IGG (8002 HK) Upbeat with Q2 profitability. Results express Share price: HK$5.47. Equity Research Tech, Media & Telecom

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1 Equity Research Tech, Media & Telecom 11 Aug 2014 IGG (8002 HK) Upbeat with Q2 profitability Net profit reached US$19.3m in Q2; mobile game income 83%: IGG announced interim results Sunday evening. For 1H 201A, revenue was US$91.9m with 72% gross margin and 40% net margin. For Q2 alone, revenue was US$47.8m and net profit was US$19.3m, which was 8.4% and 41.9% higher than those in Q1 respectively. Management indicated that it was due to scale effect as well as smaller sales expenses due to fewer titles launch in Q2. Neglecting the difference between our revenue mix assumptions and actual revenue mix, our previous annual estimates of US$85m can still be achievable. Results express Share price: HK$5.47 Bloomberg Ticker: 8002 HK Reuters: 8002.HK Castle Clash may not go as good as previously predicted: IGG major title Castle Clash (CC) was launched on Tencent platform on 5 May, which generated US$2m income for 1H 14A, where China represented 5% total income of IGG in Q2 14A. It is yet to reach RMB100m monthly gross billings. On the other hand, Management indicated that much effort was placed on integrating CC into Tencent platform without major updates in Q2 for CC. It appears to us that CC income in Q2 may be flat compared to Q1, as CC contributed 62% income in Q2 and 65% income in 1H based on public information. More titles to launch in 2H; introduces IM for longer-term prospect: Management indicated to refocus on gameplay experience and overseas channels. In 2H 14E, IGG plans to launch several mobile game titles to drive income. For instance, IGG plans to promote Brave Trials (ENG) and Deck Heroes in Q3, and targets million+ US$ monthly billings. IGG also plans to launch Clash of Gangs and Blood & Blade in 2H 14E. While CC may resume growth in overseas segment and increase billings in China, short-term growth also rely on new game titles and others launched in 2013A such as Clash of Lords II. For longer-term, IGG is to launch its own IM Link Messenger; it is initially for accumulating users without commercialization strategy. 12.3x annual P/E based on annualized Q2 net profit looks attractive: Market might be previously in doubts about CC performance on Tencent and hence short-to-medium term outlook, in our view. Share price fell to HK$4.08 in Jul before strong rebound of 29.6% yesterday. Based on annualized Q2 profit of US$78m, the counter at latest closing price is trading at 12.3x annual P/E. Based on Bloomberg consensus, adjusted net profit was US$71.6m and US$95.7m for 2014E and 2015E, which represents 13.1x and 9.8x P/E. Even without major growth contribution from CC China, which we suggested caution on, we now recommend investors for speculative trading in short-term. Kevin Mak, CFA Analyst kevin.mak@dfzq.com.hk

2 Table 1. Profit and loss summary Year-end Dec (US$m) 2012A 2013A 1H 12A 2H 12A 1H 13A 2H 13A 1H 14A Revenue Cost of revenue (10.4) (22.3) (4.7) (5.7) (6.8) (15.4) (25.3) Gross profit Selling and distribution expenses (12.1) (23.2) (3.8) (8.3) (6.3) (17.0) (19.1) Administrative expenses (7.1) (10.9) (3.0) (4.1) (4.3) (6.5) (6.4) R&D expenses (6.3) (9.3) (3.0) (3.4) (3.8) (5.5) (6.9) EBIT Other income and gains (0.1) Fair value loss of redeemable convertibles (20.6) (14.2) (10.2) (10.4) (14.2) - - Other expenses (0.1) (0.5) (0.1) 0.0 (0.1) (0.4) (0.2) EBT (12.9) 8.3 (4.5) (8.5) (6.7) Income tax (0.2) (1.3) (0.1) (0.1) (0.4) (0.9) (2.4) Total profit (13.1) 6.9 (4.6) (8.5) (7.2) Net profit (13.1) 6.9 (4.6) (8.5) (7.2) Fair value loss of redeemable convertibles (20.6) (14.2) (10.2) (10.4) (14.2) Adjusted net profit Diluted EPS (US$) (0.010) (0.003) (0.005) DPS (US$) Table 2. Profit and loss summary - quarterly Year-end Dec (US$m) Q1 2013A Q2 2013A Q3 2013A Q4 2013A Q1 2014A Q2 2014A Revenue Cost of revenue (3.3) (3.5) (5.8) (9.7) (11.9) (13.4) Gross profit Selling and distribution expenses (3.1) (3.2) (6.5) (10.5) (11.1) (8.0) Administrative expenses (1.3) (3.0) (2.6) (3.9) (3.0) (3.4) R&D expenses (1.8) (2.1) (2.6) (2.9) (3.3) (3.6) EBIT Other income and gains 0.1 (0.0) Fair value loss of redeemable convertibles (8.4) (5.7) Other expenses (0.1) 0.1 (0.1) (0.2) (0.4) 0.1 EBT (3.7) (3.1) Income tax (0.2) (0.2) (0.5) (0.4) (1.0) (1.4) Net profit (3.9) (3.3) Adjusted net profit Table 3. Revenue and game types breakdown Year-end Dec (US$m) 2011A 2012A 2013A 1H 13A 2H 13A 1H 14A Revenue Browser games Client-based games Mobile games and others Source: Orient Securities 2 / 5

