TapTap returns to the pre-liberation era, and Heartbeat lacks a second explosive product.

Beijing time, noon on August 31, XD INC.HK (2400.HK) released its performance for the first half of 2023.

The overall performance of Xindong fully demonstrates the core issue that we have repeatedly discussed - whether it is to make money through revenue and profit, or to rely on TapTap's MAU growth to boost valuation, it is very important for Xindong to have self-developed games that are popular or have sustained supply.

Although "T3" and "Torchlight" were tested in the mainland in the first half of the year, the popularity of these two games still lags behind "Sausage Party". In addition, the decline in revenue from other old games was faster, so game revenue in the first half of the year was basically flat compared to the same period last year.

At the same time, in addition to the impact of the pandemic, there were other factors in the first half of the year that led to a significant decline in TapTap's monthly active users.

It is precisely because of the control of marketing expenses that we have achieved profits beyond expectations, and the company also issued a profit forecast at the beginning of the month. However, this profitable turnaround under cost control comes at the expense of the activity of the TapTap platform, which is not what the market wants to see.

On the other hand, we have to consider the following question:

In the first half of the year, while the industry supply was good and even caused a rapid increase in the cost of buying users, TapTap's user base shrank when the platform reduced its external marketing expenses. If Xindong does not have another hit game like "Sausage Party," this issue will affect Xindong's "medium to long-term" growth prospects.

In the "short term," according to third-party data, Dolphin Research suggests that everyone pay attention to whether the company has adjusted its strategy and whether marketing expenses for the second half of the year will rebound.

Due to the high cost of user acquisition in the current gaming industry,

In terms of valuation, the current market expectations may not be very high, but this is also related to the collective valuation suppression of Hong Kong stocks. Since the self-developed pipeline is not large (4-5 games), this "small" product cycle has basically reached its halfway point, and the next self-developed game, "Sword of Bellflower," is expected to be delayed until Q4, while others will have to wait until the year after next.

Therefore, in the short term, the company's fundamental alpha returns are limited, and it will fluctuate more based on market sentiment. If we do not consider the factors of valuation suppression at the beta level (liquidity, exchange rate), under neutral expectations, we believe that Xindong is expected to return to a valuation level of HKD 10 billion.

The following are specific points of the earnings report:

I. TapTap: Offline diversion, proactive cost control, MAU returns to pre-pandemic levels

In the first half of the year, the average monthly active users (MAU) of TapTap in China was 3.33 million, a decrease of 7.2 million compared to the second half of last year. Although the industry supply has indeed improved in the first half of the year, TapTap's activity did not stabilize due to users' return to offline entertainment activities after the pandemic and the company's reduction in marketing activities.**

Both "T3" and "Torchlight" were launched in mainland China in the first half of the year, but their popularity still lags behind the updated version of "Sausage Party" from last year. Therefore, it is difficult to reverse the decline in the user base of TapTap.

Overseas TapTap is still digesting the impact of the high user base from the successful launch of games such as "Genshin Impact" and "Sausage Party" in 2021-2022. The average monthly active users in the first half of this year further weakened compared to the previous period.

Since overseas TapTap has not yet been commercialized, the main source of information service revenue comes from the game promotion revenue of the domestic TapTap platform, as well as a small proportion of cloud gaming subscription revenue.

The information service revenue in the first half of this year was 600 million yuan, a year-on-year increase of 29%. In the case of shrinking user base, the main driving force for growth comes from the rising cost of industry user acquisition. With abundant supply and intensified competition in new games in the first half of the year, the demand for user acquisition has rapidly increased, leading to a sharp increase in the price of game user acquisition. Channels have clearly benefited, and TapTap is no exception.

2. Games: Decline of Old Games Too Fast

The growth contribution of game revenue in the first half of the year mainly came from the new revenue generated after the launch of two self-developed mobile games, "T3" and "Torchlight: Infinite," in mainland China.

However, the old games continue to decline to varying degrees, so the overall game revenue is basically flat compared to the same period last year.

The overall game revenue in the first half of the year reached 1.15 billion yuan, a year-on-year increase of 2%. Although the macro environment was poor in the first half of last year, there was still a high level of enthusiasm due to the updated version of "Sausage Party," so the user base was not low.

When breaking down the user and per-user payment situation, it is mainly driven by the power of per-user payments. The number of paying users may have declined by 14% due to the return of offline entertainment activities compared to the same period last year.

**Heartbeat currently operates 20 online games (2 of which were shut down in the first half of the year) and 29 paid games. The number of games is large, but their commercial capabilities vary. Among the top five games in terms of revenue contribution, the newly released "Torchlight: Infinite" for the domestic market in the first half of the year surged ahead, offsetting the revenue gap caused by the decline in revenue from "Sausage Party".

The other three games are basically in an irreversible sunset stage, with an operating period of over 3 years. Unless significant changes are made, they are essentially in a passive waiting-for-shutdown stage.

It is expected that "Torchlight: Infinite" will continue to contribute significantly to revenue growth in the second half of the year. The public beta of "Torchlight" was launched in May, and there is not much confirmed revenue for the first half of the year. In addition, "Torchlight" operates on a seasonal basis, so there won't be a continuous decline in revenue. It will surge at the beginning of each season, making it suitable for long-term operation.

Apart from "Torchlight", based on the current pipeline, there is still one self-developed game, "Sword of Bellflower", planned to be launched this year, while the other three will not be released until the year after next.

