[CITIC Securities] gives Netdragon a "buy" rating with a target price of HK$18.

Profit was temporarily under pressure due to a one-time deferred income tax deduction.The company announced its 1H24 performance report, recording revenue/net income attributable to shareholders of CNY 3.3 billion / CNY 0.4 billion. In terms of profitability, the gross margin was 66.6% / +4.5 pcts YoY; sales/administrative/research and development expense ratios were 10.7% / 16.7% / 21.1%, YoY changes of -1.4 / +1.2 / +8.6 pcts, among which the increase in research and development expenses was mainly due to the company's strengthening of new game development and expansion of the development team. The pre-tax profit margin was 21.3% / +5.5 pcts YoY, but due to the one-time non-cash deferred income tax deduction (impacting approximately CNY 0.3 billion), the net income margin attributable to shareholders was 12.1% / -1.2 pcts YoY. After excluding this impact, the net income attributable to shareholders increased by 24% YoY.

Gaming and application services business: Revenue remained stable, with a slight decline in gross margin.The company's game and application service business revenue in 1H24 was 2.12 billion yuan, a year-on-year decrease of 0.8%. Among them, game business revenue was 1.86 billion yuan, divided as follows:① By region:Domestic/overseas revenue was 1.61/0.25 billion yuan, of which the fluctuation in overseas business was mainly due to the impact of game versions of Magic Domain abroad and the impact of temporary power restrictions on the game version of Conquer overseas in Egypt.② By platform:Revenues from PC games/mobile games were 1.58/0.28 billion yuan. Looking ahead, the company is expected to release 4-5 new games in the next 6-9 months, which we believe will contribute the main increment to the company in 2025.

Mynd.AI: revenue is still under pressure, but gross margin improved.The company's Mynd.AI had a revenue of 1.18 billion yuan in 1H24, a year-on-year decrease of 23.5%, mainly due to the normalization of overseas education informationization demand. The gross margin was 29.7%, a year-on-year increase of 4.3 percentage points, mainly due to the reduction in material costs and freight charges. The company has launched its first SAAS product (Explain Everything Advanced) this year. We believe that with the normalization of overseas education informationization demand and a high penetration rate of the company's education tablet hardware, the company will continue to improve its profitability with the SAAS business.

Profitability, valuation, and rating:We adopt the sum-of-the-parts valuation method. For ① Gaming and App Services business, we forecast the net income of this business in 2024 to be 1.07 billion yuan. Referring to the valuation levels of comparable companies in the industry (Zhejiang Century Huatong at 10x PE, Perfect World at 16x PE, both based on Wind's consensus expectations), we assign a 7x PE valuation to the company's Gaming and App Services business, corresponding to a market cap of 7.49 billion yuan. For ② Mynd.AI, referring to the valuation levels of comparable companies in the industry (Guangzhou Shiyuan Electronic Technology at 0.8x PS, Kangguan Technology at 0.8x PS, both from Citic Securities' research institute forecasts), we assign a 0.7x PS valuation to the company's Mynd.AI business. Taking into account the company's 74.4% shareholding, we value the company's Mynd.AI business at 1.25 billion yuan.A comprehensive target price of HK$18 is given to the company for 2024, maintaining a 'buy' rating.

Risk Factors:Pressure on macroeconomic growth; Game development falling short of expectations; Rise in raw material prices; Changes in overseas education policies; Orders falling short of expectations, and more.