Kakao Corp. (A035720) Earnings Call Transcript & Summary

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Now Q&A session will begin. [Operator Instructions] The first question will be presented by Jae-min Ahn from NH Investments and Securities.

[Interpreted] Yes. Hello. I'm from NH Investment Securities. I am Jae-min Ahn. I would like to ask about 2 or 3 questions. My first question relates to the recent fire incident at Kakao. I would like to understand what the financial impact is going to be for Q4 in terms of any losses from -- on the revenue line item and potential compensation to your users? And I think you mentioned this briefly in your presentation, will we -- do we need to expect any changes with regards to the business direction as NK had previously stepped down? Also, would like to understand what the long-term implication is for your investment into infrastructure? My second question relates to the fact that Kakao is seeing quite significant level of increase in its number of subsidiaries and there is also a growing criticism from outside. I would like to understand what the company's position is with respect to the growing number of subsidiaries within Kakao?

[Interpreted] Hello. This is Simon, the CEO. I will respond to your first question and then I will have our SVP, Jae respond to your second and the third question. The fire incident that we recently experienced was an opportunity and an occasion for us to once again really understand that the Kakao is truly an essential service that is being provided to the entire population and it was an opportunity for us to have an awakening and really look back on the fact that we had some shortcomings with regards to such service offerings. And I do expect that in the process of living up to the duties that we have against the society, there could be some short-term costs that may be generated, but we believe that, that financial impact will be short term and one-off. We were able to successfully restore the service. However, I believe that it will take more time for us to earn back the trust from our user base. Basically, through these efforts through the compensation and the countermeasures that we were put in place going forward, we wish to lay the basis for enabling a more long-term and more stable services, which our users can trust. For your information, in terms of the financial impact that includes the revenue loss as well as our short-term financial impact with regards to user compensation is expected to be around KRW40 billion. But with regards to the specific plan for support, we have not yet finalized the package. So, it will be difficult for me at this point in time to share with you the specific details. We will receive the filing for damages that our users and partners have experienced up until November 6. And once we come up with an appropriate support-related guidelines, we will come back to you and share that information with you. Also relating to that first question, you mentioned NK's resignation and any potential impact that will have on the overall direction of the company strategy, as I mentioned during my presentation, I even before being appointed as the CEO of Kakao, as the Head of the CAC Center from the beginning of this year, together with NK, we have consulted very closely with regards to the strategic direction for Kakao service and its business. And we have worked together in setting the new vision for the company. And we already have in place a road map that will be implemented up until next year with regards to the service -- with regards to services and businesses. Of course, the specific details may change as we implement this road map. But in terms of the big framework regarding the growth strategy of Kakao Talk, there will not be any changes. Now having said that, #1 priority for the company as of today is to respond to and deal with the recent incidents that we have experienced and make sure that we have preventive measures in place so that such failures do not repeat itself. And because of that, there may be about a 1- or 2-month delay in the services that we have been working on. However, for us, what is most important is for us to earn back the trust from our Kakao users. And we will endeavor and we will do our utmost to make sure that all the plans that we've put in place are well implemented.

