The company's adjusted net profit for 2020 fell 35%-40% yoy
The company issued a negative profit alert on January 21, that it is expected that the adjusted profit for 2020 will fall by about 35%-40% yoy. The main reason for the decline is the huge yoy increase in R&D expense and the delay in the launch of the games, causing a mismatch in return vs investment. According to the company's management, as of the end of 2020, the company has more than 1,200 employees, with 87% of them being R&D personnel. Further, the company has newly hired roughly 300 employees in 2020, of which about 90% of whom are R&D personnel. On the other hand, in addition to the R&D expenses brought by the new R&D personnel, the company also mentioned that since the company's original R&D team is one of the few R&D team in China who can effectively apply UE4 engine on mobile game development, hence the average salary of the team has increased by a certain amount in 2020. In the long run, we are confident in the company's R&D capabilities. The salary increase of the company's original R&D team in 2020 can bind the company's outstanding R&D talents and reduce the loss of R&D personnel. At the same time, the expansion of the R&D team will help the company to explore game genres other than MMORPG. Further, the company's continuous and substantial R&D investment can help the company maintain competitive advantages in the game industry that is gradually shifting toward premium games. We believe that with the successive launch of the games in the pipeline, the company's profit margin will rebound.
Noah's heart (¿Õ¨È¤§¤ß) is expected be launched in 2021 year-mid
Noah's heart (¿Õ¨È¤§¤ß) is expected be launched in 2021 year-mid. Noah's Heart (¿Õ¨È¤§¤ß) is an open world MMORPG game based on UE4 and the company's own IP, and introduces new designs and gameplay such as the 8000x8000 spherical seamless big map. The company has spent a lot of investment in the design of the spherical seamless big map of the game. The introduction of the seamless big map eliminates the loading time when the game scene is switched, which can greatly enhance the continuity of the game and gamers` gaming experience. As for the design of the spherical map, it can make the gameplay more realistic. Up to now, Noah's Heart (¿Õ¨È¤§¤ß) has no other competing products in the market. After the game is launched, it is expected to become a hit MMORPG game. Tencent will be responsible for the distribution of the game in China region, which fully demonstrates Tencent's high recognition of the game. At the same time, Tencent's strong game distribution capabilities and traffic support can greatly increase the gross billing performance of the game. According to the company's management, in addition to the China region, Noah's Heart (¿Õ¨È¤§¤ß) will also be launched in overseas markets, including Europe, America, Japan and other regional markets. Given that the R&D team has incorporated a lot of elements from the US and Europe market in the design of the game, so we are also optimistic about the overseas distribution of the game.
We believe that the excellent performance of Genshin Impact (ì¯«), also an open world game, in both China region and oversea regions have shown that market potential of an open world RPG game. At the same time, Genshin Impact (ì¯«)'s distribution has also explored many potentials gamers for Noah's heart (¿Õ¨È¤§¤ß).
The company will focus on strengthening the ability of independent distribution in China region
In recent years, with the changes in the Chinese game distribution channels, the company has strategically chosen to cooperate with Tencent in the game distribution in China. Under the escort of Tencent, the company's games have all achieved eye-catching performances. In the future, the company will focus on strengthening its ability of independent distribution in China region. We believe that the close integration of R&D and distribution operations can effectively lower the communication barriers between the R&D team and the distribution team, allowing the distribution team to formulate a more refined distribution strategy based on the characteristics of the games, thereby greatly increasing the performance of the games after launching. In the future, the company will focus on hiring distribution experts in various vertical fields (including SLG and female-oriented game genres), with the aim to build a top tier game distribution system.
Valuation and investment thesis
We continue to be optimistic about the company's strong R&D capabilities and high probability of hit game output. Considering 1) the delayed launch of Under the Firmament (ÂE¹Ï¤§¤U) and The New World (¹Ú·Q·s¤j³°) have a higher impact on the company's actual gross billing than we previously predicted 2) The launch of Noah's Heart (¿Õ¨È¤§¤ß) will be delayed until mid-2021 3) The company's higher-than-expected R&D expense, we lowered the company's adjusted net profit for 2020/2021/2022 to RMB 215/714/1043 million (-63.1%/-34.9%/-29.8%). We have rolled over the relative valuation to 2022 and maintain target adjusted PE of 20x. Our Dec-22 TP is HKD 30.10, with corresponding 2020/2021/2022 adjusted PE at 94.1x/29.2x/20.0x. We maintain Buy rating. (Market closing price as of 10th Feb) (exchange rate: RMB 0.85/HKD)
1) The tightening on Game regulations 2) The Games underperform comparing to expectation 3) Games launching are delayed due to unexpected reasons
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