U.S. Markets close in 2 hrs 38 mins

NetEase Fights Rising Competition

Dan Caplinger, The Motley Fool

With new titles debuting constantly from developers all over the world, the video game industry today is more competitive than ever. That's especially true in the game-hungry Chinese market, where many companies are fighting for market share and profit. NetEase (NASDAQ: NTES) has faced big struggles for more than a year now, and even though its fundamental business metrics are generally moving in the right direction, the pace of its growth hasn't lived up to all investors' expectations.

Coming into Wednesday's fourth-quarter financial report, NetEase shareholders were hoping to hear that the Guangzhou-based video game company had gotten itself back on track. The report was not entirely positive, but there were some aspects of it that should give shareholders hope that NetEase could return to its former glory at some point.

Person in red shirt holding video game controller in hands.

Image source: Getty Images.

The game goes on for NetEase

NetEase in Q4 did end its troubling trend of decelerating profit growth. Revenue jumped 36% to $2.89 billion in local-currency terms, outpacing Q3's growth. That was, however, a bit slower than the 40% growth rate that most of those following the stock had forecast. On the bottom line, adjusted net income climbed 26% in local-currency terms to $343.2 million. That worked out to adjusted earnings of $2.55 per share, well above the $2.06 per share that NetEase earned in Q4 2017 on an adjusted basis.

The company's best results came from its online gaming segment. Net revenue from online game services rose 38%, which worked out to a more than 40% rise in gross profit. E-commerce delivered more of a mixed performance, with revenue rising but gross profit falling. Segment sales for the unit rose 44%, but a big boost in costs caused gross profit to fall 13% from year-ago levels. The advertising services business was even more sluggish, with sales gains of just 3% and a 4% drop in gross profit. NetEase's innovative businesses segment came in mixed as well, with a 14% rise in revenue but a modest negative gross profit that almost doubled from the year-earlier quarter.

Among the biggest drivers of NetEase's results were mobile games, and the company continued to get a rising contribution from them -- they accounted for almost 70% of video game revenue for the quarter. New games like Night Falls: Survival and Ancient Nocturne were the primary contributors to performance there. But in e-commerce, larger-scale promotions and sales discounts weighed on gross profit, and seasonality had an impact on advertising services' performance.

On the expenses front, the news was good: Total operating expenses were up just 25%, a fact that allowed faster sales growth to produce a healthier bottom line.

CEO William Ding said he was happy with how things were going. "2018 was a very fruitful year of diversification for our online games," Ding said, and "while our flagship titles remain stronger than ever, we also introduced a number of highly successful titles for PC-client and mobile platforms." Ding also pointed to NetEase's efforts to widen its footprint in Japan as integral to its global growth strategy.

What's ahead for NetEase?

Management is looking beyond video games for NetEase's future successes. Ding said it will focus on the promising e-commerce, music, and online education segments; the company intends to make substantial investments in those areas as part of its broader business strategy for 2019.

Despite the progress NetEase made during Q4, the company still has some ground to make up. Under its variable dividend policy, it declared a $0.48 per share payout for the quarter. That's higher than the $0.45 per share that shareholders received in Q3, but well below the company-best $0.61 per share dividend it paid two quarters ago.

NetEase did specifically discuss concerns that some analysts voiced regarding Chinese government regulators holding up the approvals of its games. CFO Yang Zhaoxuan said that Chinese regulatory agencies are indeed making minor changes to their approval process, but NetEase remains confident that it's being treated fairly and won't be held back by regulators.

Investors didn't react strongly to the earnings report; the stock was down 1% in pre-market trading Thursday following the Wednesday night announcement. NetEase's good results should help build investor confidence, but it'll take more progress to convince shareholders that the Chinese video game giant can hold off rising competition both at home and across the globe.

More From The Motley Fool

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends NetEase. The Motley Fool has a disclosure policy.