Yuewen: Online literature stabilizes, Xinli pulls up explosively

After the Hong Kong stock market closed on August 12th Beijing time, $CHINA LIT(00772.HK) released its performance for the first half of 2024.

In the first half of the year, there were many blockbusters on the side of XINLI, with successes in both TV dramas and movies. However, while online literature still did not show much improvement, continuing to drag down the overall performance of the group, the good news is that the decline rate has slowed down.

Compared to the overall performance and the expectations of major institutions (Bloomberg's institution expectations are lower and the error is larger), revenue slightly exceeded expectations. However, due to higher marketing expenses, the operating profit of the main business ended up missing expectations.

Specifically:

1. XINLI's "Bumper Harvest": The blockbuster film "Hot and Spicy" that topped the box office at the beginning of the year, followed by three hit dramas "With Phoenix", "Joy of Life 2", and "The Story of Roses", brought XINLI Media to a peak in the first half of the year - with revenue of 1.05 billion and a net profit of 300 million, nearly doubling year-on-year.

2. IP Cooperation Drives High Growth: In addition to film and television revenue, the remaining copyright operation revenue also increased by 78% year-on-year.

On one hand, with the success of the dramas, there were more IP copyright cooperation projects, mainly reflected in "Joy of Life 2". In addition to this, IPs such as "The King's Avatar" and "Lord of the Mysteries" also generated revenue through blind boxes, action figures, merchandise, etc.

On the other hand, in the first half of the year, the games "Douluo Continent: Shrek Academy" and "Battle Through the Heavens: Peak Showdown" developed by Yuewen went online, generating revenue sharing.

3. Slowdown in Online Literature: The online literature business is still affected by the contraction of low ROI distribution channels, with Tencent's product channel revenue still rapidly declining year-on-year, albeit with a certain slowdown in the rate of decline.

Self-operated channels have barely maintained stability, with paid users basically limited to the core user group, with little change. Average payment per user has slightly decreased, which the company explains as a change in product structure. It is possible that there may also be macroeconomic influences.

Third-party platforms seem to have completed their adjustments and returned to positive growth. However, this revenue also includes revenue from self-operated games, and in the first half of the year, Yuewen just launched a self-operated game "Battle Through the Heavens: Three-Year Pact". Therefore, it is highly probable that third-party platform revenue from online literature distribution is still declining, and the growth in 1H24 mainly comes from the contribution of new games.

4. Rapid Rebound in Marketing Spending: Perhaps due to the simultaneous launch of new dramas and games in the first half of the year, the company spent more on marketing expenses compared to the previous two years, but the expenditure rate is not considered excessive. Administrative expenses have remained stable year-on-year in absolute terms, and the operating profit margin of the main business still increased by 1.5 percentage points year-on-year, reaching 9%, but lower than the relatively optimistic market expectations.

5. Performance Indicators Overview

Dolphin's Viewpoint

Last quarter, Dolphin pointed out that the turnaround of China Reading depends on when online literature will stop declining and no longer be a drag. Although this time the performance of online literature is still declining, the rate of decline has slowed down. The core users of paid online literature have been identified. It is expected that next year, as long as there is no major macro crisis, the online literature business can reverse the decline and return to growth. Dolphin believes that the future revenue scale of online literature will probably remain stable, and it will be quite challenging to restore rapid double-digit growth.

The current valuation implies a forward adj. net profit multiple of around 16x, which is not considered high but is within a reasonable range. However, the current awkward point is that the performance of XINLI in the first half of the year was somewhat priced in during the peak period, and even in the second half of this year or the first half of next year, the pipeline of XINLI is slightly interrupted. The four major IP dramas announced at the beginning of the year were completed in the first half of the year, leaving only one "Da Feng Da Geng Ren" in the second half of the year, and a relatively bland police-themed drama "Sao Hei Feng Bao" targeting the general public.

As a result, there may be some concerns in the market about the sustainability of growth. Of course, this point is recommended to be discussed in the upcoming conference call to see if some explosive dramas will be brought out to maintain the momentum. However, if there are not many additions to the drama lineup, the market reaction may also be relatively flat.

Detailed Interpretation of this Financial Report

I. Online Literature: Gradually Defining Core Users

Since the second half of 2022, the company's strategy has shifted to focus on premium paid content, emphasizing combating piracy and shrinking distribution channels (reducing free reading on Tencent's in-house channels, while temporarily suspending third-party channels with low customer acquisition efficiency), and implementing varying degrees of price increases on its platforms. This is reflected in the trend of "reducing the total user base while increasing the payment rate".

After more than a year, the paid online literature on self-operated channels has basically stabilized, while free reading has been affected by channel contraction and industry competition, but the impact has been further reduced in 1H24:

(1) The overall monthly active users (MAU) continued to decline to 176 million, mainly due to the company's active reduction of free content distribution on Tencent's in-house channels, while macro pressures and industry competition have caused marginal users from Tencent's channels (free users/low-paying users) to leave at a faster rate.

In the first half of the year, the MAU of self-operated platforms increased instead of decreasing, but the MAU of Tencent's channels decreased from 95 million to 70.7 million.

（2）The number of paid users remained stable year-on-year at 8.8 million, indicating that the dividend of cracking down on piracy is coming to an end. The overall payment rate has increased to 5% due to the rapid loss of free users.

