Mirae Asset Daewoo NCSOFT (036570 KS ) Prepare for new title momentum in 3Q Game 1Q16 preview: Improved earnings quality We forecast NCSOFT’s 1Q16 revenue and operating profit to come in at W225bn (+19.6% Earnings Preview YoY) and W74bn (+64.4% YoY), respectively. April 20, 2016 We estimate Blade & Soul US (launched in January) generated more than W20bn in new revenue, and believe revenue from all of the company’s cash cow titles ( Lineage I , Lineage II , Aion , Blade & Soul , and Guild Wars 2 ) also remained solid in the quarter. Earnings were (Maintain) Buy likely further supported by lower expenses, with both special items (e.g., pro fessional baseball team contracts) and marketing spend declining QoQ. Target Price (12M, W) 420,000 Three new titles to be released in 3Q and 4Q each Share Price (4/19/16, W) 236,500 NCSOFT’s 2016 title lineup remains largely unchanged from its original plans announced earlier this year. In 3Q16, the company will roll out its first mobile title based on its intellectual property (IP), Lineage Red Knights . In addition, Lineage II: Dawn of Aden Expected Return 78% (developed by Netmarble) and the PC game Master X Master (MXM) will be launched in Korea, Japan, and Taiwan during the quarter. OP (16F, Wbn) 323 Three more titles are expected to come out in 4Q16, including Lineage on Mobile (a Consensus OP (16F, Wbn) 349 mobile version of Lineage I ), Lineage II: Oath of Blood Mobile (developed by China’s Snail EPS Growth (16F, %) 54.9 Games), and Aion Legions . Market EPS Growth (16F, %) 12.2 Buy on the cheap; Maintain Buy and TP of W420,000 P/E (16F, x) 20.2 Lately, investors have stopped pricing in expectations for Blade & Soul Mobile China . Market P/E (16F, x) 11.3 While the title has brought attention to the value of the company’s Blade & Soul IP, it has KOSPI 2,011.36 yet to materialize into higher earnings. Our earnings estimates do not reflect the title , Market Cap (Wbn) 5,186 which is still in the early stages of its rollout. Shares Outstanding (mn) 22 While beta tests for Lineage Eternal are expected in 2Q16, we think the event is unlikely to Free Float (%) 83.8 have a meaningful impact on shares, as the title has yet to reach commercial ization Foreign Ownership (%) 33.9 (which is what matters to earnings). But, we believe the upcoming 1Q16 earnings report Beta (12M) 0.95 will provide confirmation of the sustained earnings growth potential of existing titles . 52-Week Low 181,500 52-Week High 263,500 In addition to the steady growth of existing titles, we believe another key factor providing strong downside protection is the company’s large asset holdings, which include over (%) 1M 6M 12M W900bn in cash, more than W500bn worth of real estate (two buildings in Seoul’s Absolute -7.3 21.9 27.8 Samseong-dong, which generate roughly W20bn in annual rental income), a 9.8% stak e in Relative -8.1 23.1 36.2 soon-to-go-public Netmarble (classified as available-for-sale securities ; market value of W3.8tr at time of purchase), and treasury shares (680,000 shares or 3% of total shares 150 NCSOFT KOSPI outstanding). Also positive is the company’s shareholder return policy, which allocates 130 more than 30% of net profit to dividends and buybacks. 