The suspension of SMS recharges has impacted the game industry, and local chess and cards need to be strengthened
Liberal Arts issued a profit warning, mainly due to the suspension of SMS recharge services of operators
It will take time for SMS recharge to fully recover, and new Liberal Arts products have yet to make a significant contribution to revenue
We downgraded the company's rating to neutral and gave a new target price of HK$4.88
The suspension of operators' SMS recharges had a big impact on the revenue growth of gaming companies
Liberal Arts Interactive announced that its 1H15 profit is expected to show a clear year-on-year decline. We recently learned during channel research that after telecom operators suspended SMS recharge in March, their customers needed to re-submit applications and pass a series of reviews each province before they can resume SMS recharge services. Therefore, we believe that the impact of the suspension of SMS recharges on game companies' revenue will continue in the second quarter and may extend to the third quarter. Since users using carrier SMS recharge account for a high proportion of total paying users (over 40%), we believe that this incident will have a negative impact on the number of paid users, payment rates, and ARPPU of Liberal Arts in 2Q15, while Liberal Arts's switch to other recharge channels with a higher share ratio will reduce the company's overall gross margin level.
The impact of operators in the second half of the year is uncertain, and the contribution of new games to revenue growth is limited
The progress and efficiency of the operator's resumption of SMS recharge services fell far short of our expectations, so it is difficult for us to determine how long it will take for Liberal Arts to fully resume SMS recharge services. We estimate that under the most pessimistic circumstances (the recovery progress of operators' SMS recharge business stalled in the second half of the year), its revenue and net profit for the full year of 2015 will fall 18% and 30%, respectively. Furthermore, although local chess and cards such as Yibin chess, bullfighting, and roller games launched by Liberal Arts in the first half of the year all received good market feedback, we believe these new products will still take some time to accumulate active users before they can increase the degree of monetization. In overseas markets, the number of active users of the “Three Gong” games launched by Liberal Arts in Thailand has increased significantly, and they have already begun to receive clear recharge flows, while game product promotion in other countries is also being carried out according to the planned plan.
Valuation and Ratings
Based on uncertainties on the operator side, we lowered the company's 2015/16/17 revenue forecast by 19%/12%/11%, and our net profit forecast by 34%/12%/11%. At the same time, due to increased channel sharing, we lowered Liberal Arts gross margin to 55% in 2015. However, we still believe that with 1) excellent chess and card product experience and user base; 2) the good partnerships established with operators, Liberal Arts can take the lead in fully restoring the SMS recharge function and restoring growth in game revenue and the number of paying users. We used the average 2015 EP/E12.2x of Chinese game companies currently listed overseas to arrive at a new target price of HK$4.88, and the rating was downgraded from buying to neutral.