coverage initiated with a Buy

Transcription

Global
Equity Research
Asia Korea
Technology/Software
26 November 2004
Initiation of Coverage
NCSoft
Company Focus
Reuters: 036570.KS
Buy
Bloomberg: 036570 KS
Exchange: KOSPI
Ticker: 036570.KS
The best game in town;
coverage initiated with a Buy
Jae Min Lee
(822) 316 8902
jaemin.lee@db.com
95,600
130,000 (+36.0%)
110,000 - 62,500
NA
872.56
Key changes
Price target (chg)
Sales (FYE chg)
Op prof margin (FYE chg)
Net profit (FYE chg)
130,000
250.92
45.18
88.96
NA
NA
NA
NA
Price/price relative
Still more catalysts to drive outperformance
NCSoft should outperform the KOSPI on catalysts that include: the global
release of Guild Wars in early 2005 (potentially an even larger success
than City of Heroes); Lineage 2’s growing user base overseas; and
positive affiliate earnings from 2005. Despite the 37% outperformance
YTD, valuations remain attractive. Coverage initiated with a Buy.
Growth, growth and more growth
Despite saturation of the domestic MMORPG market, revenues should
grow 24% in 2005 and 13% in 2006, driven by Lineage 2’s expanding
users overseas and 4 new title releases during 2005 that will target the
under-penetrated US market and domestic light-users. Accordingly, we
forecast earnings will grow 42% in 05 and 20% in 06.
First-mover advantage, superior R&D capabilities
In a highly competitive market, we believe NCSoft will maintain a
dominant position, bolstered by first-mover advantage, strong brand
recognition in the domestic market and abundant cash flow generation,
which supports superior R&D and marketing capabilities.
Target price of W130,000 represents 36% upside potential
Our 12-month target price of W130,000 is based on 2005F valuation
measures of 20x PER and 0.5 PEG, within the historical trading band and
in line with most growth stocks. The key risks to our recommendation are:
weaker-than-expected take-up of the new game releases; and the
potential stock overhang from stock options.
Forecasts and ratios
Year End Dec 31
Sales (Wonm)
EBITDA (Wonm)
Net profit (Wonm)
EPS consensus (Won)
EPS New (Won)
EPS Old (Won)
Chg to previous EPS
EPS growth
PER (x)
EV/EBITDA (x)
DPS (net) (Won)
Yield (net)
Price at 24 November 2004 (Won)
Price target - 12mth (Won)
52-week range (Won)
Previous rating
KOSPI
200
120000
100000
150
80000
100
60000
40000
50
20000
0
11/03
0
2/04
5/04
KOSPI (L.H. SCALE)
NCSoft (R.H. SCALE)
Performance (%)
1m
Absolute
-11.3%
KOSPI
5.4%
2003A
166.54
57.30
31.67
1,682.6
NA
NA
-40.4%
26.51
12.68
0.0%
2004F
250.92
116.99
88.96
4,132.4
4,726.8
NA
NA
180.9%
20.23
14.19
0.00
0.0%
2005F
309.96
144.53
125.87
4,855.3
6,687.9
NA
NA
41.5%
14.29
10.89
0.00
0.0%
2006F
351.06
162.85
150.65
6,140.9
8,004.4
NA
NA
19.7%
11.94
8.59
0.00
0.0%
3m
14.9%
10.1%
12m
50.9%
15.8%
Stock data
Market cap (Wonm)
Market cap (US$m)
Shares outstanding (m)
Avg daily volume (US$m)
Major Shareholders:Taek Jin Kim
Free float
Beta (2 years)
Est. 3 year EPS growth
Financial data
ROE
ROA
Net debt/equity
Book value/share (Won)
Price/book
Net interest cover
Operating profit margin
Upcoming events
2002A
154.82
78.38
53.11
2,822.0
NA
NA
343.2%
14.52
8.20
0.0%
8/04
Premier China Conference
4Q04 earnings result
Related recent reports
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Takeshi Koyama
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Takeshi Koyama
PSP launch set for 12 December
Takeshi Koyama
Game Sector Monthly
Takeshi Koyama
1,893,167
1,777.6
19.80
11.95
32%
62.0%
1.00
68.2%
FYE
32.4%
28.7%
-70.5%
17,605.32
5.4x
NM
45.2%
Date
28 Feb 2005
1 Feb 2005
Date
16 Nov 2004
11 Nov 2004
28 Oct 2004
21 Oct 2004
Source: Deutsche Bank AG estimates, company data
1Pre-exceptionals/extraordinaries
2Multiples and yields are calculated
using average historical prices for past years and spot prices for current and future years with the exception of
the price to book ratio which uses the year-end close for historical values.
Deutsche Bank AG
Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, 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.
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.
26 November 2004
Technology/Software NCSoft
Model updated: 24 November 2004
Y/E 31 December
Equity Research
Asia
Korea
Internet
SUMMARY
Headline EPS (Won)
P/E ratio Headline (x)
Headline EPS growth (%)
EPS FD (Won)
P/E ratio FD (x)
Operating CFPS (Won)
Free CFPS (Won)
P/CFPS (x)
DPS (Won)
Dividend yield (%)
BV/Share (Won)
Price/BV (x)
Weighted average shares (m)
Average market cap (Won bn)
Enterprise Value (Won bn)
EV/Sales
EV/EBITDA
EV/EBIT
EV/Operating Capital
NC Soft
Reuters code
036570.KS
Buy
Price as at 23-Nov
Won95,600
Target Price
Won130,000
Company Website
http://www.ncsoft.net
Company description
NC Soft Corporation develops and publishes on-line
games.
2000
2001
2002
2003
2004E
2005E
2006E
1,513
15.6
nm
1,513
15.6
1,574
1,251
15.0
0
0
5,671
2.36
16
377
304
5.2
10.1
10.4
237.7
637
42.4
-57.9
637
42.4
866
566
31.2
0
0
7,201
5.42
18
494
390
3.1
21.6
23.0
49.8
2,822
14.5
343.2
2,822
14.5
4,305
4,213
9.5
0
0
10,273
2.51
19
771
643
4.2
8.2
8.3
nm
1,683
26.5
-40.4
1,683
26.5
830
698
53.7
0
0
11,555
5.71
19
839
726
4.4
12.7
13.1
22.6
4,727
20.2
180.9
4,116
23.2
6,817
6,339
14.0
0
0
17,605
5.43
19
1,893
1,660
6.6
14.2
14.6
202.5
6,688
14.3
41.5
5,824
16.4
5,530
4,999
17.3
0
0
24,293
3.94
19
1,893
1,573
5.1
10.9
11.3
32.9
8,004
11.9
19.7
6,970
13.7
7,418
6,886
12.9
0
0
32,298
2.96
19
1,893
1,398
4.0
8.6
8.9
59.5
58
30
1
0
29
2
0
0
0
8
0
24
125
18
1
0
17
4
-6
0
0
4
0
12
155
78
1
0
77
6
-9
-5
0
16
0
53
167
57
2
0
55
5
-24
-3
0
1
0
32
251
117
4
0
113
7
-7
-1
0
24
0
89
310
145
5
0
140
9
17
-1
0
39
0
126
351
163
6
0
157
9
32
-1
0
46
0
151
25
0
-5
20
-17
65
0
0
4
69
73
-73
16
-3
-5
10
-3
28
0
0
-4
24
32
-32
81
18
-2
79
-50
0
0
7
-5
2
31
-24
16
-42
-2
13
-3
0
0
0
-26
-25
-15
15
128
29
-9
119
-17
0
0
-8
18
11
113
-121
104
-10
-10
94
0
0
0
0
-8
-8
86
-86
140
15
-10
130
0
0
0
0
45
45
175
-175
73
5
0
0
17
9
103
0
12
12
91
0
91
0
-73
18
105
9
1
0
20
16
150
0
18
18
132
0
132
3
-105
27
136
9
3
0
70
23
241
7
40
47
193
0
193
-15
-128
65
121
10
1
0
72
46
249
8
24
32
217
0
217
27
-113
105
234
15
1
0
90
31
370
0
39
39
331
0
331
-2
-234
98
320
22
3
0
90
46
481
0
24
24
457
0
457
28
-320
137
495
33
3
0
90
52
673
0
65
65
608
0
608
-7
-495
113
nm
51.5
50.5
0
26.7
123.6
nm
8.9
8.6
-80.1
nm
114.2
14.5
13.6
0
10.5
36.5
283.3
4.4
4.8
-79.2
nm
24.1
50.6
49.8
0
32.7
105.1
nm
1.1
1.4
-66.4
nm
7.6
34.4
33.2
0
15.4
31.8
387.2
1.5
1.2
-51.9
nm
50.7
46.6
45.2
0
32.4
82.3
441.5
3.6
2.5
-70.5
nm
23.5
46.6
45.1
0
31.9
101.1
381.7
3.2
2.1
-70.0
nm
13.3
46.4
44.8
0
28.3
114.7
337.2
2.8
1.8
-81.4
nm
INCOME STATEMENT (Won bn)
Sales revenue
Operating EBITDA
Depreciation
Amortisation
Operating EBIT
Net interest income (expense)
Associates/affiliates
Investment and other income/expense
Exceptionals/extraordinaries
Income tax expense
Minorities/preference dividends
Net income
Research Team
CASH FLOW (Won bn)
Jae Min Lee
+822 316 8902
Cash flow from operations
Movement in net working capital
Capex
Free cash flow
Other investing activities
Equity raised/(bought back)
Dividends paid
Net inc/(dec) in borrowings
Other financing cash flows
Total cash flows from financing
Net cash flow
Movement in net debt/(cash)
jaemin.lee@db.com
BALANCE SHEET (Won bn)
Cash and other liquid assets
Tangible fixed assets
Goodwill
Other intangible assets
Associates/investments
Other assets
Total assets
Interest bearing debt
Other liabilities
Total liabilities
Shareholders’ equity
Minorities
Total shareholders’ equity
Net working capital
Net debt/(cash)
Capital
Absolute Price Return(%)
1m -11%
3m
12m
13%
RATIO ANALYSIS
47%
-15%
0%
15%
52-week Range:
Market Cap (m):
30%
45%
Sales growth (%)
Op. EBITDA/sales (%)
Op. EBIT/sales (%)
Payout ratio (%)
ROE (%)
Return on Capital (%)
Operating Return on Capital (%)
Capex/sales (%)
Capex/depreciation (x)
Net debt/equity (%)
Net interest cover (x)
60%
Won62,500 - Won110,000
Won 1,893,167
US$ 1,778
Company identifiers
Bloomberg
Cusip
SEDOL
036570 KS
NA
6264189
Price and Price Relative
120,000
160
Margin Trends (%)
Return Ratios (%)
120
0
350
-100
-20
75
300
250
-200
-40
60
200
45
150
100
-300
-60
50
0
-400
-80
105
90,000
120
60,000
80
30,000
40
0
0
1/04
4/04
7/04 10/04
Net Debt (Cash)/Equity (%)
450
400
90
30
15
0
NCSoft (L.H.S.)
