August 16, 2010 Korea ă Equity Research NCsoft (036570 KS) Game Chang Kwean Kim +822-768-4321 [email protected] Jee-Hyun Moon +822-768-3615 [email protected] New games to drive share price Buy (Maintain) Bloomberg: 036570 KS Target Price (12M, W): 280,000 2Q sales up 27.2% YoY as Lineage1 becomes popular again Share Price (08/13/10, W): 204,000 NCsoft’s 2Q10 sales jumped 27.2% YoY as the rejuvenation of its oldest game (12-years Expected Return (%): 37.3 old) Lineage1 eclipsed weak seasonality and the negative effect of the World Cup. Revenue Sector: Game from Lineage1 rose again thanks to robust sales of game-related items (micro-transactions). Sector Rating: Overweight On a parent-basis, 2Q sales of Lineage1 outpaced that of Aion. Operating profit surged EPS Growth (10F, %): 17.0 43.7% YoY in 2Q, but net profit fell 12.7% YoY because the company booked W33bn in one- time charges related to the defeat of a lawsuit against its former game developer Richard Market EPS Growth (10F, %): 68.1 Garriott. P/E (X): 20.4 Market P/E (08/13/10F, x): 9.2 3Q10F Sales to increase 2.2% QoQ Market Cap (Wbn): 4,447 Shares Outstanding (mn): 22 We forecast the company’s 3Q10 sales will increase 2.2% QoQ in the absence of new game launches. Profit margin will decline only marginally QoQ due to an increase in labor costs. Avg Trading Volume (60D, '000): 187 Net profit is forecast to rebound to W59.6bn because the company booked all of the one-time Avg Trading Value (60D, Wbn): 37 charges related to the legal battle with Richard Garriot in 2Q10. Furthermore, equity method Margin Balance ('000 sh): 107 gains should steadily flow from overseas subsidiaries. In 2H10, the company will try to apply Dividend Yield (10F, %): .2 the micro-transaction model to other games, such as Lineage2 and Aion. Free Float (%): 65.2 52-Week Low/High: 116,000/213,500 Guild Wars 2 to hit market with fanfare; Maintain Buy Beta (12M, Daily Rate of Return): 1.0 The share price should respond positively to promotional events in 3Q for new games, such Price Return Volatility (12M Daily,%,SD): 2.9 as Guild Wars2 and Blade and Soul. The shares rallied in August 2009 when it first Foreign Ownership (%): 29.4 introduced Guild Wars2 at GamesCom in Germany and in November when it revealed an early version of Blade and Soul at G-Star in Korea. NCsoft is scheduled to go to GamesCom Major Shareholder(s): in August and the U.S. conference PAX in September to show how well Guild Wars2 has TJ Kim and et. al (25.45%) developed thus far. The new games have long been anticipated to hit the market with fanfare Treasury stock (9.36%) in 2011 given the favorable reviews they have received to date. We maintain our Buy Call Mirae Asset Mgmt. and et. al (8.91%) and target price of W280,000 on the counter. Price Performance Guild Wars2 is being developed by NCsoft’s wholly-owned U.S. subsidiary ArenaNet. NCsoft (%) 1M 6M 12M sold 6.5mn copies of Guild Wars1 globally. Guild Wars2 holds the highest rating in Absolute 3.3 61.3 54.5 MMORPG.COM, the official MMORPG community. Relative 2.6 51.7 42.9 Share price FY Sales OP OP MarginNP EPS EBITDAFCF ROE P/E P/B EV/EBITDA 180 KOSPI (Wbn) (Wbn) (%) (Wbn) (W) (Wbn)(Wbn) (%) (x) (x) (x) 160 12/08 240 46 19.0 27 1,334 57 10 6.4 39.4 2.6 15.6 140 120 12/09 453 200 44.1 183 8,560 213 234 34.8 17.5 5.1 13.3 100 12/10F 548 289 52.7 218 10,013 301 195 29.8 20.4 5.4 12.7 80 12/11F 748 438 58.5 403 18,496 449 338 39.2 11.0 3.6 7.6 60 12/12F 1,112 672 