading game evaluation system, helping it to optimize quality control and resource allocation. The three-funnels evaluation process involves evaluating the game and artistic designs, playability and infrastructure, testing of the game by members of management and quality assurance and assessing the commercial appeal of the game.

As a result, the company screens thousands of potential games, selecting fewer than 10% to add to its portfolio each year. This has lead to a significantly better game publishing efficiency rate than many of its peers, allowing for four to five new game releases per quarter, up from one to two a few years ago. 

The amount of success garnered domestically for Shanda in the Chinese market hasn't stifled its growth plans one bit. A few years ago the company started aggressively licensing out its games to overseas operators for country specific versions of its games. In 2010, it acquired U.S.-based Mochi Media, a California-based developer and operator of browser-based games to help it get a foothold on the American market and enhance the brand's awareness with gamers and local distribution channels.

Revenues have grown 133% the past five years, while net income increased 113% during that same time frame. Shares are up 11.5% so far this year, but are off their April 2012 highs, presenting an intriguing buying opportunity. 

The first quarter results saw in-line revenues, but the company provided second-quarter guidance below analyst expectations due to declining monetization of its two largest legacy products. But with a robust pipeline of games due to drop this year, now might be the time to bank on the company repeating what it's been able to accomplish for so many years.

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