Rel. to KOSPI (R.H.S.)
00
01
02
03
04E 05E
Sales growth(%)
Op. EBITDA/sales (%)
00
01
02
03
04E
05E 06E
06E
ROE(%)
Return on Capital(%)
Operating Return on Capital(%)
-500
0
00
01
02
03 04E 05E 06E
-100
Net debt/equity (%)
Net debt/(cash) (Won bn)
Source: Deutsche Bank AG estimates, company data
Page 2
Deutsche Bank AG
26 November 2004
Investment thesis
Outlook
NCSoft has outperformed the market by 376% since listing and 37% YTD through
delivering superior growth. We expect a similar performance over the next 12-18
months. Growth should be driven by expansion into overseas markets, including
China and the US, and penetration of the domestic light-user and female markets,
with four new game releases scheduled for next year.
Lineage 2. Although Lineage 2 is already highly penetrated in Korea, we project
healthy growth that will be driven by overseas markets, including China, Japan and
Taiwan. The commercial launch in China of Lineage 2 was on 10 November. During
the first week of open-beta service in China, concurrent users exceeded 100,000,
reaching 21% of the No. 1-ranked game, Legend of Mir. Moreover, active-user
figures continue to exceed management’s expectations in Japan and Taiwan.
City of Heroes (CoH). The game acquired 160,000 active users in the US during the
first 6 months of release, compared to 435,000 users for the first-ranked game,
Everquest. Updates, including City of Villians (expansion package), which will be
launched in 2005, should drive stronger box sales.
Guild Wars. Guild Wars received positive reviews in the US and has been rated one
of the top massively multiplayer online role playing games (MMORPGs) to be
released. Guild Wars could be a bigger success than CoH in the US, due to its
unique pricing strategy and gameplay.
Alterlife. The game Alterlife is a light MMORPG, which targets females. Assuming
that around 10% of females in the 10-35 age group begin playing MMORPG games
(compared to over 40% of males in the same age group), the domestic MMORPG
market could expand by around 20%.
Auto Assault and Tabula Rasa. As these two games are still in development and
their market reception is unpredictable, the market could be underestimating their
revenue potential. Thus, these games may surprise on the upside, in our view.
Valuation
Our 12-month target price of W130,000 is based on 2005F valuation measures of
20x PER and 0.5 PEG, within the historical trading band and largely in line with most
growth stocks. We have also performed a scenario analysis to determine the bestand worst-case scenarios. In the best-case scenario, we value NCSoft at W180,000
and in the worst case at W90,000.
Risks
The key risk to our recommendation is the potential for weaker take-up of the new
game titles. A major sell-off of Korean stocks by foreign investors could also impact
the share price.
Deutsche Bank AG
Page 3
26 November 2004
Looking overseas for growth
Overseas expansion should deliver growth going forward
NCSoft was established in 1997 as a groupware solution, system-integration
provider, but emerged as a game developer and publisher through the launch of
Lineage 1 in 1998. Since 1997, NCSoft has delivered 160% Cagr revenue growth
and is currently the No. 1 online game provider in Korea, with 38% market share.
Nonetheless, as market diffusion for MMORPG (which accounts for the largest
portion of the online game market in Korea) is already high, we believe NCSoft will
have to focus on overseas expansion and target lighter users in the domestic
market to deliver growth.
Domestic online game market to post a 3-year Cagr of 25%
Korea is the largest online
game market globally
Online game sector will
slow, but remain robust
With a 31% global share, Korea is the largest online game market in the world.
Korea’s game market amounts to W1.5tr, with online games accounting for 49.3%
of the total on a pure platform basis (excluding PC and game rooms). Including
revenues generated from PC rooms, the total game market swells to W3.9tr (see
Figure 1). Of this market, online games constitute 62%. Compared to the rest of the
world, arcade and console games take up a much smaller share, just 7.9% and
5.6%, respectively.
The dominance of the online game sector in Korea is attributable largely to the early
development of broadband services, the widespread availability of Internet cafes
and advanced Internet-payment-gateway systems. Nonetheless, as the online game
market in Korea is already well established, it should grow at a lower 25% Cagr
during the 3-year period beginning in 2004, compared to 38% growth projected for
the global market.
Figure 1: Online games, the largest segment
Wbn
2002
2003
2004F
2005F
2006F
Online
452
754
1,094
1,422
1,706
Mobile
100
146
219
306
414
Video
156
223
290
348
400
PC
165
94
75
68
66
Arcade
378
312
296
305
320
1,475
1,691
1,827
1,918
1,975
676
654
648
667
700
0
65
88
110
132
3,403
3,939
4,535
5,143
5,713
PC Room
Game Room
Composite Game room
Total
Source: Korea Game Development Institute
Online games: casual and hard-core
We define online games as those that require Internet access to dedicated remote
servers to facilitate play. Online games can be categorised into two segments:
casual and hard-core.
Page 4
Deutsche Bank AG
26 November 2004
Hard-core players want
complex, time-consuming
games
Casual games are generally for the mainstream audience and include games like
cards, trivia, and puzzles. Casual game providers generate revenue mostly from
online advertising. On the other hand, hard-core games are a genre of more
complex, time-consuming games that can be categorised under role playing, action,
sports or strategy. These games usually charge for the up-front software required to
play the game, a one-time registration fee to join a gaming community, or on a per
usage basis (hourly or monthly). MMORPG, within the hardcore segment, is the
largest genre within the global online game market, accounting for 40%.
Compared to
characteristics:
Six distinctive
characteristics of MMORPGs
other
games,
MMORPGs
have
the
following
distinctive
1) Longer life expectancy: The life expectancy of an MMORPG is about five to
ten years, longer than most other games. This is due to the greater time
required to advance levels;
2) No ultimate ending: A continuous set of short-term quests replaces an
ultimate ending. Developers/publishers update the games every three to six
months with new sites, characters, maps, and other features to extend the life
of the games;
3) Accumulated power and/or wealth are the retention factors: A player’s
accumulated power and/or wealth within the games are the main retention
factors;
4) First-mover advantage: As substantial time is required to play and advance in
the game, gamers have limited time to play competing games. As such, once a
game is established, there is limited threat of losing players;
5) Community game: Community set-up is among the most important factors in
an MMORPG. Players can set up guilds or fight each other. In a typical
MMORPG, each server can accommodate thousands of players; and
6) High barriers to entry: Compared to most other games, substantial time,
development expense and marketing costs are required to launch a game.
The key differences between casual and hard-core MMORPG are listed in Figure 2.
