Netease.com (Nasdaq: NTES), a leading Chinese online game developer and operator of Fantasy Westward Journey, the most popular online game in China, announces second quarter earnings on Wednesday, November 7.
We estimate the performance of the company’s games using our proprietary online game tracking software and derive online gaming revenues from game usage statistics. We predict that Netease will report flat online gaming revenues for the third quarter, in line with the results achieved during Q2. Early fourth quarter data indicate significant growth.

Fantasy Westward Journey resumes growth during Q3
In the second quarter Netease reported a 4% decline in the average concurrent users of FWJ, the game responsible for over 60% of the company’s revenues. Fortunately for Netease, this decrease did not trigger the beginning of a downtrend in the game’s popularity. Our tracking data shows a September average concurrent user number of over 520,000. We have incomplete tracking data for June and July. Overall, our Q3 ACU estimate for FWJ is 500,000-510,000.

Transitional quarter for the Westward Journey Online Franchise
Westward Journey Online III, an upgraded version of the aging Westward Journey Online II game began commercial operation in mid September after a month of open beta testing.  As expected, the player migration to the upgraded game had a negative effect on the WJOII ACU and revenues. Our estimate of the ACU is 135,000, from 162,000 achieved during the previous quarter.

Early Q4 trends
Trends for the fourth quarter are positive for both FWJ and WJO:
- FWJ statistics are considerably higher in Q4, the game's peak concurrent users reaching 1.6 million.
- After some initial confusion generated by Netease’s conflicting strategy on WJOII player migration to WJOIII, recent game tracking data show players returning to both games. The newly released game is now competing with WJOII in terms on peak and average concurrent users.
Daily estimates for the average and peak concurrent users, number of servers and server uptime percentage for the FWJ, WJOII and WJOIII games are updated daily for a limited time on the CasualAnalyst.com site (http://casualanalyst.com/finance/content/view/31/1/).

Summary

Netease is a well balanced company: a successful online game developer and operator, it operates one of the largest portals in China.
The company is developing a search engine. The Chinese search market is currently dominated by Baidu and Google which may leave little room for a third search engine to grow. Netease is hoping to penetrate the search market by catering to its massive portal population. If the search engine turns out to be a competitive product, it could be a successful strategy. Time will tell.

In the online gaming market, Netease has build a franchise around the FWJ and WJO games, and is still successful in attracting players. We may need to consider that while FWJ and WJO transform into successful series, their lifecycle is getting longer. Look at Electronic Arts for a model: the Madden NFL 06 is the best selling game in the United States for 2006. Not bad for a game series that started 17 years ago.

Our Q3 estimates
Net revenues: $73 million.
EPS: $0.30

Figure 1: Westward Journey Online II ACU Trend  - June vs. Q3.

About the Author
Daniel Vlad, PhD, MBA specializes in the development of custom IT solutions for the Financial Industry. He is particularly interested in the Chinese online gaming companies trading in the US.
For comments and information about subscribing to Netease's game reports, please contact the author of this report at dhvlad@casualanalyst.com
 
Disclosure
The author of this report owns Netease stock and call options.