Information Technology / Pan Asia 24 October 2014 Platforms have a new role to play Pan-Asia Mobile Games Sector • Smart devices are fast becoming the primary “screens” through which entertainment content is consumed • After casual games, we highlight “mid-core” RPGs as the next driver of growth in the region’s mobile-game industry • We favour integrated platforms over pure developers; our top picks are Daum Communications, Tencent and Square Enix How do we justify our view? See important disclosures, including any required research certifications, beginning on page 70 Information Technology / Pan Asia 24 October 2014 Platforms have a new role to play Pan-Asia Mobile Games Sector • Smart devices are fast becoming the primary “screens” through which entertainment content is consumed • After casual games, we highlight “mid-core” RPGs as the next driver of growth in the region’s mobile-game industry • We favour integrated platforms over pure developers; our top picks are Daum Communications, Tencent and Square Enix How do we justify our view? the big 3 markets to account for 38% games and other services. We also like of the global game market (including Japan’s Square Enix (Outperform mobile and other games) in 2015. [2]), which should lead the way in meeting the region’s rising demand Mid- to hard-core role-playing for quality RPGs. Thomas Y. Kwon games (RPGs) should spur (82) 2 787 9181 ARPU and extend service cycles. We rate Nexon a Buy (1), as it is [email protected] We forecast user demand for mid- to focusing on global publishing of hard-core games to rise strongly over blockbuster mobile games, while Satoshi Tanaka 4Q14-2016, driven by improving Bandai Namco (Outperform [2]) is (81) 3 5555 7049 [email protected] service infrastructure, more advanced seeing solid growth from internally devices, and growth in the number of developed IP. But we downgrade John Choi players globally. This should translate Naver and NCsoft to Outperform (852) 2773 8730 into increasing game-service cycles, (2). We believe Naver faces lower- [email protected] ARPU, and paying users for Asia’s than-expected game sales on LINE as dominant mobile-game platforms: gamers shift their time and money to Daum Kakao and Tencent’s WeChat. mid- to hard-core games, while ■ What's new NCsoft’s online games in China should Thanks to rapid improvements in Bright spots for online generate only weak royalties and its game content and supporting developers. We believe leading new mobile games won’t hit the infrastructure, we are seeing faster- online-game developers, such as market until 2015. The main risk to than-expected growth in gamers Nexon and NCsoft, will be able to roll our Positive sector view would be playing mid- to hard-core titles, as out advanced mobile RPGs, and shorter mobile-game life cycles if opposed to casual ones, on mobile potentially boost earnings growth gamers were to shift from RPGs. devices. Judging from our recent visits from 2015, by leveraging their proven to major players in the mobile-game franchises, loyal user bases and ■ How we differ industry, this trend should accelerate service expertise, backed by robust We are the first to highlight the Pan- further in 2015 and 2016. cash flow from their established titles Asia market opportunity for mid- to and R&D knowhow. hard-core games and the value in the In our view, companies with dominant leading platforms. and integrated mobile-game ■ What we recommend platforms will, in the coming months, We prefer the platforms over the pure Key stock calls increasingly harness their large and developers, as we expect the former to New Prev. loyal bases of active gamers and have more scalable and sustainable Daum Communications (035720 KS) Rating Buy Outperform scalable business models through revenue and earnings streams. Target 190,000 139,000 non-game services such as social Upside 25.1% functions and payment transactions. Daum Communications Tencent Holdings (700 HK) (upgraded to Buy [1]), is our top sector Rating Buy Buy ■ What's the impact pick in Korea and the region, as we Target 150.00 150.00 Mobile games: more than a fad. believe it has all the attributes to Upside 30% For Asia’s 3 largest mobile-games become an even more powerful Square Enix Holdings (9684 JP) markets of Korea, Japan and China, mobile ecosystem. Tencent (Buy [1]) Rating Outperform Outperform we forecast mobile-game revenue is our top pick in China, as it looks Target 2,600 2,600 Upside 25% CAGRs for 2013-15 of 15-82%, expect well placed to leverage its mobile Source: Daiwa forecasts. See important disclosures, including any required research certifications, beginning on page 70 Pan-Asia Mobile Games Sector 24 October 2014 Executive summary Platforms