Figure 2: Casual game vs. MMORPG
Average usage time per session
Entrance barrier
Users
Development time
Risk
Casual game
30 min to 1 hour
low
all ages and both genders
below 6 months
Development cost low
MMORPG
over 2 hours
high
mostly male (teens to 30's)
1 to 3 years
Development and marketing costs high
Domestic MMORPG market is saturated
Domestic MMORPG market
is already highly penetrated
The penetration rate for MMORPG from monthly access numbers is already high.
Based on our calculation, players of the top 3 MMORPGs already represent around
36% of the total male population aged 10-35 (see Figure 3).
Although there could be some overlap on the monthly access numbers between
games, most players do not have time to play more than one MMORPG at a time.
Deutsche Bank AG
Page 5
26 November 2004
Figure 3: Top four games occupy around 40% of addressable population
Game title
Monthly access
1,685
1,078
781
36%
L1
L2
Mu
% of total pop aged 10-34
HCU
148
110
80
Source: NCSoft, Webzen
Multi-pronged strategy for growth
As the domestic MMORPG market is close to saturation, we believe domestic
game developers and publishers (including NCSoft) that are focused on MMORPGs
will have to implement a multi-pronged strategy to sustain growth:
Overseas and new game
genres for growth
1) Expansion into overseas markets. China and the US offer higher growth
potential vs. the domestic market;
2) Non-hardcore MMORPGs. Given the high penetration of hardcore MMORPGs
in Korea, future growth is likely to be driven by different genres;
3) Targeting the female market. At present, the male population dominates the
MMORPG market; and
4) Maintain a stable domestic cash flow stream to develop new games.
Global online game market offers good growth potential
Online game penetration
low in global markets
As of the end of 2003, the global game market was about US$62bn, with arcade
and console games accounting for 47% and 31%, respectively. Although they have
been the fastest growing segment in recent years, online games now account for
just 3% of the total market. Asia (excluding Japan) dominates the global online
market.
The online game market should grow at a Cagr of 38% to US$6.2bn by 2006.
Increasing PC and broadband penetration will drive the growth.
Figure 4: Online game market is one of the fastest growing segments
US$bn
2001
2002
2003
2004F
2005F
2006F
Arcade game
Chg (%)
PC game
Chg (%)
Video game
Chg (%)
Online game
Chg (%)
Mobile game
Chg (%)
Others
Chg (%)
Total
Chg (%)
28.0
29.4
5
3.5
-5
21.5
15
1.1
106
0.6
190
5.2
79
61.3
14
29.4
0
3.4
-3
19.4
-10
2
83
0.9
59
7
35
62.1
1
30.0
2
3.3
-2
13.9
-28
3.2
62
1.4
52
9.2
31
61.1
-2
30.9
3
3.3
-1
16
15
4.7
45
2.1
47
12.1
32
69.1
13
32.2
4
3.4
2
23.2
45
6.2
32
2.9
39
15
24
82.8
20
3.7
18.7
0.5
0.2
2.9
53.9
Source: DFC, Informa Media Group, IDATA, Datamonitor, ARC Group, Igda, NPD Group, Screeedigest, Inform Pty Lty, Ireserach, Wanfang Data, Idsa, CESA, Jamma,
IDC, OVUM
Page 6
Deutsche Bank AG
26 November 2004
China and the US are growth markets
We identify China and the US, where broadband penetration rates are low (see
Figure 5), as the future growth markets for domestic online game
developers/publishers (including NCSoft).
Figure 5: Low broadband penetration offers growth potential in China and the
US
Australia
China
Italy
UK
Germany
France
Sweden
US
Singapore
Austria
Japan
Spain
Canada
HongKong
Belgium
Taiwan
(%)
Korea
0
10
20
30
40
50
60
70
80
Source: Deutsche Bank AG estimates
China is Korea’s largest online game export market
China is the second largest
online game market in Asia
China’s online game market is worth around US$236m and is the second largest in
Asia after Korea (20% market share). The Chinese online game market should grow
at a 54% Cagr from 2004 to 2006, based on industry forecasts released by
WanFang, IDC and Ovum. In our view, the growth will be driven by the following:
1) Growing broadband penetration: At present, the broadband penetration rate
in China stands at a low 3% of households, but our DB China telecoms team
forecasts this figure will rise closer to 20% by 2008;
2) Higher PC penetration: China’s PC penetration is currently just 3% of the
population. However, our DB China team projects PC shipments to China will
grow 15-18% p.a.; and
3) Growth in MMORPGs: MMORPGs are the main constituent for online games
in China. Based on our calculations (see Figure 6), the top five MMORPGs
attract just c.7% of the total male population aged 10-35 (we calculated the
monthly access numbers based on the highest concurrent users). Even
considering that these numbers are understated, due to illegal game playing,
Chinese penetration rates appear much lower than those in Korea or Taiwan.
Deutsche Bank AG
Page 7
26 November 2004
Figure 6: Top five games account for 7% of the addressable market in China
Game title
Mir2
Mir3
Mu
World of Legend
Seo Yu Gi dream
% of pop ages 10-35
China
Monthly access
7,556
3,935
3,306
3,148
2,361
HCU
480
250
210
200
150
7%
Source: Deutsche Bank AG estimates, Actozsoft, WEbzen
Chinese Government places
restrictions on foreigners
Korean game developers and publishers dominate the Chinese online game market
with a 53% share. However, we believe this figure could decline over the longer
term, based on the Chinese Government’s strategy to promote local companies,
which currently hold just a 27% share. Heavy restrictions on foreign entrants are a
part of this strategy. The restrictions include a long approval process for new game
launches and mandating JV distribution channels with local companies (foreigners
are limited to taking a maximum 49% stake).
Despite the potential for market share declines in China, we believe Korean online
game exports to China will remain robust for three reasons:
1) The strong growth potential of the Chinese online game market;
2) Korean companies’ already well-established presence in the market; and
3) Demand outpacing local supply increases.
US gamers’ tastes are different
US online market to grow at
a 50% Cagr between 04F and
06F
The US online game market is about US$465m, representing a small 3% of the total
game market, which is dominated by arcade and console games (see Figure 8). The
US online game market should grow at a 50% Cagr between 2004 and 2006,
according to the Korea Game Development Institute.
In our view, this high growth rate makes sense, as US broadband penetration,
which is currently low at around 30%, should rise to just under 60% by 2008 (based
on DB US telecom team’s projections).
Nonetheless, the US market is more difficult to penetrate for Korean game
developers whose experience is mainly in the hard-core, MMORPG genre. US
gamers prefer console or arcade games to hard-core online games
Page 8
Deutsche Bank AG
26 November 2004
Figure 7: Online games dominate in Korea
Mobile
10%
Figure 8: Console games dominate in the US
PC
6%
Console
15%
PC
8%
Arcade
49%
Online
49%
Console
40%
Arcade
20%
Online Mobile
0%
3%
Arcade and console games dominate in Japan
Online games represent 2%
of the total market
Japanese market to grow at
a 21% Cagr over 2004-06F
The online game market in Japan is worth around US$82m and represents just 2%
of the total market. Unlike Korea and China, Japan’s game market is dominated by
arcade and console games.
According to the Korea Game Development Institute, the Japanese online game
market should grow at a Cagr of 21% between 2004 and 2006, driven by several
factors:
1) Japanese game developers (including Sony Computer Entertainment, Sega and
Nintendo) have focused mainly on the development of console and arcade
games in the past, but are now paying more attention to online games; and
2) Broadband penetration is low (currently less than 30%), but we expect this to
rise closer to 60% by 2008.
However, one risk to this growth projection is that PC specs are too low for
hardcore online games – the Japanese tend to use notebook computers over PCs.
Taiwan is already saturated
Korean game developers and publishers dominate the Taiwanese market. Taiwan’s
online game market is US$157.9m and represents 13.6% of the total Asian market.
It is the third largest online game market in Asia after Korea and China and is more
mature. Similar to Korea, the early adoption of broadband spurred rapid penetration
of online games.
At present, with broadband penetration of more than 70% and the top 5
MMORPGs occupying 44% of the male population aged 10-34, growth of online
games, in particular MMORPGs, should be lower than the rest of the world. The
Korea Game Development Institute forecasts Taiwanese online game market to
grow at 5% Cagr between 2004 and 2006.
