China's leading games company NetEase has released its financial results for Q3 2020. The company generated total net revenues of RMB18.7 billion (US$2.7 billion), an increase of 27.5% year-on-year (YoY). Online game net revenues were RMB13.9 billion (US$2.0 billion), up by 20.2% YoY.

Overall, the company continued to be a top performer in the market. However, NetEase's gaming revenues were almost flat compared to the previous quarter (they were actually up by 100 million RMB (around $15m) in local currency but in USD the results were flat due to currency fluctuations). By comparison, Tencent had 8% growth in games revenues quarter-on-quarter, and according to the government-backed China Audio-Video and Digital Publishing Association, China's gaming games market generated RMB 68.522 billion (US$10 billion) in sales in Q3 2020, up 3.37% from the previous quarter. In fact, as the second-largest games company in China, NetEase's games business was growing steadily YoY, but it seemed to lose some momentum recently compared to its rivals, suggesting that the new products of NetEase failed to boost the growth of the company. As a result, the gap between Tencent and NetEase widened.  

NetEase's classic titles remained strong; new titles waiting to be discovered

NetEase is an expert in the long-term operation of its classic titles and franchises. As mentioned in the quarterly report, the most profitable IP series, Fantasy Westward Journey, is still contributing a robust cash flow to NetEase, even though the first product of the series was released 19 years ago in 2001. Immortal Conquest (released in 2015, a strategy war game), Onmyoji (released in 2016), Knives Out (released in 2017) and Identity V (released in 2018) are also some of the top-grossing titles of NetEase which continued to drive strong performances in this quarter. However, NetEase has not launched any new products that can be compared with these titles in the last two years, which puts the company at a disadvantage when its biggest rival Tencent started to shine with its blockbuster games such as PUBG Mobile - Peacekeeper Elite in China.

The good news is that NetEase is preparing to launch several much-anticipated products in China. As the quarterly report notes, Revelation Online will be another MMO to be released before the Chinese New Year (Feb 12, 2021). The product is expected to have a successful launch due to the popularity of the IP on the PC platform and NetEase's wealth of experience in developing and operating MMOs. However, with similar, hugely successful products in the market, its long-term performance remains to be seen. World of Warcraft: Shadowlands was launched in China on November 24, and NetEase, as the publishing partner of Blizzard Activision in China, has been promoting it through various channels, trying to attract lapsed players return back to the game. Harry Potter: Magic Awakened is in open beta and can be officially launched soon as NetEase has obtained the government approval. As it was adapted from a non-game IP, the key to its success will be how it interests a broader gaming audience. 

NetEase's global strategy is becoming reality

NetEase re-emphasised its global strategy in its shareholder letter for its secondary listing in the Hong Kong Stock Exchange in May 2020, and mentioned in its post-hearing briefs that it plans to use the proceeds from the public offering to promote its ongoing innovation on the one hand, and its global strategy and opportunities on the other.

NetEase has a significant presence in the Japanese market because of the introduction of high-quality products and localised marketing strategy back in 2017 when mobile title Knives Out came to Japan. NetEase now has become one of the top grossing mobile games companies in this market which has a high average revenue per paying user (ARPPU), a large number of gamers and a unique culture. NetEase's titles such as Knives Out, Life-After and Identity V continued their strong performances in Japan, as the quarterly report notes. The success in the Japanese market could serve as a model for NetEase’s future global strategies, when NetEase is strengthening its overseas presence to avoid becoming too dependent on any single market.  

About 10% of NetEase's games revenue now comes from overseas markets, suggesting that its business is still considerably centred in mainland China. Compared with Tencent's 20% games revenue from overseas markets, NetEase needs to strengthen its pipeline overseas to push its global strategy forward. NetEase is working with international partners on developing a premium IP pool which currently includes Diablo, Marvel, Harry Potter, The Lord of The Rings, and more. After taking over the development of the mobile game Harry Potter: Magic Awakened from Warner Bros, NetEase licensed another IP, The Lord of The Rings, from Warner Bros in Jun 2020, which is perhaps proof that NetEase's expertise in mobile games has been recognised by renowned IP-holders. Therefore, developing mobile games for non-games IP is a possible business model for NetEase in the future.  

The partnership with Blizzard is more likely to enable the emergence of the next breakthrough growth point for NetEase. Daniel Alegre, Chief Operating Officer at Activision Blizzard, mentioned in the company's latest quarterly earnings call that Diablo: Immortal is seeing a "hugely enthusiastic" response from internal playtesting. In the context of Blizzard planning mobile games for all of its franchises, the performance of Diablo: Immortal will be extremely important: it determines the likelihood of NetEase continuing this business model, and collaborating with Activision Blizzard on more valuable IPs such as Overwatch, World of Warcraft and StarCraft. It can be predicted that such products would have substantial global potential.

Console games will be the next battlefield

NetEase has a strong investment portfolio in global console games developers, including Bungie, Behavior Interactive, Bossa Studios and Quantic Dream. It has also established two studios in Tokyo and Montreal which are focused on next-generation console game production. NetEase's very first action battle royale product on PC and console platforms, NARAKA: Bladepoint, has started its beta testing in North America and Asia, and has already received an ISBN in mainland China, thereby it is expected to be released soon. Tencent is also setting up a new studio for the development of console games in California. The competition between the two companies in the realm of console games may have just begun.