Search Seeing Flywheel Effect, but Global Still Needs Momentum

NAVER

(035420 KS)

Search seeing flywheel effect, but global still needs momentum

Internet

2Q18 review: Revenue beats consensus, but OP misses; NP boosted by one-off gain

For 2Q18, NAVER’s revenue came in above the consensus, but operating profit missed.

Results Comment July 27, 2018

Positives: Revenue from the business platform segment (which includes the core search ad business) was stronger than expected, growing 17% YoY and surpassing W600bn for the first time on a quarterly basis. Ad performance improved, due to increased options for a mobile search ad offering, while shopping search ads also contributed to growth. LINE’s ad revenue also jumped 42% YoY.

(Maintain)

Buy

1,000,000

751,000
33%

At the parent IT platform and content services segments, revenue grew a robust 74% and 27% YoY, respectively. The IT platform segment was helped by NAVER Pay’s increased transaction volume, while the content services segment was supported by traction in webtoons and V LIVE. Meanwhile, net profit was temporarily boosted by a W112.7bn gain from the disposal of subsidiary investments caused by the exclusion of LINE Mobile (a Japan-based MVNO subsidiary) from consolidation, as a result of Softbank’s investment.

TargetPrice(12M, W)

Share Price(07/26/18, W) Expected Return

Negatives: The ad segment (which includes display ads) grew a weaker-than-expected 11% YoY. The ad segment bears close watching, as it could be affected by NAVER’s mobile app overhaul planned in 3Q18. Agent/partner commissions and marketing expenses were higher than anticipated, mainly due to NAVER Pay.

OP (18F, Wbn) ConsensusOP (18F, Wbn)
1,106 1,108

EPS Growth (18F, %) Market EPS Growth (18F, %) P/E(18F, x) Market P/E(18F, x) KOSPI
7.8
10.4 29.7

Nstore’s merger with NAVER Webtoon part of global content expansion

Original premium content: We expect NAVER Webtoon to play an important role in NAVER’s original premium content. NAVER plans to spin off its Nstore business, which handles digital content distribution (VOD, e-books, etc.), and merge it with NAVER Webtoon. NAVER has so far invested a total of W210bn in NAVER Webtoon this year. As for content, NAVER has spent W400bn since 2017 and intends to spend another W200bn by 2019. We expect the global platform business and the intellectual property (IP)-based drama/film investment and production to gain traction.

9.0
2,289.06

MarketCap (Wbn) Shares Outstanding (mn) Free Float(%)
24,755
33
78.4
ForeignOwnership (%) Beta (12M) 52-WeekLow
59.9 0.80
652,000 950,000

UGC: We believe Apollo will lead NAVER’s user-generated content (UGC) operations. Apollo, a company-in-company (CIC) created in May that operates and develops NAVER services, like blogs, posts, and Knowledge IN, plans to revamp domestic blogs with a focus on videos, and later launch a global UGC service.

52-Week High

We view NAVER’s efforts to expand its content business as part of its move to catch up with global video providers like Netflix (premium content) and YouTube (user content). We note that a growing number of Chinese internet firms have recently boosted their enterprise value by separately listing their content and video businesses.

(%)

Absolute Relative

1M

2.2 4.9

6M

-19.0
-8.9

12M

-9.0 -3.2

120 110 100
90

NAVER

KOSPI

Maintain Buy and TP of W1,000,000 (not adjusting for October stock split)

We maintain our Buy rating on NAVER. We believe the search business is in the “running on its own” stage of the ‘flywheel effect’ (spinning a heavy flywheel takes significant effort, but once momentum builds the mechanism can eventually run by itself without additional fuel). The commerce business, meanwhile, is in the “momentum building” stage. Meanwhile, LINE, NAVER Webtoon, and Apollo are still in the stage where the company needs to make considerable efforts in order to achieve its medium/long-term growth objective of global expansion.

80 70

7.17

11.17

3.18

7.18

Mirae Asset Daewoo Co., Ltd.

[Internet/Game/Advertising]

FY (Dec.)

Revenue (Wbn) OP (Wbn) OP margin(%) NP (Wbn) EPS (W) ROE(%) P/E(x) P/B(x)

12/15

3,254
830 25.5 519
15,737
26.5 41.8
6.8

12/16

4,023 1,102
27.4 749
22,732
26.2

12/17

4,678 1,179
25.2 773
23,447
18.5

12/18F

5,665 1,106
19.5 834
25,287
16.3

12/19F

6,830 1,674
24.5
1,069
32,441
18.0

12/20F

8,070 2,061
25.5
1,320
40,058
18.6

Jee-hyun Moon

+822-3774-1640 [email protected]

34.1
5.2
37.1
4.8
29.7
3.7
23.1
3.2
18.7
2.7

Dividend yield (%)

0.2

0.1

0.2

0.3

Note: Allfigures are basedon consolidated K-IFRS;NP refers to net profit attributable to controllinginterests Source: Company data, Mirae Asset Daewoo Research estimates