Deutsche Bank AG
Page 9
26 November 2004
Figure 9: Taiwan’s market is as mature as the Korean market
Game title
L1
L2
Ragnarok
Crazy Arcade
Seal Online
Taiwan
Monthly access
720
206
1,094
Korea
HCU
148
57
300
44%
Source: NCSoft, WEbzen
NCSoft is well positioned to deliver growth
A number of competitive
strengths
We believe NCSoft is well positioned both in the domestic and overseas markets to
deliver growth, due to a number of competitive strengths:

Page 10
The largest domestic online game developer and publisher. Due partly to
the first-mover advantage, NCSoft has a dominant 38% share of the domestic
market. Considering that MMORPGs have high-user-retention power, this
dominant position is unlikely to change, in our view;
Strong domestic brand power. NCSoft’s strong brand power within the
domestic online game market should make marketing easier and less expensive
for new game titles;
Abundant cash flow generation from established markets. NCSoft’s
Lineage 1 and 2 are already well established in the domestic and Taiwanese
markets. With the abundant cash flow generated from these established game
titles, NCSoft should be able to readily fund regular game updates to retain
established players, develop new games to penetrate the high-growth overseas
markets and market new products forcefully;
Powerful R&D capabilities: At present, NCSoft has the largest development
team in Korea consisting of 572 personnel. NCSoft recruited Richard Gariott for
its US development base, NC Austin. Richard Gariott was one of the core
members that developed the Ultima series. Further NCSoft holds a 100% stake
in Arenanet, whose development team consists of Blizzard veterans who
created online hits Diablo, Starcraft and Warcraft;
Superior server technology: Server technology is essential for a successful
online game. With extensive experience and copius cash flows, NCSoft has
been able to quickly invest in servers and maintain service levels to meet
gamers’ demands;
Efficient distribution base: NCSoft has already established distribution
networks in all major markets including China, Japan, the US, Taiwan and
Thailand;
Beach head in the US: NCSoft launched two new games (CoH and Lineage 2)
in North America on 28 April. It is difficult to determine whether the US market
will be a longer-term success, but, considering that CoH has posted 160,000
active users in the first six months of launch, compared to around 435,000
active users on the top ranked Everquest, the game appears to be an initial hit.
Deep penetration of CoH in the US should set the stage for future game
releases, including Guild Wars, Auto Assault and Tabula Rasa, which are more
geared to the tastes of US gamers;
Deutsche Bank AG
26 November 2004

Better reception in China. The commercial launch of Lineage 2 in China was
on 10 November. During the first week of open beta testing, which began on 26
August, concurrent users surpassed 100,000 vs. the top game in China, Legend
of Mir, which records around 480,000 concurrent users. NCSoft has been
unable to penetrate China in the past due to a late entrance. Once Lineage 2 is
established in China, the company should be able to better introduce new
games into this growth market; and
Product diversification. The company will launch a strategy-based role playing
game named Guild Wars in early 2005. The game is targeted at a different user
pool vs. Lineage 1 and 2, so avoiding cannibalisation of Lineage 1 and 2’s base.
The company is also developing a new game called Alterlife, which is a light
role playing game targeted at female gamers. Assuming that around 10% of
females aged 10-35 begin to play MMORPG games in Korea (compared to over
40% of males in the same age group), we expect the domestic MMORPG
market could grow 20% from current levels. In the past, female gamers were
not attracted to MMORPGs, due to their violent characteristics and medieval
settings (which generally attract male gamers). Beside Guild Wars and Alterlife,
NCSoft plans to launch two additional games in 2005, targeted mainly at US
gamers.
Figure 10: Only a strong presence in Korea and Taiwan until recently
US
Game title
Date
Concurrent
user*
Company
Mkt
cap(US$bn)
Revenue(US$m)
1
2
3
4
Everquest
Starwars Galaxy
Ultima online
Dark age of Camelot
1999
2003
1997
2002
400,000
200,000
100,000
100,000
Sony online
Sony online
EA
Mythic Entertainment
unlisted
unlisted
15,111
unlisted
n/a
n/a
2,957
n/a
Japan
1
2
3
Ragnarok
Lineage 1
Lineage 2
2002
2001
2004
50,000-60,000
25,000
15,000-20,000
Gravity
Ncsoft
Ncsoft
unlisted
1,142
1,142
n/a
146
146
Taiwan
1
Lineage 1
2
Ragnarok
3
Lineage 2
2000
2002
2004
130,000
100,000
60,000
Ncsoft
Gravity
Ncsoft
1,142
unlisted
1,142
146
n/a
146
China
1
2
3
Nov-01
Jul-03
Nov-02
480,000
250,000
150,000
ActozSoft
ActozSoft
Webzen
91
91
244
49
49
40
Mar-03
90,000
Gravity
unlisted
n/a
Legend of Mir 2
Legend of Mir 3
Mu
Thailand
1
Ragnarok
Note: * in the case of US, active users
Source: NCSoft WEbzen, Korea Game Development Institute
Deutsche Bank AG
Page 11
26 November 2004
Adena = real cash
Anticipate successful launch of new games
New games look promising
for a number of reasons
The biggest difficulty we face in analysing NCSoft is forecasting the success of its
future games. Nonetheless, we took the approach of playing NCSoft’s and
competitors’ games, surveying domestic gamers, and assessing US reviews of
NCSoft’s recently released game titles, Lineage 2 and CoH to project the outlook for
future game launches. Further, we studied previews of Guild Wars and competitors’
new game titles to gauge the competitive environment. We reached several
conclusions:

Stable growth expected on Lineage 2 users. Lineage 2 should have lasting
value in the Asian markets, due to high retention factors including: significant
time investment to reach high levels; an abundance of item trades; and easy
conversion of virtual items to cash;
Sufficient knowledge for penetration of the US market. For the recent
release CoH, NCSoft solved most of the problems (e.g., level grinding, difficulty
in learning, boring combat sessions that turn US gamers away from a typical
MMORPG). With the initial success of CoH, we believe NCSoft has gained
sufficient knowledge of the western market to make bigger successes out of
future releases in the US;
Guild Wars, a widely anticipated release in the US. NCSoft is to launch Guild
Wars in the US and Korea in early 2005. Guild Wars ranks at the top of expected
future releases, in most US reviews. Based on our assessment, Guild Wars has
the features to attract US players.
WoW unlikely to be a major threat. WoW is a traditional MMORPG focusing
on hard-core gamers. Although the game has been rated as a high-quality
MMORPG, most reviews state that it is not substantially different from existing
titles. WoW gained a similar number of users as Lineage 2 during its open beta
testing phase in November. However, according to NCSoft, this has had no
impact, so far, on NCSoft’s Lineage 1 and 2 users. WoW is unlikely to
cannibalise Lineage 1 and 2’s user bases, due to their first-mover advantages
and high retention factors, in our opinion.
According to NCSoft, if there is any negative impact from a competitor's game
launch, it would appear during the competitor's beta testing (if NCSoft's users
were interested in playing WoW, they would not wait until commercialisation
when they have to start paying to play).
Further, virtual item trades (a crucial incentive to play) are difficult in WoW,
questioning the game’s long-term popularity in Korea.
What is driving demand for Lineage 2?
Each MMORPG has a unique
virtual economy
Page 12
Lineage 2 was released in Korea in 4Q03 and in the US, Taiwan, Japan and China
earlier this year. The game is currently ranked No. 2 in Korea after Lineage 1, and its
rankings are rising in other Asian markets. We believe Lineage 2 has lasting value in
the Asian market, due to the following factors:
Deutsche Bank AG
26 November 2004
Earn real-income utilising
virtual wealth
More than 100 Internet sites
selling virtual game items
More players mean an
efficient economy
Make money playing
games?
1) Virtual item trades: According to Actozsoft (the domestic online game
publisher) around 50% of MMORPG players in Korea trade in game assets offline,
while in China this figure is closer to 40%. On itembay.com, a domestic game item
sales site, there are more than several thousand buy and sell listings for Adena
(Lineage’s in-game currency). In all major item trading sites, Lineage 2 item listings
sharply outnumber other games’ item listings.
According to gamers, Lineage 2’s large universe (many players) allows for liquiditem trades offline. A good game (early entry helps) will attract more players – more
players will create an efficient virtual economy – an efficient economy allows easier
item trades offline – liquid offline trades attract more players, creating a virtuous
cycle.
Further, in Lineage 2, item prices have a unique curve – it is very expensive for lowlevel players and more reasonable for higher-level gamers. For example, each
monster kill results in around 150 Adena at level 20 (the highest level is 75), but
most of the useful weapons to advance levels cost 3-5m Adena. So low-level
players either have to kill 25,000-45,000 monsters to buy useful weapons to
advance levels or they can enhance their gaming experiences (as the real meat of
the game is at the higher levels) by supplementing in-game assets through
purchases offline. Lineage’s 1m Adena sells for US$10-16 offline.
