Event: China Literature released the semi-annual report of 2022. In the first half of 2022, the company achieved operating income of 4.087 billion yuan (yoy-5.9%) and Non-GAAP homing net profit of 666 million yuan (yoy + 0.2%).

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Revenue declined slightly compared with the same period last year, and the copyright operation business is expected to continue to develop rapidly. In the first half of 2022, the company achieved 4.087 billion yuan in revenue, a decrease of 5.9% over the same period last year.

The revenue from online reading business was 2.307 billion yuan, down 9.2% from the same period last year, including 1.763 billion yuan for self-owned platform products, down 6.3% from the same period last year; the self-owned channel for Tencent's products was 347 million yuan, down 1.7% from the same period last year; and 196 million yuan for third-party platforms, down 35.8% from the same period last year. The decline in revenue from self-owned platforms is mainly due to the measures taken by the company to increase efficiency and reduce costs to reduce expenditure on promotion. The slight decline in revenue from Tencent's product proprietary channel is mainly due to the decline in the cash efficiency of free reading advertisements affected by macroeconomic; the sharp decrease in business revenue on third-party platforms is due to the company's suspension of cooperation with some distribution platforms.

The revenue from copyright operation business was 1.731 billion yuan, down 0.5% from the same period last year, mainly due to the decline in revenue from the company's own games, while revenue from films, copyright licensing, animation and other businesses grew steadily; revenue from other businesses (mainly paper book sales) was 49 million yuan, down 21.1% from the same period last year.

Looking forward to the second half of the year, we expect that the company's online reading business will continue to actively reduce promotion costs, shift to strategies to improve operational efficiency and optimize cost structure. There are many bright spots in copyright operation business in the first half of the year, film and television works such as "the World", "Heart residence", "Wind from Longxi" and "Please call me Director" have a good audience rating. Under the IP visualization strategy, the company will be able to continue to create popular film and television works and drive copyright operations to achieve rapid growth.

In the first half of the year, the gross profit margin of the company was stable, and the rate of sales expenses and management expenses decreased significantly.

In the first half of 2022, the company's overall gross profit margin was 52.5%, down 0.2% from the same period last year, of which the gross profit margin for online reading was 50.3%, up 2.9% from the same period last year, mainly due to the optimization of content costs and distribution costs. Affected by the increase in the production cost of the series, the gross profit margin of copyright operations and other businesses was 55.4%, down 4.8% from the same period last year. Under the strategy of reducing costs and increasing efficiency, the company's expenses were optimized. During the reporting period, the sales expenses were 1.111 billion yuan, the sales expense rate was 27.2%, down 3.8% from the same period last year; the management expenses were 558 million yuan, and the management expense rate was 13.6%, down 1.0% from the same period last year; Non-GAAP 's homing net profit was 666 million yuan, up 0.2% from the same period last year, and the net interest rate was 16.3%, up 1.0% from the same period last year. The increase in the company's net interest rate is mainly due to the company's reduced spending on online reading promotion and research and development.

The scale of free reading users has increased, and the value of paid reading users has increased. By the end of the reporting period, the average number of monthly active users of the company's own platform products and proprietary channels was 265 million, an increase of 13.8% over the same period last year. Among them: driven by high-quality content, the number of monthly active users of the company's own platform products was 120 million, an increase of 4.5% over the same period last year; driven by the growth of users of free reading content, the number of monthly active users of Tencent's product self-supporting channel reached 145 million, an increase of 22.7% over the same period last year. In terms of free reading business, by the end of the reporting period, the company's average daily active users of free reading reached 14 million. In terms of paid reading business, the ARPU value of paid reading users during the reporting period was 38.8 yuan per month, an increase of 6.6% over the same period last year. We believe that the future growth points of the company's online reading business come from: 1) the growth of free reading users and the increase of advertising loading rate; 2) with the continuous accumulation of high-quality content and the improvement of content operation and recommendation efficiency, the company's large group of free users is expected to be converted into paying users.

Tamp the basic ability, excavate the value of IP with more circumference. In terms of IP creation, about 300000 writers and 600000 novels were added to the company's online literature platform during the reporting period. at the same time, the company accelerated the incubation of high-quality content of specific types (such as science fiction) through the optimization of support mechanisms and operational activities, driving the rapid development of the corresponding categories. IP visualization is still the focus of the company's current work, the company around high-quality IP reserves, in film and television, animation, comics, games and other fields have made rapid progress. In addition, the company further shortens the conversion time from IP to merchandise, broadens the quantity and commodity form of IP, focuses on the opportunities in the areas of consumer goods, trendy toys and offline live consumption, and makes initial progress in the commercialization of IP: for example, the single statue of Medusa, which is authorized by the company to launch, is sold out in advance, and the GMV reaches RMB 5 million.

We believe that, relying on the huge and high-quality IP reserves and constantly improving the development capacity of the whole industry chain of IP, the company is expected to continue to enhance the influence of IP, and the value of IP is expected to be accelerated.

Profit forecast and rating: with network literature as the starting point, the company gradually extends to a variety of IP forms, such as film and television, animation, games, physical goods, etc., and is expected to continuously strengthen its IP industry chain business capabilities and achieve IP full-link development and realization. Taking into account the impact of the domestic epidemic on the production progress of film and television projects and the weaker-than-expected recovery of consumption, we reduce the company's revenue and return net profit: the company's operating income is estimated to be 9.17 billion yuan, 10.61 billion yuan and 12.29 billion yuan in 2022-2024. The net profit of Non-IFRS is 1.52 billion yuan, 1.87 billion yuan and 2.4 billion yuan respectively, the EPS is 1.51,1.86 yuan and 2.38 yuan respectively, corresponding to the existing share price PE is 20XPower16X and 12x respectively, maintaining the "highly recommended" rating.

Risk tips: (1) the continuous impact of the free reading mode leads to a reduction in the number of paying households; (2) the epidemic repeatedly affects the production progress of the company's film and television projects; (3) the strong supervision policy of the film and television industry is higher than expected; (4) the progress of the integration of the company's IP industry chain is lower than expected.