NetEase: It refrains from cash-burning operations and still lives off its established legacy gains, and its solid accumulated capital base cannot be easily shaken.
NetEase released its Q2 2026 financial report after the Hong Kong stock market close on August 20 Beijing time. The Q2 performance is generally solid, while the profit figure seemingly missed market expectations, which is mainly dragged down by investment losses. The profit from its core main business maintained high growth, driven by the rising proportion of self-developed games and strict cost control. The remaining shortcoming is still the pressure on the revenue side brought by the product pipeline gap, which has already been reflected in the deferred revenue of Q2.
Details are as follows:
1. Overall performance slightly beats expectations: Total revenue reached 30.1 billion yuan, up 8% year on year, mainly driven by the core gaming business.
Core profit hit 12.1 billion yuan, with a profit margin of 40%, up nearly 8 percentage points year on year. The adjusted profit (only excluding share-based payment expenses, including investment gains and losses, interest income, foreign exchange impact and other items) stood at 7.8 billion yuan, down 19% year on year. This is mainly dragged down by investment losses: the company recorded a net investment loss of 3 billion yuan this quarter, compared with a net investment gain of 300 million yuan last quarter, leading to a total gap of 3.3 billion yuan.
2. Steady gaming business growth, evergreen titles remain the key driver in the second half of the year: Gaming revenue increased by 10% with a sequential improvement, driven by new game *Sunny Days in Star Canvas* and evergreen titles including *Fantasy Westward Journey*, *Where Winds Meet*, and *Eggy Party*.
As one of the few new games launched this year, *Sea of Oblivion* underperformed market expectations after its public beta in July. The main reasons are its over-stacked gameplay and excessive information load, which set a high threshold for new players and made it lose a large number of casual gamers. In addition, issues such as stuttering and overheating on device sides were quickly optimized later, but have already left a negative first impression on players.
Investment banks have downgraded the estimated first-year revenue of *Sea of Oblivion* from the 3-billion-yuan level to the 1-2 billion-yuan level. There is only one "semi-new" game in the second half of the year, the mobile title *Fantasy Westward Journey: New Covenant*. Compared with the old version of the *Fantasy Westward Journey* mobile game, this new version enables data interconnection with the PC-side casual server, which essentially extends the popularity of the "Fantasy IP + casual server" model and cannot be regarded as the incremental revenue brought by a completely independent new game.
The next product cycle will mainly start next year, and the earliest launch window will be at the end of Q4. The only positive factor is that the base effect will decline in the second half of the year, which will ease some of the revenue growth pressure.
3. Other businesses are lukewarm, their low proportion has limited impact on the group: Businesses outside the gaming sector barely provide support for NetEase's performance and valuation, and their individual development is also unsatisfactory, so we at Dolphin Research do not discuss them very often.
In Q2, Youdao was still dragged down by the declining learning machine business (affected by fierce competition), which offset the continuous recovery of its online courses, leading to a modest 3.5% year-on-year overall revenue growth. Cloud Music faced the same challenges as Tencent Music, including competition from Qishu Short Video and user time erosion by short dramas, posting flat year-on-year revenue.
4. Deferred revenue confirms the product pipeline gap issue: Deferred revenue (the portion to be recognized within one year) in Q2 was 19.3 billion yuan, with year-on-year growth slowing to 14% and a 12% sequential net decline. This decline is far larger than the seasonal fluctuation in previous years (the maximum decline in past years was in the high single-digit percentage range), which indirectly reflects that the current quarterly revenue from in-game spending is relatively mediocre. Dolphin Research calculates that the growth rate of total in-game revenue is less than 3%.
This indicates that even with the incremental contribution of the new game *Sunny Days in Star Canvas*, and the 11th anniversary collaboration campaign between *Fantasy Westward Journey Mobile* and *Chinese Paladin 3* that pushed the daily active users to the highest level since 2017, Q2, just like Q1, still lacks sufficient new game supply. The incremental revenue brought only by operation campaigns of several evergreen games cannot fully offset the natural decline of other titles.
5. Core profitability potential continues to be released: The profit side in Q2 delivered a more impressive performance, with core profit growing 33% year on year, far exceeding the revenue growth rate.
Breaking down the drivers, this growth mainly comes from the rising proportion of high-gross-margin self-developed games (including self-developed PC games such as *Where Winds Meet*, and evergreen games that come with inherently high gross margins, where every operation campaign brings very considerable incremental profit margins), as well as the cost control on sales and administrative expenses (lower staff incentives and controlled user acquisition spending).
6. Stable but not yet high shareholder returns: The company plans to pay a dividend of $0.096 per share ($0.48 per ADS) this quarter, totaling $310 million, with a dividend payout ratio of 30%. Excluding the special dividend paid at the end of each year, the regular dividend payout ratio is basically stable at around 30%.
In terms of share repurchases, the company repurchased $197 million worth of shares in Q2 ($180 million on cash flow basis), up nearly $70 million sequentially. NetEase's management usually adjusts the repurchase pace according to market value fluctuations, and there is still about $2.7 billion remaining in the current repurchase authorization (valid for three years).
If we simply annualize the dividend and repurchase scale in the first half of this year, plus the special dividend that has been customary in the past three years, the total annual shareholder return will be around $2.5 billion, accounting for 3% of the $80.5 billion market cap at yesterday's close, which is not a high return rate.
7. Overview of key financial indicators
Dolphin Research Viewpoints
The core Q2 performance continues the trend seen in recent quarters including Q1: during the product pipeline gap period, the company leverages the strength of evergreen games, implements group-wide cost control and improves operational efficiency, to offset the revenue pressure and deliver strong profit performance.
Compared with other internet peers that have to sacrifice current profits and cash flow to burn money on AI transformation while their core businesses are under pressure, NetEase's strategy will be favored by value-oriented capital. In other words, NetEase, with a stable core business and limited AI investment, is at least regarded as a relatively high-quality safe-haven asset that stands opposite to AI tech growth stocks this year.
This is also the core reason why during the global market correction in July, after the positive catalyst of NetEase being included in the Stock Connect scheme was fully priced in, its market value still moved upward against the trend. It also explains why after the underperformance of *Sea of Oblivion* in its first week of launch at the end of July and the market expectation of a scarce product pipeline in the second half of the year, the bottom of its share price kept rising amid fluctuations.
However, the impact of the product pipeline gap has begun to show in Q2. After the Stock Connect positive catalyst is fully realized, there will be a general lack of positive catalysts for the stock in the second half of the year. Of course, the operation of evergreen games and the lower base effect are expected to keep the revenue side stable without a sharp decline, continuously playing a strong supporting role.
In the short term, for NetEase to get rid of the roller-coaster fluctuations and achieve a steady upward breakthrough, it still heavily relies on positive catalysts from its product pipeline. For example, the trailer and first public test of *Beneath the Misty Sea* released earlier this month received very positive user feedback, which has already played a certain positive role.
Therefore, before the arrival of the next product cycle at the end of this year or early next year, trading opportunities will mainly arise during range-bound fluctuations. Investors can consider building positions boldly when AI skepticism resurfaces, or wait until the valuation adjusts to leave more upside space, to improve the holding comfort level.
