Heart Moving Inc.: TapTap has missed its step, saying "Heart Moving" is not easy.

On the afternoon of March 30th Beijing time, Xindong Company (2400.HK) released its financial report for the second half of 2022 and the full year.

The main points are as follows:

1. Accelerated performance recovery: Overall performance reflects the trend of recovery as expected. As most of Xindong's revenue comes from the contribution of several self-developed games, performance recovery is highly correlated with its own product cycle. During the suspension of approvals for publication, the company spent half a year adjusting its strategy and concentrating its resources on overseas versions of self-developed games. In the first half of the year, due to the resurgence of the head game "Sausage Party," revenues increased, while in the second half of the year, the speed of performance recovery was mainly driven by several self-developed games going overseas.

In addition, the high gross profit margin of self-developed games and the fast optimization of the R&D team also make the overall trend of performance recovery quite evident.

2. Transitional phase of supply + lack of self-development, TapTap faces short-term bottlenecks: The valuation floor of Xindong is determined by its gaming business. From the current perspective, the stock price has absorbed many expectations of recovery.

Whether the valuation of Xindong can rebound depends on TapTap: In the second half of the year, the user scale and activity of TapTap did not increase month-over-month, but instead lost 560,000 users despite the peak season in summer. This should be the key point that the market is not satisfied with this financial report.

However, since the average daily usage time is increasing, and TapTap itself is constantly optimizing its advertising ROI, the revenue growth rate obtained from TapTap is still strong, with a year-over-year growth rate of 43% in the second half of the year. Excluding the newly added cloud gaming and TDS revenue, the advertising revenue increased by 34% year-over-year, which is also good.

Dolphin believes that although the company has communicated TapTap's data, and third-party platforms can also see that the monthly activity of TapTap has not changed much in the second half of the year, the market is still biased towards optimism due to the relaxation of publication approvals and the improvement of supply of new games in the industry.

In addition to the recovery of publication approvals, there is a transitional phase of industry supply improvement. If combined with the company's product launch schedule, it can also explain the reasons. In the first half of the year, "Sausage Party" set a new record for users and revenue, and TapTap also added more than 6 million users against the trend. However, in the second half of the year, although publication approvals were relaxed, Xindong did not launch any self-developed games in China, corresponding to the situation of TapTap, where user activity remained stable month-over-month.

Of course, from this perspective, it shows that in the short-to-medium term, TapTap as a channel for vertical categories, still needs to rely on self-development to significantly improve user activity, and the effect of improving industry supply on user growth is average.

3. Significant increase in gross profit margin: The comprehensive gross profit margin in the second half of the year increased significantly to 57%, returning to a historically relatively high level. The gross profit margins of games and TapTap have also improved significantly, with self-development boosting the gross profit margin of games (the total revenue method requires additional revenue sharing for games with exclusive IP); the improvement of TapTap's gross profit margin is because the mismatch between input and output is gradually disappearing (early investment was relatively high, and TDS and cloud gaming began to generate revenue in the second half of the year). 4. Accelerating layoffs and project reorganization, there is still room for optimization of R&D expenses: The optimization of operating expenses mainly reflects the effect of layoffs. At the end of the year, there were 1,196 R&D personnel, a decrease of 190 compared to the mid-year. Since 2020, the rapidly increasing R&D investment of Xindong has always been criticized by the market, especially since the treatment of R&D personnel has increased, but the progress of game R&D has not kept pace.

However, R&D expenses in the second half of the year showed a month-on-month decline for the first time. If the compensation for layoffs of 0.5 billion is excluded, the decline is even more obvious.

Therefore, there is still room for optimization of R&D expenses this year, and AIGC’s improvement in R&D efficiency is expected to reduce R&D costs in the medium and long term.

Other expenses have not changed much and have limited room for optimization. Sales expenses may be difficult to compress and may continue to expand with the launch of new games.

