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Filed Pursuant to Rule 424(b)(4)
Registration No. 333-161708
            
83,500,000 American Depositary Shares
 
(SHANDA GAMES LIMITED LOGO)
 
Shanda Games Limited
Representing 167,000,000 Class A Ordinary Shares
 
 
 
 
 
This is the initial public offering of American depositary shares, or ADSs, of Shanda Games Limited, or Shanda Games. Shanda Games is offering 13,043,500 ADSs, and Shanda Interactive Entertainment Limited, or Shanda Interactive, which is our parent, existing sole shareholder and the selling shareholder, is offering an additional 70,456,500 ADSs. Each ADS represents two Class A ordinary shares, par value US$0.01 per share, of Shanda Games. The ADSs are evidenced by American depositary receipts, or ADRs. We will not receive any of the proceeds from the ADSs being sold by the selling shareholder.
 
Our share capital consists of Class A and Class B ordinary shares. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. Each Class A ordinary share is entitled to one vote per share, and each Class B ordinary share is entitled to 10 votes per share and is convertible at any time into one Class A ordinary share. Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances. Shanda Interactive holds all of our outstanding Class B ordinary shares through Shanda SDG Investment Limited, its wholly-owned subsidiary. Assuming the underwriters do not exercise their over-allotment option to purchase additional ADSs, upon the completion of this offering, Shanda Interactive will hold 409,087,000 Class B ordinary shares, or 71.01% of the combined total of our outstanding Class A and Class B ordinary shares (representing 96.08% of the total voting rights) in our company. Our dual-class ordinary share structure involves certain risks. See the relevant risk factors on pages 29 and 50 of this prospectus for a detailed discussion of such risks.
 
Prior to this offering, there has been no public market for our ADSs or our ordinary shares. The ADSs have been approved for listing on the NASDAQ Global Select Market under the symbol “GAME”. The initial public offering price per ADS is US$12.50.
 
See “Risk Factors” beginning on page 14 to read about factors you should consider before buying our ADSs.
 
 
 
 
Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.
 
 
 
 
                 
    Per ADS   Total
 
Public offering price
  US$ 12.50     US$ 1,043,750,000  
Underwriting discount
  US$ 0.78125     US$ 65,234,375  
Proceeds, before expenses, to Shanda Games
  US$ 11.71875     US$ 152,853,516  
Proceeds, before expenses, to the selling shareholder
  US$ 11.71875     US$ 825,662,109  
 
The underwriters have agreed to reimburse us for up to an estimated US$6.0 million of expenses in connection with the offering. See “Underwriting”. To the extent that the underwriters sell more than 83,500,000 ADSs, the underwriters may purchase up to an additional 12,525,000 ADSs from the selling shareholder at the initial public offering price, less the underwriting discount.
 
 
 
 
The underwriters expect to deliver the ADSs evidenced by the ADRs against payment in U.S. dollars in New York, New York on or about September 30, 2009.
 
Goldman Sachs (Asia) L.L.C. J.P. Morgan
Nomura Oppenheimer & Co. Susquehanna Financial Group, LLLP
 
 
 
 
Prospectus dated September 24, 2009.


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shadda games denotes games in announced pipeline

 


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shadda games denotes games in announced pipeline

 


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we are ames

 


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PROSPECTUS SUMMARY
 
The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements included elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in our ADSs, discussed under “Risk Factors”, before deciding whether to buy our ADSs.
 
Overview
 
We are China’s leading online game company in terms of the size and diversity of our game portfolio. Our online game revenues and game player base are also among the largest in China. Through our extensive experience in the online game industry in China, we have created a scalable approach to develop, source and operate online games, as well as license our games to third parties. We use multiple channels to assemble a large and diversified game portfolio of various genres. We operate a nationwide, secure network to host hundreds of thousands of game players playing simultaneously, and monitor and adjust the game environment to optimize our game players’ experience.
 
Our online game business includes the business of developing, operating and licensing our massively multi-player online role-playing games, or MMORPGs, and advanced casual games, which are collectively referred to in this prospectus as our online games. Advanced casual games, which is a sub-category of casual games, are generally less time consuming than MMORPGs but possess certain elements of MMORPGs including a story line, elaborate graphics, availability of virtual items and frequent interactions among game players. We develop and source a broad array of game content through multiple channels, including in-house development, licensing, investment and acquisition, co-development, and co-operation. Through these channels, we have built a large, diversified game portfolio and a robust game pipeline. As of August 31, 2009, we operated 20 MMORPGs and 11 advanced casual games and had 16 MMORPGs and eight advanced casual games in our announced pipeline.
 
Our game player base, which consisted of over 9.73 million active paying accounts for the three-month period ended June 30, 2009, is one of the largest in China. Active paying accounts refers to the number of game player accounts that spend virtual currency at least once during a given period and includes accounts of game players who spend virtual currency in beta testing of our online games. We seek to strengthen our game players’ loyalty by, among other things, closely monitoring our players’ preferences and introducing updates, expansion packs and other game improvements in a timely manner. An expansion pack is an addition to an existing game that usually includes additional game play areas, weapons, objects or an extended story line to a previously released game. We believe the size of our game player base is a key factor in attracting and retaining new game players and additional game content.
 
We are a leader in the development and innovation of China’s online game industry. In 2003, we launched The World of Legend, or Woool, which we developed in-house and was one of China’s first domestically developed MMORPGs. We were among the first in China to adopt the item-based revenue model for advanced casual games and were the first to adopt this revenue model for MMORPGs on a large scale, which has since become the prevailing revenue model in China. In 2006, we established 18 Capital, which is one of the first investment initiatives in China focused exclusively on investing in independent online game development and operating studios.
 
Our online game business has been widely recognized in China with our online games receiving numerous industry and user awards in China. For example, our online games that have won awards include:
 
  •  Woool, which was voted the “Most Popular Original Online Game in China’s Online Game Industry in the Past Ten Years” at the Ten-Year China Online Game Industry Award Ceremony and one of the “Top Ten Most Popular Games” at the 2008 China Game Industry Annual Conference;
 
  •  AION, an MMORPG which we launched in April 2009, which was voted one of the “Top Ten Most Anticipated Games” at the 2008 China Game Industry Annual Conference; and


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  •  Company of Heroes Online, one of our co-developed MMORPGs, which was voted one of the “Top Ten Most Anticipated Games” at the 2008 Annual ChinaJoy Conference, a game industry annual conference in China.
 
We use two different revenue models for all games that we operate: item-based and time-based. Compared with the time-based model, under which game players pay for game-playing time, the item-based model allows game players to play the basic features of the game for free. Game players may then choose to purchase virtual items that enhance their playing experience, such as weapons, clothing, accessories and pets. Most of our virtual items are priced between less than US$0.01 and US$1.47. However, unit prices of certain virtual items can be as high as approximately US$129. We have adopted the item-based model for substantially all of our MMORPGs and all of our advanced casual games.
 
Our online game business was founded by Shanda Interactive Entertainment Limited, or Shanda Interactive, in 2001 and was operated by Shanda Interactive until Shanda Interactive’s reorganization effective July 1, 2008, which we refer to as the reorganization in this prospectus. Pursuant to the reorganization, Shanda Interactive transferred substantially all of its assets and liabilities related to the online game business to us. We have benefited from and intend to continue leveraging our relationship with Shanda Interactive, which, through Shanda Online and its variable interest entities, or VIEs, operates an integrated service platform on which diverse multi-media content is offered, including online games, literature and music. By offering our online games through this platform, we can access Shanda Interactive’s large user base and broaden our marketing reach. In addition, we have successfully established a separate brand identity, “Shanda Games”, building on Shanda Interactive’s established brand name as one of China’s leading interactive entertainment media companies. We believe our powerful brand in China helps us to further strengthen our leading industry position.
 
Our net revenues increased 45% from RMB2,322.8 million in 2007 to RMB3,376.8 million (US$494.3 million) in 2008, of which 65.7% was derived from online games licensed from third parties, and 43% from RMB1,540.0 million in the six months ended June 30, 2008 to RMB2,198.5 million (US$321.9 million) in the six months ended June 30, 2009, of which 69.8% was derived from online games licensed from third parties. Our net income attributable to our company increased 58% from RMB591.9 million in 2007 to RMB935.5 million (US$136.9 million) in 2008, and 75% from RMB382.7 million in the six months ended June 30, 2008 to RMB671.2 million (US$98.3 million) in the six months ended June 30, 2009.
 
Industry Background
 
According to the International Data Corporation, or IDC, the number of China’s online game players reached 49.4 million in 2008, which we believe was the largest online game population in Asia, generating revenues of US$2.7 billion, representing a 76.6% increase over 2007. According to IDC, China’s online game revenues are expected to grow to US$5.8 billion by 2013, representing a compound annual growth rate, or CAGR, of 16.7% from 2008 to 2013. The number of paying online game players is expected to grow from 30.4 million in 2008 to 59.5 million in 2013, representing a CAGR of 14.3%.
 
Many factors have supported and we believe are likely to continue to drive the growth in the online game industry in China, including the following:
 
  •  increasing Internet and broadband penetration;
 
  •  online games becoming a more attractive form of entertainment relative to other forms of entertainment;
 
  •  low entry cost and convenience of play for game players; and
 
  •  high degree of user loyalty.
 
Trends in China’s online game industry include the following:
 
  •  increasing market acceptance of item-based revenue model;


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  •  growing popularity of casual games, as well as web games;
 
  •  growing popularity of domestically developed online games;
 
  •  increasingly competitive market dynamics; and
 
  •  prevalence of cheating programs and hacking activities.
 
Our Strengths
 
We believe that the following competitive strengths contribute to our success and differentiate us from our competitors:
 
  •  China’s leading online game company;
 
  •  comprehensive, multi-channel game content development and sourcing capabilities;
 
  •  leading technological expertise;
 
  •  proven operational expertise;
 
  •  leading innovator in China’s online game industry;
 
  •  strong management team with a proven track record; and
 
  •  benefits from ongoing relationships with Shanda Interactive and other partners.
 
Our Strategies
 
We aim to become a leading global online game company. Our business strategies primarily include:
 
  •  broaden and strengthen our large, diversified game portfolio and build franchise titles;
 
  •  strengthen and expand our communities of game players;
 
  •  further monetize our content and communities; and
 
  •  further expand our business internationally and domestically.
 
Our Challenges
 
The successful execution of our strategies is subject to certain risks and uncertainties, including those relating to:
 
  •  our ability to develop and source new online games that will be commercially successful;
 
  •  our dependence on two online games for a substantial portion of our revenues;
 
  •  the growth of the online game industry and the continuing market acceptance of our online games and virtual items in China and elsewhere;
 
  •  our ability to respond to competitive pressure, including competition that arises from new online games introduced by our competitors and other forms of entertainment;
 
  •  our ability to protect our intellectual property rights;
 
  •  our ability to maintain an effective system of internal control over financial reporting; and
 
  •  regulatory environment in China.


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Our History and Corporate Structure
 
Our online game business was founded by Shanda Interactive, our parent, in 2001 and was operated by Shanda Interactive through various subsidiaries and VIEs until the reorganization effective July 1, 2008. In November 2001, Shanda Interactive launched its first online game, Legend of Mir II, or Mir II, which it had licensed from Actoz Soft Co., Ltd., or Actoz. In October 2003, Shanda Interactive launched Woool. In May 2004, Shanda Interactive completed an initial public offering of ADSs. Shanda Interactive’s ADSs are traded on the NASDAQ Global Select Market under the symbol “SNDA”.
 
As part of the reorganization, we were incorporated in the Cayman Islands on June 12, 2008 as a wholly-owned subsidiary of Shanda Interactive to be the holding company for the online game business. Pursuant to a Master Separation Agreement, Shanda Interactive transferred substantially all of its assets and liabilities related to its online game business to us. Concurrently, we transferred to Shanda Interactive certain assets and liabilities not related to the online game business. See “Our Relationship with Shanda Interactive” for a description of the Master Separation Agreement and other agreements relating to the reorganization. As a result of the reorganization and in order to comply with PRC laws restricting foreign ownership in the online game business in China, we conduct our online game business through Shanghai Shulong Technology Development Co., Ltd., or Shanghai Shulong, which we control through a series of contractual arrangements, including VIE agreements, between our wholly-owned subsidiaries, Shengqu Information Technology (Shanghai) Co., Ltd., or Shengqu, and Shengji Information Technology (Shanghai) Co., Ltd., or Shengji, and Shanghai Shulong and/or its shareholders. The VIE agreements are a series of contractual arrangements between our PRC subsidiaries, on the one hand, and Shanghai Shulong and/or its shareholders, on the other hand, including contracts relating to the provision of services, software licenses and equipment, and certain shareholder rights and corporate governance matters. As a result of these contractual arrangements, we are considered the primary beneficiary of Shanghai Shulong and its subsidiaries and accordingly, consolidate the results of operations of Shanghai Shulong and its subsidiaries in our financial statements. See “Our History and Corporate Structure” for a detailed discussion of these contractual arrangements.
 
In the second quarter of 2009, Shanda Interactive transferred to us its entire equity interest in Actoz for a cash consideration of US$70.2 million.


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The following diagram illustrates our corporate structure and the corporate structure of Shanda Online, an entity controlled by Shanda Interactive, immediately prior to this offering.
 
(FLOW CHART)
 
 
(1) Shanda Online Holdings Limited was renamed Shanda Investment Holdings Limited on November 5, 2008.
 
(2) Employee of Shanda Interactive.
 


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Our Relationship with Shanda Interactive
 
Prior to the reorganization, our online game business was operated by Shanda Interactive, our parent, through its various subsidiaries and VIEs. In connection with the reorganization, which became effective on July 1, 2008, we entered into agreements with Shanda Interactive with respect to various ongoing relationships between the two companies, including a Master Separation Agreement, a Non-Compete and Non-Solicitation Agreement, a Cooperation Agreement and a Sales Agency Agreement. These agreements include provisions relating to (i) the transfer of assets and liabilities related to the online game business from Shanda Interactive to us, (ii) cross-indemnification of liabilities arising from breaches of the Master Separation Agreement or any related intercompany agreement, (iii) limitations on Shanda Interactive from competing with us in the online game business for a five-year period commencing July 1, 2008 with certain exceptions and (iv) our engagement of certain VIEs of Shanda Online to provide certain services that are critical to our business, including online billing and payment, user authentication, customer service, anti-fatigue compliance, prepaid card marketing and distribution and data support services for a five-year period commencing July 1, 2008. For additional details of our agreements with VIEs of Shanda Online and the fees that we pay these VIEs, see “Our Relationship with Shanda Interactive”. A majority of our executive officers and employees are former employees of Shanda Interactive.
 
Upon the completion of this offering, Shanda Interactive will continue to be our controlling shareholder, with a shareholding of 71.01% of the combined total of our outstanding Class A and Class B ordinary shares, representing 96.08% of the voting rights of the combined total of our outstanding Class A and Class B ordinary shares due to the proportionately greater voting rights of the Class B ordinary shares it holds, which are entitled to 10 votes on matters subject to shareholders’ vote (as compared with one vote for Class A ordinary shares) or, assuming the underwriters exercise in full their over-allotment option to purchase additional ADSs, 66.66% of our combined total outstanding Class A and Class B ordinary shares, representing 95.24% of the combined total voting rights of our outstanding Class A and Class B ordinary shares. However, Shanda Interactive is not subject to any contractual obligation to maintain its share ownership other than the 180-day lock-up period as described in “Underwriting”.
 
We believe that our establishment as a standalone entity to focus on the online game business as part of the reorganization:
 
  •  helps us to focus on developing, sourcing and operating high-quality online games;
 
  •  provides us with a sharper focus and greater flexibility to pursue strategic opportunities to further strengthen our leadership position in the online game industry in China and to grow our online game business;
 
  •  promotes greater accountability for our employees; and
 
  •  better motivates our employees.
 
Our Corporate Information
 
Our principal executive offices are located at No. 1 Office Building, No. 690 Bibo Road, Pudong New Area, Shanghai, 201203, People’s Republic of China, and our telephone number is +86 (21) 5050-4740. Our website address is http://www.shandagames.com. The information on our website does not form a part of this prospectus. Our agent for service of process in the United States is CT Corporation System, located at 111 Eighth Avenue, New York, New York 10011.


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Conventions That Apply to This Prospectus
 
Unless otherwise indicated, information in this prospectus assumes that the underwriters have not exercised their over-allotment option to purchase up to 12,525,000 additional ADSs representing 25,050,000 Class A ordinary shares from the selling shareholder and assumes that there has been no vesting of options to purchase Class A ordinary shares or restricted shares granted to our executive officers and employees.
 
Except where the context otherwise requires and for purpose of this prospectus only:
 
  •  “our PRC companies” refers to our PRC subsidiaries and our PRC operating companies;
 
  •  “our PRC operating companies” refers to the Shulong entities, Chengdu Aurora and Chengdu Simo;
 
  •  “our PRC subsidiaries” refers to Shengqu and Shengji;
 
  •  “Shanda Interactive” refers to Shanda Interactive Entertainment Limited, a Cayman Islands company and our parent and indirect controlling shareholder, whose shares of ADSs are listed on the NASDAQ Global Select Market under the symbol “SNDA”, and, unless the context requires otherwise, its subsidiaries and VIEs, but excludes Shanda Games and its subsidiaries and VIEs;
 
  •  “Shanda Group” refers to Shanda Interactive and its subsidiaries and VIEs and, unless the context requires otherwise, includes Shanda Games and its subsidiaries and VIEs;
 
  •  “Shanda Online” refers to Shanda Investment Holdings Limited, a Cayman Islands company wholly-owned by Shanda Interactive, and, unless the context requires otherwise, its subsidiaries, including Shanda Computer (Shanghai) Co., Ltd., or Shanda Computer, and, in the context of describing its operations, also includes its VIEs, including Shanghai Shanda Networking Co., Ltd., or Shanda Networking, Nanjing Shanda Networking Co., Ltd., or Nanjing Shanda, and Shanghai Shengfutong Electronic Business Co., Ltd., or Shengfutong;
 
  •  “Shulong entities” refers to Shanghai Shulong, Shanghai Shulong Computer Technology Co., Ltd., or Shulong Computer, and Nanjing Shulong Computer Technology Co., Ltd., or Nanjing Shulong; and
 
  •  “we”, “us”, “our company” and “our” refer to Shanda Games, and, unless the context requires otherwise, its subsidiaries, including Shanda Games Holdings (HK) Limited, or Shanda Games (HK), Shanda Games International (Pte) Ltd., a Singapore company and our wholly-owned subsidiary, Shanda Games Korean Investment Limited, a British Virgin Islands company and our wholly-owned subsidiaries, Shengqu and Shengji, and, in the context of describing our operations, also include the Shulong entities, Chengdu Aurora Technology Development Co., Ltd., or Chengdu Aurora, a PRC company wholly-owned by Shanghai Shulong, and Chengdu Simo Technology Co., Ltd., or Chengdu Simo, a PRC company wholly-owned by Shanghai Shulong; when required by the context, references to “we”, “us”, “our company” and “our” include the online game business Shanda Interactive operated through its various subsidiaries and VIEs from January 1, 2007 to June 30, 2008.
 
This prospectus contains translations of certain Renminbi, or RMB, amounts into U.S. dollars at the rate of RMB6.8302 to US$1.00, the noon buying rate in effect on June 30, 2009. We make no representation that the Renminbi or U.S. dollar amounts referred to in this prospectus could have been or can be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. On September 18, 2009, the daily exchange rate reported by the Federal Reserve Board was RMB6.8270 to US$1.00.
 
References in this prospectus to the operations of our business, financial condition and results of operations with respect to the period from January 1, 2007 to June 30, 2008 are to Shanda Interactive’s online game business operations as conducted by Shanda Interactive’s subsidiaries and VIEs. References in this prospectus to the operations of our business, financial condition and results of operations with respect to the period from July 1, 2008 to June 30, 2009 are to our operations as a standalone company subsequent to the reorganization. Since July 1, 2007, the results of operations of Actoz have been consolidated into our results of operations.


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THE OFFERING
 
The following assumes that the underwriters will not exercise their over-allotment option to purchase additional ADSs in the offering, unless otherwise indicated.
 
ADSs offered by Shanda Games
13,043,500 ADSs.
 
ADSs offered by the selling shareholder
70,456,500 ADSs.
 
Price per ADS
US$12.50 per ADS.
 
ADSs outstanding immediately after this offering
83,500,000 ADSs (or 96,025,000 ADSs, if the underwriters exercise in full their over-allotment option to purchase additional ADSs).
 
Class A ordinary shares outstanding immediately after this offering
167,000,000 Class A ordinary shares (or 192,050,000 Class A ordinary shares, if the underwriters exercise in full their over-allotment option to purchase additional ADSs).
 
Class B ordinary shares outstanding immediately after this offering
409,087,000 Class B ordinary shares (or 384,037,000 Class B ordinary shares, if the underwriters exercise in full their over-allotment option to purchase additional ADSs).
 
Ordinary shares
Our share capital consists of Class A and Class B ordinary shares. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. Each Class A ordinary share shall be entitled to one vote on all matters subject to shareholders’ vote, and each Class B ordinary share shall be entitled to 10 votes on all matters subject to shareholders’ vote. Each Class B ordinary share is convertible into one Class A ordinary share at any time by the holder thereof. Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances.
 
The ADSs
Each ADS represents two Class A ordinary shares, par value US$0.01 per share. The ADSs will be evidenced by the ADRs.
 
The depositary will hold the Class A ordinary shares underlying your ADSs and you will have rights as provided in the deposit agreement among us, the depositary and beneficial owners of ADSs from time to time.
 
If we declare dividends on our Class A ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our Class A ordinary shares, after deducting its fees and expenses.
 
You may turn in your ADSs to the depositary in exchange for Class A ordinary shares underlying your ADSs. The depositary will charge you fees for any exchange.
 
We may amend or terminate the deposit agreement without your consent, and if you continue to hold your ADSs, you agree to be bound by the deposit agreement as amended.
 
You should carefully read the section in this prospectus entitled “Description of American Depositary Shares” to better understand


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the terms of the ADSs. You should also read the deposit agreement, which is an exhibit to the registration statement that includes this prospectus.
 
Reserved ADSs
At our request, the underwriters have reserved for sale, at the initial public offering price, up to an aggregate of 1,500,000 ADSs, to our directors, officers, employees, business associates and related persons through a directed share program.
 
Listing
The ADSs have been approved for listing on the NASDAQ Global Select Market.
 
NASDAQ symbol
“GAME”
 
Depositary
JPMorgan Chase Bank, N.A.
 
Over-allotment option
Shanda Interactive, the selling shareholder, has granted to the underwriters an over-allotment option, exercisable within 30 days from the date of this prospectus, to purchase up to an additional 12,525,000 ADSs.
 
Timing and settlement for ADSs
The ADSs are expected to be delivered against payment on or about September 30, 2009. They will be deposited with a custodian for, and registered in the name of a nominee of, The Depository Trust Company, or DTC, in New York, New York. In general, beneficial interests in the ADSs will be shown on, and transfers of these beneficial interests will be effected through, records maintained by DTC and its direct and indirect participants.
 
Use of proceeds
We expect that we will receive net proceeds of approximately US$155.1 million from this offering (after deducting underwriting discounts, commissions and estimated offering expenses payable by us).
 
We intend to use the net proceeds from this offering for general corporate purposes, including capital expenditures and funding possible future investments, joint ventures and acquisitions. See “Use of Proceeds” for additional information.
 
We will not receive any of the proceeds from the sale of the ADSs by the selling shareholder.
 
Risk factors
See “Risk Factors” and other information included in this prospectus for a discussion of risks you should carefully consider before deciding to invest in our ADSs.
 
Lock-up
We have agreed for a period of 180 days after the date of this prospectus not to sell, transfer or otherwise dispose of any of our ordinary shares or ADSs representing our Class A ordinary shares. Furthermore, each of our directors and executive officers and our existing shareholder, which is also the selling shareholder, have agreed to a similar 180-day lock-up. See “Underwriting”.
 
Dividend
In 2009, we declared an aggregate of US$102.6 million in cash dividends payable solely to Shanda Interactive. As of June 30, 2009, we had paid Shanda Interactive US$24.5 million of this amount and intend to pay Shanda Interactive the remaining amount from a bank loan. Purchasers of ADSs in this offering will not be eligible to participate in the foregoing dividends.


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SUMMARY CONSOLIDATED FINANCIAL INFORMATION
 
The following summary consolidated financial information for the periods and as of the dates indicated should be read in conjunction with our financial statements and the accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, both of which are included elsewhere in this prospectus.
 
The summary consolidated financial data presented below as of December 31, 2007, 2008 and June 30, 2009 and for the two years ended December 31, 2007 and 2008 and for the six months ended June 30, 2009 are derived from our audited consolidated financial statements included elsewhere in this prospectus. Our audited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP, and have been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, an independent registered public accounting firm. The report of PricewaterhouseCoopers Zhong Tian CPAs Limited Company on those consolidated financial statements is included elsewhere in this prospectus. The summary consolidated financial data presented below as of and for the six months ended June 30, 2008 have been derived from our unaudited interim consolidated financial statements included elsewhere in this prospectus. We have prepared the unaudited consolidated financial statements on the same basis as our audited consolidated financial statements. The unaudited consolidated financial statements include all adjustments, consisting only of normal and recurring adjustments that we consider necessary for a fair presentation of our financial position and operating results for the periods presented.
 
Prior to the reorganization, our online game business was operated by Shanda Interactive through its various subsidiaries and VIEs. Effective July 1, 2008, pursuant to the reorganization, we assumed substantially all of the assets and liabilities related to Shanda Interactive’s online game business.
 
The reorganization was accounted for as a common control transaction, and, accordingly, our consolidated financial statements have been prepared as if our current corporate structure had been in existence throughout the periods presented and as if the online game business, including Actoz that Shanda Interactive subsequently transferred to us in the second quarter of 2009, was transferred to us from Shanda Interactive as of the earliest period presented.
 
For the period from January 1, 2007 to June 30, 2008, our consolidated financial statements were prepared by combining the assets, liabilities, revenues, expenses and cash flows of the entities that were directly engaged in the online game business.
 
Our statements of operations and comprehensive income for the periods prior to the reorganization include all the historical costs related to the online game business including payments for certain services performed by various subsidiaries and VIEs of Shanda Interactive, which became Shanda Online after the reorganization, and an allocation of certain general corporate expenses of Shanda Interactive. These general corporate expenses primarily relate to corporate employee compensation costs, professional service fees and other expenses arising from the provisions of certain corporate functions, including finance, legal, technology, investment and executive management. We allocated these expenses based on estimates that our management believes are a reasonable reflection of the utilization of services provided to, or benefits received by, us.
 
For the period from July 1, 2008 to June 30, 2009, our consolidated financial statements consist of the financial statements of Shanda Games, including its subsidiaries and VIEs, as a standalone company.
 
Our management believes that the assumptions underlying our consolidated financial statements and the above allocations are reasonable. Our consolidated financial statements for the years ended December 31, 2007 and 2008, however, may not be reflective of our result of operations, financial position and cash flows had we been operated as a standalone company during those periods. Our historical results for any prior periods are not necessarily indicative of results to be expected for any future period. In addition, our audited results for the six months ended June 30, 2009 may not be indicative of our results for the full year ending December 31, 2009.


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Summary Consolidated Statements of Operations Data
 
                                                 
    For the Year Ended December 31,   For the Six Months Ended June 30,
    2007   2008   2008   2009
    RMB   RMB   US$   RMB   RMB   US$
                (unaudited)        
    (in millions, except per share data)
 
Net revenues:
                                               
Online MMORPG revenues
    2,016.1       2,987.8       437.4       1,335.1       2,026.1       296.6  
Online advanced casual game revenues
    280.4       358.9       52.5       187.1       159.8       23.4  
Other revenues
    26.3       30.1       4.4       17.8       12.6       1.9  
                                                 
Total net revenues
    2,322.8       3,376.8       494.3       1,540.0       2,198.5       321.9  
                                                 
Cost of revenues:
                                               
Third parties
    (492.0 )     (768.3 )     (112.5 )     (367.6 )     (476.1 )     (69.7 )
Related parties
    (769.1 )     (721.1 )     (105.6 )     (379.1 )     (405.0 )     (59.3 )
                                                 
Total cost of revenues
    (1,261.1 )     (1,489.4 )     (218.1 )     (746.7 )     (881.1 )     (129.0 )
                                                 
Gross profit
    1,061.7       1,887.4       276.2       793.3       1,317.4       192.9  
                                                 
Operating expenses:
                                               
Product development
    (136.4 )     (238.8 )     (35.0 )     (112.9 )     (151.9 )     (22.2 )
Sales and marketing
                                               
Third parties
    (125.4 )     (124.4 )     (18.2 )     (58.4 )     (79.1 )     (11.6 )
Related parties
          (80.1 )     (11.7 )           (102.3 )     (15.0 )
General and administrative
    (175.2 )     (287.2 )     (42.0 )     (137.9 )     (152.5 )     (22.3 )
                                                 
Total operating expenses
    (437.0 )     (730.5 )     (106.9 )     (309.2 )     (485.8 )     (71.1 )
                                                 
Income from operations
    624.7       1,156.9       169.3       484.2       831.6       121.8  
Interest income
    26.3       33.4       4.9       21.5       11.5       1.7  
Investment income
    *                         0.2       *  
Other income (expense), net
    28.7       6.1       0.9       (16.2 )     38.0       5.5  
                                                 
Income before income tax expenses and equity in earning (loss) of affiliated companies
    679.7       1,196.4       175.1       489.5       881.3       129.0  
Income tax expenses
    (67.1 )     (249.9 )     (36.6 )     (101.6 )     (190.7 )     (27.9 )
Equity in earning (loss) of affiliated companies
    (13.6 )     0.9       0.1       (0.2 )     (10.2 )     (1.5 )
                                                 
Net income
    599.0       947.4       138.6       387.7       680.4       99.6  
Less: Net income attributable to non-controlling interest
    (7.1 )     (11.9 )     (1.7 )     (4.9 )     (9.2 )     (1.3 )
                                                 
Net income attributable to Shanda Games Limited
    591.9       935.5       136.9       382.8       671.2       98.3  
                                                 
Earnings per ordinary share
                                               
Basic
    1.08       1.70       0.25       0.70       1.22       0.18  
Diluted
    1.08       1.70       0.25       0.70       1.22       0.18  
Earnings per ADS
                                               
Basic
    2.16       3.40       0.50       1.40       2.44       0.36  
Diluted
    2.16       3.40       0.50       1.40       2.44       0.36  
 
Share-based compensation included in:
                                                 
Cost of revenues
    (0.3 )     (0.8 )     (0.1 )     (0.6 )     (0.6 )     (0.1 )
Product development
    (0.8 )     (1.9 )     (0.3 )     (1.4 )     (1.0 )     (0.1 )
Sales and marketing
          (1.0 )     (0.1 )     (0.6 )     (0.4 )     (0.1 )
General and administrative
    (16.4 )     (17.1 )     (2.5 )     (8.3 )     (16.5 )     (2.4 )
 
 
* Less than 0.1.


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Summary Consolidated Balance Sheets Data
 
                                         
    As of December 31,   As of June 30,
    2007   2008   2009
    RMB   RMB   US$   RMB   US$
    (in millions)
 
Total current assets
    904.4       1,582.7       231.7       1,923.1       281.6  
Total assets
    1,857.3       2,444.1       357.8       2,856.4       418.2  
Total current liabilities
    606.9       1,178.0       172.5       1,798.1       263.3  
Total liabilities
    640.9       1,208.2       176.9       1,826.6       267.4  
Total Shanda Games Limited shareholder’s equity
    1,001.2       1,097.0       160.6       865.7       126.8  
Non-controlling interest
    215.2       138.9       20.3       164.1       24.0  
Total equity
    1,216.4       1,235.9       180.9       1,029.8       150.8  
Total liabilities and equity
    1,857.3       2,444.1       357.8       2,856.4       418.2  
 
Summary Consolidated Statements of Cash Flows Data
 
                                                 
    For the Year Ended December 31,   For the Six Months Ended June 30,
    2007   2008   2008   2009
    RMB   RMB   US$   RMB   RMB   US$
                (unaudited)        
    (in millions)
 
Net cash provided by operating activities
    672.7       1,144.5       167.6       568.8       935.3       136.9  
Net cash used in investing activities
    (132.1 )     (144.2 )     (21.1 )     (133.5 )     (1,299.9 )     (190.3 )
Net cash provided by (used in) financing activities
    (376.0 )     (748.3 )     (109.6 )     (232.4 )     532.4       77.9  
Effect of exchange rate changes on cash
    (7.1 )     (16.7 )     (2.4 )     (7.4 )     2.8       0.4  


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Summary Operating Data
 
The following table sets forth certain operating statistics for our MMORPGs.
 
                                                 
    For the Three Months Ended
    March 31,
  June 30,
  September 30,
  December 31,
  March 31,
  June 30,
    2008   2008   2008   2008   2009   2009
 
Quarterly active paying accounts (in thousands)(1)
    4,110       4,239       5,189       5,889       7,189       8,582  
Average monthly revenues per active paying account (in RMB)(2)
    51.9       54.7       49.6       49.8       43.9       41.9  
 
The following table sets forth certain operating statistics for our advanced casual games.
 
                                                 
    For the Three Months Ended
    March 31,
  June 30,
  September 30,
  December 31,
  March 31,
  June 30,
    2008   2008   2008   2008   2009   2009
 
Quarterly active paying accounts (in thousands)(1)
    1,661       1,421       1,380       961       1,052       1,152  
Average monthly revenues per active paying account (in RMB)(2)
    19.8       20.8       23.7       25.5       27.8       20.9  
                                                 
                                               
 
(1) Quarterly active paying accounts refers to the aggregate number of active paying accounts for our online games during a given quarter.
 
(2) Average monthly revenues per active paying account refers to our online game revenues during a given quarter divided by quarterly active paying accounts, further divided by three.


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RISK FACTORS
 
You should consider carefully all of the information in this prospectus, including the risks and uncertainties described below, before investing in our ADSs. Any of the following risks and uncertainties could have a material adverse effect on our business, financial condition, results of operations and prospects. The market price of our ADSs could decline due to any of these risks and uncertainties, and you may lose all or part of your investment.
 
Risks Relating to Our Business and Our Industry
 
If we are unable to successfully develop and source new online games, our business prospects, financial condition and results of operations would be materially and adversely affected.
 
To remain competitive, we must continue to develop and source new online games that appeal to game players. We develop and source new online games through our multi-channel strategy, including in-house development, licensing, investments and acquisitions, co-development and co-operation. However, we cannot assure you that we will be successful in executing such strategy. If we fail to do so, our business, financial condition, results of operations and business prospects would be materially and adversely affected. The following summarizes risks relating to our multi-channel strategy.
 
  •   In-house development of new online games and introduction of expansion packs for our existing online games
 
We must continue to successfully develop new online games in-house to expand our game portfolio and introduce updates and expansion packs, which are more substantial enhancements than updates, for our existing games to extend the commercial lifespan of our existing games.
 
