Kakao Corp. (035720 KS ) Focus on value of content and fintech Internet 2Q18 review: Revenue and OP in line with consensus Results Comment Kakao reported 2Q18 earnings results that were broadly in line with consensus expectations. August 10, 2018 Positives: Consolidated revenue grew 26% YoY. In the content segment, PC game revenue roughly doubled YoY, boosted by the switch to paid services at PC cafes for PlayerUnknown's Battlegrounds . The company’s webtoon businesses, KakaoPage and Japan-based Piccoma, recorded robust growth of 55% and 254% YoY, respectively. Commerce revenue also (Upgrade) Buy expanded 52% YoY. Labor and marketing expenses were lower than expected. Negatives: Ad revenue grew 10% YoY, slower than the rate in 1Q18. In the content Target Price (12M, W) ▲ 150,000 segment, mobile game revenue was weaker than anticipated. Operating profit slumped 38% YoY, as operating expenses surged 32% YoY, outpacing revenue growth. In particular, Share Price (08/09/18, W) 125,500 content commissions as a percentage of content revenue was higher than expected. Expected Return 20% Value of content business to come into focus in near term Games: Kakao Games is preparing to go public on KOSDAQ by the end of the year. We forecast Kakao’s consolidated game revenue to reach W457bn in 2018 and W514bn in 2019. OP (18F, Wbn) 102 Based on the proposed IPO price range, Kakao Games’ market value is expected to range Consensus OP (18F, Wbn) 120 between W1.2tr and W1.9tr. Key drivers of revenue growth this year are: 1) the launch of EPS Growth (18F, %) -22.4 paid services for the PC game PlayerUnknown's Battlegrounds ; and 2) a greater number o f Market EPS Growth (18F, %) 10.1 mobile title releases. As of end-March, Kakao held a 61.7% stake in Kakao Games. P/E (18F, x) 101.0 Webtoons: KakaoPage and Piccoma are generating stronger-than-expected revenues. Market P/E (18F, x) 9.0 We believe their business models—i.e., ”wait then free,” paid content, and KOSPI 2,303.71 advertising—are working well. The successful development of the webtoon What’s Market Cap (Wbn) 9,574 Wrong with Secretary Kim into a TV show is also encouraging. Looking ahead, we Shares Outstanding (mn) 76 expect revenue to accelerate, driven by VOD distribution, IP-related projects, and Free Float (%) 64.4 overseas business expansion. Foreign Ownership (%) 24.9 Entertainment: After its merger with Kakao M in September, Kakao intends to spin off Beta (12M) 1.85 its music/video content business (not including the Melon platform). In June, Kakao M 52-Week Low 103,500 made stake acquisitions in BH Entertainment, J Wide Company, a nd Ready 52-Week High 161,000 Entertainment, and also established a strategic partnership with Soop Management. Given that the existing Kakao M was mostly valued for the Melon platform, we believe (%) 1M 6M 12M the entertainment/production business could be properly valued following the spinoff. Absolute 6.8 6.4 15.7 Relative 6.0 9.1 18.9 Focus on value of fintech business in the medium/long term 150 Kakao Corp. KOSPI We view the following as positive to Kakao’s fintech business: 1) the move to ease 130 regulations on the separation of financial and non-financial capital; and 2) the proliferation of offline QR code payments. We believe that policy tailwinds will help 110 bolster monetization at Kakao Bank and Kakao Pay. 90 Upgrade to Buy (from Trading Buy) and raise TP to W150,000 (from W130,000) 70 We upgrade our rating on Kakao to Buy and raise our target price to W150,000. We 8.17 12.17 4.18 8.18 believe the value of the content business will come into focus in the near term and expect the fintech business to bolster growth over the medium and long term. Mirae Asset Daewoo Co., Ltd. [ Internet/Game/Advertising ] FY (Dec.) 12/15 12/16 12/17 12/18F 12/19F 12/20F Revenue (Wbn) 932 1,464 1,972 2,417 2,813 3,115 Jee -hyun Moon +822 -3774 -1640 OP (Wbn) 89 116 165 102 171 185 [email protected] OP margin (%) 9.5 7.9 8.4 4.2 6.1 5.9 NP (Wbn) 76 58 109 94 150 159 EPS (W) 1,269 874 1,602 1,243 1,972 2,089 ROE (%) 3.0 1.9 2.9 2.0 2.8 2.9 P/E (x) 91.2 88.1 85.5 101.0 63.6 60.1 P/B (x) 2.7 1.5 2.3 1.8 1.8 1.7 Dividend yield (%) 0.1 0.2 0.1 0.1 0.1 0.1 Note: 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 August 10, 2018 Kakao Corp. Earnings review and forecast Table 1. 2Q18 review (Wbn, %) 2Q18P Growth 2Q17 1Q18 Mirae Asset Preliminary Consensus YoY QoQ Daewoo Revenue 468 555 589 590 589 25.7 6.0 Operating profit 45 10 28 17 29 -38.1 165.2 OP margin (%) 9.5 1.9 4.7 2.9 4.9 Net profit 13 15 25 29 31 103.8 74.0 Notes: All figures are based on consolidated K-IFRS; net profit is attributable to controlling and non-controlling interests Source: Company data, FnGuide, Mirae Asset Daewoo Research estimates Table 2. Earnings trends and forecasts (Wbn, %) 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18P 3Q18F 4Q18F 2017 2018F 2019F Revenue 444 468 515 545 555 589 618 655 1,972 2,417 2,813 1) Ads 133 151 151 160 155 166 168 176 596 665 742 1-1) PC 63 70 64 65 59 65 62 65 267 251 241 1-2) Mobile 71 82 88 94 96 101 105 112 334 415 502 2) Content 224 236 261 266 286 303 315 333 985 1,237 1,427 2-1) Game 80 79 94 89 106 112 116 124 342 457 514 2-2) Music 110 118 122 129 126 130 135 140 479 532 593 2-3) Other 33 39 45 48 54 61 65 69 165 249 321 3) Other 87 83 102 119 115 120 135 145 391 515 643 Operating profit 38 45 47 35 10 28 30 34 165 102 171 OP margin 8.6 9.5 9.2 6.4 1.9 4.7 4.9 5.1 8.4 4.2 6.1 Net profit 54 13 40 21 15 25 42 26 125 108 173 Net margin 12.3 2.7 7.7 3.8 2.6 4.3 6.8 3.9 6.3 4.5 6.1 YoY growth Revenue 83.0 24.4 31.7 20.0 25.2 25.7 19.8 20.2 34.7 22.5 16.4 1) Ads 3.0 11.2 19.4 12.8 16.0 9.9 10.8 10.6 11.6 11.7 11.6 1-1) PC -12.0 -5.3 2.3 -3.7 -6.2 -6.8 -2.0 -1.3 -3.0 -6.0 -4.0 1-2) Mobile 21.3 30.5 35.7 27.9 35.7 24.1 20.0 18.8 29.0 24.0 21.0 2) Content 144.1 24.1 31.8 20.0 27.7 28.1 20.5 25.4 40.4 25.5 15.4 2-1) Game 14.2 0.5 19.7 -4.3 31.5 41.9 23.1 39.2 6.8 33.6 12.4 2-2) Music 3164.8 30.5 27.7 20.6 14.5 10.4 10.4 8.6 61.5 11.1 11.6 2-3) Other 84.4 78.6 86.5 122.9 62.9 57.2 42.6 45.3 93.3 50.7 29.0 3) Other 303.5 65.6 54.9 31.3 32.7 44.9 31.5 21.6 71.3 31.6 25.0 Operating profit 81.8 67.5 56.5 -8.8 -72.9 -38.1 -35.9 -3.2 42.1 -38.2 68.2 Net profit 397.5 -5.6 192.8 -25.2 -73.1 103.8 5.4 25.1 91.0 -13.6 60.1 Notes: All figures are based on consolidated K-IFRS; Game (2-1) revenue includes Kakao VX from 1Q18; other content (2-3) revenue includes webtoons, web novels, and emoticons; other (3) revenue includes commerce, Kakao Friends, Pay, and Mobility; net profit is attributable to controlling and non-controlling interests Source: Company data, Mirae Asset Daewoo Research estimates Table 3. Earnings forecast revisions (Wbn, W, %) Previous Revised % chg. Notes 18F 19F 18F 19F 18F 19F Ad estimates revised down ward; other revenue Revenue 2,446 2,806 2,417 2,813 -1.2 0.2 estimates revised upward Operating profit 100 176 102 171 2.0 -2.6 Content commission estimates revised up ward Non -operating income estimates revised Net profit 113 167 108 173 -4.4 3.6 downwards , effective tax rate revised upwards EPS (W) 1,297 1,900 1,243 1,972 -4.2 3.8 OP margin 4.1 6.3 4.2 6.1 Net margin 4.6 6.0 4.5 6.1 Notes: All figures are based on consolidated K-IFRS; net profit is attributable to controlling and non-controlling interests; EPS is attributable to controlling interests Source: Mirae Asset Daewoo Research estimates Mirae Asset Daewoo Research 2 August 10, 2018 Kakao Corp.