NetEase layoff rumors: staff churn or a bigger restructuring?

Speculation is swirling that NetEase has started to cut its workforce, with headcounts reportedly slashed by up to half in some divisions, but the gaming giant has dismissed reports of sweeping layoffs 

Key Takeaways:

• Rebutting the claims, NetEase said personnel adjustments were part of the normal course of business and insisted the company was still actively hiring 
• The company has overtaken Meituan to become China’s fourth most valuable internet business 

Bai Xin Rui

The story of China’s gaming industry has been full of dramatic twists lately. At the end of last year, the government’s sudden release of draft restrictions on gamers’ spending triggered a sector selloff. Then on Jan. 19 rumors began flying that gaming giant NetEase Inc. (NTES.US; 9999.HK) was on a downsizing mission.

But the company swiftly dismissed the talk of far-reaching layoffs.

Some media reports, quoting company insiders, described deep staff cuts from December last year as NetEase slimmed down its media, content creation and online learning enterprises.  Workers involved in content, marketing, sales and products were reported to be most affected, and even the core gaming division was not spared. Departmental headcounts were said to have shrunk by between 10% and 50%.

According to some sources, NetEase Media’s departing workers were being offered severance pay plus one month’s salary in lieu of notice. Some employees were encouraged to resign and claim the compensation package. The NetEase gaming business offers a more generous package for a swift departure, with three months’ salary on top of a severance payout. 

Hiring continues 

But in response to media inquiries, the company brushed aside the market rumors as inaccurate, saying workforce tweaks were part of standard business practice. NetEase also said it was continuing to hire top talents.

On the day of the layoff reports, NetEase stock performed well on the Hong Kong market, opening with a 2.1% gain at HK$140 and closing 1.3% higher on the day at HK$138.9. Its US shares rose by a bigger margin of 2.5% after the company played down the layoff reports.

NetEase, the undisputed leader of the mainland gaming industry, saw its stock rise 22.8% last year, bucking a 13.8% fall in the Hang Seng Index. Among blue chip stocks it was the eighth-biggest market gainer, boosted by rising earnings. 

The company was founded by Ding Lei in Guangzhou in 1997, starting out as a provider of free e-mail. In 2000 it became China’s first US-listed web company, when its shares launched on the Nasdaq. A year later the company bought Teamax Technology Group Co. Ltd. and set up an online gaming division, paving the way for it to become a powerhouse in the industry. In 2008, NetEase took the business to a new level when it bought Blizzard Entertainment Inc., gaining control of StarCraft II and Warcraft III games.

Numbers looking good

NetEase turned in a positive earnings performance last year, fighting off fierce competition in the market. Its third-quarter revenue rose 11.6% from the year-earlier period to 27.3 billion yuan ($3.8 billion). Its non-GAAP net profit rose 15.7% to 8.65 billion yuan. Gaming revenue, accounting for nearly 80% of total turnover, increased by 16.5% year on year to 21.8 billion yuan, thanks to demand for flagship titles such as Fantasy Westward Journey Online and Treacherous Waters, a game with more than 50 million registered users.

China’s market is dominated by mobile gaming, which has a 75% share of the country’s total gaming business. Strong competition in the industry has spurred Chinese companies to develop high-quality products appealing to foreign as well as Chinese gamers. Sales of China-produced games reached $16.4 billion last year, exceeding the 100 billion yuan mark for the fourth straight year.

The US and Japan are the two main export destinations for Chinese game manufacturers, which have 32.5% and 18.9% of those markets respectively. The US market is dominated by console and computer games, leaving room for Chinese brands such as NetEase to expand into the underdeveloped mobile arena there. When the quarterly results came out, NetEase founder Ding was upfront about his ambitions to conquer overseas markets. He said the company was always on the lookout for partners to develop and launch competitive content overseas for long-term growth.

Overtaking Meituan 

Beyond the gaming world, another NetEase business is making headway. Its US-listed subsidiary Youdao Inc.(DAO.US), a provider of smart learning services, reported a 9.7% rise in revenues in the third quarter to 1.54 billion yuan, while its net loss shrank 44% to 100 million yuan. The company improved its gross margins by applying AI technologies across various products and services. The margin on learning services rose 3.3 percentage points to 67.8%, while smart hardware products gained 2.2 points to 42.6% and online marketing services raised their margin by 4.8 percentage points to 31.9%.

Bolstered by its earnings performance, NetEase was one of the few Chinese online businesses to achieve a share price rise last year. It overtook Meituan (3690.HK) last month by market valuation, becoming the fourth most valuable internet company in China after Tencent (0700.HK), Pinduoduo (PDD.US) and Alibaba (BABA.US; 9988.HK).

NetEase is relatively inexpensive right now, with a forward price-to-earnings (P/E) ratio of 12.6 times, below its five-year average of 16.3 times. And market watchers expect its return on equity to stay above 20% over the next couple of years, outperforming most mainland internet companies. Its overseas expansion ambitions could also spell potential gains. If the Hong Kong stock market finds its feet, NetEase could deliver an upside surprise for investors.

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