Our ability to develop successful new online games in-house will largely depend on our ability to (i) anticipate and effectively respond to changing game player interests and preferences and technological advances in a timely manner, (ii) attract, retain and motivate talented online game development personnel and (iii) execute effectively our online game development plans. In-house development requires a substantial initial investment prior to the launch of a game, as well as a significant commitment of future resources to produce updates and expansion packs.
 
Our ability to introduce successful updates and expansion packs for our existing online games will also depend on our ability to collect and analyze user behavior data and feedback from the player community in a timely manner and to effectively incorporate features into our updates and expansion packs to improve the variety and attractiveness of our virtual items. We cannot assure you that we will be able to collect and analyze game player behavior data on a timely basis or that such data will accurately reflect game player behavior.
 
  •   Maintaining good relationships with our licensors, extending licenses for our existing licensed online games and licensing new online games
 
We license many of our online games, including some of our most popular games, from third parties. In 2008 and the six months ended June 30, 2009, we derived approximately 65.7% and 69.8% of our net revenues, respectively, from online games that were licensed from third parties. We must maintain good relations with our licensors to ensure the continued smooth operation of our licensed games. Additionally, we depend upon our licensors to provide technical support necessary for the operation of the licensed games, as well as updates and expansion packs that help to sustain interest in a game. Moreover, certain marketing activities often require the consent of our licensors. Finally, our licenses may be terminated upon the occurrence of certain events, such as a material breach by us. Only some of our license agreements allow us to automatically extend the term of the license without renegotiating with the licensors. We may want to extend a license upon its expiration but may not be able to do so on terms acceptable to us or at all. Our licensors may also demand new royalty terms that are unacceptable to us. Our ability to continue to license our online games and to maintain good


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relationship with our licensors also affect our ability to license new games developed by the same licensors.
 
  •   Investments in and acquisitions of other businesses that we believe may benefit our business
 
We intend to continue to invest in or acquire other businesses that complement our business or games that we believe may benefit us in terms of game player base or game portfolio. However, our ability to grow through such investments and acquisitions will depend on the availability of suitable candidates at an acceptable cost and our ability to consummate such transactions on commercially reasonable terms, as well as our ability to obtain any required governmental approvals. The identification and completion of these transactions may also require us to expend significant management and other resources. Moreover, the benefits of an investment or acquisition may take considerable time to materialize, and we cannot assure you that any particular transaction will achieve the intended benefits. Future acquisitions could also expose us to potential risks, including those associated with the integration of new operations, technologies and personnel, unforeseen or hidden liabilities, the inability to generate sufficient revenues to offset the costs and expenses of the acquisitions and potential loss of, or harm to, our relationships with employees, customers, licensors and other suppliers as a result of integration of new businesses.
 
  •   Sourcing of new online games through co-development and co-operation
 
We co-develop online games with international game developers. We also co-operate certain games in China under nonexclusive licenses granted by third-party Chinese developers who also operate those same games on their own platform. We must maintain good relations with our co-developers and co-operators to ensure the continued smooth development or operation of our co-developed and co-operated games. We may incur significant cost overrun in game product development in our co-development arrangements. In addition, our newly co-developed games may not be well received by our game players. Our ability to co-develop and co-operate successful online games also depends on the availability of co-development and co-operation partner candidates.
 
We depend substantially on two MMORPGs, which accounted for approximately 75.9% and 77.0% of our net revenues in 2008 and the six months ended June 30, 2009, respectively, and have finite commercial lifespans.
 
Mir II and Woool, which are two of our MMORPGs, contributed approximately 55.3% and 20.6% of our net revenues, respectively, in 2008 and 56.4% and 20.6% of our net revenues, respectively, in the six months ended June 30, 2009. We expect to continue to derive a substantial majority of our net revenues from Mir II and Woool in the near term. Thus, our business prospects, financial condition and results of operations would be materially and adversely affected by any factor that contributes to a decline in revenues from Mir II or Woool, including:
 
  •  any reduction in purchases of virtual items by Mir II or Woool players;
 
  •  a decrease in the popularity of either game in China due to increased competition or other factors;
 
  •  failure to improve, update or enhance Mir II or Woool in a timely manner; or
 
  •  any lasting or prolonged server interruption due to network failures or other factors or any other adverse developments specific to Mir II or Woool.
 
As with other online games, Mir II and Woool have finite commercial lifespans. We believe that Mir II and Woool, which we launched in 2001 and 2003, respectively, are in the more mature stages of their commercial lifespan. While we were able to reverse the decreasing trend in revenues from these two games with the adoption of our item-based revenue model in November 2005 and have since been able to continue to increase our revenues from both games, we cannot assure you that revenues from these games will not decline in the future. We may also be able to extend the commercial lifespan of Mir II and Woool by enhancing, expanding and upgrading Mir II and Woool to include new features that appeal to existing players and attract


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new players. If we are not able to extend the commercial lifespan of Mir II and Woool, our business prospects, financial condition and results of operations may be materially and adversely affected.
 
Our new games, such as AION, may not be commercially successful, and we may fail to launch new games according to our timetable, or at all.
 
In order to remain competitive, we must introduce new online games that are attractive to our game players and can generate additional revenues and diversify our revenue sources. The games in our announced pipeline only represent our current expectations. We cannot assure you that we will launch these games or that these games, if launched, will be commercially successful, and you should not use the success of our existing games as an indication of the future commercial success of any of the online games in our pipeline. Although we have launched several new online games in the past three years, none of these games individually has been able to contribute 10% or more of our net revenues annually. There are many factors that could adversely affect the popularity of our new games, and if our new games are not commercially successful, our business prospects and results of operations would be materially and adversely affected and we may not be able to recover our game sourcing or development costs, which can be significant. For example, in April 2009, we launched AION, an MMORPG that we licensed from NCSoft Corporation, a leading South Korean game developer, operator and publisher. While the launch of AION has generated significant market attention, we cannot assure you that AION will be commercially successful or meet market expectations. The failure of new games such as AION to become commercially successful could adversely affect market confidence in our future growth prospects and result in a drop in the market price of our ADSs.
 
The timing of the launch of our pipeline games is also critical to our business. We also cannot assure you that we will be able to launch these games based on our current timetable or at all. A number of factors, including technical difficulties, insufficient game development personnel, a lack of marketing or other resources or acceptance of or interest in the new games among game players during the testing phase and adverse developments in our relationship with the licensors of our new licensed games, could result in delays in launching or prevent us from launching our new games or at all. If we fail to launch new games according to our timetable or at all, we may disappoint the game player base, fail to meet the targets for our anticipated financial and operating results or lose our market leadership position to our competitors, any of which may have a material adverse effect on our business, financial condition and results of operations.
 
Our new games may attract game players away from our existing games, which may have a material adverse effect on our business, financial condition and results of operations.
 
Our new online games may attract game players away from our existing games and shrink our existing games’ player base, which could in turn make those existing games less attractive to other game players, resulting in decreased revenues from our existing games. Players of our existing games may also spend less money to purchase virtual items in our new games than they would have spent if they had continued playing our existing games. In addition, our game players may migrate from our existing games with a higher profit margin to new games with a lower profit margin. The occurrence of any of the foregoing could have a material and adverse effect on our business, financial condition and results of operations.
 
Changes or adjustments we make to our existing or new games may not be well received by our game players.
 
As we develop new online games or introduce updates and expansion packs to our existing games, we closely monitor our game players’ tastes and preferences and may introduce or change certain game features or game play styles to make our games more attractive. We cannot assure you that these changes or adjustments will be well received by our game players, who may decide not to play the new game or cease playing the existing game. As a result, any changes or adjustments we make to existing or new games may adversely impact our revenues and business prospects.
 
There are risks that the revenue models we adopt for our online games may not be suitable.
 
We currently operate substantially all of our online games using the item-based revenue model and have generated, and expect to continue to generate, a substantial majority of our revenues using this revenue model.


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Although we have adopted the item-based revenue model for substantially all of our online games, it may not be the best revenue model for our games. The item-based revenue model requires us to develop or license online games that not only attract game players to spend more time playing, but also encourage them to purchase virtual items. The sale of virtual items requires us to track closely game players’ tastes and preferences, especially as to in-game consumption patterns. If we fail to develop or offer virtual items which game players purchase, we may not be able to effectively convert our game player base into paying users. In addition, the item-based revenue model may cause additional concerns from PRC regulators who have been implementing regulations designed to reduce the amount of time that the Chinese youth spend on online games and intended to limit the total amount of virtual currency issued by online game operators and the amount purchased by an individual game player. A revenue model that does not charge for playing time may be viewed by the PRC regulators as inconsistent with this goal. Furthermore, we may change the revenue model for some of our online games if we believe the existing revenue models are not optimal. We cannot assure you that the revenue model that we have adopted for any of our online games will continue to be suitable for that game, or that we will not in the future need to switch our revenue model or introduce new revenue model for that game. A change in revenue model could result in various adverse consequences, including disruptions of our game operations, criticism from game players who have invested time and money in a game and would be adversely affected by such a change, decreases in the number of our game players or decreases in the revenues we generate from our online games.
 
Our business could suffer if we do not successfully manage our current growth and potential future growth.
 
To execute our growth strategies, we anticipate that we will need to manage and supervise our current game portfolio, as well as develop and source additional games. We also will need to continue to expand, train, manage and motivate our workforce, and manage our relationships with our game licensors, co-developers, co-operators, game players and third-party service providers. In addition, we need to implement various new or upgraded operational and financial systems, procedures and controls and to improve our accounting and other internal management systems, all of which will require substantial management efforts and financial resources and may divert our management’s attention from running our business or otherwise harm our operations. We cannot assure you that we will be able to efficiently or effectively implement our growth strategies or manage our growth, and any failure to do so may limit our future growth and hamper our business strategy.
 
We face risks associated with the licensing of our games internationally, and if we are unable to effectively manage these risks, our ability to expand our business internationally could be impaired.
 
As of June 30, 2009, we licensed six online games to game operators in a number of countries or regions. We plan to further license our existing and new games in more countries and regions.
 
Licensing our games in the international markets exposes us to a number of risks, including:
 
  •  identifying and maintaining good relations with game operators who are knowledgeable in, and can effectively distribute and operate our games in, international markets;
 
  •  negotiating licensing agreements with game operators on terms that are commercially acceptable to us and enforcing the provisions of those agreements;
 
  •  developing games, updates and expansion packs catering to overseas markets and renewing our license agreements with game operators upon expiration;
 
  •  maintaining the reputation of our company and our games, given that our games are operated by game operators in the international markets with different standards;
 
  •  protecting our intellectual property rights overseas and managing the related costs;
 
  •  auditing the royalties we are entitled to receive;


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  •  complying with the different commercial and legal requirements of the international markets in which our games are offered, such as game import regulatory procedures, taxes and other restrictions and expenses; and
 
  •  managing our foreign currency risks.
 
In addition, our plan to continue to license our games in international markets may also be adversely affected by public opinion or government policies in markets in which we license our games. For example, South Korea requires online game operators, including our subsidiary Actoz, to obtain ratings classifications for online games and implement procedures to restrict minors from accessing online games. If we are not able to license our games internationally as planned, our business, financial conditions and results of operations would be materially and adversely affected.
 
We or our licensors, co-developers, co-operators or investees may be subject to intellectual property infringement claims, which may force us to incur substantial legal expenses and, if determined adversely against us or our licensors, co-developers, co-operators or investees, may materially disrupt our business.
 
We cannot be certain that in-house developed, licensed, co-developed or co-operated online games or other content posted on our website do not and will not infringe upon patents, copyrights, trademarks or other intellectual property rights held by third parties. As of August 31, 2009, 14 of the games we operated were developed in-house, 10 were licensed from third parties and five were invested in or acquired from third parties. We or any of our licensors, co-developers, co-operators or online game developers and operators in which we have invested through 18 Capital may be perceived or alleged to infringe upon patents, copyrights, trademarks or other intellectual property rights held by third parties and become subject to legal proceedings and claims from time to time relating to the intellectual property rights of others. For example, in 2003, Actoz and Wemade Entertainment Co., Ltd. filed a lawsuit against Shanda Interactive in the Beijing First Intermediate People’s Court alleging copyright infringement and unfair competition claims with respect to Woool. These claims were settled in February 2007.
 
If we, our licensors, co-developers, co-operators or online game developers and operators in which we have invested through 18 Capital are found to have violated the intellectual property rights of others, we may be subject to monetary damages and be enjoined from using such intellectual property, or we may incur new or additional licensing costs if we wish to continue using the infringing content, be forced to develop or license alternatives or be forced to stop operating a game, any of which may materially and adversely affect our business and results of operations. In addition, we may incur substantial expenses and require significant attention of management in defending against these third-party infringement claims, regardless of their merit.
 
Some of our employees were previously employed at other companies, including some of our current and potential competitors. To the extent these employees or any employees we may hire in the future are involved in research that is similar to the research that they performed at their former employers, our competitors may file lawsuits or initiate proceedings against us alleging that these employees violated the intellectual property rights, such as trade secret rights, of their former employers. Although we are not aware of any pending or threatened claims alleging these types of violations of intellectual property rights, if any such claim arises in the future, litigation or other dispute resolution proceedings may be necessary to retain our ability to offer our current and future games, which could be costly and divert financial and management resources.
 
Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business.
 
We regard our copyrights, trademarks, service marks, trade secrets and other intellectual property as critical to our success. Unauthorized use of the intellectual property used in our business, whether owned by us or licensed to us, may adversely affect our business and reputation.
 
We rely on copyright, trademark, trade secret and other intellectual property law, as well as non-competition, confidentiality and license agreements with our employees, licensors, business partners and others to protect our intellectual property rights. Our employees are generally required to sign agreements


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acknowledging that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property, and assigning to us any ownership rights that they may claim in those works. Despite our precautions, third parties may obtain and use intellectual property that we own or license without our consent. Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights may materially and adversely affect our business.
 
For instance, pirate game servers illegally operate unauthorized copies of our online games and enable players to play those games without purchasing prepaid cards for our online games. Despite our efforts to shut down pirate game servers, we believe that a significant number of pirate game servers continue to operate unauthorized copies of our online games. If pirate game servers continue to operate any of our online games, our business, financial condition and results of operations may be materially and adversely affected.
 
The validity, enforceability and scope of protection of intellectual property in Internet-related industries are uncertain and still evolving. In particular, the laws and enforcement procedures in the PRC are uncertain and do not protect intellectual property rights in this area to the same extent as do the laws and enforcement procedures in the United States and other developed countries. Policing unauthorized use of intellectual properties is difficult and expensive. Any steps we have taken to prevent the misappropriation of our intellectual properties may be inadequate. Moreover, litigation may be necessary in the future to enforce our intellectual property rights. Future litigation could result in substantial costs and diversion of our resources, and could disrupt our business, as well as have a material adverse effect on our financial condition and results of operations.
 
Our business may be materially harmed if our online games are not featured prominently in a sufficient number of Internet cafes in China.
 
A substantial number of game players access our games through Internet cafes in China. Due to limited hardware capacity, Internet cafes generally feature a limited number of games on their computers. We thus compete with a growing number of online game operators to have our online games featured on these computers. This competition has intensified in China due to a nationwide suspension of approval for the establishment of new Internet cafes in 2007. See “— Risks Relating to Regulation of Our Business and to Our Structure — The PRC government has tightened its regulation of Internet cafes, which are currently one of the primary venues for our users to play online games. Intensified government regulation of Internet cafes could restrict our ability to maintain or increase our revenues and expand our game player base”. If we fail to feature our games prominently and sufficiently in Internet cafes in China or fail to do so in a cost-effective manner, our business, financial condition and results of operations may be materially and adversely affected.
 
We depend on certain VIEs of Shanda Online to provide services that are critical to our business. The termination of either or both of these service agreements or any failure of or significant quality deterioration in these services could have a material adverse effect on our business, financial condition and results of operations.
 
We have engaged certain VIEs of Shanda Online to provide certain services that are critical to our business. Pursuant to the Amended and Restated Cooperation Agreement between Shanda Networking and Nanjing Shanda, on the one hand, and the Shulong entities, on the other hand, we have engaged Shanda Networking to provide certain services, including, among others, online billing and payment, user authentication, customer service, anti-fatigue compliance, prepaid card marketing and data support services for a period of five years commencing July 1, 2008. Pursuant to the Amended and Restated Sales Agency Agreement between Shengfutong and the Shulong entities, we have engaged Shengfutong for a period of five years commencing July 1, 2008 as the sales agent for the distribution of prepaid cards which are required to purchase virtual items or time units in our online games. Under the terms of these agreements, we are not permitted to engage any other party to provide such services to us, while Shanda Networking and Shengfutong are permitted to provide such services to other parties.
 
Since we do not control Shanda Networking and Shengfutong, and because we depend on Shanda Networking and Shengfutong for the provision of services that are critical to the operation of our online game


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business, we face certain risks with respect to our arrangements with such entities. If Shanda Networking or Shengfutong breaches its respective obligations under the respective agreements, terminates these agreements, or refuses to renew these agreements on terms acceptable to us or at all, we may not be able to find a suitable alternative service provider or be able to establish our own integrated service platform or distribution network in a timely manner. Similarly, if we breach the terms of the agreements, Shanda Networking or Shengfutong could terminate these agreements and halt services that are critical to our online game business. Termination of either or both of these agreements could have a material adverse effect on our business, financial condition and results of operations.
 
Any failure of or significant quality deterioration in Shanda Networking’s integrated service platform could materially and adversely affect our business. For example, we rely on Shanda Networking’s customer service representatives as the first point of contact to serve our game players. Shanda Networking handles customer requests such as providing account settlement-related services, retrieving forgotten passwords and recovering lost user accounts, and liaises with our game management team if the inquiries involve game-related technical problems, such as recovering virtual items and in-game characters. We also rely on Shanda Networking to provide user authentication services for our game players who access our games through Shanda Networking’s integrated service platform. If Shanda Networking fails to address customer service requests properly and in a timely manner, our game players may be unable to access our games or attribute any unpleasant experience with Shanda Networking’s customer service to us, which could harm our reputation. As a result, we may fail to retain existing and attract new game players and our business, financial condition and results of operations could be materially and adversely affected.
 
Furthermore, we rely on Shengfutong to provide prepaid card distribution services. Shengfutong relies heavily on a distribution network composed of third-party distributors for its sales to game players. As Shengfutong does not enter into long-term agreements with any of its distributors, there can be no assurance that Shengfutong will be able to continue to maintain favorable relationships with them. If Shengfutong fails to maintain a stable and efficient distribution network or if there is any failure of or significant quality deterioration in Shengfutong’s distribution services, our game players may be unable to purchase prepaid cards for our games, and as a result, we may fail to retain existing and attract new game players, and our business, financial condition and results of operations could be materially and adversely affected.
 
Shanda Networking provides integrated platform services to some of our competitors, which may have a material adverse effect on our business.
 
Shanda Networking provides integrated platform services to other online game companies that compete with us, including Kingsoft Corporation Limited, or Kingsoft, LineKong Entertainment Technology Co., Ltd. and Shanghai Storm Information Technology, Co., Ltd., or Shanghai Storm, and may enter into additional similar commercial relationships with other online game companies. These commercial relationships may strengthen these online game companies’ market share and enable them to achieve market acceptance of their game and services, which may have a material adverse effect on our business. In particular, the online games that our competitors offer through Shanda Networking’s integrated service platform may attract away players of our games and shrink our games’ player base, which could in turn make our games less attractive to other players. Furthermore, if our current game players spend money to play or purchase virtual items in our competitors’ games offered through Shanda Networking’s integrated service platform that would otherwise have been spent on our games, our business, financial conditions and results of operations could be materially and adversely affected.
 
We could be liable for any failure, service interruption or security breach of Shanda Networking’s online payment platform, and the reduction in sales made through those channels may have a material adverse impact on our revenues.
 
Currently, we rely on the online payment system on Shanda Networking’s integrated service platform for all of our direct sales of our virtual prepaid cards to our game players. Secured transmission of confidential information, such as game players’ credit card numbers and expiration dates, personal information and billing addresses over public networks, is essential to maintaining consumer confidence in such payment channels and


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to allowing us to collect payments on a timely basis. We expect that an increasing amount of the direct sales of prepaid cards will be conducted over the Internet as a result of the growing use of online payment systems. As a result, associated online crime will likely increase as well and we cannot assure you that Shanda Networking’s current security measures and those of the third parties with whom Shanda Networking transacts business are adequate. Security breaches of these online payment systems could result in non-collection of payments, expose us to litigation and possible liability for failing to protect confidential game player information and could harm our reputation and our ability to retain existing and attract new game players and to encourage the consumption of our online games by game players.
 
We face the risks of uncertainties in the growth of the online game industry and market acceptance of our online games.
 
The growth of this industry and the level of demand and market acceptance of our online games are subject to a high degree of uncertainty. Our results of operations will depend on factors beyond our control, including:
 
  •  the growth rate in the number of users of personal computers, Internet and broadband in China and other markets in which our online games are offered;
 
  •  whether the online game industry, particularly in China and the rest of the Asia-Pacific region, continues to grow and the rate of any such growth;
 
  •  changes in consumer demographics, tastes or preferences;
 
  •  the popularity and price of new online games and virtual items that we and our competitors launch and distribute;
 
  •  our ability to timely upgrade and improve our existing games to extend their commercial lifespan and to maintain or expand their market share in the online game industry;
 
  •  the availability and popularity of other forms of entertainment, particularly console system games such as those made by Microsoft, Nintendo and Sony, which are already popular in many other countries and may gain popularity in China and other countries or regions in which we market our online games; and
 
  •  general economic conditions, particularly economic conditions that impact the level of discretionary consumer spending.
 
Our ability to plan for product development and distribution and promotional activities will be significantly affected by our ability to anticipate and adapt to relatively rapid changes in consumer tastes and preferences. Although MMORPGs are currently popular in China, there is no assurance that they will continue to be popular in China or elsewhere. A decline in the popularity of online games in general, or the MMORPGs that we operate, would adversely affect our business prospects and results of operations. We must be able to track and respond to these changes in game players’ preferences in a timely and effective manner. Furthermore, given that the item-based revenue model relies on in-game purchases, we must be able to track and respond quickly to changes in game preferences and consumer spending trends.
 
We may not be able to adapt to the rapidly evolving online game industry in China.
 
China’s online game industry is evolving rapidly. We need to adapt to new industry trends, including changes in game players’ preferences, new revenue models, new game content distribution models, new technologies and new governmental regulations. We evaluate these changes as they emerge and strive to adapt our business and operations in order to maintain and strengthen our leadership in the industry. However, we cannot assure you that we will be able to do so successfully, which may have a material adverse effect on our business, financial condition and results of operations.


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We face significant competition which could reduce our market share and materially and adversely affect our business, financial condition and results of operations.
 
The online game industry in China is highly competitive. In recent years, numerous competitors have entered the online game industry in China. We expect more companies to enter the market and we expect a wider range of online games to be introduced to China. Competition from other online game operators, both based in China as well as overseas, is likely to increase in the future. Other online game operators or developers, such as China-based Changyou.com Limited, Giant Interactive Group, Inc., Kingsoft, NetDragon Websoft Inc., NetEase.com, Nineyou International Limited, Perfect World Co., Ltd., Tencent Holdings Limited and The9 Limited, as well as international game developers, such as Activision Blizzard, Inc., Electronic Arts Inc., NCSoft Corporation, Nexon Corporation, NHN Corp. and Webzen, Inc., are our current or potential future competitors. As the online game industry in China is constantly evolving, our current or future competitors may compete more successfully as the industry matures. In particular, any of these competitors may offer products and services that provide significant performance, price, creativity or other advantages over those offered by us. These products and services may weaken our brand name and achieve greater market acceptance than ours. In addition, even if we are successful in launching new online games, competitors may launch similar online games which compete for potential game players. Furthermore, any of our current or future competitors may be acquired by, receive investments from or enter into other strategic or commercial relationships with larger, more established and better financed companies and therefore, obtain significantly greater financial, marketing and game licensing and development resources than us. In addition, increased competition in the online game industry in China could make it difficult for us to retain existing players and attract new players. Moreover, we may face competition from console systems that have achieved significant success in markets other than China but have yet to be permitted to be sold legally in China due to regulatory and other reasons. If these console systems, many of which are strengthening their online game features, are permitted to be sold in China, we may face additional competition. We also compete with other forms of entertainment, such as television and movies. If we are unable to compete effectively, our business, financial condition and results of operations would be materially and adversely affected.
 
We depend on our key personnel, and our business and growth prospects may be severely disrupted if we lose their services or are unable to attract new key employees.
 
Our future success is heavily dependent upon the continued service of our key executive officers and other key employees. In particular, we rely on the expertise, experience and leadership ability of Mr. Qunzhao Tan, our chairman, the president and chief technology officer of Shanda Interactive and the co-founder of our business, Mr. Tianqiao Chen, our director, the chairman of Shanda Interactive and the co-founder of our business, Ms. Diana Li, our director and chief executive officer, Mr. Hai Ling, our president, Mr. Richard Wei, our chief financial officer, Mr. Xiangdong Zhang, our chief producer and Mr. Jisheng Zhu, our chief technology officer and acting chief operating officer. We also rely on a number of key technology officers and staff for the development and operation of our online games. In addition, as we expect to focus increasingly on the development of our own online games, we will need to continue attracting and retaining skilled and experienced online game development personnel to maintain our competitiveness.
 
If one or more of our key personnel are unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all and may incur additional expenses to recruit and train new personnel, our business could be severely disrupted, and our financial condition and results of operations could be materially and adversely affected. We do not maintain key-man life insurance for any of our key personnel. In addition, if any of our executive officers or key employees joins a competitor or forms a competing company, we may lose know-how, trade secrets, suppliers and key professionals and staff. All of our employees, including each of our executive officers and key employees, have entered into an employment agreement with us, which contains customary non-compete provisions. Although non-compete provisions are generally enforceable under PRC laws, PRC legal practice regarding the enforceability of such provisions is not as well-developed as those in countries such as the United States. Thus, if we are required to enforce our rights under the non-compete provisions, we cannot assure you that a PRC court would enforce such provisions. Furthermore, since the demand and competition for talent is intense in our industry, particularly for


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online game development personnel and related technical personnel, we may need to offer higher compensation and other benefits in order to attract and retain key personnel in the future, which could increase our compensation expenses. We cannot assure you that we will be able to attract or retain the key personnel that we will need to implement our strategies and achieve our business objectives.
 
Our business may be adversely affected by the global economic downturn and the slowdown of China’s economy.
 
We rely on the spending of our game players for our revenues, which may in turn depend on the players’ level of disposable income, perceived future earnings and willingness to spend. Economies around the world have deteriorated since 2008. Global markets have experienced significant financial turmoil and upheaval characterized by the extreme volatility and declines in prices of securities and commodities, diminished credit availability, inability to access capital markets, waves of bankruptcies, rising unemployment rates and declining consumer and business confidence. In addition, China’s economy experienced a slowdown after the second quarter of 2008, when the quarterly growth rate of China’s gross domestic product reached 11.9% and was further exacerbated by the recent global financial crisis and economic downturn. In the first quarter of 2009, the growth rate of China’s gross domestic product decreased to 6.1% on an annual basis. As a result, beginning in September 2008, among other measures, the PRC government began to loosen fiscal measures and monetary policies by reducing interest rates and decreasing the statutory reserve rates for banks. In addition, in November 2008, the PRC government announced an economic stimulus package in the amount of US$586 billion.
 
It is uncertain how long the global crisis in the financial services and credit markets will continue for and how much of an adverse impact it will have on the global economy in general and the economies in China and other jurisdictions where we license our online games in particular. We cannot assure you that the various fiscal measures and monetary policies adopted by the PRC government, including the economic stimulus package discussed above, will be effective in sustaining the growth rate of the Chinese economy. In addition, such measures and policies, even if they benefit the overall Chinese economy in the long term, may adversely affect us if they result in a reduction of the disposable income of our game players. Due to such uncertain economic conditions, our game players may reduce the amount they spend on our online games. In addition, our plan to expand our business internationally may be adversely affected by an economic downturn in the countries or regions where we license or intend to license our online games. The occurrence of any of the foregoing would adversely affect our business, financial conditions and results of operations.
 
If we fail to anticipate or successfully implement new technologies, our games may become obsolete or uncompetitive, and our business prospects and results of operations could be materially and adversely affected.
 
The online game industry is subject to rapid technological change. We need to anticipate the emergence of new technologies and assess their market acceptance. In addition, government authorities or industry organizations may adopt new standards that apply to game development. We also need to invest significant financial resources in product development to keep pace with technological advances. However, development activities are inherently uncertain, and our significant expenditures on technologies may not generate corresponding benefits. If we fall behind in adopting new technologies or standards, our existing games may lose popularity, and our newly developed games may not be well received by our game players. In addition, we may incur significant cost overrun in product development, which would materially and adversely affect our business prospects and results of operations.
 
Errors or defects in our online games and the proliferation of cheating programs could materially and adversely affect our business prospects and results of operations.
 
Our online games may contain errors or other defects. In addition, parties unrelated to us have developed, and may continue to develop, Internet cheating programs that enable game players to obtain unfair advantages over other game players who do not use such programs. Furthermore, certain cheating programs could cause the loss of a character’s superior features acquired by a player. The occurrence of errors or defects in our


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online games or our failure to discover and disable cheating programs affecting the fairness of our game environment could disrupt our operations, damage our reputation and discourage our game players from playing our games. As a result, such errors, defects and cheating programs could materially and adversely affect our business, financial condition and results of operations.
 
Network interruptions, security breaches or computer virus attacks could have a material adverse effect on our business prospects and results of operations.
 
Any failure to maintain the satisfactory performance, reliability, security and availability of our network infrastructure, including as a result of natural disasters such as earthquakes and floods, may cause significant harm to our reputation and our ability to retain existing and attract new game players. We maintain a distributed server network architecture with third-party service providers hosting servers in more than one hundred cities throughout China. We do not maintain full backup for our server network hardware.
 
Major risks involved in such network infrastructure include:
 
  •  any break-downs or system failures resulting in a sustained shutdown of all or a material portion of our servers, including failures which may be attributable to sustained power shutdowns, or efforts to gain unauthorized access to our systems causing loss or corruption of data or malfunctions of software or hardware; and
 
  •  any disruption or failure in the national backbone network, which would prevent our players outside Shanghai from logging on to any of our games, or playing games for which the servers are all located in Shanghai.
 
In the past, our server network has experienced unexpected outages for several hours and occasional slower performance in a number of locations in China as a result of failures by third-party service providers. Our network systems are also vulnerable to damage from fire, flood, power loss, telecommunications failures, computer virus, hackings and similar events. Any network interruption or inadequacy that causes interruptions in the availability of our games or deterioration in the quality of access to our games could reduce our game players’ satisfaction. In addition, any security breach caused by hacking, which involves efforts to gain unauthorized access to information or systems, or to cause intentional malfunctions or loss or corruption of data, software, hardware or other computer equipment, and the inadvertent transmission of computer viruses could have a material adverse effect on our business, financial condition and results of operations. We do not maintain insurance policies covering losses relating to our systems and we do not have business interruption insurance.
 
The successful operation of our business and implementation of our growth strategies, including our ability to accommodate additional game players in the future, depend upon the performance and reliability of the Internet infrastructure and fixed line and wireless telecommunications networks in China.
 
Although there are private sector Internet service providers in China, almost all access to the Internet is maintained through state-owned telecommunications operators under the administrative control and regulatory supervision of the Ministry of Industry and Information Technology, or the MIIT. We rely on this infrastructure to provide data communications capacity primarily through local telecommunications lines and wireless telecommunication networks. In addition, the national networks in China are connected to the Internet through international gateways controlled by the PRC government. These international gateways are the only channels through which a domestic user can connect to the Internet and may not support the demand necessary for the continued growth in Internet usage. Although the PRC government has announced plans to develop aggressively the national information infrastructure, we cannot assure you that this infrastructure will be developed as planned or at all. In addition, we have no access to alternative networks and services on a timely basis, if at all, in the event of any infrastructure disruption or failure, which could have a material adverse effect on our business, financial condition and results of operations.


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The limited use of personal computers in China and the relatively high cost of Internet access may limit the development of the Internet in China and thus impede our growth.
 
Although the use of personal computers in China has increased in recent years, the penetration rate of personal computers in China is still much lower than that in the United States. In addition, despite a decrease in the cost of Internet access in China due to a decrease in the cost of personal computers and the greater availability of broadband Internet access, the cost of personal Internet access, in contrast with Internet access through Internet cafes, remains relatively high in comparison to the average per capita income in China. These factors may limit the growth of our business. Furthermore, any Internet access or other telecommunications fee increase could reduce the number of game players who play our online games.
 
We may need to record impairment charges to earnings if our acquisition goodwill, investments in affiliate companies or acquired intangible assets are determined to be impaired, which would adversely affect our results of operations.
 
As part of our multi-channel game content sourcing strategy, we acquire or invest in online game companies and license online games from third parties. We record acquisition goodwill, investments in affiliate companies and acquired intangible assets on our balance sheet in connection with such acquisitions, investments and licensing arrangements, respectively. We are required to review our acquisition goodwill for impairment at least annually and review our investments in affiliate companies and acquired intangible assets for impairment when events or changes in circumstances indicate that the carrying value may not be recoverable, including a decline in stock price and market capitalization and a slow down in our industry, which may result from the recent global economic slowdown. If the carrying value of our acquisition goodwill, investments in affiliate companies or acquired intangible assets were determined to be impaired, we would be required to write down the carrying value or to record charges to earnings in our financial statements during the period in which our acquisition goodwill, investments in affiliate companies or acquired intangible assets is determined to be impaired, which would adversely affect our results of operations.
 
We have limited business insurance coverage in China.
 
China’s insurance industry is still at an early stage of development. In particular, PRC insurance companies do not offer many business insurance products available in other countries. As a result, we do not have any business liability or disruption insurance coverage for our operations in China. Any business disruption, litigation or natural disaster might cause us to incur substantial costs and the diversion of resources.
 
If we fail to maintain an effective system of internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud, and as a result investor confidence and the market price of our ADSs may be adversely affected.
 
We will be subject to the reporting obligations under the U.S. securities laws following this offering. The Securities and Exchange Commission, or the SEC, as required under Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, has adopted rules requiring every public company to include a report of management on the effectiveness of such company’s internal control over financial reporting in its annual report. In addition, an independent registered public accounting firm must issue an attestation report on the effectiveness of the company’s internal control over financial reporting. These requirements will first apply to our annual report on Form 20-F for the fiscal year ending December 31, 2010. When we were a business unit of Shanda Interactive, we were required to maintain an effective internal control over financial reporting as part of Shanda Interactive’s compliance with Section 404 of the Sarbanes-Oxley Act. However, in light of our new status as a public company upon the closing of this offering, our management will have to evaluate our internal control system independently with new thresholds of materiality and to implement necessary changes to account for that status. Our management may conclude that our internal control over financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may still issue an adverse report on the effectiveness of our internal control over financial reporting or may issue a report that is qualified if such firm is not satisfied with our internal control over financial reporting or the level at which our controls are


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documented, designed, operated or reviewed, or if such firm interprets the relevant requirements differently from us. During the course of such evaluation, documentation and testing, we may identify deficiencies which we may not be able to remedy in time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. We also anticipate that we will incur considerable costs and devote significant management time and efforts and other resources to comply with Section 404 of the Sarbanes-Oxley Act.
 
