Can This Cheap Gaming Stock Continue to Outperform?

Chinese online gaming company Shanda Games has had a massive turnaround in fortunes over the past six months. The stock has gained just over 40% since reporting better-than-expected first-quarter results in May. Shanda has even outperformed bigger peers such as Giant Interactive and NetEase in the last six months as it focuses on developing cutting-edge mobile games.

With Shanda expected to release its third-quarter results later this month, investors are expecting more mobile gaming progress from the company. And Shanda might not disappoint on this front.

A strong mobile strategy
Shanda has seen rapid growth in its mobile gaming business recently. Mobile gaming revenue accounted for 10% of overall revenue in the previous quarter, up from nil in the prior-year period. This might not sound much, but Shanda had guided for 50% growth in this segment in the third quarter with more progress expected going forward. Hence, it is clear that the company is counting big on mobile and it also has a strong gaming title to aid its growth.

Million Arthur has turned out to be a hit for Shanda. Earlier this year, it was the fifth top-grossing game on Google Play and Shanda launched it in China to build upon its popularity. The move was successful as Million Arthur was the second top-grossing app on Apple's Chinese app store as Shanda aggressively marketed the title.

Looking ahead, Shanda has a strong pipeline of games. In fact, it has readied 36 mobile games for launch going forward, including the mobile version of its popular online game, Dragon Nest. Out of this massive pipeline, Shanda is expected to launch five to six mobile games in Korea and Taiwan, respectively, by the end of the year. China is expected to receive three to four mobile games as well. Shanda management expects that at least three of these games have got good potential.

A difficult fight
However, the Chinese mobile gaming space is getting crowded as online gaming companies NetEase and Giant Interactive make their move. NetEase is counting on its YiChat messaging platform to attract more users to its mobile platform, and eventually get more players to download its upcoming mobile games. NetEase is expected to launch several mobile games before the end of the year.

On the other hand, Giant Interactive is also looking to make its mark in mobile games. Giant is expected to release its first two games in the coming quarters, including ZT Online Mobile. ZT Online is one of Giant's most successful PC-based online games, and the company is probably making a smart move by introducing it in the mobile form to attract more users.

A sound MMO strategy, but will it work?
As mentioned above, mobile games were just 10% of Shanda's overall revenue in the second quarter. Hence, Shanda is also stepping up its game in massively multi-player online (MMO) games. Mir II, which accounts for 31% of Shanda's total revenue, is its most popular game. Shanda has lined up fresh content for Mir II as it looks to keep gamers engaged, while another game, Woool, will also receive an expansion pack. 

Shanda will be launching Final Fantasy XIV and Dungeon Striker going forward to add to its existing portfolio of games. An expanded portfolio will help Shanda benefit from the rapidly growing Chinese gaming market, which is expected to be worth $22 billion by 2017 according to IDC. In addition, Shanda would be able to better compete with Giant Interactive and NetEase, both of which are aggressively developing new online games.

Giant's recently released MMO, World of Xianxia, has turned out to be quite a success even during its testing phase. As the game is released for the masses, it should be generating more revenue. In addition, Giant has already started work on Jianghu, the MMO gaming flagship for 2014.

On the other hand, NetEase has also been focusing on developing more in-house games, apart from mobile. NetEase had launched Heroes of Three Kingdoms and Dragon Sword earlier this year, accompanied by aggressive marketing activities. Going forward, NetEase expects that expansion packs for Ghost II and Kung Fu Master will lead to higher revenue on the back of renewed user interest. 

The takeaway
While Shanda has been delivering good growth in its mobile business, it needs to do the same in MMO gaming. The company has made some decent moves by rolling out new content for existing games and developing new ones, but it remains to be seen how they perform in the next few quarters.

Shanda has gradually improved. Analysts are expecting around 8% growth in revenue in the third quarter from the prior-year period, a massive improvement over the 22% decline that it had witnessed in the first quarter. Moreover, at a trailing P/E of just 6.5, Shanda is very, very cheap and those looking for a turnaround play should definitely take a closer look at it.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends Giant Interactive Group and Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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