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The Game Is On for NetEase Inc.

March 26, 2014 | About:

Internet technology company NetEase Inc. (NTES) is one of China’s most popular Internet portals, and is leader on the development of online games, applications, services and other technologies. NetEase provides various online gaming services, which include multiplayer online games developed in-house, online role-playing games as well as licensed titles from developers such as Activision Blizzard. The firm provides moreover online advertising, community services, entertainment content, and free e-mail and blogging services, in addition to wireless value-added services such as news and information content, music and photos from the web and Color Ring-back Tone technologies, among others. Currently, 90% of total sales at NetEase come from gaming revenue, mostly in the form of hourly game-play fees.

The company achieved 6.7% revenue growth year over year, mostly due to the stable performance of its core online games, namely Fantasy Westward Journey, Westward Journey Online II and Ghost II. NetEase has a diversified gaming portfolio which is yet its strongest asset, but the advertising segment is growing fast as well, with increased advertising demand in the automobile, Internet services and real estate sectors, leading to a 38% year over year revenue growth for the segment. The increased investment in the development of new games has however narrowed operating margins by 0.7% to 44.5%.

A gaming passion

Starting off more than 10 years ago as an Internet portal, NetEase decided to open its way as a major online gaming operator. The expansion the Chinese gaming market has experiences over the past years boosted the company’s revenues and allowed it to expand its game portfolio, both in-hose and licensed. Chinese gamers are esteemed to reach 320 million, and most popular games are usually those with both adventure and team efforts. Indeed Tencent Holdings Ltd. (TCEHY) is yet the number one game operator in china, but NetEase follows it closely, generating close to 90% from gaming. The firm has built strong in-house research capabilities and its games remain competitive and top-listed, even among the hectic gaming market.

NetEase has developed several games and has created a loyal gamer community, but hasn’t ceased to improve them, launching new games with 2.5-D and 3-D features and innovative content. Moreover, an extension of the relationship with Activision Blizzard (ATVI) to operate “World of Warcraft” exclusively in China has proven a smart move to broaden the reach to gamers while diversifying its product portfolio.

NetEase @U.S.?

The company has recently announced its plans to compete among the U.S. market, seeking new growth opportunities. NetEase has no doubt a popular presence in China, however the western markets has different preferences. The firm will certainly have to adapt to market’s desires, as well as to compete with strong local players. NetEase has already tried its luck in other markets such as S. Korea, Vietnam and Thailand and found good response. But this new incursion is yet to start.

Challenges

NetEase is indeed top game operator within the crowded gaming market of China. Nevertheless, the fierce competition in this gaming industry pushes companies towards constant innovations and, in order to maintain their presence, to keep investing in new marketing campaigns and expansion plans. Competition isn’t coming only from top companies such as TenCent, but also from other popular online services, such as social networking, microblogging, or online videos. Moreover, the fact that gaming trends are constantly changing makes this business unpredictable and customers’ preferences, volatile. Therefore, having a massive and loyal user base is crucial for these companies. However, the increased spending in product development and marketing strategic campaigns higher expenses and thus erodes investment returns. Therefore, companies such as NetEase have to keep the balance between expansion and earnings in order to sustain their profitability margins.

What to Expect

NetEase has a strong brand name, and its experience in the gaming industry will certainly allow them to profit from the significant growth opportunities in the blooming Chinese internet market. Nevertheless, desktop games are falling out of fashion, while simple mobile games are becoming more popular. NetEase has a desktop focus, but is, although, developing new mobile games, as it launched last year its first three mobile games in China. This tendency, in addition to the highly competitive market, and the new popularity of social networking and microblogging is a hindrance to the company, as 90% of revenues derive from gaming. Still, in-house developed games account for most of its game offering, and the company can adapt very fast to market changes, and keep generating profits. NetEase has long-running games which have been available for almost 10 years now, and maintain players’ loyalty. Analysts suggest a close look towards this company’s moves in order to evaluate future performance.

Disclosure: Damian Illia holds no position in any stocks mentioned.

About the author:

Damian Illia
A fundamental analyst at Lonetreeanalytics.com constantly looking for value and income investments.

Visit Damian Illia's Website


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