Shanda Interactive and the Importance of Guanxi (SNDA, DIS, CHL)

Includes: CHL, DIS, SNDA
by: Shaun Rein

Ever since I stepped off my snorting bus into Tianjin, China 9 years ago, all I have heard from many Chinese and foreigners trying to do business here is that Guanxi (connections in Chinese) ensure business success in China. Somehow, these people believe strong Government connections can magically wipe out the need for good management teams, viable products, and international level business practices. While I agree relationships are important in China as they are anywhere in the world companies or investors looking at today's China should not overestimate the importance of Guangxi.

On the front page of my firm's website, I have a quote, "As China's economy continues to reform, what you know will become more important than who you know."

Consumers don't play a game based on who the CEO knows. They play based on the coolest game at the right price point that has the distribution channels that gets the game in front of their face. Women do not buy cosmetics based on the cousin of the brother of the wife's father.

Seems like a basic idea, but it amazes me how many businessmen and investors forget to put enough stock into the importance of actually knowing how to run a business in China.

The idea to write a quick article comes to mind because I read a comment on Shanda's prospects by Stephen on May 16th who wrote "I bet on LONG on SNDA. Never underestimate the # 1 game company in China with very good Government Connection."

I am not here to argue whether or not Shanda has good connections in China, and I don't want to criticize Stephen, but let us suppose that Shanda does indeed have great Guanxi. What has that gotten them? Ok, maybe they can get better licenses quicker than their competitors and get approval to buy stakes in SINA and get tax breaks. Maybe it lets them the right to sell the EZ Pod? (does anyone know anyone who has actually bought this thing?). That is definitely helpful, and it gives them an edge over competitors. I don't deny that. But such connections does not let one have a sustainable business plan that should make investors wanting to buy a piece of the company.

Imagine how good a company Shanda (NASDAQ:SNDA) would be if it had Guanxi and a well-run company.

But Shanda fails on some major major points. Their top talent keeps leaving in droves because a small inner circle makes all the decisions. This inner circle should be applauded for scaling the company from nothing to their current size, but they do not have the ability to make the company an international player.

It is time to bring in professional management, delegate authority, and spend money wisely.

Do you really think today's announcement of Disney's (NYSE:DIS) partnership with Shanda to do a game targeting children and women is going to solve Shanda's and Disney's problems in China? (On a separate note, I just gave a speech last week at a Marcus Evan's conference blistering Disney in Hong Kong. How can the MD for Disney in HK be quoted in Time saying that he did not know that so many Chinese would visit HK Disney during their public holidays, thus leaving total chaos at the gates? That is a case of not knowing your customer! And the price Disney pays for housing and the such for their expats!)

Anyway, as you know, I always analyze a company first by management team. If the quality does not pass muster, then I do not care how many connections they have, the business will collapse.

Shanda might have great Guangxi, but they are flapping about like a beetle on its back.

Now, this article critiques Shanda, but it can be viewed by businessmen and investors in general looking at a China play. Yes, spend time getting to know people here in China just as Goldman (NYSE:GS) does when building up relationships in the US and look at companies to see if they have the government connections needed to scale a business (as China Mobile (NYSE:CHL) does).

But don't think that Guanxi is some sort of a magic pill. You really need to have a business plan and team that can execute well. Without that, your Guanxi will whittle to nothing much as Shanda's stock price continues to do so.

Author Bio:
Shaun Rein is the Managing Director of the China Market Research Group and has been living in China for 9 years. He received his graduate degree from Harvard focused on China¡¯s economy and served on the Advisory Committee for Shareholder Responsibility to the Harvard Corporation. He is fluent in Mandarin.

The China Market Research Group helps American and European companies enter or expand in China by getting them the market intelligence they need to make informed decisions.