Internet AI roadmap: Smart speakers in B2C and cloud services in B2B Internet firms’ AI businesses taking shape Overweight (Maintain) The artificial intelligence (AI) businesses of global and domestic internet companies are increasingly taking shape and entering the execution phase. The most notable Industry Report development in the B2C space is the launch of AI-based voice-controlled speakers. In the B2B space, cloud services supported by AI are gaining increasing attention. June 19, 2017 B2C: Launch of voice-activated speakers and everyday services Mirae Asset Daewoo Co., Ltd. An increasing number of everyday services integrated with voice-controlled speakers and AI platforms are coming onto the scene. Amazon (NASDAQ: AMZN, [Internet/Game/Advertising] CP: US$995.17) is the current leader of this market, with its Echo smart speaker and Jee-hyun Moon Alexa virtual assistant. Last week, the company launched an Alexa-enabled smart +822-3774-1640 shopping device called Dash Wand the same day it announced its US$13.7bn [email protected] acquisition of the Whole Foods grocery chain. Also last week, NAVER’s Japanese subsidiary, LINE, unveiled smart speakers, named Wave and Champ, to which LINE will tie services like shopping and delivery. Domestically, both NAVER (035420 KS, BUY, TP: W1,160,000, CP: W878,000) and Kakao (035720 KQ, BUY, TP: W125,000, CP: W103,800) plan to release their own voice-controlled speakers this summer. B2B: Rapid growth of cloud services among firms strong in AI IT companies with strong AI capabilities are seeing rapid growth in their cloud revenue. Amazon , IBM (NYSE: IBM, CP: US$154.84), and Microsoft (NASDAQ: MSFT, CP: US$70.87) - with the Alexa, Watson, and Cortana, respectively - are enjoying double-digit growth in cloud revenue, which now makes up a meaningful percentage of overall revenue at all three companies. Among domestic firms, NAVER kicked off its global B2B cloud services in 2Q17. NAVER and Kakao deserve attention We think NAVER and Kakao deserve attention, given their increasing presence in AI. In addition to AI, NAVER’s cloud business is also gaining traction. Following the rollout of its AI platform Clova in March, the company in April unveiled plans to launch its global B2B cloud business. We think a Clova-based smart speaker could come out as early as July in Korea and Japan. We reiterate the stock as our top pick in internet and maintain our target price of W1,160,000. We expect Kakao’s smart speaker to hit the domestic market in August. In the B2B segment, Kakao has been seeing a pickup in ad revenue. We raise our target price on the stock to W125,000 from W115,000. AI market leader Amazon expanding presence via M&As; NAVER launching smart speakers, cloud services Source: Company data, Mirae Asset Daewoo Research Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. June 19, 2017 Internet CONTENTS I. Voice-activated speakers and everyday services 3 B2C: Everyday services integrated with voice- activated speakers and AI platforms 3 II. Cloud business: Firms with strong AI capabilities grow rapidly 5 Rapid growth of cloud services among firms with strong AI capabilities 5 III. Investment strategy 7 1. NAVER stock to track Amazon’s on greater focus on shopping and AI 7 2. Kakao stock to receive boost from ad revenue and KOSPI relocation 8 Key Recommendations 9 NAVER (035420 KS) 10 Kakao Corp. (035720 KQ) 13 Mirae Asset Daewoo Research 2 June 19, 2017 Internet I. Voice-activated speakers and everyday services B2C: Everyday services integrated with voice- activated speakers and AI platforms 1) Hardware device sales Sales of hardware equipped with voice-recognition AI should increase. Membership and exclusive services for long-term customer retention should constantly generate replacement demand on top of initial demand. These services include Amazon’s Prime membership, SKT’s NUGU, and KT’s Giga Genie (Melon/Genie Music) services. 2) E-commerce revenue The development of voice-recognition technology should boost revenue from product sales and transaction commissions. The technology could increase traffic to everyday services, including shopping, food delivery, restaurant reservation, and local information search. Of note, Amazon announced on June 16th that it will acquire the US organic grocery chain Whole Foods. We believe that the acquisition of Whole Foods is a way for Amazon to expand its food business. At its IR meeting, held at its headquarters in 1Q, company spokespersons had mentioned that it would be difficult to expand the food category on Amazon.com, due to the high cost of building a cold chain system and difficulty of food delivery. Amazon is likely to see revenue growth for food and daily necessities by connecting the Whole Foods chain to Dash Wand (Amazon’s smart shopping device). NAVER’s Shopping Window, booking, and payment