NEXON Co., Ltd. (3659) Earnings Call Transcript & Summary

Hello, everyone. Thank you very much for joining this session. My name is Minami Munakata. I'm games and internet analyst based in Japan. And Michael Ng, video games, theatre, internet and toys analyst based in U.S. is joining as well. Today, we have Owen Mahoney. Owen is President and CEO of NEXON, one of the world-leading video game publishers and developers. NEXON was founded in Korea 1994 and now headquarter in Tokyo and traded on the Tokyo Stock Exchange. NEXON pioneers the general of deeply immersive multiplayer online games. And revenue from strong franchise provide NEXON with USD 1 billion in annual operating cash flow and the balance sheet with USD 5 billion in cash. Liquidity will be invested in acquisition, new IT and other growth opportunities. In 2019, NEXON completed the acquisition of Stockholm-based Embark Studio for -- studio which is developing games primarily for western audience. And earlier this year, Nexon announced USD 1.5 billion initiative for investing in companies with strong sustainable internal IP. Owen joined NEXON in 2010 as the company's CFO and became CEO in 2014. Prior to this, he served 9 years as SVP Corporate Development for Electronic Arts. And executing some of the company's most successful acquisitions. Owen, thank you very much for joining us today. And today's schedule is hopefully Owen has opening remarks, then we move on to fireside chat. As the fireside chat, we will have 10 minutes Q&A section for investors. Investors, if you have a question to Owen, you can send the question through webcast. So now I'd like to hand over to Owen. Owen, could you start your opening remarks?