[Interpreted] This is Jae. I will respond to your question about our long-term infrastructure investment. Our infrastructure investment, especially including data centers, helped to drive Kakao's infrastructure capabilities. And at the same time, we expect it's going to help us be more cost efficient. As of today, we are renting out data center space and we are paying rentals and electricity and utility fees, all in all amounting to about KRE 150 billion per year. From a short-term perspective, as we expand Kakao and its affiliates, we are seeing -- we are expecting rise in infrastructure demand. So, if we think about the actual running of our own ID centers, there will be headcount-related costs and operational costs as well as additional depreciation costs for the buildings and fixtures. However, from a long-term perspective, by operating our own data centers, we will be able to manage our costs more efficiently and be able to operate our service in a more stable manner. Just to provide you an update with regards to the construction of the data center, in order to preemptively respond to higher demand for data as we are seeing a rise in traffic from our Kakao services as well as expansion and broadening of our cloud business, we have -- we have been implementing our own data center build-out plan since year 2018. We are in the process of building a data center at Ansan, the Hanyang University's campus that would be the #1 data center, which is expected to be completed by year 2023 and is targeting on operation from January of 2024. The second data center, we have entered into an MOU with Seoul National University's [indiscernible] campus as well. Now the fact that we are building a data center inside the campus of university, this is something that is rarely seen in even other global cases. We have chosen that location so that we can fully leverage our cooperation with the academia and also our interests aligned with the universities and academias and the fact that we could train and nurture talent for a cloud business going forward. That's why we were able to receive very positive conditions in getting the idle lot of land at these university campuses had and we were able to significantly reduce the investment burden. In terms of the CapEx supported by very steady financial stream of Kakao, in 2017, the CapEx amount was about KRW100 billion, which increased to KRW370 billion as of 2021. And on Q3 '22, cumulative basis, we have spent above KRW456.3 billion in CapEx. Basically with the expansion of Kakao services and its business, we have seen rise in investment into tangible assets, which include servers and other infrastructure. And with the groundbreaking of #1 data center end of 2021, we are seeing significant rise in tangible investment for construction and process since end of 2021. So however, the actual spending is not going to be all at once. We would be fully able to support this from the cash flow that we generate from our operations as the relevant CapEx spending is going to be spent and allotted across -- over a period of time. Responding your question about growing concern over a large number of subsidiaries under Kakao Group, I think what's important is not to look at the simple number itself, but the characteristics of who these subsidiaries are. If you look at all the subsidiaries under Kakao Group, small-sized companies with less than 30 headcount account for 80% of our total subsidiary profile. And if you look at these small companies, what they do is they are IP producing studios coming up with webtoons, web novels and producing games, music and video content. So, these are small studios and developers who actually produce and create the original IPs. So, they are mostly in the areas of content production and there are also other start-up companies as well. So, if you set aside these small-scale studios and developers, the actual number of, I guess, major-sized subsidiaries under Kakao is less than 10. So, aside from these content producers, most of the subsidiaries are startups. From the very beginning of our business, we have taken an approach of investing into a startup and growing together with these start-ups side by side. And at Kakao, we have been driving growth of all of these entrepreneurship-based startups within the -- within our group. Going forward, Kakao would continue to live up to its social duty and its status and make sure that we come up with the most optimal ways to invest into the overall start-up ecosystem.

[Interpreted] We will take the next question, please.

The next question will be presented by Jong Hwa Sung from eBest Investment and Securities.

[Interpreted] I would like to pose 2 questions. First is on your marketing expense guidance. In the second quarter, you've guided that you were looking at about 7% to 8% of marketing expense against the revenue. I would like to understand whether there will be -- you could expect actually lower marketing cost as against the revenue less than 7%. I would like to get some color on that aspect as well, that aspect. And second part of this question is, if you look at your other expense, it is KRW60 billion and you've been experiencing quite steep Q-on-Q rise for some time now. I would like to understand which business is driving the steep price in other expense. And is it not possible to control this line item for the benefit of improving your profitability? Another part of the question is, as of September 30, you introduced Bizboard on the Friends tab, if I look at the first week metrics, I see that you're making about KRW8 billion to KRW9 billion in revenue on a monthly basis based on the selling out of the inventory as of and after the first week of after the release. I would like to understand what the current metrics looks like. Are you still making that KRW8 billion to KRW9 billion in revenue every month?

