‘Warcraft’ return to NetEase signals extension of China’s gaming relaxation

A new deal to bring popular ‘World of Warcraft’ games back to China after a one-year absence will have relatively little financial impact on the game’s local host

Key Takeaways:

• This week’s renewal of NetEase’s agreement to operate games from Blizzard in China will have relatively little financial impact on either company
• The deal signals China’s continued relaxation of regulatory policy and encouragement of global exchanges for the gaming sector

By Doug Young

The return of “World of Warcraft” to China looked like big news when local gaming giant NetEase Inc. (NTES.US; 9999.HK) announced a new agreement this week to relaunch the popular title from Blizzard Entertainment after a more than one-year absence. But market reaction tells a different story that is far more nuanced.

The bottom line was that shareholders never fretted too much about the fracturing of the partnership between China’s second-largest gaming company and Blizzard more than a year ago. Instead, the bigger significance seems to be the agreement’s reflection of a recent shift in Beijing’s attitude towards China’s gaming sector. That shift has seen the government start showing new respect for the group in the last year, following several years of just the opposite when it was subject to repeated crackdowns.

This agreement also seems to reflect a more recent signal by Beijing that it wants China to remain an active player in major global industries like gaming. And last but not least, there’s a certain element of pride about China’s important role in the global gaming sector, which was evident in NetEase CEO William Ding’s statement with the new announcement.

The 15-year-old partnership fell apart last year, reportedly over issues involving intellectual property and data control. In particular, NetEase reportedly felt it wasn’t being given due credit for creating mobile versions of some Blizzard titles like “Diablo Immortal,” which are quite popular among Chinese gamers.

“Celebrating our collaborations, we are thrilled to embark on the next chapter, built on trust and mutual respect, to serve our users in this unique community that we’ve built together,” said NetEase CEO William Ding in the statement announcing the partnership’s renewal.

Blizzard reportedly looked for new partners in China after the split, but apparently couldn’t find anyone to match NetEase. That’s not too surprising since NetEase and rival Tencent (0700.HK) are China’s clear top-two gaming companies, well ahead of any other rivals in the huge market. It’s possible that Blizzard approached Tencent, though NetEase’s position as number-two probably made it more willing to offer Blizzard favorable terms.

Under their renewed deal, Blizzard’s “World of Warcraft,” along with many of its other titles, including “Hearthstone” and its “Diablo” series, will start returning to China this summer, the two sides said, adding they were “working diligently on relaunch plans.” In a separate development, they also announced a new plan to bring some of NetEase’s self-developed titles to the popular Xbox gaming console owned by Microsoft (MSFT.US), which completed its acquisition of Blizzard’s parent, Activision Blizzard, last fall.

Next, we’ll review each of the threads we’ve mentioned above, starting with the big yawn the new deal received on Wall Street. NetEase shares rose 3.8% the day of the announcement, but they gave back most of the gains over the next two trading days.

At the time of the original deal’s collapse, NetEase said the loss of Blizzard’s titles wouldn’t have a material impact on its revenue or profit, adding that those games were contributing a “low single-digit” percentage of its profit. Reports at the time said the relationship provided about 3% of Activision Blizzard’s revenue.

Gaming growth

The relative unimportance of the relationship is apparent in both NetEase’s and Blizzard’s business in the year after the breakup.

NetEase reported its gaming revenue rose 9.4% last year to 81.6 billion yuan, which looks quite respectable and is well ahead of the 3.5% rise in Tencent’s value-added services revenue last year, which includes its gaming business. Blizzard did even better, reporting its revenue rose 160% in last year’s second quarter, its final reporting period before being acquired by Microsoft, crediting the launch of the latest title from its “Diablo” series.

In terms of valuations, NetEase remains the clear number-two in China with a price-to-earnings (P/E) ratio of 16 compared to Tencent’s 24. NetDragon (0777.HK), which is typical of the many smaller companies in China’s gaming market, has an even lower P/E ratio of 10. Again, all this shows that the new Blizzard deal is having a relatively insignificant impact on China’s gaming order.

Next there’s the issue of Beijing’s recent changing stance towards the gaming industry, which is at least partly in response to the nation’s slowing economy and China’s growing isolation from the rest of world. The industry was subjected to several freezes on approvals for new gaming titles in recent years, usually lasting half a year or longer. And new rules in 2021 placed strict restrictions on the amount of time that minors could play games each day.

But the regulator has shifted to a far more conciliatory stance since the end of the last freeze in April 2022. That’s included generous approvals of new game titles, as well as the apparent withdrawal of potential new restrictions that sparked concerns about a new crackdown after their publication late last year.

As we’ve noted, the easing up on gaming is probably partly due to government concerns about the slowing economy, since games are a huge economic engine in China. Then there’s also the “de-coupling” element, which has seen foreign companies increasingly move away from China due to difficulties associated with the market. Beijing has strongly opposed such actions, and thus, this new NetEase-Blizzard partnership can be seen more broadly as China’s recent push to stay engaged with the global gaming community.

China’s share of the global gaming market rose from 15% in 2012 to peak at 33% in 2017, before trending down to about 25% in 2020, according to data from Statista. While Statista doesn’t provide more recent data, it’s probable that China’s share of the market has stayed at that level or even dropped more under pressure from the recent crackdowns.

Now, Beijing seems to be realizing such crackdowns may be good for young people’s study habits but aren’t so conducive to helping China retain its place as a leading global gaming center. That could bode well for more cross-border gaming collaborations going forward, which is where the true significance of the new NetEase-Blizzard deal lies.

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