Blizzard Pushes Deeper Into China

Stephen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Blizzard Entertainment, of Activision Blizzard (NASDAQ: ATVI), announced on July 8 that it will be extending its partnership with the Chinese internet company NetEase (NASDAQ: NTES) to bring Blizzard's new trading card game, Hearthstone, to China. Blizzard currently relies on NetEase to deliver World of Warcraft and StarCraft to Chinese gamers.

NetEase has a sizable portfolio of over a dozen self-developed online games with over 600 million registered accounts and earns over 80% of the company's total revenues ($1.16 billion) from online gaming, including StarCraft and World of Warcraft. The company doesn't provide a breakdown of sales per game, but NetEase reports the outstanding balance of licensing fees to Blizzard through 2015 to be $183 million. The company has not announced what licensing fees will be paid for Hearthstone. Adding another Blizzard title to its offerings is a nice feather in NetEase's cap, but the true winner of this arrangement is Blizzard.  

It's clear Blizzard has been trying to push its way into the Chinese gaming market. Last year, the company chose Shanghai to host their World Championship Series finals, which featured both World of Warcraft and StarCraft. China has been specifically cited as the major driver of World of Warcraft subscription losses over the last year. The Chinese massive multiplayer online, or MMO, game market is very competitive and largely based on a free to play model, and World of Warcraft seems to lack the staying power it enjoys in the West.

Blizzard has also announced it is going to begin beta testing a micro-transaction system in Asia that would allow gamers to purchase the ability to level their character more quickly. This is a common feature of free to play business models and is another indicator the company is doubling down on its efforts to breach the Chinese gaming market. 

There are three reasons why the addition of Hearthstone to Blizzard's Chinese game offerings is a potential windfall. First of all, the game will be free to play. Players will have the option to purchase card packs rumored to be around $1 for a pack of 5 cards. The free to play business model is increasingly popular among gamers, especially to casual gamers and mobile gamers.

According to Newzoo, a gaming market research and consultancy, free to play games were by far the most profitable games downloaded in 2012. In the United States, they accounted for 72% of all iOS revenues in 2012, compared with 54% in 2011.

Activision Blizzard competitor Electronic Arts (NASDAQ: EA) was the No. 1 iOS publisher by revenue for 2012. EA reported a 51% increase in "extra content" and free to play revenues from 2011 to 2012, along with a 30% increase in mobile sales. Activision Blizzard's latest 10-K barely mentions mobile gaming, and the company has been taking modest strides to enter this space.

This leads into my next point why Hearthstone is China is a big win - there will be an iPad version. Compared to other Blizzard games, Hearthstone is graphically simple and doesn't require a mouse and keyboard to play. The game is perfect for mobile, and it's a positive development to see the company entering this space finally.

In 2012, mobile games accounted for 33% of all iOS app downloads and 66% of all money spent. It is estimated in 2012 there were over 500 million mobile gamers spending over $9 Billion. The mobile market in China is booming. China's mobile gaming market was valued at over $350 million in the first quarter of 2013, a 30% increase from the previous quarter. Blizzard is making a great move bringing a free to play game into this market.

Finally, enough emphasis cannot be placed on the scale of the opportunity for Blizzard in China. In 2012, there were over 450 million internet users in China and 87 million online gamers. The online gaming market in China is estimated to nearly reach $12 billion in 2013 and increase by $2 Billion each year for the next five years. For comparison, the worldwide online game market delivered $11 billion in revenues in 2011. Entering this space with the free to play business model so familiar to Chinese gamers is a no-brainer for Blizzard.    

Small announcement, major upside

The Hearthstone announcement was met with a collective shrug from the market. Blizzard is traditionally known for its blockbuster titles and flashy announcements typically made during their annual convention. It may have failed to turn a lot of heads, but it's a genius move from a business perspective.

The development cost is likely minimal, especially compared with the costs of developing titles like Diablo and World of Warcraft. The game only has 15 developers, compared to the 100 developers the mysterious project Titan had at its peak before the development was "reset."  

It will be an incredibly high margin business. Players buy card packs that cost Blizzard basically nothing to deliver beyond data transfer and storage. The financial success of the game will certainly depend on the willingness of players to purchase the cards instead of earning them through gameplay, but this model has already proven itself to be wildly successful for many developers. I'd expect no less in Blizzard's case. 

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Stephen Benz owns shares of Activision Blizzard. The Motley Fool recommends Activision Blizzard and The Motley Fool owns shares of Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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