NetEase, Inc.
(Nasdaq.GS: NTES)
Watchlist
Analysts
Jiaze Li
Danyun Wang
Peiyang Liu
Zhonghao Zhu
Presented on April 18, 2017
Key Statistics:
P/E (TTM): 20.92
Market Capitalization: $35 Billion
Current Price:
$262.50(As of April 17, 2017)
Valuation:
DCF Valuation: $216.65
Upside (18.5%)
Comparable (China): $335.18
Upside 26%
Comparable (Global): $323.61
Upside 23%
Company Overview
Business Model
NetEase, Inc. operates a leading interactive online community in China, including online game services, advertising services, E-mail, E-commerce and other businesses. Online game constitutes 73% of total revenue by charging its users on a time-based, item-based or combined models. Its web portal has large user base and attracts well-known advertisers to its websites. It also provides free web e-mail services and other products.
Corporate Structure
NetEase, Inc. conducts its business in China solely through its subsidiaries and VIEs (variable interest entities), including Guangzhou NetEase, NetEase Advertising, Hangzhou Leihuo, as well as certain other affiliated entities.Under the contracts, these affiliated entities operate the NetEase online games, websites, and the online advertising business as well the e-mail and e-commerce business.
Industry Overview
The increasing personal final consumption expenditure and pervasive telephone networks support the development of online games industry. Industry revenue is projected to grow at an annualized rate of 7.5% to 39.8 billion. Internet services industry is at growing stage and will continue to grow at CAGR of 39.3% in future five years to $1.54 tillion.
Financial Analysis
ROE and ROA generally increases in past five years. Year 2016 posts record high ROE of 34%. Profit margin decreases primarily because product mix shift from PC games to mobile and licensed games. Greenblatt ratios demonstrate that NetEase is generating favorable return for its shareholders. Based on DuPont analysis, increasing asset turnover is the key drive for earnings growth.
Projection and Valuation
DCF Valuation
NetEase will enjoy strong momentum in game segment in future two years, as new licensed game and mobile games will attract more players. Growth in advertising services will decline due to increasing competition. E-commerce segment growth rate will decline as Kaola.com platform reaches at a mature stage. We also projected that gross profit margin will decline due to product mix change. Using a WACC of 15%, we arrive at DCF price of $216.65.
Comparable Valuation
We did two comparable valuations: One compare NTES with its Chinese competitors, the other one compare with global game companies. The multiples used for estimation include EV/Sales, EV/EBIT, EV/EBITDA, and P/Diluted EPS. The implied prices for NTES are $335.18 and $323.61, respectively.
Recommendation
The business has been highly profitable and is growing rapidly since IPO in year 2000. However, we have several concerns over this company. First is its multi-layered corporate structure. Rights and obligation agreement are unclear between each layer of VIE structure. This may pose lots of political and sovereign risks to shareholders. Secondly, NetEase’s business model highly depends on its relationship with third party licensor, such as Blizzard and Mojang. If any of these license contracts expires ordiscontinues, NetEasewill be affected negatively. As a result of this complicated nature of foreign companies, we decided to put it into our watch list. Future analysts should be cautious when analyzing ADRs with complex corporate structure.