Sure. Thanks very much for inviting us today. And I thought that just -- first of all, thanks for the nice introduction as well. I thought I would just highlight a few of the trends that are driving growth in the games industry and particularly for NEXON. We think we're particularly well positioned to benefit from many of these trends. So I'll just talk about 3. The first is about the fundamental shift that's going on in the entertainment industry. And we get asked the question a lot, well, is there business benefiting from COVID? And when COVID goes away, is your business going to go down again? I think a lot of game companies are getting asked this, but the trends that we're seeing as a results, that we're seeing right now, we think, have been in place for some time now for several years. And they are part of a much bigger picture that is not often talked about, particularly in the West and in Japan but are very, very important. And that trend is the secular shift that's going on in the entertainment industry. That secular shift is about the transition from off-line to online and from linear entertainment to highly interactive entertainment. One of the phrases that we used to describe this is in the industry, is lean-back media where someone tells you a story or sings you a song or read you a book to lean from lean back to lean forward, where you're participating in that story and you change that story in some way. And this is happening all across media. And this is what we mean when we say, people call the games industry, the gaming industry, but we call it interactive entertainment within the industry because of that interactivity part. And we think that shift has been going on a lot. And it's been accelerating and COVID is just bringing that forward. We're all living much more in a virtual world than we were even on January 1. So that's theme number one. Theme number two or the second big trend is the explosion of new technology and how much that benefits our business. Now there's a lot of aspects about this. People talk about cloud gaming. That's important in broadband and so on. But just think for a second about the device that's in your pocket. That device, if it's an iPhone 10 or equivalent android device or more recent than that, that device is what we use it call just a few years ago, a workstation. And just a little bit before that, that was a super-computer. The graphics processing unit that is in that device is incredibly powerful. And as important, if not more important for a company that makes deeply immersive virtual worlds like NEXON does, it's the networking layer that allows us to render thousands or tens of thousands or millions of people in the same game world at the same time. That's revolutionary. And it's not just in your pocket. It's in the pockets of billions of people around the world. So the total addressable market that NEXON built its business on that is very substantial and has been primarily based off of PC, that total addressable market of game playable PCs was about 200 million to 300 million game playable PCs in the world. That is now addressable by 2 billion to 3 billion highly powerful mobile devices that are in our pockets. That's a TAM expansion, a total addressable market expansion of roughly 10x. And so that's incredibly powerful in our industry. And so people have thought about this mobile device game business really as a casual business because that's all those devices could do for the last 10 years, is deliver a casual single-player experience, but now they can really deliver a deeply immersive online game experience. And we think this is revolutionary for the industry and revolutionary, especially for a company like NEXON, which has built its business on highly immersive games. So the third big theme here is that this -- again, we're not in the casual games business. We're not single-player games. We don't make sort of single-player RPGs. We are on a deeply immersive world's business. We think that better -- sometimes people make analogies of the games business to the movie business. For our side, that doesn't really explain much. It doesn't help you understand our business. We think of it almost as like a virtual theme park. So just like you used to go to Disneyland. You now pull that virtual theme park out of your pocket on your mobile device and you start playing that. And the skill set to render a deeply immersive online world actually and build it for a matter of decades as NEXON has, that's a highly unique skill set. It's not widely shared around the industry. Only a few companies have done it sustainably for very long. And NEXON is one of a small handful of companies around the world that can do it well. So we think we are incredibly well positioned because that skill set is very hard to learn. It comes from experience, and there's only a few companies in the planet who have that kind of experience. We're one of them. So all those trends, we think, favor our business very, very strongly. And we are very determined to lean forward into those secular trends that are going on in the industry. So we're very excited about the future. Probably more excited than -- actually definitely more excited than we've ever been in the past. Before I take your questions, for those folks who are watching this, who follow us closely, I want to address a topic that is probably on the minds of those investors and players, which is the recent delay in the launch of the mobile version of Dungeon&Fighter. By way of background for those of you who are not as familiar with us, Dungeon&Fighter is our largest game. It's also possibly the largest game of all time in the video games industry in terms of life-to-date revenue. It's well over $15 billion in life-to-date revenue. That puts us at the #1, #2 or #3 position up there with several other massive Western franchises. Most people in the West don't understand this because its biggest success has been in China, but it's a massive game. And that's been only on PC until now. We've created a mobile version in the game, the mobile version of the game, we call Mobile Dungeon&Fighter, which we are about to launch, and we're very excited about that. But shortly before the scheduled launch in August, the game was delayed on the advice of our publishing partner in China, Tencent. We are working very closely with them. We trust their judgment. They've asked for some changes, and we're in close contact, and we hope that the game will be available soon. We expect, based on our conversations, that it will be a matter of weeks. And -- but we and our partners remain extremely excited about the game. And we're joining our customers and being very excited about the game. We've generated a really unprecedented number of preregistrations. It's well over 60 million preregistrations at this point. So we hope to be launching it soon, and we remain very, very excited about that game. Beyond that, I can't really offer more details on the situation or the launch date. So with that, I'd be happy to talk about anything that you would like to talk about, Mike?

Great. Well, thank you so much, Owen, for that really fantastic overview. As a follow-up to your first point about the acceleration of secular trends, including interactive entertainment, can you see -- can you talk about what type of content consumers are engaging with your portfolio during the pandemic? Are you seeing new customers come in and engage with more casual titles? Are you seeing your more hard-core players engage with more on your more mid-core and hard-core titles? And does that vary by region?

Sure. We've just come off a very, very good quarter. A lot of people think of our biggest business being in China, which traditionally has been, but Korea has been extraordinary in the last couple of quarters. And I'll give you a few examples. Most people don't know this, but the largest or the longest-running -- the first MMORPG of all time is a game called Kingdom of the Winds. It was NEXON's game. It came out in the mid-'90s. And so that game is -- well, that's about 25 -- 24, 25 years old now. So long before World of Warcraft and Ultima Online in those games is Kingdom of the Winds. And that game has been a very long-lasting game, and we just launched the mobile version of that game. And what's interesting about that game is on the surface, it looks fairly pixelated and fairly simple, but under the hood is a deeply immersive online experience. It's really very much of a virtual world. And it was the one that started the whole genre. And it's done phenomenally well on mobile. Now again, proof -- being another proof point to this thesis that deeply immersive online games when made accessible as mobile does now is really compelling entertainment. And so we've been really excited about it. It's been in the top 3 on Android and iOS for the last 6 or 7 weeks since it's launched. I checked that numbers this morning. It's #1 on iOS right now and has been for quite some time. So we're really happy with the performance so far. That's one example. Another example is MapleStory. Again, looks very simple on the surface. It's a 2D, side-scrolling, pixelated experience but under the hood is a deeply immersive virtual theme park. Now that game was up in Korea over 170% in the most recent quarter. Last quarter, it was up over 150% -- excuse me, 170% in the U.S. and Korea was up over 150%. And so it's done very, very well. It's been up double or triple digits in the last several quarters now. This is a game that's just celebrated its 17th anniversary. So the types of games that we make are typically easy to learn but hard to master and the experience once you get into them are very, very deep, and that's been the theme for us. We don't really make, as I said, casual games anymore. We've experimented. It hasn't been so interesting to us. Our idea is that you want to make a world inviting and then you want to give a lot of things to do within that virtual world. So people want to come in and then they just want to stay in for years on end.

