Throw This Stock Away

The house rules are simple in this weekly column.

  • I bash a stock that I think is heading lower.
  • I offset the sting by recommending three stocks as portfolio replacements.

Who gets tossed out this week? Come on down, Shanda Interactive (Nasdaq: SNDA  ) .

Fasten your seatbelts
Shanda investors may be doing victory laps after last night's better-than-expected quarterly report, but what are we celebrating, exactly?

Revenue climbed a mere 2% year over year to $232.3 million, devoid of strength in Shanda's two core businesses. Its Shanda Games (Nasdaq: GAME  ) online gaming arm posted a 14% year-over-year decline in revenue. Shanda's online portal suffered a 9% top-line dip.

Shanda's revenue only inched higher because its hodgepodge of endeavors lumped together as "other" revenue actually more than doubled.

Hold your applause until you see what's really behind Door No. 3. Shanda's "other" businesses include difficult-to-monetize sites featuring literature, video-sharing, and board games. Investors buying into Shanda for the promise of China's booming online gaming industry or sizzling portal potential may be shocked to find those flagship endeavors slipping even as China's web migration grows.

This wouldn't be so bad if there were some "other" catalyst, but there isn't. Gross profit margin for Shanda's "other" revenue clocked in at a pathetic 22%. Compare that to the gross margins in the company's fading online and gaming businesses, at 75% and 61%, respectively.

The end result of this sad stew: Adjusted earnings were nearly cut in half to $0.46 a share, despite the flattish top-line showing. Sure, analysts were only targeting a profit of $0.39 a share on $217.7 million in revenue, but this only means that investors should adjust their level of pessimism.

Once-great Shanda was one of the earliest Motley Fool Rule Breakers recommendations, but David Gardner chose to take the small gain amassed over six years and bump it off the scorecard back in January.

It's just no longer the growth stock that some investors think they're still buying. It's also not much of a value stock, fetching more than 20 times trailing earnings.

There are companies growing in gaming and cyberspace in China. Buy those instead.

As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

Sohu.com (Nasdaq: SOHU  )
China's best match for Shanda is Sohu.com, a dot-com pioneer with a strong presence in both website portals and online gaming through Changyou.com (Nasdaq: CYOU  ) . It makes this week's cut because it moved ahead during the same three months in which Shanda retreated. Revenue surged 30% during the fourth quarter. Sohu's brand advertising, online gaming, and search businesses all posted year-over-year gains of 30% or better. There were no "other" sandbags here. Margins widened as earnings shot up 41% during the period. It's also even cheaper than Shanda, trading for 17 times this year's projected profitability vs. a forward multiple of 23 at Shanda.

Baidu (Nasdaq: BIDU  )
Shares of China's leading search engine aren't cheap, but that's never stopped Baidu from becoming one of the best-performing Internet stocks over the past few years. Its latest quarter was so full of win that Charlie Sheen wants to hang out with it. Revenue soared 94%. Earnings skyrocketed 171%! If investors are looking for a growth-stock vehicle in China, this is the bullet train.

Activision Blizzard (Nasdaq: ATVI  )
Investors gun-shy about actually investing in China can get the best of both worlds by buying into this leading gaming software company. Activision Blizzard's World of Warcraft has been a huge hit in China since it was reintroduced there in 2009 through licensing partner NetEase.com (Nasdaq: NTES  ) . On the console front, Activision Blizzard took its lumps when it axed its fading Guitar Hero franchise, but the company still set initial sales records with Call of Duty: Black Ops back in November.

I'm sorry, Shanda. You're just no longer in demand-a.

Baidu, NetEase.com, and Sohu.com are Motley Fool Rule Breakers picks. Activision Blizzard is a Motley Fool Stock Advisor recommendation. Motley Fool Options has recommended a synthetic long position on Activision Blizzard. The Fool owns shares of Activision Blizzard. Motley Fool Alphaowns shares of Activision Blizzard. 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.

Longtime Fool contributor Rick Munarriz doesn't mind taking out the garbage every so often. He does not own any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (14) | Recommend This Article (2)

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  • Report this Comment On March 02, 2011, at 7:18 PM, Varchild2008 wrote:

    The Hodgepodge of "Other" in (GAME) happens to not be such a Hodgepodge if you actually bothered to listen into the Earnings Conference Call....Or if you actually knew what you were talking about....which you do not.

    That "Other" primarily consists of one of the companies acquisitions post IPO in an America based company called:

    Mochi Media

    Mochi Media is a Flash Based Gaming Portal site that sells their developer technology, Advertisement Technology (Ads are placed into the Flash Game) to generate Revenue.

    They also developed a Mobile Flash Gaming Platform on Android. They have also recently been introduced to CHINA as (GAME) has been developing a CHINA Mochi Media.

    Tencent Holdings has recently placed MOCHI Media Flash Games on one of their Web Pages without any approval from Mochi Media.

