Kingsoft Corporation (3888 HK)

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1 Company Research Results Review Kingsoft Corporation (3888 HK) Strong Beat on Mobile Game Expansion Kingsoft s stunning 3Q16 profit surged 151% YoY to RMB304m, 75% above our forecast thanks to stellar performance of JX Mobile I and operating leverage kicking-in. We raise our FY16-18 non-gaap profit forecast by 8-13% on better-than-expected game outlook for FY16-18 while slightly lower Cloud business growth. Reiterate BUY with unchanged SOTP-based TP at HKD22, implying 25x FY17F P/E. 3Q16 A Strong Beat Kingsoft s 3Q16 non-gaap net profit surged 151% YoY/ 92% QoQ to RMB304m, 75% above our forecast. Total revenue grew 48% YoY/ 26% QoQ to RMB2.2bn, driven by JX Mobile I and Cloud business. GPM contracted 3ppt QoQ to 65% due to i. higher revenue sharing associated with JX Mobile I and ii. continued investments in Cloud and Cheetah Mobile. Nevertheless, OPM expanded 3ppt YoY to 16% with lower opex/ revenue ratio (excl. SBC) to 50% in 3Q16 from 59% in 2Q16 as the operating leverage of online games started to kick in. Key Businesses in Better Shape Online Game. We see increasing visibility going forward because: i. JX Mobile I and JXSJ should likely sustain current high grossing entering into FY17 leveraging on Tencent and Xiaomi s platforms, ii. Its third mobile game, JX Mobile III, to launch in 1H17, should boost its growth from FY17 and iii. PC-based JX Online III continues to enjoy secular uptrends in both active user base expansion and ARPU growth. Cheetah Mobile's 3Q16 revenue jumped 9% QoQ from the bottom in 2Q16 on solid performance of its utility apps. We model 7% QoQ revenue growth for 4Q16 on seasonality. On the mid-to-long term, we expect Live.me, News Republic and other content apps to enjoy healthy user growth in oversea markets (e.g. Live.me ranked 5 th on App Store by grossing), implying future monetization potentials. Kingsoft Cloud managed to grow at 150% YoY in 3Q16 boosted by strong revenue growth in game and video verticals. During the post-result conference call, management lowered FY16F Cloud revenue guidance to ~150% from 200% YoY, probably due to lack of steam in videos and increasing industry competition, in our view. As such, we cut our Cloud revenue growth by 5-8%, and now expect it to grow at 149%/80% in FY16/17. Although Cloud is still at early investment phases and could remain in red in FY16, we expect improving profitability in FY17-18 as it continues to expand its market share in game and video Cloud. Maintain BUY on Higher Earnings Forecast We raise our FY16/17/18 non-gaap NP by 13%/8%/12% mainly on higher game revenue and margins. Our SOTP-derived TP remains unchanged at HKD22, or 25x FY17F P/E, on higher game profit but lower Cloud revenue forecast. Given robust game & Cloud growth and improving Cheetah s fundamentals, we remain positive on Kingsoft and view the recent price weakness as a good entry opportunity. Key risks include Cloud pricing pressure and new game cannibalization. Figure 1: Financial Summary Year to Dec 31 (RMBm) FY14A FY15A FY16F FY17F FY18F Revenue 3,350 5,676 7,975 10,106 12,736 Operating Profit ,122 1,516 Reported Profit (369) 872 1,217 Underlying Profit ,187 1,626 Underlying EPS (RMB) Underlying EPS growth (%) P/E (x) P/B (x) ROA (%) ROE (%) Source: Company Data, Bloomberg, Guosen Securities (HK) Research China TMT Technology 23 Nov 2016 BUY Target price HKD22.00 Last price (21 Nov 16) HKD17.76 Upside/downside (%) 23.9 HSI Mkt cap (HKDb/USDb) 23.1/ week range (HKD) Avg trading volume daily (USDm) Free float (%) 56 Performance HKD Nov-15 Price(LHS) Performance 1M 3M 12M Absolute (%) (14.2) Absolute (USD, %) (14.3) Relative to HSI (%) (12.5) Company background Kingsoft Corporation Ltd. develops and markets computer software. The Company develops role-playing computer games and security, word processing, and spreadsheet software. Kevin Jiang SFC CE No.: BGL kevin.jiang@guosen.com.hk Christopher Tse SFC CE No.: BAZ christopher.tse@guosen.com.hk Jul-16 Rel. to HSI(RHS) 100% 90% 80% 70% 60% See the last page of this report for important disclosures 1

