Equity Research Information Technology Kingsoft (3888 HK) Buy (maintained) Target price: HK$2.77 2Q16 results in line, renewed growth outlook; maintain Buy with target price of HK$2.77 2Q16 results in line Kingsoft s revenue was up 38% YoY to Rmb1,76m in 2Q16, of which Cheetah, online games and its WPS & cloud segment accounted for 7%, 27% and 16% respectively. GAAP net profit saw a big loss of Rmb88m, compared to a profit of Rmb134m in the previous quarter, mainly due to the provision for impairment on its investment in XunLei and 21Vianet, and other financial assets. Excluding this non-cash provision for investment impairment and share-based compensation costs, adjusted net profit rose 67% YoY or 19% QoQ to Rmbm, 7% higher than consensus of Rmb192m. Ryan Zhu, CPA SFC CE No. BDK82 zhuran@gfgroup.com.hk +86 7 8826 316 GF Securities (Hong Kong) Brokerage Limited 29-3/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Cheetah to regain growth from 2H16 Revenue from the Cheetah business increased by 18% YoY (-7% QoQ) to Rmb1,14m in 2Q16, reaching the upper limit of its previous guidance. In response to the headwinds led by the decline in ecpms from its largest partner Facebook, the company is accelerating its transformation from a mobile utility app company to a content driving mobile internet company. With confidence in its content business and direct sales team set-up, Cheetah s management expects sequential sales growth and a profitability improvement from 2H16. For 3Q16, they have guided for -1% QoQ sales growth and that they will turn losses into gains on a GAAP basis. Mobile games to make strong contribution in 2H16 Revenue from online games increased by 6% YoY or 4% QoQ to Rmb477m in 2Q16, driven by the significant success in its first mobile version of JX online and the sustainable strong growth in its core PC game JX online III. Launched at the end of May on the Tencent platform, JX mobile I generated Rmb8m in gross billings and a total of about Rmb1bn by Aug 19. We estimate Kingsoft will record around 24% of total gross billings as net revenue. Meanwhile, the company plans to commercialize the second and third versions of JX mobile game partnered with Xiaomi and Tencent in 4Q16 and 1H17. We expect Kingsoft to see a substantial earnings contribution from mobile games in 2H16 and 217 along with the consecutive launch of three JX mobile games. Stock performance 3% 2% 1% Kingsoft HSI Significant performance in its cloud business and solid development in WPS Revenue from its WPS & cloud segment increased by 123% YoY or 31% QoQ to Rmb274m. Its strategic cloud business continued to post substantial sales growth of 2% YoY in 2Q16, driven by its strong performance in the video cloud and game cloud fields, as well as its quick move into the healthcare and government sectors. WPS also maintained solid growth with the enhanced monetization of the WPS personal version, especially with the successful breakthrough of WPS mobile traffic monetization in 2Q16. % -1% -2% -3% Source: Bloomberg Renewed growth outlook; maintain Buy We believe Kingsoft will return to growth in 2H16 and 217 based on: 1) sequential sales growth and a profitability improvement in its Cheetah business from 2H16; 2) sustainable strong momentum in mobile games, cloud and WPS businesses; 3) gradual profitability improvement as its online games, WPS and cloud service businesses grow in scale. We expect adjusted net profit to increase by 31%/4%/38 YoY to Rmb821m/1,3m/1,88m in 216/17/18. The stock is trading at 14.x 217E P/E. We maintain our Buy rating and target price of HK$2.77, based on 2x FY17E P/E. Key data Aug 19 close (HK$) 14.98 Shares in issue (m) 1,33 Major shareholder Lei Jun 27.12% Market cap (HK$ bn) 19. 3M avg. vol. (m) 9.27 2W high/low (HK$) 21.2 / 12.82 Source: Bloomberg Key risks Failure of Cheetah Mobile to implement its content strategy, and intensified competition in the cloud services industry. Stock valuation Turnover YoY (%) Net profit * Adj. net YoY (%) * Adj. diluted YoY P/E P/B ROE Dividend Net gearing (Rmb m) (Rmb m) profit (Rmb m) EPS (Rmb) (%) (%) yield (%) (%) 214 3, 4 769 76 -.4 (19) 28.2 3.6 16.9.7 cash 2,676 69 369 6 9.49 7 26.3 2.1 4.7.4 cash 216E 7,72 36-337 821 31.63 3 2.3 2.1-4.3.3 cash 217E 9,684 26 782 1,3 4.88 4 14. 1.8 8.6.8 cash 218E 12,211 26 1,179 1,88 38 1.22 38 1. 1.6 11. 1.1 cash * excluding share-based compensation costs and non-cash provision for investment impairment
Figure 1: 2Q16 results review Rmb m 1Q 2Q 3Q 4Q 1Q16 2Q16 YoY QoQ 1H14 2H14 1H 2H 1H16 YoY Online games 3 298 331 4 47 477 6% 4% 62 6 623 746 934 % Cheetah Mobile 692 861 972 1,119 1,8 1,14 18% -7% 646 1,28 1,49 2,9 2,99 41% Office software and others 93 123 24 244 21 274 123% 31% 177 246 278 448 484 74% Revenue 1,19 1,282 1,7 1,778 1,72 1,76 38% 1% 1,426 1,924 2,392 3,28 3,17 47% Cost of sales (224) (37) (369) (42) (47) (6) (223) (367) (31) (789) (1,3) Gross profit 886 97 1,138 1,8 1,281 1, 24% -6% 1,23 1,7 1,861 2,496 2,486 34% GPM (%) 79.8% 76.1% 7.% 76.4% 73.2% 68.3% -7.8% -4.9% 84.4% 8.9% 77.8% 76.% 7.7% -7.1% S&M (29) (396) (477) (93) (493) (481) 21% -2% (324) (474) (686) (1,69) (973) R&D costs (294) (3) (363) (36) (46) (42) 29% 3% (419) (37) (62) (728) (826) Admin exp. (11) (117) (131) (94) (137) (148) 27% 8% (133) (164) (218) (2) (284) SBC (8) (6) (1) (113) (114) (13) 71% -1% (78) (124) (118) (238) (217) Opex (743) (898) (1,96) (1,16) (1,) (1,1) 28% % (94) (1,299) (1,641) (2,26) (2,3) Opex/Revenue (%) -67.% -7.% -72.7% -6.% -6.6% -6.2% -66.9% -67.% -68.6% -68.8% -6.4% Operating profit 138 1 6 142 86-14% -39% 4 26 238 3 227-4% OPM(%) 12.4% 7.8% 4.3% 14.1% 8.1% 4.9% -2.9% -3.2% 17.8% 13.% 9.9% 9.6% 6.% -3.% Finance income 2 46 46 46 38 17 132 98 96 84 Finance costs (2) (18) (22) (18) (22) (27) (34) (42) (39) (39) (49) Others (26) (3) (71) 11 (97) 112 173 (26) (11) (96) Pre-tax income 144 127 63 28 177 (879) -792% -97% 439 23 271 271 (72) -9% Taxation (28) (34) (26) (113) (49) (34) (9) (36) (61) (139) (61) Net profit 1 94 48 113 134 (88) -99% -74% 364 44 29 161 (674) -423% NPM(%) 1.3% 7.3% 3.2% 6.4% 7.6% -4.8% -3.1% -3.4%.