Commentary

Dubious Shanda Still Playing Games With Investors

Tech Market WatchBy Perry Wu
Shanda, an online games provider in China, had its first quarterly earnings report since it became public and it was mostly good news. As expected, revenues and net income were both sharply higher from last year. Users of Shanda's games were also higher than last year, by about 25% from the first quarter of 2004. Shanda's CEO, Tianqiao Chen, said he was pleased with the results, and he should be. It sounded like a positive quarter, but potentially harmful ghosts still exist in the company's background.

Beyond the numbers, Shanda is now taking positive strategic steps to respond to what might be its harshest criticism, that it is a one-trick pony. At the time of its IPO, most of Shanda's profits and success were based on one game, "Legend of Mir". But this dependence is now changing. In the second quarter, the company launched two games developed internally, an MMORPG and a game called The Sign. Going forward in the second half of the year, Shanda says it will launch two more games. So by going out and launching other games, a potential decline of "Legend of Mir" may not have such a crippling effect on the company.

But similar to last week's conference call made by Linktone, Shanda's behavior during the conference call defeated the whole purpose of having a live conference call. Shanda's executives simply read from a lengthy script that should have simply been issued as a written release. If Shanda ever wanted to get out of the online gaming business, it might do well in the pharmaceutical business; its conference call proved to be a good cure for insomnia. It was a ridiculous waste of time.

Shanda's conference call had a script with all the right buzzwords. One executive said that Shanda has successfully built "higher barriers to entry" and "strengthened core competencies". But let's think about that: what is Shanda's core competency? Its most successful game was actually developed by an outside Korean company (thus the licensing fees problem mentioned below), and although it says it is now developing games internally, its recent acquisitions say otherwise. So is its "core competency" in developing games, in buying games, or licensing games or a little of each? Shanda itself probably has not figured it out. Its marketing gloss is getting rusty and the public relations shield for the company is crumbling.

Additionally, the news coming from Shanda over the last month shows that Shanda is not wasting any time in using the cash raised from its IPO. Just in time for its first quarterly report to investors, Shanda squeezed in two acquisitions. In July 2004, Shanda announced the acquisitions of Haofang Online and Bianfeng Software. Together, these two companies boast about 520000 peak users.

But the manner in which Shanda has reported these acquisitions is particularly alarming. There is simply no information in Shanda's public releases on how much Shanda paid for the two companies. But in due course, the price Shanda paid for these two companies will be made public. Future SEC filings over the course of the next year will almost certainly force Shanda to disclose how and how much these two companies were acquired. Does Shanda think that it overpaid for these companies? Does it think it overpaid on professional fees for acquiring the companies? Why not just come clean and tell us now?

One of the most pressing issues facing Shanda is its ongoing dispute with a Korean games company about licensing fees on its successful "Legend of Mir" game. Shanda's Profit and Loss Statement still show this as a major issue. Of Shanda's US$34.7 million of online games revenue, licensing fees make up US$6.7 million, or about one-fifth. But the earnings release is totally silent on this issue. Knowing Shanda thus far, no news is probably bad news. Again, a status report is needed on this situation. To an outside observer, it seems like Shanda is running itself like a messy fiefdom, common among state-owned Chinese enterprises.

Also interesting is the "General and Administrative Expenses" in the Income Statement. This line item is notorious for its use as an all-purpose vehicle that includes costs that management does not itemize. These costs are not broken down, but seeing as the costs increased three-fold, from US$11.6 million to US$31.3 million, some explanation is needed. Are the executives suddenly paying themselves much higher salaries since the IPO? Or are they just lax about costs? Are monkeys running the accounting department?

Covered in the press release is information on "government financial intervention" that Shanda has received. It is unclear exactly what sort of government intervention this means (perhaps tax rebates) but it has contributed significantly to the rise in revenue that Shanda reports. Of the US$ 8.4 million increase in revenue for second quarter 2004 over the first quarter 2004, this "government intervention" accounts for half of this (US$4.1 million). So without this government support, net income would have increased 49% from the first quarter of 2004, instead of doubling as reported. But give Shanda credit for at least pointing this item out now.

With Shanda's issues, all that can be said for certainty is that Shanda is not worth the US$1.4 billion that the market is now saying it's worth. When we revisit this company after several months or a couple of years, this will not be the case. As sure as the sun rises in the east, Shanda's valuation will be sharply lower.

About the author:
Perry Wu is a writer and correspondent for ChinaTechNews.com and can be reached here at the site. Perry Wu does not hold any positions, long or short, on any of the Chinese or American company securities mentioned in this article.

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