Companies in China across different sectors are facing an unprecedented regulatory crackdown. After the recent focus of Chinese regulators on the education sector, it seems that now it is the turn of gaming companies.
Late last month, the Chinese Government cracked down on the gaming industry, as regulators in Beijing placed a gaming time limit on minors of 3 hours per week. Yet this is not the first time that Chinese regulators have tried to rein in the gaming sector.
Back in 2019, regulators had limited video gaming among teens to 1.5 hours a day. Still, investors are concerned about how these new curbs will affect gaming stocks.
Using the TipRanks Stock Comparison tool, let’s compare two Chinese gaming companies, Tencent Holdings, and NetEase, and see how Wall Street analysts feel about these stocks.
The author is neutral about both Tencent Holdings and NetEase.
Tencent Holdings (TCEHY)
Tencent Holdings is a Chinese Internet giant whose businesses span from communication and social services like Weixin and QQ to gaming, targeted advertising, and fintech platforms, such as Weixin Pay.
In Q2, the company posted revenues of $21.4 billion, up 20% year-over-year. Tencent reported a net profit attributable to the company’s equity holders of $5.3 billion, up 13% year-over-year.
Tencent’s Chairman and CEO Ma Huateng said, “In the quarter, we enhanced our services and achieved healthy growth rates across our business lines, particularly Business Services and advertising, while our game revenue benefitted from international growth.”
At Tencent’s Q2 earnings call, the company’s management said that from August onwards, it had already started limiting its customers’ gaming time beyond regulatory requirements, initially for games such as Honor of Kings and Peacekeeper Elite.
Tencent’s management also said that it has prevented in-game spending by players under the age of 12 years and has cracked down on minors who misuse adult accounts. Furthermore, the company has “reduced the time limit for minors to 1 hour per day on non-statutory holidays, and 2 hours per day on statutory holidays.”
The company also clarified that in Q2, users below 16 years of age made up 2.6% of its “China game grossing receipts and under 12-year olds accounted for 0.3%.” (See Tencent stock chart on TipRanks)
Martin Lau, President of Tencent, referred to the regulatory environment on the company’s earnings call, saying, “I would like to say in terms of the regulators, the regulators are very focused on identifying and rectifying industry misbehaviors and also establishing regulations…And we should expect in the future — in the near future, more regulations should be coming.”
Considering this situation, Mizuho Securities analyst James Lee anticipates the “games business to be more conservative managing minor gamers,” but the analyst also pointed out that Tencent’s revenue exposure to gaming is small.
Tencent’s mobile gaming revenue from value-added services (VAS) rose 13% year-on-year to RMB 41 billion ($6.3 billion). However, analyst Lee believes that the Street estimate for a growth rate of 23% in FY21 for Tencent’s mobile gaming revenues appeared to be “aggressive.”
The analyst lowered the FY21 growth rate estimate for mobile gaming from 24% year-over-year to 18%.
Summing it up, analyst Lee noted, “To support regulatory initiatives, we expect Tencent to be conservative on game promotions and restrictive on online entertainment content.” The analyst believes that along with these initiatives and its “investments to diversify its business, would enable the company to grow longer-term.”
Lee is sidelined on the stock with a Hold rating and has lowered the price target from HKD 650 to HKD 530 on the stock.
Turning to the rest of the Street, analysts are cautiously optimistic about Tencent Holdings, with a consensus of Moderate Buy, based on 2 Buys and 1 Sell.
The average Tencent Holdings price target of $90 implies an approximately 39.4% upside potential from current levels.
NetEase develops and operates popular mobile and PC games in China. Its other service offerings include online learning services offered through its subsidiary, Youdao (DAO), music streaming services, and its private-label e-commerce platform, Yanxuan.
In Q2, the company’s revenues went up 12.9% year-over-year to $3.2 billion and were in line with the Street’s expectations. Revenues from online gaming services grew 5.1% to $2.3 billion.
Adjusted earnings came in at $0.97 per ADS, surpassing analysts’ expectations of $0.91 per ADS. Earnings, however, declined 21.6% from the year-ago quarter.
According to J.P. Morgan analyst Alex Yao, the growth in NTES’s gaming revenues without the launch of any major gaming title in Q2 indicated the “resilience of NetEase’s gaming business.”
However, the analyst also cautioned that according to his estimate, 70% of the company’s gaming revenue came from martial-arts massively multiplayer online gaming (MMOG) on both PCs and mobile. If these users were to switch to the multiplayer online battle arena (MOBA) or survival shooting, NTES’s growth in gaming revenues could be adversely impacted, according to Yao.
The analyst reiterated a Buy and a price target of $120 (23.8% upside) on the stock, following the Q2 results.
Amid the tightening of gaming regulations, specifically for minors, NetEase’s management clarified on its Q2 earnings call that minors, that is gamers below the age of 18 as defined by Chinese law, make up “less than 1% of our total games gross billing financial implication.” (See NetEase stock chart on TipRanks)
The company also addressed the regulatory crackdown on the education sector and its likely impact on Youdao, its education platform, on its earnings call. Last month, Chinese regulators had announced new education policy directives including registering institutions providing after-school tutoring (AST) services in China as non-profit, and changing the current registration-based system for operating online AST institutions to one requiring government approval.
NetEase’s management was of the opinion that Youdao will be “somewhat less affected by the recent regulations as it has other high-growth businesses in addition to existing K-12 [Inaudible] after-school tutoring classes, whose revenues accounted for around 41% of Youdao’s total revenue in the second quarter.”
Turning to the rest of the Street, analysts are bullish about NetEase, with a consensus of Strong Buy, based on 6 Buys.
The average NetEase price target of $132.50 implies an approximately 36.7% upside potential from current levels.
While analysts are cautiously optimistic about Tencent, they are bullish about NetEase. Looking ahead, it remains to be seen how these companies tackle the current regulatory environment in China.
Based on the upside potential over the next 12 months, Tencent Holdings seems to be a better Buy.
Disclosure: At the time of publication, Shrilekha Pethe did not have a position in any of the securities mentioned in this article.
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