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NetEase Sees Online Game Revenue Fall

By Dan Caplinger - Feb 8, 2018 at 7:18AM

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A surprising hit to the video-game giant shocked shareholders.

The Chinese video-game industry has been a successful niche for many companies, and NetEase (NTES 1.45%) in particular has done a good job of finding ways to grow its business even as consumer preferences shift from online games toward mobile and other alternatives.

Coming into Wednesday's fourth-quarter financial report, NetEase investors were ready to deal with slowing revenue growth and a weaker bottom line, but they nevertheless wanted to see signs of continued success and good prospects for the year to come. NetEase's news wasn't as good as many had expected, and a substantial drop in revenue from online games wasn't well received.

Let's take a closer look at NetEase to see what it told investors about its recent experience.

Hand holding mobile device in front of Chinese flag.

Image source: Getty Images.

Tough times for NetEase

On their face, NetEase's fourth-quarter results weren't so bad. Revenue rose 21% in local currency terms to the equivalent of $2.25 billion, which was stronger than the $2.2 billion that most investors were looking to see. Adjusted net income of $288.8 million translated to adjusted earnings of $2.18 per share, which was a bit higher than the $2.11 consensus forecast among those following the stock.

But the big surprise came in NetEase's segment breakdown. The key online game services division saw revenue fall almost 11%. That wiped out a good part of the gains from e-commerce, which jumped 175% from year-ago levels, and email, which was higher by 55%. The advertising services segment also bounced back, posting gains of slightly more than 10%. Yet the size of the online game division is so large that its losses were instrumental in holding back NetEase's overall growth.

NetEase said decreased revenue from self-developed mobile games such as Onmyoji were primarily responsible for the fall in online video game revenue. Mobile games made up 68% of net revenue, continuing to rise from previous-year figures. Strength in the automobile, internet services, and real estate sectors helped to boost advertising services revenue, while the rapid development of NetEase's and Yanxuan sites boosted the company's take from e-commerce.

NetEase also continued to fail to control its costs. Operating expenses jumped 66% from the fourth quarter of 2016, as selling and marketing expenses almost doubled. Research and development costs and overhead expenses were also up sharply. Gross profit also fell as NetEase's cost of sales climbed disproportionately.

CEO William Ding tried to put the results in context. "Although a few mobile titles such as Onmyoji and the mobile version of New Ghost experienced a decline," Ding said, "we have introduced new content for these games to attract players." The CEO also pointed to investments to build high-growth parts of its business as bearing out well for the company.

What's next for NetEase?

NetEase is still optimistic despite its setback. The company hopes that promotions to support battle arena games will translate to new sales and extend its reach beyond its core audience. Ding also noted that new titles and partnerships with industry leaders could make its video game offerings even more robust in 2018. Combined with e-commerce expansion, NetEase wants to boost its scope and be an even more important part of the Chinese internet market.

Yet NetEase disappointed investors with a big dividend decrease. The company will pay out just $0.38 per share, down by nearly half from what it paid in the third quarter and marking the third straight decline this year.

NetEase shareholders weren't happy with the report, and the stock plunged 7% in after-hours trading following the announcement. Until the company can bounce back from its alarming lack of performance in the core online gaming business, NetEase investors will wonder whether there's a fundamental problem with the company's operations that could hurt their investing results well into the future.

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