2018 Outlook Internet/Game/Advertising Market changes spurring shifts in business strategy Jee-hyun Moon +822-3774-1640 [email protected] 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. Contents [Summary] 3 I. 2017 review 4 II. 2018 outlook 7 III. [Internet] Commerce, voice interface, cloud 12 - NAVER, Kakao, NHN Entertainment, Interpark IV. [Game] Overseas revenue growth, new titles 101 - NCsoft, Netmarble Games, Com2uS, Pearl Abyss, Webzen V. [Advertising] Inorganic growth, stable affiliate billings 144 - Cheil Worldwide, INNOCEAN Worldwide, Nasmedia [Conclusion] 162 [Summary] Shifts in business strategy coming into focus Market changes call for strategic shifts; Only those that are able to adapt and create new markets will survive Shifts in strategy [Internet] Online commerce [Game] New titles based on existing intellectual [Advertising] Strengthening ties property (IP), global expansion with affiliates, M&As Source: Mirae Asset Daewoo Research Source: Mirae Asset Daewoo Research 3 | 2018 Outlook [Internet/Game/Advertising] Mirae Asset Daewoo Research I. 2017 review In 2017, game stocks and • In 2017, game stocks and Kakao delivered robust share performances among internet/game/advertising plays. Kakao delivered robust • Kakao: Recovery in ad revenue and expectations for expansion in the value of subsidiaries share performances • Game: Expectations for new titles (NCsoft), solid earnings and valuation merits (Com2uS), IPO (Netmarble Games) 2017 share performance: Kakao and NCsoft outperformed peers Expectations reflected in 2017 (1/17=100) - Game: Expectations for new 220 NAVER Kakao titles, IPO of Netmarble Games, NCsoft Com2uS potential regulatory easing 200 Cheil Worldwide INNOCEAN Worldwide - Kakao: Spin-offs; expectations for advertising recovery 180 160 140 120 100 80 1/17 3/17 5/17 7/17 9/17 11/17 Source: Thomson Reuters, Mirae Asset Daewoo Research 4 | 2018 Outlook [Internet/Game/Advertising] Mirae Asset Daewoo Research I. 2017 review Key shifts in Kakao’s • For Kakao, ad revenue fell around 10% YoY in 2016. drivers • In 2017, however, ad revenue resumed growth, boosting the stock. • In November, the company rolled out new ad products, including Shopping Plus and Moment Circle, a performance-based ad platform boasting superior targeting capabilities. • In December, Kakao announced a plan to issue US$1bn worth of new shares/global depositary receipts (GDRs) in 2018. In 2017, shares of Kakao rebounded on an upturn in ad revenue The advertising business (%, YoY) (Wtr) represents a key revenue model 24 Ad revenue growth (L) 10 for internet firms. Market cap (R) - Advertising is a core revenue model for internet firms. 16 9 - Tencent has seen performance- based ad revenue exceed traditional display ad revenue since 3Q16. 8 8 0 6 -8 5 -16 4 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17F Source: Company data, Thomson Reuters, Mirae Asset Daewoo Research 5 | 2018 Outlook [Internet/Game/Advertising] Mirae Asset Daewoo Research I. 2017 review Game stocks displayed • Biggest event of 1H17: Netmarble Games IPO (KOSPI) strong rallies • Netmarble Games’ market cap stands at around W16tr. Globally, there are around 10 game stocks with market caps of more than W10tr (e.g., Tencent, Activision Blizzard, Nintendo, NetEase, Electronic Arts, Take-Two Interactive, NCsoft, Netmarble Games, Nexon). • For most game companies, earnings remain solid amid increased new game momentum; valuation re-ratings are well underway. Major game stocks have advanced since the beginning of the year Impact of the Netmarble Games (1/17=100) IPO on game stocks: 220 NCsoft Com2uS NHN Entertainement - Game stocks enjoyed a boost DoubleU Games Webzen Gamevil following confirmation of the 200 Netmarble Games Pearl Abyss upper bound of Netmarble’s price range. 180 - Marketing for new titles drew attention to the game sector. 160 - M&A possibilities shined a spotlight on small/medium- 140 sized game stocks. 120 100 80 60 1/17 2/17 3/17 4/17 5/17 6/17 7/17 8/17 9/17 10/17 11/17 12/17 Note: For Netmarble Games and Pearl Abyss, 100 represents the IPO price. Source: Thomson Reuters, Mirae Asset Daewoo Research 6 | 2018 Outlook [Internet/Game/Advertising] Mirae Asset Daewoo Research II. 2018 outlook Shifts in business • In 2018, shifts in business strategy (aimed at achieving growth) and new revenue sources to enter the spotlight strategy to drive growth • Internet: Details (e.g., monetization) regarding AI and global businesses to come to light; existing businesses (e.g., commerce) to deliver additional growth • Game: New title launches and overseas publishing to continue; expectations for M&As to pick up • Advertising: Ad firms to enhance their stability via stronger links with affiliates, as well as experience growth potential boosts Major variables and