Massively multiplayer online role-playing games, or MMORPGs, are hot. Sony (NYSE:SNE) was making the MMORPG rumor mill early this year by hiring programmers and a key consultant who had worked at Microsoft's (NASDAQ:MSFT) Game Studios. And for readers of our Motley Fool Rule Breakers newsletter service, MMORPGs were behind the January recommendations of Shanda (NASDAQ:SNDA) and NetEase (NASDAQ:NTES).
Let's look at Shanda. At the heart of the company is a subscription-based business model. Every month, gamers shell out a pay-to-play fee. And if you know gamers, you know that's probably the first bill they pay every month! It is a growing market, too: International Data expects online gaming to grow from $160 million in 2004 to $823 million in 2008. So what better way to ride this consumer phenomenon than with China's No. 1 provider?
Well, get ready for a shock. Last Friday, Shanda announced that it is "adopting an additional revenue model." The first part is a free-to-play service. If you're wondering how "free" is a revenue model, it is when it's combined with "pay-for in-game value-added services" -- essentially, add-ons that will cost you money. If Shanda's description seems like an impenetrable word fog, try this: "We believe that adopting the Avatar-based revenue model for more games will benefit the company in the long run."
Avatar? No, don't do a ticker search. It's not a company that holds the future of Chinese gaming. An avatar is an image or graphic that gamers use to represent themselves when playing. So if you were to encounter me playing a Shanda game, you might see someone who looks like Sean Connery but dressed in an Indianapolis Colts jersey and wearing Nike (NYSE:NKE) shoes. Don't laugh. Computer game site There has a deal with Nike for its avatars. For that matter, there's the potential for a lot more than cutesy avatars -- there currently exists a huge black market for "character upgrades" in MMORPG stateside, and it resides on eBay (NASDAQ:EBAY) and other Internet mediums. Imagine the prospect of bringing some efficiency to that market and, well, monetizing it. Sure, it cheapens the game a bit, but with the game comes a certain sort of . you might call it . obsession that overcomes screams for fiscal prudence.
The Shanda move is companywide. The Legend of Mir II and MagicalLand games will be the first to move to the free format, followed eventually by all MMORPGs -- including the kingpin The World of Legend.
Those looking for the silver lining will find one. A number of free games have cropped up in recent months, and some pundits were starting to question the subscription-based model when it was thought that free games would eventually tempt gamers to try the companies' wares -- and then buy in. Perhaps more significant, the emergence of government-mandated restrictions in China on the number of hours that gamers can spend online represents a significant threat in the form of declining revenue (or not-so-rapid growth) per its traditional model.
The company stresses that its research indicates it is making the best move for its long-term future but that doing so might have a negative impact on short-term revenue. Investors fled from the stock Monday morning on the news, sending it down by 15.7% to hit a new 52-week low. But the stock did climb back and ended the day with just a 6.4% loss.
The bad news is that analysts have no company guidance for their forecasts. Still, you have the leading MMORPG company in China, selling for 12.5 times trailing earnings, with a net cash position (cash minus debt) of $152.5 million. That's a good combination, and at today's prices, it provides an interesting speculation on Chinese gaming.
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Fool contributor W.D. Crotty does not own any shares of the companies mentioned. Click here to see The Motley Fool's disclosure policy.
