Information Technology / Pan Asia 24 October 2014

Platforms have a new role to play Pan-Asia Mobile Games Sector

• Smart devices are fast becoming the primary “screens” through which entertainment content is consumed • After casual games, we highlight “mid-core” RPGs as the next driver of growth in the region’s mobile-game industry

• We favour integrated platforms over pure developers; our top picks are Daum Communications, Tencent and How do we justify our view?

See important disclosures, including any required research certifications, beginning on page 70

Information Technology / Pan Asia 24 October 2014

Platforms have a new role to play Pan-Asia Mobile Games Sector

• Smart devices are fast becoming the primary “screens” through which entertainment content is consumed • After casual games, we highlight “mid-core” RPGs as the next driver of growth in the region’s mobile-game industry

• We favour integrated platforms over pure developers; our top picks are Daum Communications, Tencent and Square Enix How do we justify our view?

the big 3 markets to account for 38% games and other services. We also like of the global game market (including ’s Square Enix (Outperform mobile and other games) in 2015. [2]), which should lead the way in meeting the region’s rising demand Mid- to hard-core role-playing for quality RPGs. Thomas Y. Kwon games (RPGs) should spur (82) 2 787 9181 ARPU and extend service cycles. We rate a Buy (1), as it is [email protected] We forecast user demand for mid- to focusing on global publishing of hard-core games to rise strongly over blockbuster mobile games, while Satoshi Tanaka 4Q14-2016, driven by improving Bandai Namco (Outperform [2]) is (81) 3 5555 7049 [email protected] service infrastructure, more advanced seeing solid growth from internally devices, and growth in the number of developed IP. But we downgrade John Choi players globally. This should translate Naver and NCsoft to Outperform (852) 2773 8730 into increasing game-service cycles, (2). We believe Naver faces lower- [email protected] ARPU, and paying users for Asia’s than-expected game sales on LINE as

dominant mobile-game platforms: gamers shift their time and money to Daum Kakao and Tencent’s WeChat. mid- to hard-core games, while ■ What's new NCsoft’s online games in should Thanks to rapid improvements in Bright spots for online generate only weak royalties and its game content and supporting developers. We believe leading new mobile games won’t hit the infrastructure, we are seeing faster- online-game developers, such as market until 2015. The main risk to than-expected growth in gamers Nexon and NCsoft, will be able to roll our Positive sector view would be playing mid- to hard-core titles, as out advanced mobile RPGs, and shorter mobile-game life cycles if opposed to casual ones, on mobile potentially boost earnings growth gamers were to shift from RPGs. devices. Judging from our recent visits from 2015, by leveraging their proven to major players in the mobile-game franchises, loyal user bases and ■ How we differ industry, this trend should accelerate service expertise, backed by robust We are the first to highlight the Pan- further in 2015 and 2016. cash flow from their established titles Asia market opportunity for mid- to and R&D knowhow. hard-core games and the value in the In our view, companies with dominant leading platforms. and integrated mobile-game ■ What we recommend platforms will, in the coming months, We prefer the platforms over the pure Key stock calls increasingly harness their large and developers, as we expect the former to New Prev. loyal bases of active gamers and have more scalable and sustainable Daum Communications (035720 KS) Rating Buy Outperform scalable business models through revenue and earnings streams. Target 190,000 139,000 non-game services such as social Upside  25.1% functions and payment transactions. Daum Communications Tencent Holdings (700 HK) (upgraded to Buy [1]), is our top sector Rating Buy Buy ■ What's the impact pick in Korea and the region, as we Target 150.00 150.00 Mobile games: more than a fad. believe it has all the attributes to Upside  30% For Asia’s 3 largest mobile-games become an even more powerful Square Enix Holdings (9684 JP) markets of Korea, Japan and China, mobile ecosystem. Tencent (Buy [1]) Rating Outperform Outperform we forecast mobile-game revenue is our top pick in China, as it looks Target 2,600 2,600 Upside  25% CAGRs for 2013-15 of 15-82%, expect well placed to leverage its mobile Source: Daiwa forecasts.

See important disclosures, including any required research certifications, beginning on page 70 Pan-Asia Mobile Games Sector 24 October 2014

Executive summary

Platforms have a new role to play

Mid- to hard-core games should drive industry revenue growth, boost ARPU and enjoy longer life cycles in the coming years. We favour integrated platforms over pure developers.

 Investment thesis Our recent visits to industry players in Asia confirm that mobile-game The smartphone boom led to content is seeing a strong upswing in usage times and dollars spent, the rise of casual games… particularly among young users. This process is being driven by the rapid adoption of mobile phones and tablets, growth in the number of mobile gamers, rollouts of 3G and Long-Term Evolution (LTE) networks, falling data fees and device prices, and the presence of free-to-play game services.

In the coming years, we expect the dominant and integrated mobile-game …and our research indicates platforms -- chiefly Daum Kakao, Tencent and Square Enix -- to harness the next leg of industry their large and loyal user bases, active gamers, and scalable business growth should come from models through non-game services, such as payment and content transactions and social functions. Moreover, we expect mobile gamers’ mid- to hard-core RPGs demand for mid- to hard-core games, like Summoners War by Com2uS in Korea, to continue growing, due to improving service infrastructure and enhanced device functionality (new sensors, graphics and user feedback).

We believe quality mobile games with differentiated storylines and strong Companies that offer game IPs are best placed to capture the growing opportunity we see for differentiated content and mobile games in China and other Asia markets. On our forecasts, Asia’s strong game IPs, backed by leading online-game developers (such as NCsoft, Nexon, and Square Enix) should see a boost to earnings-growth momentum from 2015, with the integrated platforms, should rollout of advanced mobile RPGs and on the back of leveraging their emerge as winners strong game franchises, loyal user bases and service-operation expertise.

 Profit outlook We forecast 2014-16 EPS CAGRs of 39% for Daum and 28% for Tencent, and a 2013-15E CAGR of 52% for Square Enix, on the back of ongoing We forecast strong earnings launches of new mobile games and non-game services, a solid rise in growth for the 3 leading ARPU and their number of paying users, and their expansion into new mobile-game platforms for areas within Asia. next two years  Valuation We see the valuations of Daum, Tencent and Square Enix as attractive Main players’ valuations relative to their trading ranges for 2005-13. Based on our EPS forecasts look attractive, given their (2015 for the first 2 companies, FY15 for Square Enix), the stocks are trading at respective PERs of 29x, 27x and 16x, yet our forecasts call for integrated ecosystems strong EPS growth for all 3. In our view, these companies’ integrated mobile-game platforms warrant continued PER premiums to their peers outside Asia, given their sustainable revenue and earnings streams.

Meanwhile, 6-month target price for Nexon is set a 2014E PER of 13x (the average of its regional peers, based on Bloomberg-consensus forecasts) but expect the stock to be rerated once its new mobile and online sequel games penetrate overseas markets. And we contend NCsoft should trade at a 10% premium (14.3x) to the 2014E PER of its regional peers, given the better visibility that we see for its expanding game portfolio.

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Sector stocks: key indicators

EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg Daum Communications 035720 KS 151,900 Buy Outperform 190,000 139,000 36.7% 3,475 3,418 1.7% 5,230 4,855 7.7% Naver 035420 KS 796,000 Outperform Buy 900,000 925,000 (2.7%) 17,407 18,573 (6.3%) 29,397 30,127 (2.4%) NCsoft 036570 KS 139,000 Outperform Buy 152,000 230,000 (33.9%) 10,630 12,449 (14.6%) 12,663 15,278 (17.1%) Nexon 3659 JP 865 Buy Buy 1,100 1,150 (4.3%) 85 88 (4.2%) 99 104 (4.8%) Tencent Holdings 700 HK 115.40 Buy Buy 150.00 150.00 0.0% 2.763 2.763 0.0% 3.418 3.418 0.0% Bandai Namco Holdings 7832 JP 2,528 Outperform Outperform 3,190 3,190 0.0% 173 173 0.0% 188 188 0.0% Square Enix Holdings 9684 JP 2,080 Outperform Outperform 2,600 2,600 0.0% 97 97 0.0% 133 133 0.0% Source: Daiwa forecasts

Asia’s 3 largest mobile-games markets: key metrics (As of 2013) Korea Japan China Total population 50.4m 121m 1361m Mobile Internet users (no.) 33m 100m 500m Mobile Internet users as % of total population 65% 83% 37% users (no.) 20m 27m 311m Mobile gamers as & of mobile Internet users 61% 27% 62% ARPU of mobile gamers (USD) 34 55 6 Average paying user ratio 3% 6% 2% Smartphone penetration (as of 1Q14, 2013 for Japan) 70% 47% 32% Revenue for online game market USD7.0bn USD1.2bn USD12.0bn Revenue for mobile game market USD1.2bn USD6.1bn USD1.8bn Main publishing platforms Kakao Talk Google/ App store Top three platforms: WeChat, Baidu, Qihoo Market share of main publishing platforms 66% 85% 40% (for WeChat, Baiidu, Qihoo combined) Game genre that generates the most revenue RPG Casual Casual and puzzles Main mobile game title and developer Blade (Action Square) Puzzle and Dragons (Gungho) Timi speed everyday (Tencent) Monthly revenue by main mobile game title (USD) 14m 123m 50m Source: Statista 2014, CESA, White paper on Korean game, NewZoo, Daiwa

 Pan-Asia: mobile game revenue in 3 key markets  Global market: number of mobile gamers by region (m) (USDbn) 450 18 100% 400 15 80% 350 12 60% 300 9 250 40% 6 200 3 20% 150 0 0% 100 2012 2013 2014E 2015E Korea mobile 50 Japan mobile China mobile 0 % of online game revenue (China, RHS) E.Europe W.Europe N.America L.America ME/Africa Asia Pacific % of online game revenue (Japan, RHS) % of online game revenue (Korea, RHS) Mobile gamers Paying gamers Source: KOCCA,CESA, Daiwa forecasts Source: Applift & NewZoo (August 2013), Daiwa

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Smartphone games on the rise ...... 7 Preparing for the next wave of mobile games ...... 7 Gamers now looking for more immersive games on mobile ...... 14 New games to play, new ways to pay ...... 14 Moving up the value chain of Asia’s mobile-game industry ...... 16 Rediscovering the value of the online game companies...... 19 Conclusion ...... 21 Platforms trump developers ...... 21 Dominant and integrated mobile-game platforms: our preferred segment ...... 22

Company Section Daum Communications ...... 26 Tencent Holdings ...... 32 Square Enix Holdings ...... 40 Nexon ...... 44 Naver ...... 50 NCsoft ...... 56 Namco Bandai ...... 62

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 Global market: no. of mobile gamers by region in August 2013 (m) 450 400 350 300 250 Smartphone games on 200 150 the rise 100 50 0 Smart devices are rapidly becoming the E.Europe W.Europe N.America L.America ME/Africa Asia Pacific primary platform for games played by Mobile gamers Paying gamers

consumers. Source: Applift & NewZoo (August 2013), Daiwa

According to industry research consultancy Applift & Preparing for the next wave of NewZoo, the global mobile game market had 960m players as at August 2013, of which 370m are paying mobile games users (38% paying user ratio). Mobile gamers in the Asia-Pacific region account for 43% and 46%, Our industry research shows that in Asia as well as respectively, of total mobile-game players and paying globally, gamers are migrating to smart devices users globally, with growth being driven largely by (smartphones and tablets) to access entertainment China and Japan. content, due to the greater accessibility, better interface, and easier usage on smart devices than on Within Asia, young casual gamers are driving the PCs and consoles. Even sooner than we had expected, mobile-games industry’s revenue growth, as they smart devices have become the “primary screens” for generally buy low-end smartphones and use these to playing games (Mobile gaming set to take the smart communicate with friends on social networks. Due to route, published on 21 September 2011). typically shorter game-play times on mobile devices than for online games and games accessed on consoles, Gamers are fast going mobile more casual young game players are increasing their time and dollars spent on mobile-game content. Our research also indicates the mobile-games industry globally is seeing strong secular growth, driven by: 1) In Korea, of 20m total mobile gamers, male gamers an increase in the number of mobile gamers, 2) account for 48%, female players 52%, while gamers powerful game distribution channels, and 3) a rise in aged below 30 comprise 68%, according to a survey by smartphone penetration. Unlike the conventional game the Korea Creative Content Agency (KOCCA) in July devices, mobile games aim to attract the largest and 2014. most diverse base of consumers possible, in our view.  Korea: mobile-gamer distribution by age (July 2014) Based on our research, the number of mobile gamers is 50s rising strongly in Asia and other regions, on the back of 5.4% 10s 17.3% the rapid adoption of smartphones, high-speed mobile broadband, falling data fees, rising use of free-to-play 40s (F2P) game services, and diversification of both the 26.6% types of gamers and the game genres on offer. Mobile devices enable users to download and consume mobile entertainment content easily and economically, 20s 23.7% supported by improving service-infrastructure as a result of roll-outs of low-end smartphones, introductions of unlimited data plans through 3G and 30s LTE networks, and mobile devices’ enhanced user 26.9%

interface with wider screens and advanced sensing Source: KOCCA technologies.

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In our view, the popularity of smart devices amongst  Pan-Asia: mobile-game market outlook not just casual players but core gamers presents a (USDbn) golden opportunity for game developers and game- 8 20% platform operators to strengthen their gamer bases, 6 15% broaden their target markets, activate in-game communities, and boost in-game item commerce. 4 10%

Gartner forecasts revenue generated by the worldwide 2 5% game market (including all revenue from 0 0% console hardware and software, online, mobile and PC 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 games) to increase at a CAGR of 12% to USD111bn for Revenues (Pan-Asia, US$bn, LHS) 2012-15, mainly boosted by a strong mobile gaming % of mobile-game revenues to total market YoY growth

segment, whose revenue is forecast to rise at a CAGR of Source: PWC/KOCCA (2014), Daiwa 33% for 2012-15. As one of the most advanced mobile-game markets in Gartner also forecasts revenue from mobile games to Asia, Korea has seen strong growth in revenue from double from USD13.2bn in 2012 to USD22bn in 2015, these markets over the past few years, on the back of a and account for 20% of the total game market in 2015 rise in smartphone penetration, rollouts of mobile from 12% in 2012. broadband networks, the emergence of powerful game- distribution platforms like Kakao Talk by Daum Kakao,  Global: the game market opportunity (2012-15E) the diversification of game genres and game offerings (USDm) 60 as a result of the migration of leading online-game developers into the mobile space. We forecast mobile- 50 game revenue to grow at a CAGR of 15-82% for 2013-15 40 and account for 15% of the total game market in Korea 30 by the end of 2015.

20  Korea: total game-market opportunity (2007-15E) 10 (KRW tn) 14 0 2012 2013E 2014E 2015E 12 Video Game Console Handheld Video Games Mobile Games PC Games 10

8 Source: Gartner (Forecast: Video Game Ecosystem, Worldwide, 4Q13 by Brian Blau, October 2013) 6 4 In the Pan-Asia region, we expect strong growth of 2 mobile game revenue over the next few years, as the 0 penetration of low-end smart devices accelerates. We 2007 2008 2009 2010 2011 2012 2013 2014E 2015E see potential for in-app transactions to surge in these Online PC Café Mobile Video console Arcade PC package Others markets, because many young game players want to purchase game items and game titles for less expensive, Source: KOCCA, Daiwa forecasts but more versatile, mobile devices compared with PCs and consoles. In Japan, mobile games provide a convenient distraction for commuters during their often long According to PWC and KOCCA (2014), mobile-game commutes by public transportation. This suggests that revenue in the region should outgrow the global mobile games are not directly competing with consoles market, rising at a CAGR of over 10% for 2013-17. and other home entertainment content. In particular, These companies believe mobile will become a key smartphone users aged over 30 (male) as key paying gaming platform in the region, accounting for 18% of gamers are unlikely to consider consoles as an total game revenue in 2017, from 16% in 2013. alternative game device.

In our view, these factors provide the perfect mix for the significant growth of the mobile-game market in Japan. As such, we forecast mobile-game revenue to increase at a CAGR of 14.8% for 2013-15, and account for 59% of the total game market in Japan by end-2015.

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 Japan: mobile-game market outlook (2002-15E) offering F2P games, which players can consume (JPYbn) content without costs. 1,600 1,400 1,200 Meanwhile, mobile-game developers and publishers 1,000 have been successfully monetising mobile gamers by 800 offering freemium (free + premium) services, where 600 mobile games can be downloaded for free, but 400 incorporate micro-transactions and virtual currencies, 200 0 encouraging users to unlock additional features, new levels, and premium content. 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E Hardware for consol Software for consol Smart device  Global: mobile-app revenue growth rate by country (YoY Feature phone PC Software for online growth, 2013) Source: Enterbrain, Daiwa 800% 700% China also benefits from huge numbers of Internet 600% users and online gamers who have just begun to 500% consider mobile-game content a primary 400% entertainment resource. Mobile game revenue in China 300% rose by 247% YoY to CNY11bn in 2013. We forecast 200% industry revenue to hit CNY52bn in 2016, rising at a 100% CAGR of 67% from 2013-16, and accounting for 32.3% 0% of China’s total game market. US UK China Japan Russia France  China: mobile-game market opportunity (2008-16E) Germany South Korea (CNYbn) 60 40% Source: DFC Intelligence, Daiwa

50 30% In our view, the increasing number of younger and 40 female mobile gamers bodes well for the in-game 30 20% purchase market, as we believe casual games and social 20 games can boost overall in-game item sales. Based on 10% 10 our knowledge of the online game industry, overall trading volume for mobile-game items escalates on a 0 0% 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E rise in free gamers and paying users, virtual goods, and available game titles. Mobile games are likely to Mobie-game revenues (LHS) % of mobile-game sales to total market (RHS) leverage social platforms globally by: 1) giving virtual

Source: GPC, CNG and IDC, Daiwa forecasts gifts, 2) promoting competition, 3) and effectively sending messages inviting gamers to join a particular Historically, we note that globally game devices have game. triggered an industry evolution, as shown in the case of PCs, handheld, and console devices. However, we  Global: mobile apps users by region (2013) believe the mobile game market will continue to rise on ME and Africa the back of the combination of a growing gamer base 13% Europe globally, the ongoing addition of new content, and the 28% Latin America quick release of new titles to cope with changes in 10% gamers’ preferences. We also expect a strong social ecosystem and in-app communication platform to help mobile games remain the key entertainment content among the young generation. North America 17% Games are the entertainment of the future, Asia Pacific and F2P is the future of games 32%

Mobile games have become a key component in the use Source: Portio Research (2013), Daiwa of smart devices and a must-download application across over-the-top (OTT) mobile apps. We believe this entertainment app has a compelling value position by

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According to Portio Research, mobile apps users and The number of mobile gamers in China surged by app downloads in the Asia-Pacific region should 249% YoY to 311m in 2013 from 89m in 2012, boosted outgrow those of the global market (in terms of by the entry of Tencent into the mobile-game segment, numbers of users and downloads), rising at CAGRs of through the roll-out of mobile games on its WeChat 40% and 46% for 2012-17, respectively, compared with platform. We expect the number of mobile-game 30% and 36% for the global market over the same players to reach 470m by 2016, accounting for 72% of period. We expect mobile app users in Asia to account total mobile Internet users in China, on the back of the for around 50% of total mobile apps users in 2017, due increasing ubiquity of smart devices and the broad to strong user growth for free mobile apps. variety of mobile-game offerings.

 Global: mobile-app market outlook  China: mobile-gamer penetration (bn) (m) 1,000 70 500 80% 60 70% 800 400 50 60% 50% 600 40 300 40% 400 30 200 30% 20 200 20% 10 100 10% 0 0 0 0% 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E App downloads (LHS) App users (bn, RHS) Mobile gamers (LHS) % of total population App revenues (USDbn, RHS) % of mobile Internet users

Source: Portio Research (2013), Daiwa Source: GPC, CNG, IDC, Daiwa forecasts

In particular, Korea has huge numbers of game players  China: mobile users on Beijing subway using mobile phones and strong industry infrastructure for game services for both online and mobile. According to Nielsen Koreanclick (July 2014), in Korea more than 21m users play mobile games and spend 42 minutes each day. In fact, the total number of mobile gamers and play times rose sharply after the launch of Kakao Talk’s Game Centre in July 2012.

 Korea: mobile gamers and total time played on mobile games (Minutes bn) (M) 45 25 40 35 20 30 25 15 20 10 15 Source: Daiwa 10 5 5 0 0 Better service infrastructure, stronger ecosystem Jul-12 Jul-13 Jan-13 Jan-14 Mar-12 Mar-13 Mar-14 Sep-12 Nov-12 Sep-13 Nov-13 May-12 May-13 May-14 We consider an enveloping gaming experience on rapid Total mobile game playing time (LHS) Total mobile game users (RHS) adoption of smart devices as one of the key industry Source: Nielsen Koreanclick (July 2014), Daiwa growth drivers over the medium term. In Korea, mobile penetration and smartphone penetration was 101% and 73%, respectively, at the end of June 2014, indicating that mobile phones and smart devices could become a more powerful platform than even the PCs were in the early 2000s. We estimate that 40.5m people (smartphone penetration of 73%) accessed the Internet through smartphones and tablets in Korea in 1Q14, compared with 57.3m (smartphone penetration ratio of 46.6%) in Japan in 2013.

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 Korea and Japan: smartphone penetration  Pan-Asia: most popular game devices to play games - Aug (m) 2014 (multiple responses) 100 100 (%) 100 80 80 80 60 60 60 40 40 40 20 20 20 0 0 2010 2011 2012 2013 2014E 2015E 2016E 0 Smartphone users (Korea) Smartphone users (Japan) Smartphone Tablet PC Feature phone Penetration (Korea, %) Penetration(Japan,%) Korea Japan China Taiwan Source: Daiwa forecasts Source: KOCCA, Daiwa Interestingly, we expect strong mobile-game demand from woman players aged 30+ in Japan for 2014-16, One of the key positives in offering mobile games is the due to the relatively high adoption of smartphones. substantial improvement seen over the past few years in billing systems and communication through free In China, we believe the combination of the widespread mobile instant messaging (MIM) applications, such as adoption of smartphones and upgrades in hardware Kakao Talk in Korea, LINE in Japan, and WeChat in and mobile operating systems (OSs), such as Apple’s China. By leveraging social graphs within the apps, iOS and Google’s Android, could drive smart devices to these applications are effectively luring, monetising, become a sustainable platform for mobile gaming and and retaining mobile users. As a dominant mobile invite many new mobile-game developers in China. game-platform in Korea, Daum Kakao has 16.24m With enhanced Internet connectivity through 3G and mobile gamers (62% of total mobile gamers in Korea) 4G/TD-LTE networks, we believe China’s mobile game who play 3.4 games per user and spend 27 hours per market will likely attract more wireless Internet users week. and definitely mobile gamers in 2014-16.  Korea: mobile-gamer distribution by MIMs (Jun 2014)

Given the increasing target customer base and gamer 80% experience, we expect the industry to move on to the 70% second phase of the evolution, while offering advanced 60% mid- to hard-core mobile games on improving 50% functionalities of smartphones and growing numbers of 40% mobile-entertainment consumers. 30% 20% Across the region, our market research suggests that 10% smartphones are the most powerful devices to 0% download mobile games and play with other gamers, Kakao LINE BAND Afreeca TV helped by falling handset prices and data fees. We Male Female 10s 20s 30s 40s 50s 60s expect tablets to continue to gain share in the mobile- Source: Nielsen Koreanclick, Daiwa game segment due to their wider screens, light weight, and improving hardware specification including In Japan, teenagers show a high retention rate for graphics cards. Over the medium term, we believe mobile games, while those in the over 20s-mid 30s tablets will drive game demand for mid- to hard-core group demonstrate strong loyalty for their key games. games, due to their big screens, ease-to-play interface, and immersive content as experienced with PCs and consoles.

