X.D. Network: One year of "excitement," one year of "frustration"?

On March 28th, Beijing time, $XD INC(02400.HK) released its performance for the second half of 2024. Since it had just issued a profit warning at the beginning of the month, market expectations were not low.

In reality, revenue remained flat, and although the final net profit was within the guidance range, it mainly relied on other gains and losses. Looking at the operating profit of the core business, it fell short of expectations due to the variance in sales expenses.

Specifically:

1. Game Harvest, Pressure This Year

In the second half of the year, game revenue grew by 71% year-on-year, reaching 2.78 billion, in line with forecasts and market expectations. The incremental contribution mainly came from several newly launched self-developed games, such as "Let's Go Muffin" from the first half of the year, with the company mentioning that 200 million in revenue was deferred to the second half.

The newly launched "Heartwarming Town" in the second half is also expected to be a big hit, as predicted by Dolphin Research. As a simulation game with high DAU and low commercialization, Dolphin Research has always been relatively optimistic.

Since March this year, the iOS ranking of Heartwarming Town has fluctuated, but Dolphin Research believes there is no need for excessive concern for now. Games that rely on DAU require repeated operations to activate and attract new users; as subsequent operational activities catch up, popularity will rebound.

However, the pipeline issue still exists. Last year can be said to be the peak of this product cycle. Although there are two self-developed games to be launched this year, the potential hits are average, and the number has halved. Among them, "Ragnarok: Love Guardian 2" is a sequel to an old IP, with the previous version launched 8 years ago in 2017, which may lead to aesthetic fatigue among old users.

Additionally, "Muffin" and "Heartwarming Town" are set to launch in overseas markets. While it cannot be ruled out that they may unexpectedly perform well like "Muffin" in the Hong Kong and Taiwan regions, games like "Muffin," which combine two-dimensional elements and idle gameplay, face competition in the recently launched Japanese and Korean markets in February, so successful experiences cannot be simply replicated; it will require a watch-and-see approach.

2. TapTap's Performance is Average, Long-term Potential Exists

Due to the summer gaming competition and expectations for Heartwarming Town, market expectations for TapTap's performance were not low, but the actual performance showed some discrepancies.

First, looking at user numbers, TapTap's monthly active users increased domestically but decreased internationally, with the decline mainly due to the loss of Indian users. However, when looking specifically at the second half of the year, the international version's monthly active users returned to year-on-year growth, indicating that the impact of Indian user loss has bottomed out and is recovering; however, the sustainability of future growth is temporarily in doubt, and the company has currently controlled resources tilted towards the international version.

Domestically, the second half saw a quarter-on-quarter increase, mainly driven by "Heartwarming Town," which is also the most important development mission for "Heartwarming Town." However, the growth rate may have higher expectations than what is evident.

Currently, TapTap has introduced Deekseek and developed an AI Q&A module, which helps strengthen user engagement As for the commercialization aspect, compared to last year, the monetization efforts may not have deepened, as reflected in the advertising revenue per user being flat compared to last year. However, with the expansion of the user base, it has already secured an important position in the market share of the game advertising industry.

The company's restraint on the short-term commercialization of TapTap does not mean that the future potential is limited to this. After AI has weakened the traffic advantages of traditional general channels, Dolphin Research is relatively optimistic about content-focused vertical platforms.

3. Profitability continues to improve, but there are discrepancies in meeting targets

In the earnings surprise at the beginning of the month, a net profit guidance range of 860 million to 940 million yuan was provided. At that time, this was far beyond institutional expectations.

However, after the earnings surprise was announced, institutions have significantly raised their expectations accordingly. And under certain revenue conditions (not exceeding expectations), the market's expectations for operating expenses have been boldly reduced, mainly because the marketing expenses for the two new games have already been reflected in the upfront investments made in the first half of the year.

The actual situation is that the annual net profit is 890 million, which is indeed within the guidance range. However, the net financial income has increased by nearly 50 million compared to last year (due to the redemption of convertible bonds and a significant reduction in interest expenses). Therefore, from the perspective of core business operating profit, it falls short of market expectations.

The increase in the proportion of self-developed games continues to reduce the cost of developer revenue sharing. However, due to the overseas launch of several games such as "Maifen," the channel revenue sharing has significantly increased year-on-year (overseas still relies on channel giants like Google Play for distribution). Nevertheless, with one increasing and one decreasing, the overall game gross margin is still on an improving trend.

On the other hand, TapTap has also seen a continued improvement in gross margin due to proactive optimization of server costs.

4. First dividend, more significant in terms of expression: In addition to performance, Xindong has declared its first dividend of HKD 0.4 per share, with a dividend yield of 1-2%, and a payout ratio close to 25%, which is considered a normal level of dividends.

5. Performance indicators vs. market expectations

Dolphin Research's Viewpoint

Xindong's performance in the second half of the year is not bad, but the expectations were quickly met after the earnings surprise. Among the few institutions that are still tracking, the expectations for performance growth in 2025 are not low—25% revenue growth and 45% profit growth.

This is either a linear extrapolation or overly optimistic expectations for TapTap. After all, the game pipeline is transparent; although the emergence of a second "Maifen" cannot be ruled out, it is a bit overly optimistic to expect an entry into the blockbuster category right now.

In general, Hong Kong game stocks are normally valued at 10-15x, with very poor ones at 8x, and better ones can be valued at over 15x, but this requires being within a product boom cycle. Xindong's market value of over 18 billion HKD before the earnings report corresponds to the aforementioned optimistic expectations from institutions, which also implies a valuation of 15-16x. If it were the first half of the year, it could still push higher, especially since there is a major release of "Xindong Town" in the second half. However, standing in the present, we need to face the reality that Heartbeat's pipeline this year is relatively thin. Unless we look forward to TapTap, of course, the rise at the beginning of the year also had this factor, as the Apple tax was investigated by relevant departments, which provided a very strong valuation boost—optimistically, the iOS version of TapTap could also download games. However, Dolphin Research believes that the process will not be so smooth and will require a long time of pulling.

