Is Shanda Games a Good Buy Right Now?

Shanda Games was battered after the company released its third-quarter results. Despite beating consensus estimates, a decline in key operational metrics and the weak performance of its massively multiplayer online (MMO) games snapped a bullish run that Shanda had enjoyed over the last six months. The company's online gaming segment wasn't doing as well as its mobile division, and it looks like competition from bigger rivals such as NetEase and Giant Interactive is hurting Shanda.

In a tight spot...but looking to bounce back
According to Morgan Stanley analysts, revenue from Shanda's top PC games -- Mir II, Dragon Nest, and Woool -- declined in the range of 12%-25% on a year-over-year basis. These three games accounted for 53% of Shanda's revenue in the previous quarter, which is why their decline is a cause for concern. In addition, Shanda closed down the operation of RIFT, a MMO game, during the quarter as it didn't perform up to management's expectations. 

It is evident that things aren't looking quite rosy for Shanda right now as far as online gaming is concerned. There may be no respite until the first half of 2014, when Shanda plans to release some new titles. The company has successfully completed a round of closed beta testing of Final Fantasy XIV and claims that it has received "very favorable user feedback." It has been downloaded more than 1.5 million times in just over three months since being relaunched in Japan and continues to gain more users. 

Shanda will conduct some more testing in the second quarter next fiscal year before putting out the complete version of Final Fantasy XIV. If the company manages to keep gamers interested in this well-known MMO franchise, then there might be some positives going forward. In addition, Shanda is readying Dungeon Striker for launch in Japan and China next year while another title, Age of Dawn, is about to enter closed beta testing.  

A difficult battlefield
Shanda management intends to expand its portfolio of MMO games in the next two to three years by adding more games.  But for the time being, the current titles are not performing very well as other gaming companies seem to be stepping on the gas in the MMO segment. Both NetEase and Giant Interactive are playing with a good strategy in this market and their games seem to be doing quite well.

NetEase, which is looking to reduce dependence on Activision's World of Warcraft, has found success with its self-developed games such as Heroes of Three Kingdoms and Dragon Sword. Moreover, the company recently released fresh content for its longest-running games -- Fantasy Westward Journey II and Westward Journey Online II. Looking forward, NetEase is looking to release Crisis 2015 -- a first person shooter game -- and Revelations, a 3D epic fantasy game. 

NetEase's has got more marketing muscle than Shanda as its cash balance is five times that of Shanda's. That's why it could continue to create pressure on its smaller peer by way of aggressive promotions and superior games.

Giant Interactive, on the other hand, is looking to add to the success of the ZT Online and World of Xianxia franchises. ZT Online is one of Giant's most successful games and the company has replicated the success with World of Xianxia, which was launched earlier this year. Now, Giant is looking to add one more weapon to the arsenal.  

Giant recently announced that its MMO gaming flagship for 2014 -- Jianghu -- will enter the test phase this month. The company has already spent three years developing this game, which indicates the amount of research and development put into it. In addition, Giant's partnership with Qihoo 360, known for its security products and a fast-growing game platform, gives it an advantage in terms of distribution.

The mobile gaming business has been the lone bright spot for Shanda. The segment grew 50% quarter over quarter, driven by the success of Million Arthur in China. Mobile now accounts for 14% of overall revenue and Shanda is working on increasing this share further. It will be launching Guardian Cross, developed by Square Enix, in China along with two self-developed games -- Dragon Nest and the Hell Lord -- going forward. 

What to do?
But then, mobile is a pretty small percentage of total revenue for Shanda. Until and unless the company's MMO games start delivering, I think it would be prudent for investors to book their gains and instead look at other options in the Chinese online gaming industry.

But for investors looking for a dirt cheap stock that might deliver in the long run, Shanda could prove to be a good bet. At a trailing P/E of just 7, Shanda trades at half the industry average. Its mobile business is growing and the MMO segment might spring to life with the launch of new games this year. As such, depending on the risk profile, investors might think of picking up some shares and count on a turnaround in the MMO business.

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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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