The Chinese OBESSION with Video Games Offers Investment Opportunities 2010
Stock-Markets / Investing 2010 Jan 07, 2010 - 07:43 AM GMTBy: Tony_Sagami
My sister calls them Asian nerds. She is talking about some of our single Asian male friends who spend most of their spare time playing games, like golf and video games, instead of meeting girls.
My three boys have a little bit of that nerd in them, too. They are great kids, but one of the things that we regularly butt heads over is how much time they spend playing video games. They’d play all day long if I let them.
The most enthusiastic video gamers in the world might be the Chinese, though. There are millions of young Chinese boys that love video games and play them so much that the Chinese government enacted strict rules that limited playing time.
These rules impose penalties on players who spend more than three hours a day by reducing the abilities of their characters and any players that spend more than five hours simply are forced to take a five-hour break before they can return to a game.
Video gaming got so out of hand that the Chinese government opened video game addiction clinics and while it sounds extreme to me, these clinics used electro-shock treatments to zap players out of their addiction.
Video gaming has really changed in the last few years. Instead of playing on a console, like an Xbox or Sony PlayStation, most Chinese play video games on personal computers. Chinese youths flock to internet cafes to play these games.
The reasons are twofold: (1) Most Chinese youth cannot afford the $200 to $500 cost of a gaming console and (2) a new generation of video games called massively multi-player online role-playing games, or MMORPGs.
MMORPGs? It is a mouthful of a name and something that a hopelessly out-of-touch parent like me will never play, but MMORPGs are a new genre of video games that are played over the internet instead of a game console.
Players assume fictional roles and play over the internet with a large number of players — sometimes in the thousands — within a make-believe, virtual world. It is a world in which general gamers can shed away their true identities and assume the characters of anyone or anything that they desire. Not only that, but they can assume great and wonderful powers.
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| Chinese boys spend so much time playing video games that the government enacted strict rules to limit play time. |
Players take control of a character and guide it through certain tasks such as killing a monster to receive skill level points for successfully completing the task. In combat games, a player’s fighting ability increases when he slays opponents, finds weapons, or reaches goals.
A great aspect of playing an MMORPG is that players work together to combat difficult enemies or pool resources in order to advance the goals of the team.
This team or community aspect is reinforced from real-time chat between players. Typed messages can be displayed to other players and the other players — who may be thousands of miles away — help form friendships. These internet friendships are what make MMORPGs so popular … addictive … to players. A few companies are making a mountain of money from all those MMORPG players and you can, too, by investing in their stock. The one I like the best is Shanda Games Limited (Nasdaq:GAME).
Shanda Games operates 18 popular MMORPGs such as The World of Legend, Aion, and Company of Heroes, as well as 20 other games in development. Plus, it is China’s largest operator of MMORPGs in China with 10 million active paying customers.
Shanda Games recently went public and is my #1 pick to profit from the video gaming obsession of Chinese youths.
The Chinese OBESSION with Video Games
My boys love to play video games, but Chinese youth really LOVE their video games.
Gaming is one of the cheapest social activities available in China. Online games are a cheap form of entertainment, for the average young person in China that makes the equivalent of $100 to $120 per month. An hour’s worth of play at an internet gaming café in China costs 25 cents versus $12 for a movie.
According to researcher IBISWorld, Chinese youth spent $1.4 billion in online games in 2008. Now, that’s a lot of money and it is going to do nothing but grow larger.
I say that because gaming penetration is at only 19% among Chinese internet users, which is less than half of Korea, and that is why ROTH Capital forecasts that China’s online gaming industry will grow at a 25% annual rate over the next five years to $8.3 billion by 2013.
300 Million (and Growing) Potential Customers
According to the China Internet Network Information Center (CNNIC), the number of Chinese connected to the internet grew by 41.9% in 2008 and now stands at a staggering 300 million.
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| Internet gaming is one of the cheapest social activities available in China. |
That makes China the most “wired” country in the world. China, however, has only scratched the surface of the wired world because 300 million still only represents a 22% penetration rate.
