27 January 2014 Asia Pacific/Japan Equity Research Softbank, Sony, KDDI and mobile games Connections Series Painting the future: Cross-sector investment strategy ■ Domestic hypothesis 1 (Nakayasu/Hayakawa) – Japan SNS game market about to hit a ceiling, high-end gaming developers could claim superior market position: The key to investing in game stocks is to get in early and exit early. Japan’s mobile ARPU (telecom fees + digital content charges) is rebounding and accounting for a higher percentage of users’ disposable income. However, as the telecom services market expands (increase of telecommunication expenditure), the domestic SNS game market is hitting a ceiling. The market’s recognition of this trend is moving up The Credit Suisse Connections Series the exit timing for game stocks. Console game developers like Square Enix leverages our exceptional breadth of that can develop high-end games could be able to claim superior market macro and micro research to deliver position. incisive cross-sector and cross-border thematic insights for our clients. ■ Domestic hypothesis 2 (Hayakawa) – revaluation of telecoms nearly completed as sector enters latter half of eight-year cycle: Our eight-year Research Analysts mobile telecom cycle theory projects sales to expand as the industry moves Hitoshi Hayakawa to smartphones and LTE technology over a cycle consisting of five upbeat 81 3 4550 9952 years followed by three tough years. Smartphone penetration in Japan is [email protected] approaching 50%, but realizing takeup of smartphones by the so-called “late Shunsuke Tsuchiya majority” will entail higher costs and more compelling rate plans. We 81 3 4550 9740 [email protected] therefore are standing down from our bullish stance on the telecom sector and downgrading our sector weighting from Overweight to MARKET Yuki Nakayasu 81 3 4550 9966 WEIGHT. We also downgrade KDDI from Outperform to NEUTRAL. [email protected] ■ Overseas theory 1 (Tsuchiya/Hayakawa) – “Global Sony” and “Global Softbank”: Softbank has enhanced its position as a global company with the recent acquisitions of Supercell, the Finnish game developer of the global smash hit Clash of Clans, and Brightstar, a US-based handset wholesaler with a global marketing network with annual handset sales of over 100mn. The Softbank/Sprint/Brightstar combination could well boost the presence of Sony smartphones and tablets in the North American market. ■ Overseas thesis 2 (Tsuchiya) Sony to start fee-based service with PS4: Sony’s PS4 game console differs greatly from the PS3 in two key regards: (1) it will generate increased ARPU via a fee-based online gaming service and (2) it will bring down Sony’s hardware costs. We expect the game business to be Sony’s primary profit growth driver in FY3/15. Once consumer electronics companies get announcements of additional restructuring and downward earnings revisions out of the way, we look for the stock market to begin factoring in PS4-related upside for Sony. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 27 January 2014 Table of contents Hayakawa: Telecom sector enters latter half of eight-year cycle 3 However, smartphone momentum fading 4 Current rebound in industry ARPU 5 Nakayasu: Mobile game market outlook: Market maturing as smartphone ARPU converges, signs of shift to high end? 6 Game spending up due to device commoditization 6 Mobile game spreading, growth in smartphone games 7 Mobile game market: Smartphone expansion on hold? 7 User numbers and ARPU: Smartphone game ARPU has hit ¥800 8 Casual household-use console ARPU ¥500–700 8 Smartphone game market: tug-of-war between falling ARPU and growing user numbers 9 Mobile game market: low single-digit quarterly growth rate points to maturing market 10 Shift to high end in mobile games? 10 DeNA, Gree: Urgent need to create hit titles to offset decline in feature phones, which account for 30% of coin usage 11 Valuation 12 Impact of mixi game launches on share prices 12 Historical valuations (1): DeNA and Gree have always traded on a P/E of 10–15x 12 Historical valuations (2): Expectations of GungHo likely to increase until valuation peaks; P/E should subsequently fall to around 10x 13 Historical valuations (3): Colopl seeking peak 13 Need to beware of rapidly piqued expectations as new titles climb up the rankings 14 Dual-axis digital content market 15 Online ratio highest for video games 15 Softbank’s global strategy: games and devices 16 Softbank and mobile device makers: how will the relationship change after Brightstar acquisition? 