Loen Entertainment (016170 KS) Loen Entertainment

Korea Consumer Discretionary 8 July 2016

Target price: KRW87,000 Share price (7 Jul): KRW71,700 | Up/downside: +21.3%

Initiation: turning up the volume

 Dominant digital-music platform; large number of paying subscribers Thomas Y. Kwon (82) 2 787 9181  Strong earnings-growth cycle set to emerge from 2H16 on price hike [email protected]  Initiating with a Buy (1) rating and 12-month TP of KRW87,000

Investment case: We initiate coverage of Loen Entertainment, the leading Share price performance digital-music service platform in Korea, with a Buy (1) call. We believe the (KRW) (%) company is set for strong revenue and earnings growth from 2H16, 100,000 140 boosted by a combination of an increase in its digital music service prices, 90,000 125 paying subscribers, revenue from new content publishing and operating 80,000 110 70,000 95 synergies as a result of its collaboration with parent company Kakao 60,000 80 (035720 KS, KRW95,000, Buy [1]). Jul-15 Oct-15 Jan-16 Apr-16 Jul-16

Loen Ent (LHS) Relative to KOSPI (RHS) Catalysts: Powering up the Melon platform: In our view, Loen will continue to enhance its revenue streams, while ramping up its business 12-month range 64,300-96,900 expansion in related commerce and overseas. We forecast revenue from Market cap (USDbn) 1.57 its Melon B2C platform to grow at a CAGR of 20% for 2015-18E, on 3m avg daily turnover (USDm) 3.35 Shares outstanding (m) 25 paying-user growth, an increase in average revenue per paying user Major shareholder Kakao (76.4%) (ARPPU) and the growing scale of its music-content related businesses. Financial summary (KRW) Kakao and Loen will pollinate and grow: We expect both companies to Year to 31 Dec 16E 17E 18E find potential service synergies in acquiring paying consumers, locking in Revenue (bn) 432 580 639 Operating profit (bn) 76 114 122 user traffic, lowering marketing costs and selling new entertainment Net profit (bn) 63 94 102 content. Including around 1.7m Kakao Music users, we believe Loen will Core EPS (fully-diluted) 2,501 3,710 4,023 increase the proportion of paying users to total registered users to 18% in EPS change (%) 26.1 48.4 8.4 Daiwa vs Cons. EPS (%) (0.5) 7.7 2.4 2018, from 13% in 2015, thanks to better accessibility and user experience. PER (x) 28.7 19.3 17.8 Dividend yield (%) 0.7 1.0 1.2 Streamlining the ecosystem; winning strategies: By enhancing its DPS 500 750 850 PBR (x) 6.0 4.4 3.5 platform power for content distribution and production in Korea, Loen EV/EBITDA (x) 15.7 10.4 8.8 should continue to strengthen its revenue streams and earnings-generating ROE (%) 23.5 26.3 21.8 power. Management expects non-Melon platform revenue to grow strongly Source: FactSet, Daiwa forecasts in 2017 and contribute to improve its overall profitability, as it accelerates content production and distribution in Asia and China.

Valuation: Our 12-month TP of KRW87,000 is based on our average EPS (KRW3,106) for 2016-17E, applying a target PER of 28x, the average for 2011-15. We believe investors should consider the full business impact of the hike in its digital music service price as well as Kakao and Loen’s joint efforts to create service synergies from 2H16. Our Buy (1) rating reflects what we see as Loen’s competitive positioning in Korea’s music industry, its powerful business-expansion strategy and its scalable revenue model with high profitability.

Risks: The key risks to our call include a slowdown in paying subscribers for Melon services, intensifying competition from both global music-service providers and local sites, lower visibility on content production and its artist- management business, and a slower-than-expected ramp-up in new business-growth initiatives.

See important disclosures, including any required research certifications, beginning on page 25

Loen Entertainment (016170 KS): 8 July 2016

Table of contents

Changing the way many listen ...... 6 A leader in streaming digital music ...... 8 Moving music: now and future ...... 13 Playing a new tune ...... 17 Earnings outlook ...... 20 Investment concerns ...... 22

Loen Entertainment (016170 KS): 8 July 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook Loen: revenue mix by service offering (2009-18E)

We expect Loen to continue to add paying subscribers 700 100% and record higher revenue from the hike in its Melon 600 platform subscription price in 2H16, and fully from 2017. 500 90% Its profitability should start to improve from 3Q16 as 400 Loen starts to work closely with its parent company, 300 80% Kakao, to promote its music content, acquire new paying 200 subscribers, and pursue effective promotional 100 campaigns. We forecast the company’s revenue from its 0 70% content platform including Melon B2C services to grow 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E at a CAGR of 20% for 2015-18E, and account for 85% Others (concerts and miscellanies) Merchandise of its total revenue for 2016E. Products Contents % of contents sales to net revenue Source: Company, Daiwa forecasts

Valuation Loen: share-price trend and quarterly operating profit

We expect Loen’s share price to perform strongly in (KRW) 2H16 and 2017 and trade at a target PER of 28x, the 120,000 20 average for 2011-15, as we expect its operating profit 100,000 15 and earnings to enter a strong growth cycle from 4Q16. 80,000

This should be supported by strong operating leverage 60,000 10 from increase in prices to download and stream songs 40,000 on its platform, effective control on marketing costs, and 5 the growing scale of its content-production business. 20,000 0 0 Jan-13 Aug-13 Mar-14 Oct-14 May-15 Dec-15 Jul-16 Operating profit(KRWbn, RHS) Share price(LHS) Paying users(m, RHS) Source: Company, FNData, Daiwa forecasts

Earnings revisions Loen: Daiwa’s EPS forecasts vs. Bloomberg consensus The Bloomberg-consensus 2017 earnings forecasts for (KRW) Loen have been revised up since 3Q15 to factor in an 3,800 increase in paying subscribers, the potential benefit from 3,600 3,400 the price hike for its online streaming and song 3,200 downloading services, and the recent service synergies 3,000 with its parent company (Kakao) in acquiring new music 2,800 players. 2,600 2,400 2,200 2,000 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16

Daiwa forecast 2016 Consensus 2016 Daiwa forecast 2017 Consensus 2017

Source: Bloomberg, Daiwa forecasts

Loen Entertainment (016170 KS): 8 July 2016

Financial summary Key assumptions Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Total registered users (m) 20 23 25 26 27 28 28 28 Total paying users (m) 2.0 2.5 2.8 3.1 3.6 4.4 4.9 5.0 Portion of streaming paid users (%) 52.4 53.2 54.0 54.8 55.0 52.0 50.0 49.0

Profit and loss (KRWbn) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Music content Revenues 147 160 230 292 309 368 482 522 Products Revenues 13 16 17 19 22 32 37 46 Other Revenue 7 10 5 12 27 32 62 71 Total Revenue 167 185 253 323 358 432 580 639 Other income 0 0 0 0 0 0 0 0 COGS (3) (5) (7) (11) (14) (40) (51) (66) SG&A (135) (150) (208) (254) (281) (315) (416) (451) Other op.expenses 0 0 0 0 0 0 0 0 Operating profit 29 30 37 58 63 76 114 122 Net-interest inc./(exp.) 2 3 2 3 3 5 6 8 Assoc/forex/extraord./others (3) (1) 5 (2) (1) 2 3 3 Pre-tax profit 28 32 45 60 66 83 123 133 Tax (7) (8) (11) (14) (16) (20) (29) (31) Min. int./pref. div./others 0 0 0 (0) (0) (0) (0) (0) Net profit (reported) 21 24 34 46 50 63 94 102 Net profit (adjusted) 21 24 34 46 50 63 94 102 EPS (reported)(KRW) 846 943 1,349 1,801 1,983 2,501 3,710 4,023 EPS (adjusted)(KRW) 846 943 1,349 1,801 1,983 2,501 3,710 4,023 EPS (adjusted fully-diluted)(KRW) 846 943 1,349 1,801 1,983 2,501 3,710 4,023 DPS (KRW) 170 189 0 711 0 500 750 850 EBIT 29 30 37 58 63 76 114 122 EBITDA 39 41 51 77 83 100 142 154

