After an extended four-week pre-marketing period, roadshows were finally launched yesterday (Tuesday) for a Nasdaq IPO by Shanda Interactive Media. The 17.5 million ADS offering is being pitched between $13 and $15 and should raise $225 million to $260 million prior to the exercise of a 15% greenshoe.
The Goldman Sachs-led deal is scheduled to price on May 11, with Bear Stearns, CLSA/CIBC, HSBC and Piper Jaffray as co-leads. The transaction will combine old shares (56%) and new shares (44%). Majority shareholder Skyline Media (owned by one of China's richest entrepreneurs Tianqiao Chen) will drop from 74.2% to 57.9% and SB Asia Infrastructure Fund (a private equity fund affiliated to SOFTBANK Corp) from 25.1% to 17.4%.
Fund managers say the reason for a slight setback in the roadshow schedule stems from delays receiving comments from the SEC. And despite a sluggish IPO market in Hong Kong, many expect the deal to sell because of its reasonable valuation relative to comps. The company is also considered one of the best China tech players in a lengthy pipeline – it has a dominant 60% share of the broadband online games market in China.
Initially, Shanda had been expected to raise upwards of $300 million and price on a PE ratio of at least 25 times 2004 earnings. It is now being pitched at 19 to 22 times 2004 earnings. Its smaller size and more modest valuation are a reflection of share price weakness across virtually the entire China-related spectrum of stocks including the SMS services companies against which it is primarily benchmarked.
None of the China comps are a perfect match since Netease and Sina still derive a majority of their revenue from SMS services rather than broadband online gaming. However, it is an area into which both companies and many others are moving aggressively.
Sina has established a joint-venture with Korean online gaming giant NCSoft to distribute its products in China, including Lineage the world's most popular online game. Netease has developed a successful online game of its own - Journey to the West. During the fourth quarter of 2003, 44% of Netease's revenue derived from gaming.
Sina is currently trading on a forward PE ratio of 30 times 2004 earnings and Netease 29 times 2004 earnings. Specialists believe Shanda needs to be priced at a discount to both because it does not have the same diversified revenue stream to act as a cyclical buffer and investors have long expressed concerns about the rocketing share price performance of the SMS operators.
Sina and Netease have both started to trade back up again over the past few days after falling about 8% to 10% since the beginning of April. Sina is currently up 6.16% on the year and Netease 39.3%. One a one-year basis, Sina is up 247% and Netease 165%.
The other main comparables for Shanda are the Korean online gaming companies NCSoft and Webzen. These are both better comps in terms of their business models. Foreign games still dominate in China and Korea remains the market leader.
NCSoft has fared well in the last few weeks benefiting from its inclusion into the FTSE series of indices and an influx of foreign funds into the Kosdaq. Since Shanda started pre-marketing, it has seen its stock price rise from Won71,000 to Won88,000 and its PE multiple expand from 17.2 times 2004 earnings to 22.65 times. Year-to-date it is up 34.55% and 266.19% on a one-year basis.
Webzen, on the other hand, has fallen pretty consistently since its Nasdaq listing late last year. Year-to-date it is down 14.73% and in Korea is currently trading at Won110,000, representing a PE ratio of 10.5 times 2004 earnings.
Specialists believe Shanda deserves to trade at a premium to the Koreans. Korean stocks typically trade at a discount to their counterparts in HK/China and many believe the locals will be able to break the dominance of the Korean operators in China and maximise the growth potential of their home market.
Asia is the world's biggest player of broadband online games and Korea was still the market leader in 2003, with a 54.3% share of users compared to 25.9% in Taiwan and 16.8% in China. But Korea is a more mature market, whereas market research company IDC forecasts the China online gaming market should grow from $159 million in subscription revenue in 2003 to $810 million by 2007. Globally the online gaming market is forecast to grow from $875 million in 2002 to $5 billion in 2008.
It is often said the over 30's and female half of the population have difficulty understanding the concept and popularity of online gaming. Unlike traditional offline games (purchased in shops and slotted into computers), online games link thousands of online users at once and popularity of games is evaluated by the number of concurrent users.
The products are known as MMORPGs (massively multiplayer online games), which each create their own virtual worlds where users can assume ongoing characters. Because the games are so complicated and require time to master, user stickiness tends to be high and players spend far longer on them than other internet applications.
When Shanda was first established in 1999 it licensed online games from other companies, primarily the Koreans. In 2001 it launched Legend of Mir II, still China's most popular online game.
But by November 2003, it was ready to launch a proprietary game of its own, Woool (World of Legend), now the country's fourth most popular game. In mid-February this year it started beta testing another in-house game, The Sign.
It is now a developer as well as an operator.
Most of its revenue derives from pre-paid cards, which are sold via 317,000 retail points throughout China, 40% of which are located in internet cafes. Specialists say the company's extensive and entrenched distribution network is one of the IPO's strongest selling points.
Shanda also believes its first mover advantage gives it strong brand recognition, which will play to its advantage once broadband penetration moves away from internet cafes and into users' homes. IDC forecasts that China's broadband market will grow from 9.8 million subscribers in 2003 to 33.6 million by 2008.
However, the online gaming sector is attracting a lot of new entrants and specialists believe there are now over 250 online games in China, many of which are unprofitable. The entire sector faces a problem of too many games competing for too few users.
So too every single company is faced with the challenge of continually creating new games. All operators currently rely on just one or two games to maintain profitability.
In Shanda's case, 56.7% of first quarter revenues derived from Mir II and 30.8% from Woool. In total, 67.8% of revenues derived from third party licensing rather than in-house development, although this was a huge decrease from the third quarter of 2003 when the figure stood at nearer 100%.
Specialists also point out that while software piracy is not an issue in the online games world, intellectual piracy is. Competitors are frequently in litigation with each other and Shanda has been in dispute with Korea's Actoz Soft over Mir II (now settled) and Korea's Wemade over Woool (pending).
Yet Shanda's profit margins remain high; its current games are extremely popular and the barriers for new entrants continue to get ever higher.
Most games are extremely expensive to develop – award-winning director Chen Kaige is creative advisor on one of Shanda's new games, which will also have a full-blown orchestral score. Games also require considerable customer care including 24-hour service centres and online technicians.
In 2003 net income increased 95.9% from Rmb 139 million to Rmb272.9 million ($33 million). Fund managers say they have been told net income should grow about 65% this year to Rmb430 million. Gross margins are expected to top 60% and operating margins 35%.
Since 2001, Shanda has seen average concurrent users rise from 43,736 to 683,917 and peak concurrent users from 72,000 to 1.18 million.
