Posted by: Gwynn Guilford on 2009.07.09 18:24 in gwynn

This Seeking Alpha article on NetEase (Nasdaq:NTES) by Zhang Xiaofan – a blogger with whom I’m not familiar – brings up the useful point that NTES’s share price tracked closely with the PCU of its blockbuster game Fantasy Westward Journey (FWWJ), until NTES won the rights to World of Warcraft (WoW) in mid-April, sending NTES to its current heights.

Conversations I’ve had with Guo Cheng Gang, our games analyst, add a little more nuance to this discussion.

As Zhang points out, FWWJ has seen its PCU bounce back from lulls at several points in the last few years. This is important, ostensibly, because even though WoW sent NTES’s share price up, FWWJ’s sustained high performance will likely keep it aloft as the company struggles with administrative and technical issues impeding the WoW launch (more on this later).

Yet FWWJ’s recent announcement of a 2.29 million PCU on July 5 might not necessarily be another comeback kid moment. Guo recently told me that, based on interviews and monitoring of the game, the increased activity may be attributable to an influx of gamers protesting the delay of the relaunch of WoW. Specifically, WoWers are entering the game not to journey westward fantastically, but rather to use the platform to criticize NTES in the chat sections and in open conversations.

What does this mean for NTES? For one thing, it clearly suggests that FWWJ’s numbers are not necessarily a cause for relief. In addition, Guo thinks NTES may be dropping the ball on refreshing FWWJ content. As the game ages – it's been around since 2004 – NTES must renew the appeal by putting out expansion packs and running promotions at fairly frequent intervals. If the lack of promotions during several recent holidays is anything to go by, promotions are something that NTES may have started neglecting. Of course, this is probably because the company is busy inflating its much-celebrated life raft, WoW.

Which brings us to another issue. Again, I'm merely rehashing arguments made by Guo here, but, despite the resounding investor confidence suggested by a 140% stock price increase spurred by NTES's nabbing of WoW rights, WoW is hardly the cash cow that FWWJ has been. Most obviously because Blizzard, which is owned by Activision Blizzard (Nasdaq:ATVI), has rights to around 30% of WoW operating revenue, leaving NTES with a margin of around 45%, compared with FWWJ's 50-60%. NTES recently tried to douse rumors that it would pay more to Blizzard than would WoW's former custodian, The9 (Nasdaq:NCTY), saying that it would pay no more than $60 million as a base fee. Guo has said, however, that many industry rumors cast doubt on the accuracy of this assertion. In addition, NTES's recent 20-F implies that it is obligated to pay a "technical support fee" to StormNet, a new JV between NTES and Blizzard.

That said, WoW has a huge incipient Chinese user base, and even if it is less profitable than FWWJ, it looks to be a reliable long-term revenue source. NTES will most likely get WoW servers up in August, meaning that it is likely to miss the summer boom period for online gaming. Chinese MMORPGers are fickle beasts, and already many of them flocking to alternatives, including Kingsoft's (3888.HK) JX Online 3, Perfect World's (Nasdaq:PWRD) Zhu Xian and Shanda's (Nasdaq:SNDA) AION, according to our polls. NTES should be worried about more attrition – and possibly a drop in its FWWJ numbers – as the protesting WoWers stop lobbying in FWWJ and start playing other games.