NCSOFT (036570.KS) Plenty of positive momentum remains Company Note │Jul 6, 2020 Despite the recent sharp rise in NCSOFT’s share price, we believe that plenty ※ Refer to page 2 for of additional upward momentum remains in play, considering expectations ESG index/event tables for new games, global growth, and platform expansion. Buy (maintain) TP W1,270,000 (raise) Several attractive points on offer CP (’20/07/03) W944,000 Sector Game Adhering to a Buy rating on NCSOFT, our sector top pick, we raise our TP from Kospi/Kosdaq 2,152.41 / 752.18 W1,000,000 to W1,270,000. Given expectations for new title releases, including Market cap (common) US$17,270.50mn Blade & Soul 2 (2H20), Lineage 2M (2H20, Japan & Taiwan), Aion 2 (2021), Outstanding shares (common) 22.0mn and Project TL (2021, PC/console/mobile), the company’s new game 52W high (’20/07/02) W964,000 low (’19/07/03) W468,500 momentum looks to be entering full swing. Believing that it still boasts Average trading value (60D) US$75.08mn significant drivers of positive momentum, including: 1) the entering of a high Dividend yield (2020E) 0.64% OP growth cycle, with OP rising from W479bn in 2019 to W998.1bn (+108.4% Foreign ownership 52.0% y-y) in 2020E and W1.51tn (+51.2% y-y) in 2021F; 2) PC/mobile/console Major shareholders platform expansion; and 3) Korea/global business growth, we expect NCSOFT’s TJ Kim & 9 others 12.0% share price to continue climbing despite its recent sharp increase. NPS 11.5% Share perf 3M 6M 12M Absolute (%) 45.9 67.1 101.5 Low valuations vs those of global competitors Relative (%p) 17.0 68.9 96.2 2019 2020E 2021F 2022F We believe that concerns towards NCSOFT, such as its long break between new Sales 1,701 2,839 3,709 3,983 game launches, high revenue exposure to the domestic market, and slow Chg -0.8 66.9 30.6 7.4 platform expansion, will ease gradually from 2H20. And, in our view, there is no OP 479.0 998.1 1,509 1,615 longer any justification for the firm to be undervalued versus global competitors. Chg -22.1 108.4 51.2 7.0 In particular, given its global top-tier development capabilities, we think that OPM 28.2 35.2 40.7 40.5 NCSOFT deserves valuations on par with the highest among global peers. For NP 358.2 811.0 1,217 1,317 reference, NCSOFT’s 2021F P/E sits at just 17.0x, significantly below that of EPS 16,320 36,942 55,412 59,968 Netmarble (25.5x), EA (26.7x), Blizzard (25.6x), and NetEase (21.0x). Chg -14.4 126.4 50.0 8.2 P/E 33.1 25.6 17.0 15.7 P/B 4.8 6.5 4.9 3.8 2Q20 preview: A phase of rest EV/EBITDA 21.0 18.6 11.9 10.6 We expect NCSOFT to log 2Q20 sales of W617.3bn (+50.3% y-y, -15.6% q-q) ROE 14.7 28.5 32.7 27.2 and OP of W214.1bn (+65.5% y-y, -11.3% q-q), with OP falling short of both Debt/equity 33.2 25.6 20.7 17.4 our previous estimate of W249.8bn and the consensus of W254.1bn. Having Net debt -719.7 -1,258 -2,139 -2,984 come in lackluster in June, the firm’s earnings should recover from July, backed Unit: Wbn, %, won, x Note 1: NP excludes minority interests by the third-anniversary update for Lineage M and Chronicle 3 update for Note 2: EPS, P/E, P/B, ROE based on NP (excl minority interests) Lineage 2M (in progress from July). Source: NH I&S Research Center estimates 2Q20 preview (Unit: Wbn, %) 2Q20E 2Q19 3Q19 4Q19 1Q20 3Q20F Actual y-y q-q Estimate Consen Sales 410.8 397.8 533.8 731.1 617.3 50.3 -15.6 684.4 645.3 651.3 OP 129.4 128.9 141.2 241.4 214.1 65.5 -11.3 249.8 254.1 220.8 OPM 31.5 32.4 26.4 33.0 34.7 - - 36.5 39.4 33.9 Pre-tax profit 147.1 153.2 97.6 255.6 229.8 56.2 -10.1 266.1 264.3 235.2 NP (excl minority Jaemin Ahn, Analyst 116.4 113.3 54.2 195.5 175.6 50.9 -10.1 203.4 198.2 179.9 interests) 822)768-7647, [email protected] Note: K-IFRS consolidated basis; Source: NCSOFT, FnGuide, NH I&S Research Center estimates NCSOFT www.nhqv.com Summary Founded in Mar 1997, NCSOFT was listed in May 2003. As a leading domestic mobile and online game developer, the firm booked 2019 sales of W1,705.7bn (-0.8% y-y), with game sales representing about 94% (mobile: 81.1%, PC: 18.9%) of