If we fail to timely achieve and maintain the adequacy of our internal control over financial reporting, we may not be able to conclude that we have effective internal control over financial reporting. Moreover, effective internal control over financial reporting is necessary for us to produce reliable financial reports and important to help prevent fraud. Our failure to achieve and maintain effective internal control over financial reporting could impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis and result in the loss of investor confidence in the reliability of our financial statements. As a result, our business, financial condition, results of operations and prospects, as well as the trading price of our ADSs, could be materially and adversely affected.
 
You may not be able to rely on our quarterly operating results as an indication of our future performance because our quarterly operating results may be subject to significant fluctuations.
 
We may experience significant fluctuations in our quarterly operating results due to a variety of factors, many of which are beyond our control. Significant fluctuations in our quarterly operating results could be caused by any of the factors identified in this section, including, but not limited to:
 
  •  our ability to retain existing users, attract new game players at a steady rate and maintain user satisfaction;
 
  •  the announcement or introduction of new games or updates or expansion packs to existing games by us or our competitors;
 
  •  the range, number and pricing of virtual items available for sale;
 
  •  technical difficulties, system downtime or Internet failures;
 
  •  the amount and timing of operating costs and capital expenditures relating to expansion of our business, operations and infrastructure;
 
  •  the adoption of new, or changes to existing, governmental regulations;
 
  •  seasonality effect during holidays in the second quarter and the fourth quarter, when generally, fewer game players play our games;
 
  •  a shortfall in our revenues relative to our forecasts and a decline in our operating results;
 
  •  the introduction and nationwide roll-out of the third-generation wireless telecommunication network in China; and
 
  •  economic conditions in general and specific to the online game industry and to China.
 
As a result, you should not rely on quarter-to-quarter or semi-annual-to-semi-annual comparisons of our operating results as set forth in this prospectus as indicators of our likely future performance. Our operating results may be below our expectations or the expectations of public market analysts and investors in one or more future quarters. If that occurs, the price of our ADSs could decline and you could lose part or all of your investment.


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Risks Relating to the Reorganization and Our Continued Relationship with Shanda Interactive
 
We have limited experience operating as a standalone company.
 
As a part of the reorganization, Shanda Interactive, our parent, transferred substantially all of its assets and liabilities relating to its online game business to us and we began to operate as a standalone company. Although we had operated as a business unit of Shanda Interactive prior to the reorganization, we have had limited experience in conducting our operations as a standalone company. For example, we only recently formed our senior management team. As we adjust to operating as a standalone company, we may not be able to react as quickly as our competitors to changes in the industry and markets in which we compete. In addition, since we are becoming a public company, our management team will need to develop the expertise necessary to comply with the numerous regulatory and other requirements applicable to public companies, including requirements relating to corporate governance, listing standards and investor relations, any of which may divert our management’s attention from running our business.
 
As we have limited experience in operating as a standalone company, we may need to acquire assets in addition to those contributed to us in connection with the reorganization. We may fail to acquire these assets that prove to be important to our operations or may not be able to integrate all of our assets.
 
Our ability to operate our business effectively may suffer if we do not, quickly and cost-effectively, establish our own financial, administrative and other support functions in order to operate as a standalone company.
 
Historically, we have relied on financial, administrative and other resources of Shanda Interactive to operate our business. In view of our proposed initial public offering, we must continue to build up our own financial, administrative and other support systems or contract with third parties to replace those previously provided by Shanda Interactive. Any failure or significant disruption in our own financial or administrative systems could have an adverse impact on our business operations, such as paying our suppliers and employees, executing foreign currency transactions or performing other administrative services on a timely basis.
 
Our financial information included in this prospectus may not be representative of our results as a standalone company.
 
For the period from January 1, 2007 to June 30, 2008, our consolidated financial statements were prepared on a combined basis. We made numerous estimates, assumptions and allocations in our financial information because Shanda Interactive did not account for us, and we did not operate, as a standalone company for any period prior to July 1, 2008. Before Shanda Interactive transferred the assets and operations of its online game business to us effective July 1, 2008, the operations of our online game business had been carried out by Shanda Interactive.
 
For the period from January 1, 2007 to June 30, 2008, our consolidated financial statements were prepared by combining the assets, liabilities, revenues, expenses and cash flows of the entities that were directly engaged in the online game business. With respect to operating expenses, an allocation of certain general corporate expenses of Shanda Interactive which are directly related to the online game business, such as corporate employee compensation costs, professional service fees and other expenses arising from the provisions of certain corporate functions including finance, legal, technology, investment and executive management, was also included. The allocation is based on a variety of factors depending upon the nature of the expenses being allocated, including the number of employees and historical revenue, as well as estimated time incurred by Shanda Interactive’s executives for the online game business.
 
Although our management believes that the assumptions underlying our consolidated financial statements for the periods prior to the reorganization and the above allocations are reasonable, our consolidated financial statements for the years ended December 31, 2007 and 2008 may not be reflective of our result of operations, financial position and cash flows had we been operated as a standalone company during those periods.


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Therefore, our historical financial information may not be a reliable indicator of what our results of operations, financial position and cash flows will be in the future.
 
We may not be able to continue to receive the same level of support from Shanda Interactive.
 
Our online game business has benefited significantly from Shanda Interactive’s brand name and strong market position in China. In addition, we have benefited from using Shanda Networking’s integrated service platform, which provides Shanda Interactive’s large number of registered game players with access to our online games, and Shengfutong’s prepaid card distribution services. Although we have entered into the Amended and Restated Non-Compete and Non-Solicitation Agreement, Amended and Restated Cooperation Agreement, Amended and Restated Sales Agency Agreement and other related agreements with Shanda Interactive, we cannot assure you that we will be able to continue to receive the same level of support from Shanda Interactive in the future.
 
Some of the terms of our agreements with Shanda Interactive and its affiliates may be less favorable to us than similar agreements negotiated between unaffiliated third parties.
 
The various agreements that we, as a wholly-owned subsidiary of Shanda Interactive, entered into with Shanda Interactive and its affiliates may be less favorable to us than would be the case if they were negotiated with unaffiliated third parties. For example, pursuant to the Amended and Restated Cooperation Agreement and the Amended and Restated Sales Agency Agreement, we have engaged certain VIEs of Shanda Online to provide services that are critical to our business, including online billing and payment, user authentication, customer service, anti-fatigue compliance, prepaid card marketing and distribution and data support services for a five-year period commencing July 1, 2008. While we believe we benefit from these agreements, such agreements were negotiated between a parent company and its wholly-owned subsidiary in connection with the reorganization and therefore may not reflect the terms that would have been reached by two unaffiliated parties negotiating at arm’s length. Moreover, pursuant to our Master Separation Agreement with Shanda Interactive, we agreed to indemnify Shanda Interactive for, among other things, liabilities arising from litigation and other contingencies related to our online game business and assumed these liabilities as part of the reorganization. The allocation of assets and liabilities between Shanda Interactive and our company may not reflect the allocation that would have been reached by two unaffiliated parties. Moreover, so long as Shanda Interactive continues to control us, we may not be able to bring a legal claim against Shanda Interactive in the event of a contractual breach, notwithstanding our contractual rights under the agreements described above and any other agreement we may enter into with Shanda Interactive from time to time.
 
The Amended and Restated Non-Compete and Non-Solicitation Agreement with Shanda Interactive, our parent, contains certain exceptions and may not be effective in preventing Shanda Interactive from engaging in certain transactions that directly or indirectly may compete with (or be perceived to be in competition with) our online game business.
 
In connection with the reorganization, we entered into a Non-Compete and Non-Solicitation Agreement (which was amended and restated on September 10, 2009) with Shanda Interactive, our parent, pursuant to which Shanda Interactive has agreed, for a period of five years commencing July 1, 2008, not to engage, and to cause each other member of the Shanda Group (other than Shanda Games) not to engage, directly or indirectly, in the online game business anywhere in the world. This agreement is subject to important exceptions, namely, (1) certain of Shanda Interactive’s subsidiaries may continue to engage in their current PC network and e-sports platform businesses, online interactive music community, and online chess and board game platform business, (2) Shanda Interactive may acquire equity interests in a company that does not have more than 25.0% of its gross revenues (based on the latest annual audited financial statements of the investee company) attributable to the online game business and (3) Shanda Interactive may operate virtual communities with certain online game features, provided that such features do not constitute the core business model of such community. In addition, the agreement permits Shanda Interactive to acquire or invest in any third party engaging in the online game business if, after using its reasonable best efforts to make such investment opportunity available to us as required under the agreement, we do not pursue such opportunity; provided that


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Shanda Interactive’s equity interest in such third party shall not exceed 50%. Because of the exceptions to the agreement described above, we cannot assure you that the Amended and Restated Non-Compete and Non-Solicitation Agreement will be effective in preventing Shanda Interactive from engaging in certain conduct or transactions that directly or indirectly may compete with (or be perceived to be in competition with) our online game business. Even if there is no actual direct or indirect competition to our online game business, the perception by investors or securities analysts of possible competition from Shanda Interactive could adversely affect our business prospects and the price of our ADSs. Nor can we assure you that Shanda Interactive will not breach the Amended and Restated Non-Compete and Non-Solicitation Agreement. Although non-compete and non-solicitation agreements are generally enforceable under PRC laws, PRC legal practice regarding the enforceability of such agreements is not as well-developed as those in countries such as the United States. Thus, if we were required to enforce our rights under the Amended and Restated Non-Compete and Non-Solicitation Agreement, we cannot assure you that a PRC court would enforce such agreement. Even if such agreement is enforced, we may not receive adequate remedies from courts in China or elsewhere. In addition, Shanda Interactive may not extend or renew the Amended and Restated Non-Compete and Non-Solicitation Agreement and may decide to compete with us upon expiration of the agreement.
 
Shanda Interactive will control the outcome of shareholder actions in our company.
 
Under our amended and restated memorandum and articles of association, our ordinary shares are divided into Class A ordinary shares and Class B ordinary shares. Holders of Class A ordinary shares are entitled to one vote per share, while holders of Class B ordinary shares are entitled to 10 votes per share. We will issue and sell, and Shanda Interactive, which is the selling shareholder, will sell, Class A ordinary shares represented by our ADSs in this offering. Assuming the underwriters do not exercise their over-allotment option to purchase additional ADSs, upon the completion of this offering, Shanda Interactive will hold 409,087,000 Class B ordinary shares, or 71.01% of the combined total outstanding ordinary shares (representing 96.08% of the total voting rights) in our company. Shanda Interactive’s shareholding, in particular the greater voting rights of the Class B ordinary shares it holds, gives it the power to control any actions that require shareholder approval under Cayman Islands law, our amended and restated memorandum and articles of association and the NASDAQ requirements, including the election and removal of any member of our board of directors, mergers, consolidations and other business combinations, changes to our amended and restated memorandum and articles of association, the number of shares available for issuance under share incentive plans and the issuance of significant amounts of our ordinary shares in private placements. Due to the disparate voting rights attached to the two classes of our ordinary shares, Shanda Interactive could have sufficient voting rights to determine the outcome of all matters requiring shareholder approval even if it should, at some point in the future, hold considerably less than a majority of the combined total of our outstanding Class A and Class B ordinary shares.
 
As a result of Shanda Interactive’s ownership of Class B ordinary shares, Shanda Interactive’s voting power may cause transactions to occur that might not be beneficial to you as a holder of ADSs and may prevent transactions that would be beneficial to you. For example, Shanda Interactive’s voting power may prevent a transaction involving a change of control of us, including transactions in which you as a holder of our ADSs might otherwise receive a premium for your securities over the then-current market price. Similarly, Shanda Interactive may approve a merger or consolidation of our company which may result in you receiving a stake (either in the form of shares, debt obligations or other securities) in the surviving or new consolidated company which may not operate our current business model and dissenter rights may not be available to you in such an event. See “Description of Share Capital — Differences in Corporate Law — Mergers and Similar Arrangements” for a detailed discussion of the new merger and consolidation provisions under Cayman Islands law. In addition, Shanda Interactive is not prohibited from selling a controlling interest in us to a third party and may do so without your approval. If Shanda Interactive sells its controlling interest in us to a third party, is acquired or otherwise undergoes a change of control, any acquiror or successor will be entitled to exercise voting control over the Class B ordinary shares held by Shanda Interactive and may do so in a manner that could vary significantly from that of Shanda Interactive.
 
In addition, our director, Mr. Tianqiao Chen, owns a substantial equity interest in Shanda Interactive, serves as its chairman and chief executive officer and controls its corporate actions, and thereby controls the


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outcome of shareholder actions in our company indirectly through Shanda Interactive. Mr. Chen’s voting control could also cause transactions to occur that might not be beneficial to you as a holder of ADSs and could prevent transactions that would be beneficial to you.
 
We may have conflicts of interest with Shanda Interactive. Because of Shanda Interactive’s controlling ownership interest in our company, we may not be able to resolve such conflicts on terms favorable to us.
 
Conflicts of interest may arise between Shanda Interactive and us in a number of areas relating to our past and ongoing relationships. Potential conflicts of interest that we have identified include the following:
 
  •  Indemnification arrangements with Shanda Interactive.  In connection with the reorganization, we have agreed to indemnify Shanda Interactive with respect to liabilities relating to our online game business, including operations of that business when it was a business unit of Shanda Interactive prior to the reorganization. These indemnification arrangements could result in our having interests that are adverse to those of Shanda Interactive, such as different interests with respect to settlement arrangements in the event of litigation.
 
  •  Non-compete agreement with Shanda Interactive.  Shanda Interactive has agreed not to compete with us in the online game business anywhere in the world for a five-year period commencing July 1, 2008, subject to certain exceptions that may present conflicts of interests. See “— Risks Relating to the Reorganization and Our Continued Relationship with Shanda Interactive — The Amended and Restated Non-Compete and Non-Solicitation Agreement with Shanda Interactive, our parent, contains certain exceptions and may not be effective in preventing Shanda Interactive from engaging in certain transactions that directly or indirectly may compete with (or be perceived to be in competition with) our online game business”.
 
  •  Employee recruitment and retention.  Because both Shanda Interactive and we operate primarily in Shanghai and are engaged in the interactive entertainment business, we may compete with Shanda Interactive in the hiring of new employees, in particular with respect to those involved in interactive entertainment content development and operation. While the Amended and Restated Non-Compete and Non-Solicitation Agreement restricts Shanda Interactive from inducing any of our employees to terminate his or her employment with us, we cannot assure you that Shanda Interactive will not breach this agreement.
 
  •  Our board members or executive officers may have conflicts of interest.  Mr. Qunzhao Tan, our chairman, currently also serves as president and chief technology officer and as a member of the board of directors of Shanda Interactive. In addition, Mr. Tianqiao Chen and Mr. Danian Chen, both of whom are our directors, currently also serve as Shanda Interactive’s chairman and chief executive officer, and chief operating officer and as a member of the board of directors of Shanda Interactive, respectively. A majority of our directors and executive officers also own shares and/or options to purchase shares in Shanda Interactive. Shanda Interactive may continue to grant incentive share compensation to our board members and executive officers from time to time. These relationships could create perceived or actual conflicts of interest when these persons are faced with decisions with potentially different implications for Shanda Interactive and us.
 
  •  Transfer of assets.  In connection with the reorganization, Shanda Interactive transferred substantially all of its assets and liabilities related to its online game business to us. However, there may be assets (such as intellectual property rights) that are required for our business but were not part of the assets transferred to us pursuant to the Master Separation Agreement or otherwise have not been transferred to us. If Shanda Interactive refuses to transfer such assets to us or if we are not able to secure similar assets on terms acceptable to us or at all, our business, financial condition and results of operations may be materially and adversely affected.
 
  •  Sale of shares in our company.  Shanda Interactive may decide to sell all or a portion of the Class B ordinary shares that it holds to a third party, including to one of our competitors, thereby giving that third party substantial influence over our business and our affairs. Such a sale could be contrary to the


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  interests of certain of our shareholders, including our employees and our public shareholders, and affect the implementation of our business strategy.
 
  •  Allocation of business opportunities.  Business opportunities may arise that both we and Shanda Interactive find attractive, and which would complement our respective businesses. Although Shanda Interactive has agreed in the Amended and Restated Non-Compete and Non-Solicitation Agreement with us not to acquire equity interests in third-party online game businesses without first using its reasonable best efforts to make such investment opportunities available to us, subject to certain limited exceptions, we may not be able to pursue the business opportunities effectively if Shanda Interactive decides to take advantage of such opportunities itself notwithstanding such agreement.
 
  •  Services provided by Shanda Networking to our competitors.  Shanda Networking provides integrated services to other online game companies that compete with us. These commercial relationships are beyond our control and may negatively affect our business. See “— Risks Relating to Our Business and Our Industry — Shanda Networking provides integrated platform services to some of our competitors, which may have a material adverse effect on our business”.
 
  •  Developing business relationships with Shanda Interactive’s competitors.  So long as Shanda Interactive remains our controlling shareholder, we may be limited in our ability to do business with its competitors, such as other interactive entertainment media companies in China.
 
Although our company is a standalone entity, we expect to operate, for as long as Shanda Interactive is our controlling shareholder, as a part of the Shanda Group. Shanda Interactive may from time to time make strategic decisions that it believes are in the best interests of the Shanda Group as a whole. These decisions may be different from the decisions that we would have made on our own. Shanda Interactive’s decisions with respect to us or our business may be resolved in ways that favor Shanda Interactive and therefore Shanda Interactive’s own shareholders, which may not coincide with the interests of our other shareholders. We may not be able to resolve any potential conflicts, and even if we do so, the resolution may be less favorable to us than if we were dealing with an unaffiliated shareholder. Even if both parties seek to transact business on terms intended to approximate those that could have been achieved among unaffiliated parties, this may not succeed in practice.
 
Risks Relating to Regulation of Our Business and to Our Structure
 
If the PRC government finds that the agreements that establish the structure for operating our China business do not comply with its restrictions on foreign investment in the online game industry, we could be subject to severe penalties.
 
On December 11, 2001, the PRC State Council promulgated Regulations for the Administration of Foreign-invested Telecommunications Enterprises, or the FITE Regulations, which became effective on January 1, 2002 and were subsequently amended on September 10, 2008. Under the FITE Regulations, foreign ownership of companies that provide value-added telecommunication services, which includes online game operation, is limited to 50%. In addition, foreign and foreign-invested enterprises are currently not able to apply for the licenses required to operate online games in China. Since we are a Cayman Islands exempted company and therefore are a foreign or foreign-invested enterprise under PRC law, neither we nor our PRC subsidiaries are eligible to hold a license to operate online games in China. In order to comply with the foreign ownership restrictions, we operate our online game business in China through Shanghai Shulong, which is wholly owned by Dongxu Wang and Yingfeng Zhang, two PRC citizens, and its wholly-owned subsidiaries, Shulong Computer and Nanjing Shulong. Except as otherwise disclosed in “— The laws and regulations governing the online game industry and related businesses in China are developing and subject to future changes. If we or any of our PRC operating companies fail to obtain or maintain all applicable permits and approvals, our business and operations would be materially and adversely affected”, Shanghai Shulong holds the licenses and approvals that are required to operate our online game business. Our PRC subsidiaries have entered into a series of contractual arrangements with Shanghai Shulong and/or its shareholders. As a result of these contractual arrangements, we are considered the primary beneficiary of Shanghai Shulong and its subsidiaries and consolidate the results of operations of Shanghai Shulong and its subsidiaries in our


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financial statements. For a description of these contractual arrangements, see “Our History and Corporate Structure”.
 
On July 13, 2006, the MIIT issued the Circular on Strengthening the Administration of Foreign Investment in Value-added Telecommunication Services, or the MIIT Circular 2006. According to the MIIT Circular 2006, since the FITE Regulations went into effect, some foreign investors had engaged in value-added telecom services illegally by conspiring with domestic value-added telecom enterprises to circumvent the requirements of the FITE Regulations by delegating domain names and licensing trademarks. In order to further strengthen the administration of FITEs, the MIIT Circular 2006 provides that any domain name or trademark used by a value-added telecom carrier shall be legally owned by such carrier or its shareholders. The MIIT Circular 2006 also provides that the operation site and facilities of a value-added telecom carrier shall be installed within the scope as prescribed by operating licenses obtained by the carrier and shall correspond to the value-added telecom services that the carrier has been approved to provide. In addition, value-added telecom carriers are required to establish or improve the measures to ensure network security. As to the companies which have obtained the operating licenses for value-added telecom services, they are required to conduct a self-examination and self-correction according to the above requirements and report the results of such self-examination and self-correction to the provincial branches of the MIIT. As some of the domain names and trademarks that we use in our operations are not owned by Shanghai Shulong or its shareholders, we may be in violation of the provisions of the MIIT Circular 2006. As a result, we may be subject to various penalties, including fines and the discontinuation of or restrictions on our operations.
 
In the opinion of Jade & Fountain PRC Lawyers, our PRC legal counsel, (i) the ownership structures of our company, our PRC subsidiaries and our PRC operating companies are in compliance with existing PRC laws and regulations, (ii) the contractual arrangements between our PRC subsidiaries, on the one hand, and Shanghai Shulong and/or its shareholders, on the other hand, are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect and (iii) the business operations of our company, our PRC subsidiaries, and our PRC operating companies, as described in this prospectus, are in compliance with existing PRC laws and regulations in all material aspects, except for the failure to own certain domain names and trademarks as mentioned in the preceding paragraph, as well as the failure to obtain an Internet publishing license and online bulletin board service approval as disclosed in “— Risks Relating to Regulation of Our Business and to Our Structure — The laws and regulations governing the online game industry and related businesses in China are developing and subject to future changes. If we or any of our PRC operating companies fail to obtain or maintain all applicable permits and approvals, our business and operations would be materially and adversely affected”. There are, however, substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations. Accordingly, we cannot assure you that the PRC regulatory authorities will not ultimately take a view contrary to that of Jade & Fountain PRC Lawyers. If we, our PRC subsidiaries, or any of our PRC operating companies are found to have violated any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such violations, including:
 
  •  revoking our PRC operating companies’ business and operating licenses;
 
  •  discontinuing or restricting our PRC operating companies’ operations;
 
  •  imposing conditions or requirements with which we or our PRC companies may not be able to comply;
 
  •  requiring us or our PRC companies to restructure the relevant ownership structure or operations; or
 
  •  taking other regulatory or enforcement actions, including levying fines, that could be harmful to our business.
 
Any of these actions could cause our business, financial condition and results of operations to suffer and the market price of our ADSs to decline.


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The contractual arrangements related to critical aspects of our operations with Shanghai Shulong and its shareholders may not be as effective in providing operational control as direct ownership.
 
We rely on contractual arrangements with Shanghai Shulong and its shareholders to operate our business. These contractual arrangements may not be as effective as direct ownership in providing us with control over Shanghai Shulong and its subsidiaries which constitute all of our PRC operating companies. Direct ownership would allow us, for example, to directly or indirectly exercise our rights as a shareholder to effect changes in the boards of directors of Shanghai Shulong, which, in turn, could effect changes, subject to any applicable fiduciary obligations, at the management level. However, under the current contractual arrangements, as a legal matter, if Shanghai Shulong or its shareholders fails to perform its, his or her respective obligations under these contractual arrangements, we may have to incur substantial costs and expend significant resources to enforce those arrangements and rely on legal remedies under PRC law. These remedies may include seeking specific performance or injunctive relief and claiming damages, any of which may not be effective.
 
Under the equity pledge agreement described in “Our History and Corporate Structure”, the shareholders of Shanghai Shulong have pledged their equity interests in Shanghai Shulong to Shengqu. According to the PRC Property Rights Law, which became effective on October 1, 2007, a pledge is created only when such pledge is registered with the relevant office of the administration for industry and commerce. We have registered the equity pledge by the shareholders of Shanghai Shulong with the relevant office of the administration for industry and commerce. However, all of these contractual arrangements are governed by PRC laws and provide for the resolution of disputes through either arbitration or litigation in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC laws and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. In the event we are unable to enforce these contractual arrangements, we may be unable to exert effective control over our PRC operating companies, and our ability to conduct our business may be materially and adversely affected.
 
Shareholders of Shanghai Shulong may potentially have a conflict of interest with us, and they may breach their contracts with us or cause such contracts to be amended in a manner contrary to the interest of our company.
 
We conduct substantially all of our operations, and generate substantially all of our revenues, through our PRC operating companies. Our control over these entities is based upon contractual arrangements with Shanghai Shulong and its shareholders that provide us with the substantial ability to control Shanghai Shulong and its subsidiaries which constitute our PRC operating companies. These shareholders are employees of Shanda Interactive, our parent, and may potentially have a conflict of interest with us, and they may breach their contracts with us or cause such contracts to be amended in a manner contrary to the interest of our company, if they believe such action furthers their own interest or that of our parent, Shanda Interactive, or if they otherwise act in bad faith. They are not our directors, principal shareholders or employees. Therefore, they do not owe any fiduciary duty to us and may take actions that adversely affect us. If the shareholders of Shanghai Shulong breach their contracts with us or otherwise have disputes with us, we may have to initiate legal proceedings, which involve significant uncertainty. Such disputes and proceedings may significantly disrupt our business operations, adversely affect our ability to control our PRC operating companies and otherwise result in negative publicity, and we cannot assure you that the outcome of such disputes and proceedings will be in our favor.
 
Our arrangements with our PRC operating companies may be reviewed by the PRC tax authorities for transfer pricing adjustments.
 
We could face material adverse tax consequences if the PRC tax authorities determine that the contractual arrangements between our PRC subsidiaries and Shanghai Shulong were not entered into based on arm’s length negotiations. Although we based our contractual arrangements on those of similar businesses, if the PRC tax authorities determine that these contracts were not entered into on an arm’s length basis, they may adjust our income and expenses for PRC tax purposes in the form of a transfer pricing adjustment. A transfer


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pricing adjustment could adversely affect us by increasing our PRC operating companies’ tax liabilities without reducing our PRC subsidiaries’ tax liabilities, which could further result in late payment fees and other penalties to our PRC operating companies for under-paid taxes. As a result, any transfer pricing adjustment could have a material adverse effect on our financial condition and results of operations.
 
Our holding company structure may restrict our ability to receive dividends from, or transfer funds to, our PRC subsidiaries and our PRC operating companies, which could restrict our ability to act in response to changing market conditions and reallocate funds among our Chinese entities timely.
 
We are a Cayman Islands holding company and conduct substantially all of our operations through our PRC operating companies. We may rely on dividends and other distributions on equity by our PRC subsidiaries for our cash requirements, including the funds to pay dividends on the Class A ordinary shares underlying our ADSs and to service any debt we may incur or financing we may need for our operations. If any of our PRC subsidiaries incurs its own debt in the future, the instruments governing the debt may restrict such PRC subsidiary’s ability to pay dividends or make other distributions to Shanda Games (HK) and to us. Furthermore, under PRC laws and regulations, each PRC subsidiary is only permitted to pay dividends out of its retained earnings, if any, determined in accordance with PRC accounting standards and regulations. Under PRC law, each PRC subsidiary is also required to set aside at least 10% of its after-tax profit based on PRC accounting standards each year to its general reserves until the cumulative amount of such reserves reaches 50% of its registered capital. These reserves are not distributable as cash dividends, loans or advances. Each PRC subsidiary may also allocate a portion of its after-tax profits, as determined by its board of directors, to its staff welfare and bonus funds, which may not be distributed to us. As a result of these and other restrictions under PRC laws and regulations, each PRC subsidiary is restricted from transferring a portion of its assets to us as dividends, loans or advances, which restricted portion amounted to approximately RMB456.9 million (US$66.9 million), or 52.8% of our total consolidated net assets as of June 30, 2009. Any limitation on the ability of our PRC subsidiaries to transfer funds to us as dividends, loans or advances could materially and adversely limit our ability to grow, make investments or acquisitions that could benefit our businesses, pay debt or dividends, and otherwise fund and conduct our business.
 
In addition, any funds we transfer to our PRC subsidiaries, either as a shareholder loan or as an increase in registered capital, is subject to registration or approval of PRC governmental authorities, including the relevant administration of foreign exchange and/or the relevant examining and approval authority. Our PRC companies are prohibited by PRC law to directly lend money to each other. Therefore, it is difficult to change our capital expenditure plans once the relevant funds have been remitted from our company to our PRC subsidiaries. These limitations on the free flow of funds between us and our PRC companies could restrict our ability to act in response to changing market conditions and reallocate funds among our PRC companies on a timely basis. Moreover, according to a circular jointly issued by the Ministry of Finance and the State Administration of Taxation on September 19, 2008, the debt-to-equity ratio of a non-financial institution may not exceed 2:1 unless the shareholder loan in question can meet certain conditions. Although there is uncertainty at this time as to how the circular will be interpreted and implemented, such circular may have a negative impact on our PRC subsidiaries’ abilities to obtain loans from its shareholders.
 
We are one of China’s leading online game providers and cooperate closely with Shanda Online, which through its VIEs operates a leading online service platform in China. Some of our competitors and our users may institute claims against us and Shanda Online under the new Anti-Monopoly Law and as a result we may have to terminate our relationship with Shanda Online, which may have a material adverse effect on our business, financial conditions and results of operations.
 
The new Anti-Monopoly Law, or the AML, was approved by the National People’s Congress on August 30, 2007, which became effective date on August 1, 2008. While certain aspects of the AML are unclear and are subject to subsequent interpretation by the State Council and the Anti-Monopoly Commission and the Anti-Monopoly Enforcement Agency, the AML prohibits certain conduct, referred to as “monopolistic acts”, which include “monopoly agreements”, abuse of a dominant market position, and certain “concentrations”, which result or could result in the elimination or restriction of competition. The law also


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requires the State Council to establish an Anti-Monopoly Commission with authority to make competition policy, publish guidelines, coordinate anti-monopoly enforcement work and conduct investigations and impose penalties on “business operators” that commit certain monopolistic acts within or outside of China that have the effect of eliminating or restricting competition in the China market.
 
It remains to be seen how the AML will be implemented in practice and what effects it will have on us and other companies in China. Given our leading position in the online game industry in China and our close cooperation with Shanda Online, which through its VIEs, operates a leading online service platform in China, some of our competitors and our users may institute claims against us and Shanda Online under the AML and as a result, we may have to terminate our relationship with Shanda Online if such claims are determined adversely to us or Shanda Online, which may have a material adverse effect on our business, financial conditions and results of operation.
 
The laws and regulations governing the online game industry and related businesses in China are developing and subject to future changes. If we or any of our PRC operating companies fail to obtain or maintain all applicable permits and approvals, our business and operations would be materially and adversely affected.
 
The Internet industry, including the operation of online games, in China is highly regulated by the PRC government. Various regulatory authorities of the central PRC government, such as the State Council, the MIIT, the State Administration for Industry and Commerce, or the SAIC, the Ministry of Culture, or the MOC, the General Administration of Press and Publication, or the GAPP, the State Administration of Radio, Film and Television, and the Ministry of Public Security, are empowered to promulgate and implement regulations governing various aspects of the Internet and the online game industry.
 
Our PRC operating companies are required to obtain applicable permits or approvals from different regulatory authorities in order to provide their services. For example, an Internet content provider, or ICP, must obtain a value-added telecommunications business operation license, or ICP license, from the MIIT or its local offices in order to engage in any commercial ICP operations within China. An online game operator must also obtain an Internet culture operation license from the MOC, an Internet publishing license from the GAPP in order to distribute games through the Internet and approval from the MIIT to provide online bulletin board services. Shanghai Shulong currently holds an ICP license, as well as an Internet culture operation license. Chengdu Aurora is in the process of applying to extend its Internet culture operation license since its old license expired on October 24, 2008. Shanghai Shulong currently does not hold an Internet publishing license and publishes its online games through cooperation with Shanda Networking, which holds such a license. In addition, Shanghai Shulong and Chengdu Aurora are in the process of applying to obtain approval to provide online bulletin board services. If any of our PRC operating companies fails to obtain or maintain any of the required permits or approvals or if our practice is later challenged by government authorities, they may also be subject to various penalties, including fines and the discontinuation of or restriction on our operations. Any such disruption in business operations would materially and adversely affect our financial condition and results of operations.
 
As the online game industry is at an early stage of development in China, new laws and regulations may be adopted in the future to address new issues that arise from time to time, such as online advertising. Also, different regulatory authorities may have different views regarding the licensing requirements for the operation of online games and related businesses. As a result, substantial uncertainties exist regarding the interpretation and implementation of current and any future PRC laws and regulations applicable to the online game industry and related businesses. While we believe that we comply in all material respects with all applicable PRC laws and regulations currently in effect, we cannot assure you that we will not be found in violation of any current or future PRC laws and regulations.


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Additional government regulations resulting from negative publicity in China regarding online games or otherwise may have a material adverse effect on our business, financial condition and results of operations.
 
The media in China has reported incidents of violent crimes allegedly provoked by, or committed in connection with, online games. In addition, there have been widespread negative media reports that focus on how online games are addictive and how excessive game playing could distract students and interfere with their education. Certain non-governmental organizations may also organize protests or publicity campaigns against online game companies in order to protect youth from the risk of becoming addicted to certain online games. The PRC government may decide to adopt more stringent policies to monitor the online game industry as a result of adverse public reaction to perceived addiction to such games, particularly by minors. In 2007, eight PRC government authorities, including the GAPP, the Ministry of Education and the MIIT, jointly issued a notice requiring all Chinese online game operators to adopt an “anti-fatigue compliance system” in an effort to curb addiction to online games by minors. Under the anti-fatigue compliance system, three hours or less of continuous play is defined to be “healthy”, three to five hours is defined to be “fatiguing”, and five hours or more is defined to be “unhealthy”. Game operators are required to reduce the value of game benefits for minor game players by half when those game players reach the “fatigue” level, and to zero when they reach the “unhealthy” level. In addition, online game players in China are now required to register their identity card numbers before they can play an online game. This system allows game operators to identify which game players are minors. It is unclear whether these restrictions would be expanded to apply to adult game players in the future. More stringent government regulations, including stricter anti-fatigue rules, could discourage game players from playing our games, which could have a material adverse effect on our business, financial condition and results of operations.
 
In addition, the State Administration of Taxation recently announced that it will tax game players on the income derived from the trading of virtual currencies at the rate of 20.0%. However, it is currently unclear how the tax will be collected or if there will be any effect on our game players or our business.
 
Furthermore, similar adverse public reaction may arise, and similar government policies may be adopted, in other jurisdictions where we license out our online games, which could materially and adversely affect our overseas licensing revenues.
 
