[ANALYST REPORT] NCsoft: Lineage remains strong

NCsoft posted operating profit of KRW86.1bn (+14% QoQ) for 2Q16, exceeding the market consensus of KRW72.9bn. 

Key positives included: 1) continued solid earnings from Lineage 1 and Blade & Soul (B&S); and 2) improvement in operating margin to 35.8% (+4.4ppt QoQ), with labor costs and marketing expenses down versus 1Q16. 

NCsoft's legendary MMORPG Lineage. NCsoft

In 3Q16, we expect operating profit to fall to KRW76bn (-12% QoQ) from the absence of new game releases and drop in the size of promotional events for existing games. However, we expect the increase in online in-game item sales for the year-end peak season and release of new mobile games (Lineage RK, Lineage M, and Lineage 2: Revolution) to cause operating profit to rebound in 4Q16 to KRW91.6bn (+21% QoQ). 

The shares are currently trading at a P/E of 18.9x, near the low of 18x recorded in 2013, ahead of the release of highly anticipated new games. While we expect the shares to take a short breather from the absence of new games in the near term, momentum should resume, following the release of new games in 4Q16



2Q16 review: Strong earnings from Lineage 1 and B&S

NCsoft recorded revenue of KRW240.5bn (flat QoQ) and operating profit of KRW86.1bn (+14% QoQ) for 2Q16, exceeding the Bloomberg operating profit consensus of KRW72.9bn. Key points included: 1) growth in revenue from Lineage 1, at KRW94.4bn (+20% QoQ), backed by in-game item events; and 2) a slower decline in revenue from B&S, at KRW48.9bn (-10% QoQ), thanks to strong earnings from the US and Europe. Positives were also seen in costs, with the absence of new game releases leading to a drop in marketing expenses to KRW5.1bn (-42% QoQ), and the removal of oneoffs versus 1Q16 (bonus payments) lowering labor costs to KRW91.4bn (-8% QoQ). As a result, operating profit improved to 35.8% (+4.4ppt QoQ) in 2Q16.



New game releases to dip in 3Q16, but rebound in 4Q16

For 3Q16, we expect NCsoft to report revenue of KRW230.3bn (-4% QoQ) and operating profit of KRW76bn (-12% QoQ), in line with the market consensus (KRW74.5bn in operating profit). Lineage 1 revenue should dip to KRW86.4bn (-9% QoQ), despite the release of in-game items, such as the ‘fishing rod of growth’ and ‘relic of Arca’, as the impact of a major event in 2Q16 fades. Revenue from B&S should continue to decline in 3Q16, falling to KRW43.4bn (-11% QoQ), as the impact of the new release in 1Q16 dims. However, earnings should rebound in 4Q16, with revenue of KRW284.7bn (+24% QoQ) and operating profit of KRW91.6bn (+21% QoQ), backed by: 1) strong seasonality for online games, such as Lineage 1 and 2) the release of two in-house developed mobile games (Lineage RK and Lineage M) and one IP licensed-out game (Lineage 2: Revolution).

BUY and target price of KRW310,000 maintained

In all, we maintain our BUY rating and target price of KRW310,000 for NCsoft. Slight delays in the release of highly anticipated games may weigh on momentum, but we remain upbeat on the continued growth in revenue from existing online games, such as Lineage 1. NCsoft shares are currently trading at a P/E of 18.9x, near the low of 18x recorded in 2013 ahead of the release of highly anticipated new games, but below the average of 24x. While we expect the shares to take a short breather, from the absence of new games in the near term, momentum should resume, once the company reveals detailed schedules for the release of new games in 4Q16.


Source: Mirae Asset Securities