Shanda Interactive Entertainment Limited (Shanda), founded in Shanghai in 1999, is a leading online gaming company in China. Shanda offers a portfolio of diversified entertainment content including some of the most popular massively multi-player online role-playing games (MMORPGs) and casual online games in China, as well as online chess and board games, network PC games and a variety of cartoons, literature works and music. Shanda's interactive entertainment platform attracts a large and loyal user base, of which more and more is coming from homes.
Shanda has traditionally made its money mainly from subscription fees that gamers pay in order to access its popular massive multiplayer games, which, combined with its casual games, have attracted as many as 3.08 million active paying users at the end of September 2007. For its games, which reached their mature stages of the lifecycles, Shanda uses item-based revenue model to attract game players. Item-based revenue means that Shanda would no longer charge for access to the games, but rather would generate fee income from providing in-game services to players. This item-based revenue model has been very successful to extend the lifecycles of its games and increase the revenues.
In 2005, Shanda made one significant move to grow its business through aiming to become a leader in interactive entertainment in China, offering movies, music, games, and other services. It created a series of software products to that end, partnering with Vivendi Universal [V], Apple [AAPL], and Intel [INTC], among others. Shanda hoped to charge users monthly subscription fees to access services provided on its platform. Eventually, Shanda gave up this strategy because such markets didn't exist at that time in China. Although this unsuccessful move almost killed Shanda, the management team managed to recover its profitability.
Shanda s revenue and earnings for the third quarter showed strong growth, which exceeded market expectations. We think Shanda s results demonstrate the strengths of its item-based revenue model and its comprehensive operating platform despite the fierce competition in the Chinese online gaming market. However, we are concerned how long the company can maintain this growth momentum without new hit games in this competitive market. Therefore, we are initiating coverage on Shanda with a Hold rating.