KOREA - EQUITY RESEARCH Internet 9 May 2007 NCSOFT (036570) Momentum From Upcoming New Games Starting NCsoft posted sales of W57.5bn (-0.4% qoq), operating profit of W13.6bn (+18.4% Buy qoq), and net profit of W14.1bn (-24.3% qoq) in 1Q07, beating both the market consensus and our expectations. Profitability improved due to cost reductions. Kim Chang Kwean NCsoft’s 2Q07 earnings are also projected to be strong, thanks to the momentum +822-768-4321 ESEARCH generated from new games. Tabula Rasa will begin beta testing on May 1, while beta [email protected] R testing for Aion, the release of Guild Wars’ expansion pack, and commercialization of Tabula Rasa are slated for 3Q07. Bloomberg: 036570 KS QUITY We reiterate Buy with a six-month target price of W84,000. Reuters: 036570.KS E Target price (6M): W84,000 Share Price (08/05/07): W70,000 EXPECTATION OF NEW GAMES TO BE FACTORED INTO THE SHARE PRICE BASED ON SOLID Par Value: W500 ARNINGS 2Q07 E 52-W Lo/Hi: W41,100/72,000 NCsoft posted non-consolidated sales of W57.5bn (-0.4% qoq), operating profit of KOSPI: 1,582.7p W13.6bn (+18.4% qoq), and net profit of W14.1bn (-24.3% qoq) in 1Q07, beating both the Mkt Cap: US$1,545.6mn/W1,428.3bn market consensus (sales of W57.7bn, operating profit of W12.7bn, and net profit of Shares Issued: 20.4 mn shr W12.0bn) and our expectations (operating profit of W13.4bn and net profit of W13.3bn). Avg Volume (60D): 132,177 shr Profitability improved in 1Q07 thanks to cost reductions, including the decline in: 1) Avg Value (60D): US$8.3mn/W7.7bn marketing expenses as there were no new game launches in 1Q, 2) labor costs following Foreign Ownership: 41.2% the payment of Korean Thanksgiving and year-end bonuses in 4Q06, and 3) depreciation Dividend Yield (2006): 0.0% expenses as the useful life of its game development equipment and servers are nearing an Major Shareholder(s): end. It is also worth noting that NCsoft’s overseas subsidiaries in the U.S. and Europe T. J. Kim (27.39%) recorded strong performance in 1Q07 thanks to the company’s Guild Wars Series. Blue Ridge Ltd. Partnership (9.52%) Momentum for new game launch should pick up as NCsoft is anticipated to continue Price Performance posting solid earnings in 2Q07. However, sales and operating profit should decline due to (%) 1M 6M 12M seasonality and possible decline in the sales of Guild Wars. Marketing expenses related to Absolute 9.5 13.1 8.5 the upcoming commercialization of Tabula Rasa are also expected to increase. Relative 2.9 -1.6 -0.5 EPORT R Forecasts/Valuations KOSPI Relative performance Chart FY Sales OP NP EPS yoy FCF ROE P/E P/B EV/EBITDA Share price 120 (Wbn) (Wbn) (Wbn) (W) (%) (Wbn) (%) (x) (x) (x) KOSPI OMPANY 110 12/05 232.8 72.0 66.7 3,305 -14.3 -21.6 18.7 23.2 4.0 15.8 C 100 12/06 227.5 51.8 38.1 1,867 -43.5 30.8 9.4 28.6 2.6 12.9 90 80 12/07F 227.2 48.7 61.2 3,001 60.7 29.2 13.6 23.3 3.0 19.5 DWS DWS 70 12/08F 304.8 76.2 105.7 5,185 72.8 46.2 19.9 13.5 2.4 12.0 60 4/06 8/06 12/06 4/07 12/09F 342.1 87.8 125.7 6,166 18.9 63.6 19.4 11.4 2.0 10.1 Source: Company data, Daewoo Securities Please carefully read important notices in the last pages of this report. 