The PRC government has tightened its regulation of Internet cafes, which are currently one of the primary venues for our users to play online games. Intensified government regulation of Internet cafes could restrict our ability to maintain or increase our revenues and expand our game player base.
 
Internet cafes are one of the primary places where our games are played. In March 2001, the PRC government began tightening its regulation and supervision of Internet cafes. In particular, a large number of unlicensed Internet cafes have been closed. The PRC government has also imposed higher capital and facility requirements for the establishment of Internet cafes. Furthermore, the PRC government’s policy, which encourages the development of a limited number of national and regional Internet cafe chains and discourages the establishment of independent Internet cafes, may slow down the growth of Internet cafes. In February 2004, the government agencies in charge of Internet cafe licensing jointly issued a notice suspending the issuance of new Internet cafe licenses for a period of six months. In February 2007, 14 PRC government departments jointly issued a circular to strengthen the regulation of Internet cafes and online games. According to the circular, local authorities were banned from issuing new Internet cafe licenses for the remainder of 2007. Since this ban was imposed in 2007, to our knowledge, local authorities have not issued new Internet cafe licenses and it is unclear when local authorities will start issuing new licenses again. Governmental authorities may from time to time impose stricter requirements, such as the customers’ age limit and hours of operation, among others, as a result of the occurrence and perception of, and the media attention on, gang fights, arson and other incidents in or related to Internet cafes. Since a substantial portion of our users play our games in Internet cafes, any reduction in the number, or slowdown in the growth, of Internet cafes in China, or any new regulatory restrictions on their operations, could limit our ability to maintain or increase our revenues and expand our game player base, thereby adversely affecting our business and results of operations, as well as growth prospects.


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The PRC government may prevent us from distributing, and we may be subject to liability for, content deemed to be inappropriate.
 
China has enacted laws and regulations governing Internet access and the distribution of news, information or other content, as well as products and services, through the Internet. In the past, the PRC government has stopped the distribution of information through the Internet that it believes violates PRC law. The MIIT, the GAPP and the MOC have promulgated regulations that prohibit games from being distributed through the Internet if the games contain content that is found to, among other things, propagate obscenity, gambling or violence, instigate crimes, undermine public morality or the cultural traditions of China, or compromise state security or secrets. In addition, certain PRC social organizations have recently discussed the possibility of implementing a rating system for online games. The effect that such a system could have on our business is unclear.
 
If any games we offer were deemed to violate any such content restrictions, we would not be able to obtain the necessary governmental approval, may not be able to continue such offerings and/or could be subject to penalties, including confiscation of income, fines, suspension of business and revocation of our license for operating online games, which would materially and adversely affect our business, financial condition and results of operations.
 
We may also be subject to potential liability for unlawful actions of our users or for content we distribute that is deemed inappropriate. Furthermore, we may be required to delete content that violates PRC law and report content that we suspect may violate PRC law. It may be difficult to determine the type of content that may result in liability for us, and if we are wrong, we may be prevented from operating our games or offering other services in China.
 
The PRC government controls virtually all Internet access in China, and requires all computers sold in China to be installed with government-designated software to censor websites deemed inappropriate by the government, which may potentially discourage or restrict the use of the Internet or our online games by the players, and consequently adversely impact our business, financial conditions and results of operation.
 
The PRC government controls virtually all Internet access in China and may occasionally block Internet access throughout the country or in certain regions due to political concerns, in particular in response to, or out of concerns with respect to, special incidents or significant events, thereby preventing people in China, including our game players, from accessing the Internet and playing our online games.
 
On May 19, 2009, the MIIT issued a circular regarding the Pre-installment of Green Dam Web Filter Software on Computers. According to this circular, commencing on July 1, 2009, all computers sold in China are required to be installed with a government-designated software, called Green Dam — Youth Escort, to block “unhealthy words or pictures”. However, according to media reports, such software may compromise the security of personal information. Given the controversy generated by this circular, the MIIT announced on June 30, 2009 that it would extend the deadline for the implementation of the circular. According to recent media reports, the minister of the MIIT further stated on August 13, 2009 that the Chinese government will not require all computers sold in China to be installed with the filter software but that computers used in schools, Internet cafes and other public places will be required to be installed with the filter software in order to prevent young people from being harmed by unhealthy online content. It is currently unclear to what extent this circular would be implemented. Although this circular is not intended to block access to online games, if any content of our online games is found by the filter software to contain “unhealthy words or pictures”, our website may be blocked by the software, and as a result users who play our games will not be able to access our online games, which would have an adverse effect on our business, financial conditions and results of operation.
 
We may be required to reapply for approvals for online games licensed from overseas licensors.
 
The MOC issued a Circular Concerning the Examination and Declaration of Imported Online Game Products on April 24, 2009. Imported online games refers to online games that are licensed from licensors


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outside of China. According to this circular, in the event of a change of the operator of an imported online game, the game’s existing import approval will be automatically revoked and the new operator must apply to the MOC for a new approval for the same game. As this circular is newly issued, it remains unclear how and to what extent this circular will be implemented or enforced.
 
We currently operate substantially all of our imported online games under import approvals granted by the MOC to Shanda Networking. Under this new circular, we may be required to reapply to the MOC for approvals for our imported online games. We are committed to complying with the requirements of this circular. However, we cannot assure you that we will succeed in obtaining all the approvals as required by this circular in time or at all. If we fail to comply with the requirements of this circular or fail to obtain all the approvals for our imported online games, we may be subject to fines, revocation of the relevant operating licenses, the discontinuation or restrictions on our operations or other sanctions. As a result, our business, financial condition and results of operations could be materially and adversely affected.
 
Currently there is no law or regulation specifically governing virtual asset property rights and therefore, it is not clear what liabilities, if any, online game operators may have for virtual assets.
 
In the course of playing online games, some virtual assets, such as special equipment, player experience grades and other features of our users’ game characters, are acquired and accumulated. Such virtual assets can be important to online game players and have monetary value and in some cases are sold among players for actual money. In practice, virtual assets can be lost for various reasons, often through unauthorized use of the game account of one user by other users and occasionally through data loss caused by a delay of network service, a network crash or hacking activities. Currently, there is no PRC law or regulation specifically governing virtual asset property rights. As a result, there is uncertainty as to who is the legal owner of virtual assets, whether and how the ownership of virtual assets is protected by law, and whether an operator of online games such as us would have any liability to game players or other interested parties (whether in contract, tort or otherwise) for loss of such virtual assets. In case of a loss of virtual assets, we may be sued by our game players and held liable for damages, which may negatively affect our reputation and business, financial condition and results of operation. We have been involved in a limited number of virtual assets-related lawsuits, most of which have been settled while two such cases are still pending.
 
Based on several judgments by PRC courts regarding the liabilities of online game operators for loss of virtual assets by game players, the courts have generally required the online game operators to return the virtual items or be liable for the loss and damage incurred therefrom.
 
Compliance with the laws or regulations governing virtual currency may result in us having to obtain additional approvals or licenses or change our current business model.
 
The issuance and use of “virtual currency” in the PRC is regulated by recently adopted regulations. In January 2007, the Ministry of Public Security, the MOC, the MIIT and the GAPP jointly issued a circular regarding online gambling which has implications for the use of virtual currency. To curtail online games that involve online gambling, as well as address concerns that virtual currency could be used for money laundering or illicit trade, the circular (i) prohibits online game operators from charging commissions in the form of virtual currency in relation to winning or losing of games; (ii) requires online game operators to impose limits on use of virtual currency in guessing and betting games; (iii) bans the conversion of virtual currency into real currency or property; and (iv) prohibits services that enable game players to transfer virtual currency to other players. In February 2007, 14 PRC regulatory authorities jointly promulgated a circular to further strengthen the oversight of Internet cafes and online games. Under the circular, the People’s Bank of China, or the PBOC, has authority to regulate virtual currency, including: (i) setting limits on the aggregate amount of virtual currency that can be issued by online game operators and the amount of virtual currency that can be purchased by an individual; (ii) stipulating that virtual currency issued by online game operators can only be used for purchasing virtual products and services within the online games and not for purchasing tangible or physical products; (iii) requiring that the price for redemption of virtual currency shall not exceed the respective original purchase price; and (iv) banning the trading of virtual currency.


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There are substantial uncertainties regarding the interpretation and implementation of these two circulars, and we cannot assure you that the PRC regulatory authorities will not take a view contrary to ours. If the PRC regulatory authorities deem our online operations to violate either circular, the PBOC may confiscate the revenues generated through such activities and/or impose fines and other penalties under the law of the PBOC as well as other laws and regulations of the PRC.
 
More recently, on June 4, 2009, the MOC and the Ministry of Commerce, or the MOFCOM, jointly issued a notice regarding strengthening the administration of online game virtual currency, or the Virtual Currency Notice. The notice requires businesses that (i) issue online game virtual currency (in the form of prepaid cards or pre-payment or prepaid card points) or (ii) offer online game virtual currency transaction services to apply for approval from the MOC within three months following the date of the notice. The notice also prohibits businesses that issue online game virtual currency from providing services that would enable the trading of such virtual currency.
 
We issue online game virtual currency to game players for them to purchase various virtual items or time units to be used in our online games. We intend to comply with the Virtual Currency Notice and to apply to the MOC for approval to issue online game virtual currency, as required under the Virtual Currency Notice. However, we cannot assure you that we will be able to obtain the approval in a timely manner or at all. If we are not able to obtain the approval, we may be prohibited from issuing virtual currency and thus may have to change our business model. We are in the process of adjusting the content of our online games, as well as the form of payment settlement between Shanda Online and us, but we cannot assure you that our adjustments will be sufficient to comply with the Virtual Currency Notice. Moreover, although we believe we do not offer online game virtual currency transaction services, we cannot assure you that the PRC regulatory authorities will not take a view contrary to ours. For example, certain virtual items we issue (such as coupons) are transferable and exchangeable in the games. If the PRC regulatory authorities deem such transfer or exchange to be a virtual currency transaction, aside from being engaged in the issuance of virtual currency, we may also be deemed to be providing transaction platform services that enable the trading of such virtual currency. Simultaneously engaging in both of these activities is prohibited under the Virtual Currency Notice. In that event, we may be required to cease either our virtual currency issuance activities or such deemed “transaction service” activities and may be subject to certain penalties, including but not limited to mandatory corrective measures and fines. The occurrence of any of the foregoing could have a material adverse effect on our business and results of operations.
 
In addition, the Virtual Currency Notice also prohibits online game operators from setting game features that involve the direct payment of cash or virtual currency by players for the chance to win virtual items or virtual currency based on random selection through a lucky draw, wager or lottery. The notice also prohibits game operators from issuing currency to game players through means other than purchases with legal currency. It is unclear whether these restrictions would apply to certain aspects of our online games. For example, certain of our games contain features known as “treasure boxes”. Players may use “yuanbao”, a type of virtual item they obtain in the games, to acquire keys to open treasure boxes that, if opened, award the player with rewards, such as game points or virtual items. As no cash or virtual currency is directly paid by the players in opening treasure boxes, we believe this feature is distinct from those prohibited by the Virtual Currency Notice. However, we cannot assure you that the PRC regulatory authorities will not take a view contrary to ours and deem such feature as prohibited by the Virtual Currency Notice, thereby subjecting us to penalties, including mandatory corrective measures and fines. In addition, since we believe many of our game players find treasure boxes to be an enjoyable feature of our games, if we are required to eliminate this from our games, our games could be less attractive to players. The occurrence of any of the foregoing could materially and adversely affect our business and results of operations.
 
We may be subject to, and may expend significant resources in defending against, government actions and civil suits based on the advertising content provided in our virtual advertising space; we may also be penalized by the governmental authority for such content.
 
Shanghai Shengyue Advertisement Co., Ltd., or Shengyue, a wholly-owned subsidiary of Shanda Interactive, acts as our advertising agent to sell the virtual advertising space in our online games to third-party


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advertisers. Civil claims may be filed against Shengyue or us for fraud, defamation, subversion, negligence, copyright or trademark infringement or other violations due to the nature and content of the information displayed in the virtual advertising space in our games. Offensive and objectionable content and legal standards for defamation and fraud in China are less defined than in other more developed countries and we may not be able to properly screen out unlawful content. If such activities result in damages to any third party or violates any other regulation related to advertising business, PRC governmental authority may penalize us by revoking our game license, imposing fines, suspending our business license or imposing criminal liability on us, which would materially and adversely affect our business, financial condition and results of operations.
 
Risks Relating to the People’s Republic of China
 
The PRC’s economic, political and social conditions, as well as government policies, could affect our business.
 
Most of our business operations are conducted in China and most of our revenues are generated in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including the amount of government involvement, the level of development, the growth rate, the control of foreign exchange, and the allocation of resources.
 
While the Chinese economy has grown significantly in the past 30 years, the growth has been uneven geographically among various sectors of the economy, and during different periods. We cannot assure you that the Chinese economy will continue to grow, or that if there is growth, such growth will be steady and uniform, or that if there is a slowdown, such slowdown will not have a negative effect on our business. For example, the Chinese economy experienced high inflation in the second half of 2007 and the first half of 2008. China’s consumer price index soared 7.9% during the six months ended June 30, 2008 as compared to the same period in 2007. To combat inflation and prevent the economy from overheating, the PRC government adopted a number of tightening macroeconomic measures and monetary policies, including increasing interest rates, raising statutory reserve rates for banks and controlling bank lending to certain industries or economic sectors. However, due in part to the impact of the global crisis in financial services and credit markets and other factors, the growth rate of China’s gross domestic product decreased to 6.8% in the fourth quarter of 2008, down from 11.9% reached in the second quarter of 2007. As a result, beginning in September 2008, among other measures, the PRC government began to loosen macroeconomic measures and monetary policies by reducing interest rates and decreasing the statutory reserve rates for banks. In addition, in November 2008, the PRC government announced an economic stimulus package in the amount of $586 billion. We cannot assure you that the various macroeconomic measures, monetary policies and economic stimulus package adopted by the PRC government to guide economic growth and the allocation of resources will be effective in sustaining the fast growth rate of the Chinese economy. In addition, such measures, even if they benefit the overall Chinese economy in the long term, may adversely affect us if they reduce the consumable income of our game players.
 
The PRC legal system embodies uncertainties which could limit the legal protections available to us.
 
The PRC legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing general economic and business matters. The overall effect of legislation since 1979 has been a significant enhancement of the protections afforded to various forms of foreign-invested enterprises in China. Each of our PRC subsidiaries is a wholly foreign owned enterprise, or WFOE, which is an enterprise incorporated in China and wholly owned by foreign investors. Our PRC subsidiaries are subject to laws and regulations applicable to foreign investment in China in general and laws and regulations applicable to WFOEs in particular. However, these laws, regulations and legal requirements are constantly changing and their interpretation and enforcement involve uncertainties. These uncertainties could limit the legal protections available to us. In addition, we cannot predict the effect of future developments in the PRC legal system, particularly with regard to the Internet, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the


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preemption of local regulations by national laws. Furthermore, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.
 
Regulations relating to offshore investment activities by PRC residents may subject us to fines or sanctions imposed by the PRC government, including restrictions on our PRC subsidiaries’ abilities to pay dividends or make distributions to us and our ability to increase our investment in our PRC subsidiaries.
 
In October 2005, the State Administration of Foreign Exchange, or the SAFE, promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Corporate Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or Circular 75, which states that if PRC residents use assets or equity interests in their PRC entities as capital contributions to establish offshore companies or inject assets or equity interests of their PRC entities into offshore companies to raise capital overseas, they must register with local SAFE branches with respect to their overseas investments in offshore companies. They must also file amendments to their registrations if their offshore companies experience material events involving capital variation, such as changes in share capital, share transfers, mergers and acquisitions, spin-off transactions, long-term equity or debt investments or uses of assets in China to guarantee offshore obligations. Under this regulation, their failure to comply with the registration procedures set forth in such regulation may result in fines or sanctions imposed by the PRC government, including restrictions being imposed on the foreign exchange activities of the relevant PRC entity, including the payment of dividends and other distributions to its offshore parent, as well as restrictions on the capital inflow from the offshore entity to the PRC entity.
 
We are committed to complying with and to ensuring that our shareholders who are subject to the regulations will comply with the relevant rules. However, we cannot assure you that all of our shareholders who are PRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements required by Circular 75 or other related rules. Any future failure by any of our shareholders who is a PRC resident, or controlled by a PRC resident, to comply with relevant requirements under this regulation could subject us to fines or sanctions imposed by the PRC government, including restrictions on our PRC subsidiaries’ abilities to pay dividends or make distributions to us and our ability to increase our investment in our PRC subsidiaries.
 
We may be required to obtain prior approval from the CSRC for the listing and trading of our ADSs on the NASDAQ Global Select Market.
 
On August 8, 2006, six PRC regulatory authorities, including the MOFCOM, the State Assets Supervision and Administration Commission, the State Administration for Taxation, the SAIC, the China Securities Regulatory Commission, or the CSRC, and the SAFE, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rules, which became effective on September 8, 2006. This regulation, among other things, purports to require that an offshore special purpose vehicle formed for purposes of overseas listing of equity interests in PRC companies and controlled directly or indirectly by PRC companies or individuals obtain the approval of the CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published procedures regarding the approval of overseas listings by special purpose vehicles. Approval from the CSRC may take several months. The application of this new regulation remains unclear.
 
Our PRC legal counsel, Jade & Fountain PRC Lawyers, is of the opinion that prior CSRC approval for this offering is not required because (i) Shengqu was incorporated by a foreign-owned enterprise, and there was no acquisition of the equity or assets of a “PRC domestic company” as such term is defined under the New M&A Rules and (ii) there is no provision in the New M&A Rules that clearly classifies the contractual arrangements between our PRC subsidiaries and Shanghai Shulong as a kind of transaction falling under the New M&A Rules. As a result, we did not seek prior CSRC approval for this offering. However, we cannot assure you that the relevant PRC government authorities, including the CSRC, will reach the same conclusion as our PRC legal counsel. If the CSRC or other relevant PRC government authorities subsequently determine that prior CSRC approval is required, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory authorities. These regulatory authorities may impose fines and penalties on our


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operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from this offering into the PRC or take other actions that could have a material adverse effect on our business, as well as the trading price of our ADSs. The CSRC or other PRC regulatory authorities may also take actions requiring us, or making it advisable for us, to halt this offering before settlement and delivery of the ADSs offered by this prospectus. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery, you do so at the risk that settlement and delivery may not occur.
 
SAFE rules and regulations may limit our ability to convert and transfer the net proceeds from this offering to Shanghai Shulong, our VIE in the PRC, which may adversely affect the business expansion of Shanghai Shulong, and we may not be able to convert the net proceeds from this offering into Renminbi to invest in or acquire any other PRC companies or establish other VIEs in the PRC.
 
On August 29, 2008, SAFE promulgated Circular 142, a notice regulating the conversion by a foreign-invested company of foreign currency into Renminbi by restricting how the converted Renminbi may be used. The notice requires that the registered capital of a foreign-invested company settled in Renminbi converted from foreign currencies may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC. In addition, SAFE strengthened its oversight of the flow and use of the registered capital of a foreign-invested company settled in Renminbi converted from foreign currencies. The use of such Renminbi capital may not be changed without SAFE’s approval, and may not in any case be used to repay Renminbi loans if the proceeds of such loans have not been used. Violations of Circular 142 will result in severe penalties, such as heavy fines. As a result, Circular 142 may significantly limit our ability to transfer the net proceeds from this offering to Shanghai Shulong through our subsidiary in the PRC, which may adversely affect the business expansion of Shanghai Shulong, and we may not be able to convert the net proceeds from this offering into Renminbi to invest in or acquire any other PRC companies, or establish other VIEs in the PRC.
 
Restrictions on currency exchange may limit our ability to utilize our capital effectively.
 
Substantially all of our revenues and operating expenses are denominated in Renminbi. The Renminbi is currently freely convertible under the “current account”, which includes dividends, trade and service-related foreign exchange transactions, but not under the “capital account”, which includes foreign direct investment and loans.
 
Currently, our PRC subsidiaries may purchase foreign exchange for settlement of “current account transactions”, including payment of dividends to Shanda Games (HK) and payment of license fees to international game licensors, and our PRC operating companies may purchase foreign exchange for payment of license fees to international game licensors without the approval of the SAFE. Our PRC subsidiaries may also retain foreign exchange in its current account, subject to a ceiling approved by the SAFE, to satisfy foreign exchange liabilities or to pay dividends. However, we cannot assure you that the relevant PRC governmental authorities will not limit or eliminate our PRC subsidiaries’ abilities to purchase and retain foreign currencies in the future.
 
Since a significant amount of our future revenues will be denominated in Renminbi, the existing and any future restrictions on currency exchange may limit our ability to utilize capital generated in Renminbi to fund our business activities outside of China, if any, or expenditures denominated in foreign currencies.
 
Foreign exchange transactions under the capital account are subject to limitations and require registration with or approval by the relevant PRC governmental authorities. In particular, if we finance our PRC subsidiaries by foreign currency loans, those loans cannot exceed certain statutory limits and must be registered with the SAFE, and if we finance our PRC subsidiaries by capital contributions using, for instance, proceeds from this offering, those capital contributions must be approved by the MOFCOM. In addition, because of the regulatory issues related to foreign currency loans to, and foreign investment in, domestic PRC enterprises, we may not be able to finance our PRC operating companies’ operations by loans or capital contributions. We cannot assure you that we can obtain these governmental registrations or approvals on a


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timely basis, if at all. These limitations could affect the ability of these entities to obtain foreign exchange through debt or equity financing, and could adversely affect our business and financial conditions.
 
Fluctuations in exchange rates could result in foreign currency exchange losses.
 
Substantially all of our revenues are denominated in Renminbi, while a portion of our expenditures are denominated in foreign currencies, primarily the U.S. dollar. Fluctuations in exchange rates, particularly those involving the U.S. dollar, may affect our costs and operating margins. Where our operations conducted in Renminbi are reported in U.S. dollars, such fluctuations could result in changes in reported results which do not reflect changes in the underlying operations. On July 21, 2005, the PRC government changed its policy of pegging the value of the Renminbi to the U.S. dollar. Under the policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 21% appreciation of the Renminbi against the U.S. dollar between July 21, 2005 and June 30, 2009. Provisions on Administration of Foreign Exchange, as amended in August 2008, further changed China’s exchange regime to a managed floating exchange rate regime based on market supply and demand. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar. As substantially all of our revenues are denominated in Renminbi, any potential future devaluation of the Renminbi against the U.S. dollar could adversely affect our results of operations. The fluctuation of foreign exchange rate affects the value of these monetary assets and liabilities denominated in U.S. dollars. Generally, an appreciation of the Renminbi against the U.S. dollar results in a foreign exchange loss for monetary assets denominated in U.S. dollars, and a foreign exchange gain for monetary liabilities denominated in U.S. dollars. On the contrary, a devaluation of the Renminbi against the U.S. dollar results in a foreign exchange gain for monetary assets denominated in U.S. dollars and a foreign exchange loss for monetary liabilities denominated in U.S. dollars. With very limited hedging transactions available in China, we have not entered into any hedging transactions to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to successfully hedge all or part of our exposure or at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into U.S. dollars. Conversely, an increase in the value of the Renminbi could increase our reported earnings in U.S. dollar terms without a fundamental change in our business or operating performance.
 
Since our revenues are primarily denominated in Renminbi, our valuation could be materially and adversely affected by the devaluation of the Renminbi if U.S. investors analyze our value based on the U.S. dollar equivalent of our financial condition and results of operations.
 
The discontinuation, reduction or delay of any of the preferential tax treatments or the government financial incentives currently available to us in the PRC could materially and adversely affect our business, financial condition and results of operations.
 
Prior to January 1, 2008, under the then-current enterprises income tax law, or the Old EIT Law, our PRC companies were subject to a 33.0% income tax rate, which was subject to certain tax holidays and preferential tax rates. Under the new enterprise income tax law effective January 1, 2008, or the New EIT Law, both foreign-invested enterprises and domestic enterprises are subject to a unified 25% income tax rate. Under the New EIT Law, preferential tax treatments will be granted to enterprises that conduct business in certain encouraged sectors and to enterprises that qualify as “high and new technology enterprises”, a status reassessed every three years. In addition, an enterprise is entitled to a 10.0% income tax rate for the year in which it is recognized as a “national key software enterprise”, a status reassessed every year. Shengqu, Shanghai Shulong and Chengdu Aurora were recognized as high and new technology enterprises in 2008 and are entitled to a 15.0% preferential income tax rate for the three-year period ending December 31, 2010. In addition, Shengqu was recognized as a national key software enterprise for 2008 and was entitled to a 10.0% income tax rate for 2008. However, we cannot assure you that Shengqu, Shanghai Shulong and Chengdu Aurora will be able to maintain their status as “high and new technology enterprises” and/or as a “national key


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software enterprise”. If any of our PRC companies that qualified as a “high and new technology enterprise” or “national key software enterprise” fails to continue to qualify, our income tax expenses would increase, which would have a material adverse effect on our net income and results of operations. For additional details on the preferential tax status, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Taxation — PRC Enterprise Income Tax”.
 
Furthermore, pursuant to the New EIT Law, certain enterprises established prior to March 16, 2007 that are entitled to the lower tax rates in accordance with the then prevailing tax laws and regulations shall be eligible for a five-year transition period beginning from January 1, 2008. On December 26, 2007, the State Council issued a notice on the implementation of the grandfathering preferential policies under the New EIT Law, under which it is uncertain whether the transitional tax rates would apply to the companies that enjoyed preferential tax rates of 15.0% under a local preferential tax policy. If our PRC companies cannot enjoy the grandfathering treatment, our income tax expenses would increase, which would have a material adverse effect on our financial condition and results of operations.
 
In 2007, 2008 and the six months ended June 30, 2009, Shengqu received financial incentives from the government in the aggregate amount of RMB54.3 million, RMB18.4 million (US$2.7 million) and RMB37.4 million (US$5.5 million), respectively, which were calculated with reference to taxable revenues and taxable income. To be eligible for the government financial incentives, we are required to continue to meet a number of financial and non-financial criteria and, even if we meet these criteria, the grant of any incentive is still subject to the discretion of the municipal government. Moreover, the central government or municipal government could determine at any time to eliminate or reduce these government financial incentives. Since the government has discretion in the timing of payment and the amount of the financial incentive, we cannot assure you that we will be able to continue to enjoy these government financial incentives or receive such incentives promptly. The discontinuation, reduction or delay of these government financial incentives could have a material adverse effect on our business, financial condition and results of operations.
 
There are significant uncertainties under the New EIT Law relating to our PRC enterprise income tax liabilities.
 
Under the New EIT Law, the profits of a foreign invested enterprise arising in 2008 and onwards which are distributed to its immediate holding company outside the PRC will be subject to a withholding tax rate of 10.0%. Pursuant to a special arrangement between Hong Kong and the PRC, such rate is lowered to 5.0% if a Hong Kong resident enterprise owns over 25% of the PRC company. However, according to a tax circular issued by the State Administration of Taxation in February 2009, if the main purpose of an offshore arrangement is to obtain a preferential tax treatment, the PRC tax authorities have the discretion to adjust the preferential tax rate enjoyed by the relevant offshore entity. In addition, under the New EIT Law, enterprises established under the laws of jurisdictions outside China with their “de facto management bodies” located within China may be considered to be PRC tax resident enterprises for tax purposes. For additional details on the preferential tax status, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Taxation — PRC Enterprise Income Tax” and “Regulation — Regulation of Foreign Currency Exchange and Dividend Distribution”.
 
Although we are a Cayman Islands company and Shanda Games (HK) owns 100% of the equity interests of all of our PRC subsidiaries, the PRC tax authorities may regard the main purpose of Shanda Games (HK) as obtaining a lower withholding tax rate of 5.0%. As a result, the PRC tax authorities could levy a higher withholding tax rate to dividends received by Shanda Games (HK) from our PRC subsidiaries. In addition, a substantial majority of the members of our management team, as well as the management team of Shanda Games (HK), are located in China. Under current PRC laws and regulations, it is also uncertain whether Shanda Games (HK) and we would be deemed to be PRC tax resident enterprises under the New EIT Law. If we or Shanda Games (HK) is deemed to be a PRC tax resident enterprise, our global income will be subject to PRC enterprise income tax at the rate of 25.0%, which would have a material adverse effect on our financial condition and results of operations.


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We face risks related to natural disasters, health epidemics and other outbreaks of contagious diseases, including avian flu, SARS and H1N1 flu.
 
Our business could be adversely affected by natural disasters, avian flu, SARS, H1N1 flu, also known as swine flu, or other epidemics or outbreaks. On May 12, 2008, China experienced an earthquake with a reported magnitude of 8.0 on the Richter scale in Sichuan Province, resulting in the death of tens of thousands of people. As a result of the earthquake, we observed a three-day period of national mourning for the victims, during which period we suspended our online games, in accordance with a public notice issued by the PRC government. There have been recent reports of outbreaks of a highly pathogenic avian flu caused by the H5N1 virus, in certain regions of Asia and Europe. In 2005 and 2006, there were reports on the occurrences of avian flu in various parts of China, including a few confirmed human cases. Since April 2009, there have been reports on the occurrences of H1N1 flu in Mexico, the United States, China and certain other countries and regions around the world. An outbreak of avian flu or H1N1 flu in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, particularly in Asia. Additionally, any recurrence of SARS, a highly contagious form of atypical pneumonia, similar to the occurrence in 2003 that affected China, Hong Kong, Taiwan, Singapore, Vietnam and certain other countries and regions, would also have similar adverse effects. These natural disasters, outbreaks of contagious diseases, and other adverse public health developments in China could severely disrupt our business operations and adversely affect our financial condition and results of operations. We have not adopted any written preventive measures or contingency plans to combat any future natural disasters or outbreaks of avian flu, H1N1 flu, SARS or any other epidemic.
 
We may be subject to fines and legal sanctions if we or our Chinese employees fail to comply with recent PRC regulations relating to employee stock options granted by overseas listed companies to PRC citizens.
 
On December 25, 2006, the PBOC issued the Administration Measures on Individual Foreign Exchange Control, and its Implementation Rules were issued by the SAFE on January 5, 2007. Both took effect on February 1, 2007. Under these regulations, all foreign exchange matters involved in an employee stock holding plan, stock option plan or similar plan in which PRC citizens’ participation requires approval from the SAFE or its authorized branch. On March 28, 2007, the SAFE issued the Application Procedure for Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plans or Stock Option Plans of Overseas Listed Companies, or Notice 78. Under Notice 78, PRC individuals who participate in an employee stock option holding plan or a stock option plan of an overseas listed company are required, through a PRC domestic agent or PRC subsidiary of the overseas listed company, to register with the SAFE and complete certain other procedures. We and our Chinese employees who have been granted restricted shares or stock options pursuant to our share incentive plan are subject to Notice 78. However, in practice, there are significant uncertainties with regard to the interpretation and implementation of Notice 78. We are committed to complying with the requirements of Notice 78. However, we cannot provide any assurance that we or our Chinese employees will be able to qualify for or obtain any registration required by Notice 78. In particular, if we and/or our Chinese employees fail to comply with the provisions of Notice 78, we and/or our Chinese employees may be subject to fines and legal sanctions imposed by the SAFE or other PRC government authorities, as a result of which our business operations and employee option plans could be materially and adversely affected.
 
Risks Relating to Our ADSs and This Offering
 
There has been no public market for our ordinary shares or ADSs prior to this offering, and you may not be able to resell our ADSs at or above the price you paid, or at all.
 
Prior to this initial public offering, there has been no public market for our ordinary shares or ADSs. Our ADSs have been approved for listing on the NASDAQ Global Select Market. Our ordinary shares will not be listed or quoted for trading on any exchange. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected.


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The initial public offering price for our ADSs will be determined by negotiations among Shanda Interactive, us and the underwriters and may bear no relationship to the market price for our ADSs after the initial public offering. We cannot assure you that an active trading market for our ADSs will develop or that the market price of our ADSs will not decline below the initial public offering price.
 
The market price movement of our ADSs may be volatile.
 
The market price of our ADSs may be volatile and subject to wide fluctuations. Among the factors that could affect the price of our ADSs are risk factors described in this section and other factors, including:
 
  •  announcements of competitive developments, including new games by our competitors;
 
  •  regulatory developments in our target markets affecting us, our game players or our competitors;
 
  •  actual or anticipated fluctuations in our quarterly operating results;
 
  •  failure of our quarterly financial and operating results to meet market expectations or failure to meet our previously announced guidance;
 
  •  changes in financial estimates by securities research analysts;
 
  •  changes in the economic performance or market valuations of other Internet or online game companies;
 
  •  additions or departures of our executive officers and other key personnel;
 
  •  announcements regarding intellectual property litigation (or potential litigation) involving us or any of our directors and officers;
 
  •  fluctuations in the exchange rates between the U.S. dollar and the Renminbi;
 
  •  release or expiration of the underwriters’ post-offering lock-up or other transfer restrictions on our outstanding ordinary shares and ADSs; and
 
  •  sales or perceived sales of additional shares or ADSs.
 
In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular industries or companies. For example, the capital and credit markets have been experiencing volatility and disruption for more than 12 months. Starting in September 2008, the volatility and disruption have reached extreme levels, developing into a global crisis. As a result, stock prices of a broad range of companies worldwide, whether or not they are related to financial services, have declined significantly. These market fluctuations may also have a material adverse effect on the market price of our ADSs.
 
You will experience immediate and substantial dilution in the net tangible book value of ADSs purchased.
 
The initial public offering price per ADSs will be substantially higher than the net tangible book value per ADS prior to the offering. Consequently, when you purchase ADSs in the offering, you will incur immediate dilution of US$11.74 per ADS based upon the initial public offering price of US$12.50. See “Dilution”. In addition, you may experience further dilution to the extent that additional ordinary shares are issued upon exercise of outstanding options we may grant from time to time.
 
We may need additional capital and may sell additional ADSs or other equity securities or incur indebtedness, which could result in additional dilution to our shareholders or increase our debt service obligations.
 
We may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating


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and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.
 
We may be required to withhold PRC income tax on the dividends we pay you (if any), and any gain you realize on the transfer of our ordinary shares and/or ADSs may also be subject to PRC withholding tax.
 
Pursuant to the New EIT Law, we may be treated as a PRC resident enterprise for PRC tax purposes. See “— Risks Relating to the People’s Republic of China — There are significant uncertainties under the New EIT Law relating to our PRC enterprise income tax liabilities”. If we are so treated by the PRC tax authorities, we would be obligated to withhold PRC income tax of up to 5.0% on payments of dividends on our shares and/or ADSs to investors that are non-resident enterprises of the PRC located in Hong Kong and 10.0% on payments of dividends on our ordinary shares and/or ADSs to investors that are non-resident enterprises of the PRC located outside Hong Kong, because the dividends payable on our ordinary shares and/or ADSs would be regarded as being derived from sources within the PRC. In addition, any gain realized by any investors who are non-resident enterprises of the PRC from the transfer of our ordinary shares and/or ADSs could be regarded as being derived from sources within the PRC and be subject to a 10.0% PRC withholding tax. Such PRC withholding tax would reduce your investment return on our ordinary shares and/or ADSs and may also materially and adversely affect the price of our ordinary shares and/or ADSs.
 
