Shanda (SNDA): A Nice Case Study

Shanda （盛大）, the largest online game provider in China, droppd almost 20% today following its quarterly report which showed its first (big) loss in its young history. I've followed SNDA even before it went public - back in early 2003, when I seemed to be the only person not playing Shanda's online games everytime I visited the crowded "net cafes" in Shenzhen.

SNDA went to a high of 45 after it went public. I tried to short SNDA when it was down to 20s, but couldn't do it because no shares were available for me to borrow. Anyway I think I made the right call and it can be used as a classical case study for not buying such a 'hot' company, even though it had the number one market position. The rationals for my trying to go short at the time were the following:

First the fundamentals:

• Although Shanda had its spectacular growth in recent years, almost all of its revenue was from a few game s such as ChuanQi and PaoPaoTang.
• Shanda's games were developed by South Korean companies, which means that SNDA really doesn't have its own IP rights.
  
• Its business model, technologies and products can be imitated by others, i.e., with no barriers to new entrants.
• Kids tend to get tired of old games and instead want to play games from competitors: Netease and 9City.
• Government-imposed rules limiting playing time by youngsters.
• On my visit to Hunan Province in October '05, the “net cafes" there were almost deserted, a shocking contrast to a year ago.
  
• Teenagers in Shenzhen told me that the hottest online game then was another game called ReXueJiangHu，which was NOT Shanda’s game!

And technically the chart clearly showed that the best time was over for Shada:

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Note that, below SNTA's chart, I've also shown the one of UtStarcom (UTSI) albeit it's for the years of 2003-04. UTSI is another company that I've followed for many years (and did make a profit from it). See the striking similarities between the two charts? The similarities are not incidental: Both companies were growing rapidly by taking advantage of the explosive market demand for its products/services. However both had esentially one product and no technologies. Both are at the mercy of the Chinese government policies. When the market cooled down, competition heated up, they started to suffer greatly, and very rapidally indeed.

The prices for the companies today? UTSI at 6.4 and SNDA at 13.8! Both had a high of 45 not too long ago.

One more piece of information: during SNDA's stock price decline in the past year, the stocks of its competitors have been doing much better. Another warning sign!

The company have tried to to diversify reveneu sources, but it takes time to implement the strategies and chances are that they will fail to meet the expectations. Shanda also made investment in other companies such as Sina and a South Korean game developer, but have actually lost money on these investments which explains the bulk of the huge loss in the past quarter.

Lessons here? Be careful with companies with one hot-selling product or service but no competitive advantages in technology or business model. Secondly, charts do work, at least in this case it did. Very often charts are the only hard data an individual investor will have access to.

The flip side of this is: if timed right, these companies offer great opportunities for shorting.