NetEase Undervaluation Could Be Short-Lived

Last Wednesday night, NetEase, one of China's biggest online gaming companies reported earnings that surpassed Wall Street estimates by a mile.

The company reported earnings of $4.75 per share on revenues of $2 billion versus Street expectations going into the earnings event of $3.98 and $1.72 billion. That is a earnings per share beat of 20% and a revenue beat of 16%.

The following statement from management pretty much sums up the astounding rates of growth the company is seeing, and if one thinks about the size of the company (a couple of billion dollars in revenue per quarter run rate), the growth rates are even more impressive.

"During the first quarter we advanced a number of strategic initiatives in each of our core divisions, increasing out total net revenues by approximately 72.3% year-over-year; and 12.7% quarter-over-quarter. Specifically we introduced multiple new mobile games and added new expansion packs to our popular PC client games. We also enhanced our monetization capabilities for our advertising services and expanded our e-commerce business. Led by our self-developed mobile games the year-over-year increase of net revenues from our online game services was 78.5%. Net revenues from our advertising services and email, e-commerce and all other segments were also up by 15.2% and 63.2% respectively or compared to the same period last year."

That is the sort of growth rate that would make most companies here at home and in the rest of the West pretty much salivate.

However, after popping by about 4% in post-market trade and also in pre-market trading activity, shares of NetEase actually closed lower the next day in regular market trade and lower still on Friday.

Earnings estimates for the company for FY17 going into the earnings event were $15.61 per share and after the company announced its Q1 numbers, estimates are currently at $15.59 per share, which gives us a current price to earnings multiple of 17.4x. Revenue growth is expected to average 28% for the next two years.

So the two-year average consensus revenue growth (till year-end 2018) is estimated by Wall Street to come in at 28% and still the shares are trading at a P/E multiple of barely above 17 and well below the S&P earnings multiple.

Opportunity knocking, maybe?

The company finished the March quarter with cash and equivalents of a hair under $6 billion, generated about $590 million in cash in the quarter, announced a quarterly dividend (March 2017 quarter) of $1.08 per share and has a $1 billion share buyback program in place and the shares are still undervalued?

NetEase is cheap at current levels and the sell-off on Thursday and Friday (post-earnings) is an opportunity that more than likely will not last long.

Words to the wise.

(Long ntes, calls, might short the puts if the under-valuation persists )

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