By: Gregory Glaab, 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) NetEase,
Inc. is involved in a multitude of tech subsector operating segments. It
operates through the following segments: Online Games, Advertising, e-mail
Services and E-commerce. The Online Games segment offers multi-player online
role-playing games and mobile games on iOS and Android. The advertising segment
involves banner advertising, channel sponsorships, direct e-mail, interactive
media-rich sites, sponsored special events, games and contests. The e-mail services
segment comprises free and fee-based premium e-mail services. The company was
founded in 1997 and is headquartered in Beijing, China.
•
NTES entered into collaborative operations with Tencent (TCEHY) for music licensing,
increasing their content without expensive fees from primary sources.
•
Potential risks outlined from 2017 are slowly coming to fruition in regard to
market volatility and reliance on third party distribution.
• NETS is being
sued by game developer, Playerunkown’s Battlegrounds Corp (PUBG), for copyright
infringement and unfair trade practices for two of their mobile games, Knives
Out and Rules of Survival.
•
After seeing incredible growth in 2017, the stock price has plummeted in 2018
erasing all returns from LTM.
Key points:
NTES
announced that their cloud music operating segment has reached an agreement
with Chinese tech giant, Tencent (TCEHY) in order ease licensing. It is
reported that the two will exchange more than 99% of their premium content and
collaborate in future operations according to Bloomberg. This would allow NTES
to access new content without having to pay substantial fees for content, which
we have seen other companies have to do such as Netflix and Spotify. The deal
has the potential to increase NTES consumer market immensely given the size of
Tencent and their influence on Chinese culture. Tencent’s own music operating
segment has grown so immensely over the past two years, that there have been
rumors that Tencent may break off their cloud based music segment and look to
take it go public in the coming years.
In
the initial write up for NTES, the risks mentioned were the potential of
volatility and reliance on third party distribution. Volatility reentered the
markets in the beginning of February and have not left since. Large cap international
equities have been hit the hardest especially in Asian markets ever since Trump
threatened a trade war with China. Both countries implemented their own
tariffs, however in the past couple weeks tension has eased and the probability
of a trade war has diminished greatly. In regard to third party distribution
which NTES is highly reliant on iOS and Android, the decrease in smartphone
sales has shown in the stock price as well. Apple has seen flatted growth in
iPhone sales in recent years.
NTES’s
game, Knives Out tops the world list of most downloaded games by generating $24
million in sales for the month of February. PUBG Corp. claimed NetEase’s mobile
games Rules of Survival and Knives Out illegally copied crucial elements unique
to PlayerUnknown’s Battlegrounds PC/Console game. The allegations highlight
specifically the gameplay, art style, buildings, vehicles, weapons, clothing,
landscapes were all mimicked to tee. Because of these allegations PUBG is suing
for unfair trade practice, along with copyright infringement. What makes this
lawsuit more intriguing are the rumors that, Tencent is attempting to gain a
substantial share in PUBG. This would increase tension between the two
companies, which as I mentioned prior, they recently entered into collaborative
efforts in the music industry. Late last year, TCEHY purchased the remaining equity
of Riot Games. The company also has investments in Activision Blizzard, Epic
Games and Clash of Clans developed by Supercell.
What has the stock done
lately?
Q1
of 2018 has officially brought volatility back into the markets. NTES has not
been susceptible to this and has seen a -22.83% YTD return. Just in April the
stock has dropped 7%, this could mainly be due to the lawsuit and decreased
smartphone sales. Earnings season has not been positive for major tech
companies so far. If earnings keep on coming up short, the entire industry
could continue to fall. The S&P ADR index has seen a YTD return of -1.14%
and a 1 month return of almost 4%.
Past Year Performance:
The
50-day moving average is now below the 200 day, signaling no momentum for the
stock. Even though majority of international companies have suffered this year,
NTES individually did not help themselves towards the end of the year. The
company missed 2017 Q4 earnings by $0.43, a surprise of -23.1% according to
Factset. This was their lowest EPS since June of 2015 that had seen tremendous
momentum for the past two years. This has led to the company being at the wrong
side of the 52-week H-L.
1 Year Stock
Chart vs. S&P ADR
Source: FactSet
NetEase
has massive potential given that they’re in China and have positioned
themselves to thrive in several operating segments within the IT industry. With
their most recent operating segment, ecommerce, beginning to grow and gain
popularity, this could lead to the company shifting its focus away from its
main segment of video game development. That being said NTES would really have
to find ways to differentiate themselves from the rest of the market given that
their main competitors are some of the largest in the world i.e BABA, BIDU, and
TCEHY. Even though the company has seen massive losses the past 6 months,
nothing has changed fundamentally about the company. If the company can get
back on track and not have as many delayed releases/developments with their
video games, can continue to grow their e-commerce business segment, and are
able to resolve this lawsuit with PUBG, I believe the stock will rebound along
with the rest of the IT industry throughout the year.
1 Month Stock
Chart
Source: FactSet