2 3Q16 Results Highlights Mobile Game Operating Leverage Kicking in Kingsoft s 3Q16 non-gaap net profit climbed 151% YoY or 92% QoQ to RMB304m, 75% above our forecast. Total revenue grew 48% YoY or 26% QoQ to RMB2.2bn, underpinned by i) release of JX Mobile I during the quarter ii) solid revenue growth of Cloud businesses. Gross profit increased 27% YoY or 20% QoQ to RMB1.4bn with contracted GPM of 65% versus 2Q16 s 68%. This was mainly due to a greater portion of revenue sharing associated with JX Mobile I and continued investments in Kingsoft Cloud and Cheetah Mobile. Excluding SBC, total opex/ revenue ratio declined 14ppt YoY or 9ppt QoQ to 50% as a result of healthy operating leverage in online game business. Operating profit excl. SBC surged 83% YoY or 84% QoQ to RMB348m. Figure 2 3Q16 results highlights Actual Actual Actual Our est. RMBm 3Q16 3Q15 YoY 2Q16 QoQ 3Q16F Diff. Total Revenue 2,227 1,507 48% 1,765 26% 2,035 9% Gross profit 1,441 1,138 27% 1,205 20% 1,414 2% GPM (%) 65% 75% (11ppt) 68% (4ppt) 70% (5ppt) R&D costs, net of gov grants (491) (363) 35% (420) 17% (478) 3% Selling and distribution expenses (472) (477) (1%) (481) (2%) (576) (18%) Administrative expenses (146) (131) 12% (148) (1%) (165) (11%) Share-based compensation costs (83) (125) (34%) (103) (19%) (147) (43%) Operating profit % % % Operating profit excluding SBC % % % Operating margin excluding SBC (%) 16% 13% 3ppt 11% 5ppt 11% 5ppt Reported net profit % (808) (118%) % Non-GAAP net profit % % % Non-GAAP net margin (%) 14% 8% 6ppt 9% 5ppt 9% 5ppt Source: Company Data, Bloomberg, Guosen Securities (HK) Research Guosen Securities (HK) 2

3 Figure 3 FY16-18 forecast revision New Old New Old New Old RMBm FY16F FY16F Chg FY17F FY17F Chg FY18F FY18F Chg Total Revenue 7,975 7,841 2% 10,106 10,374 (3%) 12,736 13,225 (4%) Gross profit 5,407 5,528 (2%) 6,872 7,573 (9%) 8,660 9,721 (11%) R&D costs, net of gov grants (1,818) (1,827) (0%) (2,274) (2,427) (6%) (2,802) (3,108) (10%) Selling and distribution expenses (1,994) (2,235) (11%) (2,476) (2,977) (17%) (3,120) (3,769) (17%) Administrative expenses (542) (588) (8%) (657) (799) (18%) (790) (1,005) (21%) Share-based compensation costs (399) (486) (18%) (505) (633) (20%) (637) (794) (20%) Operating profit % 1, % 1,516 1,256 21% Operating profit excl. SBC 1,152 1,015 13% 1,627 1,535 6% 2,152 2,050 5% Reported net profit (369) (487) (24%) % 1, % Non-GAAP net profit % 1,187 1,096 8% 1,626 1,452 12% Key metrics assumptions (%) GPM 68% 71% (3ppt) 68% 73% (5ppt) 68% 74% (5ppt) Opex/ revenue ratio excl. SBC 55% 59% (5ppt) 54% 60% (6ppt) 53% 60% (7ppt) Operating margin 9% 7% 3ppt 11% 9% 2ppt 12% 9% 2ppt Operating margin excl. SBC 14% 13% 2ppt 16% 15% 1ppt 17% 16% 1ppt Non-GAAP net margin 11% 10% 1ppt 12% 11% 1ppt 13% 11% 2ppt Source: Company Data, Guosen Securities (HK) Research Figure 4 P&L details and forecasts RMBm FY14 FY15 FY16F FY17F FY18F 1Q16 2Q16 3Q16 4Q16F Online game 1,253 1,369 2,327 2,909 3, Cheetah Mobile 1,674 3,562 4,381 5,170 6,203 1,085 1,014 1,104 1,178 Cloud, WPS and others ,267 2,028 3, Total Revenue 3,350 5,676 7,975 10,106 12,736 1,752 1,765 2,227 2,232 YoY growth (%) 54% 69% 41% 27% 26% 58% 38% 48% 26% Cost