On the surface, NetEase.com (NASDAQ:NTES) delivered yet another blowout quarter. Revenue climbed 22% to $127.7 million. The Chinese online-gaming giant delivered a profit of $0.53 a share, just ahead of the $0.50 it earned a share last year.
The numbers look great when lined up against Wall Street's expectations of $0.45 a share in earnings on $120.4 million.
However, a single shift in revenue recognition inflated NetEase's results for the quarter. Back in May, NetEase told gamers that it would begin cleaning out accounts that have been dormant for 540 days, starting in June. That move was enough to pad gross profits by a whopping $12.1 million.
That's a lot of chump change found beneath the couch!
While many of NetEase's games are free or cheap to play, gamers pre-purchase points that can be used for enhanced virtual goodies. They are accounted on NetEase's books the same way gift cards or Microsoft's (NASDAQ:MSFT) Xbox points are stateside: In short, NetEase can recognize the revenue only when the points are redeemed.
There's apparently a lot of abandoned property in these virtual worlds, and NetEase will now be cleaning them out regularly for accounting purposes.
NetEase also recorded a healthy foreign-currency gain during the period, reversing an exchange-based loss a year earlier. There's no breakdown of how everything would have lined up on an apples-to-apples basis, but it would have definitely fallen short on all counts.
This doesn't mean the gravy days are over for NetEase. In fact, the next leg up is just beginning, as the company has been beta testing China's version of Activision Blizzard's (NASDAQ:ATVI) World of Warcraft for two weeks. All it needs is regulatory approval, and then the cash cow's commercial re-launch will be under way.
Online gaming now makes up 90% of the revenue mix at NetEase, so there's a lot weight on the game license that Activision Blizzard awarded NetEase that was formerly The9's (NASDAQ:NCTY) bread and butter.
NetEase isn't the fastest grower in this booming, high-margin niche. Changyou.com (NASDAQ:CYOU) and Perfect World (NASDAQ:PWRD) are today's speedsters. The next few quarters may change that. If World of Warcraft was healthy enough to carry The9, imagine its reach under the guidance of one of China's oldest -- and largest -- online-gaming companies.
With 1,000 developers under its command, NetEase has a pipeline of proprietary titles that's also unlikely to run dry anytime soon.
So approach last night's quarterly report realistically. It should have been better. It's not as rosy as it seems. Thankfully, the next few quarters are the ones worth waiting up for.
Three more ways to play in China:
