NetEase Shock Singes Chinese Net Sector

Wednesday brought another bloodbath in the once-hot Chinese Internet sector.

NetEase.com ( NTES) warned of a second-quarter revenue shortfall, whacking its stock along with those of rivals Sina ( SINA) and Sohu ( SOHU).

Blaming increasing competition and new subscription policies instituted by China's major mobile-phone operators, NetEase.com said that text-messaging revenue hadn't met expectations for the second quarter ended June 30.

As a result, the company says second-quarter revenue will fall in the range of $23.4 million to $23.8 million. That's short of the $25 million consensus expectation of analysts surveyed by Thomson First Call. The company's complete second-quarter results are slated to be released Aug. 2.

The setback highlights the pitfalls of investing in this heavily played sector. Though China boasts a young and potentially massive commercial Internet market, Wednesday's developments show that steady revenue growth is far from assured even there.

After falling as much as 20% Wednesday morning, NetEase.com's shares were trading at $31.95, down $5.76, or 15%. Shares in Sohu.com fell 71 cents, or 4.2%, to $16.35, while Sina fell nearly 10% to $26.85. Shares in all three companies have lost more than a third of their value since peaking over the last year.

Churn and Burn

NetEase.com says that its revenue from wireless value-added and other fee-based premium services -- primarily short-messaging services over cell-phones -- will decline from $6.8 million in the first quarter to between $4 million and $4.3 million in the second. That's a decline in the range of 37% to 41%, compared with a 12.3% sequential decline from the fourth quarter of 2003 to the first quarter of 2004.

The decline, says NetEase.com, results from a decrease in the total number of new users of these services, and an increase in the rate at which subscribers drop their SMS.


Reversal
Chinese Net stocks slide after long runup


One factor behind the second-quarter shortfall was "intense competition in the SMS market in China," NetEase.com executive director Michael Tong said in a statement.

The other major factor, he said, was new policies adopted by mobile operators China Mobile ( CHL) and China Unicom ( CHU) under the direction of "the Chinese governmental authorities."

Under these policies, says Tong, it's easier for mobile-phone users to cancel wireless value-added monthly subscription services from third parties such as NetEase.com, and it's "more complicated" to order and receive new services, since consumers now have to use their mobile phone to reconfirm new services that they ordered over the Internet.

"The first measure we believe has led to the increased churn rate, and the second measure we believe has led to the slowdown in growth rate of our new subscribers," Tong said.

Meanwhile, the company said that revenue from online games and advertising had grown in line with expectations. Gaming amounted to 54% of the company's first-quarter revenue of $22.6 million, while advertising amounted to 16%.

"We remain extremely excited about the long-term growth prospects for these businesses in China," Tong said. "In addition, our management is focused on a variety of strategic initiatives designed to stabilize and enhance our wireless value-added services revenue, including developing new higher-end wireless value-added services for our users in order to differentiate us from the more commoditized services offered by many other service providers in China."

Shares in NetEase.com climbed from sub-$1 levels in early 2002 to past $70 in October 2003, but they have since given up more than half of that gain. Sohu.com ran up to $43.40 last summer but has since lost more than 60% of its value. Sina, which peaked at $49.50 in January, is down 46%.

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