On the other hand, hard-core players with more time to commit earn ‘real-income’
utilising their virtual wealth. Although a W30,000 monthly fee for a personal account
appears steep, hard-core players can easily recover this monthly cost and earn cash
from virtual item trades on top of that;
2) Superior 3D graphics: Graphics are one of the most important elements in an
MMORPG. In our view, NCSoft’s full 3D graphics are one of the main attractions;
3) Strong community element: As the top MMORPG in Korea, Lineage 2’s virtual
universe is large (many players). The larger the universe, the more enjoyable the
community experience becomes (clan vs. clan and player vs. player); and
4) Significant time investment: To reach the highest level, players may have to
spend months to years playing the game. As substantial time is required to play and
advance in the game, after reaching higher levels it becomes difficult to stop playing
the game.
Why isn’t Lineage 2 a hit in the US?
NCSoft commercialised Lineage 2 in the US during 1Q04. Although the initial
reception is better than Lineage 1, it is unlikely to be a major hit. This is because the
game was designed for the Asian market and there are some striking differences of
play style and game preference between users in Asia and the US. In our view,
Lineage 2 has not gained the same success in North America for the following
reasons:
1) Monthly fees are expensive: US gamers are not accustomed to paying a
monthly fee (they are more used to an upfront cost for the console game box and
CDs). Further, Lineage 2’s monthly fee of US$15 per month is higher than the
US$10 monthly cost for Everquest (the No. 1 MMORPG in the US);
Deutsche Bank AG
Page 13
26 November 2004
US players’ tastes are
different
2) US players want better servicing: One of the major drawbacks of the game is
that low-level players have very little guidance if they do not interact with other
players. As most US gamers play at home, they need to learn the games on their
own. In contrast, Korean gamers play with their friends in PC rooms and learn from
each other. Moreover, US players want customer service, unlike the Korean players
who tend to solve problems on their own. However, enhanced customer support is
not available in the US;
3) Tasks and combat are repetitive and tedious: Lineage is known for heavy time
consumption and repetitive tasks to level up, while US players want immediate
gratification from the game;
4) No offline trades: In contrast to Korea, offline item trading, one of the major
incentives to playing MMORPGs, is uncommon in the US. Moreover, leveling up is
tedious and difficult if players are unable to purchase items offline to enhance the
gaming experience; and
5) Lack of character customisation: American players place heavy emphasis on
character customisation.
What attracts US players to CoH?
Most characteristics unfit for
US market addressed in CoH
Most of the problems of Lineage 2 that make it unfit for the US market have been
addressed in CoH in the US (currently one of the top ranked MMORPGs in the
country). Several features are different in this title from Lineage 1 and 2, including:
1) Lots of action: Game play is non-stop combat-focused. Most MMORPGs
employ an auto-attack during combat, and only occasionally use special attacks. In
contrast, CoH gives players full control over combat scenes. With speedy game
play, CoH resembles an action game rather than an MMORPG. This fits well with
the US gamers who mostly play action-console games;
2) Easy to learn: Game play is simple to learn, and, as such, is fit for US players
who are unaccustomed to MMORPGs;
3) Side kick system: Once players reach level 10, they can create a side-kick duo.
This bond enables a lower-level player to fight at about the same level as his
mentor;
4) Detailed character customisation: Almost all reviews of the game state that
the character customisation in the City of Heroes is one of the best available in an
MMORPG; and
5) Nostalgia issue: One of the game’s strongest assets is the nostalgia created for
anyone who enjoyed reading superhero comic books. The game is unique in that it
is not set in a typical medieval setting like most MMORPGs.
On the downside, there is no player vs. player combat in CoH, which means players
are limited to fighting computers. Further, there is less to do at higher levels as
there are no items to collect. However, an announced expansion, City of Villains
(expected to be released in late 2005), which allows players to take on roles of
villains and fight other players, should drive stronger box sales.
Page 14
Deutsche Bank AG
26 November 2004
Guild Wars will be released globally in 1Q05
To attract lighter users in
Korea and US players
Based on our assessment of reviews of Guild Wars, we believe that the game has
the features to attract a different set of players vs. Lineage 1 and 2.
1) Strategy-based game – not likely to target hard-core MMORPG players:
Most reviews described it as similar to the strategy-based game, Diablo – probably
as the developer Arenanet was founded by Blizzard veterans. The game is not a
deep MMORPG, and, as such, would target a different pool of users vs. Lineage 1
or 2 or the widely anticipated WoW and EQ2.
2) Less level grinding vs. a typical MMORPG: In contrast to a typical MMORPG,
players do not have to spend countless hours on a leveling treadmill to get to the
interesting parts of the game. They can log on for an hour of fun. Players’ skills and
creativity are more important than levels.
3) Easy to play: The interface is user friendly.
4) No monthly fees: Guild Wars will be the first MMORPG to eliminate the monthly
fee. Players can play for free after purchase of the initial box. However, there will be
an expansion package sold every six months. As US players are not accustomed to
paying a monthly fee, this new payment strategy could drive more demand vs. CoH,
which is on a monthly fee scheme.
5) Character customisation is good: Although there are limited appearances to
choose from at the start of gameplay, with 400 skill sets available in the game,
every virtual character is unique.
6) All servers work together as one universe: Most MMORPG limit players to
play with others within a unique server. In the case of Guild Wars, all servers work
together as one universe.
Deutsche Bank AG
Page 15
26 November 2004
Strong earnings growth
Strong growth to continue
We project EPS to grow 42% in 2005 and 20% in 2006, driven by an expanding
user base of Lineage 2 and new game launches that are targeted mainly at the US
and domestic light-users markets.
Strong growth driven by
four new game releases
Revenue growth driven by new game launches
By the end of 2005, we expect at least four new games launches (see Figure 11),
mainly in new genres, to drive revenue growth of 24% in 2005 and 13% in 2006.
Figure 11: At least four new titles to be launched in 2005F
Game
Lineage I
Developer
NCSoft
Lineage II
NCSoft
City of Heroes Cryptic Studio
Commercialisation
Game genre Type
1998
Hard-core
Medieval fantasy
MMORPG
28-Apr
Hard-core
Medieval fantasy
MMORPG
29-Apr
MMORPG Superhero based
modern fantasy
4Q04
MMORPG Mission based
Guild War
Arenanet
(100% subsidiary)
Auto Assault
Alterlife
Net Devil
NCSoft
1Q05
1Q05
MMORPG
Light RPG
Tabular Rasa
NC Austin
2005
MMORPG
Interface NCSoft
2D
development/
publishing
3D
development/
publishing
3D
Publishing
Comments
3D
Acquired Arenanet in 2001 (Arenanet's
developers are from the same team that
developed Diablo, Starcraft and Warcraft
Car combat based 3D
Targets female
3D
players
Theme park
3D
(science fantasy)
Publishing
Publishing
Development/
publishing
Development/
publishing
Launched in US, Canada only
In contrast to other games, characters will be
females
In development stage by Richard Gariott (was a
part of the team that developed the Ultima
series).
Source: NCSoft
Up until 2003, NCSoft generated almost all of its revenues from a single MMORPG,
Lineage 1. The company only recently released two additional titles: Lineage 2 and
CoH. Although difficult to predict, by 2006, we expect games unrelated to Lineage
to account for 20% of sales.
Figure 12: Lineage 1 & 2 represent 100% of sales
(2003)
Lineage 2
12%
Figure 13: New games portion to reach 19% of
sales (2006F)
Others
19%
Lineage
1&2
81%
Lineage 1
88%
Source: Company data
Page 16
Source: Deutsche Bank AG estimates, Company data
Deutsche Bank AG
26 November 2004
Lineage 1 and 2
Lineage 2’s growth to offset
Lineage’s decline
Lineage 1 and 2 should continue to generate c.80% of operating revenues through
to 2006F. Combined Lineage 1 and 2 sales should post a Cagr of 6% for 04-06,
reaching W283bn by 2006F.
Domestic: Our forecast calls for Lineage 1 and 2 subscribers in Korea to reach a
total of 3m by the end of 2006. Our assumption for 3m active users represents 31%
of the domestic male population aged 10-34. Combined domestic sales from these
two games should grow marginally – sharply below the 25% Cagr (2004-06)
assumption for the domestic online market. The sluggish growth is a result of
declining Lineage 1 sales (13% compounded annually for 2004-06F) as the game is
old and the domestic MMORPG market is already saturated. On the other hand, we
assumed Lineage 2 sales to rise to the peak sales levels of Lineage 1 by 2006.
Overseas: Sales of Lineage 1 and 2 in the overseas markets (mainly Taiwan, the US,
Japan, China, Hong Kong and Thailand) should total W71.1bn by the end of 2006.
The growth rate is slightly below the 38% Cagr growth projection for the global
online market over the period.
