China Information Technology 24 June 2016
NetEase (NTES US) NetEase
Target price: USD190.00 Share price (23 Jun): USD172.91 | Up/downside: +9.9%
Initiation: raising its game John Choi (852) 2773 8730 Strong mobile-game pipeline and Overwatch point to revenue upside [email protected] Prudent management warrants valuation premium, in our view Alex Liu (852) 2848 4976 Initiating at Outperform (2) with 12-month target price of USD190 [email protected]
Investment case: We initiate coverage of NetEase, the second-largest Share price performance online-game platform by revenue in China (after Tencent), and one of the (USD) (%) most established China Internet players, with an Outperform (2) call. We 185 130 believe NetEase has pursued a sound catch-up strategy in the mobile- 164 115 game market with its launch of 2 popular titles, FWJ Mobile and WWJ 143 100 121 85
Mobile, in 2015. 100 70 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 We see upside for the stock following its 20% rise in the past 3 months (vs. NetEase (LHS) Relative to S&P 500 Index (RHS) 5% for the MSCI China index) and recommend that investors position themselves ahead of NetEase’s 2Q16 results (August 2016). We are 12-month range 107.14-184.73 upbeat on NetEase’s 2H16 mobile-game pipeline and potential revenue Market cap (USDbn) 22.75 upside from Overwatch, the hit PC game it has licensed from Blizzard. The 3m avg daily turnover (USDm) 79.98 Shares outstanding (m) 132 Bloomberg consensus forecast calls for only 12% HoH revenue growth for Major shareholder William Ding (44.0%) NetEase in 2H16, which we think understates the incremental revenue to come from the mobile-game pipeline. Indeed, our 2016-18 earnings Financial summary (CNY) forecasts are 14-15% above the market’s. Year to 31 Dec 16E 17E 18E Revenue (m) 36,298 44,079 51,712 Operating profit (m) 11,972 13,568 15,376 As for NetEase’s ecommerce business, despite near-term regulatory Net profit (m) 11,277 12,826 14,520 headwinds, the company has deep pockets to gain ground in the Core EPS (fully-diluted) 85.065 96.750 109.528 cross-border ecommerce market in China. On the other hand, EPS change (%) 51.6 13.7 13.2 Daiwa vs Cons. EPS (%) 14.3 15.3 14.3 management’s CNY50-100bn long-term annual ecommerce GMV target PER (x) 13.4 11.8 10.4 seems aggressive. Dividend yield (%) 1.7 2.0 2.2 DPS 19.834 22.424 25.273 PBR (x) 3.9 3.1 2.5 We consider NetEase’s management to be one of the most prudent EV/EBITDA (x) 8.8 7.1 5.7 among its China Internet peers, given its capital market-friendly stance (it ROE (%) 33.5 29.8 27.1 is the only large-cap China Internet stock to offer a quarterly dividend). Its Source: FactSet, Daiwa forecasts track record of solid corporate governance and 11-year listing history on the NASDAQ also argue for a valuation premium, in our view.
Catalysts: We would see the following as share-price catalysts: 1) a continuation of the high rankings for FWJ and WWJ, in terms of gross revenue, 2) improved rankings for newly launched mobile games, including New Ghost and FWJ: Warrior, and 3) positive news flow for Overwatch.
Valuation: We have a 12-month TP of USD190, based on a target PER of 14x applied to the average of our 2016-17E non-GAAP EPS. Our target multiple is in line with NetEase’s average past-10-year forward 12-month PER. Hence, we view the stock’s 11x 2017E PER as attractive, backed by our forecast 14% earnings CAGR for 2016-18.
Risks: The main risks include: 1) slower-than-expected mobile-game roll- outs, 2) faster-than-expected declines in revenue from its legacy PC-game titles, and 3) regulatory uncertainty over NetEase’s Kaola platforms.
See important disclosures, including any required research certifications, beginning on page 44
NetEase (NTES US): 24 June 2016
Table of contents
Initiation: raising its game ...... 6 Executive summary ...... 6 Mobile game: assessing revenue sustainability ...... 7 Success of FWJ and WWJ: a recap ...... 7 Mobile game pipeline also looks strong ...... 8 The bigger question: is online game a hit-or-miss business after all? ...... 10 PC game: stable yet flattish revenue growth ...... 16 Maturing in-house titles; licensed titles stabilizing ...... 16 PC game pipeline looks thin with the exception of MineCraft ...... 20 Booming PC game broadcasting sector: NetEase is a major beneficiary ...... 20 Ecommerce: where’s the sky? ...... 22 Kaola: NetEase’s cross-border ecommerce venture ...... 22 Yanxuan: NetEase’s private label ecommerce business ...... 25 Advertising: leading mobile products with monetisation ramping up ...... 28 NetEase Music (网易云音乐) ...... 28 NetEase News (网易新闻手机版) ...... 29 NetEase Portal & Email ...... 30 Financial Analysis & valuation ...... 31 Financial forecasts ...... 31 Valuation ...... 35 PER-based target price of USD200 ...... 35 Risks ...... 37 Appendix 1: company background ...... 39 Appendix 2: online game industry landscape ...... 41
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NetEase (NTES US): 24 June 2016
How do we justify our view? Growth outlook Valuation Earnings revisions
Growth outlook NetEase: revenue growth forecasts
We forecast NetEase’s total revenue to increase by 59% CNYm 95% YoY to CNY36.3bn in 2016 and 21% YoY to CNY44.1bn in 60,000 100% 2017, backed by solid revenue performance from 50,000 51,712 80% NetEase’s PC-game business (with the help of the newly 59% 40,000 44,079 launched Overwatch) and healthy mobile-game revenue 60% performance given the company’s strong pipeline. 30,000 36,298 27% 40% 20,000 21% 22,803 17% 12% 12% As for NetEase’s ecommerce business, we continue to 10,000 20% expect robust revenue growth as we believe the company 8,201 9,196 11,713 0 0% will start to consolidate the market despite some regulatory 2012 2013 2014 2015 2016E 2017E 2018E uncertainties currently. Netease total revenue YoY growth %
Source: Company, Daiwa forecasts
Valuation NetEase: past-10-year forward 12-month PER NetEase has traded at 9-16x forward 12-month PER 25 over the past 10 years, in line with global game 23 platforms but lower than China large-cap Internet 21 19 +2 SD = 18.1 companies such as Tencent and Baidu, likely due to 17 +1 SD = 15.8 market concerns over the revenue sustainability of 15 10 yr average = 13.5 NetEase’s popular PC games. 13 11 -1 SD = 11.2 9 The stock has had a significant rerating since 2015, after 7 -2 SD = 8.8 NetEase launched Fantasy Westward Journey Mobile. 5
We believe NetEase’s expanded position in the PC and
Jun-10 Jun-11 Jun-06 Jun-07 Jun-08 Jun-09 Jun-12 Jun-13 Jun-14 Jun-15
Dec-06 Dec-07 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 mobile-game industries merits a premium valuation over Dec-08 the stock’s historical average. Source: Bloomberg
Earnings revisions NetEase: consensus earnings forecasts The Bloomberg consensus 2016 and 2017 non-GAAP CNY earnings forecasts have been steadily increasing over the 90 80 past year. The upward revisions stem mainly from the 70 strong revenue performance of NetEase’s mobile-game 60 and ecommerce businesses, as well as margin expansion 50 40 resulting from a more rational competitive landscape for 30 the cross-border ecommerce sector in China. 20 10
Our 2016-18 non-GAAP earnings forecasts are 14-15% 0
Jul-15
Oct-15 Apr-16
higher than the consensus, likely as the market is being Apr-15
Jun-15 Jan-16
Feb-16 Feb-15 Mar-15 Mar-16
Nov-15 Dec-15
Aug-15 Sep-15
May-15 May-16 unduly conservative on NetEase’s expected mobile-game non-GAAP EPS - 2016 non-GAAP EPS - 2017 revenue growth in 2H16 and 2017. Source: Bloomberg
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Financial summary Key assumptions Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Mobile game revenue (CNYm) 0 0 40 759 7,900 18,440 23,007 27,158 Mobile game revenue YoY growth % 0.0 0.0 0.0 1,810.3 940.5 133.4 24.8 18.0 Ecommerce revenue YoY growth % 51.5 90.9 47.8 220.1 235.7 66.1 45.0 30.0 Ecommerce business gross margin % (9.0) 0.7 (6.7) 42.7 7.9 13.3 14.0 15.0
Profit and loss (CNYm) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Online game 6,449 7,201 7,864 9,266 17,314 27,851 32,405 36,950 Ecommerce, email and others 122 233 344 1,102 3,699 6,146 8,912 11,585 Other Revenue 720 767 987 1,345 1,789 2,302 2,762 3,177 Total Revenue 7,291 8,201 9,196 11,713 22,803 36,298 44,079 51,712 Other income 0 0 0 0 0 0 0 0 COGS (2,372) (2,578) (2,479) (3,262) (9,399) (15,631) (20,046) (24,235) SG&A (1,129) (1,193) (1,443) (2,363) (3,973) (5,740) (6,876) (7,964) Other op.expenses (465) (718) (922) (1,323) (2,159) (2,955) (3,588) (4,137) Operating profit 3,323 3,712 4,353 4,765 7,272 11,972 13,568 15,376 Net-interest inc./(exp.) 258 424 506 602 597 527 540 550 Assoc/forex/extraord./others 34 143 117 92 241 173 200 200 Pre-tax profit 3,616 4,278 4,976 5,458 8,110 12,672 14,308 16,126 Tax (393) (692) (531) (663) (1,273) (2,218) (2,504) (2,822) Min. int./pref. div./others 11 51 (1) (39) (102) (101) (100) (100) Net profit (reported) 3,234 3,637 4,444 4,757 6,735 10,353 11,704 13,204 Net profit (adjusted) 3,356 3,840 4,750 5,106 7,420 11,277 12,826 14,520 EPS (reported)(CNY) 24.760 27.702 34.206 36.427 51.266 78.670 88.936 100.331 EPS (adjusted)(CNY) 25.695 29.248 36.564 39.102 56.476 85.689 97.460 110.331 EPS (adjusted fully-diluted)(CNY) 25.607 29.198 36.469 38.952 56.120 85.065 96.750 109.528 DPS (CNY) 0.000 6.300 8.657 9.038 12.805 19.834 22.424 25.273 EBIT 3,445 3,915 4,659 5,114 7,957 12,896 14,690 16,692 EBITDA 3,739 4,148 4,817 5,289 8,139 13,259 15,131 17,209
Cash flow (CNYm) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Profit before tax 3,616 4,278 4,976 5,458 8,110 12,672 14,308 16,126 Depreciation and amortisation 293 234 158 174 182 363 441 517 Tax paid (393) (692) (531) (663) (1,273) (2,218) (2,504) (2,822) Change in working capital 436 180 645 869 443 (784) (337) (890) Other operational CF items 121 224 (13) 34 614 1,531 1,804 2,112 Cash flow from operations 4,073 4,224 5,236 5,873 8,077 11,563 13,713 15,043 Capex (411) (178) (215) (617) (1,029) (1,379) (1,675) (1,965) Net (acquisitions)/disposals (39) 0 (200) (20) (188) 0 0 0 Other investing CF items (2,758) (4,276) (5,038) (3,883) (1,320) 0 0 0 Cash flow from investing (3,208) (4,454) (5,453) (4,520) (2,537) (1,379) (1,675) (1,965) Change in debt 0 0 0 0 0 0 0 0 Net share issues/(repurchases) 0 (415) (107) 0 (132) 0 0 0 Dividends paid 0 0 (815) (1,983) (1,468) (2,611) (2,951) (3,326) Other financing CF items 74 25 1,009 1,205 (33) 0 0 0 Cash flow from financing 74 (390) 87 (778) (1,633) (2,611) (2,951) (3,326) Forex effect/others (9) (4) (2) (11) 142 0 0 0 Change in cash 930 (624) (132) 563 4,050 7,574 9,087 9,752 Free cash flow 3,662 4,046 5,021 5,256 7,048 10,184 12,038 13,078 Source: FactSet, Daiwa forecasts
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Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Cash & short-term investment 13,232 16,333 21,122 25,205 27,871 35,448 44,535 54,288 Inventory 0 0 0 28 818 1,536 2,228 2,896 Accounts receivable 230 269 403 873 2,614 4,161 5,053 5,928 Other current assets 1,012 1,266 1,274 1,626 3,106 4,701 5,621 6,523 Total current assets 14,474 17,869 22,798 27,733 34,409 45,848 57,437 69,636 Fixed assets 860 827 883 1,359 2,331 3,347 4,581 6,028 Goodwill & intangibles 0 0 0 0 0 0 0 0 Other non-current assets 110 583 865 1,263 4,418 4,418 4,418 4,418 Total assets 15,445 19,278 24,546 30,355 41,157 53,612 66,436 80,082 Short-term debt 0 0 976 2,050 2,273 2,273 2,273 2,273 Accounts payable 134 158 219 411 701 1,115 1,354 1,589 Other current liabilities 2,148 3,419 3,038 4,296 8,694 11,963 14,573 16,690 Total current liabilities 2,283 3,577 4,233 6,756 11,667 15,351 18,200 20,551 Long-term debt 0 0 0 0 0 0 0 0 Other non-current liabilities 64 100 145 106 166 166 166 166 Total liabilities 2,346 3,676 4,378 6,863 11,834 15,517 18,366 20,718 Share capital 1,005 737 858 1,363 1,710 2,634 3,755 5,072 Reserves/R.E./others 12,122 14,944 19,388 22,161 27,530 35,374 44,227 54,205 Shareholders' equity 13,127 15,681 20,245 23,524 29,240 38,007 47,982 59,277 Minority interests (28) (79) (77) (32) 84 87 87 87 Total equity & liabilities 15,445 19,278 24,546 30,355 41,157 53,612 66,436 80,082 EV 136,428 133,275 129,465 126,500 124,173 116,600 107,513 97,760 Net debt/(cash) (13,232) (16,333) (20,146) (23,156) (25,598) (33,176) (42,263) (52,015) BVPS (CNY) 100.494 119.419 155.834 179.129 222.570 288.799 364.594 450.412
Key ratios (%) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales (YoY) n.a. 12.5 12.1 27.4 94.7 59.2 21.4 17.3 EBITDA (YoY) n.a. 10.9 16.1 9.8 53.9 62.9 14.1 13.7 Operating profit (YoY) n.a. 13.6 19.0 9.8 55.6 62.1 13.9 13.6 Net profit (YoY) n.a. 14.4 23.7 7.5 45.3 52.0 13.7 13.2 Core EPS (fully-diluted) (YoY) n.a. 14.0 24.9 6.8 44.1 51.6 13.7 13.2 Gross-profit margin 67.5 68.6 73.0 72.2 58.8 56.9 54.5 53.1 EBITDA margin 51.3 50.6 52.4 45.2 35.7 36.5 34.3 33.3 Operating-profit margin 47.3 47.7 50.7 43.7 34.9 35.5 33.3 32.3 Net profit margin 46.0 46.8 51.7 43.6 32.5 31.1 29.1 28.1 ROAE 51.1 26.7 26.4 23.4 28.2 33.5 29.8 27.1 ROAA 43.5 22.1 21.7 18.6 20.8 23.8 21.4 19.8 ROCE 52.6 27.3 25.4 21.9 27.9 35.8 32.4 29.8 ROIC (2,223.7) (719.3) (1,095.5) 2,336.9 301.9 228.5 208.7 192.8 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 10.9 16.2 10.7 12.1 15.7 17.5 17.5 17.5 Accounts receivable (days) 5.8 11.1 13.3 19.9 27.9 34.1 38.2 38.8 Current ratio (x) 6.3 5.0 5.4 4.1 2.9 3.0 3.2 3.4 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 0.0 22.7 25.3 24.8 25.0 25.2 25.2 25.2 Free cash flow yield 2.4 2.7 3.4 3.5 4.7 6.8 8.0 8.7 Source: FactSet, Daiwa forecasts
Company profile
Founded in 1997 by William Ding, NetEase is one of the oldest internet companies in China and the second largest online game platform in China (ranking before Tencent).
