"Double-Up Stock" XD: Was 2023 a Bust? The Savior Has Arrived

At noon on March 28th Beijing time, $ XD INC(02400.HK) released its full-year performance for 2023. Dolphin Jun pays more attention to marginal changes, so the analysis mainly focuses on the performance in the second half of the year.

Specifically:

1. Old games underperformed, new products struggle to make up for the gap

Overall, the performance in the second half of last year fell short of expectations, with issues arising in the gaming business. The gaming revenue in the second half of the year was only 940 million, the lowest in nearly three years, with a nearly 30% year-on-year decline. Despite the launch of new games like "T3" and "Torchlight Infinite" in the second half of the year, the highest revenue-contributing game "Sausage Party" saw a year-on-year decline.

The decline of "Sausage Party" may be related to competition from popular DAU casual games like "Egg Party" from last year. On one hand, these two games have a high overlap of core players, and on the other hand, "Egg Party," a UGC-driven small game, can partially replicate the gameplay of "Sausage Party." Therefore, with the launch of "Yuanmeng" this year to join the competition, we suggest being cautious about the future revenue trend of "Sausage Party."

However, fortunately, "Set Off Muffin" became popular outside of Hong Kong, Macau, and Taiwan in January, with a total revenue of 9.85 million US dollars on iOS + Android platforms from January 23 to early March. Based on this revenue trend, assuming no operational accidents occur, Dolphin Jun estimates that the revenue in Hong Kong, Macau, and Taiwan regions is expected to exceed 500 million RMB for the whole year. The domestic version is planned to be launched in May, and if the revenue scale during the six-month operation period can also reach over 400 million, it means that this game alone may bring nearly 1 billion in incremental revenue.

In addition to the well-performing "Sword of the Bellflower," if the old games assume a 10-20% decline, the game revenue this year can still see a good growth rate (Dolphin Jun estimates 40%-50%). Besides, attention can also be paid to the launch plans of "Isa Restart Day" and "Heartbeat Town," both of which obtained licenses at the end of last year and early this year.

2. TapTap's monthly active users decline, but monetization efficiency improves

TapTap's domestic MAU in 2023 decreased to 35.81 million, a 14% year-on-year decline. However, compared to 33.97 million in the first half of the year, the user loss situation in the second half of the year should have significantly improved with the launch of new games, as the company revealed that Q4 MAU has exceeded the level of the same period in 2022.

Although the monthly active users declined year-on-year, TapTap's advertising revenue for the whole year of last year maintained a growth of over 30%, accelerating to 36% in the second half of the year. Apart from industry recovery, this also indirectly reflects the company's continuous optimization of TapTap's advertising conversion efficiency, which has shown good results. Dolphin Jun believes that the core barrier for TapTap's efficient conversion lies in TapTap's unique position in the gaming industry, which is a key reason why game developers recognize TapTap's advertising conversion effect and increase investmentTapTap, although mainly relying on advertising for monetization, has a different business model from the gaming business. However, the driving force behind the traffic still relies on self-developed/exclusively authorized popular games. Therefore, the popularity of "Let's Go Muffin" at the beginning of this year will not only be reflected in the explosive increase in game revenue but also significantly impact the user base of TapTap.

3. Self-development + Efficient monetization on TapTap drives gross profit margin to a new high in recent years

More self-developed games mean fewer external revenue sharing. Higher advertising conversion efficiency means that more revenue can be generated per unit server cost. These two factors are the core drivers that have raised the company's overall gross profit margin to 63% in the second half of the year, which is the highest level in nearly three years.

Of course, the company has also been actively reducing costs in the past year. Looking at the detailed breakdown of costs, game development revenue sharing, bandwidth hosting fees, and channel commissions have all decreased year-on-year.

4. Layoffs to increase efficiency and timely elimination of low ROI projects

Starting from 2022, the company has been intentionally reducing the employee costs incurred during the previous two years of blind expansion. In addition to reducing average compensation and benefits, low ROI projects are also promptly shut down to reduce development personnel. For example, at the end of last year, the company shut down the project "Unhappy Raccoon" that had been launched overseas for only a year.

