Global Equity Research

03 January 2011

Nothing But Net
2011 Internet Investment Guide

Internet Imran Khan
AC

(1-212) 622-6693 imran.t.khan@jpmorgan.com J.P. Morgan Securities LLC

Bridget Weishaar

AC

(1-212) 622-5032 bridget.a.weishaar@jpmorgan.com J.P. Morgan Securities LLC

Lev Polinsky, CFA
(1-212) 622-8343 lev.x.polinsky@jpmorgan.com J.P. Morgan Securities LLC

Shelby Taffer
(212) 622-6518 shelby.x.taffer@jpmorgan.com J.P. Morgan Securities LLC

Vasily Karasyov
(1-212) 622-5401 vasily.d.karasyov@jpmorgan.com J.P. Morgan Securities LLC

China Internet Dick Wei
AC

(852) 2800-8535 dick.x.wei@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited

Japan Internet Hiroshi Kamide
AC

(81-3) 6736 8602 hiroshi.kamide@jpmorgan.com JPMorgan Securities Japan Co., Ltd.

Korea Internet Sungmin Chang, CFA
AC

(82-2) 758-5719 sungmin.chang@jpmorgan.com J.P. Morgan Securities (Far East) Ltd, Seoul Branch

Russian Internet Alexei Gogolev
AC

(7-495) 967-1029 alexei.gogolev@jpmorgan.com J.P. Morgan Bank International LLC

See page 412 for analyst certification and important disclosures, including non-US analyst disclosures.

J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com

Global Equity Research 03 January 2011

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January 3, 2011 Dear Investors and Internet Enthusiasts, The past year was an exciting one for the internet business. 2010 saw many of our key investment themes play out, with a significant recovery in display advertising, eCommerce outperforming the retail market, online travel agencies gaining market share and a very healthy M&A market. Internet stocks performed strongly as the broader market rebounded, with several of our 2010 top picks outperforming the S&P. We expect 2011 to be a significant inflection point in the development of the internet market, as a number of major trends are taking shape that could potentially disrupt many existing businesses. In fact, in our view there is more innovation in the sector today, and more uncertainty, than at any time since the industry was commercialized in the mid-1990s. In particular, we see five trends as disruptive forces to the over $1 trillion market cap industry. First, social media consumption has fundamentally changed consumer behavior, personal information/privacy boundaries, communication patterns and time allocation. Second, new mobile and internet-enabled technology devices — phones, readers, tablets and TVs — have allowed consumers to demand ubiquity of information, communication and entertainment in all places, across all devices, at all times. (We are especially excited to see what surprises the CES has in store for us this week!) Third, monetization of “over the top” video consumption has taken off. After years of speculation about its potential, Google finally released data showing that YouTube is monetizing 2 billion views per week; and with Netflix among others making impressive subscriber gains, we think fragmentation of media consumption, potential cord cutting (small scale) and content viewership will continue to drive over-the-top video consumption. Fourth, localization has become a key theme, driven by trends toward personalization and new devices. Again, growth here is coming following years of speculation. Finally, international growth remains a significant story, with a growing middle class and continued internet penetration driving new business opportunities. We hope that this report will help you sort through the complexities of the internet in 2011. While we don’t have a crystal ball, we have spoken with various entrepreneurs around the globe, surveyed over 1,000 internet users to get insight into consumer behavior and eCommerce trends and broadened our global internet expertise with analyst contributions from China, Russia, Japan and Korea. We aim to provide useful research and ideas in your investment decision-making process and hope that our work helped you in 2010. May 2011 bring all of you continued good fortune and exciting opportunities! Sincerely,

Imran Khan
Managing Director J.P. Morgan

J.P.Morgan Securities LLC • Equity Research • 383 Madison Avenue

New York, NY 10179

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Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com

Global Equity Research 03 January 2011

Table of Contents
Key Investment Themes ................................................................................. 7 Dot.Khan’s Top Ten Things to Watch ........................................................... 19

U.S. Sector Outlooks ..............................................................21
State of Advertising Overview ....................................................................... 23 Online Advertising Primers ............................................................................ 28 Search Advertising ........................................................................................ 33 Display Advertising ........................................................................................ 37 Mobile Advertising ......................................................................................... 44 Local Advertising ........................................................................................... 64 Social Networking.......................................................................................... 68 eCommerce Outlook ..................................................................................... 80 Online Alternative Payments ......................................................................... 95 "Over the Top" Survey Results ................................................................... 106 Online Travel Agencies ............................................................................... 111 Cloud Computing......................................................................................... 123 eReaders ..................................................................................................... 131

International Sector Outlooks .............................................139
China: Top Predictions for 2011.................................................................. 141 China Internet Market Overview.................................................................. 143 Online Advertising ....................................................................................... 147 Display Advertising ...................................................................................... 152 Online Search.............................................................................................. 153 Online Video ................................................................................................ 162 Social Networking........................................................................................ 167 Miniblog Platform......................................................................................... 170 eCommerce ................................................................................................. 171 Group Buying: A Hot Trend in China, Too .................................................. 177 SNS and Microblogs: Help Drive Social eCommerce ................................. 179 Leading C2C Players in China .................................................................... 179 Leading B2B Players in China .................................................................... 180 Online Gaming ............................................................................................ 181 The Rise of Social Gaming ......................................................................... 185 Summary of Gaming Regulations in China ................................................. 188 Online Gaming Primer ................................................................................. 189 Japan Internet Market Overview ................................................................. 195 Korea: Sector Summary .............................................................................. 219 Russia Internet Industry .............................................................................. 221

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Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com

Global Equity Research 03 January 2011

U.S. Company Outlooks .......................................................237
Amazon.com ............................................................................................... 239 AOL Inc. ...................................................................................................... 243 Blue Nile ...................................................................................................... 247 Dice Holdings, Inc. ...................................................................................... 251 eBay, Inc ..................................................................................................... 255 Expedia, Inc................................................................................................. 259 Google ......................................................................................................... 263 IAC/InterActive Corp.................................................................................... 267 Liberty Interactive ........................................................................................ 271 MediaMind ................................................................................................... 275 MercadoLibre, Inc........................................................................................ 279 Netflix Inc ..................................................................................................... 283 Orbitz Worldwide, Inc. ................................................................................. 287 Priceline.com ............................................................................................... 291 QuinStreet, Inc. ........................................................................................... 295 ReachLocal ................................................................................................. 299 Shutterfly, Inc. ............................................................................................. 303 Yahoo Inc .................................................................................................... 307

International Company Outlooks ........................................311
Alibaba.com Limited .................................................................................... 313 Baidu.com ................................................................................................... 317 China Finance Online .................................................................................. 323 Netease ....................................................................................................... 327 Shanda Games ........................................................................................... 331 Shanda Interactive Entertainment Ltd ......................................................... 335 Sina Corp .................................................................................................... 339 Sohu.Com ................................................................................................... 343 Tencent ....................................................................................................... 347 The9 Limited................................................................................................ 351 DeNA (2432) ............................................................................................... 355 Gree (3632) ................................................................................................. 363 Mixi (2121) ................................................................................................... 371 Rakuten (4755)............................................................................................ 377 Yahoo Japan (4689) .................................................................................... 391 Daum ........................................................................................................... 403 Mail.ru Group............................................................................................... 407 Please see our separate rating change notes on Blue Nile (NILE/December 31st close, $57.06/Neutral) and MercadoLibre (MELI/December 31st close, $66.65/Overweight), also published on January 3, 2011. The authors acknowledge the contribution to this report of Jigar Vakharia and Ritesh Gupta of J.P. Morgan Services India Private Ltd.

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Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com

Global Equity Research 03 January

J.P. Morgan US Internet Technology Universe
U.S. Rating Ticker Price 12/29 Search/Advertising AOL AOL Google QuinStreet ReachLocal MediaMind Yahoo* Group Average Leading e-Com m erce brands Amazon Blue Nile Dice eBay Expedia InterActive Corp Mercadolibre Netflix Orbitz Worldw ide Priceline.com Shutterfly Group Average Average
* Yhoo's Enterprise Value assumes Yahoo!'s Asian assets are wort h $8/share Not e: EBITDA= Operating income+D&A+/- Extraordinary charges All EPS estimat es are GAAP, except EXPE, PCLN, and M ELI ^ indicates First Call consensus estimates are used for revenue and EPS

Dec'11 Price Target

Mkt Cap 12/29

Ent .Val. 12/29 2,446 160,369 883 463 204 12,091

EPS 2009 2010E 3.42 2.18 0.76 0.42 2.96 0.88 0.54 0.89 2011E 0.86 28.32 0.96 (0.46) 0.68 0.79

Y/Y EPS Grow th 2012E '10/09E 0.52 32.82 1.11 0.18 0.83 0.92 -13% 24% -60% 78% -29% 110% 11/10E -71% 12% 9% -5% 26% -11% 12/11E -40% 16% 16% -139% 22% 16% 2009 7.0 29.4 8.9 -71.7 17.9 39.4 5.2

Cal PE 2010E 8.1 23.7 22.1 -40.3 25.4 18.7 9.6 2011E 27.9 21.2 20.3 -42.6 20.2 20.9 11.3 2012E 46.1 18.3 17.5 109.2 16.5 18.1 37.6 2009 1.4 0.8 0.4 -3.6 0.9 1.6 0.3

PEG 2010E 2011E 2012E 1.6 0.7 1.1 -2.0 1.3 0.7 0.6 5.6 0.6 1.0 -2.1 1.0 0.8 1.2 9.2 0.5 0.9 5.5 0.8 0.7 2.9 2009 877 11,001 67 1 17 1,722

EBITDA 2010E 661 13,116 82 0 20 1,599 2011E 445 15,485 93 13 26 1,692

Y/Y EBITDA Grow th 2012E '10/09E 375 17,787 111 44 31 1,893 -25% 19% 23% -62% 19% -7% -5% 11/10E -33% 18% 13% 2830% 33% 6% 478% 12/11E -16% 15% 20% 249% 18% 12% 50% 2009 2.8 14.6 13.2 412.2 12.2 7.0 77.0

Ent. Val/EBITDA 2010E 2011E 2012E 3.7 12.2 10.8 1076.5 10.2 7.6 186.8 5.5 10.4 9.5 36.7 7.7 7.1 12.8 6.5 7.9 10.5 6.5 6.4 7.8 2009 3,248 293 213 65 4,682

Rev ($M) 2010E 2,388 21,866 381 291 80 4,557 2011E 2,150 26,100 463 408 95 4,470

Y/Y Revenue Grow th 2012E '10/09E 11/10E 12/11E 1,996 29,208 537 561 112 4,670 -26% 25% 30% 37% 24% -3% 14% -10% 19% 22% 40% 18% -2% 15% -7% 12% 16% 38% 17% 4% 13%

N OW OW OW OW OW

24.09 601.00 19.48 19.42 13.71 16.61

$26 $625 $24 $23 $18 $20

2,551 193,749 918 541 298 22,309

GOOG QNST RLOC MDMD YHOO

20.41 25.40 (0.27) (0.48)

9.0 17,477

AMZN NILE DHX EBAY EXPE IACI MELI NFLX OWW PCLN SFLY

OW N N N N N OW OW N OW OW

183.37 58.05 14.08 28.36 25.58 30.02 69.82 180.27 5.53 405.70 34.89

$199 $49 $11 $25 $31.5 $35 $82 $186 $8 $484 $39

83,433 865 952 37,153 7,323 3,252 3,081 9,722 583 20,715 952

78,938 818 967 32,255 8,002 1,774 3,030 9,665 927 19,709 792

2.03 0.84 0.20 1.85 1.38 0.54 0.75 1.99 (4.02)

2.55 0.93 0.29 1.32 1.73 0.87 1.26 2.82 0.09

3.67 1.12 0.41 1.47 2.06 1.25 1.63 4.33 0.15 17.31 0.48

5.14 1.33 0.52 1.62 2.26 1.32 2.20 5.72 0.16 21.18 0.68

25% 12% 43% -28% 26% 59% 67% 42% -102% 54% 92%

44% 20% 40% 11% 19% 44% 30% 54% 59% 32% 14%

40% 18% 28% 10% 9% 6% 34% 32% 9% 22% 43%

90.3 69.4 68.9 15.3 18.6 55.3 92.7 90.6 NM 47.6 159.8 70.9 46.2

72.0 62.2 48.3 21.4 14.8 34.7 55.5 64.0 60.1 30.9 83.4 49.8 35.6

50.0 51.8 34.6 19.2 12.4 24.1 42.7 41.7 37.9 23.4 73.0 37.3 28.2

35.6 43.8 27.1 17.5 11.3 22.7 31.8 31.5 34.8 19.2 51.0 29.7 32.5

4.5 3.5 3.4 0.6 1.9 5.5 3.1 4.5 NM 3.2 8.0 3.8 2.5

3.6 3.1 2.4 0.9 1.5 3.5 1.9 3.2 6.0 2.1 4.2 2.9 2.1

2.5 2.6 1.7 0.8 1.2 2.4 1.4 2.1 3.8 1.6 3.6 2.2 1.8

1.8 2.2 1.4 0.7 1.1 2.3 1.1 1.6 3.5 1.3 2.6 1.8 2.2

1,851 29 50 2,663 876 169 48 449 143 548 50

2,458 32 52 3,223 963 257 85 587 151 884 62

3,202 38 69 3,624 1,094 281 119 712 165 1,202 71

4,232 42 82 3,813 1,158 288 158 854 179 1,460 85

33% 9% 4% 21% 10% 53% 76% 31% 6% 61% 23% 30%

30% 19% 34% 12% 14% 9% 40% 21% 9% 36% 15% 22%

32% 12% 19% 5% 6% 3% 33% 20% 8% 22% 20% 16%

42.6 28.1 19.5 12.1 9.1 10.5 62.6 21.5 6.5 36.0 15.8 24.0 42.7

32.1 25.8 18.8 10.0 8.3 6.9 35.6 16.5 6.12 22.3 12.8 17.7 77.4

24.7 21.7 14.0 8.9 7.3 6.3 25.5 13.6 5.6 16.4 11.1 14.3 13.6

18.7 24,508 19.4 11.8 8.5 6.9 6.2 19.2 11.3 5.2 13.5 9.3 11.8 10.4 302 110 8,727 2,955 1,376 159 1,670 738 2,338 246

34,293 329 128 9,197 3,336 1,643 216 2,161 752 3,082 297

44,904 372 168 10,275 3,710 1,771 296 3,004 802 3,732 347

56,397 414 198 11,197 3,967 1,855 392 3,758 850 4,300 412

40% 9% 16% 5% 13% 19% 36% 29% 2% 32% 20% 20%

31% 13% 31% 12% 11% 8% 37% 39% 7% 21% 17% 21%

26% 11% 18% 9% 7% 5% 32% 25% 6% 15% 19% 16%

8.52 13.12 0.22 0.42

Source: Company reports and J.P. Morgan estimates.

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Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com

Global Equity Research 03 January 2011

Key Investment Themes
The Internet Is Becoming Increasingly Social, Which Could Be Disruptive to Many Businesses If They Can’t Adapt to It
Over the last five years, there has been a fundamental change in consumer behavior on the web, as consumers are now more expressive and willing to share personal information online. As a result, social, which was ignored as a diversion by many observers (e.g., the ’05 and ’06 editions of this report barely mentioned social networking), has emerged as a major medium of the web, and we believe it is a potentially significant disruptive factor to many existing businesses over the next five years. While Facebook is the ten-thousand-pound gorilla in the space, we expect social to be a key theme in the internet space, and the category as a whole to become a significant portion of consumers’ online life. We think many companies will have to adopt a social component into their businesses in the coming years. Facebook now represents over 10% of all US internet usage time and over half of all global time spent on social networking sites, as reported by comScore. We view the social sites (especially Facebook) as network platforms, like Visa/MasterCard. As such, they don’t necessarily need to monetize directly from their customers: they can enable applications such as casual games (or payments, or eCommerce, or virtual gifts) and collect a small fee as the providers of the network. We believe linking the social graph with a platform for payments, advertising and commerce, and improved micropayments capacity, represent a landscape-shifting opportunity.

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Global Equity Research 03 January 2011

Social Networks as a Platform
eCommerce sites such as Zappos.com Analytics Comparison shopping such as shopping.com

Google
Content sites such as NY Times

Windows

Intuit

MS Office

Adobe

Photoshop

Payment Networks (e.g. Visa/MasterCard)

Chase MasterCard Chase Visa Debit Card

US Bank Visa Wells Fargo MasterCard

Social Networking Sites

Social Games such as Farmville Utility apps such as Birthday Cards & Horoscopes

Business/Nonprofit apps such as Causes Communication tools such as Windows Live Messenger

Source: J.P. Morgan.

Additionally, casual games, integrated into the social network landscape, experienced another very strong year of growth in 2010. We think such applications are one of several paths toward the successful monetization of social networks. The disruptive nature of social networking sites becomes even more apparent when examining the traffic sources of some major websites. The last year has seen a dramatic shift in the volume of traffic driven to key sites by social networks, especially Facebook. As seen in the graphs below, Google remains the largest driver of traffic to sites such as nytimes.com and Amazon. At the same time, the portion of traffic coming from Facebook has increased rapidly.

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7% 11. Online Ad Growth Fundamentally Remains Strong We think the online advertising market is at interesting inflection point.9 1. J. IAB 3/04 and Yahoo! 2010 Analyst Day presentation.0% 0.7% -28. Universal McCann 6/03. Facebook.0 2003 2004 2005 2006 2007 2008 % change 2009 2010 New spaper ad spend Source: NAA.com Global Equity Research 03 January 2011 Sources of Traffic to nytimes.4% 2.9% 4.2 34.8% Facebook. Facebook.8%30. Time Spent in 2003 and 2009 60% 50% 40% 30% 20% 10% 0% Print Radio Time Spent TV Online 23% 7% 27% 8% 24% 14% 3% 52% 50% 40% 30% 20% 10% 0% Print Radio Time Spent TV Online 26% 12% 16% 9% 39% 31% 28% 13% Ad Spend Ad Spend Source: SRI Knowledge Networks. 9 .8 -17.com 25% 20% 15% 10% 5% 0% Google. -2% Y/Y Oct-09 Source: comScore.0 22.9% 46.0 -7.6% 50. +66% Oct-10 10% 5% 0% 20.8% 20.8% 11.7% 42. -2% Y/Y Oct-09 Source: comScore.4 1.6% 4.9 20.4% 2.0 10.0 40. Ad Spend vs.0% -20.5% 46.6% 1.0% -10.0 0. time spent online continues to grow.t.7 3.0% 44.7% Google.4% 24.0% -40. DVR usage is on the rise and newspaper advertising revenues are consistently declining.9% 47.org.0% -30. Source of Traffic to Amazon sites 25% 20% 15% Source of Traffic to eBay sites 14% 12% 10% 8% 6% 4% 2% 0% 20. Newspaper Ad Spend Continues to Decline $ in billions 10.6 -1.0% 19.P. +81% Oct-10 Advertising Continues to Go through a Structural Change.Imran Khan (1-212) 622-6693 imran.khan@jpmorgan. -3% Oct-09 Source: comScore.7 -9. Morgan estimates.8% 7. +328% Oct-10 Google. On the one hand.

784 82. in line with our search advertising growth estimate. Overall.761 105.000 60.374 2011E International 2012E 2013E 2014E Growth in US Display Advertising to Match Search For a long time. search revenue grew at a ~32% CAGR from 2004 to 2009. and we think consumers are seeking ubiquity and the unbundling and ability to share this content. search advertising growth significantly outpaced display ad growth as advertisers flocked to the proven performance model.067 48. we are starting to see signs of this trend reversing due to the following two factors:  Brand advertising.com Global Equity Research 03 January 2011 The cost of content creation and distribution is decreasing. and therefore. we think brand advertisers are latecomers to online advertising and that display advertising will make more sense for them to get their messages across. many traditional media sources are not equipped to fulfill consumers’ changing demand.  Thus.Imran Khan (1-212) 622-6693 imran. Currently. Morgan estimates.P. Furthermore. 39. we believe online publishers will experience strong growth in advertising and are modeling global paid search revenues to grow at a 17% CAGR over the next four years and global graphical advertising to grow at a four-year CAGR of 11%. Social networking.000 0 2007 2008 2009 2010E US Source: J.368 60. we think time spent online will continue to grow.000 40. For example.611 51. consumers have more ways than ever to consume content. We Expect Global Online Advertising to Reach $105B by 2014 $ in millions 120.000 20.072 93. which brings in new content to consumers. However.000 80. we forecast global online advertising to reach ~$105B by 2014. which is roughly 2x the growth of display revenue over the same period.khan@jpmorgan. First. As a result.t. we note that social networking has had a large impact on viewership trends and that advertisers are likely to follow the eyeballs. 10 .279 70. Second.000 100. we see 2011 as a strong year for display advertising and are modeling 13% Y/Y growth.

Morgan estimates.933 0.8% 6. Thus.05 13.737 0.31 $1. the implications for carriers are somewhat less attractive. we can claim that the mobile phone market is on its way to maturity.000 pages) US Graphical Forecast ($M) Y/Y Growth 2006 203 45 3.164 0.237 10% 2013E 239 68 5.458 $3. 115 million US households possessing at least 1 TV.045 15% 2011E 231 61 5.60 2.50 $1.61 2. While this reach offers interesting possibilities to the advertising market.967 0.385 0.25 $2.05 $1.60 2.150 $3.63 3.847 23% 2007 211 47 3.881 3% 2010E 227 57 4.20 $2.50 1.P.341 0. Mobile Phone/Devices on Par with Television = Huge Ad Opportunity With approximately 233 million mobile phone users in the US. Morgan’s US Graphical Advertising Revenue Forecast Units as indicated United States Internet Population (M) Pages Viewed / User / Day Total Pages Viewed (B) Impressions / Page Total Impressions (B) CPM (per 1. + 3% May -09 May -08 226 233 Jan-10 234 Additionally.438 $3. handsets and content experience are becoming as key to carrier growth as they are to handset manufacturers and content providers.99 7.75 5. Therefore.7% Source: J. We think such growth is driving a significant increase in web usage and changing consumer behavior.608 0.237 13% 2012E 235 65 5.166 23% 2008 217 50 3. Nielsen//NetRatings.076 7% 09-'14E CAGR 1.577 0.02 11. 11 . IDC. If we assume that there are 2.759 $3. we expect significant growth of tablet devices this year (J.com Global Equity Research 03 January 2011 J.Imran Khan (1-212) 622-6693 imran.64 4. we believe a failure to establish mobile leadership and understand the mobile audience could be dangerous for content aggregators.000 impressions) RPM (per 1.25 $1.25 $2.2% 1. Further.15 $1. consumers now have more freedom to access and spend time on the web.t.95 7.05 12.218 9% 2014E 243 72 6.307 0. Carrier growth is now dependent on winning customers from competitors and coming up with new data services packages.5 people to a household.681 7% 2009 222 53 4.0% 2. this would imply that almost 93 million US households have a mobile phone vs.3% 8.khan@jpmorgan. IWS and IAB.83 7. comScore.3% 9. and as a result the web is becoming integrated into people’s daily lives.98 10. company reports.165 $3.P.61 3.3% 10.6% 1.671 $3.086 $3. estimates that 46M tablets will be sold in 2011).P.890 $3. Mobile Phone Market Is on Its Way to Maturity Subscribers in millions 240 235 230 225 220 215 210 205 200 Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation and March 2010 press release. Morgan’s hardware analyst. publishers and advertisers. Mark Moskowitz.91 9.62 2.62 3.13 $1.584 $3.

com is instructive: the site launched in 2005 and was bought by Amazon for $540M five years later after achieving predominance in its vertical.9% 5. At the same time. The key growth drivers are as follows. respectively.7% 2007 2008 2009 eCommerce as % of all US retail Source: US Census Bureau. .9% 10. Magna Global.4% 2002 1.2% 6. the sector represents less than 5% of all retail sales in the US and is even less developed in many other countries. Thus. increasing user comfort shopping online and the decline of certain brick-and-mortar retailers.4% 3.2% and 18.9%.Mobile Usage Only Accelerates this Trend 35% 30% 25% 20% 15% 10% 5% 0% Print Source: Yahoo! 2010 Investor Day presentation.khan@jpmorgan.8% 2003 2.9% in F’10 and at a 19. as the economic environment appears to be getting at least marginally better.0% 6.P.5% 13. we think there are still tremendous opportunities for rapid growth. including the continued rollout of broadband.4% 3. Online as % of all US Adv ertising 12 . . J. Economic rebound + Secular market shift = Robust growth We believe that eCommerce is benefiting from several positive trends.Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 Time Spent across Platforms Is Becoming More Fragmented -. 31% 28% 16% 12% Radio TV Online eCommerce Continues to Gain Significant Market Share We expect the global eCommerce market to grow 18.1% 2004 2.4% CAGR over the next three years. and have a long way to go Even after several years of very robust growth in eCommerce.4% 8. We think the experience of Diapers.5% 2005 2006 2.1% 5. We’ve come a long way .8% 5% 0% 1. eCommerce Penetration Lags Online Advertising 15% 10% 4. .6% 3.t. Morgan estimates. We expect F’11 US and global eCommerce growth of 13. we see an additional tailwind for eCommerce growth.

12% of our sample said they do not have a cable/satellite TV subscription. 54% of pay TV subscribers with incomes over $100K would prefer to pay less for a smaller package of channels. Over the Top: Changing TV Consumption. only 6% of those with incomes over $100K said they didn’t have a cable/satellite TV subscription. 39% said they would consider dropping their package (and another 8% already don’t have cable). getting a customer in the store was half the battle for a retailer. compared to only 45% of those who make less than $50K. Netflix Matches the Total # of DIRECTV Customers in the US Another major trend is that consumers are willing to consume more video content on the internet.t. 13    . are changing consumer behavior. the internet TV space has been long on speculation and short on data.Imran Khan (1-212) 622-6693 imran. and thus more power to the shopper. Those who are more regular users of Netflix streaming are even more likely: among those who use streaming 1-2 times a month or more. Additionally.khan@jpmorgan. also less happy with it. Netflix subscribers are more likely to consider dropping their cable packages. In recent months. Higher-income households less likely to go without pay TV. We think many of the elements of the company’s success are creating virtuous circles that will enable above-market growth to continue. Of these. However. A slight majority (52%) of pay TV subscribers said they would want to pay less for their cable subscription in exchange for getting fewer channels. Although most pay TV subscribers (72%) would not even consider getting rid of their cable/satellite package in favor of getting video over the internet. pricing. compared to 18% of those with incomes below $50K. Within our sample. Amazon continues to gain market share. Those wanting the biggest cut in their packages were also the most likely to consider dropping pay TV. as well as massive growth in tablet devices. Unbundling could help consumers. Following are our key findings:  More than a quarter would consider Over the Top. even in-store. innovation and reducing friction that creates a best-in-class user experience. significant increases in device penetration that allow users to stream online content to the TV. So we probed online video trends as one of the areas of focus in our proprietary survey of 1. Additionally. Prime and Fulfillment by Amazon (FBA) are two such key elements. Historically.com Global Equity Research 03 January 2011 Mobile eCommerce could further hurt brick-and-mortar retailers We think that the proliferation of mobile devices and mobile apps could have a profoundly negative impact on the business model of traditional retailers. 45% said they would want to get 25% fewer channels and pay 25% less. We continue to believe that pressure on traditional retail can accelerate eCommerce growth. 28% of our respondents said they would consider it.002 US internet users. 63% would do it even if it meant losing access to live sporting events. Of these. Mobile apps turn this dynamic on its head by giving consumers more price and product comparisons. size is an entry barrier We think the secret of Amazon’s success is highly unglamorous: an obsessive focus on execution.

frequent leisure travelers who tend to favor supplier sites. Second. Much of the growth in supplier websites in 2010 came from the unmanaged and managed business travelers who returned to the road. Third. online penetration in hotels is much lower than in air. In 2011. online travel agency companies in the US performed relatively well compared to offline agencies and suppliers.com Global Equity Research 03 January 2011 Online Travel Agencies Gain Share as Consumers Remain Focused on Bargain Hunting In 2010. margins are much higher in this segment than in air. we think Priceline will continue to gain market share. Among the reasons for this outperformance are that supplier websites were particularly affected by the pullback among older. We expect online travel agencies to be the biggest beneficiary of these trends as consumers will likely remain focused on bargain hunting and employ the social networking. Moreover. segment-specific drivers are making airlines even less attractive going forward. we continued to see the shift between online travel agencies (OTAs) to online supplier sites stabilize. especially in heavily fragmented markets. First. Hotels: the most promising growth opportunity We think hotels will continue to be the most attractive opportunity for online travel agents for a number of reasons. they are projected by PhoCusWright to grow at only half the rate of OTAs in 2010.Imran Khan (1-212) 622-6693 imran. review sites. PhoCusWright estimates that only 30% of hotel sales were booked through hotel websites and OTAs in 2009.khan@jpmorgan. 14 . We think Priceline’s strength can be attributed both to its opaque business model and lowestprice/discount-brand positioning. In 2011. and personalized offers that are OTA strengths.t. 17% growth at Expedia and 16% growth at Orbitz during the same period despite both Expedia and Orbitz removing and discounting booking fees. Priceline dominates domestic market share gains Priceline posted domestic gross bookings growth of 16% Y/Y in the first 3 quarters of 2010 vs. especially now that booking fee removals/discounts are comped. Although supplier websites outperformed the market overall. we expect to see a restrained recovery continue as corporate travel increases and consumers continue to spend more but unemployment levels remain high.

Tenth Edition. we expect them to have the resources: large internet and media companies continue to generate significant cash flows. at 45% in 2009. in 2010 we saw a strong pickup in M&A activity as management teams began to feel more comfortable with the economic outlook.khan@jpmorgan. Priceline. To the extent acquirers are willing to part with cash. as market fundamentals continue to improve. 15 . we expect M&A activity to remain healthy. 9% US Market Share. 43% Priceline. at 31% and 29%. In 2009. Source: PhoCusWright US Online Travel Overview. We think OTAs with a higher exposure to underpenetrated markets (OTAS such as Priceline) will continue to outperform the competition in 2011. 26% Source: PhoCusWright US Online Travel Overview. 1H08 Trav elocity 22% Ex pedia. France and Germany have similar online penetration rates. respectively. However. we do note that there is much variance on a country-by-country basis. Tenth Edition. France and Spain are expected to be the main share gainers. However. We Expect Healthy M&A Activity As expected. The UK remains the largest online travel market in Europe. Additionally.Imran Khan (1-212) 622-6693 imran. the UK generated 28% of European online bookings. In 2011.com Global Equity Research 03 January 2011 US Market Share. despite the overall low online penetration of the European travel market as a whole. Spain and Italy are the major markets with the lowest online booking penetration at 22% and 18%. 11% 44% Orbitz. over time Germany. 26% Orbitz. with the UK just behind at 44%. Scandinavia has the highest online leisure and unmanaged business penetration. the loosening of the credit markets should make financing more accessible to companies seeking to borrow funds. 1H10 Trav elocity 19% Ex pedia. International markets benefit from online penetration We expect online underpenetration to remain a tailwind to OTAs in 2011.t.

com Global Equity Research 03 January 2011 Selected M&A Activity in the Internet Space.44 N/A N/A N/A N/A N/A N/A N/A 70.00 N/A 700.00 N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A 6.com Ltd Meetic Aardvark ReMail Octazen Singlesnet Certain Assets Live Corp Picnik Inc Smartmoney.com DocVerse Citizen Sports Episodic Divvyshot Inc Plink Agnilux Inc LabPixies ICQ Instant Messaging Service Bump Technologies Inc WorldwideWorker Global IP Solutions Holding AB Associated Content Inc Traveljigsaw Ltd DailyBurn.00 N/A N/A N/A N/A N/A Payment Stock Undisclosed Cash and Stock Cash Cash Undisclosed Undisclosed Undisclosed Cash Cash Cash Undisclosed Undisclosed Cash Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Cash Cash Undisclosed Cash Cash Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Cash Undisclosed Cash Undisclosed Undisclosed Undisclosed Cash Undisclosed Cash Undisclosed Undisclosed Undisclosed Cash Undisclosed Cash Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Status Complete Complete Complete Complete Complete Complete Complete Complete Complete Pending Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Pending Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Pending Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete World of Good Inc Hearst Corp AOL Inc Hearst Corp AOL Inc Occipital Rightmove PLC AOL Inc 16 .63 65.50 N/A 225.com Inc Google Inc Facebook Inc Google Inc Google Inc QuinStreet Inc Google Inc Dice Holdings Inc Google Inc Facebook Inc Google Inc Facebook Inc Google Inc Seller News Corp Yahoo! Inc TCI MCM Solution Inc Yahoo! Inc Annc’d Tot N/A N/A 36.com Inc InterActiveCorp Google Inc Google Inc Yahoo! Inc Facebook Inc Google Inc News Corp Criterion Capital Partners LLC eBay Inc Expedia Inc uSamp Elevation Partners LP Amazon.com Inc Multiple Targets Rigzone.Imran Khan (1-212) 622-6693 imran.khan@jpmorgan.00 N/A N/A ComparisonMar ket Inc N/A 36.00 N/A N/A N/A N/A N/A 120.67 187.t. 2010 Symbol NWSA YHOO AOL GOOG YHOO IACI GOOG GOOG Facebook IACI EBAY RLOC GOOG NWSA GOOG YHOO GOOG Facebook GOOG GOOG GOOG AOL GOOG DHX GOOG YHOO PCLN IACI GOOG GOOG YHOO Facebook GOOG NWSA AOL EBAY EXPE AOL Facebook AMZN GOOG Facebook GOOG GOOG QNST GOOG DHX GOOG Facebook GOOG Facebook GOOG Deal Type DIV DIV ACQ DIV DIV JV ACQ ACQ ACQ ACQ ACQ ACQ ACQ DIV ACQ ACQ ACQ ACQ ACQ ACQ ACQ DIV ACQ ACQ ACQ ACQ ACQ ACQ ACQ ACQ ACQ ACQ ACQ DIV DIV DIV DIV DIV ACQ ACQ ACQ ACQ ACQ ACQ DIV ACQ ACQ ACQ ACQ ACQ ACQ ACQ Date 01/04/10 01/12/10 01/25/10 01/25/10 02/03/10 02/05/10 02/11/10 02/18/10 02/22/10 02/25/10 02/25/10 02/26/10 03/01/10 03/02/10 03/05/10 03/17/10 04/02/10 04/02/10 04/12/10 04/21/10 04/27/10 04/28/10 05/02/10 05/10/10 05/18/10 05/18/10 05/18/10 05/20/10 05/20/10 05/21/10 05/25/10 05/26/10 06/02/10 06/14/10 06/17/10 06/23/10 06/24/10 06/24/10 06/28/10 06/30/10 07/01/10 07/08/10 07/16/10 08/06/10 08/09/10 08/11/10 08/12/10 08/13/10 08/15/10 08/20/10 08/21/10 08/27/10 Target Rotten Tomatoes Zimbra Inc StudioNow Inc DART business HotJobs.com Simplify Media Inc Ruba Inc Koprol Sharegrove Inc Invite Media Skiff Inc Bebo Inc RedLaser Holiday Lettings Holdings Ltd DMS Insights Facebook Inc Woot ITA Software Inc Nextstop Metaweb Technologies Inc Slide Inc Insurance.50 N/A 1.50 N/A 39.com Hot Potato Angstro Acquirer Flixster Inc VMware Inc AOL Inc Google Inc Monster Worldwide Inc InterActiveCorp Google Inc Google Inc Facebook Inc InterActiveCorp eBay Inc ReachLocal Inc Google Inc News Corp Google Inc Yahoo! Inc Google Inc Facebook Inc Google Inc Google Inc Google Inc Digital Sky Technologies Google Inc Dice Holdings Inc Google Inc Yahoo! Inc priceline.com Jambool Inc Chai Labs Like.

com.me Inc Acquirer Google Inc News Corp Amazon.com Inc Phonetic Arts Widevine Technologies Inc Zetawire Critical Path Inc Pictela Inc brands4friends. and larger companies are often willing to pay for sites that have proven an ability to generate traffic.Imran Khan (1-212) 622-6693 imran.khan@jpmorgan.00 49. but the technology is often a motivator for the buyer. Transactional. Technology. Companies with proven track records of revenue and sales generation can make attractive targets as well. We continue to see three key factors as motivating drivers for M&A activity in the internet space:   Traffic. Acquirers will likely seek a company that garners recognition and respect from both its customers and partners.00 N/A Payment Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Cash Cash Undisclosed Cash Cash Cash Cash Undisclosed Undisclosed Undisclosed Stock Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Cash Undisclosed Status Complete Complete Complete Complete Pending Complete Complete Pending Pending Complete Pending Complete Pending Complete Complete Complete Complete Complete Pending Complete Complete Complete Pending Complete Complete Complete Pending Pending InterActiveCorp Drop.com Certain Assets Pacific Corporate Park Zenbe Walletin Mobiata Certain Assets Milo.de about.com Certain Assets Substantially all assets BILLSAFE Quidsi Inc CarInsurance. We think acquirers will seek out companies that have the products viewed as best by customers.com Global Equity Research 03 January 2011 Selected M&A Activity in the Internet Space.48 N/A N/A N/A N/A N/A N/A 200.io WMSG Inc CB Richard Ellis Group Inc InterActiveCorp Source: Bloomberg. Companies that develop a technology that is difficult or uneconomical to replicate are often targets for acquisitions. partners and competitors.com Inc QuinStreet Inc Shutterfly Inc AOL Inc Facebook Inc Facebook Inc Expedia Inc Liberty Media Corp .  Key attributes of acquisition targets We believe the attributes that potential acquirers will seek in a target include:   Brand strength. Product leadership.au Amie Street 5min Media TechCrunch Inc Thing Labs Inc BlindType Inc Dapper Inc BuyVIP. 17 .com Inc AOL Inc AOL Inc AOL Inc Google Inc Yahoo! Inc Amazon. news reports.Capital eBay Inc Google Inc Google Inc Google Inc eBay Inc AOL Inc eBay Inc AOL Inc Seller Annc’d Tot N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A 545. such companies may also generate traffic.) Symbol GOOG NWSA AMZN AOL AOL AOL GOOG YHOO AMZN IACI Facebook EBAY AMZN QNST SFLY AOL Facebook Facebook EXPE LINTA EBAY GOOG GOOG GOOG EBAY AOL EBAY AOL Deal Type ACQ ACQ ACQ ACQ ACQ ACQ ACQ ACQ ACQ DIV DIV ACQ ACQ ACQ DIV DIV ACQ ACQ ACQ DIV ACQ ACQ ACQ ACQ ACQ ACQ ACQ ACQ Date 08/30/10 09/06/10 09/09/10 09/28/10 09/28/10 09/28/10 10/01/10 10/05/10 10/07/10 10/25/10 10/29/10 11/04/10 11/08/10 11/08/10 11/08/10 11/16/10 11/16/10 11/16/10 11/18/10 12/02/10 12/02/10 12/03/10 12/03/10 12/14/10 12/15/10 12/16/10 12/20/10 12/20/10 Target SocialDeck Inc Getprice.t. Developing high-traffic sites is difficult.00 144. company reports.com Inc Hi-Rez Studios Facebook Inc eBay Inc Amazon.50 N/A N/A N/A 753. 2010 (cont.70 6.

-buy decision-making process. MercadoLibre (price target $82) for our mid cap stocks. With an increasing focus on profitability in this time of economic uncertainty. Please see the company sections for detailed analyses of our thesis for each.  Within our universe. we believe the two independent companies that best embody these attributes are MercadoLibre and Netflix. Additionally.t.khan@jpmorgan. Our Top Picks In our coverage universe. we think the internet companies that are best positioned and offer the best risk/reward return for investors are: Amazon (price target $199) and Priceline (price target $484) of our large cap stocks.Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011  Ease of integration. we think companies will attach more importance to the level of challenge in integrating the company and the time required to recognize synergies. Morgan’s China internet analyst Dick Wei’s top picks are Tencent and NetEase. J. 18 . This will likely be a key determining factor in the buildvs. Barriers to entry. and ReachLocal (price target $23) among our small cap names.P.

we estimate Google generates ~15% of its query volume from mobile devices. 8.com Global Equity Research 03 January 2011 Dot. Increased penetration of smartphones and tablet devices will further proliferate mobile web usage and app development. 3. we think display advertising growth should match search revenue growth in 2011. where brick-and-mortar brands are relatively weaker compared to the US. Brick-and-mortar market share losses could accelerate in the US. We expect a major effort by internet companies around the world to woo the local advertising dollar.khan@jpmorgan. The online hotel business still retains significant runway for international growth. 10.Khan’s Top Ten Things to Watch 1. Monetization of mobile searches is a critical factor for Google’s growth. additionally. In our view. which could potentially be disruptive to the way we shop. Continued consumer adoption of social media and its impact on other existing businesses. Primarily. content owners and advertisers must also accept this new order and will have to either partner with Netflix and other services or launch their own online services. 6.t. Despite its underperformance of the search market growth rate for most of the last ten years. Consumers are embracing “over the top” video consumption. 5.Imran Khan (1-212) 622-6693 imran. we expect material share shifts in countries such as China. India and Eastern European countries. 9. yet mobile searches contribute just ~3% of revenue. 7. 4. we expect US companies to continue to face major challenges in markets such as Russia. entertainment and eCommerce. 2. China. We believe rapid internet and smartphone penetration growth will create many more exciting internet businesses outside the US. Korea. We expect more consolidation/M&A rather than share buybacks. 19 . consume content and communicate. and we expect an above-industry-average growth rate in this segment. such as advertising.

khan@jpmorgan.t.Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 20 .

Sector Outlooks .U.S.

Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 22 .khan@jpmorgan.t.

We think this new world of content consumption offers significant challenges for advertisers. Google TV and a new Apple TV. Advertisers and content providers still seem to be struggling with targeting. US consumers have also embraced the internet. Amazon introduced the Kindle. giving consumers worldwide portable information access similar to that provided by BlackBerry to businesses. accessing media and shopping. new devices have been the driver of this revolution.2 channels. performance-based 23 .khan@jpmorgan. 12M eReaders will have been sold in the US market. reading and internet content onto a single device. changing the way people access written information and entertainment. We believe that there is currently a large disconnect between ad spend vs. in the following sections. Additionally. with over 24 hours of video uploaded every minute and over 2B views per day.t. Consumers Are Seeking Ubiquity Consumers want access to information. In the traditional media model. all of which combine TV. In 2007. This additional content means more fragmented audiences. making the bottleneck consumers’ time. reading and buying/viewing entertainment.Imran Khan (1-212) 622-6693 imran. 2010 saw the launch of many more innovative devices. However. Consumers have more choices than ever when it comes to consuming content. but by 2007 this number had increased to 107. We see two devices as responsible for changing how people think about communicating. Below we will look at drivers of the total advertising market and then. there were multiple steps from author to consumer and production costs were high. Unbundling of Content Creates an Interesting Opportunity The cost of content creation and distribution is decreasing. we will study the issues relating specifically to search. YouTube is monetizing over 2B views per week. This has revolutionized how people think about communicating. In the two quarters after its release. time spent online continues to grow. In our opinion. On the one hand. That same year. there are fewer steps to distribution and lower productions costs. In addition to increasing options on TV. time spent on each medium and that the rectification of this will help drive internet ad spend in 2011. in the new model. successful brand advertising campaigns. Apple sold 7. In 1980. entertainment. We estimate that by the end of 2010. These activities were once distinct. DVR usage is on the rise and newspaper advertising revenues are consistently declining. music. which brings new content to consumers. Apple had sold ~74M iPhones and spurred the development of many other competitive products. seeking information. retail and communications at all times.4 channels.com Global Equity Research 03 January 2011 State of Advertising Overview We think the online advertising market is at an interesting inflection point. Social networking has gained so much traction that an average 124M US consumers (59% of the internet population) spent almost an hour per week (58 min) on Facebook over the last 12 months. the average US household received 10. copyright issues and the massive amounts of inventory. but we believe they are now thoroughly enmeshed. including Apple’s iPad. As of 3Q’10. video and mobile advertising. The cost of content creation and distribution is decreasing. display. All of the bottlenecks were upstream in the process. the iPhone launched. in all places and across all devices.5M iPads.

7 -9.Imran Khan (1-212) 622-6693 imran.2 34.9% 46. blogs are becoming more accepted as a trusted news source and opinion provider.4% 24. Time Spent in 2003 and 2009 60% 50% 40% 30% 20% 10% 0% Print Radio Time Spent TV Online 23% 7% 27% 8% 24% 14% 3% 52% 50% 40% 30% 20% 10% 0% Print Radio Time Spent TV Online 26% 12% 16% 9% 39% 31% 28% 13% Ad Spend Ad Spend Source: SRI Knowledge Networks. In our opinion.0 0. 24 .com Global Equity Research 03 January 2011 advertising will continue to get traction as advertisers are looking for more ROIdriven ads.0% -40. we think the existing cost structure will make this business model unsustainable in the future.0% Y/Y in September 2010.8 -17.9 1. Given the decline in both circulation and ad spend. an acceleration in declines from 2008’s 18% Y/Y drop and 2007’s 9% drop. IAB 3/04 and Yahoo! 2010 Analyst Day presentation.7% 42.0 40.7 3.8%30.t. Ad Spend vs.9 20. Newspaper Ad Spend Continues to Decline $ in billions 10.4 1.6% 50.0 2003 2004 2005 2006 2007 2008 % change 2009 2010 New spaper ad spend Source: NAA.khan@jpmorgan.6 -1. with average daily circulation down 5.0% -10.P.0% -30.7% -28.org. J. people are becoming increasingly dependent on the internet for breaking news. Universal McCann 6/03.5% 46.0% 44.0 -7. Newspaper circulation is also falling.0 10.0% 0.0 22. We estimate that newspaper ad spend declined 29% in 2009.0% -20.9% 47. Furthermore. Our Thesis on Newspaper Market Share Declines Plays Out We believe that newspaper advertising declines will continue to accelerate going forward. Morgan estimates.

25 . The rise in total viewership is despite roughly flat viewership among the big 4 broadcast networks. It Is Increasingly Difficult to Reach TV Viewers Overall TV viewership continues to rise. the alternatives offer interesting challenges for advertisers to justify significant cost-perthousand (CPM) price increases every year.6% -2.5% -2.6% -3.1% -8.6% -4.7% -5. While Content Consumption Is Growing.8% -2. However. J.6% Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Y/Y change in av erage daily circulation Source: Audit Bureau of Circulation. Additionally.1% -2. which are more than offset by rising cable audiences.khan@jpmorgan. it is increasingly difficult to reach engaged TV viewers as the growing number of alternatives increases fragmentation.Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 Newspaper Circulation Declines Are Accelerating 0% -4% -8% -12% -2. Morgan estimates.6% -7.P. with total TV use growing 1% Y/Y through 3Q’10 according to Nielsen.0% -10.t.

