Korea/Asia, Events, IPOs, Douglas Research Advisory

Douglas Kim

Korea/Asia, Events, IPOs

Event-Driven

In this report, we provide a valuation analysis of <a href="https://www.smartkarma.com/entities/16032" target="_blank" data-smartkarma-citation="entities:16032:1">Nexon Co Ltd (3659 JP)</a>. A key question is "How much are investors willing to pay for Nexon which would drive higher EV/EBIT multiples and inversely reduce the earnings yield (measured by EBIT/EV)?" 
In our view, we believe that investors would be comfortable with earnings yield (measured by EBIT/EV) of about 7-9% given the risks of operating a global game franchise such as Nexon. This would suggest EV/EBIT of about 11x to 14x, using 2019 estimates. Our sensitivity analysis suggests that at the top end of the EV/EBIT valuation range of 14x, this would imply market cap of 1,905 billion yen, which would be 21% higher than current market cap. As such, despite Nexon's share price rising 25% YTD, we think there could be further upside in the months ahead. 
Having digested plethora of public information on this deal (but not privy to all the bankers' discussions) in the past several days, we believe that the US based companies including Amazon and Comcast are better positioned to acquire NXC Corp/Nexon, rather than the consortium led by Tencent. 
We believe there is an intense Chinese government pressure on Tencent to not do this deal. (This is just our guess based on public information). The game industry is not strategically important to China, unlike other industries such as semiconductors, energy, or financial. Depending on how much controlling stake Tencent wants to take, it is likely to involve several billions of dollars ($4 billion to $7 billion for Tencent, for example). This is a lot of money. Plus, China Inc's balance sheet is not as strong as pre-GFC of 2008. Forking over $4 to $7 billion out of China into Japan/Korea would be meaningful. In short, although Tencent would like to do this deal, we think that behind the scenes, the Chinese government appears to be putting intense pressure on Tencent to not do this deal.

In this report, we provide a valuation analysis of Nexon Co Ltd (3659 JP). A key question is "How much are investors willing to pay for Nexon which would drive higher EV/EBIT multiples and inversely reduce the earnings yield (measured by EBIT/EV)?" 
In our view, we believe that investors would be comfortable with earnings yield (measured by EBIT/EV) of about 7-9% given the risks of operating a global game franchise such as Nexon. This would suggest EV/EBIT of about 11x to 14x, using 2019 estimates. Our sensitivity analysis suggests that at the top end of the EV/EBIT valuation range of 14x, this would imply market cap of 1,905 billion yen, which would be 21% higher than current market cap. As such, despite Nexon's share price rising 25% YTD, we think there could be further upside in the months ahead. 
Having digested plethora of public information on this deal (but not privy to all the bankers' discussions) in the past several days, we believe that the US based companies including Amazon and Comcast are better positioned to acquire NXC Corp/Nexon, rather than the consortium led by Tencent. 
We believe there is an intense Chinese government pressure on Tencent to not do this deal. (This is just our guess based on public information). The game industry is not strategically important to China, unlike other industries such as semiconductors, energy, or financial. Depending on how much controlling stake Tencent wants to take, it is likely to involve several billions of dollars ($4 billion to $7 billion for Tencent, for example). This is a lot of money. Plus, China Inc's balance sheet is not as strong as pre-GFC of 2008. Forking over $4 to $7 billion out of China into Japan/Korea would be meaningful. In short, although Tencent would like to do this deal, we think that behind the scenes, the Chinese government appears to be putting intense pressure on Tencent to not do this deal. 

