SHANGHAI (TheStreet) -- I have been in China for the last week visiting with different companies. Throughout the trip, I'm going to be reporting on it in regular updates in
as well as
On Monday, I met with
Shanda Interactive Entertainment
( SNDA) in Shanghai. Going into the meeting, I had no idea that Chinese gaming and Internet stocks were going to have such a strong week. What sent the entire sector rocketing higher was
positive earnings results which showed advertising revenue strongly ahead of analysts' expectations. This sent other Chinese portals like
and online gaming companies like
rocketing higher. Changyou is the publicly-traded online gaming company owned by Sohu.
The good news of Sohu showed that China's economy is still hot and growing, bringing more and more advertising revenue and usage to Web companies there.
Which brings us back to Shanda. The company is as old as other first-generation Chinese Internet companies like Sohu and Sina, yet they haven't been as high-flying of late -- especially after missing their second-quarter earnings' estimates by 12 cents a share. The key questions are why have they lost their mojo and can they get it back?
There are two Shanda-related companies which trade in the U.S.: Shanda Interactive, which is the original parent company with whom I met, and
, which is the online gaming business subsidiary of Shanda Interactive.
Shanda Gaming was spun-out from Shanda last year to better let investors assign its value as a stand-alone from the parent. However, investors have tended to ignore both the online gaming company and the parent since that spin-out. The enterprise value to EBITDA ratios of Shanda and Shanda Gaming are 3.6x and 5.2x respectively. Contrast that to Sohu's and its online gaming subsidiary Changyou's of 10x and 8.6x. It's clear that Shanda has been lost in the shuffle.
The parent Shanda relies on its online gaming group as its cash cow to bring users back. It has done a great job over the last 10 years of producing a number of hit games. It's also established its platform as a popular enough forum for developers to build and show their games on. The company is relying on the belief that its open and popular platform will continue to attract gamers. Most of their games are played online on computers, but they are working to allow more and more games to be available to play on mobile phones, including the very popular iPhone 4 and iPad from
So, a bet on Shanda is a heavy bet on Shanda Gaming continuing to not only keep its online gaming business relevant but grow it in the future. However, why own the parent's stock over Shanda Gaming?
Of the other assets controlled by the parent, the largest and most meaningful today is Shanda's Literature group. It controls a substantial number of titles in its portfolio and it monetizes it today through mobile downloads and advertising revenue associated with that. However, it recently launched China's version of
Kindle, called Bambook, as the primary vehicle for monetizing this stock of content. Kindle isn't available in China because it doesn't support Chinese characters.
The Bambook is new and Shanda isn't providing any hard numbers on how well it's selling so far, although they claim it has been very popular. Shanda says they're not trying to make money on the hardware but on the software
More recently, Shanda acquired
, which is vying to be China's YouTube and Hulu in the user-generated and professional content video space. YouTube, recall, is blocked in China. So, ku6.com is battling with Youku and Tudou for that position -- although some would say from behind. Ku6.com lost $12 million in the second quarter, so this has been a drag on Shanda (although so was YouTube a drag on
for a long time).
Other companies that Shanda has bought up over the last couple of years are all content-related, typically involving movies, TV, or online content. Shanda calls these "incubated" businesses. Rough translation: they're currently losing money.
Will they or ku6.com or Bambook amount to anything? Right now, the market doesn't think so. Shanda is a $2.46 billion company with $1.46 billion in cash. Yet it's generating $836 million in revenue and $176 million in net income. Basically, the market isn't assigning any value to any of these future options in the Shanda portfolio.
Indirectly, then, the market is betting against the ability of Shanda CEO and Founder Tianqiao Chen to make the right investment decisions that will benefit the company and its shareholders in the future. I personally think that's an unwise bet.
Chen has made bad calls in the past. In 2004 and 2005, he directed Shanda to invest in an early play on IPTV and set-top boxes that would help bring Shanda's content more directly to users. He was early and wrong. Failure is a good thing with someone who has succeeded multiple times, because winners learn from failures.
Shanda has basically retooled after that set-top box failure and is still trying to be a new kind of content or media company owning a direct relationship with its users. Shanda is unloved right now because of its recent earnings miss and because investors are unwilling to give Chen and management the benefit of the doubt that they can be successful in the future with their investments. To me, it sounds like just the contrarian time to invest on Shanda -- especially when every other ad-supported web company in China is blowing out good numbers.
At the time of publication, Jackson had a long position in AAPL and GOOG.
Eric Jackson is founder and Managing Member of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. In January 2007, Jackson started the world's first Internet-based campaign to increase shareholder value at Yahoo!, leading to a change in CEOs in 2007. He also spoke out in favor of Yahoo!'s accepting Microsoft's buyout offer in 2008. Global Proxy Watch named Jackson as one of its 10 "Stars" who positively influenced international corporate governance and shareowner value in 2007.
Prior to founding Ironfire Capital, Jackson was President and CEO of Jackson Leadership Systems, Inc., a leadership, strategy, and governance consulting firm. He completed his Ph.D. in the Management Department at the Columbia University Graduate School of Business in New York, with a specialization in Strategic Management and Corporate Governance, and holds a B.A. from McGill University.
He was previously Vice President of Strategy and Business Development at VoiceGenie Technologies, a software firm now owned by Alcatel-Lucent. In 2004, Jackson founded the Young Patrons' Circle at the Royal Ontario Museum in Toronto, which is now the second-largest social and philanthropic group of its kind in North America, raising $500,000 annually for the museum. You can follow Jackson on Twitter at www.twitter.com/ericjackson or @ericjackson.
You can contact Eric by emailing him at email@example.com.