China online gaming: Another vote for Shanda (SNDA)

"Its most popular offerings are role-playing games that allow thousands of gamers to play the same game together.

"Many of these games combine historical, martial arts and combat themes. More than 80% of China's gaming revenue comes from multiplayer role-playing games.

"Shanda's popular entertainment platform has driven compound annual revenue growth (CAGR) of 48.5%, a figure made all the more impressive by Shanda's enviable 35% net margin. China's online game market generated $3 billion in 2008, a 52.2% increase from the year before.

"That trend continues. First-quarter results showed a 42% increase in revenue from the year before and a 25% gain in earnings. There's no sign that such growth will abate: Industry experts predict 20% growth for the next five years, which will vault the Chinese gaming market ahead of the United States.

"More important than revenue and industry growth, however, is the continued expansion of Shanda's active-player accounts, which now total 9.25 million. It is that growth in Shanda's reach -- up nearly 60% since year-end 2007 -- that will converge with Shanda's latest acquisition and significantly juice its earnings.

"Now, acquisitions are common in the software industry. It's as likely to buy a company to get a new program as it is to develop one in-house, and that goes for small players and industry titans like Microsoft or Google.

"Shanda, for its part, has engineered eight significant acquisitions since 2004. But its latest purchase isn't for a new game, it's for an online music distributor called Hurray! that not only sells songs but also produces concerts and sells music-related products like ringtones.

"The marriage of these two companies brings together a large and loyal tech-savvy community willing to pay for content with a company ready to move other digital products through Shanda's channel.

"This not only is an obvious win for consumers, but it also has the support of record companies, who are dismayed that China's entire music market is unlicensed.

"Shanda's stock has given up some ground recently, though even at 21 times earnings it has to be considered cheap given its growth and its prospects, not only in gaming but in music.

"Applying Shanda's five-year CAGR in earnings to its current earnings per share implies a fair market value of $93.50 a share within a year, assuming an earnings multiple of only 25. That's roughly 60% above Shanda's current price."

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