Day 326: China Playing Games?

Mother's Little Helper portfolio was UP today +$4,256.18 (+0.50%).

Overall GAIN YTD: +$263,435.01 (+45.12%).

Our benchmark index, the S&P 500 is up +15.19% Year To Date.

http://money.cnn.com/data/markets/sandp/

Opportunities multiply as they are seized.

- Sun Tsu

China Play's Games

In this post I want to comment on one company, a stock that is rarely discussed in the financial news, NetEase, Inc, NASDAQ symbol NTES. NetEase is part of the blog portfolio and I've been on the receiving end of a little bit of ribbing about investing in a Chinese gaming company. "Hey Clay, those Chinese are communists, they don't have time to play games". "Wow, buying a single stock in China, sounds pretty risky". You get the idea. I love companies like this, off the radar, out of the news operations that simply focus on great execution and their own core competency. But NetEase is unique in that they are also building out the internet services, email and eCommerce operations that Chinese consumers need in order to buy and use the games they sell.

While the oxygen has been sucked out of the room by WalMart shares increasing 10%, and Cisco System reporting better than expected earnings, Tesla announcing their semi truck and new roadster, something else has been quietly growing and growing and growing in China.

Today, $48 billion dollar Chinese gaming and internet services company NetEase saw its shares rise $41.26 per share or 12.65% to close at $367.50. Shares were as high as $375.10 on the day. Year-to-date we've seen our shares of NetEase grow 63.61%. Over 6 million shares traded hands today, that's 6X normal levels. By share price increase NTES was the most active on the NASDAQ exchange and by percentage increase NTES is #2 today; behind Shoe Carnival?

Why?

While retailers got a boost today because investors with short positions had to cover their shorts after Walmart's big beat, NetEase has consistently executed on its core mission; innovation, high-quality content and community. Put an emphasis on community. NetEase, has China's most popular mobile and PC-client games as well as some of the country's most prominent advertising, communication and e-commerce services. The biggest gaming company in China is Tencent and together, NetEase and Tencent manage a duopoly that accounts for 70% of the mobile Chinese gaming market.

When NetEase reported recently we learned that they had advanced each of their core business segments year-over-year, growing quarterly net revenues by nearly 36%. Their growth was spearheaded by their online game services sector and, in particular, mobile games, which accounted for approximately 68% of this segment's net revenues.

In line with their expansion strategy to export game titles, one of their top games, Onmyoji was introduced in Japan and Southeast Asia, Onmyoji was also successfully launched in Korea, followed by promising user feedback during closed beta testing in the U.S. and Canada. They also introduced a number of new expansion packs that extend life cycles of games as well as launching new mobile titles.

The highly anticipated release of Minecraft in China went exceptionally well as NetEase introduced the game for PC JAVA and iOS in the third quarter and Android shortly thereafter in October. On its first day of release, Minecraft was ranked the #1 downloaded mobile game on both the iPhone and iPad, accumulating nearly 30 million registered users.

In addition to Minecraft, NetEase also introduced Index, a Japanese-themed RPG, to millions of gamers and fans during the third quarter. NetEase is focused on growing their portfolio with a number of new exciting games in the pipeline that broaden and diversify their offering in a variety of genres.

In addition to domestic offerings, NetEase is bringing their vision to audiences across the globe. Games like Onmyoji and Crusaders of Light are performing very well overseas, and Crusaders of Light has now been recognized as one of the top-grossing games in more than 20 different countries since its launch.

But NetEase isn't just a gaming company. Leveraging their technology advantage, premium brand and larger user base, they continue to strengthen their market position with NetEase Media. During the third quarter, NetEase grew advertising services net revenue by approximately 12% year-over-year, with automobile, real estate and Internet services as their top-performing verticals. Investment in both original and third-party, high-quality content, customized smart push technology, video content and innovative marketing solutions make NetEase one of the most sought after advertising platforms in China.

NetEase also provides e-mail and e-commerce services which also grew in the third quarter, with net revenues increased by nearly 80% year-over-year, primarily due to increased revenue contribution from their e-commerce businesses such as Kaola and Yanxuan. These e-commerce platforms accounting for approximately 71% of the segment's net revenues.

As NetEase continues to amass one of China's preeminent game portfolios, they are simultaneously focused on advancing their Internet service offerings to support their overall business. Sounds a little like the bundling our US based tel-cos offer.

NetEase continues to grow their gross profit and is maintaining very high margins in most segments of their business. While margins have been declining over the past three quarters, they do remain above 60%. For the third quarter of 2017, gross profit margin for online games was 62.5% compared to 63.1% and 65.0% for the preceding quarter and the third quarter of 2016, respectively.

Gross profit and margin for advertising services business increased year-over-year and quarter-over-quarter in the third quarter of 2017, with a gross margin of 68.0% compared to 67.6% and 65.3% for the preceding quarter and the third quarter of 2016, respectively.

Gross profit decreased year-over-year for their e-mail, e-commerce and others businesses for the third quarter of 2017, with gross margin of 11.9% compared to 11.3% and 33.5% for the preceding quarter and the third quarter of 2016, respectively.

For all the ribbing about what a big risk this company could be I've found NetEase to be exceptionally shareholder friendly. That's a Wall Street term for 'they pay dividends to shareholders'. Typically technology companies are all about growth and as such they reinvest everything back into the company. NetEase has managed to do that and return a bit to the shareholders plus buy back some shares to further strengthen the stock price for all of us, the owners.

Under their current share repurchase program, NetEase bought back approximately 1.1 million shares as of November 14, 2017, the last day of the program. The board has approved a new 12-month share repurchase program beginning on November 16, 2017, for up to $1.0 billion more.

Stay Invested

Clay Baker

Disclosure: I am personally invested long in these stocks that appear in the MLH portfolio and may purchase or sell shares within the next 72 hours. I am also invested in other stocks that do not appear in the MLH portfolio: BA, BRK.B, CELG, CSCO, CTXS, CVX, DOW, DVAX, FB, IBM, NTES, NVDA, OMER, PFE, PG, RDHL, SCHW, TBT, THO, TWX, VEEV, VZ, XLNX, XOM

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is not intended to offer investing advice, guarantee 100% accurate predictions, or to be interpreted as providing a personal recommendation.