Cash flow (KRWbn) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Profit before tax 28 32 45 60 66 83 123 133 Depreciation and amortisation 10 11 14 18 19 23 28 32 Tax paid (6) (12) (6) (8) (17) (18) (27) (30) Change in working capital (25) (4) 9 10 14 15 (9) 16 Other operational CF items 0 1 (8) (3) (4) (0) (0) (0) Cash flow from operations 8 28 54 77 79 104 114 152 Capex (4) (4) (4) (5) (3) (3) (4) (5) Net (acquisitions)/disposals (7) (4) (25) (44) 6 (6) (6) (7) Other investing CF items (12) (11) (21) (15) (18) (28) (28) (28) Cash flow from investing (23) (20) (50) (64) (15) (37) (39) (40) Change in debt 0 0 0 0 0 0 0 0 Net share issues/(repurchases) 10 0 0 0 0 0 0 0 Dividends paid (4) (4) (5) 0 (18) 0 (13) (19) Other financing CF items 13 0 (0) (0) (0) 0 0 0 Cash flow from financing 18 (4) (5) (0) (18) 0 (13) (19) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 3 4 (1) 13 46 66 62 93 Free cash flow 3 24 49 72 76 100 109 146 Source: FactSet, Daiwa forecasts

Loen Entertainment (016170 KS): 8 July 2016

Financial summary continued … Balance sheet (KRWbn) As at 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Cash & short-term investment 63 71 95 162 187 253 347 464 Inventory 1 0 0 0 0 0 1 1 Accounts receivable 27 31 51 56 57 69 93 102 Other current assets 25 25 21 23 26 27 28 28 Total current assets 115 128 167 240 271 350 468 595 Fixed assets 8 10 12 13 12 11 10 9 Goodwill & intangibles 18 18 36 34 47 56 61 63 Other non-current assets 15 17 22 17 33 40 47 54 Total assets 157 173 237 304 363 456 585 721 Short-term debt 0 0 0 0 0 0 0 0 Accounts payable 22 21 34 43 59 86 100 126 Other current liabilities 27 23 40 53 53 54 55 56 Total current liabilities 48 45 74 96 112 140 155 181 Long-term debt 0 0 0 0 0 0 0 0 Other non-current liabilities 0 0 3 2 5 7 8 10 Total liabilities 48 45 77 98 117 147 164 192 Share capital 13 13 13 13 13 13 13 13 Reserves/R.E./others 96 115 144 190 225 288 400 507 Shareholders' equity 109 128 157 202 237 301 412 520 Minority interests 0 0 3 4 9 9 9 9 Total equity & liabilities 157 173 237 304 363 456 585 721 EV 1,744 1,736 1,722 1,655 1,635 1,569 1,476 1,358 Net debt/(cash) (63) (71) (95) (162) (187) (253) (347) (464) BVPS (KRW) 4,299 5,064 6,206 7,993 9,386 11,881 16,308 20,553

Key ratios (%) Year to 31 Dec 2011 2012 2013 2014 2015 2016E 2017E 2018E Sales (YoY) 20.3 10.7 36.5 28.0 10.6 20.9 34.3 10.1 EBITDA (YoY) 60.1 4.9 24.1 49.7 7.8 20.8 41.8 8.7 Operating profit (YoY) 91.6 2.4 24.1 56.6 8.4 20.6 49.1 7.0 Net profit (YoY) 143.9 11.4 43.1 33.5 10.1 26.1 48.4 8.4 Core EPS (fully-diluted) (YoY) 143.9 11.4 43.1 33.5 10.1 26.1 48.4 8.4 Gross-profit margin 98.2 97.4 97.1 96.7 96.2 90.7 91.3 89.7 EBITDA margin 23.5 22.3 20.3 23.7 23.1 23.1 24.4 24.1 Operating-profit margin 17.6 16.3 14.8 18.1 17.7 17.7 19.6 19.1 Net profit margin 12.8 12.9 13.5 14.1 14.0 14.6 16.2 15.9 ROAE 23.8 20.1 23.9 25.4 22.8 23.5 26.3 21.8 ROAA 14.8 14.4 16.6 16.8 15.0 15.4 18.0 15.6 ROCE 32.7 25.4 25.9 31.9 28.1 27.6 31.2 25.7 ROIC 76.1 44.4 46.6 82.0 94.1 102.0 133.5 133.7 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 24.7 24.4 23.6 23.2 23.6 23.6 23.6 23.6 Accounts receivable (days) 54.8 57.4 59.3 60.1 57.5 53.2 50.8 55.6 Current ratio (x) 2.4 2.9 2.3 2.5 2.4 2.5 3.0 3.3 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 20.1 20.1 0.0 39.5 0.0 20.0 20.2 21.1 Free cash flow yield 0.2 1.3 2.7 3.9 4.2 5.5 6.0 8.1 Source: FactSet, Daiwa forecasts

Company profile

Loen is a leading online-music streaming platform in Korea, with more than 60% market share. It has 28m registered users and 6.85m unique visitors. Kakao is the major shareholder, with a 76.4% stake.

Loen Entertainment (016170 KS): 8 July 2016

Changing the way many listen

Buy Loen shares at the current level Initiating with a Buy (1) We initiate coverage of Loen with a Buy (1) rating and 12-month TP of KRW87,000, based rating and 12-month TP on the average EPS (KRW3,106 for 2016-17E), using target PER of 28x, the average PER of KRW87,000 multiple for 2011-15. We expect the company to enter a strong earnings-growth cycle from 2H16 on higher profits from a price hike in its digital music services, new revenue from content sales, and strong operating leverage as a result of the service integration initiatives with Kakao, its parent company.

Three reasons to buy In our view, Loen is well positioned to capitalise on growing opportunities from the thriving demand for digital music content in Korea and Asia, by leveraging its strong expertise in the music streaming services. Here are the 3 reasons for our positive stance on Loen.

 1) An undisputed leader in the digital-music service industry: Loen is the No.1 music streaming platform in Korea, with a dominant market share of over 60% in terms of unique visitors, and is now ready to move up the value chain of the entertainment content industry, related commerce and possibly advertising. It has recurring and highly visible revenue streams, which we think would be of great value to investors in the prevailing difficult economic and equity-market conditions.

 2) Market outlook is as good as it sounds: We think Loen has an addressable and scalable target market, where it could benefit from a growing number of paying users, rising selling prices after the recent government-initiated price hike, and its expansion of its service span. We forecast Korea’s digital music revenue to grow at a CAGR of 8% for 2015-18E and account for 80% of the total music industry in Korea in 2016. We also believe that entertainment-content publishing and related commerce are good target markets for Loen, with promising business prospects and appealing investment opportunities. We believe Loen could successfully capture the emerging market opportunities from the B2B segment, social platform and overseas.

 3) Forging ahead with Kakao: We expect both Loen and Kakao to find the optimal solutions to accelerate their platform monetisation through effective acquisition of new users and paying listeners, as well as a joint promotion of all the services of both the companies at reduced cost. With a potential migration of Kakao Music users (around 1.8m unique visitors and 23m total users as at 1Q16), we forecast Loen will increase its paying subscribers at a CAGR of 12% in 2015-18E.

We expect Loen’s revenue and earnings to increase strongly for 2016-18E, on strong revenue from its Melon platform, strong operating leverage as a result of collaboration with Kakao, and new revenue from its overseas and artist-management businesses. We forecast Loen’s EPS to grow a CAGR of 27% for 2015-18E and its operating-profit margin to improve to 19.1% in 2018 from 17.7% in 2015.

Attractive with compelling investment case Premium-priced, but We expect Loen’s share price to perform strongly in 2H16-2017 and should trade at justified average PER of its historical range (12.5-51.8x for 2011-15), as we expect it to enter a strong earnings-growth cycle from 2H16 and its new business initiatives to pay off. With a diversifying revenue mix (Melon Shopping, Melon Ticket, and other content publishing), Loen should see its revenue and earnings growth accelerate over the next 3 years.

Once a dominant leader Investors could view Loen shares as overvalued if they consider the company as a pure can evolve, it is bound to music streaming site, but we think it is still undervalued, as we believe that Loen, already a win big, in our view dominant player with the largest market share, could garner a lion’s share in the rapidly growing market, by leveraging its strong platform power, extensive service expertise and strong cash flow from premium paying subscribers.

