Shanda Interactive Entertainment Ltd ADR (SNDA) must have missed the recessionary memo.  The Chinese gaming company continues to grow earnings and sales despite weakness in the global economy.  Last quarter Shanda cleared $136.7 million in revenues and handily beat consensus expectations with EPS reported at $0.68 per share.  In fact, this was the 10th consecutive time the company has beat consensus expectations.

A few years back, investors were a bit skeptical about the revenue model for many of the firms in the industry.  Typically, online games are available for free or for a very small charge.  This yields a large number of “non-paying” customers who use the game but do not add to the revenue base.  But premium products within the game are sold to a handful of subscribers and this revenue is enough to drive margins to extravagant levels.  For the last quarter, SNDA posted a gross margin of 73%.

Another profitable source of revenue has turned out to be in-game advertising.  With 77 million total users, it would make sense for an advertiser to pay premium dollars to feature their product within a particular game.  Currently Shanda has more than 20 games in operation.  This provides a significant amount of non-traditional advertising space.

Shanda has worked hard to build the largest online game revenue base in China.  Currently, the company receives roughly 70% of revenue from its two most popular games: “World of Legend,” and “Legend of Mir 2.”  Initial reactions may be that the company is not well diversified, but it is interesting to note that these two games have been in existence for more than 7 years.  So obviously the company is talented at managing the progression of these games to keep players interested for so long.

But Shanda is not sitting back and enjoying its success.  There are actually more than 50 games currently in the pipeline and  the company has an aggressive schedule to put these games in front of users.  Over the next 12 to 18 months, Shanda will launch 10 multi-player role playing games and 6 casual games.  If any one of these turns out to be a blockbuster, the company could realize significant profit growth.  At worst, the new games should still bring in a moderate number of new users and give current gamers a new reason to stick with Shanda.

The company owes much of its success to a healthy financial position.  With no debt and roughly $587 million in cash and alternatives, Shanda is in an excellent spot to be able to buy out struggling competitors, or purchase new content for future games.  Much of the cash is also being used to retire shares as an aggressive buyback program is in place.  This will increase the value of each remaining SNDA share.

With the stock trading at just 12 times earnings and the potential for significant growth, SNDA appears to be a strong investment candidate.  In fact, the stock is currently the best performing member of the ZachStocks Growth Model.  If the stock were to trade at just 15 times the consensus expectations for 2009 (which appear to be conservative), we would see a price of $42.75.  There is certainly risk that expectations could turn out to be too optimistic, but at this time it appears the potential reward far outweighs the risk.

FD: Author does not have a position in SNDA
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Additional Reading:
Forbes: One Boom Market Remains In China
Barrons: Shanda Boosts Share Repurchase