NCsoft (036570 KS) Buy low in 1H and sell high in 2H Games Earnings to be weak in 1H but strong in 2H During January and February, the average total time spent per day on NCsoft games Company Update remained relatively resilient compared to 4Q14 data. Daily average figures were up 0.2% March 11, 2015 and 3.3% (vs. 4Q14), respectively, for Lineage I and Aion , and down 7.8% and 8.7%, respectively, for Lineage II and Blade & Soul . We forecast 1Q15 revenue at W179bn (+0.4% YoY). More specifically, we project (Maintain) Buy Lineage I revenue to jump 50.4% YoY to W62bn, buoyed by a microtransaction event held in February. Target Price (12M, W) 240,000 We expect 1Q15 operating profit of W52bn (+15.9% YoY). Overall operating expenses Share Price (3/10/15, W) 171,500 should decline on the removal of several items, including pro baseball team-related expenses as well as the bonus payouts and G-Star marketing spend seen in 4Q14. Expected Return 40% New release momentum concentrated in 2H The second beta test for Blade & Soul China mobile as well as beta tests for Lineage OP (15F, Wbn) 311 Eternal and Master X Master (MXM ) are anticipated to take place in early 2Q. The release Consensus OP (15F, Wbn) 310 schedule for the Guild Wars 2 expansion pack should also become clear in 2Q. Guild EPS Growth (15F, %) 22.5 Wars 2 has so far sold 4.6mn copies since its debut in August 2012, with around 2.5mn Market EPS Growth (14F, %) -1.9 copies sold in its first year of release. Meanwhile, a mobile version of Aion and the P/E (15F, x) 13.5 mobile and PC versions of MXM are expected to hit the market in 2H. Market P/E (14F, x) 13.7 KOSPI 1,984.77 Further pullback would raise likelihood of Nexon assuming control NCsoft’s stock has been falling ever since its 4Q14 earnings release, weighed down by 1) Market Cap (Wbn) 3,761 worries that the company may have overpaid for Netmarble shares in its recent share Shares Outstanding (mn) 22 swap, 2) concerns over 1H15 earnings, 3) a lack of new game momentum, and 4) the Free Float (%) 84.9 waning of M&A expectations ahead of the March 27 th general shareholders’ meeting. Foreign Ownership (%) 38.9 Beta (12M) 0.42 Earnings and new release momentum will be concentrated in the second half of this 52-Week Low 123,500 year, as was the case in 2013 and 2014. We believe the current management will focus 52-Week High 227,500 on preparing for next year’s annual general meeting in March (when the terms of many (%)(%)(%) 1M1M1M 6M6M6M 12M12M12M executive board members are set to end), or for any special meeting that could be called Absolute -20.0 17.9 -16.1 by Nexon. Relative -22.0 21.7 -17.4 NCsoft’s dividend yield would be 2% based on its 2014 DPS of W3,430 and the current 130 NCsoft KOSPI share price. The company also has W1.9tr in assets, including W800bn in cash, W700bn in real estate and W380bn in Netmarble shares, and generates a cash flow of over 110 W200bn every year. 90 Against this backdrop, the company’s major shareholders are vying for control . 70 Regardless, the stock has so far failed to gain upside m omentum. We recommend 50 3.14 7.14 11.14 3.15 buying on the cheap in 1H in light of expectations for positive earnings and new release momentum in 2H. We reiterate our Buy call and target price of W240,000. Daewoo Securities CCo.,o., Ltd. FY (Dec.) 12/11 12/12 12/13 12/14 12/15F 12/16F Revenue (Wbn) 609 754 757 839 921 1,067 [Internet/Game/Entertainment] OP (Wbn) 136 151 205 278 311 353 Chang-kwean Kim OP margin (%) 22.3 20.0 27.1 33.1 33.8 33.1 +822-768-4321 NP (Wbn) 121 156 159 228 279 303 [email protected] EPS (W) 5,529 7,120 7,245 10,378 12,710 13,806 ROE (%) 14.6 16.8 14.8 18.2 19.1 18.1 Jeong-yeob Park +822-768-4124 P/E (x) 55.6 21.1 34.3 17.5 13.5 12.4 [email protected] P/B (x) 7.0 3.0 4.4 2.7 2.3 2.0 Notes: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, KDB Daewoo Securities Research estimates Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. March 11, 2015 NCsoft Share price drivers Table 111.1. Key variables Variables Base case Release dates for and performances of new mobile games 2Q-3Q15 Results of Lineage Eternal beta test 1H15 Release date and performance of Guild Wars 2 expansion pack 2H15 Performances of existing games Management issues - 2015 shareholders’ meeting: another term for CEO Kim Taek- jin No movement until 2016 - 2016 shareholders’ meeting: terms of five of seven executive board