April 12, 2011 Company Report NCsoft (036570 KS) Game Emerging new game momentum Chang-kwean Kim +822-768-4321 [email protected] Share performance to be determined by new game momentum Jee-hyun Moon We reiterate Buy on NCsoft with a TP of W330,000. We lowered our 2011 EPS +822-768-3615 estimate by 11.8% to reflect 1) the Japanese earthquake relief donation [email protected] (JPY500mn) and 2) equity-method losses from ArenaNet (a wholly-owned game- development subsidiary). However, we maintain our TP, as it is based on 2010 EPS (P/E of 40x, the average P/E for the years in which NCsoft launched new games). We do not expect sluggish 1Q earnings to considerately affect NCsoftÊs shares. Rather, its share performance will likely be determined by expectations of large- scale CBT for Blade & Soul (scheduled for April~May) as well as imminent Buy (Maintain) announcements of sales contracts in China for Lineage I and II and Blade & Soul. Target Price (12M, W) 330,000 Back in 2003, despite weak second and third quarter earnings, NCsoftÊs share price Share Price (04/11/11, W) 268,000 soared on the back of positive closed-beta testing results for Lineage II. Although the Expected Return (%): 23.1 23.1 companyÊs long-term share performance should be determined by its stream of operating EPS Growth (11F, %) 12.2 profits, its short-term performance seems relatively unaffected by earnings momentum. Market EPS Growth (11F, %) 24.2 P/E (11F, x) 29.9 1Q11 Preview: Sluggish earnings due to increase in expenses Market P/E (11F, x) 10.7 KOSPI 2,122.39 NCsoftÊs 1Q earnings are projected to fall shy of forecasts; sales and OP are Market Cap (Wbn) 5,844 forecast to decline 4.7% and 21.3% YoY. User indicators for the companyÊs games Shares Outstanding (mn) 22 have turned sluggish since the start of school semester in March. The number of Avg Trading Volume (60D, '000) 268 average monthly users for Lineage I and II and Aion have decreased QoQ in 1Q. Avg Trading Value (60D, Wbn) 60 Dividend Yield (11F, %) 0.2 Earnings were also eroded by increased expenses (e.g., equity-method losses from Free Float (%) 65.2 ArenaNet and Japanese earthquake relief donation), as well as the fact that the number of 52-Week Low 141,000 promotional days for the companyÊs microtransaction system for Lineage I decreased. 52-Week High 273,000 Beta (12M, Daily Rate of Return) 0.6 Clearer launch schedules to contribute to new game momentum Price Return Volatility (12M Daily,%,SD) 2.6 Foreign Ownership (%) 28.0 Momentum from new game launches is growing. We once again confirmed Major Shareholder(s): NCsoftÊs schedules for Blade & Soul (closed-beta testing in 1H11; open-beta TJ Kim and et. al (25.44%) testing and commercialization in 2H11). Considering ChinaÊs game approval Treasury stock (9.35%) process has become speedier (Aion was commercially available four months after Mirae Asset Management (5.15%) being commercialized in Korea), Blade & Soul is likely to be commercialized in Price Performance China in 1H12. Guild Wars 2Ês launches in the U.S. and Europe are anticipated to be (%) 1M 6M 12M later than expected (in 1H12), but the console version of the game is likely to be Absolute 7.2 21.0 88.7 rolled out earlier than expected (in 2H12). Relative -1.3 8.7 65.7 Share price § Earnings & Valuation Metrics 200 KOSPI OP EV/ Sales OP NP EPS EBITDA FCF ROE P/E P/B 180 FY Margin EBITDA (Wbn) (Wbn) (Wbn) (W) (Wbn) (Wbn) (%) (x) (x) 160 (%) (x) 140 12/09 453 200 44.1 183 8,560 213 234 34.8 17.5 5.1 13.3 120 12/10 515 251 48.7 174 7,985 265 194 24.1 26.1 5.7 15.0 100 80 12/11F 567 272 48.0 195 8,962 288 191 21.6 29.9 5.9 17.8 60 12/12F 820 479 58.4 369 16,928 498 381 31.3 15.8 4.3 9.6 40 12/13F 913 548 