Impact of new Government regulations on Chinese gaming companies

Chinese government came out with a few new regulations yesterday for the online gaming market. In this article, I will try to list these regulations and their impact to various gaming companies in China.

First, it is going to forbid the exchange of in-game currency to the real currency. This has to be a bad news to Tencents game and SNDA. Both of these companies have very active in-game currency.

But there is a silver lining. This regulation might help to crack down on pirate servers and bots.
http://news.sina.com.cn/c/2009-06-27/153915860437s.shtml
I will describe the main point of the above article. Many bots companies use in-game bots to get in-game items and experience points. It then converts them to in-game currency. They then convert the in-game currency to the real money.

I don’t know how effective this regulation will help cracking down on the pirate servers and bots. But if it can largely eliminate the bots, it will help out many games greatly. Many games are destroyed because of the proliferation of the bots. Many games are barely surviving because of the infestation of the bots.

Another important new regulation is that the lottery box might be outlawed.
http://tech.sina.com.cn/i/2009-06-29/04113217976.shtml

The lottery box might be considered as a form of gambling and gambling is illegal in China. I will describe the working of lottery box using an example. Player A wants a very precious sword. He can buy that sword with $100 through the in-game store. Or he can spend $1 to buy a lottery box. When he opens that lottery box, there is a 1% chance that the precious sword is in the box.

Therefore, the theory behind it is very similar to lottery in the US. I have no idea if this shall be considered as a form of gambling or not. But I do know this effect can’t be neglected.

GA is the first company that uses this concept. It caught fire right away. Now everybody does it.

This regulation will affect every company that use free-to-play item-based model. That means every company except NTES.

It is a good thing that this regulation comes at this time. If it comes 1 year ago, it could really devastate a lot of companies. But as players get more and more used to the concept of lottery box, they are being used less and less. It is becoming less of a feature for the game companies. As a matter of fact, GA just announced that they will stop using lottery box altogether (to meet this regulation):
http://tech.163.com/09/0630/03/5D1BUHQO000915BF.html

Now, I will summarize the effects of these regulations. The stoppage of in-game currency to real currency will negatively affect Tencent and SNDA games. Outlawing the lottery box will negatively affect all item-based games. Therefore, all Chinese gaming companies (except NTES) will be negatively affected. Most of NTES’s games revenues come from time-based games that are not affected. Finally, if the regulation can contribute to the elimination of the bots and pirate servers, it will greatly benefit all game companies.

WOW had already passed 3 fourth of the way in its approval process

One can find my previous article on WOW here:

http://chinese-net-gaming-stock.blogspot.com/2009/05/ntes-will-get-wow-players-statistics.html

On 6/7/2009, the operation of WOW in China was officially transferred from NCTY to NTES. NTES then start to submit to Chinese government for the approval to operate WOW.

It is required to get approval from four levels of government agencies, the Culture Department, the local level News Department, the provincial level News Department, and the National News Department.

NTES announced that it will start to operate WOW starting at the end of July, see the following:

http://chinese-net-gaming-stock.blogspot.com/2009/05/ntes-to-operate-wow-starting-end-of.html

Some Wall Street analysts doubted that it would happen that fast.

From the following article:

http://it.sohu.com/20090615/n264529993.shtml

NTES had already received the approval from the first three departments (Beijing city News department counts as two levels of departments). It only needs one more department to go. In a period of one week, it had already gone through ¾ of the way.

It is looking more and more likely that NTES is going to start operating WOW by the latter part of June. This is definitely a good news.

Finally, for one who wants to see the official government questions and answers regard to this subject, go to the following (the link might not be there for long though):

http://www.bjppb.gov.cn/xxhd/zxwd/ckjd_new.jsp?subjectID=2

Conflicting signals from NTES

One can find my previous NTES related article below:
http://chinese-net-gaming-stock.blogspot.com/2009/06/ntess-new-games-part-3-progress-of-new.html

I am still going to go through every NTES’s new game development, as some of you requested. But in the last few days there are two very important news stories that I shall address.

