It may finally be
( SNDA) time to break out.
Shares of the Chinese online gaming company gained more than 4% Friday to close at $34.38. But that rally followed a selloff earlier in the week during which the stock lost 10%.
Despite the late-week bounceback, Shanda is poised to move much higher.
While Shanda is a leading player in the red-hot Chinese Internet gaming market -- revenue for the industry rose 77% year over year in 2006, according to research firm IDC -- the stock trades at only 18 times forward earnings.
However, analysts see the company growing earnings by 30% a year during the next five years, leaving the company with a price-to-earnings-to-growth ratio (PEG) of less than 0.7.
Compare those figures with better-known Chinese Internet companies such as
, which trade at 76 and 33 times forward earnings, respectively, and command PEG ratios of about 2.3.
Given the growth that looks to be in store for Shanda, the stock looks cheap.
Wall Street's skittishness toward the company may stem from the change to its revenue model that Shanda made at the end of 2005: It decided to stop charging users for the amount of time they spent playing a game.
Instead, the company would sell virtual items within games to high-end users. It's not a surprise that swapping a tried-and-tested model, such as having users pay for time, for a speculative one in which they pay for virtual goods could give investors reason for pause.
But the new model seems to be working out very well. The number of online gamers -- and the hours spent playing online -- has been soaring. And most important, so has the company's closely watched Average Revenue Per User (ARPU) metric and its overall financial performance. Shanda has beat Wall Street's profit forecast by at least six cents a share for the last five quarters.
"The new business model allows Shanda to generate higher ARPU by targeting a smaller number of high-end players who are willing to pay for performance," UBS analyst George Chu wrote in a research note. UBS makes a market in Shanda shares.
This week's selloff may create a buying opportunity for long-term investors. That's because the dip wasn't created by any bad news for the company or its sector; it was created because the holding company that controls Shanda --
-- decided to sell some of its stake.
Flooding more shares into the market is bound to drive down the price.
But Skyline isn't selling shares because it sees trouble ahead. The company is controlled by Shanda founder and CEO Tianqiao Chen, Citigroup analyst Jason Brueschke pointed out in a research note. And Shanda management has said that Chen's family is seeking funds for new opportunities.
Skyline Media will continue to own about 50% of Shanda shares, meaning that Chen will still have plenty of incentive to make sure it keeps growing.
Meanwhile, the company's third quarter -- which it will report on Nov. 8 -- seems to be shaping up well. The period tends to be seasonally strong, and the company plans to release a highly anticipated new game, which could give it a further boost. "Our check suggests that the quarter is doing very well and the fundamentals of the business are still strong and intact," Breuschke wrote. Citigroup makes a market in shares of Shanda.
Another big beat by Shanda could get even more investors to pile into the stock.