its total revenue. Thanks to the Nov 2019 launch of Lineage 2M (sequel to 2017’s Lineage M) and the planned release of B&S 2 in 2020, the firm’s top line should enjoy strong growth. We present a Buy rating and TP of W1,270,000. Share price drivers/earnings momentum Downside risks B&S 2 launch in 2020 High dependency on domestic market due to lack of global hit games Rising game playtime in line with slowing in outside activity amid the spread of Covid-19 Globally competitive game development capabilities sufficient to roll out cloud-based games Cross valuations (Unit: x, %) Historical valuations (Unit: x, %) P/E P/B ROE Company Valuations 2018 2019 2020E 2021E 2022F 2020E 2021F 2020E 2021F 2020E 2021F Tencent 38.6 31.1 8.3 6.6 22.2 22.1 P/E 24.5 33.1 25.6 17.0 15.7 Activision Blizzard 28.2 25.6 4.2 3.6 15.9 14.5 P/B 4.3 4.8 6.5 4.9 3.8 Electronic Arts 9.6 26.7 3.9 4.8 47.5 18.4 P/S 6.0 7.0 7.3 5.6 5.2 Zynga 39.1 30.6 5.3 4.5 7.4 16.4 ROE 16.4 14.7 28.5 32.7 27.2 NetEase 24.1 21.0 5.0 4.3 20.8 20.2 ROIC 47.7 27.0 64.0 85.7 80.5 Source: Bloomberg, NH I&S Research Center Source: Bloomberg, NH I&S Research Center ESG index (Unit: %, Wbn, yrs, hours, 1000 TJ, mntCO2e, mn tons) BOD composition Human resources 2017 2018 2019 Kim Taek-jin President, CEO, BOD chair Inside Portion of female employees 30.7 31.6 31.9 Park Byeong-mu Compensation Committee chair Inside Portion of contract workers 5.0 4.3 3.1 Audit Committee chair, Outside Director Candidate Hwang Chan-hyeon Outside Average service period per employee 4.8 5.2 5.4 Recommendation Committee chair Hyeon Dong-hun - Outside Average training hours per employee N/A N/A N/A Cho Guk-hyeon - Outside Baek Sang-hun - Outside Environment 2017 2018 2019 Choi Young-joo - Outside Energy consumption N/A N/A N/A Greenhouse gas emissions N/A N/A N/A Recycled water consumption N/A N/A N/A Recycled waste N/A N/A N/A Source: NCSOFT, NH I&S Research Center ESG events E - - N/A - Outsourced tasks related to graphic development and character goods production to 30 outside contractors without properly 2017.2 S signing contract sheets 2015.3 - Reaped unjust gains in the process of selecting vendor companies - Nexon expanded its stake in NCSOFT to 15.08%, a development that highlighted the possibility of a hostile takeover; to protect G 2014.10 its management rights, NCSOFT decided to conduct a stake exchange with Netmarble (which has since come to own an 8.9% stake in NCSOFT) Source: NCSOFT, NH I&S Research Center 2 NCSOFT www.nhqv.com NCSOFT’s new Despite the recent sharp rise in NCSOFT’s share price, we see plenty of additional game momentum to upward momentum in play. enter full swing We believe that the success of Lineage M and Lineage 2M—titles released in 2017 and 2019, respectively, which continue to lead app store gross sales rankings—has proven NCSOFT’s competitiveness in the mobile game market. In addition, the company’s new game momentum looks to be entering full swing, given the anticipated launches of: 1) Blade & Soul 2 and Lineage 2M (Taiwan, Japan) in 2H20; and 2) Aion 2 and Project TL (PC, console, mobile versions) in 2021. Overall, the company appears to be striving to shorten the break between new game launches and diversify its game lineups. Expanding its Moreover, NCSOFT is set to strengthen its non-MMORPG lineup. Specifically, PC/mobile/console NCSOFT’s US subsidiary NCWEST is planning to roll out Fuser, a new console/PC platform offerings platform music game developed by Harmonix and published by NCSOFT in autumn of this year. NCSOFT has also unveiled three game titles developed by its domestic subsidiary, Ntreev Soft—Trickster M (MMORPG), Pangya M (sports), and Pro Baseball H3 (sports). Regarding Project TL, for which a closed beta test is planned this year, console, PC, and mobile versions are to be launched. Of note, NCSOFT is also conducting two~three additional console game projects. Earnings to enter Helped by a series of new game launches, NCSOFT’s earnings are predicted to enter a strong upcycle robust upcycle.