Coverage initiated on: 2020-08-05 ResearCh Coverage Report By Shared ResearCh InC. Last update: 2021-08-06 3656 KLaB Shared ResearCh InC. has produCed this report By request from the Company disCussed in the report. The aim is to provide an “owner’s manual” to investors. We at Shared ResearCh InC. make every effort to provide an aCCurate, oBjeCtive, and neutral analysis. In order to highlight any Biases, we Clearly attriBute our data and findings. We will always present opinions from Company management as suCh. Our views are ours where stated. We do not try to ConvinCe or influenCe, only inform. We appreCiate your suggestions and feedBaCk. Write to us at [email protected] or find us on BloomBerg. INDEX ExeCutive summary . .3. Key finanCial data . .5. ReCent updates . .6. Trends and outlook . 8. Business . .1.8. Business overview . .1.8. Earnings model . .2.9. Strengths and weaknesses . 3. .4. Group Companies . .3.5. Market and value Chain . .3.5. HistoriCal performanCe . .4.3. InCome statement . .5.4. BalanCe sheet . .5.5. Cash flow statement . .5.7. Other information . 5. .8. News and topiCs . 6. .2. Company profile . .6.4. KLaB/ 3656 ResearCh Coverage Report By Shared ResearCh InC. | pdf.summary.Company_weBsite 2 ExeCutive summary Business overview Business desCription: KLaB InC. plans, develops, and operates moBile games*1. The majority of the Company’s revenue and profits Comes from the Game Business, whiCh aCCounted for 98.9% of total revenue and 97.7% of gross profit in FY12/20. With FY12/20 revenue of JPY34.0Bn, KLaB is a medium-sized speCialist Company Compared with industry leader Mixi, whiCh logged a segment revenue of JPY100.6Bn in its Digital Entertainment Business in FY03/21. CharaCteristiCs of KLaB’s games: The most popular games of Competitors GungHo Online Entertainment, InC. (TSE1: 3765) and Mixi, InC. (TSE1: 2121) are Based on their own intelleCtual property (IP). In Contrast, KLaB’s mainstay games are Based on existing IPs from anime and manga. Although the Company’s mainstay games vary in genre (sports, rhythm aCtion, and aCtion RPG), they share elements in Common: eaCh Captures the feeling of the world of its respeCtive IP, eaCh inCludes rare CharaCters that Can Be developed By the player, and eaCh allows the player to form teams from multiple CharaCters. Many moBile games fail to generate revenue despite Being Based on well-known anime or manga. Simply Being fun to play is not enough to guarantee CommerCial suCCess—games need to have meChanisms that enCourage players to make in-game purChases. Shared ResearCh thinks KLaB has BeCome highly aCComplished at enCouraging players to spend on games. The Company has leveraged its years of experienCe in developing and operating ColleCtiBle Card games sinCe they Boomed in popularity in the early 2010s to inCorporate elements of ColleCting and training rare CharaCters into its games in Clever ways. Mainstay games: The Company’s mainstay games are sports simulation Captain TsuBasa: Dream Team (hereafter Captain TsuBasa), aCtion RPG BLEACH: Brave Souls, rhythm aCtion game Love Live! SChool Idol Festival (hereafter Love Live! SChool Fest), rhythm aCtion RPG Love Live! SChool Idol Festival All Stars (hereafter Love Live! All Stars) (see “Business”). These four titles aCCount for the majority of Game Business revenue. Competitors are highly reliant on a single game to drive results: 55.2% of GungHo Online Entertainment’s FY12/19 revenue Came from its puzzle RPG Puzzle & Dragons, and over 60% of Mixi’s FY03/19 revenue Came from its Co-op RPG Monster Strike. KLaB’s earnings, By Contrast, are diversified aCross multiple games and therefore not easily affeCted By the potential deCline of any single one. High overseas revenue ratio: KLaB’s games are BasiCally free to play. However, many players purChase in-game CurrenCy to use on gaCha*2 to help them progress through the game. The resulting revenue is the Company’s main sourCe of inCome. In FY12/20, KLaB’s overseas revenue Composition ratio was 34.9%. The Company plans, develops, and operates games Based on Japanese anime and manga that are well known overseas. It also develops games with the intention of releasing them overseas as well as in Japan, and is thus aBle to release gloBal versions of its games at nearly the same time as the Japanese versions, whiCh Boosts overseas revenue. Developing games under the assumption of releasing them in Both Japan and overseas also helps to CurB overall development Costs. Revenue, numBer of users, average spend: Revenue per game = monthly aCtive users (MAU) × Conversion rate (ratio of paying users to MAU) × average revenue per paying user (ARPPU; average monthly revenue for one player). The Company says it Cannot present average values for eaCh KPI BeCause they fluCtuate even for the same game due to