Industry Update: NetDragon Websoft

When the sea is red... and your ocean is blue

We had started buying NetDragon Websoft (ND) at HKD 17.42 and had proceeded to average down till HKD 16.58. We have taken our foot off the pedal when the share price went up to HKD 18+.

Please see our first report on ND here (behind paywall). In our 2020 4Q report (behind paywall), we had written the below.

NetDragon range of games from the PC era had been transferred to the mobile era. The transition is not smooth but the monetisation has been. The game is still too tough for newbie and they are still relying on that nostalgic feeling for people to pay up.

The main upside is in the Edutech business segment. Schools which had signed up for e-learning is not going to abandon e-learning due to the end of pandemic. We are sure that e-learning and Zoom is going to stay with students of all ages. It also means that NetDragon investment like Edmodo (e-learning platform) and Promethean (learning equipment maker) will continue to do good business. We believe that NetDragon has a chance to dominate the learning environment of many emerging countries.

This report is an update on the competitive situation within the online education space in China. As a recap ND uses the profit from their gaming division to bankroll their online education division. We think that the market is over discounting ND investment in a growth sector.

While ND operates in China online education space, their main growth story is coming from the online education from the rest of the world. We continue to buy on the story that growth will continue for ND for the emerging countries which are onboarding their solution on a ministry/school district level.

We had tried selling education software on a school district level, trust us it is really hard to do!

When you buy a conglomerate or a business with two different operating business, there is three possible scenario,

  1. Both divisions are roaring and the management is seen as a genius with soaring share price.

  2. Both divisions are failing and the management is seen as an idiot on a diworsification plan.

  3. One division is doing well subsidising the losses at the other division leading to a share price which could not decide where to go.

Coupled with a conglomerate discount, on scenario 2 and 3 and you could possibly have an undervaluation scenario.

We believe that NetDragon Websoft (ND) is such a company now.

Mobile gaming company share prices like IGG, FriendTime and ZenGame had rallied since our last report (behind paywall) while ND had stayed relatively flat. If they are only valued for their gaming division, the shares would have done a lot better. Since the education technology arm is losing money, they are being discounted heavily now.

China focused Edutech companies like Mishumao raised $750m round in June 2020, after school tutoring startup YuanFuDao had secured $300m late 2020 making the valuation at $2.2b, TAL Education and GSX listed in the US sold $1.5b of yuan denominated shares in November 2020 and $870m worth of new share in December 2020 respectively.

“ It is not normal to do business while burning through money… so much capital is flowing in. The company can tolerate losses at this stage of expansion and we need to focus on life cycle of our customer base, instead of aiming to make a profit from the first order.”

-Chen Xiangdong GSX Founder

Youdao, an online education subsidiary of internet giant NetEase had a loss of 878m yuan widening their losses from the year before.

Coupled with the offline education firms who are going online, the Chinese online education business is a sea of red!

“ You have to spend two bucks before you earn a dime”

-Micheal Yu, Founder and President New Oriental Education and Technology

Companies targeting the red-hot education market in China is spending more on marketing dollar (on customers who will eventually drop out) than improving their product.

Unlike everyone here, ND education arm Edmodo is an international product. Coupled with Promethean interactive screen, they are on-boarding the education ministries of the emerging countries.

For once, we think that onboarding on a B2G, B2B level makes more sense here. The moat created is much wider and impregnable.

While the Chinese online education market basked in a sea of red, ND education arm in China will suffer too. But ND will be putting up good growth numbers on the international side and that could only bode well for the company in the long term for that business has high moat and scalability.

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