We
are
placing
NetEase
[NTES]
under
review
following
the
Chinese
government’s
release
of
new
draft
regulations
affecting
the
gaming
sector.
Should
these
rules
be
put
into
effect,
they
could
adversely
affect
the
revenue
of
gaming
companies,
with
NetEase
potentially
facing
considerable
challenges.
Latest
developments
have
triggered
a
sharp
decline
in
the
stock
values
of
Tencent
[TCEHY] and
NetEase,
with
shares
dropping
more
than
10%
last
week.
We
believe
this
market
reaction
is
justified
due
to
the
expansive
scope
of
the
new
draft
rules.
But
while
these
developments
could
have
far-reaching
consequences,
we
are
maintaining
our
current
fair
value
estimates
for
Tencent
and
CMGE Technology,
as
they
appear
to
face
a
less
severe
impact
from
the
draft
rules.
Our
position
is
subject
to
change
as
we
await
further
information
from
gaming
companies
as
to
how
the
new
regulations
will
affect
their
sales.
How
Will
The
New
Rules
Work?
No
More
Daily
Login
Rewards
or
Bonuses
Rule
18
of
the
proposals
eliminates
daily
login
rewards,
bonuses
for
first-time
top-ups,
and
rewards
for
consecutive
purchases –
key
elements
that
drive
player
engagement
and
in-app
purchasing
behaviour.
The
removal
of
these
incentives
is
likely
to
reduce
daily
active
users
and
in-app
revenue,
and
could
eventually
force
publishers
to
fundamentally
overhaul
their
game
design
and
monetisation
strategies.
No
Converting
in-Game
Assets
into
Real
Cash
Rule
23
is
set
to
prohibit
publishers
from
facilitating
the
conversion
of
in-game
assets
into
real
cash.
This
is
a
heavy
blow
for
companies
like
NetEase,
which
operate
numerous
massively
multiplayer
online
role-playing
games,
or
MMORPGs,
with
intricate
economies
and
a
wealth
of
virtual
assets
such
as
gear,
currency,
and
collectibles.
Preventing
the
cash-out
of
these
assets
threatens
to
drain
the
in-game
economy’s
liquidity
and
could
dissuade
players
from
making
investments
in
virtual
goods.
Reduction
in
Revenue
from
Loot
Boxes
Lastly,
Rule
27
mandates
that
game
providers
offer
players
alternative
methods
to
acquire
virtual
items
that
are
also
available
in
loot
boxes.
This
requirement
could
diminish
the
rarity
and
value
of
items
currently
exclusive
to
loot
boxes,
which
have
traditionally
been
a
significant
revenue
stream
for
gaming
companies.
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