% 21.% 8.7% 4.9% -19.2% -27.9% Adj. operating profit before SBC 196 16 19 363 6 189 18% -26% 332 384 6 3 444 % Adj. OPM(%) 17.7% 12.% 12.6% 2.4% 14.6% 1.7% -1.8% -3.9% 23.3% 19.9% 14.9% 16.8% 12.6% -2.2% Adj. net profit before SBC 136 118 143 199 (7) -67% -48% 41 46 291 261 (6) -291% Adj. NPM(%) 14.% 1.6% 7.8% 8.% 11.3% -42.7% -3.3% -4.1% 28.7% 24.2% 12.2% 7.9% -.8% -28.% Adj. net profit before SBC and investment loss or gains 173 123 133 27 172 67% 19% 293 282 296 34 377 27% Adj. NPM(%).6% 9.6% 8.8% 11.6% 9.8% 11.6% 2.% 1.8% 2.% 14.6% 12.4% 1.3% 1.7% -1.6% Figure 2: Forecast revisions Rmb m New Previous Chg (%) FY16E FY17E FY18E FY16E FY17E FY18E FY16E FY17E FY18E Revenue 7,72 9,684 12,211 7,469 9,77 12,227 3% 1% % Adj. net profit 821 1,3 1,88 79 1,31 1,462 8% 12% 9% Adj. EPS (Rmb cents).6.9 1.2.6.8 1.1 8% 12% 9% Gross margin(%) 7.8 7.4 7.2 74.2 72.3 71.9 (3.4) (1.9) (1.7) Adj. operating profit (%) 14.2 16.9 18.8 16.1 18.2 22.1 (1.9) (1.3) (3.3) Adj. net margin(%) 1.7 11.9 13. 1.2 1.8 12.. 1.1 1. Figure 3: Revenue breakdown (Rmb m) 14, 8% 12, 69% 1,19 7% 1, 787 6% 4% 4% 1,13 8, % 6 67 4 4% 6, 37 36% 7,331 371,676 3% 4,396 26% 26% 4, 133 2% 94 291 3,62 2, 289 1,674 1% 694 2,127 2,34 2,74 1,96 1,3 1,369 - % FY13 FY14E FY FY16E FY17E FY18E Cloud business Office software Cheetah Mobile Online gaming Overall growth (%) Figure 4: Revenue and gross margin forecasts 14, 8. 86.8 86.3 12,211 82.4 12, 76.8 7.8 7.4 7.2 1, 9,684 8, 7,72 6,,676 4, 3, 2,174 2, 1,21 1,411 FY11 FY12 FY13 FY14 FY FY16E FY17E FY18E Revenue (Rmb m) Gross margin (%) 1 9 8 7 6 4 3 2 1 2
13/1 13/3 13/ 13/7 13/9 13/11 14/1 14/3 14/ 14/7 14/9 14/11 /1 /3 / /7 /9 /11 16/1 16/3 16/ 16/7 Figure : Adjusted operating profit and OPM forecasts 2, 2,291 34.2 34.2 32.8 2, 1,64 1, 21.4 18.8 16. 1,9 99 16.9 1, 743 7 14.2 462 349 4 3 2 1 Figure 6: Adjusted net profit and net margin forecasts 1,8 32.3 31.3 1,88 1,6 3 1,4 1,2 1,3 1, 17.2 2 821 8 68 13. 6 11.9 76 6 4 11. 1.7 1 4 2 FY11 FY12 FY13 FY14 FY FY16E FY17E FY18E FY12 FY13 FY14 FY FY16E FY17E FY18E Adjusted operating profit (Rmb m, LHS) Adjusted operating margin (%, RHS) Adjusted net profit (Rmb m, LHS) Adjusted net margin (%, RHS) Figure 7: 1-year forward P/E trend 4 3 2 1 Share price x 2x x 3x 4x Sources: Wind, GF Securities (HK) 3
Figure 8: Financial statements Income Statement Balance Sheet Year-end Dec (Rmb m) 214 2 216E 217E 218E Year-end Dec (Rmb m) 214 2 216E 217E 218E Online games 1,3 1,369 2,127 2,34 2,74 Cash and ST deposit 6,984 8,66 9,837 11,476 13,891 Cheetah Mobile 1,674 3,62 4,396,676 7,331 Other cash equivalent 2 177 177 177 177 Office software 291 371 4 6 787 Account receivables 89 1,83 1,741 2,716 2,94 Kingsoft cloud and others 133 37 67 1,13 1,19 Inventory 7 16 11 23 Turnover 3,,676 7,72 9,684 12,211 Other Current Assets 3 YoY (%) 4 69 36 26 26 Total current assets 8,72 1,642 11,821 14,43 17,4 Property, plant & equipment 84 966 98 979 98 Cost of sales (9) (1,319) (2,1) (2,868) (3,641) Intangible assets 