Business Context and Reporting Period
This summary covers the Annual Report on Form 20-F for NetEase, Inc. for the fiscal year ended December 31, 2009. NetEase is a leading Chinese Internet technology company primarily engaged in providing online games, advertising services, and wireless value-added services. The company operates through subsidiaries and Variable Interest Entities (VIEs) in China, with its primary revenue driver being online games, which accounted for 88.9% of total net revenues in 2009.
Key Financial Metrics (Year Ended Dec 31, 2009)
| Metric | 2009 (RMB) | 2009 (US$) | 2008 (RMB) |
|---|---|---|---|
| Total Net Revenues | 3,756,947,133 | 550,395,864 | 3,084,584,149 |
| Net Income (Attributable to Shareholders) | 1,850,436,004 | 271,090,405 | 1,596,687,907 |
| Operating Profit | 2,023,436,206 | 296,435,079 | 1,914,562,678 |
| Operating Cash Flow | 2,094,494,979 | 306,845,248 | 2,017,799,188 |
| Total Assets | 8,803,468,839 | 1,289,715,471 | 6,345,893,303 |
| Total Liabilities | 1,378,125,128 | 201,896,471 | 829,248,062 |
| Shareholders' Equity | 7,425,343,711 | 1,087,819,000 | 5,516,645,241 |
| Cash & Time Deposits | 7,016,668,426 | 1,027,947,733 | 5,613,408,022 |
| Long-Term Debt | 200,000 | 29,300 | 200,000 |
Note: US$ amounts are translated at the rate of RMB 6.8259 = US$1.00 as of December 31, 2009.
Material Changes vs. Prior Period
- Revenue Growth: Total net revenues increased by 21.8% to RMB 3.76 billion. This was driven primarily by a 27.0% increase in online game services revenue to RMB 3.34 billion, largely due to the successful re-launch of World of Warcraft in September 2009 and growth in internally developed titles like Westward Journey Online II and Tianxia II.
- Advertising Decline: Advertising services revenue decreased by 6.7% to RMB 346.7 million, attributed to internal reorganization, staff training impacts, and tightened advertiser spending due to the global economic slowdown.
- Cost Increases: Cost of revenues surged 70.2% to RMB 952.2 million. The online game segment saw a 134.5% cost increase due to royalties, server custody fees, and amortization of license fees associated with World of Warcraft, as well as increased staff costs.
- Profitability: Despite higher costs, net income attributable to shareholders rose 15.9% to RMB 1.85 billion. The effective tax rate was 14.6% in 2009 compared to 15.8% in 2008.
- Capital Expenditures: Capital expenditures increased significantly to RMB 407.7 million (US$59.7 million), primarily for servers related to World of Warcraft and construction of a new R&D complex in Hangzhou.
Guidance, Outlook, and Risks
Management Commentary & Outlook: Management expects online games to remain the primary revenue source. The company is transitioning from a purely time-based revenue model to include item-based models (e.g., Tianxia II). Future growth depends on the successful launch of new games, the continued popularity of existing titles, and the expansion of the World of Warcraft franchise in China.
Key Risks and Contingencies:
- Regulatory Risk: Significant exposure to Chinese government regulations regarding online game content, virtual currency, and foreign investment in the telecommunications sector. Delays in government approvals for game expansion packs (e.g., Wrath of the Lich King) could impact profitability.
- Concentration Risk: In 2009, 86.0% of total net revenues were derived from a specific group of games: Fantasy Westward Journey, Westward Journey Online II & III, Tianxia II, and World of Warcraft.
- Blizzard Licensing: The company has substantial contractual commitments (approx. RMB 1.7 billion outstanding) to Blizzard Entertainment for royalties and marketing. Failure to meet these obligations could lead to license termination.
- Variable Interest Entities (VIEs): Operations rely on contractual arrangements with VIEs. Changes in Chinese law could challenge the enforceability of these arrangements or the consolidation of these entities.
- Competition: Intense competition in the Chinese online game and advertising markets from domestic and international players.
Investor Verification Checklist
- Blizzard Commitments: Verify the status of the World of Warcraft license renewal and the approval status of expansion packs (specifically Wrath of the Lich King) with Chinese authorities.
- Game Lifecycle: Monitor player retention and revenue trends for the core titles (Westward Journey series and World of Warcraft) to assess the risk of revenue concentration.
- Regulatory Compliance: Review updates on Chinese regulations regarding virtual currency, anti-addiction systems for minors, and foreign ownership restrictions in the gaming sector.
- Item-Based Model Success: Track the revenue contribution and player adoption of new item-based games like Tianxia II to gauge the success of the business model transition.
- VIE Structure: Assess any legal or regulatory changes in China that could impact the enforceability of the contractual arrangements with Guangzhou NetEase and other VIEs.