CMGE Earnings: Slowing Growth and Elevated Costs Affect Shares; Valuation Cut by 33%

We have cut our fair value estimate for CMGE 00302 to HKD 2.80 from HKD 4.20. The primary drivers are the reduction in revenue assumptions for future game releases that we have previously deemed to have blockbuster potential and lower midcycle margins. This reflects the scenario where CMGE will struggle to compete with larger developers in the Chinese video game market. The group’s first-half results missed our expectations, as new releases failed to captivate players. We maintain our no-moat rating on CMGE due to its lack of long-cycle franchises, and the absence of resources to develop these titles. But with CMGE trading at around 9 times price/2023 earnings, we continue to view shares as undervalued. That said, uncertainty around the timing of game releases remains an overhang on earnings, capping share price performance over the near term.

Revenue for the first half increased by 25% year over year but remained 30% below 2021 levels. Adjusted operating income (excluding other income, gains, and other expenses) was CNY 45 million, down 40% year on year. The decline in profit, despite growing sales, was due to an unfavorable mix shift toward copublishing games. To cut costs, CMGE reduced its research and development headcount by more than 40% in the first half. Although this will improve near-term profitability, we are concerned that it might dampen the quality of games that are currently under development and translate to lower sales in the long term. All things considered, we now model a five-year revenue CAGR of 9%, down from the previous 12%.