NETEASE(NTES.O)3Q22 EARNINGS REVIEW：CORE BUSINESSES REMAIN STABLE AMID THE GLOBAL DEVELOPMENT OF PROPRIETARY GAMES

　　Core views:
　　The 3Q22 revenue of NetEase slightly exceeded expectations, while the profit beat expectations by a wide margin. However, after excluding Rmb1.347bn of investment income and Rmb1.398bn of forex gains, its bottom line was basically consistent with expectations, and its underlying business performance remained stable. Thanks to the launch of key new games + classic games with sustained vitality, the Company's game business has been more stable than the industry. NetEase has multiple key domestic and overseas products in the pipeline, incl. “Harry Potter: Magic Awakened” (overseas), “Ghost World Chronicle” (approved), “Westward Journey: Return” (approved on Nov 17), "Naraka: Bladepoint” (mobile), “Justice” (mobile), etc. In addition, the impact of Blizzard's termination of the agency agreement is limited. We believe that the Company focuses on the global development of proprietary products and is likely to continue to make breakthroughs in the domestic and overseas markets. Its online education business exceeded expectations, and its learning services and intelligent devices achieved remarkable growth. In addition, its Cloud Music and innovative businesses maintained sound development. As a company with relatively stable earnings in the internet industry, NetEase's valuation is currently at a low level. We are optimistic about the potential valuation recovery brought about by the industry's recovery and the Company's medium- and long-term development momentum. We reiterate the "BUY" rating.
　　Abstract:
　　3Q22 earnings overview: The profit was much higher than expected, and the core business performance remained stable after excluding investment income and forex gains.
　　NetEase achieved revenue of Rmb24.427bn in 3Q22 (+10.1% YoY, +5.5% QoQ, vs. our forecast of Rmb23.836bn). The gross profit margin (GPM) was 56.3% (+3.0ppts YoY, +0.4ppts QoQ). The selling/administrative/R&D expense ratio was 15.4%/5.2%/16.2% (+1.3ppts/+0.1ppts/-0.7ppts YoY, +1.2ppts/+0.4ppts/+0.8ppts QoQ). 3Q22 non-GAAP attributable net profit (ANP) reached Rmb7.47bn (vs. our forecast of Rmb4.947bn), up 93.6% YoY and up 38.1% QoQ. 3Q22 revenue slightly exceeded expectations, while the profit beat expectations by a wide margin. After excluding Rmb1.347bn of investment income and Rmb1.398bn of forex gains, however, its profit was basically consistent with expectations, and its core business performance remained stable.
　　The game segment is more stable than the industry on new game launches + classic games with sustained vitality.
　　NetEase’s games and value-added services segment achieved revenue of Rmb18.699bn in 3Q22 (+9.1% YoY, +3.1% QoQ), with the revenue of mobile games/PC games/other value-added services (VAS) at Rmb11.917bn/ 5.455bn/1.328bn (+8.3%/+11.4%/+6.1% YoY, +7.1%/-4.4%/+1.7% QoQ, vs. our revenue forecast of Rmb11.461bn/5.593bn for mobile games/PC games). Compared with the industry, the game revenue of NetEase was more stable, and classic products such as “Fantasy Westward Journey” (FWJ) maintained stable performance. Meanwhile, the launch of a heavyweight product during the reporting period, “Diablo: Immortal”, has offset the high base impact of the launch of “Harry Potter: Magic Awakened” at the same time last year. As of Oct 31, “Diablo: Immortal” ranked No. 7 on the bestseller list of iOS games on average, and its contribution to incremental gross bookings and profit looks upbeat. In addition, the annual celebration and new map activities of “Naraka: Bladepoint” in the reporting period have improved the activity of the title. NetEase has the following domestic and overseas products in the pipeline, such as “Harry Potter: Magic Awakened” (overseas), “Ghost World Chronicle” (approved), “Westward Journey: Return” (approved on Nov 17), "Naraka: Bladepoint” (mobile), “Justice” (mobile), etc.
　　Blizzard's termination of the agency agreement should have a limited impact, and with the international development of proprietary products, NetEase may continue to make breakthroughs at home and abroad.
　　On Nov 17, NetEase and Blizzard announced that the authorization agreement for Blizzard games such as “World of Warcraft” would expire on Jan 23, 2023, and would not be renewed. NetEase estimates that the contribution of these games to its revenue and net profit in 2021 and 9M22 would be low in single digits, with limited impact on future earnings. The co-development and release of “Diablo: Immortal” would not be affected by this agreement. Going forward, more products of NetEase will rely on self-development and cooperation with many internationally renowned producers and overseas studios that NetEase continues to introduce, including the acquisition of the well-known developer Quantic Dream, former Capcom producer Hiroyuki Kobayashi, etc. These overseas studios will focus on the development of PC and console games and the global market, and with the support of well-known producers, sufficient freedom, and adequate art & program resources and others, we expect that this batch of works may have a higher probability of success and contribute long-term incremental revenue, and the related PC and console game products also have the potential for conversion into mobile versions and growth in the domestic market.
　　Online education business exceeded expectations, and learning services and intelligent devices achieved remarkable growth.
