Another Letdown From NetEase.com

Perfect World's (Nasdaq: PWRD  ) descent on Monday was just an opening act for investors cynical about China's online gaming speedsters.

Pioneer NetEase.com (Nasdaq: NTES  ) also delivered soft quarterly results last night.

You may not sense the disappointment from the report itself. Revenue rose 53% to $175.1 million, as the company is now promoting Activision Blizzard's (Nasdaq: ATVI  ) World of Warcraft throughout China after an interminable delay. Also, toward the end of last year, it released expansion packs for its Fantasy Westward Journey and Tianxia II blockbusters that opened up the experience to many new gamers.

Earnings of $0.51 per American depositary share aren't much of an improvement over last year's showing, but the company was hit with a net foreign exchange loss during the quarter. Its effective tax rate also spiked, because World of Warcraft revenue is taxed at a higher 25% rate.

Decent numbers turn ugly, though, when one realizes that analysts had expected a profit of $0.61 per ADS on $185.9 million in revenue.

It wasn't a shining quarter for the four Chinese online gaming companies that have reported.

  • Perfect World's stock fell 25% on Monday after the company posted a dramatic quarter-to-quarter drop in active gamers.
  • Giant Interactive (NYSE: GA  ) has been a laggard  and will stay that way after posting declines of 19% for year-over-year revenue and 20% for earnings in its latest quarter.
  • Changyou.com (Nasdaq: CYOU  ) held up relatively better with its quarterly numbers last month, but the stock is still trading off more than 40% from last summer's high.

Shanda Games (Nasdaq: GAME  ) is the only major player yet to report, but it has been just as disastrous since going public last year. Shanda shares hit a new low yesterday.

The news isn't all glum at NetEase.com. Its original dot-com portal is rocking. Advertising revenue more than doubled, and it landed the most new email accounts it had in more than a year. Unfortunately, online gaming still represents 91% of the revenue mix at NetEase.com, so it will continue to be the driver here.

NetEase.com did close the quarter with more than $1.1 billion in cash and equivalents on its balance sheet. That's a healthy mattress of roughly $8.50 per ADS that may come in handy if the company needs to diversify into new areas or acquire smaller gaming rivals.

The valuations in this industry are ridiculously low, but now we're starting to find out why.

Are you comfortable investing in Chinese stocks these days? Share your thoughts in the comments box below.

NetEase.com and Perfect World are Motley Fool Rule Breakers recommendations. Motley Fool Options has recommended a synthetic long position on Activision Blizzard, which is a Motley Fool Stock Advisor selection. The Fool owns shares of Activision Blizzard and Perfect World. 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 gaming stocks for a long time. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. He does not own shares in any of the companies in this story. The Fool has a disclosure policy.


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