513 529 2008 18.Imran Khan (1-212) 622-6693 imran.Bloomberg First TiVo DVR launched Netflix launched "Hulu Is An H-Bomb Ready To Destroy The TV Industry" .1% -10.131 17. we expect internet advertising to grow the fastest.948 7.804 51.020 15.0% 6. We expect radio and newspapers to be the weakest platforms.604 18.Journal Enterprise 8:09 Netflix launches online streaming Analog to digital transition YouTube launched 7:40 "Bye-bye TV? YouTube debuts live streaming" .634 52.643 58.726 9.3% -2. 26 .P.2010 TV Season Source: Nielsen Media Research and J.630 16.685 14. with total TV expenditures up 6% Y/Y.878 2.355 20.616 58.849 19. We think syndication could face significant challenges from Netflix services.1980 1984 .266 21.587 22.471 18.407 16.6% Y/Y.578 15.402 2.304 2.0% 13.892 24. J.344 11.966 6.2005 2009 .202 23.359 12.773 57.792 15.493 6.020 23.924 13.211 25.633 43.698 20.0% 8.0% Network Spot National Cable Syndication Total TV Radio Magazines Newspapers Outdoor Internet Cinema Source: ZenithOptimedia.992 400 2006 18.688 49.402 2.113 18.218 23. We also see TV expenditures continuing at a healthy clip.1995 1999 .568 32.661 55.0% 6.237 5.954 7.566 55. Network ad dollars are still below 2007 levels.723 21.669 6.823 608 2009 16. driven by spot advertising (up 8% Y/Y) and cable (up 6% Y/Y). Morgan estimates. at 13.587 2.1990 1994 .106 670 % Change 2010E 5.1975 1979 .0% -5.khan@jpmorgan.322 19.1970 1974 .1955 1959 .6% 5. Thus.390 20. July 2010. while national cable is still below 2008 levels.t.1950 1954 .Fortune DVD format launched 7:12 VOD launched Blu-Ray Disc launched HD television launched Hulu launched 6:43 Hour:Min Launch of HBO Channel Pay-per-view launched VHS launched 6:14 5:45 Launch of DTH service "TiVo May Be `Disaster' for TV Industry" .com Global Equity Research 03 January 2011 TV Viewership Alternatives Grow 8:38 "Can Netflix kill premium cable TV?" .902 23.P.589 23.338 638 2010E 17. Trends in Ad Dollar Expenditure by Platform $ in millions 2005 17.Business Insider 5:16 4:48 4:19 1949 .040 14.2000 2004 .086 460 2007 18.184 29.1960 1964 .1965 1969 .790 2.0% 3. Morgan.1985 1989 .0% 1. Cable and Internet Advertising Are Gaining Share In 2010.902 40.

com Global Equity Research 03 January 2011 We expect the trend for national cable will continue. and we expect internet ad dollars to reach 20% of overall ad spend in less than 5 years.Imran Khan (1-212) 622-6693 imran. but our bullishness on internet ad dollars is unabated.khan@jpmorgan.t. 27 .

28 . We think many users are beginning to tune out the standard banner ads on a page view. graphical ads are less targeted than search ads since search ads are dictated by the interest of the user whereas graphical ads are generally determined by the content of the host website. However. while non-premium CPMs can be below $1. will become more widespread. As a result. Revenue model Revenue for graphical advertising can be cost per thousand (CPM). CPM-based advertising is the traditional TV model employed in graphical advertising. Some key developments that we expect to see:  Sponsorship advertising.com Global Equity Research 03 January 2011 Online Advertising Primers Graphical Advertising 101 Graphical advertising. the following factors should be evaluated when looking at the graphical advertisement space.t.  Time-based advertising. We think that display ads need to be better targeted through use of behavioral targeting and interest-based ads. Thus a range of advertisements from traditional banner ads to video and lead generation are included in this category.khan@jpmorgan. Examples of non-premium inventory include social networking sites and email. We expect more innovation in the display advertising market We think display advertising companies will aggressively tackle challenges including 1) unlimited inventory. Premium inventory can carry CPMs north of $30. Premium inventory is more focused on a specific vertical of content or demographic. Typically. particularly with brand advertisers. Because the likelihood of a target market user seeing the ad is much higher on premium inventory than on nonpremium inventory (for which advertisers likely pay for many non-target users to see the ad). cost per click (CPC) or cost per action (CPA). we think sponsored ads.  New ad formats. We think content providers are misusing page views by creating excessive content and ads. 2) lack of marketer confidence with ROI. Non-premium inventory includes very general untargeted pages. As a result.Imran Khan (1-212) 622-6693 imran. includes all forms of advertising excluding search. An example of premium inventory would be the Yahoo! Finance page. and 3) declining RPMs. the range of CPMs is wide. Content quality Probably one of the most important factors in ad placement is the content near where the ad will be placed. This could then give guidance as to what ads are shown and how much of an impact they had on a user. also known as display advertising.  More optimization. which allow the advertiser to control the entire user experience. advertisers negotiate a rate that will be paid for every thousand times the ad is displayed. We think advertisers will begin to use time spent on a page as a measure of user engagement. web pages are grouped into two categories: premium inventory and non-premium inventory. Because of the range included in this category. In this model. we think new ad formats beyond those of the IAB need to be introduced to engage user attention. it is more difficult to make generalizations about graphical ad characteristics. In general.00.

However. First. and performance measurement and content monetization are currently hotly debated topics. the advertiser is charged when a predefined action is taken by the user (such as providing contact information on a form). when mixed with a search advertising campaign. the advertiser is charged per click on the ad. participants were split into three groups: those who clicked only on search advertisements. Larger websites typically have their own sales force. However. Positioning on the web page is also a key concern. A price and budget is then negotiated with the content website. These factors are all important in the consideration of setting a price for the advertisement. and can be incorporated into pop-ups. In CPC advertisements. The ad is then provided to each website or to the ad network for placement and performance tracking. As different websites might have different requirements. Ad characteristics A final consideration in graphical advertising is the specifics of the advertisement. with which advertisers deal directly. In a study conducted by Atlas Solutions. Users exposed to both search and display convert at an even higher rate – 22% better than search alone and 400% better than display only. this form of advertising is very attractive to brand advertisers who are hoping to cultivate name recognition and brand identification rather than to drive immediate sales. Using the display-click-only group’s conversion rate as a baseline. those who clicked only on display advertisements and those who clicked on a search advertisement and also viewed or clicked a display advertisement. Atlas found that search-click-only users convert at a rate over 3 times higher. can be in video form. Banner ads can be found in a variety of sizes and shapes. the format may have to be altered to meet various content website demands.t. These technologies have begun to render page views as a less important metric of performance (time spent at a site is becoming more important). Why use graphical advertising? Since no action is required on the part of the user. New technologies have made the measurement of display advertisements more difficult.com Global Equity Research 03 January 2011 CPC and CPA models fall into the category of performance-based advertising since an action by the user is required before the advertiser is charged for the advertisement. Placing and measuring a graphical advertisement The graphical ad placement process is a little more intensive than the search ad placement process.Imran Khan (1-212) 622-6693 imran. In CPA models. How graphical ad revenue is determined The total revenue of a publishing site is determined by 3 factors:  Page views (the total number of pages viewed in a given period). For example. 29 . smaller websites often outsource the process of finding advertisers and hosting ads to ad networks that standardize the process across multiple host websites. the banner ad or video needs to be created according to the specifications of the host website. there has been some evidence that graphical advertisements can directly increase sales. AJAX technology now allows users to preview the contents of a page without actually clicking over to the page itself.khan@jpmorgan.

Finally.t. the latter excluding TAC payments. the revenue is split between the parties. An example of this is the Newspaper Consortium developed by Yahoo!. Search Advertising 101 Search advertising has become the leading form of online advertising due to multiple characteristics. some content providers have chosen to outsource the placement of display ads with larger content providers or ad networks. For the content providers which provide the outsourced display advertisements (such as Yahoo!).   Advertisements are very targeted since the searcher enters a key word or phrase describing the information he would like to receive. Average CPM (the average price advertisers paid per 1. The searcher is very receptive to looking at advertisements since information gathering is the focus of his activity (this in contrast with television or radio ads. The TAC rate is the percentage of revenue which is paid to the content owner for obtaining the traffic.    30 . Search advertisements have significant reach given the large volume of searches conducted. Given the automated nature of search advertising.Imran Khan (1-212) 622-6693 imran. search advertising is considered a form of performance-based advertising. Typically.com Global Equity Research 03 January 2011   Coverage (the proportion of pages which had an ad).000 ad views). the company usually reports gross revenue and net revenue. advertisers do not pay to have the ad appear.khan@jpmorgan. this rate is lower than the TAC rate for search as the graphical advertising process is more complex and less automated. In these cases. Because an action is required on the part of the searcher (clicking on the ad) and advertisers do not pay unless this action occurs. but only pay when a searcher clicks on their advertisement and is transferred to the website. advertisers of all sizes and all ad budgets can easily take advantage of this marketing method. Page Views x Coverage x CPM x 1/1000 = Revenue The role of TAC rates in graphical advertising Because of the relatively high costs associated with developing and maintaining the graphical advertising platform and with attracting and servicing advertisers. The traffic acquisition cost (TAC) rate is established in negotiations and is in force for the length of the partnership. for which the main focus of the viewer is being entertained).

and social networks. which is the amount an advertiser is willing to spend to have one searcher click on the ad and be transferred to the advertising website. Average CPC (the average price advertisers paid for each click received). there are occasions when ads with lower maximum-CPC bids appear above ads with higher bids. that advertiser is charged a CPC based on other bids in the auction and the quality determination of the advertiser. we think real-time results will become more the standard.com Global Equity Research 03 January 2011 Efforts are being made to innovate in search After years of the same format for search results. Advertisers also select their monthly budget and their maximum cost per click. Click-through rate (CTR) (the number of ads which were clicked as a proportion of total ads).khan@jpmorgan. advertisement or description of the website. Thus. We think a greater focus will be made to target results based on geographic location and other factors. The auction process Advertisers or search engine marketers (SEMs are advertising agencies which manage the search ad campaigns of larger companies) first create a text ad. which is a very short (~70 characters in length). Twitter. With data constantly being added to the web through blogs. 31 . we have seen most of the key players start to innovate in the space. a search algorithm compares all of the maximum bids for the key word and the quality of the advertising site. Advertisers then select the key search words or phrases which they would like their ads to appear alongside. Some key developments that we expect to see:  Multimedia search results.t. text-only. If the searcher clicks on an ad. image and audio results into searches. The ads then appear in the order determined by the algorithm. Coverage (the proportion of searches which had an ad).Imran Khan (1-212) 622-6693 imran.  Dynamic results. Both factors are usually used in the formula for selecting an advertisement and determining the order in which advertisements appear since search engines are concerned with providing the most relevant ads to users to maximize the user experience. We think search companies will embrace the diversity of data media and incorporate more video.  Increased personalization. How search revenue is determined The total revenue of an owned and operated search engine is determined by 4 factors:     Query volume (the total number of searches in a given period). When a searcher uses the key word in a search.

com Global Equity Research 03 January 2011 Query Volume x Coverage x CTR x CPC = Revenue The role of TAC rates in search advertising Because of the relatively high costs associated with developing and maintaining the search advertising platform and with attracting and servicing advertisers. 32 . which excludes TAC payments.khan@jpmorgan. this rate is north of 75%. which outsource search advertisements to Google. Examples of this include both AOL and Ask. The TAC rate is the percentage of revenue which is paid to the content owner for obtaining the traffic.Imran Khan (1-212) 622-6693 imran. The traffic acquisition cost rate is established in negotiations and is in force for the length of the partnership. the revenue is split between the parties.t. some search and content providers have chosen to outsource the placement of text ads with larger search engines. the company usually reports gross revenue and net revenue. In these cases. For the search engine which provides the outsourced search advertisements (such as Google). Typically.

First. Nov 09-Oct 10 Other Ask Jeev es bing Yahoo! Google 0. within the US we expect the market to start to enter the maturation phase. Diana Pouliot (director of mobile advertising at Google) stated that one-third of all Google searches via the mobile web pertain to some aspect of the searcher’s local environment.2% 0. Yahoo! appears to be 33 . we think international markets will continue to benefit from increased search usage and broadband subscriber growth.com Global Equity Research 03 January 2011 Search Advertising The search advertising market had a solid year in 2010. Following are our more detailed thoughts on the space. including contextual shortcuts (hovers). Looking forward. followed by local search advertising programs (18%).khan@jpmorgan. According to the research. At a Mobile Marketing and Advertising event in Las Vegas. benefited from an increased share of advertising dollars and a recovery in costs per click (CPCs). we mean that we think internet population and query growth will slow and market share shifts will stabilize. Google will likely do well with shifts to local and mobile spend.0% 80. Secondly.t. US Mobile Search Market Share. we think Google’s market share has begun to stabilize as it now commands ~72% of the search market (including AOL and Ask searches).0% 70. However.0% 90.0% 20. we have started to see some trends emerge. and mobile search advertising (11%).3% market share of mobile searches in the US.0% 100. with the beginning of Microsoft/Yahoo! search integration and changes in search methodology.0% 60. now that Bing is starting to anniversary its launch and comScore data has adjusted for methodology changes. However. in addition to having more favorable ad budgets as a whole. Bing. which started to change market share dynamics. slideshows and Google Instant Results.0% 40.0% Source: StatCounter.6% 97.8% 1. Further changes came in 2010. StatCounter data reveal that Google has a 97.0% 30.0% 50.0% US Market Share Shifts 2009 saw the introduction of Microsoft’s new search engine. Although Facebook would likely be one of the biggest beneficiaries of social media spend. mobile search and local search going into 2011. social media advertising on Facebook was top of the list of priorities for almost half (46%) of respondents.3% 10. 36% of US advertisers listed their top SEO priority to be social media program integration.Imran Khan (1-212) 622-6693 imran. By this. Advertisers Likely to Explore New Search Avenues We think advertisers will show a new interest in social media search. 0. Furthermore. We think this industry. In a recent survey by Covario.1% 0.

3 2.1% 11.3% 16.6 1.6% 2. Worldwide qSearch Market Share % of total worldwide searches Google Sites Yahoo! Sites Microsoft Sites FACEBOOK Ask Network Baidu.8 7.3 1.2 7.0 3.0 1.2 8.2% 16.4% Jun-10 66. We continue to see personalized search and vertical search as hot topics.6 1.5 1.2 0.6 0.9% 10.3 2.4% 17.2 7.4 1.9 0.0% 3.0% 3.1 3.7% 11.7 0.6 1.5 1.7 0. we think monetization will improve this year as ad budgets will likely result in more bidding for key words. Country-specific search engines also appear to be doing well.6% from 65.6 1.2 0.6 1.6 3.6 7.t.1% 3.1 7.8% 3. However.5% May-10 66. Finally. We anticipate a climb in search usage as consumers are still price-conscious and engage in comparison shopping.7 0.2 0.1 0.8% 3.3% from 1.7 1. While Google’s search market share has fallen to 62.8% at the beginning of the year. 34 .8% 2.2% 3.3% Aug-10 65. Domestic Explicit Core Search Market Share Google Sites Yahoo! Sites Microsoft Sites Ask Network AOL LLC Apr-10 66. Worldwide Market Share Trends On a worldwide basis.com Global Equity Research 03 January 2011 losing share.1 1. we believe that query volumes will grow 18% in F’11.COM TENCENT Alibaba.7 1.Imran Khan (1-212) 622-6693 imran.8 Apr-2010 63.7 3.6 1.7% 2.6 3.4% 16. however.2 7.1 0. we have begun to see our thesis regarding social media play out.6 1.6% 10.3% Oct-10 66. From a metrics standpoint.7 1.7 1.8 1.7 0.0 0.khan@jpmorgan. Global Search Expected to Grow 20% in F’11 We forecast that global paid search revenues will grow by 20% in 2011 on the back of 18% Y/Y growth in F’10.1 8.3 1.7% 11.2 7.9 Jul-2010 62.7 8.5% 3.8% 17.0 Jun-2010 63. Morgan estimates. while RPS will grow 2%.2 1.8% 2.6 1.5 2.com eBay CONDUIT.7 3. Tencent and Alibaba either maintaining or growing market share during the year.4% Jul-10 65.9 1.3% Sep-10 66.3 2.com Jan-2010 65.5 1.1 7.9 3.2 7.4 2.0 7.0 0.2 2.9 Oct-2010 62.4 1. we think some of this could be due to the shift to the Microsoft platform.4 3. with Baidu.P.1 1.4% 11.7 Mar-2010 63.8 7.7 3.3 1.1 7.3 0.4 7. Microsoft gains appear to be leveling off.3 1.1 7.8% 2.1% 16.1% Source: comScore data and J.1 Source: comScore qSearch data.4 3.6 1.4 2. Facebook has grown its share to 2.5% 11.0% 16.2 7.4 2.7 0.3% in the same period.8 May-2010 63.6 0.2 7.6 1.3 1.9 Aug-2010 61.9 0.6 0.9 Feb-2010 65.2 7.2 1.9 Sep-2010 62.8% 2.8% 2.7 0.6 0.8 1.

81 44.0% 28. and IWS.896 $74.474 $38.26 45.64 61.203 9% 09-’14E CAGR 1.8% 26.986 $72.1% $0.2% 17.6% $0.65 63.999 48% 2008 1.475 $34.304.1% 0.45 14.561 81 1.080 $81. flat with 2010 performance. On the monetization front.36 37.3% $0.46 21. Nielsen//NetRatings.5% $0.5% 0.14 in 2010 (a 1% increase). Nielsen//NetRatings.5% 25.86 62.1% 0.46 8.645 89 1.9% 0.4% Source: J.000 searches) % Coverage % Clickthrough Rate $ Revenue / Click US Search Forecast ($M) Y/Y Growth 2006 203 47 114.295 60 936.293 $70.64 61. J. we believe that international markets will be a key growth driver in the upcoming year.P.719 97 1.t.73 per 1.73 61.5% 21.153 18% 2011E 1.5% 27.37 70.05 43.2% 11.2% $0.4% $0.3% $0.2% $0.58 43.000 searches) % Coverage % Clickthrough Rate $ Revenue / Click Global Search Forecast ($M) Y/Y Growth 2006 1.0% 21.755 $34. driven by an increase in the number of searches conducted per user and a slight increase.020 36 441.5% Source: J.4% $0.4% $0.80 45.46 23. comScore.721 $35. up slightly from $70.47 14.385 67 1.9% 20.9% 0.22 62.8% 8. The international market is now larger than the domestic market.6% 25. company reports.36 31.5% 25.358 $33.37 44. comScore.37 61.0% 22.39 21.205 53 760.0% 25. we are modeling US query volume growth of 12% Y/Y in 2011 (a deceleration from the 14% we observed in 2010). IWS.718 13% 2012E 235 104 293.40 29. which should lead to higher keyword bids.45 16.511 34% 2009 1.6% $0. 1%. IDC.2% 25.520.0% $0.8% 10.758.639 1% 2010E 227 87 236. Although these searches admittedly have lower revenue per search (RPS).46 25.2% 25.32 61.110. company reports.0% 16. As smartphone uptake continues. US Search Expected to Grow 13% in F’11 We are now modeling 13% Y/Y growth in F’11.148 10% 2014E 243 120 348.0% $0.46 18.796 $33.3% $0.044 12% 2013E 239 112 323.3% $0.com Global Equity Research 03 January 2011 J.5% 21.47 11. we expect the domestic RPS to reach $70.482 73 1.509 14% 09-’14E CAGR 5.37 52. In our estimate. IDC.03 44. Thus.14 61. we expect it to continue to be a large driver of growth.5% 21.8% -0.925 19% 2013E 1.606 16% 2014E 1. in the domestic internet population.188 $70.518 23% 2009 222 78 208.764 37% 2008 217 68 177.113 44 585.602 47% 2007 211 57 144.73 43.2% 0. Morgan’s Global Search Advertising Revenue Forecast Global Internet Population (M) Queries / Month / User Number of Queries (M) RPS (per 1. We think the largest driver will be query growth.5% $0.6% $0. we think usage of search on mobile phones is healthy and on the rise.8% 21. we believe international 35 . International Search Growth Accelerates We continue to believe the opportunities for paid search in the international marketplace are even more significant than in the US.9% 10.938 $81.P.58 44. Broken down by metric. We expect higher levels of RPS in 2011 to be driven by stabilization in advertisers’ budgets.395 $37.6% 21.000 searches in 2011.759 $71. Morgan’s US Search Advertising Revenue Forecast Units as indicated United States Internet Population (M) Queries / Month / User Number of Queries (M) RPS (per 1.59 62.573 13% 2011E 231 95 264. reaching $21B in F’10E. while the UK is at par with or ahead of the US market.135 $71.097 $33.6% $0.835 63% 2007 1.47 43.37 14.4% 0. the overall international paid search market is still 2+ years behind the US in terms of development.648 $70.Imran Khan (1-212) 622-6693 imran.P. We expect mobile search usage to be the main driver of query volume growth.586 7% 2010E 1. Morgan estimates.999. Morgan estimates.7% 21. While we expect the US to experience query growth of 12% Y/Y in 2011.P.khan@jpmorgan.909 $35.413 20% 2012E 1.

8% 0.827 $24.996 $25.406 85 1.31 16.33 38.79 41.P.32 25.580 21% 2011E 1.Imran Khan (1-212) 622-6693 imran.7B.5% 0.993 46% 2009E 1.306 18% 09-’14E CAGR 6.98 41.233 90% 2007 903 41 441.27 38.5% 0. J.07 37.7% Source: J.khan@jpmorgan.650.30 6.6% 10.0% 19.19 38. IDC.2% 17.8% 3.923 $27.1% 0.4% 0.226.0% 19.com Global Equity Research 03 January 2011 markets will see a 19% Y/Y lift in the number of queries.74 38.3% 1.000 searches) % Coverage % Clickthrough Rate $ Revenue / Click Int'l Search Forecast ($M) Y/Y Growth 2006 817 33 326.585 $26.170 $23. IWS. Morgan’s International Search Advertising Revenue Forecast International Internet Population (M) Queries / Month / User Number of Queries (M) RPS (per 1.44 42.3% 21.251 69 1.536 $25. Morgan estimates.8% 0.33 10.71 39.458 21% 2014E 1.072 57 728. We are now modeling F’11 paid search revenue growth of 25% Y/Y to $25.33 45.476 93 1.947 13% 2010E 1.t.8% 0.882 24% 2013E 1.3% 18.55 39. Nielsen//NetRatings.804 $23. Accenting these gains are likely increases in foreign currency exchange rates.35 14.P.315 $23.5% 19.8% 0.326 77 1.4% 1.695 25% 2012E 1.235 64% 2008 988 49 582.435.8% 0.0% 19. We see international RPS growing 5% in USD.0% 19.33 31.5% 19.039.0% 19.5% 17.2% 0. 36 . comScore.158 63 873.900 $19. company reports.31 20.

103 5% 2010E 1.099 12% 2009 1.205 41 17.  Better integration of real-time consumer intent data.154 $1. First. comScore. in-line with our search advertising growth estimate.155 10% 2014E 1. However.858 $1. Growth in US Display Advertising to Match Search For a long time. we believe global graphical advertising revenues will grow 14% in F’11.561 48 27. we think that brand advertisers are latecomers to online advertising and that display advertising will make more sense for them to get their messages across.829 26% 2007 1. we believe page views will grow 12% Y/Y (driven by social networking and mobile devices) while revenue per thousand impressions (RPMs) increase 2% Y/Y.385 43 21.1% 1.06 23.371 14% 2012E 1.4% 11. From a metrics standpoint. we are starting to see signs of this trend reversing due to a couple of factors.P.97 13. reaching 1.Imran Khan (1-212) 622-6693 imran.09 34.khan@jpmorgan.645 49 29.777 $1. we think the following improvements would greatly aid the industry:  Interactive brand sponsorships.275 $0.986 $1. particularly in the premium space. Specifically.865 8% 09-'14E CAGR 5.602 $1. and that this rebound will continue into 2011.8% 4. IWS and IAB. search advertising growth significantly outpaced display ad growth as advertisers flocked to the proven performance model. We expect the global internet population growth to remain strong at 7% Y/Y.482 45 24. Second.909 $1. 37 .  Folding in purchase data for better targeting of branded ads. We Think Global Graphical Advertising Will Grow 14% Y/Y in 2011 We think that 2010 showed signs of recovery for graphical advertising publishers.113 39 15.t. This is essential to tapping into this growth opportunity.08 32.07 29. IDC. social network platforms continue to develop and mobile devices gain traction.146 11% 2013E 1.295 42 19.020 38 14. We expect this to be supported in 2011 as brand advertisers shift spend online from newspapers and TV to match audience viewing patterns. J. company reports. we think the display advertising industry needs to do a better job of educating clients and presenting clear metrics for the industry. which yield better content integration.07 17.000 pages) Global Graphical Forecast ($M) Y/Y Growth 2006 1. we see 2011 as a strong year for graphical advertising and are modeling 13% Y/Y growth. we note that social networking has had a large impact on viewership trends and that advertisers will follow the eyeballs.com Global Equity Research 03 January 2011 Display Advertising We believe that there was a resurgence in interest in display advertising in 2010.P.07 26.07 19. We think this trend will remain very strong as online video continues to proliferate. Morgan estimates.719 51 32. On the back of estimated 15% Y/Y growth in 2010. we see plenty of challenges continuing in the space. Nielsen//NetRatings.02 20.068 23% 2008 1. as we expected.0% 10. However. As discussed later. Thus. Morgan’s Global Graphical Advertising Revenue Forecast Units as indicated Global Internet Population (M) Pages Viewed / User / Day Total Pages Viewed (B) RPM (per 1. despite this positive driver.018 $1.6% Source: J.702 $1.5B in 2011.126 15% 2011E 1.

Morgan’s US Graphical Advertising Revenue Forecast Units as indicated United States Internet Population (M) Pages Viewed / User / Day Total Pages Viewed (B) Impressions / Page Total Impressions (B) CPM (per 1. IWS and IAB.25 $2.000 pages) US Graphical Forecast ($M) Y/Y Growth 2006 203 45 3.737 0.25 $1.000 impressions) RPM (per 1.20 $2.P.05 $1.307 0.25 $2.63 3. driven by flat growth in impressions per page offset by a 4% increase in cost per thousand (CPM).086 $3. page view growth will be driven by an increase of 2% in internet users and an increase of 7% in usage per internet user.218 9% 2014E 243 72 6. we are modeling RPM increases of 1% Y/Y. 38 . Morgan estimates. Google 10% Other 71% Source: Company reports and J.98 10.681 7% 2009 222 53 4.P. However.05 13.3% 10.438 $3.458 $3.671 $3.164 0.237 10% 2013E 239 68 5. We think this will accent increased broadband penetration and increased ad spend moving online.62 2.62 3. J.3% 8.02 11.Imran Khan (1-212) 622-6693 imran.150 $3. company reports.13 $1.50 1.7% Source: J.64 4.237 13% 2012E 235 65 5. 2010E growth of 15%.61 3.759 $3.15 $1. We are modeling RPMs to increase 4% in 2011. 2009 Global Display Market Share Yahoo! 8% Microsoft 5% AOL 6% 2010 Global Display Market Share Yahoo! 9% Microsoft 5% AOL 4% Google Other 71% Source: Company reports and J.05 12.95 7.890 $3.com Global Equity Research 03 January 2011  Time-based ads which leverage user engagement.P. up from 11% in 2010E.3% 9.99 7.  Creative ad formats with real-time updating for better targeting.2% 1.91 9. We expect the US graphical advertising market to grow 13% in 2011 vs.076 7% 09-'14E CAGR 1.khan@jpmorgan.385 0.608 0.60 2.045 15% 2011E 231 61 5.60 2. We believe that page views will grow 9% in 2011 (down only slightly from 10% in 2010) as social networking sites and blogs drive usage. Morgan estimates.577 0. Nielsen//NetRatings.P.166 23% 2008 217 50 3.8% 6. 11% International Growth More of a Driver in 2011 International markets will likely benefit not only from higher ad spend due to the macro economy but also from higher foreign currency exchange rates. We think page view growth will hold up and reach 13% Y/Y in 2011.584 $3.61 2.6% 1.165 $3.847 23% 2007 211 47 3.t.75 5.50 $1. IDC.341 0.0% 2.83 7.881 3% 2010E 227 57 4. Morgan estimates. In our estimate.933 0. comScore.967 0.31 $1.

t.937 11% 2014E 1.439 $0. Perhaps even more surprising than its high penetration rates is the fact that online video usage is still growing at a fast clip.Jun.634 $0. comScore. Company reports. unique viewers grew 7% Y/Y while videos viewed grew an impressive 31%.134 15% 2012E 1. such as Facebook.000 20.902 24% 2008 988 39 13.000 30.378 $0. Online Video Viewer Trends thousands 40.406 46 23.82 14.1 hours per viewer. In October.000 180. Drivers of Display Advertising Growth Since the downturn.Nov .Sep.000.418 15% 2009 1.000 160.158 41 17.081 15% 2011E 1. Therefore.476 48 25.P.222 7% 2010E 1. However.Imran Khan (1-212) 622-6693 imran. We believe both performance-based marketers and brand advertisers are looking at three variables in determining their investment: reach.Jan. 185.072 40 15.8% 10. Nielsen//NetRatings.80 9.000 Videos (000) 39 .May .000.251 43 19. social networking sites.84 19.000 10.Oct2009 2009 2009 2010 2010 2010 2010 2010 2010 2010 2010 2010 2010 Total Unique View ers (000) Source: comScore data. the 175M unique viewers watched an average of 15. as of October 2010 almost 85% of the US web population had viewed a video online. we think 2010 was marked by a shift of quality video content online and thus believe ad dollars will grow in 2011. are more focused and have improved the self-service ad model.Jul. Although reach has been growing over the last few years.735 $0. With such great reach and engagement.925 $0.000.6% 3. Morgan’s International Graphical Advertising Revenue Forecast Units as indicated International Internet Population (M) Pages Viewed / User / Day Total Pages Viewed (B) RPM (per 1. Morgan estimates.6% 1.982 28% 2007 903 38 12.khan@jpmorgan. IDC. with Google reporting that it is seeing ~2B monetized views/week. Viewing videos online has become the norm According to comScore.Apr.P. On a per viewer basis.909 11% 2013E 1.470 $0.326 45 21.85 21.73 7. we think many publishers have focused on innovation to drive ad growth. Additionally. we are changing our outlook on the space and are bullish on online video ad growth in 2011.000 165.Mar.com Global Equity Research 03 January 2011 J.000 170.79 12.934 $0. our concerns about content quality caused us to be cautious on the space.172 $0. Online video advertising We think the online video advertising space is taking off.000.000 155.83 16.82 11. it is easy to see how this platform would attract the attention of advertisers.577 $0. content quality and performance measurability.789 9% 09-'14E CAGR 6.Dec.000 175.000 0 Oct. IWS and IAB.Feb.83 17.Aug.000 pages) Int'l Graphical Forecast ($M) Y/Y Growth 2006 817 37 10.3% Source: J.5% 12.

2.5% Viacom Digital. publishers and advertisers.Imran Khan (1-212) 622-6693 imran. 2. Google Sites. 69. according to comScore. Often. independently produced and made by professional and semiprofessional crews and production teams. in video ads. time guaranteeing viewership for any specific video the way television does in the up-front model. Additionally. We think the amount of premium and web video content is growing. or guess. Performance-based marketer interest We think performance-based marketers are solely focused on a measurable return on investment. Web video.khan@jpmorgan.5% Top Ten Sites. or for companion ads to allow the viewer to buy related merchandise. exercise segments or niche-specific informational videos (travel.com Global Equity Research 03 January 2011 Content quality is improving We believe online video can be classified into 3 groups: 1. 2. So far. 44. no advertising format seems widely accepted by users. such as howto videos. which video will be popular. Videos that feature content as information and education. it is very hard to tell. We do think that some videos are well suited to the cost-per-action (CPA) model. 4.t. 7. 3. We think this is a valuable opportunity to deliver highly relevant advertising at a great point in the purchase cycle. professional talks. post-rolls.3% ADAP. 3. etc. which includes videos uploaded on social networking or video sharing sites. performance measures are limited Many online video sites have experimented with video pre-rolls. Video ads accounted for 13% of all videos viewed and 1% of all minutes spent viewing video online. This makes it 40 . we think most of the ads are shown on a CPM basis.3% Fox . advertising breaks in the video and advertisements running concurrent with the video at the bottom of the screen. 2. We note that video ads reached 45% of the total US population an average of 34x during the month. User-generated content.4% VEVO. Videos Streamed Share of Top 10 Video Sites Hulu.9% Non-Top-Ten Video Sites. if not impossible.) would be excellent candidates for clickable overlays.7% BrightRoll. 2.4% Yahoo! Sites.1% Tremor Media.5% Ad formats are diverse. 55. Premium content. professionally produced by traditional media and entertainment companies.1% Microsoft Sites.3% Source: comScore data. September 2010. Video presents many challenges for brand advertisers We believe publishers have a difficult. 3. 2.TV.

targeting and managing their online media campaigns. We see this as an encouraging development as some of the control. A DSP is a system that allows digital advertisers to manage multiple ad exchange and data exchange accounts through one interface. we recognize that many page views are meaningless to advertisers unless user information can be gathered and ads targeted.  Folding in purchase data for better targeting of branded ads. Real-time bidding for display online ads takes place within the ad exchanges.Imran Khan (1-212) 622-6693 imran. Yahoo!. Conversely. Ultimately. we believe publishers need to do a better job of improving measurement so they can attract more TV dollars. down from 42% in August 2002. Specifically. While increasing user reach is half the battle.  Creative ad formats with real-time updating for better targeting. automation and measurement/analytic capabilities associated with search advertising are now being transferred to the display space. DSPs are becoming increasingly popular As a result of the fragmentation of inventory. we think the following improvements would greatly aid the industry:  Interactive brand sponsorships. Some Challenges Internet users have faced a large influx of inventory While portals were once dominant. Thus. Meanwhile social networking websites have experienced 44% Y/Y growth in 2010 to date (October) in minutes spent online and now account for 13% of time spent online. marketers can manage their bids for the banners and the pricing for the data that they are layering on to target their audiences. According to IAB/PwC data.khan@jpmorgan. which yield better content integration. impression-based revenue fell to 35% from 38% in the same period. need more measurement We see advertisers placing higher value on clear ROIs. demographic profiles and reach targets. This is clearly demonstrated in the ongoing shift toward performance in internet ad revenues. 2011 will likely be a year of innovation We think the display advertising industry will continue to do a better job of educating clients and presenting clear metrics for the industry. AOL and Microsoft accounted for ~19% of minutes spent online in August 2010. and by utilizing a DSP. In order to most effectively target the ads.  Time-based ads which leverage user engagement. performance-based revenue grew to 61% of total internet ad revenues in 1H10 from 58% in 1H09.  Better integration of real-time consumer intent data. demand-side platforms (DSPs) have become increasingly popular as a way to manage campaigns. 41 .t. publishers need to have access to user behavior on multiple sites to collect data and to repeatedly show ads to the user. We believe more advertisers will embrace display advertising with better measurement and ROI potential. Performance focus remains a headwind. demand-side platforms are designed to give advertisers greater control over pricing.com Global Equity Research 03 January 2011 difficult for publishers to determine pricing and for brand advertisers to strategically invest in videos to meet their content quality requirements. This fragmented audience not only makes it more difficult for advertisers to reach their target audience through only a few publishers but also makes it difficult for publishers to attract advertisers given their limited scale.

com Global Equity Research 03 January 2011 1H09 Internet Ad Revenues by Pricing Hy brid. Marketers appear to value targeted advertising as demonstrated by Google’s well-targeted search ads generating revenue per query (RPQ) more than double Yahoo!’s. We expect that this same principle will apply to graphical advertising and note that Revenue Science estimates a 15x CPM premium for behaviorally targeted ads.t. However. the industry has encountered some problems using behavioral targeting in getting the scale necessary for this to be effective for advertisers and to effectively fight off privacy issues. 42 . But. 38% 1H10 Internet Ad Revenues by Pricing Hy brid. only about 25% of AdSense sites are serving targeted ads. and it has been held out as a solution to declining CPMs for some years now. Monetizing non-premium inventory The concept of behavioral targeting is not a new one. founder of PrivacyChoice. Google is the latest to offer behavioral targeting capabilities in its interest-based advertising product launched in March 2009. 4% Impressi onbased.khan@jpmorgan. and a former senior VP at Yahoo!. Historical Pricing Model Trends % of total revenue 70% 60% 50% 40% 30% 20% 10% 0% 2005 2006 CPM 2007 2008 Performance 2009 Hy brid 1H10 Source: IAB Internet Advertising Revenue Report 2010 First Half-Year Results. 4% Impressi onbased. Performa ncebased.Imran Khan (1-212) 622-6693 imran. 58% Source: IAB Internet Advertising Revenue Report 2010 First HalfYear Results. chairman of Attributor. 61% Source: IAB Internet Advertising Revenue Report 2010 First HalfYear Results. according to estimates by TechCrunch and Jim Brock. 35% Performa ncebased.

75 .t.1.Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 Behavioral Targeting Effects on CPM 1600 1400 1200 80 70 12 10 8 Tier 1 $10+ Tier 2 $1-10 Tier 3 < $1 Revenue Science Targeting ~$10.khan@jpmorgan.00 .50 20 3 4 40 5 6 60 7 8 80 9 Web impressions Percent Source: Revenue Science presentation. 43 .00 Average CPM Dollars 1000 800 600 6 4 400 200 0 Traditional optimized ad network $0.50 .1.12.00 2 0 1 2 Exchange model potential benefits ~$0.

Mobile Subscriber Growth Is Slowing Subscribers in millions 240 235 230 225 220 215 210 205 200 Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation and March 2010 press release.khan@jpmorgan. Broadband Penetration Billions 6 4 2 0 2005 2006 Mobile Subscriptions Fix ed Broadband Subscriptions Source: adenyo presentation. 115M US households possessing at least 1 TV. + 3% May -09 May -08 226 233 Jan-10 234 Worldwide Mobile Phone vs.5 people to a household.Imran Khan (1-212) 622-6693 imran. the implications for carriers are somewhat less inspiring. Thus handsets and content experience are becoming as key to carrier growth as they are to handset manufacturers and content providers. 2007 2008 Internet Users 2009 2010 Mobile Broadband Subscriptions 44 .t.com Global Equity Research 03 January 2011 Mobile Advertising Mobile Phone Scale on Par with Television = Huge Ad Opportunity With approximately 233M mobile phone users in the US. we can claim that the mobile phone market is on its way to maturity. If we assume that there are 2. While this reach offers interesting possibilities to the advertising market. this would imply that almost 93M US households have a mobile home vs. Carrier growth is now dependent on winning customers from competitors or driving share gains through data service packages.

18% Non-smartphone Users. and game applications are showing the second-highest annual growth rate at 111% (comScore). camera. The top 5 activities on cell phones still relate to SMS. Only about 18% of mobile subscribers use smartphones according to Nielsen.com Global Equity Research 03 January 2011 There Is Much Room for Broadband Subscription Growth However. As these users are 3x as likely to browse the mobile web. unlike mobile phone subscribers. Smartphone Penetration by Country 60% 50% 40% 30% 20% 10% 0% 2010 N. and messaging services. mobile games now rank in the top 10 activities. and 2x as likely to send photos or videos (per comScore). Europe Middle East and Africa Asia-Pacific 2014 Latin America Use of the Mobile Web Is Becoming Mainstream According to Nielsen data the number of mobile web users has risen to 61M in 2009 (up 33% from 2008). we think smartphone penetration is key to mobile advertising growth. and more versatile data plans are driving this uptake.Imran Khan (1-212) 622-6693 imran.t. 2010. but this number is up from 13% in 2008. smartphone users are still growing at a healthy clip. better data speeds. 2012 W.khan@jpmorgan. America Central and Eastern Europe Source: adenyo presentation. We think improved hardware. 3x as likely to use a mobile app. 82% Source: Nielsen 2010 Media Industry Fact Sheet. Smart vs. 45 . however. Nonsmart Phone Penetration Smartphone Users.

3% 24.9 32.khan@jpmorgan.1% 13.9% 18.0% 15.0% 27. an amount of time that equals if it does not exceed that of PC users.5% 23. Furthermore. 46 .0% 41.3% 42. Mobile users access their smartphones across all times and days.3% 48.6 30.1% 18.6% 14. By Creating More Media Fragmentation.8% 30.t.1% 25.4% 111.7% 22.5% 19.com Global Equity Research 03 January 2011 Usage of Available Mobile Services Ranking 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Activity Sent text message to another phone Took photos Used network services for photos/videos Sent photo directly to another phone Received an SMS ad Changed to native ringtone Played games Set graphics with camera Changed to native graphics News or info via browser Transferred photo to PC Used email Captured video News or info via SMS IM Made own ringtone Listened to music on mobile phone News or info via app Uploaded video to computer Listened to music transferred from PC # Users (M) 138.0% 12. browsers were used by ~29% of US mobile subscribers according to comScore January 2010 data.2 % Users (of 233M cell phone subscribers) 59.9 67.Imran Khan (1-212) 622-6693 imran.3% 51. improved data speeds.3 visits per day.1% 7.7% 29. and more attractive data plans.8% 23. with strong web brands dominating mobile devices.1% 31.2 52 47.1 73.8% 33. who spend 27.3 42.9 57 55.8% 13.4% Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation. We think this offers advertisers an attractive pattern as ad rates and consumer reach should not be dependent on certain prime-time hours and days.5% 51.5% 63. Mobile Is Posing New Challenges/Opportunities for Advertisers and Content Publishers With better devices.4 55.1% 10.3 visits.6% 13.9 58.9% 29.2% 17.5% 9. On the more traditional content side.5minutes per day and average 2. Top 5 Mobile Websites and Video Channels 1 2 3 4 5 Websites Google Search Yahoo! Mail Gmail The Weather Channel Facebook Video Channels YouTube Fox Interactive Media The Weather Channel Comedy Central CBS Source: Nielsen 2010 Media Industry Fact Sheet.1% % Y/Y change 21.3% 29. Mobile users spend ~24 minutes per day on Facebook and average 3.3 28.6 105.7 46.5% 32.5 22.5% 9.5% 45. with slight peaks during the daytime and evening hours that are consistent with sleeping patterns.3% 84.3% 20.3 24. content and service providers have been able to recognize distinct growth in usage.9 31.1 21.3 40.4% 14. branding remains key.

Bottom line We think mobile web browsing is creating even more fragmentation in media consumption. In our opinion. Historically. Surprisingly. all day ) Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation.khan@jpmorgan.com Global Equity Research 03 January 2011 Segments by Day of the Week subscribers 4600000 4400000 4200000 4000000 3800000 3600000 3400000 Sunday Monday Tuesday Wednesday Thursday Friday Saturday Source: comScore. March 2009. content publishers (both new and traditional media) need to be aggressive in reaching out to the mobile audience as it will assist them in bolstering their main platform. March 2009.t. Feb 2009. Segments by Day Part subscribers 6000000 5000000 4000000 3000000 2000000 1000000 0 Early Morning (MF 6am-8am) Day time (M-F. 11pm-6am) Weekends (SatSun. early data indicate that mobile usage is actually providing a site visitation lift rather than cannibalizing the existing internet site visitor base.Imran Khan (1-212) 622-6693 imran. 8am-5pm) Ev ening (M-F. comScore found that the business directories category actually saw a 3% site visitation lift due to mobile visitation. we learned that not having a web 47 . 5pm-11pm) Late Night (M-F. Cross-Platform Website Reach Directories % Mobile users accessing content via PC 64% 28% 43% 64% % PC users accessing content via mobile device 2% 1% 4% 5% Site visitation lift (Increase in internet site visitor base due to mobile visitation) 1% 4% 6% 3% Google Yahoo! Yellowpages. In a cross-media panel conducted in February 2009.com Business Directories Category Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation.

t. failure to understand the mobile audience could lead to market share loss for producers and advertisers. 31% 28% 16% 12% Radio TV Online Still Very Early Stage of Mobile Ad Adoption Cycle It is not a large leap of logic to conclude that advertisers will be attracted to mobile media as cell-phone adoption has reached critical mass. We note that.Mobile Usage Only Accelerates this Trend 35% 30% 25% 20% 15% 10% 5% 0% Print Source: Yahoo! 2010 Investor Day presentation. well over 50% of cell-phone users take advantage of non-voice features.com Global Equity Research 03 January 2011 presence early in the internet life cycle hurt many traditional media companies. we also think 2011 will still be an experimental year in mobile advertising as advertisers are forced to deal with the variety in devices and capabilities and the fragmented usage of SMS. browsing and applications. In the same way.Imran Khan (1-212) 622-6693 imran. ad spend is shifting to better reflect user behavior. However. and smartphone launches and consumer purchases are increasing exponentially. we think failure to establish early mobile leadership could hurt content aggregators and publishers. 48 . Time Spent across Platforms Is Becoming More Fragmented -. while there is still a large gap between ad spend and time spent on a medium.khan@jpmorgan. At the same time.

applications and SMS.itu. Furthermore.com Global Equity Research 03 January 2011 As the mobile time spent grows. we think the space will be able to attract ad dollars similar to the way the internet did. 2009 50% 40% 30% 20% 10% 0% Print Radio Time Spent TV Online 26% 12% 16% 9% 39% 31% 28% 13% Ad Spend Ad Spend Source: SRI Knowledge Networks.t. There Is a Clear Correlation between Internet Ad Spend and Broadband Penetration 25% 20% 15% 10% 5% 0% 2005 2006 2007 2008 2009 Broadband Penetration of Total US Population Internet Ad Spend as % of Total Source: “Advertising Expenditure Forecast. When looking at the relationship between internet ad spend as a percentage of total ad spend in the US and broadband penetration growth. http://www. comScore estimates that subscribers are pretty evenly divided between accessing content through browsing.int/ITU-D/ict/statistics). 49 .P. Ad Spend vs. 2003 60% 50% 40% 30% 20% 10% 0% Print Radio Time Spent TV Online 23% 7% 27% 8% 24% 14% 3% 52% Ad Spend vs. We think that this may be indicative of the pattern mobile ad spend will follow as smartphone adoption increases.” ZenithOptimedia. 3/04. Right now.cia. we notice that there was an inflection point in ad spend when broadband penetration traveled north of 20%.P. of the top search and portal sites Google and Yahoo! maintain the largest reach on mobile devices. Universal McCann 6/03 and IAB Source: Yahoo! 2010 Analyst Day presentation. Morgan US Internet Advertising forecast. we notice that there is a clear correlation. Time Spent.Imran Khan (1-212) 622-6693 imran.gov/cia/publications/factbook/index. Time Spent. and J. International Telecommunications Union (http://www. J. As in the offline space. Morgan estimates. we think both content publishers and advertisers will utilize all three platforms.html.khan@jpmorgan. As we expect users to continue to test these various platforms.

com Global Equity Research 03 January 2011 Lead Online Search and Content Provider Reach reach % within category AOL Google Microsoft Yahoo! Other Browsing 24. Feb 2009. In terms of the types of advertisers.6% 21.0% 2.5% Total 29.0% 12.Imran Khan (1-212) 622-6693 imran.8% 87.6% 28.5% 39. Mobile Display.2% 47.0% 14.6% Applications 27. nonmobile sectors are also adopting mobile banner ads.t.4% 50. However.0% 4.4% 82.0% 8.5% 30.5% 47. Resorts & Cruise Lines Education Serv ices Computer & Electronics Retail Internet Softw are & Serv ices Computer Hardw are Automotiv e Retail Div ersified Banks Apparel. We have subdivided mobile internet advertising into 4 categories: Message Advertising.2% 24.7% 35. With approximately 60M Americans now actively using mobile internet service.7% Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation.0% Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation.380 ad instances Braodcasting & Cable TV Automobile Manufacturers Communications Equipment Personal Products Wireless Telecommunication Serv ices Mov ies & Entertainment Application Softw are Hotels. Mobile Search and Video. & Lux ury Goods Internet Retail Adv ertising Specialized Consumer Serv ices Aerosplace & Defense Apparel Retail Household Products Food Retail Soft Drinks Publishing Leisure Products 0. May 2009 % share of 191. it is not surprising that mobile-related industries are dominating mobile banner advertising. Feb 2009. we think that the market has reached enough scale to begin to be attractive to advertisers.4% 22.khan@jpmorgan.2% SMS 24.7% 48. Top Nonmobile Advertising Industries.0% 16.1% 41. Accessories.0% 10. 50 .0% 18.2% 13.6% 54.0% 6.