First, from the following two articles:
http://tech.sina.com.cn/i/2009-06-13/10373176394.shtml
http://www.financeasia.com/article.aspx?CIaNID=105381
CEO of NTES sold 2 million shares of stocks. It corresponds to 1.6% of the outstanding share capital and just about one day's worth of trading volume. It definitely is a lot of money. But the CEO still have a lot of shares in NTES, he held 46.3% of the company as of March 2008.

This is definitely not good news. This could be neutral in that he just needed the money now. Maybe he needs the money to start his pig farm. Maybe he needs the money to bride some Chinese government department. It could be many reasons why he just need the money now.

It is also equally possible that he felt NTES’s price represents a top (either short term or long term) and he is trying to cash out before the stock goes down.

I don’t know which case it is. But both represent legitimate cases.

In another development, NTES is currently embroiled in an ugly rumor. A blog reports that a disgruntled NTES employee is accusing NTES of neglect XYQ in favor of its hot new game, Blizzard’s WOW. See the following article:
http://linlinsong773.blog.sohu.com/118280571.html

Of course, it makes no sense. NTES got majority of its revenue from XYQ. Even with the addition of WOW, NTES will get more revenue from XYQ than from WOW. NTES is definitely not going to throw away its cash cow in XYQ.

In China, different game companies sling outrageous accusations against each other (through anonymous sources). This is no different. This accusation is so outrageous that it is not going to stick. But it does require announcement from NTES to dispel the rumor. Sure enough, the CEO of NTES made an official announcement the next day, on 6/11/2009. The following is the announcement from the CEO of NTES:
http://news.duowan.com/0906/108664529998.html
The announcement said that the rumor is completely false. It turns out that this employee doesn’t even exist. So the story ends there. It has no effect on the stock what so ever. So why am I mentioning about this story. Well, I found gold nugget in the most unlikely places. I just found one. In the second paragraph of his announcement, in order to emphasize how ridiculous the accusation is, he said the following:

“…..I want to tell everybody, at this point in time, every products of our gaming department are at their peak. Our old products are growing stably. In addition, our new products are beyond our expectation. ….”

I find the above statement extremely significant. The CEO of NTES is very media shy. Every statements he had made regards NTES had proven to be true. He would have never make statement like this except for this exceptional case. NTES made $114 millions in 1st quarter 2009. The analysts’ estimate for the 2nd quarter is $120 millions. Therefore, analyst’s estimates only reflect the stable growth of the old games. It doesn’t capture the unexpected strong growth of the new games.

On the surface, this contradicts with the first story (the selling of NTES’s CEO stocks represents a temporary top). Actually, it doesn’t have to be.

I know exactly what the NTES’s CEO means about their new product(s) is(are) beyond expectation. TX2 and XYW are growing fine. But the game he is talking about is the new FF.

I talked about this game in my last three articles. The popularity of this game definitely caught NTES by surprise (Interestingly, I was not surprised). As I mentioned in my previous articles, NTES provided very little marketing prior to the commercialization of the game. After the game goes commercial, as the game becoming more and more popular, NTES is doing major marketing for this game right now.

Starting this week, NTES is putting ads on all major game verticals for new FF. It is sending all its ground sales teams to internet cafes to promote this game.

This represents major expenditure that was not expected. Since new FF is an item-based game. It is not going to starting to make major money until the third quarter. The net effect is in the second quarter, there will be more expense for NTES. On top of that, the majority of WOW’s expense will probably occur in the second quarter.

The net result is there will be big expenses in the second quarter. At this point, no Wall Street analyst mentioned anything about the new FF. The great success of new FF is completely under everybody’s radar screen. Thus, nobody is going to know about this extra expense.

In the intermediate term (starting 3rd quarter 2009) and long term, NTES is going to surprise everybody on the upside. But in the short term, there might be negative surprise in that there might be more expenses than expected for the 2nd quarter.

In a nutshell, by combining the two stories, we can make the following conclusions. If the CEO of NTES just wants some money now, the stock of NTES will have great upside surprise in the intermediate and long term. If the CEO of NTES sold his stock because he is worry about expenses in the 2nd quarter, the stock of NTES will have temporary top in the short term but have great upside surprise in the intermediate and long term.