1. Expected to turn a profit next year: The operating loss of the core main business in the second half of the year was 223 million yuan, and both month-on-month and year-on-year improvements have been made. There are currently two self-developed games with license plates expected to be launched in 2023, and TapTap's advertising ROI optimization will continue. Currently, the ad loading rate is not high, and there is still room for further commercialization.

Coupled with the continued reflection of the layoff effect, the Dolphin King expects that the company will probably achieve positive profits next year.

1. Cash flow is not a big problem: As of the end of December, the company's cash + investment on account was RMB3.6 billion. Operating cash outflow in the second half of the year was RMB140 million, with little short-term debt. In April 2024, a convertible bond worth nearly 1.8 billion yuan (280 million US dollars) is likely to be redeemed in advance. However, considering that the operating surface is in the stage of recovery and upward trend, the cash flow is generally not a problem.

The view of the Dolphin King

During the semi-annual report, the Dolphin King reminded that the product cycle of Xindong is approaching, and the suspension of license plates is only a slowdown, but the direction and trend will not change. This financial report, especially from the situation in the second half of the year, can basically confirm the above views.

The only thing that the market is not very satisfied with is that the number of TapTap users did not increase month-on-month. From a linear extrapolation perspective, this may raise questions about the growth of TapTap.

After all, for Xindong, most investors are buying TapTap. The current stock price is in the reasonable range, basically incorporating the expectations of normal game repair and stable growth of TapTap. Therefore, although the game business in this financial report is actually slightly better than expected, the market is not convinced because the number of TapTap users did not increase.

The Dolphin King is not so pessimistic in the medium and long term, although TapTap's user growth is too slow and basically needs to be driven by self-developed games. But in fact, due to the continuous optimization of advertising ROI, advertising revenue has been growing well, indicating that game companies still relatively recognize the channel value of TapTap. At the same time, the ad loading rate of TapTap is still not high. The company considers the platform's ecology and intends to slow down the release speed in the short term, but this is still a growth driver with room for imagination. This time, the buyers who left due to lower than expected user numbers might come back again when TapTap's monthly activity is boosted by the new self-developed game launch and as the industry transitions and supply significantly recovers. It can only be said that this time the large drop in stock price after the financial report is basically reasonable and there is no significant cost-effectiveness relationship.

Later, we will release the "Heartbeat Performance Conference Summary" in the investment research group. Users who are interested are welcome to add the WeChat account "dolphinR123" to join the Dolphin Investment Research Circle and discuss global asset investment opinions together!

Detailed analysis of this season's financial report:

1. TapTap: The lack of new games resulted in no increase in user activity

In the second half of last year, the average monthly activity of TapTap in China was 41.17 million, which was a decrease of more than 500,000 compared to the first half of the year. Although there was summer vacation and the distribution of game licenses resumed, the supply of the industry also improved. However, due to no new games launched in China by Heartbeat itself, there was no significant user growth.

According to the total number of downloads/average monthly activity, looking at the download frequency of individual users, although the game licenses have resumed, the industry is still in a transitional period, so the supply of new products has not immediately increased.

Overseas TapTap is also still digesting the high base effect of the successful launch of games such as "Sausage Party" and "Genshin Impact" in 2021. In the second half of the year, the average monthly activity was 9.29 million, which was weaker than the same period last year, but there was still a certain increase compared to the first half of the year due to the overseas launch of new games such as "T3", "Genshin Impact: Infinite", and "Raccoon Frowning."

Since overseas TapTap has not yet commercialized, the income from information services mainly comes from the game promotion income of the domestic TapTap platform, and a small proportion of revenue from cloud gaming subscriptions.

In the second half of the year, information service revenue was 510 million yuan, a year-on-year increase of 43%. If we exclude the revenue of cloud gaming and TDS, and only look at the advertisement, the year-on-year growth rate in the second half of the year is 34%.

Although platform advertising revenue is closely related to platform activity, the growth rate of TapTap's monthly activity slowed significantly in the second half of the year, and advertising still maintained high growth. This was closely related to TapTap's continuous optimization of its ROI.