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 Japan: smartphone gamers distribution by age (as of end 2013) Sharing users with online and consoles 80% At the beginning of the industry growth, we thought 70% mobile games would grow at the expense of the existing 60% games on PC and consoles. Looking at the following 50% chart, in the initial stage of growth, mobile games 40% seemed to gain market share at the expense of existing 30% games on PCs and consoles. However, going forward, 20% we believe both gaming platforms could coexist without 10% encroaching upon each other’s target markets. We also 0% think mobile games could expand industry revenue by Total 3~9 10~14 15~19 20~24 25~29 30~34 35~39 40~49 50~59 60~69 70~79 acquiring new gamers, boosting item commerce on Male Female multi-platforms, and extending the play time of mobile

Source: CESA, Daiwa games.

According to IGA Works (Not listed), around 4% of  Global: game market outlook by game device total smartphone users in Korea pay for Android-based 100% mobile games per month, while 3% of iOS-based mobile gamers purchase in-app items. Meanwhile, 80%

KOCCA notes that more than 37% of Korean mobile 60% gamers paid for in-game items over 2009-13; while 63% of male users and 37% of female gamers paid for 40% mobile-game services in Korea over the same period. 20%  Korea: mobile-game market by mobile OS-1H14 0% 100 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E Consoles Online PC game Mobile

80 Source: PWC/KOCCA, Daiwa 60 We do not believe either the online or console gaming 40 platforms will disappear in the near future due to solid

20 and steady demand from loyal gamers. Meanwhile, a few leading game developers would likely continue to 0 capitalise on solid demand from online gamers due to Market share (%) Paying-user ratio (%) Avg. spending per play the less intense competition in this space, ongoing (US$) Android iOS content updates, strong franchise value, and active in-

Source: IGA Works, Daiwa game community.

According to CESA in Japan, 26.5% of mobile gamers In Korea, competition within the mobile game segment engaged in paid games in 2013. MMD research would likely continue to intensify, especially for simple forecasts the paying-user ratio in Japan to expand to casual and possibly RPG genres, as new players come 41.7% in 2014 from 22.8% in 2013, helped by an to the market with more new games features. Mobile- increasing frequency of engaging in paid games. game developers prefer to engage in diverse game Interestingly, male pay gamers tend to represent a genres ranging from casual games to puzzle games in higher ARPPU, but have a shorter retention rate than order to minimise their investment risk, while game female mobile gamers in Japan, due to the underlying publishers are keen to acquire RPG and mid- to hard- game features and different game genres they core games to leverage their gamer bases and participate in. distribution channels effectively. As for target markets, developers aim to tap into the global markets, rather We attribute the high paying-user ratio in Japan to than just China and Japan, to build strong ecosystems strong game spending on rare characters or items and enhance their brand equity internationally. through the Gacha algorithm. The popularity of Gacha has led to mobile-game developers incorporating this random function into most of their games in order to allow gamers to select characters or items in card battle modes.

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 Korea: developers prefer diverse game genres (Aug 2014)

Others 18% RPG 28%

SNG 7%

Shooting 9%

Puzzle Action 13% 25%

Source: GAMESS (www.gamess.co.kr)

At the end of August 2014, more than 28 RPG games (over 60% of all the games available in Korea) were ranked on the top-50 list of the highest-grossing games on Google Play, implying that new players might face a sharp rise in marketing costs in order to acquire gamers.

 Korea: top-15 highest-grossing games on Google Play (Aug 2014) Game title Developer/Publisher Genre Distributor Everyone’s Marble CJ E&M Board Kakao Seven Knights CJ E&M RPG Kakao Clash of Clan Supercell Strategy Supercell Blade 4:33 RPG Kakao Monster Training CJ E&M RPG Kakao Anipang 2 SUNDAYTOZ Puzzle Kakao FIFA Online 3M Nexon Sports Nexon Cookie Run Devsisters Racing Kakao Summoners War Com2uS RPG Com2uS Be a Star GAMEVIL RPG Gamevil Dragon Guard CJ E&M RPG Kakao Dragon Flight Next Floor Racing Kakao Candy Crush Saga King.com Puzzle Kakao Anipang SC SUNDAYTOZ Puzzle Kakao Kritika GAMEVIL RPG Gamevil Source: Google Play, complied by Daiwa

But, we think new mobile games featuring first-person shooting (FPS) and Aeon of Strife (AoS) genres could capitalise on growing demand for mid- to hard-core mobile games in Asia and globally. We also see greater opportunities for strategic simulation games which provide real time player-versus-player (PvP) battle modes on smart devices.

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 Pan-Asia: most popular game genres (Aug 2014) (%) 60

50

40 Gamers now looking 30 20 for more immersive 10

0 games on mobile Korea Japan China Taiwan Thailand Single mode Level-ups Simulation Battle plays Others

Mid- to hard-core titles promise longer Source: KOCCA, Daiwa service spans, higher ARPU, and more Actually, mid-core RPG games on smartphones have a stable revenue streams higher ARPU than that for casual mobile games due to a combination of more male gamers, a high dependency on in-game items related to game battles, New games to play, new ways to and longer service cycles to play. pay Ironically, LINE in Japan offers more casual and puzzle We see increasing evidence that gamers are seeking games, which exclude Gacha functions, but focuses on and paying for more immersive games, in terms of game-play items for revitalisation and accessory game play and game episodes, given mobile RPGs are weapons. Despite its low item prices, this MIM benefits now gaining popularity in the region. from a high portion of paying users competing against each other within the same social graphs.

Mobile gamers likely to prefer battle plays  Korea: monthly game spending by game genre (as of 1H14) and social interaction going forward 100% We believe the future of mobile gaming does not lie 90% with proprietary hardware, but rather is in user-choice 80% for game content and in-game playability. Based on our 70% recent meetings with a number of leading mobile-game 60% developers in Korea, Japan, and China, we learned they 50% 40% are focusing more on RPGs, rather than casual, social, 30% and action games. They prefer longer service-spans, 20% higher ARPU, stronger loyalty, and more stable 10% revenue streams. 0% over KRW0.5m KRW0.1~0.5m KRW0.05~0.1m under KRW0.05m Core Casual

Japan’s mobile-game industry is following the same evolution path, focusing on social features for RPGs to Source: IGA Works, Daiwa trigger competition and item purchases. Following our recent visits to the domestic game developers, we Basically, mobile casual games can acquire free gamers confirm they are rapidly shifting their strategic focus to and provide novice gamers with a better PC and console mid- to hard-core games, offering immersive storyline gaming experience. Meanwhile, they have low ARPU, and matching plays. short life cycles, and low entry barriers. Importantly, it is difficult to differentiate amongst the various developers in terms of game episodes and game plays.

Meanwhile, mid- to hard-core mobile games benefit from strong user loyalty, a high paying-user ratio, and active in-app social activities, leading to a likelihood that they will evolve as a platform. However, they might see tough challenges in luring gamers, meeting hardware specifications, building franchise value, and addressing regulatory risks related to gamer addiction and excessive spending on in-game items. - 14 - Pan-Asia Mobile Games Sector 24 October 2014

 Brief overview of mobile games by genre  Korea MIMs: comparison of gamer base (m) (June 2014) Genre Casual Mid- to hard core Gamers Beginners/female Experts/male AfreecaTV Gamer interface Easy Sophisticated Development period Short (below 6 months) Long (over 18 months) Generation Young Old LINE Service span Short (1-6 months) Long (over 12 months) Development costs Low(below KRW1bn) High(over KRW3bn) BAND Major features Puzzle, racing, sports, shooting RPG, simulation, strategy Popular games Anipang (Sunday Toz), Poko Summoners War (Com2uS), Clash of Pang (NHN Ent.), Puzzle and Clans (Supercell), Legion of Heroes Daum Kakao Dragons (Gungho), and Monster (Nexon), Blade (Action Square) Strike (Mixi) Source: Daiwa 0 5 10 15 20 25 30 gamers non-gamers

Thriving on advanced smart technologies Source: Nielsen Koreanclick, Daiwa We expect smartphones and tablets to become the primary screen for gamers who are keen to play more The leading MIM platforms in Asia are successfully sophisticated games. The accelerating uptake of monetising mobile gamers by selling in-game items smartphones has been the main growth driver for the with low distribution and marketing costs. MIMs application market thus far, with high quality touch provide a good publishing platform for mobile games, screens, powerful programmable processors, improved based on casual game content and social networks, graphics and cameras, increased storage, accelerometer which are key to communicating and entertaining for and GPS. In our view, these technologies have become in-app users. With their diverse game genres and standard and contributed to an improved mobile gamer bases, both platforms benefit each other by gaming experience. enriching the content offerings, and reducing the costs to acquire and retain gamers, and publish mobile  Next generation technologies for mobile games games. Category Technologies Descriptions Hardware Augmented Allows users to be more interactive and provide immersive  Korea MIMs: comparison of game-platform power (June 2014) reality experiences (bn) (hours) Tri-axis Detects marginal accelerations tri-dimensionally within a short 18 30 accelerometer instant 16 A-GPS sensor Allows capturing accurate timing, location, and speed 25 14 Gyro sensor Detects tri-dimensional motions and rotation using Gyroscope 12 20 Software 3D game engine Provide more realistic 3D experiences to the users 10 Source: Daiwa 15 8 6 10 New mobile-game technologies should have the ideal 4 5 specifications (sensors and game engine) to host games 2 every bit as compelling as those formerly found only on 0 0 PCs and consoles. Accordingly, we see more room for Kakao Game Center BAND Games Number of users (LHS) Average time to play game (RHS) mobile games to incorporate high quality content and embrace innovative game play technologies. Source: Nielsen Koreanclick, Daiwa

Social features a key driver to boost in-app We believe mobile games will likely become a core service with which the games developers could build a transactions mobile platform or ecosystem, enhancing the user The key challenges for game developers and game experience. Mobile-game developers are able to publishers remain how to get games discovered on generate sustainable revenue on social platforms, mobile platforms and how to come up with a hit game helped by the longer service spans of mobile games that will stand out amongst the hundreds of thousands with higher ARPU and a greater number of loyal of competitor games. RPGs and social games on gamers within in-game communities. smartphones are rapidly overtaking simple casual and copycat games thanks to more immersive game content and active in-game activities.

- 15 - Pan-Asia Mobile Games Sector 24 October 2014

According to a survey by KOCCA conducted this year, Moving up the value chain of Korean mobile gamers spend on average 86 minutes Asia’s mobile-game industry during weekdays and 117 minutes during weekends playing games on their mobile devices, longer than The value chain within Asia’s mobile-game industry is their Japanese counterparts, but shorter than those in being enhanced with the addition of more service China and Taiwan. We attribute this difference to the platforms and broader target markets. Game popularity of casual games in Korea, whereby casual developers are cooperating, and sometimes competing, gamers tend to play various different games and with game publishers like MIMs. engage in active communications on the same app.

Mobile games have come of age in Asia  Pan-Asia: average time spent playing mobile games (2014) (minutes) We see several factors driving Pan-Asia’s mobile-game 250 industry growth: 1) this region is home to the world’s largest number of Internet users and mobile 200 subscribers, 2) gamers’ extensive experience in free-to- 150 play games, 3) improving mobile broadband networks and falling data fees, 4) higher handset penetration 100 than desktop PCs, and 5) increasing demand for mid- 50 to hard-core games. 0 Korea Japan China Taiwan In addition to the large mobile subscriber base of Weekday Weekend potential mobile gamers, there is a much greater Source: KOCCA, Daiwa number of users for mobile Internet and online games in Asia than in other regions in the world. They tend to In China, demand for casual mobile games from local play for longer and have stronger loyalty with higher mobile gamers is strong. These mobile gamers tend to ARPU levels than mobile gamers in Western countries. favour sports and strategy type games, rather than martial-arts role playing games. Major differences among mobile games in the Pan-Asia region In China, casual games and puzzle games accounted for One of the key trends in Asia is that the total time spent the largest percentage of games played on both the playing games on mobile devices is gradually Android (29%) and iOS (41%) platforms in 2013. Mid- increasing, while the total number of playing games is core games like RPGs are more profitable and have decreasing. This trend can be seen clearly in advanced higher ARPU than other mobile casual games in China. mobile-games markets such as Korea and Japan, as By incorporating battle, action, shooting, and defence mobile gamers are focusing more on a few titles and features, mobile RPGs have since 2013 successfully increasing their loyalty to specific games and in-app penetrated the China market due to their advanced communities. In our view, other emerging mobile- game plays and immersive game storylines, and we are game markets will follow the same path in the seeing the same trend in Korea and Japan. We expect industry’s evolution over the medium term. to see an increasing number of mid-core games in China over 4Q14-16.  Pan-Asia: average number of mobile game plays (Aug 2014) 20 We also view the improvement of mobile payment ecosystem in China as one of the key industry growth 15 drivers, as game developers should benefit from diverse payment methods and monetise both casual 10 and social gamers effectively. Actually, Chinese gamers have a wide variety of payment options, like Alipay, 5 WeChat pay, prepaid cards, online payment and payment through mobile carriers. 0 Korea Japan China Taiwan Thailand weeks of playing game # of playing games

Source: KOCCA, Daiwa

- 16 - Pan-Asia Mobile Games Sector 24 October 2014

Tencent’s WeChat, with 438m monthly active users Korea and Japan game developers: the best (MAU), is the most powerful platform for distributing ways to play with the global markets mobile games in China. The company’s WeChat Game developers in both countries have the best Payment offers a safe, fast and convenient payment testing environment, helped by a large array of wireless solution for mobile gamers in China, and is highly subscribers and addressable game players, relatively trusted by its paid mobile gamers. high-paying gamers with high levels of gaming spending, a world-class network infrastructure, and In Japan, card battle games have become mainstream powerful distribution platform. Based on the in the mobile game segment, while action RPGs still experience of PC online and video-console games, we remain a niche market due to the narrow gamer base; believe the leading game companies in both Korea and and casual games on the LINE platform have driven Japan have considerable expertise to develop new the industry revenue growth since 2013. games, operate mobile-game services, monetise free gamers, and promote new content effectively. As witnessed with Monster Strike, White Cat Project, etc. in Japan, demand is on the increase for network  Korea and Japan: penetration of mobile gamers (Aug 2014) mobile games, where gamers cooperate with other 100% gamers using various wireless networks like Bluetooth, and features in-game communication and multi-player 80% battles. 60%

 Pan-Asia: most popular mobile games by country (Aug 2014) 40% Japan China Taiwan Thailand Puzzle and Dragons Tian Tian KuPao Candy Crush Cookie run 20% Monster Strike Mahjong Tower of Saviors Candy Crush LINE: Disney Tsum Tsum Plant vs. Zombie Poko Pang Hay Day 0% Candy Crush Carrot Fantasy Cookie run Plant vs. Zombie % of mobile gamers Male Female Paid gamers Poko Pang 2048 2048 Angry Bird to total gamers LINE Pop Temple run Angry Bird Ranger Korea Japan

Others Angry Bird Ranger Subway Surf Source: KOCCA, Daiwa Source: KOCCA, Daiwa

Meanwhile, we expect game players’ preference in the Korean companies in particular have (since 2013) been region to lead the future product development of targeting global markets due to the intensifying mobile games, with game developers shifting their competition in their domestic market and their R&D focus from sports and strategy games to RPGs, experience from featured phone services for overseas advanced strategy games, and simulation games going markets. They have know-how to work with global forward. handset makers and local partners, understand local gamers, and market new game titles, in our view. Valuable lessons from mega hit games Compared with the US and European markets, Asia is In Korea, we view a mobile game as becoming a hit the primary target market for Japanese mobile-game once it records over 1m game downloads, daily companies, given that their game IPs, game episodes, activations of more than 4x per day, and a retention and game-play modes work better in the Pan-Asia rate of more than 10% within one month of the game’s region. The companies also expect Asia’s mobile game release. We estimate such successful games generate market to continue to outgrow the global market due to monthly revenue of more than KRW0.2-0.3bn and the rapid adoption of smart devices and growing rank in the top-30 highest-grossing games. number of paying gamers. With more customised content for both regional and global gamers, Japanese From our on-the-ground research, we found that companies aim to penetrate overseas markets like mobile game developers and publishers in the region Korea and China, given that the mobile-game market in need to be able to move quickly to capture gamers’ Japan is gradually becoming saturated. demand, develop new and differentiated game genres and content, and leverage the strong social Despite the strong growth potential in China, both communities. With strong expertise in the free-to-play Korean and Japanese mobile-game developers are revenue model, hit casual and social games in Asia concerned about low profitability from game services have successfully lured novice gamers and further in China due to relatively high fee for platforms and extended their reach to mid- to hard-core gamers application markets. playing RPGs over the past 3 years.

- 17 - Pan-Asia Mobile Games Sector 24 October 2014

MIMs: from partners to competitors  China: market share of mobile-game developers (2013) Tencent Korea’s mobile-game industry has grown rapidly, to 9% Yinhan revenue of KRW1.3tn for 2013 from KRW0.3tn for 6% Good321 2010, backed by a well-developed service infrastructure 5% (billing system and distribution platform) through Others Linekong Kakao Talk. Mobile-game companies have been 44% 5% leveraging MIM platforms by reducing their costs for Playcrab game distribution and gamer acquisition. They have 5% Wistone enjoyed the benefits from the mobile social platforms Locojoy 4% by enhancing game content and lowering marketing Hanfeng game 4% 3% Muhenet expenses. Morefunteck Egls Sqage 4% 3% 4% 4%

In the region, leading MIMs like Kakao, LINE and Source: Sootoo Research, Daiwa WeChat have disrupted the landscape, taking a significant share of traditional games in various In China, we think game platforms or distributors play markets. We expect these 3 MIM apps to record 2.4bn a key role in determining the success of a game, and users combined globally, at the end of 2014, hence capture a significant amount of the revenue representing 37% YoY growth. Especially in Asia, these share in the mobile gaming value chain. A platform MIM apps have become major content distribution operator typically gets 42.75% of the revenue, the channels for games and other digitalised items such as publisher and developer get 20.31% separately, the stickers, news, and tunes. payment channel fee accounts for 10% and the rest 6.64% goes to the tax department.  Pan-Asia: fee structure by MIM platform and open market (Jun 2014) Compared with outside China, they benefit from 100% favourable revenue-sharing schemes by leveraging local app marketplaces, a large gamer base, high 80% mobile traffic, internal payment systems, and powerful 60% promotion channels like viral marketing.

40% Newcomers like Alibaba and Baidu could trigger fee 20% competition to source high quality mobile games from overseas over the next few years, resulting in higher 0% royalties for game developers in Korea and Japan. Appstore Google Play LINE Daum Kakao Wechat Market fee Platform fee Developer In Korea, Daum Kakao has been a dominant platform

Source: Nielsen Koreanclick (June 2014), Daiwa for mobile game since July 2012, with more than 16m gamers (a 66% share of total mobile gamers) as of Among the participants in China’s mobile-game 2013, far ahead of other competitors such as BAND, market, we are positive on the game distributors, such LINE, and other minor platforms. By charging around as Tencent, due to their strong market leadership, a 21% fee for gaming channelling on its Game Center, advantageous business model based on diversified and Daum Kakao has different strategies to change the recurring revenue, and more visible and lucrative competitive landscape and enhance its platform power earnings streams. These leading mobile-game by teaming up with niche game developers. platforms should continue to leverage their powerful platforms, based on active mobile traffic within social We believe 3 types of market participants are networks, given the China market is highly fragmented competing and sometimes working together in Korea: and game developers depend on the distribution big mobile-game publishers (CJ E&M, Nexon, WeMade channels. Entertainment, NHN Entertainment), niche game development studios (Gamevil, Com2uS, 4:33), and global game publishers (Supercell and King Digital).

Although Kakao has become less aggressive than it was previously in promoting game activity using SMS (casual gamers complained about receiving too many invitations to join games), we believe this leading MIM platform in Korea still has considerable power to boost

- 18 - Pan-Asia Mobile Games Sector 24 October 2014

overall game downloads and sell in-app items. Daum Kakao increased its game sales by 43% YoY and 8% Rediscovering the value of online QoQ to KRW56bn for 2Q14, accounting for 64% of the game companies total revenue for the Kakao division. LINE’s game sales rose by 36% YoY to KRW82bn for 2Q14 and accounted Smart devices and F2P mobile games are doing globally for 12% of Naver’s total revenue then. what online game services did for entertainment consumers. We believe the big game developers that  LINE and Daum Kakao: quarterly trend of game revenue provide online game services are likely to make a foray (KRW bn) into the promising mobile-game market sometime 140 soon, given that the overall life cycle of a mobile game 120 is rapidly becoming longer. 100 80 Online games look set to play a smaller role 60 40 We believe that handheld devices dedicated to games and traditional online games will play a smaller role in 20 the game market globally, and become less important 0 platforms in the long term. Also, we believe

1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 differentiated and advanced game content and new 3Q14E 4Q14E Kakao LINE game genres for smart devices will help the online-

Source: Companies, Daiwa game companies to move up the industry value chain over the medium term. We note that LINE has a slightly different market position in Japan compared with Daum Kakao in Korea We understand investor concerns relating to online- and WeChat in China, given that most hit titles are game services, whose usage continues to lose ground casual games from Korean game companies and in- when accessed via PCs and in distribution channels like house development studios, rather than third-party offline Internet cafés, due to limited accessibility and developers. It is still too early to see a rush of Japanese less intuitive interfaces. Also, we believe such games game developers into the LINE platform due to its are less likely to attract younger gamers. small gamer base and lack of successful games from third-party and non-casual game genres. We think  NCsoft: revenue mix by franchise game third-party developers in Japan might try to capitalise (KRW bn) on LINE’s large user base globally once new games are 1,200 launched by NHN Entertainment, Ateam, and gumi. 1,000 LINE purchased just under a 10% stake in gumi in 800 August this year. 600

Despite concerns in the market about a potential 400 exodus of talented game developers from MIM apps to 200 open app stores, we believe the dominant MIM apps 0 (Daum Kakao and WeChat) on mobile-game platforms 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E will continue to attract high-quality games, extending 1 Linegae 2 Aion B&S (Korea) GW2 Wildstar Other games Royalties their services to game-related value-added services, and proving their platforms’ power to generate strong Source: Company, Daiwa forecasts game sales in the coming years. Compared with consoles and handheld games, we believe online games could take a backseat as loyal customers are likely to stick to high-quality MMORPG titles. In addition, we believe that 2015 will be an important year for the leading online-game players, such as Nexon and NCsoft, given that they are ready to launch high-quality mobile games for hard-core users and next-generation RPG titles that will leverage on their large gamer bases and strong franchise values.

