Citing near-term headwinds, investment banking firm Jefferies downgraded NetEase (NASDAQ:NTES) from buy to hold earlier this month, slashing the stock's price target from $330 to $290. Analysts Ani Tu and Karen Chan believe that a lack of new game releases in the near future, and the tepid performance of NetEase's existing lineup, will hurt the Chinese video game specialist's top and bottom lines.
The analysts carried out channel checks showing a drop in the average monthly gross of one NetEase title -- Onmyoji -- while other titles remained largely stable. Jefferies believes that this lack of growth could reduce the company's mobile game revenue by 20% sequentially during the third quarter (which ended in September).
Image source: Getty Images.
Investors, however, should ignore this downgrade and stop focusing on the short-term headwinds that NetEase faces. There is enough evidence that the company is built for long-term growth, and any hiccups along the way should be treated as buying opportunities. Here's why.
NetEase's mobile business will keep improving
It seems Jefferies is trying to play it safe before the next earnings release, as the firm admits that NetEase's recent updates to its mobile games have helped build some momentum. For instance, the company added to the popular mobile MMORPG (massively multiplayer online role-playing game) Crusaders of Light with a new expansion pack known as Arrival of the Paladin. This update will give players more reasons to stick around thanks to the addition of new levels and rewards, adding to the company's revenue going forward on the back of higher in-app purchases.
The analysts also indicated that the updated anniversary version of Onmyoji boosted the title's gross-revenue ranking. But the update was launched at the end of the quarter, so it might not help NetEase much when it releases its next report. Regardless, Foolish investors need to look beyond the single quarter, as NetEase is setting up the Onmyoji franchise for long-term success.
The company recently revealed that it's launching an English-language version of the franchise on both the iOS and Android platforms. Onmyoji will be available for download in the U.S. and Canada later this year, as NetEase tries to replicate the popularity of the game in these big mobile gaming markets. In fact, the game has already been downloaded over 200 million times, so it brings a strong track record to North America.
Newzoo forecasts that the U.S. alone will generate $25 billion of video gaming revenue this year. A substantial portion of this revenue should come from smartphones and tablets, as these two platforms are expected to account for 42% of global gaming revenue. NetEase's latest move will open the doors to a massive new opportunity beyond its home market of China.
To boost the mobile business, NetEase has also brought the highly popular Minecraft franchise to China. The company launched a Chinese iOS version of the game in September, while the Android version is expected this month. Minecraft is an extremely popular game, with more than 100 million registered players. What's more important is that more than half of Minecraft players in the Asia-Pacific region are on the mobile platform, so it should give NetEase's mobile gaming revenue an additional shot in the arm.
These are just some of the games that NetEase is banking on to drive growth. Earlier this year, the company had revealed a pipeline of more than 30 titles, including 13 new mobile games set to be launched in the coming quarters.
In all, NetEase's mobile gaming business is unlikely to slow down given the number of titles it has up its sleeve, especially in mobile, as that segment already makes up almost three-fourths of total revenue.
Growth beyond gaming
NetEase is trying to augment its mobile gaming business by hunting for opportunities in the e-commerce and email markets. Last quarter, revenue from this business jumped an impressive 69% to $494 million thanks to the improving adoption of its Kaola and Yanxuan e-commerce platforms, outpacing the 47% annual growth in the gaming business.
Encouraged by this growth, NetEase has decided to spend over $3 billion on European products over the next three years to bring more than 2,000 brands into the Chinese market (on top of thousands of additional brands from the U.S., South Korea, and Japan). The company believes that this move will increase the appeal of Kaola to the big spenders in China, as European products rank second for online sales in the region.
The company is trying to differentiate its e-commerce platform by reducing delivery times, with plans to build an automated warehouse spread across 2.7 million sq. ft. next year, so Chinese consumers can get faster access to foreign goods. This should help NetEase claim a larger piece of the fast-growing Chinese e-commerce market, which is expected to exceed $956 billion in revenue by 2022, according to one estimate.
NetEase is a compelling value
NetEase is one of the most undervalued Chinese internet stocks out there. In fact, the stock trades at bargain levels when compared to the likes of Tencent and Alibaba.
Data by YCharts.
The stock's price-to-earnings ratio comes in at less than half the industry average of 37 for internet information stocks, while the low price-to-sales multiple indicates that investors don't have to pay through the nose for NetEase's fast-growing revenue. This is especially compelling considering the company is growing its top line faster than its peers.
Data by YCharts.
Don't let short-term thinking scare you away from a well-established player in the world's largest video gaming and e-commerce markets.
Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends NetEase. The Motley Fool has a disclosure policy.
