Kakao (035720 KS ) Time to show its strength Internet 3Q19 review: Slightly above our estimates Company Report For 3Q19, Kakao announced revenue of W783.2bn (+31% YoY) and operating profit of November 8, 2019 W59.1bn (+93% YoY), slightly exceeding our expectations (W760bn and W58 bn, respectively). Earnings improved thanks to: 1) the recognition of new revenue from KakaoTalk chat tab ads (product name: Bizboard); 2) strong paid cont ent revenue (KakaoPage, (Maintain) Buy KakaoMusic); and 3) revenue growth in New Biz (KakaoPay and Kakao Mobility) . Notably, revenue from Talk Biz (KakaoTalk-related revenue) grew 52% YoY, driven by Target Price (12M, W) ▲ 185,000 brisk ad sales. OP margin was 7.5%, the highest level since 3Q17. Labor expenses increased by W15bn Share Price (11/07/19, W) 151,000 QoQ due to Chuseok bonus payments and payments for unused vacation time. Despite the increase in the absolute amount of labor expenses and active investments in new Expected Return 23% businesses, we believe the earnings structure began to stabilize in 3Q19. The 3Q19 earnings release confirmed various positive business indicators. Transaction OP (19F, Wbn) 208 volumes for KakaoPage and Japan-based Piccoma, which are Kakao's webtoon services Consensus OP (19F, Wbn) 177 (and potential IPO candidates), increased in 3Q19. During 1Q-3Q19, to tal transaction volume for Kakao’s webtoon services amounted to 160% of the full-year 2018 level. In EPS Growth (19F, %) 226.0 addition, KakaoPay’s transaction volume increased to W12.9tr in 3Q19. Meanwhile, we Market EPS Growth (19F, %) -31.6 expect money transfer fees, a key cost factor, to decline in early 2020 with the P/E (19F, x) 75.6 introduction of the open banking system. Market P/E (19F, x) 14.3 KOSPI 2,144.29 New Biz (mobility and financial product sales) to materialize in 4Q19 Market Cap (Wbn) 12,664 For 4Q19, we forecast Kakao to post revenue of W866bn (+28.6% YoY) and operating Shares Outstanding (mn) 86 profit of W80bn (+1,768% YoY). We expect OP margin to improve markedly in 4Q19, Free Float (%) 66.1 supported by a sharp increase in high-margin KakaoTalk Bizboard sales. Foreign Ownership (%) 29.9 We expect Kakao to fully implement new mobility businesses (Kakao T Blue and Kakao Beta (12M) 0.06 T Venti) and KakaoPay’s insurance business ( jeonse deposit insurance) in 4Q19. 52-Week Low 95,600 52-Week High 151,000 Lift TP to W185,000 (%) 1M 6M 12M In light of the 3Q19 earnings report, we revise up our 2019 and 20 20 revenue forecasts Absolute 12.3 18.4 57.9 by 0.7% and 1.9%, respectively, and our 2019 and 2020 net profit forecasts by 7.1% and Relative 5.9 20.2 53.1 4.0%, respectively, reflecting growing expectations for KakaoTalk chat tab ads in 2020. We maintain our Buy rating on Kakao and lift our target price to W185,000 (from 160 Kakao KOSPI W177,000). Our target price is based on the sum of the values of Kakao’s business 140 segments, derived by applying the average P/S of peers to the revenues of the 120 respective units. 