Bought Shanda interactive Entertainment - SNDA @ $40.20

Shanda Entertainment is one of the largest operators of online games in China through Shanda Games. In 2009 it spun off Shanda Games for $1B in an IPO. This is capitalizing on china’s exploding online gaming market. As part of its growth strategy, the company in 2009 acquired 51% of ringtone provider Hurray! Holding Co. -- later renamed Ku6 Media Co. -- in a deal valued at $46.2 million. Then, in 2010 Shanda and Ku6 completed an asset swap: Ku6 acquired 75% an online audio business of Shanda in exchange for about 415 million newly issued shares of Ku6, while Shanda acquired Ku6's recorded music and wireless value-added services businesses for some $37 million in cash. The deal is part of Shanda's use of proceeds from the 2009 spinoff and IPO of its games unit.


Shanda has unique model. It includes a venture capital fund that invests in fledgling independent game studios, and taps the full potential of promising new games by leveraging the firm's management expertise and gaming platform. This strategy can be particularly effective in expanding and refreshing the game portfolio, to keep its large gamer community "hooked" to the Shanda platform. Currently, the company offers 33 multiplayer and casual games on its website, with another 28 games in the pipeline.

Shanda is also into online literature, online video and other media related businesses.

Competitors: The main competitors are Tencent and NetEase. Currently there is talk that Shanda is lagging behind the competitors as Shanda is dependent on few aging games for the bulk of the revenue.



What can go wrong with this stock?

- Mismanagement of cash due to bad acquisitions. Currently we have not seen anything like that

- If Chinese market crashes, the stock price might temporarily gets depressed but we have strong downward protection with $25 cash

- Accounting Fraud is one other biggest concern for us. We have seen more of that in smaller Chinese companies but not in large companies

Why do you invest in technology stocks and it is not deep value investing ?

- We do not go with conventional definition of deep value. We have strong downside protection with more than $20/share cash. Currently the stock price is close to $40.

- In technology and some businesses, sometimes the future is not very clear but we know that they have valuable digital assets. Even if you put $0 value for all those assets, still it damn cheap selling for less than 4 times EV/EBITDA. The value of online games is just $42.

- Shanda Literature and online video has the potential to be huge. They recently came up with Chinese version of kindle. They also get their revenue from ring tones

(Recent Excerpts from an interview from Mason Hawkins on Shanda Entertainment. Very respected Value investor. Thanks Value investor insight)



We wouldn’t expect a company with “Chinese” and “Internet” in its business description to have a value-priced stock. Why do you consider that the case with Shanda Interactive?



- KS: Shanda Interactive is a leading online entertainment media company in China, basically providing the platform for players of online games created by its publicly traded and 70%-owned subsidiary, Shanda Games. They run more than 30 online games, the blockbuster being Legend of Mir II, a multi-player online role-playing game akin to Activision Blizzard’s World of Warcraft. The business model varies, but for the most part the network’s 100 million registered users can start playing any given game for free, but they then pay to upgrade their capabilities or powers to advance further into the game. Shanda’s stock got hit earlier this year after they tweaked Legend of Mir II so that it was easier to just buy new powers than have to earn them, which turned some hardcore players off. Usage went down and they had to revise earnings expectations, which sent the stock in January from almost $60 to less than $40. We saw that as a temporary problem they will work through, so that gave us an excellent buying opportunity. On a consolidated basis, Shanda Interactive has cash on its balance sheet worth 65% of its current market cap, so obviously whether value is created or destroyed going forward has a lot to do with how they spend that cash. We like that the CEO, Tianqiao Chen, owns more than 40% of the company and has his entire net worth invested in it. He also has a clear eye on increasing shareholder value and has spent more money in the past two years on share repurchases than on anything else by far. At one point he issued convertible debt with a strike price of $35 and used the proceeds to buy back stock at an average of $28 per share



How cheap do you consider the shares today, at a recent price of $40.90?

- KS: The current market value is around $2.7 billion and they have nearly $1.9 billion in net cash, so the enterprise value is only about $800 million. We estimate the company will make $270 million in free cash flow over the next twelve months, so the multiple of that on an EV basis is only about 3x. That makes no sense to us for a company with 35%-plus operating margins, an attractive network effect, a sticky revenue model, and still-vibrant growth prospects in an underpenetrated market. We value Shanda Games on its own at $11.25 per share [versus a current market price of around $5.80], which assumes a 7x multiple of free cash flow (after cash) for a business that should grow at least at a low-teens rate. That valuation translates into roughly $42 per share in Shanda Interactive value. There’s another $20 per share in cash

- at the holding company level. On top of that is the “rent” Shanda Interactive receives from Shanda Games for access to

- its online network – at 17x free cash flow, that’s worth another $10 per share. That brings our intrinsic value estimate for the holding company to more than $70 per share. If we’re right about management investing the cash wisely, that could easily turn out to be conservative.