Therefore, looking at this year, in terms of performance, the further driving force behind the HKD 16 billion market value after today's drop may be relatively ordinary, specifically depending on the company's commercialization rhythm.

Otherwise, we have to see if there is an opportunity for the valuation multiple to adjust again to below neutral (Dolphin Research's neutral valuation is HKD 14 billion, for reference only). With a little more safety cushion, there is hope to enjoy valuation repair or even a valuation premium in the potential follow-up event catalysis of TapTap.

The following is a detailed commentary on the specific financial report.

1. TapTap's performance is mediocre, but it has long-term potential.

In the second half of the year, TapTap's domestic monthly active users (calculated) were 44.85 million, a year-on-year increase of 19%, with a net increase of 1.61 million quarter-on-quarter. This was mainly driven by "Heartbeat Town," and the company also mentioned marketing promotion factors. Dolphin Research believes that the chaotic competition during the summer may have also increased user stickiness for TapTap.

Looking solely at the second half of the year, the international version's monthly active users returned to year-on-year growth, indicating that the impact of user loss in India has bottomed out and is recovering, but the sustainability of subsequent growth is temporarily in doubt. The company has also controlled the resources tilted towards the international version (significantly reducing marketing customer acquisition). This year, "Heartbeat Town" is expected to be internationalized, which may bring back some international users.

In the first half of the year, the company mentioned that TapTap deliberately controlled commercialization. Dolphin Research's calculations found that the monetization attitude in the second half of the year may not have changed much, reflected in the advertising revenue per user being on par with last year. However, with the expansion of the user base, it has already occupied an important position in the revenue market share of the game advertising industry.

The company's restraint on TapTap's short-term commercialization does not mean that the future space is limited to this. After AI weakens the traffic advantages of traditional general channels, Dolphin Research is relatively optimistic about content-focused vertical platforms.

II. Game Harvest, Pressure This Year

In the second half of the year, game revenue doubled year-on-year under a low base, reaching 2.79 billion, in line with forecasts and market expectations.

The incremental contribution mainly comes from several newly launched self-developed games. For example, the self-developed game "Let's Go Muffin" from the first half of the year has a deferred revenue of 200 million to the second half.

The newly launched "Heartwarming Town" in the second half has also exploded as expected by Dolphin Research. As a simulation game with a large DAU and low commercialization, Dolphin Research has always been relatively optimistic.

Since March this year, "Heartwarming Town" has seen fluctuations in its iOS download rankings, but Dolphin Research believes there is no need to worry excessively for now. Games that rely on DAU require repeated operations to activate and attract new users; as subsequent operational activities catch up, popularity will rebound.

However, one advantage of large DAU games is that revenue tends to be relatively stable in the long run (fluctuating with seasonal changes), especially given the low commercialization of "Heartwarming Town." This is better than games that rely on numerical value and in-game purchases (for example, "Let's Go Muffin" also belongs to this category), which have shorter lifecycles.

In the second half of the year, per capita spending was slightly pulled back by "Heartwarming Town," which also includes the decline in spending on "Muffin."

But more importantly, the pipeline issue still exists; the company has not reported any new self-developed reserves waiting to be launched. Last year can be said to be the peak of this product cycle; although there are two self-developed games to be launched this year, "Ethereal Restart Day" and "Ragnarok: Love Guardian 2," the potential hits are average, and the number has halved. Among them, "Ragnarok 2" is a sequel to an old IP, with the previous version launched 8 years ago in 2017, which may lead to user fatigue.

Additionally, "Muffin" and "Heartwarming Town" are being launched in overseas markets. While it cannot be ruled out that they may unexpectedly explode like "Muffin" in the Hong Kong and Taiwan regions, games like "Muffin," which are 2D and idle mobile games, face competition in the newly launched Japanese and Korean markets in February, so success cannot simply be replicated; it still requires careful observation.

At the end of last year, deferred revenue was 322 million, with no increase compared to the previous quarter. Although the calculated revenue scale is on the rise, this indicates the low commercialization of "Heart Town" and the relatively few high-spending users. Most users have a consumption habit of paying immediately, which results in "Heart Town" having lower deferred revenue than "Muffin."

Overall, the speed and efficiency of R&D remain a somewhat uncontrollable factor for Heart. Small and medium-sized game companies can only closely follow the product cycle to find short-term investment opportunities.

III. The profit improvement trend remains unchanged, but there are discrepancies in meeting standards

Although the net profit for the entire year of 2024 is 890 million, which is indeed within the guidance range, the net financial income has increased by nearly 50 million compared to last year (redemption of convertible bonds, significant reduction in interest expenses). Therefore, purely from the perspective of the operating profit of the core business, the profit performance in the second half of the year is actually below market expectations.

The proportion of self-developed games has increased, continuing to reduce the developer revenue share costs, resulting in an overall improvement trend in game gross profit margins. TapTap's gross profit margin is also improving, mainly related to the optimization of its operating costs (server bandwidth costs). There is still room for improvement as commercialization deepens.

Although operating expenses are higher than institutional expectations, except for sales expenses (such as the launch of "Heart Town," TapTap promotions, etc.), R&D and management expenses have only seen single-digit growth. The number of R&D personnel has decreased to 724, nearly 300 fewer than at the end of last year. However, possibly due to good product performance, incentives were issued, and per capita benefits have improved.