Sell #2 -- Shanda Interactive (SNDA)

This sale is a little bittersweet. I really had high hopes for Shanda (SNDA). I sold off some of my holdings in this Chinese Internet and gaming company about two months ago, but held on to a portion in hopes that the company would be able to right the ship.

It may still happen, and there hasn't been any big news since then, but I've lost confidence in management's ability and, more importantly, in their new business plan.

So I sold the balance of my Shanda holdings today at $13.27 -- not too far a cry from the price I got back in March, but certainly well below the purchases I made at roughly $28 and $32 over the past year or so to build this position.

Shanda is now banking not just on a few new games over the coming year or two -- and new games that will enter an incredibly competitive environment, it's much harder to sell games now than it was just two years ago when Shanda was the dominant player -- but on their new EZ hardware/software solution that will essentially bring an entertainment version of the internet to people's homes and hands.

And regardless of whether their new games, like Dungeons and Dragons, capture a big audience, I see management focusing largely on the EZ stuff and I no longer believe this is going to work.

EZ looks to me like a combination of an inferior console/handheld gaming system with a way to deliver a dumbed down, supposedly easier to use, version of the internet -- they'll have something like Napster or Itunes for music, something for video on demand and/or internet television, something for educational materials.

But really, the internet can provide all of those things, in an increasingly user-friendly way, without intermediaries. In someways, EZ seems like the America Online of 1995 ... and my guess is that China, with their tremendous growth of internet usage, will skip the "intermediated internet" that the US latched on to for several years in AOL and just go straight to the real thing, using home grown products and tools like Netease's games and email, Baidu's search, and some of the various IM systems being pushed in the middle kingdom. I don't think EZPod, EZStation, EZCenter or whatever else they're now calling this confusing mishmash of products will find much of a market.

I don't think that a set-top box a'la webtv, or a handheld PSP clone, or special computer software a'la AOL, will be needed to encourage Chinese users to go online or use the new generation of interactive media ... it's possible that they might succeed, especially if they dramatically cut prices (right now all the EZ stuff I've seen is only going to be affordable for China's truly wealthy families -- who can probably just as easily afford a Lenovo computer and figure out how to use it just fine) ... but I don't think this is going to be a growth industry in the long term. Shanda is only creating the online platform and the content for these devices, they're licensing the design to hardware manufacturers like HP ... and I'm imagining that these hardware companies will drop it like a hot potato if it sells as tepidly as initial reports indicate may be the case.

Shanda's CEO Shen Tiangtiao has basically implied that any critics of Shanda's business model don't understand the Chinese market -- that may be true, I certainly don't understand Chinese consumers very well ... but I think they're going to get up to speed on computer technology much faster than US consumers did in the 1990s, if only because the WWW and associated products that are now available to them are much more sophisticated than we saw ten or fifteen years ago, when many of us thought that AOL's content WAS the Internet.

I still hold Netease, and I think their gaming focus is continuing to work well and, as importantly, they still have a focus on maintaining web traffic on their sites and building audiences for their games, and introducing new games from a solid pipeline. That doesn't seem to be the case for Shanda anymore.

I wrote a few months ago,when I sold a portion of my Shanda shares, that I thought they might still make it work. That's still possible, but I'm no longer a believer. It may be that I'm selling at the bottom, that we're in a bout of pessimism over SNDA that will be overcome with spectacular success from their new games or from the EZ business ... but I'm not wiling to bet on that.

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Don't know what to do about Shanda (SNDA)

Okay, so I've been probably too patient with Shanda Interactive Entertainment (SNDA -- click to register for free RT streaming quote). Clearly, the market was hoping for something a bit more optimistic when they released their earnings this week, and so was I. That 20% decline in the stock should tell us something about how well their earnings went.

And now the question is, do I sell my shares, or part of my shares? Or do I look at the value proposition and the possible turnaround the Shanda is now embarked on and decide that it's worth sticking with it?

