Caixin
Jan 16, 2019 10:00 AM
TECH TALK

Online Games Face Cleaner, Less-Cluttered Future After Protracted Winter

We’ll take a break this week from the near nonstop cloak-and-dagger developments at telecom-equipment maker Huawei to turn our attention to the more-benign but also recently turbulent online game sector. Of course everything is relative, and participants in this particular industry may find developments of the past year anything but benign due to the fickle ways of China’s paternalistic regulator that must approve all new titles.

For those who don’t follow these things that closely, China’s online game industry is now home to more than 600 million users, roughly double the size of the entire U.S. population. The big bucks generated have spawned a huge sector led by giants Tencent and NetEase, following by a large field of way too many smaller players for whom a single hit or dud title can mean life or death.

That crowded field suffered through much of last year after the regulator abruptly stopped approving new titles in March following a major government reshuffle. Before that, most titles had taken three to six months for approval. The tap finally got turned back on in December with the release of a list of 80 newly approved titles, which was followed last week by a second batch of titles.

Most observers have focused on the absence of Tencent, NetEase and foreign titles from the first two lists, with some interpreting that to show the regulator’s desire to help the smaller players whose situation may be most dire. Others have said the absence may owe more to the higher complexity of games operated by the giants, which means they require more-thorough reviews that take longer.

All that said, the key takeaways I’ve gathered from my various industry sources and research notes is that “winter is not over yet,” to quote one of my contacts who works at a foreign game importer. From my perspective, perhaps the most exciting thing that may finally be coming down the pipeline is much-needed consolidation to cleanse the market of some of the smallest players.

As a longtime China tech watcher, I’ve seen the online game industry remain stubbornly resistant to such consolidation for reasons that seem quite China-specific. I can pinpoint two particular factors that seem to underlie this particular resistance. One is the fact that many of these companies are the empire of a single individual who doesn’t want to give up his control, even if that means running his company into the ground. Another factor is the presence of many titles that can be licensed for small fees from third-party developers, meaning barriers of entry are low for operators.

A good case that illustrates both points is The9 Ltd., a company I’ve followed for more than a decade after it became one of the industry’s first players to list, way back in 2004. The company was initially a huge success as an early arriver to the then-nascent market, and saw its shares skyrocket to as high as $147 in its first three years after making an IPO at $17.

But then The9 lost the rights to its big revenue spinner, the popular “World of Warcraft” franchise, about a decade ago, and it’s been downhill ever since. The stock now trades at just $1.17, and has pretty much flatlined in the $1 to $3 range over the last two years. Its performance looks strikingly similar to many other smaller players out there that are listed, and whose life and death often depends on individual titles and very small revenues. More than a decade after its listing, The9 was still posting relatively minuscule revenue of just 73 million yuan ($10.8 million) for all of 2017.

Clearing Out the Pipeline

All that said, we’ll spend the remainder of this Tech Talk looking at what’s ahead for the industry as a whole, as well as smaller players like The9, whose current market cap totals just $47 million.

One of my sources concurred with the view that the lack of Tencent and NetEase on the first two lists since approvals resumed doesn’t necessarily show a bias against these companies. To the contrary, he said, the regulator may be trying to show it’s not biased toward those larger companies that have more resources and better government connections, he said.

He added the backlog of games from last year’s nine-month hiatus means it now takes a minimum of six to eight months to get new titles approved, about double the earlier waiting period. Jefferies analyst Karen Chan estimated the regulator could now issue about 2,000 to 3,000 licenses per year, even as it grapples with a backlog of 7,000 to 8,000 titles that piled up during the freeze.

The main conclusion from this huge discrepancy between applications and license recipients is that most people think the regulator will ultimately become far more selective in granting new licenses. That will be bad for many of the smallest players that don’t exactly have the depth of resources to withstand a rejection or two, nor do they have the luxury of waiting extended periods for the backlog to clear.

Pretty much everyone I’ve seen is saying the resumption is a big relief overall, but that 2019 will continue to be a year of transition. China’s regulators have already sent out numerous signals indicating they are cracking down on content owners of all types, and now it seems almost inevitable those newer standards will start getting applied. In the gaming space, one of the biggest announcements came last summer when the regulator announced it will cap the number of new approvals each year.

“The biggest concern I think isn’t when games will be approved but more of the landscape of gaming when things finally get going,” said one of my contacts. Another expressed similar sentiment: “Now that some licenses have been granted, I am expecting tougher regulations,” he said. “Hence in the short term I still expect pain. But in long term, it will produce a more-sustainable growth in our industry with less but higher-quality games in the stores and with more ethical content for audiences.”

Doug Young has lived in Greater China for two decades, including a 10-year stint at Reuters, where he led China corporate news coverage. Send your questions or comments to DougYoung@caixin.com.

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