Investors in Shanda Interactive Entertainment (SNDA) have dealt with some significant disappointment over the last week. The company completed it’s spin off transaction where it listed its gaming division – Shanda Games (GAME) as a separately trading ADR. The new stock was listed at $12.50, netting the company more than $825 million as the parent company sold more than 70 million shares. Shanda Games also sold roughly 13 million shares for net proceeds of about $152 million.
Leading up to the deal, it appeared that the spin off was going to be a positive catalyst for the company. A separately trading gaming ADS would allow investors to concentrate their capital in the fast-growing portion of Shanda’s business, and since the parent company retained 71% ownership in Shanda Games (and 96.08% voting rights), investors in SNDA still retained the ability to participate in the long-term growth.
Unfortunately, it looks like the underwriters botched the deal which is unusual for Goldman Sachs (GS) who was the lead. The number of shares offered to t he public increased by 20 million as the deal neared completion, and the underwriting discount may have been a bit too much for the current environment. Goldman and the other underwriters received roughly 78 cents for each share they placed with investors – a tidy sum when you consider more than 83 million shares were placed. Underwriting has typically been a very strong business for investment banks, but in today’s market we may eventually see margins on these transactions come under pressure.
Shares of GAME were offered to the public at $12.50 per share, but at the end of the first day of trading they closed at a disappointing $10.75. Monday the shares made up a small bit of the loss and the stock is flat to positive in early trading on Tuesday. But the bottom line is that the transaction was relatively disappointing and with a lower stock price on GAME, it will be more difficult for SNDA to sell more shares if it so chooses in the future.
The stock price in SNDA took a similar hit on Friday and we are likely seeing two forces at work here. First, you have the lower market value for the gaming portion still owned by the parent company. Fluctuations in GAME will have a very real affect on the value of SNDA because the parent company still owns 71% of the spin-off. The second issue is that investors who want pure exposure to the gaming side of Shanda’s business are likely to be selling the parent company and buying GAME over the next several weeks.
Despite the negative initial action in GAME, I think that the stock will offer investors a great opportunity in the coming weeks and months. Online role playing games are attracting a growing customer base and China is the epicenter of this movement. Shanda Games has a strong pipeline of new features for existing games as well as completely new games which will likely drive future revenue. The stock is not cheap based on historical earnings attributed to the spin-off, but the valuation is also not unreasonable. Future growth even in a difficult economic environment should attract investor attention and lead to a higher multiple.
I think GAME is worth pursuing, but would wait for the stock to re-take the IPO price. There is a chance that the stock could wash out a few more holders and if the selling gets extremely heavy, we may be able to pick up shares at a much better discount. So for now it is a waiting game with the intention of buying when it breaks above the IPO price ($12.50) or starting a small position if the stock experiences heavy selling (likely down to $9.00 or so). This is a risky name and will likely have plenty of volatility, but it is also an opportunity for very strong returns.
FD: Author has a position in SNDA in the ZachStocks Growth Model
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