Matters:

NetEase 24Q3 achieved revenue of 26.2 billion yuan (YOY -3.9%, QOQ +2.84%), of which games and related services achieved revenue of 20.9 billion yuan (YOY -4.21%, QOQ +4.03%); for the first time in history, Youdao achieved third-quarter profit. Achieved revenue of 1.573 billion yuan (YOY +2%); innovation and other business revenue of 1.774 billion yuan (yoy -10%); cloud music business revenue of 1.999 billion yuan (yoy +1.32%). The company achieved net profit of 6.538 billion yuan (yoy -16.57%). Non-Ifrs net profit to mother was 7.499 billion yuan (yoy -13.26%, qoq -4.12%).

Looking at it from a year-on-year perspective: The decline in revenue is mainly due to the high base of mobile games against the cold last year, partly offset by the launch of Everlasting mobile games and the growth of mobile games and Warcraft mobile games; gross profit is basically stable, and the three fees are basically flat. The profit gap was mainly due to an increase of 0.65 billion yuan in exchange losses and a decrease of 0.2 billion yuan in other net income.

From a month-on-month perspective: The decline in mobile games is expected to result from a decline in inventory. Mobile games are expected to grow by 1.35 billion yuan for Blizzard's return, so both revenue and operating profit are relatively stable, mainly due to exchange rate losses, which led to a decline of 1.056 billion yuan in exchange rate (exchange loss of 1.056 billion yuan this quarter, an increase of 0.816 billion yuan over the previous quarter).

Commentary:

The overall game business was under slight pressure, but PC was better than previously expected; Blizzard returned strong performance and achieved revenue of 20.9 billion yuan (YOY -4.21%, QOQ +4.03%); online game revenue of 20.196 billion yuan (YOY -1.04%, QOQ +4.8%); mainly due to the year-on-year decline in game-related services, core game revenue remained nearly flat year over year. Furthermore, the overall GPM was 68.8%, a decrease of 1.2% pct over the previous month, which is expected to be mainly due to increased revenue from Blizzard, which has a low gross margin; in addition, deferred revenue increased by 1.927 billion yuan month-on-month. Among them, mobile games achieved 14.3 billion yuan (yoy -9.71%, qoq -2.89%). The estimated loss is mainly due to the decline in ultra-high base + egg boy against the cold, and the launch of Everlasting Mobile Games is expected to partially offset the pressure to reduce the amount. Among them, mobile games achieved 5.897 billion yuan (yoy +29.01%, qoq +29.65%), which is mainly expected to be the return of Blizzard (Warcraft) + the growth of Everlasting mobile games.

Stock resilience exceeded expectations, and short-term concerns were mitigated; Q4 game revenue may improve. I am optimistic about the relative performance in December. Previously, the core concerns were about the decline in Dream PC, Against the Cold M, and Egg Boy stock, but Q3's mobile game performance may partially confirm that Dream Journey to the West PC has returned to stability after undergoing revisions. Looking at Q3, although stocks have not been corrected, we believe revenue concerns can be mitigated; moreover, much of the reason for the decline in profits is due to exchange rate fluctuations; therefore, we believe that the actual performance of Q3 was better than previous pessimistic expectations, that is, the relative stability of stocks brought opportunities for recovery.

Looking at the Q4 revenue side, “Hearthstone”, which was launched again, will contribute throughout the quarter or drive a return in Q4 game revenue; in terms of the product line, we can expect the launch of “Marvel Clash” and “The Sixteen Voices of Yan Yun” in December, the “Outsider Frenzy” test+ “Code Name: Infinity” exposure and catalytic intensity, and the relative performance of December is optimistic.

Profit forecasting, valuation and investment ratings

Based on the 2024 Q3 results, we adjusted our performance expectations; we forecast that the company's net profit from 2024 to 2026 will be 28.9 billion yuan/31.9 billion yuan/34.8 billion yuan, respectively (previously 29.8 billion yuan/33.3 billion yuan/35.9 billion yuan). The current stock price for 2024-2026 PE is 13.8/12.5/11.4X, respectively, and the net profit for non-Gaap is approximately 32.8 billion yuan/35.8 billion yuan/38.7 billion yuan, respectively. Valuation is carried out using the SOTP method:

The game business is given 15 to 18 times PE. According to the current US stock market value, Cloud Music belongs to NetEase 1.415 billion yuan; according to the current market value, Cloud Music belongs to NetEase 14.146 billion yuan, and other businesses are given 2XPS. After aggregation, it corresponds to the 2025 target price range of HK$168 to HK$199, maintaining a “recommended” rating.

Risk warning: game version restrictions; game launch falls short of expectations; overseas policy risks.