NetEase Remains China's Class Act in Online Gaming

The booming online gaming industry is getting more competitive in China, but NetEase.com (Nasdaq: NTES  ) remains the one to beat.

The Web-based gaming pioneer came through with another blowout quarter last night. Net revenue climbed 31% to $247.5 million, fueled by a 31% spike in online gaming and a 27% spurt in online advertising.

Net income climbed 25% to $108 million, or $0.83 per American depositary share, and that's without baking in the headwinds of a currency-related hit this time around and the tailwinds of a gain a year earlier. In other words, margins aren't really contracting. Even with the foreign currency hit, it's not easy to find companies sporting 44% in net margins the way NetEase just did.

Why is a Chinese company taking a foreign currency hit when the yuan's only going to keep heading higher? The rub here is the $1.2 billion in largely euro-denominated time deposits that NetEase is sitting on. Yes, NetEase is raking in a ton of dough. It has nearly $11 per ADS in cash and time deposits napping away on its balance sheet.

Once again, the pros underestimated NetEase's potential. Analysts figured that the dot-com darling would earn $0.70 per share on $220.2 million in revenue.

It's not just NetEase rolling along nicely. Even some of the laggards are holding up well. Giant Interactive (NYSE: GA  ) posted 33% and 17% gains in revenue and earnings growth, respectively, in its latest quarter. Changyou.com (Nasdaq: CYOU  ) came through with a 30% uptick in year-over-year top-line growth.

Perfect World (Nasdaq: PWRD  ) and Shanda Games (Nasdaq: GAME  ) report next month.

NetEase was growing faster through the first nine months of 2010, largely the result of its plum role as the licensee of Activision Blizzard's (Nasdaq: ATVI  ) World of Warcraft in China. Regulators didn't let that massive multiplayer juggernaut kick in until September 2009, so we're now finally comparing apples to apples -- or orcs to orcs.

There will always be risks in this niche. The government can restrict Internet access and young Chinese gamers can move on to new diversions. However, the uncertainties are also priced into these stocks. NetEase closed yesterday at a mere 14 times this year's projected profitability. If that seems cheap, the other four public companies trade at even lower multiples.

The risks are high, but the potential rewards are even greater.

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

NetEase.com is a Motley Fool Rule Breakers pick. Activision Blizzard is a Motley Fool Stock Advisor recommendation. 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. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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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  • Report this Comment On February 26, 2011, at 12:32 PM, crca99 wrote:

    Thank you as always for helping me follow NTES. I am long 2 Chinese stocks, NTES and CTRP, and doing well in both thanks to TMF. Now, if only I didn't have losses elsewhere.

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