After market close on May 21 (HKEX), NetEase released its Q1 2026 financial results. The report card of "stabilized fundamentals and profit release" was met with a more than 7% surge in Hong Kong-listed shares the next day.

Revenue hit RMB 30.6 billion, up 6.1% YoY; gaming revenue reached RMB 25.7 billion, up 6.9% YoY; gross margin surged to 69.4%, with gaming-related gross margin hitting 75%. Non-GAAP net profit attributable to parent company stood at RMB 11.3 billion, flat YoY.

It was a stellar report, but suspiciously so—administrative expenses slumped 33% YoY, sales expenses dropped 33% from RMB 4.022 billion to RMB 2.7 billion, and stock-based compensation nearly halved YoY. A company sitting on RMB 167.5 billion in net cash—with net cash still growing by RMB 4 billion QoQ in Q1—boosted profits through "austerity."

More notably, NetEase's new game launches shrank from over a dozen annually to just 9 in 2025 and 4 planned for 2026. Over the past year, at least 14 in-development projects were canceled, with overseas studios shutting down continuously. The open-world martial arts title The Legend of the Condor Heroes, developed over six years with RMB 1 billion investment, officially shut down in November 2025.

Since Ding Lei's return to frontline operations in 2024, the 27-year-old company has transformed from an offensive "cast-a-wide-net-for-blockbusters" player into a defensive "protect-legacy-IPs-and-streamline-pipeline" operator. This pivot was forced by a product failure.

After The Legend of the Condor Heroes, Ding Lei no longer believes in "casting a wide net"

To understand today's NetEase, one must revisit the RMB 1 billion failure in 2024.

The Legend of the Condor Heroes was Ding Lei's flagship bet on the open-world genre—six years of development, RMB 1 billion invested, martial arts theme, targeting MiHoYo. Launched in March 2024, it shut down in November 2025. Before this debacle, Ding Lei's management style was described by employees as "decentralized," with studios enjoying significant autonomy in project approvals. The "horse racing" mechanism had been NetEase's methodological cornerstone for discovering hits like Onmyoji, Identity V, Eggy Party, and Naraka: Bladepoint over the past decade.

After The Legend of the Condor Heroes, Ding Lei personally paused this playbook.

Visible external actions included relentless project culls. Since 2024, NetEase has canceled development of at least 14 games, including The Legend of Meteor Heroes (Meteor Butterfly Sword), Non Human Academy (Non-Human Academy), and Pokémon Quest. The shutdown list grew longer: Tianqi Action closed after just 45 days of operation, while over a dozen previously buzzworthy titles like Marvel Super War and Harry Potter: Magic Awakened were axed.

Overseas, the Nagoshi Studio—founded by Toshihiro Nagoshi, former series producer of Yakuza and high-profile hire by Ding Lei—saw its debut project Gang of Dragon rejected for an additional ~JPY 7 billion (~RMB 299 million) R&D budget request. NetEase chose to withdraw funding and shutter the studio.

The move sent shockwaves through Japan's gaming circles—Nagoshi had been NetEase's poster boy for 3A ambitions, and the divestment signaled a reevaluation of "acquiring Japanese 3A R&D capabilities through capital."

During the Q3 2025 earnings call, Ding Lei attributed the reduced new game launches to "greater focus on existing successful products." A source close to NetEase revealed a blunter internal directive: Projects without RMB 5 billion annual revenue potential aren't worth pursuing. This effectively declared the end of the "small studio + horse racing + wide net" model.

The pivot reflects objective pressures.

Post-game license tightening, the cost of trial-and-error for single titles soared. With the AI programming era arriving, the marginal returns of expanding product matrices through sheer manpower and pipeline inflation rapidly declined.

More critically, the failure cost of heavy-investment genres like open-world games became unparalleled in the mobile era—the R&D investment for The Legend of the Condor Heroes alone could have funded three to five NetEase mid-sized projects in the past.

Post-pivot, NetEase's new game launches plummeted from over a dozen annually to just 4, compressing blockbuster hit rates to near-zero for the next 1-2 years. Analysts project RMB 3-5 billion in first-year revenue for Forgotten Seas (Q3 2025 launch) and RMB 10 billion for Infinite Horizon (delayed to 2027)—these two titles now shoulder nearly all of NetEase's new growth expectations.