5 16.500. Sep 2010.3 (36%) $2.0 $2.036.000.5 3.0 $500.1 (79%) $1.102. 2010.khan@jpmorgan.com Global Equity Research 03 January 2011 US Mobile Ad Spend Forecast $ in millions $3. direct spending on a message campaign and spending on promotional coverage of end-user messaging costs.000.500.000.549.0 (30%) $743. 2010. Global Advertising Spend $ in billions 35 30 25 20 15 10 5 0 2008 2009 2010 2011 2012 2013 7.5 (25%) US Mobile Ad Spend Source: emarketer.3 21.2 25.9 2014 Source: adenyo presentation.3 28.501.0 $1.0 $2009 2010 2011 2012 2013 2014 $416. Sept.8 (36%) $2.8 11. SMS advertising We think that mobile message advertising is currently the largest medium for mobile advertising as text messaging usage does not require high data speeds or advanced phone capabilities.Imran Khan (1-212) 622-6693 imran. Campaigns can include placement in text messages.0 $2.t. 51 .0 $1.4 (48%) $1. US Mobile Ad Spend Share by Format 2014 2013 2012 2011 2010 2009 0% 10% 20% 30% 40% 50% Display 60% Search 70% Video 80% 90% 100% Messaging Source: emarketer.

such as MobileSafari on the iPhone. are designed to bypass mobile websites and display full-size. eliminating the need for a special mobile ad network with different technology. or icons placed on WAP or mobile HTML sites or embedded in mobile applications such as maps or games and videos. we actually think CPC will grow as adoption increases.khan@jpmorgan. Thus.t. Unlike mobile CPM. this has meant about 1-3 ads at the top of a results page with the remainder down the right side of the page. the latest browsers. Some Opportunities and Challenges Impact on the Content Ecosystem Search News Sites Games Aggregators Opportunity more searches more targeted more product/place oriented reinstates the importance of a strong brand people download branded apps more time spent less barriers to entry slow loading speed will make aggregators more attractive to consumers reach larger audience with more available time high demand for video content while traveling larger audience than print can access for immediate demand Challenge less coverage less transactional (eCommerce) application demand less space to put ads companies with lower brand recognition will be less likely to sell apps multiple platform/device compatibility issues smaller screen/fewer buttons hard to differentiate in crowded app market less coverage apps allow consumers to create own personal aggregation smaller screen still run into internet issue of how to monetize may be harder to track source for in-store use Video Coupons Source: J. 52 . Mobile search advertising Mobile search advertising includes spending on sponsored display ads and text links that appear alongside mobile search results as well as spending on audio ads played to mobile phone callers making a directory inquiry (e. which specialize in delivering ads for phone browsers. In addition to high growth. Small screen Over time internet publishers and search engines have learned to balance the number and placement of ads on a page to maximize revenue with the creation of a user experience which would encourage repeat visits.. For search. We think mobile search advertising will be a high-growth area given its high volume and starting-point status.g. links.Imran Khan (1-212) 622-6693 imran. to GOOG-411 and 1-800FREE411. Morgan estimates. we see growth in mobile internet users and increased advertiser spend slightly offset by declines in CPM due to available inventory increases.com Global Equity Research 03 January 2011 Mobile display advertising Mobile display advertising includes spending on display banners. However. We think mobile display advertising will be a highgrowth area over the next few years as improvements to data-loading speeds and better phones fuel mobile internet usage.P. hi-fi websites and ads. the iPhone browser loads an ad the same way a computer does. We think that the trend toward these advanced phones will favor existing internet players which already have many advertiser partnerships. Early mobile display advertising was dominated by mobile-specific ad networks such as Third Screen Media and AdMob. we think that the mobile display market will also undergo a competitive shift favoring traditional internet display companies. However.

A recent key development which has been able to offset these small screen size concerns is the introduction of the iPad and the expectation of more tablet devices. the current default standard is applied. on the iPhone. with WBMP being the most basic (and the most common). JPG. LG VX-8500 Chocolate Motorola RAZRs. a role that is pretty much absent online. We note that. However. WAP 2. with AdMob estimating that mobile CPCs averaged about 11-12 cents and mobile CPMs around $12-$14 in 2009 (Business Insider. GIF and BMP.0)..com Global Equity Research 03 January 2011 For quality publishing sites. Many content publishers have resorted to putting a small display ad in a long narrow bar format (taking up about the same amount of space as a search text ad). There are hundreds of handsets in the market. We think these devices will help spur mobile advertising. the MMA notes that the biggest difference between buying mobile web display ads and internet display ads is that mobile web ads are not sold by unit size. typically PNG. ad readability. As a result publishers and ad networks will likely request advertisers to provide multiple versions of the banner with mobile web campaigns. MMS. This is particularly true in the case of mobile operators. This problem has resulted in significantly lower coverage on both content and search results pages. on mobile phones. To create the best experience for both consumers and advertisers. LG VX-8000. However. where anyone can publish content without negotiating with an ISP.t. For color images. Dec 2007.7 inches (diagonally). we note that the greater load times on mobile devices makes users less likely to click on ads and thus the greater pricing is more than offset by lower coverage and click-through rates. On average. we now see about 1 large ad and 1-2 smaller ads discreetly placed around the content. Google and Yahoo! are putting only ~1-2 ads at the top of a mobile search results page with ~2-3 more at the bottom (much scrolling is required to see these). the size of mobile web banners are optimized to best fit the handset on which the ad is being viewed to maximize the user experience. Multiple-player value chain For advertisers.khan@jpmorgan. Handsets Display and Corresponding Ad Images Handset X-Large Large Medium Small Approx Handset Screen Size (pixels) 320 x 320 240 x 320 176 x 208 128 x 160 Example Handsets Palm Treo 700p. Motorola ROKR E1 Motorola V195 Ad Size (pixels) 305 x 64 215 x 34 167 x 30 112 x 20 Source: Mobile Marketing Association Mobile Advertising Guidelines (North America). Thus.Imran Khan (1-212) 622-6693 imran. In cases where the ad-serving system can’t identify the device’s capabilities. At about 9. We think some of this weakness will be offset by better pricing. Lack of a standard mobile platform The Mobile Marketing Association has published mobile advertising guidelines. another significant difference between advertising on the internet and advertising on mobile devices is the number of players in the value chain. creative flexibility and effectiveness.g. which possess a large degree of control of content distribution. we saw only one ad on the screen at a time. neither of these standards will work as one traditional search ad would occupy almost one third of the screen and one traditional display ad would take up the whole screen. but it is difficult to keep such guidelines current in such a fast-developing area. this device is still small enough to be considered mobile but large enough to show ads more similar to those seen on a computer. and they differ by screen size and supported technologies (e. Nokia E70 Samsung MM-A900. June 2009). 53 .

74% stated that they preferred to search for local products and services rather than having ads sent directly to them. Typical Revenue Splits in Mobile Data Marketing/Deliv ery . 12% We believe it is fair to say that the mobile advertising market is still in the very early stages of development and that models for payment systems are still being worked out. However. Wireless Media Strategies. Consequently. marketing and delivery includes operators. Finally. . Publishers and aggregators are specialists who take content from multiple sources. test and validate that it operates on different devices and networks. 25% Publishing/ Aggregation. publishing/aggregation.khan@jpmorgan. Although the revenue split among players in the value chain varies with brand equity. Much of the user content in the mobile world (everything from ringtones to complex multiplayer games and location-based information) originates with a commercial entity. Design and development exists as a separate step in the value chain because existing content often has to be modified for mobile platforms. Provisioning and hosting includes providing hosting services that physically store and deliver content ordered from network operators. Often this step is made more complicated by the multitude of devices. 5% Source: Strategy Analytics.000 US internet users in 2007. AdMob (Strategy Analytics. design/development 12%. this is typically done on a work-for-hire basis. and marketing/delivery. User expectations According to a Nielsen/NetRatings survey of 2.t. and the desirability of having content available on many devices has to be weighed against the costs of making different versions for different handsets. there are very few standard practices. 2008). two thirds favored more targeted ads. and marketing/delivery 25%. Distribution of revenue for advertising within content is likely to be managed by the mobile operator or ad networks. OEMs (handset makers) and independent retailers. provisioning/hosting.com Global Equity Research 03 January 2011 We like Strategy Analytics’ model. Third Screen Media. Games originally intended for console or PC play may have to be redesigned or recoded for devices with smaller screens and less graphics-processing power.Imran Khan (1-212) 622-6693 imran. which breaks the value chain into 5 components: content ownership. price and promote the content to operators and other distributors. and create content bundles when appropriate. in general Strategy Analytics estimates that for every $1 of revenue. content owners receive 33%. publishing/aggregation 5%. design/development. such as Yahoo!. 92% said that they would be irritated by advertising on their mobile phones. 33% Design/Dev elopment Prov isioning/Hosting . 25% Content Ow nership. provisioning/hosting 25%. 56% of 54 . value-add attributes and proximity to the customer. When designers/developers create the ads themselves. Doubleclick.

In addition to the annoyance of receiving ads they don’t want. Early Leaders in the Field Phone OEMs According to comScore. 55 .1 0. users must deal with the fact that load times are much slower on phones and thus the time spent loading ads or clicking through to pages will be much higher on a mobile device than on the internet.khan@jpmorgan. these results demonstrate the importance of carefully targeted advertising.5 -0.1% Sep-10 23.t. BlackBerry 9530 Storm at 6% and BlackBerry 8100 Pearl at 5%. We think that people will use their phones to actively search for products and services. RIM still leads the market with a 37% share. Microsoft (10% share) and Palm (4% share). especially on a local level. However.Imran Khan (1-212) 622-6693 imran.8% 8.3% 7. 3-mo avg ending June 2010 Motorola LG Samsung Nokia RIM Source: comScore MobiLens. Samsung ranked as the top OEM.5% 21. followed by the Apple iPhone 3G at 15%.1% 18.7 When looking only at the smartphone market. Google (21% share). Jun-10 22. with ~24% of US mobile subscribers in the 3-month average ending September 2010. Apple iPhone 3G S at 12%. Research in Motion with a 9% share and Nokia with a 7% share. Motorola with an 18% share. Top Mobile OEMs 3-mo avg ending Sept 2010 vs.8% 21. BlackBerry and iPhone dominate.5% 8.1 -2. the BlackBerry 8300 Curve has the largest market share at 17%.2% 20.4% 9. Rounding out the top 5 were LG with a 21% share. Top Smartphone OEMs Blackberry 8300 Other 45% 15% Apple iPhone 3G S Blackberry 8100 Pearl 5% Source: Nielsen 2010 Media Industry Fact Sheet.com Global Equity Research 03 January 2011 respondents said they only get ads relevant to them when using the internet and 53% said the same of television. According to Nielsen data. Curv e 17% Apple iPhone 3G 12% Blackberry 9530 Storm 6% Phone Operating Systems (OS) Of the smartphone platforms (now totaling ~59M out of the total 234M mobile subscribers). followed by Apple (24% share).4% Point Change 0.7 -0.

there were six devices running the iPhone OS.khan@jpmorgan.9% 12.5 Android OS According to the most recent AdMob Mobile Metrics Report (March 2010).3% 24. However.7% Sep-10 37.1 1.6 1. iPhone OS According to AdMob data.5 1. The top three devices in the US were the Motorola Droid. iPhone OS traffic is composed of two device types: the iPhone (60%) and the iPod touch (40%).8 0. released in September 2009. 3 mo ave ending Jun 2010 RIM Apple Microsoft Google Palm Source: comScore MobiLens. followed by the secondgeneration iPod touch. the Android ecosystem is gathering ever-increasing penetration and diversity.5 -2.com Global Equity Research 03 January 2011 Top Smartphone Platforms 3 mo ave ending Sep 2010 vs. The second-generation iPod touch generated over 2x more traffic than the third-generation iPod touch.0 6.1 NA Manufacturer Motorola HTC HTC HTC Motorola Samsung Samsung HTC NA Resolution (px) 854 x 480 320 x 480 320 x 480 320 x 480 320 x 480 320 x 480 320 x 480 800 x 480 NA Keyboard Yes No Yes No Yes No No No NA CPU 550 MHz 528 MHz 528 MHz 528 MHz 528 MHz 800 MHz 800 MHz 1 GHz NA ROM (expandable) 512 MB (32 GB) 256 MB (16 GB) 256 MB (16 GB) 512 MB (16 GB) 512 MB (32 GB) 512 MB (16 GB) 512 MB (16 GB) 512 MB (32 GB) NA RAM 256 MB 288 MB 192 MB 192/288 MB 256 MB 256 MB 320 MB 512 MB NA Motorola Droid HTC Hero HTC Dream HTC Magic Motorola CLIQ Samsung Moment Samsung Behold 2 Google Nexus One Other Source: AdMob Mobile Metrics report. The most popular iPhone OS device in the AdMob network is the iPhone 3GS.5 2. only seven months later.8% 4.0% 4. iPhone 3GS traffic share increased from 30% in September 2009 to 39% in March 2010. 11 devices represented 96% of Android traffic in the AdMob network. HTC Dream and Motorola CLIQ. March 2010.Imran Khan (1-212) 622-6693 imran. Android Devices % of March 2010 Android Traffic 32% 19% 11% 11% 10% 6% 2% 2% 6% Operating System 2.3% 21.8 -0.t.2% Point Change -2. 56 .6 1.5 1. two Android devices (the HTC Dream and HTC Magic) represented 96% of Android traffic. In September 2009. The first-generation iPhone only generated 2% of iPhone OS requests in March 2010. as of March 2010 (prior to the launch of the iPad).4% 10.3% 14.5 1. Jun-10 40.1% 24.

those offered by Apple. we find that the average app store user comes from a higher income level than traditional online users. App Store Sizes total number of applications Window s Palm Nokia Android Blackberry Apple - 693 1. According to comScore research.998 20.450. Mobile World Congress 2010. 12% iPhone 3G.000 160. over 25.120 and 4. 39% Mobile Applications: A New Form of Content Consumption Within the first 8 months of the Apple App Store. We think apps have proven to be an interesting way for advertisers to reach an attractive consumer base through self-selection.756 150. Google comes in a distant second. 6.000 40. March 2010. respectively.452 6. with over 150. When looking at the user profile of the iTunes App Store.000 Source: Distimo presentation.000 60. Now more tech companies want to get in on the action. Nokia and Microsoft. More than half of app users come from households making at least $75K per year. Apple’s App Store has a significant advantage. 2% Source: AdMob Mobile Metrics report. RIM. Windows Mobile. Palm. iPhone 3GS.000 apps. with just under 20. Nokia and BlackBerry trail have 690. Ovi Store (Nokia) and others.t. 35% had a household income of more than $100K per year.000 140.000 80. and we have seen or soon expect to see Android Marketplace (Google).000 120. Palm. 20% iPod touch 2nd Gen. 2% iPod touch 1st Gen. March 2010 iPod touch 3rd Gen. 25% iPhone 1st Gen. SkyMarket (Microsoft Windows Mobile). BlackBerry App World (RIM). Mobile app analytics company Distimo has compiled its findings on the six largest mobile app stores.897 4.com Global Equity Research 03 January 2011 iPhone OS Handset Distribution.000 applications were introduced and over 800M applications were downloaded by users. 1. 57 . Google.000 100.khan@jpmorgan.000.Imran Khan (1-212) 622-6693 imran.118 19.760. 32% above that level for the average online user. For quantity of apps. Worldwide.

62 $8. Apple’s 14.000 16.000 4.khan@jpmorgan.000 new apps per month (9% growth).Imran Khan (1-212) 622-6693 imran.00 $0.00 $2.00 $8.000 12.000 10. RIM’s apps were the most expensive. Apps sold by Nokia.005 501 13. Mobile World Congress 2010. Android’s growth rate is faster (off a lower base). at an average of $7. 58 .00 $4. Apple.26 $6.000 14.50$3.53 Blackberry Android Nokia Palm Window s Source: Distimo presentation. In terms of pricing.000 8.47 $2. App Store Growth new applications per month (Dec 2009-Jan 2010) Nokia Android Blackberry Apple - 734 3. at an average of $8.00 $6. posting roughly 3. followed by Windows Mobile’s.60.000 6.000 Source: Distimo presentation. Paid App Price Comparison average price for all paid apps $10.000 new apps per month (15% growth) vs.t.99 $3. Google and Palm all came out in roughly the same average price range of $2. Mobile World Congress 2010.00.com Global Equity Research 03 January 2011 However.00 Apple $3.27 $3.865 2.26.

almost half thought there should be none at all (Cellular-News. App stores are the preferred distribution model for only 15% of North American developers. They offer plenty of options for targeting – e. Mobile World Congress 2010. 22% 32% 15% 57% 78% 68% 85% 43% 76% 75% 60% Paid 80% 100% 120% Monetizing apps We think that the majority of the best-known app stores have fallen roughly in line with the 30/70 revenue split introduced by Apple.) – but do not usually allow advertisers to choose specific websites.t. at the other extreme are networks focused on premium publishers. according to the Spring North American Development Survey of over 400 developers in April 2010. Premium networks focus on a limited number of high-quality publishers – mobile operators and big-name destinations – for which they act like an extension of their direct-sales team. Apple’s acquisition of Quattro Wireless and the announcement of the iAd advertising platform have ignited investor interest in the mobile ad space. Unsurprisingly. Mobile ad networks play an important role in connecting mobile marketers with mobile publishers. Mobile Ad Networks Google’s acquisition of AdMob. and while a third thought content restrictions were acceptable. At one extreme there are blind networks that work mostly on a cost-per-click basis. blind networks are usually the largest in terms of publishers. MobiThinking has divided networks into three categories based on business model. Because the mobile ad network space is still in its infancy. This means CPMs can vary greatly. Premium networks attract big-brand advertisers who are prepared to pay premium prices to secure the prime locations on top-tier mobile destinations. According to MobiThinking. with over half preferring direct sales to end users or enterprises. the market is very fragmented and there is no real way to estimate market share as there are no published revenue data. They serve a high volume of advertising to an extensive base of mostly independent mobile publishers (mobile sites and applications). much of the mobile inventory they sell is on Nokia or AOL sites. Paid Apps Window s Palm Nokia Android Blackberry Apple 0% 24% 25% 20% 40% Free Source: Distimo presentation.com Global Equity Research 03 January 2011 Free vs. over 70% thought that app stores should not impose any restrictions on price. advertisers and impressions.g.com). from $5 to $75. In the case of Nokia and AOL. etc..khan@jpmorgan. sports. supplemented by premium publishers’ unfilled inventory.Imran Khan (1-212) 622-6693 imran. which work mostly on a cost per thousand impressions basis. Finally. by country and by content channels (news. Advertisers should 59 . 80% of developers in North America think they should receive more than 70% of the revenue generated by their apps.

Publishers should expect to receive a majority share of advertising revenue.Imran Khan (1-212) 622-6693 imran. roughly 50%-70%.khan@jpmorgan.t. Following is a summary of a selective list of mobile ad networks based on MobiThinking’s Mobile Ad Network Guide.com Global Equity Research 03 January 2011 expect more direct sales and support and a multitude of targeting options. Deals are usually negotiated on a case-by-case basis. 60 .

India. Each ad deal is negotiated. predominantly.Imran Khan (1-212) 622-6693 imran.mobi and Nokia Internet Radio. Bouygues Telecom and independent publishers such as MSNBC. CPC and CPA Cost Range for Advertiser CPM ranges from US$5-US$25. US. depending upon region. class of publisher and targeting selected 61 . WA. Windows Live Hotmail and the Bing search engine NIA focuses on advertising on Nokia services. there is no self-service marketplace common with blind and premium blind networks Either CPM or CPC. Airtel in India and Sprint in the US International advertisers include Unilever. Southeast Asia. representing over 100 sites and applications # of Advertisers on Network Over 100/year Page Impressions Over 1B page impressions/month Geographic Coverage Primarily focused on the US.t. Africa CPM.khan@jpmorgan. Denmark. such as RTL in Germany. France Nokia Interactive Advertising 2004 Boston.000 different ads/month Americas. Brazil 52 premium publishers Microsoft Mobile Advertising 2007 Redmond. Belgium. depending on campaign objectives and parameters This varies according to how many impressions the advertiser buys. US Key partners include Verizon Wireless. Canada. US # Publishers on Network Over 75 publishers. DHL and Mitsubishi.50. Middle East. being a premium network From US$15 to US$75 CPM. MA. Europe. Germany. and works with strategic partners. European HQ: Paris.com/AOL 2005 HQ New York. CNBC and Fox Sports. such as Nokia. with growing presence in Canada. Italy. NY. However CPM is on average US$20 N/A Hands 1999 São Paulo.000 campaigns for over 350 brands Over 5. UK and other countries All of Brazil Pricing Model CPM. local advertisers include Loterias da Caixa and INPG N/A N/A Nearly 2B page impressions/month US. Sweden. top-tier publishers and operators.05US$0. Netherlands and Norway 100% CPM. Microsoft also selectively offers advertisers the option to purchase mobile media on a CPA basis In 2008 NIA ran almost 4.com Global Equity Research 03 January 2011 Summary of Mobile Ad Networks Year Established Premium Networks Advertising. France. CPC ranges from US$0. Spain. UK. Windows Live Messenger. Microsoft mobile sites include: MSN. GM.

depending on campaign requirements.Imran Khan (1-212) 622-6693 imran.3B impressions/month globally. but most are served in the US CPM for brand advertising (about 70% of business). 30% performance) Hundreds of campaigns running every week 7. USA The network includes thousands of sites. Walt Disney and Coca-Cola Over 500M page impressions/month This varies per region. CPC. Germany and France campaigns are run on a CPM basis. apps and carrier portals Over 500 premium and performance advertisers Monthly. Italy and France Pricing Model CPM and CPC Cost Range for Advertiser US$2 to US$15 CPM.khan@jpmorgan.000 to US$500. and premium can be as high as US$20 CPM Costs range from US$10. Offers both selfservice. MA. auction-based campaigns and premium managed campaigns. Vodafone.000 premium sites. Jumptap serves: 900M premium (CPM) display impressions and 8B performance (CPC) impressions USA 90%. Performance and run of network can be as low as US$0.000 per campaign. 10% other Madhouse 2006 Shanghai. Philippines and Vietnam 50% in UK. depending on country Advertisers include SAP. CPC for performance 62 .05 CPC.t. In the UK and Austria CPC and CPM are implemented N/A Premium Blind Networks Jumptap 2005 Cambridge (MA) USA Over 1. Austria. complexity and level of targeting CPM cost varies from US$2 to US$15 depending on a number of factors Varies depending on goals Millennial Media 2006 Baltimore. Malaysia. USA Quattro Wireless 2006 Waltham. China 1. with some exclusive partners Over 50 leading brands and 20 advertising agencies approaching 1B targeted ad impression/month 100% Mainland China. Indonesia. followed by Germany. CPA or a combination thereof Fixed ad position / time.4B impressions come from US consumers 4B mobile ads/month USA (85%) and Europe. MD. CPC for performance ads (30%) CPM for premium/brand ads. Mercedes. scale. Germany # Publishers on Network Major mobile operators in APAC. During 2010 Pudding expects network to be connected 10 major carriers in APAC Over 196 publishers # of Advertisers on Network 50 premium brands Page Impressions 100M page impressions/month Geographic Coverage Singapore. Quattro serves ads in nearly every country on the planet. CPM. Opel. of which 6. In Spain.000 publishers. but 80% of impressions come from Nielsen’s top 100 sites Thousands of sites and applications Around 300 advertisers/month on the network (70% brand. Thailand. Advertisers can purchase CPM. This varies widely.com Global Equity Research 03 January 2011 Year Established Pudding Media 2006 HQ Singapore YOC Group 2005 Berlin. CPC and CPA.

70% are mobile companies Delivers 3B ads/month Top 10 countries for Admoda: South Africa. MTV. but the vast majority is CPC. from mobile social networking to adsupported download sites. which represent 32. Indonesia (32%). India (8 percent). Reality Kings. Adidas.000 publishers. Dada. 63 . RIM. UK. Australia 4%. Admoda/Adultmoda turn down 70% of sites that apply to join the network Advertisers on Admoda include: Gameloft. Spain. US. Best Buy. Italy. Kenya. Toshiba. Africa 18%. Toyota and Jaguar Page Impressions More than 10B impressions/month. Zed. predominantly independent and mobile-focused. CA. Other (16%) 95% CPC CPC predominantly. CPC for performance ads. UK.000 applications # of Advertisers on Network Advertisers include Adidas. Top 10 countries for Adultmoda: US. France. determined by bids in the auction-based self-service market place For untargeted campaigns: average CPC across network is US$0.1B mobile ads/month BuzzCity Network 2006. the maximum bid price is determined by the advertiser’s bid.09 This varies between countries.400 ads/day Geographic Coverage US (49%). Over 150 4B ads served in Aug '09 ~10K unique visitors according to Compete in April 2010 (as cited by TechCrunch) Asia 55% of business. Americas 9%. India 2. Indonesia. Brazzers. US # Publishers on Network 9. Mobclix 2008 Palo Alto. France. Virgin and Coca Cola Source: MobiThinking’s Mobile Ad Network Guide.11. Gap.com Global Equity Research 03 January 2011 Year Established Blind Networks AdMob 2006 HQ San Mateo. UK (5%). Australia. Canada (2. Advertisers on Adultmoda include Private. Branded media sites use BuzzCity to fill unsold inventory Over 750 More than 200 regular advertisers.01. Germany. mConnect 2.4%).t. P&G. calculated through an auctionbased pricing system Cost Range for Advertiser The auction system calculates a CPC bid price that could start at US$0. India (5. South Africa. Europe 14%.000 Mobile Web sites and 3. India.1%). Australia – US$0. iPorn.20. Diet Coke.000 different ads/month and 9. Norway 200 countries in total: South Africa (34%). US (5%).03. United Kingdom – US$0.9%). Indonesia (3.7%) defined by ad requests (Oct 2009) Pricing Model CPM for brand ads. Germany. CPM prices fluctuate according with geography and availability of inventory This varies widely depending on the targeting options chosen Admoda/Adultmoda 2006 London Over 2. Fox. Australia. UK (4. Disney. company 1999 Singapore InMobi 2007 Bangalore. Crest. Netherlands. MTV. Buongiorno.9%). average CPC in South Africa – US$0. CPC and CPM are both available. American Express. others (34.000.khan@jpmorgan.Imran Khan (1-212) 622-6693 imran. CA. US 20+ ad networks Advertisers include Bank of America. Italy.

newspapers.7B to $15.9 million businesses with less than 50 employees. US Local Advertising Spend by Medium in 2010E Magazines. according to Borrell Associates.9B. according to Dun & Bradstreet.000 businesses in the US employing 50 employees or more. 24% Yellow Pages. Furthermore. 2% TV. comprise a significant portion of global business revenue. according to the Office for National Statistics. Historically.5B in 2007 to $73. 14% New spapers. according to Veronis Suhler Stevenson.khan@jpmorgan.t. local advertising is an ~$82B industry. Looking forward. we believe the internet is poised to gain further share within advertising. in Australia. 64 . TV. is projected to decline from $101. more than three million spent an average of $1. Over the same period. 33% Source: Veronis Suhler Stevenson. Of these. as well as their associated online platforms. magazines. there were 2.Imran Khan (1-212) 622-6693 imran. 7% Local advertising spend in the US through traditional media sources. contractors. local online ad spend in the US is projected to grow from $8. Pure-play Internet.com Global Equity Research 03 January 2011 Local Advertising Local Online Advertising Is a Small % of Overall Market In the US. these 15B SMBs represented approximately 62% of US business revenue. there were ~1. 6% Radio. and out-of-home media. as a result. including yellow pages. we think internet companies will increase their efforts to unlock the local dollars revenue stream. 14% Out-of-home.200 per month on advertising.6B in 2011. For example. J.P. According to Borrell Associates. given that nearly half of media consumption occurs online. SMBs: Spenders of Local Advertising Small and medium-size businesses. florists. with the remainder from the ~100. there were more than 15 million businesses with less than 50 employees in the US in 2008. with only ~15% of the total estimated to be spent online in 2010. or SMBS (including such businesses as lawyers. radio. SMBs have not been very well served by the major online advertisers and agencies. plumbers and auto dealers.4 million businesses with less than 20 employees in 2009. The picture is broadly similar in several other countries. small retailers. in the UK. Morgan estimates. to name a few). physicians. we expect ad expenditure to more closely parallel consumers’ time spent with media. Over time.

which are generally declining and difficult to transition online. such as Groupon. maintain and retain customers via the internet Provider of local online advertising services to SMBs. Group buying companies. Share of Local Ad Spend 50% 40% 30% 20% 10% 0% 2005 2006 2007 New spapers Source: Veronis Suhler Stevenson. Yelp) help customers find. 65 .P.5B of local ad spend is estimated to be spent with Yellow Pages in 2010. many of these services have a selfservice model which is not well-suited for local businesses. such as Google AdWords. representing ~14% of the total. including search marketing and optimization. respectively.g. SMB marketing platform providers. However. Social networking sites such as Facebook allow local businesses to create fan pages and are a useful way for SMBs to maintain contact with their customers. with newspapers. OrangeSoda and Web Visible. Technology-Focused SMB Marketing Providers Companies ReachLocal Yodle OrangeSoda Web Visible Description Provides a suite of online marketing and reporting solutions to help SMBs acquire. 24% and 14% of local ad spend. Additionally. Yodle. Group buying. also offers a white-label solution via partnerships Offers a software-as-a-service (SaaS) technology aimed at SMBs’ marketing needs Source: Company reports and J. offers marketing services including search engine optimization. pay-per-click advertising and search engine maps optimization. These companies provide local advertising services to SMBs. connect with and review local businesses.. site setup and call tracking Local internet marketing company aimed at SMBs. and online review sites (e.Imran Khan (1-212) 622-6693 imran. Morgan. television and radio comprising 33%. social media and review sites. roughly $11. Examples of these include ReachLocal. they are beholden to legacy businesses. Pure-play internet players Internet publishers and search engines. including search and display advertising.com Global Equity Research 03 January 2011 Major Players in the Local Ad Market Traditional media sources Traditional media sources represent the largest players in the local advertising market. These websites offer services for local targeted ads. and search engineoptimization.khan@jpmorgan. 46% 45% 42% 39% 36% 21% 14% 22% 14% 33% 24% 14% 18% 15% 19% 15% 20% 15% 2008 Telev ision Radio 2009E 2010E We note that while many of the traditional offline media companies have digital offerings.t.

the internet itself is highly fragmented. consumers used online sources for 64% of local business searches. Citysearch. and the owner is the primary source of revenue for the business. budget allocation.com Global Equity Research 03 January 2011 Rapid Changes in the Advertising Landscape Create Customer Acquisition Challenges The growth of local advertising spend has lagged the growth in online media consumption. We think most SMBs are unfamiliar with the process and lack the dedicated resources to allocate their spending given the fragmented nature of the internet. forcing advertisers to choose between thousands of websites and ad formats. Many SMBs often do not have the tools or know-how necessary to balance the spend between these varied media. directory sites. Online ad campaigns involve several steps. Complexity of online advertising. local SMB advertisers have faced the additional challenge of media fragmentation as consumer habits change. Most SMBs are owner-operated. SMBs spend just 11% of their ad budgets online. According to Forrester Research. consumers who used to read the newspaper are turning to online news sites. an online ad campaign generally requires constant tweaking to maintain effective performance.khan@jpmorgan. including account creation.) and searching on Google. keyword selection. etc. According to a TMP Directional Marketing and comScore Local Search Usage Study. Likewise. social networking sites or blogs.    Fragmentation a growing challenge Over the past several years. We believe the following factors have contributed to the lag in online local ad spend from SMBs:  Lack of time. Successfully advertising online demands familiarity with multiple forms of advertising and media: search. In addition to overall media fragmentation. roughly 50% of weekly media consumption among US adults is done online.” which is not an intuitive measure for SMBs to understand their advertising ROI.. Any results from time spent on an online marketing campaign are offset by the opportunity cost of lost revenue that could have been generated by using that time serving clients. Additionally. Whereas many consumers used to search for a local business in the yellow pages. social media. an estimated 15% of local advertising spent online). according to Borrell Associates (vs. 46% contacted the business owner over the phone and 37% visited the business following their online search. Lack of transparency. 66 .Imran Khan (1-212) 622-6693 imran. Lack of media knowledge. etc. display. sites such as Yelp. they are now increasingly using the internet (e.t.g. and of these consumers. In addition. etc. Much of online marketing is aimed at tracking “clicks. they have difficulty getting access to publishers or the right advertising inventory. However.

khan@jpmorgan. 67 . we think ReachLocal is well positioned for a local market that continues to develop.Imran Khan (1-212) 622-6693 imran. Given the challenges discussed above.com Global Equity Research 03 January 2011 Our Outlook for the Local Ad Market We believe 2011 will see continued increases in online local advertising spend.t.

khan@jpmorgan. we view the social sites (especially Facebook) as network platforms. plus improved micropayments capacity.g. or virtual gifts) and collect a small fee as the providers of the network. the site was still reaching only half of US internet users. Additionally. 2) robust app economy. User adoption continues to grow. and the category as a whole to become a significant portion of consumers’ online life. While Facebook is the ten-thousand-pound gorilla in the space. Facebook’s user reach is now north of 70% of all US internet users. there are not many major public companies that are primarily social. given our view on the disruptive potential of the space. Google In many ways. 68 . we are taking a longer look at this emerging field. which was ignored as a diversion by many observers (e. Expect significant revenue/user growth over the next few years. A year ago. Facebook now represents 10% of all US internet usage time. they don’t necessarily need to monetize directly from their customers: they can enable applications such as casual games (or payments. Outside Mail. Facebook is becoming the ten-thousand-pound gorilla of the internet.    Facebook Reach Now Comparable to Yahoo!. as reported by comScore. Social. represent a landscape-shifting opportunity. We believe linking the social graph with a platform for payments. and we believe it is a potentially significant disruptive factor to many existing businesses over the next five years. we expect social to be a key theme in the internet space.t. has emerged as a major medium of the web. In the second half of 2010. However. becoming a large traffic source.com Global Equity Research 03 January 2011 Social Networking Key Takeaways  Disrupting existing business models. experienced another very strong year of growth in 2010. and 3) scalable technology platform that makes it easier for users to connect and share. We think Facebook is beating MySpace and other similar platforms because of its 1) trusted network effect.ru and Tencent. like Visa/MasterCard. Social networks are platforms. or eCommerce. integrated into the social network landscape. As such. users are for the first time spending more minutes on Facebook than they are on Yahoo! sites. and over half of all global time spent on social networking sites. Additionally..Imran Khan (1-212) 622-6693 imran. We think such applications are one of several paths toward the successful monetization of social networks. advertising and commerce. As we highlighted in last year’s guide. the ’05 and ’06 editions of this report barely mentioned social networking). casual games.

Traffic Growth Accelerating. During the past decade. which posted 79% user growth and 106% growth in time spent through the first ten months of the year.t.P. Thus. which represented 63% of minutes spent worldwide at social networking sites in October 2010. An additional outperformer was the Russiafocused VKontakte. J. Source: comScore.com Global Equity Research 03 January 2011 Facebook’s Expanding User Reach 100% 80% 60% 40% 20% 0% Yahoo Google Facebook 79% 84% 79% 81% 48% 70% FB Minutes Surpass Yahoo!’s 14% 12% 10% 8% 6% 4% 2% 0% Users as % of US Internet % of All US Internet Minutes 12% 9% 4% 4% 5% 10% Yahoo Google Facebook Aug-Oct '09 Aug-Oct '10 Aug-Oct '09 Aug-Oct '10 Source: comScore.Imran Khan (1-212) 622-6693 imran. though several added users. with comScore estimating that minutes of usage across all worldwide social networking sites were up 48% Y/Y through the first ten months of 2010.khan@jpmorgan. Paid search drove the first shift in the early 2000s. just as paid search did. As noted in the table below. accelerating from the growth last year.. Morgan estimates. In the coming decade. there are strong players targeting specific verticals or geographies (e. while Facebook appears to be dominating more casual uses. J.ru (“in contact”). we think social can become a tollbooth for the internet. worldwide minutes spent decreased at most of the other key players in the social networking space. our view is that social is bigger than just Facebook. However. we think social. However. Note that the high US growth rates for VKontakte are coming off a very low base. the majority of the growth occurred at market share leader Facebook. rapidly transforming the web and creating/enabling previously unworkable business models. Facebook Not the Only Winner The growth of social networks in 2010 remained very strong. Morgan estimates. according to comScore. as a category.g. large though the site’s user base is.P. VKontakte). is poised to do the same thing. Specifically. 69 . we saw a fundamental shift in how people do business on the internet.

t. 2010 worldwide minutes spent.9% -42. The Tollbooth at the Center of the Internet The unquestioned champion of online monetization up to now has been Google.2% -25.5% -46. 70 .8% -6. We believe social networks are in a position to join – or even displace – Google.1% 246.7% -31. a majority could be described as nearly constant users.0% -92. which collects ~36% of all online ad revenue.7% 3. Data from comScore bear out this point: the daily user base of Facebook represents a percentage of its monthly traffic similar to those for Google or Yahoo!. Y/Y 134. Y/Y 73.9% -55.5% 28.P.5% Worldwide Minutes. Google has achieved this by efficiently bringing users to the sites they want to see.8% -57.2% 11. By comparison. Y/Y 62.8% -0. visiting the site at least once a day.9% -37.6% Facebook VKontakte Orkut MySpace Hi5 Bebo Friendster Classmates All Social Nets All Internet Source: comScore.khan@jpmorgan.9% 309. Note: sites ranked in order of Oct.8% -51. Morgan Internet Survey 2010. and User Time Growing Even Faster Y/Y growth in first ten months ’10 vs ’09.8% -9. Y/Y 174. as they play a variety of roles.5% -18.3% -51.1% 22.5% -14.3% -51.4% 9. As can be seen in the figure above. among those US internet users in our survey who reported using Facebook.6% -81.6% 15.2% 47.9% 15.7% -36.com Global Equity Research 03 January 2011 Select Social Networks’ Traffic: Users Growing Fast. Either Always or Never: More than Half of Facebook Users Visit the Site Daily 40% 30% 20% 10% 0% At least once a day Facebook Source: J.4% -38.Imran Khan (1-212) 622-6693 imran.4% 47. Amazon sees only ~9% of its monthly user base on a given day. 38% 8% Almost ev ery day 13% 1-2x a w eek 13% 1-2x a month 29% Nev er One key aspect to Facebook achieving a role as a user’s entry point to the internet is daily usage.0% -42.7% -50.4% -29.7% US Users.5% -69. select sites Users.3% Minutes.0% 78.9% 105.

Specifically. which opens a variety of monetization opportunities.khan@jpmorgan. which drives repeat usage. As with Google.t. We think this strategy maximizes the user experience. sites can be more open to the growth of the tools that are most effective. Morgan estimates. and using those connections. We believe social networking sites have the capacity to work in a similar fashion. These tools can be used to earn revenue. One benefit of such a platform strategy is that it encourages the social sites to allow the development of an ecosystem of applications without the need to pick specific winners. Social Networking Sites (Primarily Facebook) Are Becoming the Next-Generation Web Platform We think social networking sites are increasingly becoming web platforms. which benefit from network effects without a need to charge consumers directly.com Global Equity Research 03 January 2011 Google.P. 71 . we think a useful analogy is to look at payment networks such as Visa or MasterCard. of which the underlying platform site takes a cut. Data from Jul-Nov 2010. As a result.Imran Khan (1-212) 622-6693 imran. Yahoo! and Facebook Get Visited by ~40% of their User Base Each Day Average # of Daily Visitors/Average # of Monthly Visitors 100% 80% 60% 40% 20% 0% Google 42% 80% of US internet users go online each day 40% 41% Yahoo Facebook Source: comScore. J. On that platform. successful monetization is driven not only by the value of a social site’s own product but also by its ability to integrate communication. The sites aggregate their users’ social connections and provide a platform. entertainment and commerce resources in a valuable way. others can create tools (such as games or other applications).

On a revenue/user basis. eBay.com Analytics Comparison shopping such as shopping.P.P. Traffic source – A potential threat to Google? The last year has seen a dramatic shift in the volume of traffic driven to key sites by social networks. whereas – as of now – Facebook is bringing up the rear. Morgan estimates.0B is based on press reports. as cited by Bloomberg 12/16/10. For Facebook. Yahoo! and Facebook unique users from comScore.com Global Equity Research 03 January 2011 Social Networks as a Platform eCommerce sites such as Zappos. J. revenue estimate of $2.P. Globally. especially Facebook. Visa/MasterCard) Chase MasterCard Chase Visa Debit Card US Bank Visa Wells Fargo MasterCard Social Networking Sites Social Games such as Farmville Utility apps such as Birthday Cards & Horoscopes Business/Nonprofit apps such as Causes Communication tools such as Windows Live Messenger Source: J.ru. Morgan estimates. Bloomberg.com Google Content sites such as NY Times Windows Intuit MS Office Adobe Photoshop Payment Networks (e. Google remains 72 . At the same time. As seen in the figures below. Mail. monetization of social sites remains in a very early stage.khan@jpmorgan. Note: For public companies.ru Yahoo Tencent Baidu Facebook $189 $39 $24 $10 $8 $4 $4 $4 Rev enue per Unique User Source: comScore.g. Google. eCommerce sites appear to perform the best (though margins are less favorable). Google Generates 6x More Revenue per User than Facebook $200 $150 $100 $50 $0 Amazon Ebay Google Mail. Amazon. Morgan.Imran Khan (1-212) 622-6693 imran. F’10E revenue.t. We expect monetization to continue to improve as the model matures. Tencent and Baidu usage numbers are J.

Fragmentation heightens the value of discovery One of our core theses is that the web continues to become more and more fragmented. Morgan. many large blogs use the Disqus service for comments. there were limited news 73 .7% Google. Sources of Traffic to nytimes. In our view. +66% Oct-10 10% 5% 0% 20. -3% Oct-09 Source: comScore. Facebook. -2% Y/Y Oct-09 Source: comScore.9% 4.4% 2. At the same time.8% 11.8% 20.0% 19. As seen in the above table. Facebook Connect enables Disqus to let users maintain their identity across multiple sites. on a fragmented web. For example. The Recent Evolution of Discovery Medium Example Curator Fragmentation Limitation Traditional Newspaper Editor Minimal Interests of editors may not match readers’ Early Web Portal site Editor Limited User has to know where to look 2000s Web Search site User Growing User has to know what to search for Social Web Social site User’s connections Multiplying Lack of intent-based search Source: J. Alternatively. The result is better engagement at the other site and a relatively seamless user experience. social sites will become more crucial in enabling consumers to find and discover content.t. -2% Y/Y Oct-09 Source: comScore.P. In our view.4% 2. Incorporating such a social component can make reviews more compelling than when similar recommendations are made by strangers. Source of Traffic to Amazon sites 25% 20% 15% Source of Traffic to eBay sites 14% 12% 10% 8% 6% 4% 2% 0% 20.com and Amazon.Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 the largest driver of traffic to sites such as nytimes.8% 7.6% 1.6% 4. This enables users to use their Facebook login on other sites and to link their activity on such sites back to their profile. We believe that.7% 11. social networking both builds on and causes greater fragmentation. The company has reported that over 250M users are using Connect monthly. +81% Oct-10 Facebook Connect We believe a key driver of the increasing importance of Facebook as a traffic source is the company’s Facebook Connect initiative. Facebook.com 25% 20% 15% 10% 5% 0% Google.khan@jpmorgan. +328% Oct-10 Google. the portion of traffic coming from Facebook has increased rapidly.8% Facebook. Rather than forcing users to create a separate Disqus sign-in. this creates another growing point of potential competition between Google and Facebook. an eCommerce site can use Facebook Connect to enable users to comment on or review an item and then allow their friends to see it. in a traditional media environment.

