Analyst Note| Ivan Su |
We have taken a fresh look at wide-moat Tencent, narrow-moat NetEase, and no-moat CMGE, and our top picks are Tencent and NetEase. We believe the market has dramatically overreacted to recent regulatory risks while overlooking two firms' long-term revenue opportunities and margin upside. As we start to see signs of a stabilizing regulatory environment going into 2022, we have confidence that fears will subside as investors gradually understand headline risks do not represent fundamental game-changers to our long-term investment theses. Among the three names, NetEase and CMGE are pure gaming plays, while Tencent has about 40% of operating income exposure to games, with the rest coming from multiple other sources like advertising and fintech. On the game side, Tencent and NetEase are China's largest and second-largest publishers, respectively. Both companies own a vast number of well-known franchises that captivated multiple generations--Tencent is the owner of internationally renowned video game franchises like PUBG, Clash of Clans, League of Legends, Honor of Kings, and Fortnite (through Epic stake). At the same time, NetEase specializes in publishing Chinese domestic titles like Fantasy Westward Journey, Onmyoji, Identity V, and Naraka Bladepoint. We believe both firms will continue to capitalize on the success of existing franchisees while leveraging their capital and influence to develop next-generation titles.