Loen Entertainment (016170 KS): 8 July 2016

Valuation premium from In our view, Loen shares deserve to trade at a valuation premium to its local peers, as we profitability, business expect the company to: 1) demonstrate strong earnings growth on its new business-growth scope, and synergies initiatives and improvement in profitability, 2) increase its market leadership in Korea, by expanding its business scope into non-streaming services and content production, and 3) strongly benefit from the potential synergies in its core-service operations and monetisation, as a result of jointly cooperating with all affiliates of the Kakao group.

Business positives from Over the next 12 months, we believe investors will start appreciating Loen’s business vertical expansion and initiatives: 1) value-chain expansion into music-content production, publication and Kakao users commerce, and 2) potential synergies from its efforts to capitalise on Kakao’s vast mobile users. We advise investors not to underestimate the synergies from social media platforms like Kakao, where the music platform can strongly benefit from sharing feedback, play lists and song/artist ratings. We think Loen shares should not be valued entirely as a pure music streaming site, but as an integrated content platform covering multiple entertainment industry domains inside and potentially outside Korea.

We believe the following could be positive share-price catalysts for Loen: 1) the announcement of a clearer roadmap for collaboration with Kakao (early-3Q16), 2) increased investor confidence that it can produce and publish appealing music content in Korea and China, and 3) a surge in the transaction volume on its commerce platforms (Melon Shopping and Melon Ticket).

Global peer group valuation Ticker Mkt cap PER (x) REV. Growth (YoY %) EPS Growth (YoY %) OPM (%) Company (Bloomberg) (USD $m) FY15 FY16E FY15 FY16E FY15 FY16E FY15 FY16E Korea LOEN ENTERTAINMENT INC* 016170 KS 1.6 36.2 28.7 10.6 20.9 10.1 26.1 17.7 17.7 KT MUSIC CORP 043610 KS 0.2 54.2 - 3.3 - 4.4 - 2.2 - BUGS CORP 104200 KS 0.2 33.9 21.5 10.9 18.5 N.M. 73.1 11.7 12.9 SORIBADA INC 053110 KS 0.1 - - (1.4) - N.M. - (18.2) - Korea Average 41.4 25.1 5.9 19.7 7.3 49.6 3.4 15.3

PANDORA MEDIA INC P US 2.9 - - 26.4 22.3 N.M. N.M. (14.6) (8.8) SIRIUS XM HOLDINGS INC SIRI US 19.8 38.9 27.5 9.3 8.6 0.0 33.7 25.8 30.0 Macau Average 38.9 27.5 17.9 15.5 0.0 33.7 5.6 10.6 Asia Average 40.8 25.9 9.9 17.6 4.8 44.3 4.1 13.0

Source: Bloomberg, FNData, *Daiwa forecasts

 Loen: PER bands  Loen: EV/EBITDA bands (KRW) (KRW) 120,000 120,000 50.5x

100,000 100,000 40.5x 31.1x 80,000 80,000 24.6x 30.5x 60,000 60,000 18.0x 20.5x 40,000 40,000 11.5x 10.5x 20,000 20,000 4.9x 0 0 Sep-12 Aug-13 Jul-14 Jun-15 May-16 Sep-12 Jun-13 Mar-14 Dec-14 Sep-15 Jun-16

Source: Bloomberg, FNData, Daiwa forecasts Source: Bloomberg, FNData, Daiwa forecasts

Loen Entertainment (016170 KS): 8 July 2016

A leader in streaming digital music

Largest provider of paid-music services in Korea About Loen and its Loen controls more than 60% of Korea’s paid-music streaming and downloading market, in Melon platform, one of terms of unique visitors (UVs). Melon, the company’s paid-music service platform, the first legal digital recorded 3.7m paying users as at end-1Q16 (end-2014: 3.1m; end-2015: 3.6m), and offers music services digital song downloads and a streaming service both for PC online and mobile devices. Loen was founded in October 1978 as Seoul Records and its shares were listed on the Kosdaq in December 2000.

After SK Telecom (SKT, 017670 KS, KRW214,500, Outperform [2]) acquired a 60% stake in Seoul Records (now Loen) in December 2008 and integrated its internal music service (Melon), the company kicked off the digital-music streaming services commercially. SKT sold its majority stake of 52.56% in the company to a private equity fund in September 2013. Kakao became a major shareholder of Loen after acquiring a controlling stake of 76.4% from private equity fund Affinity Equity Partners and SK Planet (not listed) on 16 March 2016.

Specialising in music streaming services Areas of expertise that In our view, Loen’s innovative music platform and marketplace should continue to benefit differentiate Loen’s music consumers, as shown by strong demand for its service offerings. As Korea’s online- Melon music streaming service pioneer, we believe Loen’s Melon platform stands out from the music services provided by domestic competitors in Korea in the following areas;

 Well-organised personal services: Melon provides the curation features (Melon DJ/Smart Radio), which allow users to take advantage of the customised play-list and song recommendation by user profile. By leveraging its long operational expertise and its vast database for users, transactions, and music plays, we think Melon platform offers appealing streaming services, more value-added services (Melon TV) and a better experience for players compared to its local peers.

 Effectively leveraging its service partnerships: SKT strategically supports the Melon service to lure new users, retain wireless subscribers, and promote its service packages. In addition to SKT, Loen’s Melon service also stands to benefit from Kakao’s mobile social platform from 2H16. We think Loen has a strong capability to leverage mobile users, data traffic, and other service infrastructure like billing, payment, and promotion channels, which should also help it attract users.

 In-house content publishing: Unlike other paid-music services, Melon is able to offer appealing music content produced by its affiliate management companies. With its strong value chain in the music-content business, Loen can diversify its song offerings and effectively promote more valued-added services, leading to stable and lucrative revenue streams, in our view.

Loen Entertainment (016170 KS): 8 July 2016

Melon: screen shots of the main page and personalised service

Source: Company, Daiwa

Management believes Loen’s expertise in music-platform operations and data mining could enhance its revenue models in content production, related commerce (Melon Shopping), and potentially advertising. With the company’s strong brand equity and first-mover advantages in music streaming service, management expects Melon to continue to generate strong cash flow, which could help the company penetrate other entertainment segments.

Melon: a pioneer in Korea’s paid music industry Undisputed market Melon is the No.1 platform for music streaming and download in Korea, recording 6.9m leader average UVs and 2.6bn minutes of total time spent during January-March 2016. Actually, we estimate the number of paying subscribers for Melon rose by 15% YoY to 3.7m as at end-1Q16, on the diversification in its song offerings, effective promotional events, ongoing migration of the young generation to paying services, and solid subscription demand prior to the forthcoming price hike for the existing users.

Loen: key operating metrics (2006-18E) 20% 9,000 8,000

15% 7,000 6,000 5,000 10% 4,000 3,000 5% 2,000 1,000 0% 0 2006 2009 2012 2015 2018E % of paying user to registered users(LHS) Paying users (thousands, RHS) ARPPU(KRW, RHS)

Source: Company, Daiwa forecasts

Three competitive In our view, Loen has 3 competitive advantages over its competitors in Korea. First, Melon advantages: subscriber has a sizeable and loyal subscriber base. Its number of total paying users rose by a CAGR base, library, value- of 12% for 2012-15, and it expects this growth rate to continue for the next few years, added services supported by its joint user-acquisition initiatives with Kakao. Loen has been adding more than 0.35m new paying users annually since 2012, and expects this trend to continue in 2016 and onwards, backed by the diversification in song offerings, listener coverage, and logon ID sharing with Kakao.

With MAUs of 41m in Korea, Kakao has 23m registered users and 1.8m UVs for Kakao Music as of 1Q16. While it is currently working with Bugs Music (104200 KS, not rated), we

Loen Entertainment (016170 KS): 8 July 2016

believe the company is likely to incorporate Melon services into its mobile-messaging platform, in order to increase its users, traffic, and transactions on its Kakao Pay, Kakao Story, Kakao TV and other mobile-to-offline (M2O) services. We believe Loen will roll out new music services and content specifically optimised and customised for mobile and Kakao’s vertical M2O platforms over the long term.