2. Games: Entering the Product Cycle

The second half of the year's game revenue was mainly driven by self-developed games such as "T3", "Torchlight: Infinity", and "Raccoon Unhappy" going global. In addition, "Flash Party" was also launched in China in April last year, and contributed to the second half of the year's revenue. However, except for the first month after its launch, "Flash Party" quickly declined in revenue, possibly due to the mediocre quality of the product itself. After struggling for half a year, the company has now quickly shrunk the project team size and improved the input-output ratio.

The revenue from paid game downloads declined by 56% year-on-year in the second half of the year compared to the same period in 2021, due to a lack of new games to compare with the popular "Terraria". However, this part accounts for a relatively small proportion and does not have a significant impact on the total revenue.

Overall game revenue in the second half of the year reached 1.33 billion, a year-on-year increase of 37%, with the advantage of a low base, but self-developed reserves gradually released, entering the product cycle is relatively certain.

Breaking down to user and single-user payment, both were driven up. Apart from "Sausage Party", "T3", a shooting MOBA game, and "Torchlight", an ARPG game, are also games that can be operated for a long time, with low overseas payment potential, especially "T3", which has promoting the increase in the number of users and the amount of payments.

At present, both games have obtained domestic version numbers. "Torchlight" will be in public beta in May, and "T3" also plans to be launched this year.

Xindong is currently operating 22 online games and 25 paid games. The commercialization capabilities vary widely despite the large number of games. Among the top five games in terms of revenue contribution, except for "Sausage Party", which has recently been launched in overseas regions and has continuously broken revenue records, the other four games have been in operation for over 3 years. If no major changes are made, they are basically in the latter half of their life cycle.

At the TapTap Game Conference in July this year, Xindong also released updates on 27 game projects, including new games and updates to old games. Nine of them were self-developed games. Compared to previous disclosures, four new projects were added, including "Reboot of Isla", "Go, Muffin", "Starfire Editor", and "Raccoon Unhappy". At the same time, considering the input-output ratio, four projects, including "Cui Xing Story", were cancelled.

3. Gross Margin As Repaired on Schedule

When reviewing the mid-term report, Dolphin predicted that there was still considerable room for improvement in gross margin, which was basically confirmed in the second half of the year. As the proportion of self-developed game revenue increases and the impact of TapTap's misallocation of investment returns, overall gross margin has improved greatly.

Compared to normal levels of previous years and industry peers, the gross margin of the two businesses still has room for further optimization.

1. Gross margin of gaming business is expected to stabilize at 60%: Generally speaking, the financial gross margin of self-developed games will be higher than that of exclusive distribution games, but lower than that of agent games based on net income recognition. However, considering that self-developed and exclusive games are beneficial to TapTap users, and Dolphin has already leaned resources towards self-developed and exclusive games, it is expected that in the future, unless there are major works from competing companies, the proportion of cooperative development will decrease.

The contribution of cooperative development revenue to total revenue is rapidly decreasing as the revenue from existing games declines due to the end of the game's lifecycle.

Therefore, with the launch of more self-developed games and their revenue contribution in the next two years, the gross margin of Heartbeat's games will gradually catch up with those of gaming giants that are basically self-developed, such as NetEase. NetEase's gaming gross margin is currently above 60%, and Heartbeat still has hope to stabilize and increase to 55%-60%.

2. After the misallocation period of TapTap, the platform's scale effect will become prominent: With the end of the misallocation period of investment returns, TapTap's business is expected to continue to improve.

Currently, the commercial prospects of overseas TapTap are still uncertain. This not only requires higher operational capabilities, but also requires a success story like Garena's. TapTap also needs a big hit game like "Free Fire". Although "Sausage Party" is popular, it still lags behind "Free Fire", and Garena has been unable to come up with a new "Free Fire", which has led to a continuous decline in platform activity. Therefore, Dolphin currently does not have particularly high expectations for the monetization of overseas TapTap. Our expectation for the improvement of TapTap's gross margin is still based on the improvement of domestic supply, the increase in demand from game developers and marketers in the industry, and the improvement of TapTap's conversion efficiency and an increase in advertising placements.