However. the ability of a user to find relevant content was constrained. a Facebook advertiser creates a campaign to target a specific type of user. we think social sites can enable the success of an even more fragmented web.Imran Khan (1-212) 622-6693 imran. Including only eCommerce and travel. Potential to become a major payment network We view payments as one of the most significant growth opportunities for social network sites. However. As content began to shift onto the web. demographics Create ad copy. choose keywords. Facebook’s The difference between social discovery and discovery through search is manifested in the different ways that Google’s and Facebook’s ad platforms are built. link Target (geographic. rather than readers. J.P. We think social discovery can address this last point: users’ interests are likely to be similar to their friends. We believe the integration of a successful micropayments solution with a social site can be a 74 . with users who share interests helping each other discover content. without an effective discovery mechanism. Source: Company websites. bid type) Optional advanced settings for scheduling. link. user interests) Determine campaign budget parameters Finalize and pay. the addition of peer-to-peer transfers and other adjacent categories could drive the size of the pie even higher. it created more opportunities for niche sites and catering to personalized interests. magazines. Specifically. Morgan. online payments volume in the US alone exceeded $260B last year. On Google. demographic. triggering significant growth in fragmentation as thousands of sites catering to niche interests could count on search engines to help users discover them. Search engines helped to resolve this problem. Case Study: Starting an Ad Campaign on Facebook vs. advertising targets actions. image.t. TV networks). Google’s ad platform vs. the search paradigm is still dependent on a user knowing what to look for. set bid parameters Finalize and pay. the campaign must still be driven on the basis of specific keywords. so even if an advertiser seeks a specific demographic. ad rotation.com Global Equity Research 03 January 2011 sources (a few newspapers. and editors and producers. as per the figure below.khan@jpmorgan. were in the driver’s seat. As such. devices. Google Facebook ad creation flow: Create ad copy. Google ad creation flow: Create an Adwords Account Create Campaign (choose location.

as it would enable all sorts of online businesses to more seamlessly get paid by users. E. NPD estimates games to be a ~$15B market. Paying for games. While consumers have been conditioned to view online content as free. in order to pay such a small amount. a number we believe could rise if payments are integrated into the social sites that the games are being played on.. if a user is already logged into a social site.P. frequent Facebook visitors are much more likely to report playing social games than those who visit the site only occasionally.khan@jpmorgan. such a model becomes more likely. part of the problem is that there is no economical way to pay.    Social games In the US alone. the low cost of the platform allows games to be aimed at audiences that may be reluctant to spend several hundred dollars on a console but may be quite willing to spend small amounts monthly for a fuller experience in an online game. A simpler payments system speeds this process. by frequency of FB visits Source: J.g. However. As usage of social sites grows.  Paying for content.. enter credit card. 75 . As social sites become a more central part of users’ identities. and only needs to press a single button to make a payment.com Global Equity Research 03 January 2011 uniquely powerful solution. The growth of social game companies such as Zynga has been explosive. etc.Imran Khan (1-212) 622-6693 imran. A healthy payment platform combined with a site’s social graph could create additional opportunities. Paying for virtual goods.g. Additionally. Unsurprisingly. More than Half of Users Who Visit Facebook Daily Say They Play Social Games Use FB: At least 1x /day Almost ev ery day 1-2x a w eek 1-2x a month 0% 6% 10% 20% 30% 40% 50% 60% 20% 54% play games 38% % of users playing social games. Morgan Internet User Survey. only 1-5% of users pay for premium in-game features. 5c for an article – and a user is unlikely to create a login. e.t. users become more willing to purchase virtual goods (such as “flowers” to send to someone as a birthday present). Currently. we expect an ever-larger portion of this spend to occur on social platforms.. Peer-to-peer payments. an integration of a payments platform with a wish list could open the opportunity for all of a user’s friends to chip in a small amount for a birthday present. and we believe an improved ability to collect small payments for in-game items can be a catalyst for incremental growth.

ru has partnered with the social network VKontakte to incorporate social components into Ozon’s growing eCommerce platform. 39% 28% 16% 17% 5% 10% 15% 20% 25% 30% 35% 40% 45% 76 . Right now. Social commerce As eCommerce continues to increase its market share within total retail. and we believe both benefit significantly from integration with a social platform – where the reviews and recommendations can come from people a user already knows. Reviews and recommendations are two of the most powerful features of good eCommerce sites.khan@jpmorgan. Although 88% of the users we surveyed noted that they have bought something online.g. both of which have seen explosive growth in recent quarters. compared to 34% of male Facebook users. As noted above. personalization and links between eCommerce and social sites are driving the development of social eCommerce 2. according to NPD). the combination of social with eCommerce can manifest itself in social buying sites such as Groupon and LivingSocial. 39% reported they were not familiar with such sites. In a way. nev er used I hav e signed up. Even Among Online Shoppers. however. we believe reviews from friends and other contacts are a much more compelling source of product information than reviews from strangers. nev er bought Bought from such a site 0% Source: J. Our survey of US internet users suggests that social shopping sites are still in a very early stage of their development.0. in Russia. E. that user is a male 83% of the time.com Global Equity Research 03 January 2011 Whereas console video games tend to be largely played by men (when a console has a primary user. our survey suggests social games are somewhat more popular with women: 40% of female Facebook users in our survey reported playing social games. we believe social extensions of the eCommerce market ($166B in the US in F’10E) can be a catalyst for incremental growth and for market share shifts. Ozon.t.com. For example. LivingSocial was founded in 2007 and has said it expects to generate in excess of $500M in revenue in 2011. Further. we believe reviews represented the original implementation of social for eCommerce.Imran Khan (1-212) 622-6693 imran. Users of Social Shopping Sites Still a Minority Not familiar w ith such sites Heard of such sites.P. less than 17% said they had bought something through a social shopping site. The combination of the social graph with a high-volume review platform could create a promising ecosystem for companies like Amazon. Morgan US Internet User Survey. Even among only those users who have bought something online.

or 5% for $60K/year. and we view different social networks as offering a variety of options for personal communication. for the “fire hose” of all updates. Morgan US Internet User Survey. A site that can attract a more professional audience can generate higher cost per thousands (CPMs). For example.P. by selling its data: through a service called Gnip. and the same is true of those on the higher end of the income distribution. By contrast. By comparison.com Global Equity Research 03 January 2011 Age and income are strong determinants of users’ familiarity with social shopping sites. but nev er bought Communications A letter to a friend is inherently different from a letter to the editor. Digital gaming has grown at a ~36% CAGR since 2004 and now represents 41% of the worldwide games market. a site such as Facebook enables users to narrowcast their daily experiences to their circle of friends. Additionally. with its focus on real-time updates. in part. Understanding Social Games Globally. (Twitter has also struck deals with large players.khan@jpmorgan.Imran Khan (1-212) 622-6693 imran. digital gaming represented an almost $16B market in 2009. Twitter. services like Twitter could become more valuable for business. Familiar w ith such sites. up from 14% six years ago. And a site such as Twitter focuses much more on real-time updates – making it much more of a broadcast medium than the others. as we move toward a more real-time web. 77 . Younger users are much more likely to have used or heard of such sites. such as Google. can monetize the service. according to Electronic Arts.) The ability to monitor trends and problems in real time can be of value to managers of large brands. a professional networking site lets users communicate with colleagues and business partners in a less personal way. The difference in focus drives a difference in business models. it is possible to buy a “halfhose” consisting of 50% of all Twitter updates for $360K/year. with the pie projected to grow to nearly $20B in 2010. Younger and Higher-Income Users Much More Likely to Use Social Shopping Sites 75% 50% 25% 30% 0% Age: 18-34 15% 35-54 55+ 40% 48% 43% 3% Income: 38% 10% $0-$49K 19% $50K-$99K 23% $100K+ 48% 46% Bought from a social shopping site Source: J.t.

2 18. we believe casual online games generated in excess of $1B in F’10. An early product was a Texas Hold’Em Poker game for Facebook.com Global Equity Research 03 January 2011 Worldwide Games Market Seeing Rapid Growth.Imran Khan (1-212) 622-6693 imran. Key games include Pet Society. such as World of Warcraft. which has surpassed 60M users within a half year of its June 2009 introduction. the company has also developed games utilizing Disney brands. However. YoVille (which was acquired in mid-2008) and Farmville. such as ESPNU College Town.t. Restaurant City and Country Story (all on Facebook). Zynga San Francisco-based Zynga has reported significant growth in recent months. London-based Playfish was acquired by Electronic Arts for ~$300M (with another $100M in possible earnouts). Playfish In November 2009. with Business Insider reports citing industry sources as estimating the company’s annual revenue run rate at $600M.2 2010E Digital Games The majority of the revenue within digital games has historically come from massive multiplayer online (MMO) games. including Mobsters and Social City. Revenue generation for casual games Although the market is fragmented and largely driven by private companies (and thus reliable figures are hard to come by).khan@jpmorgan. Playdom’s key products include games for both Facebook and MySpace. add product placements to game. Since the acquisition. we believe the key opportunity going forward is in the more casual games that predominate on social network platforms. Playdom After several financing rounds in past years that enabled it to develop and acquire games. with press reports suggesting annual revenue of ~$75M as of the time of the deal. 19. Electronic Arts. more recent hits include Mafia Wars. Boosted by Digital Games 50 40 30 20 10 0 2004 Packaged Games Source: iResearch. Key companies Three companies stand out as providing some of the most popular applications for social network-based casual games. We see three key revenue streams for these applications. Playdom was itself acquired by the Walt Disney Company in a deal announced July 2010. 78 .3 28.9 3. Advertising How: Show ads to users as they play game.

we think a sufficient proportion can become more immersed in the games and would thus be willing to pay for incremental services. roughly 0. which opened its platform to developers.5% of its active monthly users pay for virtual items. which tend to be fairly small in size. 79 . We expect innovation in the area of micropayments as well as growing user comfort with making such purchases to drive growth in virtual goods sales.. Additionally. resulting in a disproportionately high payment processing cost if using a method such as credit cards. and (c) unless there is a very large advertiser base. as Lexulous). Please see the Online Payments section for further details. Scrabulous (a Scrabble clone that was shut down as part of a rights dispute with Hasbro. Although the majority of users will remain truly casual. or advertisers promote their products with branded giveaways – but such integrations can be hard to scale. can be a catalyst for innovation.khan@jpmorgan. it is easier to justify opening your wallet. we think there may be some revenue opportunity if game designers can build more creative integrations (e. CPMs go down as users are saturated with multiple impressions of the same ad. We think the monetization story is likely to play out in this area for game companies.Imran Khan (1-212) 622-6693 imran. Lead generation How: Users can activate advanced features in a game by providing information for promotional offers. but additional in-game features and resources can be activated at extra cost. cars in a Mafia game are of a particular brand). entry-level version of a game for free. We think some of the challenges for the ad-supported models are (a) the inventory is very low quality. Playfish recently reported that it sells 90 million virtual items daily (though most are likely to be quite inexpensive if not outright free).t. many games sell advertising. We think PayPal’s PayPal X initiative. According to the company. However.com Global Equity Research 03 January 2011 Discussion: This was the revenue model for the original hit game on Facebook. we think the social aspect of such games can be a motivator: if others in your network are paying for extra features.g. Discussion: Lead generation has brought (mostly negative) attention to the industry. then reincarnated. (b) users are not hugely receptive to advertising while playing games. with Zynga saying in a statement that it gets ~90% of its revenue from such sales. many of the game companies have raised their standards to cut down on egregious abuses of this process. Currently. but with less success. Virtual goods and premium services How: Users can generally play a limited. as press reports (including the technology blog TechCrunch) have suggested some of the revenue was being driven by deceptive marketing practices. Discussion: Sales of virtual items are believed to be the largest revenue stream for game companies. One challenge is that the current online payment infrastructure is not ideally configured for such sales. As a result.

Mobile apps turn this dynamic on its head by giving more power to the shopper.com is instructive: the site launched in 2005 and was bought by Amazon for $540M five years later. Retail Moving Online Less Quickly than Advertising Online retail has lagged online advertising in terms of market share gains. we think there are still tremendous opportunities for rapid growth. . However. during the same period of time. innovation and reducing friction creates a best-in-class user experience. while adoption of online shopping has moved at a slower pace. after achieving predominance in its vertical.9%. even instore. We continue to believe that pressure on traditional retail can accelerate eCommerce growth. At the same time. going from 2. . respectively. getting a customer in the store was half the battle for a retailer. size is an entry barrier We think the secret of Amazon’s success is highly unglamorous: an obsessive focus on execution. we see an additional tailwind for eCommerce growth. online commerce in the US gained a full percentage point of market share between 2006 and 2009. the sector represents less than 5% of all retail sales in the US and is even less developed in many other countries. Mobile eCommerce could further hurt brick-and-mortar retailers We think that the proliferation of mobile devices and mobile apps could have a profoundly negative impact on the business model of traditional retailers.t. including the continued rollout of broadband.com Global Equity Research 03 January 2011 eCommerce Outlook Key Themes Economic rebound + Secular market shift = Robust growth We believe that eCommerce is benefiting from several positive trends.2% and 18. suggesting significant runway still exists for incremental growth. and have a long way to go Even after several years of very robust growth in eCommerce.khan@jpmorgan. Amazon continues to gain market share.7%. pricing. the market share of online advertising more than doubled.9%. We think the experience of Diapers. the penetration could accelerate as consumer habits change. For example. going from 6. We expect F’11 US and global eCommerce growth of 13. We think that. We think many of the elements of the company’s success are creating virtuous circles that will enable above-market growth to continue. 80 .9% of all retail to 3. Historically. Therefore. .4% to 13. as the economic environment appears to be getting at least marginally better. Prime and Fulfillment by Amazon (FBA) are two such key elements. We’ve come a long way .Imran Khan (1-212) 622-6693 imran. increasing user comfort shopping online and the decline of certain brick-and-mortar retailers.

scale can give an advantage in auxiliary items such as cost to process credit cards.7% 2007 2008 2009 eCommerce as % of all US retail Source: US Census Bureau. A new entrant can thus find it difficult to offer competitive pricing on shipping.) Shipping infrastructure.1% 69.6% 30. the ability to purchase inventory on attractive terms is a huge competitive advantage. Morgan estimates. and highvolume online retailers benefit from several sets of barriers and scale economies that make for a very challenging competitive environment. Amazon operates ~50 fulfillment centers globally. 3Q’09 vs.8% 5% 0% 1..P.8% 2003 2. PayPal charges its smallest sellers 100 bps more than larger ones. J.t.khan@jpmorgan.4% 8.4% 3.com Global Equity Research 03 January 2011 eCommerce Penetration Lags Online Advertising 15% 10% 4.1% 5. 81  . A network of fulfillment centers enables a site to optimize shipping distance (and thus lower shipping cost) by delivering items from a location that is closer to the end consumer.9% 3Q'09: Source: comScore.5% 2005 2006 2. An enterprise eCommerce site requires a massive accompanying logistics operation. Online as % of all US Adv ertising Barriers to Entry Are Rising Ultimately. Top 25 sites All others 3Q'10: Top 25 sites All others We see several significant benefits to scale that combine to create challenges for new entrants:  Purchasing..6% 3.9% 5.1% 2004 2.5% 13. Because price is often a key factor in attracting customers.2% 6. Top eCommerce Sites Gaining Market Share in US.g. we believe eCommerce is very much a volume business.g. e.9% 10. This is manifesting itself in a larger share of the pie going to large eCommerce sites.4% 2002 1. Magna Global.Imran Khan (1-212) 622-6693 imran. 3Q’10 64. (And the largest sellers of all likely pay even less than the published rate card.4% 35. e.4% 3. Additionally.0% 6.

Mobile commerce We believe the increased penetration of smartphones could have a significant impact on traditional retailers by giving shoppers the capacity to comparison shop even as they’re in a retail store.Imran Khan (1-212) 622-6693 imran. Two such sites were Zappos and Diapers. Better site optimization and streamlining of the shopping cart process can drive improved conversion and thus reduce e-retailers’ sales and marketing costs. Bringing existing customers back to your site is a lot cheaper than the initial cost of acquiring a customer. a handful of warehouses). at most. At the same time.t. being able to amortize that initial cost over multiple purchases improves profitability and boosts the value of each customer. We believe the success of companies such as Amazon is driven in part by their successful use of data: both to optimize user flow through the site and to increase user value through tools such as a recommendation engine. we think success was driven by a high degree of vertical focus (shoes for Zappos and baby for Diapers). like most internet businesses. Optimization drives a virtuous circle. Small differences in site optimization can drive large revenue improvements at very low incremental cost. is highly data-intensive.com was getting more favorable supplier pricing on certain items than Amazon at the time of the acquisition. lower selling prices increase volume and improve the capacity for additional optimization. we believe Diapers. lower marketing costs can enable lower selling prices. scale can enable a site to buy keywords more efficiently than competitors.  Offline Pain Continues to Drive Online Gain We see three trends that affect offline retail in a way we think should be a positive for online retailers: Inventory management We believe eCommerce companies benefit from their less complicated supply chain: instead of needing to maintain appropriate stock levels at several hundred stores. We think this can create a virtuous circle: better conversion lowers marketing costs. We Expect a Continued Focus on User Frequency We think companies that are best able to use their existing customer data to optimize their operations are more likely to become the winners in the eCommerce space.com Global Equity Research 03 January 2011  Data. Specifically:  Higher customer lifetime value.g . even in an environment in which large sites have the advantage. Therefore. eCommerce.khan@jpmorgan. This suggests that high-touch business models for items with 82 . In both cases. both of which managed to outflank Amazon in key verticals and eventually ended up being acquired by the giant. Additionally. small sites certainly can and do compete successfully. which we believe enabled these companies to achieve better terms with their suppliers.com. Additionally. both sites created a unique buyer experience and thus were able to differentiate themselves in the minds of consumers. E. web retailers only need to worry about inventory levels at one warehouse (or.

For some of them. it is very difficult for a retailer to cover its higher overhead if it has to price items in line with an online-only retailer such as Amazon. Specifically. 83 . We believe some consumers establish shopping habits and relationships with retailers that can be difficult to break. changes in the offline world could result in lower convenience (e. which could drive greater adoption of eCommerce. In the medium-to-long term. Similarly.Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 minimal differentiation – such as media or electronics – are likely to be challenged going forward. we think thinning the brick-and-mortar herd could prove to be a positive for online retailers.. A bankruptcy can drive these customers.khan@jpmorgan. we think Blue Nile could see its market share increase as traditional jewelers struggle.   We think one significant winner is likely to continue to be Amazon. Brick-and-mortar bankruptcies A variety of brick-and-mortar retailers have gone through bankruptcy since the start of the economic downturn. As stores enter bankruptcy and close. the store nearby closes and now the closest store is too far away). which stands to gain from the decline of players in both its core media arena (given the difficulties for Borders) and in its growing electronics business (Circuit City et al. Upheaval changes consumer behavior. both online and offline. who would have otherwise been difficult to acquire. which could find it easier to win and maintain wallet share in a marketplace with fewer competitors.). We think offline bankruptcies can have the following effects on eCommerce:  Near-term pricing pressure.g. the push to liquidate inventory could result in margin pressure on the survivors. to examine alternative options and form new shopping habits.t.

Ritz Camera Centers Rock & Republic S&K Menswear Samsonite Saratoga Shoe Depot Shoe Pavilion Sportsman's Warehouse Steve & Barry's Swoozie's Inc. Note: # of stores closing as of the date of announcement of bankruptcy filing. J. Tello's The Bombay Co.Imran Khan (1-212) 622-6693 imran. more stores may have closed subsequently. Better Bedding Shops BI-Lo Blockbuster Inc. Loehmann's Max & Erma's McGrath's Publick Fish House Mervyn’s Movie Gallery (Bankruptcy) Movie Gallery (Liquidation) Mrs. F’07-F’10 units as indicated Company name A&M Carpet A&P Active Ride Shop Advantage Rent-A-Car Inc Appco Bernies Audio Video TV Appliance Co.com Global Equity Research 03 January 2011 Notable Retail Bankruptcies.t. Boscov's Department Stores Bruno's Chernin's Shoe Circuit City Claim Jumper Restaurant Crabtree & Evelyn Drug Fair Eddie Bauer EJ's Shoes Inc Friedman's Inc Gems TV Goody’s Gottschalks Gracious Home Hudson's Furniture Jennifer Convertibles Joe's Sports and Outdoor KB Toys Kiddie Kandids Levitz Furniture Lillian Vernon Linens ’N Things Liquidation Outlet Inc.P. Ultra Stores Uno Restaurants Urban Brands Value City Furniture Walking Company Whitehall Jewelers Wickes Furniture Product line(s) Home Furnishing Super Market Sporting Goods Car Rental Convenience Stores Electronics Home Furnishing Grocery Movie Rental Departmental Store Super Market Shoes Electronics Restaurant Personal Care Medical Departmental Store Shoes Jewelry Jewelry Apparel Departmental Store Home Furnishing Furniture Furniture Sporting Goods Toys Photography Furniture Direct Retailer Home Furnishing Discount Store Apparel Restaurant Restaurant Departmental Store Movie Rental Movie Rental Cookies Store Food and Beverage Camera Equipments Apparel Men's Tailors Luggage Maker Shoes Shoes Sporting Goods Apparel Paper Products Apparel Furniture Electronics Shoes Jewelry Restaurant Apparel Furniture Shoes Jewelry Furniture # stores 4 395 29 86 55 21 230 3306 50 66 19 775 126 371 15 473 355 21 6 19 154 31 460 76 500 45 106 20 150 4600 2666 1200 79 800 135 173 115 67 175 43 8 388 96 210 181 115 ~210 100 210 375 43 120 37 # stores closing 2 25 8 35 8 15 11 145 10 ~25 155 30 32 12 455 69 13 4 31 120 Bankruptcy filing date 2-Oct-09 13-Dec-10 23-Mar-09 8-Dec-08 9-Feb-09 14-Jan-10 4-Mar-09 23-Mar-09 23-Sep-10 4-Aug-08 5-Feb-09 2-Feb-09 10-Nov-08 10-Sep-10 1-Jul-09 18-Mar-09 17-Jun-09 5-Jun-09 4-Apr-08 5-Apr-10 9-Jun-08 14-Jan-09 13-Aug-10 21-Oct-09 18-Jul-10 4-Mar-09 11-Dec-08 12-Jan-10 27-Oct-08 20-Feb-08 2-May-08 25-Mar-10 15-Nov-10 23-Oct-09 3-Feb-10 29-Jul-08 17-Oct-07 3-Feb-10 15-Aug-08 18-Nov-09 20-Feb-09 1-Apr-10 9-Feb-09 2-Sep-09 27-Aug-09 16-Jul-08 21-Mar-09 9-Jul-08 2-Mar-10 19-Mar-10 15-Oct-07 19-Feb-08 7-Dec-09 9-Apr-09 27-Jan-10 21-Sep-10 27-Oct-08 8-Dec-09 23-Jun-08 3-Feb-08 177 520 760 400 30 84 38 3 90 12 16 90 43 Source: Company reports.khan@jpmorgan. Fields Penn Traffic Co. press reports. 84 . Morgan estimates. The Sharper Image The Walking Co.

likewise. over the course of the past year.. Additionally. augmented the level of fraud protection it provides in the US from $2K per transaction to as much as the full purchase price of the transaction.Imran Khan (1-212) 622-6693 imran. (An example is eBay’s PayPal. Better fraud protection. The promise of eCommerce has been one of lower prices and/or better selection. Germany and Austria have historically seen lower rates of PayPal use than other eBay geographies due to the prevalence of bank transfers as a mode of payment there. which has. significant differences emerge: e. Finally. The threat of fraud remains present. and structures that insure buyers against fraud should help smooth operations in an eCommerce environment that is not yet fully mature. PayPal uses such protection to create buyer confidence.t. we see three key challenges to overcome for eCommerce to fulfill its potential:  Improvement of shipping infrastructure. This is not a worldwide challenge but rather a slew of country-specific challenges related to the idiosyncrasies of different countries’ banking systems and conventions.com Global Equity Research 03 January 2011 Catalysts for International Growth We believe the rising tide of increased internet use across the world is likely to help lift eCommerce globally. Postal and parcel service in many parts of the world can be unreliable. We see several drivers that sites can use to reduce friction:  Free shipping.   We note that the above is not intended to be an exhaustive list of catalysts for international growth – many specific markets can present unique challenges – such as governmental ones – for the operation of eCommerce companies. Reducing Friction Is a Key Driver of Success We think part of the success of Amazon in gaining market share in recent years has been driven by a focus on reducing friction in eCommerce so as to provide customers with a seamless user experience. with the trade-off that many purchases must be made sight unseen. Additionally.khan@jpmorgan. Improved payment systems. we think a rebound in economic growth in the global economy can boost disposable incomes. with a very customer-friendly shipping and returns policy. and a reliable distribution channel is an essential prerequisite for the growth of eCommerce. orders with free shipping tend to carry a higher average order value. The growing prevalence of free shipping offers (usually with a spending threshold) is an indication that sellers see this as a key tool in their arsenal. with transaction loss rates for the PayPal unit of 24-33 bps. as denominated by total payment volume). as an indication of the way a site can benefit from reduced shipping-related friction. we see the success of Zappos. However. Korea has an idiosyncratic payment culture that prevents high PayPal penetration. especially in the developing world – thus creating a broader middle class and extending the audience of possible online shoppers. 85 . Even in more developed countries.g.

from a seller’s perspective. such as eBay and Amazon (and likely more tomorrow). aided by search engine marketing and comparison shopping sites. Tools such as PayPal. in May 2010. In 2009. we think a third-party business – where a smaller seller is often piggybacking on the reputation of a larger one – is especially fraught with complications. Third-Party Platforms Proliferating eBay was the original model for a successful third-party platform.khan@jpmorgan.com (and perhaps Wal-Mart as its stable of sellers grows) as well as their own sites.t. a seller needs inventory management. is becoming more complicated: inventory goes through large sites. Another tool available to retailers is better merchandising through personalized recommendations. and it’s not surprising we’re seeing more sites attempting to set up third-party marketplaces. While maintaining a positive experience is challenging for all online sellers. Amazon has gained on eBay. with the stated intention of developing an additional successful third-party marketplace in the US. we think price and selection continue to be critical. competitive pricing and broad selection (we think broader selection improves traffic conversion. We think these developments are emblematic of a secular shift toward a multichannel world. a significant portion of Amazon’s success in growing its third-party business has been driven by a focus on the customer experience.  A Multichannel Environment We think eCommerce. We think recommendation engines – as well as other optimization and testing tools – will continue to be a driver of incremental sales. On top of this. we now operate in a world where sellers put their inventory on eBay – but then also on Amazon and buy. without needing to re-enter data such as shipping/billing address and a credit card number). Over time. with the company taking on no inventory but providing a meeting place for sellers and buyers. speed up the checkout process and thus reduce friction. From the perspective of the big sites. eBay was the primary avenue for an online business to move merchandise. better seller tools that can tie these needs and platforms together become a near necessity.com. As a result. and especially PayPal Express Checkout (which allows a customer to pay with only his or her email address and password. More recently. and through your own site. Multichannel Whereas in the past. 86 .com Global Equity Research 03 January 2011  Easier payment. and now over 30% of the units sold on Amazon’s sites are sold by third-party sellers. The ability to lock in customers remains low (with Amazon Prime and eBay Bucks as possible exceptions). we saw Wal-Mart begin making an effort to expand its third-party capacity. making greater use of comparison shopping engines and search engines to drive traffic. email marketing and analytics. Giving the customers what they want. which is ever-important in a more fragmented web) are key to success.Imran Khan (1-212) 622-6693 imran. Getting third-party rights is hard In our opinion. Thus. Japan-based Rakuten acquired buy.

g. buying mostly overstocked or excess inventory from brand-name designers at a discount.. In a telling side note. Items are often launched on the sites at a specific time each day and frequently sell out quickly.J. The sites can then turn around and sell the merchandise to customers at a sharp discount to retail prices. some sites (including Gilt Groupe) give shoppers a limited amount of time to complete a purchase after placing items in their carts.com Global Equity Research 03 January 2011 The scope of differences between platforms was highlighted by a November New York Times report about an online seller that used obnoxious customer service to create negative attention. . thereby making them eligible for Amazon Prime and for Super-saver shipping. T. Conversely.” Key differentiator: FBA One factor differentiating Amazon’s third-party offering is Fulfillment by Amazon. We think these “shopping clubs” are likely to continue to attract high-end designers as the perceived exclusivity of the sites does not diminish their luxury-brand image. .t. Maxx or Marshalls) do not have an exclusivity or luxury connotation and thus are less able to attract luxury-brand designers. discount retailers (e. Many of these sites are concentrated in the apparel vertical. creating a rush similar to a sample sale (with no danger of physical violence). the article noted that the seller offered good customer service on sales through the Amazon platform. Additionally. . a program that lets sellers on Amazon have their items stored and shipped by the company. which generated better search results. Private Sales: A Growing Subsector Private sale sites are members-only sites that invite their members to short-term sales. 87 . home.Imran Khan (1-212) 622-6693 imran. food and local deals.khan@jpmorgan. the shipping rates for third-party sellers (not using FBA) on Amazon’s site are largely standardized. [it] just kicks you off its site if you infuriate customers. Additionally. depending on the type of product. though other types of products that have become increasingly popular include travel. because “Amazon doesn’t mess around . These sites follow a fairly straightforward business model.

as well as home furnishings and beauty products.  Increased investment activity The area has received significant attention from investors.com Gilt Groupe HauteLook One Kings Lane Rue La La (owned by GSI Commerce) Ideeli RowNine Woot Delight. NY Los Angeles. NJ New York. Sports Products. As a result of new funding. Gilt Groupe reportedly raised a total of ~$83M in venture funding from General Atlantic LLC and Matrix 88 . Travel. MA New York. Local Fashion & Lifestyle Brands. NJ Long Beach.com. Sales ~€800M ~$500M Sales generally last 1-3 days each Members pay $10 to make a reservation and secure exclusive pricing (typically 30% off your party’s bill) Source: Company sites. gym packages and spa services and travel getaways. France New York. Jewelry. CA Carrolton. Local Luxury Merchandise Luxury Goods and Accessories Other Comments European site with strong growth Likely largest pure-play US site Site advertises ~70% discounts to retail 48-hour sales Site advertises ~50-90% discounts to retail Site offers a “concierge” service for luxury shoppers “One deal per day” site featuring one product available for sale daily Offers daily deals Offers daily wine specials Site advertises discounts of up to 75% ~$100M Est. there has been a growing trend to expand into other product and lifestyle categories including travel. CO Springfield. beauty and local deals. Travel. Accessories. a local deals service site that offers weekly deals (at least 5 at a time) for various cities in the US. Further. Travel Designer Home Goods Designer & Luxury Goods. Homeware. a private sale site offering luxury travel and vacation packages. Fashion Accessories Wine Designer Fashion Apparel. Electronics Fashion & Lifestyle brands. in April 2010. press reports. NY Home Décor. The company began selling apparel and accessories on Gilt.com VillageVines Boston. Such deals include spa and beauty packages. The company began selling luxury clothing for women.com Global Equity Research 03 January 2011 Private Sale Companies Name Vente-privee.com Cinderella Wine SecretStyle Editors’ Closet TheTopSecret. TX Denver. HauteLook. NY Millburn.Imran Khan (1-212) 622-6693 imran. Gilt Groupe launched Jetsetter. the company introduced Gilt City. In the fall of 2009. CA New York.t. discounts to high-end restaurants and tickets to exclusive events. the company is introducing new categories including gourmet food and wine. NY Sunnyvale.khan@jpmorgan. Children’s Products Designer Sample Sales Food Location Paris. men and children. Category expansion While many private sale sites are concentrated in the apparel vertical. Examples of private sale companies that have expanded into new verticals include:  Gilt Groupe. CA Verticals Fashion.

0% 137.342 $41.749 8.00 255.00 204. the company is said to have recently received ~$15M in debt financing from TriplePointCapital.228 8.25 4.75 2.Imran Khan (1-212) 622-6693 imran. Social Shopping Sites The growth of social shopping sites such as Groupon and LivingSocial in recent months has received significant attention.6% 3. In addition.38 5.745 $43. company reports.4% Source: Department of Commerce.925 $43.0% 141. and (4) further improved efficiencies from site optimization.621 9. In June. we expect a greater proportion of retail sales to continue to shift online. for a more in-depth discussion of these sites.731 10.7% 2006 203 130 1. driven by (1) increases in product selection. respectively.P. December 2009 saw One Kings Lane.289 10.6% 4. Internet World Stats.88 2.124 1. Additionally.25 101. a home décor private sale site.0% 12. Additionally. the parent company of Rue La La (a private sale site) and SmartBargains.99 3. Both Gilt Groupe and Rue La La have over 2 million members. First Round Capital and angel investor Reid Hoffman.com (an off-price eCommerce marketplace) for a package of $180M and an additional $170M in earnouts. please see Over the Top.50 81.560 $46. in October 2009.791 15.6% 2010E 227 170 2.91 3.87 3. since last November.00 156. on social networking.0% 235.693 13.0% 114.890 3. Morgan estimates.445 23.00 125.1% 2013E 239 189 2.287 8.344 20.821 $41. After a year during which the growth of eCommerce volumes slowed down significantly in much of the developed world.710 8.00 154.90 2.45 5. 2011 eCommerce Forecast We think US growth in eCommerce will experience another year of strong growth.243 $44. F’10 saw a rebound in growth.2% 2012E 235 184 2.00 230. (2) continued Y/Y improvements online for brick-and-mortar retailers.0% 165.657 8.014 8. Usage and traffic growth Private sale sites continue to see strong member growth as current members continue to invite friends to join.475 25. On a Y/Y basis.207 8. bringing the total investments to $41M.0% 2008 217 153 1.8% 8.464 $41.0% 212.8% 2007 211 143 1.13 4.khan@jpmorgan.0% 187.281 $45.3% 2009 222 160 1. receive funding from Kleiner Perkins Caufield & Byers.50 149. though without the benefit of the easy comps that enabled midteens growth through most of 2010.9% ’10-’13 CAGR 1.0% 2011E 231 176 2.t.0% 73.558 2005 195 117 1. J.8% 3.0% 144. The rebound occurred despite a headwind from a stronger dollar.50 180. especially in areas such 89 . elsewhere in this report.764 9.069 $39. We think a continued economic recovery can help eCommerce growth.427 $45. HauteLook announced a $31M Series C round of financing led by Insight Venture Partners. GSI Commerce acquired Retail Convergence.5% 12.4% 0.0% 92. US eCommerce Forecast units as indicated US eCommerce Forecast Internet population (M) Online Shoppers Shopping sessions / shopper / month Total shopping sessions / year (M) Average price / session Total eCommerce revenue (US $M)) Product return rate Net Revenue Y/Y Growth 2004 186 104 1.253 13. which tend to be primarily promotional vehicles for offline businesses rather than direct competitors to eCommerce sites. (3) volatility and uncertainty in the offline retail space. unique users to the two sites have grown 94% and 33%.com Global Equity Research 03 January 2011 Partners.

Amazon ended its affiliate relationships in those states.2% 27. Forrester Research.903 352.948 21.P. Korea National Statistics Office. Japanese Statistics Bureau.4% Source: Department of Commerce.052 29. took similar steps.t. Both in the US and worldwide.078 41. Of primary importance among these is the growing adoption of broadband. Global eCommerce Forecast (Excluding Travel) $ in millions Global eCommerce Forecast US Europe Asia ROW Total Y/Y Growth 2004 73.970 428. (2) continued investments by online retailers in broadening selection. (4) improved payment systems. so long as members of their affiliate networks (who get paid a commission for driving sales traffic to the site) are present in the state.446 107. have started collecting the NY sales tax while appealing the ruling.511 20.8% 2009 144. which focuses on offering consumer value rather than the lowest available price. In 2009. TIA. 90 . Other states. Several companies. As a result. (5) better fraud protection.651 266. which are not visible until the checkout screen. Additionally.558 52. Going forward.690 32.014 323. the state of New York began requiring online retailers to collect sales taxes even if they had no physical presence in the state.216 210.387 54.953 73.9% 2012E 212. (3) improvements in shipping infrastructure.113 680.876 208. Overstock. Other factors include: (1) continued rises in online shopping penetration in Western Europe. as noted above.0% 2008 141.com.783 34.124 188.org.718 55. We think the lower transparency of sales taxes. eMarketer.Imran Khan (1-212) 622-6693 imran. Internet Sales Tax: Mostly Headline Risk In 2008. limits the impact on sales revenue in those states where a sales tax is charged.3% 2010E 165.693 210. especially on a site like Amazon.831 32.289 283. has chosen to drop its NYbased affiliates and not charge the tax. we believe the impact of such laws is limited.5% 2007 137.204 29. Jupiter.0% 2006 114.5% 29.811 572.193 41.569 25. and (6) the continued expansion of the global middle class. where eCommerce is already at a relatively higher penetration. we think the struggles of brick-and-mortar retailers during the slowdown will be a catalyst for eCommerce growth as established consumer habits are dislocated.274 9.890 175. Additionally. Amazon has seen very rapid growth in its international business.028 17. PhuCusWright.305 76. even though the company collects sales tax or VAT in all of its major international operations. ended up choosing not to enact similar sales tax changes.065 121.560 95.047 820.911 18.4% 13.660 963. including North Carolina and Rhode Island. notably Amazon. Morgan estimates.791 195. we expect the growth of eCommerce to benefit from several drivers. we think this FX impact is likely to be more muted.253 246. IDC. including most significantly California.440 159. some region-specific and some general. Internet WorldStats. which is much more conducive to eCommerce growth than slower forms of internet access.com Global Equity Research 03 January 2011 as the UK.344 134.450 13.475 72.963 481. several other states. In all.9% 2011E 187. Iresearch.khan@jpmorgan.502 273.702 2005 92. UK eStats. on the other hand.612 12. J.174 155.6% 2013E 235.430 24.635 18.494 18. company reports.7% 19.445 98.4% ’10-’13 CAGR 12.

’06). Private Labels Could Help Margins Private label items accounted for ~22% of sales at US mass.Imran Khan (1-212) 622-6693 imran. Aug. Drivers of Private Label Development Key Driver High Trade Concentration Channel Blurring Description The more concentrated the market share at retail. Drivers of private label growth Several factors can drive growth of private label offerings for traditional retailers. doing so carries certain risks.. import logistics. Amazon is offering private label goods in certain home categories as well as connector cables and recordable media. Best Buy. Category acceptance of private label will vary. retailers run in-stock risk due to a longer supply chain The consumer products company often manufactures or sources the private label product offered by retailers. Private label risks Although branching into private labels can be an opportunity to improve sales and margins.t.P. life cycle management.P. Noncore Skillsets Extending the Supply Chain Relationship with the Brand Manufacturer Eponymous Brands Description Traditional skillsets of retailers do not include product development.g. By direct sourcing. Aug. The share represented a significant increase over the prior year. However.. Chris Horvers. Horvers. the higher the potential penetration of private label Retailers have become brands in their own right. Already. which could strain the relationship between the two Own-brand merchandise that is named after the retailer creates overall brand risk if the product underperforms eCommerce Relevance Medium Medium High High Source: J. Morgan. we expect them to look at private label as an additional margin lever. estimates that private label products account for approximately 25% of sales at retail office superstores (e. 91 . but consumer acceptance continues to grow. One in four packages purchased is a private label product Direct sourcing and supply chain efficiencies have enabled retailers to replace undifferentiated national brands The higher the mix of consumables in an assortment. grocery channel offering seasonal products in response to mass marketers expanding into food) Slow turning. “Taking Stock of the Private Label Opportunity” (C.P. the higher the private label opportunity With increased competition from nontraditional sources. few online-only retailers have had the scale to bring private label products to market.g. J.com Global Equity Research 03 January 2011 As eCommerce Matures. according to Nielsen data.khan@jpmorgan. Private Label Risks Private Label Risks Core vs. food and drug retailers in the year ending July 2010. Horvers. quality control. In the past. Staples or Office Depot) and 10%-15% at large consumer electronics or home improvement retailers (e. “Taking Stock of the Private Label Opportunity” (C. as the industry matures and as more and more eRetailers start to attain significant sales volumes. ’06). etc. at times decreasing the relative importance of consumer product labels and taking mind share from manufacturers eCommerce Relevance Medium Low Mature.. some of these have a higher relevance to online sellers than others. Slow-Growth Categories & Markets Consumer Acceptance of Private Label Supply Chain Efficiencies and Global Direct Sourcing Mix of Consumables Relative Power: Retailer vs. Manufacturer High Medium Medium Medium High Source: J. Morgan. Home Depot or Lowe’s).g. Morgan’s hardlines retail analyst. as shown below. nondifferentiated brands can be replaced by higher-margin and better-value private label brands Private label has reached 100% of households in North America. retailers create private label product in other categories to differentiate their assortments (e.

wealthier users are more likely to be online shoppers and much more likely to be heavy users of eCommerce: 33% of those with incomes over $100K reported ordering 3 or more items online per month. The portion of those who reported shopping very frequently has also grown.com Global Equity Research 03 January 2011 Margin expansion opportunity For traditional retailers. 92 . 2007 and 2010. depending on the industry vertical and the specifics of the product. and ~100-800 bps of benefit to operating margins. The key points follow. including several questions that we had previously asked in a similar survey in 2007. Penetration and frequency growing As expected.khan@jpmorgan. only 80% of internet users reported they had bought something online in the previous year. a number that has grown to 88% in three years.P. Morgan Internet User Survey In late 2010.000+ bps gross margin improvement compared to equivalent items.002 US internet users through a third party.Imran Khan (1-212) 622-6693 imran. Online Shopping Gaining Penetration Question: How many times do you purchase items online per month? 40% 30% 20% 10% 0% Don't Shop online Buy less than once/month 1-2x /month 2007 3-6x /month 2010 7-9x /month 10x +/month 20% 12% 34% 36% 28% 32% 13% 15% 2% 3% 1% 2% Source: J. compared to only 13% among those whose incomes were below $49K.P. we surveyed 1. private label goods can generally drive 1. Unsurprisingly. Morgan Internet User surveys. We asked them many questions on eCommerce. the number of those shopping online has grown over time: in 2007. J.t.

Consumer electronics. computers & videogames. music and video. up from 45% in the survey three years ago. collectibles represented the only category that saw a decline from our previous survey. per month? 50% 40% 30% 20% 10% 0% Don't Shop online 19% 9% 6% 41% 35% 27% 27% 36% 34% 23% 10% 16% 3% 2% 6% 7-9x /month 5% 1% 2% 10x +/month Buy less than once/month 1-2x /month 3-6x /month $0-$49K Source: J. the category in which the greatest number of users reported buying this year was apparel & accessories. $50K-$99K $100K+ Apparel and media Media. up from 52%. Morgan Internet User survey. with 53%. and health & beauty also saw strong increases vs.t. it’s interesting to note that the portion of internet users who reported purchasing media items in 2010 was not far different from that reported by our users in 2007: 53%. the earliest successful online retail models.Imran Khan (1-212) 622-6693 imran.P. While media held a comfortable lead in penetration in 2007. were built around media.khan@jpmorgan. Therefore. 93 . the 2007 results. On the other hand.com Global Equity Research 03 January 2011 Higher-Income Users Shop Online More Frequently Question: How many times do you purchase items online. in a result reflective of eBay’s recent struggles. 2010. have long been the staple of online shopping. such as Amazon and CDnow. including books.

2% 36.0% 43. v ideos Apparel and accessories Comp.0% 2.0% 40. Price remains key As in the past.8% 9.P.9% 1. list in order of importance? (Ranked) 2010 results: Price Selection Promotions/Advertisements Customer Service Familiarity/experience with store Payment options Access to customer reviews/product info Name Recognition Ability to purchase multiple items Recommendations from friends/relatives #1 Factor 63. In fact.5% 7. & v ideogame soft & hardw are Health and beauty Electronics (incl.5% 3. compared to only 87% who did so when we asked a similar question three years ago. Price Remains Top Factor as Consumers Have Become Even More Price-Conscious Question: What are the 5 major factors when choosing an online store.4% 37. price was chosen as by far the #1 factor for online shoppers in choosing a store.1% Source: J. 94 . Morgan Internet User Surveys.com Global Equity Research 03 January 2011 Categories Shifting Over Time Question: Which items have you purchased online in the past year? Books.4% 42. TV & stereo equipmt) Toy s Home and gardening Sports and outdoor equipment Groceries.3% 5.3% 48.6% 2.9% 1.P.7% 1.Imran Khan (1-212) 622-6693 imran.9% 40.1% 38.0% 37.4% 18.8% 49.9% 5.1% 1. 2007 and 2010.7% 14.8% 33.4% 4.khan@jpmorgan.5% 2. bev erages & other food Tools and auto supplies Collectibles 2007 2010 0% 10% 38% 32% 33% 26% 29% 23% 25% 23% 20% 16% 14% 12% 14% 10% 12% 11% 11% 15% 20% 30% 40% 50% 53% 52% 53% 45% 60% Source: J.6% 5.1% 74.t.3% 85. music.3% 43. compared to the responses three years ago. online shoppers appear to have become even more price-conscious: 96% ranked price as one of the top five factors in choosing a store.9% 6. Morgan Internet User Surveys. 2007 and 2010.4% 41.3% 3.1% Top 5 in 2007 Survey 87.3% In top 5 96.7% 23.0% #2 Factor 14.9% 46.3% 44.

Banks granted access to such funds to a limited number of legacy networks including ACH (used to settle checks. both helping the incumbents increase volume and beginning to compete with them for market share. Thus.com Global Equity Research 03 January 2011 Online Alternative Payments We thank J. Consumers trusted the banks with their money. Therefore. since they lack critical mass (chicken-and-egg problem). notably banks. 95 . since the greatest value add seems to come from adding value to the utility rather than replicating it. Amex. Where the Money Is McKinsey estimates global payments revenue reached $914B in 2009. PayPal. which was traditionally (and logically) dominated by entities consumers trust to hold onto their money. Not a lot of room on the pedestal Visa and MasterCard control ~80% of US card volume.P. for his contribution to this section. and deal with complex regulatory requirements. we believe new entrants into the space will largely be built on top of the existing payments infrastructure. carriers. However. to gain meaningful traction as a payment solution. The internet has rapidly created demand for alternative solutions. Morgan’s computer services & IT consulting analyst. and mobile person-to-person (P2P) money transfers are all in early stages of adoption in the US.Imran Khan (1-212) 622-6693 imran. including Amazon and Google. A nearly trillion dollar business is no place for a revolution Newer payment networks benefit from having attractive relationships with consumers. existing payment networks. Key Themes From top down to bottom up Historically. ATMs. They also enable much of the activity for the sole online-only player.The bottom line is that providing payment services at scale is hard for new players. often built to satisfy specific consumer needs. device makers.). must build trust. We think social networking platforms such as Facebook have the potential to create payment platforms of their own. to enter the space .t. and banks acted as a gatekeeper for those funds. existing players have access to consumer funds and maintain merchant relationships that have taken decades to develop into a business that generated $914B in 2009. and such solutions are now on the payments map. MasterCard. Contactless/near field communications (NFC) payment solutions. direct debits. Discover). it’s hardly surprising many new entrants have tried to crack into this space. despite attempts by deep-pocketed players. key growth area for 2011 Many of the entities that have a window into the space – banks. and debit/credit cards (via Visa. and we think the number of winners will be determined by those who can effectively meet consumer needs and at the same time cooperate with established payment networks. Tien-tsin Huang. mobile eCommerce. mobile banking. the payments ecosystem was designed by banks and reflected their needs.khan@jpmorgan. etc. Mobile opportunity is vast. online communication networks – are already running pilot programs to ensure a foothold in what is widely expected to be an area of rapid growth.