Due to the high expenditure on severance pay in the short term, the real impact on financial indicators will be seen starting from 2023. In 2023, the annual employee welfare expenditure decreased by 16% year-on-year, and with the continued layoffs, the number of research and development personnel decreased by 160 year-on-year.

After deliberately controlling sales expenses in the first half of the year, they increased by 3% in the second half due to the launch of three new self-developed games.

Although the growth is not significant, the inability of old games to sustain revenue led to a core operating loss of 114 million in the second half of the year, failing to continue the profit from the first half. However, compared year-on-year, the loss narrowed due to an overall decrease in expenses.

5. Performance indicators vs. market expectations

Dolphin's Viewpoint

Although TapTap is somewhat unique, the logic behind Heartbeat is fundamentally product logic. Small and medium-sized gaming companies cannot escape from this constraint. Only leading companies, relying on phenomenon-level games that can generate continuous revenue and rich long-term operational experience, can maintain relatively stable operations. Investments can be relatively long-term, but small and medium-sized companies are more suitable for closely following the product cycle to find short-term opportunities.

Comparing Heartbeat's 2023 performance with market expectations at the beginning of the year, it is actually relatively poor. Last year can be said to be a short cycle of self-developed products that Heartbeat has been waiting for for many years. "T3 (Fire Soda)" and "Torchlight: Infinite" are games that the company and the market have high expectations for, hoping for a product that can follow the popularity of "Sausage Party."In terms of actual performance, "T3" is not doing well, "Torchlight: Infinite" is okay, but the popularity has not risen that high, so it's still a bit far from taking over. At the end of the year, "Sword of the Bellflower" performed well, but it was within expectations and it's difficult to reach the scale of "Sausage Party". However, what exceeded expectations is "Let's Go Muffin", which unexpectedly became very popular.

Therefore, with the strong performance of "Muffin", the poor performance in 2023 will not have much impact. Since February, when "Muffin" went online and data exploded in a week, as of now, Xindong's market value has doubled, corresponding to 16 times the operating profit after tax in 24 years (Dolphin estimates revenue to be around 4-4.5 billion, with a 60% gross profit margin, 2.1 billion operating expenses, and a 20% effective tax rate). Considering that Xindong may not have the research and product reserves for a sustainable multi-round product cycle (currently only 2 self-developed games in reserve), this valuation indicates that the current expectations are not low.

Of course, in the short term, it is not ruled out that the valuation may continue to rise with market sentiment. However, to see solid upward elasticity, it will still be necessary to see whether "Muffin" can further stabilize its revenue (short-term focus on the revenue trend before the launch of the domestic server in May), or whether there are new games scheduled for release this year, such as "Heartbeat Town" and "Isa Restart Day". Both of these games have obtained licenses, so it is worth paying attention to the management's description of the subsequent pipeline during the conference call.

Below is a detailed financial report analysis:

1. TapTap: Domestic MAU rebounded in the second half of the year, monetization efficiency continues to improve

Last year, TapTap's domestic monthly active users (MAU) were 35.81 million. In the first half of the year, due to the return of offline entertainment activities and the company's active cost control to reduce customer acquisition spending, MAU plummeted drastically. If we simply average it out, in the second half of the year, it was 37.65 million. Although it is still declining year-on-year, it has shown some recovery compared to the first half of the year, with the release of new games and the company's advertising spending recovery.

Before the launch of "Sword of the Bellflower", the platform's new game activity mainly relied on "T3" and "Torchlight". Compared year-on-year, due to the impact of competitors on the daily active users of "Sausage Party", it also lowered TapTap's monthly active users.

Overseas TapTap users saw a more significant loss, with monthly active users almost halved in the second half of the year, reaching only 4.44 million on average. The company explained that the decline in India was largely due to the launch of competitors, and Dolphin believes that the weakening of "Sausage Party" is also relatedDue to the fact that overseas TapTap has not yet been commercialized, the revenue from information services mainly comes from the game promotion revenue on the domestic TapTap platform, as well as a small proportion of cloud gaming subscription revenue.

