This Company Is Winning in China

There's finally a winner in what was shaping up to be a ho-hum quarter for China's leading online gaming companies.

NetEase.com's (Nasdaq: NTES  ) quarterly report last night packed the pizzazz lacking in Changyou.com (Nasdaq: CYOU  ) , the growth absent from Giant Interactive (NYSE: GA  ) , and the market-thumping punch that went missing on Monday with Perfect World (Nasdaq: PWRD  ) .

In short, it was a knockout.

Revenue soared 52% to $198.6 million, well ahead of the 46% surge that Wall Street was expecting. A good chunk of that growth came from Activision Blizzard's (Nasdaq: ATVI  ) World of Warcraft going online through NetEase as a distributor partner late last year. However, there were still plenty of gains to be found from the company's in-house titles.

An encouraging sign came from the company's namesake portal, where advertising revenue doubled and operating profits grew nearly sixfold. Investors shouldn't get too excited. Online advertising is still just 11% of the revenue mix here, with gaming contributing the beefiest 88% slice. However, cyberspace growth is great for diversification. Going by the lofty earnings multiples commanded by dot-com speedsters Baidu (Nasdaq: BIDU  ) and Ctrip.com (Nasdaq: CTRP  ) , healthy gains at its website properties may help fatten the stock's meager price-to-earnings ratio -- which closed yesterday at just 15 times this year's projected profitability and a mere 12 times next year's target.

Earnings clocked in at $0.55 a share, barely ahead of the $0.53 a share it earned a year ago and short of the $0.58 a share that analysts were expecting. No matter how many times you read that, you'll have to trust me when I tell you that this still was a blowout quarter.

For starters, last year's profit included a foreign exchange gain. This quarter's profit was stung by a net foreign exchange loss of $10 million. Back that out and tax it at a nominal rate and NetEase would have earned much more than $0.60 a share. Back out last year's one-time currency gain, and it would have earned quite a bit less than $0.53 a share.

Yes, margins were dented on the bread-and-butter gaming end of the business, but that's the difference between last year's slate of proprietary games and having to shell out licensing royalties to Activision Blizzard this time around. All investors need to know is that clearly this is ultimately incremental to the bottom line.

I was started to grow concerned after the first few bland reports from the sector, but NetEase.com -- a stock that has nearly tripled since I recommended it to Motley Fool Rule Breakers subscribers six years ago -- has vindicated the industry.

How many Chinese stocks are in your portfolio? Share your thoughts in the comment box below.

Baidu, NetEase.com, and Perfect World are Motley Fool Rule Breakers selections. Activision Blizzard is a Motley Fool Stock Advisor pick. Ctrip.com International is a Motley Fool Hidden Gems selection. Motley Fool Options has recommended a synthetic long position on Activision Blizzard. The Fool owns shares of Activision Blizzard. Try any of our Foolish newsletter services, free for 30 days.

Longtime Fool contributor Rick Munarriz has been a fan of China's high-margin online stocks for a long time. He does not own shares in any of the companies in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


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