Suffering Sales for Shanda

ShandaInteractive (Nasdaq: SNDA  ) , a video games/entertainment concern based in China, unfortunately didn't have the best first quarter; if the earnings release were a character in a massively multiplayer online role-playing game, it wouldn't survive 10 seconds. There's a reason, though, for this mess, which I'll get to. Let's go over the numbers first.

To begin with, total net sales declined a steep 29% to $42.6 million. Operating income declined more than 90% to $2.3 million. Net income also declined well more than 90%, coming in at $1.5 million, or $0.02 per diluted American Depositary Share.

There were whopping declines in all of Shanda Interactive's margins from their year-ago levels. The gross profit margin came in at 66% versus 74% a year ago. The operating margin was 5.4% versus 51.1%, and the net margin was 3.5% versus 44.3%. This continues a devastating trend, as can be seen from the margins chart in the Foolish Forecast.

Want some more sad stats? Online game sales retreated 30%. Casual-gaming revenues dropped 23.4%. Sales for the online role-playing games sank 32%. Oh boy, can it get more depressing? The EZ Pod, a technology that will convert computers into a content-driven entertainment system and will be helped along by a partnership with a subsidiary of Hewlett-Packard (NYSE: HPQ  ) , is an important driver of future shareholder value for Shanda Interactive; robust sales results from this product would have been encouraging. But the company said, regarding a drop from the fourth quarter in other revenues, that "The sequential decrease was primarily due to the decline in sales of the EZ Pod in the first quarter of 2006."

OK, here's the bottom line. Shanda Interactive is definitely a Rule Breaker -- it has to be when it tussles with the competitive forces of Sony (NYSE: SNE  ) , Electronic Arts (Nasdaq: ERTS  ) , NetEase (Nasdaq: NTES  ) , and The9 Limited (Nasdaq: NCTY  ) .

The company is also in a transition, shifting its model from forcing users to pony up money for game time to instead offering a choice: Play for free or shell out coins for better versions of the software and game accessories. The company expected the downdraft in revenues, figuring that it was properly positioning itself for future growth. While that may be true, there's no question that the situation has become more speculative.

Nevertheless, there are a couple positives here: Shanda Interactive increased its concurrent-user average by just less than 4% to 1.35 million users on a quarter-over-quarter basis. Likewise, the concurrent-user average for the online role-playing games also increased, almost 29%.

If you believe in the prospects of online gaming -- I certainly do -- and if you think that the EZ Pod will eventually catch on with the Chinese public, then you might want to perform some due diligence on the company, considering how much the stock has suffered of late. My take is that we haven't seen the last of Shanda Interactive and that it may surprise all of us in a few years, although I do admit that I think the model shift was a bit of a bold move (but it could be considered somewhat of a necessity considering the Chinese government's regulations on video gaming). Investors considering buying into Shanda Interactive on its current weakness should have a long time horizon, because this is a company that looks to have more steam in the years ahead.

Some massively related Foolish reading:

The Fool has a newsletter for almost every type of investor. You can findShandaInteractive and NetEase inRule Breakersand Electronic Arts inStock Advisor.

Fool contributor Steven Mallas owns none of the companies mentioned. The Fool has a disclosure policy.

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