Substantial future sales of our ADSs or ordinary shares in the public market, or the perception that these sales could occur, could cause the price of our ADSs to decline.
 
Additional sales of our ADSs or ordinary shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. Upon completion of this offering, we will have 167,000,000 Class A ordinary shares and 409,087,000 Class B ordinary shares outstanding. All ADSs sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933, or the Securities Act. The Class B ordinary shares outstanding after this offering will be available for sale, upon the expiration of the 180-day lock-up period beginning from the date of this prospectus, subject to volume and other restrictions as applicable under Rule 144 under the Securities Act. Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of the representatives of the underwriters for this offering. To the extent shares are released before the expiration of the lock-up period and these shares are sold into the market, the market price of our ADSs could decline. Shanda Interactive, our parent and the selling shareholder, is not subject to any contractual obligation to maintain its share ownership in us other than the lock-up obligations described above and in more detail in “Underwriting” and will be free to sell its shares in our company after the expiration of the lock-up period, subject to applicable securities law restrictions.
 
Your right as a holder of ADSs to participate in any future rights offerings may be limited, which may cause dilution to your holdings and they may not receive cash dividends if it is impractical to make them available to such holders.
 
We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rights available to our ADS holders in the United States unless we register the rights and the securities to which the rights relate under the Securities Act or an exemption from the registration requirements is available. In addition, the deposit agreement provides that the depositary bank will not make rights available to you unless the distribution to ADS holders of both the rights and any related securities are either registered under the Securities Act or exempted from registration under the Securities Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under the Securities Act. Accordingly, ADS holders may be unable to participate in our rights offerings and may experience dilution in their holdings. In addition, if the depositary is unable to sell rights that are not exercised or not distributed or if the sale is not lawful or reasonably practicable, it will allow the rights to lapse, in which case you will receive no value for these rights.


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In addition, the depositary of our ADSs has agreed to pay to ADS holders the cash dividends or other distributions it or the custodian receives on our ordinary shares or other deposited securities after deducting its fees and expenses. ADS holders will receive these distributions in proportion to the number of ordinary shares their ADSs represent. However, the depositary may, at its discretion, decide that it is inequitable or impractical to make a distribution available to any holders of ADSs. As a result, the depositary may decide not to make the distribution and ADS holders will not receive such distribution.
 
You may be subject to limitations on transfer of your ADSs.
 
Your ADSs represented by the ADRs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems necessary in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.
 
As we are a Cayman Islands company, you may face difficulties in protecting your interests, and our ability to protect our rights through the U.S. federal courts may be limited.
 
Our corporate affairs are governed by our amended and restated memorandum and articles of association, the Companies Law, Cap 22 (Law 3 of 1961, as consolidated and revised) and the common law of the Cayman Islands. The rights of our shareholders to take action against the directors, actions by minority shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands, as well as that from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities law as compared to the United States and provides significantly less protection to investors.
 
There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. For instance, a U.S. court judgment imposing a monetary fine for violation of U.S. federal securities law is likely to be considered “penal” in nature and unenforceable in the Cayman Islands. Therefore, our public shareholders may have more difficulties in protecting their interests in the face of actions by our management, directors or controlling shareholders than would shareholders of a public company incorporated in a jurisdiction in the United States.
 
In addition, Cayman Islands companies may not have standing to sue before the federal courts of the United States. As a result, our ability to protect our interests if we are harmed in a manner that would otherwise enable us to sue in a United States federal court may be limited.
 
You may have difficulties in enforcing judgments obtained against us.
 
We are a Cayman Islands company and substantially all of our assets are located outside of the United States. Substantially all of our current operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons are located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state due to the lack of reciprocal treaty in the Cayman Islands or the PRC providing


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statutory recognition of judgments obtained in the United States. Furthermore, it is uncertain whether such Cayman Islands or PRC courts would be competent to hear original actions brought in the Cayman Islands or the PRC against us or such persons who reside outside the United States predicated upon the securities laws of the United States or any state. See “Enforceability of Civil Liabilities”.
 
The voting rights of holders of ADSs are limited by the terms of the deposit agreement.
 
A holder of our ADSs may only exercise the voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Upon receipt of voting instructions of a holder of ADSs in the manner set forth in the deposit agreement, the depositary will endeavor to vote the underlying ordinary shares in accordance with these instructions. Under our amended and restated memorandum and articles of association and Cayman Islands law, the minimum notice period required for convening a general meeting is five days. When a general meeting is convened, you may not receive sufficient notice of a shareholders’ meeting to permit you to withdraw your ordinary shares to allow you to cast your vote with respect to any specific matter. In addition, the depositary and its agents may not be able to send voting instructions to you or carry out your voting instructions in a timely manner. We will make all reasonable efforts to cause the depositary to extend voting rights to you in a timely manner, but we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your shares. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast, or for the effect of any such vote. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ordinary shares are not voted as you requested.
 
We will be a “controlled company” within the meaning of the NASDAQ Listing Rules and, as a result, will rely on exemptions from certain corporate governance requirements that provide protection to shareholders of other companies, and we may also rely on the foreign private issuer exemption from most of the corporate governance requirements under the NASDAQ Listing Rules.
 
After the completion of this offering, Shanda Interactive will own more than 50% of the total voting rights in our company and we will be a “controlled company” under the NASDAQ Listing Rules. As a controlled company, we are not obligated to comply with certain NASDAQ corporate governance requirements, including the requirements:
 
  •  that a majority of our board of directors consist of independent directors;
 
  •  that we have a corporate governance and nominating committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities;
 
  •  that we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and
 
  •  for an annual performance evaluation of the nominating and governance committee and the compensation committee.
 
We are not required to and will not voluntarily meet these requirements. As a result of our use of the “controlled company” exemptions, you will not have the same protection afforded to shareholders of companies that are subject to all of NASDAQ’s corporate governance requirements.
 
In the event that we no longer qualify as a “controlled company” under the NASDAQ Listing Rules, we intend to rely on the foreign private issuer exemption from most of the corporate governance requirements under the NASDAQ Listing Rules.
 
Our management will have considerable discretion as to the use of the net proceeds from this offering.
 
We have not allocated the net proceeds of this offering to any particular purpose. Rather, our management will have considerable discretion in the application of the net proceeds received by us. You will not have the opportunity, as part of your investment decision, to assess whether proceeds are being used appropriately. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. The net proceeds may be used for corporate purposes that do not improve our efforts to


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maintain profitability or increase our ADS price. The net proceeds from this offering may be utilized in ways or placed in investments that do not produce income or that lose value.
 
We may be classified as a passive foreign investment company, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or Class A ordinary shares.
 
Based upon the projected composition of our income and valuation of our assets, including goodwill, and although it is not clear how the contractual arrangements between our PRC subsidiaries and Shanghai Shulong will be treated for purposes of the PFIC rules, we do not expect to be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for our current taxable year ending December 31, 2009. However, we must make a separate determination each year as to whether we are a PFIC after the close of each taxable year. A non-U.S. corporation will be considered a PFIC for any taxable year if either (i) at least 75% of its gross income is passive income or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets during the taxable year) is attributable to assets that produce or are held for the production of passive income. Because we expect to continue to hold following this offering a substantial amount of cash and other passive assets, and because the determination of whether we are a PFIC will depend on the character of our income and assets and the value of our assets from time to time, which may be based in part on the market price of our ADSs, which is likely to fluctuate after this offering (and may fluctuate considerably given that market prices of Internet and online game companies historically have been especially volatile), we cannot assure you that we will not be a PFIC for our current taxable year ending December 31, 2009 or any future taxable year. If we were treated as a PFIC for any taxable year during which a U.S. person held an ADS or a Class A ordinary share, certain adverse U.S. federal income tax consequences could apply to such U.S. person. See “Taxation — United States Federal Income Tax Considerations — Passive Foreign Investment Company Rules”.
 
Our dual-class ordinary share structure with different voting rights could discourage others from pursuing any change of control transactions that holders of our Class A ordinary shares and ADSs may view as beneficial.
 
Our amended and restated memorandum and articles of association provide for a dual-class ordinary share structure. Our ordinary shares are divided into Class A ordinary shares and Class B ordinary shares. Holders of Class A ordinary shares are entitled to one vote per share, while holders of Class B ordinary shares are entitled to 10 votes per share. We will issue Class A ordinary shares represented by our ADSs in this offering. Our existing shareholder holds Class B ordinary shares, each of which is convertible into one Class A ordinary share at any time by the holder thereof. Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances.
 
Due to the disparate voting rights attached to these two classes, our existing shareholder will have significant voting rights over matters requiring shareholder approval, including the election and removal of directors and certain corporate transactions, such as mergers, consolidations and other business combinations. This concentrated control could discourage others from pursuing any potential merger, takeover or other change of control transactions that holders of Class A ordinary shares and ADSs may view as beneficial.
 
Our articles of association contain anti-takeover provisions that could adversely affect the rights of holders of our ordinary shares and ADSs.
 
Our amended and restated articles of association include certain provisions that could limit the ability of others to acquire control of our company. Such provisions could deprive our shareholders of the opportunity to sell their shares at a premium over the prevailing market price by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transactions.
 
The following provisions in our amended and restated memorandum and articles of association may have the effect of delaying or preventing a change of control of our company:
 
  •  our amended and restated memorandum and articles of association provides for a dual-class ordinary share structure with disparate voting rights attached to the two classes of ordinary shares;


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  •  our board of directors has the authority, without approval by the shareholders, to issue any unissued shares and determine the terms and conditions of such shares, including preferred, deferred or other special rights or restrictions with respect to dividend, voting and return of capital;
 
  •  the shareholders may by ordinary resolution appoint a candidate as director of the board to fill a casual vacancy or as an addition to the existing board;
 
  •  the chairman, a majority of our board of directors or shareholder(s) who hold(s) more than 25% of the voting rights of our company having requisitioned for an extraordinary shareholders’ meeting at least 21 days previously, have the right to convene an extraordinary shareholders’ meeting, and the agenda of such meeting will be set by a majority of the directors or the shareholder(s) who hold more than 25% of the voting rights of our company who request such meeting; and
 
  •  the amended and restated articles of association may be amended only by a resolution passed at a shareholders’ meeting by a majority of not less than two-thirds of the vote cast.
 
We will incur increased costs as a result of being a public company.
 
As a public company, we will incur a significantly higher level of legal, accounting and other expenses than we did as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and the NASDAQ Global Select Market, have required changes in corporate governance practices of public companies. We expect these rules and regulations to increase our legal and financial compliance costs. We are currently evaluating and monitoring developments with respect to these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.


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FORWARD-LOOKING STATEMENTS
 
This prospectus contains forward-looking statements that are based on our current expectations, assumptions, estimates and projections about us and our industry. All statements other than statements of historical fact in this prospectus are forward-looking statements. These forward-looking statements can be identified by words or phrases such as “anticipate”, “believe”, “continue”, “estimate”, “expect”, “intend”, “is/are likely to”, “may”, “plan”, “should”, “will”, or other similar expressions. The forward-looking statements included in this prospectus relate to, among others:
 
  •  our future business development, financial condition and results of operations;
 
  •  our ability to maintain and strengthen our position as a leading online game developer and operator in China;
 
  •  our ability to develop and commercialize additional online games;
 
  •  market acceptance of our online games;
 
  •  our various initiatives to implement our business strategies to expand our business;
 
  •  competition from other online game developers and operators;
 
  •  our planned use of proceeds;
 
  •  the expected growth of and change in the online game industry in China;
 
  •  the PRC government policies relating to the Internet, Internet content providers, including online game developers and operators, Internet cafes, virtual currency and anti-fatigue, as well as anti-monopoly rules;
 
  •  statements concerning our ongoing relationships with Shanda Interactive;
 
  •  our ability to effectively protect our intellectual property rights and not infringe on the intellectual property rights of others; and
 
  •  general economic and business conditions in China and other countries or regions in which we operate.
 
These forward-looking statements involve various risks and uncertainties. Although we believe that our expectations expressed in these forward-looking statements are reasonable, our expectations may turn out to be incorrect. Our actual results could be materially different from our expectations. Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in “Risk Factors”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Business” and other sections in this prospectus.
 
The forward-looking statements made in this prospectus relate only to events or information as of the date on which the statements are made in this prospectus. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events.
 
Industry Data and Forecasts
 
This prospectus also contains data related to the online game industry in China. These industry data, including data from IDC, include projections that are based on a number of assumptions. The online game industry may not grow at the rate projected by industry data, or at all. The failure of this industry to grow at the projected rate may have a material adverse effect on our business and the market price of our ADSs. In addition, the rapidly changing nature of the online game industry subjects any projections or estimates relating to the growth prospects or future condition of our industry to significant uncertainties. Furthermore, if any one or more of the assumptions underlying the industry data turns out to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.
 
Unless otherwise indicated, information in this prospectus concerning economic conditions and our industry is based on information from independent industry analysts and publications, as well as our estimates. Except where otherwise noted, our estimates are derived from publicly available information released by third-party sources, as well as data from our internal research, and are based on such data and our knowledge of our industry, which we believe to be reasonable.


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ENFORCEABILITY OF CIVIL LIABILITIES
 
We are incorporated under the laws of the Cayman Islands as an exempted company with limited liability. We are incorporated in the Cayman Islands because of certain benefits associated with being a Cayman Islands corporation, such as political and economic stability, an effective judicial system, a favorable tax system, the absence of foreign exchange control or currency restrictions and the availability of professional and support services. However, the Cayman Islands has a less developed body of securities laws as compared to the United States and provides protections for investors to a significantly lesser extent. In addition, Cayman Islands companies do not have standing to sue before the federal courts of the United States.
 
Substantially all of our assets are located outside the United States. In addition, a majority of our directors and officers are nationals or residents of jurisdictions other than the United States and all or a substantial portion of their assets are located outside the United States. As a result, it may be difficult for investors to effect service of process within the United States upon us or these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.
 
We have appointed CT Corporation System as our agent to receive service of process with respect to any action brought against us in the United States District Court for the Southern District of New York under the federal securities laws of the United States or of any state in the United States or any action brought against us in the Supreme Court of the State of New York in the County of New York under the securities laws of the State of New York.
 
Conyers Dill & Pearman, our counsel as to Cayman Islands law, and Jade & Fountain PRC Lawyers, our counsel as to PRC law, have advised us that there is uncertainty as to whether the courts of the Cayman Islands or the PRC would, respectively, (i) recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States, or (ii) entertain original actions brought in the Cayman Islands or the PRC against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.
 
Conyers Dill & Pearman has further advised us that the courts of the Cayman Islands would recognize as a valid judgment, a final and conclusive judgment in personam obtained in the federal or state courts in the United States against us under which a sum of money is payable (other than a sum of money payable in respect of multiple damages, taxes or other charges of a like nature or in respect of a fine or other penalty) and would give a judgment based thereon, provided that: (i) such federal or state courts had proper jurisdiction over the parties subject to such judgment; (ii) such federal or state courts did not contravene the rules of natural justice of the Cayman Islands; (iii) such judgment was not obtained by fraud; (iv) the enforcement of the judgment would not be contrary to the public policy of the Cayman Islands; (v) no new admissible evidence relevant to the action is submitted prior to the rendering of the judgment by the courts of the Cayman Islands; and (vi) there is due compliance with the correct procedures under the laws of the Cayman Islands.
 
Jade & Fountain PRC Lawyers has further advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedure Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedure Law based either on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. Jade & Fountain PRC Lawyers has advised us further that there are no treaties between China and the United States for the mutual recognition and enforcement of court judgments, thus making the recognition and enforcement of a U.S. court judgment in China difficult.


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OUR HISTORY AND CORPORATE STRUCTURE
 
Our History
 
Our online game business was founded by Shanda Interactive in 2001 and was operated by Shanda Interactive through various subsidiaries and VIEs until the reorganization effective July 1, 2008. In November 2001, Shanda Interactive launched its first MMORPG, Mir II, which it had licensed from Actoz. In October 2003, Shanda Interactive launched Woool, its first in-house developed online game. In May 2004, Shanda Interactive completed an initial public offering of ADSs. Shanda Interactive’s ADSs are traded on the NASDAQ Global Select Market under the symbol “SNDA”.
 
Shanda Interactive’s Corporate Structure Prior to the Reorganization
 
Prior to the reorganization, to comply with PRC laws restricting foreign ownership in the online game business in China, Shanda Interactive operated its online game business in China through Shanda Networking, which is wholly owned by Tianqiao Chen and Danian Chen, and through Nanjing Shanda and Hangzhou Bianfeng Networking Co., Ltd., or Hangzhou Bianfeng, which are wholly-owned subsidiaries of Shanda Networking. Shanda Networking and its subsidiaries hold the licenses and approvals that are required to operate the online game business.
 
Shengqu entered into a series of VIE agreements with Shanda Networking and its shareholders. As a result of these contractual arrangements, Shanda Interactive was considered the primary beneficiary of Shanda Networking and its subsidiaries, and accordingly, Shanda Interactive consolidated the results of operations of Shanda Networking and its subsidiaries in its financial statements.
 
In addition, Shanda Computer entered into a series of agreements with Shanda Networking and its subsidiaries, pursuant to which Shanda Computer provided certain services and software licenses to Shanda Networking and its subsidiaries.


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The following diagram illustrates Shanda Interactive’s material subsidiaries and VIEs immediately prior to the reorganization.
 
(FLOW CHART)
 
 
(1) Employee of Shanda Interactive.
 
The Reorganization
 
Effective July 1, 2008, Shanda Interactive completed the reorganization which consisted of the following primary steps:
 
  •  Establishment of Shanda Games.  We were incorporated in the Cayman Islands on June 12, 2008 as a direct wholly-owned subsidiary of Shanda Interactive to be the holding company for the online game business. Pursuant to a share exchange, Shanda Games (HK) became our direct wholly-owned subsidiary, and we became a direct wholly-owned subsidiary of Shanda Interactive.
 
  •  Separation Agreement.  Pursuant to a Master Separation Agreement, Shanda Interactive transferred substantially all of its assets and liabilities related to its online game business (including applicable


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  intellectual property rights) to us. Concurrently, we transferred to Shanda Interactive all of our assets and liabilities unrelated to the online game business, such as real estate properties which we owned. See “Our Relationship with Shanda Interactive” for a description of the Master Separation Agreement and other agreements.
 
  •  Assignment of VIE Agreements.  Shengqu assigned all of its VIE agreements with Shanda Networking and Nanjing Shanda (other than those relating to the operations of the online game business, which were cancelled) to Shanda Computer, thereby making Shanda Online the primary beneficiary of Shanda Networking and Nanjing Shanda.
 
  •  Transfer of Equity Interests.  Shanda Networking transferred its 48.6% equity interest in Shanghai Shulong to Dongxu Wang, a PRC citizen. Meanwhile, Yingfeng Zhang, a PRC citizen, terminated his loan agreement with Shanda Networking and entered into a new loan agreement with Shengqu.
 
  •  New VIE Agreements.  Shengqu entered into VIE agreements with respect to the online game business with Shanghai Shulong and its shareholders. Accordingly, Shanghai Shulong became a VIE of Shengqu and we are considered the primary beneficiary of Shanghai Shulong and its subsidiaries. For additional details, see “— Our Corporate Structure Following the Reorganization”.
 
  •  Game Licensing Agreements.  Shengqu entered into game license agreements with the Shulong entities. In addition, the Shulong entities became sublicensees under certain third-party game license agreements and Shanda Networking, Nanjing Shanda and Hangzhou Bianfeng ceased to be sublicensees under such third-party license agreements. See “— Our Corporate Structure Following the Reorganization”.
 
  •  Declaration of Dividends.  In 2009, we declared an aggregate of US$102.6 million in cash dividends payable solely to Shanda Interactive. As of June 30, 2009, we had paid US$24.5 million of this amount.
 
Our Corporate Structure Following the Reorganization
 
As a result of the reorganization and in order to comply with PRC laws restricting foreign ownership in the online game business in China, we operate our online game business in China through the Shulong entities. Shanghai Shulong, whose equity interests are 51.4% owned by Yingfeng Zhang and 48.6% owned by Dongxu Wang, currently holds an ICP license and an Internet culture operation license that are required to operate our online game business. We publish our online games through cooperation with Shanda Networking, which holds an Internet publishing license. Shengqu owns the substantial majority of our physical assets.
 
Shengqu, Shanghai Shulong and the shareholders of Shanghai Shulong entered into VIE agreements, which became effective on July 1, 2008 and provide Shengqu with effective control of Shanghai Shulong. The following is a summary of the key agreements currently in effect:
 
  •  Loan Agreements, between Shengqu and the shareholders of Shanghai Shulong. These loan agreements provide for loans of RMB6,150,000 to Dongxu Wang and of RMB4,644,000 to Yingfeng Zhang for them to acquire and make contributions to the registered capital of Shanghai Shulong in exchange for their 48.6% and 51.4% equity interests, respectively, in Shanghai Shulong. The loans are interest free and are repayable on demand, but the shareholders may not repay all or any part of the loans without Shengqu’s prior written consent.
 
  •  Equity Entrustment Agreement, between Shengqu and the shareholders of Shanghai Shulong, pursuant to which Dongxu Wang and Yingfeng Zhang acknowledge their status as shareholders.
 
  •  Equity Pledge Agreement, among Shengqu, Shanghai Shulong, Dongxu Wang and Yingfeng Zhang, pursuant to which the shareholders of Shanghai Shulong pledge to Shengqu their entire equity interests in Shanghai Shulong to secure the performance of their respective obligations and Shanghai Shulong’s obligations under the various VIE agreements, including the Equity Entrustment Agreement, the Business Operation Agreement and the Exclusive Consulting and Service Agreement. Without Shengqu’s prior written consent, neither Dongxu Wang nor Yingfeng Zhang may transfer any equity


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  interests in Shanghai Shulong. On November 27, 2008, both Dongxu Wang and Yingfeng Zhang registered the Equity Pledge Agreement with the relevant office of the administration for industry and commerce to make such equity pledge effective under PRC law.
 
  •  Equity Disposition Agreement, among Shengqu, Shanghai Shulong and the shareholders of Shanghai Shulong. Pursuant to this agreement, Shengqu and any third party designated by Shengqu have the right, exercisable at any time during the term of the agreement, if and when it is legal to do so under PRC laws and regulations, to purchase from Dongxu Wang or Yingfeng Zhang, as the case may be, all or any part of their equity interests in Shanghai Shulong at a purchase price equal to the lowest price permissible by the then-applicable PRC laws and regulations. The agreement is for an initial term of 20 years and renewable upon Shengqu’s request.
 
  •  Business Operation Agreement, among Shengqu, Shanghai Shulong and the shareholders of Shanghai Shulong. This agreement sets forth the rights of Shengqu to control the actions of the shareholders of Shanghai Shulong, including Shengqu’s rights to manage Shanghai Shulong’s daily operation and appoint and remove Shanghai Shulong’s directors.
 
  •  Exclusive Consulting and Service Agreement, between Shengqu and Shanghai Shulong. Pursuant to this agreement, Shengqu has the exclusive right to provide technology support and business consulting services to Shanghai Shulong for a fee.
 
  •  Proxies, executed by the shareholders of Shanghai Shulong in favor of Shengqu. These irrevocable proxies grant Shengqu or its designees the power to exercise the rights of Dongxu Wang and Yingfeng Zhang as shareholders of Shanghai Shulong, including the right to appoint directors, general manager and other senior management of Shanghai Shulong.
 
As a result of these contractual arrangements and various operational agreements, we are considered the primary beneficiary of Shanghai Shulong and its subsidiaries, and accordingly, we consolidate the results of operations of Shanghai Shulong and its subsidiaries in our financial statements.
 
In the opinion of our PRC legal counsel, Jade & Fountain PRC Lawyers, the ownership structure and the contractual arrangements between our PRC subsidiaries, on the one hand, and Shanghai Shulong and/or its shareholders, on the other hand, comply with, and immediately after this offering, will comply with, current PRC laws and regulations. There are, however, substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations. Accordingly, PRC governmental authorities may ultimately take a view that is inconsistent with the opinion of Jade & Fountain PRC Lawyers. See “Risk Factors — Risks Relating to Regulation of Our Business and to Our Structure”.
 
Acquisition and Transfer of Actoz
 
Between 2005 and 2008, Shanda Interactive acquired a majority of the outstanding shares of Actoz through a series of open market purchases and privately negotiated transactions as follows:
 
  •  prior to February 2005, Shanda Interactive purchased approximately 9.1% of Actoz’s then-issued and outstanding shares on the open market at an aggregate cost of approximately US$14.4 million;
 
  •  in February 2005, Shanda Interactive completed its purchase of an approximately 29.0% stake in Actoz from certain shareholders of Actoz for approximately US$91.7 million in cash, equivalent to RMB759.1 million, raising its total equity interest in Actoz to 38.1% and becoming Actoz’s largest shareholder; and
 
  •  in 2006, 2007 and 2008, Shanda Interactive purchased additional shares of Actoz on the open market and in privately negotiated transactions.
 
In the second quarter of 2009, Shanda Interactive transferred to us its entire equity interest in Actoz for a cash consideration of US$70.2 million.


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Our Current Corporate Structure
 
The following diagram illustrates our corporate structure and the corporate structure of Shanda Online, an entity controlled by Shanda Interactive, immediately prior to this offering.
 
(FLOW CHART)
 
 
(1)  Shanda Online Holdings Limited was renamed Shanda Investment Holdings Limited on November 5, 2008.
 
(2)  Employee of Shanda Interactive.


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OUR RELATIONSHIP WITH SHANDA INTERACTIVE
 
Our Relationship with Shanda Interactive Prior to the Reorganization
 
Prior to its reorganization, Shanda Interactive operated our online game business through some of its subsidiaries and VIEs. Effective July 1, 2008, pursuant to the reorganization, we assumed substantially all of the assets and liabilities related to the online game business, and we transferred to Shanda Interactive all of our assets and liabilities unrelated to the online game business.
 
Our Relationship with Shanda Interactive Following the Reorganization
 
In connection with the reorganization, we entered into agreements with Shanda Interactive with respect to various ongoing relationships between us. The following are summaries of these agreements. For the complete text of these agreements, please see the copies included as exhibits to the registration statement filed with the SEC, of which this prospectus is a part.
 
Master Separation Agreement
 
The Master Separation Agreement between Shanda Interactive and us contains key provisions regarding the transfer of assets and liabilities related to the online game business (including applicable intellectual property rights) from Shanda Interactive to us and the transfer of assets and liabilities unrelated to the online game business from us to Shanda Interactive. The following is a brief summary of the material provisions of the Master Separation Agreement.
 
Contribution and Transfer.  Shanda Interactive agreed to transfer to us the entire share capital of Shanda Games (HK), its rights under various agreements relating to the servers we lease, and the deferred revenues, the intellectual property rights and other tangible properties related to the online game business. We agreed to transfer to Shanda Interactive all of our real properties, intellectual property rights and other tangible properties unrelated to the online game business.
 
Indemnification.  Pursuant to the Master Separation Agreement, we are responsible for all liabilities associated with the assets and operations related to the online game business, while Shanda Interactive is responsible for all liabilities associated with Shanda Interactive’s other assets and operations, in each case, regardless of the time those liabilities arise. The Master Separation Agreement also contains indemnification provisions under which we and Shanda Interactive indemnify each other with respect to breaches of the Master Separation Agreement or any related intercompany agreement.
 
Liability Release.  We release Shanda Interactive from all liabilities associated with the assets and operations related to the online game business transferred to us, and Shanda Interactive releases us from liabilities associated with all of Shanda Interactive’s other assets and operations, in each case regardless of the time those liabilities arise.
 
No Representations or Warranties.  Except as expressly set forth in the Master Separation Agreement or other documents, neither we nor Shanda Interactive make any representation or warranty to each other relating to the transaction contemplated in the Master Separation Agreement.
 
New VIE Agreements and New Game Licensing Agreements.  As a part of the reorganization, Shengqu entered into VIE agreements with Shanghai Shulong. Shengqu also terminated its game licensing agreements with Shanda Interactive’s VIEs and entered into new game licensing agreements with the Shulong entities, granting the Shulong entities rights which had previously been granted to Shanda Interactive’s VIEs.
 
Furthermore, we agreed not to amend or terminate any of our contracts with third parties that were entered into for the benefit of Shanda Interactive and its subsidiaries and VIEs. We also agreed to take actions reasonably requested by Shanda Interactive to enable Shanda Interactive or its subsidiaries to receive substantially the same rights and benefits received by us under such contracts with third parties.


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Amended and Restated Non-Compete and Non-Solicitation Agreement
 
Under the Amended and Restated Non-Compete and Non-Solicitation Agreement between Shanda Interactive and Shanda Games, Shanda Interactive has agreed, for a period of five years commencing July 1, 2008, not to engage in the online game business, which refers to the sourcing, development, operation and licensing of online games and related intellectual property rights and activities incidental to such business, anywhere in the world, except that (i) certain of Shanda Interactive’s subsidiaries may continue to engage in their current PC network and e-sports platform businesses, online interactive music community, and online chess and board game platform business, (ii) Shanda Interactive may acquire equity interests in a company that does not have more than 25.0% of its gross revenues (based on the latest annual audited financial statements of the investee company) attributable to the online game business and (iii) Shanda Interactive may operate virtual communities with certain online game features provided that such features do not constitute the core business model of such community. In addition, the agreement permits Shanda Interactive to acquire or invest in any third party engaging in the online game business if, after using its reasonable best efforts to make such investment opportunity available to us as required under the agreement, we do not pursue such opportunity; provided that Shanda Interactive’s equity interest in such third party shall not exceed 50%.
 
Furthermore, Shanda Interactive has agreed, for a period of five years commencing July 1, 2008, not to solicit any customer, supplier or any other third party having any business relationship with us or any of our employees.
 
Amended and Restated Cooperation Agreement
 
Pursuant to the Amended and Restated Cooperation Agreement between Shanda Networking, a VIE of Shanda Online, and its subsidiary, Nanjing Shanda, on the one hand, and the Shulong entities, on the other hand, we have engaged Shanda Networking and Nanjing Shanda to provide certain services to us for a period of five years commencing July 1, 2008. The services Shanda Networking and Nanjing Shanda have agreed to provide us include, among others, online billing and payment, user authentication, customer service, anti-fatigue compliance, prepaid card marketing and data support services. We pay Shanda Networking a service fee, which we record as a portion of platform fees in our cost of revenues, equal to 15.5% of the portion of the face value of the prepaid cards that are used in our online games. In order to lock-in the 15.5% fixed percentage, we agreed to a five-year contract period with Shanda Networking and Nanjing Shanda and committed to generate at least RMB200 million in revenues per month. Under the terms of the Amended and Restated Cooperation Agreement, we are not permitted to engage any other party to provide such services to us, while Shanda Networking is permitted to provide such services to other parties.
 
The Amended and Restated Cooperation Agreement will be automatically extended for one year if neither party gives written objection three months prior to the expiration date of such agreement. Each party has the right to terminate this agreement if the other party fails to perform its obligations under the agreement or any key term of the agreement violates any PRC law, or upon the other party’s bankruptcy, insolvency or any other breaches of this agreement.
 
Amended and Restated Sales Agency Agreement
 
Pursuant to the Amended and Restated Sales Agency Agreement between Shengfutong, a VIE of Shanda Online, and the Shulong entities, Shengfutong has agreed, for a period of five years commencing July 1, 2008, to be the sales agent of the Shulong entities for the distribution of prepaid cards which are required to purchase virtual items or time units in our online games through Shanda Networking’s integrated service platform. For each prepaid card sold, we pay Shengfutong a service fee, which we record as a portion of sales and marketing expenses in our operating expenses, equal to the difference between (i) the amount Shengfutong receives from the sale of such card and (ii) 83.5% of the face value of each prepaid card that are used in our online games. In order to lock-in the fixed percentage, we agreed to a five-year contract period with Shengfutong and committed to generate at least RMB200 million in revenues per month. Under the terms of the Amended and Restated Sales Agency Agreement, we are not permitted to engage any other party to provide such services to us, while Shengfutong is permitted to provide such services to other parties.


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The Amended and Restated Sales Agency Agreement will be automatically extended for one year if neither party gives written objection 90 days prior to the expiration date of such agreement. Each party has the right to terminate this agreement if the other party fails to perform its obligations under the agreement or any key term of the agreement violates any PRC law, or upon the other party’s bankruptcy, insolvency or any other breaches of this agreement.
 
Domain Names and Trademarks License Agreement
 
Pursuant to the Domain Names and Trademarks License Agreement between Shanda Computer and Shengqu, Shanda Computer licenses to Shengqu on a nonexclusive, nontransferable and royalty-free basis, certain domain names and trademarks, including “Shanda”.
 
Deferred Revenues Transfer Agreement
 
The Deferred Revenues Transfer Agreement among Shanda Networking and its subsidiaries, the Shulong entities and Shengfutong, sets forth certain transitional arrangements with respect to prepaid cards which had been sold to distributors and/or users prior to the reorganization but had yet to be activated, as well as any remaining balance in game player’s accounts, to reflect the transfer of the online game business to us as a result of the reorganization.
 
Transfer of Actoz
 
In the second quarter of 2009, Shanda Interactive transferred to us its entire equity interest in Actoz for a cash consideration of US$70.2 million.
 
Our Relationship with Shanda Interactive Following the Offering
 
Upon the completion of this offering, Shanda Interactive will continue to be our controlling shareholder, with a shareholding of 96.08% of the combined total voting rights of our outstanding Class A and Class B ordinary shares, assuming the underwriters do not exercise their over-allotment option to purchase additional ADSs. However, Shanda Interactive is not subject to any contractual obligation to maintain its share ownership other than the 180-day lock-up period as described in “Underwriting”.
 
We believe that our establishment as a standalone entity to focus on the online game business as part of the reorganization:
 
  •  provides us with a sharper focus and greater flexibility to pursue strategic opportunities in further developing our leadership position in the online game industry in China and to pursue international opportunities for additional growth for our online game business;
 
  •  helps us to focus on sourcing, managing and operating the best online games;
 
  •  promotes greater accountability for our employees; and
 
  •  better motivates our employees.


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USE OF PROCEEDS
 
We estimate that we will receive net proceeds from this offering of approximately US$155.1 million, after deducting the estimated underwriting discounts and commissions and the estimated offering expenses payable by us, and based upon the initial public offering price of US$12.50 per ADS.
 
We currently intend to use the net proceeds we will receive from this offering for general corporate purposes, including capital expenditures and funding possible future investments, joint ventures and acquisitions. We have no current plans, proposals or arrangements for any material acquisitions.
 
