Internet – China
Solid Domestic Game Grossing Growth In Summer; Expect Positive Surprise From NetEase
China’s online games market is expected to deliver an encouraging momentum in 3Q23, as reflected by the resilient growth in mobile grossing amid continuous favourable industry development. We opine there are monetisation opportunities for mini-games and AIGC, which will become growth catalysts for the online games market. Maintain MARKET WEIGHT.
- Navigating a resilient 3Q23 compared with 1H23. According to Sensor Tower, domestic and global online gaming revenue ramped up 10%/9%/9% and 1%/1%/2% yoy in Jul/Aug/Sep 23 respectively. China’s mobile grossing in 3Q23 grew 9% yoy, accelerating from -1%/-2% in 1Q23/2Q23. The meaningful recovery was primarily attributed to heightened payments from users during the summer holidays and the Chinese Valentine day’s festival. Honour of Kings moderated to 1% yoy drop, while Peacekeeper Elite delivered improved performance with 15% yoy decline in September vs a 30% slump in August. These were partially offset by Maple Story Mobile and Crystal Core which achieved significant mom revenue growths. Revenue generated from new games such as MapleStory: The Legend of Maple reached Rmb5b and accounted for 3% of total domestic market share. In addition, Justice Mobile demonstrated solid retention and longevity despite delivering slightly alleviated revenue growth compared with the first two months.
- An abundance of monetisation opportunities from mini/casual games. Mini-games that are embedded in Weixin/Douyin/QQ delivered resilient ytd growth, with 80% of game users being paying users. Monthly active users (MAU) for mini-program games could potentially reach over 500m, which is comparable to traditional app games. Revenue generated from mini-games is forecasted to reach Rmb40b in 2023 vs Rmb30b in 2022. Tencent currently has over 400m MAUs and 300,000 developers for mini-games, and annual revenue of mini-games is forecasted to surpass Rmb10b, with strong improvement in user engagement and time spent. For casual games, party game is the fastest growing genre in China, and is led by NetEase’s Eggy Party, which has a strong sticky and younger user demographic ever since its launch. Tencent’s DreamStar offers diversified playing options with user generated content (UGC) tools and relatively lower monetisation.
- NetEase to deliver encouraging re-accelerated grossing growth. NetEase’s domestic and international mobile grossing surged 36% yoy and declined 13% yoy respectively in September. 3Q23 domestic grossing rose 40% yoy, primarily contributed by strong monetisation and healthy retention of Justice Mobile, Dunk City Dynasty and Racing Master. We expect the blockbuster mobile game Justice Mobile to sustain the strong growth into 2H23 and generate Rmb6b grossing in 3Q23 and Rmb14.5b for the full year, driven its healthy retention and improving ARPPU. In addition, given the rapidly emerging casual and party games market, the rising popularity of NetEase’s Eggy Party continues to be the core growth pillar. Eggy Party reached 100m monthly active users (MAU) in Aug 3, and daily active users (DAU) of Naraka: Bladepoint doubled after it became a free game on 13 July. Furthermore, the company also plans to launch international versions of Eggy Party and Racing Master by end-23.
- We opine other games such as Where Winds Meet, Naraka: Bladepoint (Mobile) and Project Mugen will facilitate a strong revenue growth for NetEase. We lift our NetEase’s 3Q23/2023 game revenue growth forecast to 16%/14% yoy from 13%/10% respectively.
- Tencent’s game grossing to remain solid. Tencent’s domestic mobile grossing remained flat yoy while international mobile grossing grew 14% yoy in September. Tencent’s domestic game grossing is supported by solid performance of HoK during the summer promotion season amid popularity of the Asian Games and cosmetic items during the Chinese Valentine’s Day. This promotion was extended into the National Day holiday period and contributed to a 14% yoy growth. In addition, consistent launch of new games including Valorant China and Maple Story: The Legend of the Maple, High Energy Heroes. Meanwhile, Tencent’s international mobile grossing is driven by strong engagement and grossing of PUBG Mobile. The company’s upcoming game pipeline includes DreamStar, HoK: Breaking Dawn, Need for Speed, and The Division 2. After a temporary softness of domestic game revenue in 2Q23, we expect domestic revenue to resume its positive yoy growth and expect international games to generate an accelerated growth in 3Q23. As such, we estimate Tencent’s 3Q23/2023 game revenue to grow 4.6%/7% yoy.
- Overview of NPPA’s new game approvals in 3Q23. The National Press and Publication Administration (NPPA) approved 89 and 88 domestic games in Sep 23 and Jul 23 respectively, sustaining from 89/86/86 in Jun/May/Apr 23. In 3Q23, Tencent and NetEase did not receive any game approvals for domestic game licences. In 1H23, Tencent and NetEase received seven and six licence approvals for domestic games respectively and ytd in 2023, they each received two imported games licences. Ytd 2023, a total of 699 game licenses have been issued, surpassing the annual total in 2022 by nearly 50%. In Aug 23, NPPA issued licences to 31 imported games – the second round of imported games approval in 2023, compared with 27 imported games in Mar 23. Among the new imported game approvals in August, Tencent received one imported games licence for Project: Fighter (Mobile), developed by Tencent’s MoFun Studio Group, the team behind the Naruto mobile game. NetEase also received one imported games licence for The Lord of the Rings: Rise to War, a Strategy and Leadership Game (SLG) product based on The Lord of the Rings IP. We believe the new batch of games would continue to lay the foundation for solid grossing and pave the way for continuous licence approval in 4Q23.
- Key things to watch: a) Increasing competition within the party games genre, with the recent release of Tencent’s multi-player party game DreamStar an emerging rival to NetEase’s Eggy Party. The official launch date is likely at end-23/early-24; b) expecting the approval for NetEase’s Naraka mobile as well as Tencent’s updates from mobile Dungeon & Fighter (mDNF), and c) Tencent minigame migration to the App store.
- We trim Tencent’s 3Q23/2023 revenue forecasts by 2%/1%, in view of lukewarm mobile grossing performance from its legacy games. We raised NetEase’s 3Q23/2023 revenue forecasts by 2%/0.4%, after factoring in strong performance from the rising popularity of Justice Mobile and Eggy Party. We raise non-GAAP net profit by 2%/1%, benefitting from continuous margin improvement.
- Maintain BUY on NetEase Inc (9999 HK) with a higher target price of HK$193.00 (US$120.00), factoring in the solid online games growth and promising pipeline in the upcoming months. We expect to see solid profitability improvement as NetEast benefits from lower channel cost with ongoing migration to NetEase’s proprietary channel. Our target price implies 18x 2023F PE. The company is trading at 15x 12-month forward PE, in line with its historical mean of 16x.
- Maintain BUY on Tencent Holdings (700 HK) with a lower target price of HK$420.00 which implies 25x PE based on 2023 EPS. We forecast game revenue to ramp up by 4.6% yoy in 3Q23 and grow 7% yoy in 2023. Tencent is confident on its mini-game development and expects the upcoming new game licence approval to stimulate further innovation. The company is trading at 17.7x 12-month forward PE, 1SD below its historical mean of 27x. Our target price implies 25x 2023F PE against its historical average of 27x. We prefer Tencent in the online game universe as a value pick.
- Catalysts: a) Increasing user stickiness, b) continued improvement in the number of paying users, and c) launch of new game genres and expansion packs.
- Risks: a) Regulatory changes (ie further restriction on time/money spent), and b) fewer players trying to gain market share via unconventional distribution channels.