NetEase's (NTES 1.02%) stock price slipped about 15% this year as investors fretted over the slowing growth of its gaming business and regulatory challenges in China. Rising interest rates, which drove investors away from higher-growth tech stocks, exacerbated that pain.
Some investors might be tempted to nibble on NetEase at these levels since it looks reasonably valued at 20 times forward earnings, and its core businesses are well insulated from inflationary and supply chain headwinds. Unfortunately, three red flags suggest it's still too early to turn bullish.
Image source: Getty Images.
1. NetEase's stock could still be delisted
In early May, the U.S. Securities and Exchange Commission (SEC) added NetEase to a growing list of Chinese stocks that could be delisted in three years if they don't fully open their books to U.S. regulators. The new rules were introduced after the Holding Foreign Companies Accountable Act (HFCAA) was signed into law in December 2020. However, China's regulators, citing national security concerns, have been reluctant to allow the country's businesses to comply with those demands.
That stalemate has made it tough for U.S. investors to buy Chinese stocks as long-term investments. NetEase launched a secondary initial public offering (IPO) in Hong Kong to address those risks, and U.S. investors could potentially swap their shares for Hong Kong-listed shares if they're ever delisted from the Nasdaq.
However, the conversion fees might make that trade too expensive for smaller retail investors. They could also be barred from making that trade if their brokerage doesn't have access to the Hong Kong Stock Exchange.
2. China's regulators aren't approving its newest games
In China, new video games must be approved by the government and granted licenses before they're released. After approving a large batch of games last July, the Chinese government intentionally throttled the pace of its new approvals to curb "gaming addiction" among minors.
That was dire news for NetEase, which generated 72% of its revenue from online games in 2021. It was also a painful development for other leading game publishers, like Tencent (TCEHY 3.23%) and Bilibili.
The Chinese government finally approved a new batch of games this April and then greenlit another batch of games in June. However, NetEase and Tencent -- the two largest game publishers in China -- were notably excluded from both batches.
Neither NetEase nor Tencent has had a single new game approved in China since last July, which strongly suggests the government is intentionally handing out more licenses to their smaller domestic rivals to promote fresh competition.
3. It just delayed one of its biggest games
NetEase recently postponed the launch of Diablo Immortal, the eagerly anticipated mobile game it co-developed with Activision Blizzard, from June 23 to July 8 for the Asia-Pacific region. That unexpected delay came after a few screenshots of Diablo Immortal's social media account on Weibo were circulated online. A post from late May reportedly asked, "Why hasn't the bear stepped down?" in an apparent jab at President Xi Jinping.
President Xi had been repeatedly mocked as "Winnie the Pooh" after meeting with President Barack Obama in 2013. Those comparisons eventually drove the Chinese government to ban all references to Winnie the Pooh in 2018, turning the cartoon bear into an unlikely symbol of defiance.
NetEase's announcement also sparked controversy by referring to Diablo Immortal's new release date in Asia as "July 8, Taiwan time." That added detail was odd since the Chinese government explicitly forbids companies from referring to Taiwan as a separate country. So, it certainly suggests that someone inside the company is trying to sabotage the game's release.
Unfortunately for NetEase, China's censors quickly spotted those posts. Diablo Immortal's Weibo account was barred from posting any new content, and any references to the bear post were scrubbed from the internet. The game's launch in China now seems to have been postponed indefinitely, even though it had been approved before the process stalled out last year.
During NetEase's most recent conference call in late May, it said more than 15 million gamers in China had already preregistered for the game. CFO Charles Yang also expected the launch of Diablo Immortal to be a "huge opportunity to showcase "NetEase's strong R&D capability" to Western gamers and the world.
The wrong stock at the wrong time
NetEase's stock might recover in the future, but the delisting threats in the U.S., the regulatory headwinds in China, and the delay of Diablo Immortal will all prevent the bulls from rushing back to this stock. Investors should stick with better blue-chip tech stocks instead of this struggling video game company.
