NetEase Excites Investors with Prospects of Spinning News Business

Summary

Over the last five years, NTES demonstrated strong revenue and gross profit growth

During the last four quarters, NTES ROE has also improved, which is rare among internet technology companies during fast growth periods

NTES has a PE of 22.07, which we believe is a steal compared to its growth potential

Year-to-date, NTES stock has gone up by 34.14% and the news business spin off would likely push the stock much higher in the last quarter of 2016

Company Overview

NetEase Inc (NASDAQ:NTES) is a leading Internet technology company based in China that pioneered the interactive online community. Their service offerings span over online gaming, internet media, e-mail service, and e-commerce. NetEase Inc’s operations could be segmented into three sections, online gaming, advertising, e-commerce and other fringe services.

NetEase Inc is well known in China for offering multiplayer PC games and mobile games. Besides PC games, they also have a large stake in the Chinese mobile gaming market, where they have a substantial market share. NetEase Inc’s advertising segment is based on their portal, where the company develops content and has a large community of daily visitors. The main source of revenue from this segment arrives from advertising as well as sponsored content. In the third segment, NetEase Inc offers a range of free and freemium services including e-mail and other online communications.

As of September 12, 2016, NetEase Inc had a market capitalization of $31.46 billion and employed around 13,000 people to run its operations.

Review of Recent Financial Performance

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Figure 1: NetEase Inc Revenue and Price Correlation

Over the last five years, NetEase Inc’s quarterly revenue has gone up by almost a billion dollars, 349.4% to be precise. At the same time, NetEase Inc’s stock price has climbed from around $50 per share and currently trading at $231.37 per share, representing a 389.1 % increase during this time frame. If we closely examine the Figure 1, it would be clear that there is a strong positive correlation between NetEase Inc’s superb revenue growth and its stock price.

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Figure 2: NetEase Inc Had Healthy Gross Profit Growth

While a lot of internet and technology companies decide to grow first, then think about their bottom line, NetEase Inc management has successfully done both. During the last 20 quarters’ their gross profit has gone up by 290.9%. However, the gross profit margin has slightly gone down from around 77% in 2013 to 58.98% in 2016, which is still a great margin for a predominantly internet technology company.

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Figure 3: NetEase Inc ROE ((TTM)) Has Been Picking Up

During the first two years of high growth, NetEase Inc’s ROE slightly went down, but still maintained around a 22 % return at the lowest point in Q2 2015. However, since then, their ROE has been picking up and in Q2 2016, it reached 31.63%, a substantial improvement considering how fast they have been growing in the last few years.

No wonder investors love NetEase Inc, the management has been able to meet, if not exceed, all the expectations that investors have from a fast growing company. High growth and improving return on equity.

NetEase’s Future Looks Even Brighter

NetEase Inc is operating in an industry that has a lot of potential, especially for the Chinese market.

“Often times, a rising tide will lift all boats in an industry, as there can be broad trends taking place in a segment that are boosting securities across the board.” said Zacks Investment Research while commenting on the potential of NetEase Inc.

“This is arguably taking place in the Internet Software/Services space as it currently has a Zacks Industry Rank of 71 out of more than 250 industries,” they added.

NetEase to Shed Online News Unit

Online gaming has been the key growth area for NetEase Inc in the last few years and earlier today, Bloomberg reported that they are going to increase their efforts in online gaming by spinning off its news business.

“NetEase Inc is seeking to raise about $300 million by spinning off its news operations to focus on its core business of online gaming,” reported Bloomberg on September 13, 2016.

The upcoming spin off would likely to increase the secular growth momentum of NetEase Inc’s online gaming segment.

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Figure 4: Year to Date, NetEase Stock Price Has Gone Up by 34.14%

As a result, over the last two days, NetEase Inc’s stock price has gained over 12%, pushing the year to date increase to almost 34.14%

Conclusion

NetEase Inc investors would be pleased to know that for a company with $31 billion market capitalization that has a 34.14% ROE, NetEase Inc’s price to earnings ratio ((P/E)) is still around 22.07.

Considering the growth opportunity from spinning off the news business would make the P/E even more attractive. Also, NetEase Inc’s Beta is only 1.0285, making it one of the least volatile internet technology stocks in the Chinese market. Usually, these kind of companies have a much higher volatility. So, investors who are looking for a more stable price action, NetEase Inc could fit perfectly into a stable portfolio as well.

We strongly recommend that secondary investors who are looking for foreign companies to diversify their portfolio, consider NetEase Inc for their portfolio. This Chinese company is going places and at this P/E, this is a great investment opportunity.