The Best Times to Buy Shanda's Stock

As the first and largest U.S.-traded Chinese online gaming company, Shanda Interactive Entertainment (SNDA) has many followers: Covered by 16 brokerage firms, SNDA's market cap exceeds $3.5 billion and its average trading volume was 1.3 million in the last three months. This article analyzes the best times to buy SNDA historically (see graph below), and discusses investment strategies.

1. The first great period to buy SNDA was the first three months after its IPO on May 13, 2004. At that time, online gaming was a new concept to most investors in the U.S., where console games dominated the video game market. As a result, investors were generally cautious on SNDA, the first Chinese online gaming IPO on U.S. exchanges. What they ignored was that the Chinese online gaming industry was at the expansion stage of its life cycle, driven by fast-growing Internet usage, PC ownership, and broadband penetration in China. From August to the end of 2004, Shanda reported great earnings for 2Q04 and 3Q04, and its stock surged to around $45.40 on December 30, 2004, quadrupling its $11 IPO price.

Graph: Four Best Opportunities to Buy SNDA

2. The second great opportunity was the whole year of 2006. In 2005, Shanda's core game Mir 2 was bothered by illegal private servers run by unauthorized companies, and faced strong competition from new games such as WoW and Yulgang. In late 2005, Shanda started its strategic transition from time-based business model to the item-based model, which allows free access by players but sells virtual items to make money. This new concept caused investors to be cautious again, and Shanda's stock was weak as a result. Most investors did not know that Shanda made the change because the item-based model was already proven to be very lucrative for private server operators. Shanda's move countered private servers, expanded revenue potential, and won back users from competitors, killing three birds with one stone. Entering 2007, Shanda's stock began to soar, as investors realized the item-based model was becoming increasingly successful and popular in China.

3. The third great period was the two months following the Sichuan earthquake on May 12, 2008. The severe earthquake caused some disruptions to online gaming companies, and investors worried about its impact. However, the earthquake only had limited short-term impact because it was not recurring and it did not change the healthy fundamentals of the Chinese online gaming industry.

4. The latest great opportunity to buy SNDA emerged between mid-September and late November 2008, amid the global financial crisis. During this period, Shanda's stock fell sharply as major market indexes plunged and investors worried about Chinese players reducing their spending on games. Many investors did not realize that in terms of average spending, online gaming had become a widespread and inexpensive form of entertainment in China. When the economic slowdown increasingly constrained people's budgets, they first cut more expensive entertainment, such as going to bars and cinemas, and they shifted their spending to less expensive online games.

Investment strategies for investors: The common characteristic of these four opportunities was the great uncertainty surrounding Shanda at those times. Smart investors view these uncertain periods as potential opportunities, and try to discover hidden gems by doing in-depth research on what's really happening to the company, its industry, and its customers.

Disclosure: No positions.

Comments

[Ryan Barnes:]

You seem to be quite familiar with the company's history and offerings. I've been researching the company for some time, and I missed a chance to step in earlier this year. The multiple is now such that it will need to keep executing 25% + top-line growth in order to fulfill it.

How do you view the company's competitive position? Do you have any data on the number of monthly users, average purchases per user, etc? Enjoyed the article but I'm hungry for some fundamental metrics.

Best of luck in your investing efforts.

EpiphanyOne

Jul 10 04:37 PM

[kagame:]

"Many investors did not realize that in terms of average spending, online gaming had become a widespread and inexpensive form of entertainment in China"

While I agree with your overall assessments of the events that preceded irrationally low prices for SNDA, I would take issue with the actual cause of that mispricing. It surely wasn't a great "misunderstanding" of the company by normal everyday investors. I am on the message boards constantly and everyday normal Joe types were fully informed as to the actual growth and strength of SNDA's business model and online gaming in general.

I would tend to think it was massive forced hedge fund liquidations that clobbered the price. Or perhaps manipulation by large market makers to make a killing on options positions. Anything besides rational investors deciding to sell. Because that just doesn't hold up to logic.

If you ever watch the way SNDA trades, its actual tape, you will see it is incredibly illiquid in terms of price levels and will fluctuate wildly. It is very thin, and highly volatile. Shorts have abused long term investors in the this over and over, and most likely will again.

I would be willing to be we see another irrational selloff in the near future, probably related to the lack of transparency regarding the IPO of the gaming unit, or maybe at the slightest collapse in the overall market.

Lets remember this is a company who has crushed estimates every quarter for years. Yet look at that stock chart. Ever since the switch to the CSP business model SNDA has been a rock star outperformer, in a booming recession resistant sector, in a stronger economy, with a stronger currency. Did that prevent SNDA from selling off almost 50%? Nope.

Efficient markets for ya.

Jul 11 06:11 PM

[Xiaofan Zhang:]

Hi Ryan:

This article includes a table which lists some metrics about key online games in China:
seekingalpha.com/artic...


On Jul 10 04:37 PM Ryan Barnes wrote:

> You seem to be quite familiar with the company's history and offerings.
> I've been researching the company for some time, and I missed a chance
> to step in earlier this year. The multiple is now such that it will
> need to keep executing 25% + top-line growth in order to fulfill
> it.
>
> How do you view the company's competitive position? Do you have any
> data on the number of monthly users, average purchases per user,
> etc? Enjoyed the article but I'm hungry for some fundamental metrics.
>
>
> Best of luck in your investing efforts.
>
> EpiphanyOne

Jul 12 05:02 PM