I'm tempted to sell my taxable shares, and let the shares that I hold in a Roth IRA stay where they are for the long term as a bet that this turnaround will really work. I re-read the conference call transcript and the earnings releases and I was struck by a few things:

First, of their two new games expected to be in release fairly soon, one will use their free-play system and one will require a subscription payment. That's the downside of working with licensed games instead of coming up with your own, you don't get to decide how to distribute them. Still, both games have the potential to be successful so it might be a useful test to see which model is more effective in China. Already most of the big games in Korea, which is a more mature market, are free to play with avatar add-ons bringing in the money, and Chen Tiangtiao is clearly betting that the Chinese market will follow the Korean lead.

Second, although their major game franchises have matured their two new games should be strong contenders by the end of this year, with the possibility that the free play system will help to launch Archlord, at least, with some fanfare.

Third, they remain a huge presence in the fastest growing gaming and internet market in the world ... even as their biggest games cycle down from their peaks and competitors take market share. If you add in their 20% stake in SINA that they may eventually be able to use to build some synergies, there is great potential for Shanda to continue to reach more and more people ... which would have an impact as soon as they can figure out how to get those people monetized through advertising or direct purchases.

And fourth, this EZ system is starting to make me fairly nervous. I'm still not sure I really understand the concept, but they have the various hardware devices that include portable set-top boxes, portable PSP clones, and a remote that runs a home network of some kind. Shanda is aiming to license the software and sell a subscription package of content. I guess the real things to remember here are that the game boxes that otherwise dominate world markets aren't widely available in China (piracy concerns), and that there isn't a strongly entrenched Cable TV infrastructure that will compete with Shanda to deliver IPTV content, so they do have some opportunity here. I can't say with any certainty that I understand the scope of their opportunity, but I do believe that those of us in the West are a bit handicapped by not really clearly understanding the Chinese marketplace and I'm willing to give some benefit of the doubt to Shanda's management. One analyst reportedly is saying the he doesn't expect any impact from EZ until 2007, but I don't mind if it grows slowly as long as it actually develops into a real service -- it still seems more like an idea than a product, which is the heart of the reason for my unease with EZ.

But what it really comes down to is whether or not we trust CEO Chen Tiangtiao and believe that his massive turning of the good ship Shanda is going to get them pointed in the right direction, at the right time. He continues to maintain that Shanda is aiming to become "China’s leading interactive entertainment media company" ... can they do it?

I may well be making a mistake, but I think I've talked myself into it. I'll offload some shares to harvest a bit of a loss on some holdings I have that were on a bit of margin and in a taxable account, but hold on to the remainder of my shares to see how the story develops. I was surprised that the downside was as strong as it was with the relatively tepid news, but if internet and game advertising builds into a significant business in China -- as I believe it will -- I think Shanda has a good chance to again be on the front lines ... eventually.

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Cisco likes Shanda? (SNDA)

**Correction, Feb. 17** Like a lot of folks, I took the news alerts regarding Cisco's SNDA position at face value and didn't dig deeper into the filings. Ooops. That was just an amended filing, Cisco owns the same number of shares of Shanda s they did a year ago. My general opinion still holds, that I like the fact that Cisco's involved with Shanda and I think they're likely interested in SNDA because of the home EZ box business, but obviously this wasn't a change and there's no reason for it to have moved the stock. Shoddy reporting by everyone, and shoddy followup by me

Here's the original post from earlier this week that no longer makes much sense, for what it's worth:**

Like everyone else, it seems, I was quite surprised to hear this morning that Cisco (CSCO -- click to register for free RT streaming quote) had acquired a significant stake in Shanda (SNDA) -- just under 10%, according to the news.

The China Stock Blog has a link to the filing and some notes from an analyst here. The very brief AP article is here. I last wrote about Shanda a few days ago when I highlighted it as one of my worst investments this year.

I'm not sure what to make of this news. Cisco picked up a little more than half of this through Softbank, and I presume they bought the rest on the open market, probably at prices significantly above today's depressed level if they picked up all their shares last year.

But regardless of how they picked up the shares, you'd have to say that holding about $100 million in SNDA shares is significant even for a huge company like Cisco, and they must have a reason.

