Square Enix Holdings (9684 / 9684 JP) Rating (From Neutral) OUTPERFORM* Price (09 May 13, ¥) 1,230 UPGRADE RATING
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10 May 2013 Asia Pacific/Japan Equity Research Entertainment Software (Video Game (Japan)) / MARKET WEIGHT Square Enix Holdings (9684 / 9684 JP) Rating (from Neutral) OUTPERFORM* Price (09 May 13, ¥) 1,230 UPGRADE RATING Target price (¥) (from 1,150) 1,450¹ Chg to TP (%) 17.9 Announcement of additional structural reforms Market cap. (¥ bn) 141.54 (US$ 1.41) should mark the end of bad news Enterprise value (¥ bn) 81.64 ■ Action: We foresee a risk of Square Enix revising guidance concurrently with its Number of shares (mn) 115.07 Free float (%) 50.0 13 May results. Further restructuring measures should enhance its resilience 52-week price range 1,501 - 974 against slumping sales of packaged software. SNS/online games—two segments *Stock ratings are relative to the coverage universe in each with substantial growth potential—have enjoyed firm momentum in Asia, and an analyst's or each team's respective sector. improved product mix for these should contribute to profits. Earnings are likely to ¹Target price is for 12 months. grow YoY in FY3/15 supported by the launch of new blockbuster titles. Accordingly, Research Analysts we expect the company’s relative P/B, which has been languishing at historically Shunsuke Tsuchiya low levels, to correct. We revise our forecasts, raise our TP from ¥1,150 to ¥1,450 81 3 4550 9740 (potential return 17.9%) and upgrade the stock from Neutral to OUTPERFORM. [email protected] ■ Additional restructuring: Restructuring in FY3/14 is likely to center on overseas development (former Eidos Interactive). Assuming further write-downs, we believe BPS could drop to just below ¥1,000 (restructuring charges of ¥5.0–6.0bn). However, the shares have fallen substantially following the sharp cut to FY3/13 targets in March, so risk of BPS erosion looks already priced in. If the shares drop on below-consensus FY3/14 guidance (and particularly, a lower-than-expected NP target), we would welcome this as an opportunity to accumulate on weakness. ■ Growth potential: Although obscured by the slump in packaged software sales, we see potential for earnings growth driven by SNS/online games, sales of which are trending firm. Overseas native applications developed with local makers have taken off, with monthly sales of ¥600mn in South Korea spiking as high as ¥1.0bn. Square Enix plans to develop similar applications for China and Taiwan. In FY3/14, we expect high-margin remake titles to help stabilize earnings in the troubled package software business, while SNS/online games should also easily contribute. ■ Catalysts: Catalysts include growth in SNS operations overseas, development of Dragon Quest titles for SNS platforms, and announcement of blockbuster titles. The main downside risk is the absence of further restructuring measures. ■ Valuation: Although we revise down our forecasts, we raise our TP to ¥1,450 based on a P/B of 1.3x (on par with the industry average) and our FY3/15 BPS forecast. We previously valued the shares using P/E, but shift to P/B as the company is embarking on another period of restructuring. Share price performance Financial and valuation metrics Year 3/12A 3/13E 3/14E 3/15E Price (LHS) Rebased Rel (RHS) Revenue (¥ bn) 128.1 143.4 140.0 150.0 1800 140 Operating profit (¥ bn) 10.7 -6.0 7.5 16.7 1300 90 Recurring profit (¥ bn) 10.3 -5.0 7.7 16.9 800 40 Net income (¥ bn) 6.1 -13.0 1.3 10.0 EPS (¥) 52.7 -113.0 11.3 86.9 Change from previous EPS (%) n.a. n.m -88.3 -10.7 IBES Consensus EPS (¥) n.a. -48.5 58.7 75.6 The price relative chart measures performance against the EPS growth (%) n.m. n.m. n.m. 669.2 TOPIX which closed at 1181.83 on 09/05/13 P/E (x) 33.0 -10.9 108.9 14.2 On 09/05/13 the spot exchange rate was ¥100.62/US$1 Dividend yield (%) 1.7 2.4 2.4 2.4 EV/EBITDA(x) 8.2 81.6 5.7 3.2 Performance Over 1M 3M 12M P/B (x) 1.5 1.2 1.2 1.1 Absolute (%) 14.2 5.4 -18.1 ROE(%) 4.5 -10.1 1.1 8.3 Relative (%) 8.8 -18.0 -72.5 Net debt/equity (%) net cash net cash net cash net cash Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 10 May 2013 Table of contents (1) Factors driving downward revision to FY3/13 guidance 3 (2) Additional restructuring in FY3/14 4 (3) Gauging share price downside 7 (4) Growth potential 8 (5) Valuation 10 (6) Timing of share price rally 13 (7) Room to reduce SG&A costs 14 (8) Earnings forecasts 15 Square Enix Holdings (9684 / 9684 JP) 2 10 May 2013 (1) Factors driving downward