- 19 - Pan-Asia Mobile Games Sector 24 October 2014

We believe they are heading in the right direction due Today’s follower could become tomorrow’s to the growing popularity of advanced smart devices consolidator and changes in gamer tastes for mid- to hard-core Despite concerns about mobile cannibalisation, we games. In our view, both Nexon and NCsoft have think the new growth strategy for advanced mobile appealing assets, such as popular game IPs, ready- games is likely to reverse the revenue decline seen by made substantial user bases and strong partnerships this segment over the past few years. Given we see with local publishers (ie, Tencent in China), which 2013-14 as a transition period, we expect 2015 to be a could help them leverage their expertise in game much stronger year, in terms of both revenue growth development, commercial launches, monetisation, and and the changing influence of leaders (Nexon and service operation. NCsoft) in the global mobile-games industry.

Do profitability and game-development capability matter? We believe the online game companies in Asia have just started to realise the power of mobile gamers and plan to roll out new flagship mobile games that capitalise on their valuable game franchises. We expect these companies to adjust to a new set of rules, rather than simply wait and see what happens once the online-games market becomes saturated, as gamers are demanding multiple ways to consume entertainment content.

 Nexon: mobile games and profitability (JPY bn) 250 50%

200 40%

150 30%

100 20%

50 10%

0 0% 2012 2013 2014E 2015E 2016E PC (LHS) Mobile (LHS) Operating-profit margin (RHS)

Source: Companies, Daiwa forecasts

We have seen the profitability of online-game companies decline since 2011, due to rising operating costs relating to platform fees, headcount additions, and marketing costs as their revenue mix shifts to mobile. In fact, Nexon’s operating-profit margin fell to 20% in 2Q14, from 35% in 2Q13, as the revenue proportion of its mobile games rose to 20% from 10% over the same period. However, we believe leading online-game developers like Nexon and NCsoft have strong enough game-development and publishing capability to develop next-generation mobile games, which should reshape the industry landscape over the medium term.

- 20 - Pan-Asia Mobile Games Sector 24 October 2014

licensing concept will become increasingly popular in China over the next few years as developers look for new ways to differentiate their game titles.

We show the game-publishing value chain in Asia 3 largest mobile-game markets in the following table and Conclusion go on to discuss market penetration strategies and progress of the major players. Improving service infrastructure and Pan-Asia: value chain of game publishing growth in the number of paying users are Publisher spurring the evolution of new kinds of Hit game Developer Korea China Japan games and new ways of interacting with Puzzle and Dragons Gungho Neocyon Gungho Million Arthur Square Enix Actoz Soft Shanda Games Square Enix users. Summoner's war Com2uS Com2uS - Com2uS Ace Fishing Com2uS Com2uS - Com2uS Ani Pang Sunday Toz Sunday Toz - LINE Platforms trump developers Taiming Monsters CJ E&M CJ E&M Tencent LINE Atlan Story WeMade WeMade Shanda Games - We believe mobile gaming is much more than a fad. We Football day NHN BlackPick NHN Ent. Shanda Games NHN PlayArt LINE Disney Tsum Tsum NHN PlayArt LINE - LINE see it as a key business growth driver of the overall Source: Daiwa Pan-Asia game industry, where the regional value chain for the mobile-game service business is evolving Japan players’ inroads in a smart way. Successful games: Million Arthur by Square Enix has become popular in Korea. Square Enix Different approaches by different players of Japan has successfully penetrated Korea with its We have found that the Korea game companies Million Arthur mobile game in 2012. This game consider China and Japan as among their main target incorporates a card-battle feature, cartoon-rendering markets due to both countries’ large user bases, technologies, game episodes and dynamic battle improving service infrastructure and growing paying modes. It has benefited from its strong brand equity in gamer bases. Japanese mobile-game companies view Japan, loyal gamer base in the region, and very good Korea as one of the key testing markets for their graphic quality. overseas expansion strategies, while many of these companies are gearing up to penetrate the China The following mobile games –iFighter2: The Pacific market with their hit games in Japan. The leading 1942 by gumi, Battle Cats by Ponos, and Love Live mobile-games players in both Korea and Japan are published by NHN Entertainment and developed focusing on expanding into high-growth markets such jointly by KLab and Bushiroad – had also acquired a as China, by leveraging their expertise in the mobile- large number of gamers in Korea so far, with 1-3m game service in the domestic markets. downloads and rankings of 10-60 in the top grossing list for Google Play in Korea, as at September 2014. We In addition, we have observed that Chinese-made believe Japanese mobile games will continue to gain mobile games are gradually gaining popularity in Korea market share in Korea and elsewhere in Asia through as they have started to offer more local content with Japan mobile-games companies leveraging on their reliable game operations and differentiated game strong game IPs, solid and loyal gamer bases that features. We have found that 3 Chinese-made games, generate high ARPU, and monetisation expertise. namely Legend of King by Khunroon, Beauty Blade Online, by Chukong, and Sam Gum Ho by Windplay Tencent’s market penetration have successfully acquired local gamers in Korea year In Korea, Tencent has made inroads through various to date. investments since 2010, ranging from acquisitions of new game IPs to purchases of stakes in talent game In the advanced mobile-game markets in Asia (ie, development studios, specialising in mobile games. We Korea and Japan), companies are now incorporating believe Tencent wants to diversify its game offerings by licensed characters into their mobile games. sourcing different game content from overseas, and in Integrating already popular content into mobile games this way is addressing the recent trends in new game in this way enables developers to save considerably on services in Korea, which is one of Asia’s advanced marketing expenditure, while at the same time to mobile-game markets. attract a very broad user base. We believe the content- - 21 - Pan-Asia Mobile Games Sector 24 October 2014

 Tencent: investments in Korean game and content developers  Com2uS: revenue and operating-profit margin Amount invested (KRW bn) Year Company (KRWbn) Investment details 50 50% 2010 Studio Hon 1.5 Not disclosed Reloaded Studios 5.5 Under 10% stake 40 40% Top Pig 2.0 Not disclosed Next Play 1.5 Not disclosed 30 30% Red Duck 1.5 80% of series B stock (preferred) Eyedentity 4.0 No stakes as of 2013 20 20% GH Hope Island 2.5 Not disclosed 2011 Future Stream Network 4.2 Not disclosed 10 10% 2012 Kakao Talk 72.0 13.8% stake 2014 CJ games 533.0 28% stake 0 0% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 Source: Tencent, various media, compiled by Daiwa Overseas revenue (LHS) Domestic revenue (LHS) Operating-profit margin (RHS)

In Tencent’s domestic market of China, in the next few years, we expect the company to evolve from a game- Source: Com2uS distribution channel into an integrated mobile-service platform, thereby capitalising on its successful track We believe the key success factors for overseas record in publishing third-party games and benefiting expansion for a local game developer like Com2uS from growing mobile-games revenue with developers include: 1) offering differentiated game plays, 2) in China. featured comments from app stores like Google Play and Apple’s Appstore, and 3) having a powerful However, in order to capture rising demand for mid- to platform. Com2uS has stated that its Summoners War hard-core games in China, over the coming years, we game is benefiting strongly from growth in the number believe talent-game developers in Korea and Japan will of RPG users globally and appealing content standing seek greater business opportunities by shifting away out from that of competitors’ RPGs. from the leading mobile-game distributors such as Tencent and distributing their games through To become a long term winner in the mobile-games alternative channels such as third-party marketplaces market globally, we believe a company should have: 1) and second-tier publishers, as these channels typically a good track record of promoting and selling hard-core have more mid-core gamers, offer stronger marketing games (RPGs) in overseas markets, 2) strong support and better revenue-sharing terms. partnerships with local publishers in overseas markets, 3) experience of working with MIM platforms, 4) Global journey is just beginning talented software engineers, and 5) a global brand and platform with a high number of downloads and an Korean developer Com2uS has successfully penetrated active user base. the international mobile-games market with its RPG title, Summoners War, since 2Q14. Also, over the past decade, Com2uS has leveraged its expertise to develop Dominant and integrated mobile- low-end games for mobile phones, incorporating differentiated content in order to set its games apart game platforms: our preferred from existing mobile RPGs. Com2uS promotes its segment games through Hive, the integrated game platform of the Hub and Live online portal owned by Gamevil (its In the Pan-Asia Mobile Games Sector, our stock parent company), and which also offers featured preferences lie with the integrated platform operators comments by app stores. (For more background, see with dominant positions in the mobile-games segment, too Building a strong games platform, published on 3 over pure game developers and local game publishers. September 2014.) This reflects primarily our view that the major integrated platform operators have: 1) highly scalable business models, 2) sustainable revenue and earnings growth outlooks, and 3) strong earnings-generating power with the ability to maintain stable profitability over the coming years.

We also like GaaP (games as a platform), game developers that are evolving into platforms with growing user bases globally, enhancing their brands and increasing their in-game items commerce activities.

- 22 - Pan-Asia Mobile Games Sector 24 October 2014

We show where the stocks in our coverage lie Importantly, we believe Square Enix can capture within the sector’s value chain in the following chart. successfully the mobile-games opportunity in the Pan- Asia region by leveraging its strong game IPs with mid-  Pan-Asia Mobile Games Sector: value chain to hard-core RPG features and established user base Platform through its Million Arthur game that is currently available in Korea and China. Square Enix’s successful launch of Crossgate in China in July 2014 supports our positive view on the company as this mobile game has LINE generated monthly game sales of around JPY1bn since Daum Kakao its launch.

In the Japan mobile-games space, we also like Bandai Com2uS Namco Holdings, with an Outperform (2) rating. This Tencent game developer has strong potential to monetise its Gamevil popular game IPs among Asian users, in our view. Devsisters Bandai’s mobile-game services should help it to Party games NHN Ent. 4:33 generate solid growth in sales and earnings over the Sunday Toz CJ E&M Nexon Square Enix next few years, as its mobile-game business model is WeMade less prone to piracy issues than its off-line game Developer Publisher distribution.

Source: Daiwa Games as a platform (GaaP). We are positive about

game companies evolving into GaaP (ie, where hit Top sector picks games will become pseudo platforms, boasting vast We summarise these here and provide further details user bases, traffic, and well-recognised brands), which in the company sections in this report. should enable the game companies to capitalise on economies of scale to drive earnings. Integrated and large mobile ecosystems leveraging strong gamer bases. In this vein, Game companies that deploy the GaaP model should Daum in Korea and Tencent in China are our top be able to benefit strongly from their large bases of picks in these mobile-games 2 markets. We upgrade active users who spend a lot on in-app items and have our rating on Daum to Buy (1) (from Outperform [2]) strong loyalty as part of an in-game community. Due to and reaffirm our Buy (1) rating on Tencent. significant users and in-game activities offered within a game, companies can utilise GaaP as an effective tool to We believe both companies, which have become market new games, sell items, and generate value- dominant MIM platforms in their respective home added revenue, in our view. markets, will record strong revenue and earnings growth for 2014-16, driven by their offers of several In the Pan-Asia region, we view Puzzle and Dragons by non-game mobile services like payments, content Gungho (3765 JP, not rated), The World of Mystic Wiz transactions, advertising, commerce, and mobile-to- by Colopl (3668 JP, not rated), Monster Strike by Mixi online/offline services. Also, we believe they have the (2121 JP, not rated), and Summoners War by Com2uS ability to monetise their large and active user bases and (078340 KS, not rated), as GaaP. Thus, to invest in the in-app communities for various mobile-to- Gaap theme, we like Com2uS (not rated) and Colopl online/offline (M2O) services. (not rated).

Global game-franchise builders. Our top pick in  Korea and Japan: blockbuster mobile games evolving into GaaP Japan is Square Enix, with an Outperform (2) rating. Category Korea Japan China Over the medium term, we expect this leading Game title Summoners War Puzzle and Dragons Monster Strike Japanese game developer to become a global player Game launch 17-Apr-14 20-Feb-12 10-Oct-13 servicing several markets, launching new games on Total downloads* 13m 31m 14m Daily active users* 1.2m n.a. n.a shared platforms, and benefiting from economies of Monthly revenue* KRW4bn JPY13bn JPY6bn scale in game development. In our view, Square Enix Game genre RPG Puzzle Action RPG has strong assets such as solid game IPs and brand Developer Com2uS Gungho Mixi value, a large user base and powerful distribution Source: Companies, Daiwa channels, which we believe could help the game Note: * data corresponds to that since launch, developer become a successful platform.

- 23 - Pan-Asia Mobile Games Sector 24 October 2014

What if a hit game faces a slowdown? game ecosystems trade at PERs of 16-33x based on our We are concerned about the long-term growth earnings forecasts (2015E for Daum and Tencent and potential of the pure mobile-game companies, FY15 for Square Enix) still lower than Daum’s and particularly those focusing on specific genres and Tencent’s historical PER peaks of 40-50x during the devices with small target markets, and those with 2005-13 period. limited ability to develop quality games and involved in weak value chains with global partners. We expect the market to ascribe an expanding PER premium to the dominant and integrated platform In our view, the pure game developers will likely find it operators in the coming years, as we believe their hard to keep up with players’ ever-changing tastes in mobile ecosystems are well placed to reap the rewards mobile games. from the rise of smart devices in the game industry’s evolution and, crucially, to support diversification into Valuations appear compelling given the non-game services. growing power of platforms However, we believe the valuations of the pure mobile- The region’s mobile game stocks have strongly game developers are hard to justify currently, given our outperformed their respective markets since 2H13, concerns over revenue and earnings visibility at a time particularly in the year-to-date with Daum, Tencent of growing competition globally and a declining ratio of and Square Enix outperforming by 18-90%. We hit games. attribute this outperformance to their effective monetisation of the growth in the number of Investment risks smartphone users, successful penetration of global The main risk to our Positive investment thesis on the markets, and increase in the number of paying gamers Pan-Asia Mobile Games Sector would be a rapid and spending on in-game items. change in gamers’ demand for certain types of games

and in-game communications, which could shorten the In our view, the dominant and integrated mobile-game lifecycle of game services while increasing R&D costs platforms, such as Daum Kakao in Korea and Tencent and reducing the sustainability and visibility of mobile in China, could trade at higher valuation multiples than game revenue. currently, as we believe these MIM platforms could become more powerful mobile ecosystems for non- A secondary risk would be an increase in competition game services by leveraging the rise in active gamers among game developers and game-publishing and expanding mobile traffic, and launching and platforms, which would ramp up the costs related to promoting new mobile services aimed at multiple gamer acquisition and user retention, and lower the channels. return on investment (ROI) on mobile game titles.

 Pan-Asia mobile-game companies: share-price performance 120% Another risk would be the emergence of an aggressive 100% F2P business model, whereby games are made 80% available at no charge but feature paid ads and e- 60% commerce transactions, as such a shift could reduce the 40% revenue from games that enjoy strong user loyalty. 20% 0% Other risks include changes in the policy for (20%) application updates and payments by mobile OS (40%) providers such as Google and Apple, which we believe (60%) could have an impact on the monetisation strategies of all game developers and MIM platform operators in the Jul-14 Jul-14 Jul-14 Apr-14 Apr-14 Oct-14 Jun-14 Jun-14 Jan-14 Jan-14 Feb-14 Feb-14 Mar-14 Mar-14 Aug-14 Aug-14 Sep-14 Sep-14 Dec-13 May-14 May-14 region. Further regulatory initiatives to control game Naver* Daum* Ncsoft* content (violence, adult themes and graphics, etc) and Nexon** Square Enix** Tencent*** gameplay (card battles, PvP, and in-game item Source: Bloomberg purchases) could also pose a risk to our positive stance Note: relative performance against *Kospi, **TPX ***HSI on the sector.

In our view, the prevailing valuations of Daum Kakao, Tencent, and Square Enix are attractive relative to their respective historical ranges. The shares of 3 mobile-

- 24 - Pan-Asia Mobile Games Sector 24 October 2014

 Global online and Internet companies: valuation comparison Market EPS growth Share price cap PER (x) EV/EBITDA (x) Price/BVPS (x) Rev. growth (%) (YoY) ROAE (%) Ticker (local curr.) (USDbn) 2013 2014E 2015E 2013 2014E 2015E 2013 2014E 2015E 2014E 2015E 2014E 2015E 2014E 2015E *SEARCH/PORTAL Naver* 035420 KS 796,000 24.9 99.5 45.7 27.1 40.0 24.2 17.0 17.8 12.9 9.3 27.6 25.9 117.5 68.9 32.7 39.9 Daum* 035720 KS 151,900 8.1 31.2 43.7 29.0 68.8 55.8 19.9 3.7 13.4 10.5 29.8 78.7 -28.7 50.5 14.4 41.3 Korea average 65.3 44.7 28.1 55.2 40.8 18.7 10.8 13.1 9.9 21.8 52.3 44.4 59.7 23.6 40.6 Baidu BIDU US 222.35 78.0 45.3 35.5 25.3 32.8 27.6 18.6 10.7 9.1 6.7 55.3 42.5 27.4 40.4 28.4 30.2 Facebook FB US 78.69 203.6 126.9 48.4 38.6 49.8 23.9 17.5 11.0 11.0 8.4 55.7 34.6 162.3 25.3 21.6 23.5 Google GOOG US 526.54 359.7 n.a. 20.1 17.0 16.8 11.3 9.3 n.a. 3.3 2.8 -11.5 19.3 n.a. 18.4 16.8 17.0 Yahoo YHOO US 40.18 40.0 30.9 29.6 32.2 24.0 27.8 27.4 1.1 2.0 2.0 -7.3 1.7 4.5 -8.2 10.1 8.5 US average 67.7 33.4 28.3 30.8 22.6 18.2 7.6 6.4 4.9 23.1 24.5 64.7 19.0 19.2 19.8 Search/portal average 66.5 39.1 28.2 43.0 31.7 18.5 9.2 9.7 7.4 22.5 38.4 54.6 39.3 21.4 30.2

* ONLINE/CONSOLE GAME NCsoft* 036570 KS 139,000 2.9 19.2 13.1 11.0 10.0 7.0 5.5 2.7 2.3 1.9 12.2 13.8 46.6 19.1 18.7 18.7 Korea average 19.2 13.1 11.0 10.0 7.1 5.6 2.7 2.3 1.9 12.2 13.8 46.6 19.1 18.7 18.7 Tencent* 700 HK 115.4 139.4 54.6 33.0 26.6 36.8 21.2 16.5 14.8 9.4 7.1 33.3 31.5 66.4 20.8 35.5 31.0 Shanda Games GAME US 6.49 1.7 6.7 n.a. n.a. 5.3 n.a. n.a. 8.8 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. China average 30.7 32.8 26.5 21.1 21.9 17.1 11.8 9.6 7.2 33.3 31.5 66.4 23.7 35.5 31.0 Nexon* 3659 JP 865 3.5 12.5 10.2 8.7 2.8 2.0 1.2 1.2 1.1 1.0 8.9 15.2 22.4 17.0 11.7 12.5 Namco Bandai 7832 JP 2,528 5.2 22.2 15.3 14.3 6.5 5.2 4.5 2.0 1.9 1.7 5.7 2.6 44.9 7.2 12.7 12.8 Square Enix 9684 JP 2,080 2.2 36.3 23.3 16.6 9.8 6.6 5.0 1.9 1.7 1.6 2.9 13.3 56.1 40.5 7.7 9.5 Japan average 23.7 16.3 13.2 6.4 4.6 3.6 1.7 1.6 1.4 5.8 10.4 33.2 21.6 10.7 11.6 Online/console game average 24.5 20.7 16.9 12.5 11.2 8.8 5.4 4.5 3.5 17.1 18.6 48.7 21.5 21.6 20.4

* MOBILE GAME Gamevil 063080 KS 118,400 0.7 51.2 28.2 16.3 50.2 31.2 14.9 4.4 3.9 3.1 75.4 37.8 81.6 72.7 15.9 22.6 Com2uS 078340 KS 180,000 1.7 89.4 21.5 15.9 171.1 16.7 11.5 14.2 9.7 6.1 185.7 29.3 316.7 35.4 56.7 46.2 Korea average 70.3 24.8 16.1 110.7 23.9 13.2 9.3 6.8 4.6 130.6 33.5 199.1 54.0 36.3 34.4 Gree 3632 JP 743 1.7 10.0 13.4 9.5 3.0 3.6 3.2 1.5 1.4 1.2 -16.8 12.2 -25.2 41.2 12.7 12.7 Dena 2432 JP 1,302 1.8 5.4 13.7 10.5 2.4 3.7 4.2 1.2 1.1 1.0 -27.2 12.0 -60.9 30.1 10.5 10.5 Colopl 3668 JP 3,360 3.9 123.5 29.0 18.9 66.4 15.7 9.4 15.5 13.6 7.9 234.0 42.9 325.8 53.2 n.a. n.a. Gungho Online 3765 JP 414 4.5 8.7 7.3 7.1 4.3 3.7 4.2 4.8 3.7 2.7 14.8 0.4 20.0 1.8 52.6 52.6 Cyberagent 4751 JP 3,970 2.3 23.9 23.3 17.5 15.2 8.3 6.6 5.0 4.5 3.7 24.5 11.9 2.3 33.6 21.2 25.9 Japan average 34.3 17.3 12.7 18.3 7.0 5.5 5.6 4.9 3.3 45.9 15.9 52.4 32.0 24.3 25.4 Mobile game average 52.3 21.1 14.4 64.5 15.5 9.4 7.5 5.9 4.0 88.2 24.7 125.8 43.0 30.3 29.9

* INTERNET SERVICES Mixi 2121 JP 5,720 4.4 n.a. 19.9 13.8 144.4 12.3 8.1 18.3 12.1 7.4 618.0 40.0 T.B. 44.5 66.4 48.8 Rakuten 4755 JP 1,172 14.5 36.0 30.4 22.6 3.0 12.7 n.a. 4.9 4.3 3.6 12.7 12.8 18.2 34.8 16.3 16.3 Ebay EBAY US 50.86 63.2 23.1 17.3 15.5 12.7 10.6 8.7 3.2 2.8 2.4 11.8 12.4 34.0 11.2 9.9 15.4 Internet services average 29.5 22.5 17.3 53.3 11.9 8.4 8.8 6.4 4.5 214.2 21.7 26.1 30.2 30.9 26.8 Source: Bloomberg, Daiwa estimate Note: Share price as at 21 Oct 2014 *Daiwa forecast

When a report covers six or more subject companies please access important disclosures for Daiwa Capital Markets Hong Kong Limited at http://www.daiwacm.com/hk/research_disclaimer.html or contact your investment representative or Daiwa Capital Markets Hong Kong Limited at Level 26, One Pacific Place, 88 Queensway, Hong Kong.