Kakao: monthly active users (MAUs, m) (3Q13-1Q16) 8% 50 6% 40 4% 30 2% 20 0%

10 (2%)

0 (4%) 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Korea Global Total growth (YoY, RHS)

Source: Kakao, Daiwa

A vast library of songs is Second, Loen had 7.2m songs available for download at end-1Q16, compared with 7.0m key to every leading for KT Music (the second largest player in the market). Meanwhile, it offers 2.5bn music streaming platform streaming services and 58m song downloads per month to 5m active users. By investing in new artists and content production, Loen would likely continue to lead the competition against local peers in Korea. Based on our channel checks, third-party content producers prefer the Melon platform due to the potential benefits from its growing scale of loyal users, significant traffic, and paid-music consumption.

We view Loen’s Partner Centre as a strong ecosystem, where artists benefit from ongoing feedback from industry experts and analytic solutions on users and market trends. More than 750 management companies and around 22,000 artists are capitalising on a total of 28m Melon users through this powerful platform.

We are excited about Third, we believe Loen will be able to increase the user experience by offering some value- Melon’s strong brand added services such as calendar, community sites, and a marketplace for merchandise and user asset products. In our view, users’ expectation that they can get what they want with ‘ease and speed’ will continue to rise. This should change the fundamental underpinnings of Loen’s core businesses and create rising demand from paying music consumers. Its personalised services allow users to get music services and related content on their own schedule. We expect Loen to harvest its big data on users and artists, which we think will be critical for differentiating its services.

Loen expects its increasing interaction with artists under contract (through its artist- management company) to boost overall activities on the Melon platform, and potentially help it find ways to lure new subscribers and moreover increase the number of paying users. With the enhancing ecosystem of the music industry in Korea, the company expects to tap into the content publishing service in China and ASEAN countries from 2017.

Evolving as a next-generation content publisher Business model: The company’s main businesses include the music streaming and download service streaming/download (Melon), content distribution (1theK), and music production with its affiliates (Loen Tree, services, content Starship Entertainment, King Kong Entertainment, Plan A Entertainment). Basically, since distribution, and its launch, its business model has continued to shift towards consumer-driven and value- production based offerings, which provide sustainable growth on all business metrics. The company’s revenue mix for 1Q16: Melon (75%), content distribution (11%), products/merchandise (7%), and others (7%). Overseas revenue remained insignificant, accounting for 4.8% of its total revenue in the quarter.

Loen Entertainment (016170 KS): 8 July 2016

Loen: revenue breakdown by service (2009-18E) 700 40%

600 35% 30% 500 25% 400 20% 300 15% 200 10% 100 5% 0 0% 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E Contents Products Merchandise Others (concerts and miscellanies) Revenue growth (%, YoY)

Source: Kakao, Daiwa forecasts

For the Melon service (B2C model), Loen sells digital songs for download in sets of songs (40 x MP3 downloads for KRW10,000) or individually (KRW700 each), as well as a streaming service via a monthly subscription (KRW7,900). It also sells a monthly package, bundled with MP3 downloads and an unlimited streaming service. We forecast the subscriber mix for 2016 by key products to be as follows: streaming only (52%), download only (4%), and bundled package (44%).

Based on the industry’s standard fee structure, Loen shares revenue with its various business partners within the value chain. As a content provider, the company also generates royalty revenue by distributing internally produced songs, which we believe is more profitable due to the lack of royalty costs to content producers. For its B2B music business, it provides digitalised music to enterprise customers and other service platforms.

Korea music industry: revenue-sharing scheme (as of 1Q16)

Digital music Music Labels, service(40%) distributor(44%)or managements(35%) Digital music revenue(100%) License Composers, KOMCA(10%) holders(60%) songwriters

FKMP(6%) Singers, performers

Source: Company, Daiwa Note: KOMCA: Korea Music Copyright Association, FKMP: Federation of Korean Music Performers

Loen also publishes other entertainment content outside Korea. The company aims to accelerate its global expansion through K-Pop related content production as it expects to benefit from thriving demand for Korean songs and cultural offerings in Asia and globally. Management expects its strong partnership with Kakao and other local content distributors in China to help Loen gain traction in the overseas market. It plans to increase its distribution scope from online music to merchandise, video and content production from 2H16, according to management. Strategically, Loen is rapidly stepping up in the value chain of the country’s entertainment content business.

Forging ahead with Kakao, a dominant mobile social platform Shareholding structure Kakao became a major shareholder of the company with the acquisition of a 76.4% stake on 16 March 2016, following a rights offering for Kakao shares made to Loen’s previous shareholder (Star Investment Holdings and SK Planet).

Loen Entertainment (016170 KS): 8 July 2016

Loen: shareholding structure (as at end-1Q16) Others 23.6%

Kakao 76.4% Source: Company, Daiwa

Loen Entertainment (016170 KS): 8 July 2016

Moving music: now and future

Korea is different from global markets Globally: ad-supported According to Music White Paper (KoCCA, 2015), revenue from digital music sources will streaming remains a grow a CAGR of 2.6% for 2014-18 globally. Meanwhile, International Federation of popular choice Phonographic Industry (IFPI, 2015) noted global digital music revenue rose by 6.9% YoY to USD6.85bn in 2014 on robust demand for streaming services (up by 39% YoY; 23% of total digital music revenue from 18% in 2013), while permanent downloads fell by 8% YoY. Globally, the number of paying subscribers for digital music services grew steadily on ongoing migration to smart devices, improving billing infrastructure, and ongoing addition of new songs. In particular, ad-supported streaming services grew noticeably in 2014 and accounted for 9% of the total digital music markets globally.

Global: music industry opportunity (USDbn) 50 70%

60% 40 50%

30 40%

20 30% 20% 10 10%

0 0% 2011 2012 2013 2014 2015E 2016E 2017E 2018E

Offline source Digital source Concert % of digitalised music, RHS Digital music growth(YoY), RHS Source: PWC, Music White Paper (Korea Creative Content Agency: KoCCA, 2016), Daiwa

Korea: music-streaming- Korea’s digital music industry has evolved differently from the global markets, with users driven market with large focusing on music-file sharing (~2011) and then rapidly jumping into music streaming and number of paying audio-on-demand (2011-15), and now radio music streaming (2015~) compared to the file listeners sharing (napster), downloading (itunes store) and music streaming (Spotify) trend witnessed globally. We think Korea’s digital music industry has several unusual characteristics such as:

 An addressable market of paying subscribers: Unlike other global digital music markets, Korea is one of the earliest countries where commercial services started and the number of paying users grew rapidly. As at end-1Q16, Loen’s total registered users (28m) included 3.7m paying subscribers. We estimate Korea had around 6.3m total paying users of digital music services as of 1Q16 and forecast the figure to grow at a CAGR of 14.4% for 2016-20.

 Strong demand for flat-rate subscriptions: Korean music consumers prefer flat-rate subscription packages to single song downloads or time-based play, thanks to favourable discount service plans being offered by strategic partners like local telcos. We estimate Loen has around 85% users subscribing for flat-rate monthly subscription by paying around KRW6,000-12,000 per month, compared to the industry average of around 60%.

 Trendy, music-streaming-driven market: Korean users tend to consume music content rapidly, as popular tunes can change within a short period of time, and users like trendy music offerings. In addition to telcos’ efforts to increase data traffic, this tendency to consume content quickly has led to a relatively high portion of streaming users (including bundled packages), representing around 90% of total subscribers. As such, a market leader like Loen is able to leverage its strong position in song offerings, user database, and competitive curation features; but we believe late-comers could face difficulties in catching up with this trend.

Loen Entertainment (016170 KS): 8 July 2016

 Tight partnership with wireless operators: Loen’s Melon service has strongly benefited from joint promotion with SKT. We note that even KT Music (043610 KS, not rated) has worked closely with KT Corporation (KT, 030200 KS, KRW30,400, Outperform [2]) in acquiring users and penetrating the B2B segment by offering music streaming subscription price discounts in order to lure subscribers on to its wireless services. We estimate that around 60% of Melon users subscribed to SKT’s wireless services in 2Q16. In our view, local telcos have taken advantage of digital music content as a useful promotion tool and value-added service. Strategically, they are keen to increase data traffic through streaming services and music-video content.

