The company announced results for the third quarter of 2024. In Q3, total revenue was 26.2 billion yuan, a year-on-year decrease of 4%, a month-on-month increase of 3%, and non-GAAP net profit of 7.5 billion yuan, a year-on-year decrease of 13% and a decrease of 4% month-on-month.

The main business is steady, and the profitability of YouDao and Cloud Music continues to improve. 2024Q3 achieved revenue of 26.2 billion yuan. Gaming declined slightly year over year. Youdao and Cloud Music continued to grow, and revenue from innovation and other businesses declined. The Q3 company achieved gross profit of 16.5 billion yuan, a year-on-year decrease of 2.9%. In terms of expenses, operating expenses decreased by 0.8% year-on-year and increased 3.1% month-on-month to 9.3 billion yuan. The month-on-month increase was mainly due to an increase in marketing expenses for games and related value-added services.

Q3 by business situation:

1) The launch of new products superimposes existing games to expand new regions, further enhancing the influence of diverse game categories.

Q3's game and related value-added service business achieved revenue of 20.9 billion yuan, a year-on-year decrease of 4.2%. Among them, the online game business accounted for 96.8%, and mobile game revenue accounted for 70.8%. It was 77.6% in the same period last year, mainly due to the increase in PC game revenue of 29% and 30%, respectively. The overall performance of Q3's games has been steady, and the “Everlasting” mobile game has steadily increased in popularity since its launch in July, and the September season update reached fourth place in the iOS bestseller list; “World of Warcraft” and “Hearthstone” returned to the Chinese market. “World of Warcraft” DAU increased by more than 50% compared to before it was discontinued, and “Hearthstone” DAU achieved a significant increase of 150%; in addition, “Pinnacle Speed” quickly climbed to the top of the Apple and Google App Store free lists after launching in Japan in August; “The Fifth Person” and “Never Kill” quickly climbed to the top of the Apple and Google App Store free lists in popularity after launching in August; “The Fifth Personality” and “The Last Man” quickly climbed to the top of the Apple and Google App Store free lists after launching in August; “The Fifth Personality” and “The Last Man” quickly climbed to the top of the Apple and Google App Store free lists after launching in August; “The Fifth Personality” and “The Last Man” quickly climbed to the top of the free Apple and Google App Store lists in August; Unabated, long-term operational capabilities are continuously verified. The gross margin of the game business this quarter was 68.8%, down 0.2 pct and 1.2 pct from year to month, respectively, mainly due to changes in the product portfolio. In terms of subsequent pipelines, “Destiny: Rising” and “Marvel's Arcane Frenzy” were publicly unveiled. “The Sixteen Voices of Yan Yun” is expected to be released in December, “Marvel Clash” will be launched globally on December 6, and the “Against the Cold” mobile game will be launched in Hong Kong, Macao and Taiwan on November 29, which is expected to further enrich the product matrix.

2) Profitability improved significantly, and operating profit turned a year-on-year loss into a profit. Q3 Youdao Business achieved revenue of 1.6 billion yuan, a year-on-year increase of 2.2%. For the first time, it achieved profit in the third quarter, and quarterly operating profit reached a record high. The gross margin was 50.2%, down 5.7 pcts year on year and up 2 pcts month on month. The year-on-year decline was mainly due to the decline in learning service revenue, and the month-on-month increase was mainly due to the increase in revenue from smart hardware and learning services.

3) Cloud Music continues to improve the music ecosystem, increasing membership subscriptions and increasing gross margin under cost control. The Q3 cloud music business achieved revenue of 2 billion yuan, an increase of 1.3% over the previous year, and the number of subscription members increased further. On the basis of cooperation with Kakao Entertainment and JYP Entertainment, a copyright cooperation was also reached with CJ ENM to enrich the K-POP music library. The gross margin reached 32.8%, up 5.6 pct year on year and 0.7 pct month-on-month, mainly due to an increase in membership subscription revenue and continuous improvement in cost control.

4) Significant improvement in gross margins of innovation and other businesses. Q3 Innovation and other businesses achieved revenue of 1.8 billion yuan, a year-on-year decrease of 10.3% and a gross profit margin of 37.8%. The year-on-year increase was 10.5 pct and 3.8 pct, respectively. The main reason was the increase in gross margin of various businesses in the sector. NetEase Careful Selection focuses on branding strategies, and the size of Strict Selection Pro membership increased 56% year over year; NetEase Media improved the quality of content and achieved a significant increase in the number of new creators and interactions; in addition, NetEase Shufan and Guangzhou Public Transportation Group Co., Ltd. formally reached a cooperation to enhance the public bus travel experience with big data technology.

Maintain a “Highly Recommended” investment rating. Considering some of the company's game flow fluctuations and product launch pace, we expect the company's revenue to reach 105.9, 114, and 123.1 billion yuan in 2024-2026, and adjusted net profit of 31.9, 33.4, and 36.7 billion yuan. The corresponding PE is 12.6, 12.0, and 11.0x, respectively, maintaining the “Highly Recommended” rating.

Risk warning: policy risks, macroeconomic risks, new game launches falling short of expectations, and slow progress in AIGC technology.