However.P. Newer platforms are built on top of direct consumer relationships.Imran Khan (1-212) 622-6693 imran.khan@jpmorgan.t. and thus catered mostly to their needs. Social Networks We think this new environment enables business models that are more focused on the consumer. consumption is becoming more digital on large network platforms that consumers frequent more often than their traditional bank. As a result. Morgan.P. but we believe it illustrates a key difference between previous-generation vs. had banks as their primary customers. newer payment platforms: traditional platforms. social networks and smartphones. thanks to the web. and we believe social networking sites are uniquely 96 . Banks Have Served as the Gatekeepers of the Payment System Merchants ACH et al Consumers Banks ATM networks Card networks Source: J. As System Evolves.com Global Equity Research 03 January 2011 Traditionally. consumers are increasingly demanding more dynamic ways to initiate payments and unwittingly are creating new billing relationships with new age payment networks. Consumers Are in the Driver’s Seat eCommerce Content sites Merchants ACH et al Online Games Consumers Banks ATM networks Card networks Mobile Source: J. PayPal is one illustration of this trend. Morgan. such as Visa or MasterCard.

com Global Equity Research 03 January 2011 positioned. competition is already quite heavy. We think that the new platforms’ access to the user is a key catalyst for their continued growth and for their ability to start cutting into the nearly trillion dollar payments pie currently under the incumbents’ control. allowing the old and new networks to coexist in the medium term. etc. leverage existing payment networks (e. if not permanently. . PayPal was the big winner in landing on the payments map during the formative years of eCommerce by developing an elegant. part of its success came from leveraging existing payment networks. this could be a template for how mobile payments will evolve. While new age networks have access to lots of content and consumers. with all key players in the food chain developing pilots in an attempt to gain early-mover advantage. via credit/debit card. On the mobile payments side.Imran Khan (1-212) 622-6693 imran. as they are personal relationship management platforms for millions of people.g. . . direct ACH debit from checking account). The Web Spawned PayPal . giving consumers the flexibility to pay the way they want (e.. we think incumbents must invest in innovation or risk displacement in the longer term. large consumer billing relationships already exist or are developing. are as follows. For 2011. in many cases these build on trends already more advanced in other markets. Visa/MasterCard. consumers are not very open to change when it comes to matters of their money. . What Will Mobile Spawn? In line with what we are seeing on the internet landscape. In our view. convenient consumer/merchant solution when incumbents were slow to innovate. ATM networks) to gain scale. In our view. but branded as a PayPal transaction. Incremental. Some of the key mobile payment strategies in place today in the U. In both cases. they lack the same level of relationship with merchants (necessary to conduct a transaction) and still need to build up trust with consumers to manage their money (and avoid the associated fraud.S. In our view. This should buy time for banks and legacy networks to develop business models in partnership with new age networks. . we believe there are two key emerging payment battlegrounds to watch:   Mobile payments and Web platforms. However. A risk to watch for the new age networks will be if the banks make it more difficult for nonbank entities to access consumer checking accounts.g.khan@jpmorgan. ACH.). . especially in Asia: 97 . we view consumers’ growing desire for ubiquity as driving innovation in payments.. since existing payment networks have access to both consumer funds and merchants. security risks. Not Revolutionary We believe the winning models will initially.t.

and extending their mobile banking platforms could be a means to achieve this. a customer may use his or her cell phone to generate an authentication. First Data also has a product. Even though PayPal appears to benefit from a network effect in terms of having the largest installed base. NFC embedded through phone add-ons. BofA announced it would make them available next year. Note that the ability to transfer money in this way varies widely country by country. Visa is partnering with DeviceFidelity on an add-on solution. Essentially. Visa with DeviceFidelity is pushing this approach. that it is shopping to various issuers. For example.t. called Go Tag. such as a microSD card. is pursuing this strategy initially. there is room for innovation in payments through mobile solutions. a physical swipe is replaced by NFC authentication. or NFC This is a technology solution. Extension of mobile banking Many banks are looking to own the mobile wallet. There are various forms of mobile NFC being tested today:  NFC sticker that can be attached to a phone and substitutes for a card. At this point. a mobile carrier joint venture aiming to develop its own mobile commerce platform.   As noted. services are still in the early stages.khan@jpmorgan. We believe Visa’s US mobile strategy is focused on supporting issuers – allowing consumers to use existing bank accounts – and building upon smartphone mobile banking solutions. NFC built directly into the phone itself: Isis. Separately. which has patents for technology related to this space. A merchant can scan that code to complete the transaction. but the merchant must be equipped with an NFC reader (only about 150K merchants are contactless ready versus nearly 8 million that take traditional Visa/MC cards). and they host the money. P2P has been very much a secondary business for the company. Citi and Discover have full-fledged contactless stickers available to any customer who requests one. bringing to mobile phones the “wave” or “bump” near field communications (NFC) technology resident on certain credit/debit cards. Mobile eCommerce In addition to expanding traditional eCommerce platforms beyond the web and onto mobile browsers and apps. Person-to-person payments P2P has historically been a fairly tough nut to crack. these apps can allow a phone to function as a tool to transact business via credit card. As noted above. banks have an inherent advantage in that they have already established consumer trust. but this is an area to watch. Google has acquired a company called Zetawire.com Global Equity Research 03 January 2011 Contactless. with the US in many ways lagging other developed economies. 98 . which is then displayed on the phone like a bar code. To conduct the transaction.Imran Khan (1-212) 622-6693 imran.

is that the price users may be willing to pay tends to be quite small. the credit card ecosystem is not. ZashPay is a P2P payments service. a limit that can increase with time and use.com Global Equity Research 03 January 2011 Challenges for person-to-person payments include regulatory concerns as well as network compatibility – if both participants are not on the same network. 99  .com. social networks. enables consumers to electronically send money to receivers’ bank accounts. Western Union WU. requiring no separate account and. taking significantly less time (~1 day vs. Getting Micropayments Right: Watch . Future initiatives for ZashPay include enabling money requests. The service can be accessed via the ZashPay website or through the bill payment systems of participating financial institutions. content sites are not generating hoped-for levels of revenue through advertising. PayPal has opened its system to developers. designed to manage small payments. and publishers are increasingly exploring alternatives (such as micropayments) to better monetize content. and a variety of similar sites. Account-to-account transfer services are offered in the US/Brazil/Mexico only. transactions cost ~$0. Online money transfer is an area of focus for the company and is growing transactions at around 20% globally (50% growth at international locations. though off a much lower base). the level of difficulty in fraud prevention and monetization both increase. mobile phones. Fiserv has sized the personal payments opportunity at 1. or to a physical location for cash pickup. Simply put. ZashPay currently has signed up over 200 financial institutions and 250K registered users. Apple? One of the challenges in monetizing content websites.Imran Khan (1-212) 622-6693 imran. with almost no electronification at present.t. prepaid cards. as a result.75 per transaction and are capped at $100. Companies pursuing this space include PayPal as well as ZashPay (owned by Fiserv) and Western Union. . and merchants pay significantly more for payment processing if all the payments they process are in the sub-$5 range.4B check transactions and 10B cash transactions. . ZashPay Officially launched at the end of July. Western Union’s online money transfer service. Initially. However. 3-6 days) to transfer payments. group collections and small business payments and collections. at present.khan@jpmorgan. broadening the number of people working to improve the online payment landscape. It enables users to electronically send and receive money from and to existing bank accounts using solely the recipient’s name and e-mail address or mobile phone number. We see several factors that lead us to expect progress in micropayments:  PayPal X. Ad-supported sites continue to struggle. Improved micropayment platforms were among the targeted areas of development. ZashPay leverages its parent’s network advantages. casual games.

When a buyer hands cash to a seller. Chase. published on June 5.Imran Khan (1-212) 622-6693 imran. In terms of economics. The acquirer provides merchant services to the merchant. handling all the card and/or electronic payment acceptance needs of the merchant. which we describe below.khan@jpmorgan. Further. by J. etc. several other parties become involved in the transaction. 2009. Along with Apple. micropayments may bring in a competitor few associate with the payments space: Apple. Casual games have become immensely popular. another big player that we believe could pursue an avenue into the ecosystem through micropayments is Google. Payment Business Basics For a primer on the payments industry. Payments on social networks Please see this report’s section on Social Networking for a more detailed discussion of this opportunity. If a credit (or debit) card is involved.g. However.P. Bank of America. since they wouldn’t be able to buy things on iTunes – so they wouldn’t want to be blackballed. The need to process such transactions efficiently increases the demand for a solution. depending on the type of card) and passes the remainder to the . complete with email and password authentication and bank card information. The company has developed a bustling business in its iTunes store and its app stores. Key positives for the opportunity include the size of the user base and the possibility of leveraging the social graph to improve fraud prevention. though no announcements to that effect have been made by the company. Morgan’s computer services & IT consulting analyst.t. Acquirer (commonly the merchant’s bank).. Challenges will include creating avenues for consumers to put money into (and especially out of) the system as well as whether these sites can create platforms for their payment systems that stretch beyond the core networking sites. will you be able to buy an airline ticket using your Apple account? Is Apple willing to take receivables risk? Apple could be more successful in managing risk than others: consumers don’t want to risk losing their Apple account. the bank that issued the consumer’s credit card takes the purchase price.. more interesting than the phone opportunity is the prospect of Apple commercializing its iTunes payment capability. since it already has a unique (and frequent) billing relationship with iTunes users. Apple has filed several payment patents that would enable it to adopt NFC technology into future iPhones. please see Payment Processing: Payments Market Share Handbook.com Global Equity Research 03 January 2011  Demand from casual games. . ~170-225 bps. much of it in 99c songs. Can Apple build upon its account base and make it possible for consumers to buy any online good with their Apple accounts – e. however. Apple has had to grow its expertise in processing small payments efficiently.  Issuer (cardholder’s bank). . Thus. The merchant’s acquiring bank accepts the payment.to  100 . Tien-tsin Huang. Card transactions start with a card issued by an issuing bank (e.g. and these applications are often monetized via the sale of virtual goods.) to a consumer. collects its interchange fee (in the US. the transaction is self-contained. collects a merchant discount (generally in the 30. selling nearly $1B quarterly. via apps for the Android platform as well as the existing need to process payments for the Android marketplace.

debit card) and translates it into a format that can be accepted by the merchant acquirer. In the online world. Paying all network and associated fees for a merchant’s transactions. Payment gateway.g.000 customers when acquired in 4Q’05. Payment network (e. As the backbone of the payments industry.com Global Equity Research 03 January 2011 50-bp range in the US) and forwards the balance to the seller/merchant.Imran Khan (1-212) 622-6693 imran. MasterCard). clearing and settlement services. PayPal already functions as a payment gateway. and Providing incremental services. e. which had 144. the gateway generally connects an eCommerce site with the merchant acquirer. Facilitating clearing and settlement of card payments. largely as a result of its acquisition of VeriSign’s payment business. Both the issuer and the acquirer pay a small (~7-9 bps each) fee to the payment network (see below).. Merchant acquirer functions include:       Signing up merchants to enable them to accept card payments. sending out statements.khan@jpmorgan.g. credit.  101 .t.. Networks also set rules and interchange rates (earned by the issuing bank). the payment gateway is the equivalent of a point-of-sale terminal that accepts the payment type (e. Enabling merchants to authorize card payments via the network. In the offline world.g. networks connect various banks that need to process credit card payments with merchants and provide authorization. etc.. Visa.

Additionally.khan@jpmorgan. Morgan. if not more. for a large retailer (e.Imran Khan (1-212) 622-6693 imran.” Figures are rounded and can vary depending on payment and merchant type.g. in some instances these functions are performed by the same entity in which case there wouldn’t be an explicit “processing fee.t. Wal-Mart). however. its merchant acquirer will charge only a handful of basis points over the standard interchange fees. as financial data are handled by a trusted intermediary as opposed to a merchant with which the consumer may have no previous experience. the best deal available may be at ~100 bps over interchange (when factoring in all fees). On the cost side. for a small merchant with minimal bargaining power. On the other hand.com Global Equity Research 03 January 2011 Example of a Credit Card Payment Processing Cycle Note: The sample transaction flow above assumes the acquiring and processing functions are performed by separate entities. using an online payment service can help boost a consumer’s willingness to consummate a transaction. functioning in some ways like a Merchant and a Merchant Acquirer and an independent sales organization (ISO). online payment services such as PayPal or Amazon Payments arbitrage the spread charged by merchant acquirers. Source: J. the largest service. An online payment service can use its scale to bridge this gap – though at times its service may be less flexible or offer less hands-on service than a merchant acquirer. 102 . Understanding the Role of Online Payment Services Essentially. PayPal.P.. while at the same time allowing merchants to increase consumers’ level of trust for the transactions. wears multiple hats within the business.

we believe that as much as half of PayPal’s total payment volume (TPV) represents volume that is coming from extremely small vendors – vendors that likely would not have had the capacity to accept credit cards without using PayPal. Visa volume excludes Visa Europe. Morgan estimates.000 1. On the other hand. Payment networks sit at the top of the value chain in payments. successfully making itself a formidable payment network and brand alongside dominant payment brands Visa.com Global Equity Research 03 January 2011 The Challenge for Incumbent Players We think part of the challenge for Visa and MasterCard.P. Note: Parts of PayPal volume may be processed using Visa’s or MasterCard’s network.500 1. such as Visa and MasterCard. PayPal Remains the Largest Online Player. we think it could be more difficult for these large incumbents to squeeze out online-only providers than their market share might suggest. Consequently.t. PayPal is an established payment network and brand – A rare commodity PayPal is in rare company. is that they have historically been involved in the marketplace on a B2B level.497 484 86 Visa (Credit) Visa (Debit) MasterCard (Credit) MasterCard (Debit) Pay Pal Source: Company reports. PayPal’s Volume Dwarfed by Incumbents’ $ in billions. PayPal overcame the classic chicken-and-egg dilemma and now has a critical mass of users in its network. It remains the largest player focused solely on online payments. J. and thus it is more difficult for them to actively market to consumers. PayPal’s volume remains fairly small: its F’09 $72B TPV was just over 1% of the total volume of payments processed during that year by Visa and MasterCard combined. American Express and Discover.000 500 0 1. online payments is a much more consumer-driven business.Imran Khan (1-212) 622-6693 imran. MasterCard. with the trust and safety concerns of consumers driving them to choose some solutions over others.235 1. we think PayPal broadens the playing field in online payments. the two largest incumbent players in the space. collecting high-margin fees for facilitating payments from participants seeking access to a network of trusted merchants and consumers. Still a Drop in the Bucket Compared to Credit Cards PayPal is quickly establishing itself as a global payment processor with scale.500 2. however. 12 months ending 3Q’10 2. Additionally. facilitating over $86B in total payment volume in the 12 months ending 3Q’10.910 1. 103 . Therefore. when compared to the total volume of large global players.khan@jpmorgan. differentiated as a trusted brand for facilitating online payments with the potential to extend its presence into offline opportunities longer term.

khan@jpmorgan. MasterCard. and not all aspects were intended for mass use.g. PayPal gives virtually anyone the capacity to accept payments. benefit from this simplification in several ways:  Ease of use. there are no minimum requirements for payment volume in order to use PayPal)..com Global Equity Research 03 January 2011 One driver of PayPal’s growth is that. unlike traditional payment methods that developed in an offline world and have been overlaid onto eCommerce.Imran Khan (1-212) 622-6693 imran. PayPal Simplifies the Payment Process Source: J. PayPal is gradually expanding its presence off eBay by promoting itself as an integrated payment offering alongside other payment brands (e. making it well positioned to penetrate the small business payments market. The payments system is not very transparent. and sellers in particular. enabling a merchant to operate even at an initial scale that would otherwise be uneconomical (i. PayPal has developed tools and risk management measures to address the unique complexities of handling card-notpresent payments over the web – one of the fastest growth categories in payments. A trusted central clearinghouse like PayPal can encourage use of online payments by lowering users’ safety concerns and raising their willingness to send money online. Morgan. PayPal’s platform was built with eCommerce in mind. small merchants can get all of their payment needs and do not necessarily need a separate merchant bank account or payment gateway services provider. based on the size and needs of the merchant: 104 .t. PayPal is elegantly structured to simplify the web of connections required in a traditional payment system. Visa) in that it is a vertically integrated payment provider. in our view. We think the online marketplace.. supported by PayPal’s own merchant services offering and alliances with payment vendors such as CyberSource (payment gateway) and Chase Paymentech (largest merchant acquirer in the US).g.e.P. PayPal’s product offerings for online sellers PayPal offers several different products for payment acceptance. Moreover.. PayPal is a single source provider of payment services. Higher level of trust. By contracting directly with PayPal Merchant Services.  PayPal is differentiated beyond just online commerce PayPal is different from other payment brands (e. Thus. Visa). MasterCard. In other words.

in which case all payments are charged at the 5% + 5c rate.2% of transaction + 30 cents 1. with no site of their own on which they need to integrate PayPal. all three major providers in the US – PayPal.2% of transaction + 30 cents 1.9% of transaction + 30 cents Varies by currency but ~1% extra. Amazon Payments and Google Checkout – use similar fee structures.000 / month $3K-$10K $10K-$100K $100K and above Cross-border PayPal 5% of transaction + 5 cents for each transaction Same as below 2.t.Imran Khan (1-212) 622-6693 imran.    Fee Structures of Current US Online Payment Providers At this point. Amazon Remain Similar Transaction Type/Volume Micropayments Transactions under $10 Up to $3.com Global Equity Research 03 January 2011  Email Product.5% of transaction + 30 cents 2. This is the offering used largely by smaller eBay merchants. Google. Website Payments Pro. the Pro product is better integrated into a seller’s site.9% of transaction + 30 cents 2.5% of transaction + 30 cents 2.2% of transaction + 30 cents 1.0% of transaction + 5 cents 2.9% of transaction + 30 cents 1% of transaction Checkout by Amazon See below 5. Fees for PayPal.khan@jpmorgan. 105 . Express Checkout. who receive payments entirely via email. When a shopper uses Express Checkout. The product is intended for small to medium-size sellers and requires the seller to be using a compatible shopping cart vendor (most are compatible).9% of transaction + 30 cents 2. payments with currency conversion add 2. With an incremental $30 monthly fee.9% of transaction + 30 cents US only (seller and buyer must have US-based account) Source: Company websites.5% charge Google Checkout Same as below Same as below 2. Note that PayPal allows users to sign up for a separate micropayments pay schedule. and when a user is ready to check out.9% of transaction + 30 cents 2. This allows an existing PayPal user to bypass entering personal and shipping information again.5% of transaction + 30 cents 2. This product allows merchants to place a PayPal button on their sites. the user hits the button and is taken to the PayPal site where the actual checkout occurs. Website Payments Standard. s/he logs into PayPal. and PayPal then forwards address and other info to the merchant. Express Checkout is incremental to the payment acceptance service used by a vendor – it gives users an additional checkout option. Intended for larger merchants (those already accepting include Dell and Barnes & Noble). as shown in the table below. even if it is the user’s first time using the specific merchant.

t. we think it’s interesting to see that 72% of the survey participants answered “No. Netflix subscribers are more likely to consider dropping their cable packages. compared to only 45% of those who make less than $50K. the internet TV space has been long on speculation and short on data.002 US internet users. Although most pay TV subscribers (72%) would not even consider getting rid of their cable/satellite package in favor of getting video over the internet. 54% of pay TV subscribers with incomes over $100K would prefer to pay less for a smaller package of channels. Those wanting the biggest cut in their packages were also the most likely to consider dropping pay TV.Imran Khan (1-212) 622-6693 imran. 45% said they would want to get 25% fewer channels and pay 25% less. we probed online video trends as one of the areas of focus in our proprietary survey of 1. only 6% of those with incomes over $100K said they didn’t have a cable/satellite TV subscription. 39% said they would consider dropping their package (and another 8% already don’t have cable).khan@jpmorgan. Therefore. A slight majority (52%) of pay TV subscribers said they would want to pay less for their cable subscription in exchange for getting fewer channels. 63% would do it even if it meant losing access to live sporting events. Unbundling could help consumers. However. also less happy with it. compared to 18% of those with incomes below $50K. Additionally. Of these. Within our sample. 28% of our respondents said they would consider it. 12% of our sample said they do not have a cable/satellite TV subscription.    Price and Choice Seem to Drive Consumers’ Willingness to Consider New Services Our survey showed that 28% of respondents who currently have a pay TV subscription would consider dropping it in favor of video delivered via the internet.” 106 . Main Takeaways from Our Survey  More than a quarter would consider Over the Top (OTT). Higher-income households less likely to go without pay TV. In this light. Please note that the question wasn’t whether or not respondents are planning to change the way they currently consume video entertainment in the immediate future but if they would merely consider it. Those who are more regular users of Netflix streaming are even more likely: among those who use streaming 1-2 times a month or more.com Global Equity Research 03 January 2011 “Over the Top” Survey Results In recent months. Of these.

for the most part. Would You Consider Dropping Your Cable TV Subscription If Doing So Meant You Would Not Be Able to Watch Live Sporting Events on Your TV? Among those responding “yes” to the question above No. This suggests that (a) pay TV providers retain some power: even unsatisfied customers do not.t. Not surprisingly.com Global Equity Research 03 January 2011 Would You Consider Dropping Your Cable TV Subscription and Using Broadband Internet (Such as Netflix Streaming. etc. see a viable alternative. 107 . Morgan consumer survey. 37% Yes.) for Video Content? Among users who subscribe to a cable/satellite TV package 75% 50% 72% 25% 28% 0% Yes Source: J.khan@jpmorgan. Morgan consumer survey. those who are dissatisfied with their current cable/satellite lineup and pricing were more likely to consider switching to internet video: 39% of those who would prefer to pay less for a smaller cable package would consider dropping their pay TV subscription vs.Imran Khan (1-212) 622-6693 imran.P. only 16% of those who were satisfied with their package. and (b) some who are dissatisfied could be convinced to remain subscribers with lower pricing. Hulu.P. 63% Source: J. No Further analysis shows that 37% of those who said they would consider dropping pay TV in favor of internet-only video options would not be willing to do so if they lose access to live sports programming while 63% would not be deterred.

Imran Khan (1-212) 622-6693 imran. Netflix subscribers are more open to OTT options than those who don’t use Netflix. We note that.com Global Equity Research 03 January 2011 Pay TV Subscribers Less Likely to Consider Dropping If They’re Satisfied with Their Channel Lineup and Price 90% 60% 30% 0% Satisfied w ith current lineup/price Would prefer to pay less for a package w ith few er channels Would consider dropping pay TV Source: J. Those Who Use Watch Instantly Are More Likely to Consider Switching from Cable 75% 50% 25% 0% Not a NFLX subscriber Nev er us ed streaming/tried once Stream at least 1-2x /month Would not consider 67% 33% 42% 58% 47% 53% Would consider dropping pay TV / don't hav e pay TV Source: J. We believe Netflix Watch Instantly to be the most widely available streaming-to-TV service and think this question offers an important insight into the preferences of consumers who are in a position to compare traditional pay TV packages with the OTT experience.khan@jpmorgan. people who use Watch Instantly are more likely to say they would consider dropping their current pay TV package.t. 16% 84% 39% 61% Would not consider Those with Access to Netflix Watch Instantly Are More Open to Substituting OTT for Pay TV We also looked at how those respondents who have access to the Netflix streaming service responded to this question.P. On the other hand.4x as likely to subscribe to a premium channel (such as HBO) as those who are not Netflix subscribers. As illustrated in the figure below.P. in general. Morgan consumer survey. Netflix subscribers were 1. 108 . Morgan consumer survey.

Would You Want to Pay Less for Your Cable Subscription to Get a Smaller Number of Channels Offered? No. 45% 30% 17% 9% 25% lower price and 25% fewer channels 50% lower price and 50% fewer channels 75% lower price and 75% fewer channels Our survey found that higher-income households were significantly less likely than lower-income households to go without a pay TV subscription: 18% of those with incomes below $50K do not subscribe compared to only 6% of those with incomes over $100K. 48% Source: J. as shown in the figure below. Interestingly.P. Morgan consumer survey.P. Morgan consumer survey. 109 .khan@jpmorgan. I am happy with the current Yes. In Which of the Following Changes Would You Be Most Interested? % 50% 40% 30% 20% 10% 0% 10% lower price and 10% fewer channels Source: J.com Global Equity Research 03 January 2011 Roughly Half of Respondents Are Happy with Their Current Package while the Other Half Could Give Up Channels to Pay Less Our survey shows that current pay TV subscribers are almost evenly split between those who are happy with the TV package they have and those who would like to pay less for fewer channels. Both of the more extreme options – a 10% lower price and 10% fewer channels and a 75% lower price and 75% fewer channels – were chosen by a minority of respondents. I would like to pay less for a smaller package.Imran Khan (1-212) 622-6693 imran. it appears that the highest percentage of those respondents who would like a cheaper and smaller pay TV package would prefer 25% fewer channels for a 25% lower price. 52% package.t.

. Satisfied w ith current lineup/price Source: J. 110 .P. Morgan consumer survey.com Global Equity Research 03 January 2011 On the other hand. Morgan consumer survey. But Less Likely to Be Satisfied with Package Lineup/Pricing % of all pay TV subscribers 20% 15% 10% 5% 0% $0-49K 18% 6% 60% 40% 20% 0% $100K+ 55% 46% $0-49K $100K+ Don't subscribe to Pay T V Source: J. pay TV subscribers in the higher-income category were more likely to say they were not satisfied with either their channel lineup or the price of their pay TV package (see figure on right below).khan@jpmorgan.P. % of all households . . . Higher-Income Households More Likely to Subscribe to Pay TV .Imran Khan (1-212) 622-6693 imran. .t.

Surprisingly.com Global Equity Research 03 January 2011 Online Travel Agencies In 2009. Corporate Travel Becomes a Bit of a Headwind We think the hardest-hit area of the recession was business travel. Although supplier websites outperformed the market overall. We expect online travel agencies to be the biggest beneficiary of these trends as consumers will likely remain focused on bargain hunting and employ social networking. Total Travel Market Y/Y Growth Rates 15% 10% 5% 0% -5% -10% -15% -20% 2008 2009 Online Leisure/Unmanaged Biz Source: PhoCusWright US Online Travel Overview. We think that. economic recovery in 2010 has not changed this story. Much of the growth in supplier websites in 2010 came from the unmanaged and managed business travelers who returned to the road. managed corporate travel declined ~23% Y/Y in 2009 vs. Online vs. In 2011.t.Imran Khan (1-212) 622-6693 imran. Thus. we expect to see a restrained recovery continue as corporate travel increases and consumers continue to spend more but unemployment levels remain high. we think 2009 was one of the first years when shifts between online travel agencies to online supplier sites stabilized. which are a strength of OTAs. review sites and personalized offers. only a ~7% decline in online leisure and unmanaged business travel and a ~18% decline in offline leisure channels. they effectively used both online travel agencies (OTAs) and promotional activity to clear some of their levels. We think OTAs were the biggest beneficiary of this decline as suppliers moved the excess inventory that had previously gone to corporate sales to leisure sales on OTA sites. online travel agency companies in the US performed relatively well compared to offline agencies and suppliers. as suppliers were faced with excess inventory. 2010 Total Trav el Market 111 . Tenth Edition. they are projected by PhoCusWright to grow at only half the rate of OTAs in 2010. Among the reasons for this outperformance are that supplier websites were particularly affected by the pullback among older. primarily due to some countercyclical effects of the weak macroeconomic environment. According to PhoCusWright estimates. frequent leisure travelers who tend to favor supplier sites.khan@jpmorgan.

according to PhoCusWright data. As a result. Second. online leisure/unmanaged business share jumped to 38% in 2009 from 35% in 2008 as corporate travel demand fell dramatically. OTAs and supplier websites tend to attract different types of consumers. In 2010. which is booked primarily through offline channels. segmentspecific drivers are making airlines even less attractive going forward. 112 . we see them continuing to gain a larger piece of the pie. we expect this trend to reverse itself in 2011 as corporate travel recovers. while the total travel market grew 10%. margins are much higher in this segment than in air. we expect traditional travel agents to grow their share vs.khan@jpmorgan. PhoCusWright estimates that online leisure/unmanaged business penetration of the total travel market will be flat at 38% as corporate travel recovers. 2009 67% 33% 56% 44% 44% 56% 66% 34% 12% 88% 60% 40% 2010 66% 34% 54% 46% 44% 56% 66% 34% 12% 88% 59% 41% 69% 31% 59% 41% 41% 59% 66% 34% 12% 88% 62% 38% Hotels Will Likely Be the Most Promising Growth Opportunity For a number of reasons. For the first time in a while. OTAs Gain Market Share from Suppliers Supplier websites’ share of the online travel market was as high as 62% in 2008 but had fallen to 59% in 2010 as a result of OTAs’ countercyclical performance.t. In 2010. First. especially in heavily fragmented markets. Tenth Edition. Looked at another way. We think the fact that the recovery from the recession has been slow and fraught with job/housing concerns will continue to benefit OTAs going forward. online penetration in hotels is much lower than in air. we think hotels will continue to be the most attractive opportunity for online travel agents. It is important to note that this would not be due to a shift from offline to online booking but simply to a recovery of corporate travel. and expect online travel to outpace the total travel market again after corporate travel recovers to more normal levels. due to business travel trends. We think this is a one-time anomaly. Third.com Global Equity Research 03 January 2011 However. Channel Market Share of Online Revenue by Segment 2008 Air Supplier Website Share of Online Revenue OTA Share of Online Revenue Hotel Supplier Website Share of Online Revenue OTA Share of Online Revenue Cruise Supplier Website Share of Online Revenue OTA Share of Online Revenue Car Supplier Website Share of Online Revenue OTA Share of Online Revenue Packaging Supplier Website Share of Online Revenue OTA Share of Online Revenue Total Supplier Website Share of Online Revenue OTA Share of Online Revenue Source: PhoCusWright US Online Travel Overview. PhoCusWright estimates that only 30% of hotel sales were booked through hotel websites and OTAs in 2009. PhoCusWright estimates that the online travel market increased approximately 8% Y/Y in 2010. with OTAs targeting budget-conscious travelers willing to shop around for deals and suppliers attracting more frequent travelers with greater budgets and business travelers. online travel bookings.Imran Khan (1-212) 622-6693 imran.

793 7% 9% 29.com Global Equity Research 03 January 2011 Google announced its intention to acquire ITA.248 13% 4% 5.902 -6% 94.828 3% 8% 27.048 7% 30% 884 13% 1.t.873 -4% 40% 1.281 2% 15.012 -13% 9% 27.693 8% 52% 749 11% 11. with airline executives voicing the opinion that sellers should be paying them to access their content.954 -19% 4% 4. Priceline posted domestic gross bookings growth of 16% Y/Y in the first 3 quarters of 2010 vs.511 -5% 232.890 8% 110.340 -15% 30% 783 -5% 1.766 -3% 89.5% growth at Expedia and a 6. We think these occurrences will push OTAs to focus on the hotel market.569 17% 96. tensions have increased between OTAs and airlines.153 20% 13.893 -7% 97. Although Google has stated that it has no intention of becoming a transactional engine. Additionally.017 1% 26% 825 32% 1. its huge sway over traffic and the potential to favor its own travel content pages have some OTAs concerned about advertising costs. Tenth Edition.564 -8% 50% 674 -9% 9.100 12% 48% 6. with domestic gross bookings growth of 18.867 -17% 50% 6.208 3% 14.194 2% 35% 2009 48.Imran Khan (1-212) 622-6693 imran. 2008 52. rather than the airlines paying distributors. Airlines are also keeping capacity suppressed to keep fares up.682 8% 274.736 4% 42% 1.934 8% 255. American Airlines took this attitude to the next level declaring that it would deny Orbitz the ability to sell its inventory as of December 1st.658 -15% 38% 2010 52. Strength continued for Priceline in 2010. 17% growth at Expedia and 16% growth at Orbitz during the same period despite both Expedia and 113 .988 6% 108.248 -3% 92.289 -5% 4% 4.038 -4% 14.791 0% 117.587 4% 45% 6.447 8% 99.186 10% 38% Priceline Dominates Domestic Market Share Gains In 2009 Priceline blew the competition away. Online and Total Travel Market by Segment $ in millions Airline Online Growth Airline Total Growth Online as a Percentage of All Air Revenue Car Online Growth Car Total Growth Online as a Percentage of All Car Revenue Cruise Online Growth Cruise Total Growth Online as a Percentage of All Cruise Revenue Hotel and Lodging Online Growth Hotel and Lodging Total Growth Online as a Percentage of All Hotel and Lodging Revenue Rail Online Growth Rail Total Growth Online as a Percentage of All Rail Revenue Packaging Online Growth Packaging Total Growth Online as a Percentage of All Packaging Revenue OTA-Int'l Suppliers/Other Growth Total Online (Leisure/Unmanaged Business) Growth Total Travel Market Growth Online as Percentage of all Travel Revenue Source: PhoCusWright US Online Travel Overview.189 7% 12.698 14% 49% 741 7% 12.9% decline at Orbitz during the same period.3% vs. 1.106 -4% 12.155 -11% 43% 1.khan@jpmorgan.

in some ways we think this has been beneficial to OTAs as it has forced a sometimes change-averse society to try new things. 9% Orbitz.9 66.Imran Khan (1-212) 622-6693 imran. 146.com Global Equity Research 03 January 2011 both to its opaque business model and lowest-price/discount-brand positioning. Travelers hesitant to book online are beginning to turn to the internet to find more affordable options. we think Priceline will continue to gain market share. especially now that booking fee removals/discounts are comped. International Markets Benefit from Online Penetration Economic recovery in Europe has been slow. However. the UK generated 28% of European online bookings. over time Germany.3 2008 175. 1H10 Trav elocity 19% Ex pedia. 1H08 Trav elocity 22% Ex pedia. According to PhoCusWright. 44% Orbitz.4 2010 Offline/Business However. US Market Share. at 31% and 29%. we do note that there is much variance on a country-by-country basis. Tenth Edition.2% for 2010 due to macroeconomic factors and complications from the volcanic ash cloud. Tenth Edition.4 2009 Online Leisure/Unmanaged Business Source: PhoCusWright European Online Travel Overview. European Travel Market Share by Channel (Euros in billions) 300 250 200 150 100 50 0 65.t. PhoCusWright estimates that European travel growth is just 2. In 2009. 114 . at 45% in 2009. Sixth Edition.5 148. France and Germany have similar online penetration rates. Source: PhoCusWright US Online Travel Overview. The UK remains the largest online travel market in Europe. 26% Priceline. However. 43% Priceline. this trend has contributed to drive the total market share of online leisure and unmanaged business bookings to 31% in 2009 from 27% in 2008. In 2011. France and Spain are expected to be the main share gainers.7 73. 26% Source: PhoCusWright US Online Travel Overview.khan@jpmorgan. despite the overall low online penetration of the European travel market. 11% US Market Share. with the UK just behind at 44%. Scandinavia has the highest online leisure and unmanaged business penetration.

Lower levels of internet access. at 22% and 18%. In contrast. 2009 Euros in billions 50 40 30 20 10 0 45. Sixth Edition.1 Italy 11. European Online Leisure/Unmanaged Business Gross Bookings. Priceline grew its share to 33% from 27%. Most of Priceline’s gains appear to come from Travelocity Europe. 115 . whose market share has fallen to 15% in 2009 from 19% in 2008.7 3.khan@jpmorgan. Spain and Italy are the major markets with the lowest online booking penetration. the company has experienced such dramatic growth that it has passed market leader Expedia’s market share among the top 5 pan-European online travel agencies.6 20.t.6 16. As a result.Imran Khan (1-212) 622-6693 imran.5 12.com Global Equity Research 03 January 2011 respectively. Priceline Passes Expedia in European Market Share Despite Priceline’s niche hotel focus in European markets. we see most market share gains coming from offline and smaller OTAs rather than directly from other OTAs.4 18.3 39. we note that the European market is most characterized by its fragmented nature and that the top 5 OTAs account for 49% of the total European online travel agency market.2 Germany UK Total Market France Spain Scandinav ia Online Leisure/Unmanaged Bus iness Source: PhoCusWright European Online Travel Overview.4 13. However.8 5.1 4. ongoing economic challenges and a powerful traditional travel distribution network contribute to this weakness (PhoCusWright).9 42.

Imran Khan (1-212) 622-6693 imran. The effects of the slowdown were more pronounced in countries highly dependent on the US economy. 27% ity Europe.3 15. Australia and New Zealand.P.1 12. Sixth Edition. 32% Trav eloc ity Europe. Finally. 9% Trav eloc Ex pedia Europe.2% -10.4 62. and J.7 22.6% -4. predominantly inbound travel markets.com Global Equity Research 03 January 2011 Top 5 Pan-European OTA Market Share. 15% Priceline Europe. The APAC Travel Market Is Not Far Behind the US in Size PhoCusWright estimates that the Asia Pacific (APAC) travel market totaled ~$202B in F’09. 19% Priceline Europe. Total Travel Market Growth by Country US$ in billions China India Japan Australia/New Zealand Singapore 2008 61. demonstrating that the region is not far behind the US at $232B and Europe at $317B. Singapore.7 5. differences emerged in the magnitude of the impact on a countryby-country basis. Morgan estimates. Source: PhoCusWright European Online Travel Overview.6% 19. 12% Orbitz WW Europe. 11% Ex pedia Europe. 2009 Opodo.7% Source: PhoCusWright Asia Pacific Online Travel Overview.0 % growth -4. Although it can be said that all countries experienced a slowdown in travel starting in 4Q’08.9 65.6 2009 58.7 5.khan@jpmorgan. 2008 Orbitz Opodo. Third Edition. were somewhat shielded from the impact of the recessionary global economy.4% -4. such as India. such as China and Japan. 12% WW Europe. countries with large and well-established domestic markets. were pressured by declining international passenger revenues and a lack of domestic demand. However.7 23. 116 . 33% Source: PhoCusWright European Online Travel Overview. Hong Kong and Malaysia. 31% Top 5 Pan-European OTA Market Share.t. Sixth Edition. including Thailand.

4 7. Japan had a 38% market share.6 2009 58.7 -4. 2008 Domestic Market Size         Internet Penetration         Credit Card Adoption         Competitive Airline Space         Multimodal Opportunity         Lodging Supply         Japan ANZ China India Singapore S. Korea Taiwan Hong Kong Key: Supportive Regulations          High  Medium  Low Source: PhoCusWright Asia Pacific Online Travel Overview. respectively.2% 5 -10.5 5. we think Japan. Third Edition.P. air accounted for 53% of total online bookings followed by lodging at 34%.7 5.1 2.6% 22. and J. We think this offers great future upside. Based on PhoCusWright’s 2008 data points.4% 62.2 4. the APAC region has roughly an 18% online travel booking penetration level.7% 2010E 61. Breaking it down by segment.0% 5. Third Edition. China held a 23% share and Singapore and India came in at 3% and 10%. as estimated by PhoCusWright.Imran Khan (1-212) 622-6693 imran. Australia/New Zealand and Singapore due to their high levels of internet penetration and credit card adoption. Australia/New Zealand and Singapore will post 2%.4% 64. based on PhoCusWright estimates. Morgan estimates. APAC Significantly Trails US and European Markets in Online Travel Penetration Although the APAC region offers a significant addressable market.3 -4.6 9.4 14.8% Source: PhoCusWright Asia Pacific Online Travel Overview.4 19.7 -4. In fact.5 5. which control ~93% of the industry. 117 . We think three of the most attractive markets are Japan.0% 2011E 65.5 3.2% 19.5% 17 10.7% 26.2% 24.9 65. As a whole.1% 66. Total Travel Market Forward Growth Estimates by Country US$ in billions China Y/Y Growth India Y/Y Growth Japan Y/Y Growth Australia/New Zealand Y/Y Growth Singapore Y/Y Growth 2008 61.com Global Equity Research 03 January 2011 Comparative Characteristics of APAC Markets. Australia/New Zealand accounted for 20%. vs the US at 37% and Europe at 32%. recent upside has been limited by very low online travel booking penetration rates. The APAC online travel industry includes five markets.3 6. relatively supportive regulatory systems and decent lodging supply.t.6% 15.1 12.7 23. 8% and 4% Y/Y growth respectively in 2010.khan@jpmorgan.5% 5.

the international market remains important to China. Online Travel Booking Penetration Rates. France and Italy. at $41B in 2008.t.khan@jpmorgan. However.3B 1. respectively.Imran Khan (1-212) 622-6693 imran. following only the US.6B Total Online Leisure/Unman aged Business Travel Market $6.9 6.9B $3.2 83% 11.9B $65. Spain. a number of GDS/CRS) systems exist but are incapable of communicating with each other.1B $11.7B $23. Inbound Travel Demand to China Is an Opportunity According to the World Tourism Organization.2B $0.1 19% 6.5B $6.8B Online Travel Penetration 11% 24% 17% 26% 14% China India Japan Australia/New Zealand Singapore 1. 2008 Population Internet Penetration 18% 8% 74% 87% 65% Total Travel Market $61. Furthermore. countries such as Singapore and India are largely deregulated.1B $12. enabling a variety of competitive lowcost carriers (LCCs) to thrive. Third Edition.5 74% 14 12 10 8 6 4 2 0 Online Market Size (USD billions) Source: PhoCusWright Asia Pacific Online Travel Overview. at 17% and 11%. 2008 100% 80% 60% 40% 20% 0% Singapore 0.1B 127M 25M 4M Source: PhoCusWright Asia Pacific Online Travel Overview. In Japan. limiting the entry of new players. The Asia Pacific region as a whole received 21% of international tourist arrivals in 2009. The Online Travel Market Opportunity.com Global Equity Research 03 January 2011 The variance in penetration levels can be chalked up to both regulatory and cultural differences. Surprisingly. Third Edition. Although travel was somewhat dampened in 2009 due to the impact of the recession on the US and Europe and concerns about the flu epidemic. China generates the fifth-highest international tourism receipts. 118 .8 6% India China ANZ Internet Penetration Japan 62% 3. Japan (the most technologically advanced market) and China (the market with the highest domestic potential) have some of the lowest online travel penetration rates. This discourages integrated inventory for airlines in Japan. We think Priceline would be attractive to the Chinese hotels given its international consumer reach and brand recognition.7B $5. China has a GDS monopoly with travelsky. China significantly increased its hotel inventory availability in conjunction with hosting the Olympics.

0 Africa.6% 10.3% 2.7% -1.8% -0.6 13.3 11.0% 2008/2007 13.6 54.5% 21.0 Asia and the Pacific.0% 13.6 13.6% 12.7% 2. 119 .com Global Equity Research 03 January 2011 International Tourism Receipts US$ in billions (growth is local currencies.4% 18.7 57.1% 7.5% 1.3% 7.6 10.6% 3.4 14.3 42.1% 6.0 38.5 13.5% Source: UNWTO World Tourism Barometer.0 2008 110.5 2007/2006 12.0 15.8% 8.9 12.4 14. 180.6 17.9 16.5% 9.2 9.0 Americas.7% 3.1 2007 96. current prices) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 United States Spain France Italy China Germany UK Australia Turkey Austria Thailand Greece Hong Kong (China) Malaysia Canada Switzerland Macao (China) Netherlands Mexico Sweden 2006 85. 140.8 14. However.5% 5.0 24. January 2010.3 12. other markets reconsidering the model and the GDS monopoly in China.3 38.1 15.1 14.4% -4.6% -0.3 12.7% 4.1 33.2% 2. we see lodging as the more exciting APAC segment for OTAs.8 11. 460. with the airline commission model eliminated in Japan.9% -6.8% 3.2 36.Imran Khan (1-212) 622-6693 imran. 52.9 32.3 15. International Tourist Arrivals.8 40. Fragmented Markets Make this Region Attractive to OTAs The LCC market and the fragmented hotel segment represent opportunities for OTAs to develop.t.3 15.6 22.0% 5.0 21.8 9.1 46.3% -0.8 18.8 16.2 17.3% 18.4 13.3 12.8% 11.5 18.1 61.7 37.0% 39.7 51.5% 9.4 13. 2009 millions Middle East.3 12.4% 1.4% 5.7% 26.3 18.5% -2.3% -0.2 13.7 22.3 13.9 16.7% 7.6 55.7 40.7% 0.0 36.0 Source: UNWTO World Tourism Barometer. Oct 2009.0 Europe.6 10.7 15.1% 9. 48.khan@jpmorgan.8 34.6 45.

Commission rates vary regionally.7% 3. Hong Kong.6% 8.0% 19. 10% Recruit.8% 25.1% 2. Malaysia. 11% Recruit. Singapore and Hong Kong coming in next with a moderate inventory.5% 5.8% 2. Thailand. Ctrip. the Japanese hotel market saw a real estate bubble burst in 2008. The largest OTAs are based in Japan. Combined. with Australia. 5% Rakuten Trav el.Imran Khan (1-212) 622-6693 imran.4% 23. in the online 120 .). 2008 Wotif.8% 34. The Hotel Segment Seems Most Attractive for OTAs The hotel category should see strength across markets.7% 3. these five OTAs reported about $8. with OTAs asking for an 8% commission for booking hotels in Japan (Ikyu). Third Edition. 2007 Wotif. Both China and Japan have more than 2 million rooms. Similarly. 6% Ctrip.5% Market Share 3.khan@jpmorgan. The top five local OTAs in APAC are Rakuten Travel. Wotif and AsiaRooms.3% 7. India and Vietnam are still at relatively low room inventory levels.0% 1.7% 24. Singapore and Thailand – are generally handled by foreign OTAs such as Expedia and Orbitz. Major APAC OTA Growth Rates and Market Share Country China Japan OTA eLong Ctrip Others Ikyu Rakuten Travel Recruit Others Wotif Webjet Others Y/Y Growth 2008 15. 23% Asia Rooms. car. leading to excessive room supply and deteriorating demand. 28% Rakuten Trav el. Third Edition.1% 11.6B in gross bookings in 2008. Primarily inbound markets – including Macau.1% 30. We believe this growing hotel inventory is a key condition for suppliers and consumers valuing the use of OTAs and for OTAs to thrive.5% 58.5% 16.t. However.com Global Equity Research 03 January 2011 Top 5 APAC OTA Market Share. Third Source: PhoCusWright Asia Pacific Online Travel Overview.7% Australia/NZ Source: PhoCusWright Asia Pacific Online Travel Overview. China and Australia. OTAs had a combined 43% share of gross bookings in the total market (including air. Recruit. 34% Asia Rooms. with about 50-75% of revenues coming from hotel bookings.8% 7. etc. Edition. The 2008 Olympics in Beijing fueled an enormous increase in the supply of hotel rooms. 32% Top 5 APAC OTA Market Share. In 2008. compared to 57% for supplier websites (PhoCusWright data). 10% in Australia (Wotif) and about 15% for India and China (PhoCusWright). 27% Source: PhoCusWright Asia Pacific Online Travel Overview. 24% Ctrip.

