Following a major shift in direction last November, Nasdaq-listed Chinese online games operator Shanda Entertainment has reported a net loss of $66.8m in the fourth quarter of 2005 and has laid off staff.

Shanda's difficulties illustrate intensifying competition in China's online games market, particularly due to popular new entrants like World of Warcraft, analysts say.

Shanda, Nasdaq's best performing stock in 2004, surprised the market in November when it decided to make its most profitable game, Legend of Mir II, free to play in China.

At the same time, the software company threw its weight behind a series of new hardware products in cooperation with Intel. Shanda's new EZ series includes a mini gaming console, a PC home theatre adapter kit and a TV set-top box.

The EZ series is designed to provide a new revenue stream for the company by letting the user play Shanda's proprietary games and entertainment content.

By switching to a free play model, Shanda hoped to prolong the life of the popular, but aging, Legend of Mir II, and at the same time use it and other games it to promote sales of the EZ Series.

But industry observers have predicted a bumpy road ahead for Shanda as it tries to transform itself from a one trick pony to a company with a horse for every course.

"For Shanda, the move [to free play] is likely to have a short-term effect on staunching user defection, but the impact on margins will be heavy and further downside is likely," Deutsche Bank predicted in a report prior to Shanda's latest financial release.

Jim Sun, a research analyst at Evolution Securities, added: "We believe that the lack of content will hamper the take-up of EZ series products. As a result, we do not expect that this product will emerge as a significant growth driver for Shanda until late 2007."

Shanda said in its latest financial filing that it has sold 83,700 EZ Pods to date, generating revenue of about $2.8m.

A further 839,000 EZ Pods have been pre-ordered by various companies for shipment during the year, Shanda claimed, but the company warned that profit margins on the hardware are lower than it is accustomed to earning from games.

The EZ Pod is the cheapest offering in the EZ series and the only one launched so far. The product is a package of software and hardware that adapts PCs into a home entertainment centre to play Shanda content.

The device has a retail price of about $50, although our analysis of Shanda's financial filings indicate that it receives less than $35 in revenue per unit sold.

The company made no substantive comment on plans or pre-orders for the more expensive EZ Mini, a handheld game player, or EZ Station, a set-top box PC.

Sales of the EZ Pod have failed to impress some analysts. "Shanda's EZ Pod has not proved successful, so it may face risks in the future," Chen Wen, of government-backed CCID Consulting, told the Shanghai Daily.

Shanda's net revenues for 2005 fell 16.3 per cent to $44.7m and net income was down 73 per cent to $20.5m. Most of the company's $66.8m fourth-quarter loss resulted from a re-evaluation of a shareholding in a partner, not from Shanda's core business.

However, the partner's share value appears to be directly linked to the falling popularity of Shanda's games. Shanda was also reported as closing an office in Beijing earlier this week and laying off staff.