　　NetEase's online education business achieved revenue of Rmb1.402bn (+1.1% YoY, +46.7% QoQ, vs. our forecast of Rmb1.028bn), of which the revenue of learning services/intelligent devices/online marketing services was Rmb889mn/357mn/158mn (+37.2%/+40.1%/+14.9% YoY), and the earnings of the Youdao segment exceeded expectations. Among them, the growth of the learning service business is mainly due to the new services launched after the burden reduction initiative. For example, the sales of digital content services exceeded Rmb400mn, and STEAM courses revenue increased by 200%+ YoY. The intelligent device business continues to improve product strength and expand the product matrix. On Oct 27, NetEase released Youdao AI learning machine X10, Youdao Dictionary Pen P5 and other products. Meanwhile, Youdao Dictionary Pen X5 was the champion under the electronic dictionary category by sales via JD.com and Tmall during the “Double 11” shopping festival around Nov 11. We believe NetEase will continue to expand in four major directions: learning products, STEAM quality education, adult education and digital education solutions.
　　Cloud Music & innovative businesses maintained sound development.
　　Cloud Music achieved revenue of Rmb2.357bn in 3Q22 (+22.5% YoY, +7.6% QoQ, vs. our forecast of Rmb2.411bn); the GPM continued to rise to 14.2% (+12.0ppts YoY, +1.2ppts QoQ). The scale and activity of Cloud Music users remained stable, while the paying rate of music users continued to improve. The number of paying users of online music services was 37.61mn in 1H21 (+43.9% YoY), implying a paying rate of 20.7% (+6.5ppts YoY) and notable upside compared with about 40% in the US. In terms of content, in addition to expanding the scope of copyright cooperation and supporting original musicians, podcasts and audiobooks on the platform are also expanding. In Sep, the first audiobook festival opened to present hit intellectual properties (IP) such as "A Dream of Splendor", "The Three-Body Problem", and "Soul Land". We believe that the policy of abolishing exclusive music copyrights could alleviate the pressure of competition and help its Cloud Music platform control the cost of content. At the same time, on Oct 13, commercial music service provider Vfine Music and Cloud Music’s copyright service platform Cloud Village Exchange reached a copyright cooperation agreement to expand the distribution capacity of Cloud Music copyright content. We are optimistic about the long-term growth and marginal improvement trend of the Cloud Music business. Innovative and other businesses achieved revenue of Rmb1.968bn in 3Q22 (+13.6% YoY, +5.2% QoQ, vs. our forecast of Rmb2.021bn). For NetEase Yanxuan, its private label consumer lifestyle brand, sales vial all channels and the number of Pro members continued to grow during the Double 11 shopping festival, achieving impressive performance in pet, home furnishing, cleanser and other advantageous categories. As NetEase Yanxuan continuously improves product quality and SKUs, we expect its sales and user base to continue to grow.
　　Potential risks:
　　Tighter policy regulation in games, education and other industries; the launch time and performance of new games missing expectations; overseas game business expansion not up to expectations; online education business development failing expectations; the development of innovative businesses falling short of expectations.
　　Investment recommendation:
　　The 3Q22 revenue of NetEase slightly exceeded expectations, while the profit beat expectations by a wide margin. However, after excluding Rmb1.347bn of investment income and Rmb1.398bn of forex gains, its bottom line was basically consistent with expectations, and its underlying business performance remained stable. Thanks to the launch of key new games + classic games with sustained vitality, the Company's game business has been more stable than the industry. NetEase has multiple key domestic and overseas products in the pipeline, incl. “Harry Potter: Magic Awakened” (overseas), “Ghost World Chronicle” (approved), "Naraka: Bladepoint” (mobile), “Justice” (mobile), etc. In addition, the impact of Blizzard's termination of the agency agreement is limited. We believe that the Company focuses on the global development of proprietary products and is likely to continue to make breakthroughs in the domestic and overseas markets. Its online education business exceeded expectations, and its learning services and intelligent devices achieved remarkable growth. In addition, its Cloud Music and innovative businesses maintained sound development. We adjust our 2022E-2024E non-GAAP net profit forecasts to Rmb23.49bn/24.61bn/ 28.32bn (from Rmb20.89bn/25.06bn/29.02bn), corresponding to 14x/13x/12x non-GAAP PE (per ADR) at the current price. As a company with relatively stable earnings in the internet industry, NetEase's valuation is currently at a low level. We are optimistic about the potential valuation recovery brought about by the industry's recovery and the Company's medium- and long-term development momentum. Factoring in the valuation of 16x-20x 2022E PE for comparable peers of NetEase as a leading game company in China, such as Tencent (00700.HK), Activision Blizzard (ATVI.O), TakeTwo (TTWO.O), Electronic Arts (EA.O) and other US and Chinese comps under the CITCS industry classification of the game sector (based on CITICS forecasts of the internet & media team for Tencent, Wind consensus estimates for other US and Chinese comps and Thompson Reuters consensus estimates for the rest), we assign 18x 2022E PE to derive a 2022E target price of US$90 per ADR and reiterate the "BUY" rating.
【免责声明】本文仅代表第三方观点，不代表和讯网立场。投资者据此操作，风险请自担。

   【免责声明】本文仅代表第三方观点，不代表和讯网立场。投资者据此操作，风险请自担。