110 We expect an absence of new releases in May and June, but think this factor is already 90 priced in. In our view , May and June could be seen as an opportune time to buy the stock 70 in anticipation of the positive momentum ahead. We reiterate our Buy rating on NCSOFT 4.15 8.15 12.15 4.16 with a target price of W420,000. Daewoo Securities C o., Ltd. FY (Dec.) 12/13 12/14 12/15 12/16F 12/17F 12/18F Revenue (Wbn) 757 839 838 960 1,097 1,206 [Internet/Game/Entertainment ] OP (Wbn) 205 278 237 323 396 456 Chang -kwean Kim OP margin (%) 27.1 33.1 28.3 33.6 36.1 37.8 +822 -768 -4321 NP (Wbn) 159 230 165 256 313 357 [email protected] EPS (W) 7,245 10,487 7,542 11,685 14,264 16,278 ROE (%) 14.8 18.4 10.6 13.7 15.0 15.3 Jeong -yeob Park +822 -768 -4124 P/E (x) 34.3 17.4 28.2 20.2 16.6 14.5 [email protected] P/B (x) 4.4 2.7 2.6 2.6 2.3 2.1 Notes: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, Mirae Asset Daewoo Research estimates April 20, 2016 NCSOFT Earnings and forecasts Table 1. Quarterly and annual earnings (Wbn, %) 1Q15 2Q15 3Q15 4Q15 1Q16F 2Q16F 3Q16F 4Q16F 2014 2015 2016F Revenue 188 218 196 237 225 228 242 265 839 838 960 Lineage I 66 85 78 83 78 85 77 83 263 313 324 Lineage II 11 16 16 20 17 16 17 18 59 63 68 Aion 18 20 17 19 17 19 18 20 94 74 74 Blade & Soul 27 30 25 32 47 42 43 41 83 114 174 Guild Wars 2 20 22 21 37 23 20 22 20 86 101 85 WildStar 3 2 2 3 2 2 1 1 50 9 6 MXM 0 0 0 0 0 0 14 21 0 0 35 Royalties 26 21 23 29 27 25 25 29 137 99 106 Other 18 20 15 14 15 19 24 32 67 67 89 Revenue proportion Lineage I 35.1 39.3 40.0 35.1 34.7 37.5 32.0 31.4 31.4 37.3 33.8 Lineage II 5.9 7.5 8.0 8.5 7.6 7.0 7.0 6.8 7.1 7.5 7.1 Aion 9.7 9.2 8.6 7.8 7.6 8.4 7.4 7.5 11.3 8.8 7.7 Blade & Soul 14.2 13.7 12.7 13.7 20.8 18.4 17.9 15.6 9.9 13.6 18.1 Guild Wars 2 10.6 10.3 10.6 15.8 10.0 8.9 9.2 7.5 10.2 12.0 8.9 WildStar 1.4 1.0 0.9 1.1 0.8 0.7 0.6 0.2 5.9 1.1 0.6 MXM 0.0 0.0 0.0 0.0 0.0 0.0 5.8 7.9 0.0 0.0 3.6 Royalties 13.6 9.6 11.7 12.3 12.0 11.0 10.3 10.9 16.3 11.8 11.0 Other 9.5 9.4 7.6 5.7 6.5 8.2 9.8 12.1 8.0 7.9 9.2 Operating expenses 143 150 145 162 151 155 154 177 561 601 637 Operating profit 45 67 51 75 74 73 88 88 278 237 323 OP margin (%) 23.9 30.8 25.9 31.6 32.8 32.1 36.3 33.2 33.2 28.3 33.6 Net profit 36 58 31 42 61 60 68 68 227 166 258 Net margin (%) 18.9 26.6 15.7 17.8 27.1 26.5 28.2 25.6 27.1 19.8 26.8 YoY growth Revenue 5.6 1.7 -7.5 0.8 19.6 4.7 23.6 11.8 10.8 -0.1 14.5 Lineage I 61.0 50.3 14.2 -14.0 18.2 -0.1 -1.1 0.1 -8.6 18.9 3.6 Lineage II -5.0 19.9 5.2 3.0 54.9 -1.4 9.2 -10.5 4.1 5.8 8.2 Aion -17.8 9.5 -49.1 -11.2 -6.4 -5.0 6.7 7.6 -1.4 -21.9 0.5 Blade & Soul 39.2 55.6 26.1 31.9 75.2 40.8 74.2 27.3 20.1 37.7 52.4 Guild Wars 2 -20.3 1.2 5.1 93.7 12.4 -9.7 7.3 -46.5 -30.6 17.4 -15.5 WildStar - -92.6 -89.3 -51.4 -28.0 -24.4 -15.0 -75.2 - -81.7 -38.6 Royalties -42.5 -44.2 3.1 -10.1 5.2 19.0 8.8 -0.5 107.5 -27.9 7.3 Other 23.9 13.1 -16.1 -16.4 -18.0 -8.9 59.6 135.4 15.9 -0.6 33.3 Operating profit 0.8 3.3 -37.8 -14.3 64.4 9.1 73.4 17.3 35.5 -14.6 35.9 Net profit -2.7 9.3 -59.5 -32.2 71.2 