Thoughts on Q3 Earnings from China Online Game Companies (SNDA, NTES, NCTY)

Fellow China blogger (and co-founder of CBSMarketWatch) Bill Bishop regularly posts excellent comments on China and China Internet companies here. The following are his thoughts on Q3 earnings results from China online game companies Shanda (ticker: SNDA), NetEase (ticker: NTES) and The9 (ticker: NCTY) (permission to post granted):

This was a tough week for shareholders of Netease, Shanda and The9. While they all make a lot of money, and have toplines and cash reserves that most companies would kill for, investor's expectations had become out of synch with the realities of China game market.

Here are what I see as some of the takeaways from the results this week:

1. The China game market is still large and growing but the revenues are spreading across more companies (Duh, but some folks believe it is collapsing);

2. Gamers care about content a lot more than they care about distribution (and with Bittorrent and online payments physical distribution will become increasingly marginalized), and no company has or will have a lock on game distribution and publishing in China;

3. The top 3 publishers have very weak pipelines, and right now none of them has anything particularly promising for at least the next 2 quarters (I think longer, given how hard it is to actually release a 3D game like Dungeons & Dragons or Tianxia);

4. The free model has taken off here and is really making in dent in all the games except, it appears, World of Warcraft. And the dominant incumbents are going to have a hard time cannibalizing their fee revenue games to compete with the free ones;

5. World of Warcraft may still have a lot of legs. They are just starting to push into 2nd- and 3rd-tier cities. If they get traction in those cities, usage numbers could almost double, and this game is so good that people will pay;

6. With the exception of Netease, none of the top 3 have been successful at self-developing games, and not even Netease has released a 3D game yet. They need to either start buying promising local studios or really pay up and import some top Western/Japanese game development talent to build studios for them;

7. In-game advertising needs to start being built into these games, especially the MMOs. Companies like Netease, with an existing ad sales force, should be able to harvest many more high-margin dollars every month from their gamer base.

I have no position in any of these stocks. Of the three--The9, Shanda and Netease--The9 is the stock that may have the most upside potential in the near term. Yes, they appear to have a weak pipeline, and yes, they give away a lot of revenue to Blizzard, but if they can really move into the next tier of cities of China they should show very decent growth in Q4, something that is hard to say about Shanda or Netease right now. The other stock that seems poised to benefit from its growing share of the China game pie is Tencent.

Related:

• You can access Q3 earnings results here.
• Goldman on the New Online Gaming Model.
• All articles on Shanda (SNDA), NetEase (NTES) and The9 (NCTY).
• A list of full Q3 2005 conference call transcripts available on the Seeking Alpha Network.

Comments

[4eyed]

of the three, The9 is too small and later to the game, while Netease is a portal plus games provider. Shanda is so far the most focused on online game development, even though it has made wrong investments as well. For the next 12 month period performance, my bet is on Shanda.

2005 Nov 28 03:39 AM