Figure 14: Still predominantly a Korean business
Overseas
Developer
Royalty
Original Launch date
Korea
CU (000s)
US
CU (000s)
Japan
CU (000s)
China
CU (000s)
Taiwan
CU (000s)
Thailand (JV)
CU (000s)
London (Europe)
CU (000s)
Lineage 1
Ncsoft
25-30%
Lineage 2
Ncsoft
25-30%
City of Heroes
Cryptic Studio
Less than 15%
4Q04
Guild Wars
ArenaNet
20-30%
Auto Assault
Net Devil studios
Less than 15%
End of 2004
Tabula Rasa
Ncsoft (NC Austin)
25-30%
May\00
failed
Sep\01
15
Apr\03
failed
Jul\00
130
Apr\04
22
Jun\04
33
Nov\04
n/a
May\04
66.5
Dec\04
n/a
Dec\04
n/a
Apr\04
1000
1Q05
n/a
Jun\05
n/a
2H05
n/a
Dec\04
n/a
Outside the Lineage family games
Increasing portion of nonLineage games
Games other than Lineage 1 and 2 should contribute to 20% of sales by 2006F,
having generated nothing in 2003. We expect the sales from new titles to reach
W28bn in 2005 and W68bn in 2006. The growth should be stronger than that of
Lineage 1 and 2, as these games will target the less-penetrated, lighter-user
markets.
For Guild Wars in the domestic market, we applied 15% of Lineage 1’s peak
revenues to derive a sales figure for 2005F. As for Alterlife, we applied around 5%
of Lineage 1’s peak revenues for our 2005 projection.
Deutsche Bank AG
Page 17
26 November 2004
Three revenue streams
At present, the largest portion of NCSoft’s revenues comes from PC cafes. Over
the longer term, the royalty portion of revenues will increase with rising overseas
penetration.
1) PC cafes: PC cafes can choose between two pre-paid methods – fixed monthly
charge per IP or hourly cards. This portion of revenues contributes about 60%
of the total.
2) Personal accounts: Individuals can choose to pay a fixed monthly, quarterly or
hourly fee. This portion contributes to 31% of total.
3) Royalty fees: NCSoft has 100% ownership of its US distribution channel;
elsewhere, it holds a 49% stake. NCSoft’s income statement books royalty fees
(equivalent to around 25% of revenues from these subsidiaries) as revenues
and equity income from these subsidiaries’ earnings in non-operating income.
The equity income should contribute to 13% of total net profit in 2005F.
Figure 15: Ownership of distribution and R&D capabilities major countries
Country
US
Japan
China
Taiwan
Thailand
London
Company name
NC Interactive
ArenaNet
NC Austin
NC Japan
NC Sina
NC Taiwan
NC Tor
NCSoft Europe
Stake
100%
100%
NCSoft US office
60%
49%
49%
49%
100%
Entity
publisher
developer
developer
publisher
publisher
publisher
publisher
publisher
JV with Softbank
JV with Sina.com
JV with Gammania
JV with Tor
Source: NCSoft
Figure 16: PC rooms account for the largest portion of sales
Royalty
9%
Personal
31%
PC
Rooms
60%
Margins to remain relatively flat
Margins to remain relatively
stable
Since 1999, when NCSoft launched its first game, Lineage 1, margins have been
stable at 47-50%, with the exception of 2001 and 2003. The margin declines in both
2001 and 2003 were mainly one-off events. In 2001, the margin dip was a result of
costs incurred from the recruitment of Richard Gariott. In 2003, the decline was due
to new hires ahead of the Lineage 2 launch in October.
We estimate EBITDA margin to be relatively stable at 47% throughout our forecast
horizon. NCSoft’s largest cost components are R&D spending, labour costs,
depreciation of servers and marketing expenses.
Page 18
Deutsche Bank AG
26 November 2004
In our view, these cost components will move in line with revenues - i.e., increased
development spending will result in more game titles and additional games require
new servers (higher depreciation costs) and marketing costs.

R&D spending: R&D spending refers to labour expenses for development staff.
R&D spending is booked under both Cost of Sales and SG&A. R&D costs for
games that are commercialised are booked under Cost of Sales and for games
under development in SG&A.
If a game commercialises, R&D costs as percentage of sales should decline. On
the other hand, when commercialised games get old and more titles require
development, the cost should rise as percentage of sales. Commercialised
games require updates every three to six months, and, as such, older games
also require R&D.
Although we are projecting new game launches in 2005, we forecast R&D
costs as percentage of sales at 11-12% throughout our forecast horizon, an
increase from 10% in 2004F, as management will likely begin development of
additional titles.

Depreciation costs: Depreciation costs are mainly associated with servers and
have been stagnant at 4% of sales in the past. We expect depreciation costs to
remain at 4% of sales throughout our forecast period. User additions drive
revenue growth, while additional users require more servers, which raises
investment and depreciation.
Marketing costs: Marketing costs can be broken down into three key expenses
– commissions, advertising and promotions. Around 20% of PC room revenues
are paid out as commissions to outsourced agents for PC room sales. These
commissions take up around 50% of total marketing costs. Usually, marketing
expenses jump one quarter ahead of a new game launch. However, on an
annual basis, they remain relatively stagnant. Generally, marketing costs have
remained at 11-15% of sales in the past. We project marketing costs will remain
at 13-14% of sales throughout our forecast horizon.
Wages: Wages refer to labour costs of all non-development staff. We
conservatively forecast wages at 10-11% of sales throughout our forecast
horizon vs. 11% in 2004F, despite the likelihood of administrative labour
expenses growing slower than revenues in the future.
Figure 17: Margins to remain stable
EBITDA Margin
120%
100%
80%
60%
40%
20%
0%
-20%
-40%
97
98
99
GP Margin
00
01
OP Margin
02
03
NP Margin
04F
05F
06F
Deutsche Bank AG
Page 19
26 November 2004
Positive equity income from 2005F
Affiliated earnings to turn
around in 2005
Most of NCSoft’s subsidiaries should turn a profit from 2005F, based on new title
launches in the US (including Guild Wars, Tabula Rasa and Auto Assault) and stable
increases in user base on Lineage 2 in other overseas markets. We expect equity
income to turn positive to W16.6bn in 2005 vs. a net loss of W6.2bn in 2004F.
Figure 18: To post positive equity income from 2005F
(Wm)
NC Interactive (100%)
NC Gamania (49%)
NC Japan (60%)
ArenaNet (100%)
NC-SINA (49%)
NC Taiwan (49%)
Total
2003
-8,169
-790
-1,526
-7,071
-1,107
-436
-19,099
2004F
2,777
0
-2,043
-10,167
-1,330
3,901
-6,863
2005F
8,621
0
763
282
987
5,971
16,624
2006F
12,288
0
1,629
770
2,211
14,624
31,521
Plans to invest excess cash on game development
Growing cash position
The company was in a net cash position of W112bn as at the end of 2003. We
forecast the cash position to increase, as we have not incorporated any major
acquisitions or investments.
Nonetheless, there is a greater chance that NCSoft will use a large portion of its
cash generation to invest in new games. According to management, it will spend
excess cash to publish more titles – provide funds to independent game developers
at initial development stages to become the exclusive publisher. Moreover, it will
invest to set up or acquire additional developers. NCSoft recently established a
development base in China and acquired Arenanet in the US in 2001.
Figure 19: Net cash position grows
(Wbn)
600
500
400
300
200
100
0
2001
2002
2003
2004F
2005F
2006F
Page 20
Deutsche Bank AG
26 November 2004
Returns are likely to remain high
Returns high
Returns are likely to rise and remain closer to 30% throughout our forecast period.
Figure 20: ROE to remain closer to 30% throughout forecast period
%
35
30
25
20
15
10
5
0
2001
2002
2003
2004F
2005F
2006F
Figure 21: No major difference between parent and consolidated
2002
Wbn
Sales
NP
Net debt/equity
Parent
155
53
-66%
2003
Consolidated
155
53
-41%
Parent
167
32
-52%
Consolidated
169
32
-62%
Source: Company data
Deutsche Bank AG
Page 21
26 November 2004
Growth justifies higher PER
Target price of W130,000 indicates 36% upside potential
12-month target price
indicates 36% upside
Our 12-month target price of W130,000 is based on 2005F valuation measures of
20x PER and 0.5 PEG, within the historical trading band and largely in line with
growth stocks. We prefer to work with near-term multiples to value NCSoft, as
forecasting longer-term revenue streams from the company’s future game lineup is
very difficult.
Trades at the lower-end of the historical trading band
Trades at lower end of
trading band
The stock trades on 14x 2005F PE, at the lower-end of the historical trading band.
Historically, at the peak NCSoft traded close to 35x 1-year forward PE (excluding
during the internet boom) to as low as 5x PE in 2003 on concerns over Lineage 2’s
age rating issues.