[Interpreted] This is Jae. Responding to your question about marketing spend. In Q3, our marketing spending is against revenue posted 6%. For each of the business line, Kakao Piccoma in particular, has been quite aggressive in expanding its marketing -- excuse me, let me stand corrected there. Previous quarter, the businesses have been quite aggressive in spending marketing costs. While the Piccoma and Kakao Entertainment, as we enter into this quarter, have been much more conservative. Hence, we've seen a decline in the marketing spend. On the other hand, Kakao Games have slightly increased their marketing expenditure on the back of release of a new title, Umamusume. The reason why we have adopted this strategy is because of the uncertain macro backdrop and we are in a market where compared to the amount of investment that we put in, we're not getting as appropriate level of marketing result. Also, if you look at North America's story business, for us, we slashed on the marketing expense because for us at this point, our priority is to reach a breakeven point. And also for Piccoma, our #1 priority is to make sure that we solidify its fundamentals in terms of the key indicators, such as the conversion rate as well as the retention rate for the users. So in Q3, on a cumulative basis, the percent of marketing spend against revenue reported 7.1%. And on a per annum basis, we are looking to see at around 7% level. Now responding to the question about other expenses. This is mainly attributable to the valuation disposition loss with regards to derivatives that's been used by KP, Kakao Pay Securities and also some of the rise in the rental fees that we pay from our subsidiaries and affiliated companies. Now for Kakao Pay Securities, because they provide an overseas or global stock trading services, there is an FX hedge that is taken. And if the FX rate actually rises compared to at the timing of the forward contract for that foreign currency, there is going to be an FX translation -- derivative-related translation loss that's going to be incurred. But on the flip side, there's also going to be a positive impact on the revenue line item from the valuation gain from the derivatives.

[Interpreted] This is Simon. I will respond to your third question. Yes, you are correct. On September 30, we released a beta version of Bizboard CPT product. We decided to launch this product because we felt that advertisers were seeking for a product that will help them maximize their branding impact and that they are -- because we identified that they existed and a need for them to employ a product that provides them with high level of freedom with abundant advertisement elements. And since the release, we've been testing this new product, but then unfortunately, we had to experience the unfortunate incident on October 15, and we have to put on hold the testing of this product because we've been using that space to provide information and notification regarding the incident and to receive a filing from our users with respect to any damages that they may have experienced. So we would, for the time being need to resume that test. And only then we will be able to provide you with more clear guidance as to the -- what the metrics and the performance that we are seeing from this product. But in light of the appeal that this product provides and the fact that this is located under the Friends tab, I believe that the level of activation of the Friends tab is going to have a direct impact on the amount of revenue that's generated. And once we do additional facelift on the profile page, I believe that this will have a positive impact on the Friends tab, thereby having a positive impact on this ad product as well because we now see that there are about 9 million users that actually visit the updated Friends segment, which we have added. And as such, once we revamp our profile segment, we will be able to further bolster the level of activation that we see on the Friends tab. And so come next quarter, we will be able to share with you more tangible figures.

[Interpreted] We will take the next question, please.

The next question will be presented by Stanley Yang from JPMorgan.

[Interpreted] Thank you. I would like to ask 2 questions. First, it seems that you will probably be missing the 10% OP margin guidance that you previously communicated. So, can you provide some color as to what your outlook is for your next year's margin? And also, do you expect your labor cost will rise as we enter into next year? What do you think is going to be the margin trend do you expect to see going forward? Second question is, we are seeing a higher level of discount being applied to your NAV, the holdco level, you still have many unlisted subsidiaries. Would like to get some color as to what your IPO plans are for your subsidiaries?

[Interpreted] This is Jae. Responding to the question first on listing of the subsidiaries. We are fully aware of the concerns that our stakeholders have. Hence, we are going to revisit our IPO plan from point 0 from a governance perspective. Our approach will be to have focus on and protecting our shareholders, our existing shareholders and further enhancing the shareholder value. So, we will closely discuss and consult with our existing group of shareholders and our investors in making the relevant decisions. On OP margin for next year, currently, we are in the process of writing up our business plan. So, we will be able to share with you more details later. But due to the macro headwind, this is having a negative impact on our ad business. And hence, in Q4 revenue growth is actually slowing. And on top of that, there was the IDC-related incident. So, with regards to the OP margin for Q4, we are taking a more conservative stance. But we would do once again our utmost to make sure that we bring all the services that we are working on at this point, successfully into the market, and we will make sure we explore and identify business opportunities along the way.

