Shanda Interactive Entertainment Ltd.

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Shanda Interactive Entertainment Ltd.
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Shanda Interactive Entertainment Limited

• Chinese company providing interactive
  entertainment services with online access
• Most popular online games in China
• Massively Multiplayer Online Role Playing Games
  (MMORPGS)
• Online role playing games
• MIR II
• 460 million registered accounts
• 18.5 million active paying accounts
• 2.5 million total concurrent users for all of its
  games in commercial service.
• Integrated entertainment solution - movies,
  music, games etc

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• Most well known brand globally Largest search
  engine in the world
• Main Features
• easy to use
• totally free
• totally fast
• Over the years Google has carried out a series of
  acquisition in order to diversify into different
  markets. Example-D Marc, You Tube
• Biggest Source of Revenue ADVERTISING!
• Foray into Chinese Market - 5m stake in BAIDU
  sold for 60m

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INDUSTRY ANALYSIS

• Chinese Online Game Industry
• Revenues 8 billion Yuan 1.2 billion
• 30 billion Yuan 3.9 billion by 2010
• Spillover Effects Telecoms Industry/ Computer
• which earned 33bn Yuan (4.8bn) from the online
  game industry in 2006
• Young people (aged 18 30) - 31 of 30m gamers
• Domestic share of Chinese online game industry
  was 65 in 2006 and exports generated revenues of
  20m in 2006

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SWOT ANALYSIS OF SHANDA

• STRENGTHS
• Diversified portfolio of online games
• MMORPGS
• casual online games
• network pc
• Variety of services to customers
• simple and efficient payment system
• 24/7 customer service

• WEAKNESS
• Difficult to maintain
• high quality
• customer service
• System Maintenance Costs High
• Negative Impact on Profits

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SWOT ANALYSIS OF SHANDA

• OPPORTUNITIES
• Revenue from Chinas online gaming market is going
  to quadruple by 2009
• Internet
• Broadband
• Home made games
• 65 market share 2006
• 20 million exports
• Double in next 10 Years

• THREATS
• Competition
• Taiwan and South Korea
• Hackers
• Chinese economy growing fast
• Difficult to hold position

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SWOT ANALYSIS OF

• STRENGTHS
• most well known brand
• largest search engine in the world
• organizes the world information and makes it
  universally accessible to all
• Customer Loyalty due to Simple Design

• WEANKNESS
• Overdependence on Advertising
• Google Earth
• security concerns by many governments
• Piracy Concerns
• cookie and information related practices

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SWOT ANALYSIS OF

• OPPOPRTUNITIES
• Diversify into other markets
• radio
• print publications
• Experiments
• selling advertisement
• offline newspaper and magazines
• Partnership
• Companies
• Governments Agencies

• THREATS
• Competition
• Yahoo
• MSN
• Foreign Exchange Risk

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DUE DILIGENCE

• Market Presence and Sales Issues
• Knowledge
• Acquisition of a content producer
• Google to build reputation and perception in
  Chinese market
• Growth of the Chinese economy as
• SHANDA increases customer base
• Information
• SHANDA- consistent growth in revenues from
  MMORPGs
• 994 mn Yuan (2004) to 1.25bn Yuan (2005)
• Steady increase in user base of SHANDA
• 2.68m (2005)
• 1.3mn average concurrent users

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Trend of Shanda User Base
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DUE DILIGENCE

• Cross Border Issues
• Knowledge
• Foreign Currency and Exchange Rate Risk
• FitchRatings positive outlook
• Information
• SHANDA - Revenue dominated in Yuan
• - Expenses denominated in US dollars

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DUE DILIGENCE

• ACCOUNTING ISSUES
• Knowledge
• Financial statements produced under U.S GAAP -
  comparable
• Financial reports convey thorough picture
• Cost Reduction Synergy Sales Marketing
• Information
• Although in 2005 SHANDAS Profit margin declined
  from 47 to 9 it was mainly attributed to equity
  loss in affiliated companies
• 30 Average Revenue Growth Shanda vs 18 -
  Indusrty
• 47.6 Growth Rate Shanda
• Expected to beat SP500 benchmark by 1.6 points

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VALUE RANGES FOR BIDDER AND TARGET

• Value ranges for bidder and target were
  calculated using the triangulation method
• The biggest weight was given to the DCF method
• Historical performance was obtained from YAHOO
  finance
• The terminal value was estimated using the
  terminal multiple approach

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VALUE RANGES FOR BIDDER AND TARGET

• The tax rate of 30 was used per GOOGLEs 10-K
  annual report
• The WACC for GOOGLE is 14.23
• The enterprise value was estimated to be
  170,547,154
• Sensitivity analysis resulted in low and high
  values of 492.87 and 599.02 for Google stock
  respectively

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VALUE RANGES FOR BIDDER AND TARGET

• 5 year revenue growth rate of 16 was used for
  SHANDA (REUTERS)
• SHANDA received tax benefits in the past
• Tax rate of 30 is assumed for the projected
  period
• Long term growth rate is assumed to be 11
  (growth rate of Chinese GDP)
• SHANDAs WACC was estimated to be 15.98
• Risk free rate and market risk premium were the
  same for both companies

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VALUE RANGES FOR BIDDER AND TARGET

• Sensitivity analysis for SHANDA resulted in low
  and high values of 18.77 and 41.64
• The average triangulated values for GOOGLE and
  SHANDA were 498.17 and 28.07 respectively
• According to the calculations both companies are
  slightly undervalued by the markets

