NetEase Remains Undervalued Despite World Of Warcraft Weakness

| About: NetEase, Inc (NTES)

All of the talk of declining subscribers for World of Warcraft in China have stalled NetEase's (NASDAQ:NTES) share growth. The popular MMORPG from Activision Blizzard (NASDAQ:ATVI) continues to lose subscribers in the United States and more rapidly in China. Through a partnership, which began in 2008, NetEase brings the game to China. However, NetEase has much more than WoW to offer to shareholders and customers.

First Quarter Earnings

NetEase recently reported first quarter earnings. Total revenue increased 12.7% compared to the prior year. Game revenue increased 11.3%, while advertising revenue increased 15.3%. The quarter was led by price increases for games like "Fantasy Westward Journey" and "Westward Journey Online II". New expansion packs also helped revenue.

Here is a look at revenue:

Online games: $326.6 million

Advertising: $26.6 million

Email and others: $10.5 million

New Releases

NetEase has a great schedule of games coming out over the next three quarters. The company has expansion packs coming for "Kung Fu Master", "Soul of the Fighter", and "New Fly for Fun". New games like "Dragon Sword" and "Legend of Tibet" will also be released. Mobile games may also be coming to NetEase's portfolio. "Fantasy Westward Journey", which is one of the most popular games in China will see a massive upgrade in the third quarter of 2013.

Other Assets

Along with its strong gaming assets, NetEase also holds valuable internet assets for the Chinese market. The company leads the way for the email market in China and has been number one for ten years. At the end of March, NetEase had 550 million email users through assets like,,,,,, and corporate emails.

In April, NetEase launched a new music service under the name "NetEase Cloud Music". NetEase also owns an online payment service (WangYiBao), online dating site (Huatian), and photo sharing site (Yinxiangpai). All of these assets are seeing strong growth, but get buried behind the online games and Blizzard partnership.

Of the three business segments, the email and other makes up the smallest amount of revenue. However, the business segment saw a 65% increase from the prior year's first quarter. The segment continues to show the potential of NetEase's strong assets in China. While NetEase has a great market share in online games, its dominance in email will continue to pay off as China's internet market grows.

Cash Position

One important reason to buy shares of NetEase is its cash position. With $2.6 billion in cash and minimal debt, NetEase has $20.35 cash per American Depository Share. This represents almost 33% of the company's share price. Here is an interesting look at NetEase's price to earnings ratio when cash is stripped out.

With Cash Included

With Cash Taken Out

Fiscal 2013 EPS ($5.30)



Fiscal 2014 EPS ($5.85



As you can see, NetEase already trades at relatively cheap price to earnings with its $20.35 cash per share position. With a price to earnings of 11 going forward, shares still look cheap with new releases and email powering shares.

However, when cash is taken out of the share price, the price to earnings ratio drops to 8.3 in fiscal 2013 and less than 8 times next year's earnings. With a simple price to earnings ratio of 10 times $5.85, plus the cash position added in, shares would trade at $78.85. This represents upside of 22% at current share prices.

New Dividend

In January, NetEase shareholders were rewarded with a one-time special dividend of $1.00 per American Depository Share of the company. Going forward, NetEase has promised to pay out 20-25% of anticipated net income in the form of an annual dividend. With analysts predicting earnings per share of $5.30 for the fiscal year, the payout would be $1.06 to $1.33. The shares will yield over 1.5% going forward.

Activision Blizzard Partnership

Despite the weakness of "World of Warcraft", NetEase did announce it was bringing new Blizzard game "Hearthstone: Heroes of Warcraft" to China. The free to play digital card game was recently launched (March 2013) in the United States for Windows, Macs, and iPads. The game now gives NetEase WoW, Hearthstone, and Starcraft II all under license from Activision Blizzard. Going forward, it will be interesting to see if more expansion packs are released for "World of Warcraft", and if the subscribers come back. Also, keep in mind that Blizzard could unveil its newest MMORPG "Titan" at any time. The highly anticipated WoW replacement would be NetEase's to lose for the Chinese market.


Despite trading close to 52-week highs ($65.49), shares of NetEase are undervalued. The negativity surrounding the World of Warcraft subscribers has held shares back. NetEase is buying back shares, paying a dividend, and has a large amount of cash to reward shareholders. It's time for the share price to represent the large cash balance.

*Information for this article found at NetEase's investor relations website found here.

Disclosure: I am long ATVI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.