9 May 2007 NCsoft Table 1. Quarterly Earnings Forecasts (Wbn) 1Q06 2Q06 3Q06 4Q06 1Q07P 2Q07F 3Q07F 4Q07F 1Q08F 2Q08F 3Q08F 4Q08F Sales 57.4 55.5 56.9 57.7 57.5 56.8 56.9 56.0 72.5 73.2 74.2 75.4 Lineage I 28.3 26.8 26.9 27.5 28.8 27.0 25.4 24.1 23.4 22.3 20.7 19.7 Lineage II 20.7 20.2 21.7 21.2 21.0 21.9 22.8 23.0 23.4 23.9 25.0 25.8 New games 1.2 0.2 0.1 0.1 1.1 0.1 1.1 1.0 18.3 18.1 19.1 20.0 Overseas 8.1 8.3 8.2 8.9 7.5 7.8 7.6 7.9 8.3 8.8 9.3 9.9 Sales breakdown (%) Lineage I 49.3 48.3 47.3 47.7 50.2 47.6 44.7 43.0 32.3 30.5 27.9 26.1 Lineage II 36.1 36.3 38.1 36.8 36.6 38.5 40.1 41.0 32.3 32.7 33.8 34.2 New games 2.2 0.4 0.1 0.2 1.9 0.2 1.9 1.8 25.2 24.8 25.7 26.5 Overseas 14.2 15.0 14.5 15.4 13.0 13.7 13.3 14.1 11.5 12.0 12.6 13.1 Growth (% qoq) Sales -1.0 -3.3 2.5 1.4 -0.4 -1.1 0.2 -1.5 29.3 1.1 1.3 1.7 Lineage I 2.0 -5.2 0.2 2.4 4.7 -6.3 -5.9 -5.2 -2.8 -4.7 -7.2 -4.9 Lineage II -0.5 -2.7 7.5 -2.1 -0.8 4.0 4.3 0.7 1.8 2.3 4.6 2.9 New games 730.2 -83.6 -63.1 16.0 1,179.3 -89.0 782.4 -5.6 1,692.2 -0.7 5.0 5.0 Overseas -12.3 2.4 -1.0 7.5 -15.5 4.0 -2.8 4.6 5.2 5.7 5.9 6.1 Operating profit 13.6 12.5 14.4 11.5 13.6 11.2 12.8 11.1 23.8 23.7 24.3 24.4 Operating margin (%) 23.6 22.5 25.2 19.9 23.6 19.8 22.4 19.9 32.9 32.3 32.7 32.4 % qoq -2.0 -8.1 15.1 -20.2 18.4 -17.2 13.8 -12.9 114.4 -0.7 2.5 0.6 Recurring profit 8.9 3.0 16.4 19.0 18.3 13.1 19.3 24.2 37.1 37.0 37.6 37.7 Recurring margin (%) 15.5 5.4 28.9 32.9 31.9 23.0 34.0 43.2 51.2 50.5 50.6 50.0 % qoq -60.9 -66.3 447.7 15.6 -3.5 -28.7 48.1 25.3 53.2 -0.5 1.6 0.4 Net profit 6.8 -0.2 12.8 18.6 14.1 10.7 15.8 20.6 30.3 30.2 30.7 30.8 Net margin (%) 11.9 -0.4 22.5 32.3 24.6 18.8 27.8 36.9 41.9 41.3 41.4 40.9 % qoq -67.0 TR TB 45.7 -24.3 -24.4 48.1 30.6 47.0 -0.5 1.6 0.4 Source: Company Data, Daewoo Securities TABULA RASA, GUILD WARS, AND AION TO BE COMMERCIALIZED IN 2H07 Momentum has been picking up since April, thanks to the upcoming release of Tabula Rasa, Aion, and Guild Wars’ expansion pack in 2Q07 and 3Q07. Tabula Rasa is a MMOFPS being developed by the Garriot Brothers at the U.S. studio since May 2001. Development costs amounted to a whopping W70bn. More than 10,000 players are waiting to beta test Tabula Rasa, which has been in testing by 2,000 players in the U.S. and Europe since May 1. NCsoft’s share price has recently rallied thanks to the positive reviews received at the U.S. Game Developers Conference in May. The game is scheduled to be commercialized in the U.S. and Europe in 3Q07. Beta testing of Aion in Korea, which should be one of NCsoft’s most prominent games since the 2003 launch of Lineage 2, is slated for the summer vacation season with the commercial roll-out planned for 4Q07. Guild Wars’ expansion pack called the “Eye of the North” is scheduled for release in 3Q07. Guild Wars generated sales of W11.5bn in the U.S. and Europe during 1Q07, and W18.3bn in 4Q06, when the second expansion pack was released. We reiterate Buy on NCsoft with a six-month target price of W84,000. 2 9 May 2007 NCsoft Chart 1. Game product lineup of NCsoft 1H07F 2H07F F/F Test Closed Beta Aion Korea Account integration Ver 2.0 Service Platforms Establish Portfolio for Casual Games Exteel (Partial commercialization) Tabula Rasa North America/ Europe Dungeon Runners (CD Sales) Guild Wars (Final Version) China Guild Wars Source: Company Data, Daewoo Securities, Korea Click Chart 2. NCsoft’s Stock Price and Net Visitors to Lineage 2 (W) Share price (L) ('000 people) 120,000 Net v isitors (R) 600 100,000 500 80,000 400 60,000 300 Commercialization 40,000 Open beta 200 20,000 100 2nd closed beta 1st close beta 0 0 4/02 10/02 4/03 10/03 4/04 10/04 4/05 10/05 4/06 10/06 4/07 Source: Daewoo Securities 3 IMPORTANT NOTICES Equity Research for International Investors (ERII) As of May 9, 2007, Daewoo Securities Co., Ltd and/or its affiliates do not have any special interest with the subject company and do not own 1% or more of the subject company's shares outstanding.