NetEase at a Crossroads 网易走到十字路口
After piling through the mountain of corporate earnings that have just come out in the last 24 hours, I’ve decided to focus on online game veteran NetEase (Nasdaq: NTES), which appears to be at a critical juncture that could simply mark a pause in its recent rise or be the beginning of a longer-term decline. NetEase has been one of the most resilient companies throughout the current confidence crisis for US-listed China stocks, perhaps due to its status as one of China’s oldest publicly listed Internet firms and also due to solid performance from its core online game business.
The company’s shares, together with most US-listed Chinese stocks, tumbled last fall at the height of the confidence crisis sparked by a series of accounting scandals at several players. But since then, NetEase shares have bounced back strongly and now trade above pre-crisis levels — a rarity among its peers.
So perhaps it was inevitable that the company’s stock needed to take a rest, which is what has happened following the release of its latest earnings report that revealed its online game business declined in the second quarter, perhaps marking the start of a longer term decline. (results announcement) Shareholders certainly didn’t like the news, bidding down NetEase shares by 8 percent in after-hours trading after the results came out.
Let’s take a look at some of the numbers to see what lay behind the concerns. Probably most worrisome was a quarter-on-quarter decline in online game revenues, which dropped 6 percent to 1.7 billion yuan in the second quarter from first-quarter levels. The company’s profit also fell by 7 percent over the same period, even though it was up 13 percent from last year’s second quarter.
In discussing its results, the company blamed the revenue drop on declining popularity of its popular World of Warcraft title, which it licenses from leading global game developer Activision Blizzard (Nasdaq: ATVI). The decline of an individual gaming title isn’t unusual, as every game has a natural life cycle that usually lasts around 5 years. But the importance of a licensed title to its top and bottom lines undermines the impression many investors have that NetEase relies mostly on self-developed games.
What’s more, a recent new strategic alliance between Activision Blizzard and NetEase rival Tencent (HKEx: 700) looks a bit ominous (previous post), since Activision may choose to license its future World of Warcraft games to Tencent when its current agreement with NetEase expires. Some readers may recall that former high-flying online game company The9 (Nasdaq; NCTY) was the original license holder for World of Warcraft in China, only to see its business plunge when it Activision licensed the title to NetEase several years ago.
It’s obviously too early to say if this new revenue decline for NetEase is just a hiccup or the start of a longer-term trend. But the company would be well advised to start thinking about replacements for World of Warcraft, as I do think it could easily lose the title to Tencent when its current license expires.
Bottom line: NetEase’s latest results could mark the beginning of a broader decline that could accelerate if it loses its license for its popular World of Warcraft game.
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