60.4 538 24,669 683 573 36.1 8.3 2.5 4.2 40 8/09 12/09 4/10 8/10 Source: Company data, Daewoo Securities Research estimates Please read carefully important notices at the end of this report. August 16, 2010 NCsoft Figure 1. NCsoftÊs share price after the unveiling of Guild Wars 2 at GamesCom 2009 (W) 200,000 180,000 GamesCom 2009 (Aug 17-23): Guild Wars2 was unveiled; Aion named best game 160,000 140,000 120,000 100,000 7/1/09 7/15/09 7/29/09 8/12/09 8/26/09 9/9/09 9/23/09 Source: Thomson Reuters, Daewoo Securities Research Figure 2. NCsoftÊs share price after the unveiling of Blade and Soul at G-Star 2009 (W) 180,000 G-Star Premier (Nov 24): NCsoft unofficially unveiled Blade and Soul 160,000 140,000 G-Star in Busan (Nov 26-29): NCsoft introduced 120,000 Blade & Soul 100,000 10/1/09 10/15/09 10/29/09 11/12/09 11/26/09 12/10/09 12/24/09 Source: Thomson Reuters, Daewoo Securities Research Figure 3. Guild Wars 2 holds the highest rating among MMORPG Source: MMORPG.COM Daewoo Securities Research 2 August 16, 2010 NCsoft Table 1. Quarterly and annual earnings trend and forecast (Wbn, %) 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10F 4Q10F 2008 2009 2010F Sales 103 104 106 139 132 133 136 148 240 453 548 Lineage 1 25 21 21 44 43 48 49 51 102 111 190 Lineage 2 20 18 21 22 17 16 17 24 84 80 75 Aion 43 39 36 40 45 42 43 44 10 158 174 Overseas 14 25 26 30 24 25 27 28 42 96 105 Sales breakdown Lineage 1 24.7 20.0 19.7 31.8 32.4 35.7 35.8 34.4 42.6 24.6 34.6 Lineage 2 19.2 16.9 19.6 15.6 13.2 12.0 12.4 16.5 35.2 17.7 13.6 Aion 41.4 37.5 34.3 28.8 34.1 31.9 31.6 29.9 4.0 35.0 31.8 Overseas 13.5 24.2 24.6 21.9 18.1 18.7 20.2 19.2 17.7 21.2 19.1 Operating profit 43 48 40 68 71 69 69 80 46 200 289 OP margin 42.1 45.9 37.6 49.2 53.7 51.8 51.0 54.3 19.0 44.1 52.7 Pretax profit 45 46 50 86 75 40 76 90 37 227 282 Pretax margin 43.9 43.9 47.4 61.8 57.1 30.4 56.2 60.8 15.5 50.2 51.4 Net profit 35 35 43 70 58 30 60 70 27 183 218 Net margin 33.7 33.3 40.5 50.4 44.1 22.9 43.9 47.5 11.4 40.3 39.8 YoY growth Sales 71.6 84.8 91.7 103.4 28.1 27.2 28.1 6.3 7.9 88.4 21.2 Lineage 1 -7.2 -17.3 -16.6 78.8 68.3 127.1 132.8 15.3 -2.9 8.7 70.4 Lineage 2 -10.1 -16.7 -0.3 6.5 -12.3 -10.0 -18.8 12.2 -0.6 -5.3 -6.8 Aion 313.1 5.8 8.0 17.9 10.4 1,464.1 1,534.0 10.3 Overseas 36.3 161.1 191.6 124.2 71.2 -1.5 5.0 -6.9 34.5 125.6 9.2 Operating profit 215.6 439.4 291.6 435.5 63.8 43.7 73.4 17.3 -2.8 337.8 45.0 Pretax profit 406.7 409.8 525.1 656.9 66.9 -12.1 51.9 4.6 -36.0 509.0 24.1 Net profit 330.6 468.4 756.7 763.8 67.5 -12.7 38.7 0.0 -39.4 568.2 19.6 QoQ growth Sales 51.1 1.3 1.5 31.0 -4.8 0.6 2.2 8.7 Lineage 1 3.1 -17.8 -0.1 111.0 -2.9 11.0 2.4 4.5 Lineage 2 -2.7 -11.0 17.7 4.4 -19.9 -8.6 6.3 44.2 Aion 340.5 -8.1 -7.2 10.0 12.8 -6.1 1.2 3.0 Overseas 3.1 81.2 3.2 16.3 -21.3 4.2 10.0 3.1 Operating profit 239.8 10.5 -16.7 71.2 3.9 -3.0 0.5 15.8 Pretax profit 298.7 1.5 9.6 70.7 -12.1 -46.6 89.3 17.6 Net profit 328.9 0.1 23.4 63.1 -16.8 -47.8 96.0 17.6 Source: Company data, Daewoo Securities Research Table 2. 2010~2011 Earnings forecast revisions (Wbn, W, %, %p) Previous Revised %Diff. 2010F 2011F 2010F 2011F 2010F 2011F Sales 540 709 548 748 1.5 5.5 Operating profit 287 389 289 438 0.7 12.6 Net profit 254 387 218 403 -14.2 4.1 EPS 11,658 17,740 10,013 18,496 -14.1 4.3 OP margin 53.3 54.9 52.7 58.5 -0.6 3.6 Net margin 47.1 54.5 39.8 53.9 -7.3 -0.6 Source: Daewoo Securities Research Estimates Daewoo Securities Research 3 August 16, 2010 NCsoft Table 3.