Phiromya Intawongpan
Introduction
NetEase (NASDAQ:NTES) recently reported its first quarter earnings that beat EPS and met on revenues, however, shares are slightly down. I don’t think the report was bad, given there were no major releases for the quarter. I believe it was still a decent quarter in terms of growth, however, I would like to see these growth numbers improve as the company releases more exciting games going forward.
Q1 Results
Total revenues came in at $3.7B, a 7.2% y/y increase. Most of the revenue came from its gaming division ($3B), however, Youdao (DAO), a subsidiary of NTES, saw its revenue grow 19.7% y/y. It still brings in less than 10% of total revenues but if it can continue going this way, it could become a much better revenue generator in the future. Less than 10% of total revenues bringing in the Cloud Music segment hardly grew at around 3.6%, while Innovative businesses came in at $272.8m, an increase of 6.1%. On non-GAAP EPADS came in at $1.84, a beat of $.12
So, overall, I would say it was a lackluster performance from NTES on all accounts. I like that it's growing but I don’t think it is growing as well as I have hoped. It's growing at around the same pace as it had in the past, which isn’t bad. I guess, since there weren’t any major releases in the first quarter, it’s understandable that the growth was on the lower end of what I would have liked to see.
Games like Eggy Party, Identity V, and Dunk City have been performing well since launch, which were the big revenue contributors. The monetization of these games seems to not bother many of the players, and may not be considered too predatory, which should translate to the longevity of these games going forward and continue to bring in decent revenues.
As of the latest quarter, the company repurchased 8.9m ADSs, a total cost of $811m. I believe this is a great way of creating shareholder value, especially since I still think the company’s share price is trading at a discount.
On other financial metrics, the gross margin on the gaming segment stood flat q/q and up 280bps from a year ago quarter, coming in at 69.5%. The increase was due to the company’s more self-developed games and expanding existing games onto more platforms.
In the Cloud Music segment, we can see a massive increase in gross margins, going from 22.4% to 38%, with a 16.4% increase y/y, “due to the one-off adjustment of certain copyright costs, increased net revenues from sales of membership subscriptions and continued improvement in cost control measures.” That is an impressive increase, however, I don’t expect this to be sustained going forward due to that one-off adjustment.
Youdao’s gross margin decreased by 90bps due to decreased revenue contributions from its learning services and sales of smart devices.
The company’s financial position is still strong. As of the latest quarter, the company had around $6B in cash and equivalents and another $12.4B in what they call “Time Deposits”, which are Chinese banking instruments that mature in less than 12 months and are considered cash items. The company’s long-term debt stood at around $60m, or virtually non-existent. The company is flushed with cash, which should bode well for the future growth of the company. Such a mountain of cash allows for further acquisitions of gaming studios, self-developed games, and supporting region expansions of already established games.
What’s ahead for the company?
In terms of gaming, which is the highest revenue generator, there's a lot of promise from upcoming games recently announced. The company plans to further expand regions for Eggy Party, Racing Master, and Identity V, with expansion packs, crossovers, and events, which should continue to engage the current player base and attract more casual gamers to try them out.
On the upcoming games side, I'm hearing a lot of excitement still about Naraka: Bladepoint Mobile. It's currently in a testing phase and has been received with a lot of positivity so far. The company is swiftly addressing bugs and other glitches, and that is very well received by the community.
Another highly anticipated game, Where Winds Meets, an open-world action-adventure RPG, is still very early to judge but from reading reviews of the playtest, people are enjoying what they are seeing so far.
Once Human, an open-world survival game that is slated to be released in Q3 of this year, looks very interesting. The open world the company has built looks very fun and interactive, with many different bosses and world events that look like they will capture a lot of people’s interest. It certainly piqued my interest. It’s in a looter-shooter genre, which has been played out quite a bit right now, but with what looks like an exciting world, this should bring a decent number of players.
In the more distant future, I'm also very excited about the potential that Marvel Rivals holds. The game is basically Blizzard’s (MSFT)(MSFT:CA) Overwatch 2 with a third-person perspective and a re-skin of Marvel characters. So far, the game is in an alpha testing phase with many YouTube creators jumping in on the action are loving the experience so far, and already think the game is much more fun than Blizzard’s OW2. Given it's in the alpha testing phase, there are major imbalances of some characters, but the polish so far looks great.
Speaking of Blizzard, the company recently renewed its partnership with NTES, so all the popular games like OW2 and World of Warcraft will be returning to China after a year of absence. I wonder how much of a negative effect will this have on Marvel Rivals in the future since OW2 already has a dedicated player base in China. I think the following of the Marvel universe, in general, is large enough to warrant the two games in the region and will do well no matter what, especially if players may think that the partnership is a big risk and will not dedicate so many hours to a game that may disappear once again. Marvel Rivals doesn’t have that risk, and I could see people putting in a lot of hours into it from the get-go. Overwatch 2 so far hasn’t done very well overall, and when the company scrapped its PVE mode, it got worse, so if Marvel Rivals introduces something like that in the future, that could be game over for OW2.
Closing Comments
I believe the future is still very bright for NetEase. The company’s successful games continue to generate decent revenues even during the times with no major releases, which speaks volumes of the appeal of such games. The company is constantly trying to innovate in well-established genres, even if it’s just slight improvements on the formula and that should bring people to try out these games like Once Human.
Upcoming games are very promising in my opinion, and I will be checking out some of them, specifically, the Marvel Rivals and Once Human.
The company’s huge pile of cash will continue to sustain the company’s future growth and I'm excited to see what the company will be doing with it in the future. I would like to see more titles come out for a wide audience, acquire more game developers worldwide, and see what they can create. The company can take a lot of risks since the games it has under its belt are already very successful, so why not try to innovate more going forward?
In short, I'm sticking with my buy rating and I believe there's a lot of potential for the upcoming games to perform well given the early reception, and for existing games to continue to bring in recurring revenues from expansions and other events.
