Incident: Zhejiang Digital Culture released its 2023 annual report. During the reporting period, the company achieved total revenue of 3,078 billion yuan, a year-on-year decrease of 40.65%, net profit to mother of 663 million, an increase of 34.91% year-on-year, and net profit after deducting 359 million yuan, a year-on-year decrease of 38.95%. Net operating cash flow in 2023 was $840 million, down 18.4% year over year.

Comment: Revenue declined due to the contraction of online social networking services. Are marketing business additions expected to drive future revenue growth? 1) Gaming and social networking business: Game revenue for the full year of 2023 was 1,317 billion, down 23.63% year on year. The decline was mainly due to subsidiary cost control; social business revenue was 769 million, down 70.2% year on year. The overall contraction of social networking business had a significant impact on the company's revenue. On the gross margin side, the annual gross margin of the game business was 92.17%, up 0.09 percentage points from 2022, and the gross margin of the social business was 57.18%, an increase of 12.54 percentage points over the same period last year. Cost control led to a recovery in gross margin. The subsidiary Wingman Network's revenue in 2023 was 2,211 million yuan, down 49.8% year on year, and net profit was 639 million, a slight decrease from 706 million in the same period in 2022, but the net interest rate level increased significantly, reaching 28.9% in 2023, a significant increase from 16% in the same period in 2022.

2) IDC business: Develop IDC business through Fuchun Cloud Technology to provide infrastructure construction and operation services. In 2023, Fuchun Cloud achieved revenue of 378 million yuan, an increase of 4.7% over the previous year. The current charging rate of existing cabinets is high. In the future, it will make every effort to promote the sales of Beijing Fuchun Cloud's existing cabinets. Net profit in 2023 was 72.93 million, down 16.1% year over year.

3) Innovative businesses such as Big Data Trading Center, Communication Brain, and Hangzhou Urban Brain: Communication Brain Technology Company will continue to build the province's financial media “One Network” to promote “Tianmu Blue Cloud” to achieve basic coverage of county-level financial media centers and major municipal media throughout the province. Hangzhou Urban Brain Company will further optimize the vertical model of social governance. The Zhejiang Big Data Trading Center initially built a “1+N” integrated data circulation service platform. It has 4 industry-specific zones: “International Data Exchange Zone”, “Industrial Data Circulation and Trading Zone”, “Credit Zone” and “Electricity Data Zone”, as well as 7 regional zones in Ningbo, Wenzhou, Shaoxing, Huzhou, Yuhang, Yiwu, and Xinchang.

Sales expenses are well controlled, management expenses have increased, and the number of R&D personnel has declined: sales expenses in 2023 were $424 million, down 69.6% year on year; sales expenses were 13.8%, down 13.1 percentage points from the same period in 2022; management expenses were 466 million, up 18.7% year on year, and management expenses rate was 15.2%, up 7.6 percentage points from the same period in 2022. The increase in management expenses was mainly due to employee remuneration and amortization of new buildings; R&D expenses were 443 million, a year-on-year decrease 13.5%, the R&D cost rate is 14.4%. The decline in R&D expenses is mainly due to a reduction in R&D personnel remuneration expenses. The total number of technical personnel in the company was 771 in 2023, a decrease of 152 compared to 2022.

Profit forecast and valuation: Considering the nine days of interaction between the company's acquisitions, the company's revenue forecast for the full year 2024-2025 was appropriately raised, but due to low gross profit in the marketing business and fluctuations in investment business, the profit forecast for 2024-2025 was expected to be 3,558 billion yuan (previously 3.307 billion) and 3.37 billion (previously 3.32 billion), respectively, up 16% and 5% year-on-year, with net profit attributable to mother of 740 million (original 815 million) and 843 million (original 861 million), year over year. Increased by 12% and 14%. The current market value is 18.8x and 16.5x for 2024 and 2025 PE, maintaining a “buy” rating.

Risk warning: 1) Game regulation policies are getting stricter; 2) The risk that the information data used in the research report is not updated in a timely manner.