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Kingsoft (3888.HK) – Buy on solid growth propects

Wednesday, December 24, 2008

6998

Kingsoft(3888)

Recommendation on 24 December 2008
Recommendation	Buy
Price on Recommendation Date	$2.370
Target Price	$2.840

Weekly Special - 3306 JNBY Design Limited

Company Background

Kingsoft is a leading software developer, distributor, and service provider in Mainland China. The Group offers a wide range of innovative entertainment and applications software. The Group launched their first domestically produced PC games in 1996, and their first online game in 2003. Since its establishment, the Group has received warm receptions from the users and has won awards for both its entertainment and applications software products.

Financial Highlight

Kingsoft posted a satisfactory result for the 3Q08. Its revenue increased 48% to RMB217 million from RMB147 million compared with the same period last year.

The entertainment software and applications software contribute the majority of the company`s revenue, accounting for 69% and 30% of total turnover respectively.

The revenue from entertainment software represented the main business for the company. It has increased 38% QoQ and increased 47% YoY. The MMORPGs “JX online world” and other JX games inclusive of JX online I, JX online II have been a great success with 1.2 million monthly average paying users in 3Q08, which was an increase of 20% QoQ. This increase in monthly paying users resulted from the expanded player base of JX online world. In addition, the company`s research and development costs have decreased 6% QoQ due to the recognition of government grants related to specific research projects.

The revenue from the applications software business increased by 3% QoQ and 41% YoY. The QoQ increased primarily due to the increased sales of WPS, whereas the increase for YoY was primarily due to a rise in the number of subscribers for online services of Kingsoft Internet Security. However, the number of subscribers for online services of King Intenet Security was impacted by increasing competition in China and held flat quarter-over-quarter.

Online game ensures robust growth

China`s online game market is booming, with massively multiplayer online role playing games (MMORPGs) growing rapidly. The market size of China online games has reached RMB5.47 billion (USD0.8 billion) in 3Q08, a growth of 51.9% YoY.

The market size of online games in the world reached US8.6 billion, an increase of 32% YoY. Furthermore, the market size of online games has been increasing at a speed of over 30% each year since 2003. It is predicted that the global market of online games will keep on a double-digit increase in the next 2-3 years.

Online games will not be involved in the world financial crisis sweeping across the globe. On the contrary, with a decline in consumer revenue, online games costing an average monthly RMB30 will be even more popular as low-cost entertainment. Network gaming is likely to be the last item cut in consumers` budget.

New project

Kingsoft also pays attention to expansion opportunities in overseas markets in order to expand business in all fronts. Hence, the company decided to enter Malaysia`s market and formed a subsidiary after they successfully developed in Vietnam, Japan and Thailand markets. The company plans to use Chinese games to open the market and enter English game markets gradually.

Risk Factors

- The designs for some the Group`s online games were based on famous Chinese novels. The initial launch of related online games had drawn strong market response, but rollout of the second or higher editions of the games may see diminishing interest from game players.

- The online games market in the Mainland is highly competitive. The Group may face severe rivalry from other software developers like Shanda Interactive.

- The taste and habit of on-line game users may change from time to time, making the Group`s revenue flow more volatile.

Valuation

We maintain our view that the game sector is likely to see good growth even with a macro slowdown, as games are a low-cost form of entertainment.

We set our 2009E PE for Kingsoft to be 9x. We give a “Buy” rating on Kingsoft and our target price for Kingsoft is HK$2.84

Financial Data

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