- 25 -

Information Technology / Korea 035720 KS Information Technology / Korea 24 October 2014

Daum Communications

Daum Communications Target (KRW): 139,000  190,000 Upside: 25.1% 035720 KS 21 Oct price (KRW): 151,900

The next-generation mobile ecosystem for daily life 1 Buy (from Outperform) 2 Outperform • Daum Kakao is rapidly evolving as an integrated platform for all 3 Hold mobile services 4 Underperform • Raising our 2014-16E EPS by 1.7-7.7% on the back of strong 5 Sell revenue from monetising various social transactions and graphs • Upgrading to Buy with new target price of KRW190,000

How do we justify our view?

Management emphasised that the dominant mobile platform and company would continue to add new generate earnings for 2014-16. ad products optimised for Kakao Talk and enhance its ecosystem by engaging third-party partners. Forecast revisions (%) Thomas Y. Kwon Year to 31 Dec 14E 15E 16E (82) 2 787 9181 Full speed ahead to monetise Revenue change 0.4 3.7 4.0 [email protected] various social graphs. Taking into Net profit change 1.7 7.7 5.1 Core EPS (FD) change 1.7 7.7 5.1 account the added contribution of ■ What's new Kakao, we now forecast Daum’s ad Source: Daiwa forecasts Following discussions on 17 October sales and game sales to rise at Share price performance with the co-CEOs of Daum respective CAGRs of 18% and 26% for 2014-16 (from 17% and 23%). Our 1.7- (KRW) (%) Communications (Daum) (to be 180,000 200 renamed Daum Kakao effective 31 7.7% upward revisions to 2014-16E EPS reflect the strong monetisation 150,000 170 October 2014, post its merger with 120,000 140 we expect of mobile services on Daum Kakao), we have more confidence in 90,000 110 the power of the new Daum Kakao Kakao’s platform, and greater-than- 60,000 80 platform to monetise active, loyal, and previously-expected service synergies Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 premium users, and lead the company from 2015 by capitalising on its high Daum Com (LHS) Relative to KOSPI (RHS) into a strong earnings growth cycle. number of active users and powerful mobile ecosystem. 12-month range 68,700-177,100 ■ What's the impact Market cap (USDbn) 8.34 Connecting everything for ■ What we recommend 3m avg daily turnover (USDm) 102.06 We upgrade our rating for Daum to Shares outstanding (m) 57 mobile life innovation. Top Major shareholder Kim, Beom Su (22.2%) management presented its powerful Buy (1) from Outperform (2) and raise our 6-month target price to vision for the new Daum Kakao Financial summary (KRW) platform to change people’s daily KRW190,000 (from KRW139,000), Year to 31 Dec 14E 15E 16E mobile life by connecting everything based on our revised 2015E EPS and Revenue (bn) 689 1,231 1,485 from people to people, information, new target PER of 36.5x (formerly Operating profit (bn) 106 360 462 28.6x), a 10% premium to global Net profit (bn) 84 296 379 data, and machines. Core EPS (fully-diluted) 3,475 5,230 6,697 peers’ 2015E PER (on Bloomberg EPS change (%) (28.7) 50.5 28.0 Both CEOs underscored that Daum consensus EPS). The key risk is Daiwa vs Cons. EPS (%) (12.4) 3.4 15.2 Kakao would pursue a more balanced sharper-than-expected operating cost PER (x) 43.7 29.0 22.7 strategy, and expand into new social rises for new services and new staff. Dividend yield (%) 0.7 0.7 0.7 DPS 1,133 1,133 1,133 graphs by rolling out new vertical apps PBR (x) 13.4 10.5 7.6 ■ How we differ and integrating new innovative EV/EBITDA (x) 55.8 19.9 15.1 services into the platform, such as We are more positive on Daum ROE (%) 14.4 41.3 39.5 Kakao Pay and Yellow ID. Kakao’s power to monetise its Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 70 Pan-Asia Mobile Games Sector 24 October 2014

1 Buy (from Outperform) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  Daum: revenue mix and operating-profit margins With the added contribution from Kakao, we now (KRW bn) forecast Daum’s ad sales and game sales to rise at 300 30.0% respective CAGRs of 18% and 26% for 2014-16, (vs. 17% 250 25.0% and 23% previously). We forecast non-game revenue 200 20.0% for the Kakao Talk service to increase at a CAGR of 66% 150 15.0% for 2014-16, while accounting for 53% of total revenue in 100 10.0% 2016, driven by strong mobile-ads sales and in-app 50 5.0% digitalised item sales on diverse vertical apps and 0 0.0% integrated services for monetisation. 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14

3Q14E 4Q14E Search ads Display ads Transaction Game Kakao Operating-profit margin (RHS) Source: Company, Daiwa forecasts

 Valuation  Daum: share-price and PER band Daum shares are trading currently at PERs of 29.0x and (KRW) 22.7x for 2015E and 2016E, respectively. Despite a 250,000 strong performance in the share price following the 200,000 merger announcement in May 2014, we believe the valuation rerating for Daum will continue on the back of 150,000 53.1x the increasing power of the mobile ecosystem in Korea, 41.6x 100,000 the company’s agile strategic moves to capitalise on 30.0x mobile communications through advanced revenue 50,000 18.5x models for ads, commerce, and entertainment content. 7.0x 0 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Dec-07 Sep-08 Dec-08 Sep-09 Dec-09 Sep-10 Dec-10 Sep-11 Dec-11 Sep-12 Dec-12 Sep-13 Dec-13 Sep-14

Source: Dataguide, Daiwa

 Earnings revisions  Daiwa earnings-forecasts vs. the market consensus We believe the consensus forecasts for Daum’s 2014- (KRW) 16 earnings will be revised up further once its 11,000 enhancing ecosystem starts to show strong leverage 10,000 on the services, top line, and cost fronts. We expect 9,000 8,000 the consensus to reflect Daum’s lucrative revenue 7,000 models through the mobile ecosystem in 2015-16. 6,000 5,000 4,000 3,000 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 2014E consensus 2015E consensus 2014E Daiwa 2015E Daiwa Source: Bloomberg, Daiwa forecasts

- 27 - Pan-Asia Mobile Games Sector 24 October 2014

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E % of ads revenues to total sales 93.8 93.9 95.5 84.8 70.0 80.0 60.7 56.7 Kakao Talk users (m, person) 0.0 0.0 0.0 70.0 130.0 170.0 210.0 250.0 Search query M/S(%) 22.0 21.0 20.0 20.0 20.0 20.0 21.0 22.0

 Profit and loss (KRWbn) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Display ads 105 149 207 230 231 245 256 279 Paid searches 125 180 195 182 261 267 297 322 Other Revenue 45 16 19 42 40 177 679 883 Total Revenue 274 345 421 453 531 689 1,231 1,485 Other income 00200000 COGS 00000000 SG&A (230) (248) (305) (352) (449) (583) (871) (1,023) Other op.expenses 0 (7) (4) 00000 Operating profit 44 90 114 102 82 106 360 462 Net-interest inc./(exp.) 2 4 11 11 10 9 22 32 Assoc/forex/extraord./others (7) (5) 0 (12) (8) (7) (7) (9) Pre-tax profit 39 90 125 101 84 108 375 486 Tax (6) (25) (28) (20) (15) (24) (79) (107) Min. int./pref. div./others 0 40 9 (5) (3) (0) (0) (0) Net profit (reported) 32 104 106 76 66 84 296 379 Net profit (adjusted) 32 104 106 76 66 84 296 379 EPS (reported)(KRW) 2,494 7,893 7,892 5,627 4,873 3,475 5,230 6,697 EPS (adjusted)(KRW) 2,494 7,893 7,892 5,627 4,873 3,475 5,230 6,697 EPS (adjusted fully-diluted)(KRW) 2,494 7,893 7,892 5,627 4,873 3,475 5,230 6,697 DPS (KRW) 0 749 1,607 1,110 1,133 1,133 1,133 1,133 EBIT 44 90 114 102 82 106 360 462 EBITDA 69 114 142 138 121 148 402 507

 Cash flow (KRWbn) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 39 90 125 101 84 108 375 486 Depreciation and amortisation 25 24 27 36 40 42 42 45 Tax paid (6) (25) (29) (29) (19) (10) (19) (81) Change in working capital (16) (7) (1) 9 20 (20) 28 (9) Other operational CF items 15 53 (10) 7 1 (5) (5) (5) Cash flow from operations 56 134 112 123 126 116 420 436 Capex (13) (33) (43) (37) (43) (57) (65) (75) Net (acquisitions)/disposals (1) (4) (63) 21 (17) 55 (32) (42) Other investing CF items (8) (45) (8) (35) (37) 27 18 19 Cash flow from investing (22) (82) (114) (51) (98) 26 (79) (98) Change in debt (16) (20) (0) (1) 1 (1) 0 0 Net share issues/(repurchases) 0 0 (5) 0 (11) (35) 0 0 Dividends paid 0 0 (10) (22) (15) (15) (63) (63) Other financing CF items 4 15 1 (10) (13) 0 0 0 Cash flow from financing (12) (5) (14) (32) (39) (51) (63) (63) Forex effect/others (0) (31) 0 (0) (0) 0 0 0 Change in cash 21 17 (16) 39 (11) 91 278 275 Free cash flow 42 101 69 86 83 59 355 361 Source: FactSet, Daiwa forecasts

- 28 - Pan-Asia Mobile Games Sector 24 October 2014

 Balance sheet (KRWbn) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 127 203 230 268 276 339 586 860 Inventory 00000000 Accounts receivable 50 56 72 58 50 116 128 155 Other current assets 16 35 22 21 25 68 122 147 Total current assets 193 294 324 348 350 524 836 1,162 Fixed assets 58 64 89 101 120 165 155 183 Goodwill & intangibles 1 1 43 74 86 76 60 43 Other non-current assets 56 89 103 89 102 102 139 186 Total assets 308 448 559 612 658 867 1,190 1,575 Short-term debt 20 0 101000 Accounts payable 8 9 11 10 22 42 43 50 Other current liabilities 61 81 83 66 64 149 303 368 Total current liabilities 88 90 94 77 87 191 346 418 Long-term debt 0 0 000000 Other non-current liabilities 10 7 8 15 16 24 22 19 Total liabilities 98 97 102 92 104 215 368 437 Share capital 7 7 7 7 7 29 29 29 Reserves/R.E./others 203 345 450 509 532 608 777 1,093 Shareholders' equity 210 351 457 515 539 637 806 1,122 Minority interests 0 0(0)515151516 Total equity & liabilities 308 448 559 612 658 867 1,190 1,575 EV 8,477 8,382 8,347 8,320 8,324 8,261 7,989 7,680 Net debt/(cash) (107) (203) (229) (268) (275) (339) (585) (860) BVPS (KRW) 16,050 26,292 33,930 38,954 40,735 11,374 14,422 20,112

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 5.5 26.0 21.9 7.6 17.1 29.8 78.7 20.6 EBITDA (YoY) 7.6 66.3 23.9 (2.8) (11.7) 21.9 171.5 26.2 Operating profit (YoY) 8.4 104.9 26.9 (11.1) (19.6) 29.4 240.3 28.4 Net profit (YoY) (27.8) 221.3 1.9 (28.2) (13.4) 27.9 250.2 28.0 Core EPS (fully-diluted) (YoY) (64.0) 216.5 (0.0) (28.7) (13.4) (28.7) 50.5 28.0 Gross-profit margin 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 EBITDA margin 25.0 33.1 33.6 30.3 22.9 21.5 32.6 34.1 Operating-profit margin 16.1 26.1 27.2 22.4 15.4 15.4 29.3 31.1 Net profit margin 11.8 30.2 25.2 16.8 12.4 12.3 24.0 25.5 ROAE 17.0 37.2 26.3 15.7 12.5 14.4 41.3 39.5 ROAA 10.7 27.6 21.1 13.0 10.4 11.1 28.8 27.4 ROCE 20.1 31.1 28.3 20.8 15.2 17.5 48.9 47.2 ROIC 34.4 52.0 47.5 34.2 25.3 27.9 103.6 140.4 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 16.6 27.9 22.2 19.6 17.8 21.9 21.0 22.0 Accounts receivable (days) 69.8 56.0 55.5 52.4 37.0 43.9 36.3 34.8 Current ratio (x) 2.2 3.3 3.4 4.5 4.0 2.7 2.4 2.8 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 9.5 20.4 19.7 23.3 32.6 21.7 16.9 Free cash flow yield 0.5 1.2 0.8 1.0 1.0 0.7 4.1 4.2 Source: FactSet, Daiwa forecasts

 Company profile As one of the leading Internet portals in Korea, most of Daum’s revenue comes from online advertising (paid searches and display ads). On 1 October 2014, Daum merged with Kakao, the leading mobile messaging company in Korea.

- 29 - Pan-Asia Mobile Games Sector 24 October 2014

Asia and other markets, where MIM has a dominant position in distributing game content.

To enhance its mobile-game platform in Korea, Daum aims to add more games which feature location-based play, and support more in-app social communications, Connecting everything and more network plays within the same social graphs.

Daum has a strong vision to make the Business outlook Kakao platform an integrated mobile ecosystem connecting everything for its In our view, Daum Kakao will change people’s daily users mobile life by connecting everything from people to people, information, data, and machines. We believe it is taking a totally different approach from its competitors in Investment summary terms of how to create value from mobile ecosystems, where communications, rather than search, is the key We upgrade our rating on Daum to Buy (1) from component to generate traffic and monetise users. Outperform (2), and raise our 6-month target price to KRW190,000 (from KRW139,000). Our new target price Management expects Daum Kakao to pursue a more is based on our revised 2015E EPS and new target PER of balanced strategy, and expand into new social graphs by 36.5x (formerly 28.6x), a 10% premium to global peers’ rolling out new vertical apps and integrating new 2015E PER (on Bloomberg consensus EPS), which we innovative services into its platform, such as Kakao Pay believe reflects its strong earnings-generating power, and Yellow ID. It emphasised that the company would effective monetisation initiatives for active users with continue to add new ad products optimised for mobile advanced non-game services, and potential to penetrate social platforms like Kakao Talk and enhance its the addressable online and offline target markets ecosystem by engaging with more third-party content successfully. providers and advertisers.

Following a recent meeting with the co-CEOs (William With the contribution from Kakao, we now forecast Choi and Vino Lee), we have become more confident in Daum’s ad sales and game sales to increase at respective the power of Daum Kakao’s platform to monetise active, CAGRs of 18% and 26% for 2014-16 (vs. 17% and 23% loyal, and premium users and lead the company into a previously). We forecast the non-game revenue for the strong earnings growth cycle from 2015, by enhancing its Kakao Talk service would increase at a CAGR of 66% for revenue streams through various mobile-to-online/offline 2014-16E, while accounting for 53% of total revenue in services. 2016, driven by strong mobile-ad sales and in-app digitalised item sales on diverse vertical apps and We now prefer Daum to Naver (035420 KS, integrated services for monetisation. KRW796,000, Outperform [2]) in the Korea Internet Sector, due mainly to Daum’s dominant position in the mobile-game market in Korea, faster-than previously Earnings-forecasts revisions expected monetisation initiatives toward paying consumers for digitalised content on its platform, and Our 1.7-7.7% upward EPS revisions for 2014-16E reflect more scalable business model with high numbers of loyal the strong monetisation we expect for mobile services on and active users. Daum Kakao’s platform, especially related to mobile- game services for mid-to-hard core gamers, earlier- and stronger-than-previously-expected revenue from Mobile game strategy payment and mobile-to-online/offline services, and greater-than-previously-expected service synergies from Basically, Daum is keen to diversify the Kakao Talk 2015 by capitalising on its high number of active users platform by working closely with third-party and traffic and powerful mobile ecosystem. developers and supporting business expansion in Korea and overseas. By sharing its vast number of users and strong distribution channels in the region, it plans to publish third-party games into the growing

- 30 - Pan-Asia Mobile Games Sector 24 October 2014

Valuation and investment risks

Daum shares are trading at PERs of 29.0x and 22.7x on our earnings forecasts for 2015 and 2016, respectively. Despite the strong performance of the share price after the merger announcement in May 2014, we expect the valuation rerating for Daum to continue on the back of the increasing power of the mobile ecosystem in Korea, Daum’s agile strategic moves to capitalise on mobile communications through advanced revenue models for ads, commerce, and entertainment content.

The key risk is sharper-than-expected operating cost rises for new services, marketing in overseas markets, and new staff. Another risk could be slower- and weaker-than- expected synergies in operation, service integration, and cost-saving initiatives.

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Information Technology / China 700 HK Information Technology / China 24 October 2014

Tencent Holdings

Tencent Holdings Target (HKD): 150.00  150.00 Upside: 30.0% 700 HK 21 Oct price (HKD): 115.40

Staying ahead of the game 1 Buy (unchanged) • Management is intentionally slowing the monetisation of mobile 2 Outperform games to focus on improving the user experience 3 Hold • We believe Tencent’s mobile-game revenue has just scratched 4 Underperform the surface in terms of its potential 5 Sell • Reiterate Buy (1) rating and HKD150 target price

How do we justify our view?

as mid-core games (eg, card ■ How we differ collecting or monster battle games), Unlike some brokers, we are more considering the popularity of such positive on the monetisation outlook games in key Asian markets like for WeChat over 2014-16.

Korea and Japan. Half of the mobile Forecast revisions (%) John Choi games launched domestically in Year to 31 Dec 14E 15E 16E (852) 2773 8730 2Q14 were mid-core games. This Revenue change - - - [email protected] was a clear departure from earlier Net profit change - - - Core EPS (FD) change - - - this year, when most of the new launches were for casual games. Source: Daiwa forecasts ■ What's new After launching its first mobile game Overall, we view the strategy change Share price performance in 3Q13, Tencent’s revenue from on mobile-game monetisation as (HKD) (%) mobile games reached CNY3bn in positive for the company longer- 135 150 2Q14, which represents just over 119 135 term, as it should enhance player 103 120 one-quarter of the company’s total experience and allow the company online games revenue. 86 105 to retain traffic for other 70 90 monetisation opportunities. Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Interestingly, management appears Tencent (LHS) Relative to HSI (RHS) to have deemed the growth to be too ■ What we recommend quick, as the company intends to We reiterate our 6-month target strike a balance between mobile- 12-month range 78.52-133.50 price of HKD150, based on an Market cap (USDbn) 138.67 game monetisation and user unchanged target PER of 34x 3m avg daily turnover (USDm) 311.34 experience starting from 2H14. The applied to our 2015E EPS, derived Shares outstanding (m) 9,320 Major shareholder Naspers Limited (33.8%) company is also looking at by applying around a 20% premium expanding its mobile-game genres. to its China Internet peers’ median Financial summary (CNY) trading 2015E PER. We reaffirm our ■ What's the impact Year to 31 Dec 14E 15E 16E Buy (1) rating. In our view, Tencent Revenue (m) 80,562 105,979 136,284 Our positive view on Tencent’s deserves a higher multiple due to its Operating profit (m) 31,955 39,205 52,147 mobile-game business has been strong leadership in mobile Net profit (m) 26,236 32,473 42,945 largely confirmed by the 2Q14 Core EPS (fully-diluted) 2.763 3.418 4.521 platforms. The key risk to our view EPS change (%) 66.5 23.7 32.2 results, when the company reported would be slower-than-expected a significant mobile-game top-line Daiwa vs Cons. EPS (%) 7.6 2.7 8.2 revenue growth from WeChat and PER (x) 33.0 26.6 20.1 contribution after only 1 year of online games. Dividend yield (%) 0.5 0.6 0.8 launching its first game on WeChat. DPS 0.422 0.523 0.691 Going forward, we believe Tencent PBR (x) 9.4 7.1 5.3 will shift its game launch mix EV/EBITDA (x) 21.2 16.5 12.0 ROE (%) 35.5 31.0 30.8 towards higher-ARPU genres such Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 70 Pan-Asia Mobile Games Sector 24 October 2014

1 Buy (unchanged) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  Tencent: annual revenue

We forecast continual strong revenue growth for (CNYbn) 120 70% Tencent out to 2016, driven by its mobile-game 58% 54% business, WeChat monetisation, and the increasing 100 60% 45% value proposition of advertising on Tencent’s social 50% 80 38% media platforms. This translates into a revenue CAGR of 33% 32% 40% 60 around 31% for 2014-16E. 106 30% 40 81 20% 60 20 44 10% 20 28 0 0% 2010 2011 2012 2013 2014E 2015E Total Revenue (LHS) YoY Revenue Growth (RHS)

Source: Company, Daiwa forecast

 Valuation  Tencent: 1-year forward PER bands We reiterate our Buy (1) rating and maintain our 6- (HKD) 140 month target price of HKD150, based on a target PER of 40.9x 34x applied to our 2015E EPS, derived by applying 120 36.5x around a 20% premium to its China Internet peers’ 100 32.1x median trading 2015E PER (on the Bloomberg 27.7x consensus forecasts). 80 23.2x In our view, Tencent deserves a higher multiple due to 60 its strong leadership position in mobile platforms. 40

20

Jul-12 Jul-13 Jul-14 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Jan-12 Jan-13 Jan-14

Source: Bloomberg

 Earnings revisions  Tencent: consensus 2014-15E EPS revisions The Bloomberg consensus 2014 and 2015 EPS forecasts (HKD) have been raised continually YTD, likely reflecting the 3.5 faster-than-expected revenue growth of Tencent’s mobile platform. Our 2014EPS forecast is around 8% 3.0 higher than the current consensus forecast, and we see 2.5 upside to the consensus forecast in the next few months, as we believe the consensus forecasts do not fully reflect 2.0 the potential of Tencent’s mobile games and advertising revenue potential. 1.5

Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Sep-10 Dec-10 Sep-11 Dec-11 Sep-12 Dec-12 Sep-13 Dec-13 Sep-14 2015 Consensus EPS forecast 2014 Consensus EPS forecast

Source: Bloomberg

- 33 - Pan-Asia Mobile Games Sector 24 October 2014

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Number of WeChat (Weixin) register n.a. n.a. 50 300 600 800 1,000 1,150 users (m) Monthly Active Users (MAU) of n.a. n.a. 0 0 355 500 650 800 WeChat/Weixin (m) WeChat implied revenues (CNYbn) 0.0 0.0 0.0 0.0 0.7 12.4 19.7 29.6 Online game revenue (CNYbn) 5.4 9.5 15.8 22.8 32.0 45.8 66.0 85.1 Community value-added services 4.1 6.0 7.2 9.1 13.0 20.2 25.6 32.6 revenue (CNYbn)

