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NetEase Seeks to Rediscover Its Winning Ways

By Dan Caplinger - Nov 15, 2018 at 8:04AM

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The Chinese video game company saw revenue growth accelerate even though profits fell.

The stock market in China has gone through an extremely tough year, and that's had a downward impact on some of the biggest companies in the world's second-largest economy. Video game specialist NetEase (NTES 0.12%) had to deal with big declines early in 2018, and it's had trouble finding strategies that would break it out of its slump and get its business back on track to produce the impressive growth that has made the stock such a strong long-term performer.

Coming into Wednesday's third-quarter financial report, NetEase investors wanted to see progress toward getting key metrics moving back in the right direction. NetEase's results were mixed, but investors were happy that rising sales growth pointed to a potential recovery in the future.

Animated characters fighting a fire-breathing dragon.

Image source: NetEase.

NetEase looks for the winning move

NetEase's third-quarter results continued the trends of higher sales but lower earnings that the video game company has seen throughout much of 2018. Revenue was higher by 35% as measured in renminbi, working out to $2.45 billion and accelerating from the company's 22% growth rate during the second quarter. Once again, though, adjusted net income was down, falling 25% and working out to $328.9 million. That translated to adjusted earnings of $2.55 per share, which was $0.04 better than the consensus forecast among investors.

From a segment perspective, NetEase got significant sales contributions from most of its business units. The online game revenue division saw its growth bounce back from sluggish levels earlier in the year, posting a 28% gain in revenue that translated into a 33% rise in gross profit. E-commerce continued to provide even greater growth for the company, with a 67% sales gain that sent gross profit up by 46%. E-mail and other services boosted segment sales by 32%, but advertising services managed to pick up just 2% in its top line, and neither of those two areas fared well in terms of gross profit growth.

NetEase pointed to several factors driving its results. Mobile game revenue actually fell as a percentage of total revenue, coming in at 68% versus nearly 75% three months ago. However, self-developed mobile games continued to push gross profit for the unit higher, and the Kaola and Yanxuan websites pushed e-commerce results higher. However, more expensive licensing fees kept weighing on the other-business segment, especially related to the NetEase Cloud Music platform.

Operating expenses kept soaring as well, coming in 60% higher than year-earlier figures. Marketing costs, research and development investment, and overhead expenses were all markedly higher from the same period a year ago, and tax rates soared as well.

CEO William Ding kept his eyes on the future. "While the performances from our flagship titles remain remarkably steady," Ding said, "we are innovators at our core, [and] NetEase is one of the very few companies that has consistently created distinct new game IP for both PC-client and mobile platforms." The CEO also pointed to international expansion efforts as instrumental to the company's long-term prospects.

Can NetEase gain more ground?

One of the biggest wins that NetEase claimed was its collaboration with Activision Blizzard (ATVI 0.91%) on the new Diablo Immortal role-playing game. That's been a controversial move, with Activision taking fire for restricting the latest release in the popular series to mobile platforms rather than launching a PC-based version as well. Nevertheless, Ding believes that the move will result in "increasing our visibility and expanding our foothold in the global online games market."

NetEase's latest dividend reflected the company's policy of tying payouts to earnings. Investors will receive $0.45 per share in their third-quarter payment. Unfortunately, that's down from the $0.61 per share payment that NetEase made three months ago, even though it's higher than the payouts from the two quarters prior to that.

NetEase shareholders seemed to breathe a sigh of relief at the results, and the stock climbed 5% in pre-market trading Thursday following the Wednesday night announcement. NetEase still has work to do in order to regain its ascendancy in the global video gaming industry, but at least this quarter's results restored a faster pace of revenue growth that could serve as a foundation for a more complete recovery in the remainder of the year and in 2019.

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Stocks Mentioned

NetEase, Inc. Stock Quote
NetEase, Inc.
NTES
$93.47 (0.12%) $0.11
Activision Blizzard, Inc. Stock Quote
Activision Blizzard, Inc.
ATVI
$78.57 (0.91%) $0.71

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