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NetEase (NTES US): 24 June 2016
Initiation: raising its game
“There are only two things in this world that can truly make a person happy – one is dining, the other is gaming.” “世上只有两件事可以让人真正地感到快乐，一个是吃饭，另一个就是游戏。”
- William Ding Lei, founder & CEO of NetEase
Executive summary Founded in 1997, NetEase is one of the oldest Internet companies in China. It has a broad range of service offerings, including online portals, online news, search, email, online music and online games. Online games are now the company’s major revenue contributor (76% of total revenue in 1Q16), making NetEase the second-largest online-game player by revenue in China after Tencent (700 HK, HKD176, Buy [1]).
Key question 1: is NetEase’s mobile-game revenue growth sustainable? Mobile-game pipeline We expect healthy yet stable revenue growth from NetEase’s 2 core mobile-game titles, looks strong Fantasy Westward Journey Mobile and Westward Journey Mobile, heading into 2H16. New titles such as New Ghost have performed solidly so far, in terms of revenue, and we believe the 2H16 mobile-game pipeline (both in-house and licensed) is strong. We see large integrated online-game platforms such as NetEase having a much higher “hit rate” than smaller developers for new game launches. Finally, we foresee several trends, including a shift in genre towards hard-core games and a greater emphasis on existing intellectual property (IP), leading to some smaller game developers exiting the market in China. Hence, we consider NetEase to be a major beneficiary of the ongoing consolidation of the mobile-game industry.
Key question 2: how is NetEase’s PC-game revenue outlook? Maturing in-house PC We see key in-house titles (such as Fantasy Westward Journey PC) maturing and titles; Overwatch could expect a further deceleration in their revenue contribution. surprise on the upside Licensed titles from Blizzard (such as Hearthstone) should continue to perform well, while the newly launched Overwatch (also licensed from Blizzard), could yield a revenue upside surprise.
Key question 3: how should the market view NetEase’s cross-border ecommerce business? Cautious on near-term We believe recently announced regulations governing cross-border ecommerce have sentiment given lack of created confusion among consumers and industry participants, which has hit retailer regulatory visibility sentiment and near-term demand. However, in the long run, even allowing for the higher tax rate and tighter controls of the availability of product SKUs, we believe end-demand for cross-border ecommerce will remain healthy. On a long-term basis, we expect NetEase to expand its business into non-cross-border ecommerce (we see its recent private-label initiative as a case of testing the water), bringing it into direct competition with the likes of Alibaba and JD.com. The company’s CNY50- 100bn annual direct sales GMV target by 2020 seems aggressive, in our view.
Key question 4: is now a good time to buy the stock? Upside potential to We see upside to the market’s 2016 revenue forecast, which seems to assume little consensus 2016-18 contribution from new mobile games in 2H16 and minimal YoY growth for the revenue forecasts; solid ecommerce business. Also, the market does not appear to have incorporated the good management track performance of Overwatch since its launch in May 2016, which we believe could drive record merits valuation up NetEase’s PC-game revenue by 10%-plus in 2Q16. premium, in our view NetEase’s management is one of the most prudent and market-friendly among the China Internet players (it is the only large-cap China Internet stock to pay a quarterly dividend), which deserves a valuation premium, in our view.
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Mobile-game: assessing revenue sustainability
Key takeaways Revenue from NetEase’s current cash-cow game titles, FWJ Mobile and WWJ Mobile, is likely to be stable HoH in 2H16. The company’s mobile game pipeline in 2016-17 looks strong. We believe large online-game players such as NetEase are much less affected by volatility in the revenue performance of any single game than many investors believe.
NetEase was a relative latecomer to mobile games, entering the market only in 2014. However, it has quickly replicated its success in PC games in the mobile-game business. As the charts below show, NetEase trailed Tencent in mobile-game monetisation for almost 2 years but rapidly ramped up its mobile-game revenue from 2Q15. Mobile games accounted for a full 63% of NetEase’s online-game revenue in 1Q16 (and 46% of Tencent’s mobile-game revenue).
NetEase: mobile-game revenue vs. PC-game revenue NetEase: comparison with Tencent on mobile-game revenue CNYm CNYm 7,000 14,000 3,789 3,789 6,000 12,000 2,763 3,137 3,137 5,000 10,000 2,763 4,000 8,000 1,353 1,353 3,000 379 647 6,000 647 61 110 209 379 2,000 4,000 110 209 61 1,000 2,000 1,972 2,094 2,113 2,328 2,294 2,304 2,450 2,366 2,226 1,800 3,000 2,600 3,800 4,400 4,500 5,300 7,100 8,200 0 0 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Netease PC game revenue Netease mobile game revenue Tencent mobile game revenue Netease mobile game revenue
Source: Company, Daiwa estimates Source: Company, Daiwa estimates
Success of FWJ Mobile and WWJ Mobile: a recap NetEase’s mobile-game revenue has come mainly from 2 major games, Fantasy Westward Journey and Wide Westward Journey, which are both derived from the popular NetEase’s Westward Journey PC-game series. We estimate the 2 games contributed over 90% of NetEase’s mobile-game revenue in 1Q16. We look at the 2 games in detail below:
Fantasy Westward Journey (FWJ Mobile, 梦幻西游手机版) Genre: Real-time MMORPG (massive multi-player online role-playing game) Launch date: 30 March 2015 Ranking: iOS App Store No. 1 top grossing game in China since April 2015 Monetisation model: free-to-play, in-game item-sale monetisation model
FWJ Mobile, the mobile version of NetEase’s popular Fantasy Westward Journey PC game, is by far the company’s most successful mobile game in terms of both revenue and gamer base. NetEase has replicated the PC version’s social interaction features in the mobile version, which we believe has greatly enhanced the game’s engagement level. Also, NetEase has been able to migrate many of the existing PC-version gamers to the mobile version while also expanding the base of gamers to new non-PC players. These efforts have made FWJ Mobile China’s top-grossing iOS game since April 2015, and we estimate the game currently brings in gross revenue of CNY20-23m a day.
Westward Journey (WWJ Mobile, 大话西游手机版) Genre: Real-time MMORPG Launch date: 21 August 2015 Ranking: iOS App Store No. 2 top grossing game in China since September 2015 Revenue model: free-to-play, in-game item-sale monetisation model
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NetEase (NTES US): 24 June 2016
WWJ Mobile, similar to FWJ Mobile, is based upon NetEase’s in-house legacy PC-game title, Westward Journey. The game is more action-oriented than FWJ Mobile, and currently has a gross revenue run rate of CNY15-18m per day, on our estimates.
NetEase: screenshot of FWJ NetEase: screenshot of WWJ
Source: Company Source: Company
Mobile -game pipeline looks strong In-house games: executing IP-based strategy Following the success of FWJ Mobile and WWJ Mobile, NetEase is executing a strategy of bringing popular in-house PC-game franchises to mobile devices. We show below some of the mobile games in its pipeline, along with our initial take on these titles. NetEase’s mobile-game pipeline for the next 1-2 years looks strong, as it revolves around the hard-core RPG/Action genres, which we believe NetEase has accumulated deep operating insight into.
The New Ghost (倩女幽魂手机版) Genre: Real-time MMORPG Launch date: 21 April 2016 Revenue model: free-to-play, in-game item-sale monetisation model
Our comment: The New Ghost has shown a healthy performance since its launch, and is currently the No. 7 top-grossing game in the iOS App Store in China. We estimate the game has a daily gross revenue run rate of around CNY6-10m, and hence it could bring CNY300-400m of incremental revenue to NetEase in 2Q16.
Fantasy Westward Journey: Warrior (梦幻西游无双版) Genre: Real-time action MMORPG Launch date: 26 May 2016 Revenue model: free-to-play, in-game item-sale monetisation model
Our comment: Fantasy Westward Journey: Warrior is a derivative of FWJ Mobile which focuses more on battle and action, as opposed to character development. The game is currently the No. 49 top-grossing game in the iOS App Store in China.
NetEase: screenshot of FWJ: Warrior NetEase: screenshot of New Ghost
Source: Company Source: Company
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Fantasy Westward Journey: Connect (梦幻西游互通版) Genre: Real-time MMORPG Expected launch: 30 June 2016 (invitation-only closed testing) Revenue model: time-based and in-game item-sale monetisation model
Our comment: NetEase has announced plans to launch FWJ Connect, a new mobile game using the same log-in credentials as FWJ PC, which allows gamers to access the game in “omniscreen” fashion (ie, playing a single game on different devices, or “screens”). Based on the testing screenshots we have seen, FWJ Connect closely resembles the PC version (unlike FWJ Mobile, which is more akin to a remake of FWJ). FWJ Connect will be NetEase’s first mobile game with a time-based monetisation model. We believe FWJ Connect has the potential to be NetEase’s next major hit title in 2H16, and its success could ultimately help to extend the life cycle of FWJ PC (even allowing for possible cannibalisation of the PC version of FWJ in the short term). Also, we expect NetEase to extend this strategy of “connecting PC and mobile games” to its other games in the future.
NetEase: comparison of major FWJ-derived games (mobile and PC) English name Chinese name Short name PC/Mobile Launch date Ranking Notes Monetisation model Fantasy Westward FWJ PC 梦幻西游 PC March 2003 Top 10 PC game in China Time-based & item- Journey PC based Fantasy Westward FWJ Mobile 梦幻西游手游 Mobile March 2015 No. 1 top-grossing mobile Native mobile game derived Item-based Journey Mobile game in China from FWJ PC Fantasy Westward FWJ: Warrior 梦幻西游手游无双版 Mobile May Native mobile game derived Item-based Journey: Warrior 2016 from FWJ Mobile Fantasy Westward FWJ: Pocket 梦幻西游口袋版 Mobile March 2014 Mobile version of FWJ PC Item-based (no time- Journey: Pocket with limited functionality; based charging shares log-in with FWJ PC required) Fantasy Westward FWJ: Connect 梦幻西游互通版 Mobile Expected June Upgraded version of FWJ: Time-based and item- Journey: Connect 2016 Pocket; same gameplay as based FWJ PC, with same log-in
Source: Company, Daiwa compiled
Tianxia (天下 3D) Genre: Real-time MMORPG Expected launch: 3Q16 Revenue model: free-to-play, in-game item-sale monetisation model
Our comment: Tianxia is derived from NetEase’s popular in-house PC game, Tianxian. Tianxia (mobile version), and is currently in closed beta testing.
Datang (大唐无双) Genre: Real-time MMORPG Expected launch: 3Q16 Revenue model: free-to-play, in-game item-sale monetisation model
Our comment: Datang is derived from NetEase’s popular in-house PC game, Datang. Datang (mobile version), and is currently in closed beta testing.
Onmyouji (阴阳师) Genre: 3D Card & Action Expected launch: June 2016 Revenue model: free-to-play, in-game item-sale monetisation model
Our comment: Onmyouji is derived from a popular Japanese folk story and marks NetEase’s first venture into the Japanese mobile-game market. Onmyouji will include turn- based action and card battling, and will feature popular Japanese character voices (CV).
Demon Seals (镇魔曲) Genre: 2.5D MMORPG Expected launch: 4Q16 Revenue model: free-to-play, in-game item-sale monetisation model
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Our comment: Demon Seals Mobile is derived from NetEase’s popular in-house PC game, Demon Seals, which was launched on 16 April 2015.
Legend of Chu Liu Xiang (楚留香传奇) Genre: 3D MMORPG Expected launch: 1H17 Revenue model: free-to-play, in-game item-sale monetisation model
Our comment: Legend of Chu Liu Xiang is the first mobile game to come out of NetEase’s acquisition of the rights to adapt 5 popular martial art novels by Gu Long. NetEase plans to launch the remaining 4 titles from 2017 onward.
Licensed titles: expanding the range of genres NetEase seems to be more open to licensing mobile-game titles, whereas in the PC-game segment it focuses largely on in-house title development. Although we believe in-house games are likely to remain the focus of the company’s R&D, licensed games represent a way to expand the range of genres offered by NetEase at a much lower upfront cost.
Audition (劲舞团) Genre: Dance Launch: 24 June; limited testing starts on the Android platform Revenue model: free-to-play, in-game item-sale monetisation model
Our comment: Audition is the most popular dance-genre PC game in China. The PC version is currently operated by Jiuyou, but NetEase has an exclusive licence from developer T3 to operate a mobile version of Audition in China. We see great potential in this game as: 1) the dance genre in general has a large user base, as evidenced by the success of the PC version of Audition and Tencent’s casual dance game DA (节奏大师), 2) there is currently no direct competition for the mobile version of Audition, 3) and Audition has a good track record of monetisation (over CNY200m in annual revenue despite having been up and running in China for 10 years).
Minecraft (我的世界) Genre: Real-time sandbox Expected launch: 2H16 Revenue model: free-to-play, in-game item-sale monetisation model
Our comment: On 20 May 2016, NetEase announced it had secured the exclusive rights to roll out PC and mobile versions of Minecraft in China. We like the extendibility of Minecraft and are positive on its life cycle (also see page 20). Of particular note, NetEase will abandon the pay-up-front model used in other markets for Minecraft in favour of a free-to- play model with in-game item monetisation.
The big question: are online games a hit-or-miss business after all? The market has long been concerned about the life cycles of online games. Many investors seem to have taken the view that online games are similar to movies and other digital content in being a hit-or-miss business. By extension, the concern is that revenue visibility is limited and therefore related stocks warrant valuation discounts compared with other Internet companies.
But are online games really a hit-or-miss business?
Yes, for standalone game developers (CP). Game development is a high-risk business given the need for upfront R&D investment along with limited visibility on future revenue.
