-Kingsoft issued profit warning on Oct 23 that the 3Q operating profit was expected to decline significantly yoy.
-The decline was mainly due to significant increase of selling and marketing expenses, R&D cost and share-based compensation.
-We adjusted up the 2015 onwards revenue forecasts, while significantly increased the cost and expenses estimates.
-Since the serious declining in stock price, we upgrade Kingsoft¡¦s rating to ¡§Accumulate¡¨ with target price HK$ 19.83, equivalent to 27.2x/37.2x of 2014 and 2015 forecasted EPS.
Financial Highlights
Kingsoft issued profit warning on Oct 23 that the operating profit of the 3Q was expected to decline significantly, compared to the same period last year. This was mainly caused by 1) the sharply increase of selling and marketing expenses for mobile games launching and international mobile internet penetration; 2) the R&D cost rose significantly as the expansion of mobile application team; 3) the rapid rise of share-based compensation costs granted to employees.
How we view this
Mentioned in the last report, the management had already expected the dropping in margins, around 10% to 20%, while restated that the increase in expenses was in line with their business strategies of 2014. However, when it mentioned a much lower 3Q operating profit compared to 2013, it was still out of our estimates and thus we turn to pessimistic in the second half margins of 2014. We maintain the revenue of 2014 and adjusted up the afterwards, due to the company¡¦s heavy investment on mobile and internet and the considerable growth in the mobile monthly active users. But we sharply increased the cost and expenses estimates, especially in 2014 and 2015.
Investment Action
However, since the stock price had suffered from serious declining after the 2Q results and a rapid slump at the day of profit warning, we believe it is indeed undervalued. Thus, we upgrade our rating of Kingsoft to ¡§Accumulate¡¨ with target price of HK$ 19.83, equivalent to 27.2x/37.2x of 2014 and 2015 forecasted EPS.
Business event tracking
1. Disposal of Kuaipan Personal with estimated consideration of US$33 million to Cheetah in September. With this the one-off disposal gain, Kingsoft was able to maintain yoy growth on profit before tax in 3Q2014.
2. Kingsoft¡¦s subsidiary Chengdu Westhouse will acquire the stake of a web games developer, Zhuhai Funova with total consideration of approximately RMB50 million. After all, Westhouse will hold 20% stake of Zhuhai Funova.
3. The company had collaborated with Amazon to help in developing office software for its Kindle Fire.
4. News on PRC government¡¦s instruction towards state departments on replacing Windows with mainland developed software.
Valuation
The forecasted 2014 profit was sharply cut down by 13.5% to RMB 697 mn. The target price of HK$ 19.83 was calculated by business value shown as below, plus net cash per share of HK$ 6.39.
Potential Risks
Growth on mobile business cannot maintain;
Rapid rise on cost and expenses.
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