In the second half of 2023, the revenue from information services was 694 million yuan, with a year-on-year accelerated growth of 36%. In a situation where the user base is shrinking, the main driving force for growth comes from the increase in industry acquisition costs under intensified game competition and the improvement in self-advertising conversion efficiency.

2. Games: Decline in old games, difficulty in filling the gap with new games

The game revenue in the second half of the year remained poor, mainly due to the underperformance of old games. Among them, the top revenue contributor "Sausage Party" faced a decrease in user activity due to the increase in similar competitive casual games, leading to a decline in revenue. Although there was additional revenue from "T3" and "Torchlight: Infinite" in the second half of the year, it was difficult to make up for the gap caused by the old games.

The game revenue in the second half of the year only reached 942 million, a 29% year-on-year decline. Apart from the inherent poor performance, the continued popularity of "Sausage Party" after its update in the second half of 2022 also contributed to the decline due to the high base, exacerbating the downward trend.

When broken down to the number of paying users and the per-user payment situation, the core factor affecting the decline in revenue is the significant reduction in the number of paying users, mainly due to the loss of players from "Sausage Party."

Currently, Xindong operates 20 online games and 31 paid games, with varying commercial capabilities. Among the top five revenue-contributing games, the domestically launched "Torchlight: Infinite" in the second half of the year has risen to the second place in revenue contribution, second only to "Sausage Party."

The other three games are basically in an irreversible sunset phase, with an operating period of over 3 years. If significant changes are not made, they are basically in a passive state waiting to be shut down.

Among the new games, "Torchlight" operates on a seasonal basis, so there won't be a continuous decline in revenue. It will peak at the beginning of each season and is suitable for long-term operation. In addition, the domestically released "Sword of the Bellflower" at the end of the year actually received a good response, but because it was released at the end of November, its contribution to this year's performance was minimal. According to data from Qimai, "Sword of the Bellflower" generated 42 million yuan in revenue on iOS in the first month, and based on a simple estimate for the Android platform, an annual revenue contribution of 300-400 million is still expected.From the current pipeline, only "Isa Restart Day" and "Heartbeat Town" are left in self-developed games, while "Raccoon is Unhappy" announced the cessation of operations in November last year. Both of these upcoming games have obtained licenses and have undergone testing. Although "Heartbeat Town" has undergone significant modifications from its initial proposal, Dolphin is still looking forward to its performance after it goes live.

However, the speed and efficiency of research and development remain uncontrollable factors, which is why Dolphin believes that small and medium-sized game companies can only seek short-term investment opportunities by closely following the product cycle.

III. Gross profit margin hits a new high in nearly three years

In the second half of last year, Heartbeat turned profitable for just half a year, only to return to its original state under the drag of game revenue. Excluding gains and losses from financial assets and changes in value, the core operating loss was 114 million, with a loss rate of 7%.

As the proportion of self-developed game revenue and advertising and other information service revenue increases, it naturally drives the gross profit margin of the game business and TapTap business to rise. In the second half of the year, the overall gross profit margin of the company increased to 63%, reaching a new high in nearly three years.

In addition to changes in revenue structure, the company has actively reduced costs over the past year. Looking at the detailed breakdown of costs, the absolute values of game development royalties, bandwidth hosting fees, and channel commissions have all decreased year-on-year. Therefore, the gross profit margin of the game business and advertising business has been optimized on average year-on-year in 2022.

Considering that the gross profit margin of the TapTap business has already reached the level Dolphin previously expected (above 80%), which is a good level for the commercialization and realization of general platform companies, we believe that there will be more room for improvement in the gross profit margin of the game business in the future.

Generally, the financial report gross profit margin of self-developed games will be higher than that of exclusively licensed games (with fewer developer royalties), but lower than that of agent games that recognize revenue on a net basis. However, considering the favorable impact of self-developed and exclusive games on TapTap user engagement, Heartbeat has already shifted its resources mainly to self-developed and exclusive games. Therefore, Dolphin expects that unless there are major works from competitors in the future, the proportion of agency distribution will continue to decrease.

