Nexon (3659 JP): Given the Challenges Ahead, Can the Good Run Continue?

Nexon is a unique Japanese Internet company in that it achieves more success overseas than in the domestic market. The company is famous for a number of long-running titles of PC games. It is working to replicate this success by leveraging popular IPs on the PC platform onto the mobile platform and developing new franchises to broaden its international reach through M&A and partnerships. The stock has enjoyed a good run recently, reaching ¥2,943 on September 19th, up from ¥2,211 on August 10th. Based on a comparable valuation approach, the “intrinsic” value of Nexon’s share price is ¥3,020, which is a mere 3% above September 19th’s record high level.  
We struggle to find new catalysts that could support further share price appreciation. The Chinese and South Korean PC gaming markets are saturated with Nexon’s titles, while there is no guarantee that the shift to mobile gaming will be smooth. Besides, the company’s presence in Japan is unlikely to improved and efforts to accelerate growth in the Western markets are yet to bear fruit. In addition, its large exposure to fluctuating exchange rates, its active pursuit of M&A, plus the related risk of impairment losses due to titles underperforming combine to suggest earnings volatility, which risk triggering some negative market reactions. 

Key Points

• Over the FY17-19 period, about 80% of the company’s revenue is likely to continue to come from China and South Korea, while well over 70% of revenues will still likely come from the PC platform.  
• Contributions from the Japan, North America, and Europe and ‘Others’ businesses will likely remain immaterial on their own, due to cut-throat competition, Nexon’s track record, and its current title pipeline.  
• In the absence of new hit games, we think the company would struggle to maintain strong growth; sales expansion rates may fall to low single-digit rates in FY18 and FY19. As a consequence, assuming constant exchange rates, earnings may increase at an even slower pace than revenue, on the back of higher game development and operation costs as well as personnel and marketing expenses, leading to profitability deterioration.