NetEase: In-House Games Will Drive Stock Price!

  • About 3 quarters ago, NetEase ventured into in-house games.
  • In-house games business is much more profitable than that of licensed games.
  • We are bullish about NetEase, and we think the stock has a 30% upside

Netease In House Games Will Drive Stock Price

At first glance, NetEase (NASDAQ:NTES) comes across as just an online gaming company. However, look beneath the hood and you will find that NetEase is putting together an entire army of internet businesses, most of which are focused on mobile platforms.

In our Q4 2013 earnings review for Netease, we found that the company’s gaming business is chugging along nicely. So, where’s the next big push? The familiar one word answer is mobile. And the deeper you look the more you realize how much of a thrust there is on mobile platforms. While these businesses don’t contribute significantly to the company’s overall revenue currently, they could potentially drive future growth.

NetEase Revenue and Profitability

In Q4 2013, NetEase delivered a surprise on the revenue and profit front. The company delivered revenue growth of 11% excluding for-ex contribution of 3% to the top-line. In FY 2013, NetEase saw a rebound in its growth rate as revenue grew by nearly 17% Y/Y, after a decline in FY 2012.

NetEase Revenue and Profit Trend

Further, over a five year period, NetEase has delivered unwavering profit margins that cluster around their 5 year average levels. In FY 2013, the company’s profit margins remained resilient to a change in China’s tax laws subjecting online games to a value-added tax as against the business tax charged earlier. In FY 2013 NetEase delivered a robust operating profit margin of over 44% and net profit margin of over 45%.

In FY 2013, NetEase also saw a rebound in revenue from advertising, its second largest source of revenue, aided by the success of its mobile applications. The segment recorded a 30% growth Y/Y after a decline in FY 2012.

NetEase Online Games Business

NetEase’s core business of online games contributes about 85% of its revenue. In 2013, China’s online gaming market was worth about RMB 83.2 billion or USD 13.7 billion and NetEase accounted for about 10% of this market. The company’s thrust on self-developed games and mobile gaming which began in 2013, could help improve the company’s market share and become a huge driver of long term growth.

Apart from designing games targeted at overseas users, the company is currently developing new games for mobile platforms and plans to introduce mobile versions of its popular existing games. Its gaming business could also get a boost from the success of its online messaging service which we will discuss in the coming section.

NetEase moved to in-house or self-developed games about 3 quarters ago. In-house games are much more profitable than licensed games and this move coupled with its focus on mobile gaming will drive the future.

NetEase: Where the next big push could come from!

In the internet world today, the most valued commodity is probably the mobile user and NetEase seems to be collecting the right ingredients to lure its target audience.

In 2013, NetEase launched an instant messaging service YiChat. To enter the crowded instant messaging space, the company has struck a tie-up with China Telecom. YiChat currently gives users access to books, music and news in addition to more standard features like messaging, voicemail, international voice calls.

NetEase also plans to integrate mobile games and mobile payment services with this messaging service. The next progression could possibly be to integrate its e-commerce business with the messaging service like Tencent has done with WeChat.

NetEase, China’s 6th most visited site also runs a host of other businesses like:

  • An online dating service
  • A mobile news app with over 200 million installations
  • A cloud based music app which enables listening and sharing
  • China’s leading online dictionary and translation service
  • Youdao Cloudnote, a handwritten Chinese note taking app
  • China’s leading e-mail service with 620 million registered users

NetEase Valuation

At its current price of $68.28, NetEase trades at a Price/Sales multiple of 5.8 and a Price/Earnings multiple of 12.1. Following its latest strong quarterly performance and the potential of its core and non-core businesses, we continue to remain bullish about NetEase.

We continue to stand by our target price of $89 based on our earlier valuation of NetEase representing an upside of about 30% from its current price.

To see Netease’s latest stock price movement, click here (NASDAQ:NTES)

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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