have a new role to play Mid- to hard-core games should drive industry revenue growth, boost ARPU and enjoy longer life cycles in the coming years. We favour integrated platforms over pure developers. Investment thesis Our recent visits to industry players in Asia confirm that mobile-game The smartphone boom led to content is seeing a strong upswing in usage times and dollars spent, the rise of casual games… particularly among young users. This process is being driven by the rapid adoption of mobile phones and tablets, growth in the number of mobile gamers, rollouts of 3G and Long-Term Evolution (LTE) networks, falling data fees and device prices, and the presence of free-to-play game services. In the coming years, we expect the dominant and integrated mobile-game …and our research indicates platforms -- chiefly Daum Kakao, Tencent and Square Enix -- to harness the next leg of industry their large and loyal user bases, active gamers, and scalable business growth should come from models through non-game services, such as payment and content transactions and social functions. Moreover, we expect mobile gamers’ mid- to hard-core RPGs demand for mid- to hard-core games, like Summoners War by Com2uS in Korea, to continue growing, due to improving service infrastructure and enhanced device functionality (new sensors, graphics and user feedback). We believe quality mobile games with differentiated storylines and strong Companies that offer game IPs are best placed to capture the growing opportunity we see for differentiated content and mobile games in China and other Asia markets. On our forecasts, Asia’s strong game IPs, backed by leading online-game developers (such as NCsoft, Nexon, and Square Enix) should see a boost to earnings-growth momentum from 2015, with the integrated platforms, should rollout of advanced mobile RPGs and on the back of leveraging their emerge as winners strong game franchises, loyal user bases and service-operation expertise. Profit outlook We forecast 2014-16 EPS CAGRs of 39% for Daum and 28% for Tencent, and a 2013-15E CAGR of 52% for Square Enix, on the back of ongoing We forecast strong earnings launches of new mobile games and non-game services, a solid rise in growth for the 3 leading ARPU and their number of paying users, and their expansion into new mobile-game platforms for areas within Asia. next two years Valuation We see the valuations of Daum, Tencent and Square Enix as attractive Main players’ valuations relative to their trading ranges for 2005-13. Based on our EPS forecasts look attractive, given their (2015 for the first 2 companies, FY15 for Square Enix), the stocks are trading at respective PERs of 29x, 27x and 16x, yet our forecasts call for integrated ecosystems strong EPS growth for all 3. In our view, these companies’ integrated mobile-game platforms warrant continued PER premiums to their peers outside Asia, given their sustainable revenue and earnings streams. Meanwhile, 6-month target price for Nexon is set a 2014E PER of 13x (the average of its regional peers, based on Bloomberg-consensus forecasts) but expect the stock to be rerated once its new mobile and online sequel games penetrate overseas markets. And we contend NCsoft should trade at a 10% premium (14.3x) to the 2014E PER of its regional peers, given the better visibility that we see for its expanding game portfolio. - 4 - Pan-Asia Mobile Games Sector 24 October 2014 Sector stocks: key indicators EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg Daum Communications 035720 KS 151,900 Buy Outperform 190,000 139,000 36.7% 3,475 3,418 1.7% 5,230 4,855 7.7% Naver 035420 KS 796,000 Outperform Buy 900,000 925,000 (2.7%) 17,407 18,573 (6.3%) 29,397 30,127 (2.4%) NCsoft 036570 KS 139,000 Outperform Buy 152,000 230,000 (33.9%) 10,630 12,449 (14.6%) 12,663 15,278 (17.1%) Nexon 3659 JP 865 Buy Buy 1,100 1,150 (4.3%) 85 88 (4.2%) 99 104 (4.8%) Tencent Holdings 700 HK 115.40 Buy Buy 150.00 150.00 0.0% 2.763 2.763 0.0% 3.418 3.418 0.0% Bandai Namco Holdings 7832 JP 2,528 Outperform Outperform 3,190 3,190 0.0% 173 173 0.0% 188 188 0.0% Square Enix Holdings 9684 JP 2,080 Outperform Outperform 2,600 2,600 0.0% 97 97 0.0% 133 133 0.0% Source: Daiwa forecasts Asia’s 3 largest mobile-games markets: key metrics (As of 2013) Korea Japan China Total population 50.4m 121m 1361m Mobile Internet users (no.) 33m 100m 500m Mobile Internet users as % of total population 65% 83% 37% Mobile game users (no.) 20m 27m 311m Mobile gamers as & of mobile Internet users 61% 27% 62% ARPU of mobile gamers (USD) 34 55 6 Average paying user ratio 3% 6% 2% Smartphone penetration (as of 1Q14, 2013 for Japan) 70% 47% 32% Revenue for online game market USD7.0bn USD1.2bn USD12.0bn Revenue