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No, for integrated game platforms with development, distribution and operating capabilities. We believe that large game platforms (including NetEase and Tencent in China, and Activision Blizzard and EA globally) which can supplement their strong in- house development capabilities by sourcing new licensed titles have much higher “hit rates” with new game launches than smaller players.
In addition, when comparing online-game platforms with movie studios, the business models initially seem quite similar: hefty upfront investment and low revenue visibility. But while movie production is a classic example of a hit-or-miss business, the large and integrated online-game platforms appear more resilient in terms of revenue volatility:
1. Online games usually go through multiple rounds of testing before official launch. During testing, modifications and even wholesale changes are made to the gameplay and user experience in a bid to ensure a successful launch. While movie studios regularly conduct test screenings where they monitor audience reactions to early cuts of movies, they are effectively limited to fine-tuning the content, as by then the filming process is largely complete. 2. Once a game receives good feedback and accumulates a large user base in the market, game developers can roll out new chapters or episodes at relatively low cost. This new content helps to extend the life cycle of the game. The extendibility of a game is therefore much greater than a movie, since the marginal cost of making a movie sequel does not decrease materially. 3. The lifetime value of a gamer is significantly higher than that of a movie-goer, as game developers typically get recurring revenue streams over a considerable period whereas movie studios’ revenue is largely one-off in nature.
Lessons from history: PC-game market is highly concentrated One phenomenon we have observed is that online-game revenue tends to flow largely from just a few key titles released by a few big companies. A key title can sometimes contribute more than 30% of a company’s revenue stream. In extreme cases, the revenue concentration in a single game title can exceed 90% (before NetEase signed its licensing agreement with Blizzard, The World of Warcraft accounted for 95% of the total revenue of its former Chinese operator, The 9, back in 2006-09).
We attribute this concentrated market structure to the following factors: Hardcore genre games (mobile and PC) tend to offer greater monetisation potential and have longer life-cycle compared with other genres. With unit game operating and development costs continuing to rise, the entry barriers to the hardcore game segment are becoming too high for small developers, leaving only a handful of hardcore game suppliers in the market. Online games are evolving from being a pure leisure activity into a virtual social platform. Gamers, through the avatar or character that they use within a game, are living and experiencing life inside a game’s worlds. And the shared memories and strong social ties that are being forged within games look to be increasing user stickiness. In some respects, the PC-game community served as a kind of Facebook before there was a Facebook.
By relying solely on in-house developed games, the smaller players are more at risk of single-game delays, whereas the large platforms can offset any delays in the launch of in-house games by operating more licensed titles.
Mobile games: revenue concentration has become the new norm We have seen a similar game/developer concentration phenomenon in China’s mobile- game market. According to CNC (a third-party consultancy firm), and our own estimates, the top-10 mobile games by revenue in China contributed 40% of total revenue in the mobile-game market in 2015 (the top 3 games alone accounted for over 20% of the total revenue).
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China: mobile-game ranking by revenue (2015) The power law effect, or 4,890 (CNYm) Top 1 game revenue ≈ 4.8x top 10 game revenue the “20:80 rule”, is clear Top 5 games revenue combined ≈ top 6-20 game revenue combined to see in mobile Top 10 games revenue combined ≈ 40% of total mobile game market 2,640 2,520 1,905 1,750 1,550 1,500 1,265 1,120 1,015 1,000 785 665 600 585 550 500 500 380 360 220
Source: CNC, IDC, Daiwa estimates
Mobile-game revenue is not just concentrated in only a few titles; to an ever greater extent, it is also concentrated among a few major game operators. In 2015, NetEase’s FWJ and WWJ Mobile together helped NetEase claim around 15% of the China mobile- game market in terms of revenue. The No. 1 player, Tencent, accounted for more than 40% of the market in the same year. Hence, NetEase and Tencent together accounted for more than half of China’s mobile-game market in 2015, which is not dissimilar to the consolidated structure of the PC-game industry, where the 2 companies account for more than 70% of the market.
Mobile discovery bottleneck favours companies with distribution power As shown below, the concentration of mobile gamers’ on a small number of games is a global phenomenon. For example, in Japan, the 2 top-grossing mobile games have held those positions from July 2014 to April 2016. In the US, Clash of Clans (COC), Clash Royale (a derivative of COC) and Game of War-fire Age have occupied the top spots since December 2014.
Global: iOS top 2 ranking in terms of grossing in Japan, Korea, the US and China Month Japan Korea US China 1st 2nd 1st 2nd 1st 2nd 1st 2nd
Jun-14 COC Candy Crush Saga Dot Arena Thunder Fighter Jul-14 Puzzle & Dragon Monster Strike COC Candy Crush Saga Dot Arena Thunder Fighter Aug-14 Puzzle & Dragon Monster Strike COC Candy Crush Saga Dot Arena Thunder Fighter Sep-14 Puzzle & Dragon Monster Strike Everybody's Marble COC COC Candy Crush Saga Dot Arena Thunder Fighter Oct-14 Puzzle & Dragon Monster Strike COC Everybody's marble COC Candy Crush Saga Dot Arena COC Nov-14 Puzzle & Dragon Monster Strike COC Seven Knights COC Candy Crush Saga Blade of Three Kingdoms West Arena Dec-14 Puzzle & Dragon Monster Strike COC Seven Knights COC Game of war-fire age XianJianQiXiaZhuan Shenwu Jan-15 Puzzle & Dragon Monster Strike COC Seven Knights COC Game of war-fire age I am MT 2 We Fire Feb-15 Puzzle & Dragon Monster Strike COC Seven Knights COC Game of war-fire age We Fire Shenwu Mar-15 Puzzle & Dragon Monster Strike COC Raven COC Game of war-fire age Shenwu We fire Apr-15 Puzzle & Dragon Monster Strike Raven COC COC Game of war-fire age Fantasy Westward Journey We fire May-15 Monster Strike Puzzle & Dragon Raven MU Miracle COC Game of war-fire age Fantasy Westward Journey We fire Jun-15 Monster Strike Puzzle & Dragon Raven MU Miracle COC Game of war-fire age Fantasy Westward Journey We fire Jul-15 Monster Strike Puzzle & Dragon Raven MU Miracle COC Game of war-fire age Fantasy Westward Journey We fire Aug-15 Monster Strike Puzzle & Dragon Raven Seven Knights COC Game of war-fire age Fantasy Westward Journey The Legend of Mir 2 Sep-15 Monster Strike Puzzle & Dragon Raven Seven Knights Game of War-fire Age COC Fantasy Westward Journey The Legend of Mir 2 Oct-15 Monster Strike Puzzle & Dragon Everybody's Marble Raven Game of War-fire Age COC Fantasy Westward Journey Westward Journey Online Nov-15 Monster Strike Puzzle & Dragon HIT Raven Game of War-fire Age COC Fantasy Westward Journey Westward Journey Online Dec-15 Monster Strike Puzzle & Dragon HIT Everybody's marble COC Game of war-fire age Fantasy Westward Journey Westward Journey Online Jan-16 Monster Strike Puzzle & Dragon Seven Knights HIT COC Game of war-fire age Fantasy Westward Journey Westward Journey Online Feb-16 Monster Strike Puzzle & Dragon Everybody's Marble Seven Knights COC Game of war-fire age Fantasy Westward Journey The Legend of Mir 2 Mar-16 Monster Strike Puzzle & Dragon Seven Knights Everybody's Marble Clash Royale Game of war-fire age Fantasy Westward Journey Westward Journey Online Apr-16 Monster Strike Puzzle & Dragon Everybody's Marble Seven Knights Game of war-fire age COC Fantasy Westward Journey Westward Journey Online
Source: App Annie
We show the top-10-grossing games in China from July 2014 to April 2016 on page 16. We note that, in April 2016, 5 of the top 10 games in China had been in the top 10 for more than 6 months — the first time this has happened. We take this as another sign that the life cycles of hit games are increasing, which in turn suggests that gamers are more prepared to continue playing their favourite legacy games rather than actively seeking new ones (the shift in game supply to hard-core genres might also be a factor).
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As we discussed in our special report (Primer: decoding Internet discovery and digital advertising, 2 March 2016), the mobile Internet faces a serious “discovery bottleneck” due to the rise of the app-centric environment. It has become increasingly hard for the smaller game developers to catch the attention of users, whereas the larger game platforms, armed with superior distribution, can promote their games at minimal cost and acquire additional users. Hence, the big developers are taking advantage of this discovery bottleneck to win mind share among gamers, in our view. .
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China: iOS store top 10 ranking in terms of total grossing (June 2014-April 2016) Name Developer/Operator Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 Fantasy Westward Journey (梦幻西游) NetEase 6 1 1 1 1 1 1 1 1 1 1 1 1 1 Westward Journey Online (大话西游) NetEase 3 2 2 2 2 3 2 2 Hero Moba (王者荣耀) Tencent 7 6 4 4 4 3 The legend of Mir 2 (热血传奇) Tencent 2 2 3 3 3 3 2 8 4 Clash Royale (皇室战争) Supercell 3 5 Hero Moba (王者荣耀) Tencent, bandai namco 6 Naruto Mobile (火影忍者) Tencent 5 7 6 7 We fly (全民飞机大战) Tencent 3 5 4 6 4 8 6 6 5 8 5 4 4 7 4 4 5 5 8 8 5 7 8 CrossFire (穿越火线) Tencent 6 6 5 9 Sword and magic (剑与魔法) Longtu game 10 The king of fighters' 98 (拳皇 98 终极之战) Tencent 10 3 5 4 6 4 7 9 9 Legend of the Qing Qiu Fox (青丘狐传说) Zilong 10 The legend of Zu (蜀山战纪之剑侠传奇) LineKong 8 Clash of Kings (列王的纷争) Elex Technology 8 7 8 7 10 Loong Craft (六龙争霸) Tencent 4 5 9 Shenwu 2 (神武 2) Duoyi 5 10 10 We fire (全民突击) Tencent 2 1 2 2 2 2 2 5 6 6 9 9 Clash of clans (部落冲突) Supercell 6 6 5 3 2 5 9 9 9 9 8 10 10 9LZ (九龙战) Tencent 7 CangQiongBian (苍穹变) GAME Dreamer, NQ Mobile, iDreamsky 9 Anipop (开心消消乐) Happy elements 10 WeChat Dash (天天酷跑) Tencent 5 3 3 4 8 6 7 Happy elements (开心消消乐) Happy elements 8 7 6 6 9 We MOBA (全民超神) Tencent 10 The journey of flower (花千骨) Baidu 3 8 MU miracle (全民奇迹) Kunlun, OurPalm, webzen 7 4 3 3 4 5 3 4 9 Craz3 match (天天爱消除) Tencent 10 10 9 8 Dot arena (刀塔传奇) Longtu, Funplus, GAEA mobile, Kunlun, VNG 1 1 1 1 1 3 5 5 7 4 6 6 6 9 Shenwu (神武) Duoyi 5 4 2 3 2 1 3 3 5 Boom Beach (海岛奇兵) Supercell 5 6 9 10 7 8 I am MT 2 (我叫 MT2) Tencent, Funplus, Nexon, Firefly 4 1 4 5 10 Landlord poker (欢乐斗地主) Tencent 9 Blade of three kingdoms (三国之刃) Tencent 7 1 3 7 6 7 7 10 West arena (乱斗西游) NetEase 2 8 8 8 8 Taichi Panda (太极熊猫) Kunlun, Snail games, Aicombo 10 10 Thunder fighter (雷霆战机) Tencent 2 2 2 2 3 9 10 10 仙剑奇侠传 (仙剑奇侠传) Tencent 1 TLBB (天龙八部) Changyou 7 横扫西游 (横扫西游) Tencent 9 Everybody's marble (天天富翁) Tencent, Line, Netmarble 6 7 10 Cross gate (魔力宝贝) Perfect world 7 8 We fight (天天炫斗) Tencent 4 4 8 9 Water margin (全民水浒) Tencent 8 7 9 欢乐西游 (欢乐西游) Tencent 10 10 放开那三国 (放开那三国) Babeltime, Kalends 10 8 Wechat speed (天天飞车) Tencent 7 9 Wetown (全民小镇) Tencent 9
Source: App Annie Note: Blue colours refers to the game that stay over 6 months on the top 10 charts
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Mobile-game monetisation power could surprise on the upside At NetEase’s investor day on 24 May 2016, management announced the following upbeat operating figures for the first time:
Annual game revenue ratio of mobile to PC of 2.6x (for games derived from the same IP) Mobile ARPU higher than PC ARPU (for games derived from the same IP)
We believe these metrics underline the monetisation power of mobile games, and we see more upside to come on this front. The mobile-game user base is significantly larger than the PC one (the mobile-game population is 3 times higher than the PC-game population, according to CNC). If we assume the same paying ratio and ARPU for both the PC- and mobile-game markets, then the mobile-game market should be at least 3 times the size of the PC-game market, in terms of revenue. Although NetEase does not disclose its mobile ARPU, if we use Tencent as our frame of reference, we have seen an increase in its mobile game ARPU over the past 2 years (up 141% from 1Q14 to 1Q16). In our view, NetEase is executing well on its strategy of launching mobile games that leverage upon proven PC-game IP, and we see upside to its mobile revenue from this initiative.
Tencent: mobile game ARPU trend, 4Q13-1Q16 Tencent’s mobile-game CNY ARPU mid-point up 300 260 141% from 1Q14 to 1Q16 250 195 175 180 200 165 165
150 185 110 110 165 170 90 155 155 150 100 70 100 100 50 80 60 0 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Source: Company, Daiwa compiled Note: The company report mobile-game revenue from net basis (excluding channel fee) to gross basis (including channel fee) starting 4Q14
Revenue forecasts We forecast NetEase’s mobile-game revenue to expand by 133% to CNY18.4bn in 2016 and by 25% YoY to CNY23.0bn in 2017, and account for 51% and 52% of its total revenue, respectively. We continue to expect healthy revenue performance from NetEase’s 2 key mobile titles, FWJ and WWJ, but we believe the growth in the company’s mobile- game revenue will mainly come from newly launched games.
NetEase: mobile-game revenue forecasts, 2012-18
We forecast mobile CNYm 30,000 71.0% 73.5% 80.0% games to contribute 74% 66.2% 70.0% of NetEase’s total game 25,000 27,158 revenue by 2018 60.0% 20,000 45.6% 23,007 50.0% 15,000 18,440 40.0% 30.0% 10,000 8.2% 20.0% 5,000 0.5% 7,900 0.0% 10.0% - 40 759 0 0.0% 2012 2013 2014 2015 2016E 2017E 2018E Netease mobile game revenue Mobile revenue as % of total game revenue
Source: Company, Daiwa forecasts
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PC games: stable yet flat revenue growth
Key takeaways Expect stable performance from legacy in-house titles, including FWJ and WWJ, going forward Licensed titles from Blizzard likely to see healthy revenue stream; Overwatch revenue could surprise on the upside in 2H16
NetEase is the second-largest PC-game company in China by revenue, but it is particularly strong in the in-house-developed MMORPG genre, where its top title, FWJ, has been one of the most popular client-based games for over 13 years.