 Vertically integrated distribution channel: In Korea, it is difficult to distribute music content exclusively, as a platform operator needs to sign a separate contract with all related parties. By producing content internally, music-platform operators like Loen can benefit from strong bargaining power in sourcing other songs, generating revenue from the B2B segment and overseas markets, and securing higher profitability.

Korea: music industry revenue by service format (KRWbn) 700 90% 80% 600 70% 500 60% 400 50%

300 40% 30% 200 20% 100 10% 0 0% 2003 2005 2007 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E Digital (LHS) Record music (LHS) % of digitalised music sales (RHS)

Source: Company, Music White Paper (KoCCA, 2016), Daiwa

In our view, these special features of Loen’s have hindered global players from penetrating Korea’s domestic market. However, we believe this relatively closed market will change over time as consumers appreciate more diversified music offerings, even from overseas competitors.

Ongoing channel shifts in playing music Music consumption: The milestones for Korea’s paid music market were Soribada (July 2006) and Bugs from ownership to Music’s (July 2004) initiatives to charge for the music content on their platforms. Before access charging was introduced, Korea’s domestic music market suffered from illegal file sharing through P2P sites and prevailing usage of unauthorised songs on the web. Three key catalysts driving the industry evolution in Korea were: 1) the industry participants’ efforts to protect content copyright, 2) the Korea Government’s initiatives to revive the music industry, and 3) advanced smart devices and network speed to support high quality streaming service.

Narrowing the value We forecast Korea’s digital music revenue to grow a CAGR of 8% for 2015-18E and game between platforms account for 80% of the total music industry in Korea in 2016, mainly driven by the increase and artists in the absolute price of a song, diversification of service packages, the rising penetration of smart devices, and the robust growth of paying subscribers for music streaming services. Including the Korean Government, all industry participants are keen to fill the gap in the value that certain digital platform extracts from music and the value that is returned to the artists.

We note that, Korea’s music industry’s jump to paid music services, skipping download services, was triggered by the rapid penetration of smartphones and the LTE network, and more importantly, due to joint promotional campaigns with local telcos.

Loen Entertainment (016170 KS): 8 July 2016

Korea music industry: user statistics and revenues of key players (as of 1Q16) Loen (016170 KS) CJ E&M (130960 KS) Bugs(104200 KS) KT Music (043610 KS) Soribada (053110 KS) UVs (m) 6.8 1.4 1.2 2.0 0.3 Page views (m) 28.0 13.4 5.6 7.6 3.8 Total time spent (min, bn) 2.6 0.6 0.4 0.5 0.1

Revenue* 357.6 1,347.3 60.9 89.2 28.6 Operating profit* 63.4 52.7 7.1 1.9 (5.2) Net profit* 50.3 52.9 5.0 3.4 (5.2)

Source: Companies, KoCCA, Daiwa forecasts Note: Price scheme does not include 3 months price discount. * indicates FY2015 financials.

The impact of the first In June 2012, the Ministry of Culture, Sports and Tourism announced its decision to raise price hike in January the absolute price for every streamed and downloaded song and bundled product, and cut 2013 was significant the share of revenue that online music-service providers receive from streaming and downloading of songs (from 46-57.5% to an across-the-board rate of 40%). As a result, in 2013, Loen’s revenue rose by 36.5% YoY to KRW252.6bn and operating profit was up 24.1% YoY to KRW37.4bn (vs. revenue of KRW185bn and operating profit of KRW30.1bn in 2012). The Korean online-music service providers including Loen believe the absolute price of downloading/streaming a song in Korea is still lower than the global market average, despite 2 hikes in the absolute price of downloading/streaming a song, in June 2012 and December 2015.

Korea music industry: changes in revenue-sharing scheme (2013 vs. 2016) MCST amendments Before Jun-12 Jun-12 Dec-15 Jun-12 Dec-15 Streaming price per song (for monthly subscription) 1.8* 3.6 4.2 100% 17% - Profit sharing - Platform : copyright holders 57.5:42.5 40:60 40:60 Download price per song 270 360 490 33% 36% Profit sharing - Platform : copyright holders 46:54 40:60 30:70 Melon price hike (KRW) Before Jul-13 Jul-13 Sep-16 Jul-13 Sep-16 Free club 4,500 9,000 10,900 100% 21% Streaming club 3,000 6,000 7,900 100% 32% Bundled with MP3 40 Plus 7,000 10,000 14,000 43% 40% Bundled with MP3 150 Plus 11,000 16,500 32,000 50% 94% MP3 40 5,000 7,000 10,000 40% 43% MP3 150 9,000 13,500 28,000 50% 107%

Source: Company, compiled by Daiwa Note: *Based on the amount charged per subscriber (KRW1,800)/Ministry of Culture, Sports and Tourism (MCST)

The second price hike The latest March 2016 hike saw the percentage increase in price of downloading a song could lead to a new wave being higher than that for streaming the same song. Unlike the previous hike in 2013, this of industry evolution initiative was smaller in scale, but gave more benefit to content producers by raising the absolute price for each download and streaming product by 17-36%, and cutting the share of revenue that online music-service providers receive from downloading the songs (from 40% to 30%). Platform operators like Loen have been applying new price schemes for new subscribers from March, and plans to charge new pricing to the existing users from September 2016.

Industry prospects Two-thirds of the next We view the following 4 factors as key driving forces for a strong increase in revenue for generation is now in paid-music consumption in Korea: a rise in smartphone penetration, higher long-term paid music services evolution (LTE) penetration, enhanced curation services, and the ongoing addition of new songs as a result of a favourable fee-sharing scheme for artists. We expect the industry to regain business growth momentum from 2H16, helped by an increase in the number of song offerings, paid consumers, service scope and distribution channels,

Increased number of We forecast total paid subscribers for Korea’s digital music industry to grow at a CAGR of paying users = strong, 14.4% for 2016-20, based on our forecast of 7m total paid subscribers as of the end-2016. visible revenue growth With enhanced consumer experience for paid content through IPTV, smart devices and momentum web content, we believe the number of total paid listeners would continue to rise over the medium term, along with effective promotions and appealing bundled products. We doubt that another price hike for paid-music services would take place over the next 3 years given there might be a price resistance from users.

Loen Entertainment (016170 KS): 8 July 2016

Competitors find it hard In our view, the current competitive landscape for Loen is unlikely to change in the to garner users owing to foreseeable future, despite Apple Music’s plan to start local services, and given that the growing platform domestic portals appear to be utilising music content as one of the useful tools to lock in dependence users and traffic. Basically, we think Apple’s service will have relatively smaller local song offerings with more overseas songs, and is likely to take time to source a similar scale of local music content.

On the other hand, local Internet portals would continue to focus on enhancing the user experience through music content and retain both users and traffic on their platforms, to ramp up ad sales, rather than paid-content sales. Meanwhile, we think the ad-supported streaming services (eg, Beat) in Korea will continue to face the difficulties in making a profit and sourcing appealing content due to their weak financial resources.

Korea music industry: competitive landscape Loen CJ E&M Bugs KT Music Soribada Platform brand Melon Mnet Bugs Music Genie Soribada Service Launch 2005 2003 1999 2012 2000

Listed prices (KRW, as of 28 Jun 16) Streaming only 7,900 7,900 7,900 6,000 7,900 Download only(MP3 30 downloads) 9,000 8,900 8,900 6,000 8,900 Bundled package (MP3 30 download) 13,000 10,900 10,900 9,000 10,900

Estimated paid subscribers (m) 3.7 0.8 0.6 1.1 0.2 # of tracks(m) as of Aug 2015 7.2 3.6 4.3 7(Jun 2016) 3.6 Business partners SKT 11st St Kakao KT 11st St

Source: company, KOCCA, Daiwa estimates Note: Price scheme does not include 3 months price discount

Loen Entertainment (016170 KS): 8 July 2016

Playing a new tune

From songs to commerce on Melon The opportunity for Loen Loen aims to evolve as a vertically integrated platform for all kinds of entertainment content is to diversify Melon such as music and video. It plans to offer new entertainment services (Melon Ticket) itself related to music content such as ticketing for concerts and online sales of merchandise products related to artists and other entertainers (Melon Shopping).