July 27, 2018

NAVER

Earnings review and forecasts

Table 1. 2Q18 review

(Wbn, %)

2Q18P MiraeAsset
Daewoo
Growth YoY

2Q17

1Q18

Preliminary

Consensus

QoQ

Revenue

1,130

285
1,309
257
1,364
251
1,363
266
1,351
267

20.7

4.2

Operating profit OP margin(%) Net profit

-12.1

-2.5

25.2 171
19.6 154
18.4 314
19.5 159
19.8

184

83.1

104.0

Note: Allfigures are basedon consolidated K-IFRS;net profit is attributable to controllingandnon-controllinginterests Source: Company data, FnGuide, Mirae Asset Daewoo Research estimates

Table 2. Quarterly and annual earnings

(Wbn, %)

1Q17 1,082

112 511
43

2Q17 1,130

134 522
49

3Q17 1,201

133 550
59

4Q17 1,266

151 586
66

1Q18 1,309

133 593
73

2Q18P
1,364

149 612
86

3Q18F
1,442

148 643
96

4Q18F
1,550

169

2017 4,678

529

2018F

2019F

6,830

676

Revenue

5,665

598

Ads

Businessplatform ITplatform

667

2,168

218
2,515
370
2,867

592

116

Contentservices LINE and otherplatforms

Operating profit

OP margin

25

27

28

30

32

33

36

105

130

149

391

291

26.9

211

19.5
400

285

25.2

171

15.2
432

312

26.0

216

18.0
446

291

23.0

172

13.6
481

257

19.6

154

11.7
486

251

18.4

314

23.0
523

270

18.7

184

12.7

563

1,669

1,179

25.2

770

2,053

1,106

19.5

863

2,546

1,674

24.5

329

21.2

212

Net profit

1,099

16.1

Net margin

13.7

16.5

15.2

YoYgrowth

Revenue

15.5

37.7 13.5 92.0 -19.8 11.0 13.2 27.8
14.4 38.5 12.9 75.8 -8.8 7.2
18.5 35.1 18.9 90.3 20.9
8.3
16.7 22.4 19.2 70.3 22.7
8.9
21.0 18.6 16.1 67.1 19.8 22.9 -11.6 -27.1
20.7 11.1 17.2 73.5 26.8 21.6 -12.1 83.1
20.1 11.0 17.0 64.0 20.0 21.0 -13.6 -14.9
22.5 12.2 13.9 74.6 29.1 26.2 13.0 23.1
16.3 32.5 16.2 80.7
1.3
21.1 13.0 16.0 70.0 24.0 23.0 -6.2
20.5 13.0 14.0 60.0 15.0 24.0 51.4 27.4
Ads Businessplatform ITplatform Contentservices LINE and otherplatforms Operating profit Net profit
8.8

4.6

10.6

9.0

0.3

7.0

-19.6

-6.2

1.5

12.1

Notes: Allfigures are basedon consolidatedK-IFRS; in 2017, revenue was reclassifiedinto five segments: ads, business platform, IT platform, content services, andLINE andother platforms; ads include generalandshoppingdisplay ads andvideo ads; business platform includes generalandshoppingsearch ads; IT platform includes NAVER Pay, IT services, andcloudservices; content services include music, webtoons, andV Live; LINE andother platforms include LINE andSnow; due to theparent firm’s merger with CampMobile in February 2018, some of the revenue from LINE andother platforms has been reclassifiedfrom 2017 onwards; the YoY revenue comparison for 2017 may have discrepancies due to CampMobile’s reclassification; 2Q18 net profit includes W112.7bn inone-off gains relatedto LINE Mobile; net profit isattributable to controllingand non-controllinginterests
Source: Company data, Mirae Asset Daewoo Research estimates

Table 3. Earnings forecast revisions

(Wbn, W, %)

Previous 18F
Revised 18F
% chg.
18F
Notes

19F

Businessplatform/ITplatform estimatesrevised upward; ad estimates revised downward

Revenue

5,664

6,797

5,665

6,830

0.0

0.5

Platformdevelopment/operation expensesrevised downward; marketing expensesrevised upward
2.1 Exclusion of LINE Mobilereflected
Operating profit Net profit
1,142
738
1,665 1,077
1,106
863
1,674 1,099
-3.1 16.9
9.0
0.6
Profits fromnon-controlling interestsinLINE Mobile reflected;based on existing share count

EPS (W)

23,191

33,506

25,287

32,441

-3.2

OP margin Net margin
20.2 13.0
24.5 15.8
19.5 15.2
24.5 16.1

Notes: Net profit is attributable to controllingandnon-controllinginterests; EPS is attributable tocontrollinginterests Source: Mirae Asset Daewoo Research estimates

Mirae Asset Daewoo Research

2

July 27, 2018

NAVER

LINE overview

Table 4. LINE’s quarterly earnings: Ad revenue grew42% YoY; shares up by 6.8% on the day following 2Q18earnings releases

(JPYbn)

