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19 Dec 2019 CMB International Securities | Equity Research | Sector Update China Game (A-share) Consolidation & Segmentation OUTPERFORM (Maintain) We initiated coverage on China Game (A share) sector, with top picks of Perfect China Internet Sector World (“PW”) and Sanqi Interactive (“Sanqi”). As China game industry has stepped into mature stage, we expect top players to get stronger, and more Sophie Huang opportunities will derive from overseas expansion, selective productions and e- (852) 3900 0889 Sports tailwinds. [email protected] Stepping into mature stage. China game market has stepped into a mature stage (with 11% YoY growth in 1H19), despite moderate recovery in 2019 for Perfect World: 12-mth Price game approvals relaunch. Mobile games, accounting for 65% of total game Performance market, are still on growth track. Game players saw 5.1% YoY growth in 1H19, (RMB) and we view players close to saturation given already-high penetration of 45 002624 CH SHSZ300 (rebased) 61.8%. Looking ahead, 5G, Cloud Game, female gamers and short-video 40 channel marketing could be further drivers. 35 30 The bigger, the stronger. We expect top players to get stronger, with 25 20 advantages of IP resources, channel marketing, data, and self-development 15 ability. As game market growth slows down and Top 2 leaders continue to 10 Dec-18 Mar-19 Jun-19 Sep-19 Dec-19 gain shares, we think it is important for players to explore other segmentations or new opportunities, including overseas market, female games, mini games Source: Bloomberg and e-Sports tailwinds. Sanqi: 12-mth Price Performance Eyes on overseas expansion and quality enhancement. After resumption (RMB) of game licenses approvals, we expect tightening regulations to continue, and 28 002555 CH SHSZ300 (rebased) game players to focus more on selective IPs and healthy & high-quality 26 24 productions. Facing tightening regulation and stiff competition in domestic 22 20 market, major players have put more efforts on overseas expansion and borne 18 initial fruits. China game companies performed well in emerging markets (e.g. 16 14 SEA), with M&A strategy and RPG & SLG as key categories. We believe 12 leaders are still positioned well in global expansion, supported by richer 10 Dec-18 Mar-19 Jun-19 Sep-19 Dec-19 experience, strategic M&A and broader network channels. Source: Bloomberg Initiate with BUY. We initiated coverage of Perfect World (002624 CH) and Sanqi (002555 CH), with TPs of RMB49 and RMB30, representing 26.7x and 26x FY20E P/E. We expect Sanqi to continuously strengthen its position in Chuanqi-themed types development, and deliver ongoing pipeline with category diversification and effective marketing. We expect Perfect World to leverage it valuable IPs to boost mobile momentum, and entertainment segment might see recovery in FY20E. Valuation Table Company Ticker Rating TP Mkt.Cap Currency Price P/E EV/EBITDA (USD mn) FY19E FY20E FY21E FY19E FY20E FY21E Game Tencent 700 HK BUY 420.0 453,672 HKD 378 33.7 28.0 23.1 24.5 20.1 16.8 NetEase NTES US NR NA 38,985 USD 305 19.3 18.8 17.1 14.2 12.8 11.7 Kingsoft 3888 HK NR NA 3,447 HKD 19 NA 71.7 40.7 141.7 28.6 17.6 Perfect World 002624 CH BUY 48.9 7,406 CNY 41 24.9 21.4 18.7 20.2 17.8 16.0 Sanqi Interactive 002555 CH BUY 30.0 7,553 CNY 26 25.4 21.9 19.4 19.6 17.1 14.7 Giant Interactive 002558 CH NR NA 5,177 CNY 18 32.3 27.3 25.6 NA NA NA Average 27.1 23.5 20.8 19.6 17.0 14.8 Source: Company data, Bloomberg PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 1 ACCESS KEY TO OUR REPORTS ON BLOOMBERG: CMBR 19 Dec 2019 Table of contents Investment Thesis .................................................................................... 3 Focus charts ............................................................................................. 4 Industry Overview .................................................................................... 5 China Game: red ocean with TOP2 dominators ..................................................... 5 Trend 1: Tightening regulations to enhance game quality ................................... 7 Trend 2: Go overseas ................................................................................................ 8 Trend 3: eSports tailwind ........................................................................................12 Trend 4: Newsfeed and Short video as new entrants into publishing market ..12 Sanqi Interactive (002555 CH) ............................................................... 13 Investment Summary ............................................................................. 14 Leveraging chuanqi-themed MMPRPGs to strengthen position ........................14 Category diversification to deliver ongoing pipeline...........................................15 Stepping-up overseas expansion to tap into broader market ............................17 Financial Analysis .................................................................................. 19 Revenue Breakdown ...............................................................................................19 Income Statement ....................................................................................................20 Balance Sheet ..........................................................................................................21 Cash Flow and Working Capital .............................................................................22 Valuation ................................................................................................. 23 Financial Summary ................................................................................ 25 Perfect World (002624 CH) .................................................................... 26 Investment Summary ............................................................................. 27 Widely-anticipated IP reserve to deliver ongoing pipeline .................................27 Rich game portfolio with great monetization potential .......................................29 Entertainment: solid pipeline with high-quality products ...................................31 Financial Analysis .................................................................................. 33 Revenue Breakdown ...............................................................................................33 Income Statement ....................................................................................................34 Balance Sheet ..........................................................................................................35 Cash Flow and Working Capital .............................................................................36 Valuation ................................................................................................. 37 Financial Summary ................................................................................ 39 PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 2 19 Dec 2019 Investment Thesis Stepping into mature stage. China game market has stepped into a mature stage (with 11% YoY growth in 1H19), despite moderate recovery in 2019 for game approvals relaunch. Mobile games, accounting for 65% of total game market, are still on growth track. Game players saw 5.1% YoY growth in 1H19, and we view players close to saturation given already-high penetration of 61.8%. Looking ahead, 5G, Cloud games, female gamers and short-video channel marketing could be further drivers. The bigger, the stronger. We expect top players to get stronger, with advantages of IP resources, channel marketing, data, and self-development ability. As game market growth slows down and Top 2 leaders continue to gain shares, we think it is important for players to explore other segmentations or new opportunities, including overseas market, female games, mini games and e-Sports tailwinds. Eyes on overseas expansion and quality enhancement. After resumption of game licenses approvals, we expect tightening regulations to continue, and game players to focus more on selective IPs and healthy & high-quality productions. Facing tightening regulation and stiff competition in domestic market, major players have put more efforts on overseas expansion and have borne initial fruits. China game companies performed well in emerging markets (e.g. SEA), with M&A strategy and RPG & SLG as key categories. We believe leaders are still positioned well in global expansion, supported by richer experience, strategic M&A and broader network channels. Initiate with BUY. We initiated coverage of Perfect World (002624 CH) and Sanqi (002555 CH), with TPs of RMB49 and RMB30, representing 26.7x and 26x FY20E P/E. We expect Sanqi to continuously strengthen its position in Chuanqi-themed types development, and deliver ongoing pipeline with category diversification and effective marketing. We expect Perfect World to leverage it valuable IPs to boost mobile momentum, and entertainment segment might see recovery in FY20E. PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 3 19 Dec 2019 Focus charts Figure 1: China games in mature stage Figure 2: Mobile games still on growth track 250 (RMB bn) 80% 160 (RMB bn) 350% 70% 140 300% 200 60% 120 250% 150 50% 100 200% 40% 80 150% 100 30% 60 100% 20% 40 50 10% 20 50% 0 0% 0 0% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 1H19 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 1H19 Market size YoY growth Market size YoY growth Source: CNG, CMBIS