The foregoing represents our current intentions with respect to the use and allocation of the net proceeds of this offering based upon our present plans and business condition, but our management will have significant flexibility and discretion in applying the net proceeds we receive from this offering. The occurrence of unforeseen events or changed business conditions may result in application of the proceeds of this offering in a manner other than as described in this prospectus.
 
Pending use of the net proceeds, we intend to invest our net proceeds in investment-grade short-term, interest-bearing debt instruments or bank deposits.
 
We will not receive any of the proceeds from the sale of ADSs by the selling shareholder.


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DIVIDEND POLICY
 
In 2009, we declared an aggregate of US$102.6 million in cash dividends payable solely to Shanda Interactive, our parent, of which amount we had paid US$24.5 million as of June 30, 2009. We intend to pay Shanda Interactive the remaining amount from a bank loan. The purchasers of the ADSs in this offering are not entitled to participate in this dividend.
 
Future cash dividends, if any, will be at the discretion of our board of directors and will depend on our future operations and earnings, capital requirements and surplus, general financial conditions, contractual restrictions and other factors as our board of directors may deem relevant. We can pay dividends only out of profits or other distributable reserves. If we pay any dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable under the deposit agreement. See “Description of American Depositary Shares”. Cash dividends, if any, on our ordinary shares will be paid in U.S. dollars. If we are considered a PRC tax resident enterprise for tax purposes, any dividends we pay to our overseas shareholders or ADS holders may be regarded as China-sourced income and as a result may be subject to PRC withholding tax at a rate of up to 10.0%. See “Taxation — PRC Taxation”.
 
We are a holding company incorporated in the Cayman Islands. In order for us to distribute any dividends to our shareholders and ADS holders, we will rely on payments made from Shanghai Shulong and its subsidiaries to our PRC subsidiaries, pursuant to contractual arrangements between them, and the distribution of such payments to Shanda Games (HK) as dividends from our PRC subsidiaries. Certain payments from our VIEs to our PRC subsidiaries are subject to PRC taxes, including business taxes and VAT. In addition, regulations in the PRC currently permit payment of dividends of a PRC company, such as each of our PRC subsidiaries, only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Each of our PRC subsidiaries is also required to set aside at least 10% of its after-tax profit based on PRC accounting standards each year to its general reserves until the cumulative amount reaches 50% of its registered capital. These reserves are not distributable as cash dividends. Each of our PRC subsidiaries may also allocate a portion of its after-tax profits, as determined by its board of directors, to its staff welfare and bonus funds which may not be distributed to us. In addition, if any of our PRC subsidiaries incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Any dividends paid by any of our PRC subsidiaries to its immediate holding company, Shanda Games (HK), will be subject to a withholding tax at the rate of 5.0%, provided that Shanda Games (HK) is not considered to be a PRC tax resident enterprise.


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CAPITALIZATION
 
The following table sets forth our total capitalization as of June 30, 2009:
 
  •  on an actual basis; and
 
  •  on an as-adjusted basis to give effect to issuance and sale of 13,043,500 ADSs representing 26,087,000 Class A ordinary shares offered by us in this offering at the initial public offering price of US$12.50 per ADS, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us and assuming no other change to the number of ADSs sold by us as set forth on the cover page of this prospectus.
 
You should read this table in conjunction with “Selected Consolidated Financial Information”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and related notes included elsewhere in this prospectus.
 
                                 
    As of
    June 30, 2009
    Actual   As Adjusted
    RMB   US$   RMB   US$
    (in millions)
 
Shareholders’ equity:
                               
Ordinary shares, par value US$0.01 per share, 20,000,000,000 shares authorized:
    40.2       5.9              
Class A ordinary shares, par value US$0.01 per share, 16,000,000,000 shares authorized; 167,000,000 shares issued and outstanding on an as-adjusted basis(1)
                12.1       1.8  
Class B ordinary shares, par value US$0.01 per share, 4,000,000,000 shares authorized; 550,000,000 shares issued and outstanding, 409,087,000 shares issued and outstanding on an as-adjusted basis(1)
                29.9       4.4  
Additional paid-in capital
    63.8       9.3       1,120.8       164.1  
Statutory reserves
    127.0       18.6       127.0       18.6  
Accumulated other comprehensive loss
    (82.1 )     (12.0 )     (82.1 )     (12.0 )
Retained earnings
    716.8       104.9       716.8       104.9  
                                 
Total Shanda Games Limited shareholders’ equity
    865.7       126.7       1,924.5       281.8  
                                 
Total capitalization
    865.7       126.7       1,924.5       281.8  
                                 
 
 
(1) Subsequent to June 30, 2009, our share capital was redesignated into Class A and Class B ordinary shares under our amended and restated memorandum and articles of association, which became effective on September 1, 2009.


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DILUTION
 
If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per Class A ordinary share is substantially in excess of the book value per ordinary share attributable to the existing shareholder for our presently outstanding ordinary shares.
 
Our net tangible book value as of June 30, 2009 was approximately RMB452.6 million (US$66.3 million), or RMB0.82 (US$0.12) per ordinary share as of that date, and US$0.24 per ADS. Net tangible book value represents the amount of our total consolidated tangible assets, less the amount of our total consolidated liabilities. Dilution is determined by subtracting net tangible book value per ordinary share from the initial public offering price per ordinary share, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.
 
Without taking into account any other changes in net tangible book value after June 30, 2009, other than to give effect to our sale of the ADSs offered in this offering at the initial public offering price of US$12.50 per ADS, after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our adjusted net tangible book value as of June 30, 2009 would have been US$221.3 million, or US$0.38 per outstanding ordinary share, including ordinary shares underlying our outstanding ADSs, and US$0.76 per ADS. This represents an immediate increase in net tangible book value of US$0.26 per ordinary share and US$0.52 per ADS, to the existing shareholder and an immediate dilution in net tangible book value of US$5.87 per ordinary share and US$11.74 per ADS, to investors purchasing ADSs in this offering.
 
The following table illustrates this per ordinary share dilution:
 
         
    US$
 
Initial public offering price per Class A ordinary share
    6.25  
Net tangible book value per ordinary share as of June 30, 2009
    0.12  
Increase in net tangible book value per ordinary share attributable to this offering
    0.26  
         
Adjusted net tangible book value per ordinary share after giving effect to this offering
    0.38  
         
Dilution in net tangible book value per ordinary share to new investors in this offering
    5.87  
         
Dilution in net tangible book value per ADS to new investors in this offering
    11.74  
         
 
The following table summarizes, on an as adjusted basis, the number of ordinary shares purchased from us as of June 30, 2009, the total consideration paid to us and the average price per ordinary share paid by our existing shareholder and by new investors purchasing ordinary shares evidenced by ADSs in this offering at the initial public offering price of US$12.50 per ADS, after deducting underwriting discounts and commissions and other estimated offering expenses payable by us.
 
                                                 
                            Average
       
                            Price per
    Average
 
    Ordinary Shares Purchased     Total Consideration     Ordinary
    Price
 
    Number     Percent     Amount     Percent     Share     per ADS  
 
Existing shareholder
    550,000,000       95.5 %   US$ 55,000,000       25.2 %   US$ 0.10     US$ 0.20  
New investors
    26,087,000       4.5     US$ 163,043,750       74.8     US$ 6.25     US$ 12.50  
                                                 
Total
    576,087,000       100.0 %   US$ 218,043,750       100.0 %                
                                                 


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The discussions and tables above also assume no exercise by the underwriters of their over-allotment option to purchase up to 12,525,000 additional ADSs representing 25,050,000 Class A ordinary shares from the selling shareholder and assume no exercise of options outstanding and no vesting of any outstanding restricted shares. As of June 30, 2009, there were options to purchase 24,700,500 Class A ordinary shares and 407,770 restricted shares outstanding and 18,943,730 ordinary shares available for future issuance upon the exercise of future grants under our Amended and Restated 2008 Equity Compensation Plan. To the extent that any such options are exercised or any such restricted shares become vested, there will be further dilution to new investors.


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EXCHANGE RATES
 
Our business is primarily conducted in China and a substantial majority of our revenues are denominated in Renminbi. This prospectus contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader, and unless otherwise indicated, conversions of Renminbi into U.S. dollars in this prospectus are based on the noon buying rate in The City of New York for cable transfers of Renminbi as certified for customs purposes by the Federal Reserve Bank of New York on June 30, 2009. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On September 18, 2009, the daily exchange rate reported by the Federal Reserve Board was RMB6.8270 to US$1.00.
 
The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods indicated.
 
                                 
    Spot Exchange Rate
Period
  Average(1)   Low   High   Period-End
    (RMB per US$1.00)
 
2004
    8.2768       8.2774       8.2764       8.2765  
2005
    8.1826       8.2765       8.0702       8.0702  
2006
    7.9579       8.0702       7.8041       7.8041  
2007
    7.5806       7.8127       7.2946       7.2946  
2008
    6.9193       7.2946       6.7800       6.8225  
2009 (through June 30, 2009)
    6.8326       6.8470       6.8176       6.8302  
2009 
                               
March
    6.8360       6.8438       6.8240       6.8329  
April
    6.8304       6.8361       6.8180       6.8180  
May
    6.8235       6.8326       6.8176       6.8278  
June
    6.8334       6.8371       6.8264       6.8302  
July
    6.8317       6.8342       6.8300       6.8319  
August
    6.8312       6.8358       6.8299       6.8299  
September (through September 18)
    6.8282       6.8303       6.8247       6.8270  
 
 
Source: For periods prior to December 31, 2008, the noon buying rates of the Federal Reserve Bank of New York; for periods subsequent to December 31, 2008, Federal Reserve Statistical Release, Board of Governors of the Federal Reserve System.
 
(1) Annual average were calculated by using the average of the exchange rates on the last day of each month during the relevant year. Monthly averages were calculated by using the average of the daily rates during the relevant month.


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SELECTED CONSOLIDATED FINANCIAL INFORMATION
 
The following selected consolidated financial information for the periods and as of the dates indicated should be read in conjunction with our financial statements and the accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, both of which are included elsewhere in this prospectus.
 
The summary consolidated financial data presented below as of December 31, 2007, 2008 and June 30, 2009 and for the two years ended December 31, 2007 and 2008 and for the six months ended June 30, 2009 are derived from our audited consolidated financial statements included elsewhere in this prospectus. Our audited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP, and have been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, an independent registered public accounting firm. The report of PricewaterhouseCoopers Zhong Tian CPAs Limited Company on those consolidated financial statements is included elsewhere in this prospectus. The summary consolidated financial data presented below as of and for the six months ended June 30, 2008 have been derived from our unaudited interim consolidated financial statements included elsewhere in this prospectus. We have prepared the unaudited consolidated financial statements on the same basis as our audited consolidated financial statements. The unaudited consolidated financial statements include all adjustments, consisting only of normal and recurring adjustments that we consider necessary for a fair presentation of our financial position and operating results for the periods presented.
 
Prior to the reorganization, our online game business was operated by Shanda Interactive through its various subsidiaries and VIEs. Effective July 1, 2008, pursuant to the reorganization, we assumed substantially all of the assets and liabilities related to Shanda Interactive’s online game business.
 
The reorganization was accounted for as a common control transaction, and accordingly, our consolidated financial statements have been prepared as if our current corporate structure had been in existence throughout the periods presented and as if the online game business, including Actoz that Shanda Interactive subsequently transferred to us in the second quarter of 2009, was transferred to us from Shanda Interactive as of the earliest period presented.
 
For the period from January 1, 2007 to June 30, 2008, our consolidated financial statements were prepared by combining the assets, liabilities, revenues, expenses and cash flows of the entities that were directly engaged in the online game business.
 
Our statements of operations and comprehensive income for the periods prior to the reorganization include all the historical costs related to the online game business including payments for certain services performed by various subsidiaries and VIEs of Shanda Interactive, which became Shanda Online after the reorganization, and an allocation of certain general corporate expenses of Shanda Interactive. These general corporate expenses primarily relate to corporate employee compensation costs, professional service fees and other expenses arising from the provisions of certain corporate functions, including finance, legal, technology, investment and executive management. We allocated these expenses based on estimates that our management believes are a reasonable reflection of the utilization of services provided to, or benefits received by, us.
 
For the period from July 1, 2008 to June 30, 2009, our consolidated financial statements consist of the financial statements of Shanda Games, including its subsidiaries and VIEs, as a standalone company subsequent to the reorganization.
 
Our management believes that the assumptions underlying our consolidated financial statements and the above allocations are reasonable. Our consolidated financial statements for the years ended December 31, 2007 and 2008, however, may not be reflective of our result of operations, financial position and cash flows had we been operated as a standalone company during those periods. Our historical results for any prior periods are not necessarily indicative of results to be expected for any future period. In addition, our audited results for the six months ended June 30, 2009 may not be indicative of our results for the full year ending December 31, 2009.


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    For the Year Ended December 31,   For the Six Months Ended June 30,
    2007   2008   2008   2009
    RMB   RMB   US$   RMB   RMB   US$
                (unaudited)        
    (in millions, except per share data)
 
Selected Consolidated Statements of Operations Data:
                                               
Net revenues:
                                               
Online MMORPG revenues
    2,016.1       2,987.8       437.4       1,335.1       2,026.1       296.6  
Online advanced casual game revenues
    280.4       358.9       52.5       187.1       159.8       23.4  
Other revenues
    26.3       30.1       4.4       17.8       12.6       1.9  
                                                 
Total net revenues
    2,322.8       3,376.8       494.3       1,540.0       2,198.5       321.9  
                                                 
Cost of revenues
                                               
Third parties
    (492.0 )     (768.3 )     (112.5 )     (367.6 )     (476.1 )     (69.7 )
Related parties
    (769.1 )     (721.1 )     (105.6 )     (379.1 )     (405.0 )     (59.3 )
                                                 
Total cost of revenues
    (1,261.1 )     (1,489.4 )     (218.1 )     (746.7 )     (881.1 )     (129.0 )
                                                 
Gross profit
    1,061.7       1,887.4       276.2       793.3       1,317.4       192.9  
                                                 
Operating expenses:
                                               
Product development
    (136.4 )     (238.8 )     (35.0 )     (112.9 )     (151.9 )     (22.2 )
Sales and marketing
                                               
Third parties
    (125.4 )     (124.4 )     (18.2 )     (58.4 )     (79.1 )     (11.6 )
Related parties
          (80.1 )     (11.7 )           (102.3 )     (15.0 )
General and administrative
    (175.2 )     (287.2 )     (42.0 )     (137.9 )     (152.5 )     (22.3 )
Total operating expenses
    (437.0 )     (730.5 )     (106.9 )     (309.2 )     (485.8 )     (71.1 )
                                                 
Income from operations
    624.7       1,156.9       169.3       484.2       831.6       121.8  
Interest income
    26.3       33.4       4.9       21.5       11.5       1.7  
Investment income
    *                         0.2       *  
Other income (expense), net
    28.7       6.1       0.9       (16.2 )     38.0       5.5  
                                                 
Income before income tax expense and equity in earnings (loss) of affiliated companies
    679.7       1,196.4       175.1       489.5       881.3       129.0  
Income tax expenses
    (67.1 )     (249.9 )     (36.6 )     (101.6 )     (190.7 )     (27.9 )
Equity in earnings (loss) of affiliated companies
    (13.6 )     0.9       0.1       (0.2 )     (10.2 )     (1.5 )
                                                 
Net income
    599.0       947.4       138.6       387.7       680.4       99.6  
Less: Net income attributable to non-controlling interest
    (7.1 )     (11.9 )     (1.7 )     (4.9 )     (9.2 )     (1.3 )
                                                 
Net income attributable to Shanda Games Limited
    591.9       935.5       136.9       382.8       671.2       98.3  
                                                 
Earnings per ordinary share
                                               
Basic
    1.08       1.70       0.25       0.70       1.22       0.18  
Diluted
    1.08       1.70       0.25       0.70       1.22       0.18  
Earnings per ADS
                                               
Basic
    2.16       3.40       0.50       1.40       2.44       0.36  
Diluted
    2.16       3.40       0.50       1.40       2.44       0.36  
Weighted average ordinary shares outstanding
                                               
Basic
    550.0       550.0       550.0       550.0       550.0       550.0  
Diluted
    550.0       550.0       550.0       550.0       550.1       550.1  
 
Share-based compensation included in:
                                                 
Cost of revenue
    (0.3 )     (0.8 )     (0.1 )     (0.6 )     (0.6 )     (0.1 )
Product development
    (0.8 )     (1.9 )     (0.3 )     (1.4 )     (1.0 )     (0.1 )
Sales and marketing
          (1.0 )     (0.1 )     (0.6 )     (0.4 )     (0.1 )
General and administrative
    (16.4 )     (17.1 )     (2.5 )     (8.3 )     (16.5 )     (2.4 )
 
 
* Less than 0.1.


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    As of December 31,   As of June 30,    
    2007   2008   2009    
    RMB   RMB   US$   RMB   US$    
    (in millions)
 
Selected Consolidated Balance Sheets Data:
                                               
Total current assets
    904.4       1,582.7       231.7       1,923.1       281.6          
Total assets
    1,857.3       2,444.1       357.8       2,856.4       418.2          
Total current liabilities
    606.9       1,178.0       172.5       1,798.1       263.3          
Total liabilities
    640.9       1,208.2       176.9       1,826.6       267.4          
Total Shanda Games Limited shareholder’s equity
    1,001.2       1,097.0       160.6       865.7       126.8          
Non-controlling interest
    215.2       138.9       20.3       164.1       24.0          
Total equity
    1,216.4       1,235.9       180.9       1,029.8       150.8          
Total liabilities and equity
    1,857.3       2,444.1       357.8       2,856.4       418.2          
 
                                                 
    For the Year Ended December 31,   For the Six Months Ended June 30,
    2007   2008   2008   2009
    RMB   RMB   US$   RMB   RMB   US$
                (unaudited)        
    (in millions)
 
Selected Consolidated Statements of Cash Flow Data:
                                               
Net cash provided by operating activities
    672.7       1,144.5       167.6       568.8       935.3       136.9  
Net cash used in investing activities
    (132.1 )     (144.2 )     (21.1 )     (133.5 )     (1,299.9 )     (190.3 )
Net cash provided by (used in) financing activities
    (376.0 )     (748.3 )     (109.6 )     (232.4 )     532.4       77.9  
Effect of exchange rate changes on cash
    (7.1 )     (16.7 )     (2.4 )     (7.4 )     2.8       0.4  


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled “Selected Consolidated Financial Information” and our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.
 
Overview
 
We are China’s leading online game company in terms of the size and diversity of our game portfolio. Our online game revenues and game player base are also among the largest in China. Through our extensive experience in the online game industry in China, we have created a scalable approach to develop, source and operate online games, as well as license our games to third parties. We develop and source a broad array of game content through multiple channels, including in-house development, licensing, investment and acquisition, co-development, and co-operation. Through these channels, we have built a large, diversified game portfolio and a robust game pipeline. In addition, we operate a nationwide, secure network to host hundreds of thousands of users playing simultaneously, and monitor and adjust the game environment to optimize our game players’ experience.
 
As of August 31, 2009, we operated 20 MMORPGs and 11 advanced casual games and had 16 MMORPGs and eight advanced casual games in our announced pipeline. Our in-house development capabilities consist of over 1,100 game development personnel and our proprietary game development platform.
 
We use either the item-based or time-based revenue model for the games we operate. Compared with the time-based model, under which players pay for game-playing time, the item-based model allows game players to play the basic features of the game for free. Game players may then choose to purchase virtual items that enhance their playing experience, such as weapons, clothing, accessories and pets. Our game players purchase electronic or physical prepaid cards to purchase virtual items and to access our time-based online games. We have adopted the item-based model for substantially all of our MMORPGs and all of our advanced casual games.
 
Our net revenues increased 45% from RMB2,322.8 million in 2007 to RMB3,376.8 million (US$494.3 million) in 2008. Our net income increased 58% from RMB591.9 million in 2007 to RMB935.5 million (US$136.9 million) in 2008. Our net revenues increased 43% from RMB1,540.0 million in the six months ended June 30, 2008 to RMB2,198.5 million (US$321.9 million) in the six months ended June 30, 2009. Our net income attributable to our company increased 75% from RMB382.8 million in the six months ended June 30, 2008 to RMB671.2 million (US$98.3 million) in the six months ended June 30, 2009.
 
We depend substantially on two online games, which accounted in the aggregate for approximately 75.9% and 77.0% of our net revenues in 2008 and the six months ended June 30, 2009, respectively. These games have finite commercial lifespan. While we may be able to extend the commercial lifespans of these games by adding new features that appeal to existing players and attract new players, we need to develop and source new online games that appeal to game players and that will be commercially successful in order to remain competitive. Furthermore, the online game industry in China may not continue to grow at current levels, and we face uncertainties regarding the continuing market acceptance of our online games in China and elsewhere. We need to adapt to new industry trends, including changes in game players’ preferences, new revenue models, new game content distribution models, new technologies and new governmental regulations. We evaluate these changes as they emerge and strive to adapt our business and operations in order to maintain and strengthen our leadership in the industry.


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The Reorganization and the Basis of Preparation
 
Our online game business was founded by Shanda Interactive, our parent, in 2001 and was operated by Shanda Interactive through various subsidiaries and VIEs, until the reorganization on July 1, 2008. As part of the reorganization, Shanda Interactive transferred substantially all of its assets and liabilities related to the online game business to us. In connection with the reorganization, we entered into agreements with Shanda Interactive and certain of its affiliates with respect to various ongoing relationships between us. See “Our History and Corporate Structure” and “Our Relationship with Shanda Interactive”.
 
As the reorganization was accounted for as a common control transaction, our consolidated financial statements have been prepared as if our current corporate structure had been in existence throughout the periods presented and as if the online game business, including Actoz that Shanda Interactive subsequently transferred to us in the second quarter of 2009, was transferred to us from Shanda Interactive as of the earliest period presented. Accordingly, for the period from January 1, 2007 to June 30, 2008, our consolidated financial statements were prepared by combining the assets, liabilities, revenues, expenses and cash flows of entities that were directly engaged in the online game business.
 
Our statements of operations and comprehensive income for the periods prior to the reorganization include all the historical costs related to the online game business, including payments for certain services performed by Shanda Interactive’s various subsidiaries and VIEs, which became Shanda Online after the reorganization, and an allocation of certain general corporate expenses of Shanda Interactive. These general corporate expenses primarily relate to employee compensation costs, professional service fees and other expenses arising from the provisions of certain corporate functions, including finance, legal, technology, investment and executive management. We allocated these expenses based on estimates that our management believes are a reasonable reflection of the utilization of services provided to, or benefits received by, us. See Note 2(1) to our consolidated financial statements included elsewhere in this prospectus for further information related to these costs. Shanda Interactive allocated an aggregate of RMB37.6 million, RMB31.3 million (US$4.6 million) and RMB11.4 million (US$1.7 million) of corporate expenses to us for the years ended December 31, 2007 and 2008, and the six months ended June 30, 2009, respectively. While the expenses allocated to us are not necessarily indicative of the expenses that we would have incurred if we had been a separate, independent entity during the periods presented, management believes that the foregoing presents a reasonable basis of estimating what our expenses would have been on a historical basis.
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and expenses during the reporting periods presented. Actual results could materially differ from those estimates.
 
For the period from July 1, 2008 to June 30, 2009, our consolidated financial statements consist of the financial statements of Shanda Games, including its subsidiaries and VIEs, as a standalone entity subsequent to the reorganization.
 
Our Agreements with Shanda Online
 
Effective as of the reorganization, we have engaged certain VIEs of Shanda Online to provide certain services that are critical to our business. Pursuant to the Amended and Restated Cooperation Agreement between Shanda Networking and Nanjing Shanda, on the one hand, and the Shulong entities, on the other hand, we have engaged Shanda Networking as our provider of certain services, including, among others, online billing and payment, user authentication, customer service, anti-fatigue compliance, prepaid card marketing and data support services for a period of five years commencing July 1, 2008. We pay Shanda Networking a service fee, which we record as a portion of platform fees in our cost of revenues. Because a substantial portion of platform fees is based on a fixed percentage of the face value of prepaid cards used in our games, we expect our platform fees as a percentage of net revenues to remain generally stable going forward. Pursuant to the Amended and Restated Sales Agency Agreement between Shengfutong and the Shulong entities, we have engaged Shengfutong, for a period of five years commencing July 1, 2008, as the sales agent for the distribution of prepaid cards which are required to purchase virtual items or time units in


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our online games. For each prepaid card sold, we pay Shengfutong a service fee, which we record as a portion of sales and marketing expenses in our operating expenses. See “Our Relationship with Shanda Interactive — Our Relationship with Shanda Interactive Following the Reorganization — Amended and Restated Cooperation Agreement” and “Our Relationship with Shanda Interactive — Our Relationship with Shanda Interactive Following the Reorganization — Amended and Restated Sales Agency Agreement” for more details on the terms of these agreements, including the fixed discount to the face value of prepaid cards used to calculate the service fees we pay under these agreements. Prior to the reorganization, the services currently provided by Shanda Networking were performed by Shanda Interactive’s various subsidiaries and VIEs and the service fees were based on certain agreements in existence at that time. Prior to the reorganization, the services currently provided by Shengfutong were performed by our own sales and marketing personnel and the costs relating to such services were recorded as a portion of sales and marketing expenses.
 
Due to the differences in the agreements in place prior to and after the reorganization, our results of operations for the periods prior to and after the reorganization are not entirely comparable. Specifically, the agreements pursuant to which we recognize platforms fees and sales and marketing expenses following the reorganization differ from the methods prior to the reorganization. Therefore, with respect to periods prior to and after July 1, 2008, cost of revenues (namely, platform fees) and operating expenses (namely, sales and marketing expense) are not entirely comparable, which also impact other line items such as gross profit, income from operations and net income. As a result, the results of operations for the years ended December 31, 2007 and 2008 and the six months ended June 30, 2008 and June 30, 2009 may not be entirely comparable.
 
Factors Affecting Our Results of Operations
 
Our results of operations are affected by several key factors including the following:
 
Our ability to continue to successfully introduce new online games and expansion packs for existing games
 
We have built the largest and the most diversified portfolio of online games in China through our multi-channel game content development and sourcing strategy. We must continue to generate and acquire attractive online games by developing in-house, licensing, acquiring through investment, co-developing or co-operating with third parties, new online games and to maintain the popularity of our existing online games by introducing updates, expansion packs and other game improvements. Our results of operations may also be significantly affected by the timing of our new game launches.
 
Our ability to maintain and expand our community of loyal game players
 
The size and loyalty of our community of game players are critical to our business. Players of online games, especially MMORPGs, are typically attracted to online games in which they can interact with many players. We have built a large community of game players and have maintained and expanded this community by enhancing our game players’ loyalty to our online games. Our loyal game players tend to remain active paying game players and in addition, such game players are likely to spend more on our virtual items or consume more playing time on our games. Our ability to retain and attract game players will depend significantly on our ability to continually strengthen our community of loyal game players and enhance their experience.
 
Game content sourcing costs
 
Significant resources are required to develop, acquire and market new online games and maintain their popularity in the market, including game development, game licensing and other online game generation and acquisition costs. We typically incur significant costs and expenses before such online games generate any revenues. If such games are not popular and do not generate substantial revenues, we may not be able to recover such game content sourcing costs.


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The reliability and quality of Shanda Networking’s integrated service platform and Shengfutong’s distribution services
 
We have engaged Shanda Networking and Shengfutong to provide certain services that are critical to the operation of our online game business, including online billing and payment, customer service, user authentication, anti-fatigue compliance, prepaid card marketing and distributions and data support services, for a period of five years commencing July 1, 2008. See “Our Relationship with Shanda Interactive”. The reliability and quality of Shanda Networking’s integrated service platform and Shengfutong’s distribution services directly affect the availability of our online games to our game players and the quality of the game-playing experience, which would have a material effect on our revenues.
 
Competition in China’s online game industry
 
The online game industry in China is highly competitive. Numerous competitors have entered the online game industry in China, including Changyou.com Limited, Giant Interactive Group, Inc., Kingsoft, NetDragon Websoft Inc., NetEase.com, Nineyou International Limited, Perfect World Co., Ltd., Tencent Holdings Limited and The9 Limited. The proliferation of the number of online game companies has placed significant pressure on the cost of sourcing and marketing online games, attracting new and retaining existing game players, and recruiting and retaining game development and management talent.
 
Revenues
 
We currently derive substantially all of our revenues from purchases of virtual items by game players of our MMORPGs and advanced casual games.
 
The following table sets forth, for the periods indicated, a breakdown of our net revenues into MMORPGs, advanced casual games and other revenues.
 
                                                                 
    For the Year Ended December 31,   For the Six Months Ended June 30,
    2007   2008   2008   2009
        % of Net
      % of Net
      % of Net
      % of Net
    RMB   Revenues   RMB   Revenues   RMB   Revenues   RMB   Revenues
                    (unaudited)        
    (in millions, except percentages)
 
Net revenues:
                                                               
Online MMORPG revenues
    2,016.1       86.8 %     2,987.8       88.5 %     1,335.1       86.7 %     2,026.1       92.2 %
Online advanced casual game revenues
    280.4       12.1       358.9       10.6       187.1       12.1       159.8       7.2  
Other revenues(1)
    26.3       1.1       30.1       0.9       17.8       1.2       12.6       0.6  
                                                                 
Total net revenues
    2,322.8       100.0 %     3,376.8       100.0 %     1,540.0       100.0 %     2,198.5       100.0 %
                                                                 
 
 
(1) Other revenues primarily include fees received from game promotions and short messaging services fees earned.
 
Our revenues from MMORPGs and advanced casual games are net of a sales discount. For the periods prior to the reorganization, the sales discount represented the difference between the face value of the prepaid card and the price at which we sold the prepaid card to our distributors or to our game players. For the periods subsequent to the reorganization, the sales discount represents the difference between the face value of the prepaid cards and the price at which Shengfutong sells the prepaid cards to third-party distributors and


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retailers or directly to our game players. Therefore, with respect to each prepaid card sold, the amount of revenues we record and service fee we pay to Shengfutong, which we record under sales and marketing expenses in our operating expenses, depend on the sales discount at which Shengfutong sells the prepaid card. A smaller discount applied by Shengfutong will result in higher net revenues to us, as well as corresponding higher service fee paid to Shengfutong, and vice versa. Notwithstanding the foregoing, with respect to each prepaid card sold, we are guaranteed a fixed percentage of the face value of a prepaid card in revenues.
 
Our revenues are also net of the PRC business tax that our PRC operating companies pay on their gross revenues. The PRC business tax ranges from 3% to 5%.
 
We operate our games using one of two revenue models. For games operated using the item-based revenue model, the most significant factors that affect our revenues are (i) the number of active paying accounts and (ii) the range, number and pricing of virtual items available for sale. The number of active paying accounts for any given period is equal to the number of game player accounts that spend virtual currency at least once during a given period and includes accounts of game players who spend virtual currency in beta testing of our online games. Our quarterly active paying accounts is equal to the aggregate number of active paying accounts for our online games during a given quarter.
 
For games operated using the time-based revenue model, the most significant factors that affect our revenues are (i) the number of users playing the game and (ii) the length of time that users play the game, or total user-hours. We calculate our total user-hours based on our average concurrent users. In a given period, the number of total user-hours equals the average concurrent users for that period multiplied by the number of hours in that period. In measuring average concurrent users, we determine the number of users logged on to our games that adopt the time-based revenue model at one minute intervals, and then average that number over the course of a day to derive daily averages. Average daily information is further averaged over a particular period to determine average concurrent users for that period.
 
Our online game business is subject to seasonality factors. Generally, our game players spend more time playing our games in the first and third quarters of each year, which typically have more holidays, allowing for more time for leisure activities, whereas the second and fourth quarters are generally slower for our business as there are fewer holidays during those quarters.
 
Cost of Revenues
 
Our cost of revenues primarily consists of platform fees, upfront and ongoing licensing fees for online games and other miscellaneous expenses. The following table sets forth, for the periods indicated, a breakdown of our cost of revenues by amount and percentage of our net revenues.
 
                                                                 
    For the Year Ended December 31,   For the Six Months Ended June 30,
    2007   2008   2008   2009
        % of Net
      % of Net
      % of Net
      % of Net
    RMB   Revenues   RMB   Revenues   RMB   Revenues   RMB   Revenues
                    (unaudited)        
    (in millions, except percentages)
 
Net revenues
    2,322.8       100.0 %     3,376.8       100.0 %     1,540.0       100.0 %     2,198.5       100.0 %
                                                                 
Cost of revenues:
                                                               
Platform fees
    735.4       31.7       864.9       25.6       451.2       29.3       459.7       20.9  
Upfront and ongoing licensing fees
    429.6       18.5       520.9       15.4       235.0       15.3       366.1       16.7  
Others
    96.1       4.1       103.6       3.1       60.5       3.9       55.3       2.5  
                                                                 
Total cost of revenues
    1,261.1       54.3       1,489.4       44.1       746.7       48.5       881.1       40.1  
                                                                 
Gross profit/margin
    1,061.7       45.7 %     1,887.4       55.9 %     793.3       51.5 %     1,317.4       59.9 %
                                                                 
 
Platform fees.  Platform fees consist of (1) costs related to various support services, including online billing and payment, user authentication, customer service, anti-fatigue compliance, prepaid card marketing and data support services, and (2) other expenses related to server leasing expense, depreciation of purchased


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servers and equipment, server and equipment maintenance fees, and software rental fees. Platform fees constituted approximately 31.7%, 25.6% and 20.9% of our net revenues in 2007, 2008 and the six months ended June 30, 2009, respectively. The decrease in platform fees as a percentage of net revenues resulted primarily from the fact that following the reorganization effective July 1, 2008, we paid Shanda Networking a service fee related to various platform services, described in clause (1) in the first sentence of this paragraph based upon a fixed percentage of the portion of the face value of prepaid cards distributed and used in our games, which has resulted in lower fees as a percentage of our net revenues. We expect our platform fees as a percentage of our net revenues to remain generally stable going forward because a substantial portion of platform fees is based on a fixed percentage of the portion of the face value of prepaid cards used in our games.
 
Upfront and ongoing licensing fees.  The cost of licensing games from third-party game content providers consists of upfront licensing fees, which are generally paid in several installments, and ongoing licensing fees, the majority of which is equal to a percentage of the revenues we generate from the relevant licensed game and, in some circumstances, includes a minimum guarantee. Upfront licensing fees are amortized on a straight-line basis over the shorter of the licensed period and the useful economic life of the relevant licensed game. Amortization of upfront licensing fees and ongoing licensing fees for games constituted approximately 18.5%, 15.4% and 16.7% of our net revenues in 2007, 2008 and the six months ended June 30, 2009, respectively. The decrease in ongoing licensing fees as a percentage of our net revenues from 2007 to 2008 is primarily due to the consolidation beginning from the third quarter of 2007 of the financial results of Actoz, which licenses several games to us, including Mir II, which is our top game in terms of revenues in 2008. While Actoz is our majority-owned subsidiary and controls the licensing of Mir II in China, we continue to classify Mir II as a licensed game because Actoz shares a portion of the ongoing licensing fees we pay to Actoz with a third party that co-owns the intellectual property rights relating to Mir II. We expect our upfront and ongoing licensing fees as a percentage of our net revenues to increase slightly in 2009 due to the full year impact of games licensed from third parties.
 