Also, NetEase has become the main licensing partner of Activision Blizzard, a major global online-game company, in China. NetEase currently has the exclusives rights to operate top Blizzard titles, including War of Worldcraft (WoW), Starcraft, Hearthstone, and most recently, Overwatch, in China. As shown in the table below, NetEase (including both in- house and licensed games) currently operates 4 of the top 10 most popular client-based games in China, according to 17173.com. We estimate that NetEase’s in-house and licensed games (from Blizzard) respectively contributed 70% and 30% of its total PC- game revenue in 2015.
NetEase: top 10 PC games in China in terms of popularity NetEase operates 4 of Rank Chinese name English name Launching time Operator Developer the 10 most popular PC 1 英雄联盟 League of Legends Sep-11 Tencent Riot Games games in China today 2 地下城与勇士 Dungeon and Fighter Jun-08 Tencent NEOPLE 3 穿越火线 Cross Fire May-07 Tencent Smile Gate 4 炉石传说 Hearthstone Mar-14 NetEase Blizzard 5 梦幻西游 Fantasy Westward Journey Dec-03 NetEase NetEase 6 剑网 3 JX Online 3 Aug-09 Kingsoft Kingsoft 7 新天龙八部 TLBB Apr-07 Changyou Changyou 8 剑灵 Blade and Soul Nov-13 Tencent NCSoft 9 魔兽世界 World of Warcraft Jun-05 NetEase Blizzard 10 守望先锋 OverWatch May-16 NetEase Blizzard
Source: 17173.com
Maturing in-house titles; licensed titles stabilising NetEase had its first success in online games in 2002 after developing WWJ, which is adapted from traditional Chinese literature. We believe the success of WWJ and subsequently FWJ has solidified NetEase’s reputation for in-house development, helping it to stand out amid fierce competition from Giant Game, Perfect World and Changyou in the early 2000s. Since then, FWJ has consistently been one of the major revenue contributors to NetEase’s PC-game business. On top of that, NetEase’s licensed titles, especially from its cooperation with Blizzard, have expanded its gamer base, enhanced its overall community of gamers, promoted cross-selling, and most importantly, solidified its reputation among active gamers, in our view.
Below we highlight the key PC-game titles currently being operated by NetEase:
In-house developed titles:
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NetEase: currently operating in-house PC games (as of June 2016) Name Chinese Name Genre Revenue Model Date of Initial Commercial Launch New Fly for Fun 新飞飞 3D MMORPG Item-Based Oct. 2008 Zhan Hun 斩魂 MMORPG Item-Based Jul. 2011 Wu Hun 武魂 2 ARPG Item-Based Sep. 2011 Tianxia III 天下 3 3D MMORPG Item-Based Oct. 2011 Qian Nv You Hun 倩女幽魂 2.5D MMORPG Item-Based Apr. 2012 New Westward Journey Online III 新大话西游 3 2D MMORPG Time-Based & Item-Based May 2013 Fantasy Westward Journey II 梦幻西游 2D MMORPG Time-Based & Item-Based Jul. 2013 Dragon Sword 龙剑 MMORPG Item-Based Aug. 2013 Heros of Kingdoms 英雄三国 MOBA Item-Based Sep. 2013 New Westward Journey Online II 新大话西游 2 2D MMORPG Time-Based & Item-Based Sep. 2013 and Aug. 2014 Heros of Tang Dynasty Zero 大唐无双零 2.5D MMORPG Item-Based Aug. 2014 Kung Fu Master II 功夫英雄 2.5D MMORPG Item-Based Oct. 2014 Revelation 天谕 3D MMORPG Item-Based Jan. 2015 Demon Seals 镇魔曲 2.5D MMORPG Item-Based Apr. 2015 X-Heroes 突击英雄 MOBA Item-Based May 2015 Wild Fire 无尽战区 MOBA Item-Based Jul. 2015 New Ghost 新倩女幽魂 2.5D MMORPG Item-Based Sep. 2015 Hegemon-King of Western Chu 西楚霸王 3D MMORPG Item-Based Nov. 2015
Source: Company
Fantasy Westward Journey (FWJ, 梦幻西游) Developer: NetEase Genre: Real-time MMORPG Launch date: 18 March 2003 Ranking: No. 5 client-based PC game in China as of 31 May 2016, according to 17173.com Revenue model: time-based monetisation model plus in-game item-sale monetisation model
The PC version of FWJ has been the single most important in-house game for NetEase in terms of its revenue contribution over the years. Derived from WWJ, the game has been in operation for 13 years, during which time it has been the subject of annual expansion packs and various upgrades. According to the company, the game so far has accumulated 310m users. Given its emphasis on in-game social networking, many gamers have come to regard WWJ not as just as a game but as a virtual social platform.
Westward Journey (WWJ, 大话西游) Developer: NetEase Genre: Real-time MMORPG Launch date: 1 August 2002 Ranking: No. 40 client-based PC game in China as of 31 May 2016, according to 17173.com Revenue model: time-based monetisation model plus in-game item-sale monetisation model
The PC version of WWJ is widely considered to be NetEase’s first “home run” with an in- house developed game. Launched 14 years ago, and the subject of numerous upgrades since then, WWJ is still one of NetEase’s best-known games. The latest version of WWJ, the fourth major version, was launched in 2015.
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NetEase: screenshot of FWJ PC version NetEase: screenshot of WWJ PC version
Source: Company Source: Company
Licensed titles:
NetEase: currently operating licensed games from Blizzard (as of June 2016) Name Chinese Name Genre Revenue Model Expansion Pack Date of commercial Term of the license launch StarCraft (latest 星际争霸系列 Real time Time-Based Wings of Liberty April 2011 3 years with an additional 1 year extension upon StarCraft 2) strategy agreement of the parties, commencing from the commercial release of the game in China Heart of Swarm July 2013 Legacy of the Void World of Warcraft 魔兽系列 3D MMORPG Time-Based Reign of Chaos (latest Warcraft 3) The Frozen Throne The Burning Crusade September 2009 Wrath of the Lich King August 2010 Cataclysm July 2011 Mists of Pandaria October. 2012 Warlords of Draenor November 2014 Heroes of the Storm 风暴英雄 MOBA Free-to-play, Item- June 2015 3 years with an additional 1 year extension upon based monetisation agreement of the parties, commencing from the commercial release of the game in China Hearthstone: World 炉石传说 Card Free-to-play, item- January 2014 3 years with an additional 1 year extension upon of Warcraft based monetisation agreement of the parties, commencing from the commercial release of the game in China Diablo III 暗黑破坏神 2.5D Subscription April 2015 2 years with an additional 1 year extension upon MMORPG package purchase agreement of the parties, commencing from the commercial release of the game in China Overwatch 守望先锋 Team-based Subscription May 2016 FPS package purchase
Source: Company, Daiwa compiled
War of Warcraft (WoW, 魔兽世界) Developer: Blizzard Genre: Real-time MMORPG Launch date: June 2015 (China) Ranking: currently No. 9 client-based game in China as of 31 May 2016, according to 17173.com Revenue model: time-based monetisation
WoW is one of the most successful client-based games in the world. This game, too, has had a long life cycle, with multiple expansion packages and updates since its initial launch in 2004. NetEase is currently the exclusive operator of WoW in China after Blizzard terminated its previous licensing agreement with The9 (九城游戏) in June 2009. WoW is also one of the major games featured in live game broadcasting in China.
Hearthstone (炉石传说) Developer: Blizzard
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Genre: Card Launch date: March 2015 (China) Ranking: currently No. 4 client-based game in China as of 31 May 2016, according to 17173.com Revenue model: free-to-play, in-game item-sale monetisation model
Hearthstone is a card-genre game based upon the storyline of World of Warcraft. It is currently one of the most popular card games globally, and one of the major games used in live game broadcasting in China.
Overwatch (守望先锋) Developer: Blizzard Genre: team-based FPS (first-person-shooting) Launch date: 24 May 2016 (China) Ranking: currently No. 10 client-based game in China Revenue model: subscription-based monetisation model mainly with in-game item-sale monetisation model
Overwatch is the most recent game that NetEase has licensed from Blizzard. The game was launched globally (including China) on 24 May 2016, and looks to have been well received by gamers so far. Gamers can choose their in-game character and conduct team- based (random or custom team formation) shooting matches with other teams. They also have the option of facing human-based teams or computer-based teams.
In our view, Overwatch is especially important to NetEase because NetEase rarely publishes or operates client-based games in the shooting genre (the most popular shooting games in China, Cross Fire (穿越火线) and Call of Duty Online (使命召唤 OL), are both operated by Tencent). Hence, we believe that if Overwatch is successful in China, it could lead to an expansion of NetEase’s game line-up in terms of the genres covered in the future.
NetEase management announced publicly that Overwatch had sold over 1m units in China within 40 hours of the official launch, beating the record set by Diablo 3 in 2015, backed by a marketing blitz by Blizzard and NetEase. Globally, Overwatch has shifted 10m units in less than a month of its launch. We show below our scenario analysis of the potential impact of Overwatch on NetEase’s 2Q16 revenue. In our best-case scenario, we estimate that Overwatch could bring 14% in incremental PC-game revenue to NetEase in 2Q16.
NetEase: scenario analysis of revenue impact from Overwatch In 2Q16 Best-case scenario: Overwatch would bring Worst case Base case Best case a Assumption: Overwatch packages sales volume (million) 1.5 3.0 5.0 14% in incremental PC- b Assumption: % of user buying CNY198 packages 90% 90% 90% game revenue (2Q16) c=1-b Assumption: % of user buying CNY328 packages 10% 10% 10% d=b*198+c*328 Blended ASP (CNY) 213 213 213 e=d*a Total gross proceeding from Overwatch (CNYm) 319.5 639 1065 f Assumption: % of gross booked in 2Q16 30% 30% 30% g=f*e Revenue from Overwatch booked in 2Q16 (CNYm) 95.85 191.7 319.5
h 1Q16 NetEase PC-game revenue (CNYm) 2226 I=g/h Overwatch incremental revenue as % of 1Q16 PC-game revenue 4% 9% 14%
Source: Daiwa estimates
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NetEase: screenshot of Heartthestone NetEase: screenshot of Overwatch
Source: Company Source: Company
PC-game pipeline looks thin except for MineCraft Although we expect the vast majority of the company’s PC-game revenue in 2016 to come from legacy titles, NetEase’s PC-game pipeline seems unexciting with the notable exception of Minecraft. On 20 May 2016, the company announced that it had signed an exclusive licensing agreement with Microsoft to offer Minecraft (both PC and mobile versions) in China.
Minecraft is a popular real-time sandbox genre online game in which users can explore the in-game environment without limitation while building many kinds of objects. The most distinctive characteristic of Minecraft is that users can devise new gameplay to supplement the existing game (for example, gamers could build an arena in which other players could play a shooting game within the existing game world). The extendibility of Minecraft should greatly increase the life cycle of the game and the length of time gamers devote to it. Although the revenue model for Minecraft is subscription-based in other countries, we see a high possibility of NetEase launching Minecraft in China with a freemium item-based revenue model in 2H16.
NetEase: PC-game pipeline (in-house & licensed), June 2016 Minecraft looks to be the Name Chinese Name Genre Developer Current testing stage Wang Yi Quan Ming 1st time closed beta test (activation code needed) on bright spot in NetEase’s 网易全明星 3D MOBA In-house Xing 12 August 2016 PC-game pipeline Closed beta test (activation code needed) finished on Legend of Rhythms 战音 OL 2.5D RPG In-house 13 January 2015 Pirates: Treasure 1st time closed beta test (activation code needed) 夺宝联盟 3D MOBA Licensed Hunters finished on 12 May 2016 Closed beta test for Chihun (炽魂) finished on 15 April Wu Jin Zhan Qu 无尽战区 3D MOBA In-house 2016 Ni Shui Han 逆水寒 3D MMORPG In-house
3D Real-time War Rage 战意 In-house MMORPG 2.5D Real-time Hero Wars 最强军团 Licensed MMORPG MineCraft (MC) 我的世界 Real-time Sandbox Licensed Expected to be launched in 2H16
Source: Company
Booming PC-game broadcasting sector: NetEase a major beneficiary It may come as a surprise to investors to learn that over 100m people in China regularly watch live online-game broadcasts (along the lines of a sports TV broadcast featuring video streams of people playing online games, complete with dedicated programme hosts). Game broadcasting, led by platforms such as Douyu, Huya TV (affiliate of YY.com) and Panda TV has garnered a huge amount of attention among gamers in China in recent years. The leading players have developed a mature monetisation model, whereby the audience can send the broadcast hosts virtual items and platform owners can get a cut of virtual-item sales.
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NetEase (NTES US): 24 June 2016
NetEase could NetEase’s PC games (including in-house and licensed games) are highly popular on the potentially start charging major live game broadcasting platforms. Although NetEase does operate its own game licensing fee for 3rd party broadcasting platform, NetEase CC, we believe the vast majority of live broadcasts of game broadcasting NetEase’s games are streamed on non-NetEase platforms. As such, we believe NetEase platforms in the future could eventually take a chunk of the revenue from external platforms for live broadcasts of its games. In a more extreme scenario, NetEase could conceivably stop other platforms from broadcasting its games in order to promote its own live game broadcasting service. We have yet to factor in the revenue impact from such an approach, but we believe it would be significantly revenue accretive if it were to be adopted.
NetEase: screenshots of live game broadcasting of Hearthstone on Douyu platform (June 2016)
Source: Douyu.com, Daiwa compiled
Revenue forecasts We forecast NetEase’s PC-game revenue to be flattish over our forecast horizon. We forecast 0% YoY growth in 2016 and a 0.1% YoY decline in 2017, with PC-game revenue accounting for 26% of total revenue in 2016 and 21% in 2017.
NetEase: PC-game revenue (2012-18)
We expect flattish CNYm 12,000 99.5% 120.0% revenue growth from 100.0% 91.8% NetEase’s PC-game 10,000 100.0% 9,792 business in 2016 and 8,000 9,414 9,410 9,397 80.0% 8,507 7,825 54.4% 2017 6,000 7,201 60.0% 33.8% 4,000 29.0% 26.5% 40.0% 2,000 20.0% 0 0.0% 2012 2013 2014 2015 2016E 2017E 2018E Netease PC game revenue PC revenue as % of total game revenue
Source: Company, Daiwa forecasts
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NetEase (NTES US): 24 June 2016
Ecommerce: how far can it go?