of revenue (590) (1,319) (2,568) (3,234) (4,075) (470) (560) (786) (752) Gross profit 2,760 4,357 5,407 6,872 8,660 1,281 1,205 1,441 1,480 Gross margin (%) 82% 77% 68% 68% 68% 73% 68% 65% 66% R&D costs, net of gov grants (956) (1,348) (1,818) (2,274) (2,802) (406) (420) (491) (502) Selling and distribution expenses (797) (1,756) (1,994) (2,476) (3,120) (493) (481) (472) (548) Administrative expenses (297) (443) (542) (657) (790) (137) (148) (146) (112) Share-based compensation costs (202) (356) (399) (505) (637) (114) (103) (83) (99) Other operating income Other expenses (30) (60) (76) (111) (140) (9) (23) (16) (28) Opex/ sales excl. SBC (%) 61% 62% 55% 54% 53% 59% 59% 50% 52% Operating profit ,122 1, OP margin (%) 15% 10% 9% 11% 12% 8% 5% 12% 12% Operating profit excluding SBC ,152 1,627 2, OP margin excl. SBC (%) 21% 16% 14% 16% 17% 15% 11% 16% 16% Non-operating gains/(losses), net 305 (73) (1,053) (960) (117) (3) Share of gain (losses) of JV (8) (24) (3) Share of gain (losses) of associates (7) (19) (72) (71) (64) (13) (20) (17) (22) Finance income Finance costs (76) (78) (114) (116) (106) (22) (27) (33) (32) Profit before tax (230) 1,207 1, (879) Taxation (95) (201) (232) (308) (390) (49) (34) (35) (114) Less: Non-controlling interests 98 (27) (92) (6) (106) 18 1 Reported net profit (369) 872 1, (808) Non-GAAP net profit ,187 1, YoY growth (%) 19% 4% 46% 39% 37% 20% 65% 151% 3% Non-GAAP net margin (%) 17% 10% 11% 12% 13% 10% 9% 14% 10% Source: Company Data, Guosen Securities (HK) Research Guosen Securities (HK) 3

4 Figure 5 SOTP valuation 2017F Non-GAAP NP Revenue P/E P/ Sales Ownership Discount Value Value per Share (RMBm) (RMBm) (x) (x) (%) (%) (RMBm) (RMB) Online Game 1,338 2,909 13x -- 90% 10% 14, Cheetah Mobile 517 5,170 30x -- 47% 25% 5, Cloud, WPS and others -- 2, x 50% 20% 2, Net Cash 7, TP (HKD) 22 Implied P/E(x) 24.8 Source: Company Data, Bloomberg, Guosen Securities (HK) Research *21 Nov 16 close price Current price* Upside 24% Figure 6 Peers comparison table Company Ticker Price Mkt cap PE (x) 3YR EPS PEG P/S (x) EV/EBITDA (x) ROE (%) LCY (USDm) LY 1FY 2FY CAGR (%) (x) 1FY 2FY 1FY 2FY 1FY 2FY Kingsoft 3888 HK , Online Game Tencent 700 HK , IGG 799 HK , Boyaa 434 HK (6.9) n.a Linekong 8267 HK n.a. n.a n.a. n.a n.a. n.a NetEase NTES US , Changyou CYOU US , (4.8) n.a Mean Mobile Internet Baidu BIDU US , (16.0) n.a Weibo WB US , n.a. n.a Facebook FB US , Mean Cloud computing 21Vianet VNET US n.a. n.a. n.a. (13.4) n.a (8.3) (7.2) SalesForce CRM US , n.a n.a. n.a IBM IBM US , Oracle ORCL US , Amazon AMZN US , Mean Software Yonyou CH , Neusoft CH , n.a. n.a Mean Source: Company Data, Bloomberg, Guosen Securities (HK) Research Figure 7 12 months forward PE curve (x) Figure 8 12 months forward PB curve (x) SD: 39.6x Mean: 27.6x SD: 4.2x Mean: 3.1x 20-1SD: 15.7x 2-1SD: 2.0x Aug-12 Feb-13 Aug-13 Feb-14 Aug-14 Feb-15 Aug-15 Feb-16 Aug-16, Guosen Securities (HK) Research 0 Aug-12 Feb-13 Aug-13 Feb-14 Aug-14 Feb-15 Aug-15 Feb-16 Aug-16, Guosen Securities (HK) Research Guosen Securities (HK) 4

5 Summary Financial Statements Profit & Loss (RMBm) FY14A FY15A FY16F FY17F FY18F Financial Ratios FY14A FY15A FY16F FY17F FY18F Revenue 3,350 5,676 7,975 10,106 12,736 Gross profit margin (%) Revenue growth (%) Operating profit margin (%) Cost of sales (590) (1,319) (2,568) (3,234) (4,075) Underlying profit margin (%) Gross profit 2,760 4,357 5,407 6,872 8,660 Net debt/equity (%) (157) (111) (117) (116) (113) Other income/(expense) (202) (269) (299) (344) (433) Net debt/total assets (%) (68.1) (55.7) (54.7) (55.8) (56.1) Operating expenses (2,051) (3,546) (4,355) (5,407) (6,712) Current ratio (%) Operating profit ,122 1,516 Dividend payout (%) Operating profit growth (%) Interest cover (x) Other non-operating inc/(exp) 305 (73) (1,053) 0 0 Dividend cover (x) Finance income Acct. receivable turnover days Finance expenses (76) (78) (114) (116) (106) Acct. payable turnover days Associates & JCE (15) (43) Inventory turnover days Profit before taxation (230) 1,207 1,658 Cash cycle days Taxation (95) (201) (232) (308) (390) Dupont Analysis FY14A FY15A FY16F FY17F FY18F Non-controlling interests (98) (27) (51) Tax burden (%) Net profit (369) 872 1,217 Interest burden (%) (30.5) Other Adjustments on UP (202) 218 1, Operating profit margin (%) Underlying Profit ,187 1,626 Asset turnover (x) Underlying profit growth (%) Leverage ratio (x) EPS (RMB) (0.279) ROA (%) Underlying EPS (RMB) ROE (%) Underlying EPS growth (%) DPS (RMB) DPS growth (%) 0.0 (10.9) Balance Sheet (RMBm) FY14A FY15A FY16F FY17F FY18F Cashflow (RMBm) FY14A FY15A FY16F FY17F FY18F Fixed assets ,217 1,524 1,898 EBIT ,122 1,516 Associates & JCE Depreciation & amortization Others 1,577 3,552 2,955 2,954 2,952 Interest expense (72) (68) Non-current assets 2,309 4,843 4,504 4,821 5,224 Change in working capital (70) Inventories Tax paid (104) (107) (217) (266) (338) Debtors & prepayments 926 1,803 2,348 2,698 3,400 Other operating cashflow Bank deposits & cash 7,004 8,783 9,569 10,841 12,383 Operating activities 952 1,435 1,310 2,375 2,911 Others Capex (633) (680) (678) (808) (1,019) Current assets 8,072 10,642 11,977 13,607 15,856 Free cash flow ,566 1,893 Bank & other borrowings Disposal of non-current assets (593) (1,467) Trade & payables Associates & JCE (net) (107) (199) Taxation Interest received Others 1,242 2,235 2,397 3,024 3,810 Dividends received Current liabilities 1,395 2,705 3,126 3,816 4,770 Other investing cashflow (2,178) 1,725 (346) 0 0 Bank & other borrowings Investing activities (3,368) (472) (1,024) (808) (1,019) Others 2,870 2,858 3,233 3,263 3,299 New loans raised Non-current liabilities 2,870 2,869 3,636 3,666 3,703 Repayment of loans Net assets 6,117 9,911 9,720 10,946 12,607 Dividends paid (189) (133) (128) (178) (244) Share capital Other financing cashflow 3,139 2, (116) (106) Premium & reserves 4,482 7,793 7,694 8,893 10,504 Financing activities 2,950 2, (294) (350) Shareholders' funds 4,487 7,798 7,699 8,898 10,509 Inc/(dec) in cash 535 3, ,272 1,543 Non-controlling interests 1,555 2,041 1,948 1,975 2,026 Cash at beginning of year 2,677 3,194 6,629 7,415 8,687 Total equity 6,117 9,911 9,720 10,946 12,607 Foreign exchange effect (18) BVPS (RMB) Cash at end of year 3,194 6,629 7,415 8,687 10,229 Guosen Securities (HK) 5

6 Information Disclosures Stock ratings, sector ratings and related definitions Stock Ratings: Buy: A return potential of 10 % or more relative to overall market within 6 12 months. Neutral: A return potential ranging from -10% to 10% relative to overall market within 6 12 months. Sell: A negative return of 10% or more relative to overall market within 6 12 months. Sector Ratings: Overweight: The sector will outperform the overall market by 10% or higher within 6 12 months. Neutral: The sector performance will range from -10% to 10% relative to overall market within 6 12 months. Underweight: The sector will underperform the overall market by 10% or lower within 6 12 months. Interest disclosure statement The analyst is licensed by the Hong Kong Securities and Futures Commission. Neither the analyst nor his/her associates serves as an officer of the listed companies covered in this report and has no financial interests in the companies. Guosen Securities (HK) Brokerage Co., Ltd. and its associated companies (collectively Guosen