My best guess is that this has something to do with Cisco's push into set-top home networking devices, which was really called to our attention with their purchase of Scientific Atlanta. I'm just guessing on this connection because Shanda's EZ Box product aims to do something similar, bring an integrated entertainment experience to the home through a box that provides access to online services for music and video and internet content as well as traditional cable TV.

On the whole, I see this as quite possibly very good news -- and the market certainly agrees, having bid up Shanda this morning by nearly 10%. What makes me optimistic about the deal is that this validates, in my mind, Shanda's product and approach -- I'm hoping that Cisco would not have bought in unless they thought the EZ system had promise, and perhaps there's hope for some kind of partnership with Scientific Atlanta, Cisco and Shanda to create a really compelling home device that can jump-start the home-based entertainment and connectivity market in China (especially now that they're cracking down on internet cafes).

I could be reading too much into this, but it's nice to at least imagine that Shanda's effort may not be just tilting at windmills -- Cisco has perhaps given them a little legitimacy that they could certainly use after a very bad six months. I'm hoping we'll hear more about this when Shanda releases earnings.

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The Three Horsemen (SNDA, TASR, OSTK)

I wanted to take a moment to post a few thoughts on a few of the worst investments in my portfolio.

First, a moment for brief celebration. All three of these stocks, which for quite some time have been the poorest performers in my portfolio, are now ONLY down on the order of 50% from my average purchase price.

OK, so that's not that impressive -- but one of them, Taser, was down by close to 80% at one point -- so there is indeed at least a little cause for celebrating.

Taser (TASR -- click to register for free RT streaming quote), Overstock (OSTK), and Shanda Interactive Entertainment (SNDA) are all former stock market darlings.

Taser was going to revolutionize law enforcement with their "less lethal" stun guns.

Overstock was going to bring the best of closeout merchandising to the web and drive high volume sales and great customer loyalty that would make Amazon blush.

and Shanda was ... well ... big in China. And there are a lot of people there. And they play these online games, for a few cents an hour, and Shanda sells them the game time. Did I mention that they're in China. And they're on the Internet. Do you know how many people live in China? Wow, it's a lot.

Now that was just the prevailing sentiment on all of these stocks at or near the time when I first bought them, and I fell victim to the exuberance as much as anyone else.

But you know, these businesses are all pretty solid if you strip away the short-term messes they find themselves in. I regret that I've lost money on all of them, but they seem to have a lot of potential long-term upside at today's prices ... which is why I haven't sold them yet.

I have sold companies whose stocks have declined, but I have sold them becaue the business lost it's way or because I lost faith in the business' ability to grow or earn money. That was the case with Great Wolf (WOLF), and with Design Within Reach (DWRI) -- click on the tickers on the top left for those takes of woe.

Taser has recovered pretty remarkably -- I still am a little uncomfortable with the level of hucksterism we see from the Smith brothers who run the company, but I think now that the furor over wrongful zapping has died down and the press releases about every positive instance of Taser use flow freely from the company's flacks, things look a bit more positive. I have always believed that they sell a useful and important product that ought to be carried by every policeman, but now it looks like we're finally concentrating on the upside of the product instead of the downside and the market has really enjoyed that. Earnings are still lagging behind thanks to their well-publicized troubles, but I expect them to return in time ... hopefully no one will notice and we'll get to enjoy TASR chugging back to respectability for several years to come.

Overstock I am really having a hard time understanding. I am very pleased that Patrick Byrne brought in his dad to be chairman, and I still do think that the business model they're running has a lot of promise -- and their sales growth reflects some of that promise. This is the one of the three that I'm closest to considering selling, however -- and one more thing that makes me question management's ability to handle this business may send me over the edge. I think they're a little bit chastened by their huge mistakes from the last six months, and I hope Byrne will leave the short sellers alone and let his lawyers argue his points -- he must realize by now that his bully pulpit has ceased to have any impact on public opinion and now merely calls attention to what the press seem universally to acknowledge is his megalomania or, at worst, his lack of focus on the business. Hopefully daddy Jack can help him right this ship and get growth going -- they've now got the technology infrastructure in place, and the sober leadership on the board, and I like Patrick Byrne as long as he's using his energy to build the Big O, not detract from it. I'm still very much on the fence.