4. With the large-scale layoff, can AIGC help more?

After less than two years of talent grabbing war, as the industry cooled down as whole due to regulatory impact, Xindong couldn't support its staff any longer and had to downsize. 190 R&D personnel were reduced in the second half of this year. As a result, R&D expenses fell for the first time on a sequential basis. If the compensation for layoffs and sufficient project expenses are excluded, the decline will be greater.

At the end of the year, ChatGPT and AIGC went viral, and many positions in gaming companies have the possibility of being replaced or optimized by AI, such as translation, original drawing, basic code, etc. At least for gaming companies with high R&D costs, AIGC is expected to improve development efficiency in the medium and long term, and compress development costs.

Regarding other expenses:

Management expenses remained stable. In the first half of the year, there were rent reductions for office buildings during the epidemic. In the second half of the year, they returned to the same level as in 2021.

Sales expenses generally vary with the rhythm of new product launches. In the second half of the year, two games of Xindong, "Genshin Impact" and "Raccoon Displeased," were launched in overseas regions, so necessary promotion and acquisition expenses were inevitable.

As XinDong is currently in this product cycle, sales expenses may continue to be high, but these self-developed games are expected to perform well. Therefore, the sales rate may decrease, and the overall improvement in operating efficiency can still be reflected.

Dolphin Investment Research "Xindong" historical articles:

Financial Report Season

September 1, 2022 Conference Call "Xindong: Speeding up the launch of core games, seeking high-quality work (1H22 conference call summary)"

August 31, 2022 Financial Report Review "Unexpected Surprise, Xindong Can Become the Focus Again"

March 30, 2022 Conference Call "Xindong: Hoping to Achieve Profit and Loss Balance by Going Abroad Without Domestic Copyright License (Conference Call Summary)" On March 30, 2022, the financial report of "Pascal’s Wager: Deep Afterglow or Abyss, can going overseas save the day?" was reviewed.

On August 27, 2021, the conference call "Summary of Management's Clear Plans for the Future" was held.

On August 26, 2021, the financial report of "Pascal's Wager: The market is in a hurry, and Pascal's Wager is calm" was reviewed.

On March 26, 2021, the conference call "Pascal’s Wager's 2020 Performance Conference Call: The Change in the Gaming Industry Is Not Immediate, and Pascal's Wager's Growth Is the Same" was held.

On March 26, 2021, the financial report summary "Patient, Patient, and Patient Again: The Essence of Pascal's Wager Investment" was reviewed.

On March 1, 2021, the interpretation of the performance warning "Dolphin Investment Research: Pascal's Wager 'Deep Squatting' After The Profit Plunge? Perhaps, It's Just A 'Fake Fall'" was published.

In-depth

On September 27, 2022, a summary report titled "The 'disappearance' of Kuaishou, Pascal's Wager, iQiYi, Tencent Music: Can they turn the tables on their predicament?" was released.

On February 1, 2021, "Dolphin Investment Research: Behind the 'Peculiarities' of Pascal's Wager: Can Pascal's Wager Move Forward?" was published.

On December 29, 2021, "Dolphin Investment Research: Heavy Investigation: How Far Away is TapTap from the Chinese Version of Steam?" was published.

On December 16, 2021, "Dolphin Investment Research: Behind the 'Peculiarities' of Pascal's Wager: Why is the Market Interested?" was published. On December 15th, 2021, "Dolphin Investment Research|The Big Changes in the Gaming Industry Behind the 'Heartbeat Phenomenon'" was published.

Highlights

On July 27th, 2021, "How to View the Heartbeat After the Big Drop?" was published.

On June 2nd, 2021, "TapTap's Review of the Download Conditions of 'Moorland Farm'" was published.

Risk disclosure and statement of this article: Dolphin Investment Research Disclaimer and General Disclosure