3 Table 4. Revenue and game titles breakdown Year-end Dec (US$m) 1H 13A 2H 13A 1H 14A Q1 14A Q2 14A Revenue Castle Clash Texas HoldEm Poker Deluxe Galaxy Online II Wings of Destiny Slot Machines by IGG Others # # Note: Clash of Lords I & II and Godswar were included in others as we apparently do not have sufficient info to construct a proper breakdown Table 5. Balance sheet summary Year-end Dec (US$m) 2011A 2012A 2013A 1H 2014A Non-current assets Property, plant and equipment Other intangible assets Non-current rental deposits Available for sale investments Deferred tax assets Current assets Account receivables Amount due from related party Prepayments, deposits and others Funds receivable Time deposits with 3months+ maturity Cash and cash equivalents Non-current liabilities Deferred tax liabilities Current liabilities Accounts payables Other payables and accruals Tax payable Deferred revenue Redeemable convertible preferred shares Total equity (42.5) (55.8) Issued capital Retained earnings (42.5) (55.8) Proposed final dividend Non-controlling interests Source: Orient Securities 3 / 5

4 Analyst Certification I, Kevin Mak (Mak Tsz Hang), being the person primarily responsible for the content of this research report, in whole or in part, hereby certify that: (1) all of the views expressed in this report accurately reflect my personal view about the subject company(ies) and its (or their) securities; (2) no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report, or our Investment Banking Department; (3) I am not, directly or indirectly, supervised by or reporting to our Investment Banking Department; (4) the subject company(ies) do(es) not fall into the restriction of the quiet period as defined in paragraph 16.5(g) of SFC Code of Conduct; (5) I and my associates do not deal in or trade in the stock(s) covered in this report within 30 calendar days prior to the date of issue of the report; (6) I and my associates do not serve as an officer(s) of the listed company(ies) covered in this report; and (7) I and my associates have no financial interests in relation to the listed company (ies) covered in this report. Meanings of Orient Securities Ratings Buy Describes stocks that we expect to provide a total return of >10% within a 12-month period. Accumulate Describes stocks that we expect to provide a total return of >0% within a 12-month period. Hold Describes stocks that we expect to provide a total return of between -20% and +20% within a 12-month period. Sell Describes stocks that we expect to provide a total return of <0% within a 12-month period. Disclosure & Disclaimer Orient Securities (Hong Kong) Limited does and seeks to do business with the company or companies covered in this report. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Orient Securities (Hong Kong) Limited and its affiliates, officers, directors, and employees may from time to time have long or short positions in securities, warrants, futures, options, derivatives or other financial instruments referred to in this report. In no event will Orient Securities (Hong Kong) Limited or any other member of Orient Securities (Hong Kong) Limited be liable or responsible for loss of any kind, whether direct, indirect, consequential or incidental, resulting from the act or omission of any third party occurring in reliance upon the contents of this report. Any information provided in this research report is for information purpose only and have no regards to the investment objectives, financial situation or risk tolerance level of any specific recipient and does not constitute any solicitation or any offer to buy or sell any securities or any other financial instruments. Before entering into any investment contract, individual should exercise judgment or seek for professional advice when necessary. Orient Securities (Hong Kong) Limited may not execute transactions for individual(s) in the securities/instruments mentioned. 4 / 5

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