UPDATE 2-NetEase faces H2 margin squeeze on cost of new games

* Q2 EPS 53 cents vs consensus estimates of 45 cents

* NetEase says H2 gross margins to be squeezed

* Shares fall 1.9 pct in after hours trade (Adds detail from conference call, analyst comment, SHANGHAI dateline, bylines)

By Alexei Oreskovic and Melanie Lee

SAN FRANCISCO/SHANGHAI, Aug 12 (Reuters) - China's No. 2 online games operator NetEase.com Inc (NTES.O) faces a squeeze on margins in the second half as it launches new games and as its older games lose their shine.

NetEase, which has a deep game pipeline for the second half, will see higher sales and marketing and personnel costs for the third and fourth quarters, Onward Choi, NetEase's acting chief financial officer told an earnings conference call. Choi was speaking after the company posted quarterly earnings that beat market expectations, helped largely by currency gains.

For the second half, the firm is set to launch two expansion packs for its in-house developed blockbuster games, Fantasy Westward Journey and Westward Journey II. It will also operate Activision Blizzard's (ATVI.O) popular online role-playing game World of Warcraft (WoW) in China.

"Given that we will have the introduction of the licenced game (WoW) to our overall game portfolio, this will definitely have a downward impact to our overall gross margin performance," Choi said.

Citigroup analyst Alicia Yap estimated that NetEase had to pay $30 million for the WoW licence. It is not clear what the royalty payments will be when WoW is relaunched. WoW is in testing mode in China and is awaiting government approval.

China has about 50 million online gamers. Sales of China's gaming market is expected to grow between 30 to 50 percent this year to between 24 billion and 27 billion yuan.

For the second quarter, NetEase's net profit rose 6.8 percent to $68.5 million, or 53 cents per American Depositary Share in the three months ended June 30, helped by net foreign exchange gains of $6.9 million.

However, its gross profit fell 4.3 percent compared to the same period a year ago and it posted a lower gross profit margin for its online games on increased personnel costs.

"I think the core games software revenue was a little bit soft...Down the road, they should still see some more margin declines due to the launch of WoW," said Dick Wei, vice president of equity research at JPMorgan.

NetEase's shares, which have more than doubled since the start of 2009, fell 1.9 percent or 90 cents in after hours trade.

INTENSE COMPETITION A KEY RISK

China's online game market is becoming increasingly cut-throat and industry players rely more on marketing and promotional schemes to get the attention of Chinese gamers.

NetEase said its sales and marketing costs for the second quarter rose 27.9 percent compared to the same period a year ago.

Analysts also said some of NetEase's games, especially Fantasy Westward Journey which is about five years old, is showing signs of gamer fatigue.

"It's getting 'old', losing its attraction while confronting a few crucial competitors," said Guo Cheng Gang a senior analyst with JLM Pacific Epoch.

NetEase said that revenue in the three months ended June 30 rose 22 percent to $127.7 million, above the $120.4 million expected by analysts, according to Reuters Estimates.

But the company said a recent change to its revenue recognition policy involving "dormant" user accounts of its online games contributed $12.2 million of revenue.

NetEase said its advertising services revenue grew quarter-over-quarter due to China's economic stimulus measures. (Editing by Lincoln Feast)