 Profit and loss (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Value-added services (VAS) 11,436 18,198 26,314 35,718 44,985 65,948 91,594 117,694 Online advertising 962 1,373 1,992 3,382 5,034 7,318 11,560 16,000 Other Revenue 41 75 190 4,793 10,418 7,297 2,825 2,590 Total Revenue 12,440 19,646 28,496 43,894 60,437 80,562 105,979 136,284 Other income 78 294 890 552 2,058 5,261 1,912 2,273 COGS (3,889) (6,320) (9,928) (18,207) (27,778) (32,055) (41,212) (51,846) SG&A (2,070) (3,004) (5,265) (8,139) (12,003) (16,458) (20,056) (25,024) Other op.expenses (538) (778) (1,939) (2,612) (3,590) (5,355) (7,419) (9,540) Operating profit 6,021 9,838 12,254 15,487 19,124 31,955 39,205 52,147 Net-interest inc./(exp.) 134 255 504 836 1,153 1,459 1,740 1,739 Assoc/forex/extraord./others (114) (180) (659) (1,272) (997) (1,582) (1,700) (2,000) Pre-tax profit 6,041 9,913 12,099 15,051 19,281 31,833 39,245 51,886 Tax (819) (1,798) (1,874) (2,266) (3,718) (5,571) (6,672) (8,821) Min. int./pref. div./others (66) (62) (22) (53) (61) (26) (100) (120) Net profit (reported) 5,156 8,054 10,203 12,732 15,502 26,236 32,473 42,945 Net profit (adjusted) 5,156 8,054 10,203 12,732 15,502 26,236 32,473 42,945 EPS (reported)(CNY) 0.572 0.886 1.122 1.393 1.692 2.816 3.484 4.608 EPS (adjusted)(CNY) 0.572 0.886 1.122 1.393 1.692 2.816 3.484 4.608 EPS (adjusted fully-diluted)(CNY) 0.558 0.866 1.098 1.367 1.660 2.763 3.418 4.521 DPS (CNY) 0.080 0.110 0.150 0.200 0.240 0.422 0.523 0.691 EBIT 6,021 9,838 12,254 15,487 19,124 31,955 39,205 52,147 EBITDA 6,558 10,616 14,192 18,099 22,714 37,310 46,624 61,687

 Cash flow (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 6,041 9,913 12,099 15,051 19,281 31,833 39,245 51,886 Depreciation and amortisation 538 778 1,939 2,612 3,590 4,515 5,654 6,949 Tax paid (456) (1,542) (1,836) (2,225) (3,118) (5,377) (6,439) (8,514) Change in working capital 2,106 3,501 15,194 21,601 27,492 2,805 1,868 1,338 Other operational CF items 170 (366) (14,038) (17,610) (22,871) (5,847) (9,955) (9,128) Cash flow from operations 8,398 12,285 13,358 19,429 24,374 27,929 30,372 42,532 Capex (821) (2,024) (4,060) (3,970) (4,788) (6,033) (7,239) (8,108) Net (acquisitions)/disposals 68 0 (6,875) (4,659) 8,059 (30,443) 0 0 Other investing CF items (4,272) (9,991) (3,632) (6,772) (21,112) 76 76 76 Cash flow from investing (5,025) (12,015) (14,566) (15,401) (17,841) (36,400) (7,164) (8,032) Change in debt 202 0 2,917 (7,041) 1,334 19,221 0 0 Net share issues/(repurchases) 91 (144) (887) 218 (1,017) 0 0 0 Dividends paid (555) (624) (895) (1,225) (1,536) (2,235) (3,937) (4,871) Other financing CF items (136) 4,880 3,238 5,662 2,927 4,154 0 0 Cash flow from financing (397) 4,112 4,373 (2,386) 1,708 21,141 (3,937) (4,871) Forex effect/others (1) (52) (172) (2) (103) 0 0 0 Change in cash 2,976 4,331 2,993 1,640 8,138 12,669 19,271 29,628 Free cash flow 7,578 10,261 9,298 15,460 19,586 21,896 23,133 34,423 Source: FactSet, Daiwa forecasts

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 Balance sheet (CNYm) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 11,354 22,134 26,328 27,189 39,851 47,897 66,697 95,797 Inventory 0 0 0 568 1,384 1,845 2,427 3,121 Accounts receivable 1,229 1,715 2,021 2,354 2,955 3,939 5,182 6,663 Other current assets 574 1,524 7,155 6,398 9,496 11,392 14,987 19,272 Total current assets 13,157 25,374 35,503 36,509 53,686 65,073 89,292 124,853 Fixed assets 2,517 3,293 5,885 7,899 10,734 12,749 15,513 17,924 Goodwill & intangibles 269 573 3,780 4,719 4,103 3,413 2,649 1,811 Other non-current assets 1,563 6,591 11,636 26,128 38,712 83,581 94,633 105,300 Total assets 17,506 35,830 56,804 75,256 107,235 164,816 202,087 249,888 Short-term debt 202 5,299 8,020 1,077 2,589 4,790 4,790 4,790 Accounts payable 697 1,380 2,244 4,212 6,680 8,297 10,579 13,309 Other current liabilities 3,664 6,343 10,919 15,376 23,998 28,527 33,532 38,601 Total current liabilities 4,563 13,022 21,183 20,665 33,267 41,614 48,901 56,700 Long-term debt 0 0 3,733 7,517 9,141 26,192 25,890 25,890 Other non-current liabilities 644 967 2,799 4,926 6,364 6,558 6,790 7,097 Total liabilities 5,207 13,989 27,716 33,108 48,772 74,364 81,582 89,687 Share capital 00000000 Reserves/R.E./others 12,178 21,757 28,464 41,297 57,945 89,904 119,860 159,434 Shareholders' equity 12,179 21,757 28,464 41,298 57,945 89,904 119,860 159,434 Minority interests 120 84 625 851 518 544 644 764 Total equity & liabilities 17,506 35,830 56,804 75,256 107,235 164,811 202,085 249,885 EV 837,304 830,916 830,463 826,419 808,600 789,820 770,818 741,838 Net debt/(cash) (11,151) (16,835) (14,574) (18,595) (28,121) (16,915) (36,017) (65,117) BVPS (CNY) 1.339 2.370 3.094 4.457 6.224 9.646 12.860 17.107

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 73.9 57.9 45.0 54.0 37.7 33.3 31.5 28.6 EBITDA (YoY) 81.9 61.9 33.7 27.5 25.5 64.3 22.1 32.3 Operating profit (YoY) 85.5 63.4 24.6 26.4 23.5 67.1 19.8 33.0 Net profit (YoY) 85.2 56.2 26.7 24.8 21.8 69.2 20.8 32.2 Core EPS (fully-diluted) (YoY) 84.3 55.1 26.9 24.5 21.5 66.5 20.8 32.2 Gross-profit margin 68.7 67.8 65.2 58.5 54.0 60.2 61.1 62.0 EBITDA margin 52.7 54.0 49.8 41.2 37.6 46.3 44.0 45.3 Operating-profit margin 48.4 50.1 43.0 35.3 31.6 39.7 37.0 38.3 Net profit margin 41.4 41.0 35.8 29.0 25.6 32.6 30.6 31.5 ROAE 53.7 47.5 40.6 36.5 31.2 35.5 31.0 30.8 ROAA 37.7 30.2 22.0 19.3 17.0 19.3 17.7 19.0 ROCE 61.4 49.6 36.0 33.8 31.6 33.4 28.8 30.5 ROIC 331.7 261.8 106.1 69.1 57.3 50.8 41.2 48.2 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 13.6 18.1 15.5 15.1 19.3 17.5 17.0 17.0 Accounts receivable (days) 32.5 27.4 23.9 18.2 16.0 15.6 15.7 15.9 Current ratio (x) 2.9 1.9 1.7 1.8 1.6 1.6 1.8 2.2 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 14.0 12.4 13.4 14.4 14.2 15.0 15.0 15.0 Free cash flow yield 0.9 1.2 1.1 1.8 2.3 2.6 2.7 4.1 Source: FactSet, Daiwa forecasts

 Company profile Tencent is the largest and most used Internet service portal in China. Over the past decade, the company has been able to maintain steady earnings growth under its user-oriented strategy. On 16 June 2004, it was listed on the main board of the Hong Kong Stock Exchange.

- 35 - Pan-Asia Mobile Games Sector 24 October 2014

This strategy also demonstrates the prudence of Tencent’s management and the team’s long-term approach to business development. We forecast total online game revenue for 2014 to grow by 43% YoY.

Strong mobile-game Mobile-game strategy revenue growth – only Tencent’s success in mobile games rests on its ability to distribute games efficiently in China, primarily through the tip of the iceberg its WeChat app (with 438m monthly active users [MAU]) in 2Q14), Mobile QQ (with 520m MAU in Despite being a leading global gaming 2Q14), and Tencent’s own app store. The Tencent App Store (Yingyongbao) commanded a 19.7% share of the company, we think Tencent’s mobile Android game distribution market in 2Q14, according game segment has merely scratched the to the China Gaming Industry Report, ranking behind surface in terms of potential. We believe Qihoo, with 29.9% market share, and Baidu (BIDU US, mobile games will remain the core USD222.35, Buy [1]) at 26.5%. revenue growth engine for the company, With three formidable game distribution channels, fuelled by its enormous social-networking management’s near-term strategy is to expand its user base and the company’s focus on portfolio of games and improve the user experience. In terms of this experience, Tencent is trying to further improving user experience. integrate its games with its social-networking platforms, which will ultimately improve user participation and customer stickiness. To accelerate the What’s next for this gaming expansion of its mobile game portfolio, the company giant? has started distributing licensed third-party games in conjunction with in-house game development. Among As the largest online-game and social-networking the 5 mobile games launched since the end of 2Q14, 3 company in China, Tencent has the highest and most are licensed from third parties. Two more licensed direct exposure to the country’s rapidly growing online- mobile games are in the pipeline right now. game industry. According to our estimates, the company’s mobile games segment makes up just over a  Tencent: mobile-game portfolio genre-mix as of Sept 2014 quarter of its total online-game revenue, which is still Board/others Action dominated by PC games. However, almost all of the 11.5% 15.4% incremental revenue in recent quarters has been driven Strategy by its mobile-game growth. According to management, 11.5% in 2Q14, the revenue from its mobile-game segment Card exceeded management’s own growth expectations, 15.4% reaching CNY3.0bn, up from CNY1.8bn in 1Q14. This comes after a tripling of revenue in 1Q14 from 4Q13. Simulation 15.4% Music With a robust backbone of integrated Internet services 7.7% Shooter Puzzle and an active user base, we believe Tencent’s mobile- 7.7% 15.4% game segment has the long-term potential to eventually eclipse that of its PC games segment. In the Source: Company, Daiwa near term, however, management has intentionally slowed the growth of its mobile-game segment to focus Tencent has also acquired stakes in a number of on the quality of growth to ensure that this growth is leading game developers such as Riot Games, CJ sustainable over the long term. This means Games and Epic Games, to secure a quality new game management will prioritise user engagement and supply. These investments bode well for Tencent’s portfolio expansion over monetisation, which we strategy to add more mid-to-hard core titles, which believe would be beneficial to the company as it aims to induce longer playing times and paying ratio. In 2Q14, secure the long-term growth of this segment. the company added 8 new titles to its platform, half of which were mid-core games, bringing the total number of mobile games to 21. - 36 - Pan-Asia Mobile Games Sector 24 October 2014

All of Tencent’s mobile games are currently free-to-play  Tencent: screenshot shows in-game purchasable items with an item-based paying business model. The freemium model has been working well and we believe it will not be changed in the foreseeable future.

 Tencent: screenshot of selective mobile RPG games

Source: Daiwa *“Fight the Landlord” (“欢乐斗地主”) |card|in-house game   Tencent: screenshot shows in-game payment options

Source: Daiwa * “Crash West” (“横扫西游 ”) | Fighting RPG | Licensed Game

 Tencent: screenshot of selective mobile shooter games

Source: Daiwa *“Fight the Landlord” (“欢乐斗地主”) | card|in-house game *Android users can choose to pay through either Tenpay or the mobile operator, but Tencent now encourages users to use Tenpay by giving them a discount on the price of the item to do so

Source: Daiwa *Left: “We Fly” (“全民飞机大战 ”) | shooter |in-house game *Right: “Thunder Fighter” (“雷霆战机”) |shooter|licensed game   Tencent: screenshot of selective card games

Source: Daiwa *“Fight the Landlord” (“欢乐斗地主”) | Card | In-house Game

- 37 - Pan-Asia Mobile Games Sector 24 October 2014

Business outlook Valuation and investment risk

Going forward, we believe Tencent will continue to We reiterate our 6-month target price of HKD150, introduce more licensed games and enhance social based on a target PER of 34x applied to our 2015E EPS, networking features within these games, enabling it to derived by applying around a 20% premium to its strike a balance between monetisation and user China Internet peers’ median trading 2015E PER. experience. We expect Tencent’s online-game revenue to grow by 43% and 44% for 2014 and 2015, We reiterate our Buy (1) rating. In our view, Tencent respectively. deserves to trade at a high multiple due to its strong leadership position in the mobile platform. Aside from the strong revenue growth that we see for its mobile-game business, we expect Tencent’s ad Risks to our investment case revenue to also increase rapidly. We believe Tencent’s • huge user base and mobile social networking know- The main risk to our view would be the slower-than- how make it an appealing marketing partner for expected monetisation of WeChat. advertisers. • A sharp decline in revenue from the company’s core games, such as League of Legends and Blade & Soul. In 2Q14, Tencent’s advertising revenue jumped 75% • QoQ, on the back of increased video platform traffic, An inability to add new, popular games to its mobile the FIFA World Cup 2014 and performance-based platform or a sudden drop in ARPU. advertising on mobile apps. The recent introduction of • Higher-than-expected marketing costs associated mobile ads on WeChat demonstrates the company’s with the promotion of WeChat in emerging markets. latest attempt to explore ways to monetise its mobile traffic.

We maintain our 2014-16 revenue forecasts of CNY80.6bn, CNY106.0bn and CNY136.3bn, respectively, which are at the high-end of the Bloomberg consensus, probably because we are more positive on WeChat’s monetisation potential.

- 38 - Pan-Asia Mobile Games Sector 24 October 2014

- 39 -

Industrials / Korea 034020 KS Other products/ Japan Publication date

Doosan Heavy Industries and Construction

Square Enix Holdings Target price: JPY2,600 Upside (%): 25.0

9684 JP 21 October price: JPY2,080

Home-use game sales brisk, 1 Buy mobile game sales surging 2 Outperform (unchanged) 3 Hold • Console sales could beat previous estimates, given the fast uptake of 4 new consoles and the company’s strong pipeline of new titles Underperform • The company is making encouraging progress in mobile games, while 5 Sell the rise of mid-to-hardcore RPGs in Asia plays to its strengths • We reiterate our Outperform (2) rating and SOTP-based target price of JPY2,600

collaboration with Cygames, continues to do well. We believe the release of other internally developed Share price performance (Y) Relative to TOPIX titles that draw on the firm’s rich 3,200 150 catalogue of intellectual properties 2,600 120 Satoshi Tanaka could boost sales and improve its (81) 3 5555 7049 sales mix. 2,000 90 [email protected] 1,400 60

Square Enix Holdings also holds 800 30 several advantages supporting its 10/11 6/12 1/13 8/13 3/14 10/14  What we recommend expansion into Asia, in our view. The We reaffirm our Outperform (2) firm tends to produce RPGs with Market data (consol) rating and three- to six-month target relatively few action gameplay Share price (JPY; 21/10/14) 2,080 price of JPY2,600. The shares have 12-month range (JPY) 1,416-3,050 elements, such as and Market cap (JPYm; 21 Oct) 239,792 potential upside of 25.0%, in our view. , making them very Shares outstanding (000; 10/14) 115,284 compatible with mobile Foreign ownership (%; 3/14) 24.9 As sales of home game consoles Shares outstanding: Common shares outstanding (excl. applications. Another positive for treasury stock) released by Sony and Microsoft late the firm, in our view, is the emerging Market cap: Based on shares outstanding and closing price last year have meaningfully popularity of the mid-to-hardcore as of indicated date outpaced those of their RPG genre in China, South Korea, Investment indicators (consol) predecessors, we believe there is a and other Asian countries. Indeed, 3/14 3/15 E 3/16 E good possibility that sales of game Square Enix’s Kaku-San-Sei Million P/E (X) 36.3 21.4 15.7 software for these consoles will EV/EBITDA (X) 9.7 7.2 5.7 Arthur (Diffusible Million Arthur) is P/B (X) 1.90 - - overshoot previous estimates. In a rare Japanese third-party title Dividend yield (%) 1.44 1.44 1.92 particular, strong sales seem likely successful in China and South ROE (%) 5.4 - - for some of the big titles in the firm’s EV: Market cap + interest-bearing debt – liquidity on hand Korea, and its Cross Gate has EBITDA: Operating profit + depreciation pipeline for future release, including become a hit in China, with recent EV/EBITDA (prospective): Based on recently disclosed Final Fantasy XV, Rise of the Tomb gross monthly sales apparently figures for interest-bearing debt and liquidity on hand ROE: Net income / average of start-FY and end-FY Raider, and Dragon Quest Heroes, approaching the JPY1bn mark there. shareholders’ equity (for SEC-reporting firms figures based due out in FY15, as well as Kingdom on those attributable to shareholders of parent) Estimates by Daiwa. Hearts III and Dragon Quest XI, due  Valuation out in FY16. We arrive at a three- to six-month Income summary (consol) target price of JPY2,600. We use a (JPYm) 3/14 3/15 E 3/16 E In the mobile game field, School Girl sum-of-the-parts approach based on Sales 155,023 152,500 174,500 Strikers, a new title based on an Op profit 10,543 17,600 23,900 our FY15 forecasts, due to the Rec profit 12,534 17,700 24,000 original intellectual property, is off expected release of several big-name Net income 6,598 11,200 15,300 to a strong start, and Dragon Quest titles in that fiscal year. EPS (Y) 57.3 97.2 132.7 Monsters Super Light, developed in DPS (Y) 30.00 30.00 40.00 Source: Estimates by Daiwa

See important disclosures, including any required research certifications, beginning on page 70 Pan-Asia Mobile Games Sector 24 October 2014

 Consolidated income statement (JPYm) FY09 10 11 12 13 14 E 15 E Consolidated sales 192,257 125,271 127,896 147,981 155,023 152,500 174,500 By segment Digital entertainment 120,119 64,204 71,871 89,482 94,564 92,000 113,000 Amusement 52,299 45,012 41,921 44,276 46,952 48,000 48,000 Publication 14,367 13,045 11,335 11,086 10,030 9,000 10,000 Merchandising 5,470 3,009 2,767 3,137 3,475 3,500 3,500 Gross profit 83,721 49,424 51,627 49,192 60,542 77,100 87,700 Operating profit 28,235 7,325 10,713 -6,081 10,543 17,600 23,900 By segment Digital entertainment 29,056 11,283 12,602 44 10,709 17,600 23,800 Amusement 3,986 2,178 2,552 -353 4,517 5,000 5,000 Publication 4,120 3,204 2,575 2,484 2,293 2,000 2,100 Merchandising 1,827 680 742 667 1,115 1,000 1,000 Eliminations/unallocated -10,755 -10,021 -7,759 -8,924 -8,091 -8,000 -8,000 Recurring profit 27,822 5,390 10,297 -4,378 12,534 17,700 24,000 Net income 9,509 -12,043 6,060 -13,714 6,598 11,200 15,300 Source: Company materials; compiled by Daiwa. Note: Segment sales excl. intercompany transactions. E: Daiwa estimates.

 Consolidated balance sheet (JPYm) FY09 10 11 12 13 Current assets 213,347 164,301 172,161 159,035 173,604 Cash and cash equivalents 111,211 111,126 111,495 100,418 115,367 Notes and accounts receivable 30,682 15,474 18,431 30,226 22,110 Securities 35,000 - - - - Inventories 19,785 23,596 28,701 18,585 23,702 Fixed assets 57,182 42,034 41,819 43,473 43,012 Tangible fixed assets 18,850 17,328 17,183 20,169 19,917 Intangible fixed assets 21,623 10,324 10,121 10,940 10,835 Investments 16,707 14,382 14,514 12,363 12,259 Total assets 270,529 206,336 213,981 202,509 216,617

Current liabilities 75,257 28,504 33,778 37,414 80,508 Notes and accounts payable 10,666 7,777 9,220 8,653 11,563 Short-term borrowings 2,808 1,338 5,253 5,726 6,852 Bonds due within one year 37,000 - - - 35,000 Long-term liabilities 41,013 42,687 42,906 43,457 8,432 Bonds 35,000 35,000 35,000 35,000 - Long-term borrowings -- - -- Total liabilities 116,271 71,192 76,684 80,872 88,940 Net assets 154,258 135,143 137,297 121,636 127,676 Shareholders’ equity 157,641 141,501 144,108 126,940 130,404 Accumulated other comprehensive income -4,960 -7,943 -8,572 -6,853 -4,094 Noncontrolling interests 861 771 783 897 1,018 Total liabilities and net assets 270,529 206,336 213,981 202,509 216,617 Source: Company materials; compiled by Daiwa.

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 Consolidated cash flow statement (JPYm) FY09 10 11 12 13 Income/loss before income taxes and noncontrolling interest 10,026 -9,970 9,866 -14,948 10,137 Depreciation 7,962 6,608 5,039 7,301 6,614 Amortisation of goodwill 13,906 1,492 - - - Impairment losses 255 8,853 130 939 158 Increase/decrease in allowances for doubtful accounts -190 -394 -1 -38 182 Interest and dividend income -531 -131 -141 -110 -123 Forex gains/losses 990 2,206 399 -780 -1,263 Decrease/increase in trade receivables -14,157 13,800 -3,008 -9,903 10,779 Decrease/increase in inventories 9,019 -4,827 -5,137 10,933 -2,601 Increase/decrease in trade payables -890 -2,007 1,102 -927 317 Other 3,133 2,297 -201 6,124 -2,537 Subtotal 29,523 17,927 8,048 -1,409 21,663 Interest and dividends received 163 198 108 691 154 Interest paid -31 -54 -39 -109 -102 Income taxes paid -5,269 -1,994 -1,842 -3,617 -1,502 Income tax refunds - 1,226 961 4,555 2,200 Cash flow from operating activities 20,838 14,827 6,786 110 21,698 Increase in time deposits -2,618 -1,062 -748 -2,366 -2,971 Withdrawals from time deposits 1,229 1,052 747 2,353 2,922 Payments for acquisition of tangible assets -6,076 -4,700 -4,620 -10,626 -4,823 Payments on acquisition of intangible fixed assets -387 -931 -842 -1,392 -566 Payment of guarantee deposits -372 -143 -1,492 -152 -354 Returned guarantee deposits 1,074 1,482 1,084 2,928 643 Other -46,624 34,709 93 66 -813 Cash flow from investing activities -53,774 30,407 -5,778 -9,189 -5,962 Increase (decrease) in short-term borrowings 15 -1,325 3,791 - - Proceeds from issuance of bonds 35,000 - - - - Redemption of bonds - -37,000 - - - Proceeds from issuance of stock 139 - - - 47 Dividends paid -3,442 -4,026 -3,446 -3,444 -3,446 Other -5 -3 -46 -37 -39 Cash flows from financing activities 31,707 -42,354 299 -3,481 -3,438 Effect of exchange rate changes on cash and cash equivalents -499 -2,744 -879 1,267 2,386 Net increase (decrease) in cash and cash equivalents -1,728 135 428 -11,293 14,684 Cash and cash equivalents at beginning of year 111,875 109,717 109,751 110,116 98,822 Increase from inclusion of subsidiaries in consolidation 65 ---- Decrease from exclusion of subsidiaries from consolidation -495 -101 -64 - - Cash and cash equivalents at end of year 109,717 109,751 110,116 98,822 113,507 Source: Company materials; compiled by Daiwa

 Company profile Square Enix Holdings develops and sells entertainment software for home video game consoles, including the Dragon Quest and Final Fantasy series. It also publishes books such as informational guides for its game software, and comic magazines. Additionally, Square Enix sells character goods and stationery items related to its software products.