7 17% 4. 2008 16.1 14% 2009 19.7 -9% 20% 11.2 -6% 18% 121 . 2008 US$ in millions Other Rail Car Rental Lodging Airline 0 2000 4000 6000 8000 OTA 10000 12000 14000 16000 18000 Supplier Website Source: PhoCusWright Asia Pacific Online Travel Overview.4 14% 2. APAC Online Gross Bookings by Channel and Segment.0 104.Imran Khan (1-212) 622-6693 imran.4 15% 10. Third Edition.5 215.t. APAC Online Travel Market by Segment US$ in billions Channel Share Airline Online Growth Airline Total Growth Airline Online Penetration Hotel & Lodging Online Growth Hotel & Lodging Total Growth Lodging Online Penetration Car Rental Online Growth Car Rental Total Growth Car Online Penetration Rail Online Growth Rail Total Growth Rail Online Penetration Other Online Growth Other Total Growth Other Online Penetration Total Online Market Growth Total Market Growth Online Penetration Source: PhoCusWright Asia Pacific Online Travel Overview.7 17% 202.3 -2% 16% 3.5 12% 60.khan@jpmorgan. Third Edition. OTAs accounted for 72% of all online lodging sales.6 11% 9% 1.3 68.0 28% 30.6 15% 24% 35.com Global Equity Research 03 January 2011 lodging sales segment (hotel only).1 19% 94.9 -11% 19% 0.6 4.4 31% 37.1 4.6 33.4 15% 0.1 5% 4.9 8% 1.

400. Jupiter.5% 2008 215.800.0 1. we expect accelerating online travel spend growth in 2011. In both Europe and the Asia Pacific.0% 9.0 2007 240. 2006 226.com Global Equity Research 03 January 2011 Market Forecast In the US.0 24.000.300.098.org.666.000.000. PhoCusWright.300.7% 2010E 220. Jupiter.0 21.0 28. TIA.5% 10. Morgan estimates.1 -3.1% 2009 202. and IPK International.646.6% 21.3% 66.200.000.0 27.4% 31.0% 10.3% Source: J.0 5.3 2.1% 10.0 5.0% 107.484.3% 2010E 256.org.0% 41.P.000. Jupiter.570.500.7% 95.0 10. eMarketer.000.6% 90.7% 88.4% 2012E 243.0% 20.302.100.8 5.800.2% 2011E 269.0% 81.188.0 -7.0% 122 .0 34.5% 2012E 282. TIA. We expect this growth to be led by a recovery in average daily rates (ADRs) and travel volume.0 -6.0% 10.0% 48.0% 2008 274.0 18.8 42.0 31.800.3 11. we expect this recovery to proceed more slowly.0 -10.0% 17.0% 87.0 38.7 5.588.018.0 0.000.600. We are modeling 2011 total travel gross bookings to be up 5% Y/Y in Europe and up 3% Y/Y in APAC.000.7 27.0 14.000.726.727.0 2.0% 10.7 4. We think shifts toward online booking will continue. Morgan estimates.0 5.0 38. TIA. We are modeling total US gross bookings to grow 5% to $269B and online leisure/unmanaged business gross bookings to grow 11% to $108B.487.679.2% 2009 215. eMarketer.0% 8.0% 17.5 33.134.0% 97.0% 2009 233.9 5.t.7% 2012E 210.300. We think these increases in online penetration will be a major growth driver for OTAs in the upcoming year.0 40.5 36.0 -15.0% 56.2% 23. eMarketer.9% 8. and we are modeling European online leisure/unmanaged business gross bookings to grow 10% Y/Y in 2011 and APAC online leisure/unmanaged business gross bookings to grow 18% Y/Y.0 21.P.2% 48.8% 59.100. Morgan estimates.8% 66.0% 36.org. PhoCusWright.6 35.3% 80. PhoCusWright.400.716.0% -5.7% 25.0% 8.0 2007 232. We expect online gross bookings to account for roughly 40% of total travel spend in 2011.7% 2011E 231.4% 2011E 202.1% 65.0 24. and IPK International.0% 16.394.0 32.0% 25.Imran Khan (1-212) 622-6693 imran.9% 21.000.0 2006 256.000. US Travel Market Forecast $ in millions Total Travel Spend % online Online Leisure/Unmanaged Biz Travel Spend Total Travel Spend Growth Online Travel Spend Growth 2005 233.115.khan@jpmorgan.7 9.800.P.2% 2007 269.3% 2008 240.000. 2006 228.0% 14.3% 73.0% 118. and IPK International.0 30.0 9.3 3. Europe Travel Market Forecast Euros in millions Total Travel Spend % online Online Leisure/Unmanaged Biz Travel Spend Total Travel Spend Growth Online Travel Spend Growth Source: J.6% 1.682.1% 2010E 196.0% APAC Travel Market Forecast Dollars in millions Total Travel Spend % online Online Leisure/Unmanaged Biz Travel Spend Total Travel Spend Growth Online Travel Spend Growth Source: J.

Cloud solutions can enable startups to go from idea to product much more rapidly. we detail the large revenue potential of cloud services. . a service that has seen exponential growth and was built largely on top of Amazon Web Services. one prominent example is Twitter. Netflix announced that it was expanding its use of Amazon Web Services to include a variety of mission-critical applications. However. reaching near-enterprise scale without making enterprise-scale investments in hardware. which we will adopt here. but growth is also coming from enterprise adoption In May. Although the term technically has a more narrow definition. . with only 5% of global IT spend currently going to cloud solutions (a number IDC expects to more than double by 2013).  Significant revenue growth opportunity. In this section. Some cloud software offerings are already becoming mainstream. .t. We believe many large enterprises are currently doing due diligence. the near term should bring significant growth in the use of cloud solutions. to a computer that isn’t on your own desk or in your own data center but at a centralized facility. is for “cloud computing” to refer. essentially. and the proliferation of devices such as the iPad should encourage this trend. content. . and services) to be a catalyst for increased uptake of cloud services.khan@jpmorgan.Imran Khan (1-212) 622-6693 imran. the more common use. Why “Cloud”? The name serves as a metaphor for the internet. Clouds enable ubiquity We view ubiquity – the ability to access content across multiple devices and locations – as a key emerging trend for the internet space. Cloud computing is now a relatively uncontroversial part of the IT marketplace. and we expect more rapid adoption beyond small and medium-size businesses and startups in the future. although the scope of the eventual opportunity remains somewhat unclear: will it take over the computing world or merely be one more option within it? In either case. We expect a growing demand for ubiquity (of data. and migrating some of these functions from internal technology solutions onto the cloud.com Global Equity Research 03 January 2011 Cloud Computing Key Themes Clouds accelerate start-up activity and foster innovation . . we also view clouds as a driver of robust start-up activity. 123 . Certain aspects of Netflix’s streaming service are operating off Amazon’s infrastructure. such as email services that bridge PCs and smartphones. . with processing and computing functions occurring in the internet “cloud” rather than on a specific server.

In the case of Amazon. The abilities to collaborate more easily with other users and to access documents from a browser window anywhere are two key benefits. Microsoft and IBM have all entered this business to some extent.com revenue is expected to accelerate growth to 23% Y/Y after rising 21% in 2009 (Bloomberg consensus). Google and Microsoft have massive economies of scale.khan@jpmorgan.com Global Equity Research 03 January 2011 IDC Expects Cloud Spending to Grow at a 28% CAGR to 2013 Worldwide IT spend in $ billions 500 400 300 200 100 0 2009 Source: IDC. Cloud storage. Salesforce. 17 (5%) 45 (10%) 359 416 On-premise Cloud Serv ices 2013E  Cloud applications aim to replace software. the bandwidth used by its Web Services division began to exceed the bandwidth used by Amazon’s own websites in mid-2007. Companies such as Amazon. Not selling excess capacity. Google.t. and it’s a lot cheaper for them to buy and operate servers and hard drives than it is for almost anyone else. in our view. e. processing aim to replace hardware. cloud solutions remain in a very early stage of growth. However. selling cloud services is a full-fledged service and not simply a case of taking already existing capacity and monetizing the unused. viewed as an overall part of the $144B application software market.Imran Khan (1-212) 622-6693 imran..   124 .g. excess portion. Amazon. Revenue growth at providers of ondemand solutions is projected to remain very strong in 2010. However. A common misconception is that cloud providers such as Amazon are merely taking advantage of excess capacity.

services include storage and processing time and allow smaller companies to lower costs by 125  . now describes its platforms as operating in the cloud. these are apps that replace software you might have otherwise used on your own computer. the idea is actually quite simple: the benefits of using applications. Many Concepts As with many internet trends. Cloud services. people can see many different things in the term. Google Docs is a frequently cited example. such as a word processor or spreadsheet. we think cloud solutions can enable innovation to continue at a faster pace than would be possible otherwise. Amazon has been the notable leader here. though. storage and processing capacity online can often outweigh the costs. We think an underappreciated aspect of the growth of cloud computing is the way this growth is fostering innovation. We will touch upon each of these in more detail below:  Cloud applications and software as a service. One Name.com Global Equity Research 03 January 2011 Web Services Bandwidth Far Exceeds that of “Core” Amazon Source: Company presentation. though others. cloud computing has broadened in meaning as diverse companies and tools have jumped on the “cloud”.  Fostering innovation. as defined by companies. At its core.t. essentially. Cloud computing. also have offerings. Fast growers such as Twitter and Playfish use Amazon Web Services.com. especially as internet connections speed up and offer near-instantaneous response.Imran Khan (1-212) 622-6693 imran. including Google and Microsoft. As a result. companies such as Salesforce. has now expanded to include two key concepts. An entrepreneur with a promising idea faces much lower costs when trying to start a business.khan@jpmorgan. appropriate to the word. At a somewhat higher level of complexity. which offers on-demand SaaS (software as a service) solutions.

8 181% 247% 198% 227% 7. almost 65% access email sites. which involve large enterprises developing their own. Nevertheless. consumer-facing applications.g. 2010 Unique Visitors in Millions and Y/Y Growth Rates 15 10 5 0 4Q'08 1Q'09 2Q'09 3Q'09 3.4 193% 4Q'09 69% 1Q'10 70% 2Q'10 38% 3Q'10 Av g. Private solutions can enable a large company to benefit from the flexibility of cloud implementation while getting around certain issues.. 2007 to Oct. such as data security. Monthly Unique Visitors (millions) and Y/ Y Grow th (%) Source: compete. Although the reach of these applications is significantly smaller than that of webmail. which may need more processor capacity than is available on. We think continued growth for cloud applications on the consumer and small business side is quite likely for several reasons: 126 . Cloud Applications For simple.t.2 13.3B worldwide internet users. which makes them behave with a user interface and responsiveness similar to what one would expect from a desktop application.4 6.8 13. Additionally. internal cloud-computing solutions. including word processing. e. companies ranging in size from startups to Google have made available a variety of applications that are more typically associated with the desktop. The most successful is perhaps not what some would first think of as a cloud application: email. there is a growing market for “private” cloud implementations. the ability to move processing off a user’s computer and onto a server could permit a larger number of devices to run more sophisticated communications tools. presentations and photo editing. that may otherwise prevent them from using public cloud solutions. Additionally.com. Beyond email. “Private clouds” are essentially hyperefficient data centers — as are the platforms used to provide cloud services in the public domain.Imran Khan (1-212) 622-6693 imran. spreadsheets. comScore estimates that out of nearly 1.7 11.com Global Equity Research 03 January 2011 taking advantage of the big guns’ superior processing power and purchasing power.7 9. cloud applications already have a foothold in replacing the more traditional software-on-your-computer model. their growth over the past two years has been quite rapid. Unique Visitors to Google Docs Grew More than 10x from Oct. And both Yahoo! and Google’s email services work using Ajax.khan@jpmorgan.1 10. a mobile phone.

For the software company. While we don’t expect these tools to make much headway at most large corporations.t. may not want to put valuable information online in a way that enables the whole world to possibly access it. and there is less of a danger that multiple copies could be made from a single source. The provider can ration access to the application. especially enterprise clients. are available for free or for an annual fee of $50/user account for businesses.com Global Equity Research 03 January 2011  Ubiquity. a smaller business may find the price compelling. and the lack of the full suite of features may not be a significant drawback. Lose your link to the network. The web application model frees the user from needing to ensure that software is up to date. Lack of features.khan@jpmorgan.     At the same time. the model brings with it a variety of drawbacks. compared to a Microsoft Office price point of over $100 retail. a tool that offers only a fraction of Excel’s capabilities is likely to be sufficient.g.. as the application is designed to work in a browser. Reliance on internet connection. the user is not confined to computers with the right software installed. for many users. Additionally. Many of Google’s tools. e. some more significant than others:  Data security. Convenience. The file can be available wherever the user can open a browser window. easier to avoid piracy. Multiple people can work on the same document and see each others’ changes in real time. We think collaboration will become an even more core component of software innovation over the next decade.   127 . Some clients. they generally remain far short of the capabilities offered by a full-featured application such as Microsoft Excel. Price point. While online applications continue to make strides.Imran Khan (1-212) 622-6693 imran. Some providers let users edit documents offline – but doing so temporarily removes some of the advantages described above. We believe that. Collaboration. and you lose your documents – a trade-off some may not be willing to risk.

792 904 317 495 1. Netsuite Inc. Google Talk Interoperability with MSFT Outlook email/calendar Sync with Blackberry Enterprise Server Collaboration Application features Google Docs. Google Calendar.0 224.5 92. Details $50 / user account / year Included 25 GB / account Can be disabled Provided by Postini Included 99. plus 500 MB / user for shared storage Private video sharing 99. Constant Contact Inc.014. Rightnow Technologies Inc.com Global Equity Research 03 January 2011 Google Apps Features Feature Price Messaging application features Gmail and Google Calendar Gmail storage Gmail: ads Email Security Resource Scheduling in Google Calendar Gmail.Imran Khan (1-212) 622-6693 imran.html.com has described its CRM product as taking advantage of cloud computing.3 214. pricing as of 12/29/10 Name Concur Technologies Inc. Vocus Inc.Com Inc.469 2.325 1. fiscal years.1 Source: Bloomberg consensus estimates. Salesforce.602 760 17.9 112. Successfactors Inc.3 118.0 296. Logmein Inc. Salesforce.t. Google Sites Google Sites storage Google Video Google Docs. is frequently delivered over the web in a way that can be said to rely on the cloud.1 242.6 255. Such offerings are also occasionally called ondemand applications.26 217. or SaaS. On-Demand Software Companies Units as indicated. 128 . including data portability and.khan@jpmorgan.9% Uptime Service Level Agreement Included For critical issues Included Included Included Included Software as a service Software as a service. Kenexa Corp.1 270. Demandtec Inc.9% Uptime Service Level Agreement Included Included Included 10 GB. Note: CNQR revenue estimate is CY'11E. CRM and DMAN revenue estimates are F’11E due to non-Dec. Taleo Corp-Class A Ultimate Software Group Inc. they can take advantage of many of the features noted above. for the vendor.com/apps/intl/en/business/details.119 1.234 573 2010 Price chg +25% +94% +19% +67% +131% +56% +35% +80% +85% +18% +66% +53% Rev ’11E ($M) 365.google.7 2. Symbol CNQR CTCT DMAN KNXA LOGM N RNOW CRM SFSF TLEO ULTI VOCS Mkt Cap ($M) 2. These tools tend to be more sophisticated (and expensive) than the small businessand consumer-targeted offerings described above. Nevertheless. Google Sites Uptime Support Email support Phone support Integration Single sign-on API User and group provisioning API Email migration tools and API Email routing and email gateway support Source: http://www. easier updating.092 1.

these web services tend to operate around a similar general concept. in terms of either storage or processing. Amazon has reported that its Web Services accounted for 2x as much bandwidth use as Amazon. “operates entirely on AWS” Processing high resolution satellite images The intended users are. At the same time.t. starting at $0. 129 . rather than purchase equipment ahead of time that can handle peak loads but that would also sit idle for the majority of the time. which may experience occasional spikes in usage and find it more economical to rent the processing capacity to deal with such spikes.com’s core website by the early part of 2008. Although the details and implementation can vary. For storage. More recently. as well as storage costs per GB per month. For example. by way of example.khan@jpmorgan. or S3) and processing (Amazon Elastic Compute Cloud. IBM has expanded the suite of cloud products it offers over the past year.com. as well.com Global Equity Research 03 January 2011 Cloud Services The web services space has seen Amazon take a leading role. We note that these services are not a case of large companies selling their excess computing capacity. large enterprise clients such as Netflix are using Amazon Web Services. both introduced in 2006. Amazon charges US users on a sliding scale. with the companies announcing in May 2010. Additionally. Google rolled out its App Engine in April 2008. that would be difficult to ramp independently. or EC2). with key products that offer storage (Amazon Simple Storage Service. Sample Companies Using Amazon Web Services Customer Autodesk Urbanspoon Linden Lab Harvard Medical School Washington Post Indianapolis 500 Playfish NASA Jet Propulsion Lab Source: amazon. for the most part. that Netflix was shifting certain functions related to processing and streaming its Watch Instantly video content away from in-house infrastructure and onto AWS. as well as small and medium-size companies. while Microsoft announced the availability of its Azure suite of web services in October 2008.15 per GB per month (see below). the pricing generally includes a per-GB cost for transferring data in or out. other large players have joined the fray. the service offers its users an ability to add scale.Imran Khan (1-212) 622-6693 imran. Description of AWS use SAAS application hosting Backbone for iPhone App Content Delivery for Virtual World Research Models and Simulations Special projects Media hosting and streaming Social games co. smaller companies such as startups that may not have the capital or know-how to build up server capacity immediately.

09/GB Over 150 TB $0.10/GB Data Transfer: Out Volume/mo Price First 1 GB Free Up to 10 TB $0. Transition costs and complications.Imran Khan (1-212) 622-6693 imran. the cloud services model can absorb the spike vs.khan@jpmorgan.com Global Equity Research 03 January 2011 Costs of Amazon S3 for US Users Storage Volume/mo Price First 1 TB $0. some businesses may not be comfortable having key data stored on someone else’s computer. Additionally.11/GB Next 100 TB $0. By outsourcing these functions to a service provider.125/GB Next 450 TB $0.amazon. 130 .  Pricing. Rather than trying to project the growth of expected computing needs.055/GB Data Transfer: In Volume/mo Price All $0.11/GB Next 500 TB $0. if a company’s needs spike unexpectedly.  Disadvantages:  Less configurable. (Google’s App Engine is the exception. especially smaller ones. The processing and storage resources that are bought in a cloud model may not offer the option of being configured in precisely the way a user would prefer.14/GB Next 49 TB $0. a company can focus on its core business. allowing them to price the services at levels that can be lower than a smaller company would be able to achieve if buying its own hardware. have a core competency in managing hardware and servers. Similarly. For companies that begin with an onpremise solution.08/GB Over 5000 TB $0. an enterprise can pay for exactly the level of computing resources it requires. for now – the service is free. services that offer processing time are priced on a sliding scale depending on usage.t.08/GB Source: http://aws.095/GB Next 4000 TB $0. The large companies that offer these services tend to benefit from immense economies of scale. needing to wait for resources to be bought and installed. As with cloud applications. Focus. up to certain usage limits. switching to the cloud can involve a somewhat complicated transition.   Data security. Few companies.15/GB Next 40 TB $0. Note: Prices for storage somewhat higher in Northern California.) Advantages of cloud services model:  Scalability.com/s3/#pricing.

Imran Khan (1-212) 622-6693 imran. Content means more than just books. a more natural use for an eReader: the current paper format is largely disposable. Three trends have helped drive adoption: increased availability of devices from multiple vendors. tablets and PCs. here is a look at key features shared by many of the devices.com Global Equity Research 03 January 2011 eReaders Since Amazon introduced the Kindle in 4Q’07. if anything. lower device prices and platforms that extend the reach of eBooks onto other devices. The majority of the population doesn’t read many books (if any). As a note. 131 . or “book club” deals where an eReader is free but the consumer must buy a certain number of titles. A niche market can still be a big market. that would represent nearly 35M people. Compared to a year ago. eNewspapers. broadening the appeal of the devices. Prices falling as devices get better. more than enough to allow for multiple winners in the eReader market – even setting aside any global opportunities.. In the near future.g. further driving adoption. Amazon’s introduction of Singles – essays that are shorter than a book – hints at the scope for continued innovation. Key Takeaways  Device proliferation is driving ubiquity. throughout this report we refer to the devices as eReaders and to the content as eBooks. and we believe we remain in a very early stage for digital reading.t. Newspapers and magazines are. But even if only 15% of US adults read 25+ books a year. eReader devices are being sold with better screens and more storage – and prices that are ~25% lower Y/Y. and we expect prices on low-end devices to dip below $100 this year. We think this trend should continue. the eReader market has undergone rapid growth. could eventually be supported partly with advertising. such as mobile phones.      eReader Marketplace Getting Crowded Below is a quick primer on eReader devices currently (or soon) available. We think the money’s in content. where the user experience suffers with interruption. just as print newspapers are. with the landscape likely to continue to shift. cell-phone-type plans with unlimited content for a set monthly fee. The past 15 months have seen the introduction of the B&N Nook as well as Apple’s iPad. We continue to believe selling the devices is likely to be a less important business than selling eBooks – and other content – for the devices. First. More than one business model can succeed. on the other hand. we think an advertising-supported approach is less plausible for books.khan@jpmorgan. We think a variety of possibilities exist for the eReader market: e.

and allows the reader to look at a surface that is like paper. as of now the display backgrounds tend to be gray.) 7-inch E Ink. which means contrast is not quite as sharp as ink on paper.5 oz 7. rather than white. Finally.4” 7.com Global Equity Research 03 January 2011 Key features The majority of recent eReader devices have many or all of the following features:  E Ink display. Google Books for public domain books 5. but extremely useful for older readers who are no longer at the mercy of publishers’ choices about which content to release in large-print editions. Variable font size. as noted in the table below. Reader Daily Edition) have a larger screen that allows for better display of certain types of content and images. 132 . Summary of Sony Reader Models Price 1-yr Px Change Available Display Interface Usable Capacity Wireless? Bookstore Size Weight Pocket Edition Touch Edition Daily Edition $179 $229 $299 Down 10% from $199 Down 23% from $299 Down 25% from $399 September 2010 September 2010 Late 2009 5-inch E Ink.1"x0. both the B&N Nook (below the reading surface) and the latest Sony models (on the whole display) have one.7"x4. gray (16 sh.6"x4.7"x0.     Key Devices Sony Reader The first Sony Reader was released in September 2006.khan@jpmorgan. Some sort of connection is now more or less standard. the price is lower even though the company has introduced new versions with updated displays. Additionally.4” 5. Wireless connection.Imran Khan (1-212) 622-6693 imran. more memory and a slightly smaller size.t. most E Ink screens are currently black & white (or multiple shades of gray). some also feature an accelerometer that allows the device to show content in either portrait or landscape when the user turns the device. All three of the models have experienced a price decline since last year.3" 6.com. an E Ink display is not backlit. As of now. Perhaps the key differentiator of eReaders from other handheld devices. but we expect color to become more broadly available in future years. which reduces eye strain for many users. Several devices (Kindle DX. Note that for the Pocket Edition and Touch Edition. A sometimes overlooked advantage. using a miniature keyboard instead. whereas higher-priced models generally use the cellular network in some way. with some cheaper devices equipped with only a wi-fi connection.6 oz 9. One downside of available displays is a slower image refresh than traditional screens.6 oz Source: Sonystyle. Macro screen. the Kindle does not. gray (16 sh.0”x0.9”x5. press reports.) Buttons Touch Screen Touch Screen ~2GB ~2GB ~ 2GB No No Yes For all three models: Sony eBook Store. and currently the company sells three versions. Increasingly the interface of choice. Touch screen. gray (16 shades) 6-inch E Ink.

with the pace of rollouts accelerating somewhat after the first year:                May 2008: Cut price to $359 February 2009: Kindle 2. Barnes & Noble Nook B&N began selling its eReader. As with both the Sony Reader and the Kindle.7” screen. Nook has seen its price decline significantly: the original version of the device (most similar to the $199 version) sold for $259 when it debuted a year ago. and a full-color Nook for $249. battery life and storage capacity. Amazon Kindle Amazon released the first version of the Kindle in November 2007. $359 March 2009: Kindle iPhone App May 2009: Kindle DX (9. All devices are enabled for free wi-fi 133 . Kindle for PC. a version that includes a 3G connection for $199. The company now sells three versions of the device: a wi-fi only Nook with an advertised price of $149. Over the last three years. in November 2009.com Global Equity Research 03 January 2011 Sony sells books for its Readers via its own eBook store and has a deal with Google for public domain books to be available as well. the company has rolled out several updated versions.t. selling for $399.Imran Khan (1-212) 622-6693 imran. Cut Kindle 2 price to $259 January 2010: Kindle DX Int’l version February 2010: Kindle for Blackberry App March 2010: Kindle for Mac April 2010: Kindle for iPad App May 2010: Kindle for Android App June 2010: Cut Kindle 2 price to $189 July 2010: New version of Kindle DX. the price of the core Kindle reader has dropped by more than half from $399 to $189. $379 August 2010: Kindle 3: wi-fi only for $139. This is despite improvements in the display. called Nook.khan@jpmorgan. most titles available through the Google deal are likely to be of extremely limited interest to most users. $489) July 2009: Cut Kindle 2 price to $299 October 2009: Int’l edition. 3G for $189 December 2010: Kindle for Web released In three years. Although the availability of public domain books expands the nominal size of the catalog.

P. Marketing Matters: Consumer Awareness Rising In July 2009. We expect new devices catering to this segment to hit the market in coming years. and we continue to believe eReaders are unlikely to reach the penetration levels of MP3 players. we believe the textbook market. that number was down to 24%. We expect eReaders to undergo a similar evolution and think the devices available five years from now are likely to have features and capabilities significantly beyond what is currently available.t.P. Morgan Internet Team December 2010 survey. However. 76% 45% 84% iPad Is the Market Big Enough? The majority of the population does not read very much.com Global Equity Research 03 January 2011 access at B&N stores as well as AT&T wi-fi hotspots. It appears Amazon’s somewhat aggressive marketing push for the Kindle is bearing fruit. B&W screen. which has over 1M titles available. which is not a dedicated reading device but a tablet with reading one of its many functions. Apple introduced the iPad.Imran Khan (1-212) 622-6693 imran. By comparison. J. Morgan estimates that nearly 12 million units will be sold globally in the first year. Apple iPad In April 2010. 134 . Additionally. and all use Barnes & Noble’s eBook store. which represents a tremendous opportunity. Barnes & Noble allows users to read full eBooks when at a B&N store and enables Nook users to “lend” eBooks to one another. mechanical scroll wheel. and found that 63% of them had either not heard of the Kindle or had heard of it but didn’t know what it was. with some devices aimed more at business-focused readers. 10 hours battery life) with current models. we surveyed 765 US internet users. When we conducted a similar survey in December 2010. the Barnes & Noble Nook has lower awareness: Marketing Efforts Paying off in Higher Awareness for Apple.khan@jpmorgan. which cuts into the possible size of the market. no Windows compatibility. Still in the early innings We think it is instructive to compare the first-edition iPod (10 GB. Amazon 100% 80% 60% 40% 20% 0% Kindle Nook Brand Aw areness (Know the name & w hat it is) Source: J. Textbook market begging for innovation Most of the eReaders currently being sold are designed primarily with readers of mass-market books in mind. will require further innovation on the device side in order to flourish.

We estimate that. with prices declining.P. While we believe such rapid uptake is unlikely. We think the majority of the target market for eReaders is in this group (although some of those who read fewer books may consume a significant quantity of other written content. With Prices Down and Awareness Up.t. Additionally. 28% of adult US Internet users would represent nearly 48M people. ~16% Read 26+ Books per Year 60% 50% 40% 30% 20% 10% 0% 0-10 books/y r 11-15 16-20 21-25 26-30 31+ 20% 9% 7% 6% 10% 49% Source: J. between the US and Europe. we think the scale of the opportunity is quite large. A year and a half later. When we asked in July 2009 about purchase interest. Globally. Although the Majority Doesn’t Read Much. we believe interest in eReaders is rising significantly. 135 . that number has quadrupled. 16% represents in excess of 35M people. Morgan Internet Team July 2009 and December 2010 surveys.Imran Khan (1-212) 622-6693 imran. in our recent survey of US internet users. EU and UK statistics on heavy readers suggest numbers broadly in line with the US (with significant variation across countries). we think the opportunity for device sales is even larger. Morgan Internet Team December 2010 survey.P. Kindles Approaching Mainstream 30% 25% 20% 15% 10% 5% 0% 7% Jul 2009 Dec 2010 28% % say ing they either ow n a Kind le or plan to buy one in the nex t 12 months Source: J. there are ~100M adults who are heavy readers. such as newspapers and magazines). Across the entire population of US adults.com Global Equity Research 03 January 2011 However. and who would thus be part of the target market for eReaders and eBooks. ~7% of our sample reported either owning a Kindle or planning to purchase one within 12 months. reading at least two books per month.khan@jpmorgan. we found that 16% are heavy readers.

The majority of eReader owners appear to be buying at least 2 books/month for their device.4B in annual sales would be equivalent to roughly 16M device sales. this represents $240/year in annual revenue – well ahead of most device prices.5B market. the $2. assuming current pricing. Comp #2: digital music We note that digital sales represented ~40% of all US music sales in 2009 (as per IFPI). 136 . the focus on adults excludes another potential market: textbooks.Imran Khan (1-212) 622-6693 imran. There is a significant cost component of textbooks related to the manufacture of the physical books. Further.P. in line with where the lowest-priced devices are selling today. The American Association of Publishers estimated net sales for K-12 and higher education books in 2009 to constitute a $9. by way of comparison.com Global Equity Research 03 January 2011 Finally. Since we expect an eReader to be a fairly durable item. which tend to get replaced as often as every 1.khan@jpmorgan. a number that is likely to continue to grow.t. two books a month comes to $120 annually. Morgan Internet Team December 2010 survey.5-2 years. Most eReader Owners Buy at Least Two Books a Month 35% 30% 25% 20% 15% 10% 5% 0% 0-1 Books/month 2 3 4 or more 27% 33% 22% 18% Source: J. we think eReaders are likely to have longer useful lives than cellular phones. and we think it is likely that a slightly differentiated set of eReader devices will develop to service the textbook market. Comp #1: the cell phone market First. Focus on Content. it’s nearly assured most users will spend more on content than on devices. or nearly 40% of the US total. Even if we assume eBook prices eventually fall to $5. If eBooks could achieve even 10% penetration (or less than 1/3 the level in music) of the roughly ~$24B books market. we note that cellular carrier service revenue (~$150B in the US last year) was approximately 7-8x as large as handset sales revenue (or 4-5x as large when adjusting for handset subsidies). Not Devices We think the opportunity from device sales pales in comparison to the scale of the opportunity from content sales. At $10/book. for several reasons.

After acquiring an eReader (possibly subsidized. 9% 3% 0. Both newspapers (especially) and magazines (for the most part) are intended for immediate consumption with little thought of long-term value. It appears that. Note: 2010 estimated based on Jan-Oct data. Below.t.khan@jpmorgan. Further. Amazon has made an early entry into this space with Amazon Singles: essay-length content that would be too short for a book but too long for a magazine article. Additionally. Morgan estimates. you sign up for a monthly plan that lets you download a certain 137 . and uncertainty about maintaining longer-term ownership of digitally acquired books – are virtual nonissues for periodicals. Barnes & Noble. We do not foresee the market shrinking to less than a duopoly: we expect publishers to be very resistant to allowing one merchant to reach the market power that Apple has achieved in digital music. Altogether.com Global Equity Research 03 January 2011 Market fragmentation less likely in eBooks than eReaders Additionally. which are largely disposable. given the history of publishing that has developed around the economics of the book. J. whereas we expect continued fragmentation in the eReader market. we see both a greater revenue potential for eBooks and greater room for market concentration. some may never get off the ground:  The cellular model. we sketch out several possibilities for alternative business models.5% 0. we think new formats are likely to emerge.P. Business Models Should Evolve We think mass adoption of eReaders could drive changes in the standard business model of selling one book at a time. Google and Sony are seriously pursuing eBook sales. two of the key consumer disadvantages of eReaders – the difficulty of sharing a book.6% 1% 2009 2010 Content Means More than Books We think one of the underappreciated aspects of the development of eReaders is the capacity to deliver medium. Some of these may succeed. we believe the devices are in many ways ideally suited for reading newspapers and magazines. eBooks Penetration of Trade Print Is Growing Exponentially 10% 8% 6% 4% 2% 0% 2006 2007 2008 eBooks as % of Trade Print Source: Association of American Publishers. as of now. Specifically. we think content sales are likely to become the province of three or four main players. like a cell phone).and long-form content other than books. only Amazon.Imran Khan (1-212) 622-6693 imran.

Ad-supported content. A format that allows students to use eReaders instead of textbooks could achieve economies through lower manufacturing cost. Search. Once writers become more comfortable with the format. As noted above. Serialized content. A variety of academic and specialty uses. faster distribution can be combined with greater depth of content. Reading is too immersive to be well-suited to the interruption of an ad. a digital book could offer the possibility of a richer user experience. or specialized business titles. Textbooks. more interlinked information.        138 . similar to existing toolbar deals between PC manufacturers and search engines. Lighter backpacks would be another plus. etc. in nonfiction. textbooks involve significant manufacturing expenses. Some of the possibilities: much deeper sourcing or footnotes..com Global Equity Research 03 January 2011 quantity of reading material each month.Imran Khan (1-212) 622-6693 imran. periodicals. An eReader combined with a micro-payments platform could allow for sales of content in ways that were not previously practical: e.g. This runs parallel to – Lower-priced content. Publishers could license content for a flat rate. In a world where publishing is not tied to physical paper. can benefit significantly from lower distribution costs. Enhanced content. rather than all at once. For publications such as scientific journals. could well develop an advertising model (their readers would be used to it). We are skeptical of ad-supported books.. we think there could be some capacity for search distribution deals. Different plans could include or exclude different types of content (e.25 for a short story. We would worry about issues of privacy (since the device seller knows exactly who the device owner is) as well as finding an ad format that’s desirable to advertisers but that does not significantly diminish the user experience. or newspapers).t. On the other hand. with shorter articles. new releases. writers and publishers may choose to release books chapter by chapter. but only to a low circulation. Publications that are of high value. or perhaps newspapers/magazines that sell individual articles for a few cents apiece. As the devices and their wireless connections improve. even if it is targeted well. esp.g.  The “Columbia House” model.khan@jpmorgan. or perhaps use revenue sharing with an imputed value for each download (a la Netflix). The user gets a (discounted/free) eReader after agreeing to purchase a specified number of titles over a specified period. $0.

International Sector Outlooks .

com Global Equity Research 03 January 2011 140 .t.Imran Khan (1-212) 622-6693 imran.khan@jpmorgan.

(6) Search continues to see solid growth. We expect internet leaders like Baidu and Tencent to formally launch middle-ware products that could include thirdparty application distribution platforms. (7) Solid consumer spending trend supports good advertising segment growth. and a familiar ad format.x. or less than 4% of retail sales. lower-price alternatives to traditional retail. but remain gradual. to drive ad budgets online. World of Warcraft Cataclysm. With the recent IPO of Youku.Dick Wei (852) 2800-8535 dick. sector rerating. TV advertisers are likely to accelerate the ad budget shift from offline to online. Expect sector margins to have very slight improvements from Rmb appreciation. Gross merchandise volume (GMV) is expected to reach Rmb723B in 2011. Expect social sites to be an emerging and important traffic generator for eCommerce companies. etc.com Global Equity Research 03 January 2011 China China Top Predictions for 2011 (1) eCommerce to see wider adoption. We believe more new listings are likely. compete with existing players UCWeb other mobile game platforms. driven by user-segregation and better online adserving/tracking technology. Highly anticipated games in 2011 include Duke of Mountain Deer. as only a small portion of costs are in US dollars (game licensing fee. etc. (5) Mobile internet to see increased competition. We believe the sector growth story remains intact: internet usage growth. which could generate greater player interest and. as such. (2) Social commerce. with wider market adoption. (8) Expect transition from time-base pricing to CPM-base pricing to accelerate in 2011. overseas video/sports content fee. Synergistic relationship between social networks and commerce merchants will fuel growth for both segments. and improved trust & safety. other players such as Soso and Sogou still unlikely to gain meaningful market share. Yet.wei@jpmorgan. driven by convenience. (3) Game segment likely to see re-rating with good game titles launch. particularly in lower-tier cities. as well as a number of sizable private companies. (4) Video advertising to prompt ad dollar shift from TV to internet. (10) More IPOs likely in 2011. Benefits to come from translation gains from Rmb-denominated EPS to US$-denominated EPS. We think China’s internet segment offers good secular growth. a broader range of online video content.. and some servers. leading portals will still benefit from their own brand influence. growing online video user base. Expect continued good macro environment to support consumer spending. 141 . We expect investors will likely continue to look for growth investment opportunities in 2011. (9) 2011 Rmb appreciation to improve sector profitability.). Baidu still maintains dominance.

x.wei@jpmorgan.com Global Equity Research 03 January 2011 142 .Dick Wei (852) 2800-8535 dick.

2%. China Internet Users and Penetration Rate 600 500 400 300 200 100 0 Dec-10E Dec-11E Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11E 103 111 123 80 87 94 46 59 68 34 137 162 210 253 298 338 384 420 454 534 40% 35% 30% 25% 20% 15% 10% 5% 0% 494 Number of China Internet Users (Left. 143 . and low-cost entertainment aspects.Dick Wei (852) 2800-8535 dick.8% growth rate.0% Penetration Rate (Urban Population) Source: CNNIC. Since late 2008. according to China Internet Network Information Center (CNNIC).7% 11.P. Morgan estimates. millions) Penetration Rate as % of Total Population (Right) Source: CNNIC J.x.2% 19. lower-priced computers.0% from 11. Further.7% 3.1% Dec-06 Dec-08 Jun-10 Penetration Rate (Rural Population) 16.wei@jpmorgan.7% in One and a Half Years 60% 50% 40% 30% 20% 10% 0% 48. This strong growth in recent years has been driven by factors such as robust GDP growth. increasing 24% Y/Y to 420M by June 2010. more affordable telecom connection fees.com Global Equity Research 03 January 2011 China Internet Market Overview Internet penetration still low at 31% China’s internet population grew at a rapid pace in 2010. Rural Internet Penetration Reached 16. China has the world’s largest internet user base. government support for internet usage. rural internet populations continued to adopt the internet in 1H10 with a 7.6% 35. or at a penetration rate of 31.

Source: CNNIC. or the penetration rate to reach ~39% of the population by the end of 2011. Ministry of Industry and Information Technology (MIIT). with lower-cost connection fees and equipment costs. We expect internet users to grow by around 17.5 years Source: CNNIC. and to 364MM (87% of total users) by June 2010. 144 Jun-15 . and Korea (over 70%).wei@jpmorgan. Japan. Morgan estimates. J. We observe that in recent years internet penetration has lagged mobile phone penetration by around four to five years. We draw the parallel between internet penetration and mobile phone penetration in China. China's internet penetration rate of about 31% of the population is still well below that of developed markets like the US. Broadband and Mobile continue rapid growth According to CNNIC.x.7% Y/Y in 2011 to reach ~534MM.com Global Equity Research 03 January 2011 How much more growth? Despite this rapid growth. China Internet and Mobile Phone Users 900 800 700 600 500 400 300 200 100 0 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 90% Mobile phone users (Mn) Intenet users (Mn) Mobile users shifted 4. Broadband Internet Users in China 400 300 200 100 0 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 77 91 122 163 270 214 319 346 364 Broadband Internet Users as % of Total Internet Users 100% 80% 60% 40% 20% 0% Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 66% 75% 78% 85% 91% 94% 87% Broadband Users (Mn) Broadband users as % of total Internet users Source: CNNIC.P. the number of users with broadband internet access grew 28% Y/Y to 346M (90% of total users) by the end of 2009.Dick Wei (852) 2800-8535 dick. This gives us confidence that internet penetration will likely continue to grow in the future.

20% Internet Café Company 145 .9% 24.wei@jpmorgan.com Global Equity Research 03 January 2011 According to the latest MIIT data.4 6. and per capita wealth. Morgan estimates. Internet access device The number of mobile internet users increased by 78% Y/Y to 277M by Jun-10.5 5. The number of people accessing the internet from the office also increased to 33% at the end of 1H10 from 30% in late 2009.1% 2006 51.5 2. the number of broadband subscriber lines reached 123.9% 9.5% 2007 66.9% 36.6% 65.x. Methods of Accessing by Device 80% 70% 60% 50% 40% 30% 20% 10% 0% Desktop Source: CNNIC (Jun-10). 73.4% 20. J.2% Source: CNNIC.2 million by October 2010.0% 28.0% 2010* 123.0% 12. We expect mobile internet usage to increase significantly once 3G penetration increases amongst consumers. Note: Data as of October 2010.60% 33.0 7.0% 2009 105. the home has become the preferred place for most users to access the internet. 88.40% 33. broadband penetration. Broadband Subscriber Penetration by Number of Broadband Lines Broadband subscribers (MM) Population Penetration (%) Households Penetration (%) 2005 37. Main Access Locations 100% 80% 60% 40% 20% 0% Home Source: CNNIC (Jun-10).9 4.8% Laptop Mobile Phone Home has become preferred place to access the internet Given the increase in internet-accessible computers.1% 2008 83.P.2 9. Ministry of Industry and Information Technology (MIIT).1% 16. as per CNNIC. with more than four-fifths of all internet users accessing the internet from home. The number of mobile internet users was 66% of all internet users and 33% of all mobile users.Dick Wei (852) 2800-8535 dick.

5 304.wei@jpmorgan.2 19. QQ.4% 70.3 231.6% Users in millions 346.Dec.5% 30. This was up from 18. ICQ) Online Games Online movie (include download)/Video Email Blog Social Networking Online literature Online shopping BBS/forum Online payment Online banking Online stock trading Online travel reservation Source: CNNIC (Jun-10).4% of mobile users while listening/downloading music was the third most popular activity with 45.6 16.1 128.0 Dec.0 13.3% 72.3%. Online news is also popular.Dec.Jun.1 63.8 13.8 hours per week online.Dec.2% 56.8% 33.7 320.com Global Equity Research 03 January 2011 Average time spent online remains stable CNNIC’s Jun-10 survey showed users spent an average of 19.4 210.Dick Wei (852) 2800-8535 dick. Online payment and online shopping have seen fast growth with 36.3 128.4 237. % of surveyed use the service 82. Media is the most popular internet use According to the Jun-10 CNNIC survey.Dec.x.3% users.Jun.5% 55.Jun.5% 15. We also note that internet usage has more than doubled compared to the 9.0 36.1% 50.1 Chinese mobile users cite chat as the most used function while accessing the internet with their phones.2% and 31.1 296. respectively.0 18.Dec.5% usage.8% 31. with 78.3 13. while search engine use was 76. Average Time Spent Online Hours/week 25 20 15 10 5 0 9.5 16.5 329.4 12.2 14.0 132.Jun.Jun. online music is the most popular use of the internet. Mobile search is chosen by 48.7 19. 146 .8 hours per week spent online in December 2002.5% 76.5% of internet users accessing online music.8 16.1% 44.Dec.4% user increases in six months by June 2010.Jun. While the overall average online time per user remains stable.0% 8.5% 30.5% 78.Jun.6 18.9 18.Jun02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 Av erage Accessing Time Per Week Source: CNNIC (Jun-10). Internet Usage by Category Service type Online Music/download News Search engine Instant messaging ( chat room. with 82.4 188.9 16.7 hours per week six months earlier.Dec.2 142.5% 63.0 15. we note old users likely spend more time online than new users.1 265.

This compares with around 67% in the US Search ads continue to grow faster than brand ads We expect search advertising to continue to see stronger growth than brand advertising in 2011.3B (US$5.2 16.x.3% 35.0% 6. higher influence of online media. 2) higher SME advertisers’ adoption of pay-for-performance advertising. search ad is ~61% of the total online ad market in China in 2011E. 3) search usage to increase with the growing eCommerce market. and government support should continue to drive internet growth in China. The total online ad market still accounts for a relatively small portion of China’s overall advertising market (expected to be around 15.wei@jpmorgan. As such.3% 43. we still see room for growth. 147 . to reach Rmb30B (or US$4.4% 16. From a top-down perspective.com Global Equity Research 03 January 2011 Chat Is the Most Used Application on Mobile 70% 60% 50% 40% 30% 20% 10% 0% 61.8% in 2011). Online Advertising Maintain positive view on 2011 and longer-term online ad market growth We expect the rising number of internet users and increasing times spent on the internet will continue to drive online ad allocation. Time spent on internet per users should accelerate from the increased penetration of smartphones and tablets. and 4) use of search ads as a brand advertising tool.6 18 18. This compares with ~70% in the US. we expect market drivers to be: 1) increasing user adoption of search.1% 20. Lower computer prices. declining connection fees.5% 21.5% 48.7 19. Increasing Time Spent on Internet per User per Week 21 20 19 18 17 16 15 Dec-07 Dec-08 Jun-09 Dec-09 Jun-10 16.8B).8 Time Spent Online (In Hr/Week) Source: CNNIC.4B) and 31% YoY growth in 2012 to reach Rmb39.1% Mobile Chat Mobile Search Online music listening or downloading Mobile Literature Mobile Online mobile Mobile Video Mobile email community game Mobile Payment Source: CNNIC (Jun-10).4% 45.Dick Wei (852) 2800-8535 dick. We forecast the online ad market to witness 23% YoY growth in 2011. China search ad is still ~50% of the total online ad market. From a bottom-up perspective.

