Downside risk #1: Mixed outlook for Tabula Rasa
Previews to date for Tabula Rasa have been mixed, with a recent preview from
MMORPG.com citing lack of “addictive” game play as a potential weakness for the game.
We believe the recently announced two-week delay in commercialization of TR is largely
attributable to the company attempting to better address the game-play issue prior to
game launch. We believe addictive game-play is a critical success factor for any MMOs
and see the recent development as a potential risk to the game’s success.
We currently forecast W57bn in 2008 revenues, compared to W53bn for Guild Wars in 2006.
We believe Guild Wars is a good reference point for Tabula Rasa due to similarities in
“instanced MMO game play” and thus cater to a similar gaming audience; we believe the
difference in profit model (subscription base for TR, box sale for GW) should be irrelevant
in the first year of TR’s launch.
Downside risk #2: L1 and L2 revenues may disappoint
As we’ve highlighted in our recent comment on September 18 (“3Q07 likely difficult for L1
& L2 revenue; PC café regulation marginal”), recent discussion with company suggests
that L1 revenues are likely to be slightly down qoq despite stronger seasonality as
management indicates that account base has stabilized but not recovered.
While L2 may have seen an increase in accounts following the launch of its expansion
Kamael, we believe 3Q is unlikely to see a boost in revenues as we suspect the increase in
accounts has largely drawn a pool of users attracted to the 100 hrs of free play.
We regard L1 and L2 as cash cow games that offers some anchor and stability in earnings
that justifies NCsoft’s higher valuation multiple than more volatile and faddish casual
game stocks. Worse-than-expected declining revenues in L1 and L2 could, over time, be a
factor for investors to start ascribing NCsoft with a lower multiple.
Downside risk #3: knock-on delays to other smaller titles
Recent delays in delivery of Aion and TR have arisen from development issues with game
play rather than bugs. While we acknowledge delays in game production is common, we
believe there is an increased risk factor that we should attribute to game development
management, since the success-critical game play issues are arising so close to
commercialization. Thus, we believe there is possibility that the problems with game
development management could bleed into production of smaller/later game titles. We
have also trialed the company’s smaller titles such as Dungeon Runner and believe
monetization may be less robust than previously expected. We have thus taken down our
casual and other game revenues from a combined W44bn to W18bn for 2008, a 5.6%
reduction in total 2008 revenue forecast.
Valuations
NCsoft is trading at 22X forward EPS, which we believe fully values the business outlook
for 2008. We see the potential for either multiple contraction and/or downward revision in
earnings estimates around 3Q earnings should 1) L1/L2 revenues disappoint and/or 2) TR appears to be less successful than expected. We note global online game peers are trading
at an average of 20.2X forward earnings.
We believe there is also liquidity driven risk for NCsoft, should a disappointment in growth
outlook lead to a sharp and rapid decline in share price as investors scramble to exit the
stock. We recall that poor 1Q06 results and downward revisions to full year guidance led to
a 36% share price correction over one month in May of 2006, which we believe was fueled
by an initial share price correction that prompted more selling as investors tried to exit
hurriedly.