services, as well as LINE’s shopping and food delivery services, are expanding and will likely be connected to smart speakers. Figure 1. NAVER and LINE’s voice-activated speakers (Likely to be launched in July) Note: Currently being jointly developed by NAVER and LINE Source: LINE, NAVER, Mirae Asset Daewoo Research Figure 2. Kakao’s voice-activated speaker to be launched in 3Q17 Note: Images of Kakao’s national AI project survey and in-house voice-activated speaker demonstration Source: Kakao, Mirae Asset Daewoo Research Mirae Asset Daewoo Research 3 June 19, 2017 Internet 3) Cloud services AI improves recognition capabilities by securing data via voice recognition and learning them for itself. Thus, cloud storage is an essential element of AI technology. Cloud storage space is also necessary for providing new and customized functions to users. 4) Sales through partnership If a company opens up the ecosystem of its platform, the number of partners – and, hence, sales through such partnerships - should increase; eventually, a platform itself could assume the role of an application store. Figure 3. NAVER’s Shopping Window/booking/payment, LINE’s shopping/food delivery, and Kakao’s grocery shopping/orders services are expanding NAVER Shopping Window Order through Kakao, delivered by Emart Reservation Kakao delivery Note: LINE DELIMA is a food delivery service. Source: Company data, Mirae Asset Daewoo Research Figure 4. Amazon’s Alexa Skill ecosystem is growing like an app store Note: Alexa’s voice-activated functions are called Skills. Source: Amazon, Mirae Asset Daewoo Research Mirae Asset Daewoo Research 4 June 19, 2017 Internet II. Cloud business: Firms with strong AI capabilities grow rapidly Rapid growth of cloud services among firms with strong AI capabilities 1) Combination of AI and cloud services IBM’s AI service Watson is officially called “Watson on IBM Cloud”. Major AI services, such as machine learning, deep learning, and natural language processing, can be offered only via a cloud infrastructure, and their quality is likely to improve further. IBM is currently expanding its cloud business to include B2B, industry-specific, and B2C services. In 1Q, IBM’s cloud revenue grew 35% YoY, accounting for 19% of its total revenue. 2) Infrastructure as a service (IaaS) The global cloud market is currently being led by Amazon in infrastructure and Salesforce.com in application. Cloud services are attractive to many firms (including start- ups) that need IT infrastructure, as they incur only operating expenses (OPEX), rather than massive capital expenditures (CAPEX) on hardware, software, and IT services. In 1Q, Amazon’s cloud service Amazon Web Service (AWS) saw revenue growth of +43% YoY, making a double-digit revenue contribution (10%) for the first time in its history. Figure 5. Note rapid growth of cloud services among firms with strong AI capabilities 43% 35% 31% 19% 11% 10% Amazon IBM Microsoft Amazon IBM Microsoft Cloud revenue growth Cloud revenue proportion Note: As of 1Q17; based on YoY growth Source: Company data, Mirae Asset Daewoo Research Figure 6. Concept map of IBM’s AI service, Watson on IBM Cloud Source: IBM, Mirae Asset Daewoo Research Mirae Asset Daewoo Research 5 June 19, 2017 Internet 3) NAVER’s noteworthy move to beef up its cloud services Following the rollout of its AI platform Clova in March, in April, NAVER unveiled plans to launch its global B2B cloud business. Cloud revenue is likely to be recognized in the IT platform category of NAVER’s new revenue breakdown. If NAVER can drive up cloud revenue, in addition to AI, the company should benefit fully from the global AI-driven IT megatrend. Figure 7. Overview of NAVER’s cloud platform service Try our stable cloud service, easily and instantly Source: NAVER Business Platform, Mirae Asset Daewoo Research Figure 8. NAVER’s IT platform revenue to rise on expansion of B2B cloud and payment services (Wbn) 80 IT platform revenue 60 NAVER Pay 40 20 0 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17F 3Q17F 4Q17F Note: IT platform revenue includes NAVER Pay, IT services, and cloud revenues; forecasts are our estimates Source: NAVER, Mirae Asset Daewoo Research Mirae Asset Daewoo Research 6 June 19, 2017 Internet III. Investment strategy 1. NAVER to catch up with Amazon by enhancing shopping and AI businesses NAVER’s stock has seen the smallest gains among global and domestic internet stocks in 1H17. We believe the company’s fundamentals remain robust, supported by the strong growth and profit stability of the parent company and AI-driven expansion (in partnership with its subsidiary LINE) of the company’s platform. Backed by the advance of shopping (among established businesses) and AI/cloud (among new businesses), we think the company could closely follow in Amazon’s footsteps over the medium and long term.