NetEase:Solid 1Q results &cautious near-term outlook Conclusion

1Q17 results beat as mobile game revenue (up 37% QoQ) was better thanexpected and PC games largely in line. Deferred revenue declined 8% QoQ,in line with MQ. In the pipeline, PC and mobile Minecraft notably will come outin July, and several major titles in late 2H17. E-Commerce/others were strongwith flat QoQ revenue growth despite Duobao exit. Inventory growth andlatest procurements suggest robust revenue growth (17E: 73% YoY). We lookforward to new pipeline titles on May 20 game conference and are cautiouson Onmyoji in the near term. We lift FY17 earnings by 3% and SOTP-basedTP from US$324 to US$330 to reflect solid 1Q17. Reiterate OP.

Mobile modestly better than expected (or not as worse). 1Q17 mobilegame revenue grew 37% QoQ to RMB8.3bn on the back of revenue deferredfrom 4Q16, stable older mobile games in 1Q17 and modestly soft Onmyoji.

That said, Onmyoji worryingly remains on the downtrend with latest iOSgrossing rank at ~10. And major game launches are back-end loaded in 2H17incl. Tribes and Empires and World of Tanks. We model 22% QoQ mobilegame revenue decline in 2Q17, and overall 48% YoY growth in 2017.

PC in line – stable in-house and softer licensed ones. In 1Q17, weestimate flat QoQ in-house PC game revenue growth, and 22% QoQ licensedPC game revenue decline on normal life cycles of WoW (post EP in 3Q16)and Overwatch (3 quarters from launch). NetEase makes Overwatch free inMay to encourage trial by new users. Item sales going forward will be helpingin monetization as well. Mgmt shared optimism on licensed games anddisclosed their Blizzard games in China recently achieved record concurrentplayers in history. Minecraft coming in July. Mgmt is pleased with MinecraftPC beta testing and plans to launch both PC and mobile versions in July.

Mobile launch is incrementally positive as its timeline was less known before.

Strong e-Com; inventory growth shows commitment. Prepayment grew25% QoQ on the balance sheet – due to increase in e-Commerce inventoryand minimum guarantees for renewal with Blizzard. Coupled with aggressiveorders lately e.g. Kaola’s EUR3bn in 3 years in Europe and Yan’s RMB10bnin China, we expect e-Commerce to gain strength sequentially and achieve73% revenue growth in 2017 – but should remain at a slight operating loss.

1Q17 results beat. Revenue grew 13% QoQ and 72% YoY to RMB13.6bn,10/15% above MQ/consensus, on the back of 37% QoQ revenue growth inmobile game revenue. Adjusted net income grew 10% QoQ and 63% YoY toRMB4.4bn, 10/18% above MQ/consensus. Deferred revenue declined 8%QoQ, in line with expectation, due to Onmyoji, WoW and Overwatch.