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Beijing Kunlun Tech Co. Ltd. Assigned ‘BB-‘ Rating With Stable Outlook

          HONG KONG (S&P Global Ratings) July 11, 2018--S&P Global Ratings assigned its 'BB-' long-term issuer credit rating to Beijing Kunlun Tech Co. Ltd. (Kunlun), a China-based mobile game developer and publisher, and owner of Grindr. The outlook is stable.
          The rating reflects our expectation that Kunlun will maintain its leading market position in the niche local mahjong app segment, and that Grindr will retain its entrenched and engaged user base over the next 12-24 months. We also expect the company to sustain its moderate debt leverage and good cash flows. However, these strengths are overshadowed by Kunlun's short record of operations, small scale, and concentrated revenue sources. The company acquired two of its three current business units in the past two to three years, and these businesses don't exhibit clear synergies with each other. 
          We estimate that the niche local mahjong app segment will account for 80%-90% of Kunlun's EBITDA over 2018-2019. Xianlaihuyu, a 58%-owned subsidiary of Kunlun, operates the company's local mahjong apps. These apps are social games that users play online with their family and friends, a feature that heightens user engagement. The social networking aspect of these apps makes it difficult to displace entrenched competitors. Xianlaihuyu has a 30%-40% market share in several very strong provincial markets. We expect Xianlaihuyu to gain share in these markets, but to lose market share in provinces where the company wasn't the first mover. Therefore, Xianlaihuyu could reach saturation over the next two to three years. Additionally, some regulatory risk exists. We see a possibility that the Chinese government could view such apps as more than a game of skill or entertainment, and tighten regulation.
          In our view, Grindr is likely to expand its geographical presence and take on more advertisement partners over the next 12-24 months. The social network benefits from its loyal target customer base of the LGBT community, with membership fees contributing to 50%-60% of its revenue. We forecast Grindr's EBITDA contribution to be limited at 7%-12% in 2018-2019, despite its robust growth. 
          We expect Kunlun.com, the mobile gaming arm of Kunlun, to remain a small player in the highly competitive gaming industry and contribute 6%-8% to the company's EBITDA in 2018-2019.
          Kunlun.com is undergoing a transition, shifting from licensed games to self-developed games. Kunlun could raise its 48% ownership stake in Opera, a web and mobile browser with some users in Europe, Africa, and Southeast Asia. We will fully consolidate Opera in our analysis of Kunlun if the company raises its interest in Opera to more than 51%. Currently, a pro forma consolidation doesn't significantly alter Kunlun's credit metrics. Meanwhile, Opera has filed for an IPO on Nasdaq in June 2018. We believe this could somewhat delay Kunlun's plan to acquire a majority stake in the entity. 
          We forecast Kunlun's revenue will increase by 8%-13% in 2018 and 5%-10% in 2019, primarily due to the growth of Xianlaihuyu and Grindr. We expect the company's EBITDA margin to stay at 30%-35% during 2018-2019, slightly lower than the 35% in 2017, due to potentially greater competition in the local mahjong app market. We estimate that Kunlun's EBITDA will grow by up to 5% in 2018 and 10%-15% in 2019.
          We expect a temporary spike in Kunlun's debt-to-EBITDA ratio to 3.7x in 2018, from 1.8x in 2017, due to cash outflows for its increased ownership in Grindr and Opera during the first quarter of the year. The ratio will then decline to 2.9x in 2019, given Kunlun's strong cash flow and minimal working capital requirement. In terms of financial policy, we expect the company to be acquisitive.
          The stable outlook reflects our expectation that Kunlun will maintain its good market position in the local mahjong app segment over the next 12 months. The outlook also takes into account the likely temporary spike in the debt-to-EBITDA ratio to 3.7x in 2018 as Kunlun increases its stakes in Grindr and Opera. 
          We could lower the rating if Kunlun's debt-to-EBITDA ratio approaches 4.0x, possibly from the company adopting an aggressive debt-financed acquisition strategy. We could also lower the rating if the company's competitive position deteriorates as indicated by a declining market share or a significant drop in the EBITDA margin. We could also lower the rating in case of any negative regulatory changes for the mahjong segment.
          Rating upside is limited in the coming 12 months. We could raise the rating if Kunlun diversifies its product offerings, with Grindr or Kunlun.com becoming meaningful profit contributors, and if the company can maintain a debt-to-EBITDA ratio of less than 2.0x.