Great. You shared a lot about some of the tailwinds from stay-at-home measures. Could you talk a little bit about the other side of the coin? Have there been any specific challenges on the development front because of productivity losses, for instance?

Well, I'd say, not really. The -- that's -- the headline, I guess, would be, not really. We -- as a matter of fact, I'd say one of the things that separates an online game company like NEXON from most of the rest of the entertainment industry is like we can literally make content in our pajamas from home, and we do. And so our team got -- when we saw this developing in China, really early in the year, we realized that it was coming our way around the world. So we needed to be way ahead of it. So they got very aggressive about making sure that we could work from home. You have to watch for things like security, and things like that. You also have to make sure that people are set up to be able to really work from home, and that's hard depending on the region. But our team has really embraced it. Now there are some -- you could argue that there's -- just the interaction of people in the office target -- working together and arguing and hashing things out in front of a whiteboard, that can affect. But we've been pretty -- made a pretty conservative effort to make sure that we don't have a productivity or a creativity hit in any way, and knock on wood, it's been going very well for us. And I would say this is a big difference from think about what's happening in sports, live entertainment, making live-action movies. All those things in other parts of the entertainment industry have been really, really affected heavily by this, but in the online games industry, at least for us, it hasn't had a meaningful impact yet.

Right. And mobile is the fastest-growing platform within the games industry. First, could you talk about some of the drivers of that platform growth? And then as a follow-up, do you ever worry about things like cloud gaming or increased competition from what I would describe as traditional PC and console publishers, leveraging their franchises on to mobile like Fortnite, Apex Legends, Call of Duty Mobile. Will that create incremental competition for what I would describe as a native mobile game publishers?

So your first question was about what's driving growth in mobile for us?

Yes.

Sure. So mobile -- the mobile industry -- the mobile side of our business, video games, has been the fastest grower over the last 10 years. But it hasn't really impacted our business so much until recently, as I said, because the platforms are just not powerful now. The heart of the GPU, but much more so the networking layer, haven't been really powerful enough to deliver a truly immersive online game on a mobile device. So it hasn't really affected us that much, but it's important to recognize that the fastest-growing part of the games market has been on that side on casual. I mean casual used to be this tiny little business. As I recall, when I was at EA, it was about a $50 million business on PC, and it's just exploded beyond that for a lot of game companies since then. But now things have really changed because technology -- Moore's Law has caught up with the mobile devices. And that device that's in your pocket is a true workstation, I mean, like really seriously powerful. And so that opens up massive creative opportunities for us. And we now have -- once we launch Dungeon&Fighter, we'll have 5 major franchises available on mobile. And the numbers are quite substantial and quite promising for us. Again, our most recent launch in the middle of COVID and everything else was Kingdom of the Winds. And it's been fantastic. And it's the full Kingdom of the Winds experience delivered on a mobile device. So it's extremely accessible. And because there's 10 times the number of game playable mobile devices out in a wild now and by game playable, I mean, able to deliver a massively multiplayer online game now, 10 times the number of game playable PCs that there are in the world, that's a massive TAM expansion and incredibly exciting for our industry. The second thing you asked about was competition. Look, I think the big limiter in the games business is not competition. People who come to the games business, especially from consumer packaged goods, they think of the pie as more or less fixed, maybe growing at a certain small space. But we find over and over again that if you bring great differentiated interesting content and great new gameplay to the games industry, it really makes them -- the whole pie a lot bigger. You're not taking share from other folks as much as you're just making the whole pie a lot bigger. In the West, the most recent proof point of that is Fortnite. Before that, it was Minecraft. And in our business, we've seen this over and over again, like just with Kingdom of the Winds, we've brought many, many people back and a whole new generation of users to playing that game who just really weren't playing a lot of games before. So people come into the industry when you give them something great to watch, something great to play.

