Applauding Shanda Interactive's Latest Strategic Move

On November 12th, Shanda Interactive (SNDA) made a new move to form a joint venture with Hunan TV. Capitalized with RMB 600 million (88 million USD) and headed by Danni Long, a talented TV producer who championed the Chinese version of "American Idol", this joint venture

will produce and distribute movies and television series, as well as engage in other related businesses such as agency services.

The market dismissed this news as a non-event. I disagree. This event offers an early hint of Shanda Interactive's grand strategy to expand into the traditional entertainment market with 2 billion dollars in its war chest.

It took me a long while to understand Tianqiao Chen, the founder and CEO of Shanda Interactive. In 2006, I thought that he was simply not smart. He tried to introduce a Chinese version of Apple (AAPL) TV, called Shanda Box, in China, which failed miserably because 1) Shanda did not have good hardware engineering capabilities and 2) the market was not there. Even Apple TV has not been a meaningful product up to today (I think this will change shortly); let alone a mediocre product in China more than 3 years ago.

However, my perception of Chen gradually changed out of my following the Chinese online gaming sector, and turned fully positive after the very recent usual carve-out of Shanda Games (GAME).

Many investors were deeply puzzled by the carve-out. Some believe that Shanda Interactive wanted to follow the successful example of Sohu (SOHU) carving out Changyou (CYOU). But Sohu carved out Changyou because Sohu had two equally profitable businesses, Internet portal and online gaming, and the carve-out helped align the interests of the gaming management. Shanda Interactive was a pure online gaming company to begin with. Why should a gaming company spin off a gaming company? It doesn't make much sense, does it? "The biggest question I have is, what do they need $1.5 billion in cash (for)?" -asks Adam Krejcik of Roth Capital.

Well, the answer might be that Chen is less committed to online gaming now. It is no secret that Chen has "original sin" feelings towards the online gaming business. It's a business he pioneered in China but is also a business causing addiction among Chinese teenagers. Many of Chen's moves can be interpreted as part of his endeavor to seek alternative, healthier business models, including piloting Shanda Box, purchasing literature websites, and carving out Shanda Games.

Chen has charged himself with a mission to create universally agreeable social values, which in the past has distracted Shanda Interactive from its core business and hurt its stock price. With the carve-out of Shanda Games, Chen is distancing himself from the business that once propelled him to become the number one richest person in China --he only assumes a board member position in the spinoff.

Chen now commits himself to building a great entertainment empire, "China's Disney" in his own words. In my view, the true intent of Shanda Interactive's carve-out is to use the IPO proceeds of Shanda Games to fund its non-game business. After the Shanda Games IPO, Shanda Interactive now has about 2.1 billion USD cash, a formidable amount. Chen also 'burned his bridges': Shanda Interactive is not going to seek business in online gaming, as restricted by its agreement with Shanda Games.

Chen has taken several steps already. He has acquired three online literature sites since 2004: Qidian.com, Hongxiu.com, and JJwxc.net. There are probably thousands of literature sites out there in China, but the majority of them are not copyrighted. Shanda's literature sites offer a copyrighted platform to allow the VIP readers to pay for premium content and they ensure that the authors get paid.

This past June, Shanda acquired 51% ownership in Hurray! Holdings (HRAY), a leader in artist development, music production and wireless music distribution and other wireless value-added services in China.

And now, we have the Joint Venture news. After entering the literature and music fields, Shanda is now into film and TV. Hunan TV is one of the best run state-owned media in China, evidenced by its active copying and localizing successful TV talent shows in the States. With the Joint Venture, Hunan TV became one of the first to morph itself into an enterprise run with proper capital structure, rather than state controlled. From an investor's viewpoint, I think this Joint Venture demonstrates a proper combination of physical capital and human capital, which should lead to synergy created in the future.

What will Shanda do next with 2 billion USD at hand? Chen hinted in an interview that he is looking for the synergy between new and old media:

The new Joint Adventure is just our first step. Please watch out for our next moves.

Here are some possibilities I see so far:

1) Acquire Polybona Films, the Chinese "Miramax".
2) Inject more capital into the new Joint Venture with Hunan TV.
3) Acquire an online Video platform, such as ku6.com, and serve copyrighted video contents.

My hunch is that Chen's new strategy is to acquire content in the traditional media, such as movie, TV, radio, newspaper, magazine, music, literature and so on, and build up an eco-system to foster copyrighted user interaction, either traditional or online. The key to the success of Shanda's new strategy is the improvement in copyright protection in China, which is going to improve to the same level of the developed countries in the future. Shanda's active participation will greatly speed up this process.

In valuing Shanda Interactive, Goldman Sachs applied a 50% discount to its cash position, believing that Shanda will substantially destroy value in its acquisition endeavors. I believe the opposite, very much due to the involvement of China E-captial, a Chinese investment bank specialized in the entertainment business. I have high respect for its CEO, Ran Wang, an HBS graduate and Goldman Sachs alum. Having followed Ran Wang's blog for years, I know that his business acumen and integrity are top grade.

If Chen has a chance to read this article of mine, I would like to let him know that he is on the right track to create very positive social value for China with his vision and commitment. As an investor, I would like him to consider spinning more Shanda Games off Shanda Interactive so that I can invest in his non-game vision at a lower cost. Also return excessive capital to investors if no proper large acquisition targets can be obtained.

Four years ago, I shorted Shanda heavily and I happened to be correct. But today I have my hat off for Shanda, and I support its new strategic move with my capital.

Disclosure: Long SNDA, Short GAME, No positions in SOHU and CYOU.

Comments

[tz647w:]

Great article.

Nov 16 11:32 PM

[ChinaLuxCul...:]

Thanks for this. Excellent article; Shanda's really a pioneer in this space, but whether the consumer will cough up for online content like Shanda'd like, but I'd say their choice to join up with Hunan is a great move. Hunan brings the innovation and experience (and connections), Shanda brings the cash and ambition. Win-win. www.jingdaily.com

Nov 18 04:11 PM