A Chinese Stock That's Not Playing Games

06/10/2009 12:00 pm EST

Focus: STOCKS

Andrea Kramer

Associate Editor, Schaeffer's Investment Research, Inc.

Andrea Kramer of Schaeffer’s Investment Research says the stock of a Chinese online gamer continues to rise despite lots of bearishness among traders.

A recent commentary in The Motley Fool ("Shanda’s Still a Player in China," June 3rd) centers on gaming guru Shanda Interactive Entertainment (Nasdaq: SNDA), which has seemingly taken the profitable road less traveled during the recession. The firm recently reported a 42% jump in quarterly revenue, with earnings per American depositary share (ADS) growing by 35% and exceeding the Street's expectations.

Behind the business boom, according to the Fool, are "die-hard gamers in China," as Shanghai-based Shanda's multiplayer role-playing games accounted for 85% of the company's profit. In fact, online gaming rivals Perfect World (Nasdaq: PWRD), NetEase.com (Nasdaq: NTES), and Giant Interactive (NYSE: GA) all exceeded analysts' predictions for quarterly revenue, thanks to the Internet gaming sensation sweeping the East.

However, Shanda's impressive quarter doesn't necessarily make it "immune to the worldwide weakness," the author, Rick Aristotle Munarriz, warns. On a monthly basis, revenue per account declined 12% from the previous quarter. What's more, the columnist questions whether or not the "spending blip is simply a matter of Chinese gamers trying to save a little money, instead of a larger trend away from online gaming."

The beauty behind Shanda's recent success is the fact that the Street has such low expectations for the stock. Since skimming the $20 level in December 2008, the shares of SNDA embarked on a quest for new highs, more than tripling atop support from their ten-and 20-day moving averages.

However, [despite] this remarkable rally, options speculators and short sellers remain skeptical of the security. During the past couple of weeks on the International Securities Exchange (ISE), speculators have bought to open more puts than calls on SNDA. In fact, the equity's ten-day put/call volume ratio of 1.09 stands only 12 percentage points from an annual pessimistic peak.

On that same note, SNDA's Schaeffer's put/call open interest ratio (SOIR) currently rests at 0.81, in the 87th annual percentile. In other words, near-term traders have been more bearishly biased toward the stock only 13% of the time during the past year.

Meanwhile, despite receding by 10.5% during the past couple of weeks, short interest on the equity remains at elevated levels. These pessimistic positions still account for 4.8 million SNDA shares, or 13.2% of the stock's total available float. At the security's average daily trading volume, it would take almost a week for these bearish bets to unwind.

Nevertheless, as contrarians we live for outperforming equities surrounded by skepticism. Should the shares of SNDA continue their journey into the black, an unwinding of pessimism in the options pits or a short-covering rally could fuel the stock even higher in the short term. (Shanda closed below $64 Tuesday, not far from its 52-week high—Editor.)

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