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NetEase looks up to e-commerce sector for a second wind

It seems the investors have lost faith in NetEase. The video game industry is facing headwinds in China with tighter regulations and the competition in e-commerce is fierce.

Nov 22, 2018 by A. Alfaro
NetEase looks up to e-commerce sector for a second wind

Image courtesy: NetEase

Founded in 1997, NetEase used to be seen as a young and cool company in China. Riding on the breakout success of the company, NetEase founder, Ding Lei, became a millionaire in his early 30’s. Under his aegis, the company forayed into video games, e-commerce and online music markets.

The NASDAQ-listed (2001) company saw a steady growth until 2018. However, this year, NetEase’s stock fell by 35% and lost USD 29 billion in market valuation. Although the third quarter report showed the revenue from video games and e-commerce services surpassed analyst expectations, it had no positive effect on the falling stock.

Writing on the wall

It seems the investors have lost faith in NetEase. The video game industry is facing headwinds in China with tighter regulations and the competition in e-commerce is fierce.

In 2014, Ding Lei hosted an exclusive dinner for the who’s who in Wuzhen during the World Internet Conference (WIC). During the conference, Ding Lei expressed his confidence in video game business and dubbed NetEase as a global video game company.

A NetEase investor told tech media, All Weather TMT (全天候科技): “Video games decide NetEase’s direction”. Lately, the poor showing of NetEase video games such as Onmyoji (阴阳师) is worrying investors. “E-commerce and other fields only represent a small fraction of NetEase’s activity. Apart from some investors in the entertainment industry, few people consider investing in NetEase,” a stock market analyst told All Weather TMT.

NetEase Music and a few other services have held independent financing rounds recently. NetEase could be considering starting separate companies for its services, so that the core company can fully focus on e-commerce, All Weather TMT reported.

NetEase claimed Koala, its online shopping portal, sealed CNY 100 million in sales in the first three minutes and 49 seconds on the Single’s Day. E-commerce is one of the major revenue sources for NetEase, accounting for 30% of the total revenue in the third quarter. Ding was quoted in All Weather TMT as saying: “Thanks to our platforms such as Koala and Yanxuan, we will see a new NetEase in three to five years”.

However, NetEase is far from being a major player in the Chinese e-commerce. During Single’s Day, by the time NetEase Koala had reached CNY 100 million mark in sales, platforms such as TMall raked in CNY 10 billion. The revenue from e-commerce hit USD 644 million, a growth of 67.2% year-on-year. However, the profit margin of e-commerce business declined year on year from 11.5% to 10%. NetEase’s overall net profit in the third quarter was USD 329 million- a decline of 25.3%.

According to Zhu Yue, executive chairman of China Insights Consultancy, NetEase has invested heavily in the e-commerce business. “Compared to JD, TMall or Taobao, it still needs to invest a large sum to generate traffic and create a supply chain system,” he told All Weather TMT.

Zhuang Shuai, another analyst, told All Weather TMT: “Services such as NetEase Music, email and NetEase News can be used to attract users to e-commerce”.

Ding Lei prefers relatively small platforms to ensure good quality-price ratio as evidenced by NetEase’s e-commerce platforms Koala and Yanxuan. But according to Zhuang Shuai, NetEase failed to innovate like Pinduoduo or JD.

NetEase is popular among urban white-collars. But Chinese e-commerce is shifting its focus to third-tier cities. Pinduoduo and Bytedance have achieved tremendous success by adopting the strategy of targeting lower-income people.

NetEase’s video games division is still going strong. Even though the recent video game releases have not been successful, the revenue increased by 28% year-on-year. In comparison, Tencent’s income from video games shrunk by 4% during the same period.

NetEase has a manga division as well with characters and story lines inspired from own videogames such as Onmyoji (阴阳师). NASDAQ- listed B-Zhan (also known as Bilibili) is reportedly contemplating acquisition of NetEase’s manga division. NetEase had ambitious plans for its manga division, including a possible IPO, which never came through.

Live video streaming is another opportunity NetEase has missed. According to Zhuang Shuai, “NetEase could have a video service similar to Taobao’s and link video, e-commerce and video games platforms”.

NetEase Music raised USD 108 million during a financing round in 2017. In 2018, the company raised USD 600 million from investors such as Baidu and General Atlantic. However, NetEase Music is still not a worthy competitor to Tencent Music. In the battle for copyright and royalties, NetEase can’t stand up to Tencent.

NetEase’s advertisement revenue reached USD 92 million during the third quarter- an unimpressive growth of 2% year-on-year (lowest in recent years).

The revenue from email services has grown significantly in the third quarter (31.5%). Nevertheless, NetEase lacks a full-stack strategy to explore the B2B field further.

The company has developed speech recognition software with services such as instant subtitles for videos, but it is still in early stages. NetEase has also developed an online translator and an interactive projector and is working on areas such as artificial intelligence and computing services.

NetEase’s translation service, Youdao, has raised USD 158 million during its financing round. Now, Youdao is focusing on the education sector and is trying to expand to the B2B field.

According to tech industry analyst Cheng Lingfeng: “Ding Lei is the most conservative and patient among Internet entrepreneurs in China. He is the kind of person who goes to the battlefield after all the soldiers are dead and then conquers the land”.

A. Alfaro

A. Alfaro is a Beijing-based freelance reporter. He focuses on China's politics, culture and society. He can be reached at varofaro@gmail.com. 

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