LINE Q4 16 – Game off.
Gaming could save LINE but the focus appears to be elsewhere.
LINE reported a difficult set of results which laid bare how difficult it will be to return to growth without expanding either its coverage of Digital Life or its user base.
With the shares trading on 5.7x 2016A EV / Sales, we think that a return to rapid growth is required just for the shares to stand still.
Q4 16A revenues / EBIT were JPY37.5bn ($332m) / JPY1.6bn ($14m) substantially missing consensus estimates of JPY38.7bn / JPY5.3bn.
Even with a one-off charge against EBIT removed from the figures, LINE still missed consensus EBIT by 50%
The lower profitability was primarily caused by marketing expenses, general and admin expenses all of which grew substantially more than sales.
The main issue is that LINE is trying to change its business model from one based on stickers and games sold through its IM platform to one based on advertising.
This is because revenues from stickers and games is beginning to decline in the face of competing services (like Facebook Messenger and WhatsApp) which offer similar content for free.
Furthermore, Edison calculates that LINE’s current offering is not broad enough to return the company to real growth.
However, it should be able to replace existing revenues should they decline to zero.
When we look at LINE, we think it is capable of driving monetisation through the Digital Life services of Instant Messaging, Shopping and Telephony giving it total Digital Life coverage of 18%.
We do not think that its Smart Portal is mature enough to give it credit for Social Networking or any other Digital Life segment that it is trying to address.
Furthermore, its user base is pretty stagnant at 217m leading Edison to calculate that LINE could generate around $1.5bn in advertising revenues on an annual basis or $373m per quarter.
During Q4 16 LINE generated $139m in advertising with content generating $193m giving $332m in total.
This clearly shows that replacing content with advertising will only allow revenues to expand to $373m per quarter, some 12% above where the company is now.
To return to growth LINE will have to successfully expand its coverage of Digital Life or start growing its user base once again.
Growing the user base will be a major challenge as LINE has consolidated its focus onto the four countries of Japan, Thailand, Taiwan and Indonesia which considerably limits its scope.
Hence, we think it will have to improve its Digital Life coverage which will be difficult given that the other segments of Digital Life are pretty well covered already.
The one exception we see is Gaming and here there is an opportunity for LINE given its heritage in selling games through its platform.
This is a big segment and if LINE can generate a thriving multiplayer gaming community, then we can see its revenues expanding once again.
Unfortunately, of this there is no sign with much of the effort being places on other areas which to date have resulted in increased investments but no real revenues.
To justify its valuation, LINE must start to grow again as 5.7x EV / Sales is way to high for a company with low growth and heavy investments hitting profits.
We can see the valuation making a major adjustment downward from here.
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