Three Potential Risks for NetEase's Hit Game TX2

| About: NetEase, Inc (NTES)

According to my tracking (chart below), NetEase's 3D online game Tian Xia II [TX2] surpassed 275000 Peak Concurrent Users [PCU] on October 6, while server utilization exceeded 95%. My checks show that such all-time high usage was created by a large-scale promotional campaign during the eight-day National Day holiday. TX2 has demonstrated strong momentum since entering open beta on September 20, and has becomes an important driver of NetEase's stock price. However, I believe now it's time for investors to know what could potentially go wrong with the game. Here are three factors that should be closely monitored by investors:

Balance between server additions and average usage per server. If the speed of adding new servers outpaces the speed of attracting new users, then TX2's average users per server will decline, hurting players' experience. Investors should become cautious if TX2's server additions are beginning to have an obvious dilutive effect on average usage per server.

In-game economy. In China, many highly-anticipated online games started well but quickly failed due to their in-game economy going out of control. Similar to the real economy, investors should focus on inflation when monitoring TX2's in-game economy - many players will leave a game because of continuous devaluation of their hard-earned game coins. Robots (Wai Gua) and gold-farming are two major causes of in-game inflation. If robots and gold-farming studios are beginning to thrive in TX2 despite NetEase's aggressive interventions, then it's time for investors to turn negative on TX2.

NetEase's commitment to TX2. Historically, many online games failed not because of poor quality, but because of their operators giving them up to pursue other games that they considered more promising. If TX2's frequency of launching patches and expansion packs drops significantly, then it might be a sign that NetEase is shifting attention to other opportunities. Although this is negative for TX2, it is not necessarily bad for NetEase's stock - to judge the overall impact, investors should analyze whether the other opportunities outweigh TX2 in terms of future earnings and cash flows.

Chart: PCU and ACU Trends of Tian Xia II

xzhang10122009Click to enlarge

Disclosure: No positions

Source: Tracking by Xiaofan Zhang