Stock thesis:
Nexon Co., Ltd. (TYO: 3659 or OTCMKTS: NEXOY) is a South Korean–Japanese video game publisher that specializes in online games for PC and mobile. Nexon was founded in Seoul, South Korea in 1994 by Kim Jung Ju and Jake Song. In 2005, the company moved its headquarters to Tokyo, Japan.
Dungeon Fighter game has been a mega hit in China for more than a decade. The new release of Dungeon and Fighter in mobile version in China will be a strong revenue driver. Nexon also benefits from favorable macro environment and strong cash flow from its IP portfolio. However, the current stock price does not capture this growth potential in China.
Reasons to buy:
1. COVID-19:
The outbreak of COVID-19 pandemic has caused steep decline in some of the traditional industries, such as hotel and airlines, while accelerating digitalization process and spurring growth for “untact” industries.
Gaming industry has been one of the benefactors of COVID-19 as it is clearly an entertainment that can be enjoyed by single person, even during lock-down periods.
As a result, the gaming market is expected to record significant growth. According to a research, “the games market will continue to grow in the following years, exceeding $200 billion at the end of 2023. By then, we forecast the games market to grow with a +8.3% CAGR to $200.8 billion.” The value of global games market stands at $160 billion as of 2020.
Source: Newzoo
Clearly, the gaming industry is growing in favorable macro environment. Now the issue is picking a winning company.
2. Strong intellectual property (IP) portfolio:
Game companies have game IP portfolios. Gaming industry is similar to pharmaceutical industry in that it takes a large amount of investment and time to develop a game, but once it does there is not so much variable/maintenance cost in making profits from its developed game. Just like pharmaceutical companies have drug pipelines, game companies have game IP portfolio, which brings in cash to be used for further game development.
Hence, when looking for gaming companies to invest, investors would need to look at their game IP portfolio and determine whether they are bringing in enough cash and whether they are diversified.
Nexon currently has 27 PC games and 17 mobile games in its IP portfolio, some of which are very famous in Asia, such as Crazyracing Kartrider, MapleStory and The Kingdom of the Winds. These games are still very popular and widely played world-wide. It would be a lie if any South Korean has neither heard of nor played any of these games in their life.
Hence, Nexon has stable cash flow coming from its game IP portfolio, which adds stability to its business model.
3. Dungeon Fighter mobile:
Dungeon Fighter Online, also known as DFO, is a multiplayer beat ’em up action role-playing game, developed and published for personal computers by Neople, a South Korean subsidiary of Nexon, and originally published by Hangame in 2005.
Dungeon Fighter Online has 7 billion users world-wide, but is especially popular in China, recording the 5 million Chinese people simultaneously playing the game in June 2014. Because of its popularity, this game alone brings in half of Nexon’s revenue, recording more than $1.6 billion in 2019.
This mega hit PC game is scheduled to be released in mobile game in China in August 2020, with 56 million Chinese users already pre-registered to download and play this game. Pre-registration of the population of 56 million is equivalent to entire South Koreans, and is unprecedented in any game history.
These loyal users have been heavily invested in PC game and are willing to spend considerable amount of money to maintain their status in the same mobile game as well. Even if Dungeon Fighter Online mobile game is half as successful as its PC game, it would mean additional $600 million revenue for Nexon.
I strongly do not think the current share price is accurately capturing this growth potential.
Chart:
I would like to compare Nexon’s forward P/E with its peers, namely Nintendo (Japan), Tencent (Hong Kong), Activision Blizzard (USA), and Ncsoft Corporation (South Korea).
It is true that all of these peer companies share prices have risen since the beginning of the year 2020. However, Nexon is still relatively undervalued compared to its peer still hanging below forward P/E multiple of 20x, as shown in the chart below.
Source: Capital IQ
Risk:
There are a number of risks to buying Nexon stocks.
- The spike in the number of and spread of COVID-19 may dampen the global economy, reducing demand for games;
- Dungeon Fighter may turn out to be less successful than anticipated; and
- Regulations on game may change abruptly in China.
Conclusion:
COVID-19 has created a favorable macro environment for game companies. Nexon has been consistently building up its IP portfolio, which now forms a strong cash cow. I strongly believe that Nexon will grow more with the launch of Dungeon and Fighter mobile game in China.
Disclosure: I am long Nexon and Nintendo. I wrote this article to myself, and it expresses my own opinions. I am not receiving compensation for it other than from Macrotrend. I have no business relationship with any company whose stock is mentioned in this article.
This article is also published on Macrotrend.
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