100 80 11.18 3.19 7.19 11.19 Mirae Asset Daewoo Co., Ltd. [ Internet ] FY (Dec.) 12/16 12/17 12/18 12/19F 12/20F 12/21F Revenue (Wbn) 1,464 1,972 2,417 3,088 3,868 4,611 Chang -kwean Kim +822 -3774 -1614 OP (Wbn) 116 165 73 208 495 628 [email protected] OP Margin (%) 7.9 8.4 3.0 6.7 12.8 13.6 NP (Wbn) 58 109 48 168 369 421 EPS (W) 874 1,602 613 1,998 4,290 4,894 ROE (%) 1.9 2.9 1.0 3.2 6.7 7.2 P/E (x) 88.1 85.5 168.0 75.6 35.2 30.9 P/B (x) 1.5 2.3 1.7 2.5 2.3 2.1 Dividend Yield (%) 0.2 0.1 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 November 8, 2019 Kakao Table 1. Quarterly and annual earnings (Wbn, %) 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19F 2018 2019F 2020F Revenue 555 589 599 673 706 733 783 866 2,417 3,088 3,868 Platform 232 251 253 303 313 327 351 395 1,039 1,386 1,822 Talk Biz 89 98 107 128 127 139 162 173 421 601 891 Portal Biz 122 128 116 130 126 137 126 139 495 528 561 New Biz 22 25 30 45 60 51 62 84 123 257 370 Content 323 338 346 370 393 406 432 470 1,378 1,702 2,046 Game 106 112 99 100 94 98 99 116 417 407 425 Music 126 130 136 140 137 145 151 151 533 584 611 Paid content 44 51 60 63 75 82 92 97 218 345 480 IP/other 48 45 50 67 87 82 90 106 209 365 529 Operating profit 10 28 31 4 28 40 59 80 73 208 495 OP margin 1.9 4.7 5.1 0.6 3.9 5.5 7.5 9.3 3.0 6.7 12.8 Net profit 15 22 7 -29 18 31 51 64 16 164 362 Net margin 2.6 3.8 1.2 -4.3 2.5 4.2 6.6 7.4 0.7 5.3 9.4 YoY growth Revenue 25.2 25.7 16.3 23.6 27.2 24.5 30.7 28.5 22.5 27.8 25.3 Platform 29.5 22.9 21.1 30.5 34.8 30.2 38.6 30.5 26.0 33.4 31.5 Talk Biz 78.5 73.7 51.8 56.4 43.3 42.4 51.6 35.3 63.2 42.8 48.2 Portal Biz 3.9 -2.1 -6.2 -1.2 3.9 6.7 9.1 7.0 -1.5 6.6 6.3 New Biz 73.9 49.0 100.7 137.6 171.6 103.0 105.3 84.4 92.7 109.0 44.2 Content 22.2 27.9 13.0 18.5 21.7 20.2 24.9 26.9 20.0 23.5 20.2 Game 31.5 41.9 5.8 12.5 -10.9 -11.9 -0.4 15.2 21.9 -2.4 4.3 Music 14.5 11.4 11.4 8.6 8.7 10.8 11.4 7.8 11.3 9.7 4.6 Paid content 77.4 75.2 69.0 69.1 70.6 60.3 52.0 53.8 72.1 58.2 39.1 IP/other -3.3 13.8 -7.9 17.2 83.7 81.8 78.7 59.3 4.7 74.3 45.0 Operating profit -72.9 -38.1 -35.2 -87.6 166.5 46.6 92.7 1768.0 -55.8 184.8 138.3 OP margin -73.1 79.9 -81.5 TTR 19.9 37.8 596.8 TTB -87.3 932.7 120.9 Source: Company data, Mirae Asset Daewoo Research estimates Table 2. Earnings forecast revisions (Wbn, %) Previous Revised % chg. Notes 2019F 2020F 2019F 2020F 2019F 2020F Revenue 3,068 3,796 3,088 3,868 0.7 1.9 Operating profit 208 483 208 495 -0.1 2.4 Net profit 153 349 164 362 7.1 4.0 OP margin 6.8 12.7 6.7 12.8 - - Net margin 5.0 9.2 5.3 9.4 - - So urce: Mirae Asset Daewoo Research estimates Mirae Asset Daewoo Research 2 November 8, 2019 Kakao Table 3. Valuation (Wbn, W) Business 2018 2019F 2020F Notes Ad revenue 670 877 1,103 Value 4,479 5,885 6,892 Target multiple is in line with the average P /S of global peers; KakaoTalk ad revenue forecast to surge in 2019; valuation re -rating is expected in 2019, as was the case with Facebook back in 2013 Gaming revenue 417 407 425 Value 2,551 2,051 1,855 Target multiple is in line with the 2020F average P/S of Netmarble, NCsoft, and PearlAbyss Music revenue 533 584 611 Value 1,780 1,963 1,663 Target multiple is based on 2020F P/S of Spotify Other content revenue 260 388 525 Value 1,127 1,425 