Slight miss in bottom line: Netease reports 2Q17 results with in-line revenue but aslight miss at the bottom line, mainly due to a change in revenue mix and higherthan-expected sales & marketing expense. We believe Netease, as a leading gamedeveloper, will be able to continue delivering strong growth in the long term. Anypotential negative reaction to the temporary miss in results would be an opportunityto add to positions, in our view. We expect solid results in the coming quarters giventhe strong underlying fundamentals, backed by 1) mobile Minecraft likely launchingby end-3Q17 (albeit delayed from July 2017), 2) a strong pipeline with Index andForever 7 in testing, and 3) a robust overseas expansion strategy and ecommercegrowth in Kaola.com and Yanxuan.    2Q results. Net revenue grew 49% y-o-y to RMB13.4bn vs our estimate ofRMB13.1bn and consensus of RMB13.1bn. Online gaming revenue increased 46.5%y-o-y to RMB9.4bn, of which mobile game revenue is 2% above our estimate but PCgame revenue is 10% lower. Email, e-commerce and other revenue growth furtheraccelerated to 69% y-o-y from 57% in 1Q due to strong growth during the Junepromotion. Gross margins were 50%, slower than our 52% estimate, as relative lowmargin businesses (mobile game and ecommerce) account for a large proportion oftotal revenue. Operating margins were 30% compared to our estimate of 34%, due toa 37% q-o-q increase in sales & marketing expense. The company increasedmarketing activities in 2Q mainly to promote Onmyogi’s new expansion packs in bothdomestic China and overseas. The company continues to expect lots of promotionactivities in the quarter to extend the lifespan of existing games as well as to increaseuser acquisition for the new games. Adjusted 2Q EPS of USD3.80 misses ourestimate by 9%. We note that deferred revenue declined 12% q-o-q due to the lack ofnew game launches in 2Q.    Estimate changes. We cut our game revenue estimates to reflect the delay ofMinecraft as well as the lower estimate for PC game revenue growth. We increaserevenue growth assumptions of ecommerce segment attributable to Kaola andYanxuan. With increasing promotion activities, we also increase our sales &marketing expenses assumption. Overall, our 2017-19 revenue estimates are largelyunchanged, but we lower our 2017-19e EPS estimates by 5-6%Maintain Buy rating, cut TP to USD336 (from USD356). Our target price is derivedfrom a 1x PEG, based on our 2017 EPS estimate of USD16.33 (from USD17.38) anda three-year EPS CAGR of 21% (was 20%). Our TP implies 6.6% upside: we rate thestock Buy as we expect NTES to deliver growth in the long term. Current marketprice and our TP implies 18.7x/20.5x 2017e respectively. Key downside risks includefurther delay of key games.

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