Chinese Internet company NetEase (NASDAQ:NTES) sailed through its third quarter, reporting a revenue increase of 63% year-on-year and net income of $13.2 million, or 34 cents per share (excluding an insurance benefit of $2 million).
Like peers SINA (NASDAQ:SINA) and SOHU (NASDAQ:SOHU), NetEase has experienced a decrease from the second quarter in revenue from short message service (SMS)-related services. The company also had a sharp decline in gross margins for this sector -- down 69% to 53.2% from the second to the third quarters. However, the story this quarter for NetEase is the same as the last -- growth in online games and advertising more than offset the decline in wireless services.
Unlike its fellow portals, NetEase already recognizes a large portion of its revenue -- two-thirds -- from online games. Its massively multiplayer online games (MMOGs) are mature, with one of them already into its fourth expansion pack. Subscriber numbers grew from 430,000 in the second quarter to 555,000 in the third, driving the 21.8% growth in gaming revenue.
Online gaming is a very appealing business because of the huge margins involved. Gross margins were 88% in NetEase's recent quarter. The reason: Once a game has been developed, the cost per additional user is minimal. NetEase sells playing time by making prepaid cards available through retail, allowing it to tap into the market for teenagers who do not own credit cards.
The fact that in-house games are based on Chinese history and mythology is important, too -- the emphasis on national culture will be an advantage when foreign competition intensifies. The first-mover advantage it has with MMOGs in China is also significant because there are huge switching costs for gamers -- the player interaction of MMOGs makes for investing more time and emotion than with offline games. As long as NetEase continues to execute and grow its subscriber base, online gaming will provide a recurring revenue stream with high margins.
This Take completes my trilogy on recent earnings reports from the three big China portals. Having examined these companies, I would recommend that those interested in China stocks buy a basket of all three. There is still plenty of room for growth, and buying all three at the current valuations would allow investors to capitalize on that, while hedging bets should any company underperform. Of course, as Fools know, we encourage you to perform your own due diligence before making any investment moves.
Other recent earnings reports from China:
SINA is one of David Gardner's Motley Fool Stock Advisor recommendations. To see which other companies David has chosen, subscribe today with the benefit of a six-month, money-back guarantee.
Fool contributor Tim Goh does not own any stake in the companies mentioned.
