The first half of 2014 wasn't a good one for Chinese gaming company NetEase (NTES 0.02%). The stock underperformed the NASDAQ Composite index in the first six months of the year, as the company is trying to execute a painful transition in its revenue mix. On the other hand, NetEase's smaller rival, Perfect World (PWRD), has done well by outperforming the market with gains of 13% in the first half.
In fact, Perfect World had dropped 10% after reporting its first-quarter results due to margin concerns, so its recovery is remarkable. Meanwhile, NetEase's first-quarter results came in below expectations, as the company saw lower revenue from Activision Blizzard's (ATVI) World of Warcraft. The common link between Perfect World and NetEase is that both companies are trying to tap mobile gaming, which is the reason behind their short-term pains.
Mobile gaming in focus
Mobile gaming has significant potential, and both of these gaming companies are trying to make the most of it. In fact, for both of them, the shift to mobile is more out of necessity than choice, as the popularity of massively multiplayer online role-playing games, or MMORPGs, is fading in China.
According to T.H. Capital analyst Tian X. Hou, MMORPG gamers in the Middle Kingdom increased less than 1% year over year to 338 million in 2013. At the same time, mobile game users went up 54% year over year to 215 million. In light of this shift, it became imperative for both Perfect World and NetEase to move into mobile. However, will the two companies be able to make a dent in mobile gaming?
Perfect World's aggressive moves
Perfect World's gross margin dropped 420 basis points year over year in the previous quarter on account of its mobile gaming investments. However, this helped the company increase its mobile revenue mix to 15% of total revenue, up from 10% in the preceding quarter. Perfect World's overall results were strong as well. Its revenue increased 43% year over year and earnings per share shot up 63% to $0.70 per share.
Looking ahead, mobile should continue driving Perfect World's growth. Two of its titles, Return of the Condor Heroes and Fantasy of the Immortals, are doing well already, while a battery of new mobile games are ready for launch.
The downside of these mobile games is that they will likely hurt Perfect World's gross margin, to some extent, in the short run. However, as the company aggressively promotes its titles, it should see a bump in the user base, ultimately allowing it to tap a greater share of the mobile gaming market.
NetEase easing into mobile
Known for operating World of Warcraft in China, NetEase's revenue growth has taken a hit due to WoW's declining user base. As a result, NetEase is now focusing on mobile games, apart from its in-house MMORPGs, to accelerate its growth.
NetEase is making a smart move by trying to leverage the success of its MMORPGs on the mobile platform. The company has already seen some success with the mobile version of Fantasy Westward Journey II. Encouraged by this success, NetEase launched its first mobile card battle game, Mini Westward Journey, to extend its mobile gaming portfolio.
This seems like another shrewd move from NetEase, as mobile card games are gaining popularity. For example, Activision's Hearthstone: Heroes of Warcraft, is seeing robust growth. As Fool contributor Sam Mattera points out, Hearthstone has a rating of 93 out of 100 on video game review site Metacritic, and is ranked among the top 20 free apps on iTunes.
Activision makes money on the game when users buy more cards to improve their chances of winning, and this strategy seems to be working fine. As a result, the company has decided to launch the game on iPhone and Android devices going forward, as it is currently exclusive to the iPad and Windows PC platforms.
Like its partner, NetEase is also trying to capitalize on the popularity of the collectible card game genre. But, at the same time, the company is trying to improve the mobile experience by adding social networking features to the mobile games. For instance, users can log on to mobile games using YiChat instant messaging accounts to share gaming achievements and experience.
The bottom line
The mobile and online gaming market is expected to grow at a compound annual rate of 23.6% till 2017, generating $60 billion in revenue, according to Digi-Capital. Clearly, the opportunity is big, and both Perfect World and NetEase are trying to capture as much share of the market as possible. They have already created a strong mobile gaming portfolio, and as they make further progress in this segment, their financial performance should improve.