4.5 122.9 60.9 43.4 -26.9 54.9 Notes: All figures are based on consolidated K-IFRS Source: Company data, Mirae Asset Daewoo Research estimates Table 2. Earnings forecast revisions (Wbn, W, %, %p) Previous Revised Change 2016F 2017F 2016F 2017F 2016F 2017F Revenue 970 1,084 960 1,097 -1.0 1.2 Operating profit 348 406 323 396 -7.2 -2.5 Net profit 280 329 258 313 -8.6 -4.9 EPS 12,785 14,996 11,685 14,264 -8.6 -4.9 OP margin 35.9 37.5 33.6 36.1 -2.2 -1.4 Net margin 28.9 30.4 26.7 28.5 -2.2 -1.8 Notes: All figures are based on consolidated K-IFRS Source: Company data, Mirae Asset Daewoo Research estimates Mirae Asset Daewoo Research 2 April 20, 2016 NCSOFT NCSOFT (036570 KS/Buy/TP: W420,000) Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F (Wbn) 12/15 12/16F 12/17F 12/18F Revenue 838 960 1,097 1,206 Current Assets 1,083 1,292 1,535 1,802 Cost of Sales 203 237 271 298 Cash and Cash Equivalents 248 337 443 602 Gross Profit 635 723 826 908 AR & Other Receivables 90 103 118 129 SG&A Expenses 398 400 430 452 Inventories 1 1 1 1 Operating Profit (Adj) 237 323 396 456 Other Current Assets 744 851 973 1,070 Operating Profit 237 323 396 456 Non-Current Assets 1,136 1,187 1,252 1,302 Non-Operating Profit 3 4 20 25 Investments in Associates 35 40 46 51 Net Financial Income 20 23 28 33 Property, Plant and Equipment 234 209 187 168 Net Gain from Inv in Associates -2 -2 -1 -1 Intangible Assets 64 59 55 51 Pretax Profit 240 327 416 481 Total Assets 2,219 2,479 2,787 3,105 Income Tax 73 69 101 122 Current Liabilities 338 386 442 486 Profit from Continuing Operations 166 258 315 359 AP & Other Payables 29 34 39 42 Profit from Discontinued Operations 0 0 0 0 Short-Term Financial Liabilities 0 0 0 0 Net Profit 166 258 315 359 Other Current Liabilities 309 352 403 444 Controlling Interests 165 256 313 357 Non-Current Liabilities 93 106 121 133 Non-Controlling Interests 1 1 2 2 Long-Term Financial Liabilities 1 1 1 0 Total Comprehensive Profit 171 258 315 359 Other Non-Current Liabilities 92 105 120 133 Controlling Interests 169 255 311 355 Total Liabilities 430 493 563 619 Non-Controlling Interests 2 3 3 4 Controlling Interests 1,770 1,966 2,202 2,461 EBITDA 272 353 422 478 Capital Stock 11 11 11 11 FCF (Free Cash Flow) 224 332 390 420 Capital Surplus 441 441 441 441 EBITDA Margin (%) 32.5 36.8 38.5 39.6 Retained Earnings 1,330 1,527 1,763 2,022 Operating Profit Margin (%) 28.3 33.6 36.1 37.8 Non-Controlling Interests 19 21 23 25 Net Profit Margin (%) 19.7 26.7 28.5 29.6 Stockholders' Equity 1,789 1,987 2,225 2,486 Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/15 12/16F 12/17F 12/18F 12/15 12/16F 12/17F 12/18F Cash Flows from Op Activities 241 332 390 420 P/E (x) 28.2 20.2 16.6 14.5 Net Profit 166 258 315 359 P/CF (x) 16.1 15.6 12.6 11.1 Non-Cash Income and Expense 124 75 98 110 P/B (x) 2.6 2.6 2.3 2.1 Depreciation 28 25 22 19 EV/EBITDA (x) 13.7 11.5 9.1 7.5 Amortization 7 5 4 3 EPS (W) 7,542 11,685 14,264 16,278 Others 89 45 72 88 CFPS (W) 13,226 15,172 18,823 21,395 Chg in Working Capital 6 44 49 39 BPS (W) 81,257 90,202 100,979 112,801 Chg in AR & Other Receivables 1 -13 -15 -12 DPS (W) 2,747 3,600