Key takeaways NetEase Kaola will stick with the direct-sale bonded-warehouse model when conducting cross-border ecommerce in the future, in our view NetEase Yanxuan, NetEase’s private label business, underlines the company’s ambitions in expanding into non-cross-border ecommerce in China CNY50-100bn GMV target by 2020 could be aggressive; investment in fulfilment and inventory control likely to weigh on profitability
Kaola: NetEase’s cross-border ecommerce venture Direct-sale business model dedicated to cross-border ecommerce NetEase launched Kaola (网易考拉), a direct-sale (inventory taking) ecommerce platform dedicated to cross-border ecommerce, in January 2015. From management’s perspective, B2C cross-border ecommerce holds significant growth potential as Chinese customers demand more sophisticated products in their daily lives. Instead of hosting merchants selling overseas-sourced products to Chinese customers (the model used by Tmall Global, part of Alibaba’s China retail platform), NetEase believes the direct-sale model — where it takes on the inventory risk for product sales via Kaola — ensures the best consumer experience and product quality.
Haitao (or “cross-border We estimate Kaola generated CNY2.1bn in revenue in 2015, representing 10% of ecommerce”, 海淘) NetEase’s total revenue. The rapid revenue growth came along with significant investment. refers to domestic Competition has been the main cap on profitability for direct-sale cross-border players, consumers in China where aggressive pricing strategies (little or negative unit gross profit), large-scale user going online to buy acquisition campaigns, and fulfilment build-outs (rental for bonded warehouses and international products inefficient delivery cost structures) have all contributed to low profitability across the sector. Overall, the company disclosed that the Kaola business is close to breaking even in terms of operating profit.
Impact of new cross-border ecommerce regulations As detailed below, the most recent changes to the regulations governing cross-border ecommerce in China have heightened uncertainty over the sector’s near-term growth outlook. We believe that underlying customer demand for online purchases of international products remains solid, but think regulations on tax rates and limits on the number of SKUs, along with limited visibility on the execution of such regulations, has hit cross-border retailers in China.
There have been 2 major changes recently in the regulations covering cross-border ecommerce in China:
Increased tax burden Under the announced new tax code (shown below), the tax rate on cross-border ecommerce has generally increased, especially for smaller price-tag items such as cosmetics and infant milk formulas. For certain large price-tag items, however, the tax rate is lower than it was before. On top of the tax-rate change, the original CNY50 tax exemption quota has been removed, meaning all cross-border orders are now subject to tax.
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NetEase (NTES US): 24 June 2016
China: cross-border ecommerce tax rate change Order price Old tax policy New tax policy Change on Under the new Category (CNY) tax rate regulations, the tax Parcel tax rate Actual tax levied Custom duty VAT Consumption tax Actual tax levied payable has risen, 0 (CNY50 tax <500 10% 0% 11.9% 0% 12% 11.9% Baby and exemption quota) particularly for low-price maternity items given the removal >=500 10% 10% 0% 11.9% 0% 12% 1.9% 0 (CNY50 tax <100 50% 0% 11.9% 21% 33% 32.9% of the tax exemption Cosmetics exemption quota) quota >=100 50% 50% 0% 11.9% 21% 33% -17.1% 0 (CNY50 tax <250 20% 0% 11.9% 0% 12% 11.9% Apparel exemption quota) >=250 20% 20% 0% 11.9% 0% 12% -8.1%
Source: Daiwa compiled
Limits on product range For the first time, regulators have proposed a “positive list” of merchandise, ie, a list of what may be sold on cross-border ecommerce platforms. Any product category not on the “positive list” will not be allowed to be imported or sold via cross-border ecommerce platforms. At the same time, for cosmetics products and healthcare supplements that are being imported to China for the first time, the new regulations require that such products are registered with China’s FDA and customs authorities beforehand.
Below we outline our views after speaking to industry participants on the latest revisions to the regulations governing cross-border ecommerce:
1. We believe the tax rate hike alone is within the expectations of major retailers and is largely manageable. The tax rate will be partly offset by higher product ASPs (indeed, many e-commerce players, including Kaola, raised their prices once the new regulations came into effect in April 2016, and these were partly borne by retailers in the form of lower gross margins).
2. The removal of the CNY50 tax exemption quota will encourage retailers to shift their product mix to higher-ASP products. It should also boost the efficiency of the fulfilment function, as many retailers had been splitting large orders into multiple small orders in order to be eligible for the exemption, which increased unit fulfilment costs.
3. The introduction of the “positive list” and stricter FDA registration requirements for first-time imports will greatly limit the range of SKUs eligible for future imports, and has caught many retailers off-guard. Many popular cross-border ecommerce products currently do not have Chinese FDA approval. Also, the money and time required to obtain the requisite registration may be prohibitive for retailers. If the new regulations are strictly enforced, we believe the relative appeal of cross- border ecommerce platforms will be greatly reduced.
4. In our view, the new cross-border regulations seem to have been introduced in a hurry, such that industry players have not had enough time to prepare. Many cross-border retailers had little visibility on the policy shift and the extent of the enforcement right now, which has led to a sharp fall in infrastructure investment and a more cautious stance as far as taking on inventory is concerned. Even after the government announced a 1-year grace period before the new regulations come into effect, we expect sentiment to remain relatively weak in the interim.
Background: regulatory shift on cross-border ecommerce in China On 24 March 2016, the Ministry of Finance (MOF) announced a new cross-border ecommerce tax policy. The new policy states that: 1. The subject (ie, the merchandise) for cross-border ecommerce retail should be treated as a “commodity”, rather than as “personal belongings”, from a tax standpoint. As a result, a cross-border ecommerce tax (in place of custom duty, consumption tax and
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VAT) will come into effect, rather than a parcel tax (ie, tax levied on parcels imported for personal use); 2. Specifically, on the tax rate for cross-border ecommerce, a 30% discount will be given on VAT and consumption tax (in cases where consumption tax applies) for cross- border ecommerce imports that are currently subject to no custom duty. Meanwhile, the parcel tax rate for personal-used imported items will increase from 10-50% to 15- 60%; 3. The CNY50 parcel tax exemption quota will be removed; 4. Cross-border ecommerce will be subject to a per order value cap of CNY2,000 and a spending cap of CNY20,000 per person per year; and 5. The new policy will take effect on 8 April 2016.
On 7 April and 15 April, the MOF announced 2 “positive lists”. The combined list includes 1,293 product categories which can be imported by cross-border ecommerce players, subject to certain registration and documentation requirements being met. For the first time, infant baby formula and health supplement products are required to obtain beforehand: 1) China FDA registration, and 2) a certificate of inspection from the General Administration of Quality Supervision, Inspection and Quarantine of the PRC (AQSIQ).
On 13 April 2016, the MOF announced that the new regulations on infant baby formula registration and certification would be rolled out at a later date than originally planned (1 January 2018).
On 25 April 2016, the MOF announced a 1-year grace period on the implementation of the new regulations for certain cross-border ecommerce categories related to cosmetics and healthcare supplement products. Hence, the rollout of the cosmetics and healthcare supplement registration and certification regulations was postponed to 11 May 2017.
Gauging Kaola’s strategy in the next 3 years NetEase will likely still focus on the direct-sale model Some observers believe that the tightening of the regulations on cross-border ecommerce will hurt the competitiveness of direct-sale (inventory-taking) players but favour the cross- border ecommerce marketplace model. For cross-border ecommerce platforms (the third- party model), marketplace owners will not assume the tax liability; instead, the merchants on these platforms will be subject to the tax liability.
We think NetEase is unlikely to turn to the marketplace model given: 1. The difficulty of controlling the quality of third-party sellers 2. Competition with existing players (ie, Tmall Global) 3. NetEase has sufficient cash flow and profitability to absorb (at least partly) the tax burden for customers, and therefore should be able to win market share from smaller direct-sale cross-border players
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NetEase: price comparison among major cross-border ecommerce platform in China (June 2016) NetEase Kaola platform Category Product NetEase JD.com - JD.com - Vipshop Tmall Amazon Kaola 3rd party direct Global China is price competitive, merchant sale partly due to its direct- Infant baby Aptamil 婴儿奶粉 2 段 800 克 (2 items) 276 462 - 316 378 328 sale merchandise formula Nutrilon 婴儿奶粉 4 段 800 克 (2 items) 276 298 318 - - - capability Wyeth SMA 奶粉 3 段 900 克/罐 2 罐装 342 420 - - - - (2 items) Hipp 有机益生菌奶粉 4 段/1+段 600 克/ 376 - - - - - 盒 3 盒装 (3 items) Diaper Merries 花王妙而舒 S 82 片/包 2 包装 208 215 - - 204 - Health Swisse 活力胶原蛋白液 500 毫升/瓶 121 - 108 132 152 - supplement Mass market Mediheal N.M.F 针剂水库保湿面膜 98 78 - 99 89 - cosmetics & Its skin 晶钻蜗牛面膜贴 5 片盒 107 - 85 - - - skincare Blackmore 维他命 E 面霜软膏 50 克 106 - 63 - 77 89 Mid-tier Kiehl's 高保湿精华爽肤水 250 毫升 179 170 - - 215 - cosmetics & skincare High end Chanel 邂逅机遇 粉色 香水 50ml 559 - 859 - - - cosmetics & Estee Lauder 特润修护肌透精华露 449 - 369 - - - skincare 30ml 小棕瓶
Source: Daiwa compiled
We conducted a brief price comparison of the major cross-border ecommerce platforms in China, and found that products sold on Kaola are competitive on price even after the ASP adjustments made to account for the new tax policy. We believe Kaola’s direct-sale model has a certain scale advantage in terms of merchandise sourcing, and hence makes it easier for NetEase to conduct a platform-wide promotion campaign to win market share.
NetEase will continue to adopt a bonded warehouse operating model NetEase’s management has clearly said that it is still committed to investing in bonded warehouses in China, contrary to some who believe that the company may turn to the direct-mail model (ie, having a stock of goods in other countries and sending orders individually to China, meaning that it only has to pay parcel tax).
We see 2 reasons why NetEase is unlikely to turn to the direct-mail model: 1. Delivery times from an overseas warehouse would be significantly longer than direct delivery from on-shore bonded warehouses 2. If it only has to pay (favourable) parcel tax vs. the more expensive cross-border ecommerce tax, we believe the government will step in and not tolerate such an obvious move to benefit from a tax loophole.
We believe that over the next 3-5 years, the difference in tax treatment for B2C cross- border ecommerce and ordinary bulk imports will narrow, perhaps by gradually reducing the tax-rate discount on cross-border ecommerce and gradually lowering custom duties. By then, there is likely to be essentially no difference between cross-border ecommerce and ordinary imports, in terms of both tax treatment and registration requirements. Kaola would then be able to compete in the same arena with the existing full-category ecommerce players in China (ie,JD.com and Alibaba).
Yanxuan: NetEase’s private-label ecommerce business Yanxuan (网易严选), a dedicated NetEase private-label ecommerce business, was launched in November 2015. The business is still contributes only minimally to revenue as it is a new business and not that well known to investors. However, we feel Yanxuan gives an indication as to management’s vision for NetEase’s ecommerce business in the longer run.
On the Yanxuan platform, all products are branded under NetEase – NetEase designs the products, operate the platform and fulfils the orders. The company, similar to all of its other
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private-label exercises, outsources the manufacturing to external venders (OEMs). Currently, Yanxuan focus on the household-appliance category, selling products from bed sheets to kitchenware. Consumers can got to Yanxuan’s website directly, or purchase via Kaola, where there’s a dedicated section for Yanxuan products.
NetEase: screenshots of Yanxuan Yanxuan fits into NetEase’s “craftsmanship” culture
Direct from brands’ manufacturer, just 20% of brands’ price.
Yanxuan brand Kitche Home Food Apparel product nware appliance
Source: Company
In our view, Yanxuan fits into NetEase’s culture of “craftsmanship” – the company’s founder, Mr William Ding, puts a lot of emphasis on in-house development and quality control. We also see Yanxuan as being very complementary to NetEase’s Kaola platform, which, in our view, will eventually extend to a non-cross-border ecommerce business. The “craftsmanship” of NetEase’s ecommerce business is an appealing slogan with which to attract middle-class customers, in our view.
On the other hand, we see 2 concerns relating to Yanxuan and NetEase’s ecommerce business in general: 1. As its direct-sale scale grows, its inventory and merchandising sourcing will likely become more complicated. NetEase has experience in selling virtual items but has no track record when it comes to the retail of physical goods, in our view. 2. Ecommerce requires upfront investment for marketing and order fulfilment (mostly warehousing), and in these areas, NetEase is lagging the major players such as JD.com and Vipshop. NetEase certainly has more organic traffic than many smaller players, yet all the necessary upfront investment in offline infrastructure is likely to dilute NetEase’s bottom line before it achieves a certain scale.
CNY50-100bn direct-sale ecommerce GMV target by 2020 too aggressive NetEase’s management has publicly announced its target to achieve a CNY50-100bn direct-sale GMV in the medium term. Our back-of-envelop calculation suggests that if we assume the company were to achieve a CNY50bn direct-sale GMV in 2020 (implying 60+% CAGR from 2016-20), and that its existing game revenue were to grow at a 10-15% CAGR from 2016-20, then its ecommerce business would account for more than 50% of its total revenue by 2020. This also means that, if NetEase were to reach this GMV target, it would become an ecommerce company instead of a game company in 2020.
In China, JD.com, the largest retailer (online and offline) in terms of direct-sale GMV, had a direct-sale GMV of CNY256bn in 2015. A CNY50-100bn direct-sale GMV for NetEase
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would imply that the company would have to grow the business to reach the equivalent of 50% of JD.com’s current direct-sale scale in 4 years, a target that seems too aggressive, in our view.
From another angle, in order to achieve a CNY50-100bn direct-sale annual GMV, NetEase would be required to make an investment in its fulfilment and marketing. We believe that for its direct-sale business, scale is the prerequisite for operational efficiency. Before NetEase is able to achieve a critical scale, its operating investment will probably adversely affect its overall operating margin, in our view.
Revenue forecasts Overall, we forecast NetEase’s ecommerce revenue to grow by 66% YoY to CNY6.1bn in 2016 and by 45% YoY to CNY8.9bn in 2017, driven by the Kaola (cross-border) and Yanxuan (private label) businesses, and respectively accounting for 17% and 20% of total revenue.
NetEase: ecommerce and other revenue growth CNYm We expect NetEase’s 236% ecommerce revenue to 14,000 220% 250% 12,000 continue see robust 200% growth (66% YoY in 2016 10,000 11,585 150% and 45% YoY in 2017) 8,000 8,912 91% 6,000 100% 48% 66% 4,000 6,146 45% 30% 50% 2,000 3,699 233 344 1,102 0 0% 2012 2013 2014 2015 2016E 2017E 2018E Netease ecommerce & others revenue YoY growth %
Source: Company, Daiwa forecasts
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Advertising: leading mobile products with monetisation ramping up
Key takeaways NetEase is well positioned in music streaming and mobile-news-aggregation services in China Advertising revenue growth likely to remain stable, although it should decelerate
Despite its heavy revenue reliance on online games, NetEase currently operates a broad range of Internet services, including email (the first to offer free email in China), music, a news portal, an online financial platform and online lottery sales (temporarily suspended since 2015). Here we highlight 2 of its most popular Internet services, NetEase Music and NetEase News, as we see potential long-term monetisation opportunities for them.
