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.