Company Reports

There have long been complaints that app stores take too big a share of in-app purchases, but nothing has managed to shake the 30% take-rate standard over the past decade. However, Bloomberg’s recent report on Huawei's talks with Tencent to establish a lower-than-industry share of 20% for in-game purchases provides hope for a reset. This move also reinforces our call for higher profitability for gaming companies over the long run. Although the Huawei HarmonyOS mobile operating system currently represents a small percentage of smartphones in China, the potential lowering of its app store fee to 20% could pressure other mobile app platforms to follow suit.

CMGE’s 2023 results were materially below our expectations, and we are cutting our fair value estimate by 14% to HKD 2.40 per share. The latest reduction in valuation reflects our more pessimistic view of revenue from the company’s upcoming game pipeline. While we still view CMGE’s shares as undervalued, there remains a lack of visibility around CMGE’s long-term launch pipeline. Therefore, our preferred picks in the Chinese video game space remain NetEase and Tencent.

CMGE is one of the earliest Chinese game companies focusing on intellectual property, being the first to bring Disney and Toei IPs into China. As of the end of 2022, CMGE holds a large number of intellectual property, or IP, on mobile games. We think that games with well-known IPs should attract some players, at least at the initial launch, because these titles already have their own loyal fan following whether they are based on films, TVs, or novels.

We are placing NetEase under review following the Chinese government’s release of new draft regulations affecting the gaming sector. Should these rules be put into effect, they could adversely affect the revenue of gaming companies, with NetEase potentially facing considerable challenges. Latest developments have triggered a sharp decline in the stock values of Tencent and NetEase, with shares dropping more than 10% by midday. We believe this market reaction is justified due to the expansive scope of the new draft rules. While these developments could have far-reaching consequences, we are maintaining our current fair value estimates for Tencent and CMGE, as they appear to face a less severe impact from the draft rules. Our position is subject to change as we await further information from gaming companies as to how the new regulations will affect their sales.

We have cut our fair value estimate for CMGE to HKD 2.80 from HKD 4.20. The primary drivers are the reduction in revenue assumptions for future game releases that we have previously deemed to have blockbuster potential and lower midcycle margins. This reflects the scenario where CMGE will struggle to compete with larger developers in the Chinese video game market. The group’s first-half results missed our expectations, as new releases failed to captivate players. We maintain our no-moat rating on CMGE due to its lack of long-cycle franchises, and the absence of resources to develop these titles. But with CMGE trading at around 9 times price/2023 earnings, we continue to view shares as undervalued. That said, uncertainty around the timing of game releases remains an overhang on earnings, capping share price performance over the near term.

CMGE is one of the earliest Chinese game companies focusing on intellectual property, being the first to bring Disney and Toei IPs into China. As of the end of 2022, CMGE holds a large number of intellectual property, or IP, on mobile games. We think that games with well-known IPs should attract some players, at least at the initial launch, because these titles already have their own loyal fan following whether they are based on films, TVs, or novels.

We lowered our fair value estimate for CMGE Technology to HKD 4.20 from HKD 4.70, following second-half 2022 results that were below our estimates. While our long-term forecasts remain largely unchanged, the firm’s cash burn in 2022 was higher than our expectations. Management struck an upbeat tone on the outlook for 2023 as domestic game license approval normalizes. With CMGE trading at around 8 times price to 2023 consensus earnings, we view its shares as undervalued.

CMGE is one of the earliest Chinese game companies focusing on intellectual property, being the first to bring Disney and Toei IPs into China. As of the end of 2022, CMGE holds a large number of intellectual property, or IP, on mobile games. We think that games with well-known IPs should attract some players, at least at the initial launch, because these titles already have their own loyal fan following whether they are based on films, TVs, or novels.

CMGE is one of the earliest Chinese game companies focusing on intellectual property, being the first to bring Disney and Toei IPs into China. According to Analysis, as of the end of 2020, CMGE was the Chinese gaming company that has the most mobile IP games. We think that games with well-known IPs should attract some players, at least at the initial launch, because these titles already have their own loyal fan following whether they are based on films, TVs, or novels.

We expect 2023 to be a better year for Chinese online gaming companies, and we see attractive buying opportunities. Some of these firms struggled in 2022 due to a lack of new gaming licenses, but since mid-2022, the National Press and Publication Administration started handing out more licenses to publishers. In January 2023, the NPPA issued 88 new domestic gaming licenses, marking the highest monthly handouts since May 2021. Based on the latest approval data, we fine-tuned near-term forecasts for three publishers under our coverage (Tencent, NetEase, and CMGE), but maintained their fair value estimates. NetEase is our top pick in the online gaming sector for its strong portfolio of existing and upcoming games.

The National Press and Publication Administration, or NPPA, issued 73 new game licenses on Sept. 13, marking the highest number of monthly approvals since its resumption in April. We are encouraged by the fact that all the Chinese gaming companies under our coverage (Tencent, NetEase, and CMGE) received one new license this month. We keep our fair value estimates and earnings forecasts unchanged, as we were already expecting the approval of new licenses to return this year, but sequential increases in monthly approval numbers should help improve investor sentiment. Our top pick in the online gaming sector is NetEase, for its strong portfolio of new and existing games.