And several people have recently posted questions for me about Shanda here on the blog and at ADVFN. I'll give you the short answer: I don't know what's going on, but I think the next year will be better, not worse, than this past fall.

What it really comes down to now is how well Shanda's EZ system of home and portable devices performs and whether they can really establish a distribution pathway for all entertainment to the consumer, and whether their next wave of MMPORPGs gets to market in good time and to a good reception. I think the market is pricing in negative news for all of that, and I would not be surprised to see pretty weak earnings for this past quarter given their massive changes to their business with free game play and the new focus on the EZ system. That said, I think bad earnings are priced in, and although they don't really provide guidance I expect the news we hear about sales of EZ and advancement of the new games, as well as about the effectiveness of the new free play model for their older games, will be the determining factor for the short term stock price. It could be a wild one, but barring more bad news I'm holding on to Shanda for potential appreciation over the next several years as their market continue to grow by leaps and bounds.

So there you have it -- one company on a serious rebound in Taser, one that the Street and I both have an itchy trigger finger on in Overstock -- a business that should work but that has been beset by management mistakes and bad press, and one in Shanda that seems completely shrouded in mystery in the short term but still with great potential if they can successfully navigate their new business plan.

This is what makes things interesting.

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Shanda giving it away? (SNDA)

Shanda Interactive Entertainment has taken another clobbering today -- down another 13% as I type this note. Their online gaming competitors, Netease (NTES) are having a rough day, too, but in NTES' case it seems directly related to the changeover at the top of the company. NTES has brought the founder back in to serve as CEO, and apparently some investors don't approve.

I've written about Shanda and Netease a few times before, and while my NTES position is still in the black I bought SNDA at significantly higher prices than we're seeing right now -- my two positions were purchased at around $32 and $28, so I'm well under water with this one today.

There are two significant trends that seem to be moving Shanda down over the past few months -- fear of Chinese regulation, and fear that the Shanda pipeline won't replace the declining earnings of their headline games.

In the short term, I'd say that both of those things are certainly fears -- but of all the many gaming companies in China Shanda is arguably the closest to the government, so I'm not too worried about the government negatively impacting them in any significant way.

Much more at issue is whether Shanda's new licensed games from Actoz and the new Dungeons and Dragons MMPORPG will help to make up for the declining revelue from Mir II, the game that made Shanda but which is getting very old in the tooth. I'm certainly willing to wait to see how that plays out, especially given the other two big developments for Shanda recently.

It seems that the analysts are all quite afraid of Shanda's new strategy to be an entertainment and education platform in the Chinese home. Their new "EZ" strategy, which encompasses a set-top box and a handheld computer, both running on Intel architecture and developed by subcontractors, is designed to allow Shanda to provide fee-based entertainment, including games, music and television, and educational materials to Chinese homes. It's certainly a risky gamble -- it's going to take significant marketing to make it work, and it's going to start out as an upper class toy, given the prices the hardware suppliers are charging ... at least at first.

But if it works, this can help Shanda become much more central to the Chinese internet experience than any pure gaming company -- even if their games continue to be very successful, as we hope they will be. The "media center" PC hasn't been much of a hit in the US, but perhaps in a country with little cable TV and few home computers the computer can begin its service in the living room, instead of making the long and treacherous trek there from the den.

And on the gaming side the news today, the catalyst for sending the shares down so quickly, stands out as a very interesting experiment on which are riding the short-term revenues of the company. Shanda is taking advantage of declining competitiveness of some of its larger games to offer them for free and adopt a different business strategy. Instead of selling game playing time, which will now be given away for free, they will sell special features, special experiences, tools or toys for use in the game. This has been huge for some games -- notably the Kart Racer game in Korea -- and it might well work in China, I have no way of knowing.

But it is certainly going to make the earnings less predictable in the near future, and the company seems to think that it's very likely to reduce fourth quarter earnings.

For anyone who didn't listen to the last Shanda earnings conference call, the folks over at China Stock Blog have done a great service by putting the call and Q&A transcripts up online -- they're both worth a read. My impression of Chen Tiangtiao is still good, and I like the aggressive moves by the company to change the pricing structure even as they're moving to a much more diversified product offering and trying to take over the Chinese living room. They are clearly not motivated by the need to hit quarterly earnings numbers or achieve short-term results, but they do seem to have a solid long term plan for building a great company. Whether it will work is anyone's guess, but I'm willing to give them a long leash.