Others.  Other expenses include employee salary and welfare benefits, such as medical insurance, statutory housing contributions, unemployment insurance and pension benefits, for employees involved in the operation of our online games, stock-based compensation for employees who operate our games and office expenses. Other expenses were approximately 4.1%, 3.1% and 2.5% of our net revenues in 2007, 2008 and the six months ended June 30, 2009, respectively.
 
Gross profit/margin.  Gross profit as a percentage of our net revenues was 45.7%, 55.9% and 59.9% in 2007, 2008 and the six months ended June 30, 2009, respectively.


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Operating Expenses
 
Our operating expenses consist of product development expenses, sales and marketing expenses and general and administrative expenses. The following table sets forth, for the periods indicated, a breakdown of our operating expenses by amount and percentage of our net revenues.
 
                                                                 
    For the Year Ended December 31,   For the Six Months Ended June 30,
    2007   2008   2008   2009
        % of Net
      % of Net
      % of Net
      % of Net
    RMB   Revenues   RMB   Revenues   RMB   Revenues   RMB   Revenues
                    (unaudited)        
    (in millions, except percentages)
 
Net revenues:
    2,322.8       100.0 %     3,376.8       100.0 %     1,540.0       100.0 %     2,198.5       100.0 %
                                                                 
Operating expenses:
                                                               
Product development
    136.4       5.9       238.8       7.1       112.9       7.3       151.9       6.9  
Sales and marketing
    125.4       5.4       204.5       6.1       58.4       3.8       181.4       8.3  
General and administrative
    175.2       7.5       287.2       8.4       137.9       9.0       152.5       6.9  
                                                                 
Total operating expenses
    437.0       18.8       730.5       21.6       309.2       20.1       485.8       22.1  
                                                                 
Operating profit/margin
    624.7       26.9 %     1,156.9       34.3 %     484.2       31.4 %     831.6       37.8 %
                                                                 
 
Product development expenses.  Our product development expenses primarily consist of salary and benefits expenses of personnel engaged in the product development of our online games, outsourced game development expenses as a result of our investments through 18 Capital, share-based compensation and other expenses incurred by our product development personnel. Product development expenses were 5.9%, 7.1% and 6.9% of our net revenues in 2007, 2008 and the six months ended June 30, 2009, respectively. We expect our product development expenses to increase in 2009, as we develop new online games, updates or expansion packs for our existing online games, customize games licensed from third parties and continue to invest through 18 Capital.
 
Sales and marketing expenses.  Our sales and marketing expenses primarily consist of advertising and promotion expenses for our online games in different media outlets, costs related to distribution of prepaid cards, salary and benefits for our sales and marketing personnel, share-based compensation and other expenses incurred by our sales and marketing personnel. Beginning on July 1, 2008, service fees paid to Shengfutong for the distribution of prepaid cards pursuant to the Amended and Restated Sales Agency Agreement are recorded as sales and marketing expenses. Sales and marketing expenses were 5.4%, 6.1% and 8.3% of our net revenues in 2007, 2008 and the six months ended June 30, 2009, respectively. We expect our sales and marketing expenses to increase in 2009 as we expect our service fee paid to Shengfutong to increase as more prepaid cards are sold and our advertising and promotion expenses to increase as we launch additional new games and expand our sales and marketing efforts in our existing markets and in new markets.
 
General and administrative expenses.  Our general and administrative expenses primarily consist of salary and benefits for general management, finance and administrative personnel, professional services fees, business tax expenses, share-based compensation and other expenses. General and administrative expenses were 7.5%, 8.4% and 6.9% of our net revenues in 2007, 2008 and the six months ended June 30, 2009, respectively. Our business tax expense relates to services and licensing fees paid by our PRC operating companies to Shengqu. We expect the general and administrative expenses to increase in 2009 due to the increased amount of business tax to be paid by our PRC operating companies, as a result of the increasing volume of services to be performed by our PRC subsidiaries for our PRC operating companies, increased headcount as we develop our own general management, financial and administrative departments and increased professional service fees as a result of being a publicly listed company.


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Operating profit/margin.  Operating profit as a percentage of our net revenues was 26.9%, 34.3% and 37.8% in 2007, 2008 and the six months ended June 30, 2009, respectively.
 
Non-Operating Income
 
Our non-operating income consists of interest income and other non-operating income.
 
Interest Income.  We earn interest income from the deposit of our cash balance with banks.
 
Other Non-Operating Income.  Other non-operating income primarily consists of government incentives. Due to the preferential treatments for qualified high technology companies in China and incentives from local governments to encourage regional business development, certain of our PRC companies receive financial incentives from local governments that are calculated with reference to taxable income and revenues, as the case may be. The amount and timing of the financial incentives are determined by government authorities. Upon receipt, these incentives are recognized as other income in our statements of operations and comprehensive income. Please see note 5 to our consolidated financial statements included elsewhere in this prospectus.
 
In 2007, 2008 and the six months ended June 30, 2009, we received an aggregate of RMB54.3 million, RMB18.4 million (US$2.7 million) and RMB37.4 million (US$5.5 million) in cash, respectively, as financial incentives from municipal governments. Going forward, eligibility for the government financial incentives we may receive requires that we continue to meet a number of government-mandated financial and non-financial criteria, which generally include:
 
  •  generating more than a minimum level of revenues from high-tech related sales or services, determined as a percentage of total revenues;
 
  •  employing more than a minimum number of employees in product development; and
 
  •  expending more than a minimum amount on product development, determined as a percentage of total revenues.
 
The continued qualification is further subject to the discretion of the municipal government. Moreover, the central government or municipal government could determine at any time to immediately eliminate or reduce these financial incentives. Upon expiration of these government financial incentives, we will consider available options, in accordance with applicable law, that would enable us to qualify for additional government financial incentives to the extent they are then available to us.
 
Taxation
 
Under the current laws of the Cayman Islands, we are not subject to tax on income or capital gains. In addition, payment of dividends by us is not subject to withholding tax in the Cayman Islands.
 
Under the Hong Kong Inland Revenue Ordinance, Shanda Games (HK) was subject to 17.5% income tax for the year ended December 31, 2007 and 16.5% for the year ended December 31, 2008 and the six months ended June 30, 2009 on its taxable income generated from operations in Hong Kong. Additionally, payments of dividends by Shanda Games (HK) are not subject to any Hong Kong withholding tax.
 
PRC Enterprise Income Tax
 
Prior to January 1, 2008, our PRC operating entities were governed by the Income Tax Law of the PRC for Enterprises with Foreign Investment and Foreign Enterprises and the Provisional Regulations of the PRC on Enterprises Income Tax, or the Old EIT Laws. Pursuant to the Old EIT Laws, PRC enterprises were generally subject to Enterprise Income Tax, or the EIT, at a statutory rate of 33% (30% state income tax plus 3% local income tax), or 15% for certain technology enterprises, on PRC taxable income. Companies that are registered in the Pudong New District of Shanghai are, however, subject to a 15% preferential EIT rate


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pursuant to the local tax preferential treatment prior to January 1, 2008. Furthermore, foreign invested enterprises were exempted from PRC state income tax for two years, beginning with their first profitable year of operations, and were entitled to a 50% tax reduction for the subsequent three years. During the year ended December 31, 2007, certain of our operations in the PRC were subject to an applicable tax rate of 15% as a result of being named new technology enterprises, except for Shengqu, which, as a foreign invested company and software development enterprise, was subject to an income tax rate of 7.5% for the year 2007.
 
In March 2007, the PRC government enacted the PRC Enterprise Income Tax Law, or the New EIT Law, and promulgated related regulation, Implementing Regulations for the PRC Enterprise Income Tax Law. The law and regulation went into effect on January 1, 2008. The PRC Enterprise Income Tax Law, among other things, imposes a unified income tax rate of 25% for both domestic and foreign invested enterprises. The PRC Enterprise Income Tax Law provides a five-year transitional period for those entities established before March 16, 2007, which enjoyed a favorable income tax rate of less than 25% under the previous income tax laws and rules, to gradually change their rates to 25%.
 
On April 14, 2008, relevant governmental regulatory authorities released qualification criteria, application procedures and assessment processes for “high and new technology enterprises”, which will be entitled to a favorable statutory tax rate of 15%. On July 8, 2008, relevant governmental authorities further clarified that high and new technology enterprises previously qualified under the previous income tax laws and rules as of December 31, 2007 were allowed to enjoy grandfather treatment for the unexpired tax holidays, on condition that they were re-approved for “high and new technology enterprise” status under the regulations released on April 14, 2008. An enterprise’s qualification as a “high and new technology enterprise” is re-assessed by the relevant PRC governmental authorities every three years.
 
In December 2008, the local governments recognized Shengqu, Shanghai Shulong and Chengdu Aurora as “high and new technology enterprises”. Accordingly, these entities are entitled to a 15% preferential income tax rate for the three-year period ending December 31, 2010. In addition, Shengqu also qualified as a key national software enterprise on December 31, 2008 and therefore is entitled to a 10% income tax rate for 2008.
 
As required by the New EIT Law, the profits of a foreign invested enterprise arising in 2008 and onwards which are distributed to its immediate holding company outside the PRC are subject to a withholding tax rate of 10%. A lower withholding tax rate will be applied if there is a tax treaty or arrangement between the PRC and the jurisdiction of the foreign holding company. Holding companies in Hong Kong, for example, are subject to a 5% withholding tax rate. As of December 31, 2008, we accrued a withholding tax of RMB37.0 million (US$5.4 million) based on the 5% withholding tax rate of the profits of Shengqu that we distributed to Shanda Games (HK) and paid such withholding tax in the first half of 2009.
 
Equity in Earning (Loss) of Affiliated Companies
 
We record our investment in affiliates using the equity method of accounting, and the profit or loss from of the affiliates is presented as “Equity in earning (loss) of affiliated companies” on the statements of operations and comprehensive income.
 
Non-Controlling Interest
 
In the second quarter of 2009, Shanda Interactive transferred to us its entire equity interest in Actoz, whose financial results were consolidated into our financial statements beginning from July 1, 2007. As a result, we recognized non-controlling interest in our statements of operations and comprehensive income for the shares of Actoz that we did not own for the period from July 1 to December 31, 2007, for the year ended December 31, 2008 and the six months ended June 30, 2009. See “— Critical Accounting Policies — Basis of Preparation”.


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Critical Accounting Policies
 
We prepare our financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities on the date of the financial statements and the reported amounts of revenues and expenses during the financial reporting period. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of our accounting policies require higher degrees of judgment than others in their application. We consider the policies discussed below to be critical to an understanding of our financial statements as their application places the most significant demands in our management’s judgment.
 
Basis of Preparation
 
The reorganization is accounted for as a common control transaction, and accordingly, we have prepared the consolidated financial statements as if the current corporate structure had been in existence throughout the periods presented and as if the online game business, including Actoz that Shanda Interactive transferred to us in the second quarter of 2009, was transferred to us from Shanda Interactive as of the earliest period presented.
 
Before the reorganization, the online game business was conducted by various subsidiaries and VIEs of Shanda Interactive. Therefore, for the period from January 1, 2007 to June 30, 2008, our consolidated financial statements were prepared by combining the assets, liabilities, revenues, expenses and cash flows of the entities that were directly engaged in the online game business.
 
Our statement of operations and comprehensive income for the periods prior to the reorganization include all the historical costs related to the online game business including payments for certain services performed by various subsidiaries and VIEs of Shanda Interactive, which became Shanda Online after the reorganization, and an allocation of certain general corporate expenses of Shanda Interactive. These general corporate expenses primarily relate to corporate employee compensation costs, professional service fees and other expenses arising from the provisions of certain corporate functions, including finance, legal, technology, investment and executive management. We allocated these expenses based on estimates that our management believes to be a reasonable reflection of the utilization of services provided to, or benefits received by, us.
 
For the period from July 1, 2008 to June 30, 2009, our consolidated financial statements consist of the financial statements of Shanda Games, including its subsidiaries and VIEs, as a standalone company subsequent to the reorganization.
 
Our management believes that the assumptions underlying our consolidated financial statements and the above allocations are reasonable. Our consolidated financial statements, however, may not be reflective of our result of operations, financial position and cash flows had we been operated as a standalone company during those periods. Our historical results for any prior period are not necessarily indicative of results to be expected for any future period. In addition, our audited results for the six months ended June 30, 2009 may not be indicative of our results for the full year ending December 31, 2009.
 
Revenue Recognition
 
Prior to the reorganization, Shanda Interactive sold prepaid cards, in both virtual and physical forms, to third party distributors and retailers, including Internet cafes, as well as through direct online payment systems. The prepaid cards entitle end users to purchase virtual items or time units in our online games. All proceeds received from distributors or retailers are deferred when received.
 
In connection with the reorganization, we entered into various agreements with subsidiaries that are under the common control of Shanda Interactive. Pursuant to the Amended and Restated Cooperation Agreement, we have engaged Shanda Networking to provide customer and other game support services, and pursuant to the Amended and Restated Sales Agency Agreement, we have engaged Shengfutong to provide agency services in


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selling prepaid cards to third party distributors and retailers, in each case for a period of five years beginning from the date of the reorganization. We have assessed the relationship and arrangements with Shanda Networking and Shengfutong under the Emerging Issues Task Force, or EITF, Issue No. 99-19, “Reporting revenue gross as a principal versus net as an agent”, and have concluded that reporting the gross amount equal to the amount that Shengfutong receives from the sale of prepaid game cards to distributors or retailers and subsequently was activated and charged to the respective game accounts by players as deferred revenue is appropriate as we are the primary obligor and we provide the online game services desired by the customers.
 
Both before and after reorganization, under the item-based revenue model, revenues are recognized over the life of the virtual items that game players purchase or as the virtual items are consumed. Under the time-based revenue model, revenues are recognized based on the time units consumed by our game players. Revenues are also recognized when game players who had previously purchased playing time or virtual currency are no longer entitled to access the online games in accordance with our published expiration policy. Deferred revenue is reduced as revenues are recognized.
 
For revenues that are recognized over the life of the virtual item, we have considered the average period that game players typically play our games to arrive at our best estimates for the lives of these virtual items. We have also considered that the estimated lives of these virtual items may be affected by various factors, including the acceptance and popularity of expansion packs, promotional events launched and market conditions. While we believe our estimates to be reasonable based on available game player information, we may revise such estimates in the future as our games’ operation period changes. Any adjustments arising from changes in the estimates of the lives of these virtual items would be applied prospectively on the basis that such changes are caused by new information indicating a change in the game player behavior patterns. Any changes in our estimates of useful lives of these virtual items may result in our revenues being recognized on a basis different from prior periods’ and may cause our operating results to fluctuate.
 
Revenues are net of the PRC business tax that our PRC operating companies pay on their gross revenues.
 
Consolidation of Variable Interest Entities
 
PRC regulations currently limit foreign ownership of companies that provide Internet content services, which includes the operation of online games, to 50%. In addition, foreign and foreign-invested enterprises are currently not able to apply for the licenses required to operate online games in China or to provide Internet information content. We are a Cayman Islands exempted company, and therefore, as foreign or foreign-invested enterprises under PRC law, we and our PRC subsidiaries are ineligible to hold a license to operate online games in China. In order to comply with the foreign ownership restrictions, we operate our online game business in China through the Shulong entities. Our PRC operating companies and other subsidiaries of Shanghai Shulong hold the licenses and approvals that are material to the operation of our online game business. Our PRC subsidiaries have entered into a series of contractual arrangements with Shanghai Shulong and/or the shareholders of Shanghai Shulong. As a result of these contractual arrangements, we are considered the primary beneficiary of Shanghai Shulong and its subsidiaries and consolidate their results of operations, assets and liabilities in our financial statements.
 
Property and Equipment, Intangible Assets, Land Use Rights and Other Long-lived Assets
 
Our accounting for long-lived assets, including property and equipment, intangible assets, long-term prepayments and other long-lived assets is described in notes 2(11), 2(12), 2(14) and 2(15) to our consolidated financial statements included elsewhere in this prospectus. The recorded values of long-lived assets, including property and equipment, intangible assets, land use rights and other long-lived assets, are affected by a number of management estimates, including the estimated useful lives, residual values and impairment charges. Significant judgment is required in the assessment of the estimated useful lives of these assets, especially for game licenses. Changes in these estimates and assumptions could materially impact our financial position and results of operations.
 
We assess the impairment for long-lived assets whenever events or changes in circumstances indicate that the applicable carrying amount may not be recoverable. In 2007, we recognized an impairment of intangible


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assets with charges to cost of revenues in the amount of RMB20.1 million, primarily relating to upfront and minimum royalty license fees relating to an online game that was not as popular as we had previously expected. The provisions represent management’s best estimate of the probable and reasonably estimable loss. During the year ended December 31, 2008 and the six months ended June 30, 2009, we did not recognize any impairment loss relating to our long-lived assets.
 
Impairment of Investment in Affiliated Companies
 
We continually review our investments in affiliated companies to determine whether a decline in fair value below the carrying value is other than temporary. The primary factors we consider in our determination are the length of time that the fair value of the investment is below its carrying value and the financial condition, operating performance and near term prospects of the investee. In addition, we consider the reasons for the decline in fair value, including general market conditions, industry specific or investee specific reasons, changes in valuation subsequent to the balance sheet date, and our intent and ability to hold the investment for a period of time sufficient to allow for a recovery in fair value. The determination of whether a decline in value is other than temporary requires significant judgment. If the decline in fair value is deemed to be other than temporary, the carrying value of the investment is written down to fair value. Write-downs for equity method investments are included in equity in earning (loss) of affiliated companies.
 
Impairment of Goodwill
 
We review our goodwill on an annual basis or more frequently if events or changes in circumstances indicate that the goodwill might be impaired as required by Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”. In performing this review, we are required to make an assessment of fair value for our goodwill under each reporting unit. When determining fair value, we utilize various assumptions, including projection of future cash flows. A change in these underlying assumptions will cause a change in the results of the test and, as such, could cause the fair value to be less than the respective carrying amount. In such event, we would be required to record a charge, which would significantly impact our earnings. We did not recognize any impairment of goodwill during the periods presented.
 
Share-Based Compensation
 
Certain of our officers (including directors) and employees have received (i) options to purchase ordinary shares of Shanda Interactive granted by Shanda Interactive to officers (including directors) and employees who were engaged in the online game business prior to the reorganization and who subsequently became our employees following the reorganization; (ii) options to purchase ordinary shares of Actoz granted by Actoz to its officers and employees and (iii) options to purchase our Class A ordinary shares granted to officers (including directors) and employees under our Amended and Restated 2008 Equity Compensation Plan.
 
We account for any stock option grants made pursuant to the respective stock option plan in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”, or SFAS 123R. Under the fair value recognition provision of SFAS 123R, share-based compensation expense is measured at the grant date based on the fair value of the stock options and is recognized as an expense either on a straight-line basis or a graded-vesting basis, net of estimated forfeitures, over the requisite service period, which is generally the vesting period. We use the Black-Scholes option pricing model to determine the fair value of stock options where the exercisability is conditional only upon completion of the service condition through the vesting date. With respect to options for which the exercisability is conditional upon completion of both the service and performance conditions through the vesting date, we use the binomial option pricing model.
 
For our option awards granted to our employees under the Amended and Restated 2008 Equity Compensation Plan, we are required to determine the fair value of our ordinary shares at the respective grant dates. Determining the fair value of our ordinary shares requires us to make complex and subjective judgments regarding our projected financial and operating results, our unique business risks, the liquidity of our ordinary shares and our operating history and prospects at the time the grants were made.


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In determining the fair value of our ordinary shares in each of the grant date, we relied in part on a valuation report prepared by an independent valuer based on data we provided. The valuation report provided us with guidelines in determining the fair value, but the determination was made by our management. We used the income approach/discounted cash flow method as the primary approach and market approach as a cross-check to derive the fair value of our ordinary shares. We applied the discounted cash flow analysis based on our projected cash flow using management’s best estimate as of the valuation date. The projected cash flow estimate included, among other things, an analysis of projected revenue growth, gross margins, effective tax rates, capital expenditures and working capital requirements. The income approach involves applying appropriate discount rates, based on earnings forecasts, to estimated cash flows. The assumptions we used in deriving the fair value of our ordinary shares include no significant contingent liabilities, unusual contractual obligations or substantial commitments; no significant pending or threatened litigation involving us as of the valuation date; no violations of any regulations or laws by us; no redundant assets as of the valuation date other than those identified by the valuer and disclosed; no significant change in our business model; management information is on a consolidated basis; and the book values of non-operating assets and total debt approximate their fair values. These assumptions are inherently uncertain and subjective. The discount rates reflect the risks the management perceived as being associated with achieving the forecasts and are based on our estimated cost of capital, which was derived by using the capital asset pricing model, after taking into account systemic risks and company-specific risks. The capital asset pricing model is a model for pricing securities that adds an assumed risk premium rate of return to an assumed risk-free rate of return. Using this method, we determined the appropriate discount rates to be 26% as of November 14, 2008 and 25% as of April 30, 2009.
 
We also applied a discount for lack of marketability, or DLOM, to reflect the fact that, at the time of the grants, we were a closely-held company and there was no public market for our ordinary shares. To determine the discount for lack of marketability, we and the independent valuer used the Black-Scholes option pricing model and assumed a liquidity event in the first quarter of 2010. Pursuant to the Black-Scholes option pricing model, we used the cost of a put option, which can be used to hedge the price change before a privately held share can be sold, as the basis to determine the discount for lack of marketability. Based on the foregoing analysis, we used a DLOM of 23% to discount the value of our ordinary shares as of November 14, 2008 and April 30, 2009. It was concluded that our fair value as a going concern was RMB11,751 million (equivalent to US$1,720.4 million) as of November 14, 2008 and RMB15,000 million (equivalent to US$2,196.1 million) as of April 30, 2009. The fair value per ordinary share and restricted share was RMB21.37 per share (equivalent to US$3.13) as of November 14, 2008 and RMB26.60 per share (equivalent to US$3.90) as of April 30, 2009.
 
We believe that the increase in the fair value of our ordinary shares from RMB21.37 per share (equivalent to US$3.13) as of November 14, 2008 to RMB26.60 per share (equivalent to US$3.90) as of April 30, 2009 was attributable to the following significant factors and events during the period:
 
  •  the successful launch in April 2009 of AION, which is a 3D MMORPG that we license from NCSoft Corporation. AION was voted one of the “Top Ten Most Anticipated Games” at the 2008 China Game Industry Annual Conference;
 
  •  the addition of several members of the senior management team, including our chief financial officer, Richard Wei, who has over fourteen years of finance-related experience, including over eight years serving as the chief financial officer of several U.S. public companies; and
 
  •  the continued growth of the online game industry in China, from which we derive substantially all of our revenues.
 
We believe that the increase in the fair value of our ordinary shares from RMB26.60 per share (equivalent to US$3.90) as of April 30, 2009 to US$6.25 per share, corresponding to the initial public offering price set


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forth on the front cover of this prospectus, was attributable to the following significant factors and events relating to our business during the period:
 
  •  the successful launch of JX Online World, a martial arts adventure MMORPG, which we co-operate with Kingsoft Corporation Limited and which has further broadened our large, diversified game portfolio;
 
  •  our release of a major expansion pack for Mir II, which was our top game in terms of revenues in 2008;
 
  •  the successful launch in the U.S. by THQ Inc. of Company of Heroes Online, a real-time strategy MMORPG which we co-developed with THQ Inc. and which we plan to launch in China to further broaden our game portfolio;
 
  •  our successful acquisition in July 2009 of Chengdu Simo, which operates Luvinia Online, a fantasy 3D MMORPG, to further broaden our game portfolio;
 
  •  our resumption in July 2009 of operations of Crazy Kart, which is one of our more popular advanced casual games. We had licensed to a related party the right to operate the game in China until July 1, 2009;
 
  •  the appointment of three independent directors, which we believe has contributed to the enhancement of our corporate governance;
 
  •  the addition of several members of the senior management team who have extensive experience in the online game industry; and
 
  •  the continued growth of the online game industry in China, from which we derive substantially all of our revenues.
 
In addition, the increase in the fair value of our ordinary shares was due to the acceleration of the anticipated liquidity event in our valuation analysis from the first quarter of 2010 to the third quarter of 2009, as well as the general improvement in the capital markets and companies in our industry beginning in the second quarter of 2009.
 
The intrinsic value of the options outstanding as of June 30, 2009 was US$75.3 million, based on the initial public offering price set forth on the front cover of this prospectus.
 
The determination of the fair value of share options on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables, including our expected stock price volatility over the vesting period, risk-free interest rate, expected dividend yield, and actual and projected employee stock option exercise behaviors. Furthermore, we are required to estimate forfeitures at the time of grant and recognize share-based compensation expenses only for those awards that are expected to vest. If actual forfeitures differ from those estimates, we may need to revise those estimates used in subsequent periods.
 
Our share-based compensation expenses totaled RMB17.5 million, RMB20.8 million (US$3.0 million) and RMB18.5 million (US$2.7 million) in 2007, 2008 and the six months ended June 30, 2009, respectively.
 
Income Taxes and Valuation Allowance
 
We account for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes”, with the required disclosures as described in note 6 to our consolidated financial statements included elsewhere in this prospectus. Accordingly, we record valuation allowances to reduce our deferred tax assets when we believe it is more likely than not that we will not be able to utilize the deferred tax asset amounts based on our estimates of future taxable income and prudent and feasible tax planning strategies. As of December 31, 2007 and 2008 and as of June 30, 2009, valuation allowances recognized were RMB3.1 million, RMB41.6 million (US$6.1 million) and RMB72.4 million (US$10.6 million), respectively. Valuation allowances were provided for because it was more likely than not that we would not be able to utilize certain


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foreign tax credit carry forward generated by one of our subsidiaries. As of December 31, 2007 and 2008 and as of June 30, 2009, we recorded deferred tax assets, net of valuation allowances, of RMB147.9 million, RMB105.1 million (US$15.4 million) and RMB113.8 million (US$16.7 million), respectively. We do not believe any further valuation allowances to reduce our net deferred tax assets are necessary as we currently anticipate future taxable profits which will allow us to fully utilize our net deferred tax assets in the foreseeable future. If, however, events were to occur in the future which are not currently contemplated, that would not allow us to realize all or part of our net deferred tax assets in the future, an adjustment would result by way of a charge to income tax expense in the period in which such determination was made.
 
FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes — An interpretation of FASB Statement No. 109”, or FIN 48, prescribes a recognition threshold and a measurement attribute for the financial statements recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Our adoption of FIN 48 did not result in any adjustments to the opening balance of our retained earnings as of January 1, 2007. We did not have any interest and penalties associated with uncertain tax positions and did not have any significant unrecognized uncertain tax positions for the years ended December 31, 2007 and 2008 and the six months ended June 30, 2009.
 
Results of Operations
 
Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008
 
Net revenues.  Our net revenues increased 43% from RMB1,540.0 million for the six months ended June 30, 2008 to RMB2,198.5 million (US$321.9 million) for the six months ended June 30, 2009. Net revenues from MMORPGs increased from RMB1,335.1 million for the six months ended June 30, 2008 to RMB2,026.1 million (US$296.6 million) for the six months ended June 30, 2009. Net revenues from advanced casual games decreased from RMB187.1 million for the six months ended June 30, 2008 to RMB159.8 million (US$23.4 million) for the six months ended June 30, 2009.
 
Our net revenues from MMORPGs increased primarily due to an increase in net revenues from our existing MMORPGs and the introduction of new MMORPGs. The increase in net revenues from our existing MMORPGs is primarily driven by net revenue increase of 49% from Mir II and Woool as a result of the release of certain updates and expansion packs. Net revenues from new MMORPGs that we introduced after the first half of 2008 totaled RMB142.6 million (US$20.9 million) for the six months ended June 30, 2009, primarily due to the commercialization of AION.
 
The number of active paying accounts for MMORPGs increased from 4.11 million and 4.24 million in the first and second quarters of 2008, respectively, to 7.19 million and 8.58 million in the first and second quarters of 2009, respectively. The average monthly revenues per active paying account was RMB51.9 and RMB54.7 in the first two quarters of 2008, respectively, compared with RMB43.9 and RMB41.9 in the first two quarters of 2009, respectively. Average monthly revenues per active paying account for the first two quarters of 2009 were lower than the first two quarters of 2008 as a result of an increase in the number of new game players and lower average monthly revenues per active paying account of these new game players. New game players generally tend to generate lower monthly average revenues per active paying account because MMORPGs are designed such that fewer premium virtual items are available for purchase at the lower level of the game. As the game player progresses to higher levels of the game, more premium virtual items are available for game players to purchase, which in general will increase such player’s spending and thus our average monthly revenues per active paying account.
 
Our net revenues from advanced casual games decreased due to the following reasons: (i) we released a major expansion pack for Maple Story during the six months ended June 30, 2008 and did not release such an expansion pack during the six months ended June 30, 2009, and (ii) we licensed the right to operate Crazy Kart in China to a subsidiary of Shanda Interactive as of July 1, 2008 and ceased to operate the game ourselves, which decreased our net revenues. We received royalties relating to Crazy Kart from the licensee,


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which we record as online advanced casual game revenues. The license agreement was terminated as of July 1, 2009 and we resumed operations of Crazy Kart beginning from that date.
 
The number of active paying accounts for advanced casual games decreased from 1.66 million and 1.42 million in the first and second quarters of 2008, respectively, to 1.05 million and 1.15 million in the first and second quarters of 2009, respectively. The average monthly revenues per active paying account for our advanced casual games increased from RMB19.8 and RMB20.8 in the first and second quarters of 2008, respectively, to RMB27.7 and RMB20.9 in the first and second quarters of 2009, respectively.
 
Cost of revenues.  Our cost of revenues increased 18% from RMB746.7 million for the six months ended June 30, 2008 to RMB881.1 million (US$129.0 million) for the six months ended June 30, 2009. This increase was primarily due to the following reasons:
 
  •  Platform fees increased 2% from RMB451.2 million for the six months ended June 30, 2008 to RMB459.7 million (US$67.3 million) for the six months ended June 30, 2009. Platform fees represented approximately 29.3% of our net revenues for the six months ended June 30, 2008 compared to approximately 20.9% of our net revenues for the six months ended June 30, 2009. The decrease in platform fees as a percentage of net revenues resulted primarily from the fact that following the reorganization, we pay Shanda Networking a service fee based upon a fixed percentage of the portion of the face value of prepaid cards used in our games which generally results in lower fees as a percentage of net revenues.
 
  •  Upfront and ongoing licensing fees for online games increased 56% from RMB235.0 million for the six months ended June 30, 2008 to RMB366.1 million (US$53.6 million) for the six months ended June 30, 2009. The increase was primarily due to an increase of revenues derived from licensed games, which increased from RMB999.3 million for the six months ended June 30, 2008 to RMB1,534.4 million (US$224.6 million) for the six months ended June 30, 2009. Upfront and ongoing licensing fees for online games represented approximately 15.3% of our net revenues for the six months ended June 30, 2008 compared to approximately 16.7% of our net revenues for the six months ended June 30, 2009.
 
  •  Other expenses decreased 8% from RMB60.5 million for the six months ended June 30, 2008 to RMB55.3 million (US$8.1 million) for the six months ended June 30, 2009. Other expenses represented approximately 3.9% and 2.5% of our net revenues for the six months ended June 30, 2008 and 2009, respectively.
 
Gross profit.  As a result of the foregoing, our gross profit increased 66% from RMB793.3 million for the six months ended June 30, 2008 to RMB1,317.4 million (US$192.9 million) for the six months ended June 30, 2009. Our gross profit margin, which is equal to our gross profit divided by our net revenues, increased from 51.5% for the six months ended June 30, 2008 to 59.9% for the six months ended June 30, 2009.
 
Operating expenses.  Our operating expenses increased 57% from RMB309.2 million for the six months ended June 30, 2008 to RMB485.8 million (US$71.1 million) for the six months ended June 30, 2009. This increase was primarily due to the following reasons:
 
  •  Our product development expenses increased 35% from RMB112.9 million for the six months ended June 30, 2008 to RMB151.9 million (US$22.2 million) for the six months ended June 30, 2009. The increase was primarily due to (i) an increase in salary and benefits from RMB87.9 million for the six months ended June 30, 2008 to RMB103.3 million (US$15.1 million) for the six months ended June 30, 2009 due to salary and headcount increases and (ii) an increase in outsourced product development costs from RMB6.3 million for the six months ended June 30, 2008 to RMB29.6 million (US$4.3 million) for the six months ended June 30, 2009 as a result of our investments through 18 Capital. Product development expenses represented approximately 7.3% and 6.9% of our net revenues for the six months ended June 30, 2008 and 2009, respectively.


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  •  Our sales and marketing expenses increased 211% from RMB58.4 million for the six months ended June 30, 2008 to RMB181.4 million (US$26.6 million) for the six months ended June 30, 2009. The increase was primarily due to (i) an increase in the number of prepaid cards sold, (ii) the impact of the Amended and Restated Sales Agency Agreement with Shengfutong, effective July 1, 2008 and (iii) an increase in advertising and promotion expenses relating to our online games from RMB38.3 million for the six months ended June 30, 2008 to RMB64.2 million (US$9.4 million) for the six months ended June 30, 2009. Sales and marketing expenses represented approximately 3.8% and 8.3% of our net revenues for the six months ended June 30, 2008 and 2009, respectively.
 
  •  Our general and administrative expenses increased 11% from RMB137.9 million for the six months ended June 30, 2008 to RMB152.5 million (US$22.3 million) for the six months ended June 30, 2009. This increase was primarily due to (i) an increase in business tax levied on the service fees paid to Shengqu by the Shulong entities from RMB46.7 million for the six months ended June 30, 2008 to RMB71.5 million (US$10.5 million) for the six months ended June 30, 2009 due to the increased services provided by Shengqu to the Shulong entities to support our online games operations, (ii) an increase in professional service fees from RMB8.7 million for the six months ended June 30, 2008 to RMB12.9 million (US$1.9 million) for the six months ended June 30, 2009 and (iii) an increase in share-based compensation from RMB8.3 million for the six months ended June 30, 2008 to RMB16.5 million (US$2.4 million) for the six months ended June 30, 2009 as a result of options to purchase our ordinary shares granted to employees after the first half of 2008. The increase in expenses was offset in part by a decrease of general corporate expenses allocated from Shanda Interactive from RMB19.9 million for the six months ended June 30, 2008 to RMB8.3 million (US$1.2 million) for the six months ended June 30, 2009, due to the fact that after the reorganization, we operated as a standalone entity and assumed more of our general and administrative functions. General and administrative expenses accounted for approximately 9.0% and 6.9% of our net revenues for the six months ended June 30, 2008 and 2009, respectively.
 