revision to FY3/13 guidance FY3/13 reforms focused mainly on domestic development and overseas headquarters/sales companies; restructuring of overseas development still insufficient On 26 March, Square Enix revised down its FY3/13 guidance, lowering its ¥7.5bn OP Domestic development estimate to an operating loss of ¥6.0bn and its ¥3.5bn NP projection to a net loss of operations and overseas ¥13.0bn. The main factors behind the revision were sluggish overseas sales of headquarters/sales blockbuster titles, and the booking of an extraordinary loss of ¥10.0bn. companies the primary targets of restructuring in We suspect the ¥10.0bn extraordinary loss reflected: (1) write-downs of domestic content FY3/13 assets, (2) a reduction in employees and offices at US headquarters and sales companies, and (3) write-downs of content assets in Europe and the US. With sales of packaged software in Europe and the US currently in a downtrend, the restructuring of development operations (former Eidos Interactive) in both regions to date, Expect further restructuring including content asset write-downs and headcount reductions, is likely to prove in overseas development insufficient, thus setting the stage for another round of reforms. operations in FY3/14 In fact, when management announced the downward revision to FY3/13 targets, new President Yosuke Matsuda commented management will determine concrete additional restructuring measures by May 2013 and announce these with FY3/13 results. Accordingly, the new structural reforms will likely be factored into FY3/14 guidance. Figure 1: FY3/13 extraordinary loss mainly reflects restructuring charges for domestic development operations and overseas headquarters/sales companies Extraordinary loss Cost Contents 0 (mn yen) (500) 1) Reduction of personnel (2,000) Cash out (1,000) (1,000) Japan - - (1,000) Europe (1,000) Head office functions (2,500) N.America (1,000) Branch office functions (1,500) (1,000) 2) Contents appraisal loss (4,000) Non cash out (1,500) (2,000) Japan (2,500) New IP for western markets (2,000) Europe (1,500) Title of former Eidos development (2,500) N.America 0 - (3,000) 3) Contents abandonment loss(4,000) Non cash out (1,000) Japan (2,000) New IP for western markets (3,500) (2,000) Europe (1,000) Title of former Eidos development (3,500) N.America (1,000) Related mobile (4,000) Contents abandonment loss Total (FY 3/13) (10,000) (4,500) Contents appraisal loss Japan (4,500) New IP for western markets (4,500) Reduction of personnel Europe (3,500) 2 titles of former Eidos development (5,000) N.America (2,000) Related mobile Japan Europe N.America Note: high likelihood of further restructuring for overseas development operations in FY3/14 Source: Company data, Credit Suisse estimates Square Enix Holdings (9684 / 9684 JP) 3 10 May 2013 (2) Further restructuring in FY3/14 Expect company to book ¥5.0–6.0bn in additional restructuring charges, centered on overseas development operations (former Eidos Interactive). We see potential for additional restructuring in overseas development operations (former Look for ¥5.0–6.0bn in Eidos Interactive), and our forecasts therefore reflect charges for further content asset additional restructuring write-downs (non-cash expenses) and headcount reductions (cash expenses). charges We estimate a maximum of ¥5.0–6.0bn in additional restructuring charges, breaking down as ¥3.0–4.0bn for write-downs of content assets (non-cash expenses) and ¥2.0bn for headcount reductions (cash expenses). Figure 2: Estimate roughly ¥3.0bn in additional write- Figure 3: Estimate roughly ¥2.0bn in additional downs of overseas content assets restructuring charges from overseas headcount reductions 30,000 3,000 (Y million) Additional (# of employee) Additional Restructuring 27,000 Restructuring 27,000 2,700 2,500 2,500 24,000 2,400 2,300 2,200 21,000 19,900 20,000 2,100 13,000 18,400 1,000 1,000 800 700 18,000 1,800 Overseas 16,000 15,700 8,400 15,000 10,000 1,500 8,400 5,700 5,700 Overseas 12,000 1,200 Japan 9,000 900 14,000 1,500 1,500 1,500 1,500 6,000 11,500 Japan 600 10,300 10,000 10,000 10,000 3,000 300 0 0 3/10 3/11 12/12 3/13E Case_1 Case_2 12/12 3/13E Case_1 Case_2 After Restructuring After Restructuring Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Write-downs of overseas content assets (Figure 2) We estimate domestic content assets shrunk from ¥14.0bn at end-December 2012 to (1) Write-downs of overseas roughly ¥10.0bn at end-March (down 30–35%), and overseas content assets from ¥13.0bn content assets to ¥10.0bn (down 25–30%).