In Korea, we estimate the total ticket revenue to have been around KRW0.8tn for 2015, where Interpark Ticket and NHN Ticketlink controlled most of the industry sales with a more than 80% share. In our view, new-comers like Melon Ticket will be able to gain share in the entertainment-content market by selling tickets to their own artists’ concerts, while major players are selling tickets for concerts and sports games only.

By leveraging Melon’s significant user base, management said Loen would further diversify its business scope into non-music streaming service markets from 2H16. According to industry experts, Loen has succeeded in leveraging its stable and visible monthly- subscription revenue from Melon to find new revenue streams, improved its service quality, and strengthened its ecosystem, especially for content.

Interpark (108790 KS): transaction volume of ticketing service (KRWbn) 450 12,000 400 10,000 350 300 8,000 250 6,000 200 150 4,000 100 2,000 50 0 0 2011 2012 2013 2014 2015 Musical Live concert Play Classic & Dance Number of products(RHS)

Source: Company, Daiwa

A content factory poised to tap into the Asia market Loen aims to become a Loen has been seeking growth opportunities for its artist management business and has regional content hub thus acquired multiple agencies over the past few years. It acquired Starship Entertainment (70% stake) in 2013, King Kong Entertainment (100% stake owned by Starship Entertainment) and Plan A Entertainment (70% stake) in 2015. Loen highlighted that it aims to create synergies with a vertical business structure that can sign talented artists, record music and distribute the music on its platform. Management also expects to see strong synergies from incorporating new businesses (such as expanding its line-up of new artists and in-house content) in 2H16 and onwards.

Loen: a brief summary of its content-business expansion (2013~) (As of 1Q16) Starship Entertainment King Kong Entertainment Plan A Entertainment FNC Entertainment Ownership 64.8% 100% owned by 70.0% 5.1% Starship Entertainment Acquisition cost 15.0 - 12.6 11.0 (KRWbn) Acquisition date 20 Dec 2013 20 May 2015 25 Nov 2015 9 Jun 2015 (KRWbn) Revenue (FY2015) 23.3 9.4 9.0 60.1 Net profit 2.1 0.8 2.6 7.9 Artists K. will, Sistar, Mad Clown Yoo Yeon Seok, Lee Kwang A Pink, Huh Gak AOA, CNBLUE, Lee Gook Soo Ju, Yu Jae Seok

Source: Company, Daiwa Note: Plan A Entertainment is formerly A Cube Entertainment. Also, it has artist management affiliates such as Muhwain (68%), Cre.Ker Ent. (80%), and Fave Ent. (80%).

Loen Entertainment (016170 KS): 8 July 2016

In December 2015, Loen announced that it had signed an MOU with China’s LeTV (300104 SZ, not rated) to establish a joint venture for artist management. Loen expects to leverage the strong network of the new entity to promote its artists and actors, and hopes to find new business opportunities beyond Korea. Starship Entertainment, its affiliate in Korea, also formed a strategic partnership with Yuehua Entertainment in China in April 2015, to tap into the China’s entertainment market.

As a leading K-pop content distributor and content producer in Korea, Loen plans to accelerate its new business initiatives for artist management and content production, in order to enhance its revenue model and platform power to engage in content publishing. More importantly, we believe that the acquisition of multiple artist agencies in recent years will be positive for its parent company, which is keen to position itself in the overseas mobile-service markets.

Loen tuning in to Kakao listeners Re-engineered platform, In our view, Loen will be a key beneficiary of its collaboration with Kakao, in terms of user increasingly acquisition, traffic monetisation and conversion of free users to paid subscribers. We personalised, curated, expect Loen to increase operating synergies with Kakao from 2H16, especially in the and scalable following 4 areas:

 New paid-subscriber acquisitions: By allowing users to login to the Melon service with Kakao ID, we expect Loen to lure more new users and increase its paid listener base. By offering easier accessibility and a powerful payment gateway through Kakao Pay, we believe Loen could capitalise on the sizeable number of free users on both Kakao and Loen, and generate additional streaming revenue. We note that around 70% of its subscribers are in the 19-35 age group, implying that Loen could further increase its user base by engaging older generation users through Kakao Talk platform.

 Better user experience: Kakao has advanced mobile-service technologies for search, data-pattern recognition and user traffic analysis. We note that the personalised features for digital-music services (by gender, location, weather, time, etc.) have become more crucial for acquiring new users and retaining the existing users. We expect Kakao to help the company to enhance user experience and engagement.

 Revenue upside from its B2B services: We think both companies could ramp up monetisation of Kakao users through background music, ring tones and social music service. We think Loen will continue to benefit from increasing captive demand for music and entertainment content from all affiliates within the Kakao group.

 Lower marketing costs: We believe both companies would do their best to lower costs related to promotional events through discounted coupons and other mileage programmes. By providing popular emoticons for Kakao’s platform, Loen would be able to access vast messaging users on Kakao Talk and reduce its marketing costs going forward.

Loen: cost mix by promotion and advertising (2009-15, KRWbn) 40 10% 35 8% 30

25 6% 20 15 4% 10 2% 5 0 0% 2009 2010 2011 2012 2013 2014 2015 Advertising cost Promotion cost Advertising: % of operating cost(RHS) Promotion: % of operating cost(RHS) Source: Company, Daiwa

Loen Entertainment (016170 KS): 8 July 2016

Loen users will During our recent discussion with Kakao’s management, the company revealed that it appreciate the social planned to ramp up the integration of Loen’s music services with all of Kakao’s mobile networking with music services by working on user interface, login process, and traffic data mining. In our view, content on Kakao users of Melon and Kakao apps will appreciate the instant availability of music content platform across different platforms, different devices and different mobile apps.

We believe both Loen and Kakao would start to see positive synergies in increasing paid subscribers from 4Q16, thanks to enhanced social platform interface, allowing instant sharing and new payment-method additions (Kakao Pay). Loen plans to roll out the upgraded version of the Melon service (Melon 4.0) in 3Q16, which we believe will enhance its features for video, social networking, commerce and other user engagement.

Furthermore, we think Kakao will benefit from the existing artists being managed by Loen by attracting significant users, generate traffic and promote new services on Kakao’s platform. With the music being country-neutral (Korean pop artists are popular in Asia), we believe it will play a key role for Kakao in its pursuit to build a vast regional audience of users in Asia.

Loen Entertainment (016170 KS): 8 July 2016

Earnings outlook

We forecast strong revenue growth on expansion in number of paying listeners Core music services We look for Loen’s 2016-18E revenue to be driven by: 1) the addition of paying subscribers, 2) new revenue from non-music streaming services, and 3) revenue from content publishing in Korea and internationally. We forecast the number of paying subscribers for Melon to reach 4.4m by end-2016 (vs. the company’s target of 4m) and record a CAGR of 12.5% for 2015-18E. Meanwhile, we expect Loen’s blended ARPU to increase by 1% YoY for 2016, 9% YoY for 2017 and 4% YoY for 2018 on the back of the recent hike in the absolute song price.

Loen: core services’ contribution to revenue (KRWbn) 700 95% 600 500 90% 400 85% 300

200 80% 100 0 75% 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E Contents Products Merchandise

Others (concerts and miscellanies) % of contents sales to net revenue Source: Company, Daiwa forecasts

For 2Q16, we project Loen’s revenue to grow by 17.3% YoY and 6.5% QoQ, and operating profit to increase by 19.7% YoY on an operating-profit margin of 18.1%, thanks to a steady rise in the number of paying subscribers, solid demand for new albums, and strong operating leverage. Meanwhile, we expect the revenue impact from the price hike to come through in 4Q16, with the company planning to apply the new pricing scheme for existing users from September.