I won't be making any more buys or sells in Shanda until there is a lot more clarity in their prospects -- and that means I want to see a few quarters of this new pricing plan for their games, and the initial response to their EZ products and services. Until then, I'll hold my underwater shares and watch.

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Shanda trouble (SNDA)

Well, today it looks like Shanda (SNDA) has joined Netease (NTES) in the Chinese internet gaming doghouse.

These two seem to be at different points in their evolution -- Netease seems to be plateauing with their hottest games, while Shanda is well over the plateua with MIR II, whose use has already declined pretty significantly. And likewise, my Netease shares are still up a good 20% or so since my purchase, but even though I've averaged down once on Shanda I'm still significantly underwater on that position. I've written at greater length on both of these companies in the past and mostly believe in their continued growth, even though it's starting to look like the online gaming market in China is going to be nearly as fast-moving and hit-driven as Hollywood -- my last Shanda writeup is here, and a rather more optimistic Netease writeup after their last earnings release here.

I think both still look good to hold long term -- NTES because of their diversification and solid product pipeline in addition to their current slate of proven games that should continue performing well for a while, SNDA because they are just ramping up development now for several casual games and, hopefully early next year, a few new big MMPORPGs that could be hits. SNDA's secret sauce is their hardware/software offerings, including an Intel entertainment PC box that folks will use with their home TVs -- that could either be a money pit or a huge hit, I don't understand Chinese consumer culture well enough to know. But with the rapidly increasing Chinese internet audience and the increasing demand for entertainment content of all kinds in Chinda, I think the rising tide will do a lot to lift all boats in this sector -- especially these two companies that, though quite new to US markets, are old, experienced, diversified and large in comparison to most of their competitors in the marketplace.

I'm relieved to see Shanda's 10% or so drop today more than made up for by Rofin-Sinar (RSTI), Intuitive Surgical (ISRG), FARO (FARO -- which has had a ridiculous yo yo of a summer and fall but sure recovered a lot of the post-earnings drop today), Universal Display (PANL), and a few other good performers in the portfolio. That's the joy of diversification, I suppose -- SNDA and NTES haven't caused me any real short-term pain because others are taking up the slack.

Both SNDA and NTES are trading at very small premiums to the market -- that makes some sense because of the risk and volatility, but if you want growth this is significant growth potential at what I consider a significant discount for patient investors. I own and will hold both, though I think I'm overcommitted to this volatile sector and don't plan to buy any more at the moment, even at these low prices.

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Buy 'em while they're down -- Shanda (SNDA)

**update** In case you needed a reminder, my purchase of a stock is generally an immediate contrary indicator -- I still think I got Shanda at a bargain for a long-term hold, but of course it began plummeting again just after I bought this position, and the price looks even better now, a day and a half later. That's the downside of being a long-term holder but an obsessive daily market and portfolio watcher, you are constantly reminded of the bargains you could have had and of the fact that your short-term prediction capabilities are virtually nil. Same thing has happened with almost all of my recent purchases, though most of them have already recovered to put at least the tops of their heads above the waterline. I repeat the mantra: long term, long term, long term.**

Just bought more Shanda Interactive Entertainment today, this stock fell out of it's nice little year-long trading range of $32-40 at the end of the summer and is now languishing at what appear to me to be true bargain levels.

Bought Shanda (SNDA) October 4, 2005 at $28.10.

I've written about Shanda at some length before, but it's been a while. My first purchase was near $32, so I've seen some highs and lows and also have a small position in Jan 2006 call options that will need a big boost to become a moneymaker for me.

At this point, I'm having a hard time understanding why Shanda has fallen so far ...



sure, they are in a very volatile industry in a very volatile and less-than-transparent economy, but still, we should not be able to buy this kind of growth and potential at these prices.