seasonal events and Campaigns. ARPPU in partiCular Can range widely, oCCasionally swinging from several thousand yen to as muCh as tens of thousands of yen. Costs and expenses: The Cost of revenue ratio was 79.4% in FY12/20. Royalties paid to IP rights holders and Commissions (platform fees) paid to platform operators (app stores) form the main Component in Cost of revenue. Royalties and Commissions are variaBle Costs, typiCally around 50% of revenue, and aCCount for over 60% of Cost of revenue. The remaining 40% of Cost of revenue Comprises fixed Costs suCh as laBor and outsourCing. The SG&A-to-revenue ratio is roughly 20%, with SG&A expenses mainly Comprising salaries and allowanCes and advertising expenses. Salaries and allowanCes are mostly fixed Costs while advertising expenses are mostly variaBle owing to performanCe-Based advertising and the Company’s aBility to adjust the advertising Budget aCCording to revenue. The advertising expense-to-revenue ratio hovers around 7%. Investment in new games (software): ACCording to FY12/19 results, large in-house titles suCh as Love Live! All Stars and Tales of Crestoria take aBout two years to develop and Call for approximately JPY1.0Bn–JPY2.0Bn in upfront spending. Games are reCorded as software (intangiBle fixed assets) at the time of release, and are amortized over two years using the straight- line method. KLaB aims to rein in game produCtion Costs By promoting joint development with external development Companies, narrowing its foCus to genres suCh as rhythm aCtion, aCtion RPG, and sports that have produCed a hit in the past, and standardizing BasiC app funCtions through the development of a Common struCture. KLaB/ 3656 ResearCh Coverage Report By Shared ResearCh InC. | pdf.summary.Company_weBsite 3 Earnings trends In FY12/20, revenue was JPY34.0Bn (+9.1% YoY), operating profit was JPY2.1Bn (+28.4% YoY), reCurring profit was JPY1.6Bn (-3.7% YoY), and net inCome attriButaBle to owners of the parent was JPY767mn (+99.9% YoY). Total revenue rose on growth in revenue from existing games. Gross profit fell YoY as a deCline in transfer to other aCCounts outweighed sales growth, But operating profit grew on lower SG&A expenses. KLaB lowered its full-year FY12/21 Company foreCast at the time of its 1H FY12/21 earnings announCement (August 2021). The Company’s revised foreCast Calls for revenue of JPY25.5Bn to JPY28.5Bn (-24.9% to -16.1% YoY), operating loss of JPY1.6Bn to operating profit of JPY1.0Bn (versus operating profit of JPY2.1Bn in FY12/20), reCurring loss of JPY1.5Bn to reCurring profit of JPY1.1Bn (versus reCurring profit of JPY1.6Bn), and net loss attriButaBle to owners of the parent of JPY2.0Bn to net inCome attriButaBle to owners of the parent of JPY20mn (versus net inCome of JPY767mn in FY12/20). The Company revised its foreCast downward in May 2021 as revenue for Love Live! All Stars and Tales of Crestoria fell short of plan, But revenue for Love Live! All Stars failed to reCover in Q2, and the falloff in revenue from BLEACH: Brave Souls exCeeded Company expeCtations. Along with the FY12/20 results, the Company unveiled its medium-term management plan, whiCh targets FY12/23 revenue of JPY50.0Bn (up 47.3% from FY12/20) and operating profit of JPY10.0Bn (+365.2%). The Company aims to grow earnings through staBle management of existing titles while growing revenue and profit from new titles. Over the Course of the plan, it also intends to seCure new sourCes of earnings other than Conventional game development and operations, suCh as through Casual games and overseas game development support. Strengths and weaknesses Shared ResearCh sees the Company’s strengths as: 1) its praCtiCe of developing games Based on popular IPs, 2) its aBility to profitaBly operate games over a long period of time, and 3) its exCellent overseas expansion CapaBility. We see KLaB’s weaknesses as: 1) the need to shoulder a greater Burden than Competitors when developing new games due to its relatively small revenue, 2) reluCtanCe to take risks to produCe BloCkBusters, and 3) a laCk of proven aBility in developing games Based on proprietary IPs. (See “Strengths and weaknesses” for details.) *1MoBile games: Most moBile games are free to play. However, players Can pay to roll gaCha (eleCtroniC lottery) to aCquire rare CharaCters and items that will help them progress through the game in an advantageous manner. Revenue earned through gaCha is the main sourCe of revenue for game operating Companies. Players who pay to roll gaCha are a small suBset of total players. Game Companies make use of player psyChology to inCrease their willingness to spend on games, inCluding the desire to ColleCt rare CharaCters, attaChment to the CharaCters they develop in the game, and desire to perform well in ranked Competition with other players.