notable stocks for 2018 Top picks and 2018 other notable stocks • In the internet platform segment, commerce/payment services should garner greater attention than ads. • Top pick: NAVER • In the global space, content platforms and cloud businesses should • Notable stocks: Kakao, Internet come into focus. NHN Entertainment, Interpark • AI services have entered the actual implementation phase, with launches of relevant devices underway. • New mobile title launches (focused on mobile MMORPGs) are likely to continue. • Top pick: NCsoft • Overseas publishing (e.g., Taiwan, China, North America) should • Notable stocks: Netmarble Games, Game increase. Com2uS, Pearl Abyss, Webzen • M&A expectations and the possibility of regulatory easing (e.g., web board games) in Korea are likely to take shape. • Ad agencies: Affiliate billings should increase further. • Notable stocks: Cheil Worldwide, • Global M&As (backed by ample cash holdings) are imminent. Advertising INNOCEAN Worldwide, Nasmedia • Digital marketing capabilities are now essential. Source: Mirae Asset Daewoo Research 7 | 2018 Outlook [Internet/Game/Advertising] Mirae Asset Daewoo Research II. 2018 outlook Internet/Game/Advertising: Maintain Overweight Top picks and other notable stocks (Wbn, W, %) Market Sector Company Ticker Rating TP CP Upside cap NAVER 035420 KS 28,348 Buy: Top pick (Maintain) 1,200,000 (Maintain) 860,000 40 NHN Entertainment 181710 KS 1,356 Buy (Maintain) 83,000 (Maintain) 69,300 20 Internet Kakao 035720 KS 9,132 Trading Buy (Maintain) 170,000 (Maintain) 134,500 26 Interpark 108790 KQ 313 Trading Buy (Downgrade) 11,000 (Maintain) 9,460 16 NCsoft 036570 KS 10,366 Buy: Top pick (Maintain) 640,000 (Maintain) 472,500 35 Netmarble Games 251270 KS 16,197 Buy (Maintain) 230,000 (Maintain) 190,500 21 Game Com2uS 078340 KQ 1,696 Buy (Maintain) 160,000 (Raise) 131,800 21 Pearl Abyss 263750 KQ 2,611 Not Rated - 216,400 - Webzen 069080 KQ 1,356 Not Rated - 38,400 - Cheil Worldwide 030000 KS 2,404 Buy (Maintain) 25,000 (Raise) 20,900 20 INNOCEAN Advertising 214320 KS 1,520 Buy (Maintain) 96,000 (Maintain) 76,000 26 Worldwide Nasmedia 089600 KQ 604 Buy (Maintain) 83,000 (Raise) 69,000 20 Source: Mirae Asset Daewoo Research 8 | 2018 Outlook [Internet/Game/Advertising] Mirae Asset Daewoo Research II. 2018 outlook Internet: Change in business focus: Ads Commerce Slower growth of internet ads Ample upside to commerce market; In 2017, Amazon grabbed headlines starting in January, with Shopify and PayPal (PYPL US/CP: US$75.3) displaying even greater share performances (%) (1/17=100) 300 Amazon 40 Online penetration of retail market Shopify Online penetration of ad market PayPal 260 Alphabet Facebook 30 220 20 180 140 10 100 0 60 07 08 09 10 11 12 13 14 15 16 17F 18F 1/17 3/17 5/17 7/17 9/17 11/17 Note: Online penetration data are based on the domestic market; Shopify is a North American online shopping solutions provider Source: KOSTAT, Thomson Reuters, Mirae Asset Daewoo Research 9 | 2018 Outlook [Internet/Game/Advertising] Mirae Asset Daewoo Research II. 2018 outlook Games: Change in business focus: Domestic Overseas Korea ranks third (in ARPU terms) among global markets; Korean firms need to advance further into China, NA, and Japan Online game revenue Online population ARPU Online game spending as % of (US$mn) (mn) (US$) per-capita GDP China 27,547.0 801.6 34.36 0.42% US 25,059.9 261.2 95.95 0.17% Japan 12,545.7 119.8 104.70 0.27% Germany 4,378.1 73.1 59.89 0.14% UK 4,217.7 61.6 68.45 0.17% Korea 4,187.7 46.9 89.34 0.32% France 2,967.1 57.4 51.71 0.14% Canada 1,947.4 33.5 58.21 0.14% Spain 1,913.0 38.5 49.74 0.19% Italy 1,874.6 43.1 43.45 0.14% Note: As of 2016 Source: Newzoo, Bloomberg, Mirae Asset Daewoo Research 10 | 2018 Outlook [Internet/Game/Advertising] Mirae Asset Daewoo Research II. 2018 outlook Advertising: Defense Offense (e.g., M&As, strengthening ties with affiliates) Ad firms: Absence of major events, deteriorating business conditions in 2017 vs. boosts from international sporting events and strengthening ties with affiliates in 2018 (1/17=100) 200 SEC Cheil Worldwide 150 100 50 1/17 4/17 7/17 10/17 (1/17=100) 150 HMC Kia INNOCEAN Worldwide 125 100 75 1/17 4/17 7/17 10/17 Note: Charts on the right side show share performance Source: IOC, FIFA, Thomson Reuters, Mirae Asset Daewoo Research 11 | 2018 Outlook [Internet/Game/Advertising] Mirae Asset Daewoo Research Internet (Overweight) • Shift in business focus: Ads Commerce • Issue 1: Introduction of voice interfaces • Issue 2: Cloud in the AI era III. [Internet] Commerce: The next online battleground Current stage: • The domestic internet index has displayed three distinct growth stages: Looking for growth via AI 1) 2007-12: The index gained 35%, in line with the expansion of the internet ad market from W1tr to W2tr.