And, for me personally, this is a step away from a sector I was focusing too much on -- I've been in danger of falling into a biotech glut in my portfolio as that's where most of my recent purchases have been -- you can see that many of the recent posts have focused on that area, not least because it's performing like gangbusters right now.

Shanda, for those who haven't heard of them or read the full writeup, is a Chinese entertainment company that is the leader (still, though barely) in online gaming in China. Online gaming in China, including both interactive multiplayer games and casual games, is a huge business for a lot of reasons -- it's cheap, there are very few entertainment options in the extremely congested Chinese cities but internet cafes are inexpensive and readily available, and there are a lot of young people in China without siblings or work or other social outlets.

Shanda has been a leader in this industry since it began a few years back, both in-licensing foreign games and developing their own popular platforms, and while they are not the hot item in gaming right now (that title belongs to Netease after their surprisingly great year so far, or to the import game World of Warcraft hosted by NCTY) , they are still a dominant player in the industry.

So why buy now, when pessimism reigns? Well, that in itself can sometimes be a good reason,


but there are other solid reasons to buy as well.

First of all, the recent pessimism and the rush of hot money to NTES and other companies means that Shanda no longer must be bought at a premium because it's a hot name. Their forward PE right now is very close to the market average and their PEG remains well below 1, which should be shocking for a company that is growing at this rate and has a good position in an exploding market.

Second, analysts are poormouthing SNDA for the near term because there have been some delays with their upcoming new games and there is some uncertainty about the eventual success of Shanda's move to become a home-based portal of entertainment and move beyond just gaming. The short term estimates that Shanda will grow at "ONLY" 20% or so for the next year are scaring some folks off, but I think those estimates are very low and, whether they're right or not, hide the fact that there is some huge potential for future growth beyond the next quarter or two once their new games (especially Ragnarok and Dungeons and Dragons) and their home console are released. And that's not even considering the fact that they already have a huge addicted base of players of their existing games, which remain popular even if they're not at the top of the charts, and the margins delivered by the continuing performance of those games are remarkable -- Shanda's game players pre-pay, and each game, even those that aren't as popular, is quite "sticky" once a player has invested time into advancing and developing his characters.

Of course, Shanda's plans might not work -- but SNDA is already priced as if they're going to stagnate for a while, whereas Netease, which I also like, is priced as though its recent success with new games is going to continue and spur dramatic growth. I'm still holding Netease, but Shanda looks like a less risky bet for new money right now. Even if I'm wrong on the execution and SNDA continues to slip in the short term, the growth in the sector and in China in general is going to lift all boats, even the ones the analysts don't like as much.

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Catch a falling knife?

Days like this are what makes me wish I had more cash on hand, while at the same time making me fearful of what I would do if I did.

The old stock market adage, "never try to catch a falling knife," is an apt one -- articles from various folks on just this topic are here and here -- but unfortunately, the urge to try is one of my weakest characteristics as an investor. Two cases in point today:

Shanda (SNDA), which I've written about before and which is one of my favorite Chinese companies, is falling for reasons I can't easily discern, and after climbing up above $40 for a little while after I purchased it it has now fallen down to near my original purchase price of $32. And that's in just a little less than two months. Business seems to be good, earnings should be quite strong when they're released, and the valuation makes it quite a bargain in my opinion -- forward PE of 16 for a company that's expected to have AT LEAST 30% annual growth going forward?

This one is always pretty volatile, so a 20% move over two months may not be a big deal, but it gets me itching to buy when it drops this far and I don't see a good reason for the drop -- although politics and competition are certainly always threats, SNDA is still the biggest force in the market and Chen Tianqiao is an icon of Chinese success. But I have to keep reminding myself, let it fall and watch for a while, don't buy just because it's cheaper than it used to be. Reconsider the fundamentals. Try to figure out why it's falling. Wait and see whether someone knows something you don't know. But also don't necessarily believe ridiculous claims like this one that "Shanda should do well because Microsoft and Marvel both also think massively multiplayer online games are a good idea."

And the other one that's collapsing as I type this is FARO technologies (FARO). This is a great company, in my opinion, with a spectacular product and very strong management. I first found out about them when they were a Motley Fool Hidden Gems recommendation back when I subscribed to that newsletter, and I really like the story. I have a full position already, but the hiccup in quarterly sales that they just announced has dropped the shares by about 14% last time I checked -- I want more!

