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The waning popularity of Activision Blizzard's (NASDAQ: ATVI ) World of Warcraft has been a concern for NetEase.com (NASDAQ: NTES ) this year, and the recently reported third quarter shows just that. NetEase hit a speed bump after reporting weaker-than-expected revenue and earnings, leading to a slight pullback in the share price.
Not too bad after all
However, NetEase's financial results were good enough for Morgan Stanley analysts to raise their price target to $77. Despite a decline in WoW users, NetEase managed to grow its online gaming revenue by 21% from the prior year period, as it has been focusing on its self-developed games.
NetEase licenses WoW in China and the game has been a major source of revenue in the past. But, Activision has been seeing steady declines in WoW subscribers. In the previous quarter, Activision reported that the franchise's subscriber count fell once again from 7.7 million to 7.3 million. This is the lowest count since 2007, and worryingly, much of this decline is coming from China.
Hence, NetEase needed to make certain moves to mitigate this decline and it has been doing the same. NetEase upgraded two of its longest-running games -- Fantasy Westward Journey II and Westward Journey Online II. These new versions have performed well so far and aided NetEase's revenue growth in the previous quarter. Moreover, NetEase is looking to carry over the popularity of Fantasy Westward Journey II to the mobile platform with the introduction of a mobile version.
NetEase's two recently launched games -- Heroes of Three Kingdoms and Dragon Sword -- have also received encouraging feedback. Going forward, NetEase expects expansion packs for Ghost II and Kung Fu Master to further increase gamer interest. Moreover, NetEase has lined up expansion packs for Heroes of Tang Dynasty II, Tianxia III, and Legends of Fairy, with the recently launched Legends of Tibet expected to push up revenue as well.
Apart from these, NetEase is also readying Crisis 2015 -- its first person shooter game – for launch in the first half of 2014. There's another 3D epic fantasy game, titled Revelations, which will be launched soon. NetEase has put three years of effort into this game and expects it to become a hit thanks to the engaging gameplay involved.
Also, NetEase might receive another shot in the arm from the new expansion pack of Activision's WoW. Warlords of Draenor, the latest expansion pack of the franchise, takes gamers back to one of the most iconic settings in the World of Warcraft universe. This could lead to a spike in subscriber count for Activision, as the last expansion pack, Mists of Pandaria, had sold 2.7 million copies on its first day last year.
Focusing on mobile
In addition, NetEase management has been working on "several high-quality mobile games" as stated on the previous conference call. To increase the popularity of its mobile games, NetEase expects its YiChat messaging platform to do the trick by attracting more users to its mobile platform. Management expects this chatting app to ultimately entice more players to download upcoming mobile games.
NetEase's mobile strategy sounds similar to that of rival Tencent (NASDAQOTH: TCEHY ) . Tencent is a leading game operator in China, famous for its popular WeChat service. Tencent recently introduced a WeChat feature that allows users to play freemium games (free to play, but users need to pay for in-game purchases). Considering that WeChat had more than 300 million users in August, Tencent can hit the jackpot with this move.
Also, Tencent management is aggressively moving into mobile and the company is considering buying game developers to roll out more free content. Hence, NetEase must navigate through a crowded mobile gaming space. But, investors should remain optimistic as NetEase is the second-biggest game operator in China behind Tencent, and it could use its reach and existing user base to make its mobile games successful.
NetEase is up almost 60% this year. Even then, the stock is pretty cheap at a trailing P/E of 13. Its latest results might not have been on par with Street estimates, but it is making some good moves to improve its gaming business. Hence, it would be wise to hold on to NetEase as the company can scale new heights going forward.
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