Loen: quarterly earnings trends 2Q16E KRW bn 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Daiwa Consensus Total Sales 84 85 78 88 92 100 97 103 99 YoY growth(%) 14.8 14.3 1.1 13.6 9.6 17.6 23.2 17.3 13.5 QoQ growth(%) 8.4 1.8 (8.0) 11.9 4.5 9.3 (3.6) 6.5 3.1 Operating profit 16 12 13 16 17 18 18 19 18 YoY growth(%) 18.0 24.6 (15.3) 3.9 4.7 49.8 40.8 19.7 16.5 QoQ growth(%) 7.4 (25.4) 9.3 18.7 8.2 6.7 2.8 0.9 (1.8) OP margin(%) 19.2 14.1 16.7 17.7 18.4 17.9 19.1 18.1 18.2

Source: Company, Bloomberg, Daiwa forecasts

For 2016, we forecast Loen’s revenue to increase by 21.0% YoY, with the Melon platform contributing 79% of overall revenue. We expect the following revenue mix for 2016: music content business (85%), products/merchandise (7%), and others (8%). On our forecasts, revenue from non-Melon services will account for 21% of overall revenue in 2016, with overseas revenue likely to remain insignificant.

Operating leverage coming from all sides Profitability outlook We expect Loen’s profitability to continue to improve throughout 2016, helped by growing operating leverage for the Melon platform and a disciplined cost strategy. While the company will likely increase investment in content production and related businesses from 2H16, we believe the subsequent rise in operating costs will be offset by strong revenue from in-house artists, effective control of promotion expenses, and overseas royalties from its own content offerings.

Loen Entertainment (016170 KS): 8 July 2016

Loen: profitability outlook (2009-18E, KRWbn) 700 25%

600 20% 500

400 15%

300 10% 200 5% 100

0 0% 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E Contents Products Merchandise

Others (concerts and miscellanies) NPM(%, RHS) OPM(%, RHS) Source: Company, Daiwa forecasts

EPS forecast to grow at We forecast Loen’s EPS to rise at a CAGR of 27% for 2015-18E, thanks to robust top line a CAGR of 27% for 2015- growth, strong operating leverage, and modest growth in interest income. With growing 18E cash from its stable music-platform business (Melon), we forecast the company’s net-profit margin to improve to 15.9% in 2018, from an average of 14% for 2012-15. It had cash of KRW76.2bn as of the end-1Q16, thanks to solid growth in operating cash flow.

Loen Entertainment (016170 KS): 8 July 2016

Investment concerns

We think the following issues relating to Loen’s core businesses are the key risks to our investment call: 1) a slowdown in paid-subscriber numbers as a result of ongoing price hikes, 2) intensifying competition as the likes of Apple Music enter the market, and 3) an increase in earnings volatility as the company starts deriving more revenue from content and overseas, as well as embarking on new business initiatives requiring capital expenditure for staff and marketing.

 Price hikes could dissuade people from becoming paying listeners. Given we have seen 2 price hikes from Loen (2013 and 2016), we think the younger generation might be hesitant to migrate to paid music services unless there is a continuation of price promotions.

 Competition with big players is intensifying. We believe the local service providers may be able to defend their market positions amid intensifying competition by offering more competitive prices, broader ranges of songs, and more effective promotional packages. However, given newcomers to the market like Apple Music as well as local Internet portals, the company may have to ramp up its expenditure on marketing (price discounts), user retention, and content outsourcing.

 Business visibility on content production is relatively low. Compared with its stable Melon platform business, Loen’s content production business may find it hard to achieve sustainable QoQ and YoY growth in revenue and earnings due to underlying uncertainties related to the timing of releases and the extent of user demand. We think the visibility on the content-production business, especially overseas, may be limited, resulting in volatile revenue streams. Loen’s greater strategic focus on the artist management business could result in higher investment risk associated with M&A activity.

 Potential share-overhang. Kakao issued exchangeable bonds (EBs) of 2.19m shares (8.67% of total shares outstanding) to raise funds for its acquisition of Loen on 25 April 2016; bondholders can exercise put options from 25 April 2019. We expect Kakao to remain the major shareholder of Loen even after the conversion of the issued EBs.

Loen Entertainment (016170 KS): 8 July 2016

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Loen Entertainment (016170 KS): 8 July 2016

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Daiwa Capital Markets America Inc. New York Head Office Financial Square, 32 Old Slip, New York, NY10005, U.S.A. (1) 212 612 7000 (1) 212 612 7100 Daiwa Capital Markets America Inc. San Francisco Branch 555 California Street, Suite 3360, San Francisco, CA 94104, U.S.A. (1) 415 955 8100 (1) 415 956 1935 Daiwa Capital Markets Europe Limited, London Head Office 5 King William Street, London EC4N 7AX, United Kingdom (44) 20 7597 8000 (44) 20 7597 8600 Daiwa Capital Markets Europe Limited, Frankfurt Branch Neue Mainzer Str. 1, 60311 Frankfurt/Main, Germany (49) 69 717 080 (49) 69 723 340 Daiwa Capital Markets Europe Limited, Paris Representative Office 17, rue de Surène 75008 Paris, France (33) 1 56 262 200 (33) 1 47 550 808 Daiwa Capital Markets Europe Limited, Geneva Branch 50 rue du Rhône, P.O.Box 3198, 1211 Geneva 3, Switzerland (41) 22 818 7400 (41) 22 818 7441 Daiwa Capital Markets Europe Limited, Midland Plaza 7th Floor, 10 Arbat Street, Moscow 119002, (7) 495 641 3416 (7) 495 775 6238 Moscow Representative Office Russian Federation Daiwa Capital Markets Europe Limited, Bahrain Branch 7th Floor, The Tower, Bahrain Commercial Complex, P.O. Box 30069, (973) 17 534 452 (973) 17 535 113 Manama, Bahrain Daiwa Capital Markets Hong Kong Limited Level 28, One Pacific Place, 88 Queensway, Hong Kong (852) 2525 0121 (852) 2845 1621 Daiwa Capital Markets Singapore Limited 6 Shenton Way #26-08, OUE Downtown 2, Singapore 068809, (65) 6220 3666 (65) 6223 6198 Republic of Singapore Daiwa Capital Markets Australia Limited Level 34, Rialto North Tower, 525 Collins Street, Melbourne, (61) 3 9916 1300 (61) 3 9916 1330 Victoria 3000, Australia DBP-Daiwa Capital Markets Philippines, Inc 18th Floor, Citibank Tower, 8741 Paseo de Roxas, Salcedo Village, (632) 813 7344 (632) 848 0105 Makati City, Republic of the Philippines Daiwa-Cathay Capital Markets Co Ltd 14/F, 200, Keelung Road, Sec 1, Taipei, Taiwan, R.O.C. (886) 2 2723 9698 (886) 2 2345 3638 Daiwa Securities Capital Markets Korea Co., Ltd. 20 Fl.& 21Fl. One IFC, 10 Gukjegeumyung-Ro, Yeongdeungpo-gu, (82) 2 787 9100 (82) 2 787 9191 Seoul, Korea Daiwa Securities Co. Ltd., Beijing Representative Office Room 301/302，Kerry Center，1 Guanghua Road，Chaoyang District， (86) 10 6500 6688 (86) 10 6500 3594 Beijing 100020, People’s Republic of China Daiwa (Shanghai) Corporate Strategic Advisory Co. Ltd. 44/F, Hang Seng Bank Tower, 1000 Lujiazui Ring Road, Pudong, (86) 21 3858 2000 (86) 21 3858 2111 Shanghai China 200120 , People’s Republic of China Daiwa Securities Co. Ltd., Bangkok Representative Office 18th Floor, M Thai Tower, All Seasons Place, 87 Wireless Road, (66) 2 252 5650 (66) 2 252 5665 Lumpini, Pathumwan, Bangkok 10330, Thailand Daiwa Capital Markets India Private Ltd 10th Floor, 3 North Avenue, Maker Maxity, Bandra Kurla Complex, (91) 22 6622 1000 (91) 22 6622 1019 Bandra East, Mumbai – 400051, India Daiwa Securities Co. Ltd., Hanoi Representative Office Suite 405, Pacific Palace Building, 83B, Ly Thuong Kiet Street, (84) 4 3946 0460 (84) 4 3946 0461 Hoan Kiem Dist. Hanoi, Vietnam

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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Loen Entertainment (016170 KS): 8 July 2016

Important Disclosures and Disclaimer

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.

Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationship For “Investment Banking Relationship”, please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

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.