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- 43 -

Information Technology / Japan 3659 JP Information Technology / Japan 24 October 2014

Nexon

Nexon Target (JPY): 1,150  1,100 Upside: 27.2% 3659 JP 21 Oct price (JPY): 865

Gearing up for mobile game migration 1 Buy (unchanged) 2 Outperform • Nexon is now focusing on global publishing of blockbuster 3 Hold mobile games 4 Underperform • Earnings forecasts for 2014-16 lowered due to slower-than- 5 Sell expected improvement in revenue mix and profitability • Target priced lowered to JPY1,100; reaffirm Buy rating

How do we justify our view?

diversified the mobile app stores at ■ How we differ which the game is available. We are more positive than the market on the 2014-16E earnings Online: struggling to sustain contribution from Korea.

current profitability. Meanwhile, Forecast revisions (%) Thomas Y. Kwon FIFA Online 3 (FIFA 3) continues to Year to 31 Dec 14E 15E 16E (82) 2 787 9181 maintain a relatively high number of Revenue change (0.9) (2.2) (2.4) [email protected] concurrent users and active players Net profit change (4.2) (4.8) (5.4) Core EPS (FD) change (4.2) (4.8) (5.4) in Korea. With FIFA 3M, its mobile version, Nexon is on track to Source: Daiwa forecasts ■ What's new generate solid mobile-game sales in At the recent Daiwa TMT 2H14. However, we expect the Share price performance Conference 2014, Nexon’s company’s profitability to improve (JPY) (%) management presented its growth only gradually due to higher 1,250 100 strategy for both online and mobile 1,125 91 operating costs for third-party 1,000 83 game services. While the developers, and higher marketing information imparted suggests that 875 74 costs. 750 65 Nexon’s profitability will improve Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 only gradually, we expect the stock Nexon (LHS) As such, we are cutting our EPS for Relative to TOPIX Index (RHS) to be rerated once its new mobile 2014-16E by 4-5% to reflect a and online sequel games penetrate slower- and weaker-than-expected overseas markets. 12-month range 782-1,216 improvement in the revenue mix Market cap (USDbn) 3.56 and operating-profit margin. 3m avg daily turnover (USDm) 7.93 ■ What's the impact Shares outstanding (m) 439 Major shareholder NXC (45.2%) Mobile: upbeat due to positive ■ What we recommend feedback on Legion of Heroes. We reaffirm our Buy (1) rating and Financial summary (JPY) At the conference, Nexon lower our 6-month target price to emphasised that sales of Legion of Year to 31 Dec 14E 15E 16E JPY1,100 (from JPY1,150), based on Revenue (bn) 169 195 203 Heroes, its mobile 3D strategy role- an unchanged PER of 13x (the Operating profit (bn) 56 66 66 playing game (RPG), have current average of its regional peers) Net profit (bn) 37 44 44 accelerated in the Korea market Core EPS (fully-diluted) 85 99 101 on our revised 2014E EPS. EPS change (%) 22.4 17.0 1.9 since its launch in 1Q14, and The key risks are a fall in revenue management expects the game to be Daiwa vs Cons. EPS (%) 3.5 13.5 11.4 from flagship games in Korea and PER (x) 10.2 8.7 8.6 just as successful when it is launched China, and a sharper-than-expected Dividend yield (%) 1.2 1.2 1.2 in other Asian markets over the next rise in operating costs for marketing DPS 10 10 10 PBR (x) 1.1 1.0 0.9 12 months. The company expects and game-development staff. revenue from Legion of Heroes to EV/EBITDA (x) 2.0 1.2 0.8 ROE (%) 11.7 12.5 11.5 accelerate in Korea, after having Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 70 Pan-Asia Mobile Games Sector 24 October 2014

1 Buy (unchanged) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  Nexon: revenue mix and operating-profit margin We forecast Nexon’s revenue to rise by 8.9% YoY to (JPYbn) JPY169bn for 2014 and by 15.4% YoY to JPY195bn for 50 50% 2015. The operating-profit margin looks likely to 40 40% improve only gradually due to ongoing launches of new mobile games, and the sequel versions of its franchise 30 30% games. We look for Nexon’s revenue mix to shift from 20 20%

77% for online in 2014 to 72% in 2015, and from 23% for 10 10% mobile in 2014 to 28% in 2015. 0 0% 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14E 4Q14E Korea (LHS) China (LHS) North America (LHS) Others (LHS) Japan (LHS) Operating-profit margin (RHS) Source: Company, Daiwa forecasts

 Valuation  Nexon: share price and PER band Nexon shares are trading currently at a 2014E PER of (JPY) 10.2x and at a 2015E PER of 8.7x, at the low end of the 2,300 2,050 stock’s PER range for 2011-13 of 8-25x. We believe 1,800 Nexon shares could be rerated once the company’s new 1,550 mobile games and online sequel games penetrate 1,300 1,050 overseas markets successfully, and start to see strong 800 operating leverage. 550 300 50 (200) Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Adj. Prc. 6.8X 10.7X 14.7X 18.7X 22.6X Source: Daiwa, Data Guide

 Earnings revisions  Nexon: Daiwa EPS forecasts vs. the consensus estimates The consensus forecasts have been revised down year- (JPY) to-date, due we believe to management’s conservative 170 guidance for quarterly earnings and the slower-than- 150 expected turnaround in gamer traffic and game sales for 130 its core online games in Korea and China. However, we 110 expect upward revisions to the consensus forecasts once the company’s new mobile games start to see strong 90 operating leverage, and particularly if they become 70 global hits. 50 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14

2014E consensus 2015E consensus 2014E Daiwa 2015E Daiwa Source: Daiwa, Bloomberg

- 45 - Pan-Asia Mobile Games Sector 24 October 2014

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Ex-Japan revenue portion (%) 76.6 82.6 85.1 82.3 76.6 81.7 80.5 79.2 Revenue contribution from Nexon 40.0 50.0 64.0 68.3 68.2 85.0 78.6 76.5 Korea (%) Nexon Korea's royalty revenue 45.1 51.8 59.4 66.9 69.1 65.9 63.3 62.5 portion (%)

 Profit and loss (JPYbn) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Korean customers Revenues 17 25 29 29 43 61 77 80 Chinese customers Revenues 14 22 33 48 64 64 67 67 Other Revenue 20 24 26 31 48 44 51 56 Total Revenue 52 70 88 108 155 169 195 203 Other income 00002123 COGS (10) (12) (15) (19) (34) (40) (46) (48) SG&A (22) (28) (34) (39) (60) (71) (83) (90) Other op.expenses 0 0 0 0 (13) (3) (3) (3) Operating profit 20 30 38 51 51 56 66 66 Net-interest inc./(exp.) (0)(0)011223 Assoc/forex/extraord./others 4 (1) (3) (8) (3) (4) (4) (4) Pre-tax profit 24 29 35 44 49 54 63 65 Tax (6) (8) (10) (15) (18) (15) (18) (18) Min. int./pref. div./others (0) 0 0 0 0 (2) (2) (2) Net profit (reported) 18 22 26 28 30 37 44 44 Net profit (adjusted) 18 22 26 28 30 37 44 44 EPS (reported)(JPY) 5,004 6,132 60 66 69 85 99 101 EPS (adjusted)(JPY) 5,004 6,132 60 66 69 85 99 101 EPS (adjusted fully-diluted)(JPY) 5,004 6,132 60 66 69 85 99 101 DPS (JPY) 0 300 0 5 10 10 10 10 EBIT 20 30 38 51 51 56 66 66 EBITDA 28 41 50 64 70 82 88 90

 Cash flow (JPYbn) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 2429354449546365 Depreciation and amortisation 8 11 12 14 19 26 22 25 Tax paid (5) (10) (14) (16) (21) (27) (28) (28) Change in working capital (5) 1 (1) (3) (1) (23) 22 (0) Other operational CF items (4) 2 8 4 14 (4) (0) (0) Cash flow from operations1934404360268061 Capex (2) (2) (14) (4) (12) (13) (16) (20) Net (acquisitions)/disposals (5) (28) (2) (74) (39) 16 (12) (13) Other investing CF items 0 1 (13) (36) 45 2 0 0 Cash flow from investing (6) (29) (29) (114) (6) 6 (28) (33) Change in debt (7) 3 (2) 37 (2) (3) 1 1 Net share issues/(repurchases) 0 0 87 0 0 (10) 0 0 Dividends paid 0 0 (1) 0 (2) (4) (4) (4) Other financing CF items 0 (0) (1) (6) (9) 0 0 0 Cash flow from financing (7) 3 83 31 (13) (17) (4) (4) Forex effect/others 1 (4) (1) 7 13 0 0 0 Change in cash 7 4 93 (33) 54 15 48 24 Free cash flow 17 32 26 39 49 13 64 41 Source: FactSet, Daiwa forecasts

- 46 - Pan-Asia Mobile Games Sector 24 October 2014

 Balance sheet (JPYbn) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 31 33 132 126 182 194 243 267 Inventory 00000000 Accounts receivable 9 11 14 22 22 44 28 29 Other current assets 2 3 4 8 13 14 16 17 Total current assets 42 47 151 155 218 252 287 314 Fixed assets 4 7 16 11 21 20 20 20 Goodwill & intangibles 40 56 44 77 72 58 52 48 Other non-current assets 9 13 25 77 108 95 107 119 Total assets 95 124 236 320 419 426 466 501 Short-term debt 0 4 3 12 13 15 15 15 Accounts payable 1 1 1 7 10 8 13 14 Other current liabilities 14 18 21 26 27 26 29 30 Total current liabilities 15 22 25 44 50 48 57 59 Long-term debt 18 20 19 44 37 33 33 33 Other non-current liabilities 16 15 15 10 18 10 (0) (10) Total liabilities 49 57 58 98 106 91 90 82 Share capital 4 4505152515151 Reserves/R.E./others 42 59 124 167 257 277 317 357 Shareholders' equity 46 63 174 219 308 329 368 408 Minority interests 043456810 Total equity & liabilities 95 124 236 320 419 426 466 501 EV 367 373 255 255 184 163 108 77 Net debt/(cash) (13) (9) (111) (70) (132) (147) (195) (219) BVPS (JPY) 13,003 17,819 409 502 702 769 861 955

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 28.2 35.3 25.6 23.8 43.2 8.9 15.2 4.4 EBITDA (YoY) 87.1 44.4 22.7 28.3 8.8 17.0 7.4 2.9 Operating profit (YoY) 101.5 49.9 26.7 32.7 (0.2) 11.1 16.5 0.1 Net profit (YoY) 113.0 22.5 19.0 9.9 7.1 23.0 17.0 1.9 Core EPS (fully-diluted) (YoY) 113.0 22.5 (1.4) 8.7 5.5 22.4 17.0 1.9 Gross-profit margin 81.5 82.9 82.9 82.8 78.0 76.6 76.6 76.6 EBITDA margin 54.8 58.5 57.2 59.3 45.0 48.4 45.1 44.5 Operating-profit margin 39.0 43.3 43.7 46.8 32.6 33.3 33.7 32.3 Net profit margin 34.2 31.0 29.4 26.1 19.5 22.0 22.4 21.9 ROAE 48.4 39.8 21.7 14.4 11.5 11.7 12.5 11.5 ROAA 20.7 19.8 14.3 10.2 8.2 8.8 9.8 9.2 ROCE 34.6 39.0 26.4 21.3 15.8 15.1 16.3 14.7 ROIC 45.3 48.5 44.3 30.0 18.9 22.0 25.6 24.8 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 26.0 27.1 28.0 35.1 37.7 28.1 28.1 28.1 Accounts receivable (days) 47.4 52.7 51.3 60.0 52.0 71.3 67.3 51.7 Current ratio (x) 2.9 2.1 6.1 3.5 4.3 5.2 5.0 5.3 Net interest cover (x) 64.3 117.0 n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 0.0 4.9 0.0 7.6 14.4 11.8 10.1 9.9 Free cash flow yield 4.5 8.3 6.8 10.2 12.8 3.4 16.8 10.7 Source: FactSet, Daiwa forecasts

 Company profile Nexon is a leading online-game developer and publisher domiciled in Korea. The company publishes a range of casual games that are unique to the online games industry and uses the free-to-play revenue model, and offers over 60 games in over 100 countries. It had 52m monthly active users as at the end of 2Q14. Nexon was listed on the Tokyo Stock Exchange on 14 December 2011.

- 47 - Pan-Asia Mobile Games Sector 24 October 2014

Nexon guides for its revenue from mobile games to rise by 19-30% YoY for 3Q14 (from 16% YoY in 2Q14) and accelerate a shift in the revenue mix to the mobile platform, which we believe will lead to a new business- growth cycle over 2015-16.

Gearing up for mobile- Although it is still struggling to improve profitability due to rising operating costs, Nexon could boost its game migration earnings from mobile by capitalising on its vast user base and paid gamers, free-to-play expertise, and Nexon is accelerating mobile-game global distribution channels for online. publishing globally to capture the huge market opportunity emerging from smart Business outlook devices and young gamers. For 3Q14, management guides for a relatively low level of revenue of JPY40-43bn (up just 0-7% YoY) and a Investment summary low-level operating-profit margin of 27-30%, based on its expectation for weak game sales in Japan and other We reaffirm our Buy (1) rating on Nexon and lower our markets, as well as rising operating costs related to 6-month target price to JPY1,100 (from JPY1,150), based marketing. However, we expect large-scale content on an unchanged 2014E PER of 13x (the current average updates and aggressive promotional marketing to of its regional peers), on our revised 2014 EPS forecast. reignite revenue-growth momentum for Nexon’s core casual games in Korea and China toward 4Q14. In our view, Nexon is heading in the right direction to catch the big mobile game wave on the global We forecast the company’s revenue derived from Korea smartphone boom. By launching a hit mobile game to rise by 35% YoY for 3Q14 on increasing mobile-game globally (ie, Legion of Heroes), Nexon should be able to sales of Legion of Heroes and FIFA 3M, and a improve its profitability, and partially offset the slowdown in the YoY revenue decline in China. Overall, slowdown in lucrative royalties from overseas. we forecast revenue of JPY42.7bn (up 7.1% YoY) for 3Q14, with a weaker-than-expected operating-profit margin of 32%. Mobile game strategy On a yearly basis, as a result of the intensifying We had the opportunity to hear management’s views competition despite Nexon’s effective monetisation on the company’s growth strategy for online and strategy, we now forecast its revenue from mobile mobile games at the Daiwa TMT Conference 2014 held games to rise by 37% YoY for 2014 (previously 42% on 23-26 September in the US and Canada. Nexon has YoY growth) and 41% YoY for 2015 (from 45% YoY). continued to invest in mobile-game development studios in the US and other Western countries since 2013 after it changed its strategic focus to game-IP Earnings-forecast revisions acquisitions from aggressive M&A initiatives. We cut our EPS for 2014-16E by 4.2-5.4%, as we now Management explained that the company is keen to see Nexon’s revenue mix and profitability improving build its business in Western markets, publish high- more slowly and less robustly than we had expected quality mobile games in the Asia market developed by previously. In our view, Nexon needs to increase its talented Western developers, and enhance its mobile- revenue contribution from online sequel games (Maple game pipeline and revenue streams. Story 2 and Sudden Attack 2) in order to improve its cost structure for game publishing and its operating- In 2H14 and 2015, the company has high expectations profit margin. for the mobile game Durango (in-house development), as well as new mobile games from Shilver Entertainment and SecretNewCo in the US. It believes new game titles should feature high-quality content differentiating them from existing games, in terms of graphics, storylines, and importantly, battle plays.

- 48 - Pan-Asia Mobile Games Sector 24 October 2014

Valuation and investment risks

Nexon shares are trading at PERs of 10.2x for 2014E and 8.7x for 2015E, below its PER range of 8-25x over 2011-13. We look for the shares to be rerated once the company’s new mobile games and online sequel games penetrate overseas markets successfully, and start to benefit from strong operating leverage.

The key risks to our view are a fall in revenue from flagship games due to intensified competition, and a sharper-than-expected rise in operating costs for third party developers.

- 49 -

Information Technology / Korea 035420 KS Information Technology / Korea 24 October 2014

Naver

Naver Target (KRW): 925,000  900,000 Upside: 13.1% 035420 KS 21 Oct price (KRW): 796,000

Facing dilemma in evolving as an integrated platform for gamers 1 Buy 2 Outperform (from Buy) • We are still positive on the business outlook for LINE as a 3 Hold leading global mobile social platform … 4 Underperform • … but we expect it to face challenges in evolving as an integrated 5 Sell mobile platform for all types of game players • Lowering target price to KRW900,000 and downgrading rating to Outperform (2)

How do we justify our view?

User traffic migration to mobile ■ How we differ and online-ads sales outlook. In We are more positive vs. the market addition to soft ad dollars in Korea, on LINE’s ecosystem, content, target we are seeing a strong rise in mobile markets and high-ARPU Japan users.

traffic on the back of the Forecast revisions (%) Thomas Y. Kwon smartphone boom. We believe Year to 31 Dec 14E 15E 16E (82) 2 787 9181 Naver’s online-ad sales will show Revenue change (1.8) (1.8) (2.0) [email protected] modest growth until the company Net profit change (6.3) (2.4) (3.5) Core EPS (FD) change (6.3) (2.4) (3.5) finds some powerful mobile-ad products, rather than the typical Source: Daiwa forecasts ■ What's new search and display ad formats. As We believe Naver’s mobile- such, we forecast its 3Q14 online-ads Share price performance messaging platform LINE is likely to sales (paid search and display ads) (KRW) (%) face challenges in attracting and to rise by just 2% QoQ to 900,000 135 monetising mid-to-hard core gamers 812,500 123 KRW475bn. 725,000 110 on its platform, given it has a more casual gamer base, a relatively weak 637,500 98 Lowering forecasts for LINE 550,000 85 value chain of third-party game sales. We reduce our 2014- Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 developers, and rising competition 16E EPS for Naver by 2-6%, as among Naver (LHS) Relative to KOSPI (RHS) with apps stores. other considerations we lower our revenue forecasts for LINE game ■ What's the impact 12-month range 560,000-853,000 services by 1-10% for our expected Market cap (USDbn) 24.88 Platform strategy for mobile slowdown in gamer monetisation of 3m avg daily turnover (USDm) 99.68 games on LINE. Recently, LINE casual games, and rising competition Shares outstanding (m) 33 Major shareholder Lee, Hae Jin and others (9.0%) announced plans to diversify its from open apps stores in the region. mobile game offerings via a series of Financial summary (KRW) strategic partnerships with talented ■ What we recommend game developers in Japan. Given Year to 31 Dec 14E 15E 16E We downgrade Naver to Outperform Revenue (bn) 2,950 3,715 4,358 LINE’s large casual gamer base, we (2), from Buy (1), and lower our 6- Operating profit (bn) 914 1,291 1,582 believe it will need more time and month target price to KRW900,000 Net profit (bn) 574 969 1,180 have to exert more effort to attract Core EPS (fully-diluted) 17,407 29,397 35,791 (from KRW925,000), based on an EPS change (%) 117.5 68.9 21.8 premium mobile gamers who typically unchanged target PER of 38x applied generate high ARPU, strong loyalty, Daiwa vs Cons. EPS (%) 13.1 15.2 5.4 to the average of our revised 2014-15E PER (x) 45.7 27.1 22.2 and longer paying cycles. LINE needs EPS, to reflect the strong earnings Dividend yield (%) 0.1 0.1 0.1 to find the optimal mix of game turnaround we expect for LINE in DPS 800 950 1,000 PBR (x) 12.9 9.3 6.9 offerings for both premium and casual 2015. The main risk to our call is gamers to avoid over-monetisation EV/EBITDA (x) 24.2 17.0 13.4 slower-than-expected monetisation of ROE (%) 32.7 39.9 35.5 risks, in our view. LINE outside Japan. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 70 Pan-Asia Mobile Games Sector 24 October 2014

1 Buy How do we justify our view? 2 Outperform (from Buy)

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  LINE: subscriber trend and revenue-growth We look for Naver’s online-ads sales to show modest (KRWbn) (bn) growth until the company finds more powerful mobile 1,000 700 600 ad products than its competitors like Daum 800 Communications, rather than relying on typical 500 search and display ad formats. Nonetheless, we 600 400 forecast revenue from the LINE platform to expand 400 300 by a robust 89% YoY to KRW0.86tn and account for 200 200 29% of Naver’s total revenue for 2014. 100 0 0 3Q13 4Q13 1Q14 2Q14 3Q14E 4Q14E Search ads (LHS) Display ads (LHS) LINE and others (LHS) Subscribers (RHS) Source: Company, Daiwa forecasts

 Valuation  Naver: share-price performance and PER bands Based on our revised EPS forecasts, Naver shares are (KRW) 1,200,000 trading currently at a PER of 46x for 2014E and 27x 1,100,000 for 2015E, lower than its past-2-year average PER of 1,000,000 900,000 47x. We believe the stock’s valuation premium is 800,000 justified, given the company’s strong market position 700,000 600,000 in mobile-instant messaging (MIM) services in Asia, 500,000 and its success in monetising its user base through 400,000 300,000 games, ads, and digital item commerce. 200,000 100,000 Jan-08 Nov-08 Sep-09 Jul-10 May-11 Mar-12 Jan-13 Nov-13 Sep-14 Adj. Prc. 18.7X 35.3X 51.9X 68.5X 85.2X Source: Dataguide, Daiwa

 Earnings revisions  Naver: Daiwa vs. consensus EPS forecasts for 2014-15E We would expect the Bloomberg consensus EPS (KRW) forecasts for Naver to be revised up once LINE starts 40,000 to monetise more its substantial mobile traffic 36,000 through mobile ads and other value-added mobile 32,000 services in Japan, as well as outside Japan. We expect 28,000 fast and steady progress in user monetisation for non- 24,000 game services, especially for the target markets where 20,000 existing competitors have strong positions. 16,000 12,000 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 2014E consensus 2015E consensus 2014E Daiwa 2015E Daiwa Source: Bloomberg, Daiwa

- 51 - Pan-Asia Mobile Games Sector 24 October 2014

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Market share of Search queries (%) 68.0 64.0 71.0 73.0 74.0 74.0 74.0 75.0 LINE subscribers (m) n.a. n.a. 11.0 98.0 330.0 650.0 900.0 1,100.0 Overseas revenue portion (%) 15 16 14 18 20 29 39 43

