UPDATE 2-Higher costs, competition weigh on China's NetEase

* Q3 44 cents per ADS vs Street view 48 cents

* Q3 revenue $128.8 million vs Street's $138.7 million

* Shares fall more than 8 pct after hours

* Sees higher sales, marketing costs in near future

* Eyes four game releases by mid-2010

(Adds analyst comment)

By Alexei Oreskovic and Melanie Lee

SAN FRANCISCO/SHANGHAI, Nov 19 (Reuters) - Licensing fees and higher marketing costs could weigh on NetEase.com (NTES.O), China's No. 3 online game operator in months ahead, as it faces fierce competition in the lucrative but crowded industry.

The company's outlook is also being clouded by a regulatory spat over its operation of blockbuster online game World of Warcraft (WoW), which has seen a key Chinese government regulator quash its application to run the game due to "gross violations" of regulations. [ID:nN02450107]

NetEase ADSs, which have almost doubled since the start of the year, fell more than 8 percent in after-hours trade after the company's sombre outlook coupled with third-quarter results that fell short of market expectations.

Company officials did not comment directly on the ongoing situation with WoW but NetEase's acting CFO Onward Choi said over the near term, the firm would spend more on promoting the Activision Blizzard (ATVI.O) game.

"Going forward we will still believe that the company will continue to put in more effort in doing selling and marketing activities," said Choi, refering to WoW.

Most observers said the Chinese regulator's order was the result of a government turf war, and less a reflection on NetEase itself.

"The regulatory concerns regarding WoW is still an overhang for the stock," said JPMorgan analyst Dick Wei. "For the fourth quarter, gross margins may be lower because they have to do revenue-sharing with Blizzard."

NEW SCREENING RULES

China's ministry of culture on Wednesday said it would require online game operators to actively screen content for violent and obscene elements and improve their product offerings, weighing more broadly on China's online game sector that often faces heavy-handed oversight from overzealous regulators.

Shares of Shanda Games (GAME.O), Changyou (CYOU.O) both fell about 1 percent after the news came out, with NetEase itself down about 3 percent in regular Wednesday trade before it announced its third quarter results.

Willian Ding, chief executive of NetEase, told an earnings conference call that he was not yet fully aware of the details of the latest regulation, but the firm is willing to comply with government rules.

NetEase said on Wednesday its net income rose to $57.7 million, or 44 cents per American Depositary Share in the third quarter, from $45.9 million, or 35 cents per ADS a year earlier.

That was short of the 48 cents a share expected by analysts, according to Thomson Reuters I/B/E/S.

Third-quarter revenue rose to $128.8 million from $118.2 million a year earlier, but was also below expectation for $138.7 million. Gross profit margin declined to 79.9 percent from 88.3 percent in the second quarter

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

NetEase said it will be releasing two online casual games by the end of 2009 and two online role playing games by mid 2010. It also buffed up its research and development department in the third quarter by 10 percent.

Revenue from China's online game market grew 39.5 percent in the second quarter from the previous year to 6.18 billion yuan ($905.3 million), according to data from research firm Analysys International. [ID:nSHA310739] (Editing by Doug Young and Valerie Lee)