Income from operations.  As a result of the foregoing, our operating income increased 72% from RMB484.2 million for the six months ended June 30, 2008 to RMB831.6 million (US$121.8 million) for the six months ended June 30, 2009. Our operating margin, which is equal to our operating profit divided by our net revenues, increased from 31.4% for the six months ended June 30, 2008 to 37.8% for the six months ended June 30, 2009.
 
Income before income tax expenses and equity in earning (loss) of affiliated companies.  Our income before income tax expenses and equity in earning (loss) of affiliated companies increased 80% from RMB489.5 million for the six months ended June 30, 2008 to RMB881.3 million (US$129.0 million) for the six months ended June 30, 2009. This increase was primarily due to the increase in income from operations, as well as an increase in other income, namely, government incentives, which increased from RMB5.7 million for the six months ended June 30, 2008 to RMB37.4 million (US$5.5 million) for the six months ended June 30, 2009. Other income for the six months ended June 30, 2009 was also higher compared to the six months ended June 30, 2008 because we donated approximately RMB12.2 million in disaster relief in response to the Sichuan earthquake that took place in May 2008.
 
Income tax expenses.  Our income tax expenses increased 88% from RMB101.6 million for the six months ended June 30, 2008 to RMB190.7 million (US$27.9 million) for the six months ended June 30, 2009, primarily due to (i) an increase in the income tax expenses of RMB98.0 million (US$14.3 million) as a result of the increase in our pre-tax income from RMB489.5 million in the six months ended June 30, 2008 to RMB881.3 million (US$129.0 million) in the six months ended June 30, 2009 after applying the new enterprise income tax rate of 25% and (ii) a valuation allowance of RMB30.7 million (US$4.5 million) for foreign tax credits due to the uncertainty surrounding their realization. The increase in income tax expenses was offset in part by a decrease in the tax expenses by RMB75.1 million (US$11.0 million) due to the preferential tax rate enjoyed by certain of our PRC companies in 2009. As a result of the foregoing, our effective income tax rate increased slightly from 21% in the six months ended June 30, 2008 to 22% in the six months ended June 30, 2009.


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Equity in earning (loss) of affiliated companies.  We incurred losses of RMB0.2 million for the six months ended June 30, 2008 and RMB10.2 million (US$1.5 million) for the six months ended June 30, 2009 as a result of our investments through 18 Capital.
 
Net income attributable to non-controlling interest.  Our net income attributable to non-controlling interest increased from RMB4.9 million for the six months ended June 30, 2008 to RMB9.2 million (US$1.3 million) for the six months ended June 30, 2009, as a result of the increase in Actoz’s profitability.
 
Net income attributable to Shanda Games Limited.  Net income attributable to our company increased from RMB382.8 million for the six months ended June 30, 2008 to RMB671.2 million (US$98.3 million) for the six months ended June 30, 2009.
 
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
 
Net revenues.  Our net revenues increased 45% from RMB2,322.8 million in 2007 to RMB3,376.8 million (US$494.3 million) in 2008. Net revenues from MMORPGs increased from RMB2,016.1 million in 2007 to RMB2,987.8 million (US$437.4 million) in 2008. Net revenues from advanced casual games increased from RMB280.4 million in 2007 to RMB358.9 million (US$52.5 million) in 2008.
 
In the four quarters of 2008, the number of active paying accounts for MMORPGs was 4.11 million, 4.24 million, 5.19 million and 5.89 million, respectively, and the average monthly revenues per active paying account for such quarters was RMB51.9, RMB54.7, RMB49.6 and RMB49.8, respectively. The number of active paying accounts for MMORPGs increased on a quarterly basis in 2008 as a result of the release of updates and expansion packs and the introduction of new virtual items in our MMORPGs, as well as numerous promotions that we offered to our game players. Average monthly revenues per active paying account for the last two quarters of 2008 were lower than the first two quarters of 2008 primarily due to lower average monthly revenues per active paying account of new game players. New game players generally tend to generate lower monthly average revenues per active paying account because MMORPGs are designed such that fewer premium virtual items are available for purchase at the lower level of the game. As the game player progresses to higher levels of the game, more premium virtual items are available for game players to purchase, which in general will increase such players’ spending and thus our average monthly revenues per active paying account.
 
The increase in our net revenues from our advanced casual games was primarily due to an increase in revenues from our existing advanced casual games in the aggregate from RMB280.4 million in 2007 to RMB358.9 million (US$52.5 million) in 2008. In the four quarters of 2008, the number of active paying accounts for advanced casual games was 1.66 million, 1.42 million, 1.38 million and 0.96 million, respectively. The average monthly revenues per active paying account for our advanced casual games for the four quarters in 2008 were RMB19.8, RMB20.8, RMB23.7 and RMB25.5, respectively. The decrease in the number of active paying accounts was primarily due to the following factors: (i) in the third quarter of 2008, we licensed Crazy Kart to a subsidiary of Shanda Interactive and ceased to operate the game ourselves and (ii) the second and fourth quarters typically are slower due to seasonality factors. The average monthly revenues per active paying account for advanced casual games increased due to the release of updates and expansion packs and the introduction of new virtual items in our advanced casual games, as well as numerous promotions that we sponsored for our game players.
 
Cost of revenues.  Our cost of revenues increased 18% from RMB1,261.1 million in 2007 to RMB1,489.4 million (US$218.1 million) in 2008. This increase was primarily due to the following reasons:
 
  •  Platform fees increased 18% from RMB735.4 million in 2007 to RMB864.9 million (US$126.6 million) in 2008 primarily due to the increased servers and services provided to support the growth in our game player base and of our revenues that we generated from our online games operations. The increase in the number of servers was partially offset by the elimination or combination of server groups for our existing online games, as well as the introduction of new virtualization technologies which improve server efficiency. Platform fees represented approximately 31.7% of our


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  net revenues in 2007 compared to approximately 25.6% of our net revenues in 2008. The decrease in platform fees as a percentage of net revenues was primarily due to the impact of the new agreements with Shanda Online, effective July 1, 2008. See “— Our Agreements with Shanda Online”.
 
  •  Upfront and ongoing licensing fees for online games increased 21% from RMB429.6 million in 2007 to RMB520.9 million (US$76.3 million) in 2008 primarily due to the commercialization in 2008 of licensed games, which commences the amortization of the upfront licensing fees, and the increase of revenues derived from licensed games, which was partially offset by the decrease in ongoing license fees as a result of the consolidation of Actoz’s financial results beginning in the third quarter of 2007. Upfront and ongoing licensing fees for online games totaled approximately 18.5% and 15.4% of our net revenues in 2007 and 2008, respectively.
 
  •  Other expenses increased 8% from RMB96.1 million in 2007 to RMB103.6 million (US$15.2 million) in 2008, primarily due to an increase in salary and benefits. Other expenses totaled approximately 4.1% and 3.1% of our net revenues in 2007 and 2008, respectively.
 
Gross profit.  As a result of the foregoing, our gross profit increased 78% from RMB1,061.7 million in 2007 to RMB1,887.4 million (US$276.2 million) in 2008. Our gross profit margin increased from 45.7% in 2007 to 55.9% in 2008.
 
Operating expenses.  Our operating expenses increased 67% from RMB437.0 million in 2007 to RMB730.5 million (US$106.9 million) in 2008. This increase was primarily due to the following reasons:
 
  •  Our product development expenses increased 75% from RMB136.4 million in 2007 to RMB238.8 million (US$35.0 million) in 2008, primarily due to (i) the launch of a bonus incentive plan at the end 2007 for our product development employees giving rise to an increase of RMB61.4 million in salary and benefit, (ii) an increase of RMB23.2 million in salary and benefits for Actoz’s employees due to Actoz becoming a consolidated entity beginning in July 2007 and (iii) an increase of RMB18.4 million in outsourced product development costs as a result of our investments through 18 Capital. Product development expenses totaled approximately 5.9% and 7.1% of our net revenues in 2007 and 2008, respectively.
 
  •  Our sales and marketing expenses increased 63% from RMB125.4 million in 2007 to RMB204.5 million (US$29.9 million) in 2008, primarily due to an increase in the number of prepaid cards sold resulting in an increase of the service fees we pay to Shengfutong. See “— Our Agreements with Shanda Online”. Sales and marketing expenses totaled approximately 5.4% and 6.1% of our net revenues in 2007 and 2008, respectively.
 
  •  Our general and administrative expenses increased 64% from RMB175.2 million in 2007 to RMB287.2 million (US$42.0 million) in 2008. This increase was primarily due to the following factors: (i) an increase of RMB49.1 million in business tax due to the increased services provided by Shengqu to the Shulong entities to support our online game operations, (ii) an increase of RMB25.4 million in salary and benefits from salary and headcount increases and (iii) an increase of RMB9.5 million in salary and benefits of Actoz’s employees as a result of the consolidation of Actoz beginning in July 2007. General and administrative expenses accounted for approximately 7.5% and 8.4% of our net revenues in 2007 and 2008, respectively.
 
Income from operations.  As a result of the foregoing, our operating income increased 85% from RMB624.7 million in 2007 to RMB1,156.9 million (US$169.3 million) in 2008. Our operating margin increased from 26.9% in 2007 to 34.3% in 2008.
 
Income before income tax expenses and equity in earning (loss) of affiliated companies.  Our income before income tax expenses and equity in earning (loss) of affiliated companies increased 76% from RMB679.7 million in 2007 to RMB1,196.4 million (US$175.1 million) in 2008. This increase was primarily due to the increase in income from operations.
 
Income tax expenses.  Our income tax expenses increased 272% from RMB67.1 million in 2007 to RMB249.9 million (US$36.6 million) in 2008, primarily due to (i) an increase in our pre-tax income from


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RMB679.7 million in 2007 to RMB1,196.4 million (US$175.1 million) in 2008, which resulted in an increase in income tax expenses of approximately RMB90.5 million, (ii) the accrual of a deferred tax liability of RMB37.0 million (US$5.4 million) relating to withholding obligations arising from the dividend in the aggregate amount of US$102.6 million that we declared solely payable to Shanda Interactive, (iii) a valuation allowance of RMB41.0 million (US$6.0 million) for foreign tax credits due to the uncertainty surrounding their realization and (iv) the elimination of certain tax holidays as a result of the New EIT law, which increased Shengqu’s tax expense by RMB29.0 million (US$4.2 million) in 2008. As a result of the foregoing, our effective income tax rate increased from 10% in 2007 to 21% in 2008.
 
Equity in earning (loss) of affiliated companies.  We incurred a loss of RMB13.6 million in 2007 due to the fact that Actoz, whose financial results we accounted for using the equity method in the first half of 2007, incurred losses in the first half of 2007. We achieved a gain of RMB0.9 million in 2008 due to the profitability of certain of our affiliates.
 
Net income attributable to non-controlling interest.  Our net income attributable to non-controlling interest increased from RMB7.1 million in 2007 to RMB11.9 million (US$1.7 million) in 2008.
 
Net income attributable to Shanda Games Limited.  Net income attributable to our company increased from RMB591.9 million in 2007 to RMB935.5 million (US$136.9 million) in 2008.


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Selected Quarterly Results of Operations
 
The following table sets forth our unaudited consolidated selected quarterly results of operations for the six quarters ended June 30, 2009. You should read the following table in conjunction with our audited consolidated financial statements and related notes contained elsewhere in this prospectus. The unaudited results of operations for the quarters ended March 31, 2008 and June 30, 2008, reflect our results of operations prior to the reorganization and therefore were not affected by the impact of the agreements we entered into with certain VIEs of Shanda Online and therefore are not entirely comparable with the periods after June 30, 2008. See “— Our Agreements with Shanda Online”.
 
                                                 
    For the Three Months Ended
    Mar. 31,
  June 30,
  Sept. 30,
  Dec. 31,
  Mar. 31,
  June 30,
    2008   2008   2008   2008   2009   2009
    RMB   RMB   RMB   RMB   RMB   RMB
    (unaudited)
    (in millions)
 
Net revenues:
                                               
Online MMORPG revenues
    639.8       695.3       772.5       880.3       946.8       1,079.3  
Online advanced casual game revenues
    98.6       88.5       98.2       73.6       87.6       72.2  
Other revenues
    9.0       8.7       7.6       4.5       5.6       7.0  
Total net revenues
    747.4       792.5       878.3       958.4       1,040.0       1,158.5  
Total cost of revenues
    (377.9 )     (368.7 )     (358.9 )     (383.8 )     (414.7 )     (466.4 )
Gross profit
    369.5       423.8       519.4       574.6       625.3       692.1  
Operating expenses:
                                               
Product development
    (54.5 )     (58.4 )     (55.7 )     (70.2 )     (80.2 )     (71.6 )
Sales and marketing
    (31.0 )     (27.4 )     (71.9 )     (74.2 )     (71.6 )     (109.9 )
General and administrative
    (62.2 )     (75.6 )     (81.7 )     (67.6 )     (72.9 )     (79.6 )
Total operating expenses
    (147.7 )     (161.4 )     (209.3 )     (212.0 )     (224.7 )     (261.1 )
Income from operations
    221.8       262.4       310.1       362.6       400.6       431.0  
Interest income
    9.7       11.8       6.5       5.5       5.6       5.9  
Investment income
                                  0.2  
Other income (expense), net
    (10.0 )     (6.2 )     20.0       2.2       3.8       34.3  
Income tax expenses
    (32.3 )     (69.3 )     (68.8 )     (79.5 )     (89.6 )     (101.2 )
Equity in earning (loss) of affiliated companies
    (0.1 )     (0.1 )     0.5       0.7       (6.9 )     (3.3 )
Net income
    189.1       198.6       268.3       291.5       313.5       366.9  
Net income attributable to non-controlling interest
    (2.7 )     (2.2 )     (3.7 )     (3.4 )     (5.5 )     (3.7 )
Net income attributable to Shanda Games Limited
    186.4       196.4       264.6       288.1       308.0       363.2  


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The following table sets forth our unaudited consolidated selected quarterly results of operations, as a percentage of our total net revenues, for the six quarters ended June 30, 2009.
 
                                                 
    For the Three Months Ended
    Mar. 31,
  June 30,
  Sept. 30,
  Dec. 31,
  Mar. 31,
  June 30,
    2008   2008   2008   2008   2009   2009
 
Net revenues:
                                               
Online MMORPG revenues
    85.6 %     87.7 %     88.0 %     91.9 %     91.0 %     93.2 %
Online advanced casual game revenues
    13.2       11.2       11.2       7.7       8.4       6.2  
Other revenues
    1.2       1.1       0.8       0.4       0.6       0.6  
Total net revenues
    100.0       100.0       100.0       100.0       100.0       100.0  
Total cost of revenues
    (50.6 )     (46.5 )     (40.9 )     (40.0 )     (39.9 )     (40.3 )
Gross profit
    49.4       53.5       59.1       60.0       60.1       59.7  
Operating expenses:
                                               
Product development
    (7.3 )     (7.4 )     (6.3 )     (7.3 )     (7.8 )     (6.2 )
Sales and marketing
    (4.1 )     (3.5 )     (8.2 )     (7.7 )     (6.9 )     (9.5 )
General and administrative
    (8.3 )     (9.5 )     (9.3 )     (7.1 )     (7.0 )     (6.9 )
Total operating expenses
    (19.7 )     (20.4 )     (23.8 )     (22.1 )     (21.7 )     (22.6 )
Income from operations
    29.7       33.1       35.3       37.8       38.4       37.2  
Interest income
    1.3       1.5       0.7       0.6       0.5       0.5  
Investment income
                                  *  
Other income (expense), net
    (1.3 )     (0.8 )     2.3       0.2       0.4       3.0  
Income tax expenses
    (4.3 )     (8.7 )     (7.8 )     (8.3 )     (8.6 )     (8.7 )
Equity in earning (loss) of affiliated companies
    0.0       0.0       0.1       0.1       (0.7 )     (0.3 )
Net income
    25.3       25.1       30.4       30.4       30.1       31.7  
Net income attributable to non-controlling interest
    (0.4 )     (0.3 )     (0.4 )     (0.4 )     (0.5 )     (0.3 )
Net income attributable to Shanda Games Limited
    24.9 %     24.8 %     30.1 %     30.1 %     29.6 %     31.4 %
 
 
* Less than 0.01%.
 
Revenues from MMORPGs as a percentage of our net revenues have increased steadily over the six quarters presented above as MMORPG revenues grew steadily while advanced casual game revenues fluctuated over these periods. As a result of the agreements described under “— Our Agreements with Shanda Online”, our gross margin has remained relatively stable since the reorganization and we achieved gross margins of 59.1%, 60.0%, 60.1% and 59.7%, respectively, in the four quarters beginning July 1, 2008. Our game players generally spend more time playing our games in the first and third quarters of each year, which typically have more holidays, allowing for more time for leisure activities, whereas the second and fourth quarters are generally slower for our business as there are fewer holidays during those quarters. The seasonality effects described above may not be indicative of our future results of operations.
 
Quarter Ended June 30, 2009 Compared to Quarter Ended March 31, 2009
 
Due to the differences in the agreements in place prior to and after the reorganization on July 1, 2008, our results of operations for the periods prior to and after the reorganization are not entirely comparable. As a result, the results of operations for the years ended December 31, 2007 and 2008 and the six months ended June 30, 2008 and June 30, 2009 may not be entirely comparable. See “— Our Agreements with Shanda Online”. To provide more useful information to investors in the period-to-period comparison, we have set forth below a comparison of our unaudited consolidated results of operations for the two consecutive quarters


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ended June 30, 2009 and March 31, 2009, as both quarters reflect our results of operations subsequent to the reorganization.
 
Net revenues.  Our net revenues increased 11% from RMB1,040.0 million for the quarter ended March 31, 2009 to RMB1,158.5 million for the quarter ended June 30, 2009. Net revenues from MMORPGs increased from RMB946.8 million to RMB1,079.3 million. Net revenues from advanced casual games decreased from RMB87.6 million to RMB72.2 million.
 
Our net revenues from MMORPGs increased primarily due to the introduction of new MMORPGs, offset in part by a decrease in net revenues from our existing MMORPGs. Net revenues from new MMORPGs that we introduced in the quarter ended June 30, 2009 totaled RMB137.6 million, primarily due to the commercialization of AION. Net revenues from our existing MMORPGs decreased from RMB946.8 million for the quarter ended March 31, 2009 to RMB941.7 million for the quarter ended June 30, 2009, primarily as a result of net revenue decreases in various games from seasonal weakness in the second quarter. Net revenues from Mir II and Woool increased 1.2% and 7.3%, respectively, primarily due to the release of updates and expansion packs for these games.
 
The number of active paying accounts for MMORPGs increased from 7.19 million for the quarter ended March 31, 2009 to 8.58 million for the quarter ended June 30, 2009, while average monthly revenues per active paying account decreased from RMB43.9 to RMB41.9. The increase in active paying accounts was mainly due to the launch of new games. Average monthly revenues per active paying account for the quarter ended June 30, 2009 were lower than the quarter ended March 31, 2009, primarily as a result of the commercialization of AION, which brought in new game players but lowered our overall monthly average revenues per active paying account for MMORPGs.
 
Our net revenues from advanced casual games decreased due to general seasonality factors.
 
The number of active paying accounts for advanced casual games increased from 1.05 million for the quarter ended March 31, 2009 to 1.15 million for the quarter ended June 30, 2009. Average monthly revenues per active paying account for advanced casual games decreased from RMB27.8 for the quarter ended March 31, 2009 to RMB20.9 for the quarter ended June 30, 2009. The second calendar quarter is typically a seasonally weak quarter due to fewer number of holidays in that quarter which results in lower levels of game playing. The increase in the number of active paying accounts was primarily due to the launch of Dead or Alive Online which partially offset general seasonality factors relating to existing games.
 
Cost of revenues.  Our cost of revenues increased 13% from RMB414.7 million for the quarter ended March 30, 2009 to RMB466.4 million for the quarter ended June 30, 2009. This increase was primarily due to the following reasons:
 
  •  Platform fees increased 5% from RMB224.6 million for the quarter ended March 31, 2009 to RMB235.1 million for the quarter ended June 30, 2009, primarily due to an increase in service fees we paid to Shanda Networking as a result of an increase in use of services provided by Shanda Networking. Platform fees represented approximately 21.6% and 20.3% of our net revenues for the quarters ended March 31, 2009 and June 30, 2009, respectively.
 
  •  Upfront and ongoing licensing fees for online games increased 24% from RMB163.5 million for the quarter ended March 31, 2009 to RMB202.6 million for the quarter ended June 30, 2009. The increase was primarily due to an increase in ongoing licensing fees paid as our revenues derived from licensed games increased from RMB702.1 million for the quarter ended March 31, 2009 to RMB832.4 million for the quarter ended June 30, 2009. Upfront and ongoing licensing fees for online games represented approximately 15.7% and 17.5% of our net revenues for the quarters ended March 31, 2009 and June 30, 2009, respectively.
 
  •  Other expenses increased 7% from RMB26.6 million for the quarter ended March 31, 2009 to RMB28.4 million for the quarter ended June 30, 2009. Other expenses represented approximately 2.6% and 2.5% of our net revenues for the quarters ended March 31, 2009 and June 30, 2009, respectively.


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Gross profit.  As a result of the foregoing, our gross profit increased 11% from RMB625.3 million for the quarter ended March 31, 2009 to RMB692.1 million for the quarter ended June 30, 2009. Our gross profit margin decreased slightly from 60.1% to 59.7% for the respective periods.
 
Operating expenses.  Our operating expenses increased 16% from RMB224.7 million for the quarter ended March 31, 2009 to RMB261.1 million for the quarter ended June 30, 2009. This increase was primarily due to the following reasons:
 
  •  Our sales and marketing expenses increased 54% from RMB71.6 million to RMB109.9 million. The increase was primarily due to an increase in advertising and promotion expenses relating to our online games from RMB21.1 million to RMB43.1 million and a 37% increase in service fees paid to Shengfutong. The increase in service fees paid to Shengfutong was due to (i) an increase in the number of prepaid cards sold and (ii) the smaller sales discount at which Shengfutong sold the prepaid cards, which resulted in higher revenues as well as higher service fee charged to us. Sales and marketing expenses represented approximately 6.9% and 9.5% of our net revenues for the quarters ended March 31, 2009 and June 30, 2009, respectively.
 
  •  Our general and administrative expenses increased 9% from RMB72.9 million to RMB79.6 million. This increase was primarily due to (i) an increase in business tax levied on the service fees paid to Shengqu by the Shulong entities from RMB34.7 million to RMB36.8 million due to the increased services provided by Shengqu to the Shulong entities to support our online games operations, (ii) RMB2.5 million in stamp duty we paid as a result of the transfer of Actoz shares from Shanda Interactive to us and (iii) an increase in share-based compensation from RMB7.4 million to RMB9.1 million as a result of additional options to purchase our ordinary shares granted to employees. General and administrative expenses represented approximately 7.0% and 6.9% of our net revenues for the quarters ended March 31, 2009 and June 30, 2009, respectively.
 
  •  The foregoing was partially offset by a decrease in our product development expenses, which decreased 11% from RMB80.2 million to RMB71.6 million. The decrease was primarily due to a decrease in salary and benefits from RMB57.8 million to RMB45.5 million, as a result of a change in our bonus incentive plan for the product development team, and was offset by an increase in outsourced product development costs from RMB12.7 million to RMB16.9 million as a result of our investments through 18 Capital. Product development expenses represented approximately 7.8% and 6.2% of our net revenues for the quarters ended March 31, 2009 and June 30, 2009, respectively.
 
Income from operations.  As a result of the foregoing, our operating income increased 8% from RMB400.6 million for the quarter ended March 31, 2009 to RMB431.0 million for the quarter ended June 30, 2009. Our operating margin decreased from 38.5% to 37.2%.
 
Income before income tax expenses and equity in earning (loss) of affiliated companies.  Our income before income tax expenses and equity in earning (loss) of affiliated companies increased 15% from RMB410.0 million for the quarter ended March 31, 2009 to RMB471.4 million for the quarter ended June 30, 2009. This increase was primarily due to the increase in income from operations, as well as an increase in government incentive, which increased from RMB1.0 million to RMB36.4 million.
 
Income tax expenses.  Our income tax expenses increased 13% from RMB89.6 million for the quarter ended March 31, 2009 to RMB101.2 million for the quarter ended June 30, 2009, primarily due to the increase in our pre-tax income.
 
Equity in earning (loss) of affiliated companies.  We incurred losses from equity in affiliated companies of RMB6.9 million and RMB3.3 million for the quarters ended March 31, 2009 and June 30, 2009, respectively.
 
Net income attributable to non-controlling interest.  Our net income attributable to non-controlling interest decreased from RMB5.5 million to RMB3.7 million for the quarters ended March 31, 2009 and June 30, 2009, respectively, as a result of a decrease in Actoz’s profitability, which was driven by a


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combination of the Korean Won’s depreciation, imposition of a new business tax on the royalty fees that our PRC operating companies pay to Actoz, and general seasonal weakness in the second quarter.
 
Net income attributable to Shanda Games Limited.  Net income attributable to our company increased from RMB308.0 million for the quarter ended March 31, 2009 to RMB363.2 million for the quarter ended June 30, 2009.
 
Liquidity and Capital Resources
 
We believe that our current cash and cash equivalents, cash flow from operations and the proceeds from this offering will be sufficient to meet our anticipated cash needs, including for working capital and capital expenditures, for at least the next 12 months. We may, however, require additional cash resources due to changed business conditions or other future developments. If these sources are insufficient to satisfy our cash requirements, we may seek to sell debt securities or additional equity securities or obtain short-term or long-term bank financing. The sale of convertible debt securities or additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in debt service obligations and could result in operating and financial covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.
 
From time to time, we evaluate possible investments, acquisitions or divestments and may, if a suitable opportunity arises, make an investment or acquisition or conduct a divestment.
 
Cash Flows and Working Capital
 
For the periods presented in our financial statements, we have primarily financed our operations through internally generated cash and loans from related parties. As of June 30, 2009, we had RMB799.6 million (US$117.1 million) in cash and cash equivalents, of which RMB236.2 million (US$34.6 million) was held by our PRC operating companies.
 
Our cash and cash equivalents primarily consist of cash on hand, demand deposits and liquid investments with original maturities of three months or less that are placed with banks and other financial institutions. Although we consolidate the results of our PRC operating companies in our consolidated financial statements and we can utilize their cash and cash equivalents in our operations, we do not have direct access to the cash and cash equivalents or future earnings of our PRC operating companies. However, these cash balances can be utilized by us for our normal operations pursuant to the contractual arrangements with Shanghai Shulong that provide us with the substantial ability to control our PRC operating companies and their operations.
 
In 2009, we declared an aggregate of US$102.6 million in cash dividends payable solely to Shanda Interactive. As of June 30, 2009, we had paid Shanda Interactive US$24.5 million of this amount. We intend to pay Shanda Interactive the remaining amount from a bank loan. The purchasers of the ADS in this offering are not entitled to receive this dividend.


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The following table sets forth, for the periods indicated, certain information relating to our cash flows.
 
                                                 
    Year Ended December 31,   Six Months Ended June 30,
    2007   2008   2008   2009
    RMB   RMB   US$   RMB   RMB   US$
                (unaudited)        
    (in millions)
 
Net cash provided by operating activities
    672.7       1,144.5       167.6       568.8       935.3       136.9  
Net cash used in investing activities
    (132.1 )     (144.2 )     (21.1 )     (133.5 )     (1,299.8 )     (190.3 )
Net cash used in financing activities
    (376.0 )     (748.3 )     (109.6 )     (232.4 )     532.4       78.0  
Effect of exchange rate changes on cash
    (7.1 )     (16.7 )     (2.4 )     (7.4 )     2.8       0.4  
                                                 
Net increase in cash and cash equivalents
    157.5       235.3       34.5       195.5       170.7       25.0  
Cash, beginning of the period
    236.1       393.6       57.6       393.6       628.9       92.1  
                                                 
Cash, end of the period
    393.6       628.9       92.1       589.1       799.6       117.1  
                                                 
 
Operating Activities
 
For the six months ended June 30, 2009, we had net cash provided by operating activities of RMB935.3 million (US$136.9 million). This was primarily attributable to our net income attributable to our company of RMB680.4 million, an increase of RMB115.6 million in licensing fees payable due to an increase in our revenues generated from licensed games, an increase of RMB114.9 million in deferred revenue due to the increased proceeds received from Shengfutong for the sale of prepaid cards which were subsequently activated and charged to our games to purchase virtual items or time units in our online games but had not yet been recognized as net revenues, and an increase in taxes payable of RMB88.3 million due to the increase in our pre-tax income. Our net cash provided by operating activities was partially reduced by payment of upfront licensing fees and prepayment of upfront licensing fees of RMB90.1 million relating to new online games that we licensed from third parties, deferred taxes in the amount of RMB50.7 million, an add-back of the non-cash expenses including share-based compensation expenses, corporate expense allocation, depreciation of property and equipment and amortization of intangible assets in the amount of RMB118.9 million and an increase of RMB49.0 million in receivable from related parties, primarily Shengfutong.
 
For the year ended December 31, 2008, we had net cash provided by operating activities of RMB1,144.5 million (US$167.6 million). This was primarily attributable to our net income attributable to our company of RMB947.4 million, an increase of RMB111.2 million in deferred revenue due to the increased proceeds received from our distributors for the sale of prepaid cards for the period prior to the reorganization and from Shengfutong beginning as of the reorganization, which were for the sale of prepaid cards and subsequently activated and charged to our games to purchase virtual items or time units in our online games but had not yet been recognized as net revenues, an increase of RMB60.1 million in licensing fees payable due to an increase in our revenues generated from licensed games and an increase of RMB48.2 million in taxes payable due to the increase in our pre-tax income. Our net cash provided by operating activities was partially reduced by an increase of RMB233.7 million in receivable due from related parties, primarily Shengfutong, an add-back of the non-cash expenses including share-based compensation expenses, corporate expense allocation, depreciation of property and equipment and amortization of intangible assets in the amount of RMB209.4 million and the payment of RMB75.5 million in upfront licensing fees and prepayment for upfront license fees relating to new online games that we licensed from third parties.
 
For the year ended December 31, 2007, we had net cash provided by operating activities of RMB672.7 million, which was primarily attributable to our net income attributable to our company of RMB599.0 million, an increase of RMB100.4 million in deferred revenue due to the increased proceeds


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received from our distributors for the sale of prepaid cards which are required to purchase virtual items or time units in our online games and an increase of RMB70.8 million in payable due to related parties for the support of our online games operations. Our net cash provided by operating activities was partially offset by the payment of RMB273.8 million in upfront licensing fees and prepayment for upfront license fees relating to new online games that we licensed from third parties, a decrease of RMB46.1 million in license fee payable to a related party as a result of the consolidation of Actoz beginning as of July 1, 2007, an add-back of the non-cash expenses including share-based compensation expenses, corporate expense allocation, depreciation of property and equipment and amortization and impairment of intangible assets in the amount of RMB210.6 million and deferred taxes in the amount of RMB37.3 million.
 
Investing Activities
 
In the six months ended June 30, 2009, we had net cash used in investing activities of RMB1,299.8 million (US$190.3 million). This was primarily attributable to a net increase in time deposits with maturity dates over three months of RMB47.1 million, the payment of RMB54.2 million for the purchase of property, equipment, software and intangible assets, the payment of RMB702.1 million for the restricted cash as the collateral for a loan in the amount equal to the U.S. dollar equivalent, and the purchase of the equity interest in Actoz from Shanda Interactive for RMB479.7 million.
 
In 2008, we had net cash used in investing activities of RMB144.2 million (US$21.1 million). This was primarily attributable to a net increase in time deposits with maturities of over three months of RMB46.7 million, the payment of RMB58.9 million for the purchase of property, equipment, software and intangible assets, the payment of loan receivables of RMB14.0 million and the repurchase by Actoz of its own shares of RMB17.9 million.
 
In 2007, we had net cash used in investing activities of RMB132.1 million. This was attributable primarily to an increase of RMB86.7 million in time deposits with maturities of over three months, the payment of RMB85.2 million for the purchase of property, equipment, software and intangible assets, the payment of loan receivables of RMB12.0 million and the payment of RMB56.5 million for the acquisition of Chengdu Aurora, net of cash acquired. This amount was offset by RMB112.2 million in cash received upon consolidation of Actoz contributed by Shanda Interactive.
 
Financing Activities
 
We had net cash provided in financing activities of RMB532.4 million (US$78.0 million) in the six months ended June 30, 2009. This was primarily attributable to cash received from a loan of US$102.5 million, equivalent to RMB702.1 million, offset by a distribution in the amount of RMB175.2 million to Shanda Interactive. We had net cash used in financing activities of RMB748.3 million (US$109.6 million) in 2008 and RMB376.0 million in 2007, respectively, which was primarily due to the distribution to Shanda Interactive.
 
Restrictions on Cash Transfers to Us
 
To fund any cash requirements we may have from time to time, we may need to rely on dividends, loans or advances made to us by our PRC subsidiaries. We conduct substantially all of our operations through our PRC operating companies, which generate substantially all of our revenues. As our PRC operating companies are not owned by our PRC subsidiaries, they are unable to make dividend payments to our PRC subsidiaries. Instead, our PRC subsidiaries have entered into contractual arrangements with Shanghai Shulong to provide services to our PRC operating companies in return for cash payments. In order for us to receive any dividends, loans or advances from our PRC subsidiaries, or to distribute any dividends to our shareholders and ADS holders, we will need to rely on these payments made from Shanghai Shulong to our PRC subsidiaries. Depending on the nature of services provided by our PRC subsidiaries to our PRC operating companies, certain of these payments are subject to PRC taxes, including business taxes and value-added tax, which effectively reduce the amount that our PRC subsidiaries receive from our PRC operating companies. In addition, the PRC government could impose restrictions on such payments or change the tax rates applicable to such payments.


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In addition, regulations in the PRC currently permit payment of dividends of a PRC company, such as our PRC subsidiaries, only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Each of our PRC subsidiaries is also required to set aside at least 10% of its after-tax profit based on PRC accounting standards each year to its general reserves until the cumulative amount reaches 50% of its registered capital. These reserves are not distributable as cash dividends, or as loans or advances. Shengqu may also allocate a portion of its after-tax profits, as determined by its board of directors, to its staff welfare and bonus funds, which may not be distributed to us. In addition, if any of our PRC subsidiaries incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us.
 
Furthermore, under regulations of the SAFE, the Renminbi is not convertible into foreign currencies for capital account items, such as loans, repatriation of investments and investments outside of China, unless the prior approval of the SAFE is obtained and prior registration with the SAFE is made.
 
Any dividends paid by our PRC subsidiaries to Shanda Games (HK) will be subject to a withholding tax at the rate of 5%, which will reduce the amount of cash available for distribution to us.
 
We do not expect any of such restrictions or taxes to have a material impact on our ability to meet our cash obligations.
 
Contractual Obligations and Commercial Commitments
 
The following table sets forth our contractual obligations as of June 30, 2009.