However.7% 2007 4. the advertising industry should benefit from this trend.0% 0.851 122 7. and low-cost entertainment alternative.44% 15. %) Ad market as % of GDP Online ad as % of Total ad market 2006 3.559 2.442 24. automobile companies will continue to increase 148 .928 621 54.8% 165.015 135 21. Automobiles advertising outlook for 2011 Driver 1: Increased auto ad dollars In 2011. and 5) GDP growth should also drive overall ad spending up. Online advertising: bottom-up perspective The few sectors that we believe are likely to see fast growth next year are: autos.8% 2011E 11. more measurable results.377 1. and lower rates vs.290 2. 3) more measurable and lower cost compared with traditional media like TV. Online advertising: top-down perspective Internet usage growth – same old story.5% 2008 6.707 20. but is that what is driving the online ad spending growth expected in 2011? We expect China's internet user base to grow around 20% CAGR (2009–11) to reach a penetration rate of 39% by the end of 2011.3% 139. and eCommerce.8% 116.301 16. China Government’s drive to push consumption in the country should continue to help drive retails sales.096 15.501 2.wei@jpmorgan.S.44% 6. Morgan estimates.0% 0.427 135 30.100 48.com Global Equity Research 03 January 2011 China Online Advertising Market Forecast from 2006 to 2012E Brand Advertising (RMB M) Search Advertising (RMB M) Other Online Format (RMB M) Total Online ad market (RMB M): Total Online ad market (US$M) Growth Rate (Rmb.0% 0. we believe the auto sales environment will become more competitive with less government subsidies and oversupply.8% 2012E 14.083 21.309 135 11. should help drive up marketing expenses by auto makers.0% 2010E 9.0% 0.422 10.42% 10. China’s 0.721 72.0% 216. Note: Growth rates are in Rmb terms. U. As a result.1% 0. Driver 2: Increased online allocation We believe that with an affluent internet population growing.328 5.213 135 14.P. 29% in 2010E.5% 0.5% 190.942 7.x.45% 18.6% 105. J.023 4. in turn.533 999 60.712 16. TV. a minimum of 20% Y/Y growth in online brand ad spending should be achievable.5% 2009E 6. Our China Autos Analyst Frank Li suggests that auto sales for personal vehicles will decline to 15% YoY in 2011 vs. We believe if the number of internet users grows 20% Y/Y (or roughly equal to the increase in media consumption).1% Source: iResearch.428 5. %) Total China ad market (Rmb M) Growth Rate (Rmb. government support of internet usage. more affordable telecom connection fees.442 109 4.48% 4.872 1.46% 8.1% 142. CNNIC. FMCG (Fast Moving Consumer Goods). 2) the internet can reach a broader audience in smaller cities in China. up from the current penetration rate of 31%. excess capacity build-up over the last few years will also lead to higher competition which.5% Ad spend as a percentage of GDP in China is still below the US level.709 14. Online ads should grow even faster.025 12. Drivers for the sector include lower-priced computers. advertising spending = 2% of GDP vs. we still believe advertising in China can grow at least in line with GDP.Dick Wei (852) 2800-8535 dick.826 31. 4) general inflation in advertising rates. given: 1) higher number of hours spent online per user.448 43.42% 12.0% 0. as such.175 3.462 18.751 135 39.

Online eCommerce advertising We believe the fast-growing eCommerce market will prompt eCommerce companies to increase spending online. other attractive ad formats would be ads in social networking websites. We believe such a situation will benefit advertising demand.x. In addition to general brand building through banner advertising. These advertisers likely advertise with leading portals such as Sina and Sohu for stronger brand influence. In addition.wei@jpmorgan. which should drive up the advertising allocation to internet from these cities. we’ve seen a significant pullback in 2009. a product-specific campaign would be more effective over the internet as Chinese consumers tend to do a lot of their own research before their first car purchase.Dick Wei (852) 2800-8535 dick. driving traffic for test drives) rather than general branding exercise. which have limited geographic coverage).3% of automobiles’ advertising budget is allocated online in China. eCommerce companies will be aggressive in online ad spending.com Global Equity Research 03 January 2011 budget allocations to online advertising. online ad spending in lower-tier cities is around 50% or less compared to Tier-1 cities. Driver 3: Geographic expansion in autos sales As we believe lower-tier cities will see faster autos sales in the next few years. 149 . We expect new drivers for the finance segment over the next few years could be insurance companies. according to iResearch. personal banking. Real estate advertising saw a big downturn in 1H10 as a result. We expect the reverse trend that begun in 2H10 to continue in 2011. Currently ~7. In addition. With a better macro environment. we think these advertisers will likely come back in 2010 and 2011. brokerage and wealth management advertisements. Currently. Financial services advertising Investment funds increased their overall ad budgets in late 2007 and 2008. CRIC. however. we expect eCommerce companies to increase spending on search as well. the policy theme should shift from curbing demand to pushing out more housing supply while limiting price increases. In our opinion. 2011 to be a better year In 2010. iResearch expects auto online advertising spending to increase to 10. For eCommerce merchants. A geographic diversification story beyond Beijing. the private real estate market was quite weak due to a series of restrictive measures to curb investment demand and housing price growth. with rising competition and fight for market share. we believe advertisers would also be well served by investing more on the internet for nationwide customer reach (rather than magazine and newspapers. we believe more advertising budget will be directed to drive product sales (through advertising particular models.9% by 2013. Real estate advertising Worst is over. and Baidu have been increasing their presence in Tier 2/Tier 3 cities. Shanghai All the major leading portals including Sohu. Although we expect the government to maintain its tightening stance in 2011.

67B. the internet would offer very cost-effective advertising. CCTV (China Central Television) holds an advertising auction for the next year’s prime time ad resources on CCTV channels.52% Y/Y: This is slightly above industry expectations of around 15%. Good growth in CCTV auctions Every year on November 18 (last year on November 8). the auction results suggest consensus (hundreds of advertisers participated) is more optimistic than cautious.Number of households w ith assets abov e US$1 million Source: ACMR.Dick Wei (852) 2800-8535 dick.wei@jpmorgan. the online brand ad rate is likely to achieve >20% growth. We expect the trend to continue to change with more allocation online. as well as finance and security. up 15. given a large internet population.x. Industry segments The top bidders were from the food and beverage sectors. (2) with the CCTV auction setting a positive tone. these advertisers allocated less spending online. we believe with an increasing trend in luxury retailing. home appliances. We note that brands like Cartier have begun advertising online. Furthermore. a wider online demographic. China . (3) published rates for leading portals and other media are likely to increase good next year. CCTV reported prime time ad auction revenue of Rmb12.Number of Households with Assets Above US$1 Million 800 600 400 200 0 2003 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 141 179 223 305 437 417 453 529 609 697 China . 150 . In November 2010. Telecom sector spending We expect telcos will continue to invest in advertising in order to drive 3G adoption (government-mandated strategy) and higher competition in the space with operators trying to recoup their capex spending. There was also an increased presence by the auto and tourism industries.com Global Equity Research 03 January 2011 Fast-moving consumer goods Historically. We continue to expect the online branded ad segment to benefit from decent 2011 overall ad market growth as well as increased online ad allocation. and more integrated marketing campaign required to differentiate a brand. This important event auctions off ~15% of the country’s total TV ad spending and sets the tone for ad growth in the coming year. We see the following implications: (1) while advertisers are generally cautiously optimistic about 2011’s outlook.

2 2. The table below shows the auction results growth rate vs.87 6.25 5.Dick Wei (852) 2800-8535 dick.8 2.97 12.80 8.7 Source: CCTV.com Global Equity Research 03 January 2011 We look at absolute dollar amounts of ads sold at the auction.wei@jpmorgan.0 3.2 2. Online Brand Ad Growth Year 2003 2004 2005 2006 2007 2008 2009 2010 2011E CCTV Prime time Auction Revenue (Rmb billion) 3. CCTV Auction Results vs.31 4.9 2. Morgan current estimates.x. 151 . online brand ad growth rate (in Rmb terms). Zenith Optimedia.41 5.6 1.3 0. Note: J.03 9. P.26 10.67 YoY Growth 26% 33% 19% 12% 16% 18% 15% 19% 16% Online Brand Ad Growth 102% 72% 37% 45% 35% 41% 8% 30% 27% Number of times (X): [Online Brand Ad Growth / CCTV Auction Growth Ratio] 3.5 1.

0% 2012E 14442 2140 26% 6. the lowest rate in the past few years. and Tudou have gained significant traffic over the last few years. blogs and video services. brand advertising growth was only around 8%. * Includes: Sina. NetEase. given the continuing increase in internet usage.6% 2009E 6.321 30% 5.P. industry-focused websites such as Soufun and CRIC are also gaining good traffic. mobile blogs and Wireless Value Added Services. %) Branded ad as % of ad market Source: J. 2006 3. we still expect leading portals to hold dominant user market share and to gain revenue market share.com Global Equity Research 03 January 2011 Display Advertising We forecast overall ad spending to see ~27% growth in 2011 For 2009. which should also support the growth of branded advertising.Dick Wei (852) 2800-8535 dick. and regulations and boundaries are well understood by industry players.9% 2008 6. Regulatory risk remains lower than other online sectors We believe the regulatory risk remains lower for the portal online ad business compared to other segments in China. Sohu. 2) higher revenue base in 2010. our China economics team expects consumer spending growth to accelerate in the next few years. Morgan estimates.P.559 605 35% 3. 152 . While these sites have driven eyeballs and ad dollars away from traditional portals.012 8% 4.377 426 45% 3. Morgan estimates. higher cost effectiveness. and 3) higher competition among leading players. such as online games.x. given: 1) Sina and Sohu are the leading news sites in China with strong brand awareness –other news sites do not have a similar level of media influence. China Branded Ad Segment Forecast 2006 to 2012E Branded Advertising (RMB M) Branded Advertising (US$ M) Growth rate (Rmb. Additionally. and 3) improving ad serving technology in China. For 2011. Longer term. J. Factors driving 2011 display ad spend include: On the positive side: 1) accelerated shift from offline to online given higher awareness in video sites and social network sites. we expect the growth rate to be slightly lower than last year. 2) higher CCTV and satellite TV rates makes online ad a lower rate alternatives. Online Brand Ad Market Share Trend for Leading Portals Year Market share of key portal players* (%) 2006 62% 2007 62% 2008 63% 2009E 58% 2010E 59% 2011E 60% 2012E 60% Source: Company reports.462 1698 27% 6. and more measurable results for advertisers.2% 2007 4. we remain positive on the online display ad outlook.7% Expect vertical sites to gain more market share Video and SNS portals such as Youku.9% 2010E 9. Online advertising is the most established online business in China (since the late 1990s).025 1. In 2010. Bloomberg estimates. the branded ad segment grew around 30%.942 1.428 932 41% 4.wei@jpmorgan. 2) portals are also aggressively expanding horizontally to offer SNS. Further. On the negative side: 1) lack of major events in 2011.5% 2011E 11. Tencent (Bloomberg estimates for Tencent).

427 2.062 134 110% 1.7% 2012E 577 521 35% 22% 0. J. Note: Excluding distributor discount.052 36% 5.644 1. How big can China’s search market grow? Using various comparisons to the US and Korean search market.610 35% 24. In addition. Please also refer to the chart below for analysis of market size comparison with the US and Korean markets.wei@jpmorgan. further.45 4. 2) significant growth in websites and pages.705 70% 12.015 1.Dick Wei (852) 2800-8535 dick. %) Search ad as % of total ad market 2006 123 81 17% 22% 0. Internet users (Mn) Number of search (Bn) Coverage Click through rate Price per click (Rmb) P4P Search Market (Rmb M) P4P Search Market (US$ M) Growth rate (Rmb.730 53% 9.x.309 770 86% 3. respectively.0B and US$4.4% 2008 253 181 24% 25% 0.472 328 133% 2.42 2.6B by 2013 This compares to our current 2013 forecast of US$3.759 67% 7.4% 2007 162 116 21% 25% 0.849 999 39% 7. leading portals have gained trusts and have an existing relationship with the government.4B and US search market 2009 size of US$15B.4B (US$2. We think the market will reach US$3. Leading portals are the most trusted by the government among internet companies and have the best compliance procedures.60 24. Morgan estimates. as per our estimates. we estimate China’s search market could reach US$3B-US$4. to reach Rmb18.1% 2010E 420 334 32% 22% 0.945 717 100% 5.6B in 2011 and 2012.667 34% 11.P. the financial impact would be less significant because still only a small portion of their revenues come from User Generated Contents. We believe search advertising is still in an early high-growth stage in China. We shifted US search market size as a percentage of nominal GDP six years to estimate China search market size in 2010-2014.34 1.50 11.com Global Equity Research 03 January 2011 We believe the leading portals have strict internal compliance departments and automated content scans to ensure contents are in compliance with government standards. China search market size potential analysis If we use Korea and US as a proxy for online search market growth rate and growth potential. China Search Market Forecast Avg. we see more upside possible upside to our base case forecast.442 182 70% 1.213 1. 3) higher search usage (due to greater mass of web content).3% 2011E 494 429 34% 22% 0. Other factors that could lead to positive surprise to our forecast include faster-thanexpected inflation and RMB appreciation. which could be subject to government regulation.56 18. We present five different scenarios for our forecast: Scenario 1: We compared search market size as a percentage of nominal GDP in China and the US. driven by: 1) rising internet penetration.048 2.7B).751 3.674 55% 18. %) Total Search Market (Rmb M) Total Search Market (US$ M) Growth rate (Rmb.4% Source: CNNIC.45 6.8% 2009E 338 254 25% 24% 0.851 378 98% 2. 153 .364 3. and 4) large number of SMEs (with small ad budgets) turning to search advertising (due to the higher ROI). Online Search Still in early high-growth stage The search advertising market in China is expected to grow 53% Y/Y in 2011.

We shifted US search market size as a percentage of personal consumption five years to estimate China’s search market size in 20102014. Scenario 4: We compared search market growth in China and the US and shifted 2003-2008 CAGR of US search market growth six years to estimate China’s search market size in 2010-2014. We think the market will reach US$3. respectively.1B and US$3. World Bank.3B in 2011 and 2012.x. Five Scenarios for China’s Search Market Size Estimate US$M 9.Dick Wei (852) 2800-8535 dick.000 1.000 6. China Search Ad Market Size (US$ M) (Scenario 2) China Search Ad Market Size (US$ M) (Scenario 4) 154 .wei@jpmorgan. respectively. Scenario 3: We compared search market growth rate in China and US. and think the market will reach US$3.0B and US$4.3B and US$3.0B and US$4. We think the market will reach US$2.000 5.000 4.P. Morgan estimates. We shifted the US search market growth rate six years to estimate China’s search market size in 2010-2014.000 8. Scenario 5: We compared search market size as a percentage of personal consumption in China and the US. respectively.5B in 2011 and 2012.0B in 2011 and 2012.000 2.000 0 2008 2009 2010E 2011E 2012E 2013E 2014E China Search Ad Market Size (US$ M) (Scenario 1) China Search Ad Market Size (US$ M) (Scenario 3) China Search Ad Market Size (US$ M) (Scenario 5) Source: iResearch. J. We think the market will reach US$2.com Global Equity Research 03 January 2011 Scenario 2: We compared search market size as a percentage of nominal GDP in China and Korea.000 3.4B in 2011 and 2012.000 7. respectively. We shifted Korea search market size as a percentage of nominal GDP five years to estimate China’s search market size in 2010-2014.

0% 0. Baidu announced that it would introduce its own e-commerce platform called Youa to compete with Taobao.com. Baidu has successfully expanded its search revenue market share by more than 10 percentage points since 1Q09.5% 0.com Global Equity Research 03 January 2011 Competitive landscape Baidu continued to gain more market share from Google China.8% by revenue in 3Q10 vs.0% 17. etc) was spin off as a separate business entity. Alibaba Group and related persons invested in Sogou.1% 3Q09 77. Taobao responded by blocking Baidu from searching goods on its website.8% 3Q09 64.x.0% 1.wei@jpmorgan.0% 0. * means difference in search volume and search revenue market share. we do not expect Etao to be successful as a general search engine.2% 1.8% 0. While Etao has the potential to become a eCommerce focus search engine.7% 1Q10 75.1% 4Q09 77.64. 1Q09 62. and web search results provided by Microsoft’s Bing in the same order.9% 5.8% 1.0% 1.7% 19.9% 24. 31. 155 .3% 2Q10 80.2% 1.6% 32.9% 31. We believe they will not be a potential threat to Baidu for the medium term.7% 10.5% 1. Baidu Gaining Market Share Consistently (by Revenues) Baidu Google Sogou SoSo Others Source: iResearch.3% 18. Google’s market share declined to 24. We note that in 2007.0%. We expect Baidu to at least continue to maintain its current share.6% 0.0% 2Q09 63. Etao aims to drive traffic for Alibaba’s Taobao.0% 1.2% and 1. Sogou and its related technology (pinyin.9% 5.8% 4Q09 64.0% 15.4% In addition to gaining search market share.2% 0. Soso and Sogou will take longer to become a challenge to Baidu Tencent’s Soso and Sohu’s Sogou have been working on developing their own search technologies. Baidu Search Market Share (by volume of search queries) Baidu Google China Others Difference in marketshare* 1Q09 74. Soso and Sogou’s total market share was 2. Baidu market share reached 72.9% 1.2% 14.5% 3Q10 72. respectively.2% in 3Q10 as per iResearch.2% 3Q10 NA NA NA Source: iResearch. Sogou and Soso both expanded markets here slightly to 1.1% 13.5% 5.5% 2.4% 18. toolbar.6% 1.8% 27. In mid-2010.3% 0.9% in 3Q09.2% 1. The search results displayed in groups include Taobao listings.1% 5.9% 2Q10 70.3% 33.6% 1.0% 32.8% 0.2% in 3Q09.1% 17.8% 4.Dick Wei (852) 2800-8535 dick.2% 1.1% 2Q09 75.6% in 3Q10 vs. Alibaba launches eCommerce search Alibaba joined with Microsoft to launch a beta version of search site Etao.4% 6. as we believe the technology of these two search engines is still behind that of Baidu.5% 14.8% 29. Google is still having trouble with its advertising agencies. We expect this to further reduce with time.3% 1Q10 67. the company significantly reduced the gap between its volume and search market share.1% 20. links to related online forums. information websites.3% 11.

坦克大战 – A basic online game.x. Baidu’s application will be based around music. Baidu launched an applications library which allows third-party offerings in the library to launch directly on Baidu rather than moving to another website.Dick Wei (852) 2800-8535 dick. Searches that led to downloadable apps or content: 三重门 – This is the name of popular fiction. etc. We do not expect these government-backed search companies to gain meaningful traction in the market. These third-party applications appear in search results when a user is looking for certain specific queries such as those related to games. While the Phoenix Nest launch led to a significant revenue increase for Baidu in 1H10. Baidu is not specific about revenue sharing with apps developers. We believe this step could drive up search volumes in the future. Users can download this game or other games on the list of recommendations. However. Xinhua News Agency and China Mobile announced plans to set up a new search engine company. e-books.com Global Equity Research 03 January 2011 Government-backed search team (1) During August 2010. Baidu Phoenix Nest latest update The full Phoenix Nest transition happened in December 2009. we expect Phoenix Nest to continue to bring benefits to Baidu. Baidu application platform: announced in September 2010 To enhance user’s search experience. 金山毒霸 – Kingsoft anti-virus software. (2) People’s Daily Newspaper group launched new search engine. Developers or book writers can get revenue from: 1) direct content purchase. info and apps. The search engine is led by former Olympics Ping Pong Champion Deng Ya Ping. In the future.com. the move could lead to the government’s closer monitoring of the search engine industry in China. Users can listen to radio directly on Baidu’s page. 156 . Baidu and third-party application providers will split revenues in a ratio of 30:70. Links to download right away.cn. music.wei@jpmorgan. Currently Baidu has 400+ partners which give Baidu content. 豆瓣电台 – Online radio station. Users can buy e-books directly from results link. Publishers or writers can put their own books online. and videos. games. Baidu estimates that 30% of search queries in China are for applications rather than information. Baidu estimates that 30% of search queries in China are for applications rather than information The company currently has more than 400 applications under this library. This initiative is part of the larger “box computing” initiatives by the company. there is no need to go to Amazon or DangDang. 2) embedded ads. Open platform strategy allows apps developers or book writers to submit content through open. We think this will be one potential strategy.baidu. goso. One of Baidu’s key initiatives is to continue to improve Phoenix Nest performance in the long term.

Baidu charges extra fixed fee for an integrated campaign with Brand Zone. The new platform allows webmasters and developers to submit data to Baidu in order to generate direct search results for dynamic information. However. 2010.com Global Equity Research 03 January 2011 新三国 – A popular soap opera. This is an ongoing effort by the company’s R&D team.1% 14% 18. The company has reported strong growth from Brand Zone in 2010. Baidu showcased 3-D maps and various mobile features: voice search. Users can directly login on Baidu page. Currently Tencent is not a partner with Baidu Open Platform. according to Analysys. map search new version of Baidu Palm and input method. 157 .g. We are encouraged to see Baidu demand leading market share in mobile search as well. Google partners with China Mobile to be their default search engine on WAP website. users can't log in QQ mailbox “QQ 邮箱" directly from Baidu page. Market share (%) 33. The site is: http://aladin. revenue only accounts for 1-2%. As such..x. As a part of Project Aladdin. Video links have been verified by Baidu for highquality content.5% 14.baidu. The service was launched in mid-April.7% Baidu’s brand zone Baidu provides additional marketing services to some of its key customers. Baidu is also building more mobile search applications (e.7% 19. We believe Baidu’s traffic from mobile devices is around 10% of its total traffic. Mobile Search Market Share by PV Company Baidu Google China 3GYY YiCha. Baidu also plans to work with web masters to help them make webpages more easily displayed on mobile phones. Key customers can engage in integrated search marketing services across Baidu platform. During 2010 Baidu World. there has been an ongoing R&D effort aimed at uncovering useful parts of the hidden web in order to enrich search results for Baidu users.com/. Baidu launched the beta version of an open data sharing platform on April 15. Mobile search: Baidu still leads in market share Mobile search is still in an early growth phase. Baidu Palm) to expand its usage.wei@jpmorgan. 开心网/126 邮箱 – NetEase mail box or SNS site. Baidu discusses various potential applications to help search users obtain content easier on a large number of mobile phone platforms. While there were no discussions on Baidu mobile phone OS.cn Others Source: Analysys International. Aladdin: to search the hidden web As announced on the last conference call.Dick Wei (852) 2800-8535 dick.

We compared the search results between “Meng Niu” Milk that uses brand zone services and “Wan Da Shan” milk that is not using the services. Search market outlook: usage Like the US.wei@jpmorgan.com Global Equity Research 03 January 2011 For example. we believe the non-entertainment related searches such as eCommerce and e-Government will continue to gain popularity. advertiser readiness vs. the company related information is less. • Communication tool. “Meng Niu” Milk product advertises across different properties on Baidu. Search usage vs. have always been popular in China. online search in China provides users with personalized information. We view search usages and advertiser readiness as the two main drivers for the monetization of the online search market.P. such as pictures and music. weblink. "Meng Niu” brand zone comes first with detailed company information. movies. such as the company’s brand logo. When we search “Wan Da Shan” Milk. We expect usage in China to continue to grow. 2) advertisers. such as MP3. or 140 million people in China. Search Monetization Driven by Both Search Usage and Advertising Readiness Source: J.Dick Wei (852) 2800-8535 dick. Migrant workers (about 10% of total population. recent events.x. etc. When we search "Meng Niu” Milk using Baidu Knows and Baidu Web Search. Morgan. Going forward. or casual board and chess games—are also low-cost alternatives to offline entertainment. MMORPG (massively multiplayer online role playing games). Growing usage in China The latest statistics from CNNIC show that the number of users in China has reached 420M as of June 2010. are floating population) as well as relocated white-collar workers visit internet cafés after work to use instant messenger and e-mail. Online games—LAN-based (local area network). we think it would be useful to look at the search space from three different perspectives: 1) search users. or to 158 .. can be downloaded from the web virtually free of cost or at a very low cost. Entertainment-related content. “Meng Niu” Milk also has banner advertise in Baidu News. As users become more experienced. driven by such factors as: • Entertainment tool. they look for information on the internet beyond the major portals. and 3) search monetization/market size. etc. Rmb40 for a movie. Digital entertainment. Internet in general is a low-cost form of entertainment—internet café access costs about Rmb2-3 per hour vs. monetization To better understand the growth potential of China’s Internet search market.

continuous education and marketing are required to drive market growth.3 million larger-size SMEs (registered directly with the SAIC).Dick Wei (852) 2800-8535 dick. 1.x. customer clearing. the number of corporate websites in China is roughly 1. We estimate 60% of the websites are corporate (excluding personal sites. According to the SAIC. it is natural that users turn to search engines to organize the high volume of information. Other government initiatives such as electronic tax filing. paid search is still a new advertising concept for these advertisers. bulletin boards. and inactive sites). we believe the overall number of SMEs is large. Most traditional media is still tightly controlled by the government. Department of Small and Medium-Sized Enterprises figures. Search market outlook: advertisers’ readiness As in the US. According to the 2010 CNNIC report. These SMEs are mainly 39 million individual businesses (small businesses registered with some government departments). Apart from growth in the number of users. Therefore. we believe the market is far from reaching a saturation point. we believe the paid search ad is particularly well suited for small and medium enterprises (SME) in generating sales leads. Yet. Despite the government constantly monitoring these services. The total number of websites in China is 2. • Information source.wei@jpmorgan. but low internet usage According to the National Development and Reform Commission.7M. 159 . there were 4. there were 43 million SMEs in China. Hence.000. the company’s penetration among larger SMEs is 6%.com Global Equity Research 03 January 2011 play games or watch movies. Statistics from the State Administration for Industry & Commerce (SAIC) suggest that the number of SMEs in China is roughly 24 million.8M (as of Jun 2010). as with the low internet adoption rate in China. Large available SME market for search advertising. Major portals have also been increasing their content over the past few years to make more information available to users. The Internet offers an alternative information source that users seem to find more friendly and entertaining to use. As a result. We do not think the market is saturated Based on Baidu’s 3Q10 active marketing customers of 272. blogs and bulletin board services have also increased in popularity in China—they serve as channels for the Chinese to express their personal views and communicate with others. Hence. more than 76% of internet users use search engines. and government agency websites also boost internet usage. the time spent online per week as well as the number of days online per week is on the rise. the number of searches in China is expected to more than double from 2009 to 2012. Users turning to search in China With information on the internet ever expanding. Despite the discrepancies.

HK.cn. IP address assignment is quite well organized in China.x. more sophisticated advertisers also 160 . 3. eCommerce should be another growth driver While C2C eCommerce has seen good adoption over the past few years. In addition. We believe the IT outsourcing companies will be key players in the future to drive Internet adoption growth and search usage for SMEs. J. We expect IP-based marketing to be more popular going forward as online advertisers become more sophisticated. acquired by Alibaba. web hosting. and 3) more regulated online payment infrastructure.Net) and Hichina (net. While ad agencies mainly focus on companies that already have websites. We expect paid search to benefit from eCommerce growth in the future. the number of keywords. as paid search is an effective method for targeting prospective buyers who already have items in mind. directory listing). Local search: another promising area Similar to the US. and larger product selection. IT outsourcing companies target SMEs that are less sophisticated in IT infrastructure. driven by factors such as: 1) better acceptance for mail order (China’s catalogue sales are nonexistent. bidding strategy and bidding period.Dick Wei (852) 2800-8535 dick. In addition.P.com Global Equity Research 03 January 2011 Number of SMEs by Different Segments Source: SAIC. eCommerce companies are leading users for paid search advertising.wei@jpmorgan. and most transactions are done face to face) through increased online and offline marketing. or CE. 5. In the US.com) provide one-stop services for SMEs—domain name registration. IT outsourcing companies such as Sino-I (250. 4. IT outsourcing companies are the main educators for search usage The two types of companies that help drive paid search usage of SMEs are ad agencies and IT outsourcing companies. Morgan estimates. Ad agencies would have to drive search market growth Paid search marketing campaigns are usually more involved than display ads. paid search. 2. 2) improved trust and safety features by eCommerce sites. we believe there is a large commercial potential for local search in China. website design. We believe a similar trend will emerge in China too. Advertisers need to decide on what keywords to use. Particularly. and promotions (mainly through search engine optimization. there are a large number of households/individual businesses eager to promote their local businesses.

advertisers would place more keywords in more search engines. The ad spending amount essentially has no limit. Monetization Increase Driven by Self-Fueling Cycle Source: J. A well-run search campaign is arguably more difficult than banner ads where advertisers simply design the banners and place them on as many relevant websites as possible. and we expect it to increase and drive monetization of the market. thus leading to higher usage.com Global Equity Research 03 January 2011 pay attention to competitors’ strategy. driven by both higher search usage by users and better adoption by advertisers. Hence. We believe education by agents and distributors can eventually help advertisers overcome these barriers. This cycle should continue. lead quality and ROI. which non-experienced advertisers do not have control over. and lead to market size expansion. and advertisers will thus increase their budgets on search campaigns. Furthermore. advertisers are generally quite cautious about the initial spending and only allocate a small daily budget for trial. 161 . As users find more relevant product information by advertisers. may simply give up on paid search campaigns. Self-fueling cycle to expand monetization We view the market as a self-fueling cycle driven by users and advertisers growth. With more high-quality leads coming from paid search.wei@jpmorgan.Dick Wei (852) 2800-8535 dick. they will conduct more searches. Morgan. Search market outlook: monetization We expect monetization of the paid search market to grow quickly.P. Higher search usage leads to a higher number of sales leads for advertisers. The coverage ratio is low compared with that of the US. budgets for search campaigns are more difficult to manage as spending is based on the number of clicks. or even worse.x.

As such.com zhidao.com tieba.2% Online Video Online video has seen strong growth in China with the number of users growing to ~300M monthly users by end of September 2010.baidu. MP3 search continues to lose dominance baidu.baidu.x.com image.com Source: Alexa.baidu. Similarly.com baike. Many of the content produced were not properly shown due to an under developed media distribution system in China.baidu.5% 13.com zhangmen.8% 1. (3) Multiple delivery platform enhances user experience. contents may not be tailor to viewers’ interests.5% 3. according to CNNIC. representing ~83% of total internet subscribers.baidu. (2) Availability of large amounts of content were not broadcasted. As such. There are large numbers of television stations and movie production companies across the country.5% 14.6% 1. As of Oct 21.com mp3. While Video Online Demand service has advantages over viewing scheduled TV programs.com hi. alternative online video would be well adopted by viewers.4% 3. For example.baidu. fewer than half are ultimately broadcast.baidu. 265 222 161 180 240 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Driving factors for growth of China Online video services include: (1) Existing media companies are not commercially driven.baidu.3% 2. leading online video companies also make content available on different devices such as 162 .com news.com video.com.000 television episodes produced each year. Contents broadcast schedule many times are not commercially driven.5% 8. 2010.com Global Equity Research 03 January 2011 Traffic Breakdown in Baidu.Dick Wei (852) 2800-8535 dick.com Domain Domain Name Traffic breakdown Image search is the third-largest search channel after web page and Tiebar.wei@jpmorgan. Existing TV broadcaster or cable operators are tightly controlled by the government.baidu. Growing Online Video Users in China (users in millions 300 250 202 200 150 100 Dec-07 Source: CNNIC. fewer than one-third of the approximately 450 movies produced in 2009 were released in theaters. out of approximately 12.6% 1. 44.

RHS) Source: iResearch. The wider choice of device allows users to enjoy content anytime in different platforms. In addition. we believe content inflation will continue. 2008. both ad-supported and subscription-based models are used in China. 2) program/channel sponsorship by brand advertisers.x. Chinese video portals have more viewership of licensed content such as movies.6 1. 2009. The average license fee for movies has also increased in 9M10 by more than 90% vs. The ad-supported model is by far more popular in China. Chinese companies often pay a high content licensing fee in order to procure premium content to retain users. and such fees have increased in 9M10 by more than 100% as compared to 2009. Online Video Advertising Revenues in China 200% 150% 100% 50% 0% 2006 2007 2008 2009 2010E 2011E 2012E 2013E Online Video Adv ertising Rev enues (Rmb Bn. tablets).9 0. Content costs on the rise From Youku’s prospectus. The adsupported model is more popular by far in China Most of the video sites in China monetize by 1) in-video advertisements. Similar to media market worldwide. As a result. both ad-supported and subscription-based models are used in China. Industry still focused on “land grabbing. Some players such as Tudou have also launched premium content service for which users will have to pay a fixed subscription fee. While US video portals which mostly have user generated content or news clips as their top content. or 3) affiliate advertising from text-based ads by search engines. drama.3 0. and internet-enabled TV.6 5. However. this content helps to further solidify branding of leading video sites. LHS) Industry outlook for 2011 Profitability still many quarters away In terms of content. Similar to the media market worldwide.1 8. this should be 163 .” profitability still quarters away As most of the online video players are focused on gaining market share rather than profitability.4 14 12 10 8 6 4 2 0 Grow th Rate (in %.1 0.wei@jpmorgan. In-house produced contents also slightly help control content costs and build brand Youku and Tudou also have their own content development department creating popular movies and dramas. 13. etc. most video portals in China operate on a mix of “Youtube" (user generated content) and “Netflix” (professional content) in China.4 2.com Global Equity Research 03 January 2011 mobile devices (phones.Dick Wei (852) 2800-8535 dick. the average license fee for television serial drama increased in 2009 by more than 200% vs.

in September 2009.4% of the total online population in China. According to iResearch. Online video should drive ad dollar shift from TV Television accounted for 39. close to 80% of the online video viewers are between 18 and 40 years of age and only 8% of online video viewers are below the age of 18.1% of overall advertising expenditures in China.Dick Wei (852) 2800-8535 dick. We expect that online video should accelerate TV ad spend to move toward brand advertising due to its similarity of format with television. including 194 variety shows. This has also led to significant price rise by TV operators over last 2 years. traditional television market in terms of users’ age. and over 231. As of September 30. Cost-effective advertising SARFT (The State Administration of Radio. Chinese online video users spent 23.wei@jpmorgan. While advertisers are still gradually adopting online video advertising. As per CR-Nielsen. Competitive landscape Video portals in China face stiff competition from both standalone video portals as well as integrated portals such as Baidu. 2010. whereas only 14% of the television audience is similarly educated.com Global Equity Research 03 January 2011 slightly eased by reduced demand for exclusivity of content from online video players. but slightly older than the overall internet population. The advertising rates for 2011 have gone up further by 20%-60% for CCTV and other satellite channels. it commands 40% (largest) share of time spent on watching videos online in 2Q10. with high content and bandwidth costs.250 television serial drama titles.000 hours of other professionally produced content. level of education and potential spending power. according to ZenithOptimedia. and offers more dispersed and targeted advertising options to brand advertisers in a similar format. As per iResearch. according to CNNIC and CSM Media Research. whereas only 14% of the television audience is similarly educated. 1. video advertising site has lower CPM. Film and Television) in 2009 published a new “Act No. on average. In addition. The company had 164 . Youku Youku is the leading online video player in China. are younger than traditional television viewers.4 hours per week on average watching online videos.x. according to CNNIC and CSM Media Research Young demographics/more affluent population China’s online video market offers more attractive and targeted user demographics vs.200 movie titles. 30% of online video viewers have a college degree or higher level of education. Thirty percent of online video viewers have a college degree or higher level of education. Sina and Sohu. their video content library contained more than 2. Online video viewers in China. In contrast. online video offers attractive user profiles (from a higher income and young adults demographics perspective) and targeted advertising than TV. which is approximately six hours more than they spent viewing television. Additionally. we expect profitability in the sector could still be many quarters away. 61” which considerably limited the advertising inventory on TV especially on prime-time. We profile some of the key players here. a CNNIC 2009 China Internet user video behavior study found that online video is the only media viewing choice for 16. Moreover.

3% Ku6.0% Others. Net losses were Rmb182. It had had total revenues of Rmb113. 1. and user-generated video clips. 22.6M in 9M10. including popular domestic and overseas movies and TV dramas.8M and Rmb83. The company had total losses of Rmb144.wei@jpmorgan.9% 56.5% Sina Video. 16. 5.6M in 2009.x.1% Sohu Video. The company also started providing mobile video services channel on China Mobile. 8.9% Tudou.0M in 2009 and 9M10.4% PPStream.0% CNTV. exclusive celebrity interviews. Sohu video Sohu has a separate video channel on its website. live webcasts. 2. 39. Source: Analysys. in-house produced online talk shows. 9. 18. 5.3M and Rmb167. Data as of 3Q10.8% Source: iResearch. 2. Youku.5% Youku. Tudou Tudou is the second-largest online video portal in China.3M video clips.6% CNTV. respectively. 2. 6. respectively. 3Q10 Market Share Based on Total Effective Time Spent Watching Online Video in China Pheonix . as per iResearch. and Rmb234. Tudou has been shrinking the losses.cn. 6.1% 3Q10 Market Share Based on Revenue Others.8M in 2009 and 9M10.2M and Rmb224. 5. 165 . The company listed on Nasdaq in December 2010. 1.6% 3. the company had a content library of more than 36. Sohu is the third largest player in terms of online video views in China.7M in 2009 and 9M10. 4.1% Xunlei Kankan.0% Joy .Dick Wei (852) 2800-8535 dick. on-demand sports games.8% Sohu Video.9% Xunlei Kankan. respectively.5% PPLiv e.com Global Equity Research 03 January 2011 total revenues of Rmb153. As of 3Q10 end. This channel provides users free access to extensive and varied video content. 22.3% Ku6.2% Sina Video.9% Joy . 6.5% Toudu. 3. Data as of 3Q10. 5.com.

760 30.817 62.298 12.5 3.COM SINA Video IFENG.809 2.780 2.CN CNTV.COM PPS.CN IMGO.CN CNTV.COM SMGBB.538 7.TV 56.COM SOHU.406 35.COM PPLIVE.4 3.COM SOHU.COM SMGBB.wei@jpmorgan.5 5.COM PPLIVE.439 65.TV 56.297 747 3.CN IMGO.7 8.COM SMGBB.CN QIYI.COM Tudou Sites KU6.COM TV JOY.CN CNTV.COM TV JOY.762 6.363 2.712 455 436 129 113 5 13 6 5.TV 56.055 862 202 162 80 Total Minutes (MM) YOUKU.CN QIYI.Dick Wei (852) 2800-8535 dick.216 9.417 24.594 1.9 4.8 2.934 2.COM SINA Video IFENG.COM SINA Video IFENG.CN IMGO.TV Average Daily Visitors (000) YOUKU.COM Tudou Sites KU6.COM SINA Video IFENG.COM SOHU.857 2.com Global Equity Research 03 January 2011 China Video Portal Data (Monthly Data for Oct 2010) Total Unique Visitors (000) YOUKU.444 1.646 13.875 4.COM Tudou Sites KU6.719 49.COM TV JOY.TV 56.2 0.COM PPLIVE.COM Tudou Sites KU6.0 4.COM PPLIVE.CN QIYI.6 2.3 166 .TV Average Minutes per Usage Day YOUKU.COM PPS.CN IMGO.171 306 322 1.482 12.487 16.COM PPS.0 8.TV 1. 77.COM PPS.COM SMGBB.702 30.TV Source: Comscore.620 1.x.6 11.CN QIYI.COM SOHU.COM TV JOY.570 1.5 6.3 3.CN CNTV.

Favorable demographic distribution As per CNNIC. the number of SNS users reached the 210 million mark (up 19. a year ago. notably by the success of Tencent. In addition to basic brand advertising and friends referrals. (2) Integrated marketing: Many companies promote themselves by putting virtual items associated with their brands in game applications. SNS Game Market Size 3000 2500 2000 1500 1000 500 0 2009 2010 2011E 2012E 2013E 240 420 780 1.6% YoY) in Jun-2010. The social networking trend in China is quite similar to that of the US.850 SNS Games Market Size (Rmb Mn) Source: Analysys. Currently 51% of China internet users are using social networks up from 46% users. and 12. (3) Fan pages: Another way of advertising on social networks is through fan pages. 167 . Revenue generation for SNS websites can be broken down into three types: (1) Banner advertising: Nearly half of the advertising revenues are generated from putting up banner advertisements on various locations on the site: e.6% spend up to 2 hours per day. selling virtual items as well as from brand advertising. We estimate this accounts for nearly a quarter of social network advertising in China.4% YoY.8% are logged on for more than 2 hours. Companies earn their revenues through a mix of social games.Dick Wei (852) 2800-8535 dick. more than half of Chinese users spend around 1 hour on SNSs. with growth of 19. In 1H10. revenue for China’s SNS market was RMB 489 million.wei@jpmorgan. profile pages of the users. social network companies help promote products through integrated product marketing such as themed games to promote products or onsite avatars to build brand awareness. SNS users already cross 200M mark As per CNNIC. 22.632 2.com Global Equity Research 03 January 2011 Social Networking Social networking has a long and successful presence in China. Key trends for 2011: social commerce We expect social networking companies tobe a key beneficiary of the rising eCommerce trend in China.x.. With increasing time spent on social networks connecting with friends. these sites would be increasingly important traffic generators for eCommerce companies.g.

1% of Chinese SNS users have a college degree and above.. Competitive landscape The four major social networks in China are: Qzone: Qzone of Tencent is the largest social networking portal in China. which focuses on college students. avatars. etc. Tencent's leadership in instant messaging and casual gaming helps Qzone capture a dominant share in the social networking market. The company reported 481M user accounts at the end of 3Q10. 34% higher than other Chinese internet users.com Global Equity Research 03 January 2011 59. Users by Access Method Only using mobile 8% Ov erlapping users 39% Only using computer 53% Source: CNNIC. The company earns most its revenues from fees charged to users for upgrading to premium features such as social games. Qzone is perceived to be more popular among teenagers than college students and office-goers. . we believe Qzone covers a wide range of users that resemble general internet users in China. 168 .x. However. Frequency of Logging Onto Social Networking Websites Not ev ery w eek 26% Once a w eek or less 40% More than Once 16% Once per day 18% Source: CNNIC.wei@jpmorgan.Dick Wei (852) 2800-8535 dick. The company also launched a portal named Xiaoyou.

com achieved breakeven. Social networking provides: (1) more innovative ways of brand promotions such as virtual items. 2011 outlook Expect healthy growth from Advertising and Social Gaming We expect social networking websites to gain a greater more share of online brand advertising revenues. we expect SNS to be a key beneficiary of rising eCommerce spending. We expect Tencent to be a key beneficiary of the rising social networking trend in China. The third tranche of revenues are from advertising. we believe it can attract the best of the applications with even less revenue sharing. which would ultimately drive higher revenues.com: 51. The second tranche of revenues are from users’ payments. This should lead to a higher number of social applications on there portals. Giant Interactive has a 25% stake in 51. By the end of 2009. the company had 178M registered users and 40M+ monthly unique users. fan pages.com has more users from lower-tier cities. Analysys Data forecasts the social gaming market to grow more than 86% YoY in 2011. Additionally.x. Social gaming should benefit as leading websites such as Qzone open.wei@jpmorgan. 51. etc. Most of its revenues generate from revenue shares from 20+ SNS games.Dick Wei (852) 2800-8535 dick. 169 . The number of users should also see healthy double-digit growth.com Global Equity Research 03 January 2011 51.com. which is young and has higher disposable incomes. In April 2010. With the traffic Tencent commands thanks to its QQ platform. (2) more targeted user base.

wei@jpmorgan.com – Open API • Rmb 200M fund to support third party developers Brand Product Line • Interaction with Weibo • Integrate online and offline events Source: Company data.000 VIP accounts which are verified by Sina. Currently 45% of active mini-blogs on Sina platform are accessed through mobile devices. J. etc.Dick Wei (852) 2800-8535 dick. miniblog usage is likely to further increase. Netease also had close to 9M users at the end of 3Q10. Morgan. Easy access from mobile phones Miniblog platform should also see more popularity from users accessing the internet from mobile devices. Miniblog registered users on Sina’s platform were close to 50M at the end of 3Q10 compared with Twitter monthly unique users of 190 million in mid-2010. Direct Monetization • Internally developed apps • SME marketing and services 170 . Direct monetization (CPM base model) from brand advertisers is expected to begin on a larger scale in late 2011.com Global Equity Research 03 January 2011 Miniblog Platform Mini blog platform has added another dimension to social networking in China. according to Twitter COO Dick Costolo.P. business leaders.x. Sina currently has around 20. Platform strategy refers to local SMEs open storefront on Weibo and revenue sharing with third-party apps developers. Monetization model becomes visible Sina recently discussed various monetization methodologies during different phases of Weibo development. Sohu and other sites are catching up with their own mini-blogs. Tencent. Sina’s Weibo Monetization Model Brand Adv Platform Model Indirect Monetization • Weibo. With strong growth in mobile internet usage. Most of the traffic revolves around following favorite movie stars. Sina has been witnessing an addition of 10M users every month. Indirect monetization or platform strategy to kick off in late 2011. A celebrity broadcasting platform Microblog traffic in China is centered around VIP accounts. Sina has seen a lot of success through its mini-blog.

2 in 2009. with many users having good online purchasing experiences. We believe the rise in disposable income should continue in coming years. As a % of Total Retail Sales (%) Factors driving growth of online shopping in china Large number of internet users: China now has the largest internet population in the world with a penetration rate of more than 30%.4% from 2005 to 2009. Source: iResearch (2010). with rapid urbanization and more people transitioning to an affluent class.1% of GDP in United States.200 1.4% of total retail sales in 2010 and is expected to grow to 6. Additionally.400 1. China’s GDP per capita has grown at a CAGR of 15.714. Additionally. increasing penetration of internet-enabled mobile phones is also driving up time spent on the internet. The China eCommerce transaction value is estimated to account for 3. 70.2% of total internet users in China with around 109M users in 2010.com Global Equity Research 03 January 2011 eCommerce eCommerce is in fast growth stage in China eCommerce usage has seen rapid growth.wei@jpmorgan. but it still only penetrated 30.000 800 600 400 200 0 476 5 2004 16 2005 26 2006 56 2007 128 263 1. China eCommerce transaction value is estimated to account for 3.4% of total retail sales in 2010 and is expected to grow to 6. (3) Well-developed payment alternatives.269 994 723 7% 6% 5% 4% 3% 2% 1% 0% 2008 2009 2010E 2011E 2012E 2013E B2C+C2C. Rising trust in online transactions: (1) Credible eCommerce companies have helped to improve China’s online shopping ecosystem and to decrease fraud and bad transactions in online shopping. according to iResearch. online eCommerce should see faster growth. we expect it to take many structural steps to boost consumption.x.Dick Wei (852) 2800-8535 dick. reaching US$3.5% of total retail sales in 2013 The internet has become an emerging sales and marketing channel for retail sellers.5% of GDP vs. Chinese online shoppers have adopted online banking payment as well as third-party payments (such as Alipay and Tenpay) based on their good experiences. China eCommerce Market Size by GMV Rmb B 1. Rising disposable incomes: As per NBSC (National Bureau of Statistics of China).5% of total retail sales in 2013. Government thrust on pushing consumption-led growth: Chin’s consumption is 34. ex cluding B2B (Rmb B) Note: Transaction for virtual goods and online utility payment are not included. 171 . (2) Well-known retail brands are starting to sell products online. With the Chinese government pushing the growth model to shift from investment and exports-led growth to consumption-driven growth. China already has the largest number of Internet users in the world. We believe there is a high potential for further growth in eCommerce.

