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Will This Gaming Stock Be Able to Come Out of Its Slump?

May 31, 2014 | About:
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kcpl

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The fading popularity of Activision Blizzard's (ATVI) games has been a worry for NetEase (NTES) for quite long time now. This was reflected in the company’s recent results that were not very impressive as it posted weaker-than-expected revenue and earnings.

Weak results

Despite the downturn in overall results, it was surprising to see that NetEase’s financial results were good enough for Morgan Stanley analysts to raise its price target to $77.00. Analysts reiterated that the company was projected to grow online revenue by 21% despite a dip in WoW users, which is good sign for the company as many competitors are seen struggling with online revenue of late.

Also, NetEase licenses WoW in China and the game has been a major source of revenue in the past. But Activision has been seeing steady declines in WoW subscribers. In the previous quarter, Activision reported that the franchise’s subscriber count fell once again from 7.7 million to 7.3 million, sequentially. This is the lowest count since 2007 and worryingly, much of this decline is coming from China.

Trying to make a comeback

Therefore, NetEase had to make certain moves to mitigate this decline and it has been doing the same. NetEase upgraded two of its longest-running games -- Fantasy Westward Journey II and Westward Journey Online II. These new versions have performed well so far and aided NetEase’s revenue growth in the reported quarter. Moreover, NetEase is looking to carry over the popularity of Fantasy Westward Journey II to the mobile platform and that’s why it had also introduced a mobile version.

NetEase was happy to receive significant positive response with respect to its newly launched games such as Heroes of Three Kingdoms and Dragon Sword. Also it counts heavily on the recently released expansion packs for Ghost II and Kung Fu Master to possibly increase interest in the game. Moreover, NetEase has lined up expansion packs for Heroes of Tang Dynasty II, Tianxia III, and Legends of Fairy, with the recently launched Legends of Tibet expected to push up revenue as well.

Growth ahead

Additionally, the company is engaged in launching Crisis 2015 -- its first person shooter game – for launch in the first half of 2014. Also, the company is planning to roll over its 3D epic fantasy game titled Revelations could possibly help the company to turn profitability this year. NetEase has put in three years of effort into this game and expects it to become a hit with gamers due to the engaging gameplay involved.

Also, NetEase might receive another shot in the arm from the new expansion pack of Activision’s WoW. Warlords of Draenor, the latest expansion pack of the franchise, takes gamers back to one of the most iconic settings in the World of Warcraft universe. This could lead to a spike in subscriber count for Activision, as the last expansion pack, Mists of Pandaria, had sold 2.7 million copies on its first day last year.

NetEase is consistently working on several high-quality mobile games that will certainly increase the popularity of its mobile games. Also it expects its YiChat messaging platform to do the trick by attracting more users to its mobile platform. Management is of the view that this chatting app will ultimately attract more players to download its forthcoming mobile games.

Competition

However, NetEase’s mobile strategy sounds pretty similar to that of rival Tencent. Tencent is a leading game operator in China, and is famous for its popular WeChat service. Tencent recently introduced a WeChat feature that allows users to play freemium games (free to play but users need to pay for in-game purchases). Considering that WeChat had more than 300 million users in August, Tencent can hit jackpot with this move.

In addition, Tencent has concrete plan to aggressively shift to mobile segment and it is considering buying game developers and roll out more free-to-play content. Hence, NetEase will have to navigate through a crowded mobile gaming space. But investors should remain optimistic as NetEase is the second-biggest game operator in China behind Tencent, and it could use its reach and existing user base to make its mobile games successful.

Conclusion

NetEase is up almost 60% this year. Even then, the stock is pretty cheap at a trailing P/E of 13. Its latest results might not have been at par with Street estimates, but it is making some good moves to improve its gaming business. Hence, it would be wise to hold on to NetEase as the company can scale new heights going forward.


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