For many up-and-coming companies, producing consistent revenue growth is the primary sign of success. When a company gets better established as a key player in its field, as Chinese video game giant NetEase (NASDAQ:NTES) has, turning that revenue into profit becomes at least as important to demonstrate its leadership in the industry.
Coming into the third-quarter financial report on Nov. 15, NetEase investors were ready to see further bottom-line pressure even as they anticipated another big jump in revenue. NetEase saw the expected boost to its sales, but a substantial jump in operating costs held back any potential profit gains. Let's look more closely at NetEase and what its latest results indicate about its prospects.
NetEase posts mixed results
NetEase's third-quarter results had their ups and downs. Revenue once again showed considerable strength, with a 35% rise in local currency terms working out to $1.88 billion, which was roughly in line with what investors were expecting to see. Adjusted net income growth continued to deteriorate, with the number climbing by just 0.25% and working out to $454.6 million, or $3.43 per share. That was flat compared with year-earlier figures, although it did beat the consensus forecast among those following the stock.
NetEase's segment performance was fairly similar to what we've seen in the past, although growth in some key areas decelerated. The massive online game services business saw net revenue climb 24%, or only about half of the growth rate that NetEase saw in the second quarter of 2017. Mobile games continued to important, although the proportion of revenue that came from the mobile side of the business actually fell sequentially from what the company saw three months ago. Meanwhile, the email, e-commerce, and others segment posted 80% year-over-year growth in its top line, approaching 30% of the overall business. The advertising services business brought up the rear in terms of revenue growth, with the segment seeing a 12% increase in sales on strength in ads from automobile, real estate, and internet services customers.
Yet one key challenge that NetEase hasn't yet overcome is controlling its costs. Operating expenses soared 37%, and the company blamed higher staff-related costs from higher headcounts and average compensation, as well as higher selling and marketing expenses. Costs from the e-commerce business also weighed on NetEase's ability to maximize its earnings. As the gaming segment has shifted more toward mobile gaming, NetEase has seen gross margin figures for the unit drop, because monetizing mobile has proved more difficult than doing so for traditional online games.
CEO William Ding took the results in stride. "We continue to amass one of China's preeminent mobile game portfolios," Ding said, although the CEO also noted an expected slowdown in the game Onmyoji among Chinese players.
Can NetEase get rolling again?
Even with headwinds, NetEase has high hopes for the coming year, pointing to new launches of expansion packs and new mobile titles that have customers have warmly received. In Ding's words, "There remain ample growth opportunities in China as we further diversify our portfolio by exploring a variety of genres."
As we saw last quarter, however, weaker profits spurred NetEase to cut its dividend yet again. With a payout tied to after-tax net income, NetEase decided to pay out just $0.72 per share in dividends for the quarter, down from $0.83 last quarter and $1.08 per share in the first quarter of 2017.
NetEase shareholders seemed satisfied with the results despite the sluggish growth in some key metrics, and the stock was up about 2% in after-market trading following the announcement. Investors would prefer to see stronger bottom-line growth, but NetEase still seems to be working toward solidifying its dominant position in the Chinese gaming industry while looking at smart international expansion plans as well.