Securities (HK) ) has no disclo sable financial interests (including securities holding) or make a market in the securities in respect of the listed companies. Guosen Securities (HK) has no investment banking relationship within the past 12 months, to the listed companies. Guosen Securities (HK) has no individual employed by the listed companies. Disclaimers The prices of securities may fluctuate up or down. It may become valueless. It is as likely that losses will be incurred rather than profit made as a result of buying and selling securities. The content of this report does not represent a recommendation of Guosen Securities (HK) and does not constitute any buying/selling or dealing agreement in relation to the securities mentioned. Guosen Securities (HK) may be seeking or will se ek investment banking or other business (such as placing agent, lead manager, sponsor, underwriter or proprietary trading in such securities) with the listed companies. Individuals of Guosen Securities (HK) may have personal investment interests in the li sted companies. This report is based on information available to the public that we consider reliable, however, the authenticity, accuracy or completeness of such information is not guaranteed by Guosen Securities (HK). This report does not take into account the part icular investment objectives, financial situation or needs of individual clients and does not constitute a personal investment recommendation to anyone. Clients are wholly responsible for any investment decision based on this report. Clients are advise d to consider whether any advice or recommendation contained in this report is suitable for their particular circumstances. This report is not intended to be an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. This report is for distribution only to clients of Guosen Securities (HK). Without Guosen Securities (H K) s written authorization, any form of quotation, reproduction or transmission to third parties is prohibited, or may be subject to legal action. Such information and opinions contained therein are subject to change and may be amended without any notification. This report is not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any jurisdictio n where such distribution, publication, availability or use would be contrary to applicable law or regulation or which would subject Guosen Securities (HK) and its group companies to any registration or licensing requirement within such jurisdiction. Guosen Securities (HK) 6

7 信息披露 公司评级 行业评级及相关定义 公司评级买入 : 我们预计未来 6-12 个月内, 个股相对大盘涨幅在 10% 以上 ; 中性 : 我们预计未来 6-12 个月内, 个股相对大盘涨幅介于 -10% 与 10% 之间 ; 减持 : 我们预计未来 6-12 个月内, 个股相对大盘跌幅大于 10% 行业评级超配 : 我们预计未来 6-12 个月内, 行业整体回报高于市场整体水平 10% 以上 ; 中性 : 我们预计未来 6-12 个月内, 行业整体回报介于市场整体水平 -10% 与 10% 之间 ; 低配 : 我们预计未来 6-12 个月内, 行业整体回报低于市场整体水平 10% 以上 利益披露声明 报告作者为香港证监会持牌人士, 分析员本人或其有联系者并未担任本研究报告所评论的上市法团高级管理人员, 也未持有其任何财务权益 本报告中, 国信证券 ( 香港 ) 经纪有限公司及其所属关联机构 ( 合称国信证券 ( 香港 )) 并无持有该公司须作出披露的财务权益 ( 包括持股 ), 在过去 12 个月内与该公司并无投资银行关系, 亦无进行该公司有关股份的庄家活动 本公司员工均非该上市公司的雇员 免责条款 证券价格有时可能非常波动 证券价格可升可跌, 甚至变成毫无价值 买卖证券未必一定能够赚取利润, 反而可能会招致损失 本研究报告内容既不代表国信证券 ( 香港 ) 的推荐意见, 也并不构成所涉及的个别股票的买卖或交易要约 国信证券 ( 香港 ) 或其集团公司有可能会与本报告涉及的公司洽谈投资银行业务或其它业务 ( 例如配售代理 牵头经办人 保荐人 包销商或从事自营投资于该股票 ) 国信证券 ( 香港 ) 不排除其员工有个人投资于本报告内所提及的上市法团 报告中的资料均来自公开信息, 我们力求准确可靠, 但对这些信息的正确性 公正性及完整性不做任何保证 本报告没有考虑到个别客户特殊的投资目标 财务状况或需要, 并不构成个人投资建议, 客户据此投资, 责任自负 客户在阅读本研究报告时应考虑报告中的任何意见或建议是否符合其个人特定状况 本报告并不存在招揽或邀约购买或出售任何证券的企图 本报告仅向特定客户传送, 未经国信证券香港书面授权许可, 任何人不得引用 转载以及向第三方传播, 否则可能将承担法律责任 研究报告所载的资料及意见, 如有任何更改, 本司将不作另行通知 在一些管辖区域内, 针对或意图向该等区域内的市民 居民 个人或实体发布 公布 供其使用或提供获取渠道的行为会违反该区域内所适用的法律或规例或令国信证券 ( 香港 ) 受制于任何注册或领牌规定, 则本研究报告不适用于该等管辖区域内的市民 居民或身处该范围内的任何人或实体 Guosen Securities (HK) 7