60.1 436 19,975 568 435 27.8 13.4 3.3 7.7 4/10 8/10 12/10 4/11 Source: Company data, Daewoo Securities Research estimates Please read carefully important disclosures at the end of this report. April 12, 2011 NCsoft Figure 1. NCsoftÊs share price and quarterly operating profit trend (W) (Wbn) 300,000 Adjusted share price (L) 100 Quarterly operating profit (R) 250,000 80 Lineage II Aion Commercialization Commercialization 200,000 60 150,000 40 100,000 20 50,000 0 0 01 02 03 04 05 06 07 08 09 10 11 Note: Adjusted share price (A stock's closing price on any given day of trading that has been amended to include any distributions and corporate actions that occurred at any time prior to the next day's open) Source: Company data, Daewoo Securities Research Figure 2. NCsoftÊs share price and quarterly operating profit trend when NCsoft launched Lineage II (W) (Wbn) 120,000 Share price (L) Lineage II 40 Operating profit (R) Lineage II Commercialization CBT 100,000 Lineage II 30 OBT 80,000 60,000 20 40,000 10 20,000 0 0 01 02 03 04 Source: Company data, Daewoo Securities Research Table 1. NCsoft game release schedule forecast 1H11 2H11 2012 2013 ‘Blade & Soul’ close beta testing ÂBlade & SoulÊ open beta testing ÂBlade & SoulÊcommercialization 'Guild Wars II' 3D version release ÂBlade & SoulÊ, 'Lineage', 'Lineage II' ÂBlade & SoulÊ commercialization : China, Japan, Taiwan, the U.S., Europe ÂBlade & SoulÊ console version release contract of export to China announcement 'Guild Wars2' commercialization : the U.S., Europe, S. Korea, China, Japan, Taiwan 'Guild Wars 2' console version release Source: Daewoo Securities Research Daewoo Securities Research 2 April 12, 2011 NCsoft Table 2. Quarterly and annual earnings trend and outlook (Wbn, %) 1Q10 2Q10 3Q10 4Q10 1Q11F 2Q11F 3Q11F 4Q11F 2009 2010 2011F Sales 132 133 122 127 126 132 135 174 453 515 567 Lineage1 43 48 36 37 34 39 40 39 111 164 153 Lineage2 17 16 16 15 17 17 18 18 80 64 70 Aion and new games 45 42 43 48 49 50 51 91 158 179 241 Overseas 24 25 24 25 25 26 26 26 96 98 103 Sales breakdown Lineage1 32.4 35.7 29.8 29.0 27.3 29.8 29.8 22.4 24.6 31.8 27.0 Lineage2 13.2 12.0 13.0 11.5 13.4 12.8 13.5 10.5 17.7 12.4 12.4 Aion and new games 34.1 31.9 35.3 37.9 39.2 37.7 37.8 52.5 35.0 34.8 42.6 Overseas 18.1 18.7 20.0 19.4 20.1 19.8 18.9 14.7 21.2 19.1 18.1 Operating profit 71 69 58 53 56 59 61 96 200 251 272 OP margin 53.7 51.8 47.6 41.3 44.4 44.7 45.6 55.1 44.1 48.7 48.0 Pretax profit 75 40 61 48 43 54 56 91 227 225 244 Pretax margin 57.1 30.4 49.9 37.8 34.2 40.5 41.8 52.4 50.2 43.7 43.1 Net profit 58 30 47 38 34 43 45 73 183 174 195 NP margin 44.1 22.9 38.7 29.7 27.4 32.4 33.4 42.0 40.3 33.8 34.5 YoY growth Sales 28.1 27.2 15.2 -8.2 -4.7 -0.3 10.4 36.4 259.4 13.7 10.2 Lineage1 68.3 127.1 74.1 -16.1 -19.8 -16.9 10.5 5.1 224.2 47.0 -6.6 Lineage2 -12.3 -10.0 -23.9 -32.3 -2.8 6.4 14.9 23.7 373.3 -20.2 10.0 Aion and new games 5.8 8.0 18.4 20.8 9.5 17.8 18.3 88.6 220.3 13.1 35.0 Overseas 71.2 -1.5 -6.4 -18.5 5.6 5.2 4.5 3.1 279.2 2.4 4.6 Operating profit 63.8 43.7 45.6 -22.9 -21.3 -14.1 5.8 81.6 257.1 25.6 8.6 Pretax profit 66.9 -12.1 21.2 -43.8 -42.9 33.1 -7.5 89.0 427.1 -1.0 8.6 Net profit 67.5 -12.7 10.2 -45.9 -40.8 41.3 -4.7 92.5 429.2 -4.8 12.4 QoQ growth Sales -4.8 0.6 -8.1 4.3 -1.2 5.2 1.8 28.9 Lineage1 -2.9 11.0 -23.4 1.7 -7.1 14.9 1.8 -3.2 Lineage2 -19.9 -8.6 -0.4 -7.1 15.0 0.0 7.6 0.0 Aion and new games 12.8 -6.1 1.7 12.3 2.2 1.0 2.1 79.0 Overseas -21.3 4.2 -1.9 1.3 2.0 3.8 -2.6 -0.1 Operating profit 3.9 -3.0 -15.6 -9.4 6.0 5.9 3.9 55.6 Pretax profit -12.1 -46.6 51.0 -20.9 -10.6 24.5 5.0 61.7 Net profit -16.8 -47.8 55.6 -19.9 -8.9 24.5 5.0 61.7 Source: Company data, Daewoo Securities Research Table 3.