Great. I'll go ahead and pass things over to Minami.

Thank you, Michael. So I'd like to ask some questions to Owen. And the first question is about Korea business for NEXON. So recently new titles launched in Korea have performed pretty well, and it looks game's hit rate has been improved. Can I ask what is the behind reason of these recent success in Korea?

Sure. So first of all, we're thrilled with how Korea has been going. We -- about a year ago, it actually started earlier. But about a year ago, we went through a significant reorganization, and the organization was based around a few ideas. First of all, we believe firmly that the secular shift that I've been talking about was in -- is in the process of becoming very obvious. And that means, again, that of all the different genres of games, you can think of games as casual or deep. You can think of games as offline or online. We think of the area that we really know well and that we care deeply about and really where our heart is, is about deeply immersive online games and virtual worlds. And that's what we know how to do. And we know how to take a deeply immersive virtual world and make it last for decades. But like a lot of game companies, we had experimented in everything. We did a bunch of casual games. We did story-driven games in the works. And those are all valid genres, but we just realized we weren't the best of those at making those games. But there's companies that are better in those different genres than we are. So we just stopped doing those. We cut off those game projects. We cut off some live games. We cut off some projects or a lot of projects that we had in development. And we just put all those resources and just targeted them towards games that -- deeply immersive online games and virtual worlds. And we found that by focusing our resources around that, we just performed a lot better. To be able to do some things really well. You have to say no to a much larger number of things that you think you're not as good at. And so I'd say more than anything, our team, our executive team thinks that, that focus has really helped us enormously.

Great. And also, I would like to ask about time frame of game operations. We believe we should judge whether the title will be successful or not for long term not short term. And do you think what the time line is the best to judge for successful for the online game?

Well, I'd say the short answer to your question is we don't know because we're -- we think we're early days in these franchises. Again, let me point out that MapleStory has generated life-to-date revenue of over $3 billion, and it was up triple digits. It's up over 150% year-over-year. So -- and this is for a 17-year-old game franchise. So we think the best days are still ahead of us in MapleStory. I know it's hard for a lot of people to understand this. But again, our business doesn't look like a movie business, it looks much more like a theme park. And 60 years in, Disneyland, until COVID, was going strong. And so we think that we should measure the answer to your question in decades, not in years and certainly not in months.

Sure. And next question is about balance sheet, cash flow. Can I ask about progress on USD 1.5 billion investment? And which company would be the target like a global IP company, Japan-style IP company or a mobile console? Could you explain a little bit more?

Sure. So by way of background, we announced a few months ago that we are going to invest a modest portion of our balance sheet, which is the amount that we're investing is USD 1.5 billion of a total of $5 billion that we have on the balance sheet. $1.5 billion of that is going to invest in separately from our M&A program and our share buyback or dividend program. Separate from that, investing in a certain number of companies around the world, particularly public companies. And the way to understand that is, as I said before, we have a very particular view on what's going on in the entertainment industry. And sadly, it's a bit of a contrarian view because it's not really written about a lot in the West or in Japan. We think that this secular shift that is going on is going to favor a whole new class of media companies. And all the ink gets spilled over traditional media companies. They're not really getting -- they're not really talking nearly as much about this new generation of interactive entertainment companies. So this viewpoint that we have of this massive secular shift that we see going on, that's very obvious to us by what's going on around the industry is not widely shared. In short, it's really going from the 20th century industrial, traditional media to 21st century interactive media. And there are some companies -- so we think NEXON is going to benefit hugely from this, but we're not the only company that we think is going to benefit from this. We think that there's other companies out there that will as well. And so we think a good use of a portion of our cash flow, which in a 0 interest rate environment would otherwise not generate any real return for us. And then a good use of that cash is -- that modest amount of cash is to invest in companies that we think could win big in this new world. And we're also particularly interested in companies that -- where we may not necessarily, but where we may be able to help them make that transition and leverage what they have in a way that provides faster growth for them. So we've put our -- we put about half of that total amount to work so far, and we're very excited about those opportunities. And we think some portion of them will be companies that -- where we could really bring something to the table. But it doesn't necessarily have to be that case. Also, we don't think that it's relegated to one country. It -- we think that those opportunities exist around the world. There are some in the U.S., some potentially in Europe, some potentially in Japan. And we'll see where it goes from here.

