1 China Gaming Stock Investors Might Want to Buy

NetEase Inc (NASDAQ: NTES), one of the largest online game developers in the world (that is currently Nasdaq-listed), is going to arrange its secondary listing on the Hong Kong Stock Exchange on 11 June 2020.

The company is expecting to raise between US$2-3 billion to bolster its R&D in the gaming business.

In this article, I’ll delve into whether NetEase could be a potential growth stock by assessing the company’s fundamentals and valuation.

Robust first-quarter earnings

NetEase’s sources of revenue are divided into four business segments: 1) Online Games, 2) Online Education, 3) Online Music, and 4) E-commerce and others.

At the moment, 80% of NetEase’s revenue is generated from their Online Games segment.

According to its first-quarter financial earnings, both revenue and net profit outperformed market expectations. Revenue increased by 18.3% year-on-year and 8.4% quarter-on-quarter to USD$2.4 billion.

The increase was mainly generated from a year-on-year growth of 14.1% from the Online Games segment and a year-on-year growth of 139.8% from the Online Education segment (otherwise known as YouDao).

Strong gaming business

Thanks to the coronavirus pandemic, the lockdown has created more screen time that has left everyone with little choice but to go online. And online gaming has easily fallen into one of the categories that benefits.

First-quarter gaming revenue reached USD$1.89 billion, within which USD$1.32 billion was contributed from mobile game revenue, an increase of 11% year-on-year.

The increase was mainly driven from the growing popularity in fantasy role-playing games (RPGs) such as “Fantasy Westward Journey”, “Fantasy Westward Journey 3D” and “Onmyoji”.

The remaining revenue was generated from PC games which saw growth of 23% year-on-year. This was due to the return of old players from “World of Warcraft” during the pandemic.

Those who often play online games will understand the draw. Like a drug, it will take you some time to quit the game once you are hooked on it.

The wide variety of online games available to users to choose from can increase their exposure in the gaming market. So far NetEase is offering more than 100 games in China, and 30 games in overseas market.

As they currently own a rich gaming pipeline, the next wave of new games are expected to launch in the coming few months to capture more gamers in the market.

All the below factors are positive for the continued growth of NetEase’s gaming business:

  • Unexpected traction gained from the pandemic
  • Significant presence in fastest-growing consumer market (China)
  • Rich online games pipeline; and
  • Its secondary listing to raise funds for further enhancement on R&D in gaming as well as expanding global presence

Shifting to online education

YouDao (NYSE: DAO) was the second catalyst to NetEase’s robust figures in its first-quarter earnings. Revenue increased by 139.8% year-on-year to US$75 million and gross profit surged by 345.6% year-on-year to US$33 million.

The revenue growth was attributable to the increase in user engagements, improved economies of scale, and structural optimisation in its learning services and products.

The pandemic lockdown has left students with no choice other than online education, and NetEase has taken the opportunity to enhance YouDao’s gross profit margin.

As users grow their reliance on e-learning platforms, they recognise the benefits of using online education platforms.

The pandemic has caused the penetration rate of online education platforms like YouDao to increase rapidly, and thereby has the ability to reduce their customer acquisition cost significantly.

Going forward, YouDao should continue to focus on investments in delivering high-quality online education and low-cost courses to ramp up their business.

Together with better access to internet infrastructure in rural areas, there will be growing demand for online education platforms like YouDao.

Online education will become a very convenient, and very important way to educate students at affordable rates, especially for many of those in China who still cannot afford education.

Foolish summary

In summary, despite the risks investing in NetEase (which is currently dominated by its gaming business), NetEase’s new product cycle and overseas expansion will be the determinants to its long-term success.

Judging from NetEase’s first-quarter earnings release, the company will continue to grow as they further diversify its product offerings and penetrates the global market more aggressively.