Generative AI Integration Will Reshape User Experience And Increase Engagement

Key Takeaways

• Kakao's AI innovations are set to enhance user engagement and operational efficiency, potentially increasing revenue and lifting net margins.
  
• Expanding beyond chat-based interactions could deepen user engagement, driving higher ad revenues and overall earnings growth.
  
• Kakao's heavy reliance on messaging limits growth opportunities, while economic and advertising challenges, costly investments, and AI risks could strain profitability and margins.

Catalysts

Operates mobile and online platforms in South Korea.

• Kakao plans to capitalize on generative AI to reshape user experience by introducing new AI-powered features, which could drive increased platform engagement and potentially boost revenue through enhanced user analytics and targeted advertising.
  
• The introduction of a discovery section within Kakao Talk aims to overcome existing user traffic limitations by creating new spaces for content exploration, which could expand monetizable traffic and drive new advertising revenue formats.
  
• The launch of AI-powered services such as AI mate and personalized AI recommendations in commerce aims to enhance user engagement and purchase conversion rates, likely increasing transaction volumes and revenue in Kakao's commerce ecosystem.
  
• The planned integration of AI across Kakao's services, in collaboration with OpenAI, is expected to enhance user engagement and operational efficiencies, potentially lifting net margins by reducing human resource dependencies for certain tasks.
  
• Kakao's focus on expanding its business ecosystems beyond chat-based interactions into more context-rich user experiences may lead to increased user time spent on the platform, contributing to higher ad revenues and overall earnings growth.

Kakao Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Kakao's revenue will grow by 5.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 0.7% today to 5.8% in 3 years time.
• Analysts expect earnings to reach ₩535.2 billion (and earnings per share of ₩1237.84) by about May 2028, up from ₩55.3 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting ₩730.0 billion in earnings, and the most bearish expecting ₩398.0 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 50.2x on those 2028 earnings, down from 303.9x today. This future PE is greater than the current PE for the KR Interactive Media and Services industry at 18.0x.
• Analysts expect the number of shares outstanding to grow by 0.08% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.73%, as per the Simply Wall St company report.

Kakao Future Earnings Per Share Growth

Risks

• Kakao has experienced a gradual slowdown in growth due to its platform's heavy reliance on messaging, leading to structural limitations in user engagement and creating new business opportunities, which could impact revenue growth.
  
• The delayed recovery of the economy is impacting Kakao's advertising revenue, particularly the Talk display ads, and economic uncertainties contribute to a cautious outlook for advertisers, which could affect future earnings.
  
• Kakao's first quarter revenue is expected to be adversely affected by the IP cycle's low point in the Content business and increasing fixed costs, which may negatively impact profitability.
  
• Despite ambitions to expand AI services, there are risks due to a lack of successful long-term consumer-facing AI services globally, and adapting these models for consumer use could require significant investment, impacting net margins.
  
• Kakao's strategic investment in AI and data centers, while necessary for growth, implies increased expenses, potentially affecting operating profit margins, especially during market downturns.

Valuation

• The analysts have a consensus price target of ₩47530.769 for Kakao based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₩56000.0, and the most bearish reporting a price target of just ₩36000.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ₩9243.8 billion, earnings will come to ₩535.2 billion, and it would be trading on a PE ratio of 50.2x, assuming you use a discount rate of 8.7%.
• Given the current share price of ₩38250.0, the analyst price target of ₩47530.77 is 19.5% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.