Company Reports

NetEase started as a Chinese internet portal in the late 1990s but has now become the second-largest mobile game company in the world. The firm owns one of the most well-known massively multiplayer franchise in China—Fantasy Westward Journey. Over the past decade, NetEase has capitalized on the industry shift toward mobile gaming and now focuses on developing innovative, high-quality, and long-cycle games with a mobile-first approach. Over the past years, the firm has established iconic titles such as Onmyoji, Knives Out, and Identity V. Every year, the company publishes dozens of games across almost every genre and game play. In addition, NetEase is also collaborating with firms such as Blizzard, Marvel, and Microsoft to release games based on famous global intellectual property like Diablo, Harry Potter, and Lord of the Rings. Over the foreseeable future, we expect NetEase to continue to leverage its in-house research and development team and user data to develop next-generation games.

Even though fourth-quarter earnings were slightly below our estimates, NetEase's enhanced commitment to capital returns reflects improving corporate governance. Our confidence in NetEase remains unshaken, as management again demonstrated unwavering dedication and patience in crafting next-generation games. This commitment should translate to continued outperformance, cementing it as our top selection in the interactive media space. We fine-tune our near-term estimates, roll forward our model, and lift NetEase’s fair value estimate by 5% to $158 per ADR (HKD 246 per H-share). Reflecting on the words from NetEase's management about the regulatory climate in China, it seems prudent to dial back NetEase’s Morningstar Uncertainty Rating to High from Very High, aligning with its status before the unsettling regulatory draft in December 2023. The firm's shares remain undervalued, trading at a 30% discount to our valuation, and we would treat any weakness in the stock as an opportunistic entry point.

NetEase started as a Chinese internet portal in the late 1990s but has now become the second-largest mobile game company in the world. The firm owns one of the most well-known massively multiplayer franchise in China—Fantasy Westward Journey. Over the past decade, NetEase has capitalized on the industry shift toward mobile gaming and now focuses on developing innovative, high-quality, and long-cycle games with a mobile-first approach. Over the past years, the firm has established iconic titles such as Onmyoji, Knives Out, and Identity V. Every year, the company publishes dozens of games across almost every genre and game play. In addition, NetEase is also collaborating with firms such as Blizzard, Marvel, and Microsoft to release games based on famous global intellectual property like Diablo, Harry Potter, and Lord of the Rings. Over the foreseeable future, we expect NetEase to continue to leverage its in-house research and development team and user data to develop next-generation games.

We fine-tuned our NetEase and Cloud Music estimates but maintained our fair value estimates. Both companies are significantly undervalued and contrary to concerns over a negative macroeconomic climate, we believe their earnings possess a degree of resilience to further economic downturns. Our top pick in the interactive media space remains NetEase. We like that its videogame business should continue to benefit from this year’s launches of a slate of open-world titles and a growing number of government-issued game licenses. Meanwhile, NetEase’s separately listed subsidiary, Cloud Music, could benefit as consumers favor affordable streaming over more costly leisure activities, especially during economic downturns. The ease of access can lead to increased usage as people spend more time at home, and the habitual nature of these subscriptions means they will be the last discretionary expenses consumers choose to cut.

After reviewing our assumptions for narrow-moat NetEase, we are maintaining our fair value estimate at $150 but raising our Uncertainty Rating to Very High from High. This comes after considering the sequence of developments that suggest a likely softening of some provisions in China’s potential gaming policies that should dilute their impact on gaming revenue substantially. Nevertheless, until the finalization of these regulations, we acknowledge increased uncertainty, primarily due to the government's ambiguous regulatory approach to the domestic gaming industry. Even if the new gaming regulations are fully implemented, we anticipate less than a 15% impact on NetEase's revenue. With the company's shares trading at a 40% discount to our fair value estimate, a substantial margin of safety should absorb the most severe regulatory challenges.

NetEase started as a Chinese internet portal in the late 1990s but has now become the second-largest mobile game company in the world. The firm owns one of the most well-known massively multiplayer franchise in China—Fantasy Westward Journey. Over the past decade, NetEase has capitalized on the industry shift toward mobile gaming and now focuses on developing innovative, high-quality, and long-cycle games with a mobile-first approach. Over the past years, the firm has established iconic titles such as Onmyoji, Knives Out, and Identity V. Every year, the company publishes dozens of games across almost every genre and game play. In addition, NetEase is also collaborating with firms such as Blizzard, Marvel, and Microsoft to release games based on famous global intellectual property like Diablo, Harry Potter, and Lord of the Rings. Over the foreseeable future, we expect NetEase to continue to leverage its in-house research and development team and user data to develop next-generation games.

