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Alibaba hasn’t given up on this high-growth market

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Tencent Holdings Ltd (HKG: 0700) and NetEase Inc (NASDAQ: NTES), China's two largest video game publishers, regularly dominate the country's mobile gaming charts.

Tencent currently publishes four of the ten highest-grossing iOS games in China, according to App Annie, including its top three games: Honor of Kings, Moonlight Blade, and Peacekeeper Elite. Two of NetEase's games, Fantasy Westward Journey and Lutu Zhibin, have cracked the top ten.

However, investors might not have noticed that Alibaba Group Holding Ltd (NYSE: BABA), China's top e-commerce and cloud company, has also been quietly climbing the charts via its gaming subsidiary, Lingxi Interactive.

Romance of the Three Kingdoms: Strategy Edition, which Lingxi launched last year, is now the fourth-highest-grossing iOS game in China -- and puts Alibaba within striking distance of overtaking Tencent's top games. Let's look back at how Alibaba entered the gaming market, and where this oft-overlooked business could be headed.

Why is Alibaba publishing video games?

Alibaba co-founder Jack Ma adamantly opposed investing in video games during his tenure as CEO, which ended in 2013. But in 2014, his successor Jonathan Lu launched Alibaba's first mobile gaming platform.

That same year, Alibaba bought UC Mobile and its gaming platform 9Game, as well as a stake in the American game developer Kabam. But Alibaba's initial gaming efforts -- which included mini games for its Taobao Mobile app and its Laiwang chat app -- couldn't gain any traction against Tencent's WeChat and its massive portfolio of mobile games.

Alibaba's gaming business subsequently stagnated, and Daniel Zhang eventually succeeded Lu as Alibaba's new CEO in 2015. In 2017, Zhang rebooted Alibaba's gaming business by buying EJoy, a gaming company co-founded by NetEase's former chief operating officer Zhan Zhonghui.

That acquisition led to the creation of Lingxi Interactive, Alibaba's dedicated game studio, and Zhan was put in charge of its future gaming projects. Lingxi launched several games, but only started gaining mainstream attention after it launched its first Romance of the Three Kingdoms game last year.

How fast is the gaming division growing?

Alibaba previously incubated Lingxi in its innovation initiatives segment, which mainly included experimental businesses that didn't neatly fit into its core commerce, cloud, and digital media segments.

But in the first quarter of fiscal 2021, which started in April, Alibaba moved Lingxi from the innovation initiatives segment to its digital media and entertainment segment, which also houses its streaming video platform Youku Tudou, its streaming music platform AliMusic, and other businesses.

Alibaba still doesn't disclose Lingxi's revenue separately. But a comparison of its innovation initiatives and digital media segments before and after the transfer in the first quarter strongly suggests the mobile gaming segment is generating at least 1 billion yuan ($152 million) in revenue per quarter:

Metric

Q3 2020

Q4 2020

Q1 2021

Q2 2021

Innovation Initiatives Revenue (RMB)

1.86 billion

2.29 billion

1.09 billion

1.17 billion

Growth (YOY)

40%

90%

(6%)

10%

Digital Media and Entertainment Revenue (RMB)

7.40 billion

5.94 billion

6.99 billion

8.07 billion

Growth (YOY)

14%

5%

9%

8%

Source: Alibaba.

Back in September, Alibaba told the South China Morning Post that Romance of the Three Kingdoms: Strategy Edition had generated 3.7 billion yuan ($563 million) in the first half of the calendar year.

Based on those numbers, Lingxi could be on track to generate over $1 billion in annual revenue. That would be a solid milestone, but it would still be tiny compared to Tencent, which generated 41.4 billion yuan ($6.3 billion) in revenue from its online gaming business in the third quarter alone. NetEase's gaming business generated 18.7 billion yuan ($2.7 billion) in revenue last quarter.

$1 billion would also only equal less than 1% of Alibaba's projected annual revenue next year. In short, Alibaba's gaming business won't reduce its dependence on its core commerce and cloud businesses anytime soon.

But its gaming business could keep growing

Lingxi is still a tiny business segment for Alibaba, but the popularity of Romance of the Three Kingdoms: Strategy Edition and its sister title, Romance of the Three Kingdoms: Fantasy Land, could bolster the studio's brand, pave the way for more games, and boost its digital media revenue. Alibaba didn't say anything about Lingxi during last quarter's conference call, but investors should still keep a close eye on this growing business.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

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Leo Sun owns shares of Tencent Holdings. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Alibaba Group Holding Ltd. The Motley Fool Australia's parent company Motley Fool Holdings Inc. recommends NetEase. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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