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, 2008. NetEase is a leading Chinese internet technology company primarily engaged in 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, specifically the "Westward Journey" series.
Key Financial Metrics (Year Ended Dec 31, 2008)
| Metric | Value (RMB) | Value (US$) |
|---|---|---|
| Total Revenues | 2,976,124,048 | 436,221,920 |
| Net Revenues (after business tax) | 3,084,584,149 | 452,119,333 |
| Net Profit | 1,596,687,907 | 234,032,672 |
| Operating Cash Flow | 2,017,799,188 | 295,756,567 |
| Cash and Time Deposits | 5,613,408,022 | 822,778,750 |
| Total Assets | 6,345,893,303 | 930,141,929 |
| Total Liabilities | 829,248,062 | 121,546,071 |
| Shareholders' Equity | 5,516,435,976 | 808,565,185 |
Note: US$ figures are translated at the rate of RMB 6.8225 = US$1.00 as of Dec 31, 2008.
Material Changes vs. Prior Period (2007)
- Revenue Growth: Total revenues increased by 29.1% to RMB 2.98 billion. Net revenues grew 39.4% to RMB 3.08 billion, driven largely by a RMB 146.8 million business tax refund received in June 2008.
- Profitability: Net profit increased 26.3% to RMB 1.60 billion. The effective tax rate rose to 15.8% in 2008 compared to 0.2% in 2007, reflecting the expiration of certain tax incentives and the implementation of the new Corporate Income Tax Law.
- Segment Performance:
- Online Games: Net revenues grew 40.7% to RMB 2.63 billion, accounting for 85.2% of total net revenues. Growth was driven by increased user concurrency in "Fantasy Westward Journey" and "Westward Journey Online II."
- Advertising: Net revenues grew 33.1% to RMB 371.4 million.
- Wireless Services: Net revenues grew 28.7% to RMB 84.0 million, significantly aided by the business tax refund.
- Exchange Losses: The company recognized a foreign exchange loss of RMB 167.1 million (US$24.5 million) due to the appreciation of the Renminbi against the US dollar and Euro.
Guidance, Outlook, Risks, and Unusual Items
- Blizzard Partnership: In August 2008 and April 2009, NetEase secured exclusive licenses to operate Blizzard games (including StarCraft II, Warcraft III, and World of Warcraft) in China through a related entity, Shanghai EaseNet. The company has guaranteed payments totaling approximately RMB 633.8 million (US$92.9 million) for marketing and hardware support, with no revenue generated from these titles as of the filing date.
- Tax Uncertainty: A subsidiary, Boguan, recorded an additional tax payable of RMB 23.3 million in June 2009 following a new tax circular that clarified the application of preferential tax rates. Management is discussing the final rate with authorities.
- Property Dispute: NetEase is involved in arbitration regarding a 20,000 square meter office building in Guangzhou. The company has deposited RMB 82.0 million as security and has not paid rent since occupying the property in 2006, though it records imputed rent expenses.
- Revenue Model Transition: The company is transitioning from a "pay-to-play" model to an "item-based" model (free-to-play with microtransactions) with titles like Tianxia II and Legend of Westward Journey, which were in open beta in 2008.
- Risks: Key risks include dependence on two primary games (Westward Journey series), regulatory changes in China regarding online games and foreign investment, and the potential for the company to be classified as a Passive Foreign Investment Company (PFIC) for US tax purposes.
Investor Verification Checklist
- Blizzard Revenue Timeline: Verify the commercial launch dates and initial revenue performance of World of Warcraft and StarCraft II in China to assess the return on the guaranteed RMB 633.8 million commitment.
- Tax Rate Stability: Confirm the final resolution of the tax rate dispute regarding the Boguan subsidiary and the sustainability of the 15% preferential tax rate for other subsidiaries post-2010.
- Guangzhou Property Resolution: Monitor the outcome of the arbitration regarding the Guangzhou office building to determine if the RMB 82.0 million deposit will be recovered or if the company faces eviction/rent liabilities.
- Game Lifecycle: Assess the user retention and revenue trends of the core "Westward Journey" titles to ensure they do not decline as the company shifts focus to new item-based games.
- Currency Exposure: Evaluate the impact of Renminbi fluctuations on future US-dollar reported earnings, given the company's significant foreign currency holdings.