Leading Chinese Online-Game Company Plans Unusual Spinoff

• Amy Reeves
• On 6:03 pm EDT, Monday September 21, 2009

Shanda Games Ltd.

Shanghai, China

(86-21) 5050-4740

shandagames.com

Lead underwriters:

Goldman Sachs and JPMorgan

Offering price: $11-$13

Expected date: week of Sept. 21

Ticker: GAME

THE BUZZ

Investing in stocks can be full of mysteries. Just look at Shanda Interactive Entertainment's decision to partly spin off its online-game division, Shanda Games.

On the one hand, the precedent is obvious. In April, Chinese Internet portal Sohu.com (NasdaqGS:SOHU - News) did an IPO of its booming game unit, Changyou , while retaining a controlling stake. Despite skepticism from some analysts, the IPO turned out the biggest return of the year so far -- more than 140% on the initial price of $16.

But that was a business that already had two distinct parts, says analyst Adam Krejcik of Roth Capital Partners. In Shanda's (NasdaqGS:SNDA - News) case, 95% of its revenue comes from online games.

"They are an online game company," he said. "They're essentially spinning out what they do right now."

From an investor's standpoint, that's not entirely a bad thing because what they do right now is working very well. Shanda currently sits at No. 96 on the IBD 100 list, thanks to sales and profits that have more than doubled since 2005. It's one of the leading players in China's booming massively multiplayer online role-playing game (MMORPG) sector.

Still, it's precisely this success that makes the IPO such a mystery. The company already has $600 million to $700 million in cash, and the offering would double that.

"The biggest question I have is, what do they need $1.5 billion in cash (for)?" Krejcik said.

THE COMPANY

Shanda Interactive formed in 1999 and entered the game business in 2001, making it one of the senior members of China's MMORPG industry. It made its name with "Legend of Mir II," which was China's biggest online game in 2002 and 2003. Since then, it has built a portfolio of 20 MMORPGs, with more in the pipeline. It also runs 11 online "casual" games.

MMORPGs allow players to enter a fantasy world in the guise of characters, interacting and fighting with other people's online avatars. Most of them are set in sword-and-sorcery realms, often based on Chinese legends. Casual games tend to be based on fun contemporary activities, such as dancing and making music.

Despite its diverse portfolio, Shanda Games derives 77% of its sales from "Legend of Mir II" and its other blockbuster, "World of Legend." That's not unusual in the MMORPG business, where many companies depend on just one game for most of their income.

Shanda says it had 9.73 million active paying accounts in the second quarter, giving it one of the largest user bases in China. It's also still growing. The count is roughly double the year-earlier quarter's.

The company was reorganized for the spinoff in the spring of 2008, leading to the incorporation of Shanda Games that June. Shanda Interactive will continue to own at least 75% of the shares after the offering.

RISKS/CHALLENGES

The MMORPG business is notoriously unreliable, since you never know which games will catch on or how long they will stick. Investors have gotten burned before when companies like Giant Interactive (NYSE:GA - News) and The9 (NasdaqGS:NCTY - News) struggled to match past successes.

Shanda both develops games in-house and licenses them from third parties, both of which carry risks. Development requires upfront investment that may not pay off, while licensing requires good relationships with outside companies. Licensing deals have already led to some intellectual-property suits.

Shanda indicates in its prospectus that it plans to expand partly through acquisition, bringing further expenses and risks. In July, for instance, the parent company bought 51% of Hurray (NasdaqGM:HRAY - News), a wireless game provider, leading an analyst to downgrade the stock.

The unusual structure of the offering means that only about $140 million of roughly $800 million in proceeds from the IPO will go directly to Shanda Games. Shanda Interactive will operate as something of a holding company, retaining most of the cash.

Krejcik also points out that Changyou's performance came partly from timing, as it debuted just a month after the market bottom. The proposed offering range for Shanda Games is in line with the expanded multiples of the whole group, he says.

THE RESULTS

In the first half of the year, revenue rose 43% from the year-ago period to $322 million. Net income climbed 75% to $98.3 million.

USE OF PROCEEDS

Shanda expects to net about $141 million from the offering. It will use the money for general corporate purposes.

THE MANAGEMENT

Qunzhao Tan

Chairman

Has been president of Shanda Interactive since April 2008 and chief technology officer since 2003. He holds an MBA from Peking University.

Diana Li

Chief executive officer and director

Became CEO of Shanda Games in April 2008 after three years in various positions at Shanda Interactive. Previously held management positions at Expedia (NasdaqGS:EXPE - News), Microsoft (NasdaqGS:MSFT - News), Fidelity Investments and Unifi Telecommunication. She holds a master's degree from Bowling Green State University in Ohio.

Hai Ling

President

Joined in April 2008 after working at the parent company since 2003. Before that he was general manager at Powerise Technology for six years. He holds a B.S. from the National University of Defense Technology.

Buzz up!