This Beaten-Down Company Is Getting Better

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Chinese online game developer Shanda Games (UNKNOWN: GAME.DL  ) has seen its fortunes turn around dramatically since it reported its first-quarter results in May. The company is up more than 30% since it sent out those signs of a resurgence in its business, and its recently reported second-quarter results indicate that further improvements might be on the way.

A look at the results reveals that Shanda is gradually getting better. The company's revenue of $175.6 million was down just 4% from the year-ago quarter, a marked improvement over the 20% drops it had reported on the two previous occasions .

The results were better than analyst estimates, and the guidance of 3%-4% sequential growth for the current quarter should help Shanda report year-over-year revenue improvement.

Going mobile
Shanda has been following a different strategy to resurrect itself than other Chinese online gaming companies. Its focus on mobile games seems to be reaping results as revenue from mobile gaming was $17 million in the quarter as compared to nothing in the year-ago period. While this is just 10% of overall revenue, Shanda expects mobile gaming revenue to increase 50% sequentially .

This growth rate is no doubt impressive, and Shanda's excellent moves in mobile gaming are worth watching. Its mobile game Million Arthur has been doing well and ranked fifth among the top-grossing games on Google Play earlier this year. To build up on the success of this game, Shanda launched the game in China early last month and its reception was positive.

On the day of launch, Million Arthur became the second top-grossing app on Apple's app store in China on the back of Shanda's aggressive marketing. The company is intent on keeping the momentum of this game intact by releasing more content going forward. Shanda has lined up 36 mobile games for release .

The company recently announced that it will launch a new mobile platform, known as G-Home, to enhance user experience and get more subscribers of its massively multiplayer online games, or MMO games, to use its mobile offerings. This cross-platform strategy looks like a smart move and should benefit the company by pulling in more mobile subscribers going forward .

MMO strategy
However, Shanda needs to turn in some good results in the MMO segment as well, since it makes up for the majority of its business. Moreover, as Chinese online gaming leader Giant Interactive (UNKNOWN: GA.DL  ) once stated, monetization prospects are better in MMO games as compared to mobile. As such, Giant has consistently focused on building strong MMO franchises.

ZT Online has been one of Giant's successes in the MMO arena and the company has kept the game interesting by way of expansion packs. In addition, Giant is expecting its next MMO, World of Xianxia, to become a strong revenue driver going forward. The game has received good feedback in closed beta testing, according to management .

Giant Interactive has done well with its MMO games, and Shanda needs to bolster this side of its business if it is to benefit from the booming Chinese online gaming market. As such, Shanda will be releasing expansion packs for Mir II and Woool this year. Mir II is Shanda's highest revenue generator with 31% of revenue, and new content should keep players interested .

Shanda has already rolled out fresh content for some of its games and it will continue following this strategy to keep revenue from MMO games flowing. Testing for Final Fantasy XIV is progressing well according to management, while another game, Dungeon Striker, is slated for launch in China and Japan going forward .

But Shanda will have to be on top of its game in MMO games, as this market is very competitive with players such as Giant, Tencent, and NetEase (NASDAQ: NTES  ) in the fray. NetEase, a much bigger competitor, has been aggressively moving into the MMO space with games such as Heroes of Three Kingdoms and Dragon Sword, while also releasing expansion packs for its other games.

NetEase is looking to reduce its reliance on Activision Blizzard's World of Warcraft and as such, it is focusing on its self-developed games. Moreover, NetEase's management stated during the previous conference call that it has "several mobile games" in the pipeline .

With Shanda competing with the likes of NetEase for game time, investors should closely watch how its games are progressing and check for signs of any weakness.

The bottom line
Shanda fell more than 10% after the earnings report despite a good performance, probably because analysts have doubts about Shanda's strategy. However, considering its dirt cheap valuation with a trailing P/E of less than 7 and probability of improvement in its business going forward, investors might consider initiating a long position at current levels.

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