The mobile game developer turned a profit last year, helped by the release of new titles, but a lack of games under development could dent future growth

Key Takeaways:

• The company is expecting to turn a profit of between 860 million yuan and 940 million yuan in its annual earnings 
• But it gained only four new game licenses last year, half as many as in 2023

Profits are rolling into China's gaming industry after the blockbuster success of Black Myth: Wukong last year.

The hit release from the Game Science studio injected fresh life into the gaming scene, helping to shake off the effects of regulatory controls and brittle consumer confidence. And smaller gaming companies are also feeling the benefit. 

Mobile gaming firm XD Inc. (2400.HK) recently projected better-than-expected annual profits after releasing new titles such as Heartopia and GoGo Muffin.

In a statement about its earnings outlook, XD forecast revenue of between 4.96 billion yuan ($680 million) and 5.04 billion yuan for 2024, a jump of around 46% to 49% from the prior-year figures. The increased turnover was projected to push the firm's bottom line into the black, with a net profit of between 860 million yuan and 940 million yuan compared with a loss of 65 million yuan in 2023. 

The positive profit alert went down well with investors. The XD share price rose 15.37% the day after the statement, taking the firm's market value close to HK$18 billion.

The gaming industry demands hefty upfront spending for creative development, but with an uncertain outcome. Developers can spend heavily on new games only for them to flop with consumers and deliver disappointing returns. With low odds of success, producing a national hit can be like hitting the lottery jackpot for companies such as XD.

Banking on new titles

The impending profits represent a plot twist for XD, which derives the bulk of its income from games while also running a platform for avid players. With falling income from older games and a big creative budget, the company had reported a string of losses, although the red ink had been receding. Net losses went from 860 million yuan in 2021 to 550 million yuan a year later and shrank further to 83.03 million yuan in 2023. Business picked up in the first half of last year when revenue rose 26.7% to 2.22 billion yuan, gross profit jumped 44.3% to 1.5 billion yuan and net profit more than doubled to 205 million yuan.

The turnaround was driven by the launch of new games such as GoGo Muffin, Sword of Convallaria and Heartopia. The core game business was the firm's main revenue engine, with turnover rising nearly 30% to 1.49 billion yuan in the first half of 2024 from the year-earlier period.

Gaming operations including in-game sales and game purchases are the company's main source of revenue. By the end of June last year, XD's game-related income accounted for 66.9% of total revenue, with the remainder coming from its TapTap game platform, which charges promotional fees.

TapTap is an interactive forum where players can connect and view game recommendations, similar to the Steam platform operated by the U.S. game developer Valve. Fans can download games through official channels via the TapTap site, as well as discussing their experiences with other players. 

Monthly active users of TapTap in the China market rose 27.3% to 43.24 million in the first half of last year, with players attracted by the heavily promoted new games.

The two new XD releases last year were well-received by the market. GoGo Muffin repeatedly topped Apple's game download rankings in Hong Kong, Macao and Taiwan after it was launched there in early 2024. Heartopia enjoyed more than 25 million downloads its first month after it debuted in mainland China in July, also taking the top spot among Apple's game rankings. According to TapTap data, the game has been downloaded over 39 million times. 

In with the new 

However, new games can drive traffic away from existing titles, cannibalizing sales. For example, the appeal of Sausage Party has declined since its 2018 debut, with falling numbers of paying and active monthly users. Novelty is the key to growth in the industry as developers need to create enough revenue from new products to offset waning sales from established games.

A report on China's game industry released at the end of last year found that  sales rose 7.53% to 325.78 billion yuan in 2024 from the previous year, and the number of domestic game users edged up 0.94% to 674 million, both industry records. 

But sales growth decelerated from a pace of just under 14% in 2023, even though 32% more games were approved than in the prior year. The figures point to slowing momentum overall and could signal increased competition in the market.

Promoting new games is an expensive business. XD spent a whopping 700 million yuan on marketing in the first half of last year, more than double the outlay for the same purpose in the year-earlier period. More was spent on marketing than on R&D, which fell 20% to 420 million yuan, suggesting the flow of new games is slowing down.

According to information from China's publication regulator, XD obtained only four game licenses last year, half the total it was awarded in 2023. Dwindling game reserves could pose a risk to revenue going forward. 

The game developer has been trading at a price-to-earnings (P/E) ratio of 606 times on the back of its earnings base and price surge. With profits rising to around 900 million yuan for 2024, the ratio is expected to fall back to 18 times, lower than the 28 times for Tencent (0700.HK) but higher than the multiple of 16 for NetEase (NTES.US; 9999.HK). Considering the relatively smaller scale of its business compared to NetEase, the XD stock is not cheap at all.