Company Note April 3, 2017 NCsoft (036570) 12M rating BUY (Maintain) NDR takeaways – Mobile MMORPG shortage compared to demand 12M TP W370,000 from W370,000 Up/downside +21% Successful mobile game market entry Stock Data We conducted an NDR in the US with NCsoft, and met with 15 institutional investors over three days starting from March 28. While falling Lineage 1 sales KOSPI (Mar 31, pt) 2,160 fueled some concerns, the focus was mostly on the mobile game strategy, Stock price (Mar 31, KRW) 305,000 Market cap (USD mn) 5,980 including Lineage M. Going forward, management plans to focus on growing its Shares outstanding (mn) 22 exposure to mobile MMORPG, which has higher average revenue per paying user 52-Week high/low (KRW) 316,000/218,000 (ARPPU) than PC-based games. Meanwhile, expectations for NCsoft’s mobile 6M avg. daily turnover (USD mn) 41.1 capabilities have grown following the sustained success of Lineage Revolution, Free float / Foreign ownership (%) 84.3/42.2 Lineage RK and Final Blade (publishing game). Given a low weighting of China Major shareholders (%) NPS 12.5 sales and low expectations for Lineage RK, we believe the ongoing THAAD Taek-Jin Kim and 7 others 12.0 controversy will have only a limited impact. Performance Mobile MMORPG supply falling short of demand 1M 6M 12M Absolute (%) 11.3 3.2 20.3 By reflecting mobile MMORPG market trends, e.g., auto gameplay, in addition to Relative to KOSPI (%p) 8.0 (2.5) 12.1 sophisticated graphics utilizing the Unreal 4 engine, Lineage Revolution has become the leading domestic mobile MMORPG. And, demand for the mobile 12MF PE trend MMORPG market has grown sharply, but supply is still limited. As such, we believe (X) 12MF PER (LHS) (W' 000) 400 price (RHS) there is still significant demand for Lineage M, the second game to be developed 25 350 domestically. Of the Lineage Revolution users, less than 30% are Lineage 1 300 20 players. And, Lineage M should secure a robust user base among existing online 250 game users. Of note, the core target market is older players familiar with Lineage 1, 15 200 150 rather than younger players in their 20s-30s. As such, relatively poor graphics on 10 100 Lineage Revolution should have only a marginal impact. Furthermore, the item 5 50 trading function, which was unveiled through the third teaser image, is not 0 0 available in any other mobile game yet, and should set Lineage Revolution apart. Apr-14 Apr-15 Apr-16 Source: WISEfn consensus Mobile position firms with successful launches Despite concerns, NCsoft is reinforcing its position in the mobile game market. Lineage RK ranked first in both domestic app markets despite a negative initial response. Furthermore, Final Blade and H2 (sports genre) are also beating expectations. As such, expectations are rising for Lineage M. If the game is a success, this should lift hopes for Aion Mobile, which is scheduled to launch in 2H17. Overall, momentum concerns should fade sharply after the launch of Lineage M. Backed by the successful games, we believe NCsoft will secure: 1) high-quality IP, 2) solid publishing games, and 3) a robust developer workforce. Yr to Sales OP NP EPS % chg EBITDA PE EV/EBITDA PB ROE DY Dec (W bn) (W bn) (W bn) (KRW) (YoY) (W bn) (x) (x) (x) (%) (%) 2015A 838 237 165 7,633 (33.7) 272 27.9 13.7 2.6 10.6 1.3 2016A 984 329 272 12,783 67.5 361 19.4 12.3 2.7 14.9 1.5 2017F 1,297 482 391 18,416 44.1 511 16.6 10.6 2.8 19.1 1.8 Andy Kim 2018F 1,479 573 465 21,907 19.0 604 13.9 8.4 2.4 19.3 2.2 822-3276-6158 2019F 1,736 716 580 27,305 24.6 748 11.2 6.3 2.1 20.5 2.7 [email protected] Note: Net profit and EPS are based on figures attributed to controlling interest 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 AT THE END OF THIS REPORT. NCsoft (036570) PC game division to remain stable Lineage 1 sales should normalize from 2Q17. Dragon treasure box sales should not be reflected in 1Q17, and this should weigh on results. However, traffic appears to