Figure 22: At the bottom of the historical trading band (PER)…
x
49
44
39
34
29
24
19
14
9
4
PER
0
Share
price
0
internet bubble
strong sales from Lineage I and
expectations of product diversification
concerns on
game rating issues
internet
bubble bursts
01
02
03
W
110,000
100,000
90,000
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
04
Source: Deutsche Bank AG estimates, Company data, Bloomberg
Figure 23: Trades at the middle of historical P/B trading band
PBR
0
0
Share
price
strong sales from Lineage I and
internet bubble expectations of product diversification
6.5
P
internet
5.5
bubble bursts
concerns on
4.5
game rating issues
3.5
x
2.5
h
1.5
01
02
03
W
110,000
100,000
90,000
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
04
Page 22
Deutsche Bank AG
26 November 2004
Global valuation comparison
Discount against global
comparables should narrow
As there are no foreign companies directly comparable, we have compared
NCSoft’s valuations to console game providers. At current valuations, NCSoft trades
at 25-30% discounts to such companies based on 2005F PER. Over time this
valuation gap should narrow because of NCSoft’s strong growth potential, global
diversification and high returns and margins.
Figure 24: Global valuation comparisons
Country
Share price(local)
Market Cap($mn)
Code
Recommendation
P/E*
03
04
05
# of games
ROE '04F
NCSoft
Korea
95600
1577
036570.KS
Buy
EA
USA
48.45
14,812
ERTS US
Hold
Nintendo
Japan
12,190
15,412
7974 JP
Buy
Sega
Japan
1568
2,450
7964 JP
Buy
Namco
Japan
1243
1,221
9752 JP
Hold
56.8
20.3
14.4
3
27.4
23.6
21.5
356
49.4
21.5
18.5
256
78.4
28.0
22.1
399
9.3
7.7
7.3
128
32.4
27.3
8.3
9.5
8.5
* Note: P/E based on diluted EPS
Compared to the Korean universe and regional tech sector
Premium justified vs. Korean
market
NCSoft currently trades at premiums (based on both PE and P/B) to DB’s Korean
and regional tech sector valuations. In our view, this is justified by the counter’s
stronger growth potential, high returns and margins and lower cyclicality.
Figure 25: Valuation of DB’s Korean and regional tech universe
DB Korean universe
2004
2005
PE(x)
8
8
PB(x)
1.2
1.1
ROE%
17
15
Sales gth%
18
4
EPS gth%
69
1
Div yield %
2.3
2.9
NP mgn %
11
10
Net D/E %
25
17
Tech sector universe
2004
2005
10
12
2.2
1.9
24
17
28
13
79
-16
1.3
1.7
14
10
-14
-16
Hit or miss?
Best case: W180,000
Worst case: W90,000
As it is impossible to determine whether NCSoft’s future game line-up will be a
success, we have also performed a scenario analysis. In the best-case scenario, we
value NCSoft at W180,000 and in the worst case at W90,000. We applied 2005F
valuation measures of PER of 20x and PEG of 0.5 to both cases – same as our base
case.
To simplify the analysis, we chose three of NCSoft’s largest games as variables
(NCSoft would have commercialised at least six games in eight countries or regions
by 2005 and using all of these variables for analyses would be difficult).
Deutsche Bank AG
Page 23
26 November 2004
The following were our assumptions for the best and worst-case scenarios.
Best case:
1) Lineage 1 & 2 revenues grow at a 2% Cagr for 2004-06F in Korea vs. base-case
assumption of almost no growth.
2) Lineage I & 2 revenues grow 40% in the overseas market vs. base-case
assumption of 30%.
3) Applied 30% of Lineage 1’s peak revenues to Guild Wars for the Korean market
(for 2005). For our base case, we applied 15% of Lineage 1’s peak revenues to
derive a sales figure for 2005.
4) In the US, we estimated 300,000 box sales p.a. for 2005-06 for Guild Wars vs.
150,000 in 2005 and 140,000 in 2006 for our base case. As NC Interactive has
sold 250,000 boxes on its CoH over a 6-month period, and, as the company
expects at least 2 update releases p.a., we believe 300,000 boxes is a
reasonable figure.
Worst case:
1) Assume Lineage 1 & 2 revenues decline 2% p.a. during 2004-05 in Korea and
grow 25% in the overseas market.
2) Applied half of our base-case assumption for revenues on Guild Wars for the
Korean market.
3) In the US, we estimated 100,000 box sales p.a. for 2005-06, lower than box
sales achieved by CoH during the initial six months of launch.
Share price performance
Should continue to
outperform
NCSoft has continued to outperform the KOSPI by delivering growth rates that are
higher than the market’s. YTD, the stock has outperformed the KOSPI by 54%,
reflecting the initial success of Lineage 2 and CoH. With the release of 4-5 new
games titles over the next 12-18 months, we believe there will be abundance of
catalysts to drive the stock up.
Stock overhang is a technical problem
Stock overhang could create
short-term pressure on the
share price
One risk is the stock overhang related to the employee stock options. NCSoft
currently has about 1.7m stock options outstanding that are exercisable as of March
2004 to January 2005. Conversion prices range from W23,700 to W57,960,
compared to the current share price of W94,900. This is equivalent to about 9% of
total outstanding shares. Moreover, the company has EBs outstanding, which can
be converted to 202,899 shares at an exercise price of W39,265 (see details in
Figure 26).
According to management, the company has no plans to buy back shares to offset
the stock-overhang concern.
Page 24
Deutsche Bank AG
26 November 2004
Figure 26: Stock options and EB
Date of issue
Mar-01
May-01
Sep-01
Jan-02
Mar-02
Mar-02
Total
Exchangeable Bonds
Date of issue
Dec-02
# of options
issued
208,121
2,121,476
105,204
3,927
149,833
1378
2,589,939
# options
exercised Remaining options
Exercise
price
Exercisable period
113,011
643,472
27,895
0
65,968
0
850,346
95,110
1,478,004
77,309
3,927
83,865
1,378
1,739,593
23,700
32,130
24,440
38,500
57,960
56,460
Mar-04-Mar 17
May-04-May-11
Sep-04-Sep-11
Jan-05-Jan-12
Mar-04-Mar-12
Mar-04-Mar-12
# of Ebs # EBs exercised
202,899
Remaining Ebs
202,899
Exercise price
39,265
Exercisable period
Dec-03-Dec-05
Source: NCSoft
Deutsche Bank AG
Page 25
26 November 2004
Appendix A: Game specifics
More than 50% of MMORPG game players in Korea trade in game assets for real
cash. Below are the websites that deal in game assets.
Figure A1: Domestic and overseas sites where game items are bought and
sold
Overseas
Domestic
www.playerauctions.com
www.adena4sale.com
www.virdaq.com
www.swagvault.com
www.ezgaming.com
www.itemmain.co.kr
www.item8949.co.kr
www.itemclub.co.kr
www.item365.com
www.itembank.com
Source: Google.com
Over 155 listings for Lineage 2’s Adena on Ebay.com.
Figure A2: 155 items listed on Ebay for Lineage 2 items
Source: Ebay.com
More than 3,000 buy and sell listings for Lineage 2’s Adena on Itembay.com.
Page 26
Deutsche Bank AG
26 November 2004
Figure A3: Over 3,000 buy and sell listings for Adena on Itembay.com
The virtual cash earned at the higher levels can be sold offline for real cash. Virtual
currency exchange rates fluctuate (just like real cash) on the supply, demand
situation.
Figure A4: Virtual currency exchange rates (highs/lows listed on Virdaq.com)
Publisher
Type
Final Fantasy XI
Asheron's Call
Final Fantasy XI
Lineage II
Currency
Accounts
Armour
Currency
sold (m)
high
low
last
average
2,045
3
2
39.3
240/100,000
179.99
79.99
3.3/100,000
8.50/100,000
129.99
69.99
1.56/100,000
11.00/100,000
129.99
69
1.56/100,000
26.34/100,000
163.32
74.5
1.90/100,000
Source: Virdaq.com
Below we have compared the scenes in Lineage II to competitors’ games.