To be honest, the development speed of this self-developed game is still a bit slow, especially considering the high dependence on TapTap for self-developed games. However, from the second half of last year to the first half of this year, the company mainly laid off game development personnel and also cut some projects with low self-assessment expectations. Therefore, short-term new supply can only rely on external agents.

III. Profits: Exceeded Expectations

In the first half of the year, Heartbeat's net profit returned to positive after a hiatus of 2 and a half years, reaching 100 million yuan. Excluding the gains and losses from financial assets valuation changes and wealth management, the core business also achieved positive profits.

As the proportion of self-developed game revenue and advertising and other information service revenue increases, it will naturally drive the gross profit margin of the gaming business and TapTap business to improve.

If compared with the normal level of previous years and industry peers, there is still room for optimization in the gross profit margin of these two businesses.

1. Gross profit margin of gaming business expected to improve within expectations, with room for further growth in the future: Generally speaking, the financial report gross profit margin of self-developed games is higher than that of exclusive agent games but lower than that of agent games that recognize revenue based on net amount. However, considering the favorable impact of self-developed and exclusive games on TapTap user acquisition, Heartbeat has already tilted its resources towards self-developed and exclusive games. Dolphin Research predicts that in the future, unless there are blockbuster games from competitors, the proportion of agent games will decrease.The revenue contribution of third-party games in the existing game portfolio continues to decline to below 10% due to the decline in the lifecycle of these games.

With the increase in revenue from self-developed games after their launch, the gross profit margin of Heartbeat Games will gradually align with that of major game companies like NetEase, which primarily focus on self-developed games. Currently, NetEase's mobile game gross profit margin remains stable at over 60%, and there is hope for Heartbeat Games to reach a stable margin of 55%-60% during the improvement period.

2. TapTap's gross profit margin is expected to recover to 80%: With the end of the period of mismatch between investment and output, TapTap's business is expected to continue to see improvement.

In the first half of the year, the gross profit margin reached 76%. Due to the high cost of user acquisition in Q3 summer, it is expected that the gross profit margin of TapTap in the second half of the year will be affected. The commercialization of TapTap overseas is still in its early stages and is not included in the growth expectations for now.

Our expectation for the improvement of TapTap's gross profit margin is based on the continued improvement of domestic supply, the short-term increase in marketing demand among game developers in a competitive market, as well as the long-term improvement in TapTap's conversion efficiency and the increase in advertising space.

On the cost side:

1. R&D expenses: As seen from the previous year, there has been a significant decrease in R&D expenses (mostly in game development and a small portion in TapTap development) both on a year-on-year and quarter-on-quarter basis. Both the scale of R&D personnel and average salary have declined.

Although two important self-developed mobile games were released in the first half of the year, the decrease in marketing activities on TapTap and limited user acquisition for these games resulted in a significant reduction in sales expenses compared to the same period last year, with a year-on-year decrease of 36%.

Dolphin Research's "Heartbeat" historical articles:

Earnings Season

March 30, 2023 conference call: "Lessons Learned from the Past Three Years: Talking about Implementation, Not Empty Promises (Heartbeat 2H22 Conference Call Summary)"

March 30, 2023 earnings report review: "Heartbeat Games: TapTap's Missteps, It's Not Easy to Say "Heartbeat""2022 年 9 月 1 日电话会《 Heartbeat: Accelerating the launch process of core games, seeking high-quality work opportunities (1H22 conference call summary)》

2022 年 8 月 31 日财报点评《 Unexpected Surprise, Heartbeat Can Beat Again》

2022 年 3 月 30 日电话会《 Heartbeat Company: Hoping to achieve a balance of profits and losses through overseas expansion without domestic version numbers (conference call summary)》

2022 年 3 月 30 日财报点评《 Heartbeat: Abyss After Abyss, Can Overseas Expansion Be the "Savior"?》

2021 年 8 月 27 日电话会《 Heartbeat Conference Call Summary: Management's Plans for the Short and Long Term Are Clear》

2021 年 8 月 26 日财报点评《 Heartbeat Earnings Report: Market "Urgent and Anxious," Heartbeat "Calm and Composed"》

2021 年 3 月 26 日电话会《 Heartbeat Company 2020 Performance Conference Call Summary: The Transformation of the Gaming Industry Takes Time, and So Does Heartbeat's Growth》

2021 年 3 月 26 日财报点评《 Heartbeat Investment Essence: Patience, Patience, and More Patience》

2021 年 3 月 1 日业绩预警解读《 Dolphin Research | Heartbeat "Squatting" After Profits Plummet? Perhaps Just a "Fake Fall"》

In-depth

2022 年 9 月 27 日综述《 ["Disappeared" Kuaishou, Heartbeat, iQiyi, Tencent Music, Can They Reverse Their Dilemma?](https://longportapp.com/zh-CN/topics/3474531?invite-code=)》

On February 1, 2021, Dolphin Research | "Behind the Fascinating Phenomenon: Can Action Be Taken When Fascinated?》

On December 29, 2021, Dolphin Research | In-depth Investigation: How Far is TapTap from the Chinese Version of Steam?》

On December 16, 2021, Dolphin Research | "Behind the Fascinating Phenomenon: Why is the Market Fascinated?》

On December 15, 2021, Dolphin Research | "Behind the Fascinating Phenomenon: Major Changes in the Gaming Industry!》

Risk Disclosure and Statement for this Article: Dolphin Research Disclaimer and General Disclosures