 Profit and loss (KRWbn) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Paid searches 632 737 1,082 1,206 1,352 1,542 1,682 1,823 Display ads 150 145 299 347 323 337 354 370 Other Revenue 815 891 741 246 637 1,071 1,679 2,165 Total Revenue 1,598 1,773 2,121 1,799 2,312 2,950 3,715 4,358 Other income 00000000 COGS (684) (833) 0 00000 SG&A (335) (315) (1,461) (1,687) (1,791) (2,036) (2,424) (2,776) Other op.expenses 0 0 0 00000 Operating profit 579 625 660 112 521 914 1,291 1,582 Net-interest inc./(exp.) 1316222115143246 Assoc/forex/extraord./others (28) 3 (50) 6 (82) (160) (47) (75) Pre-tax profit 564 644 632 139 453 768 1,275 1,553 Tax (141) (144) (180) (148) (131) (209) (332) (403) Min. int./pref. div./others (2) (1) (2) 2 2 15 25 31 Net profit (reported) 421 499 450 (7) 325 574 969 1,180 Net profit (adjusted) 421 499 450 (7) 325 574 969 1,180 EPS (reported)(KRW) 8,748 10,377 9,350 (152) 8,004 17,407 29,397 35,791 EPS (adjusted)(KRW) 8,748 10,377 9,350 (152) 8,004 17,407 29,397 35,791 EPS (adjusted fully-diluted)(KRW) 8,748 10,377 9,350 (152) 8,004 17,407 29,397 35,791 DPS (KRW) 0 0 536 616 734 800 950 1,000 EBIT 579 625 660 112 521 914 1,291 1,582 EBITDA 648 714 749 219 642 1,048 1,460 1,791

 Cash flow (KRWbn) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 564 644 632 139 453 768 1,275 1,553 Depreciation and amortisation 69 89 88 107 121 134 170 209 Tax paid (141) (144) (177) (130) (126) (209) (332) (403) Change in working capital (27) (40) 17 9 66 59 55 48 Other operational CF items 56 20 39 490 116 62 (20) (19) Cash flow from operations 521 569 600 614 630 814 1,148 1,387 Capex (137) (131) (121) (277) (361) (434) (456) (478) Net (acquisitions)/disposals (35) (55) (365) (429) 565 27 (79) (84) Other investing CF items (191) (230) (13) (3) (629) 35 36 36 Cash flow from investing (362) (416) (499) (709) (426) (371) (499) (526) Change in debt 4 61 (6) 141 55 6 5 7 Net share issues/(repurchases) (56) (176) (180) (111) 282 (115) (153) (155) Dividends paid 0 0 0 (24) (27) (22) (24) (28) Other financing CF items 0 58 (3) 17 (473) 0 0 0 Cash flow from financing (53) (57) (189) 24 (162) (131) (172) (175) Forex effect/others (11)(70)000000 Change in cash 95 26 (88) (71) 43 311 478 686 Free cash flow 384 438 479 337 269 380 693 909 Source: FactSet, Daiwa forecasts

- 52 - Pan-Asia Mobile Games Sector 24 October 2014

 Balance sheet (KRWbn) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 750 856 1,108 1,390 977 1,244 1,722 2,407 Inventory 00000000 Accounts receivable 169 160 223 242 231 360 454 532 Other current assets 120 124 101 107 128 141 145 149 Total current assets 1,039 1,140 1,431 1,739 1,336 1,745 2,320 3,089 Fixed assets 296 329 384 566 792 1,078 1,350 1,605 Goodwill & intangibles 22 59 139 122 134 112 90 69 Other non-current assets 248 447 418 501 436 529 626 728 Total assets 1,605 1,976 2,373 2,927 2,698 3,464 4,387 5,490 Short-term debt 124 32 75 136 242 94 94 96 Accounts payable 0 0 130 150 156 286 339 386 Other current liabilities 330 358 328 359 435 506 605 689 Total current liabilities 455 390 533 645 832 886 1,038 1,171 Long-term debt 22 194 147 195 110 268 271 277 Other non-current liabilities 34 25 115 184 280 282 282 282 Total liabilities 510 610 795 1,024 1,222 1,436 1,592 1,730 Share capital 2424242416161616 Reserves/R.E./others 959 1,342 1,553 1,872 1,455 2,020 2,809 3,801 Shareholders' equity 983 1,366 1,578 1,896 1,471 2,037 2,826 3,818 Minority interests 111 0 0 7 4 (9) (31) (58) Total equity & liabilities 1,605 1,976 2,373 2,927 2,698 3,464 4,387 5,490 EV 25,676 25,464 25,254 25,062 25,603 25,331 24,811 24,082 Net debt/(cash) (603) (630) (886) (1,060) (626) (882) (1,356) (2,034) BVPS (KRW) 20,435 28,384 32,778 39,403 44,636 61,784 85,723 115,815

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 15.8 10.9 19.7 (15.2) 28.5 27.6 25.9 17.3 EBITDA (YoY) 14.9 10.0 4.9 (70.8) 193.6 63.2 39.4 22.6 Operating profit (YoY) 13.8 7.9 5.7 (83.1) 366.8 75.5 41.2 22.6 Net profit (YoY) 18.8 18.6 (9.9) n.a. n.a. 76.8 68.9 21.8 Core EPS (fully-diluted) (YoY) 18.5 18.6 (9.9) n.a. n.a. 117.5 68.9 21.8 Gross-profit margin 57.2 53.0 100.0 100.0 100.0 100.0 100.0 100.0 EBITDA margin 40.6 40.3 35.3 12.2 27.8 35.5 39.3 41.1 Operating-profit margin 36.2 35.2 31.1 6.2 22.5 31.0 34.7 36.3 Net profit margin 26.3 28.2 21.2 (0.4) 14.0 19.4 26.1 27.1 ROAE 52.5 42.5 30.6 n.a. 19.3 32.7 39.9 35.5 ROAA 29.8 27.9 20.7 n.a. 11.5 18.6 24.7 23.9 ROCE 54.7 44.1 38.9 5.5 25.6 43.3 46.5 43.4 ROIC 101.7 79.1 66.2 (0.9) 43.7 66.6 73.9 74.0 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 25.1 22.3 28.5 106.5 28.9 27.2 26.0 26.0 Accounts receivable (days) 39.7 33.9 32.9 47.2 37.4 36.6 40.0 41.3 Current ratio (x) 2.3 2.9 2.7 2.7 1.6 2.0 2.2 2.6 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 0.0 5.7 n.a. 9.2 4.6 3.2 2.8 Free cash flow yield 1.5 1.7 1.8 1.3 1.0 1.4 2.6 3.5 Source: FactSet, Daiwa forecasts

 Company profile Naver is the largest search portal in Korea and offers paid searches (Naver), mobile messaging (LINE), and display ads. The LINE platform had 590m users globally as of 9 Oct 2014. Naver spun off its game division on 1 August 2013.

- 53 - Pan-Asia Mobile Games Sector 24 October 2014

attract premium mobile gamers who generally have high ARPU, strong loyalty, and longer paying cycles.

In addition, we believe LINE needs to find the optimal mix of game offerings for both premium and casual LINE: facing a dilemma gamers to avoid the risk of over-monetisation. to evolve as integrated Business outlook mobile-game platform We estimate Naver’s domestic business (paid search, display ads) remained soft in 3Q14, due mainly to weak We believe LINE will face challenges in ad-dollar spending as a result of the slowdown in the Korea economy. In addition to soft ad dollars in Korea, monetising mid-to-hard core gamers due we are seeing a sharp increase in mobile traffic on the to its gamer mix, relatively weak third- back of the smartphone boom. party developer base, and rising competition from open apps stores. We believe Naver’s online-ads sales will show modest growth until the company finds more powerful mobile ad products than competitors like Daum Investment summary Communications, rather than typical search and display ad formats. As such, we forecast Naver’s online- ads sales (paid search and display ads) to rise by just We downgrade our rating on Naver to Outperform (2), 2% QoQ to KRW475bn for 3Q14. from Buy (1). We lower our 6-month target price to KRW900,000 (from KRW925,000), based on an Strategically, LINE aims to accelerate its monetisation unchanged target PER of 38x, which is at a 5% through LINE Pay, LINE Taxi, and LINE Music in premium to the average 2014E PER of Naver’s global Japan. We think LINE is keen to leverage its peers at current share prices (on the Bloomberg- substantial user base in its 3 key markets in Asia consensus EPS), applied to the average of our revised (namely, Japan, Thailand, Indonesia) and expand its 2014-15E EPS. We use our average 2014-15 EPS target market into offline and online from mobile. By forecasts in our valuation to reflect the strong earnings connecting active mobile users, the company targets to turnaround we expect for LINE in 2015 and its increase in-app purchases and social activity, which potential to become a global mobile social platform. should help LINE generate mobile revenue through ads, commerce, and paid content. We believe LINE Pay Mobile game strategy and other mobile life related services will enhance LINE’s mobile ecosystem over the long term, rather than generating short-term revenue. At a recent media conference in Tokyo on 9 October, LINE announced plans to diversify its mobile game offerings on its platform through a number of strategic Earnings-forecasts revisions partnerships with talented game developers in Japan. In particular, LINE plans to set up joint ventures with We revise down our revenue forecasts for LINE’s game Gree (3632 JP) and Cyber Agent (4751 JP) to enrich its service for 2014-16 by 1-10% to reflect our expectation game offerings by offering more mid-to-hard core of a slowdown in gamer monetisation for casual games games, and penetrate the global mobile-game market and rising competition from open apps marketplaces in effectively. Japan and other regions.

We believe LINE will be able to leverage its large user We are reducing our 2014-16 EPS forecasts for Naver base and capture the opportunity from young mobile by 2.4-6.3% to reflect: 1) revised revenue forecasts for gamers if it can succeed in publishing mid-to-hard core LINE, in turn due in part to lower-than-previously games in Japan, Taiwan and Thailand. expected in-game item sales, 2) soft ad spending on all media in Korea, and 3) monthly active users (MAU) of Our research indicates that most of LINE’s users are 170m for early October amounting to 34% of the socially connected and casual consumers of games and company’s total user base, which was lower than our other entertainment content. We believe LINE will forecast of 52% (market consensus: 40-60%). need more time and exert more effort in order to - 54 - Pan-Asia Mobile Games Sector 24 October 2014

Valuation and investment risks

Naver stock is trading currently at PERs of 46x for 2014E and 27x for 2015E (based on our EPS forecasts), lower than its past-2-year average PER of 47x. We believe our 5% target valuation premium for Naver is appropriate, given the company’s strong market position in MIM services in Asia and successful monetisation of its user base through games, ads, and digital item commerce.

The main risk to our rating, forecasts and target price for Naver would be slower-than-expected monetisation of LINE outside Japan and non-game services. A secondary risk would be a decline in the company’s MAU as a proportion of its total user base.

- 55 -

Information Technology / Korea 036570 KS Information Technology / Korea 24 October 2014

NCsoft

NCsoft Target (KRW): 230,000  152,000 Upside: 9.4% 036570 KS 21 Oct price (KRW): 139,000

Still waiting for online blockbuster games to take off 1 Buy 2 Outperform (from Buy) • NCsoft has a cautious development strategy for mobile games 3 Hold • Reducing our 2014-16E EPS by 15-17% to reflect lower-than- 4 Underperform previously-expected royalties from overseas markets 5 Sell • Lowering target price to KRW152,000 and downgrading to Outperform (2); business outlook still favourable

How do we justify our view?

China: some challenges. We ■ How we differ believe NCsoft’s online games in We are more positive than the China still face difficulties in raising market on the future earnings gamer numbers due to a lack of contribution from game item sales.

appropriate game content, Forecast revisions (%) Thomas Y. Kwon competition from free online games Year to 31 Dec 14E 15E 16E (82) 2 787 9181 and casual mobile games, and Revenue change (5.6) (9.1) (9.5) [email protected] different tastes among Chinese Net profit change (14.6) (17.1) (17.1) Core EPS (FD) change (14.6) (17.1) (17.1) gamers vs. Korean gamers. Thus, we now forecast overseas royalties to rise Source: Daiwa forecasts ■ What's new by YoY rates of 132% for 2014, 16% for At the recent Daiwa TMT 2015 and 11% for 2016 (previously Share price performance Conference 2014, we were 178%, 45% and 22% YoY), on reduced (KRW) (%) encouraged by NCsoft’s remarks that assumptions for its number of users, 250,000 135 it would continue to focus on 217,500 116 in-game activities and paying gamers. 185,000 98 blockbuster online games rather than on mobile games but plans to 152,500 79 Softer but still-solid earnings. 120,000 60 expand into the fast-growing Our 2014-16E EPS cuts of 15-17% Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 advanced mobile-games segment in reflect reduced overseas royalties, NCSoft (LHS) Relative to KOSPI (RHS) 2015. Meanwhile, it faces some soft operating leverage, a cautious challenges in China. monetisation strategy for Lineage 12-month range 123,500-248,500 gamers for in-game item sales, and Market cap (USDbn) 2.89 ■ What's the impact higher operating cost assumptions 3m avg daily turnover (USDm) 26.62 Game platform strategy for for new game development and Shares outstanding (m) 22 Major shareholder Nexon (15.1%) next-generation era. NCsoft marketing costs for new game titles. recently conducted closed-beta Financial summary (KRW) testing for its new online shooting ■ What we recommend game, , and plans to Year to 31 Dec 14E 15E 16E We lower our 6-month target price to Revenue (bn) 849 966 1,042 unveil more detailed features for KRW152,000 (from KRW230,000), Operating profit (bn) 277 316 334 Lineage Eternal (latest game in its now based on a target 2014E PER of Net profit (bn) 233 278 304 Lineage series) at the G-Star 2014 Core EPS (fully-diluted) 10,630 12,663 13,843 14.3x, at a 10% premium to its global EPS change (%) 46.6 19.1 9.3 Game Show in November. At the peer group’s average (formerly 18.4x, TMT conference, NCsoft said it is Daiwa vs Cons. EPS (%) 5.6 12.2 10.0 in line with peers’ average at that PER (x) 13.1 11.0 10.0 focusing more on its online-game time). Thus, we downgrade NCsoft to Dividend yield (%) 0.5 0.5 0.5 platform than mobile games, as a Outperform (2), from Buy (1), but still DPS 650 700 750 PBR (x) 2.3 1.9 1.6 key revenues and earnings growth see a favourable business outlook. The drivers but plans to roll out new EV/EBITDA (x) 7.0 5.5 4.1 key risk is a sharp fall in gamer traffic ROE (%) 18.7 18.7 17.2 advanced mobile games in 2015. for its core games in Korea. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 70 Pan-Asia Mobile Games Sector 24 October 2014

1 Buy How do we justify our view? 2 Outperform (from Buy)

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 NCsoft: quarterly revenue breakdown and operating-profit  Growth outlook margin Based on our revised forecasts, we expect NCsoft’s (KRWbn) revenue from overseas royalties to account for 18.4% 250 40% of its total revenue for 2014 (compared to 8.7% for 200 30% 2013). 150 20% We now forecast NCsoft’s overseas royalties to rise by 100 10% 132% YoY for 2014, 16% YoY for 2015 and 11% YoY 50

for 2016 (revised from respective YoY growth rates 0 0% previously of 178%, 45% and 22%). This reflects our 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14E 4Q14E reduced assumptions for the company’s number of Lineage 1 Lineage 2 users, in-game activities, and paying gamers for its Aion B&S (Korea) online games launched recently overseas (including in GW2 Wildstar Other games (including royalties) Operating-profit Margin (RHS) China). Source: Company, Daiwa forecasts

 Valuation  NCsoft: share-price performance and PER bands We lower our target 2014E PER to value NCsoft to 14.3x (KRW) (from 18.4x, in line with global peers’ average at that 400,000 350,000 time), now derived by applying a 10% premium to its 300,000 global peers’ average 2014E PER. This reflects a lack of 250,000 visibility on NCsoft’s mobile-game pipeline, more 200,000 moderate earnings-growth momentum we see due to a 150,000 100,000 likely absence of new hit games in the next few quarters 50,000 and as NCsoft has yet to penetrate Asia’s online role- 0 playing game (RPG) markets outside Korea. Still, we Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 believe NCsoft merits a PER premium over its pees on Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 better visibility we see for its game portfolio expansion. Adj. Prc. 14.9X 23.2X 31.5X 39.8X 48.1X Its current trading PERs of 13.1x for 2014E and 11.0x Source: Dataguide, Daiwa 2015E are below its 15-48x range for 2009-13 and look undemanding to us.  Earnings revisions  NCsoft: Daiwa vs. consensus EPS forecasts (2014-15E) The Bloomberg consensus 2014-15 EPS forecasts for (KRW) NCsoft have trended down since May this year due to 35,000 a decelerating growth rate in the number of gamers 30,000 for its Blade & Soul game in China and weaker-than- 25,000 expected overseas royalties from other games, like 20,000 2. Our 2014-16 EPS forecasts are 6-12% above the consensus numbers, reflecting our cautious 15,000 optimism on NCsoft’s earnings and profitability 10,000 outlook on the back of its lucrative in-game item sales 5,000 and the revenue potential for its mobile games using Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 its strong game intellectual properties (IP). 2014E consensus 2015E consensus 2014E Daiwa 2015E Daiwa Source: Bloomberg, Daiwa

- 57 - Pan-Asia Mobile Games Sector 24 October 2014

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E PC café market share (%) 26.2 25.4 21.6 19.8 16.0 15.0 17.0 18.0 Number of servicing games 4.0 5.0 5.0 7.0 7.0 8.0 11.0 12.0 Revenue contribution from B&S and 0.0 0.0 0.0 30.1 28.0 31.6 33.3 28.4 GW2 (%)

 Profit and loss (KRWbn) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Lineage I&II Revenues 285 306 296 270 345 305 316 327 Aion Revenues 252 262 223 141 96 84 85 85 Other Revenue 98 82 89 342 316 459 565 629 Total Revenue 635 650 609 754 757 849 966 1,042 Other income 001700000 COGS (154) (140) 0 00000 SG&A (247) (267) (473) (602) (551) (572) (650) (707) Other op.expenses 0 0 (17) 00000 Operating profit 234 243 135 151 205 277 316 334 Net-interest inc./(exp.) 1522222520264256 Assoc/forex/extraord./others (8) (49) (1) 6 (9) (6) (2) (1) Pre-tax profit 241 215 157 183 216 296 356 389 Tax (52) (53) (40) (29) (58) (63) (78) (86) Min. int./pref. div./others (4) (1) 3 2 0 (0) (0) (0) Net profit (reported) 184 162 120 156 159 233 278 304 Net profit (adjusted) 184 162 120 156 159 233 278 304 EPS (reported)(KRW) 8,733 7,439 5,502 7,129 7,253 10,630 12,663 13,843 EPS (adjusted)(KRW) 8,733 7,439 5,502 7,129 7,253 10,630 12,663 13,843 EPS (adjusted fully-diluted)(KRW) 8,733 7,439 5,502 7,129 7,253 10,630 12,663 13,843 DPS (KRW) 500 600 600 600 600 650 700 750 EBIT 234 243 135 151 205 277 316 334 EBITDA 256 269 161 190 241 319 353 392

 Cash flow (KRWbn) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 241 215 157 183 216 296 356 389 Depreciation and amortisation 22 27 25 38 36 43 37 58 Tax paid (52) (53) (32) (30) (24) (97) (78) (86) Change in working capital 64 5 (4) 32 (6) (27) 9 7 Other operational CF items 12 23 (23) (1) (238) (40) 17 10 Cash flow from operations 287 217 124 222 (17) 175 341 378 Capex (26) (49) (191) (90) (101) (19) (21) (22) Net (acquisitions)/disposals (2) 3 89 33 (111) (81) (71) (47) Other investing CF items (255) (201) (3) (8) 264 8 21 (29) Cash flow from investing (283) (246) (105) (65) 52 (92) (72) (98) Change in debt 0 (1) 9 11 (15) (3) 0 0 Net share issues/(repurchases) 46 9 0 30000 Dividends paid (9) (10) (12) (12) (12) (12) (13) (14) Other financing CF items 0 0 0 00000 Cash flow from financing 38 (1) (3) 3 (27) (15) (13) (14) Forex effect/others (4)(3)000000 Change in cash 38 (34) 16 160 9 68 257 266 Free cash flow 261 169 (67) 133 (118) 156 320 356 Source: FactSet, Daiwa forecasts

- 58 - Pan-Asia Mobile Games Sector 24 October 2014

 Balance sheet (KRWbn) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 496 612 535 563 678 798 1,055 1,321 Inventory 12121222 Accounts receivable 716873778195108116 Other current assets 54 82 30 32 25 28 32 35 Total current assets 623 763 639 674 786 923 1,197 1,474 Fixed assets 170 189 366 426 248 224 195 197 Goodwill & intangibles 0 0 30 133 112 105 97 89 Other non-current assets 59 95 78 83 334 396 457 494 Total assets 851 1,046 1,113 1,317 1,480 1,647 1,946 2,254 Short-term debt 0 0 12 123000 Accounts payable 240789910 Other current liabilities 185 164 186 217 241 195 221 238 Total current liabilities 187 168 199 236 252 204 230 248 Long-term debt 0 3 0 125555 Other non-current liabilities 16 64 46 49 64 67 75 75 Total liabilities 203 235 245 296 321 276 310 328 Share capital 1111111111111111 Reserves/R.E./others 624 787 845 990 1,130 1,342 1,607 1,894 Shareholders' equity 635 798 856 1,001 1,141 1,353 1,618 1,905 Minority interests 1314132018181821 Total equity & liabilities 851 1,046 1,113 1,317 1,480 1,647 1,946 2,254 EV 2,554 2,442 2,524 2,508 2,374 2,247 1,925 1,623 Net debt/(cash) (496) (609) (523) (539) (669) (793) (1,050) (1,316) BVPS (KRW) 29,233 36,601 39,157 45,769 52,076 61,711 73,785 86,864

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 83.0 2.4 (6.3) 23.7 0.4 12.2 13.8 7.9 EBITDA (YoY) 268.2 5.0 (40.3) 18.0 27.0 32.6 10.4 11.2 Operating profit (YoY) 367.4 3.6 (44.3) 11.9 35.7 34.9 14.1 5.9 Net profit (YoY) 618.7 (12.1) (25.8) 29.7 1.9 46.8 19.2 9.3 Core EPS (fully-diluted) (YoY) 597.6 (14.8) (26.0) 29.6 1.7 46.6 19.1 9.3 Gross-profit margin 75.7 78.4 100.0 100.0 100.0 100.0 100.0 100.0 EBITDA margin 40.4 41.4 26.4 25.2 31.8 37.6 36.5 37.6 Operating-profit margin 36.9 37.3 22.2 20.1 27.1 32.6 32.7 32.1 Net profit margin 29.0 24.9 19.7 20.7 21.0 27.5 28.8 29.1 ROAE 35.1 22.6 14.5 16.8 14.8 18.7 18.7 17.2 ROAA 26.9 17.1 11.1 12.8 11.4 14.9 15.5 14.5 ROCE 43.6 33.2 15.9 15.7 18.6 21.8 20.9 18.7 ROIC 106.2 103.1 36.8 30.7 31.0 40.8 42.3 43.6 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 21.8 24.5 25.2 16.0 26.6 21.3 22.0 22.0 Accounts receivable (days) 31.5 39.2 42.2 36.2 38.1 37.9 38.3 39.3 Current ratio (x) 3.3 4.5 3.2 2.9 3.1 4.5 5.2 5.9 Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Net dividend payout 5.7 8.1 10.9 8.4 8.3 6.1 5.5 5.4 Free cash flow yield 8.6 5.5 n.a. 4.3 n.a. 5.1 10.5 11.7 Source: FactSet, Daiwa forecasts

 Company profile With its flagship games, Lineage, Aion, and Blade & Soul, NCsoft is a leading on-line game developer and operator in Korea and in key Asia markets. It commanded more than a 10% share of the Korea on-line gaming market in 2013.

