As the trading week winds down on Friday and heads into the holidays, there's big trouble brewing in China's big tech sector. Shares of online gaming company NetEase(NASDAQ: NTES) crashed 15% through noon today, while Huya(NYSE: HUYA), a specialist in livestreaming of online games, fell 10.7% in response to rumored regulations coming down from the Chinese government.
Gaotu Techedu(NYSE: GOTU), which isn't a gaming company at all but rather a for-profit educator, seemed to fall in sympathy with its gaming peers, down 8.1% as it had flashbacks from its own 2021 regulatory-induced stock market crash.
New Chinese regulations on gaming
In early to mid 2021, Chinese regulators issued a flurry of new regulations aimed at reining in the country's red hot for-profit education sector, based on worries that families were spending too much on an educational arms race to get their kids into the best schools. The government restricted the sale of online educational services to young children, regulated advertising of educational services, restricted the hours when tutoring could take place, and even regulated the prices companies could charge.
Stock prices in the for-profit education sector crashed. Gaotu, for example, lost 98% of its value over the space of just six months. And now it seems that history could repeat itself in the gaming sector.
So what's China up to this time around? As The Wall Street Journal reports, government regulators are worried that this time, Chinese youth spend too much time and money playing games.
To put a stop to it, China's National Press and Publication Administration, which regulates both the media and video games in China, has released draft rules that aim to suppress companies' use of incentives to encourage gamers to play more, and spend more time and money online.
Restrictions being floated might include curbs on allowing minors to participate in lotteries, banning minors "tipping" hosts who livestream games, disallowing volume discounts for in-game spending, and stopping rewards for maintaining "streaks" of daily log-ins to games.
In 2021, regulators also established rules aimed at curbing kids' time spent gaming during the school week. So what we're seeing today is connected to the earlier push and continues a long-standing goal of establishing top-down rules regulating how children spend their time.
Should China investors worry?
The Journal notes that China is currently the world's second-biggest market for video gaming after the United States -- but that could change. The regulations being proposed have the potential to reduce the amount of time players spend gaming, their spending in-game, and consequently both the revenue and profit that companies generate from creating games -- without lowering their costs much at all.
This is a clear threat to both revenue growth and profit margins in the gaming sector. And it's not like gaming companies were flourishing, exactly, after the last round of regulations!
NetEase stock has grown its revenue a total of less than 1% over the last two years, while Huya's revenue has shrunk by more than 40%, according to data from S&P Global Market Intelligence. Gaotu, which sat closer to the bull's-eye of the last round of regulations, has seen its revenue shrink closer to 62%.
And since we're just at the beginning of what looks like a new slew of regulations, the damage could be even worse this time around. Should investors in China's tech sector be worried right now? Well, yes -- I think they should be very worried indeed.
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends NetEase. The Motley Fool has a disclosure policy.
