What happened

Shares of NetEase, Inc. (NASDAQ:NTES) have dipped 26.8% in the first six months of 2018, according to data from S&P Global Market Intelligence.

So what

Esports competitive gamer seated in front of laptop in a stadium.

Image source: Getty Images.

Online game services, NetEase's largest segment, experienced a top-line slump of 18% during the first three months of the year, to $1.4 billion. Gross margin in online games dropped 1.8 percentage points to 62.1%, which the company blamed on a lower revenue contribution from its in-house-developed mobile games. Specifically, NetEase identified weaker sales in its Onmyoji game and the mobile-based version of New Ghost, which dampened the relative success of the Knives Out and Chu Liu Xiang titles.

Of course, for a company that derives the lion's share of its revenue from gaming, revenue can be cyclical, as the success of individual products fluctuates. However, without enough bona fide new hits, NetEase has lost profitability as it allocates higher selling costs and marketing expense to generate equivalent levels of revenue. For example, first quarter 2018 cost of revenues jumped 33% to $1.3 billion, and marketing expenses roughly doubled to $397.1 million, even as revenue barely advanced.

Now what

As my colleague Harsh Chauhan points out in a more extensive piece on NetEase's current state, NetEase will likely continue to invest in marketing to win back market share, especially as competitors like Tencent have recently achieved levels of growth in online gaming that used to typify NetEase's prospects.

Still, the company has many opportunities to turn its fortunes around, from traction in massive multiplayer online role-playing games (MMORPGs) like Chu Liu Xiang, to additional monetization of its Minecraft license. NetEase now claims 60 million Minecraft users in China, and it's opening up a platform for third-party developers to increase content on the site, which should advance revenue opportunities. Overall, it's not out of the question for NetEase's vaunted research and development department to re-energize the top line with new hit titles as it builds on core properties. The company is next set to report earnings on Aug. 8. 

Asit Sharma has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends NetEase and Tencent Holdings. The Motley Fool has a disclosure policy.