New segment growth slower than expected; downgrade to NeutralWe downgrade our rating of Alpha Group from Buy to Neutral. We had expected thecompany to transform into an integrated animation intellectual property (IP) group andquickly monetise IPs via toys, movies and TV series, and games. However, thetransformation has been slower than expected. Development of u17’s key IP-basedmovies has been delayed until after 2018 and the web TV series have not substantiallycontributed to profits in the short term given the small revenue share. The gamessegment continued to undergo transformation in 2016 and growth has been difficult.

    We downgrade our rating to Neutral in part due to limited upside potential and a lowbut fairly valued c38x 2017E PE.

    Earnings forecast changes; cut 2016/2017/2018E EPS by 5%/19%/30%We cut 2016/2017/2018E EPS to Rmb0.43/0.54/0.65 as we: 1) lower our estimates ofu17 2017/2018 revenue by 7%/3% due to delays in the movie segment (eg, RakshasaStreet, which the company now plans to release in 2018 or later); 2) substantiallyreduce our 2016-18 game revenue estimate by 62% as the game segment continues totransform in 2016; and 3) raise 2016/2017 toy revenue estimates by 9%/4% due torobust sales of new toy releases (eg, Super Wings) after higher-than-expected growth,but trim 2018E toy revenue by 2% due to u17’s slow capitalisation of IPs.

    Improved monetisation window for the ACG sector is approachingWe think the company and the animation sector face two problems: 1) on the supplyside, domestic companies are not yet mature or commercialised enough despite asubstantial improvement in production skills; and 2) audience numbers for animatedfilms cannot support large-scale monetisation due to weak purchasing power.

    However, as animation has become mainstream among consumers born in the 1990splus the initial success of animation movies Big Fish & Begonia and games (Onmyoji) in2016, we expect the improved monetisation window for the animation, comic andgame (ACG) sector to emerge in two to three years. Having built a presence along theentire ACG value chain, we think Alpha Group should be a key beneficiary.

    Valuation: lower price target to Rmb22.41We lower our DCF-based price target by 34% to Rmb22.41 (assuming a 6.6% WACC),and downgrade our rating to Neutral to reflect our lower EPS estimates.