FARO basically designs and sells computer aided design and measuring equipment -- notably the FARO arm, their signature product that allows extremely precise laser guided 3d measurement. They sell all over the world, and are even planning to build manufacturing capacity in Asia to meet the rising demand for their products there. Boeing just ordered 10 of the Arms, which was released along with the sales press release as perhaps a way to soften the blow.

This is one where I really might try to catch the knife, since it really appears to me as though they are falling just becauase of a little softness in the quarterly sales -- they still have a solid backlog of orders, and they have not changed their annual guidance (though this sure makes it tougher to make the annual numbers, as Bill Mann at the Fool wrote today), but some sales moved from Q2 to Q3. They are going to stop issuing these kinds of sales updates, probably with good reason, and they are going to only issue annual guidance, not quarterly, going forward. I like both of these decisions a lot.

But I am trying to be disciplined, so I am trying to wait.

You see, I've had some bad experiences. I bought Ebay when they surprised everyone this winter with bad growth numbers, just because I loved the business and thought they would come back. I ended up selling it a little while later because I thought other businesses, including Google, were more likely to grow my money.

I bought Overstock when they surprised everyone on the downside this winter as well, and I'm still holding but the chunks I bought at $58 and $53 are well underwater. I kept buying the falling knife later on, catching some in the $30s as well, so I'm close to even over all. Same with Provide Commerce -- another business I love, bought at $34 before they disappointed with Valentine's Day, then bought more as it fell at around $18. At the top of my writeup on Dreamworks Animation you'll note that I bought once before the troubles began this winter, then again after the Shrek 2 DVD problems pushed the price down to $31 ... but if I had waited, I could have picked up some today for $23. I still like the company in the long term and am holding, but I can't justify increasing my position any more even though it's now on even more of a sale (and who knows, maybe it will go down again after Wallace and Gromit this fall and I'll be tempted again).

The experts say that you should wait for a stock that's on a precipitous decline to "settle" and display a "bottom" before you buy in because it's on sale. I respect the opinion, and I understand that it comes from years of studying charts, but that smacks too much of technical analysis for me. I don't understand candlesticks or stochastics, and I never intend to, and the only bottom I really can pick out of a lineup is my own -- if I see a company go on sale that I already own or that I'm interested in, it really really really makes me want to buy in. I'll try to avoid buying the day that it falls and wait to see if the coming weeks will make it more of a bargain, but psychologically I think I'm more afraid of missing a bargain than I am of making a mistake and buying too high -- after all, these are companies that I really admire and believe in long term, so I have some faith that it will work out in the end -- especially in the case of FARO, where I think I understand why it's falling and am fairly confident that the market is overreacting.

So while I'm trying to be disciplined and wait for stable prices and the end of the decline (though if it was easy to pick the bottom, we'd all be rich), too much discipline really takes the fun out of this -- and if it's not fun why not just buy an index fund? I'll post any changes that I can't resist making to the portfolio, so all will be able to see if I'm an idiot.


Technorati tags shanda, SNDA, Chen Tianqiao, FARO, knife

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Shanda Interactive Entertainment
Bought May 28, 2005 at $32.08



(daily chart from Google)

Shanda Interactive Entertainment (SNDA) is a Chinese gaming company, specializing in massively multiplayer online role playing games -- sort of the modern equivalent of Dungeons and Dragons, only played online with thousands of other people in a virtual world. As odd as that may sound, these games are extremely popular in asia and,

indeed, in the U.S. Though home and mobile internet access is still not terribly advanced in China, internet cafes are extremely widespread, and online gaming at these cafes is a very well received and inexpensive form of entertainment.

Shanda has a lot of competition, but they are one of the few very big players in the space, with several games active at any one time. The most popular games often have hundreds of thousands of concurrent players, so you can see that even if players pay only a few cents for their time in the game the income adds up quickly for Shanda and their competitors, which include Netease, Sina, Tom Online, The9 and others, many of them very small with only one or two games available. Shanda has a few very popular multiplayer online roleplaying games, as well as a good selection of what they call "casual games".

