NetEase Q1: Profits exceeded expectations, but issues remain with the product line.

Robin Zhu+852 2123 2659robin.zhu@bernsteinsg.com China Internet NetEase Inc Charles Gou+852 2123 2618charles.gou@bernsteinsg.comMin-Joo Kang+852 2123 2644minjoo.kang@bernsteinsg.com RatingOutperformPrice TargetNTES9999.HK 150.00 USD235.00 HKD Hyrum Caesar+81 3 6777 6979hyrum.caesar@bernsteinsg.com NetEase Q1: Profits beat, pipeline remains the question Q1 beat driven by lower platform fees.NetEase’s Q1 results were solid, in contrastwith fairly negative expectations into the quarter. RMB30.6bn of revenue grew 6.1% yearon year, and was 3.7% higher than the street. Cash billings at the group level (calculatedby triangulating revenues with deferred revenue balances) grew only 2.0%, but even thiswas no worse than fears we’d heard of a decline - compared against high year-ago comps.Core Online Games revenue (RMB25.1bn) grew 6.9% year on year. Meanwhile, RMB13.3bn On the go-forward pipeline.Speaking around the quarter, company managementattributed the Q1 top-line strength to Fantasy Westward Journey and Where Winds Meet.The 69.4% gross margin this quarter was a new high, and was attributed to a higher shareof revenue from Fantasy Westward Journey and Where Winds Meet domestically, and lowerAndroid platform fees. Lower iOS platform fees in China should help here in Q2 and onward.Lower G&A costs in the quarter were partly one-off, but also reflected some headcount Why was the stock down so much?All in, the quarter felt… okay? Feedback we heardfocused on the lack of Ananta updates, 2.0% billings growth reflecting the ongoing waitfor new game launches, and the company's ongoing investments in PDD(!) in contrast with$100mn or so of buybacks this quarter (even though the latter marked the first quarter in awhile where NetEase had reported buybacks). The PDD investment irks us, but NetEase’sshares now trade on c. 12x FY+1 PE on very modest expectations for Sea of Remnants, DETAILS A SOLID Q1 BEAT, OUTLOOK STILL HINGES ON ANANTA NetEase’s Q1 results were solid compared with low expectations entering the quarter. In contrast with the last couple ofquarters, when slower than expected deferred revenue recognition weighed on earnings, 6.1% revenue growth and 2.0% RMB30.6bn of Q1 revenue was 6.1% higher year on year, while RMB25.7bn of Gaming and VAS revenue was 6.9% higher.Gaming and VAS gross margin hit 74.8% this quarter, around 500bps higher compared with the 69.2% and 69.5% that we andconsensus had estimated. According to the company this was driven by a high share of domestic PC games this quarter, led byFantasy Westward Journey PC, and high Where Winds Meet engagement following the global success. RMB13.3bn of Groupnon-GAAP operating profit was more than 20% above our prior modelling (RMB10.5bn) as well as consensus (RMB10.9bn). NetEase’s total non-GAAP operating expenses grew 12.1% from Q1 2025 to RMB7.9bn in Q1 2026. Marketing spend thisquarter was 28.6% higher year on year, compared with a very low comp from last year. One interesting tidbit from managementcommentary related to the shift in marketing seasonality related to a greater overseas presence with games like Where WindsMeet. Admin expenses decreased 25.8% year on year, in part reflecting the aforementioned one-offs, while R&D expense was Updating our estimates for NetEase Exhibit 3 shows a summary of our estimate changes. Our updated NetEase price target is based on an unchanged 16x FY+1PE, on marginally lower EPS estimates, which partly reflect stronger CNY exchange rates. Q1 2026 REPORTING IN CHARTS APPENDIX - FINANCIAL FORECASTS BERNSTEIN TICKER TABLE DISCLOSURE APPENDIX I. REQUIRED DISCLOSURES References to "Bernstein" or the “Firm” in these disclosures relate to the following entities: Bernstein Institutional Services LLC(April 1, 2024 onwards), Sanford C. Bernstein & Co., LLC (pre April 1, 2024), Bernstein Autonomous LLP, BSG France S.A. (April 1,2024 onwards), Sanford C. Bernstein (Hong Kong) Limited盛博香港有限公司,Sanford C. Bernstein (Canada) Limited, SanfordC. Bernstein (India) Private Limited (SEBI registration no. INH000006378), Sanford C. Bernstein (Singapore) Private Limited,Sanford C. Bernstein Japan KK(サンフォード・C・バーンスタイン株式会社)and analysts employed by Société GénéraleAfrica Technologies & Services to produce Bernstein research under a Global Services Agreement in place between Bernstein Bernstein is part of a joint venture between Société Générale (SG) and AllianceBernstein, L.P. (AB). Unless specifically notedotherwise, for purposes of these disclosures, references to Bernstein’s “affiliates” relate to both SG and AB and their respectiveaffiliates. VALUATION METHODOLOGY NetEase Inc We value NetEase at US$150/HK$235 per share, on a 16x FY+1 (Quarters 5-8) PE multiple. RISKS NetEase Inc The main downside risks associated with our price target for NetEase relate to (1) macroeconomic risks, including the state ofretail consumption in China, (2) fluctuation in user engagement within top game franchises, (3) the success and fail