This Game’s not Over Yet, Are you Willing to Play?

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

A few times every earnings season, a stock is brutally hammered if it comes up with a bad report, or a bad outlook, or a combination of both. The Street is quite unforgiving in this regard and sometimes even those companies that might get their act together in the future are also punished heavily, opening up an opportunity for savvy investors to get in.

Shares of Chinese online gaming company NetEase (NASDAQ: NTES) are also trading at battered levels. The stock was stripped off almost 15% of its value after posting ugly results that missed consensus estimates by a mile. A marked slowdown in gaming growth set the cat among the pigeons and led to an investor exodus.

Now, the dust over earnings has settled and shareholders should have digested their pain to some extent. But NetEase investors shouldn’t panic too much as there are a number of catalysts capable of catapulting the stock higher. In the same breath, I would say that NetEase presents an interesting investment proposition at this price.

A difficult, but enticing game

A PEG Ratio (price/earnings to growth) of 0.8, i.e. less than 1 (which means that the stock is undervalued) and a forward P/E multiple of 9.58, which is less than the trailing price to earnings multiple of 11.37, indicate that the stock has got room to run. If you throw in potential drivers for NetEase going forward, the deal might look even sweeter at current levels.

NetEase is the operator of the popular Activision Blizzard (NASDAQ: ATVI) franchise, World of Warcraft, in China. Every quarter, Activision investors keep a close watch on the number of players playing WoW, and they shouldn’t have liked what they saw in the last quarter as the number of subscribers declined 1.1 million (or 11%) sequentially. Hence, a dwindling subscriber count of the cult game didn’t help NetEase either.

Count the catalysts

But, Activision has prepared a shot in the arm for the 7-year old franchise through the Mists of Pandaria expansion pack. The pack is set to be released on September 25 and would probably enable NetEase to see a better December quarter.

But that’s not the end for sure. NetEase can expect some more favor from Activision in pulling up its fortunes. NetEase is “actively working” to get the exclusive rights for Diablo III in China. If the deal falls in NetEase’s lap, the company would be literally over the moon, as Diablo III has been on a hot selling streak, attaining the title of “fastest selling PC game ever.”

NetEase would still be feeling the pain of being ditched by Activision for Call of Duty Online in favor of Tencent (NASDAQOTH: TCEHY.PK) last month. Tencent is the biggest fish in the Chinese online gaming market and Activision went with it for CoD. However, it is widely rumored by various analysts that NetEase is set to get Diablo III, with even a few websites like this “confirming” the news.

However, NetEase is also working on its own games. It has already released a few, such as expansion packs for Warsong of Westward Journey, Heroes of Tang Dynasty, and Westward Journey Online II. NetEase expects the positive effects of these launches to be seen in its top line in the future. Apart from these, NetEase is slated to launch expansion packs for Fantasy Westward Journey, Tianxia III, Ghost and Westward Journey Online III.

But NetEase isn’t relying on just expansion packs. Its team has been developing two new games, namely Kung Fu Master and Soul of the Fighter. These two went into closed beta testing last month and the company has received positive feedback on both. NetEase expects to launch these two games to the audience in the by the end of the year. In addition, NetEase is also working on the development of Dragon Sword, which is a 3D MMORPG and a 3D action real-time strategy game known as Heroes of Three Kingdoms.

The bottom line

After going through the lineup of games, NetEase investors should be having some relief. I agree that a sharp slowdown in gaming revenue is certainly a point of concern. But with the pipeline that NetEase has in place, I believe that it can bounce back. And at these beaten down levels, the stock might turn out to be a smart choice. 

TechJunk13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard. Motley Fool newsletter services recommend Activision Blizzard and 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.If you have questions about this post or the Fool’s blog network, click here for information.

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