Hong Kong This research is distributed in Hong Kong by Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司) (“DHK”) which is regulated by the Hong Kong Securities and Futures Commission. Recipients of this research in Hong Kong may contact DHK in respect of any matter arising from or in connection with this research.

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.

Korea The developing analyst of this research and analysis material hereby states and confirms that the contents of this material correctly reflect the analyst’s views and opinions and that the analyst has not been placed under inappropriate pressure or interruption by an external party.

Name of Analyst : Thomas Y. Kwon

Disclosure of Analysts’ Interests If an analyst engaging in or a person who exercises influences on the preparation or publication of a Research Report containing recommendations for general investors to trade financial investment instruments with regard to which the analyst or the influential person has personal interests and if the recommendations contained in the Report may have impacts on the personal interests, Daiwa Securities Capital Markets Korea Co., Ltd.(“Daiwa Securities Korea”)shall ensure that the Analyst or the influential person notifies that he/she has personal interests with regard to:

1. The equity, the equity-linked bonds and the instruments with the subscription right to the equity issued by the legal entity covered in the Research Report (or the legal entity subject to the investment recommendations); 2. The stock option granted by the legal entity covered in the Research Report (or the legal entity subject to the investment recommendations); or 3. The equity futures, the equity options and the equity-linked warrants backed by the equity prescribed in the preceding Paragraph 1 as the underlying assets.

Legal Entities subject to Research Report Coverage Restrictions Daiwa Securities Korea hereby states and confirms that Daiwa Securities Korea has no conflicts of interests with the legal entity covered in this Research Report:

1. In that Daiwa Securities Korea does NOT offer direct or indirect payment guarantee for the legal entity by means of, for instance, guarantee, endorsement, provision of collaterals or the acquisition of debts; 2. In that Daiwa Securities Korea does NOT own one-hundredth (or 1/100) or more of the total number of outstanding equities issued by the legal entity; 3. In that The legal entity is NOT an affiliated company of Daiwa Securities Korea pursuant to Sub-paragraph 3, Article 2 of the Monopoly Regulation and Fair Trade Act of Korea; 4. In that, although Daiwa Securities Korea offers advisory services for the legal entity with regard to an M&A deal, the size of the M&A deal does NOT exceed five-hundredths (or 5/100) of the total asset size or the total number of equities issued and outstanding of the legal entity; 5. In that, although Daiwa Securities Korea acted in the capacity of a Lead Underwriter for the initial public offering of the legal entity, more than one-year has passed since the IPO date; 6. In that Daiwa Securities Korea is NOT designated by the legal entity as the ‘tender offer agent’ pursuant to the Paragraph 2, Article 133 of the Financial Services and Capital Market Act or the legal entity is NOT the issuer of the equity subject to the proposed tender offer; this requirement, however applies until the maturity of the tender offer period; or 7. In that Daiwa Securities Korea does NOT have significant or material interests with regard to the legal entity.

Disclosure of Prior Distribution to Third Party This report has not been distributed to the third party in advance prior to public release.

The following explains the rating system in the report as compared to KOSPI, based on the beliefs of the author(s) of this report.

"1": the security could outperform the KOSPI by more than 15% over the next 12 months, unless otherwise stated. "2": the security is expected to outperform the KOSPI by 5-15% over the next 12 months, unless otherwise stated. "3": the security is expected to perform within 5% of the KOSPI (better or worse) over the next 12 months, unless otherwise stated. "4": the security is expected to underperform the KOSPI by 5-15% over the next 12 months, unless otherwise stated. "5": the security could underperform the KOSPI by more than 15% over the next 12 months, unless otherwise stated.

“Positive” means that the analyst expects the sector to outperform the KOSPI over the next 12 months, unless otherwise stated. “Neutral” means that the analyst expects the sector to be in-line with the KOSPI over the next 12 months, unless otherwise stated. “Negative” means that the analyst expects the sector to underperform the KOSPI over the next 12 months, unless otherwise stated.

Additional information may be available upon request.

Singapore This research is distributed in Singapore by Daiwa Capital Markets Singapore Limited and it may only be distributed in Singapore to accredited investors, expert investors and institutional investors as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time. By virtue of distribution to these category of investors, Daiwa Capital Markets Singapore Limited and its representatives are not required to comply with Section 36 of the Financial Advisers Act (Chapter 110) (Section 36 relates to disclosure of Daiwa Capital Markets Singapore Limited’s interest and/or its representative’s interest in securities). Recipients of this research in Singapore may contact Daiwa Capital Markets Singapore Limited in respect of any matter arising from or in connection with the research.

Australia This research is distributed in Australia by Daiwa Capital Markets Australia Limited and it may only be distributed in Australia to wholesale investors within the meaning of the Corporations Act. Recipients of this research in Australia may contact Daiwa Capital Markets Stockbroking Limited in respect of any matter arising from or in connection with the research. 25

Loen Entertainment (016170 KS): 8 July 2016

India This research is distributed in India to Institutional Clients only by Daiwa Capital Markets India Private Limited (Daiwa India) which is an intermediary registered with Securities & Exchange Board of India as a Stock Broker, Merchant Bank and Research Analyst. Daiwa India, its Research Analyst and their family members and its associates do not have any financial interest save as disclosed or other undisclosed material conflict of interest in the securities or derivatives of any companies under coverage. Daiwa India and its associates may have received compensation for any products other than Investment Banking (as disclosed) or brokerage services from the subject company in this report during the past 12 months. Unless otherwise stated in BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action, Daiwa India and its associates do not hold more than 1% of any companies covered in this research report.

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.

Taiwan This research is distributed in Taiwan by Daiwa-Cathay Capital Markets Co., Ltd and it may only be distributed in Taiwan to institutional investors or specific investors who have signed recommendation contracts with Daiwa-Cathay Capital Markets Co., Ltd in accordance with the Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. Recipients of this research in Taiwan may contact Daiwa-Cathay Capital Markets Co., Ltd in respect of any matter arising from or in connection with the research.

Philippines This research is distributed in the Philippines by DBP-Daiwa Capital Markets Philippines, Inc. which is regulated by the Philippines Securities and Exchange Commission and the Philippines Stock Exchange, Inc. Recipients of this research in the Philippines may contact DBP-Daiwa Capital Markets Philippines, Inc. in respect of any matter arising from or in connection with the research. DBP-Daiwa Capital Markets Philippines, Inc. recommends that investors independently assess, with a professional advisor, the specific financial risks as well as the legal, regulatory, tax, accounting, and other consequences of a proposed transaction. DBP-Daiwa Capital Markets Philippines, Inc. may have positions or may be materially interested in the securities in any of the markets mentioned in the publication or may have performed other services for the issuers of such securities. For relevant securities and trading rules please visit SEC and PSE links at http://www.sec.gov.ph/irr/AmendedIRRfinalversion.pdf and http://www.pse.com.ph/ respectively.

Thailand This research is distributed to only institutional investors in Thailand primarily by Thanachart Securities Public Company Limited (“TNS”). This report is prepared by analysts who are employed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates. This report is provided to you for informational purposes only and it is not, and is not to be construed as, an offer or an invitation to make an offer to sell or buy any securities. Neither Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees accept any liability whatsoever for any direct or consequential loss arising from any use of this research or its contents. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable. However, Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees make no representation or warranty, express or implied, as to their accuracy or completeness. Expressions of opinion herein are subject to change without notice. The use of any information, forecasts and opinions contained in this report shall be at the sole discretion and risk of the user. Daiwa Securities Group Inc. and/or its non-U.S. affiliates perform and seek to perform business with companies covered in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates, their respective directors, officers, servants and employees may have positions and financial interest in securities mentioned in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this research. Therefore, investors should be aware of conflict of interest that may affect the objectivity of this research.

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 http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory.

Germany This document is distributed in Germany by Daiwa Capital Markets Europe Limited, Niederlassung Frankfurt which is regulated by BaFin (Bundesanstalt fuer Finanzdienstleistungsaufsicht) for the conduct of business in Germany.

Bahrain This research material is distributed in Bahrain by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113

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.

Loen Entertainment (016170 KS): 8 July 2016

Disclosure of investment ratings Rating Percentage of total Buy* 65.8% Hold** 21.8% Sell*** 12.4% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 30 June 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