Can NetEase Keep It Up?

NetEase (NASDAQ: NTES  ) is heating up.

Shares of the Chinese online gaming pioneer soared 19% last week, nabbing a fresh 52-week high on Friday.

The week got off to a strong start with NetEase rallying after China Daily reported that NetEase and China Telecom (NYSE: CHA  ) were teaming up to introduce an instant messaging platform in China.

The venture's Yixin will set itself apart from Tencent's market-topping WeChat by allowing users to send free text and voice message to users that haven't even installed the actual app. It will also allow communications to be sent to hardwired phones, and that's important since China Telecom is a distant third in mobile but is China's top dog when it comes to old-school landline connections. 

NetEase will have just a minority stake in the business, but it's another way that NetEase continues to diversify from its online gaming stronghold.

A dozen years ago, NetEase was one of a handful of Chinese providers of value-added services for wireless feature phones scrambling to find new areas for growth after the government and telcos cracked down on the niche's third-party players. NetEase turned to Web-based games, eventually having a monster hit in Fantasy Westward Journey.

NetEase's success was enough to convince Activision Blizzard (NASDAQ: ATVI  ) to go with the company as its licensing partner for World of Warcraft in China.

As anyone that has seen Activision's last few quarters, the once-growing multiplayer online gaming realm of orcs and blood elves has been fading in user count over the past two years. Things aren't any different in China, but NetEase's online gaming revenue still managed to climb 18% in its latest quarter despite a decline in World of Warcraft revenue. That's important since online gaming accounts for more than 85% of NetEase's revenue.

Its online advertising revenue is growing even faster these days -- up 33% in its latest quarter -- as NetEase continues to cash in on its popularity as a Web portal. NetEase now has 570 million email users, and it's been able to cash in on that traffic by drumming up 120 million installations of its mobile news application that's attracted 40 million daily active users.

Naturally NetEase will still need to be successful with its online-gaming business. Nomura downgraded NetEase earlier this month on concerns that its pipeline of new releases may slow next year.

Morgan Stanley also downgraded rival Perfect World (UNKNOWN: PWRD.DL  ) after it reported quarterly results last week, arguing that the smaller developer is richly valued at 12 times this year's earnings and 11 times next year's target. Yes, that also happens to be NetEase's multiples in Morgan Stanley's model, but at least NetEase has a whopping $2.6 billion in cash on its balance sheet.

These are interesting times for online gaming in China, and NetEase is still a big name to watch as it justifies hitting all-time highs on Friday.

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9/30/2016 4:00 PM
NTES $240.78 Down -1.28 -0.53%
NetEase CAPS Rating: ****
ATVI $44.30 Up +0.09 +0.20%
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CHA $51.04 Up +0.40 +0.79%
China Telecom CAPS Rating: **
PWRD.DL $0.00 Down +0.00 +0.00%
Perfect World CAPS Rating: ***