NetEase Music (网易云音乐) Leading online music NetEase Music was launched in 2013 and is currently among China’s top online music streaming service in streaming services in China, along with Tencent’s QQ Mucis and Alibaba’s Xiami Music. China NetEase Music labels itself as an online music social network in order to differentiate itself from its competitors.
In light of the tighter IP protection compliance requirements implemented by the National Copyright Administration of China (NCAC), effective from 2015, the major online music platforms have removed most of the illegal content and now share content with each other. For example, NetEase signed a music-content exchange agreement with Tencent in 2015. As such, its content amortisation cost relating to its online music business rose by 486% YoY in 2015 and 101% YoY in 2014, accounting for 4% and 6% of total ecommerce revenue, respectively.
The stricter copyright enforcement is in line with the shift in user behaviour to paying for digital content. An increasing number of users have started paying for digital content in China, most likely through a monthly/quarterly subscription. Currently, NetEase monetises its music services through in-app ads and membership (subscription packages). The majority of the content is still free to stream, although members will be able to download more songs to their devices and enjoy higher sound resolution. Thus, we expect revenue contribution from NetEase Music to remain immaterial in the short term.
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NetEase: screenshots of NetEase Music app
Source: Company
NetEase News (网易新闻手机版) Leading news- The NetEase News mobile app was launched in 2011 and is one of the top news- aggregator app in China aggregator apps in China. According to QuestMobile, NetEase’s News app had 19m daily active users (DAU; Android and iOS combined) as at December 2015, ranking third after Tencent News and Jin Ri Tou Tiao (今日头条) in terms of DAU.
The competitive dynamic when it comes to delivering mobile news is different to what it was during the PC era. On mobile, it is easier to personalise the service and make it more targeted, with service providers pushing and displaying news based on browsing history, demographic groups and location. As users are connected to the Internet almost all of the time now, a new business model, such as offering live news broadcasting, has emerged.
We see fierce competition among the news-aggregator apps and little product differentiation currently. In our view, exclusive content should be the key edge to retaining users, and we see the traditional portal players, including NetEase and Tencent, as being well positioned on this front, given their long online news-portal experience and extensive editorial coverage. NetEase’s management puts more emphasis on ensuring the high quality of its in-house news editorial content on its news app and will continue to invest in exclusive content.
Advertising (performance-based display ads such as in-feed ads on the news page) is the major monetisation model for its news app currently – from our market research, we see that the major news apps currently have similar ad-load levels. For example, NetEase has 1 start-up ad, 2 carousel ads and 6 ads in the first 50 news feed, while Jin Ri Tou Tiao has 1-2 start-up ads and 7 ads in the first 50 feed news. We see new ad formats, such as video ads, and increasing ad loads driving the revenue growth of NetEase’s News App in the coming 1-2 years.
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NetEase: screenshots of NetEase News app
Source: Company
NetEase Portal & Email Leading email service NetEase, Sina, Sohu and Tencent have been the 4 major portal players in China since the provider in China early 2000s. NetEase was also the first player in China to offer free email services in the late 1990s, and currently has the largest number of email accounts in China. This, combined with its search business, Youdao Search, allows NetEase to offer display ads on PC and mobile (for example, via the NetEase News app) and this business have been growing steadily. We believe the NetEase portal offers strong organic traffic for NetEase's other service, including games and music. Overall, we see stable yet decelerating revenue growth for this business, due mainly to the structural saturation of the portal-ad segment.
Revenue forecasts Overall, we expect NetEase’s advertising revenue to grow by 29% YoY to CNY2.3bn in 2016 and by 20% YoY to CNY2.7bn in 2017, driven by news-aggregator apps (display ads) and Youdao (search ads), accounting for 6% of total revenue during both years.
NetEase: advertising revenue growth We expect 20-29% YoY CNYm 3,500 36% 40% advertising revenue 33% 29% 35% growth in 2016-17 3,000 29% 2,500 30% 2,762 3,177 25% 2,000 2,302 20% 15% 20% 1,500 1,789 15% 1,345 1,000 7% 10% 987 500 5% 767 0 0% 2012 2013 2014 2015 2016E 2017E 2018E Netease advertising revenue YoY growth %
Source: Company, Daiwa forecasts
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Financial analysis and valuation Financial forecasts Revenue NetEase’s total revenue increased by 27.4% YoY in 2014 and 94.7% YoY in 2015, driven mainly by its strong game and ecommerce business. For modelling purposes, given that the company does not issue financial guidance and offers few operating metrics (no MAU, PCU, ARPU, etc), we consider its deferred revenue as an important financial figure that offers some forward-looking measurement of revenue growth. Accounting- wise, the company’s game revenue first flows into the deferred revenue account and is then recognised as revenue during the period of consumption, as shown in the following formula:
Deferred revenue (Beginning Balance) + Gross Gaming revenue in the period = Revenue recognised in the period + Deferred revenue (End Balance)
For time-based games, revenue is recognised when the gamer actually plays the game (as opposed to when a prepaid card/game package is purchased). For item-based and subscription-based games, the pace of amortisation for deferred revenue depends on the gamer’s past item-usage patterns combined with the following management assumptions. For PC games, the company usually recognises deferred revenue within 6-12 months. For mobile games, it is no longer than 3-6 months.
As mentioned in previous sections of this report, we expect solid revenue growth from NetEase’s game business, on the stable performance of its advertising and ecommerce businesses. Overall, we forecast NetEase’s total revenue to reach CNY36.3bn in 2016 and CNY44.0bn in 2017, representing year-on-year growth of 59% and 21%, respectively. We expect its online games to remain its biggest revenue contributor for the next 3 years.
NetEase: total revenue growth CNYm Total revenue expected 95% to increase by 59% YoY 60,000 100% in 2016 and 21% YoY in 50,000 51,712 80% 2017 59% 40,000 44,079 60% 30,000 36,298 27% 40% 20,000 21% 12% 22,803 17% 12% 10,000 20% 11,713 8,201 9,196 0 0% 2012 2013 2014 2015 2016E 2017E 2018E
Netease total revenue YoY growth % Source: Company, Daiwa forecasts
NetEase: revenue contribution breakdown
Online games should 100% 3% 4% 9% remain biggest revenue 9% 11% 16% 17% 11% 20% 22% 80% 8% 6% contributor in 2016-18 6% 6%
60%
88% 40% 86% 79% 76% 77% 74% 71%
20%
0% 2012 2013 2014 2015 2016E 2017E 2018E Online game services Advertising services E-mail, e-commerce and others
Source: Company, Daiwa forecasts
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Gross margin For NetEase’s online-game business, its mobile games have tended to have a lower gross margin than its PC games, mostly due to it sharing its revenue with its mobile distribution channels (Apple, Baidu, Tencent, and Qihoo 360, to name a few). Excluding this channel revenue sharing, the gross profit of its mobile-game business should be higher than it is for its PC games, according to the company. We expect the company’s total game business gross margin to decline slightly in 2016 and 2017, vs. 2015, on a higher mobile-game contribution, and remain in the range of 64-66% going forward.
NetEase’s advertising business gross margin has remained largely stable over the past few years and we expect it to remain at the current level of 60% for the next 3 years. For its ecommerce business (including Kaola and Yanxuan), we expect the gross margin to remain at the current level, at around a high single digit to low teens, which we see as the price it has chosen to pay for near-term market share expansion. The 1Q16 ecommerce business gross margin expanded to 20%, helped mainly by the lottery-like Yiyuanduobao (一元夺宝) business. Management said that its Kaola standalone business recorded a high-single-digit gross margin in 1Q16. We model for the ecommerce business gross profit margin to remain at 13.3% in 2016 and improve to 14% in 2017, from 7.9% in 2015.
Also, we have yet to factor in any revenue/gross margin contribution from the online lottery business, which was suspended by the regulators in February 2015. Although we cannot take a view on when the online lottery business might resume, we would expect it to make a positive contribution to NetEase’s gross margin if it were to happen. We estimate that the online lottery business accounted for 5-7% of NetEase’s total gross profit in 4Q14.
Overall, we expect NetEase’s gross margin to decline in 2016-18 on: 1) its higher mobile-game contribution, which has a lower gross profit than its PC-game contribution, and 2) the higher revenue contribution from its low gross margin ecommerce business. We forecast the overall gross margin to reach 56.9% in 2016 and 54.5% in 2017, vs. 58.8% in 2015.
NetEase: segmental gross profit Gross margin should 100% trend lower in 2016-18 74.0% 79.0% 77.2% 80% 68.8% 66.3% 65.2% 64.5% on the higher 60% 73.0% contribution from its 68.6% 72.2% 61% 67% 40% 53% 58.8% 60% 60.0% 60.0% low-margin ecommerce 56.9% 54.5% 53.1% 15.0% 20% 38% 42.7% 14.0% segment 13.3% 7.9% 0% 0.7% (20%) -6.7% 2012 2013 2014 2015 2016E 2017E 2018E
Blended gross margin Online game gross margin Advertising gross margin Ecommerce gross margin
Source: Company, Daiwa forecasts
Operating and net margin NetEase’s non-GAAP operating margin was stable at around the 45-50% range before 2014 but declined to 43.6% in 2014 and 34.9% in 2015, due mainly to an increase in the mobile-game revenue contribution (lower gross margin) and, more importantly, the aggressive promotion of its ecommerce business. Specifically, we expect its sales and marketing expenses to rise by a 43.5% YoY in 2016 and 20.5% YoY in 2017, on 56.1% YoY growth in 2015, based on a more rational promotional stance for the Kaola platform and less aggressive competition in the ecommerce business. In terms of its R&D expenses, we now model year-on-year growth of 36.9% in 2016 and 21.4% in 2017, with R&D expenses as a percentage of total revenue flat at 8.1% for both years.
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We believe NetEase’s management has been prudent in its financial controls in the past, and expect the company to evaluate the long-term ROI of its marketing spending regularly. Overall, we expect its non-GAAP operating margin to reach 35.5% in 2016 and 33.3% in 2017, compared to 34.9% in 2015. The decline in the operating margin would be due mostly to a contraction in the gross margin, as discussed previously.
NetEase: non-GAAP operating margin trend, 2012-18
CNYm 16,692 18,000 50.7% 60% 16,000 47.7% 14,690 43.7% 50% 14,000 12,896 34.9% 12,000 33.3% 32.3% 40% 10,000 7,957 30% 8,000 35.5% 5,114 6,000 3,915 4,659 20% 4,000 10% 2,000 0 0% 2012 2013 2014 2015 2016E 2017E 2018E Non-GAAP EBIT Non-GAAP EBIT Margin
Source: Company, Daiwa forecasts
NetEase’s P/L is quite straightforward, with little below-operating-income items (very little investment associates gain/loss, etc). We model the non-GAAP net margin to reach 29.1% in 2016 and 28.1% in 2017, compared to 31.1% in 2015.
NetEase: non-GAAP net margin trend, 2012-2018
Likely declining net CNYm margin mostly due to a 16,000 51.7% 14,520 60% contraction in the gross 14,000 46.8% 12,826 43.6% 11,277 50% margin, on a shift in 12,000 32.5% 10,000 40% revenue mix to the 7,420 29.1% 28.1% 8,000 30% ecommerce business 5,106 6,000 4,750 31.1% and mobile-game 3,840 20% 4,000 business 2,000 10% 0 0% 2012 2013 2014 2015 2016E 2017E 2018E Non-GAAP net profit Non-GAAP net margin
Source: Company, Daiwa forecasts
Balance sheet and cash flow NetEase had a cash position of USD3.1bn and no long-term debt, as at 31 March 2016. In addition to its solid balance sheet, we expect NetEase to generate free cash flow of USD1.5bn in 2016 and USD1.8bn in 2017, after incorporating our USD200m and USD250m capex forecasts for these two years. The capex would be used mostly for maintenance.
The company has adopted a prudent view on M&A activity since listing. It has invested a small amount of cash in smaller developers in the past and we expect the company to maintain its prudent stance on investing.
Share-based compensation and dividend NetEase is one of the oldest US-listed China Internet companies, having listed 11 years ago. The company has kept its stock-based compensation at a stable 2-3% of total revenue per year and we expect it to continue to do so.
NetEase is also the only large-cap China Internet stock to offer a regular quarterly dividend (Tencent also pays out a regular dividend, but only on a yearly basis). Since 1Q14, NetEase has had a quarterly dividend policy, commencing with a 25% dividend-payout
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NetEase (NTES US): 24 June 2016
ratio. We see the dividend as a testimony from management as to the strong cash- generating power of NetEase’s core game business and believe such a friendly stance towards the capital market warrants a valuation premium. We also expect its strong free cash flow to more than offset the dividend payout, and see a possible increase in the dividend payout ratio in the future.
NetEase: net cash balance, FCF and dividend
Strong balance sheet CNYm and cash flow – these 60,000 52,015 could result in an higher 50,000 42,263 dividend in the future 40,000 33,176 30,000 23,156 25,598 20,146 16,333 20,000 13,078 10,184 12,038 7,048 10,000 4,046 5,021 5,256 0 0 (10,000) -815 -1,983 -1,468 -2,611 -2,951 -3,326 2012 2013 2014 2015 2016E 2017E 2018E Net cash (ending balance) Free cash flow Dividend paid
Source: Company, Daiwa forecasts
1Q16 review NetEase reported revenue of CNY7.9bn in 1Q16, up 116% YoY, and in line with the Bloomberg consensus. Its online-game revenue was up 105% YoY, driven mainly by a 484% YoY increase in mobile-game revenue. Its ecommerce, e-mail and other revenue increased by 258% YoY but decreased 16% QoQ, which management attributed to accounting changes for the shift of certain direct-sale businesses to its marketplace model. Its advertising business grew by 32% YoY.
Its online-game revenue in 1Q16 was CNY6.0bn. Mobile-game revenue accounted for 63% of its total online-game revenue for the quarter. Its PC-game revenue saw a 3% YoY decline. Its total deferred revenue decreased by 1% QoQ, due mainly to a decline in its PC-game deferred revenue, according to management.
Its ecommerce business revenue declined by 16% QoQ, due to an accounting change, from gross method to the net method (for marketplace sales), according to management. The gross margin for the ecommerce business rose to 20% in 1Q16, from 6% in 4Q15. Management said that the Kaola standalone business still saw strong QoQ growth, with the gross margin improving to a high single digit from a low single digit.
NetEase’s 1Q16 non-GAAP operating margin was 38.8%, compared with 40.3% for the same period in 2015, and 33.0% in the previous quarter. The QoQ improvement was due to lower spending by the ecommerce business as well as the low season for game promotions. According to the company’s policy, NetEase does not provide revenue or earnings guidance.