[Interpreted] We will move on to the next question.

[Interpreted] The next question will be presented by Dong Hwan Oh from Samsung Securities.

[Interpreted] I believe that in a time where there is a building criticism on the reckless expansion of Kakao's subsidiaries or you have to go back to the most important and essential aspect, which is to focus on monetization at the mother company level. So, other than the open chatting, I would like to understand whether you have other additional models to monetize, for instance, leveraging the View tab or adopting a short-form video advertisement? Do you have any business models that you are currently thinking of to further accelerate monetization?

[Interpreted] Thank you very much for a very great question. This is Simon. I do appreciate your advice. The fact that rather than focusing on growth and revenue at the subsidiary level that it is important for us to focus on monetization at the mother company level. I appreciate that advice. The current situation is that advertising business is quite large in scale. It takes up a lion's portion of the company's structure. And to a certain extent, there is quite a bit of concentration, meaning 1% of advertisers are driving 70% of our revenue. And I feel that we would need to explore ways to fundamentally bring improvement to this. And I think there is a good possibility that we could actually achieve that. So, just as we are seeing people converse with one another through Kakao Talk, our very important strategic objective is to make sure that the businesses also communicate with one another, businesses to businesses through Kakao Talk Channel. If you look at total number of Kakao Talk Channel, there are 57,000 channels that have more than 1, 000 and 1.6 million channels that have less than 1,000 friends. So it will be quite important for us to expand that pool to include small and medium-sized advertisers as well as small merchants. And I believe that we do have that potential. Now although Kakao Talk Channel is known to be a very effective marketing tool to many of the smaller and mid-sized advertisers, they existed some entry barrier. Basically, they've found it quite difficult to massively send out messages to their Kakao Talk Channel friends. So hence, they were a bit inactive. So, there were hurdles that existed for these companies. So, one of the key business solutions that could remove such pain point for smaller-sized advertisers is Kakao Sync. Currently, there are about 23,000 businesses that have adopted Kakao Sync and we expect that we will need to expand this base further. But one of the difficulties was that when the businesses wanted to adopt Kakao Sync what they need is they need developers in the process. So, that worked as an entry point, the hurdle for the smaller to midsized companies. But within the year or early next year, we are planning to link it up with key ECPs, providing support and help to smaller merchants in their process of adopting Kakao Sync. And once we do that, I believe we will be able to see an uptrend. And also currently, we have about 70,000 sellers and vendors on Kakao Talk Store and only 4% of them, which are about 3,000 are sellers making use of Talk Channel's marketing. Hence, once we develop a seamless business tool that could facilitate the marketing activities through the use of Talk Channel for these vendors and sellers, I believe that this will significantly help us expand our advertiser pool. And so as we speak, we are developing relevant tools to provide to these sellers and vendors so that they could seamlessly and easily engage in marketing activities. So by next year, if we -- our plan is to expand the number of Talk Channels with more than 1,000 friends to 300,000. And if we do that, there will be viral effect that will be created, which will then lead to natural growth. And if we are able to move up to about 500,000 -- 500,000 businesses, then we will be able to defend against slower economy and macro headwind and be able to sustain a solid and healthy level of top line revenue. Last point I would like to mention is that it may sound a little ambiguous, but depending on who defines platform, people talk about platform in many different ways. But my definition of platform is that it is a connection and a nexus that brings together numerous number of suppliers with numerous number of consumers. So, if you look at Kakao Talk, we do have these multiple number of users. However, for it to evolve into a platform, we also need to have many number of suppliers be that advertisers or sellers. So, we still do have much more to enhance and improve. So, I ask for your continued interest along this journey. If you look at the advertisement market, be it off-line and online, the market size is more or less capped at around KRW12 billion to KRW13 trillion in size. So, all the players are dividing up that market under that cap. But if you look at business communication, the budget does not come from advertisement budget, but marketing budget and business budget can be used for that purpose. So, we can actually go above and beyond the market cap that we see in advertisement.