    Mochi Media has issued a warnings letter to Tencent Holdings as they not only placed Mochi's games on their site but they stripped out the Mochi Advertisements...

    In the meantime (GAME) recently won a 3 Milllion RMB lawsuit against another Chinese Company for violating Copyrights / Property Rights....

    I love how you say, "This wouldn't be so bad if there were some "other" catalyst, but there isn't. "

    Really?

    1) Dragon Nest (Catalyst Contestant #1)

    http://dragonnest.nexon.net/

    2) ‘Sudden Attack’ #1 Top Selling First Person Shooting Game in Korea being Introduced by SHANDA to China.

    3) ‘Point Blank' #1 Top Selling First Person Shooting Game in Indonesia being Introduced by SHANDA to China.

    4) Video Game Licensing Reaching 49 Regions around the world

    Shanda Games just added Vietnam, for example, as a country where one of their games is licensed.

    These Licensed deals are adding 4.5% to their Revenue and overtime this will increase their Top Line Growth as more *New Games* are developed and released in China.....

    Straight from the C.E.O.:

    "Additionally, we are seeing an accelerated growth in our international business, driven by successful launches of new titles in overseas markets. We expect to further expand our business geographically to take full advantage of our high-quality titles and operational expertise.”

    5) "Legend of Immortal" "Hades Realm II" "Final Fantasy 14"

    6) Shanda Games has TONS of money they are sitting on waiting to use it for possible future acquisitions. (US$328.3 million) Dec. 31st 2010.

    They recently purchased 100% of Eyedentity Games and have fully incorporated this acquisition as of end of Q4 2010.

    They bought Gold Cool Games not too long ago, Mochi Media of course, and they continue to see acquisitions as a growth option.

    7) $150 Million Share Buyback Program) Even if the buybacks have been very slow.....The program still exists and it has helped.

    The Company hasn't produced a 52-week low in Share Price since June 2010.

    8) Meanwhile: (ATVI) Activision Blizzard just lowered their Earnings Outlook for 2011. Shanda Games has been extremely bullish on their 2011 expectations.

    Straight from the C.E.O.

    "In February 2011, Shanda Games obtained an exclusive license from Bandai Korea, a subsidiary of a leading Japanese toy making and video game company, Bandai, to operate a 3D MMORPG “Dragon Ball Online” in mainland China. “Dragon Ball Online,” adapted from a popular Japanese comic book “Dragon Ball,” is one of the most anticipated game titles in the Chinese market according to various major Chinese online game websites. "

    9) DRAGON BALL Online from Bandai Korea:

    http://www.gamespot.com/pc/rpg/dragonballonline/index.html

    The Video Game has a 9.6 out of 10 USER SCORE! That's from 55 users voting.

    Check out Dragon Ball Online which I guarantee Rich Munarriz didn't even bother to look up.

    In fact.. I highly Doubt Rich ever did any shred of homework on Sudden Attack and Point Blank. ZIP ZERO NADA,.... Just wants to trash a stock he already trashed a month ago... I guess 1 Bad Article on SNDA / GAME isn't enough?

  • Report this Comment On March 02, 2011, at 7:21 PM, Varchild2008 wrote:

    Here's my Bibliography for the Post I wrote above if you want to see where I got my information from:

    http://simulator.investopedia.com/stocks/GAME

    Investopedia released the article about the Warning Letter Mochi Media sent to Tencent.

  • Report this Comment On March 02, 2011, at 7:21 PM, mcintorb wrote:

    The Fool has been a booster for ATVI, with the eternal promise of "market recognition" just around the corner, for at least a couple of years. With great product launches and much publicity in that time, the stock price has gone nowhere while the market has basically doubled (24 month record as of 3/2/2011 is ATVI up 8%, DOW up 80%, SP500 up 90%, NAZ Composite up 110%). ATVI has been dead money, and there is no catalyst to change that dynamic. Move on Fools.

  • Report this Comment On March 02, 2011, at 9:53 PM, bottomfisherman wrote:

    I agree ATVI is a dogfish cut it up and use it for shortbait. Yes even MF and most of the CAPS community have got this one wrong.

  • Report this Comment On March 03, 2011, at 3:21 AM, Calm127 wrote:

    Bottom-

    Again, I really feel like maybe you got burned on ATVI once and you just feel like coming on here and bashing it by copying and pasting comments you collect from various other message boards.

    It is likely true, though one never knows, that this stock will never skyrocket (like madcatz did, shoot), but it can be purchased at the $10.50 range and sold off in the $12 range almost like clockwork. You can argue that Rift and DCU are going to kill WoW, and now some are arguing that Battlefield 3 will kill COD, but even as you sit there typing, you must know that isn't true... at least not yet.

