Incident: The company released its 2016 semi-annual report. 24H1 achieved revenue of 2.76 billion yuan, a year-on-year decrease of 38.1%; net profit to mother -0.177 billion yuan, a year-on-year decrease of 146.6%; net profit after deducting non-return to mother -0.235 billion yuan, a year-on-year decline of 182.4%, which is in the previously forecast range. Looking at a single quarter, 24Q2 achieved revenue of 1.431 billion yuan, a year-on-year decrease of 44.0%; net profit to mother -0.147 billion yuan, a year-on-year decrease of 206.1%; net profit excluding non-return to mother of 0.077 billion yuan, a year-on-year decline of 194.7%, which is in the previously forecast range. The main reason for the decline in the company's performance was the natural decline in sales of several games in operation, and the overall performance of “One Punch Man: World”, which was tested overseas by 24H1, fell short of expectations. In addition, expenses related to personnel optimization also had a phased impact on performance. However, the company's losses narrowed month-on-month after deducting non-recurring profits and losses in 24Q2, mainly due to the corresponding reduction in the company's personnel expenses, and the use of refined project control and AI technology to reduce costs and increase efficiency. We believe that the company's future performance is expected to continue to improve as the company implements a series of measures such as sorting out adjustments and focusing on layout, and the steady progress of product development.

Losses in the game business narrowed in 24Q2, and expenses increased due to personnel optimization. The company's 24H1 gross margin was 64.9%, up 6.3pct year-on-year. 24H1's actual revenue from the game business was 2.65 billion yuan, down 27.3% year on year, net profit to mother was -0.166 billion yuan, and net profit after deducting non-return to mother was -0.155 billion yuan, down 136.4% year on year. The net profit for the single quarter corresponding to 24Q2 was -0.051 billion yuan, and the net profit after deducting non-net profit was -0.056 billion yuan. Compared with 24Q1, the loss margin was significantly narrower than in 24Q1; revenue from the film and television business was 0.09 billion yuan, down 88.3% year on year, net profit to mother was 0.089 billion yuan, and net profit after deducting non-return to mother was -0.018 billion yuan. 24Q2 sales expense ratio year-over-year/month-on-month change - 1.1 pct/+2.0pct was 19.3%. The year-on-year/month-on-month change in R&D expenses was 31.7% +11.8pct/-5.8pct. The year-on-year/month-on-month change in the management expense ratio was 14.4%, mainly due to personnel optimization in the first half of the year. We expect an increase in compensation expenses mainly due to personnel optimization in the first half of the year.

There are plenty of new products in stock, and the game is showing initial results when it goes overseas. 24H1. On the one hand, the company steadily operates existing games such as “Immortals”, and on the other hand, actively promotes the new product development process. On July 16, 2024, the new supernatural city open world RPG “Alien Ring” independently developed by Hotta Studio, a subsidiary of the company, opened for the first time in the world and will be released on all PC, mobile, and console platforms. The “Different Ring” PV and actual machine demo video showed players game content such as seamless map connection, supernatural art style, and vehicle modification. Once revealed, it received widespread attention and recognition from players. The number of reservations exceeded 2.8 million in the first week. Officials also revealed in August that a multiplayer online mode will be opened in the future, and related UGC gameplay is also being planned. The game will participate in an offline exhibition for the first time in September. The company also closely collaborated with global partners such as Nvidia, Sony PlayStation, and Epic on “Another Ring”, which sparked a buzz among players around the world and received unanimous praise. It is expected that it will be launched overseas in the future, deepening the company's game overseas. At the same time, the company also continues to steadily advance domestic and international testing and launch plans for various new games. The new mobile game “World of Immortals” received good feedback. “Immortal 2” was tested in August, “Demon Continent” will be officially launched overseas in the near future, “Divergent Million King Arthur: Ring” is imminent for public testing in Hong Kong, Macao and Taiwan regions, and reserve products such as “Code Name Barbarian” and “Code Z” are also being actively developed. In addition, the company also plans to continue the launch plan for “Persona: The Phantom of the Night” in other overseas regions such as Japan, Europe, America, and Southeast Asia, which is expected to help the company's performance grow.

Implementing AI technology to enhance game product capabilities. The company has applied AI technology to the art, procedures, planning, operation, safety, and testing of the R&D pipeline, covering application scenarios such as intelligent NPCs, intelligent game assistants, scene modeling, AI painting, AI plot, AI dubbing, etc., to assist the R&D team to build a new type of game development pipeline based on AI technology to help the company improve R&D efficiency. In addition, the company has also carried out in-depth cooperation with many major domestic and foreign technology companies such as Nvidia and Huawei to further enhance game product capabilities.

Profit forecast and investment rating: We expect net profit to be increased by -74.06%, 286.87%, and 28.82% year-on-year in 2024-2026 to 0.127 billion yuan, 0.493 billion yuan, and 635 million yuan, respectively. The current stock price corresponding to 2024-2026 PE is 112X/29X/23X, respectively, maintaining the “recommended” rating.

Risk warning: Risk of declining game volume, new game development progress falling short of expectations, and new game launch revenue performance falling short of expectations.