[Interpreted] Since we spent quite a bit of time, we would now like to take the final question.

[Interpreted] The last question will be presented by Jingu Kim from Kiwoom Securities.

[Interpreted] I would like to ask questions about the advertisers as well as the digital ad market trend. The different elements would be compounding one another. But the reason why you feel that the digital ad market is slowing, do you think that this is a temporary phenomenon as we are seeing after COVID more outdoor activities and higher spending on BTL? Or do you think that this is more macro and more secular in terms of the fact that people are expecting mid-term economic recession and are we seeing across the board change in the position taken by the advertisers? There could be multiple compounding elements and variables that are impacting this. Just would like to understand what the company's take is. And also in that same light, how do you project the advertising market to look like going forward?

[Interpreted] This is Simon. I will first paint the overall picture and then hand it over to Jae, who will talk about more specific figures. I think your question itself already includes the very important elements. And the fact that if you look at the overall online market, penetration is already at 55%, hence, the growth rate will definitely going to be slower compared to the past. And so when we are exposed to difficult market economic backdrop, then naturally large -- especially large advertisers will start to reduce their advertising budget. So, these are 2 major reasons that are the key drivers behind the slower growth that we are seeing out in the market. That is why, as I mentioned in my previous answer, as these advertisers are shedding their ad budget it will be important for us to develop ways for us to -- develop ways so that we are not dependent on the adds for that budget of the advertisers, but dependent on their marketing budget. And marketing budget would include multiple marketing activities such as giving out discounts, mileages or giving out coupons. What we want to do is we want these advertisers and businesses to actually choose Talk Channel as their first choice of marketing tool. It's a marketing tool of choice. We want to Talk Channel to be that very tool. And once Talk Channel achieves that positioning, then we would be less impacted by the advertisement budget of these advertisers because this will become one of the essential activities that the companies and businesses engage in. And so in that process, we could benefit from that as well. So, if we want to generate good performance from Kakao Talk Channel, that means that we need to have a very solid foundation of Kakao Talk so that there could be a massive outbound business messages that could be effectively used by these businesses. So, I think it's a bit confusing because we call this messaging ad. So, there is an element of confusion there. But I think soon we will be able to see these outbound messaging related budget surpass the size of the Bizboard ad budget. So underpinned by that, we hope to bring in a more robust growth.

[Interpreted] Yes, this is Jae. Just to elaborate a little more. If you look at our Talk Biz advertisement, in Q4, we believe that we will see some recovery in revenue as the advertisers are going to once again reactivate their marketing activities. Now having said that, due to economic uncertainties and the fact that advertisers have slashed their ad budget as well as lower existing revenue from the IDC fire and delay in generation of new revenue from our new businesses. Despite Q4 being the high season, we think that the growth rate is going to be somewhat limited. If you look at Talk Biz, on a Q3 cumulative basis, we reported 18% year-on-year growth. But on the back of the fire and its impact on our top line revenue and also due to the delay in our service refresh schedule, we expect that 2022 full year revenue would only post a growth of 15% year-over-year. Now from short term, we will, of course, be impacted by slower economy. But once that economy recovers, we will make sure that we are fully prepared to benefit from that recovery in terms of rising demand for advertisement. But if you look at out of the total ad market, we expect the digital ad segment to continue to grow. And considering the fact that Kakao's share in that digital ad market is 15%, we think that going forward, there is a bigger potential for growth.

[Interpreted] Well, thank you very much. This brings us to the end of Kakao's earnings presentation for third quarter of 2022. Once again, thank you very much for joining us this morning. [Statements in English on this transcript were spoken by an interpreter present on the live call.]