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SYNERGIES

• Revenue Enhancement
• Increase of the online game sales in China after
  the merger.
• Increase of the online game sales outside of
  China.
• SNDA has good and wide business relationship with
  many important Chinese enterprises which will
  help Google to diversify its business

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SYNERGIES

• According to the industry growth, in 2009 the
  revenues would be 5196m (CNY)
• ASSUMPTIONS
• After the deal, the revenue growth rate of SNDA
  will be above the industry average
• Deal happens in 2007
• Revenue enhancement in 2007-2008 would be 200m
  and reach 800m by 2011
• The total revenue in 2009 would be 5950m (CNY)
  754m more than 5196 (CNY)
• The synergy value of revenue enhancement after
  tax is
• After tax 2007 2008
  2009 2010 2011
• (CNY) 200m 500m
  754m 777m 800m

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SYNERGIES

• COST SAVING SYNERGY
• Reduction of the advertisement, research and
  development and administrative costs
• Costing saving synergies
• After tax 2007 2008 2009
  2010 2011
• ( CNY) 100m 250m 300m
  350m 400m
• Long term growth rate is assumed to be 5

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SYNERGIES

• ASSET SALE
• Redundant assets could be sold (core servers and
  related hardware)
• In 2006 the total value of assets was 349m
• Assumptions
• 5 years after the deal, 249m worth of assets will
  be sold
• The Synergy of assets sale
• After tax 2007 2008
  2009 2010 2011
• (CNY) 50m 50m
  60m 54m 35m

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SYNERGIES

• SYNERGY CALCULATIONS
• Synergies discounted by WACC of combined company
• Combined WACC 14.25
• Combined WACC easy to calculate since both
  companies are debt-free and debt financing as a
  method of payment is not considered in this
  acquisition
• PV of Revenue Synergy is 2733.50m (CNY)
• PV of Asset Sale is 198.25m (CNY)
• Total Value of Synergies is 380.17 million (USD)

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PRICE RANGE OF SHANDA

• T
• The synergies (S) were estimated to be 380.17m
  and the market value of SNDA (T) is 1.86bn
• The price per share (P) would equal 31.30
• The range of 29-30 per share was chosen (11-15
  premium to the current SHANDA stock price of
  25.98)
• The merger would create value in the range of
  93m to 164m depending on the price within the
  29-30 range that the management agrees on

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PAYMENT OPTIONS

• CASH OFFER
• Advantages
• Google has been successful with cash purchases
  (Doubleclick for 3.1b)
• Strong Message to the Market
• Google has plenty of cash on its balance sheet
• Reduce Counter bidders

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PAYMENT OPTIONS

• CASH OFFER
• DISADVANTAGES
• Reduction of financial flexibility
• Shanda shareholders - no part in post
  acquisition synergy gains
• Potentially could limit the options for the
  shareholders of SHANDA.

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PAYMENT OPTIONS

• STOCK FOR STOCK OFFER
• ADVANTAGES DISADVANTAGES
• Lower the expected value of SHANDA from Googles
  perspective
• Potential effect on the amount of control that
  Google will have over the merged entity
• Choice will affect new combined companys
  financials
• A payment by stocks will increase financial
  flexibility
• Substantial Transaction Costs

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PAYMENT OPTIONS

• VERDICT
• Cash Offer
• premium of greater than 12 over the market price

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EFFECT OF FINANCING CHOICE ON THE CREDIT RATING
AND COST OF CAPITAL

• Credit rating would not be affected as cash does
  not involve the issue of new debt
• Cost of capital will not be affected since the
  only component of WACC is cost of equity
• WACC might change in the long run depending upon
  the performance of SHANDA as part of GOOGLE, as
  it will affect the GOOGLES beta, which, in turn,
  affects the cost of equity

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IMPACT ON THE PRICE OF GOOGLE

• With an all cash deal the share price of the
  combined firm is expected to rise to 505.54
  which is based on synergy values of 318.17 and a
  previous share price 498.12. There is an
  accretion of 7.41 per share
• A stock for stock deal would cause a dilution
  0.57 per share and result in a new share price
  of 498.12 offering lesser value to SHANDA
  shareholders
• Cash payment is expected to have a minor effect
  on the Google share price

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RISKS INVOLVED

• Operational difficulties
• Domestic and foreign laws that Google is subject
  to
• Stiff competition from traditional media
  companies in China
• Foreign exchange risk
• Recent restrictions imposed by the Chinese
  government on the amount of time that minors are
  allowed to spend on online games

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SOLUTIONS TO OVERCOME THE RISKS

• Google can retain the existing management of
  SHANDA
• Google can hire some experts that are familiar
  with Chinese laws and regulations (SNDA has a
  close relationship with the Chinese government).
• Google can acquire a traditional media company in
  the near future
• Google will experience foreign exchange risk in
  any cross border business it carries out.
• Google should try to diversify its customer base
  and target more mature customers, so that the
  revenue remains stable.

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POSSIBLE COMPETITORS/COUNTER BIDDERS FOR SHANDA

• Cash financing should ensure fast deal closure
• In the past, unsuccessful attempts by American
  internet companies in Chinese markets
• E BAY bought the largest Chinese auction
  company
• AMAZON bought the largest Chinese online
  merchandiser
• Google has had success with BAIDU
• In the event of a counter bid, the share premium
  is likely to decrease as the price demanded by
  SHANDA will be bid up resulting in a lesser
  synergy value