Thematic (Sector/Industry)

The top 10 events impacting the Korean stock market, economy, &amp; politics in February were as follows:<ul>
<li>Amazon and Comcast have submitted initial bids to acquire <a href="https://www.smartkarma.com/entities/16032" target="_blank" data-smartkarma-citation="entities:16032:1">Nexon Co Ltd (3659 JP)</a>/NXC Corp</li>
<li>HOMEPLUS REIT IPO (the biggest ever REIT IPO in Korea)</li>
<li>CONTINUED CONCERNS ON SEMICONDUCTOR SECTOR</li>
<li>ECOPRO BM IPO 
</li>
<li>WAR AGAINST HUAWEI </li>
<li>CONSOLIDATION OF THE KOREAN SHIPBUILDING SECTOR</li>
<li>CLOSING OUT THE BGF CO/BGF RETAIL PAIR TRADE</li>
<li>DOOSAN HEAVY INDUSTRIES &amp; DOOSAN E&amp;C RIGHTS OFFERINGS</li>
<li>CONSOLIDATION OF KOREAN CABLE TV INDUSTRY</li>
<li>SOLAR STOCKS - POSITIVE BOOST FROM HIGHER CHINESE SUBSIDIES </li>
</ul><hr>The top three reports we wrote in February related to the Korean market were as follows (in terms of views &amp; appreciates): <ul>
<li><a href="https://www.smartkarma.com/insights/nexon-m-a-amazon-comcast-enter-the-race-it-ain-t-over-till-its-over" target="_blank" data-smartkarma-citation="insights:28283">Nexon M&amp;A: Amazon &amp; Comcast Enter the Race - It Ain't Over Till Its Over!</a></li>
<li><a href="https://www.smartkarma.com/insights/homeplus-reit-ipo-the-largest-ever-reit-ipo-in-korea" target="_blank" data-smartkarma-citation="insights:27838">Homeplus REIT IPO - The Largest Ever REIT IPO in Korea</a></li>
<li><a href="https://www.smartkarma.com/insights/a-war-between-netflix-disney-for-studio-dragon" target="_blank" data-smartkarma-citation="insights:27802">A War Between Netflix &amp; Disney = $$$ for Studio Dragon</a></li>
</ul>Our model portfolio was up 2.4% in February (cash is 35% of model portfolio), outperforming KOSPI which was down 0.4% in February. Our model portfolio is equal-weighted at the beginning of each month. The top performing stocks in our model portfolio in February included <a href="https://www.smartkarma.com/entities/15983" target="_blank" data-smartkarma-citation="entities:15983:1">F&amp;F Co Ltd (007700 KS)</a>, <a href="https://www.smartkarma.com/entities/22839" target="_blank" data-smartkarma-citation="entities:22839:1">Netmarble Games (251270 KS)</a>, and LG Chem Pref.

The top 10 events impacting the Korean stock market, economy, &amp; politics in February were as follows:
Amazon and Comcast have submitted initial bids to acquire Nexon Co Ltd (3659 JP)/NXC Corp
HOMEPLUS REIT IPO (the biggest ever REIT IPO in Korea)
CONTINUED CONCERNS ON SEMICONDUCTOR SECTOR
ECOPRO BM IPO 

WAR AGAINST HUAWEI 
CONSOLIDATION OF THE KOREAN SHIPBUILDING SECTOR
CLOSING OUT THE BGF CO/BGF RETAIL PAIR TRADE
DOOSAN HEAVY INDUSTRIES &amp; DOOSAN E&amp;C RIGHTS OFFERINGS
CONSOLIDATION OF KOREAN CABLE TV INDUSTRY
SOLAR STOCKS - POSITIVE BOOST FROM HIGHER CHINESE SUBSIDIES 
The top three reports we wrote in February related to the Korean market were as follows (in terms of views &amp; appreciates): 
Nexon M&amp;A: Amazon &amp; Comcast Enter the Race - It Ain't Over Till Its Over!
Homeplus REIT IPO - The Largest Ever REIT IPO in Korea
A War Between Netflix &amp; Disney = $$$ for Studio Dragon
Our model portfolio was up 2.4% in February (cash is 35% of model portfolio), outperforming KOSPI which was down 0.4% in February. Our model portfolio is equal-weighted at the beginning of each month. The top performing stocks in our model portfolio in February included F&amp;F Co Ltd (007700 KS), Netmarble Games (251270 KS), and LG Chem Pref. 

