Xiaofan Zhang's  Instablog

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 become 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 outpaced 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.

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TX2 reached 245K PCU during first week of open beta. NetEase's 3D game Tian Xia II (TX2) reached 245000 Peak Concurrent Users (PCU) on September 26, according to my tracking in the chart below. This represents a 32% increase from 185000 on September 19, the day before TX2's open beta. During this 7-day period, TX2's server capacity expanded 36% to 53 server groups. These two data points (32% and 36%) show that TX2's usage level has increased at a similar pace to server additions, and indicate the game's strong ability to attract new users.

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Tian Xia II (TX2) had a strong open beta debut. NetEase launched the open beta testing of its 3D game TX2 on Sunday, September 20. According to my tracking in the chart below, TX2 reached 227500 Peak Concurrent Users (PCU) on Sunday, surging 24% from 185000 in Saturday. During the peak time of Sunday, TX2's overall server utilization rate was about 90%, indicating that average popularity per server remained high despite the aggressive expansion of total capacity from 35 to 51 servers (up 46%) since last Friday.

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Tian Xia II (TX2) reached quarter-high usage last Sunday. Based on my tracking in the chart below, NetEase's online game TX2 reached 168750 Peak Concurrent Users (PCU) on Sunday, September 13. This is the game's highest usage level so far in 3Q09. My tracking also shows TX2's average daily usage was flat in August compared with July. This indicates a great summer for TX2 as the game's seasonally strong performance in July was maintained in August. Based on these data points, I forecast TX2 will generate about $11 million revenue in 3Q09, accounting for approximately 9% of NetEase's online game revenues.

Last week's strength bodes well for open beta. TX2 is scheduled to start open beta on September 20. The quarter-high usage recorded last weekend shows TX2 has gathered strong momentum ahead of its open beta. I note that TX2 achieved such performance despite a server merger on September 2 in preparation for the open beta. In my opinion, such resilience indicates TX2 has started to attract new users at a faster speed as NetEase ramps up its large-scale marketing campaign to significantly increase TX2's media exposure and public awareness. Driven by aggressive marketing and the attractiveness of free-to-play policy, I believe TX2 will likely reach 250K PCU in 4Q09, surpassing the PCUs of competing 3D games Aion and JX Online 3.

Game tracking methodology. My tracking methodology is based on these articles: Article 1; Article 2; Article 3. If you have any suggestions on improving the tracking, feel free to contact me.

Disclosure: No positions

  Chart: PCU and ACU Trends of Tian Xia II in 3Q09































Source: Tracking by Xiaofan Zhang
 

As an Internet seach engine, Baidu's earnings and stock price are highly dependent on its traffic. According to my monitoring, Baidu's traffic surged 33.5% quarter-over-quarter (Q/Q) during this summer (see table below). This data point supports my opinion that Baidu is on track to outperform its guidance of 15%-18% Q/Q revenue growth in 3Q09. Baidu's strong traffic this summer was mainly driven by search queries in five categories/industries: Online Games, Education & Training, Finance, Travel, IT & Consumer Electronics. Below is my analysis on each category:

Online Games category enjoyed a 42.5% Q/Q increase in search volume mainly due to strong seasonality in the summer, when students are in holidays and have more time to play throughout the day. Biggest winners in this category included Perfect World's Fantasy Zhu Xian (+2408% Q/Q), Tencent's Hero Island (+1689% Q/Q), and Kingsoft's JX III (+342% Q/Q).

Education & Training category saw search queries grow 37.4% Q/Q mainly due to students and parents anxiously searching for information on the annual National College Entrance Examination (Gao Kao). Searches related to scores and admissions surged 3593% and 1459% Q/Q, respectively.
 
Finance category enjoyed a 37.1% Q/Q growth in search volume, as Chinese investors eagerly searched for solutions to the large fluctuations in the A-share market: Shanghai Composite Index surged 30% in June and July, and then plunged 22% in August. Top traffic gainers included Everbright (Guangda) Securities (+154% Q/Q), mutual funds (+144% Q/Q), and Huaxia Fund Management Co. (+120% Q/Q).

Travel category saw search volume grow 32.8% Q/Q mainly driven by strong seasonality during the summer. Another factor is the cancellation of May 1st long holiday since 2008, which has caused people to shift some travel activities to the summer. Top gainers in this category included "Dalian Travel" (+183% Q/Q), "Air Ticket Booking" (+155% Q/Q), and "Qingdao Hotels" (+100% Q/Q). 

IT & Consumer Electronics category enjoyed a 23.8% Q/Q increase in search queries, thanks to the annual busy season in the summer and aggressive promotions launched by manufacturers and stores. Top winners in this category included "Cell Phone Price Quotes" (+177% Q/Q), "Nokia Cell Phones" (+82% Q/Q), and "Lenovo Notebooks" (+63% Q/Q).

Disclosure: No positions

On August 26, NetEase (NTES) will release the open beta version of Tian Xia II (TX2), one of its in-house developed 3D games. The open beta will be officially launched on September 20, accompanied by a large-scale advertising campaign. This article discusses TX2's 4Q09 outlook and potential risks, and shows the game's recent trends of Peak and Average Concurrent Users (PCU and ACU).

TX2's PCU will be substantially boosted by aggressive advertising. TX2 is the focus of NetEase's advertising campaign in the second half of 2009, and more than RMB 100 million ($14.6 million) will be allocated to TX2's promotion, according to reports by Sina and Nanfang Daily. My tracking shows TX2 has already reached 160K PCU without much advertising (see chart below). I estimate the heavy advertising surrouding the open beta will propel TX2's PCU to at least 250K in 4Q09.

TX2 players' spending and stickiness will increase significantly. The huge size of TX2's open beta patch (1G - larger than many single games) indicates rich new contents will be added. Currently, TX2's revenues rely heavily on four systems/features: Treasure Box, Soul Pearl (Yuan Hun Zhu), Dresses, and Riding Animals. I believe the open beta version's abundant new contents will diversify TX2's revenue sources, and boost players' spending to a higher level in 4Q09. In addition, the large amount of new contents will increase players' stickiness in 4Q09 because they are likely to spend much time on exploring new maps, tasks, instances (Fu Ben), etc.

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