NetEase, Inc. (NTES, $300.11):
“Let’s Take it Ease-y”
By: Arsh K. Salwan, AIM Student at
Marquette University
Disclosure: The AIM Equity
Fund currently holds this position. This article was written by myself, and it
expresses my own opinions. I am not receiving compensation for it and I have no
business relationship with any company whose stock is mentioned in this
article.
Summary
•
NetEase, Inc. (NASDAQ:NTES) provides
online services to consumers in mainland China. NTES operates through 3
segments: Online Game Services, Advertising Services, and Email/E-commerce/Others.
The Online Game Services segment accounted for 73% of total revenue in FY17.
•
NetEase has been continuously improving their online games services segment as
they have released popular games such as Fantasy Westward Journey, Speedy Ninja,
and Rules of Survival.
•
The company recently announced a new blockchain sharing platform, “Planet”,
that serves as a sharing platform amongst users along with a decentralized
value exchange. Blockchain will be an important focus of NetEase in 2018.
•
In FY17, Online Game revenue had decreased 10% YoY while E-Commerce revenue had
increased 175% YoY.
•
The YTD stock price change for NetEase has been -13.5%.
Key points: For the past couple of years, NetEase has been one of the top video game
developers in China. NTES has depended heavily on revenue generated from iconic
games created throughout the years. There was a decline in revenues and a weaker
gross margin for online games in the previous 3 quarters, and this may be a
concern moving forward.
The biggest competitor of NetEase is Tencent
Holdings Limited, a world class tech company with almost 1 billion users on its
social network, WeChat. In late 2017, Tencent announced that it would be adding
in-chat mini games which would make it easier for users to play games within
the chat. Due to the convenience of Tencent’s mini-games, NetEase’s gaming
segment could decrease.
Management recognized the “mini-game” this threat
early on and decided to release 14 new games in Q4 FY17 and to focus more on
E-Commerce. NTES opened their E-retail business, Koala, which has plans to
spend about $11 billion over the next three years on inventory from Europe, Japan,
and the U.S. The purpose of this is to attract customers and bring a global
presence of goods into China.
NetEase recognized that moving into the E-commerce
space would be dangerous because China’s other tech giant company, Alibaba,
would become an immediate competitor. To mitigate the competition risk
involved, Koala implemented a new strategy to bypass local middlemen and buy
inventory directly from international companies. Another advantage that Koala
has compared to Alibaba is the delivery time. Delivery for Chinese consumers
has averaged about 15-20 days for international orders but Koala has lowered
that to 2-3 days. The introduction and growth of Koala could push NTES back
towards its 52-week high.
What has the stock done
lately?
After meeting earnings expectations in Q3 FY17, it
was expected that the company was on a road to turn it around after missing Q2
FY17 earnings. On February 7, 2018, Q4 FY17 earnings were released and the
stock price dropped from $314 to $285 in 2 trading days. Since earnings were
released, NTES has been up ~5%.
Past Year Performance: In one year, NTES
is up ~15%. In the month of August 2017, NTES dropped 11% from $308 to $275.
This was due to the fact that the company’s Q2 earnings did not meet the
expectations of investors. That may seem worrisome, but the stock later jumped
to $371 in mid-December representing an increase of 35%. With average
performance in the previous 3 quarters, Q1 FY18 will be very significant in
regards to where the company will be heading and if adjustments have been made.
Source: FactSet
My Takeaway
William
Deng Lei, NetEase’s CEO/Founder, has run NetEase with expertise in a variety of
areas. Gaming has always been the main
focus, but management recognizes that Tencent has new plans to expand so NTES
has begun to explore into other areas of business. With NetEase’s e-commerce
platform, Koala, there have been changes to the main focuses of the company. With
the increased use of e-commerce to purchase international products in China,
Koala could have a very bright future. NTES must capitalize on any slip-ups
from Tencent and improvements must be made in the gaming segment- if this is
done, NetEase could have a promising future. However, with the previous quarter’s
missed earnings and increased competition, I am recommending a “hold” for
NetEase, Inc.
Source: FactSet