16 Smartphone games: preload Clash of Clans and distribute free gems? 17 Tsuchiya: PS4 could trigger reevaluation of Sony’s game business 18 Market environment to give PS4 a boost 19 Differences from PS3: Lower hardware costs and volume growth likely to result in higher profits 21 Differences from PS3: Monthly fee income taking off; service revenues poised for growth 22 Sony/Xbox online service 24 Software lineup (PS4 vs. PS3) 25 PS4 hardware shipments could match those for PS3 26 Overseas smartphone business 27 Softbank, Sony, KDDI and mobile games 2 27 January 2014 Hayakawa: Telecom sector enters latter half of eight-year cycle We downgrade KDDI from Outperform to NEUTRAL (see KDDI company report released concurrently) and similarly revise our telecom sector stance from Overweight to MARKET WEIGHT. Our “eight-year mobile telecom cycle” has provided the rationale behind our bullish stance on the sector to date, but that cycle is now entering its second half. Figure 1: Japanese smartphone adoption two years behind North America 80% US 70% Japan 60% 66.9% 63.9% 65.3% 50% 61.5% 55.6% 57.9% 50.3% 53.1% 40% 46.3% 46.3% 49.0% 43.3% 39.8% 41.1% 30% 36.2% 36.8% 32.4% 20% 27.5% 23.5% 10% 18.8% 14.3% 0% 10.6% 5.7% 8.4% 10-12/10 1-3/11 4-6/11 7-9/11 10-12/11 1-3/12 4-6/12 7-9/12 10-12/12 1-3/13 4-6/13 7-9/13 Source: Company data, Credit Suisse estimates The eight-year cycle theory we have been advocating consists of five years of expansion followed by three years of tougher times. The recent cycle’s five-year growth phase has seen the proliferation of smartphones and LTE, which has driven growth in wireless carriers’ sales and profits. In the three-year downcycle, the penetration rate of the new technologies and products reaches a relatively high level, and one of the telecom providers starts a price war to gain more market share, which is usually a sign that the industry is entering a period of sales and profit contraction. Figure 2: Previous eight-year cycle (2G --> 3G) (JPY bn) 3G launch phase 3G expansion phase Lack of technological drivers (Price competition) 100% 2,600 90% 80% 76.1% 2,500 70% 2,400 60% 50% 2,300 40% 30% 2,200 20% 2,100 10% 0% 2,000 1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q FY3/04 FY3/05 FY3/06 FY3/07 FY3/08 FY3/09 FY3/10 FY3/11 Penetration rate of 3G and Smartphone (LHS) Total mobile revenue at 3 major telecoms (RHS) Source: Company data, Credit Suisse Softbank, Sony, KDDI and mobile games 3 27 January 2014 Figure 3: Current eight-year cycle (3G --> smartphones/LTE) LTE era Smartphone launch phase (JPY bn) Smartphone expansion phase 100% 2,600 90% 80% 2,500 70% 2,400 60% 50% 2,300 40% 30% 2,200 20% 2,100 10% 0% 2,000 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q FY3/11 FY3/12 FY3/13 FY3/14 Penetration rate of 3G and Smartphone (LHS) Total mobile revenue at 3 major telecoms (RHS) Source: Company data, Credit Suisse Figure 4: Telecoms outperforming TOPIX by 24.5% since start of Abenomics effect 200% 182.6% Share price performance Relative performance to TOPIX 150% 128.8% 101.2% 100% 78.3% 53.7% 35.2% 37.4% 47.5% 50% 24.5% 0.0% 0% -16.3% -50% -18.6% NTT NTT DoCoMo KDDI Softbank TOPIX 4 co total Source: Thomson Reuters, Credit Suisse Many market participants thought that the shift to smartphones and LTE supported a bright outlook for industry profits over the near term. Indeed, telecom sector stocks have seen an upward revision to their valuations in 2013. Although profits were also on the upswing, we think this predominant investor view is the main reason that sector stocks have outperformed during the Abenomics-induced market rally. The rates offered by Japan’s three leading wireless carriers have reached an equilibrium condition that is likely to continue. Because LTE-based smartphones and service are more expensive than 3G phones and service, industrywide sales will expand until smartphones’ penetration rate has reached a critical point and providers lower rates to win more users. However, smartphone momentum fading We expect adoption of smartphones in Japan to continue now that NTT DoCoMo has chosen to sell the iPhone. However, based on our recent interviews, we think the customer shift toward smartphones has not picked up to the degree that would normally be expected.
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