Deutsche Bank AG
Page 27
26 November 2004
Figure A5: Lineage 2 combat scene
Figure A6: Scene from Lineage 2
Source: gamerankings.com
Figure A7: Scene from Ragnarok
Figure A8: Scene from MU
Page 28
Deutsche Bank AG
26 November 2004
CoH ranks among top 10 MMORPG in the US
Figure A9: Games rankings (released)
Game Title
World of Warcraft
EverQuest II
EVE Online
City of Heroes
Final Fantasy XI
Anarchy Online
EverQuest
Dark Age Of Camelot
Asheron's Call : Dark Majesty
Ultima Online
PlanetSide
Asheron's Call 2 : Fallen Kings
Star Wars Galaxies
Puzzle Pirates
The Saga of Ryzom
Vendetta Online
Rubies of Eventide
Priston Tale
Project Entropia
BiosFear
A Tale in the Desert II
ToonTown Online
Starport
Endless Ages
Second Life
Ragnarok Online
World War II Online
Ashen Empires
DarkSpace
Everquest Online Adventures
Jumpgate
Neocron 2
Runescape
Genre
Fantasy
Fantasy
Sci-Fi
Super-Hero
Fantasy
Sci-Fi
Fantasy
Fantasy
Fantasy
Fantasy
Sci-Fi
Fantasy
Sci-Fi
Historical
Fantasy
Sci-Fi
Fantasy
Fantasy
Sci-Fi
Fantasy
Historical
Fantasy
Sci-Fi
Sci-Fi
Real Life
Fantasy
Historical
Fantasy
Sci-Fi
Fantasy
Sci-Fi
Sci-Fi
Fantasy
Developer
Rating
Blizzard Entertainment
8.7
Sony Online Entertainment 7.6
CCP Games
7.5
Cryptic Studios
7.5
Square Enix
7.4
Funcom
7.4
Mythic Entertainment
7.4
Turbine Entertainment
7.4
Origin
7.4
Turbine Entertainment
7.4
LucasArts / SOE
7.3
Three Rings Design
7.3
Nevrax
7.3
Guild Software
7.3
Mnemosyne LLC
7.3
Priston Inc.
7.3
MindArk
7.2
Tiscali Games
7.2
eGenesis
7.2
VR Studio
7
PlayTechtonics Inc.
7
Avaria
6.8
Linden Research, Inc.
6.8
Gravity Corp.
6.7
Cornered Rat
6.7
TKO Software
6.7
Palestar Inc.
6.6
NetDevil
6.5
Reakktor
6.5
Jagex Ltd
6.5
Game Title
The Myth of Soma
The 4th Coming
Hostile Space
Dark Ages
Nexus: The Kindoms Of The Winds
Lineage 2
Helbreath
There
Tibia
Monster & Me
Thesa Online
Furcadia
Knight Online
Underlight
Spellcasters
Dragon Raja
Savage Eden
Graal
Lineage
Fung Wan Online
Legend of Mir 2
Astonia III
Prince of Qin Online
Terra World
Kingdom of Drakkar
The Realm Online
Mimesis
El Kardian
Meridian 59 : Resurrection
Blademistress
Factions
Clan Lord
Odyssey: Parsec
Genre
Developer
Rating
Fantasy Game Network
6.4
Fantasy Vircom
6.4
Sci-Fi
InterAdventure Inc.
6.3
Fantasy Nexon
6.3
Fantasy Nexon
6.3
Fantasy NCSoft
6.3
Fantasy Siementech
6.2
Real Life Forterra Systems
6.2
Fantasy CipSoft
6.2
Fantasy TQ Digital Studio
6.1
Fantasy Bridge Communicaitons
6.1
Fantasy Dragon's Eye Productions
6.1
Fantasy Wizgate and Noahsystem
6
Fantasy Lyra Studios
6
Fantasy TheLastMage
6
Fantasy Esofnet
6
Fantasy Nako
5.7
Fantasy LINUX Cyberjoueurs
5.6
Fantasy NCSoft
5.6
Fantasy Phoenix Games Studios
5.5
Fantasy Wemade Entertainment Co. 5.5
Fantasy Intent Software
5.4
Historical Object Software
5.4
Fantasy Terra World
5.3
Fantasy Kingdom of Drakkar
5.2
Fantasy Norseman Games
5.1
Sci-Fi
Tannhauser Gate
5.1
Fantasy Pacific Internet Ltd.
5.1
Fantasy Near Death Studios
5
Fantasy Blade Mistress Online
4.4
Fantasy Factions
4.3
Fantasy Delta Tao Software
4.3
Fantasy Lic
4.2
Source: Mmorpg.com
Deutsche Bank AG
Page 29
26 November 2004
Appendix 1
Important Disclosures
Additional information available upon request
Disclosure checklist
Company
NCSoft
Ticker
036570.KS
Recent price
W95,600
Disclosure
6,13
1. Within the past year, Deutsche Bank and/or its affiliate(s) has managed or co-managed a public offering for
this company, for which it received fees.
2. Deutsche Bank and/or its affiliate(s) makes a market in securities issued by this company.
3. Deutsche Bank and/or its affiliate(s) acts as a corporate broker or sponsor to this company.
4. The research analyst(s) or an individual who assisted in the preparation of this report (or a member of his/her
household) has a direct ownership position in securities issued by this company or derivatives thereof.
5. The research analyst (or, in the US, a member of his/her household) is an officer, director, or advisory board
member of this company.
6. Deutsche Bank and/or its affiliate(s) owns one percent or more of any class of common equity securities of
this company.
7. Deutsche Bank and/or its affiliate(s) has received compensation from this company for the provision of
investment banking or financial advisory services within the past year.
8. Deutsche Bank and/or its affiliate(s) expects to receive or intends to seek compensation for investment
banking services from this company in the next three months.
9. Deutsche Bank and/or its affiliate(s) was a member of a syndicate which has underwritten, within the last five
years, the last offering of this company.
10. Deutsche Bank and/or its affiliate(s) holds one percent or more of the share capital of the company whose
securities are subject of the research, calculated under computational methods required by German law (data
as of the last trading day of the past month).
11. See footnote headed Special Disclosures for any other relevant disclosures.
12. Deutsche Bank and/or its affiliate(s) holds a net short position of 1% or more of the share capital of the
company whose securities are subject of the research, calculated by methods required by German law as of
the last trading day of the past month.
13. Deutsche Bank and/or its affiliate(s) holds a trading position, as that term is defined by German law, in shares
of the company whose securities are subject of the research.
14. Deutsche Bank and/or its affiliates(s) has received non-investment banking related compensation from this
company within the past year.
15. This company has been a client of Deutsche Bank Securities Inc. within the past year, during which time it
received non-investment banking securities-related services.
For disclosures pertaining to recommendations or estimates made on securities other than the primary
subject of this research, please see the most recently published company report or visit our global
disclosure look-up page on our website at http://equities.research.db.com.
Page 30
Deutsche Bank AG
26 November 2004
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about
the subject issuer and the securities of the issuer. In addition, the undersigned lead analyst(s) has not and will not
receive any compensation for providing a specific recommendation or view in this report. [Jaemin Lee]
Rating Key
Buy: Total return expected to appreciate 10% or more over
a 12-month period
Hold: Total return expected to be between 10% to –10%
over a 12-month period
Sell: Total return expected to depreciate 10% or more over
a 12-month period
The target prices of shares mentioned in the accompanying
text are based on the assumed investment horizon of 12
months. If company notes are published on these shares in
the future, the target prices mentioned in the new notes will
have priority.
Deutsche Bank AG
Page 31
Deutsche Bank AG Asia-Pacific Equity Research
Asia-Pacific locations
Deutsche Bank AG
Deutsche Bank AG
Deutsche Equities India Pte Ltd
Deutsche Securities Limited
Level 18, Grosvenor Place
225 George Street
Sydney, NSW 2000
Australia
Tel: (61) 2 9258 1555
Fax: (61) 2 9258 1550
Level 55
Cheung Kong Center
2 Queen’s Road Central
Hong Kong
Tel: (852) 2203 8888
Fax: (852) 2203 6921
DB House, Ground Floor
Hazarimal Somani Marg
Fort, Mumbai 400 001
India
Tel: (91) 22 5658 4600
Fax: (91) 22 2201 9094
Tokyo Branch
Level 20, 2-11-1 Nagatacho
Sanno Park Tower
Chiyoda-ku, Tokyo 100-6171
Japan
Tel: (81) 3 5156 6701
Fax: (81) 3 5156 6700
Deutsche Bank (Malaysia)
Berhad
In association with
Deutsche Regis Partners, Inc.
Deutsche Securities Korea Co.
Deutsche Securities Asia Ltd
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8 Jalan Sultan Ismail
Kuala Lumpur 50250
Malaysia
Tel: (60) 3 2053 6760
Fax: (60) 3 2026 3906
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Taiwan Branch
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International locations
Deutsche Bank Securities Inc.
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Deutsche Bank AG
Deutsche Bank AG
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United States of America
Tel: (1) 212 250 2500
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London EC2N 2EQ
United Kingdom
Tel: (44) 20 7545 8000
Fax: (44) 20 7545 6155
Große Gallusstraße 10-14
60272 Frankfurt am Main
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Tel: (49) 69 910 41339
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Sydney, NSW 2000
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Tel: (61) 2 9258 1555
Fax: (61) 2 9258 1550
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Deutsche Securities Limited
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Cheung Kong Center
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Tel: (852) 2203 8888
Fax: (852) 2203 6921
Tokyo Branch
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Sanno Park Tower
Chiyoda-ku, Tokyo 100-6171
Japan
Tel: (81) 3 5156 6701
Fax: (81) 3 5156 6700
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