NetEase maintains a high level of profitability above 30% operating margin for its gaming business, thanks to stable revenue from core titles

Business Strategy & Outlook

NetEase started as a Chinese internet portal in the late 1990s but has now become the second-largest mobile game company in the world. The firm owns one of the most well-known massively multiplayer franchises in China—Fantasy Westward Journey. Over the past decade, NetEase has capitalized on the industry shift toward mobile gaming and now focuses on developing innovative, high-quality, and long-cycle games with a mobile-first approach. Over the past years, the firm has established iconic titles such as Onmyoji, Knives Out, and Identity V. Every year, the company publishes dozens of games across almost every genre and game play. In addition, NetEase is also collaborating with firms such as Blizzard, Marvel, and Microsoft to release games based on famous global intellectual property like Diablo, Harry Potter, and Lord of the Rings. Over the foreseeable future, NetEase is to continue to leverage its in-house research and development team and user data to develop next-generation games. Like its global gaming peers, NetEase maintains a high level of profitability (above 30% operating margin) for its gaming business, thanks to stable revenue from core titles and the steady development of new franchises. The firm is positioned to not only continue capitalizing on the success of Westward Journey titles, but to also keep diversifying its revenue into new franchises.

While games will remain NetEase’s core cash flow driver, the firm’s investments in other areas (music streaming, online education, e-commerce) also offer long-term potential. Cloud Village, the group’s music streaming arm, had over 180 million monthly active users in 2021 and remained the second-largest music streaming platform in China. Youdao is the group’s attempt at cracking the online education market, but recent regulatory changes in China add uncertainty to this business model.

Financial Strengths

NetEase has a rock-solid balance sheet. At the end of December 2021, the company had CNY 98 billion in cash, cash equivalents, short-term investments, and time deposits under current assets. There was also a restricted cash balance of CNY 2.9 billion under current assets. This compares with only CNY 19.4 billion of short-term debt. Thanks to its strong net cash position and strong operating cash flow that amounted to 147% of net income in 2021, the firm should have no problem funding its gaming business and innovative businesses. NetEase’s capital structure is conservative but not uncommon among Chinese internet firms, given that the company needs to have abundant cash on hand to quickly seize opportunities in the fast-changing internet industry and give it a leg up on competition. Given the growth potential in the Chinese internet space, many of these companies under the coverage do not pay dividends. However, NetEase has returned capital to shareholders via dividends and has set quarterly dividends at 20%-30% of its anticipated net income after tax in each quarter starting in the second quarter of 2019. In addition, the company announced the expansion of its share-repurchase program in May 2020, from up to $1 billion worth of outstanding ADSs to $2 billion, this amount was maintained in 2021. At the end of December 2021, approximately $1.8 billion ADSs had been repurchased under such program.

Bulls Say

NetEase’s expertise in asymmetric multiplayer (Identity V and Dead by Daylight) would allow it to capitalize on future opportunities in this genre.
The firm has done an admirable job at organically expanding into Japan, and it is likely that it will be able to replicate same success in Europe and the U.S.
NetEase Music could see stronger user growth now that Tencent Music was told to end its exclusive licensing agreements with music labels on anti-trust grounds.

Company Description

NetEase, which started on an Internet portal service in 1997, is a leading online services provider in China. Its key services include online/mobile games, cloud music, media, advertising, email, live streaming, online education, and e-commerce. The company develops and operates some of the China’s most popular PC client and mobile games, and it partners with global leading game developers, such as Blizzard Entertainment and Mojang (a Microsoft subsidiary).

(Source: Morningstar)

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