Tepid Video Game IPO Means A Better Price: GAME

Last week we discussed a unique type of bond. Today we turn more speculative. This week Shanda Interactive (SNDA), a Chinese purveyor of interactive entertainment and media technology, offered U.S. investors a piece of its video game business, Shanda Games (GAME) in one of the most widely-anticipated IPOs of 2009. The buzz surrounding Shanda Games was so intense that the company raised the offering from 63 million to 83.5 million shares just to meet demand.

Shanda Games’ chief rival, Changyou.com Ltd. (CYOU), began trading in the U.S. to great fanfare back in April, which only increased expectations for GAME. But something happened on the way to the party. Investors didn’t offer such a warm reception for Shanda Games. While the offering raised $1.04 billion for Shanda, the shares closed down 14% from the IPO price of $12.50.

Why the sell-off? Underwriters frequently try to generate interest by pricing IPOs at a low price, thereby generating an opening day pop. The opposite might have happened in this case: Lead underwriter Goldman Sachs (GS) launched GAME at a price that was fair or even a little high. A few large investors jumped out quickly, and the stampede was on. But as our editor, Ron Rowland, always says, “if the purpose of an IPO is to raise capital for the company selling the shares, then having the price fall on the day of the IPO makes it a huge success because it is evidence that they raised the maximum amount of capital.”

The question now is whether the stock will go up from here. Shanda Games has strong fundamentals, something you can’t say for every newly-listed stock this year. A123 Systems Inc. (AONE) rose sharply in its debut last week, despite the fact that the company isn’t even profitable. Shanda Games faces no such problems. Profit soared 75% to $98 million and sales rose 43% to $322 million in the first half of 2009.

Shanda Games has its risks but also packs a lot of potential, especially as a China play. The Chinese are crazy about computer and video games, but market penetration is less than 20%. A huge market with a rabid interest in its products gives GAME the potential for strong returns over the long term.

Since Shanda Games hasn’t even been trading for a week, technical analysis is difficult at this point. However, it’s worth noting the stock has rebounded to $11.70 after trading as low as $10.60. At current levels, GAME offers investors a way to speculate on the explosive growth potential of China. For a China play in video gaming, go with GAME.