have recovered in March after falling since the start of the year. Furthermore, a fall in item prices does not indicate a share drop in traffic. Overall, 2017 sales of existing PC games, including Lineage 1, should be flat YoY. Guild Wars 2 sales should rebound on the launch of expansion packs in 2H17, and MxM should begin contributing to PC sales. And, there are still hopes for Lineage Eternals, which will be released after additional closed beta testing (CBT) in 2H17. While the response to the first CBT was negative, we believe Lineage Eternals may beat expectations backed by heavy MMORPG users as no major MMORPG title has been released due to the success of League of Legends (MOBA genre) and Overwatch (shooter genre) recently. Maintain BUY, hopes continue to grow for Lineage M We maintain BUY with a TP of W370,000 (19.7x 12MF PE) as concerns over a delayed Lineage M launch have faded. Furthermore, NCsoft should benefit given: 1) a robust user base given 3.8mn dormant users, 2) Lineage M will be the only domestic mobile MMORPG, excluding Lineage Revolution, and 3) Lineage M sales may beat market expectations due to the item trading function, which was a core element to Lineage 1. Furthermore, the success of H2 has further confirmed NCsoft’s mobile competitiveness, as sales exceed that of other baseball games. Table 1.Quarterly earnings (W bn) 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F 3Q17F 4Q17F 2015 2016 2017F Sales 240.8 240.5 217.6 284.6 268.0 324.1 348.0 357.2 838.3 983.6 1,297.4 Lineage 78.9 94.4 83.8 118.4 62.9 87.9 80.0 92.2 312.9 375.5 323.0 Lineage II 17.1 19.1 20.6 20.4 18.9 19.7 21.4 20.8 63.0 77.1 80.8 AION 20.1 17.6 16.1 17.9 17.4 18.2 16.6 17.6 73.7 71.7 69.7 B&S 54.0 48.9 40.1 39.4 39.2 41.1 39.3 40.8 113.9 182.3 160.4 Guild War 2 30.6 15.9 15.3 14.9 14.7 14.4 14.1 13.7 100.5 76.6 56.9 Others 10.8 17.7 17.6 32.1 45.8 79.0 114.9 115.6 66.6 73.6 355.4 Royalty 29.4 27.0 24.2 41.5 69.1 63.8 61.8 56.4 98.7 122.1 251.1 Operating expense 165.1 154.4 152.4 182.9 185.5 204.6 210.5 214.8 600.8 654.8 815.4 Labor cost 99.3 91.4 93.5 99.2 108.9 102.4 104.0 104.8 324.9 383.3 420.1 Commissions 10.1 9.9 9.6 9.5 9.1 9.8 9.6 10.1 36.1 39.2 38.6 Marketing 8.8 5.1 6.8 14.3 8.3 19.4 13.9 13.9 34.2 35.0 55.6 Others 46.8 47.9 42.6 60.0 59.2 73.0 83.0 85.9 205.7 197.3 301.1 OP 75.8 86.1 65.1 101.7 82.6 119.5 137.6 142.4 237.5 328.8 482.0 OPM 31.5% 35.8% 29.9% 35.7% 30.8% 36.9% 39.5% 39.9% 28.3% 33.4% 37.2% EBT 81.0 97.5 63.4 104.2 91.3 128.9 147.3 152.3 239.5 346.1 519.9 NP 66.2 90.4 47.9 66.8 68.5 96.7 110.5 114.2 166.3 271.4 389.9 NPM 27.5% 37.6% 22.0% 23.5% 25.5% 29.8% 31.8% 32.0% 19.8% 27.6% 30.1% Source: Company data, Korea Investment & Securities Table 2. Release dates Game Release date Lineage M Released in 1H17 Pangya Mobile Released in 1H17 Girl’s rumble Released in 1H17 B&S mobile Released in 2017 Soft launching in 2Q17 Aion regions 3Q17 Lineage eternal 2nd test and release plan within the year Released in Korea 1Q17 MxM Released in U.S. 2Q17 Released in China 2H17 Lineage eternal mobile US studio under development, time frame similar to PC version Source: Company data, Korea Investment & Securities 2 NCsoft (036570) Figure 1. Lineage RK Korea sales ranking Figure 2. Final Blade sales ranking (Rank) Google Play iOS (Rank) Google Play iOS 0 0 10 2 20 4 30 6 40 8 50 10 12 60 14 70 Mar.13 Mar.16 Mar.19 Mar.22 Mar.25 Mar.28 Mar.31 Dec.10 Dec.30 Jan.19 Feb.08 Feb.28 Mar.20 Source: Appannie, Korea Investment & Securities Source: Appannie, Korea Investment & Securities Figure 3. March PC cafe M/S rises compared to February Figure 4. Lineage 1 Aden price trends by server (Market Share %) (KRW) Rodemai Phoenix 3.0% 10,000 Defrost Heine Oak Valakas 2.5% 8,000 2.0% 6,000 1.5% 4,000 1.0% 2,000 0.5% 0.0% 0 Jan.17 Jan.17 Jan.17 Feb.17 Feb.17 Mar.17 Mar.17 Feb.17 Mar.17 Mar.17 Mar.17 Mar.17 Mar.17 Source: Gametrics, Korea Investment & Securities Source: Itembay, Korea Investment & Securities Figure 5.