CMGE is one of the earliest Chinese game companies focusing on intellectual property, being the first to bring Disney and Toei IPs into China. According to Analysis, as of the end of 2020, CMGE was the Chinese gaming company that has the most mobile IP games. We think that games with well-known IPs should attract some players, at least at the initial launch, because these titles already have their own loyal fan following whether they are based on films, TVs, or novels.

There were no surprises in CMGE Technology's first-half 2022 results because the group issued a profit warning on Aug. 15. The poor performance was mainly due to the Chinese government's temporary suspension of new game license approval in the first quarter. Since the resumption, CMGE has received one new license, and management expects more will come. CMGE currently holds four unpublished game licenses and expects to publish them all in the second half. This should lead to solid revenue growth for the next few quarters. We maintain our fair value estimate for no-moat CMGE at HKD 4.70 and view the shares as undervalued.

We reduce our forecasts for no-moat CMGE following its first-half profit warning. Following upward revisions to long-term R&D expense assumptions, we cut our fair value estimate for the firm to HKD 4.70 from HKD 5.70. With the company’s increasing pivot toward self-developing (as opposed to third-party publishing), we now see a wider range of potential valuation outcomes—with our bull case fair value estimate at HKD 6.60 and bear case at HKD 3.10. That said, we reiterate our view that the firm’s ongoing investments in game development should translate to revenue opportunities starting in 2023. We still have a favorable view on the company’s valuation, with shares trading at 11 times our 2022 earnings estimate and 9 times 2023 estimate.

CMGE is one of the earliest Chinese game companies focusing on intellectual property, being the first to bring Disney and Toei IPs into China. According to Analysis, as of the end of 2020, CMGE was the Chinese gaming company that has the most mobile IP games. We think that games with well-known IPs should attract some players, at least at the initial launch, because these titles already have their own loyal fan following whether they are based on films, TVs, or novels.

CMGE is one of the earliest Chinese game companies focusing on intellectual property, being the first to bring Disney and Toei IPs into China. According to Analysis, as of the end of 2020, CMGE was the Chinese gaming company that has the most mobile IP games. We think that games with well-known IPs should attract some players, at least at the initial launch, because these titles already have their own loyal fan following whether they are based on films, TVs, or novels.

After an eight-month freeze, China has finally resumed new game license approvals, according to Bloomberg News. The past license freeze weighed on company earnings and negatively affected investor sentiment, but April 11's positive development should bring much-needed relief to a sector that has been shaken by negative headlines. We keep our fair value estimates and earnings forecasts unchanged for our coverage of the publishers, as we were already expecting new licenses to come back this year. Besides earnings, we think the greater implication here is that the Chinese government is committed to maintaining a vibrant domestic video game sector--a notion that has been questioned by investors over the past year.

We lower CMGE’s fair value estimate to HKD 5.70 from HKD 7.00 following the company’s weak second-half 2021 results. Management blamed disappointing results on China’s game license freeze, which began in July 2021. While we believe the government will resume approving licenses soon, any reduction in the number of new licenses it receives every year is likely to impact CMGE’s future earnings. We have cut CMGE’s 2022 net profit estimate by 31% to factor in the short-term impact of the license freeze. We have also made on average 18% downward adjustments to longer-term earnings to factor in a moderate decline in the number of licenses CMGE will be awarded. Our fair value estimate implies a price/earnings multiple of 23 times for 2022 and 20 times for 2023.

CMGE is one of the earliest Chinese game companies focusing on intellectual property, being the first to bring Disney and Toei IPs into China. According to Analysis, as of the end of 2020, CMGE was the Chinese gaming company that has the most mobile IP games. We think that games with well-known IPs should attract some players, at least at the initial launch, because these titles already have their own loyal fan following whether they are based on films, TVs, or novels.

We think China will most likely allow the majority of U.S.-listed Chinese companies to submit their audit working papers to the U.S. regulators. This is because: 1) most of these firms do not possess sensitive data that is subject to national security controls, and 2) the Chinese government seems determined to resolve Public Company Accounting Oversight Board, or PCAOB, auditing challenges. Should there be no deal between China and the U.S. over the Holding Foreign Companies Accountable Act, or HFCAA, we still expect the China internet and consumer companies that we cover to navigate through without value destruction. This is because most of the China internet and consumer companies we cover either have U.S. primary listings and secondary listings in Hong Kong (Alibaba, JD.com, NetEase, Trip.com, Baidu, Weibo and Yum China), or they are primary listed in Hong Kong (Tencent, CMGE, Meituan and Alibaba Health). So even if delisting occurs, investors can convert U.S. shares into Hong Kong shares. While Pinduoduo has yet to list in Hong Kong, it already meets the Hong Kong secondary listing requirement. Therefore, we expect Pinduoduo to apply for a Hong Kong listing if a delisting looms. In our view, it is possible that the cloud businesses of Alibaba and Baidu, and some of their artificial intelligence, or AI, businesses are deemed sensitive by Beijing, as their customers include Chinese state-owned enterprises and the Chinese government. In such a case, we think it is more likely for these three companies to list primarily in Hong Kong and abandon their U.S. listings, as opposed to reducing their stakes in these cloud business to qualify as associate investments or minority investments, given the strong growth potential of the enterprise cloud industry in China. Therefore, the fair value estimates of the China internet and consumer firms we cover remains unchanged.