On Wednesday, Chinese online game company ShandaInteractive Entertainment (NASDAQ:SNDA) will announce Q1 2006 earnings. What should investors expect?

What analysts say:

  • Buy, sell, or waffle? Seven of 12 analysts say sell, four say hold, and only one recommends a buy.
  • Revenues. Consensus calls for $39.77 million, a 33.8% drop year over year.
  • Earnings. This quarter, analysts expect only $0.07, down from $0.36 a year ago.

What management says:
"We have taken a number of key steps in our strategy to both build our content portfolio and extend our presence into the emerging digital home in China," said Tianqiao Chen, Shanda's chief executive officer. Shanda is moving away from being purely a gaming company, instead positioning itself to be the entertainment provider for Chinese households. Its super-simplified EZ Pod computer software, designed to make computers as easy to use as televisions, is its intended means of delivering entertainment content to customers.

What management does:
As Shanda switched its games from a pay-to-play model last quarter, revenue growth and especially net profit plummeted. With customers now given the choice of playing for free or spending money for enhanced versions of their favorite games, it's not surprising that more customers chose the less expensive option, pummeling revenue growth. In addition, added costs associated with the transition substantially sapped net income.

Margins %*

12/04

3/05

6/05

9/05

12/05

Gross

63.7

70.4

69.4

70.9

71.8

Operating

39.4

44.3

45.2

42.0

32.6

Net

46.9

48.3

45.1

47.1

8.2

Sales Growth %**

--

107.1

78.5

37.5

(18.4)
* Trailing-12-month data for quarter ending in month indicated.
** Year-over-year comparison for quarter ending in month indicated.
All data from relevant company 6-K filings.

One Fool says:
Foolish investors in this company need to watch Shanda's new gaming revenue stream carefully. The company is banking on its improvement, using the more mature Korean market for massively multiplayer online role-playing games (MMORPGs) as a guide. With the first full quarter of the new gaming revenue model completed, an uptick in gaming revenue, or at least flat results compared with last quarter, could indicate that the new model is working. However, a downturn might mean that customers are more interested in playing for free than investing in enhanced games. In addition, watch the statistics regarding how many people are playing a given game simultaneously. There was a spike in December, just after the revenue-model switch. If that number falls, the new revenue model might be in trouble.

Investors should also closely monitor the EZ Pod's launch, making sure that the large numbers of preorders Shanda reported last quarter have been filled, sold, and used by customers. Management expects much of Shanda's future revenue and earnings to come from the sale of these systems, entertainment content provided through them, and advertising. The EZ Pod's early performance could hint at the sustainability of Shanda's overall business model -- and the prospects for profit beyond its rocky near future.

Competitors:

  • Electronic Arts (NASDAQ:ERTS)
  • NetEase (NASDAQ:NTES)
  • Sony (NYSE:SNE)
  • The9 Ltd. (NASDAQ:NCTY)

Shanda and NetEase are growth-oriented Motley Fool Rule Breakers picks, while Electronic Arts made David Gardner's list of favorite stocks at Motley Fool Stock Advisor . Whatever your investing style, the Fool has a newsletter -- and a 30-day free trial -- for you.

Fool contributor Jim Mueller does not own shares in any company mentioned.