The actual growth in the number of video gamers confirms the size of the market. A study from Nikko Partners showed that the number of online gamers increased by 26% in 2008. Wow!
To put that into perspective, the United States is at 75%, so China’s rate is going to climb as incomes grow. Also, the Chinese government has recently awarded 3G or Third Generation licenses, which means more bandwidth and faster speed. That’s a heavenly combination for gamers.
All those hundreds of millions of Chinese internet users don’t mean squat unless Shanda Games can get them to become paying users. Let me tell you … Shanda is signing them up like crazy.
Shanda Is on Fire!
In the first half of this year, sales jumped by 49% to $322 million and profits soared 75% to $98 million. That’s extremely impressive, but there’s more:
In just the last 90 days, the number of active, paying MMORPG accounts increased by 19.4%!
Despite that rapid growth, Shanda Games has been able to maintain its sky-high profit margins. Its gross profits margin was 72.7% in Q2, compared with 72.8% in the second quarter of 2008 and 72.3% in the first quarter of 2009.
The Chinese Online Game Industry gave Shanda Games the #1 ranking in all three of its award categories. That’s the video game equivalent of winning an Academy Award for Best Picture, Best Actor, and Best Actress all in the same year!
Fortune magazine ranked Shanda Games as the 7th fastest growing company in the world and the 2nd fastest growing entertainment company.
Those accomplishments are impressive, but it really is a matter of being in the right business at the right time.
Buy Your Straw Hats in January
As a child, I never understood what my father meant by that slogan, but I sure understand it today because I do love finding stock market bargains and Shanda Games sure qualifies.
Founded in 2001 as a division of Shanda Interactive (sort of a Yahoo-type internet portal), Shanda Games just went public in September at $12.50 a share. Investors were so enthusiastic about Shanda Games that the company increased the size of the IPO from 63 million to 83 million shares.
On the first day of trading, however, Shanda Games dropped by 14%; hardly a successful IPO.
What happened? There isn’t a simple answer, but it does create a fantastic opportunity for you.
Buy the Parent, Not the Child
I’m going to throw you a curveball here because the best way to invest in Shanda Games is not by buying its stock. The best way is to invest in Shanda Interactive (Nasdaq:SNDA), the parent company of Shanda Games. Here’s why:
1. Even after selling 83 million shares and raising $1 billion, parent company Shanda Interactive still owns 71% of the outstanding stock. What that means is whatever profits Shanda Games makes, the parent company is going to get to keep most of it.
2. It is always a positive when so much stock is in “strong hands” that will hold on to the shares for years … if not decades. Unlike a lot of IPOs, you won’t have to worry about a zillion shares hitting the open market after the “lock-up” period expires.
3. After spinning off Shanda Games, Shanda Interactive added $1 BILLION of cash to the $778 million of cash it already had in the bank. We’re talking about almost $1.8 billion dollars of cold, hard cash.
4. At the current market price, I calculate that the market value of Shanda Interactive’s 71% of GAME is at least $2 billion. That $2 billion of GAME plus $1.8 billion of cash means that you are buying $1 worth of assets for only 85 cents. I’ll take that deal all day long.
5. Not only are you paying 85 cents on the dollar for a fantastic gaming business, you are essentially getting Shanda Interactive for FREE! Let me tell you, Shanda Interactive is a pretty darn good business by itself.
As I mentioned, Shanda Interactive is a Yahoo-type portal in China. Internet users use the Shanda portal to access online chess and board games, several sports games, and a wide variety of cartoons, literature, news, music, community chat, and even online bill paying.
To be fair, I must disclose that my Asia Stock Alert subscribers already own Shanda Interactive and are sitting on a BIG open gain. I am confident, however, that it is headed even higher but like always, there are no guarantees when it comes to investing in the stock market.
Lastly, I’m not suggesting that you rush out and invest today. As I just said, Shanda Interactive has moved sharply higher so you should wait for a correction.
Best wishes,
Tony
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