- 59 - Pan-Asia Mobile Games Sector 24 October 2014

service cycle. Given that the number of users of advanced mobile games, notably mid- to hard-core RPGs, is on the increase in Asia, and that these games offer an extended life cycle, we believe NCsoft will expand actively into the mobile-games market starting from 2015. Still awaiting online blockbuster games Business outlook NCsoft stated that it plans to launch commercial NCsoft has still to penetrate the next- services for 3 of its existing online games (Blade & Soul, and Wild Star) in other Asia generation mobile-games and online role- markets where it does not already have a presence, and playing games segments. in European markets from 4Q14. In addition, it plans to start another round of closed-beta testing for Master X Master during 4Q14 and has said it is likely to launch Investment summary Master X Master in 2H15.

We downgrade our rating on NCsoft to Outperform (2), Also, we expect the company to launch an expanded from Buy (1), and lower our 6-month target price to and enhanced version of Guild Wars 2 in 2015, in a bid KRW152,000 (from KRW230,000), based on the to retain gamers and boost in-game item transactions. revised parameters discussed in this report.

We expect NCsoft stock to outperform the Kospi over Earnings-forecast revisions the next 6 months. During this period, we look for the company to provide a roadmap for its launches of new We are lowering our forecasts for royalties from 3 blockbuster games for access online and via mobile online games (Blade & Soul, Guild Wars 2, and Wild devices, launch Master X Master, and generate robust Star) for China and the company’s other overseas revenue from in-game item sales for its Lineage series. markets by 17-33% for 2014-16, to reflect a weaker- than-previously-expected number of gamers, player Also, we expect a steady stream of royalties from traffic, and paying gamers for its online games NCsoft’s overseas sales for 2014-16. As mobile gamers’ launched recently. demand for mid-to-hard core games continues to rise in Asia, we believe NCsoft should be able to capitalise As such, we now forecast NCsoft’s overseas royalties to on the increasing amount of time and dollars that rise by 132% YoY for 2014 (previously 178% YoY), 6% premium gamers are spending on games compared to YoY for 2015 (previously 45% YoY), and 11% YoY for casual gamers. 2016 (previously 22% YoY). These more moderate growth rates reflect our revised expectations noted above, along with more moderate overseas royalties Mobile games strategy from its in-game activities. Still, given high profit margins generated from royalties, we expect NCsoft’s NCsoft continues to pursue a balanced strategy to profitability to improve gradually for 2014-16. develop both simple casual games through its subsidiaries like (Not listed) in Korea and We are also more cautious about the revenue mobile games using its strong game IPs. Meanwhile, contributions from online casual games and mobile we believe the company has been struggling to find an games for 2014-16, due to the company’s ongoing delay appropriate strategic focus in terms of game genres, in launching new games. play styles, target users, and business model. We reduce our EPS forecasts for NCsoft by 15-17% for At Daiwa’s TMT conference (held in the US and Canada 2014-16. This reflects our reduced assumptions for over 23-26 September), NCsoft’s management overseas royalties, soft operating leverage due to the commented that in 2015 and beyond it plans to focus company’s cautious monetisation strategy for its more on the advanced mobile-games market, rather than Lineage gamers for in-game item sales, and 4-14% on simple puzzles and casual games, in order to capture increases in our assumptions for operating costs for the benefits that advanced mobile games offer, namely new game development and marketing expenditure for higher ARPU, generally strong gamer loyalty, and a long new game titles.

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Valuation and investment risks

NCsoft stock trades currently at a PER of 13.1x for 2014E and 11.0x for 2015E (based on our revised EPS forecasts), both lower than its trading PER range of 15- 48x over 2009-13.

We lower our target PER assigned to value NCsoft to 14.3x (from 18.4x), now based on a 10% premium applied to the average trading 2014E PER of its global peer group (using Daiwa’s and the Bloomberg consensus EPS forecasts), which we apply to our revised 2014 EPS forecast. We maintain 2014 as our target year base in our valuation pending the company’s release of its 3Q14 results. We believe NCsoft’s plans to expand into the fast-growing advanced mobile-games segment in 2015 warrant a PER premium to its global peer group.

The reduction in our target PER (notwithstanding the premium now assigned to its peer group) reflects currently limited visibility on NCsoft’s mobile-game pipeline, and more moderate earnings-growth momentum than we envisaged previously given a likely absence of new blockbuster online games over the next few quarters, along with the fact that NCsoft has yet to penetrate Asia online RPG markets outside Korea.

The key risk to our rating, forecasts and target price for NCsoft would be a sharp fall in gamer traffic for Blade & Soul in China and Lineage in Korea. Secondary risks would be higher-than-expected labour and R&D costs.

- 61 -

Industrials / Korea 034020 KS Other products/ Japan Publication date

Doosan Heavy Industries and Construction

Bandai Namco Target price: JPY 3,190 Upside: +26.2%

7832 JP 21 Oct share price: JPY2,528

Domestic operations solid, 1 Buy overseas operations promising 2 Outperform (unchanged) 3 Hold • Experiencing solid growth for existing IP developed in-house while 4 actively soliciting new ideas internally Underperform • Continued expansion internationally, led by mobile games, could see 5 Sell overseas business make a larger earnings contribution going forward • We reaffirm our Outperform (2) rating and SOTP-based target price of JPY3,190

from continued business expansion overseas, particularly in Asia, as noted in this report. Some of the Share price performance (Y) Relative to TOPIX firm’s previous attempts to generate 3,300 160 profits overseas by utilising 2,600 140 Satoshi Tanaka intellectual properties that are (81) 3 5555 7049 popular, even in Asia, were 1,900 120 [email protected] abandoned due to piracy and other 1,200 100

problems. However, growth for the 500 80 mobile game market, which allows 10/11 6/12 1/13 8/13 3/14 10/14  What we recommend for better control at the server side, We maintain our Outperform (2) even if games are copied on the Market data (consol) rating and three- to six-month target client side, is probably helping Share price (JPY; 21/10/14) 2,528 price of JPY3,190. The shares have 12-month range (JPY) 1,800-3,175 accelerate monetisation of the firm’s Market cap (JPYm; 21 Oct) 555,368 26.2% potential upside, in our view. intellectual properties in Asia. Shares outstanding (000; 10/14) 219,687 Foreign ownership (%; 3/14) 45.2 The company continues to enjoy Shares outstanding: Common shares outstanding (excl.  Valuation treasury stock) solid growth overall for existing We arrived at a three- to six-month Market cap: Based on shares outstanding and closing price intellectual properties developed target price of Y3,190 using a sum- as of indicated date internally such as Gundam, Kamen of-the-parts approach based on our Investment Indicators (consol) Rider, One Piece, and Naruto, as FY14 forecasts. 3/14 3/15 E 3/16 E well as content targeting girls such P/E (X) 22.2 14.6 13.4 as Pretty Cure! and Aikatsu. In EV/EBITDA (X) 6.4 5.2 5.0 Until now, the PER has languished P/B (X) 2.08 - - addition, Yo-Kai Watch remains a at low levels relative to peers amid Dividend yield (%) 1.38 2.06 2.22 big hit. As such, its domestic toys & concerns that dependence on the ROE (%) 9.7 - - hobby business has built a system EV: Market cap + interest-bearing debt – liquidity on hand domestic market for the bulk of its EBITDA: Operating profit + depreciation with a very solid foundation. earnings made the firm vulnerable EV/EBITDA (prospective): Based on recently disclosed Furthermore, from the end of last to Japan’s demographics (declining figures for interest-bearing debt and liquidity on hand ROE: Net income / average of start-FY and end-FY year the firm began to aggressively birthrate, growing elderly shareholders’ equity (for SEC-reporting firms figures based solicit new intellectual property population). However, further on those attributable to shareholders of parent) Estimates by Daiwa. ideas internally, which could contributions to earnings from increase its opportunities to overseas, starting with mobile Income summary (consol) commercialise even higher-margin games, could not only enhance the (JPYm) 3/14 3/15 E 3/16 E intellectual properties developed in- firm’s EPS but lift its valuation Sales 507,679 539,000 563,000 Op profit 44,672 60,700 63,700 house. multiples, in our view. Rec profit 47,456 61,800 64,800 Net income 25,054 38,100 41,300 There is also the strong possibility of EPS (JPY) 114.1 173.4 188.0 bigger contributions to earnings DPS (JPY) 35.00 52.00 56.00 Source: Estimates by Daiwa

See important disclosures, including any required research certifications, beginning on page 70 Pan-Asia Mobile Games Sector 24 October 2014

 Consolidated income statement (JPYm) FY09 10 11 12 13 14 E 15 E Consolidated sales 378,547 394,178 454,210 487,241 507,679 539,000 563,000 By segment Toys & hobby 145,672 154,706 172,151 165,957 177,825 211,000 230,000 Content 161,644 170,653 211,568 251,790 261,563 260,000 265,000 Amusement facility 65,112 62,268 60,888 60,112 58,137 58,000 58,000 Other 6,117 6,550 9,603 9,381 10,152 10,000 10,000 Gross profit 128,753 139,414 167,502 183,078 190,829 200,700 203,700 Operating profit 1,883 16,338 34,606 48,642 44,672 60,700 63,700 By segment Toys & hobby 10,786 13,812 16,112 11,255 10,510 16,000 17,000 Content -7,760 3,092 17,003 36,438 37,248 45,700 46,200 Amusement facility 284 1,778 2,380 1,683 -897 -1,000 500 Other 322 810 2,050 1,692 1,646 2,000 2,000 Eliminations/unallocated -1,749 -3,156 -2,941 -2,427 -3,834 -2,000 -2,000 Recurring profit 1,907 16,399 34,960 49,972 47,456 61,800 64,800 Net income -29,928 1,848 19,303 32,383 25,054 38,100 41,300 Source: Company materials; compiled by Daiwa. Note: Segment sales excl. intercompany transactions. E: Daiwa estimates.

 Consolidated balance sheet (JPYm) FY09 10 11 12 13 Current assets 217,762 210,934 240,920 264,804 284,398 Cash and cash equivalents 96,647 88,126 106,958 119,132 131,403 Notes and accounts receivable 52,726 57,262 69,102 77,069 76,587 Securities 2,037 2,817 2,073 4,379 4,423 Inventories 40,956 41,700 37,038 36,642 45,013 Fixed assets 108,172 97,334 101,251 109,399 120,694 Tangible fixed assets 46,014 42,591 44,500 47,255 51,972 Intangible fixed assets 12,501 8,536 8,194 8,497 10,145 Investments 49,656 46,206 48,556 53,646 58,576 Total assets 325,935 308,269 342,171 374,203 405,092

Current liabilities 86,604 86,105 107,946 108,391 120,134 Notes and accounts payable 35,956 36,641 48,742 46,471 51,625 Short-term borrowings 8,876 3,428 6,773 5,596 5,501 Long-term liabilities 10,319 8,470 21,099 17,042 17,006 Long-term borrowings 3,333 - 12,883 7,500 - Total liabilities 96,923 94,576 129,046 125,433 137,141 Net assets 229,012 213,693 213,125 248,769 267,951 Shareholders’ equity 243,958 235,919 233,112 258,979 274,271 Accumulated other comprehensive income -17,292 -23,816 -21,669 -11,948 -6,749 Stock warrants - - - 44 Noncontrolling interests 1,535 1,590 1,682 1,738 385 Total liabilities and net assets 325,935 308,269 342,171 374,203 405,092 Source: Company materials; compiled by Daiwa.

- 63 - Pan-Asia Mobile Games Sector 24 October 2014

 Consolidated cash flow statement (JPYm) FY09 10 11 12 13 Income/loss before income taxes and noncontrolling interest -19,409 11,460 30,408 48,489 42,759 Depreciation 18,988 18,000 18,142 20,415 21,725 Amortisation of goodwill 4,844 2,106 369 289 120 Impairment losses 16,017 996 1,105 505 2,002 Increase/decrease in allowances for doubtful accounts 946 -83 -317 -571 -513 Interest and dividend income -584 -388 -450 -457 -715 Forex gains/losses 225 343 81 -251 -106 Decrease/increase in trade receivables 13,478 -8,155 -12,667 -5,522 5,105 Decrease/increase in inventories -1,725 -1,849 4,081 -1,558 -7,167 Amusement facility, amusement machine installations -4,410 -4,126 -2,925 -3,516 -5,132 Increase/decrease in trade payables -6,701 3,668 12,634 -4,264 812 Other -2,477 11,185 2,131 2,917 20 Subtotal 19,192 33,157 52,592 56,476 58,910 Interest and dividends received 581 379 468 461 735 Interest paid -321 -536 -115 -148 -134 Income taxes paid -8,761 -10,437 -13,834 -20,378 -18,219 Cash flow from operating activities 10,691 22,561 39,112 36,411 41,291 Increase in time deposits -121 -984 -1,582 -4,272 -711 Withdrawals from time deposits 448 275 1,498 1,920 4,230 Payments for acquisition of tangible assets -7,177 -6,642 -9,882 -8,842 -10,414 Payments on acquisition of intangible fixed assets -2,830 -2,670 -4,647 -4,689 -5,187 Payment of guarantee deposits -398 -370 -393 -609 -919 Returned guarantee deposits 2,739 1,221 900 1,174 688 Other -2,638 1,798 -1,157 457 -2,108 Cash flow from investing activities -9,977 -7,372 -15,263 -14,861 -14,421 Increase (decrease) in short-term borrowings -576 -105 1,382 -1,317 313 Repurchases of stock -9 -4,171 -16,565 -1 -6 Dividends paid -5,795 -5,797 -5,545 -5,714 -9,891 Other -8,896 -8,752 14,796 -5,468 -5,486 Cash flows from financing activities -15,276 -18,825 -5,932 -12,500 -15,070 Effect of exchange rate changes on cash and cash equivalents 2,014 -4,837 81 2,664 3,824 Net increase (decrease) in cash and cash equivalents -12,547 -8,474 17,997 11,714 15,624 Cash and cash equivalents at beginning of year 110,037 97,776 89,329 107,327 119,041 Increase from inclusion of subsidiaries in consolidation 270 27 - - - Increase from merger with non-consolidated subsidiary 61 - - - - Decrease from split-off of subsidiary -45 - - - - Cash and cash equivalents at end of year 97,776 89,329 107,327 119,041 134,666 Source: Company materials; compiled by Daiwa

 Company profile Namco Bandai Holdings Inc is a holding company established through the merger of Bandai and Namco. The group manufactures toys, stuffed animals, character goods, video games, commercial- and home-use game equipment and software, and operates video game arcades and theme parks.

- 64 - Pan-Asia Mobile Games Sector 24 October 2014

- 65 - Pan-Asia Mobile Games Sector 24 October 2014

Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Hiroaki KATO (852) 2532 4121 [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; Kosuke MIZUNO (852) 2848 4949 / [email protected] Shipbuilding; Steel (852) 2773 8273 Mike OH (82) 2 787 9179 [email protected] Regional Research Co-head Capital Goods (Construction and Machinery) John HETHERINGTON (852) 2773 8787 [email protected] Jun Yong BANG (82) 2 787 9168 [email protected] Regional Deputy Head of Asia Pacific Research Oil; Chemicals; Tyres Rohan DALZIELL (852) 2848 4938 [email protected] Thomas Y KWON (82) 2 787 9181 [email protected] Regional Head of Product Management Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game Kevin LAI (852) 2848 4926 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional) TAIWAN Christie CHIEN (852) 2848 4482 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Macro Economics (Regional) Head of Regional IT/Electronics; Semiconductor/IC Design (Regional) Junjie TANG (852) 2773 8736 [email protected] Steven TSENG (886) 2 8758 6252 [email protected] Macro Economics (China) IT/Technology Hardware (PC Hardware) Jonas KAN (852) 2848 4439 [email protected] Christine WANG (886) 2 8758 6249 [email protected] Head of Hong Kong and China Property IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer Leon QI (852) 2532 4381 [email protected] Kylie HUANG (886) 2 8758 6248 [email protected] Banking (Hong Kong, China); Broker (China); Insurance (China) IT/Technology Hardware (Handsets and Components) Anson CHAN (852) 2532 4350 [email protected]

Consumer (Hong Kong/China) Jamie SOO (852) 2773 8529 [email protected] Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Gaming and Leisure (Hong Kong/China) Head of India Research; Strategy; Banking/Finance Lynn CHENG (852) 2773 8822 [email protected] Saurabh MEHTA (91) 22 6622 1009 [email protected] IT/Electronics (Semiconductor) (Greater China) Capital Goods; Utilities Dennis IP (852) 2848 4068 [email protected]

Power; Utilities; Renewables and Environment (Hong Kong/China) SINGAPORE John CHOI (852) 2773 8730 [email protected] Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Ramakrishna MARUVADA (65) 6499 6543 [email protected] Telecommunications (China/ASEAN/India) Joey CHEN (852) 2848 4483 [email protected] Steel (China) Royston TAN (65) 6321 3086 [email protected] Oil and Gas (ASEAN/China); Capital Goods (Singapore) Kelvin LAU (852) 2848 4467 [email protected] Head of Transportation (Hong Kong/China); Transportation (Regional) David LUM (65) 6329 2102 [email protected] Property and REITs Carrie YEUNG (852) 2773 8243 [email protected] Transportation (Hong Kong/China) Evon TAN (65) 6499 6546 [email protected] Property and REITs Jibo MA (852) 2848 4489 [email protected] Head of Custom Products Group Jame OSMAN (65) 6321 3092 [email protected] Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer Thomas HO (852) 2773 8716 [email protected] (Singapore) Custom Products Group

PHILIPPINES Bianca SOLEMA (63) 2 737 3023 [email protected] Utilities and Energy

- 66 - Pan-Asia Mobile Games Sector 24 October 2014

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, (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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- 67 - Pan-Asia Mobile Games Sector 24 October 2014

Share price and Daiwa recommendation trend

 Daum Communications: share price and Daiwa recommendation trend

Date Target price Rating Date Target price Rating Date Target price Rating 14/02/12 141,000 Outperform 11/12/12 120,000 Buy 14/02/14 87,500 Outperform 10/04/12 131,000 Outperform 04/06/13 95,000 Outperform 13/05/14 83,000 Outperform 30/05/12 131,000 Buy 24/06/13 92,000 Outperform 28/05/14 103,000 Outperform 09/11/12 125,000 Buy 30/09/13 105,000 Outperform 29/07/14 139,000 Outperform

180,000

160,000 154,000 144,000 140,000 141,000 139,000 131,000 125,000 120,000 120,000

105,000 100,000 103,000 95,00092,000 87,500 80,000 83,000

60,000 Jul-12 Jul-13 Jul-14 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Jan-12 Jun-12 Jan-13 Jun-13 Jan-14 Jun-14 Feb-12 Mar-12 Feb-13 Mar-13 Feb-14 Mar-14 Nov-11 Dec-11 Aug-12 Sep-12 Nov-12 Dec-12 Aug-13 Sep-13 Nov-13 Dec-13 Aug-14 Sep-14 May-12 May-13 May-14

Target price (KRW) Closing Price (KRW)

Source: Daiwa

 NCsoft: share price and Daiwa recommendation trend

Date Target price Rating Date Target price Rating Date Target price Rating 15/02/12 370,000 Buy 07/11/12 300,000 Buy 19/12/13 285,000 Buy 04/04/12 390,000 Buy 06/02/13 200,000 Buy 14/08/14 230,000 Buy 15/05/12 370,000 Buy 01/07/13 194,000 Buy 08/08/12 330,000 Buy 14/08/13 210,000 Buy

450,000

410,000 400,000 395,000 390,000 370,000 370,000 350,000 330,000 300,000 300,000 285,000 250,000 230,000 210,000 200,000 200,000 194,000

150,000

100,000 Jul-12 Jul-13 Jul-14 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Jan-12 Jan-13 Jun-12 Jan-14 Jun-13 Jun-14 Feb-12 Mar-12 Feb-13 Mar-13 Feb-14 Mar-14 Nov-11 Dec-11 Aug-12 Sep-12 Nov-12 Dec-12 Aug-13 Sep-13 Nov-13 Dec-13 Aug-14 Sep-14 May-12 May-13 May-14

Target price (KRW) Closing Price (KRW)

Source: Daiwa

- 68 - Pan-Asia Mobile Games Sector 24 October 2014

 Naver: share price and Daiwa recommendation trend

Date Target price Rating Date Target price Rating Date Target price Rating 09/02/12 270,000 Buy 27/11/12 300,000 Outperform 14/04/14 880,000 Buy 10/04/12 300,000 Outperform 07/02/13 265,000 Outperform 08/05/14 835,000 Buy 10/05/12 290,000 Outperform 29/04/13 335,000 Buy 08/07/14 960,000 Buy 03/07/12 285,000 Outperform 28/08/13 560,000 Buy 31/07/14 925,000 Buy 09/08/12 280,000 Outperform 22/10/13 760,000 Buy 09/10/12 305,000 Outperform 06/02/14 860,000 Buy

1,000,000 960,000 925,000 900,000 860,000 880,000 835,000 800,000 760,000 700,000

600,000 560,000 500,000

400,000 335,000 305,000 300,000 283,000 300,000290,000 285,000 300,000 260,000 270,000 280,000 265,000 200,000 Jul-12 Jul-13 Jul-14 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Jan-12 Jun-12 Jan-13 Jun-13 Jan-14 Jun-14 Feb-12 Mar-12 Feb-13 Mar-13 Feb-14 Mar-14 Nov-11 Dec-11 Aug-12 Sep-12 Nov-12 Dec-12 Aug-13 Sep-13 Nov-13 Dec-13 Aug-14 Sep-14 May-12 May-13 May-14

Target price (KRW) Closing Price (KRW)

Source: Daiwa

- 69 - Pan-Asia Mobile Games Sector 24 October 2014

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Name of Analyst : Thomas Y. Kwon

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

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

Additional information may be available upon request.

- 70 - Pan-Asia Mobile Games Sector 24 October 2014

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- 71 - Pan-Asia Mobile Games Sector 24 October 2014

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The following explains the rating system in the report as compared to relevant local indices, 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 six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months.

Additional information may be available upon request.

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