members to end Source: KDB Daewoo Securities Research Table 222.2. Scenario analysis Share price scenario Potential ddriversriversriversrivers Impact Mobile games released without delay; better-than-expected sales NCsoft management to remain strong Rise (above W250,000) Successful beta testing for Lineage Eternal → Nexon could sell off its shares Guild Wars 2 sales volume in excess of 3mn copies Mobile games fail to generate meaningful revenue Lineage Eternal beta testing in 1H15 Institutional investors and foreign investors could Flat Guild Wars 2 sales volume of around 2mn copies support management control by Nexon Revenue from existing games remains at the 2014 level Delays to mobile game releases; sales fall short of expectations Delays or negative feedback to Lineage Eternal beta testing Board to be dominated by Nexon (with the Fall Guild Wars 2 expansion pack release delayed to 2016 support of institutional and foreign investors) Guild Wars 2 sales volume below 2mn copies Source: KDB Daewoo Securities Research Figure 111.1. Shareholding structure of NCsoft Kim Taek-jin + Netmarble Games: 18.9% vs. Nexon: 15.1% Nexon 15.1% Less than 1% Kim Taek-jin 54.2% 10.0% Netmarble Games 8.9% NPS BlackRock 6.9% 1.9% Vanguard 1.0% JP Morgan Asset Management Norges Bank 1.0% 1.0% Source: Bloomberg, Company data, KDB Daewoo Securities Research KDB Daewoo Securities Research 2 March 11, 2015 NCsoft Figure 222.2. NexonNexon’’’’ss revenue breakdown by region (JPYbn) 200 Other North America Japan 150 Korea China 100 50 0 2009 2010 2011 2012 2013 2014 Source: Company data, KDB Daewoo Securities Research Figure 333.3. NexonNexon’’’’ss quarterly earnings (JPYbn) 55 Revenue Operating profit 45 35 25 15 5 -5 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 Source: Company data, KDB Daewoo Securities Research Figure 444.4. Market cap trends of NCsoft and Nexon (Wtr) (JPYtr) 8 NCsoft (L) 0.8 Nexon (R) 6 0.6 4 0.4 2 0.2 0 0 1/12 4/12 7/12 10/12 1/13 4/13 7/13 10/13 1/14 4/14 7/14 10/14 1/15 Source: Thomson Reuters, KDB Daewoo Securities Research KDB Daewoo Securities Research 3 March 11, 2015 NCsoft Earnings and forecasts TableTableTable 333.3. Quarterly and annual earnings (Wbn, %) 1Q141Q141Q14 2Q142Q142Q14 3Q143Q143Q14 4Q144Q144Q14 1Q15F 2Q15F 3Q15F 4Q15F 201320132013 201420142014 2015F2015F2015F Revenue 178 214 212 235 179 181 279 283 757 839 921 Lineage 41 57 69 97 62 63 67 64 288 263 256 Lineage II 12 14 15 19 13 13 13 16 57 59 56 Aion 22 18 33 21 19 19 26 21 96 94 85 Blade & Soul 19 19 20 25 20 20 20 21 69 83 79 Guild Wars 2 25 22 20 19 17 14 84 74 123 86 189 WildStar - 28 16 5 2 2 2 3 - 50 11 MXM - - - - - - 20 32 - - 52 Royalties 45 38 22 32 27 29 26 27 66 137 110 Other 14 18 18 16 18 21 21 24 58 67 83 Revenue breakdown Lineage 23.0 26.6 32.4 41.1 34.5 34.7 23.9 22.8 38.0 31.4 27.7 Lineage II 6.5 6.3 7.0 8.3 7.5 7.5 4.8 5.7 7.6 7.1 6.1 Aion 12.5 8.6 15.6 8.9 10.6 10.5 9.3 7.5 12.7 11.3 9.2 Blade & Soul 10.8 8.9 9.3 10.5 10.9 10.8 7.0 7.3 9.1 9.9 8.6 Guild Wars 2 14.1 10.4 9.3 8.2 9.5 7.8 30.1 26.0 16.3 10.2 20.5 WildStar - 13.1 7.6 2.3 1.4 1.4 0.9 1.1 - 5.9 1.2 MXM - - - - - - 7.2 11.5 - - 5.7 Royalties 25.0 17.6 10.5 13.8 15.3 15.8 9.4 9.6 8.7 16.3 11.9 Other 8.1 8.4 8.3 6.9 10.2 11.5 7.4 8.4 7.6 8.0 9.1 Operating expenses 134 149 130 148 127 133 171 179 551 561 610 Operating profit 45 65 81 87 52 47 108 104 205 278 311 OP margin (%) 25.0 30.4 38.4 37.2 28.8 26.1 38.8 36.8 27.1 33.2 33.8 Net profit 37 53 76 62 45 42 93 99 159 227 279 Net margin (%) 20.5 24.8 35.8 26.5 25.0 23.1 33.3 35.1 21.0 27.1 30.2 YoY growth Revenue -3.6 11.4 24.7 12.0 0.4 -15.6 32.0 20.2 0.4 10.8 9.9 Lineage -37.9 -32.9 10.0 29.4 50.4 10.2 -2.6 -33.4 40.3 -8.6 -2.9 Lineage II -18.5 -5.1 13.7 25.1 16.2 -0.7 -9.2 -17.6 -12.2 4.1 -5.1 Aion -21.4 -21.1 45.7 -3.2 -14.8 3.2 -21.3 1.8 -32.2 -1.4 -9.9 Blade & Soul 16.5 35.2 -2.7 37.4 1.8 2.3 -0.9 -15.6 10.8 20.1 -3.9 Guild Wars 2 -30.9 -23.1 -19.6 -42.6 -32.1 -36.7 327.1 281.6 -25.2 -30.6 120.4 WildStar - - - - - -91.1 -84.5 -41.2 - - -78.4 Royalties 314.9 188.4 125.9 0.3 -38.5 -24.1 18.3 -15.9 2.9 107.5 -19.9 Other 13.1 32.8 2.8 13.4 27.1 15.1 17.9 45.8 13.8 15.9 24.7 Operating profit -19.8 4.3 164.7 54.0 15.9 -27.5 33.3 19.0 35.7 35.5 11.8 Net profit -30.1 54.8 187.9 36.4 22.3 -21.3 22.8 59.2 3.2 43.4 22.5 Note: All figures are based on consolidated K-IFRS Source: Company data, KDB Daewoo Securities Research estimates Table 444.4.