China gaming/NetEase: Winnie the Pooh lapse is honey for the bears

The combination of two unconnected events spells disaster for NetEase and its investors. The first involves Winnie the Pooh. A post on a social media site of the Chinese gaming group disparaged “the bear” — who President Xi Jinping resembles, according to critics. The second is the unexpected sudden delay to Chinese certification for an online multiplayer action game.

The Hong Kong-listed shares fell 7 per cent on Monday after NetEase delayed the launch of the blockbuster fantasy game Diablo Immortal, developed alongside Activision Blizzard. Investors had hoped China would become the world’s largest market for the game.

Diablo Immortal has already qualified as the biggest launch in franchise history for Activision Blizzard. The game has notched up more than 8.5mn downloads and $24mn in revenue in just two weeks since its release in markets outside China.

In China, the release would have been more than just an opportunity for NetEase. Blockbuster launches of any kind have been scarce. Chinese regulators halted new game monetisation licence approvals in July last year. Gaming giants such as Tencent and NetEase have been excluded from a recent smattering of approvals.

NetEase’s operating expenses rose a quarter to $4.8bn last year from the previous year. Marketing spending remained high despite the approvals freeze. Shares are down more than a tenth this year but still trade at 20 times forward earnings, a premium of more than a third to regional peers including Nintendo.

That gap should soon close. The coming months may be challenging for NetEase. The official Diablo Immortal account has been banned from posting on Weibo, China’s biggest social media platform, following the “bear” allusion.

Despite official promises to relax tech crackdowns, gaming companies have yet to pass the worst phase for regulatory risk. Approvals must be acquired well in advance to prepare for a game launch.

China has the world’s biggest gaming market with about $50bn in sales last year. But it is also one of the most restricted markets in the world. Investors must now price in greater political risk for NetEase.