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Tuesday, September 12, 2006

WSJ article on Shanda--I think if microtransaction works well in SK, it'll work in China

Shanda's new gaming strategy is winning over players, analysts (Wall Street Journal)
Once a Nasdaq darling, Chinese online-games company Shanda Interactive Entertainment has seen a big slide in its share price. But Shanda may be able to show that homegrown Chinese companies can understand their market better than investors think they do.
Shanda became one of the Nasdaq Stock Market's biggest success stories after its stock began trading in May 2004, rising from $11 a share to more than $44 near the end of that year. Investors liked its first-mover advantage in China's burgeoning online-games market, which some estimates put at $1.7 billion by 2010. Everybody wanted to tap China's Internet-crazy youth and middle class, and Shanda hit on a way to make money by selling game subscriptions to millions for pennies each.
The tide turned in 2005, amid concerns Shanda was losing users because its games were aging, the shine was coming off its reputation and competition from online-game providers and The9 was growing.
In November 2005, Shanda dropped a bomb: It was changing the business model for its cash-cow "massive multiplayer online role-playing games" from collecting revenue through hourly or monthly fees to a "free to play" system.
Under the new model, users join for free but pay to enhance their online-game experience with special weapons and accessories, a little like luxury goods for the virtual world. The most basic new sword might cost two yuan (about 25 U.S. cents), for example, as might virtual flowers for a friend.
It was slow to catch on, and in this year's first quarter, Shanda's net income plunged 95% from a year earlier to $1.47 million, with revenue down 31%.
But lately, that business model, borrowed from South Korea's hypercompetitive games market, has fared far better than expected. Shanda's second-quarter net income was 10 times as high as that of the first quarter. Online-game revenue rose 21% to $46.8 million.
It turns out that Chinese game players weren't satisfied with just one basic virtual sword. Some spent as much as 1,000 yuan a day to dominate games. In one game, the second-most-popular add-on was a magical golden horse, which costs a cool 180 yuan.
Shanda Chief Executive Chen Tianqiao has lashed out at Wall Street analysts he says he believes don't understand the Chinese market. In the West, online-game players usually can exchange virtual assets only through a third party, like an online club, and the game makers don't profit. Western investors and analysts, Shanda says, didn't appreciate how Chinese Internet users would like upgrading their online lives.
"Players have a greater time enjoying the interactive communication more than the game itself," says Shanda spokesman Zhuge Hui, adding that many Chinese game players are shy in real life. It has worked in South Korea, too, where two-thirds of the top 30 online role-playing games use a similar model.
According to iResearch, annual gains in the number of online gamers in China will slow to 10% in 2010 from an estimated 38% this year. William Bao Bean, an analyst at Deutsche Bank Securities in Hong Kong, was skeptical of the free-to-play business model and admits he still isn't sure why it is working. But last month, he upgraded Shanda stock to "buy" from "hold." His 12-month target price is $19; the shares traded yesterday at $16.27, up 14 cents from Friday's close. Credit Suisse, concerned about how many games are in Shanda's pipeline, has a "neutral" rating.
A bigger worry, says Mr. Bean, is that Shanda could be a victim of its own success. The way its model works, he says, players with money to burn are basically guaranteed to win, while others keep losing, which "destroys the balance in the online-gaming society." Eventually, the losers will stop playing and the model could fall apart, he says.
While Shanda makes the bulk of its money from online games, investors also should consider Mr. Chen's ambitions to turn it into an entertainment company modeled on Walt Disney.
In 2004, the company introduced a home console that turns a television set into an Internet-connected entertainment system called the EZ Pod. The hope was that it could open Shanda's market -- otherwise limited to the 123 million Chinese with Internet access -- to China's nearly 400 million homes with televisions. EZ Pod sales disappointed for several quarters, although the number sold in the latest period was 50% higher than in the first three months of 2006.
Interactive TV could prove tricky for Shanda, as it is highly regulated, and a mass audience is different from hard-core gamers. Success may depend on Shanda's ability to win a government license to provide streaming video and sound over Internet connections to the EZ Pod.
"Shanda does need to work hard on this," says Liu Bin, an analyst with BDA China, a telecommunications consultancy. "In the long term, Shanda's entire business model is surely bright. Yet there are a lot of uncertainties."


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