197 247 269 26 226 Gross profit 2,76 4,7,41 6,816 8,7 Prepaid land lease payments 281 272 272 272 272 Other income and gains 3 147 9 87 89 Goodwill 267 619 619 619 619 Selling & marketing exp. (797) (1,76) (2,24) (2,447) (3,) Financial assets 77 2,2 1,322 1,322 1,322 Admin exp. (297) (443) (6) (693) (84) Other LT Assets 43 486 486 486 486 R&D costs (96) (1,348) (1,88) (2,123) (2,473) Total non-current assents 2,39 4,843 3,94 3,939 3,884 Other expenses (226) (416) (444) (494) (4) Total Assets 1,382,48,77 18,369 2,929 Operating profit 14 42 61 1,146 1,747 Finance income 239 19 192 192 192 ST Debt 16 147 147 147 147 Finance costs (76) (78) (1) (1) (1) Trade payables 1,12 1,994 2,8 3,44 3,423 Others 28 (116) (976) Deferred revenue 311 426 78 727 916 Pre-tax income 962 42 (234) 1,238 1,839 Other Current Liabilities 7 137 137 137 137 Taxation (9) (21) (121) (19) (266) Total current liabilities 1,39 2,7 2,947 4, 4,624 MI (98) 27 18 (261) (393) Long term debt 2,792 2,711 2,711 2,711 2,711 Net profit 769 369 (337) 782 1,179 Deferred tax liabilities 42 63 8 8 8 YoY (%) (2) n/a n/a 1 Other non-current liabilities 36 9 9 9 9 Adj. net profit 76 6 821 1,3 1,88 Total non-current liabilities 2,87 2,869 2,886 2,886 2,886 YoY (%) () 9 31 4 38 Total liabilities 4,26,74,834 6,941 7,1 Diluted EPS (Rmb).63.29 (.26).6.91 Minority Interests 1, 2,41 2,23 2,284 2,677 YoY (%) (4) n/a n/a 1 Shareholders' Equity 4,61 7,871 7,918 9,144 1,743 Adj. diluted EPS (Rmb).4.49.63.88 1.22 Total Equity & liabilities 1,382,48,77 18,369 2,929 YoY (%) (19) 7 3 4 38 BPS (Rmb) 3.6 6.1 6.1 7. 8.2 YoY (%) 3 7 (1) 17 Cash Flow Statement Financial Ratios Year-end Dec (Rmb m) 214 2 216E 217E 218E 214 2 216E 217E 218E Margins Pretax profit 962 42 (234) 1,238 1,839 Gross margin (%) 82.4 76.8 7.8 7.4 7.2 Tax Paid (9) (1) (121) (19) (266) EBITDA margin (%) 2.1 12.9 11.7 14.8 17. Depr/Amort 161 19 248 287 326 Operating margin (%).3 9. 8.4 11.8 14.3 Change in working capital 17 14 294 138 368 Net margin (%) 22.9 6. -4.4 8.1 9.7 Others (183) 66 1,391 494 4 Adj. operating margin (%) 21.4 16. 14.2 16.9 18.8 Operational cash flow 92 1,397 1,79 1,962 2,812 Adj. net margin (%) 17.2 11. 1.7 11.9 13. Capex (27) (64) (27) (27) (27) Returns and profitability Assoc, MI, Invsmt (1,13) (1,368) 17 ROE (%) 16.9 4.7-4.3 8.6 11. Investment cash flow (1,4) (2,8) (289) (272) (272) ROA (%) 7.4 2.4-2.1 4.3.6 Net Change in Debt 1,677 Working capital New Capital 1,379 2, Receivables (days) 62. 84. 84. 84. 84. Dividend (111) (122) (9) (1) (1) Inventory (days) 3.2 1.7 1.7 1.7 1.7 Others 6 (194) Payable (days) 84. 96.6 96.6 96.6 96.6 Financing cash flow 2,9 2,234 (9) (1) (1) Financial health FX and others Current ratio (x) 17.3.4 24.9 28.1 27.1 Chg in Cash 2,3 1,623 1,23 1,64 2,4 Net gearing (%) cash cash cash cash cash Beginning cash 4,481 6,984 8,66 9,837 11,476 Ending cash 6,984 8,66 9,837 11,476 13,891 Others Dividend payout ratio(%).8 16. -. 16. 16. Effective tax ratio(%) 11. 2.7 1.6 11.2 11.2 4
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