Thus, in the short term, it is either neutral or negative. But in the long term, this stock is tremendously undervalued.

NTES's New Games – part 3 – Progress of the New FF

In part 2, I describe this game in detail. One can find it here:
http://chinese-net-gaming-stock.blogspot.com/2009/06/ntess-new-games-part-2-description-of.html

Now, I want to talk about the progress of this game. New FF went into Open Beta on 5/15/2009. Because it is an item-based free-to-play game, Open Beta means commercialization.

In keeping with NTES’s curious tradition, there is virtually no marketing effort for this game at all. About one week before the Open Beta, NTES began put some advertisement on 5 or 6 2nd tier game portals. As a result, new FF had an extremely underwhelming Open Beta. On the date of Open Beta, new FF only opened 4 new servers.

In comparison, SNDA started advertising for AION almost a year before the game went into commercialization. It had a terrific marketing campaign. On the date of its commercialization, it opened 80 new servers!

An example of how little marketing NTES is willing to spend for new FF, it won’t even put big banner ad on its own portal (www.163.com). What is even more interesting is that after the Open Beta, when it is clear that new FF is going to be a hit, NTES starts to put big banner ads in prominent locations on its portal.

This is got to be some kind of record. Maybe ABC should start marketing for NBA Finals after the games have finished, or maybe Toyota should market its 2010 Prius car in 2011.

One can find the promotional video for the new FF below:
http://v.zol.com.cn/video83972.html
, and the game is being advertised as the game for the 90’s new women.

I consider that as a brilliant marketing strategy. This game is pushed as a game for young women. It will have a lot of 18 to 25 years old young women. That will in turn attracts loads of 20 to 30 years old young men spending money like mad to please these young women.

At this point, there are three major in-game tournaments. The first is the fashion show tournament. The second is a tournament to find the best in-game photo/graphics. The third is the group warfare tournament. As one can see, two is catered to young women and one is catered to young men.

The following table provides the number of servers with respect to the date:

Date	Number of Servers	Notes
1/1/2009	20
2/1/2009	20
3/1/2009	20
4/26/2009	20
5/3/2009	23
5/10/2009	27
5/14/2009	30
5/15/2009	34	Open Beta
5/22/2009	40
5/28/2009	45
6/5/2009	50

From my previous articles, players had been playing the old FF for free for almost 4 years. The 20 servers are there to support the legacy players. On 4/26/2009, NTES announced that new FF will have Open Beta on 5/15/2009.

Due to the lack of marketing, only 4 servers are added on the date of Open Beta. But the game is adding players extremely quickly. Barely three weeks into the Open Beta, new FF had already required the use of 50 game servers. If won’t surprise me if it had already achieved a PCU of 120k to 140k.

From the above table, this is a game that gathers popularity not based on marketing or hype, but based on words of mouth. This is what a game with extremely long run time looks like.

In comparison, NTES’s TX2 had been in unlimited Closed Beta for 1 year, it has 37 servers. NTES’s XYW had been in unlimited Closed Beta for 9 months, it has 31 servers. Both are reasonably successful mid-level games. But new FF will eventually be many times more popular than these two.

While SNDA’s AION exploded right off the gate, new FF is like a wild fire that is burning stronger and stronger. Its growth is limitless. While I have great expectation for AION, I predict new FF will be even more successful in the long run.

Now, a few pictures of the new FF’s development team members (not all of the members are in the following photos):


Notice how many women are on the team.

Finally, more in-game pictures:

NTES's New Games – part 2 – Description of the New FF

In part 1, I gave the background of this game. One can find it here:

http://chinese-net-gaming-stock.blogspot.com/2009/06/ntess-new-games-part-1-next-mega-hit.html

Right now, everybody is concentrated on WOW. WOW is a great game. It achieved a PCU of 1.02 million in 4Q2008. That is definitely a great achievement.

But guess what, there is another title under NTES that is even more popular. That game is XYQ and it had a PCU of 2.32 million!