Why did I buy it?


I first got interested in Shanda when I saw that they had bought a large interest in Sina, Yahoo's China portal partner and a Chinese internet leader by all accounts. I read further and saw that Shanda was growing very quickly with a very high profit margin (most of the cost of online gaming is frontloaded with development and testing -- the money that keeps rolling in after that for the years the game is in use all comes at very high margins). To go beyond that, it also had -- and continues to have -- a very low PE ratio for such an explosively growing stock with good future prospects. Current PE is in the neighborhood of 35, and the growth rate for the past year has been hitting 100% year over year, with growth of at least 50-60% projected for future years by the analysts who follow this stock. Take those analyst's guesses with a grain of salt, but it seems like a reasonable guess to me given the growth in internet penetration in China and the popularity of their games. Around this same time, I subscribed to the Rule Breakers newsletter from Motley Fool and they recommended it as well, with a nice writeup on both SNDA and one of its competitors, Netease.

Finally, I also got a very good feeling about the CEO of the company. Chen Tianqiao is 32 years old, but he is the wealthiest man in China and it appears he's hungrily trying to become the Bill Gates of China (good article on him in Forbes recently, and another in Business Week). With the acquisition of a big Sina position and the partnership with a hardware company to develop a Shanda Box that would serve online game content to the home as well as being basically the equivalent of a limited media center PC, with ability to also provide music (via partnership with Universal) and other internet access, this company is becoming much more than a gaming play. While risky, I see this as another great way to diversify and drive more users to Shanda's content.

In general, I just really like the idea of a high margin business that's providing a popular service to Chinese residents (instead of just counting on cheap Chinese labor) -- growth will come from the increasing standard of living in China and the extending tentacles of Shanda's diversification into related businesses. And I especially like the fact that the PEG (Price/Earnings Ratio divided by growth rate) is about .5 -- anything below 1 is an indicator that the company might be undervalued, as I believe Shanda is despite it's relatively lofty PE.

What do I think will happen in the coming years?

I think Shanda will continue to grow very, very quickly, though there's also the possibility that they could be a major acquirer of another big Chinese player (as was speculated after the partial Sina acquisition). I expect growth to taper off over time but to stay very robust, going from the current 100% growth down to perhaps 30% year over year on average over the next five years or so.

I also think that the gaming platform and the new games coming out, especially their release of Dungeons and Dragons, will be enough to make the company very successful for the coming years -- but that the home Shanda Box and their other internet diversification and content delivery portal strategies will drive traffic and advertising and possibly drive big upside surprises in earnings.

I expect a very bumpy ride -- Shanda does not provide guidance, so analysts may well be way off base or get surprised. I generally prefer companies that don't provide guidance, not only because it confounds the analysts and makes them work harder but also because it tends to indicate a long-term focus by management and less of a short-term "hitting the numbers" obsession.

When or why would I sell?

I don't see any reason why I might sell over the coming several years, but there are a few possibilities. If Chinese authorities begin to overregulate online gaming, I might consider lightening my position. If the company is sold to another, I would probably sell out -- one thing I'm buying is the management here, so it is important to me that it continue to be run by Tianqiao Chen (even if I can't spell his name). If other short term problems come up, such as one or two unsuccessful game releases or big success by a competitor with a new game, I would probably consider any drop in SNDA as a buying opportunity.

More information about Shanda:

The China Stock Blog has some good pieces on SNDA and other Chinese investments -- one good post is here, but there are others there worth reading as well -- indexed at http://www.chinastockblog.com/ticker_snda/.

Motley Fool covers SNDA pretty well too, especially now that it's an official pick of one of their subscription services. You can view their company info here, or just search their site for commentary (or join Rule Breakers to see the full writeup and get their more detailed analysis and followup).

SNDA's annual report (10K) and other filings are available from the Edgar database from the SEC, as are those of all public companies. The 10K is a must read before investing, all SNDA filings can be found here.

Information and quotes from Yahoo, MSN, Motley Fool and Clearstation available here


Technorati tags shanda, Chen Tianqiao, mmporpg

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