（3）Slight decrease in average payment per user: This may be due to the combined effect of product structure and macro pressure. In the first half of the year, the average payment per user (ARPPU) continued to decline by 5%. Fortunately, the rate of decline has also significantly slowed down, and it is expected to remain stable at around 32 yuan per month in the future.

Looking at the distribution channels, Tencent's self-operated channels (part of free reading) actively contracted by the company are still rapidly declining. As for the self-owned platforms of China Reading (QQ Reading, Qidian, Hongxiu, Xiaoxiang, etc.), which are paid reading platforms, the revenue decreased by 4% year-on-year, with basically no significant changes.

In addition, Dolphin Jun observes changes in company strategy and market competition from the revenue categories of "free and paid". In the first half of the year, advertising revenue from free reading decreased by 17% year-on-year, with a noticeable slowdown on a month-on-month basis, while revenue from paid reading decreased by 4.8% year-on-year, showing relatively more stability. This indicates that the company's strategy is still focusing on the core of paid content.

II. Copyright Operation: Xinli's Great Harvest

In China Reading's copyright operation business, nearly half of the performance relies on Xinli since its acquisition. Xinli represents the first step of China Reading's IP monetization - IP visualization. Xinli itself has good production capabilities, and after focusing on high-quality content in the past two years, the rate of explosive hits has also been increasing.

In the first half of 2024, Xinli Media, which accurately predicted the hot spots with three big hit dramas "Yu Feng Xing", "Joy of Life 2", and "The Story of Roses" following a 3.5 billion box office hit "Hot and Spicy", ushered in a performance peak in the first half of the year - with revenue of 1.05 billion and a net profit of 300 million, nearly doubling year-on-year.

Excluding the revenue from XINLI Film and Television, the remaining copyright operation revenue also increased by 78% year-on-year.

On one hand, with the popularity of dramas, there have been more IP copyright collaborations, mainly reflected in "Joy of Life." In addition to this, other IPs with many authorizations include "The King's Avatar," "Lord of the Mysteries," etc., generating revenue through blind boxes, action figures, peripherals, etc.

On the other hand, in the first half of the year, Yuewen authorized the development of games such as "Douluo Continent: Shrek Academy" and "Battle Through the Heavens: Ultimate Showdown," which also generated revenue sharing.

The total copyright operation revenue reached 2.2 billion after aggregation, an 85% year-on-year increase, accounting for 53% of total revenue, a 5% increase compared to the previous period.

However, looking at the short term, the second half of the year seems a bit awkward. Combining the company's pipeline planning for this year - broadcasting 6-7 TV dramas, including 4 major IP dramas, 3 of which were completed in the first half of the year. With only one remaining drama "Da Feng Da Geng Ren" and the potential explosive police film "Storm of Drug Sweep," the upcoming popular dramas are relatively scarce, which may lead to a decrease in revenue from XINLI and copyright language.

III. Steady Increase in Profit Margin

Yuewen's gross profit margin remained stable in the first half of the year, increasing by 2% compared to the previous period, mainly driven by copyright revenue.

The gross profit margin of online literature business remained relatively stable, but the copyright business may experience significant fluctuations due to revenue uncertainties.

In terms of expenses, Yuewen laid off 100 employees in 2023, leading to optimization in overall employee expenses this year. However, in the first half of the year, due to the release of new dramas and games, which attracted attention, Yuewen engaged in more marketing activities, resulting in a significant increase in sales expenses.

However, looking at the expense ratio, it is not exaggerated. Administrative expenses remained stable year-on-year in absolute terms, and the operating profit margin of the main business increased by 1.5% year-on-year, reaching 9%, but lower than the market's relatively optimistic expectations.

Overall, future profit growth will mainly rely on the expansion of revenue from copyright operations, as online literature alone may only maintain stability.

Dolphin Research on "WEBNOVEL Group" Historical Articles:

Financial Report Season

Telephone conference on March 19, 2024: "WEBNOVEL: The impact of shrinking Tencent channels will not further expand (2H23 conference call summary)"

Financial report review on March 18, 2024: "WEBNOVEL Group: Online literature declining, short dramas extending life"

Telephone conference on March 17, 2023: "Management: Returning to high-quality paid content, returning to ROI (WEBNOVEL 2H22 conference call summary)"

Financial report review on March 16, 2023: "WEBNOVEL Group: Does the Eastern Disney still have a chance?"

Telephone conference on August 16, 2022: "WEBNOVEL Group: Continuing to reduce costs and increase efficiency in the second half of the year, impressive box office for Xinli (1H22 conference call summary)"

Financial report review on August 15, 2022: "Let's talk about WEBNOVEL's performance in the first half of 2022"

Telephone conference on August 17, 2021: "WEBNOVEL IP monetization enters the second phase | Conference call summary"

Financial report review on August 16, 2021: "WEBNOVEL Group: The story of the 'Eastern Disney' is too difficult!"

Telephone conference on March 24, 2021: "[WEBNOVEL's unexpected rise today 'Annual report conference call']](https://longbridgeapp.com/topics/716832?invite-code=032064)" March 23, 2021 Financial Report Review "Dolphin Research: Don't Count on Online Reading, IP Operation is the Hope of Yuewen"

In-depth

December 28, 2021 "Yuewen Group (Part 2): Bad Luck is Not Wrong, "Eastern Disney" Deserves Long-term Love"

December 20, 2021 "Yuewen Group (Part 1): Is Online Literature Too Old to Make a Living?"

Risk Disclosure and Disclaimer for this Article: Dolphin Research Disclaimer and General Disclosure