If one compares XYQ with WOW, one can’t help but wonder how can XYQ, with its outdated graphics and juvenile cartoonish play style, be twice as popular as WOW. But that is just what Chinese players like.

Similarly, the two latest most popular titles, SNDA’s AION and NTES’s new FF occupies similar category as WOW and XYQ. AION is Korea’s answer to WOW. The new FF has the same cartoon like graphics and Q style playing feature. AION emphasizes combat while new FF is heavy into relationships.

New FF has a lot of similarity to XYQ. But there are also significant differences. New FF has western theme while XYQ is based on Chinese mythology. New FF is real time game while XYQ is turn based game. XYQ is 2D while new FF is a 3D game.

Don’t want to talk too much about in game features of this game. I am not into game like this. But I am more interested in how Chinese gamers like this game. Anyway, I don’t have much experience in playing this game. Let me just hit some major points.

Graphically, what can I say about this game. This game looks just like cartoon. It is much prettier than XYQ. That is to be expected since it is a much newer game. Graphically, this game can’t be compared to games like AION, WOW, or TX2. But that is to be expected because it is not suppose to be realistic looking.

It is a full-fledged 3D game. But because it is cartoon looking (a Q style game), it is very easy on game players’ computer. This game is playable on every computer. The camera angle can be either free floating or fixed. There are still a lot of gamers in China that are not used to play 3D games. Therefore, an option to allow user to fix the camera angle is very useful.

The control is pretty standard, use left hand W, A, S, D to control the movement and use the mouse to control the attack or action.

One unique feature for this game is the 3D combat. AION has 3D combat also. But players in AION can’t fly indefinitely; the character will start to drop to the ground after certain time. For new FF, there is no such limitation. I believe it is the first game in China that has unlimited flying feature. 3D combat is certainly interesting. A lot of time, you don’t even realize who had hit you as they come from players where your camera can’t see. It definitely takes a lot of practice to be good at 3D combat. At the beginning, you wish you have 4 hands, one hand controls the movement, one hand controls the camera angle, one hand control the attack and action, and one hand controls the skills. Eventually, one get better at it. This feature would definitely draw players in and keep them here once they got better at it.

But the biggest features are the romance and relationship related features. There are so many of those relationship-related features in this game. AION can’t touch new FF in this area at all. I am not big into relationship features so I am not going to elaborate on them. But one mischievous feature is that a player can just put another player (of the opposite sex) on his/her lover list. Therefore, it creates some interesting cases where a girl is married (in-game) to one guy while is on the lovers list of several other guys.

Similar to XYQ, new FF is a relationship based game. New FF is very similar to XYQ. XYQ has very interesting combat element thank to its turn-based feature. New FF has very interesting combat element thanks to its unlimited 3D combat. But in their cores, both games are relationship games.

In the next article, I am going to talk about the progress of this game. Now, some in-game pictures:

NTES’s New Games – part 1 - The next mega hit: the New FF

One can find my last article on the new FF here:
http://chinese-net-gaming-stock.blogspot.com/2009/05/new-ff-had-great-open-beta-despite.html

There is a lack of new major hits in China’s gaming market in the last couple of years. All in a sudden, we might have two new ones hitting the market in the last two months. The first major hit is going to be SNDA’s AION. The second major hit is probably going to be NTES’s new FF.

AION’s success is probably not a surprise. A lot of Wall Street analysts had predicted. But nobody had given NTES’s new FF any look. Do people even know it exists? Do people know that new FF went into open beta less than one month ago (on May 15, 2009).

As many of you have requested, I am going to review all the new major games development in NTES. I am going to start by reviewing the most exciting new game, the new Fly for Fun (FF).

