Shanda Interactive Entertainment (SNDA)

TOP CONTRIBUTORS

Alan Hsieh

Andrew Lewis

MMORPGs make up Shanda’s largest reporting segment, with 82% of revenues in FY 2007.^[4] However, these sales are largely earned from two MMORPG titles, Mir 2 and Woool, which were released in 2001 and 2003, respectively.^[5] These two titles are nearing their end-of-life and as such the company has begun licensing new games from foreign companies in efforts to find a new blockbuster hit, in addition to its other operations (casual gaming, associated gaming sales, as well as the EZ initiative).

In 2007, Shanda was the #1 market player in the Chinese Online-gaming market by revenues^[6] , despite its transition to a new business model, competing against The9 (NCTY), Netease.com (NTES), and other gaming operators that monopolize the time and money of many Chinese youths. The company chose to move from a pay-to-play model based on play time, to a new free-to-play model where revenue is earned from micro-transactions made in the game for premium content.^[7] This move was largely made due to the end-of-life of their main titles. This move initially dented revenue and margins in 2006, lowering from ¥1,896.6MM (FY2005) to ¥1,654.5 (FY 2006), and operating margin from 33% to 23%.^[8] However the margin structure has improved in 2007, with revenues growing 50% and margins expanding to 41%.^[9] as the new-business structure matured and gamers be came comfortable with the new transaction model. It remains to be seen how the title end-of-life and the development of new businesses will play out in Shanda’s future, but the markets' expectations for China’s #1 online-gaming player are very high

Business Description and Financial Analysis

The company generates revenue in three primary reporting segments.

• MMORPG – The MMO RPG segment caters to “hardcore” Chinese gaming youth, with an immersive game experience that typically requires and commands a significant amount of time from Chinese youths. Due to the new free-to-play model, revenues are earned from paying subscribers who buy premium content. The Average Revenue per paying subscriber in 2006 and 2007 was ¥55.1 (FY 2006)^[10] and approximately ¥58 (FY 2007)^[11], respectively. However, this was accompanied by an increase in over number of paying subscribers due to new game launches, which led to a growth in MMORPG revenues. "Younger" games typically have lower revenue per subscriber since users have not been in the game world that long and don't have as much reason to spend money. The company can earn more revenues by compelling customers to spend more time in the game, thus motivating them to consider making purchases and improving their characters in game. This improves the performance of both metrics at the same time. This business is exposed to the age of the primary two titles, and is seeking a new replacement blockbuster title.

• Casual Gaming – Casual games require less user-game time and typically can be played to conclusion within a shorter period of time in one session. These simpler games appeal to a larger demographic than the MMORPGs and thus diversify the company’s earnings. These games also use the free-to-play model, as well as earnings earned from internet-revenues. The Average Revenue Per User is typically lower than that for MMORPG, for example, ¥18.1 in FY 2007^[12] and ¥12.4 in FY 2006.^[13]

• Other – the company sells software associated with running internet cafes, and also is attempting to launch its “EZ” series of home-entertainment devices. However, revenues any one of these minors business are not significant, with advertising earning about ¥21MM in 2006, and EZ earning ¥29MM in revenues.^[14] EZ’s sales come from bundling with computer manufacturers , and sis thus dependent on Shanda’s agreements with computer manufacturers. While it has a number on board^[15], Shanda does not have support from China’s #1 computer manufacturer, Lenovo. Such a type of agreement would likely dramatically improve sales figures for this new business.

^[16][17]

As seen above, MMORPG's make up the majority of the company's revenue contribution. The change in business plan affected both the MMORPG as well as the casual gaming segments, as the company moved to an all free-to-play model, decreasing their revenues. However, both segments have begun recovering in terms of revenue in 2007. The "Other" business segment has been declining, as a result of Shanda's decreased focus on a number of supplemental businesses, such as the internet cafe software.

Fore more information about the company's gaming titles, see the 20-F

For the overall business, the effects of the business model change can clearly be seen below.

^[20][21]

Revenue's decreased due to the new business mode change to free-to-play, and margin's decrease partially because gamers weren't prepared to pay for new content in the new game worlds. However, in FY2007 both revenue and margins increase dramatically, as gamers responded favorably to the new business model.

Trends/Forces

Primary two MMORPGs are games nearing end of life (2001 and 2003), and new businesses largely licensed from foreigners and unproven

Business model transition to free-to-play appears to be generating more revenues, but further exposes company to individual games' popularities

Government intervention on online-gaming and internet a risk to revenue growth

EZ-Play new business big potential for revenue growth

Shanda exposed to currency fluctuations as it has overvalued operations earned in RMB for a USD denominated shares

Competition

Primary competitors are Chinese operators of online-games. Although there is some competition from Foreigners, they are limited by Chinese law from achieving market penetration, since any Mainland Chinese venture has to be more than 50% Chinese owned/operated. Therefore, Shanda’s primary competitors are:

• Perfect World (PWRD)
• Netease.com (NTES)
• The9 (NCTY)

Market Share

In 2007, the Chinese MMO market size was estimated at $1.66 BN.^[24] The major players in this market were Shanda, Netease, Giant Interact, The9, and Perfect World. Shanda's Market share was approximately 20% by revenue generation.

References

1. ↑ Shanda Interactive "Risk Factors" pg. 4
2. ↑ Shanda Interactive "Operating Results" pg. 45
3. ↑ Shanda Interactive "Risk Factors" pg. 6-7
4. ↑ Shanda Interactive FY 2007 Results Press Release, February 25, 2008
5. ↑ Shanda Interactive "Information on the Company" pg. 25
6. ↑ SeekingAlpha "It's a Perfect World for Chinese Gaming Developers" October 3, 2007
7. ↑ Shanda Interactive FY 2006 20-F "Business Overview" pg. 26
8. ↑ Shanda Interactive FY 2006 20-F "Consolidated Statements of Operations and Comprehensive Income" pg. F-3
9. ↑ Shanda Interactive FY 2007 Results Press Release, February 25, 2008
10. ↑ Seekingalpha Shanda FY 2006 Earnings Call Transcript February 12, 2007
11. ↑ Seekingalpha Shanda FY 2007 Earnings Call Transcript February 26, 2008
12. ↑ Seekingalpha Shanda FY 2007 Earnings Call Transcript February 26, 2008
13. ↑ Seekingalpha Shanda FY 2006 Earnings Call Transcript February 12, 2007
14. ↑ Shanda Interactive FY 2007 20-F "Other Net Revenues" pg. F-24
15. ↑ Shanda Interactive FY 2007 20-F "Our EZ Initiative" pg. 33
16. ↑ Shanda Interactive FY 2007 Results Press Release, February 25, 2008
17. ↑ Shanda Interactive FY 2006 20-F "Consolidated Statements of Operations and Comprehensive Income" pg. F-3
18. ↑ Shanda Interactive FY 2007 Results Press Release, February 25, 2008
19. ↑ Shanda Interactive FY 2006 20-F "Consolidated Statements of Operations and Comprehensive Income" pg. F-3
20. ↑ Shanda Interactive FY 2007 Results Press Release, February 25, 2008
21. ↑ Shanda Interactive FY 2006 20-F "Consolidated Statements of Operations and Comprehensive Income" pg. F-3
22. ↑ Shanda Interactive FY 2007 Results Press Release, February 25, 2008
23. ↑ Shanda Interactive FY 2006 20-F "Consolidated Statements of Operations and Comprehensive Income" pg. F-3
24. ↑ SeekingAlpha "It's a Perfect World for Chinese Gaming Developers" October 3, 2007