    Since I often see your name come up on the bottom of pages that highlight ATVI's stock and you only ever blindly and thoughtlessly bash it, I can only wonder why you even bother. If you hate the stock, you must not own it. If you own it and hate it, sell it and be done with it.

    I have heard the silly kids crying for years now that COD has run its course, and I hear it again this year. Here is a fact- Battlefield 3 will be a far superior game to the inevitable Modern Warfare 3 in every facet, and MW3 will sell more. Here is another fact- When the eventual death of COD and WoW arrive, and I agree they will eventually, Activision will already have something in the pipeline to rake in the cash. Remember when Tony Hawk games were the 'in' thing until it was saturated in to oblivion? Remember how that was the end of Activision? Companies don't make billions on one-trick ponies, you're just too short-sighted.

  • Report this Comment On March 03, 2011, at 3:22 AM, Calm127 wrote:

    :)

  • Report this Comment On March 03, 2011, at 9:39 AM, FoolSolo wrote:

    @Calm127,

    I have been long on ATVI since late 2008, and unfortunately I'm down 25%. I know the risks of investing, and I'm a big boy, so I'm not here to whine about it. But I believe there are some key facts, which anyone can verify by simply looking at the charts and history of ATVI.

    For example, the stock price today is the same it was in late 2007. The price has not appreciated for 3 years.

    Since the bottom of the market in 03/2009 the rest of the market has recovered, with the S&P gaining approximately 80%, posting one of the most impressive rallies in market history, but ATVI did not participate.

    ATVI has had two very impressive releases of CoD during the past 2 years, both of which set sales records. And I believe they had one or two updates on WoW, which also had very impressive sales, but again, ATVI did not appreciate.

    I do know the company has made significant improvements in their financial position, and created a lot of great cash flow, which by all standard logic should have moved the price of the stock ahead of where it was 3 years ago.

    With all this goodness, and all these positive developments, to what do you attribute the languishing price of this stock? Or to put it another way, if all this goodness hasn't materialized in a price move, what will?

  • Report this Comment On March 03, 2011, at 10:46 AM, Calm127 wrote:

    Solo-

    I am certainly not arguing that isn't frustrating to recieve conservative guidance quarter after quarter. I am as baffled as anyone that ATVI hasn't been north of $13 in some time.

    What my point is and always has been is that there are some people who think ATVI is a dead duck, wringing the last couple of dollars from their two sole franchises before they disappear in the night. I'm just here saying that it isn't true.

    :)

  • Report this Comment On March 03, 2011, at 2:02 PM, FrugalTurtle wrote:

    The real question is, what's the outlook of ATVI over the next 2 years and, would you buy the stock at today's market price based on that outlook? I've owned the stock for over a year and am currently about even, and I like the company, but I invest to make money. If I wanted to get near 0% I'd put the money in my savings account at my bank with no risk of losing the original investment.

  • Report this Comment On March 03, 2011, at 4:42 PM, FoolSolo wrote:

    @calm127

    I don't think they will disappear either, but it would be nice to know they are doing something more concrete for the long-term besides betting on CoD and WoW. These are great franchises and I'm sure there is plenty of cash left in them, but now that GH is gone, I think another one or two huge titles need to be introduced to move the needle north.

    I was actually quite surprised that Microsoft's Kinect didn't connect at Activision. The Kinect is probably one of the most revolutionary advancements in gaming and human interfaces, and those that have jumped on board early have found success there. It makes me wonder why the largest name in gaming hasn't participated.

    Also, the competitors are working on major new games for their big franchise titles too. Ubisoft is releasing Tom Clancy's Ghost Recon 3 at the end of March, Microsoft will be releasing Gears of War 3 mid year, and EA will be releasing Battlefield-3 in the fall, so competition in first-person-shooters will be fierce through most of 2011 it seems.

  • Report this Comment On March 03, 2011, at 4:57 PM, Borbality wrote:

    It's not like ATVI is some unheard of, small-cap growth story. The company is huge and the analysts are all over it. I think the idea that the market just isn't giving it credit or noticing it is wishful thinking. This just might be the range it trades in, given the earnings, and the discount is based on the always hazy future of a software-only company that could lose favor at any minute.

  • Report this Comment On March 07, 2011, at 1:09 PM, Calm127 wrote:

    Also, you guys have heard of Bungie, right? They used to make Halo games. Well they're owned by ATVI now, just sayin.

  • Report this Comment On March 12, 2011, at 10:31 AM, benedekgb wrote:

    some info of use.

    cyou is rated a strong buy by ubs switzerland. they will be realising some mega game soon.

    should rock the party.

    thank me latter.

  • Report this Comment On March 12, 2011, at 10:35 AM, benedekgb wrote:

    also, i have to agree with first commenter.

    calling earning hodgepodge is moronic.

    earnings are earnings. it doesn matter if it comes from a crack deal. it is there, and it increase shareholder value.

    an analogy would be: ebay and that hodgepodge paypal?

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