I had been following the new FF since February 2007. See the following link:
http://chinese-net-gaming-stock.blogspot.com/2007/02/netease-ff2-info.html

I had always intrigued by the potential of this game. By 2 years ago, I think this game might pull in 5 to 10 Millions per quarter:
http://chinese-net-gaming-stock.blogspot.com/2008/05/ff2-update.html

Two weeks ago, I thought this game has all the hallmark of major hit written all over it:
http://chinese-net-gaming-stock.blogspot.com/2009/05/new-ff-had-great-open-beta-despite.html

Now, I am ready to make my prediction. If one defines a mega hit as a game that achieves a PCU (Peak Concurrent Users) of more than 500 thousands, I predict the new FF will definitely achieve that milestone. In addition, I predicted that it will break though 500k in less than one year and will keep on growing.

There were lacks of major hits in China in the last couple of years. The condition is ripe in China for a few new major hits in the coming couple of years. I think two recent games will reach the major hits status (PCU > 500k). SNDA’s AION will get to that point a lot faster. A really successful marketing effort by SNDA and the severe disruption of its major competitor (NCTY’s WOW is closing down) will allow AION to reach that status by some times this summer. But as I suggested in my last article on AION, there will be limits to its growth.

I think NTES’s new FF will be the other major hit. There was virtually zero marketing effort by NTES for new FF. There was virtually no growth the date of open beta. But as times goes on, NTES becomes adding servers after servers. The growth is getting stronger as time goes on. It probably won’t get to the major hit status until later this year or early next year. But there is nothing to keep it from growing after that.

I believe, in two years, new FF will outperform AION.

Now, I am going to give the background information on this game. A Korean company named Aeonsoft made Fly for Fun. On July 2004, NTES licensed this game from that Korean company. On December 2004, FF went into open beta. Back in 2004, all games are paying games (time-based), open beta doesn’t mean commercialization.

But NTES is not satisfied with the game. They purchased the source code of the game. They also purchased the right to completely rewrite the game from the ground up. And they did just that.

Any other companies (either Chinese or western) would have closed the game down. But NTES kept the game going. Unlike today where open beta for today’s free-to-play (item based) games just mean commercialization. Back then, open beta means free. For four years, the players play this game completely free of charge.

NTES felt the game is lacking of features. These features can’t be added because its underlining game engine is too limiting. From December/2004 to June/2005, NTES tries to fix the game engine. By June of 2005, it determined that the software rewrites are too extensive and the game engine is not salvageable.

From June 2005 to July 2006, NTES rewrote the game engine and build one from the ground up. On July 2006, NTES did something really unheard of. It splits its development team into two teams. One will develop the new FF while another one will write an expansion pact for the old FF. Considering that players are completely playing for free, it is unheard of in either China or other places that a game company would devote significant resource to support its game players without any monetary reward.

The expansion pact will use the brand new game engine but will reuse all the graphics and the play features. The expansion pact will provides about 50% more playing features than the old FF. It is completed by April 2007 and FF players had been playing it until the arrival of the new FF.

Again, this is complete free to the players. There are no in-game items to buy. There is no time-based game card to buy. Anybody can play this game completely free. The fact that Netease is willing to do this for the players says much about Netease as a company.

As an investor, I don't know if I shall be laughing or crying. To an investor, this is just money down the drain. But to the ordinary players, Netease is doing something no just unheard of in China, but to the rest of the world also.

That expansion pact was a dead end. The other members of the development team concentrated on the new FF. By May 15, 2009, the game is finally finished and it went into open beta.

The new FF toke five years to develop. This is another trademark for NTES. Most companies in China popping out games like Ford mass produce cars. Companies like Perfect World can have 8 or 9 games in one year, or a company like SNDA that can convert all its games from time-based to item-based in 6 months, nimbleness are their forte. But most of their self-developed games are of lower qualities.

NTES is on another extreme. At the end of 2005, all game companies in China are converting their games from time-based to item-based (free-to-play). Companies like SNDA spent 6 months to convert all its games. NTES stopped development on all its new games. All new games developments are starting over from the ground up to meet the new requirement change. For more than 3 years (from end of 2005 to May 2009), NTES made only one new item-based game, TX2.

NTES is a company of extremes. It has great trouble when there is a major change in industry trend. On the other hand, all games it produces are of the highest quality.

Now I provided the background of new FF. In the next article, I will describe the new FF in more detail.