NetEase’s Q4 Earnings Pressured by One-Off Expenses

The decline in NetEase’s 09999 operating profit in the fourth quarter was a one-off. Excluding CNY 1 billion in charges related to the recent breakup with Activision Blizzard, NetEase’s earnings would have been in line with our and PitchBook consensus expectations. Management maintained its outlook for 2023, and we are keeping our forecasts (which already factored in the loss of revenue from Blizzard games) unchanged. Over the past few months, there has been an improving regulatory environment for games, but we think the market is still behind the curve on raising revenue forecasts to account for more game license approvals. Building on our positive regulatory outlook and conviction in NetEase’s ability to develop topnotch games, we continue to view the shares as undervalued, trading at a 40% discount to our fair value estimate. Valuation multiples also look very cheap for a narrow-moat business, with the shares trading at 17 times earnings and 11 times core earnings (after removing net cash from market cap and net losses from Cloud Music and Youdao from the bottom line). We remain buyers as we believe the current reward/risk is attractive.

During the fourth quarter, NetEase increased game revenue by 1% year over year, primarily thanks to the revenue resiliency of legacy titles. Estimated game billings (incorporating changes in deferred revenue) were down 16% compared with the prior quarter, reflecting the one-off player refunds following the recent suspension of Blizzard games. These refunds had an estimated CNY 1 billion negative impact on operating profit. Excluding this impact, operating profit for the fourth quarter would have been CNY 5.4 billion, up 14% compared with the same period last year.