So we still have 15 minutes, and we already got some questions from investors. So let's move on to a Q&A session. So I'd like to pick up some questions. And the first question is about Embark Studio. So could you give an update on Embark and the development time line for the first game?

Sure. So by way of background for those of you who are not familiar with the details of Embark. Last year, we purchased a company in Sweden called -- in Stockholm, called Embark Studios. This is a new company, but not a new team. The team was -- are really some of the most bankable and successful AAA developers in the West. They were the team and the leadership that ran the studios at Electronic Arts from 2014 to 2018. Their founder and CEO, Patrick Söderlund, was the Head of Worldwide Studios during that time. Very, very successful. Among other things, creator of the Battlefield franchise and really ran the studio during some of their most productive and fastest growth and the highest ratings. So we're very excited to be working with them. And they are differentiating themselves or doing 2 things that are really important. Number one, they're game developers. So they're focused on building games that are AAA quality, but their reason that they were so interested in working with NEXON is they looked at games like MapleStory. And Dungeon&Fighter and Kingdom of the Winds. And they said, "Look, we want to make a hit, but we don't want to make a hit that goes away or goes down in a few months or quarters. We want to make a hit that 10 years from now or 15 years from now, we're going to be looking at double or triple-digit year-over-year growth." So that was very compelling for them. So that central idea of the acquisition was to combine what they're really good at, which is making AAA games for the Western market, and then combining that with the capability that we have internally of building out and running and growing a virtual theme park for decades on end. That was the central thesis. And the games that they have under development, I'm not at liberty to talk about yet, but we're going to be talking about a lot more towards the end of this year, 2020. And I can say I'm very, very excited about the games that they have under development. So we'll be talking about that a lot more at the end of this year. But the second thing that they've been working on is some technology development that we're very excited about. Building a AAA game, the costs have just been on a logarithmic growth path that takes us -- that has already taken us past $100 million in terms of roughly minimal development spend and is rapidly on its way to $200 million. And if present trends continue, we'll get to $1 billion in-game development spend for a AAA game and -- by 2026 or thereabouts. Meaning that the cost of doing AAA game development has just been going up. And not many companies have really looked at why this is, but one of the reasons why this is, and it's a big problem for the industry is we're still using the same old tools that we used 10 and 20 years ago. We're still using a ton of Maya and a ton of Photoshop to literally have armies of people around the world, hundreds and hundreds of people paint leaves and paint mountains and do a lot of really handwork to create these virtual worlds that we end up living in, and it doesn't need to be that way. So they were very -- spent time working on some basic tools that they could plug into other tools that already exists in the world like unreal and so on, leveraging their open APIs and add some key technologies on top of that. And by doing so, they can make game development substantially more rapid than it has been in the past and a lot faster and a lot less expensive. And so this is very exciting for us, particularly when you think about the success of a deeply immersive online virtual world is oftentimes about putting new things into that virtual world at a very rapid pace. And to this point, a lot of the industry has been focused on just putting bodies on that problem, and it's cumbersome and it's expensive. And we want to be operating in a much faster cadence. So Embark has been putting some technology work that we think is already paying off in spades. So we'll be very happy to talk a lot more about that at the end of this year.