We are placing NetEase under review following the Chinese government’s release of new draft regulations affecting the gaming sector. Should these rules be put into effect, they could adversely affect the revenue of gaming companies, with NetEase potentially facing considerable challenges. Latest developments have triggered a sharp decline in the stock values of Tencent and NetEase, with shares dropping more than 10% by midday. We believe this market reaction is justified due to the expansive scope of the new draft rules. While these developments could have far-reaching consequences, we are maintaining our current fair value estimates for Tencent and CMGE, as they appear to face a less severe impact from the draft rules. Our position is subject to change as we await further information from gaming companies as to how the new regulations will affect their sales.

We're increasing our fair value estimate for narrow-moat NetEase to $150 from $146 after incorporating our assumption of a re-engagement with Activision Blizzard starting in 2024. The company’s third-quarter earnings exceeded our and Refinitiv consensus expectations as of Nov. 16, thanks to impressive margins. ADRs went down 2% during U.S. trading on the news of the CFO's resignation for personal reasons. While we were surprised by the move, we do not expect Charles Yang’s departure to have a negative impact on NetEase’s business. We continue to view NetEase’s current stock price as attractive, with the shares trading at 17 times 2024 P/E.

NetEase started as a Chinese internet portal in the late 1990s but has now become the second-largest mobile game company in the world. The firm owns one of the most well-known massively multiplayer franchise in China—Fantasy Westward Journey. Over the past decade, NetEase has capitalized on the industry shift toward mobile gaming and now focuses on developing innovative, high-quality, and long-cycle games with a mobile-first approach. Over the past years, the firm has established iconic titles such as Onmyoji, Knives Out, and Identity V. Every year, the company publishes dozens of games across almost every genre and game play. In addition, NetEase is also collaborating with firms such as Blizzard, Marvel, and Microsoft to release games based on famous global intellectual property like Diablo, Harry Potter, and Lord of the Rings. Over the foreseeable future, we expect NetEase to continue to leverage its in-house research and development team and user data to develop next-generation games.

Narrow-moat NetEase’s ADRs fell about 6% despite in-line second-quarter results, reflecting concerns about second-half gross margins, but we believe this reaction is shortsighted, leaving investors an opportunity to buy at a 35% discount to our fair value estimate. Gaming revenue growth decelerated to 2% year on year during the quarter, but a favorable mix shift drove an almost 400-basis-point expansion in gross margin. Nonetheless, management’s expectation for a less favorable mix shift toward lower-margin mobile game revenue for the second half raised concerns about near-term profitability. We differ from the market as we expect higher revenue and better selling, general, and administrative leverage to translate to higher profits, given the continued success of the newly launched titles. We fine-tune our near-term forecast but maintain our fair value estimate at $146 per ADR (HKD 226 per H-share). With NetEase’s shares trading at just 15 times 2023 core earnings, we think the market is undervaluing the strength of its growing game portfolio, and we continue to view the current risk/reward profile as highly attractive.

NetEase started as a Chinese internet portal in the late 1990s but has now become the second-largest mobile game company in the world. The firm owns one of the most well-known massively multiplayer franchise in China—Fantasy Westward Journey. Over the past decade, NetEase has capitalized on the industry shift toward mobile gaming and now focuses on developing innovative, high-quality, and long-cycle games with a mobile-first approach. Over the past years, the firm has established iconic titles such as Onmyoji, Knives Out, and Identity V. Every year, the company publishes dozens of games across almost every genre and game play. In addition, NetEase is also collaborating with firms such as Blizzard, Marvel, and Microsoft to release games based on famous global intellectual property like Diablo, Harry Potter, and Lord of the Rings. Over the foreseeable future, we expect NetEase to continue to leverage its in-house research and development team and user data to develop next-generation games.

Narrow-moat NetEase's first-quarter earnings exceeded our and Refinitiv consensus expectations. We attribute strong margin performance during the quarter to a favorable revenue mix shift and the one-off timing benefit related to Activision Blizzard revenue recognition. Owing to NetEase's stacked game release schedule this summer, we remain upbeat on its financial performance going into the rest of this year. We have slightly raised our fair value estimate to $146 from $139. We find NetEase's valuation multiples do not recognize the company’s narrow moat, with the shares trading at 17 times price/consensus earnings and 11 times price/core earnings (after removing net cash from market cap and net losses from Cloud Music and Youdao from NetEase's bottom line). We continue to believe the current risk/reward profile is highly attractive.