At the same time, the contribution of exclusive licensed games in stock games (such as RO, Sausage) to total revenue continues to decline due to the decline in the game lifecycleSo, as the self-developed games contribute more revenue after going online, the gross profit margin of Heartbeat Games will gradually align with companies like NetEase, which are basically self-developed game giants. Currently, NetEase's mobile game gross profit margin is stable at over 60%, and there is still hope for Heartbeat to stabilize and increase to 55%-60%.

IV. Staff Reduction for Efficiency Improvement, Timely Elimination of Low ROI Projects

Starting from 2022, the company has been intentionally reducing the employee costs incurred during the blind expansion of the past two years. In addition to reducing average salary and benefits, low ROI projects will be shut down in a timely manner to reduce development personnel. For example, at the end of last year, the company shut down the overseas project "Unhappy Raccoon" that had been online for only a year.

Due to the high expenditure on severance pay in the short term, the real impact on financial indicators will be seen starting from 2023. In 2023, employee welfare expenses for the whole year decreased by 16% year-on-year, and with the continued progress of layoffs, the number of research and development personnel decreased by 160 year-on-year. The average salary level per employee also showed a certain decrease year-on-year.

After deliberately controlling sales expenses in the first half of the year, in the second half of the year, due to the launch of three self-developed new games and two independently distributed paid games, necessary promotional marketing was inevitable. Additionally, customer acquisition investment on TapTap moderately resumed, leading to a slight restrained growth of 3% in sales expenses.

Although the growth was not significant, the inability of old games to sustain revenue resulted in an operating loss of 114 million in the core main business in the second half of the year, failing to continue the profit from the first half of the year. However, compared year-on-year, due to the overall decrease in absolute value of expenses, the extent of the loss also narrowed.

Dolphin Research on "Heartbeat" Historical Articles:

Financial Report Season

August 31, 2023 Conference Call "Industry Recovery, But Heartbeat's Investment Remains Cautious (Heartbeat Company 1H23 Performance Conference Call)"

August 31, 2023 Financial Report Review "TapTap Returns to Pre-Liberation, Heartbeat Lacks a Second Hit"2023 年 3 月 30 日电话会《过去三年的经验教训：不画饼，谈落地（心动 2H22 电话会纪要）》

2023 年 3 月 30 日财报点评《心动公司：TapTap 掉链子，想说 “心动” 不容易》

2022 年 9 月 1 日电话会《心动：加快核心游戏上线进程，寻求高质量在哪工作（1H22 电话会纪要）》

2022 年 8 月 31 日财报点评《意外惊喜，心动又可以心动了》

2022 年 3 月 30 日电话会《心动公司：希望在没有国内版号下靠出海取得盈亏平衡（电话会纪要）》

2022 年 3 月 30 日财报点评《心动：深渊之后还是深渊，出海能否 “江湖救急”？》

2021 年 8 月 27 日电话会《心动电话会纪要：管理层对未来短期与长期的规划还是很明确的》

2021 年 8 月 26 日财报点评《心动财报：市场 “火急火燎”，心动 “不慌不忙”》

2021 年 3 月 26 日电话会《心动公司 2020 业绩电话会纪要】游戏行业变革不是一蹴而就，心动的成长也如此》March 26, 2021 Financial Report Review "The Essence of Exciting Investment: Patience, Patience, and More Patience"

March 1, 2021 Performance Warning Interpretation "Dolphin Research | After a Sharp Drop in Profits, Is the Excitement 'Squatting' or Just 'Faking a Fall'?"

In-depth Analysis

September 27, 2022 Overview "Can the 'Disappeared' Kuaishou, Exciting, iQIYI, Tencent Music, etc., Reverse Their Dilemma?"

February 1, 2021 "Dolphin Research | The 'Strange Phenomenon' Behind Excitement: If You're Excited, Can You Take Action?"

December 29, 2021 "Dolphin Research | Heavy Research: How Far is TapTap from the Chinese Version of Steam?"

December 16, 2021 "Dolphin Research | The 'Strange Phenomenon' Behind Excitement: Why is the Market Excited?"

December 15, 2021 "Dolphin Research | The 'Strange Phenomenon' Behind Excitement: A Major Change in the Gaming Industry!"

Risk Disclosure and Statement of this Article: Dolphin Research Disclaimer and General Disclosure