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NetEase Inc. (NTES US) - Equity Research Summary

Core Content and Key Highlights

NetEase Inc. is a leading global game provider with a strong focus on innovation and long-lifecycle games. The company is positioned to benefit from the game premiumization trend and has a robust pipeline of titles, including Diablo: Immortal and Harry Potter: Magic Awaken, which are expected to drive growth in overseas markets. NetEase also has a diversified business model that includes music, education, and e-commerce, with its non-game segments contributing to long-term TAM expansion.

Main Investment Thesis

• Global Game Provider with Ingenuity and Innovation: NetEase is the second-largest game provider globally by revenue in 2020, with flagship games like FWJ (<梦幻西游>) and Westward Journey (<大话西游>) that have long lifecycles. The company has a high-quality portfolio of products, including games, Youdao, and cloud music, which helps in building a premium brand.
• Bullish on Strong Game Pipeline and Overseas Potential: NetEase is expected to leverage its IP titles and mobile MMORPG versions to drive further upside. The launch of Diablo: Immortal and Harry Potter: Magic Awaken is anticipated to strengthen its presence in the US and European markets. Naraka: Bladepoint, a PC game, is expected to continue driving momentum. We forecast mobile and PC game revenue to grow at 16% and 7% CAGR respectively from 2020 to 2023E, with improving GPM.
• Music and Other Innovative Businesses to Unlock Long-term TAM: The music business, particularly through NetEase Cloud Music, is expected to be a key driver, supported by favorable regulations, high user stickiness, and increasing paying ratio and social entertainment revenue. Youdao, the education segment, has improved its GPM significantly and is expected to shift towards adult and interest-based education to minimize risks.
• Initiate with BUY: We set a SOTP-based target price of US$123, implying a 25x/22x FY22/23E PE. Key catalysts include the upcoming launch of highly anticipated mobile games and the easing of regulation headwinds.

Key Financials (FY19A–FY23E)

Financial Analysis

• Revenue Growth: NetEase's revenue is projected to grow steadily from RMB59.2bn in FY19A to RMB116.2bn in FY23E, with a 16% CAGR in mobile games and 7% CAGR in PC games.
• Profitability: Adj. net income is expected to grow from RMB15.7bn in FY19A to RMB23.8bn in FY23E, with a 17.3% YoY growth in FY21E and 17.6% in FY22E.
• EPS Growth: EPS is forecasted to increase from RMB24.1 in FY19A to RMB34.5 in FY23E, with a 45.8% YoY growth in FY19A and 17.6% in FY22E.
• Valuation: NetEase's current valuation is considered attractive, with a target price of US$123 (25x/22x FY22/23E PE) and a +50% upside from the current price of US$82.

Business Overview

• Global Game Provider: NetEase is a top 2 game provider globally, with long-lifecycle flagship games and a diverse portfolio across genres.
• Overseas Expansion: The company has made significant strides in Japan and Korea, and is expanding into the US and European markets with global IPs.
• Non-Game Businesses: NetEase has a growing presence in music, education, and e-commerce, with NetEase Cloud Music as the fourth largest online music app in China and Youdao as a key player in the education sector.

Strategic Advantages

• Innovative Game Pipeline: NetEase has a strong lineup of upcoming mobile games, including Diablo: Immortal and Harry Potter: Magic Awaken, which are expected to drive further growth.
• Strong R&D Capabilities: The company invests in advanced development and graphics engines, such as NeoX and Messiah, to support its game innovations.
• Defensive Position: NetEase has a stable OCF and remains in a net cash position, which makes it a defensive name amid market uncertainties.

Market Position and Growth Drivers

• Game Premiumization: The game industry is expected to see continued premiumization, with NetEase well-positioned to benefit from this trend.
• Overseas Expansion: NetEase is leveraging global IPs and effective localization to expand its presence in international markets.
• Regulatory Impact: While recent regulations on game licenses and minor protection have posed short-term pressure, the long-term secular themes remain intact.

Conclusion

NetEase Inc. is a well-positioned player in the global gaming industry with a strong R&D and operation capability. The company's long-lifecycle games and innovative IP titles are expected to drive sustained growth, while its non-game segments offer additional long-term opportunities. With a target price of US$123, we initiate with a BUY recommendation, considering its attractive valuation and strong growth prospects.