China's 'Fatigue System' -- Opportunity To Accumulate Gaming Stocks? (SNDA, NTES)

Includes: NTES, SNDA
by: The Stalwart

The Stalwart submits: In case you missed it before, China online role playing game companies are feeling the pressure of regulation:

The official Chinese media have been running alarming stories about online gamers becoming so twisted that they kill themselves, attack fellow players, or commit other crimes. Beijing therefore has recently decreed that the online-gaming companies must act against their own interest by discouraging people from using their games for too long. The government-mandated scheme, known as the Fatigue System, is designed to cut the number of hours players spend in front of their computer screens by, for instance, eliminating incentives to stay online for hours on end and gain experience that can be used to win virtual currency.

QUICKER QUESTS. While the Fatigue System was implemented only last month, NetEase Chief Financial Officer Denny Lee already blames it for some of the company's disappointing numbers in the third quarter. NetEase reported a sharp increase in revenue, to $54.8 million, for the quarter. But that increase of 8% was lower than the 13% or so that many analysts had been expecting. Moreover, NetEase on Nov. 7 said that it expects revenue for the last quarter of the year to increase just 2% to 4%.

One reason for the fall, according to Lee, was anticipation about the Fatigue System, which went into effect Oct. 1 but had been announced several months earlier. "People think, 'We might as well stop playing for a longer period of time now,'" Lee says. ...

Now, in order to accommodate the bureaucrats, NetEase and other companies may have to change the way their games operate. "If there's an [in-game] assignment that used to require more than four hours to complete, we can change it to require three hours, so people can still have time to finish it," said Lee.

While such changes may satisfy the government, some analysts are concerned. "The full magnitude of the impact of the Fatigue System...has yet to be seen," wrote William Bao Bean, a Deutsche Bank analyst, in a Nov. 8 report. However, he warned, "the system could lead to [a] decrease in playtime," among other problems.

But perhaps now's the time to pick up China game companies at PE's well under 30 (and perhaps under 20 even). Two that come to mind, Shanda Interactive (ticker: SNDA) and NetEase (ticker: NTES).

Shanda is also knocked down because it has decided to switch to a free-play model whereby people just buy add-ons within their games. Investors obviously weren't fans of this new strategy, since the stock was clobbered, but to us it actually sounds pretty interesting. A freely open online gaming world could become massive.

As for NetEase, they face maturing gamelines, which might be getting a bit stale with gamers. Still they have new products in development.

Yet as the above quoted paragraph indicates, maybe we should be a bit patient, since there could still be more bad news ahead on the regulatory front. It'd be pretty humorous if Shanda's games went free for all to use, but the government still tried to restrict your time playing them. It'd be like telling people they can't be reading CNN online for more than 3 hours at a time.

[Disclosure: One Stalwart holds shares in NetEase.]