Notably, Infinite Horizon lacked a clear release window at both the May 20 NetEase 520 Game Conference and the earnings call. Market underperformance of competitors like Honor of Kings: World and Eternal Loop may have prompted NetEase to adopt a wait-and-see approach.

By canceling 14 projects, shutting overseas studios, and capping new games at 4, Ding Lei isn't merely cutting inefficient capacity—he's dismantling the very methodology that fueled NetEase's blockbuster factory over the past decade.

Gross margins propped up by Fantasy Westward Journey can't sustain future valuations

The report's standout figure was the 75% gaming gross margin, up 6 percentage points YoY.

This level ranks among the world's elite—for context, Tencent's value-added services margin hovers around 55%. However, this 75% stems from two factors: First, Fantasy Westward Journey PC version's "Free Play Server" hit a record 3.9 million concurrent players in March, with nearly zero channel revenue sharing for PC self-developed IPs. Second, NetEase spent the past year steering players from app stores to official website recharges, coinciding with Apple's fee cuts.

In other words, Q1's margin surge relied on a 23-year-old game and an industry-wide channel bargaining dividend. The former is NetEase's moat but deepens reliance on a single legacy IP's health. The latter is a one-time gain, unsustainable as leverage.

The expense narrative requires similar dissection. Q1 administrative expenses fell 33% YoY, sales expenses dropped 33% YoY, and stock-based compensation nearly halved. A company with RMB 167.5 billion in cash reserves has no reason for such aggressive cost-cutting without external pressure—the only plausible explanation is Ding Lei's proactive organizational restructuring.

According to sources close to NetEase, the company's "centralized platform + studios" structure is being dismantled.

Functions previously under the central platform—marketing, publishing, art, and user experience—are being partially absorbed into project teams, replacing centralized platform coordination with self-sustaining flagship projects. In March, NetEase Guangzhou reportedly conducted mass layoffs of outsourcing teams, which the company attributed to "normal business adjustments and personnel turnover," with related cost optimizations expected to fully reflect in Q2. At the executive level, at least 10 core leaders have departed since 2024, including Executive Vice President Ding Yingfeng—a 23-year veteran and key architect of Fantasy Westward Journey.

Deeper concerns lie in engine technology. NetEase's proprietary NeoX engine (launched 2007) and Messiah engine (launched 2013) have been core technological assets for nearly two decades, but they're becoming liabilities in the AI programming era—their non-standard interfaces significantly raise big model adaptation costs compared to teams using standard engines.

A telling sign: NetEase's two most critical upcoming flagship titles have switched to commercial engines: The 3A buy-to-play single-player game Return to Tang uses UE5, while the urban open-world title Infinite Horizon uses Unity. For a company long identified with its "self-developed industrialized system," this represents a strategic concession.

Regarding AI, Ding Lei devoted significant time in the past two quarters' earnings calls to emphasizing "the most gaming-savvy AI," but implemented applications remain user-facing—AI teammates in Naraka: Bladepoint, AI+UGC gameplay in Eggy Party, and AI filmmaking modes in the mobile version of Justice Online. These features function more as in-game "seasoning" than transformative pipeline tools. Reports of AI replacing outsourcing roles at NetEase Guangzhou sparked concern, but AI's substantive takeover of NetEase's R&D pipeline remains in early stages.

Non-gaming narratives are even briefer. NetEase Cloud Music posted Q1 net revenue of RMB 2 billion with 147 million MAUs—surpassed by ByteDance's Ceshui Music (156 million MAUs) in March. Youdao recorded Q1 net revenue of RMB 1.35 billion, down QoQ, with smart hardware revenue plunging 42.6% YoY. Combined, the three non-gaming segments contributed just 16% of gaming revenue in Q1, leaving the "second growth curve" vacant.

Hong Kong's markets rewarded this "austerity-driven profit" with a 7% surge on May 22. But the sustainability of this premium hinges on a recurring question: With Fantasy Westward Journey still carrying the load, Forgotten Seas launching in Q3, and Infinite Horizon delayed to 2027, what will NetEase showcase in the four-to-six-quarter interim?

That March moment when Fantasy Westward Journey hit 3.9 million concurrent players encapsulated the company's 23-year legacy. It propped up a quarter's profits and a stock rally, but it won't last until 2027.