Korea Stock Market Monthly Recap #33 (February 2019)

In a surprising move, it was reported after the market close today that <a href="https://www.smartkarma.com/entities/409" target="_blank" data-smartkarma-citation="entities:409:1">Amazon.com Inc (AMZN US)</a> (market cap of US$804 billion) and Comcast (US$176 billion) will enter the race and have submitted initial bids to acquire <a href="https://www.smartkarma.com/entities/16032" target="_blank" data-smartkarma-citation="entities:16032:1">Nexon Co Ltd (3659 JP)</a>/NXC Corp. The entrance of Amazon and Comcast is a major positive surprise and it should have a strong positive impact on Nexon's share price. Prior to the entrance of Amazon and Comcast in this M&amp;A battle, the market was firmly leaning towards the consortium including Tencent, Netmarble Games, and MBK Partners to acquire NXC Corp/Nexon.Now, Amazon and Comcast's entrance into this M&amp;A battle has made it a lot more exciting and uncertain. <a href="https://www.smartkarma.com/entities/16032" target="_blank" data-smartkarma-citation="entities:16032:1">Nexon Co Ltd (3659 JP)</a>'s share price is up 19% YTD but its share price trend has been flattening out in February. In the next few weeks, we expect further boost to Nexon's share price (15%+), mainly because a lot more investors will think that the Tencent consortium, Amazon, and Comcast will try to pay higher price to acquire NXC Corp/Nexon. Kudos to Nexon shareholders!

In a surprising move, it was reported after the market close today that Amazon.com Inc (AMZN US) (market cap of US$804 billion) and Comcast (US$176 billion) will enter the race and have submitted initial bids to acquire Nexon Co Ltd (3659 JP)/NXC Corp. The entrance of Amazon and Comcast is a major positive surprise and it should have a strong positive impact on Nexon's share price. Prior to the entrance of Amazon and Comcast in this M&amp;A battle, the market was firmly leaning towards the consortium including Tencent, Netmarble Games, and MBK Partners to acquire NXC Corp/Nexon.Now, Amazon and Comcast's entrance into this M&amp;A battle has made it a lot more exciting and uncertain. Nexon Co Ltd (3659 JP)'s share price is up 19% YTD but its share price trend has been flattening out in February. In the next few weeks, we expect further boost to Nexon's share price (15%+), mainly because a lot more investors will think that the Tencent consortium, Amazon, and Comcast will try to pay higher price to acquire NXC Corp/Nexon. Kudos to Nexon shareholders!

Nexon M&A: Amazon & Comcast Enter the Race - It Ain't Over Till Its Over!

'Quantamental' Japan Specialist, LightStream Research

Campbell Gunn

'Quantamental' Japan Specialist

ja research

ja research is an independent research platform focused exclusively on Japanese equities. Leveraging data and graphic analysis provided by Japan Analytics, we provide insights on small and medium-sized companies that have been ignored by the sell-side as well as challenging conventional wisdom on larger companies. We also offer analyst and corporate access, the latter with translation if required. 

