Rift Between Gaming Giants Shows Toll of China’s Economic Crackdown

Last October, executives at the Chinese gaming company NetEase and the American video game developer Activision Blizzard joined a Zoom videoconference to discuss the future of their 14-year partnership to offer Activision’s games like World of Warcraft in China.

NetEase executives were worried about new laws imposed by the Chinese government and wanted to make changes to their longstanding contract with Activision to ensure they were in compliance.

But the companies left the call with drastically different interpretations of what had been said, according to four people familiar with the talks and a document viewed by The New York Times. What NetEase executives contended was a conciliatory gesture was seen as a threat by Activision executives. A month later, the companies broke off talks.

In January, more than three million Chinese players lost access to Activision’s iconic games when the partnership ended, and angry NetEase employees livestreamed the dismantling of a 32-foot sculpture of an ax from World of Warcraft that stood outside NetEase’s headquarters in Hangzhou, China.

The testy breakup, after months of talks, ended a relationship that had seemed to prove that global commerce could thrive despite deepening geopolitical rifts. A partnership that had been worth about $750 million in annual revenue, according to company filings and the video game research firm Niko Partners, had become another case study in the increasing difficulty of doing business in China.

Details of the breakdown in negotiations between Activision and NetEase provide an unusual, behind-the-scenes look at how Chinese and American companies are struggling to balance the interests of the Chinese government with what they believe is best for their businesses.

China’s government, under its leader, Xi Jinping, has clamped down on China’s largest internet companies and urged businesses to adhere to the Communist Party’s priorities. It has barred children from playing video games on school days and tightened its already strict approval processes for companies to distribute new games. Last year, China’s $39 billion gaming market contracted for the first time in years.

“The private sector in China is in a very weak position now,” said Duncan Clark, the chairman of the Beijing-based investment advisory firm BDA China. “The cost of accessing the China market has gone up for Western companies, and for domestic companies, there is a greater fear of arbitrary regulations.”

In a statement, Michael Lee, an Activision vice president, said the company’s experience in China had been “very positive” for nearly 20 years, including its decade-long partnership with Tencent to offer Call of Duty. “While it’s true that the partnership you’re describing took a surprising and troubling turn, it’s important to recognize that this was an anomaly,” Mr. Lee said.

Alexandru Voica, a NetEase spokesman, said NetEase had moved on, and “we suggest Activision Blizzard do the same.”

Since 2020, China’s antitrust regulators have been reviewing old mergers and joint ventures that drew large amounts of foreign capital. New antitrust amendments last summer significantly raised the fine for failing to comply with those reviews.

Last year, NetEase executives asked Activision to file relevant disclosures, such as annual revenues and details about parts of its business, to Chinese regulators, but Activision disputed that it was out of compliance with the law or that it was required to turn over more information, according to four people with knowledge of the situation and documents viewed by The Times.

In the contract renegotiations with Activision, conducted every few years since the partnership started, NetEase said it wanted to end the companies’ joint venture agreement — a business entity that helped NetEase distribute games from Blizzard Entertainment, an Activision subsidiary, in China. NetEase said it wanted Activision to license its games directly to NetEase, which would give NetEase more control over operations and allow it to better comply with the new regulations without Activision’s help.

Andrew Tang, a veteran gaming executive in China with close ties to Activision, said he thought NetEase was simply using the antitrust regulations as an excuse to get a better deal.

NetEase is “under a lot of pressure the last couple of years because of all these crackdowns and limiting kids’ play,” Mr. Tang said. “Ultimately, I think it all has to do with the bottom line.”

But tensions had been building before last year’s contract renewal discussions, according to the people familiar with the talks.

NetEase executives believed Bobby Kotick, Activision’s chief executive, had made unreasonable demands over the years, two of the people said. In 2018, NetEase announced a $100 million investment in Bungie, a game developer that worked with Activision to produce Destiny, a popular game. Mr. Kotick was unhappy with the investment because Bungie was behind schedule on developing Destiny content, and he worried the investment would further distract the company from its Destiny obligations, two other people said.

That year, NetEase invested in a game development company founded by a person who had until recently been a senior Activision employee, which also angered Activision, the people said. Mr. Kotick considered ending the partnership. A 2019 deal between Activision and NetEase included restrictions that prevented NetEase from hiring former Activision employees or investing in gaming studios directed by them.

Those tensions came to a head in the call last October. Mr. Kotick and William Ding, the chief executive of NetEase, discussed the many antitrust regulators around the world scrutinizing Microsoft’s $70 billion deal to purchase Activision, two people with knowledge of the call said. Mr. Kotick told Mr. Ding that he would consider the licensing proposal, even though he worried that a switch could rattle Chinese regulators before an important political meeting that month and cede more control over Activision’s intellectual property to NetEase.

At some point in the conversation, which was conducted at times through translators, Activision executives felt that Mr. Ding threatened Mr. Kotick. The Chinese government was reviewing the Microsoft acquisition, and the executives recalled that Mr. Ding said NetEase could sway the government either to block or support that deal depending on the outcome of the licensing discussion, according to two people familiar with the call and a document reviewed by The Times.

But NetEase executives did not intend to make a threat and were trying to be conciliatory toward Activision, said two other people familiar with the conversation. The point they intended to make was that if Activision did not switch to a licensing deal, Microsoft would face the same regulatory hurdles when it acquired the company.

Mr. Voica, the NetEase spokesman, denied that Mr. Ding had threatened Activision. He said Activision was continuing to “harass and taunt companies and regulators worldwide.”

Microsoft declined to comment.

After the Zoom call, Activision made a counteroffer: It would switch to a licensing agreement if NetEase paid it roughly $500 million upfront, rather than in payments throughout the course of the deal, according to three people familiar with the negotiations. That was meant to insulate Activision from the risk that its games could be tied up in government approval processes or be replicated without its consent.

NetEase later said in a statement that Activision’s terms were “commercially illogical,” and the stage was set for the contract to expire in January.

When the breakup became public in November, it sent shock waves through the Chinese gaming community. Shares of NetEase stock plunged in Hong Kong.

As time was running out, Activision made a last-ditch proposal to extend the partnership for six months so gamers could keep playing while it searched for a new long-term partner, as the business news site Yicai Global reported. NetEase declined the new offer, and in a statement likened it to “staying together while being divorced.”

In mid-January, NetEase contractors destroyed the World of Warcraft ax sculpture. As the contractors swung hammers at it, employees livestreamed the demolition to 30,000 people. NetEase said local law required it to clear out another company’s intellectual property after the partnership was terminated.

In late January, most of Activision’s games — including World of Warcraft, Diablo III and Overwatch — went dark in China. Chinese companies, including NetEase, released games that some analysts said bore close similarities to the shuttered Activision titles.

NetEase also made a recruiting pitch to former World of Warcraft players, hoping to get them to join Justice Online, a NetEase game in the same genre as World of Warcraft. Online, people posted photos of items from the Justice and Warcraft games that resembled each other.

NetEase said its games did not share similarities with Activision’s.

Activision has said that it plans to return to China and that it is in talks with other Chinese companies to distribute its games. In the past, both Tencent and ByteDance, which owns TikTok, have expressed interest in working with Activision. Activision has also considered teaming up with telecommunications companies like China Mobile, two people said.

For China’s gamers, the breakup was devastating. Zhang Yu, a 35-year-old World of Warcraft player in Beijing, said he was still mourning the loss of a game that had been a constant companion and connected him with thousands of people since 2005.

“What I’m most worried about now,” Mr. Yu said, “is that these friendships will disappear.”