Dragon Sword Game Helps NetEase Surpass Tencent: China Overnight

NetEase Inc., the operator of China’s second-largest online games website, rallied the most in a year last month as plans for new online titles prompted Morgan Stanley to boost profit estimates.

American depositary receipts of NetEase jumped 10 percent in February, making it the fourth-best performer on the Bloomberg China-US Equity Index. It beat Tencent Holdings Ltd.’s

1.2 percent retreat in dollar terms and Shanda Games Ltd.’s 1.6 percent slump. The China-U.S. gauge of the most-traded Chinese companies in the U.S. dropped for a fourth week, the longest stretch of declines in nine months, led by Ambow Education Holding Ltd.

NetEase said on Feb. 6 that it expects to start selling three new titles in the second half of the year, including Dragon Sword, a three-dimensional game in which large numbers of players compete within a virtual world, and Heroes of Three Kingdoms, a real-time action strategy game. Revenue, driven by new online titles, rose 14 percent in the fourth quarter. The new releases led Citigroup Inc. and Morgan Stanley to raise their 2013 earnings forecast by as much as 7 percent.

“This company will surely keep growing as it always has new self-developed games to offer,” Tian X. Hou, the founder of T.H. Capital LLC who rates the stock buy, said by phone from Beijing on March 1. “NetEase has the best research capability among all online gaming companies in China.”

ADRs of NetEase have surged 22 percent this year, the biggest gainer on the China-US gauge after online fashion store Vipshop Holdings Ltd. Hong Kong-traded Tencent, China’s largest Internet company by market value and also a web game operator, has climbed 7.9 percent in 2013.

Beating Estimates

NetEase, which earned 88 percent of its 2012 sales from online games, said fourth-quarter profit rose 12 percent from a year earlier to $1.23 for each ADR, beating the $1.08 mean forecast of seven analysts surveyed by Bloomberg.

Morgan Stanley analysts raised their estimates for Beijing-based NetEase’s 2013 net income by 4 percent to 4.1 billion yuan in a note dated Feb. 7. That would indicate a 14 percent growth from its 2012 net income. Morgan Stanley reiterated a rating equivalent to buy on the stock, citing “rich pipeline, low valuation and strong cash flow.”

Citigroup lifted its estimate for 2013 profit by 7 percent as Deutsche Bank AG raised its recommendation on NetEase to buy from hold.

Tencent Comparison

NetEase’s rally this year exceeded peers’ ranging from Shanghai-based Giant Interactive Group Inc., which has gained 15 percent, and Beijing-based Changyou.com Ltd., with an 11 percent advance.

NetEase also runs an online news portal, e-mail services and online educational courses, making its services comparable with those of Shenzhen, China-based Tencent, according to Hou at T.H. Capital. NetEase traded at 9.9 times estimated earnings on March 1, compared with a multiple of 23 for Tencent.

NetEase’s valuation still has room to rise, according to Jeff Papp, a senior analyst at Oberweis Asset Management Inc., which owns shares of NetEase, Giant Interactive, and Changyou.

“NetEase has a bunch of other hidden assets like its e-mail service, which is likely not in the stock price,” he wrote by e-mail March 1 from Lisle, Illinois.

The Bloomberg China-US gauge of the most-traded Chinese companies in the U.S. lost 0.1 percent to 94.08.

Weak PMI

China’s official Purchasing Managers’ Index was 50.1 in February, the weakest level in five months, while a separate gauge from HSBC Holdings Plc and Markit Economics also dropped to a four-month low, a signal the nation’s economic recovery from a seven-quarter slowdown may be losing steam. The China-US gauge plunged 6.2 percent in February, the largest monthly decline since May, as concern grew policy makers will take steps to curb rising home prices.

The PMI “is a little off-putting,” Mark Luschini, chief investment strategist at Janney Montgomery Scott LLC, which manages $54 billion in assets including Chinese equities, said in a telephone interview from Philadelphia March 1. “It would be worrisome if we start to see any monetary tightening associated with that at a time when an economy looks like it began to re-accelerate.”

The iShares FTSE China 25 Index Fund, the largest Chinese exchange-traded fund in the U.S., declined 0.9 percent to $38.60 for a weekly gain of 0.2 percent. The Standard & Poor’s 500 Index fell 0.2 percent to 1,518.20 on March 1.

Ambow Education tumbled 31 percent to $1.13 last week. The company was sued by investors who accuse it of orchestrating a “fake acquisition” to facilitate an initial public offering in the U.S. It dropped 3.4 percent yesterday.

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