Quantitative Analysis

<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/079/000/original/2019-02-16_10-06-13.png?1550279195" class="editor-image img-responsive" data-smartkarma-image-id="79000"></figure><div class="content-caption">Source: Japan Analytics</div>WORST Q SINCE AUTUMN 2016 - Since our last Results Flash in November - <a href="https://www.smartkarma.com/insights/japan-autumn-results-revisions-flash-flatlining-weakest-quarter-in-two-years" target="_blank" data-smartkarma-citation="insights:25804">Japan: Autumn Results &amp; Revisions Flash - Flatlining + Weakest Quarter in Two Years</a> - the operating and net profits of Japanese listed companies have peaked and declined by 2.0% and 7.5%, respectively while forecasts for the same have fallen by 1.7% and 4.1%. The stock market's initial reaction to the peaking of earnings for this cycle was a sharp 15.5% decline which climaxed on Christmas Day. A softer tone from the US Federal Reserve and a weaker Yen have helped restore a degree of confidence and the recent 12.1% rally has taken aggregate market capitalisation back to early-December.  As a result of the downturn in profits, trailing and forecast earnings multiples have reverted to August 2018 levels and can no longer be considered a bargain. For the restoration of a 'normal' market multiple (16.7x), either share prices have to rise by 18% (all else equal) or net income has to decline by a further 16%. Our money is on the latter being the more likely outcome.<div class="content-caption">
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/079/004/original/2019-02-16_10-43-29.png?1550281425" class="editor-image img-responsive" data-smartkarma-image-id="79004"></figure>Source: Japan Analytics
</div>ROLLING TTMs - Our series of rolling trailing-twelve-month (TTM) quarterly aggregates of all listed companies confirm the profit peak. Revenues are still increasing by 5-6% a year, and by 1-2% a quarter, however, the rate of increase is slowing and the implied growth rate for the current quarter is just 0.5%. Operating Income declined by 1.9% qoq in the quarter just declared and will be flat this quarter, although, as few companies revise full-year forecasts with Q3 earnings results, this forecast should be considered optimistic. Operating margins are forecast to be 33bps lower than in TTM-3. TTM Net Income fell by 8% qoq, although yoy growth is still a positive 3%. The 1.6% forecast growth for this quarter implies that the most recent quarter had an excessive level of write-offs. We are not so sanguine.SECTOR BREAKDOWNS - In the DETAIL section below we shall examine the trends in earnings results and forecasts for the 30 sectors that make up our Market Composite.

Source: Japan AnalyticsWORST Q SINCE AUTUMN 2016 - Since our last Results Flash in November - Japan: Autumn Results &amp; Revisions Flash - Flatlining + Weakest Quarter in Two Years - the operating and net profits of Japanese listed companies have peaked and declined by 2.0% and 7.5%, respectively while forecasts for the same have fallen by 1.7% and 4.1%. The stock market's initial reaction to the peaking of earnings for this cycle was a sharp 15.5% decline which climaxed on Christmas Day. A softer tone from the US Federal Reserve and a weaker Yen have helped restore a degree of confidence and the recent 12.1% rally has taken aggregate market capitalisation back to early-December.  As a result of the downturn in profits, trailing and forecast earnings multiples have reverted to August 2018 levels and can no longer be considered a bargain. For the restoration of a 'normal' market multiple (16.7x), either share prices have to rise by 18% (all else equal) or net income has to decline by a further 16%. Our money is on the latter being the more likely outcome.
Source: Japan Analytics
ROLLING TTMs - Our series of rolling trailing-twelve-month (TTM) quarterly aggregates of all listed companies confirm the profit peak. Revenues are still increasing by 5-6% a year, and by 1-2% a quarter, however, the rate of increase is slowing and the implied growth rate for the current quarter is just 0.5%. Operating Income declined by 1.9% qoq in the quarter just declared and will be flat this quarter, although, as few companies revise full-year forecasts with Q3 earnings results, this forecast should be considered optimistic. Operating margins are forecast to be 33bps lower than in TTM-3. TTM Net Income fell by 8% qoq, although yoy growth is still a positive 3%. The 1.6% forecast growth for this quarter implies that the most recent quarter had an excessive level of write-offs. We are not so sanguine.SECTOR BREAKDOWNS - In the DETAIL section below we shall examine the trends in earnings results and forecasts for the 30 sectors that make up our Market Composite.  