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NetEase (NTES US): 24 June 2016
Valuation PER-based target price of USD190 We initiate coverage of NetEase with an Outperform (2) rating and 12-month target price of USD190, based on a target PER of 14x applied to the average of our 2016 and 2017 non- GAAP EPS forecasts.
We believe a PER is the most appropriate method to value NetEase as: 1) it captures the company’s strong earnings-generating power, and 2) it serves as a consistent and convenient way to compare it to its global peers.
Our target PER of 14x is in line with the stock’s past-10-year trading average of 13.5x. We believe the stock deserve a certain premium given its leading market-share position, not just in the PC-game industry but also in the mobile-game industry. Our target multiple also does not look particularly stretched considering our 14% non-GAAP EPS CAGR for 2016- 18E.
NetEase: past-10-year 12-month forward PER Target PER of 14x does 25 not look stretched to us 23 21 19 +2 SD = 18.1 17 +1 SD = 15.8 15 10 yr average = 13.5 13 11 -1 SD = 11.2 9 -2 SD = 8.8 7
5
Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15
Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-06 Source: Bloomberg
Globally, the leading global game platforms including Activision Blizzard, EA, NCsoft and Nexon have been trading at 15-20x 12-month forward PER vs. 20-30x for the global large- cap Internet companies (all on the Bloomberg-consensus forecasts), largely due to general concerns in the market about their game concentration and the common belief that the online-game business is hit-or-miss. We do believe there are some grounds for concern but, saying that, compared to the pure game developers, we think the market should give credit to the integrated game platforms such as NetEase, which has built up a good track record in terms of developing and operating games.
NetEase: global peers’ past-5-year 12-month forward PER We think the market 35 should give NetEase 30 some credit for its good 25 track record in developing and 20 operating games 15
10
5
Oct-12 Apr-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16
Jun-12 Jun-13 Jun-14 Jun-15
Feb-12 Feb-13 Feb-14 Feb-15 Feb-16
Dec-11 Aug-12 Dec-12 Aug-13 Dec-13 Aug-14 Dec-14 Aug-15 Dec-15 Activision Blizzard EA NCsoft Nexon
Source: Bloomberg
We note that, for NetEase, the street tends to revise its earnings expectations after the results are announced rather than before (but for Tencent, for example, the street typically revises earnings expectations throughout the earnings season), which we attribute to: 1)
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NetEase (NTES US): 24 June 2016
the company not providing financial guidance and therefore not having an “anchor” for its top-line expectations, and 2) investors generally being biased to the conservative when it comes to the life-cycle of individual games, and only giving the company recognition after it delivers.
NetEase: Bloomberg-consensus 2016 non-GAAP EPS forecast revisions For NetEase, the market CNY tends to act after results 80 Netease - major earnings revisions usually have been delivered 75 start AFTER quarterly results 70 65 60 55 50 45
40
Jul-14 Jul-15
Apr-15 Apr-14 Oct-14 Oct-15 Apr-16
Jan-14 Jun-14 Jun-15 Jan-15 Jan-16
Feb-14 Mar-15 Mar-14 Feb-15 Feb-16 Mar-16
Nov-13 Aug-14 Sep-14 Nov-14 Sep-15 Dec-15 Dec-13 Dec-14 Aug-15 Nov-15
May-15 May-16 May-14 Source: Bloomberg
Tencent: Bloomberg-consensus 2016 non-GAAP EPS forecast revisions For Tencent, the market CNY tends to act before 4.5 results are delivered 4.4 4.3 4.2 4.1 Tencent - major earnings revisions usually 4.0 start BEFORE quarterly results 3.9 3.8
3.7
Jul-14 Jul-15
Apr-14 Oct-14 Apr-16 Apr-15 Oct-15
Jun-14 Jan-16 Jan-15 Jun-15
Feb-15 Mar-15 Feb-16 Mar-16
Nov-14 Dec-14 Nov-15 Dec-15
Aug-14 Sep-14 Sep-15 Aug-15
May-15 May-16 May-14 Source: Bloomberg
As we mentioned previously in this report, we see upside potential to the Bloomberg- consensus revenue forecasts for 2016-18, given NetEase’s strong mobile-game pipeline and healthy ecommerce business. We expect the market to gradually revise up earnings forecasts, probably after the next round of results (2Q16 results expected in August 2016), and see alpha opportunities for investors buying in right now. Positive near-term share-price catalysts would include: 1) consistently high rankings for NetEase’s newly launched The New Ghost and FWJ Mobile, 2) positive news flow for Overwatch, and 3) positive news flow for its upcoming new games including FWJ: Connect and Audition.
Finally, we have cross-checked our PER-based target price with our DCF valuation. Our DCF model derives a valuation of USD205, slightly higher than our PER-based target price of USD190. In our DCF, we apply the following inputs:
WACC: 11.6% Beta: 1.2 Risk premium: 7.5% Target gearing ratio: 10%; and Terminal growth rate: 1.5%
Our beta assumption of 1.2 for NetEase is in line with 1.2 for Baidu (BIDU US, USD162, Hold [3]), slightly higher than 1.0 for Tencent (700 HK, HKD176, Buy [1]) and slightly lower than the 1.5 for Alibaba (BABA US, USD78, Buy [1]).
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NetEase (NTES US): 24 June 2016
NetEase: DCF valuation DCF Model Target Price Valuation Date 6/30/2017
Projected Terminal
Period Value In million CNY FY2016E FY2017E FY2018E FY2019E FY2020E FY2021E FY2022E FY2023E FY2024E FY2025E FY2026E FY2027E Year End Date 12/31/2016 12/31/2017 12/31/2018 12/31/2019 12/31/2020 12/31/2021 12/31/2022 12/31/2023 12/31/2024 12/31/2025 12/31/2026 12/31/2027
EBIT (GAAP) 11,972 13,568 15,376 16,914 18,605 19,535 20,512 21,538 22,184 22,849 23,535 Tax rate % 18% 18% 18% 25% 25% 25% 25% 25% 25% 25% 25% EBIAT 9,877 11,194 12,685 12,685 13,954 14,651 15,384 16,153 16,638 17,137 17,651 Add: Dep & Amortization 363 234 158 174 192 211 232 243 256 268 282 Add: Decrease/(Increase) of (784) (1,368) (1,437) (1,509) (1,584) working capital (337) (890) (979) (1,077) (1,185) (1,303) Add: Share-based 924 1,122 1,316 1,448 1,592 1,752 1,927 2,023 2,124 2,231 2,342 compensation
Deduct: Capex (1,379) (1,800) (1,500) (1,500) (1,500) (1,675) (1,965) (1,900) (1,800) (1,800) (1,800) Free Cash Flow 9,000 10,538 11,305 11,428 12,861 13,629 14,440 15,251 16,081 16,627 17,191 17449
Discount Factor - 0.95 0.85 0.76 0.68 0.61 0.55 0.49 0.44 0.39 0.35 4.89 PV (Valuation Date) - 9,973 9,591 8,692 8,766 8,328 7,909 7,489 7,077 6,560 6,080 85,255
PV (2016E - 2023E) 60,748 34%
Add: PV of Terminal Value 85,255 48%
Total: Enterprise Value 146,003 81%
Add: Net cash/(net debt) 33,176 19%
Total: Equity Value 179,179 100%
No. of ADS (m) 133
Implied target price per ADS 204.78 (USD)
Source: Daiwa forecasts
NetEase: DCF sensitivity analysis WACC
10.05% 10.55% 11.05% 11.55% 12.05% 12.55% 13.05%
2.10% 245.9 233.1 221.7 211.6 202.5 194.3 186.8 1.90% 242.3 230.0 219.0 209.2 200.4 192.4 185.2 1.70% 238.9 227.0 216.4 207.0 198.4 190.7 183.6 1.5% 235.6 224.2 214.0 204.8 196.5 189.0 182.1 1.30% 232.5 221.5 211.6 202.7 194.6 187.3 180.6
1.10% 229.6 218.9 209.3 200.7 192.8 185.7 179.2
Terminal growth rate Terminal 0.90% 226.8 216.4 207.1 198.8 191.1 184.2 177.8
Source: Daiwa forecasts
Risks to our call Faster-than-expected revenue declines for FWJ Mobile and WWJ Mobile FWJ Mobile and WWJ Mobile currently rank as the No.1 and No.2 highest grossing games on the iOS China app store. These two games accounted for over 90% of NetEase’s total mobile-game revenue in 1Q16. A faster-than-expected decline in the popularity of these 2 games would have an adverse impact on the revenue outlook for NetEase, and this is the main risk to our positive call on the stock.
Weaker-than-expected PC-game revenue growth The company’s PC-game revenue declined by 3.0% YoY in 1Q16, the first YoY decline since 2013. Moreover, its deferred revenue balance as at the end of 1Q16 declined by 1.5% QoQ, the first time in 3 years. Management said the QoQ deferred revenue decline was mainly due to weakness in its PC-game business. Weaker-than-expected PC-game revenue growth would adversely affect NetEase’s revenue outlook.
Regulatory uncertainty could hurt ecommerce sentiment Recently announced cross-border ecommerce regulations have resulted in an increasing tax burden on some of NetEase’s cross-border ecommerce orders. The diversity of its SKUs on its cross-border ecommerce platform could also be adversely affected if the regulators require sellers to follow stricter registration requirements. We believe future regulatory uncertainty could hurt short-term consumer sentiment and result in decelerating revenue growth for the company’s ecommerce business.
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NetEase (NTES US): 24 June 2016
Higher-than-expected operating expenses from ecommerce business NetEase’s management has been determined to expand its ecommerce business, which requires a large upfront investment in warehousing and supply-chain technology, as well as user acquisitions. Although we believe the company has been very prudent in terms of its financial controls, higher-than-expected operating expenses relating to its ecommerce business could have a negative impact on the company’s overall bottom line, in our view.
NetEase: comparable valuation Market price Market cap PER (x) P/S (x) EV/EBITDA (x) ROE % Ticker Short Name Rating (local curr') (USDm) FY1E FY2E FY3E FY1E FY2E FY3E FY1E FY2E FY3E FY1E China Internet 700 HK Equity TENCENT* Buy 176.10 211,146 30.4 24.9 20.5 9.7 7.8 6.6 18.9 14.9 11.8 37.7 BIDU US Equity BAIDU INC-SP ADR* Hold 163.92 57,422 28.7 20.6 16.2 5.0 4.0 3.3 18.9 12.6 9.1 14.4 NTES US Equity NETEASE INC-ADR* Outperform 172.91 22,756 13.4 11.8 10.4 4.1 3.4 2.9 8.8 7.1 5.7 33.5 QIHU US Equity QIHOO 360 TE-ADR* Outperform 75.24 10,032 21.0 15.3 n.a. 5.3 4.1 n.a. 16.1 11.2 n.a. 46.7 CTRP US Equity CTRIP.COM-ADR* Buy 40.65 18,403 139.9 36.3 21.7 6.2 4.9 4.0 n.a. 34.5 16.6 8.5 WB US Equity WEIBO CORP-ADR Non-rated 27.61 5,873 50.5 29.7 19.4 9.2 6.9 5.1 37.9 23.8 13.4 7.4 SINA US Equity SINA CORP Non-rated 51.42 3,592 64.1 34.3 21.4 3.7 3.2 2.7 21.2 14.0 9.2 2.2 YY US Equity YY INC-ADR Non-rated 34.60 1,901 11.1 9.2 n.a. 1.9 1.3 1.0 8.2 6.5 n.a. 34.3 SFUN US Equity SOUFUN HOLDI-ADR Non-rated 5.19 2,467 n.a. 43.3 13.7 1.9 1.6 1.2 n.a. 27.1 11.7 (23.9) ATHM US Equity AUTOHOME INC-ADR Non-rated 23.77 2,694 14.8 12.1 9.5 2.2 1.8 1.2 11.4 8.7 6.8 23.7 EDU US Equity NEW ORIENTAL-ADR Non-rated 40.79 6,401 26.5 21.6 18.0 3.9 3.7 3.2 20.6 16.7 13.7 17.7 BITA US Equity BITAUTO HOLD-ADR Non-rated 27.05 1,633 21.8 14.4 10.2 1.9 2.8 2.3 12.7 8.3 5.6 (7.3) WUBA US Equity 58.COM-ADR Non-rated 46.63 6,602 n.a. 29.1 21.2 4.8 3.8 2.7 51.8 20.0 11.7 (19.3) QUNR US Equity QUNAR CAYMAN-ADR Non-rated 29.29 4,241 n.a. 51.8 21.0 4.7 3.6 2.6 n.a. 43.6 19.7 n.a. XRS US Equity TAL EDUCATION-ADR Non-rated 57.00 4,610 37.7 26.5 19.2 5.3 3.8 2.9 29.3 19.6 13.4 27.4 SOHU US Equity SOHU.COM INC Non-rated 38.96 1,507 n.a. n.a. n.a. 0.8 0.7 0.7 6.3 2.8 2.2 (3.2) Average 38.3 25.4 17.1 4.4 3.6 2.8 20.2 17.0 10.8 13.3 China E-commerce BABA US Equity ALIBABA GRP-ADR* Buy 79.10 193,834 31.2 24.7 19.5 12.2 8.5 6.7 22.1 17.2 12.4 24.6 JD US Equity JD.COM INC-ADR* Buy 21.46 29,427 n.a. 41.3 19.2 0.8 0.6 0.5 n.a. 44.5 14.7 - VIPS US Equity VIPSHOP HOLDINGS* Buy 11.38 6,557 17.4 14.0 10.8 0.8 0.6 0.5 11.9 7.6 5.0 58.8 JMEI US EQUITY JUMEI INTERNATIO Non-rated 4.45 653 10.2 6.2 4.1 0.4 0.3 0.3 3.8 2.2 1.9 3.4 Average 19.6 21.6 13.4 3.5 2.5 2.0 12.6 17.9 7.2 21.7 Global Internet 19.6 21.6 13.4 3.5 2.5 2.0 12.6 17.9 7.2 21.7 AAPL US Equity APPLE INC Non-rated 96.10 526,381 11.6 10.6 9.8 2.4 2.3 2.2 5.2 5.0 4.8 39.1 GOOG US Equity ALPHABET INC-C Non-rated 701.87 486,012 21.1 18.0 15.2 6.6 5.9 5.1 11.7 10.1 8.7 14.2 FB US Equity FACEBOOK INC-A Non-rated 115.08 329,164 32.1 24.9 19.6 11.8 9.5 7.1 19.2 14.7 11.4 11.0 AMZN US Equity AMAZON.COM INC Non-rated 722.08 340,698 68.4 45.7 33.3 2.4 2.1 1.7 21.9 16.5 12.5 9.1 PCLN US Equity PRICELINE GROUP Non-rated 1,390.20 69,009 20.8 17.7 15.5 6.3 5.6 4.9 17.0 14.7 12.6 29.3 EBAY US Equity EBAY INC Non-rated 24.85 28,550 13.3 12.2 11.3 3.2 3.1 3.0 8.5 8.0 7.6 12.2 YHOO US Equity YAHOO! INC Non-rated 37.78 35,888 75.1 65.4 60.5 10.3 10.0 9.8 40.0 35.6 33.9 (14.4) TWTR US Equity TWITTER INC Non-rated 17.04 11,960 33.1 25.5 18.9 4.2 3.7 3.1 13.6 10.9 8.5 (10.7) NFLX US Equity NETFLIX INC Non-rated 91.66 39,258 193.4 77.3 43.2 4.2 3.6 2.9 77.9 38.9 23.6 6.0 EXPE US Equity EXPEDIA INC Non-rated 109.90 16,386 21.6 16.5 13.5 1.8 1.6 1.4 11.1 8.9 7.5 19.0 TRIP US Equity TRIPADVISOR INC Non-rated 65.98 9,614 38.7 29.4 22.6 5.9 5.2 4.5 21.4 16.8 13.4 12.3 LNKD US Equity LINKEDIN CORP-A Non-rated 190.45 25,652 55.1 43.9 35.0 6.6 5.7 4.8 23.5 18.9 15.2 (4.0) 035720 KS Equity KAKAO CORP* Buy 93,200.00 5,466 22.0 21.5 19.6 4.9 3.8 3.4 14.9 12.0 10.4 10.2 4755 JP Equity RAKUTEN INC Non-rated 1,010.00 14,976 20.3 16.1 13.1 1.7 0.0 0.0 0.7 0.6 0.5 7.8 4689 JP Equity YAHOO JAPAN CORP Non-rated 441.00 25,430 18.7 16.8 14.9 2.9 3.4 3.1 8.9 8.0 7.4 21.9 Average 43.0 29.4 23.1 5.0 4.4 3.8 19.7 14.6 11.9 10.9 Source: Bloomberg; *Daiwa forecasts; note: prices as of close on 23 June 2016
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NetEase (NTES US): 24 June 2016
Appendix 1: company background
Company history
Jan 2015 NetEase launched cross-border e-commerce platform, Kaolao. Aug 2008 Blizzard agreed to license certain online games to NetEase. Dec 2007 NetEase launched its proprietary Internet search engine, Youdao. Jan 2001 NetEase began focusing on fee-based premium services and online entertainment services, incl. online games, wireless value-added services, premium e-mail services and other subscription-type services. Mid 1999 NetEase established its advertising sales force to sell ads to the NetEase websites and also began to offer e- commerce platforms and provide an online shopping mall and other e-commerce services in China. Mid 1998 NetEase changed its business model from software developer to an Internet technology company, and commenced developing the NetEase websites. Early 1998 NetEase began offering free web-based e-mail. Mid 1997 NetEase began offering search services. Jun 1997 NetEase was founded.
