Netease Earnings Preview: Analyst Expectations Likely On Target

Netease.com (NTES) will report fiscal fourth-quarter results on Monday, February 26. Analysts expect the China-based online game company to post earnings of 24 cents per share on revenue of $64.8 million.

Netease's Earnings to Meet Analyst Expectations

Netease derives over 80% of its revenue from two online games: Fantasy Westward Journey and Westward Online Journey II. The two games attract millions of gamers every day, each user spending a few cents per hour to play on one of the several hundred servers available for each game. Netease's third game, Datang has failed to attract a large crowd.

The company plans to release two new high profile games this year, Tianxia 2 and Westward Journey III. But while investors anxiously await for the arrival of the new games to revitalize the company's earnings, they are closely watching the performance of the two mature games, FWJ and WJOII, for potential signs of slowdown.

In order to monitor the performance of the Netease games and estimate the company's revenues, we have developed a software solution that continuously acquires the usage levels of the game servers. We use the data to estimate the peak and average concurrent users (PCU and ACU) for each game. The revenue can be easily estimated knowing the ACUs.

Q4 Estimates

• Fantasy Westward Journey Q4 average concurrent users (ACU) decreased by 8%, to 430,000, from 468,000 in the previous quarter. The decrease is the result of an one time event (the Japanese flag incident), and it was projected by Netease in November. Peaks in game usage were observed during the Mid-Autumn Mooncake Festival in early October, and during the last week of December.
• Westward Online Journey II ACU has remained relatively stable compared to the ACU registered in the previous quarter. Our estimate is 170,000, 2% lower than in Q3.
• Datang continues to struggle, posting uninspiring ACU and PCU numbers.
• Our revenues estimate is $65 million, in line with the average analyst expectations.

Q1 Forecast

• For the first quarter 2007 we are forecasting a 5-6% increase in revenues, driven by the strong performance of the Fantasy Westward Journey game in February.
• To date, FWJ ACU is up 8% in Q1. Notable peaks in usage were observed on January 1^st and during the Chinese New Year holiday.


Figure 1: Blue line: Fantasy Westward Journey Daily ACU. Red line: One week moving average.

Disclosure: the author does not own Netease stock.

NTES 1-yr chart:

Comments

[Andrew Horowitz]

Have you seen that there seems to be a problem in China? The Chinese government is resorting to electro shock therapy to get youngsters off of their internet addiction! What does this say for the future of companies like NTES, SNDA, BIDU and SINA? The fact is that while there has been a great amount of interest surrounding all things China, I question how many of thee companies will survive with such meager profits. (see www.msnbc.msn.com/id/1.../ )

For example, Baidu, has been long been said to be the "Google of the East". (NASDAQ:BIDU) Yet, even as the stock ran up to $130 recently, the earning are relatively low as compared to their western counterparts. The reason that we have seen such a run up in the post 2000 internet boom from companies in the internet space is that we have been amazed with their earnings power from advertising and other sources. Most of the companies that are in the Chinese Internet Sector have revenues from a limited area and rely on the sheer mass of the Chinese Internet citizens to each spend a small amount. Things can change in a hurry over there...!

NTES is going to report and while it may wow investors, it is a good idea to sit back and look to buy in after the news, rather than stick out your neck and enter a position before any announcement. These stocks have a history of running up into earnings and then backing down mightily once announced.

I wonder how best to play these to capture upside movement without the downside pain. maybe it would be best to buy a basket or even create your own, with some risk managed. Possibly enter long positions with an out of the money PUT that can protect you from a wile swing if earnings are light.

These are not for the faint of heart.

** No long or short positions of any mentioned stocks at this time. Clients did recently sell BIDU at an average of $115 after holding from an entry position of approx $81. We had a nice profit, yes, but the pain of the ride was a bit tough.....

Andrew Horowitz
The Disciplined Investor
www.thedisiciplinedinv...
www.thedisiciplinedinv...