Japan: Winter Results & Revisions Flash - Cycle Earnings Peak Was December 26th

Equity Bottom-Up

<ul>
<li>
<a href="https://www.smartkarma.com/entities/5169" target="_blank" data-smartkarma-citation="entities:5169:1">NCsoft Corp (036570 KS)</a>'s 4Q18 earnings fell short of the consensus earnings estimates. In 4Q18, NCsoft reported sales of 399.7 billion won (down 25.1% YoY and 1.1% lower than consensus), operating profit of 112.6 billion won (down 40.5% YoY and 13.3% lower than the consensus), and net profit of 67.6 billion won (down 44% YoY and 32.9% lower than the consensus). </li>
<li>Three different analysts raised questions about why the company changed the timing of the launch of the Lineage2M game. In the 3Q18 earnings conference call, the company previously mentioned that it will most likely launch the Lineage2M mobile MMORPG game in 2Q19. In the most recent 4Q18 earnings conference call, the company mentioned that it will launch Lineage2M by the end of 2019. </li>
<li>We expect little change to the consensus earnings estimates of NCsoft in 2019 and 2020. Although Tencent consortium acquiring Nexon could pose greater competitive threats to NCsoft in Korea, it could also lead to a consolidation of the gaming sector in Asia, which would be a positive for the company. NCsoft is currently trading at P/E multiples of 15x in 2019 and 12x in 2020, based on the consensus earnings estimates, which are attractive. We maintain our positive view of the company following its 4Q18 earnings. </li>
</ul>



NCsoft Corp (036570 KS)'s 4Q18 earnings fell short of the consensus earnings estimates. In 4Q18, NCsoft reported sales of 399.7 billion won (down 25.1% YoY and 1.1% lower than consensus), operating profit of 112.6 billion won (down 40.5% YoY and 13.3% lower than the consensus), and net profit of 67.6 billion won (down 44% YoY and 32.9% lower than the consensus). 
Three different analysts raised questions about why the company changed the timing of the launch of the Lineage2M game. In the 3Q18 earnings conference call, the company previously mentioned that it will most likely launch the Lineage2M mobile MMORPG game in 2Q19. In the most recent 4Q18 earnings conference call, the company mentioned that it will launch Lineage2M by the end of 2019. 
We expect little change to the consensus earnings estimates of NCsoft in 2019 and 2020. Although Tencent consortium acquiring Nexon could pose greater competitive threats to NCsoft in Korea, it could also lead to a consolidation of the gaming sector in Asia, which would be a positive for the company. NCsoft is currently trading at P/E multiples of 15x in 2019 and 12x in 2020, based on the consensus earnings estimates, which are attractive. We maintain our positive view of the company following its 4Q18 earnings. 


NCsoft: Major Highlights of 4Q18 Earnings Conference Call

Japan

Nexon Co., Ltd. mainly develops and services, online games for PC and mobile devices. The company also offers consulting services related to online-games. Nexon operates in Japan.

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Nexon (3659 JP)

Nexon Valuation Analysis

In this report, we provide a valuation analysis of Nexon Co Ltd (3659 JP). A key question is "How much are investors willing to pay for Nexon which...

Douglas Kim

Korea Stock Market Monthly Recap #33 (February 2019)

The top 10 events impacting the Korean stock market, economy, & politics in February were as follows: Amazon and Comcast have submitted initial...

Douglas Kim

Nexon M&A: Amazon & Comcast Enter the Race - It Ain't Over Till Its Over!

In a surprising move, it was reported after the market close today that Amazon.com Inc (AMZN US) (market cap of US$804 billion) and Comcast (US$176...

Douglas Kim

Japan: Winter Results & Revisions Flash - Cycle Earnings Peak Was December 26th

WORST Q SINCE AUTUMN 2016 - Since our last Results Flash in November - Japan: Autumn Results & Revisions Flash - Flatlining + Weakest Quarter...

Campbell Gunn

NCsoft: Major Highlights of 4Q18 Earnings Conference Call

NCsoft Corp (036570 KS)'s 4Q18 earnings fell short of the consensus earnings estimates. In 4Q18, NCsoft reported sales of 399.7 billion won (down...

Douglas Kim

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