1,624 Target multiple is in line with 2020F P/S of LINE ( LINE Manga); KakaoPage is expected to go public; the firm ’s value has been estimated by media sources at W1.5-2tr; the value of Japan-based Piccoma has not been included in the aforementioned estimates of KakaoPage ’s market value Other revenue 537 831 1,204 Revenue from KakaoBank (which is likely to go public in 2021) has not been reflected; Kakao is currently working to expand its stake in the online -only bank. Value 1,593 2,643 3,406 Target multiple is in line with the avg. 2020F P/S of peers (Amazon, eBay, NAVER) Total 11,529 13,969 15,440 The average P/S multiples of domestic/global peers were used to derive our target price Per -share value 185,000 As the firm ’s businesses are currently in the early growth phases, revenue indicators appear more relevant than profitability indicators Source: Bloomberg, Mirae Asset Daewoo Research estimates Mirae Asset Daewoo Research 3 November 8, 2019 Kakao Kakao (035720 KS/Buy/TP: W185,000) Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/18 12/19F 12/20F 12/21F (Wbn) 12/18 12/19F 12/20F 12/21F Revenue 2,417 3,088 3,868 4,611 Current Assets 2,859 3,291 4,165 5,054 Cost of Sales 0 0 0 0 Cash and Cash Equivalents 1,247 1,238 1,601 2,002 Gross Profit 2,417 3,088 3,868 4,611 AR & Other Receivables 194 247 310 370 SG&A Expenses 2,344 2,880 3,373 3,984 Inventories 36 46 57 68 Operating Profit (Adj) 73 208 495 628 Other Current Assets 1,382 1,760 2,197 2,614 Operating Profit 73 208 495 628 Non-Current Assets 5,101 5,180 5,199 5,229 Non-Operating Profit 58 77 67 48 Investments in Associates 305 390 488 582 Net Financial Income 32 44 55 70 Property, Plant and Equipment 315 340 282 235 Net Gain from Inv in Associates 7 0 0 0 Intangible Assets 3,865 3,804 3,748 3,697 Pretax Profit 131 285 562 676 Total Assets 7,960 8,470 9,364 10,283 Income Tax 115 121 200 263 Current Liabilities 2,039 2,327 2,789 3,229 Profit from Continuing Operations 16 164 362 413 AP & Other Payables 461 589 738 879 Profit from Discontinued Operations 0 0 0 0 Short-Term Financial Liabilities 623 518 523 527 Net Profit 16 164 362 413 Other Current Liabilities 955 1,220 1,528 1,823 Controlling Interests 48 168 369 421 Non-Current Liabilities 293 362 442 519 Non-Controlling Interests -32 -3 -7 -8 Long-Term Financial Liabilities 45 45 45 45 Total Comprehensive Profit 24 164 362 413 Other Non-Current Liabilities 248 317 397 474 Controlling Interests 59 188 367 419 Total Liabilities 2,332 2,689 3,231 3,747 Non-Controlling Interests -35 -24 -5 -6 Controlling Interests 5,137 5,295 5,653 6,065 EBITDA 208 344 610 725 Capital Stock 42 42 42 42 FCF (Free Cash Flow) 394 537 868 882 Capital Surplus 4,648 4,648 4,648 4,648 EBITDA Margin (%) 8.6 11.1 15.8 15.7 Retained Earnings 453 611 970 1,381 Operating Profit Margin (%) 3.0 6.7 12.8 13.6 Non-Controlling Interests 490 487 480 471 Net Profit Margin (%) 2.0 5.4 9.5 9.1 Stockholders' Equity 5,627 5,782 6,133 6,536 Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/18 12/19F 12/20F 12/21F 12/18 12/19F 12/20F 12/21F Cash Flows from Op Activities 491 637 868 882 P/E (x) 168.0 75.6