Company Background: Huaxia Animation operates a number of businesses related to the animation market, and mainly focuses on the trade of anime-derived products (mainly toys) and procures these products for toy companies and theme parks in Japan. The company also operates an indoor animation amusement park business in China. The company was listed on the Hong Kong Stock Exchange in March 2015 at an offer price of HK$365/share and issued a total of 107.3 million shares. Huaxia Animation aims to establish a multimedia animation business in China, and has been actively expanding this business over the past two years, including opening Shanghai JOYPOLIS, granting patent licenses for anime characters, and developing multimedia animation entertainment business using the company's proprietary animation characters. The Company issued 15 million shares at HK$3.60 each in September 2016.

Acquired SEGA LIVE CREATIVE. Huaxia Animation announced that its wholly-owned subsidiary China Theme Park Limited (CTP) signed a share agreement with SEGA SAMMY [6460.JP] on October 31. According to this, CTP agreed to conditionally acquire 85.1% of the issued share capital of SEGA Live Creation Inc. (SLC) from SEGA SAMMY. SLC was founded by SEGA SAMMY on 2015/4/1 through a spin-off of SEGA CORPORATION (now SEGA Games Co., Ltd.) as part of the amusement park business, which develops and operates indoor theme parks such as “JOYPOLIS” and “Orbi”. As part of the SEGA SAMMY restructuring plan, SEGA SAMMY decided to sell SLC's majority shares to strengthen its financial position and increase capital turnover. Orbi's business will be spun off from SLC and transferred to Sega Group. The management of Huaxia Animation said that the Orbi business is in a state of loss and is not suitable for the development of Huaxia Animation, so the Orbi business is not included in this transaction. In addition to the JOYPOLIS business, intellectual property (IP) businesses such as Supersonic, patents, technology and R&D, and production centers will be included in this deal.

Once completed, Huaxia Animation will own 85.1% of SLC's shares, and SEGA SAMMY will own the remaining 14.9%. The cost of the acquisition was that CTP paid 60 million yen (equivalent to HK$44.51 million) to SEGA SAMMY, which must be paid by CTP to SEGA SAMMY on the completion date. The price is determined by CTP and SEGA SAMMY in accordance with the general terms of business after fair negotiations. After the transaction is completed, Huaxia Animation can expand its participation in operating indoor amusement parks in more cities around the world, including Tokyo and Osaka in Japan, Dubai in the United Arab Emirates, and Qingdao in China. According to the announcement, SLC recorded net losses of 704.7 million yen and 780 million yen in fiscal year 2015 and fiscal year 2016 (ending March 31), respectively. The deal is expected to close by the end of December 2016.

It will not slow down operating performance. According to Huaxia Animation's management, SLC recorded net losses in fiscal year 2015 and fiscal year 2016, mainly due to: (a) higher non-cash costs, especially depreciation expenses, and (b) cost sharing arrangements with SEGA SAMMY. SEGA SAMMY said it will record a loss of 1.4 billion yen from the sale of SLC's shares after the transaction is completed. Sales losses recorded by SEGA SAMMY were mainly related to asset provisions. As a result, SLC's non-cash costs will drop significantly. SLC does not have to share the cost of SEGA SAMMY after the sale. The management of Huaxia Animation said that due to the above factors, the transaction to acquire most of SLC's shares will not have a significant negative impact on the company. The management of Huaxia Animation also stated that the acquisition cost was 600 million yen (HK$44.51 million), representing the price-earnings ratio of medium units (based on the net profit forecast for fiscal year 2017 provided by SEGA SAMMY). According to Huaxia Animation's management, Tokyo JOYPOLIS's revenue in fiscal year 2016 was 2.2 billion yen, and net profit was 220 million yen. SEGA SAMMY will continue to develop integrated resort (IR) businesses (Phoenix Sea Resort in Japan and the paradise city of Incheon in Korea) and invest its management resources in different resort projects. SLC will supply equipment and machines for the IR business operated by SEGA SAMMY.

Expansion in China: SLC will change its name to CA SEGA JOYPOLIS LTD. After the transaction is completed, the company will use an asset-light model to expand JOYPOLIS coverage in China. Huaxia Animation is in discussions with real estate developers in China. The property developer will pay approximately HK$25 million in advance license fees for each project and will acquire 49% of the JOYPOLIS project's shares through the property's contributions. Huaxia Animation will form a consortium with other investors to assume the remaining 51% of the capital. Huaxia Animation will also charge a percentage of revenue as license fees. If the JOYPOLIS project reaches the pre-determined KPIs, Huaxia Animation will share part of the net profit. The company is discussing the opening of JOYPOLIS indoor theme parks with real estate developers in Shenzhen, Changzhou and Zhuhai (Hengqin Island).

The potential of VR: Huaxia Animation said that the company will use its relationship with SLC and Zero Latency PTY LTD to promote a multiplayer VR game called Zombie Survival Chronicles. This is a special edition developed by Zero Latency PTY Ltd for JoyPolis. Zombie Survival Chronicles allows up to six players to participate in the game at the same time. This is the first time the game has been released to the public. It is also the first permanently installed game launched by Zero Latency PTY LTD. According to Huaxia Animation, players must book time for Zombies Survival at least one month in advance, and then players must pay on-site.

Our opinion: Huaxia Animation's acquisition of SLC is in line with the company's strategy to find partners in the industry to develop new businesses related to VR and indoor themed amusement parks. SEGA is currently committed to supporting the development of Huaxia Animation in JOPOLIS. This will not slow down Huaxia Animation's business performance. The company's stock price has been adjusted recently. We think this is due to the lack of news about the company and overall market adjustments. After the company releases its 2017 interim results and details about the acquisition of SLC later this month, we expect the company to explain more about the latest developments in the business, the company's strategy and roadmap to the market, which may draw the market's attention to the stock.

Catalyst: More news about business development and partnerships with peers.