According to financial reports, NetEase 3Q24 has revenue of 26.21 billion, YoY -4%; operating profit of 7.15 billion, yoY -5%; adjusted net profit of 7.5 billion, YoY -13%. The pressure on performance was mainly due to the high base for the same period last year combined with fewer new products in the first three quarters, and exchange losses. However, we believe that the pessimistic expectations of the company's fundamentals have been fully reflected.

Mobile games are growing rapidly. In Q3, revenue from gaming and value-added business yoy -4% to 20.9 billion (including online gaming yoy -1% to 20.2 billion) was better than market expectations. Looking at the mobile game YOY -10% to 14.3 billion, the main reaction was that “Mobile Game Against the Water Cold” and “Egg Boy” were under pressure; “The Fifth Personality” grew significantly. Mobile game YOY +29% to 5.9 billion. In August/September, “Warcraft” and “Hearthstone” returned and became popular, with active users increasing by 50%/150% compared to before discontinuation; the stabilization of “Dream Mobile Game” and the new high of “Big Story 2”/“Everlasting Mobile Game” are also important supports. Driven by mobile games, deferred revenue yoy was +9.5% by the end of Q3, and backtesting Q3 turnover increased by 2%, which is better than revenue side performance. The revenue expansion of proxy Blizzard mobile games also caused the gross margin of Q3 games to drop slightly by 1.2pct to 68.8% month-on-month, but better than the level before discontinuation (60-65%).

Cloud Music's gross margin was better than expected, and the losses were reversed. Q3 Cloud Music Yoy +1% to 2 billion. The membership scale maintained rapid growth. Social entertainment Q3 was slightly weaker than Q2; gross margin increased 0.7 pct month-on-month to 32.8%, better than expected. Revenue yoy was +2% to 1.6 billion, but operating profit turned a loss into a profit year over year, and quarterly operating profit also reached a record high.

Buybacks continue to accelerate, and shareholder returns are impressive. The Q3 cash dividend was 0.435 USD/ADR. The total dividend was about 0.28 billion US dollars, and the first three quarters were 0.88 billion US dollars. Q3 repurchases of 0.5 billion US dollars (vs. 2Q24 0.29 billion, 1Q24 0.17 billion, 4Q23 0.06 billion, 3Q23 0.05 billion), and repurchases accelerated markedly, totaling 0.96 billion US dollars in the first three quarters of 24. We assume that the Q4 dividend and repurchase scale is consistent with Q3, then the annual shareholder return will reach 2.61 billion US dollars, and the shareholder return will be 4.7% (if Q4 repurchases continue to accelerate, shareholder returns will be higher).

Performance and valuation are at the bottom, and we look forward to an inflection point. Overall, the Q3 pipeline is weak and the base is high. We judge that this is probably the quarter where the performance growth rate bottomed out; currently PE is also at the bottom of history. Meanwhile, the Q4 pipeline will gradually expand: the contributions of Q4 “Hearthstone” will begin to be reflected; the core products “Marvel Battle” and “The Sixteen Voices of Yan Yun” will be launched in December; new products such as “Fragpunk Outside the World” and “Marvel's Secret Method Frenzy” are expected to be launched in November; in addition, the “Destiny: Rise” mobile game that the market is concerned about will be tested in November, and “Code Name Infinity” will also begin offline testing within the year. Gaming growth is expected to pick up again and reach an inflection point in 25 years.

Maintain a buy rating. Considering the sharp decline in mobile game Q3, and considering the progress of the new product pipeline and its delayed pace, we adjusted the profit forecast. The estimated 24-26 revenue is 105.6/116.7/122.6 billion (original forecast 107.6/119.6/127.2 billion), and the adjusted net profit to mother is 32.1/35.6/37.9 billion yuan (original forecast 32.8/36.4/39.7 billion yuan). Compatible with 24-26 PE 12/11/10.5x. Considering that the company's valuation is at the bottom of history, shareholder returns are becoming more attractive, and the 25-year fundamentals are expected to be at an inflection point, we use the 25-year forecast as a base and give a target price of 174 HKD/share, based on 30% room for growth, and maintain the buying rating.

Risk warning: Macroeconomic recovery falls short of expectations, marginal changes in game regulation policies, and the life cycle of games is shorter than expected.