Source: Company
Management background
Name Position Experience Mr Ding is the founder of NetEase. He served as a director since July 1999 and as NetEase’s CEO since Nov. 2005. He also served as Co-CTO from 1999 to 2000, and as Director and Chief William Lei Ding acting COO for a few months in 2001. He holds a Bachelor of Science degree in Executive Officer Communication Technology from the University of Electronic Science and Technology of China. Mr Choi has served as NetEase’s acting CFO from July 2007. He joined in NetEase in Nov. 2003. He also serves as chairman of the audit committee and an independent non- executive director for Beijing Jingkelong Company ltd. (HK 00814), China ITS (Holdings) Onward Choi Chief Financial Officer Co. ltd. (01900 HK) and Tuniu Coporation (TOUR US). He is a member of ICAEW, a fellow member of ACCA, CPA Australia and HKICPA, and a registered practising CPA in HK. Has served as a director since Jun. 2007. She is licenced as a CPA in Taiwan and the Alice Cheng Director PRC. Has served as a director since Apr. 2002. He previously served as NetEase’s CFO from 2002-07.He currently serves as the chairman of the audit committee and an independent non-executive director on the boards of New Oriental Education & Technology Group Inc. Denny Lee Director (EDU US), Concord Medical Services Holdings ltd. (CCM US), and Qunar Cayman Islands ltd. (QUNR US). Mr Lee serves as an independent non-executive director on the board of China Metal Resources Utilization ltd. (1636 HK). Mr Tong has served as a director of NetEase since Mar. 2003. He is a member of the Joseph Tong Director AICPA. He has been a director of Parworld Investment Management ltd. since 2004. Has served as a director since Jul. 2005. He has a Juris Doctor from the Chinese Lun Feng Director Academy of Social Sciences. Has served as a director since Jul. 2002. He has held senior positions with Peregrine Michael Leung Director Capital, SG Securities, Swiss Bank and Optima Capital. Has served as a director since Dec. 1999. He joined NetEase as an executive in May 2003 and served as Co-COO from 2004-09. Also he served as a director for Qunar from Michael Tong Director 2007-11. Prior to joining NetEase, Mr Tong gained 7 years of experience in the investment industry in Techpacific VC, Softbank and Nomura.
Source: Company
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NetEase (NTES US): 24 June 2016
Company structure
NetEase, Inc. (Cayman)
100% 100% 100% 100% 100%
NetEase Media, Lede, Inc. HQG, Inc. NetEase Interactive NetEase (Hong Kong) Ltd. (HK) Entertainment Ltd. (BVI) Inc. (Cayman) (Cayman) (Cayman) 100% 100% 100% 100% 100% 100% 71.1%
Hong Kong NetEase HQG, Ltd NetEase Interactive Entertainment Guangzhou NetEase NetEase Media (provides cross- Information Lede (Hong Kong) Ltd. (HK) Boguan Youdao (Hong Kong) Ltd. border e- Technology Ltd. (HK) Telecommunication Information (HK) commerce (Beijing) Co., Technology Co., Technology business) (HK) Ltd. (provides Ltd. (provides (Beijing) Co., technical 100% 100% technical Ltd. (develops consulting and 100% 100% 100% consulting and online search NetEase related related services to related Hangzhou Langhe (Hangzhou) services to Hangzhou VIEs) technologies) VIEs) Youmai Technology Co., Ltd. Network Co., Ltd. NetEase Media (provides technical (provides Technology Co., Technology Lede Technology and consulting technical Ltd. (provides (Beijing) Co., Ltd. Co., Ltd. services for licenses consulting and technical (provides technical (provides e- games) related services to consulting and consulting and commerce VIEs) Guangzhou NetEase related services related services to services) Computer System Co., 99% for cross-border VIEs) Ltd. (operates NetEase William Lei Ding e-commerce websites and offers services) various online and other Hangzhou NetEase services) Leihuo Network Co., Ltd. (operates mobile game business) 100% 71.1% Beijing NetEase 99% Media Co., Ltd. William Lei Ding 50% 50% Beijing NetEase Youdao (provides online Wangyibao Co., Ltd. Computer System Co., Ltd. advertising services) (provides online payment (provides online search Zhipeng Tianlei system) services) Hu Hu*
*Note: Tianlei Hu is willing to entrust the person designated by NetEase (Hangzhou) Network Co., Ltd. with full authority to exercise his/her shareholder’s voting rights as the Company’s shareholders’ meetings. Source: Company
Shareholding structure
Name of shareholders No. of shares holding Percentage of ownership William Lei Ding (Shining Globe International Limited) 1456,000,000 44.3% All directors and executive officers as a group 1,457,714,075 44.3%
Source: Company Note: as of 31 December 2015; NetEase does not have a dual-class shareholding structure
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NetEase (NTES US): 24 June 2016
Appendix 2: online-game industry landscape
Mobile games The size of the mobile-game market in China has grown substantially, by 145% YoY to CNY27bn in 2014 and 90% YoY to CNY52bn in 2015. Mobile-game population growth is the major driver for the significant industry revenue growth, in our view. For the first time, the mobile-game population surpassed the web-game and client-based game population, reaching 358m by 2015, equivalent to 64% of the total mobile Internet users in China. As of 4Q15, Tencent and NetEase combined accounted for over 60% of China’s total mobile- game market.
China: PC-game market revenue Mobile-game market has CNYbn expanded significantly 18 15.9 16 14.6 but is still smaller than 14 11.5 PC-game market in 12 9.5 10 terms of revenue 7.6 6.7 7.3 7.1 8 5.9 5.0 5.3 6 3.9 3.8 4.4 4.5 2.8 3.0 2.6 2.8 3.1 4 2.2 1.8 0.8 1.5 1.4 2 0.3 0.5 0.1 0.1 0.2 0.4 0.6
0
3Q14 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 4Q14 1Q15 2Q15 3Q15 4Q15 Total mobile game market revenue Tencent mobile game revenue Netease mobile game revenue
Source: iResearch
PC games Though the revenue growth rate of the China mobile-game market has been the major driver of the overall game market in the country over the past 3 years, its PC-game revenue was stable over this period, despite market concerns about potential cannibalisation by mobile games. China’s PC-game revenue reached CNY20.5bn as at 4Q15, compared to CNY16.3bn in 1Q13. As the entry barriers for PC-game development are getting higher, we think the revenue of the established players that can supply high- quality hard-core genre games will continue to grow and they will retain users, despite the shrinking size of the overall PC-gamer population. As of 4Q15, Tencent and NetEase combined accounted for 55% of China’s total PC-game market.
China: PC-game market revenue Flat PC-game industry CNYbn growth from 1Q13 to 25 20.0 19.7 20.6 20.6 20.4 20.5 20.5 18.7 19.5 19.3 4Q15 20 17.5 16.3 15
8.6 8.1 8.7 8.2 8.9 8.5 9.0 8.9 10 7.1 7.1 7.6 7.0
5 1.9 1.9 2.0 2.0 2.0 2.1 2.1 2.3 2.3 2.3 2.5 2.4
0
1Q14 1Q13 2Q13 3Q13 4Q13 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 Total PC game market revenue Tencent PC game revenue Netease PC game revenue
Source: iResearch
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Daiwa’s Asia Pacific Research Directory HONG KONG SOUTH KOREA Takashi FUJIKURA (852) 2848 4051 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Research Head Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; John HETHERINGTON (852) 2773 8787 [email protected] Shipbuilding; Steel Regional Deputy Head of Asia Pacific Research Mike OH (82) 2 787 9179 [email protected] Rohan DALZIELL (852) 2848 4938 [email protected] Banking; Capital Goods (Construction and Machinery) Regional Head of Asia Pacific Product Management Iris PARK (82) 2 787 9165 [email protected] Kevin LAI (852) 2848 4926 [email protected] Consumer/Retail Chief Economist for Asia ex-Japan; Macro Economics (Regional) SK KIM (82) 2 787 9173 [email protected] Jonas KAN (852) 2848 4439 [email protected] IT/Electronics – Semiconductor/Display and Tech Hardware Head of Hong Kong and China Property Thomas Y KWON (82) 2 787 9181 [email protected] Cynthia CHAN (852) 2773 8243 [email protected] Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game Property (China) Kevin JIN (82) 2 787 9168 [email protected] Leon QI (852) 2532 4381 [email protected] Small/Mid Cap
Banking (Hong Kong/China); Broker (China); Insurance (China) TAIWAN Yan LI (852) 2773 8822 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Banking (China) Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design Anson CHAN (852) 2532 4350 [email protected] (Regional) Consumer (Hong Kong/China) Christie CHIEN (886) 2 8758 6257 [email protected] Adrian CHAN (852) 2848 4427 [email protected] Banking; Insurance (Taiwan); Macro Economics (Regional) Consumer (Hong Kong/China) Steven TSENG (886) 2 8758 6252 [email protected] Jamie SOO (852) 2773 8529 [email protected] IT/Technology Hardware (PC Hardware) Gaming and Leisure (Hong Kong/China) Christine WANG (886) 2 8758 6249 [email protected] Dennis IP (852) 2848 4068 [email protected] IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer Power; Utilities; Renewables and Environment (Hong Kong/China) Kylie HUANG (886) 2 8758 6248 [email protected] John CHOI (852) 2773 8730 [email protected] IT/Technology Hardware (Handsets and Components) Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Helen CHIEN (886) 2 8758 6254 [email protected] Kelvin LAU (852) 2848 4467 [email protected] Small/Mid Cap Head of Automobiles; Transportation and Industrial (Hong Kong/China) Brian LAM (852) 2532 4341 [email protected] INDIA Transportation – Railway; Construction and Engineering (China) Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Thomas HO (852) 2773 8716 [email protected] Head of India Research; Strategy; Banking/Finance Custom Products Group Saurabh MEHTA (91) 22 6622 1009 [email protected] Capital Goods; Utilities PHILIPPINES Patricia Tamase (63) 2 797 3024 [email protected] SINGAPORE Banking Ramakrishna MARUVADA (65) 6499 6543 [email protected]
Head of Singapore Research; Telecommunications (China/ASEAN/India) Royston TAN (65) 6321 3086 [email protected] Oil and Gas; Capital Goods David LUM (65) 6329 2102 [email protected] Banking; Property and REITs Shane GOH (65) 64996546 [email protected] Small/Mid Cap (Singapore) Jame OSMAN (65) 6321 3092 [email protected] Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)
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Daiwa’s Offices Office / Branch / Affiliate Address Tel Fax DAIWA SECURITIES GROUP INC HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 (81) 3 5555 0661 Daiwa Securities Trust Company One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. (1) 201 333 7300 (1) 201 333 7726 Daiwa Securities Trust and Banking (Europe) PLC (Head Office) 5 King William Street, London EC4N 7JB, United Kingdom (44) 207 320 8000 (44) 207 410 0129 Daiwa Europe Trustees (Ireland) Ltd Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469
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DAIWA INSTITUTE OF RESEARCH LTD HEAD OFFICE 15-6, Fuyuki, Koto-ku, Tokyo, 135-8460, Japan (81) 3 5620 5100 (81) 3 5620 5603 MARUNOUCHI OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6756 (81) 3 5555 7011 (81) 3 5202 2021
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This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Group Inc., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person.
Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including market making activities, derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures.
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Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship Within the preceding 12 months, the subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: econtext Asia Ltd (1390 HK); Mirae Asset Life Insurance Co Ltd (085620 KS); China Reinsurance Group Corporation (1508 HK). *Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd.
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Relevant Relationship (DHK) DHK may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage.
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There is no material disciplinary action against Daiwa India by any regulatory authority impacting equity research analysis activities as of the date of this report.
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United Kingdom This research report is produced by Daiwa Securities Co. Ltd. and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange and Eurex. This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.
Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at
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http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory.
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United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (Tel no. 212-612-7000).
Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.
Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.
DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.
Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.
Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.
The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months.
Disclosure of investment ratings Rating Percentage of total Buy* 66.9% Hold** 19.7% Sell*** 13.5% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 March 2016. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.
Additional information may be available upon request.
Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)
If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements. There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.
When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.
Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association
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