QoQ

2Q17

41.6

37.2 19.1
7.5

3Q17
44.3

40.1 22.0
7.5

4Q17
47.9

41.4 23.7
7.1

1Q18
48.7

42.7 25.2
7.4

2Q18P
50.6

44.6 27.2
7.3

YoY 22%

20% 42% -3%
Revenue

4%

1) Corebusiness

Ads

8%

Communication Content
-1%
10.1
0.5

9.9

9.7

9.2

9.3

-7%

2%

Other

0.7

0.9

0.8

59%

42% 64%
8%
-17%

0%

2) Strategicbusiness

LINEFriends

4.3

4.2

6.3

6.1

2.5

3.0

4.1

3.4

4.1

21%

-28% 544%

628%

Fintech/AI/commerce/mobile Otheroperating profit Operating profit OP margin

1.8

1.2

2.2

2.7

2.0

10.7

0.5

1.5

9.7

-10%

-38%

14.6

35.1

5.9

13.2

0.6

1.3

1.2

2.6

9.1

17.9

1) Corebusinessoperating profit 2) Strategicbusinessoperating losses
11.8 -3.8
16.8 -4.3
12.9 -6.9
12.8 -7.1

7.0

-41%

82% -59%
-45%

-3%

-6.9

Net profit

8.9

21.5

1.6

3.7

-4.0

-8.3

-1.8

-3.6

3.7

7.3

-308%
Net margin

Key indicators

Global MAU (mnpersons) Globalpaid officialaccounts (ads) LINEPaytransaction value(JPYbn) Ad platformimpressions (bn)
169 605 105
15
168 631 115
16
168 645 228
16
165 657 173
18
164 672 195
21
-3% 11% 86% 44%
-1% 2%
13% 20%

Note: 1) NAVER holds a73.28%stake in LINE. LINE’s2018 revenue classification has been changedfromads, communication/content, andother to core businesses (ads, communication/content, other) andstrategic businesses (fintech, AI, commerce, other)
2) In 2Q18, LINE postedaone-off gain on stake sales of JPY9.4bn, resultingfrom Softbank’s investments in LINE Mobile 3) As LINE Mobile has not been includedin LINE’s consolidatedfinancials startingin 2Q18, LINE recognizedearnings from the strategic businesses (fintech/AI/commerce/mobile),in the form of equity-method gains Source: Company data, Mirae Asset Daewoo Research

Figure 1. LINE shares have been rising sharply since June, giving a boost to NAVER shares
Figure 2. LINE’s annual earnings consensus: Profit to rebound in 2019, amid continued strong revenue growth

Revenue (L) Operating profit (R) Net profit (R)

(18.1=100)

(Wbn) 3,000
(Wbn)
300

120 110 100
90
LINE NAVER

2,500 2,000 1,500 1,000
500
250 200 150 100 50

80 70

0

1/18

2/18

3/18

4/18

5/18

6/18

7/18

2017

2018F

2019F

Source: Thomson Reuters, Mirae Asset Daewoo Research

Note: Allfigures are basedon won-basedvalue

Source: Bloomberg, Mirae Asset Daewoo Research estimates

Mirae Asset Daewoo Research

3

July 27, 2018

NAVER

Stock split; Nstore to merge with NAVER Webtoon

Table 5. Following 5:1 stock split, NAVER to list shareson October 12th; any impact on EV to be marginal

Beforestock split

Afterstock split

Per-sharevalue (W)

500

100

No. oftotalissued shares

32,962,679

164,813,395

General shareholders

’

meeting

Sep. 7^th

Existing share submission Suspension of trading Registry closure
Sep. 10^th– Oct. 10^th
Oct. 8 ,10^th, 11^th(three businessdays)

th

Oct. 11^th– 18^th

Listing ofnew shares

Oct. 12^th

Objective

Expansionofoutstanding shares

Source: Company data, Mirae Asset Daewoo Research

Table 6. NAVER to spin off its Nstore business andmerge it with NAVER Webtoon

NAVER Webtoon
(wholly-owned subsidiary)
Nstore

Decision Value
Spunoff from NAVER
W391,138,693
Set to acquire the spun-offNstorebusiness
W473,594
2017revenue of W34.1bn, and netlossofW36.5bn

Key financials

-

Spin-off/mergerratios Spin-off/merger contractdate Record date
1:0.0000000 [0.0000003(spinoff ratio)×0.0012108(mergerratio)]
Jul. 25^thAug. 10^th

Registry closure

Aug. 13^th– 16^th

Notice of shareholder intent to exercise appraisal rights

Shareholders’ meeting Exercise ofappraisalrights

Effective date of merger Merger registration

Aug. 23^rd– Sep.6^th
Sep. 7^thSep. 8^th– 27^thNov. 1^stNov. 5^th
Increaseinthenumberoforiginal content (webtoons/web novels) users via contentdistributiononVODapps
Major expected benefits

Note: Merger value is basedon Han Kyung AccountingCorp’s data Source: Company data, Mirae Asset Daewoo Research

Figure 4. Cases of content subsidiary spin-off:Shares of relevant Chinese players
Figure 3. Cases of stock-split: SEC’s 50:1 stock split