The decline in NetEase’s operating profit in the fourth quarter was a one-off. Excluding CNY 1 billion in charges related to the recent breakup with Activision Blizzard, NetEase’s earnings would have been in line with our and PitchBook consensus expectations. Management maintained its outlook for 2023, and we are keeping our forecasts (which already factored in the loss of revenue from Blizzard games) unchanged. Over the past few months, there has been an improving regulatory environment for games, but we think the market is still behind the curve on raising revenue forecasts to account for more game license approvals. Building on our positive regulatory outlook and conviction in NetEase’s ability to develop topnotch games, we continue to view the shares as undervalued, trading at a 40% discount to our fair value estimate. Valuation multiples also look very cheap for a narrow-moat business, with the shares trading at 17 times earnings and 11 times core earnings (after removing net cash from market cap and net losses from Cloud Music and Youdao from the bottom line). We remain buyers as we believe the current reward/risk is attractive.

We expect 2023 to be a better year for Chinese online gaming companies, and we see attractive buying opportunities. Some of these firms struggled in 2022 due to a lack of new gaming licenses, but since mid-2022, the National Press and Publication Administration started handing out more licenses to publishers. In January 2023, the NPPA issued 88 new domestic gaming licenses, marking the highest monthly handouts since May 2021. Based on the latest approval data, we fine-tuned near-term forecasts for three publishers under our coverage (Tencent, NetEase, and CMGE), but maintained their fair value estimates. NetEase is our top pick in the online gaming sector for its strong portfolio of existing and upcoming games.

We retain our fair value estimate of USD 139 (HKD 216) for narrow-moat NetEase after it reported third-quarter earnings. While regulatory approvals remain a constraint to near-term growth, we continue to see long-term revenue opportunities outside China. As for the reported breakup with Blizzard Entertainment, we believe the two will eventually reach a deal to keep Blizzard's games live in China, but a re-engagement might only happen after Microsoft's takeover of Activision Blizzard. Blizzard's games only contribute about 2% of NetEase's earnings, so we think the market could have overreacted to the headlines. We view NetEase's shares as undervalued, trading at 50% discount to our fair value. We would treat volatility in the stock as an opportunistic entry point.

NetEase started as a Chinese internet portal in the late 1990s but has now become the second-largest mobile game company in the world. The firm owns one of the most well-known massively multiplayer franchise in China—Fantasy Westward Journey. Over the past decade, NetEase has capitalized on the industry shift toward mobile gaming and now focuses on developing innovative, high-quality, and long-cycle games with a mobile-first approach. Over the past years, the firm has established iconic titles such as Onmyoji, Knives Out, and Identity V. Every year, the company publishes dozens of games across almost every genre and game play. In addition, NetEase is also collaborating with firms such as Blizzard, Marvel, and Microsoft to release games based on famous global intellectual property like Diablo, Harry Potter, and Lord of the Rings. Over the foreseeable future, we expect NetEase to continue to leverage its in-house research and development team and user data to develop next-generation games.

The National Press and Publication Administration, or NPPA, issued 73 new game licenses on Sept. 13, marking the highest number of monthly approvals since its resumption in April. We are encouraged by the fact that all the Chinese gaming companies under our coverage (Tencent, NetEase, and CMGE) received one new license this month. We keep our fair value estimates and earnings forecasts unchanged, as we were already expecting the approval of new licenses to return this year, but sequential increases in monthly approval numbers should help improve investor sentiment. Our top pick in the online gaming sector is NetEase, for its strong portfolio of new and existing games.

Narrow-moat NetEase's second-quarter results were ahead of our and PitchBook consensus expectations, but management struck a cautious tone for the second half. We surmise that the initial performance of the firm's new mobile game, Diablo Immortal, is running below expectations, and the shortage of game licenses is also going to limit NetEase's new game releases for this year. As a result, we lower our 2022 revenue and net profit forecasts, but maintain a USD 139 (HKD 216) fair value estimate for NetEase as our long-term forecasts remain intact. The firm's shares are undervalued, and we would treat volatility in the stock as an opportunistic entry point.

Narrow-moat NetEase had a solid start to the year, reporting 29% operating income growth for the first quarter of 2022. We expect the strong financial performance to continue for the rest of 2022, supported by the release of Diablo Immortal in June. More importantly, the record-breaking performance at Fantasy Westward Journey (launched in 2003) reaffirms our view that the company has a moat around its legacy franchises. Coupled with the firm's industry-leading capability in developing new games, we see plenty of revenue opportunities (both inside and outside of China) for the firm to grab. We maintain our fair value estimate at $139 and view NetEase shares as very undervalued.

After an eight-month freeze, China has finally resumed new game license approvals, according to Bloomberg News. The past license freeze weighed on company earnings and negatively affected investor sentiment, but April 11's positive development should bring much-needed relief to a sector that has been shaken by negative headlines. We keep our fair value estimates and earnings forecasts unchanged for our coverage of the publishers, as we were already expecting new licenses to come back this year. Besides earnings, we think the greater implication here is that the Chinese government is committed to maintaining a vibrant domestic video game sector--a notion that has been questioned by investors over the past year.