Back in NetEase – at a higher price

Beat of highest estimates

Again this wonderful company delivers very strong results, and I realize it was a mistake to sell out of the company. A small comfort is that at least since I sold I managed to recycle the cash in other profitable investments. But now I can’t stand on the sideline and therefor I take a position of 5% of my portfolio in this company. If you know nothing about this company, start by reading my analysis from 1 year ago: NetEase – Chinese Gaming.

Since that analysis a year ago, the company released extremely strong figures. For Q1 this year NetEase delivered the following headline results:

• Net revenues rose 72.3% to 13.6B yuan (about $2B, above consensus for $1.73B); gross profit rose 63.2% to 7.5B yuan (about $1.1B).
• Meanwhile, non-GAAP earnings per ADS were $4.75, above expectations for $4.03.

Taking the revenue of Q1 times 4, we end up at 2017 revenue which according to my analysis 1 year ago would be reached in 2021-2022. Geez I was wrong on this one (and most other people too). I’m going to stop putting shorter term target prices on this one and just keep it as a long term holding for now, since obviously I am not capable to model future cash flows at anywhere near correct levels. Just as a side remark a quick update of financials with the same future percentage growth (as my assumptions 1 year ago), a DCF gives a fair value of about 320 USD per share.

Three reasons why I think NetEase will continue to have a strong future, even-though competition is heating up:

1. They have the scale to distributing their games through their own platform in China, which means not sharing revenue with other sites. Also they are now confident enough to start launching their games outside of China in larger scale.
2. They are launching (world-wide) a potential blockbuster called Crusaders of Light (https://crusadersoflight.com/) this summer, which might become the first truly successful mobile MMO. The game was released in Beta a few weeks ago and so far reviews are very strong among gamers.
3. Launching of Minecraft in the Chinee market this year, as a free-to-play game (with in-game purchases) in co-op with Microsoft. The game will be available both on PC and Mobile, another highly likely blockbuster. Here income will be share with Microsoft, and I believe quite a lot of it is priced in already in the share price, but anyhow, it will generate significant cash-flow.

I recommend this video on NetEase, which I wish I would have found earlier:

The downside

NetEase is already a huge player in the Chinese market place and launching new games will not only take market share, but also cannibalize on their own games. On top of that, the gaming sector is very hot right now, with competition being very fierce. Like a drug company a gaming company like NetEase needs a portfolio of games in the pipeline, which needs to keep delivering the best games in the market, or the competition will quickly step in at fill their place. Extrapolating earnings in to eternity of this type of companies and doing so with high multiples, might be a too bullish way of looking at the company.

A personal downside with this investment is again getting a too high China concentration in the portfolio. The reasons for the long silence in the blog is that I have been doing my best to analyze companies for a potential new investment. I have been looking at Biotech in the US, Vaccine companies, breweries and much else. But really struggled to find something worth buying. I have two interesting companies on the radar though, but the valuation has unfortunately run a bit crazy right now