Can This Small Cap Stock Engineer a Turnaround?

Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Not all small cap companies are destined for greatness and the same holds true for Chinese online gaming company Shanda Games (NASDAQ: GAME), at least for now. While the industry in which Shanda plies its trade is growing, its revenue and stock price have been shrinking at an alarming rate. The stock has depreciated around 30% in the last 52 weeks, and there aren’t any signs of relief yet.

Falling behind

Although online gaming will be one of the primary drivers behind the growth of the overall gaming industry according to Digi-Capital, Shanda doesn’t seem ready to ride this growth yet. The company posted yet another disappointing quarter just recently where it missed the earnings estimate. To make things worse, revenue dropped 20% from the prior-year period and this was accompanied by a 26% decline in non-GAAP net income.

In addition, it seems that the company is focusing more on quantity rather than quality. Even though it witnessed a slight increase in average monthly active users, the number of average monthly paying users declined almost 5% since Shanda tried to attract more users by giving away freebies. This is in stark contrast to its peer Giant Interactive’s (NYSE: GA) performance in its recently reported quarter.

A solid business model helped Giant deliver impressive revenue and earnings improvement in the previous quarter. Its active paying accounts rose 6.1% driven by its addictive games and strategy of platform diversification. Moreover, Giant is quite confident about its online gaming business and is now taking a leap into mobile in search of more room to run.

Where are the results?

On the other hand, even though Shanda has been following similar strategies to salvage itself, they hardly seem to be effective. The company has been trying to develop a portfolio of long-lasting games in the mould of Activision Blizzard’s (NASDAQ: ATVI) World of Warcraft which would help it establish a steady revenue stream in the long run.

WoW has been in action for around 8 years now as Activision has kept the game in good health through a series of expansion packs. The game accounts for almost 30% of the game publisher’s revenue and the Street keeps one eye on the subscriber count of WoW every time Activision reports results. Thus, Shanda’s initiative of developing similar games is noteworthy and it is trying to turn Mir II, Woool, and Age of Wushu into long-term revenue generators.

However, these initiatives haven’t delivered revenue growth yet and this is why it would make sense to take management’s optimistic tunes with a grain of salt. But Shanda might make a minor comeback of sorts as the year progresses. Let’s see why.

Rays of hope

The company is slated to release a few games and expansion packs this year, such as the highly-anticipated title Rift along with AION 4.0, Final Fantasy XIV, World Zero, and Dungeon Striker. In addition, Shanda’s Korean subsidiary Actoz has hit gold with its mobile game titled Million Arthur and was the top grossing app on Apple’s app store in Korea for 42 days on the trot since being launched on Dec. 20.

Also, Shanda’s games have been gaining traction overseas driven by solid performance of titles such as Dragon Nest. As a result, Shanda witnessed a sequential improvement of 61% in its overseas revenue in the previous quarter. These are a few positive takeaways from Shanda’s last quarterly report which was otherwise quite gloomy and might help the company arrest its declining revenue. But, as I mentioned earlier, management has been upbeat about the company’s prospects and strategies since last year but positive results and stock price performance haven’t followed suit.

The bottom line

So what should investors do in such circumstances? On one hand, Shanda’s revenue is on a slide while on the other there are a few sparks which might light up its engine. Thus, potential investors’ decision depends entirely on their risk profile.

Considering the fact that Shanda trades at a dirt-cheap trailing P/E of just 4.8 and might perform well if its games click, those willing to take a risk might initiate a long position. As far as the cautious ones are concerned, they should watch the stock from the sidelines and wait for signs of a turnaround.

TechJunk13 has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard and Giant Interactive Group. The Motley Fool owns shares of Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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