6% 213 36. The company announced the independent domain name for Taobao Mall in Nov 2010.x.wei@jpmorgan. Since its launching. China B2C eCommerce Market Size by GMV Rmb B 250 200 150 100 50 0 2009 15 31 110% 103% 118 62 201 90% 71% 120% 100% 80% 60% 40% 20% 0% 2010E 2011E 2012E YoY Grow th (%) 2013E B2C eCommerce GMV (Rmb B) Note: B2C marketplace is not included.2% 145 20.4% 180 34. In 2010.0% 32.0% 10. following with a series of promotion events.0% 0.Dick Wei (852) 2800-8535 dick.2% 245 40. China internet giants focus on developing B2C eCommerce marketplace (1) Taobao started B2C eCommerce in 2008. As a % of Totla Internet Users (%) B2C eCommerce enjoys significant growth in 2010 Players converging to marketplace model B2C eCommerce in China can be categorized into B2C retailers and B2C marketplace operators by business model. 172 . Source: iResearch (2010).4% 109 30.0% Online Shopping Users (M) Source: iResearch (2010). (2) Tencent upgraded its “QQ members store” to “QQ Mall” in Mar 2010 to leverage its C2C Paipai experience to B2C eCommerce. (3) B2C sites emerge as a new sales and promotion channel for retail brands. Taobao Mall has earned a high reputation and recorded the highest transaction value of Rmb1B on Nov 11 2010.2% 26.8% 80 28.com Global Equity Research 03 January 2011 Fast Growth of China Online Shopping Users 300 250 200 150 100 50 0 2007 2008 2009 2010E 2011E 2012E 2013E 55 26. (2) B2C retailers began to introduce third-party merchants to their platform.0% 30. we have seen: (1) Leading C2C eCommerce operators expand and develop the B2C eCommerce marketplace (such as Taobao expanding to Taobao Mall).

1. 2.2% Redbaby .1% New egg. We have summarized some facts about these companies below. but Sina Mall is still struggling to attract customers under tough competition. (1) B2C eCommerce operators can lower delivery cost. Self-established logistics B2C eCommerce companies have endeavored to build their own logistical systems. while Taobao Mall is the leading B2C marketplace operator in China.4% Vancl. and (3)Vancl that is a well-recognized online apparel seller. Popular online selling products are apparel.1% New 7.com Global Equity Research 03 January 2011 (3) Baidu launched “Lekutian.3% Joy o Amazon. We believe well-built logistics is one of the key factors for further growth of B2C eCommerce. 8. 4. (2) B2C companies can shorten processing time on returned goods to improve user experiences.3% Mecox Lane. (2) 360Buy that emphasizes online IT and electronics products selling. cosmetics and IT products.9% 360Buy . shorten delivery time and expand to tier-2 and tier3 cities.9% Source: iResearch (2010). Leading B2C players in China 360Buy. These companies have seen the demands from third-party merchants to use well-established B2C platforms as a sales and marketing channel. We have seen: (1) Dangdang and Joyo-Amazon that are well-known for online books selling. 35. media products such as books and music." an online B2C marketplace. (2) NetEase also started B2C eCommerce 10 years ago. incumbent delivery companies and logistics services are not sophisticated. including warehouses and logistics centers.com. NetEase started to focus more on its eCommerce sector this year and launched B2C marketplace in December 2010.wei@jpmorgan. Dangdang. 8. China portals entered B2C eCommerce market. B2C retailers start to mix B2C marketplace model with their online retailing model The leading B2C retailers such as Dangdang and Vancl have introduced third-party merchants to their B2C platform. still at an early stage (1) Sina started B2C eCommerce around 10 years ago. 360Buy is also preparing to open its platform to third-party sellers. In addition.9% Dangdang. 1. China B2C Retailers Market Share by GMV in 3Q10 Coo8. Others.x.3% icson.6% 173 .Dick Wei (852) 2800-8535 dick. 26. These are the products that B2C retailers are focusing on. 2. jointly with Japanese eCommerce leader Rakuten in June 2010. Joyo Amazon are the three leading B2C retailers. 5. 3.com.

Acquired by Amazon in 2004. Taobao started to establish its own distribution center and invested in one logistics company in 2010. Suzhou. Chengdu and Wuhan.com Global Equity Research 03 January 2011 Leading B2C Players in China (Taobao Mall. Besides that. 1. Online Banking Payment 3. 2. etc. Guangzhou. consumer electronics) 3. Free of charge for delivery service. 2. Xiamen. Merchants need to pay gurantee money of Rmb 10. 2. products from Dec 20. including books. Mobile payment 6. Amazon gift card payment 1. cosmectics. electronic goods. Morgan. Amazon. 3.Dick Wei (852) 2800-8535 dick. Founded in 2000.000 to open a store in Taobao Mall. B2C Retailers 360Buy Joyo Amazon 1. Credit card payment 3. Alipay 5. Cash-on-delivery Third-party logistics companies. Tenpay and 99Bill 5. Banking Account Transferring 9. Well-known for its 3C (computer. Well-known for its media products products. Taobao Mall with independent domain name was launched in Nov 2010. Installment payment 7. Shenyang. Cooperate with third-party logistics companies. Credit card payment 4.000 and online transaction technical fee of 1% ~ 5% as of transaction value per transaction. Cash-on-delivery 2. 174 . Expand to sell software products. Shanghai. 2. Announce to offer group buying and baby products. communication. Credit card payment 3. Chengdu. Cooperate with third-party logistics companies. time saving for online payment 2. Five logistics centers are in Beijing. Xi'an. 3. Supported by international B2C giant 2. Source: Company reports. 360Buy and Joyo Amazon) B2C Marketplace Taobao Mall 1. 170M in 2009 (Including Taobao C2C) Rmb 208. cosmetics. Self-established logistics networks reach 24 cities. Online banking Payment 4. Around 15k merchants sell products with 20k brands.P. Remittance 8. household 4. The largest B2C marketplace in China in terms of transaction value. Guangzhou.wei@jpmorgan. Remittance 8. J. jewelry. Banking Account Transferring 1. Alipay Katong payment: link with debit card. Online Banking Payment 3.2B (GMV) 1. n/a n/a 1. The largest B2C retailer in China in China in terms of transaction value. Business Description Registered Members Revenue/GMV (2009 estimated) Payment Logistics History 1. 2. Third-party payment: Alipay. Taobao Mall charges annual service fee of Rmb 6. sales such as books and music. Cash-on-delivery and mobile POS payment 2. products. Nine self-established logistics centers in Beijing.3B (GMV) 1. Expand to sell various products. 2. household products and etc. terms of transaction value. toys. B2C marketplace started in2008. 3. Consumer card payment 6.x. watches 4. Wuhan. 14M+ in 2010 Rmb 10. 2010. Third-party payment: Alipay and PayEase 7. Founded in 2004. The third-largest B2C retailer in 1.

Invite third-party merchants to sell general merchandize at play" platform. J. Listed on NYSE in Dec 2010.5B 1. Active customers were 6. Tenpay. and music. PayEase and UnionPay 5. 3.2B 1. Cooperate with 104 third-party inter-city transportation companies and courier companies. 2. The second-largest B2C retailer in China in terms of and physical stores in China.Dick Wei (852) 2800-8535 dick. beauty and healthcare products and other products. Ten self-established logistics centers: two central logistics centers in Beijing. Cash-on-delivery: cover 750+ cities and towns in China 2. baby products and etc. Chengdu and Guangzhou. We present the transaction service fees that the key B2C marketplace operators charge. Online Banking Payment 3. Remittance 6. 2.com Global Equity Research 03 January 2011 Listed Leading B2C Players in China (Dangdang and Mecox Lane) B2C Retailers Dangdang Mecox Lane 1. Warehouse space totals around 58. 1.1M as of June 2010. 2. 175 . Online Banking Payment 3. Founded in 1999. (2) a percentage of sales per transaction as real-time technical service fee. transaction value. 1. Well-known for its its media products sales such as books products. Cooperate with third-party logistics companies. Cash-on-delivery: cover 100+ cities in China 2. Business Description Registered Members Revenue (FY09) Payment Logistics History Source: Company reports. Founded in 1996. Remittance 6. Active online customers were 2. 1. 2. other three in Beijing. Expand to sell various products. household products. Centralized logistics center in Shanghai.P. selected 3rd party brands. 1. 99Bill.x.7k square meters and can handle 50k orders per day. 2. Average daily unique visitors of the company’s website: 671k in June 2010. Listed on NASDAQ in Nov 2010. B2C marketplace transaction service fees Third-party merchants at B2C marketplace need to pay: (1) “guarantee money”. Third-party payment: Alipay.6M in Sep 2010. Credit card payment 5. The products include apparel and accessories. Morgan. Credit card payment 4. eight regional logistics centers in five major cities outside Beijing. Average daily unique visitors were 1. Invite third-party merchants to sell products at its "plug-and4. electronic goods. 2010. A B2C retailer to offer fashion products through its website 1. Banking Account Transferring 7: Dangdang gift coupon payment 1. 2. Warehouse space totals 180k square meters and can handle 165k+ orders per day. including cosmetics. Tenpay. Rmb 1. 2. Rmb 1. Banking Account Transferring 1. and (3) annual technical service fee to B2C marketplace operators. Third-party payment: Alipay.8M for the nine months ended Sep 30. Dangdang platform under its marketplace program.wei@jpmorgan. and 99Bill 4. under its own brands of Euromoda and Rampage as well as 3. home 2.

Rmb 2.5% 4.5% 4.6% 4.5% 4. Rmb 300/month.000 Lekutian Rmb 15.5% 1.000/month QQ Mall Rmb 20.000.5% 4.5% 0.5% 4.5% 1.Rmb 10.5% 4.000 5% 5% 5% 2% 2% 2% 2% 5% 5% 2% 4% 2% 1% 5% 5% 5% 2% nm nm 2% 2% 1% 1% 2% 2% nm Rmb 6. Morgan.com Global Equity Research 03 January 2011 B2C Marketplace Transaction Service Fees Guarantee Money Real-time Technical Service Fee Ratio Fashion & Accessories Outdoors Home & Decor Water Heater Bathroom Warmer Shaving Razor Baby Infant Formula Children's Wear Intelligence Toys & Baby Carrier & Child Cot & Schoolbag Diapering Cosmetics Jewelry Gold Natural Jade Natural Pearls Natural Amber Electronics & Technology Electronics Parts Home Appliance Motors Foods & Health Care Products Tea Drink & Vegetable Drink Cooking Oil & Food Grains Books.5% 1.5% 4.000 .5% nm nm 1.6% 0. J. such as Tickets.x.5% 1. Virtual Recharge Annual Technical Service Fee Taobao Mall Rmb 10.000/month 4) SKU>2.6% 1. Movies & Music Serivces.Dick Wei (852) 2800-8535 dick. 176 .6% 0 Dangdang Rmb 3. Internet Serivces and etc. Rmb 1.5% 1.000.wei@jpmorgan.000.5% 4.000 4.5% 0. 2) 500<SKU<1. Rmb 500/month 3) 1.000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Source: Company reports.000<SKU<2.5% 1.P.000 4% 4% 4% nm nm nm nm nm nm nm nm nm 2% nm nm nm nm 1-2% 4% 2% 2% nm nm nm nm nm nm 1) SKU<500.5% 0.5% 4.5% 3.

000 2.664 Note: The statistics is as of Nov.000 980 1.  Major cities: Tier-1 cities.S. white-collar workers and college students aged 20-35.800M in 2013. such as Beijing. restaurant coupons. etc. Chengdu.  Classification of group buying categories: Location-based Group Buying Sites and Products-based Nationwide Group Buying Sites。  Main customers: Young.com Global Equity Research 03 January 2011 Group Buying: A Hot Trend in China Too Group buying market size grows from zero to Rmb980M in one year The group buying eCommerce model originated from the U. Changsha.wei@jpmorgan. Source: 2010 Group Buying Industry Credit Research Report.'s GroupOn and became popularized in China in 2010. Wuhan and Tianjin. 177 . Cheap price. Group buying sites offer products that are attractive to young people with low prices. Number of Group Buying Sites in China Beijing Shanghai Guangzhou Shenzhen Changsha Xi'an Hangzhou Chengdu Wuhan Tianjin Others Total # of Sites 473 183 77 75 65 56 53 52 49 44 537 1.800 2013E Group Buy ing Transaction Value (Rmb M) Source: Analysys (2010). We have seen the emergence of hundreds of independent group buying sites. Baidu. Internet Society of China. Attractive products. who would like to try fresh things.000 0 2010E 2011E 2012E 1. 2. etc. laser gun game coupon. beauty & hair salon coupons.Dick Wei (852) 2800-8535 dick.x. Many small. The 60%-90% discount price is very attractive. the group buying market size is around Rmb980M in 2010 and is expected to reach Rmb3.to medium-sized merchants use group buying sites as a promotion channel and offer high discount price to attract customers. Guangzhou. and Sohu. Shanghai. such as cake-making class coupons. China Group Buying Market Size by Transaction Value Rmb M 4.  Major products: Entertainment products such as movie tickets and karaoke coupons. travel & hotel coupons.650 2. According to Analysys. a leading internet industry research firm in China. Sina. Xi’an. Factors driving growth of group buying market in china 1. Shenzhen.620 3.000 3. as well as sites launched by China's key internet players such as Tencent. 2010. Hangzhou.

2010 12 Cities Meituan is the leading group buying site in China. Group buying sites and other internet sites could complement each other’s advantage. Living social sites have the networks of local merchants. 2010 7 Cities Dingping Tuan is launched by Dingping. 178 . 2009 100+ Cities 1. Vise versa.com Global Equity Research 03 January 2011 3.wei@jpmorgan.com/ July. Launching Date Networks Business Description Source: Company reports. Online banking payments and third-party online payments are the major payment methods for group buying sites. Living Social Sites and SNS Sites.com/ Mar. We observe that the group buying market is in disorder and the user experiences are poor.to medium-size merchants to attract new customers from internet users. Consolidation. Dingping Tuan http://t.taobao. Morgan. such as "Check-in" and SNS games. It is a product based group buying site.com. 2010 11 Cities QQ Tuan is launched by Tencent. especially the ones in tier-1 cities. With increasing internet usage. Lashou is trying to add more functions to its group buying site.to medium-size merchants. have increased their trust in online payment with their online shopping experiences. A new promotion channel for small.P.com/ June. Juhuansuan http://ju. QQ Tuan http://tuan.x. Chinese customers. 2011 Outlook for group buying market 1. Combination with Portals. Portals and SNS sites have large user basees. 2. QQ Tuan also offers group buying products only for QQ members with lower discount price. The promotion cost of using group buying sites is relatively smaller than that of print media. Meituan http://www. group buying services can improve user experiences for the above sites. 4. group buying sites can help small. Because of low entry barriers.com/ Sep.meituan. covering across whole China rather than location based. a wellknown living social site in China. We believe we will see consolidation in the group buying sector. eCommerce sites can provide products for group buying.qq. We think that the group buying sites serving low-quality products will be acquired by bigger sites or go bankrupt.Dick Wei (852) 2800-8535 dick. J. eCommerce Sites. Alibaba's subsidiary on eCommerce. Lashou is the first and largest group buying site in China. Select Group Buying Sites in China Lashou http://www.dianping.lashou. 2010 Products based nationwide site Juhuansuan is launched by Taobao. 2. Customer’s adoption of online payment method.com/ Mar. It plans to expand to 200-300 cities by 2011. hundreds of group buying sites emerged in a short period of time.

11. It is generally straightforward for a user to forward a Cafe’s information at Dingping. Paipai includes GMV from both C2C Paipai and QQ Mall.6% Taobao . Source: iResearch (2010). 84. leveraging Tencent’s large IM user base. Taobao includes GMV from both Taobao C2C shopping mall and Taobao Mall. Second step.wei@jpmorgan.com to a Sina Microblog.Tencent micro-blog and Sina microblog.com Global Equity Research 03 January 2011 SNS and Microblogs: Help Drive Social eCommerce We observe that social networking sites (SNS) and microblogs are the new channels to promote online shopping products and social living information. SNS and microblogs include the most popular ones.” Third step. Click “forward” to share social living information Same as the link at online shopping sites. Leading C2C Players in China Taobao.8% Note: 1. is the leading online marketplace operator in China. 2. the links to SNS and mirco-blogs are also located under or above the picture of social living information at social living site. the user can check that the Cafe information has been published on Sina’s Microblog.x. China C2C eCommerce Market Share by GMV in 3Q10 Eachnet. First step: the user selects the Cafe and clicks Sina Microblog label under the picture of the Cafe. Click “sharing” to share the information of online shopping products Sharing links with SNS and microblogs’ labels are located under or above the product picture at online shopping malls and group buying sites. Paipai is Tencent’s C2C marketplace and ranks second.Dick Wei (852) 2800-8535 dick. the eCommerce subsidiary of Alibaba. 179 .6% Paipai. 3. Netizens can also click to copy the URL and paste it to MSN or QQ or their emails. Taobao reached registered members of 170M by 2009 and is one of the world’s Top 20 most visited websites. at the pop-out webpage the user can log into Sina Microblog and click “forward.

8% My steel. Japanese marketplace. Generate revenue from (1) subscription fee from online services (2) advertising income from industry portals. 4.2009: US$174.1% Global Resources.1% a) Online services: 48. 180 . Revenue breakdown (FY09) . Industrial Market Research Registered Members Mainland China registered online users and magazine readers: 2M+ Online marketplace Mai-Mai-Tong .8M) .com.1% Founded in 1999.com Global Equity Research 03 January 2011 Leading B2B Players in China The B2B eCommerce sector has seen stable growth in 2010.3k 1. 10. Alibaba is still the leading player.1% .Others: 1. Chinese marketplace. Auctiva. 1. Acquisition: acquired AliSoft. HC Yellow Page Directory.7% Source: iResearch (2010).wei@jpmorgan.Seminars and other services: 8. 1.67% Founded in 1992. 1. 2.5M 2. with market share of 57% in 3Q10. Ali loan: outstanding portfolio of Rmb 20BRmb 30B. HiChina.2% .Online services: 40% .6% GlobalMarket. yellow page directories and printed periodicals (3) hosting of trade exhibitions and business seminars (4) customer-specific market research reports .2009: Rmb 3.2% Toocle.3% Made-in-China. 57. The company's principal business is to provide services that allow global buyers to identify suppliers and products.Online and other media services: 66.Profit Margin: 26.# of paying users of China Gold supplier members: 108. China B2B eCommerce Market Share by Revenue in 3Q10 Others. Morgan.9M) 2.Market research and analysis: 16% .5% .Dick Wei (852) 2800-8535 dick. 2.Operating Margin: 9.com. Generate revenue from (1) membership payment (2) value-added services . 1.0% China’s Leading B2B Players Business Description Alibaba Alibaba operates the leading online B2B marketplace in China.Registered users (2009): 10M .56% . 1. Chinese marketplace: 42M .9% b) Print services: 17.875M (US$569.7M) 2. and OneTouch as a part of "Work at Alibaba" strategy. Source: Company reports.5% .2% .x.2009: Rmb 317.International marketplace: 62.Chinese marketplace: 36. .4% HC360. Bloomberg. and enable suppliers to market their products to a large number of buyers. HC International HC International offers both online and offline B2B services in China.Gross Margin: 52.452M (US$801. 1.Gross Margin: 36.Profit Margin: 0.2010E: Rmb 5.Exhibitions: 31.2% Founded in 1971. J.4% Global Resources Global Sources is a leading B2B media company and a primary facilitator of trade with Greater China. and global wholesale marketplace. Alibaba. 3.# of China Trust Pass members: 631. 16.Profit Margin: 9.Operating Margin: 26.7% . Revenue breakdown (FY09) .P.com.Gross Margin: 86.6% Margin (FY09) History . International marketplace.Operating Margin: 0.Trade catalogues and yellow page directories: 36% . International marketplace: 15M .1% .6k . Vendio. Revenue breakdown (FY09) .# of paying users of Int'l Gold Suppliers: 11k 2. 3.0% DHgate. trade catalogues.Mai-Mai-Tong IM users: 7M Revenue 1.6% . Offline marketing products: HC Trade Catalogues. Online marketplace: Mai-Mai-Tong (买 卖通) 2. 3. Generate revenue from (1) online and other media services (2) exhibitions .2% .7M (US$46.

6 8. success of the freeto-play (item-based sales) model (contributing ~79. better quality.097 1. up from ~76.2 6.767 3. 2) Upside in gamer penetration.8% 3. also.7 15.3 17.com Global Equity Research 03 January 2011 Online Gaming Growth outlook remains robust The online gaming sector continued to see good growth in 2011. 4) Efforts of game companies – new genre.1% 25.472 65% 2008 17. 181 .318 23% 2012E 43.5% 3.5 18. which is still less than one-third of Korea’s penetration (also below HK and Taiwan).3B).5 24.1 29. Morgan estimates.386 6. The casual and social game segments are likely to benefit from SNS sites opening up their platforms for new social games.714 2.7 18.380 5.4% of industry revenues in 2009.8 4.6% 19.896 5.242 19% China Casual and Social Game Market Forecast Casual game players (million) Casual players penetration APRU per month (Rmb) Market size (Rmb million) Casual Market size (US$M) Growth Rate: Source: J.5% 27. with the launch of few key games next year with different genre.5 3.043 762 27% 2007 37.0 17.5% 27.1 25.P. 2006 32.8% 4. with ~23% Y/Y growth to reach Rmb35.186 30% China Total Game Market Forecast Total Game Market size (Rmb million) Total Game Market size (US$M) Growth Rate: Source: J.0% 3.005 1.5% 2.589 375 73% 2009 88.608 3. CAGR of ~47% over the last five years. 2006 7. or 87% of total internet users.4B.463 1.Dick Wei (852) 2800-8535 dick.158 912 33% 2012E 145.277 3.6 24.wei@jpmorgan.5 18.669 535 43% 2010E 102. as per our estimates.192 75% 2009 66.9 24. 3) Increasing broadband penetration. Morgan estimates.125 2.7 18. The MMORPG segment (~84% of total gaming market) expected to growth ~21% Y/Y in 2011 to reach ~US$4.8% 2.3 9.P. 2006 25.6 18.313 22% 2011E 35.005 37% 2010E 77.7 6. Overall for 2011.626 21% 2011E 91. as per IDC estimates).2% 4.8 20.6% 21.568 74% 2009 24.539 38% 2010E 29.5% 26.6 23. Morgan estimates. as per our estimates.P.255 65% 2008 53.6 35.086 893 30% 2007 11.1 22.9 1. with 364MM broadband internet users as of Jun-10. more innovative games and more effective promotions to continue to attract players.7 1.738 4. we expect companies with strong operating and marketing capabilities and healthy game pipelines to continue to benefit from the market’s growth.2 2. with additional gamers coming particularly from lower-tier cities.694 687 28% 2011E 122.634 217 65% 2008 68. China MMORPG Market Forecast MMORPG gamers (million) Game users penetration Average ARPU per month (Rmb) Market size (Rmb million) MMORPG Market size (US$M) Growth Rate: Source: J.044 132 52% 2007 47.9% 23. such Final Fahe.3 22.460 4.x.8 24.2% in 2008.406 21% 2012E 106.9B (~US$5.428 21% Key industry drivers We expect continued robust growth of online gaming in China to be driven by: 1) Continued strong internet user growth in China (2009-12E CAGR of 17%).

Expect to be launched in 1H11 2. we think only “Dragon Nest.wei@jpmorgan. In 2010. Netease may launch Blizzard’s “WoW: The Catastrophe” as well as “Starcraft II”. 2011 -.com Global Equity Research 03 January 2011 5) Limited leisure alternatives – teenagers in first-tier China cities spending more on entertainment like internet/games. Morgan estimates. Key MMORPG New Games in 2010 and 2011 Game Dragon Nest Duke of Mountain Deer Chinese Title 龙之谷 鹿鼎记 Genre Action Martial arts adventure Visual Dimensions 3D 3D Game Operator Shanda Games Sohu Changyou Game Developer Eyedentity Games (acquired by Shanda Games in 2010) Sohu Changyou Launch Date Jul-10 1. Key MMORPG Games in 2011 We expect new games launching in 2011 to lead industry growth. with the trend being replicated in smaller cities. but it still depends on the approval procedures of China-related bureaus. Started unlimited closed beta testing in Nov-10.P. In 2011. The new version has been launched in other countries except mainland China in Dec-10. Expect to be launched in 1H11 2. We look for companies with game-specific drivers going into 2011.” launched by Shanda Games in late July. Started closed beta testing in Dec10. performed well with PCU of 700k+. 1.x. 182 . Final Fantasy XIV will also be a game to watch which will be launched by Shanda Games.Dick Wei (852) 2800-8535 dick. Shanda Games announced the acquisition of an exclusive license for the game in Sep-10. a few key games we will watch for are Changyou and Giant Interactive to release “Duke of Mountain Deer” and “ZT Online II” in 1H11. J.Look for companies with product specific drivers With market growth slowing down from the high double-digit level a few years ago. ZT Online II 征途2 Martial arts adventure 2D Giant Interactive Giant Interactive Final Fantasy XIV 最终幻想14 Fantasy 3D Shanda Games Square-Enix World of Warcraft: The Catastrophe 魔兽世界:大灾变 Fantasy 3D NetEase Blizzard Source: Company reports. we expect more intense competition among leading game companies. respectively.

4% 3Q10 101 2. thus.4% 214 16.2% 259.1% 2.190 -4.7% 1.5% 186 3.138 2.447 2Q08 2.2% 266 12.2% 240.4% 299.2% 1.5% 130 3.5% 285.3% 323 10. which creates the need for newer software and also drives consumer demand.1% 9.4% 2.189 22.5% 1.7% 1Q09 5.6% 126 -4. in turn.760 21.2% 2.3% 1Q10 98 9.108 -8. J.2% 2Q09 6.435 4.110 1. Leaders in MMOG Quarterly ARPU per Active Paying Accounts (Free-to-play Model) (In Rmb) Tencent Sequential growth Shanda Sequential growth Sohu Changyou Sequential growth Perfect World Sequential growth Giant Interactive Sequential growth 1Q08 68 156 192 151 325.377 21. the game software industry is relatively less vulnerable in an economic slowdown.5% 4Q09 90 2.6% 190 2.0% 4Q09 8.701 1.464 -5.189 22.526 0.1% 9.9% 184 -8. 183 .620 2.1 -1.5% 1.6% 1.6% 3Q09 8.670 -23. Morgan estimates.919 16.5% 106 0.9% 237 -2.0% 2.1% 1.684 35.3% 149 0.9% 2Q09 83 2.9% 9.2% 1.4 -13.P.8% 5.518 2.239 3.188 33.6% 9.3% Source: Company reports. in developed markets such as the US.7% 2Q10 8.497 4. Morgan estimates.8% 4Q08 5.400 0.204 -2.7 9. Leaders in MMOG Quarterly Active Paying Accounts (Free-to-Play Model) (In '000s) Tencent Sequential growth Shanda Sequential growth Sohu Changyou Sequential growth Perfect World Sequential growth Giant Interactive Sequential growth 1Q08 921 4. J.3% 1Q09 81 3.1% 8. Game software industry typically not correlated with macroeconomic growth.546 -4.5% 196 3.713 194.3% 1.4% 9.P.400 0.8% 179 -7. the videogame software industry has historically exhibited cyclicality driven by game hardware launches (consoles.2% 937 -46.390 5.4% 176 -8.4% 5.1% 3Q08 33 -0.270 14.2% 220 -8.6% 3Q08 3.5% 2Q10 99 0.5% 3Q10 9.7% 2.6% 225 14.3% 18% Source: Company reports.3% 132 -11. For instance.243 8.3% 188 24.9 -12.1% 1.807 19.1% 2.0% 1. As a result.6% 2.790 16.514 1.6% 225 0.2% 223 -16.960 18.580 19.2% 1.3% 1.1 2Q08 33 -51.5% 292 -4. iResearch.006 11.wei@jpmorgan.3% 1. should be less vulnerable in an economic slowdown Historically.304 -0.3% 149 -9.981 -1.6% 7. the game software industry has not been significantly correlated with macroeconomic growth.6% 306 37. Morgan estimates.4% 194 9.1% 201 2.1% 1.236 -4.9% 244 8.7% 106 -21.290 37.5 -7.530 -10.5% 1. handheld devices).com Global Equity Research 03 January 2011 Comparison of Leading Games and Game Companies Market Share of Leading Online Gaming Companies by Revenue 2007 Tencent Shanda NetEase Sohu Changyou Perfect World Giant Interactive Kingsoft NetDragon The9 Others 6% 17% 14% 2% 5% 12% 3% 5% 10% 25% 2008 11% 16% 12% 7% 7% 8% 3% 3% 8% 23% 2009 20% 18% 12% 7% 8% 5% 3% 2% 3% 21% First Nine Months of 2010 29% 14% 15% 7% 8% 4% 2% 2% 0.420 4.7% 4.Dick Wei (852) 2800-8535 dick.7 -3.400 0.373 20.877 28.8% 196 4.x.3% 4Q08 78 136.P.9% 300 0. compared to other industries and software segments.3% 177 0.610 5. These.4% 1.610 -6.643 -12.4% 1.3% 282.889 13.0% 1.0% 1.2% 1.8% 272.060 5.9% Source: Company reports.7% 1Q10 8.640 0.433 -14. result from technological advances by the hardware manufacturers – in terms of faster processing devices with superior graphics and game play capabilities – typically every four to five years.1% 3Q09 88 5.274 -11.3% 2.3% 135 3.0% 164 5.6% 223 1. J.0% 2.1% 105 -0.024 36.

wei@jpmorgan. including women and children).19 (weak correlation). US GDP (Nominal) Growth 70% 60% 50% 40% 30% 20% 10% 0% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Game Company Rev enues US GDP grow th rate 7% 6% 5% 4% 3% 2% 1% 0% Source: DataStream.Dick Wei (852) 2800-8535 dick. Activision. 184 . 3) emergence of innovative business models such as free-to-play online games and in-game advertising making gaming more affordable for consumers. games being seen as a family entertainment avenue. THQ and Take Two.g.. Note: Correlation coefficient: -0.g. and 4) greater variety of games (e. in recent times.. other aspects contributing to potentially greater resilience of the gaming sector have been: 1) the increasing acceptance of gaming among a wider demographic (e. 2) Prior game platform cycles were 1995-2000 and 2000-05. In addition to the above.com Global Equity Research 03 January 2011 US Game Software Leading Companies’ Revenue Growth vs. casual games such as music and dancing games) to appeal to diverse tastes. 2) increasing penetration of the internet and more broadband connections driving online gaming. current console cycle started in 2005 (Xbox 360 launch). 1) Leading US game software companies’ revenue growth based on total revenue of Electronic Arts.x.

and then harvesting at the right time. the concept has been adapted from Facebook and other English-based social networking websites. providing nutrients. Sticky platform What really makes social games sticky is the amount of user-engagement that these games have. their updates are more frequent than MMORPGs. making updates frequently. They differ from casual games in the sense that they have more community-based features and are more frequently updated. For most of the popular games in China such as farm and aquarium games. However. 3) The SNS platform assists in doing viral marketing for the game. casual gamers. sowing seeds.Dick Wei (852) 2800-8535 dick. Game companies keep adding new items making users' farming better. Chinese social games are supposed to be more competitive and have some added features like stealing items. 2) social games attract new sets of users who were traditionally non-gamers or did not have time to do heavier games (such as housewives). casual games. social games find their popularity amongst advanced gamers. 3) better stickiness and monetization vs. they are involved with choosing crops. For example: Many users playing Farmville actually start feeling like farmers. We believe the social gaming trend will continue to pick up in China because 1) community features add to the stickiness of social games.x. which again gives birth to a sense of competitiveness and makes the platform stickier. b) can be played with both online and offline friends. Many users often set alarms to wake up at the right time for harvesting. Members are aware of actions of other friends in the game.wei@jpmorgan. How social gaming is different from casual gaming? 1) Social gaming has community features: a) people can track the progress of their friends trough SNS platform. and have no high hardware requirements. Social games are quite different from traditional MMORPG games in the sense that they are not heavy on strategy. What’s unique about social gaming in China? Social games in China are quite similar to the popular ones on Facebook. 2) The development team is continuously involved. do not have heavy graphics. and people who have traditionally been non-gamers. which keeps the user interested in the game continuously. Increasingly. Users start engaging in a virtual life with the game. As social games do not have a lot of graphic interface.com Global Equity Research 03 January 2011 The Rise of Social Gaming What is social gaming? Social gaming is a new form of gaming which is closer to casual games in complexity level accompanied by community features and frequent updates. 185 .

aquarium. but it already becomes a popular 186 .7% 1. they are expected to have smaller life cycles and continuous churn of new games becomes necessary. Qzone Continues Stable Growth 500 400 300 200 100 0 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 115 131 138 150 183 228 305 388 428 459 481 Qzone Activ e Users (M) Source: Company reports.500 1.000 2. • Tencent announced its open platform strategy after “QQ vs.6% 109.500 2.com Global Equity Research 03 January 2011 China SNS Game Market Forecast 3. Social gaming proves to be a goldmine for Tencent With the rising popularity of social games on Facebook and other Chinese websites. Social gaming – a big opportunity for China game publishers China internet companies focus on an open platform strategy.000 500 0 2009 2010E 2011E 2012E YoY Grow th (%) 2013E 240 420 75.2% 2.2 0 SNS Game Market Size (Rmb M) Source: Analysys. As social games are simple.6 0. 360 war. which should help developers publish their social games. The success of social games on Qzone led to a rise in the number of users from 150M in 4Q08 to 481M in 3Q10. The revenues have also gone up to 35. Tencent introduced many new social gaming applications with more interactive functionalities such as farming.8 0. The company has adopted a mixed content sourcing strategy where it is sourcing the popular games like social farm from third-party vendors while also working in-house to keep the game launch pipeline green. etc.” Tencent’s SNS open platform is still in open beta testing.Dick Wei (852) 2800-8535 dick.x.0% 85.4 0.000 1. We estimate daily active users on Chinese SNS websites playing social games to be comparable to the number of active users on Facebook (500M+ active users). to increase user stickiness.850 1 0.1% YoY in 3Q10 to reach Rmb580M.632 780 74.wei@jpmorgan.

a mobile game platform developer and operator. in July 2010. We believe Chinese social game developers will grow fast with the popularity of SNS and social games in China as in other countries.000 mobile game developers are registered to integrate OpenFeint's SDK into their games and there are over 50 million registered users and approximately 4.000 games in the Apple App Store and Google Market running on OpenFeint's platform.x.Dick Wei (852) 2800-8535 dick. up to a maximum of US$100M. • The9 invested in Openfeint. 187 . Playfish will receive additional variable cash consideration. Playfish was acquired by Electronic Arts for approximately US$275M in cash and approximately $US25 M in equity retention arrangements.com Global Equity Research 03 January 2011 channel for third-party application developers to publish their SNS games at Qzone. recorded 70M game users. In addition.” a popular third-party game at Qzone developed by Kingnet. key social game developers such as Zynga and Playfish have been attracting large numbers of players to their games. The OpenFeint software is one of the most successful mobile social gaming network software for iOS and Android devices in the US. In the US. contingent upon the achievement of certain performance milestones through December 31.wei@jpmorgan. The9 signed a five-year license to use OpenFeint's mobile social gaming network software in China. according to an article by GamesBeat. Zynga has more than 320M registered users. according to Kingnet’s CEO. “Skyscraper. In December 2010. 2011. More than 13.

released “Interim Measures for Online Games” in 2010 In late September 2009. 2010. . China's State Commission Office for Public Sector Reform issued a notice clarifying responsibilities of various government bodies in the regulation of animation. online gaming. or other non-game product purchases. However. This is because online games were assumed to be publications by online game companies.x. The key points are: . On September 7. MoC gets involved .Real name registration for players. management of the industry. . and. and the cultural market in general. The implementation of “Interim Measures” began on August 1. According to this notice.Application process: If there is a change in operator for imported games in China. responsible for market planning. On July 11.com on June 22. and the cultural market in general. games have already been approved by other departments (GAPP).wei@jpmorgan. they turn to GAPP for approvals.No illegal game content which are considered as negative to Chinese culture. . etc. Games should include details for suitable age groups. the game needs to be filed with MoC within 30 days of operation. project development. the State Council issued “Three Regulations” outlining responsibilities of various government bodies (including Ministry of Culture [MoC] and GAPP) in the regulation of animation. and market oversight for the animation and online gaming industries.) for online game companies to obtain “Online Culture Operating Permit. conferences. 2009. (2) game operators to keep record 188 .Virtual game currencies: (1) cannot be used for payment. 2008.com Global Equity Research 03 January 2011 Summary of Gaming Regulations in China Summary of historical gaming regulations The General Administration of Press and Publication (GAPP) has been the key regulatory body since online games were introduced 10 years ago. For domestic developed games. other physical product purchases.Dick Wei (852) 2800-8535 dick.Detailed the requirements (registered capitals of no less than Rmb10M. as such. By the end of 2009. News about the rules was reported on Sina. 2010. MoC held a meeting with leading games companies stating that MoC will be the key regulatory body.” MoC is responsible for reviewing online game content. Even after this regulation. GAPP and the MoC both conduct their own approval process independently. Online game companies are required to implement “anti-addiction system” (time limits) for minors. no separate review is required by MoC. after about two years of preparation. 2010. the game needs to be re-filed with MoC. all the transition in responsibility should be complete. MoC is the key regulatory body. the game needs to be re-approved. society. online gaming. etc. No gambling items in game allowed. . MoC released “Interim Measures for Online Games” on June 3. If game content is substantially changed.

wei@jpmorgan. The trading and account information should be kept for at least 180 days. The trading platform should require real name registration for buying/selling parties and the registration information should match bank account information. These games are not simply about shooting and killing or finding treasures and saving the princess.com Global Equity Research 03 January 2011 of game currencies trading for at least 180 days. these games are free. The most popular games that account for most of China’s online game revenues (~84% of total online gaming market. Regulations on virtual currency and virtual items trading platform Separation of online game operators that issue virtual currencies and online game items trading platform MoC and the Ministry of Commerce (MOFCOM) jointly issued a notice regarding strengthening the administration of online game virtual currency on June 4. and even have virtual marriages. Very often.Virtual game currencies cannot be used for other payments instead of online game products and services. What is a MMORPG online game? These are more complex games with a large number of scenes. and potential criminal charges. as in some other games. Online Gaming Primer What are online games? Broadly speaking.If a game ceased to operate for 30 days. (3) data for game currencies types/prices/total amount issued to be filed with MoC. operators will return money to gamers. and some old arcade games. “Interim Measures” regulates virtual game currency and virtual currency trading platform . Data for virtual game currency types/price/total amount issued should be filed with MoC-related bureaus. and 2) online games that are not approved or filed with MoC. . Serious game players are also more committed to the games than casual players. and 2) serious games/MMORPG. They usually comprise young adults or teens who spend more than 10 hours per week on online games. . There are fines for non-compliance. form coalitions with acquaintances to fight battles. Virtual game currency issuers cannot issue virtual currencies for the purpose of occupying the prepaid capital. as per our estimates) are Massively Multiplayer Online Role Playing Games (MMORPG).x. The record of purchasing virtual game currencies should be kept for at least 180 days. make villages more livable. board games. Some examples are puzzles. 189 . MMORPG are community-based and players can interact with other players. Causal games are easy to play and only require brief tutorials. 2009. Demographics for casual games are diverse: they cut across age groups (from young children to senior citizens) and are equally split across genders. we can separate online games into two segments: 1) casual games. multiple players and characters.Virtual online game currency trading platform cannot provide trading service for: 1) minors. The notice prohibits businesses that issue online game virtual currency from providing services that would enable the trading of such virtual currency.Dick Wei (852) 2800-8535 dick.

and “members only” games). Crazy Racing. Successful casual games generate more revenue compared to board and chess games. Typically. 190 . Board and chess games. depending on his or her availability and needs. QQ Dancer. The revenue model for casual games is in-game item sales. as the name suggests.e. Therefore. Players typically only spend less than 30 minutes per game session. they likely would turn to casual games. create new weapons and run special virtual events. special features (i. chess. AVA. if a player has 15 minutes to kill. weapons. playing a simple casual game is likely to become too boring. Casual and MMORPG are complementary rather than competing products We believe casual games and MMOPRG satisfy needs of players at different times.Dick Wei (852) 2800-8535 dick. Casual games can be broadly classified into 1) board and chess games. Gamers spend less than an hour per game session. operators have a new release every month and a major upgrade once a year—and users can download them free of cost. For example. We believe new innovative advanced casual games attract non-game players to online games and further expand the gamer base. and other traditional games put online. monetization is typically lower. and 2) advanced casual games. Audition. QQ Speed. and difficult to differentiate from competitors.com Global Equity Research 03 January 2011 MMORPG games are very dynamic. if they find online gaming interesting. and requires fewer skills or less training to play the games. CSOnline.wei@jpmorgan.x. etc. What is a casual game? Casual games are online games that are typically less evolving compared with MMORPG games..e. Typical game items are: avatars (virtual clothing. virtual golf clubs to play golf). and bring in new ideas to the market space. As such. accessories. they are not as involved as MMORPG. and membership (priority access to game servers. The popular advanced casual games include: Cross Fire. These additional players could perhaps become MMORPG gamers down the road. These are viewed more as commodity products. this same player could play both types of games at different times. ability to see competitors’ cards in card games). different types of card games. However. but if a player has a few hours everyday. game developers and operators always extend the map. We observe this from the demographic differences between casual games and MMORPG games. The content and depth is much simpler. Successful advanced casual games are typically more innovative. are board games. tools (i.. and decorative products). Advanced casual games are online games that have more depth and content compared with board and chess games.

Second. Game operators hire game masters or ‘GMs’ who patrol the game space to check for unfair practices.2% Male. To further increase user loyalty.6% Age Breakout of Online Gamers in China Abov e 50. 7. an expanded casual game user base should also bring new users to MMORPG.1% 41-50. as well as giving up weapons and armors accumulated over time. First. as such. Online games—a sticky business In online games. game operators organize special events in the virtual space. One good example is Lineage in Korea. it is not uncommon for users to play multiple games. We believe this may be true. 14.x.com Global Equity Research 03 January 2011 Gender Breakout of Online Gamers in China Female. Source: IDC (2010).1% Below 11. players have proved to be quite loyal to the games. in our opinion. 12. Leaving the game means severing ties with the community. Hacking not only demoralizes players but also seems to cause “community unrest” and to threaten the “social order” in the game space. they start building their seniority and respect within the gaming community. and. 24. 0. Investors are concerned that this would reduce spending on MMORPG games. As such.Dick Wei (852) 2800-8535 dick. 85. As such. 14. the market trend is to develop advanced casual games that are more complex and involved. Once players have been playing for a certain period. 21-30. Client software is distributed free of charge and can be downloaded from a game operator's site at any time.2% Do gamers have time to play both advanced casual and MMORPG? In China. 41. which was launched in Korea about six years ago and remains one of the top games in the country. Server software is installed inside game companies’ servers. fair play becomes very important.7% 11-20. and the operators’ goal is to make their game stickier. Any piracy issues in online games? Online games are designed to get around the piracy issue.4% Source: IDC (2009). as well as their stock of accumulated weapons.wei@jpmorgan. and remove those users who violate the rules.8% 31-40. players build a strong community with other game players. The game server is designed to protect against hackers trying to copy or alter the server software. but the effects on MMORPG should be minimal. A well-run game is therefore very sticky. Since client 191 . these casual games consume more time compared with before. They communicate through instant messengers in the game. so users can play both MMORPG and casual games during the same day. There are two sets of software – server software and client software. as well as organize offline promotions and parties.

Also. or take tools from others. for example. NetEase. However. etc. there could be a time delay in addressing a particular hacking issue. What are pirated servers? This refers to the situation where the main server software is stolen from game companies or the server software is being reverse-engineered. For example. These are referred to as “pirated” servers. “criminals” put stolen/pirated server codes on home-run servers and charge users a lower fee than authentic servers to play the game on their servers.com Global Equity Research 03 January 2011 software is free.x.wei@jpmorgan. What are hacking tools software? Hacking in online games typically refers to special (purchased or self-written) programs that run on players’ PCs. this is a fairly frequent issue raised by operators in China. and Lineage are well known for having pirated servers in China. piracy problems are very limited. As such. 192 . With these special hacking tools. new games have more security features to protect the server software from being pirated. war. game players can. The first option is the most effective way to deal with the problem. science-fiction. we have not noted any pirated servers for World of Warcraft.000 average concurrent users. medieval. However. nuke all the adjacent players. martial arts. Games that are operated widely across the globe are more prone to being pirated. Hacking demoralizes other players and results in their leaving the game. online game operators can: 1) amend the actual game software. For example. get infinite lives. Aion. In fact. many of these will likely be small-scale games that we expect will target niche audiences. unlike game consoles where game software is charged a fee. In this situation. 2) hire more game masters to patrol the virtual community. as many online game operators only purchase games from other developers and do not have access to the source code. has not seen any pirated server issues. a game can achieve an operational breakeven at 4. This is because game developers need to distribute a source code to outside game local operators. mystery. With relatively low breakeven user numbers. Economy of games We believe the required number of concurrent users is low for a MMORPG game to break even.000-5. To tackle the issue. and as such. and has led to the decline of some early online games. much like different types of movies: action-adventure. Excluding development costs or licensing fees. we believe the number of MMORPG game titles will continue to grow. there is no reason to make pirated copies. there is a higher chance of the source code being leaked out. Mir2. which develops its games in-house.Dick Wei (852) 2800-8535 dick. and 3) bar hacking players from playing the game.

000 9 49. amortization of licensing fee or revenue sharing with game developer. Note: Excluding development cost. mainly due to hacking and cheating tools.000 50.x.375 48.040 25. The rate of decline from the peak varies depending on different factors. We believe the rate of decline from the peak varies. typical popular MMOPRG games reach their peak in around three years.000 9 792. How fast would a game decline from its peak? As a rule of thumb. Some games decline at a faster rate compared with others.000 44.000 158.000 40. mainly due to pirated servers.000 0 1Q 05 3Q 05 1Q 07 1Q 06 3Q 07 3Q 06 1Q 08 3Q 08 3Q 04 1Q 09 3Q 09 1Q 10 3Q 10 193 Lineage 1 Source: Company reports.125 144.200 3 16.000 9 316. Some of the Korean games have still maintained a high level of usage for over 10 years.400 158.P. Revenues for Long-Running Korean Online Games (In KRW M) 60.135) Case 2 4. For example.000 10.000 20.000 110.833 64. Lineage 2 .520 (88.000 110.800 4 21. while Mir 2 declined 30% Q/Q in 3Q05. operated by 9Webzen. 2) ongoing promotion and user activities.400 282. experienced a step function (around 50% drop each step) type of sharp fall.000 30.wei@jpmorgan.047 Case 3 10.Dick Wei (852) 2800-8535 dick. depending mainly on these factors: 1) hacking or pirated server issues.075 Source: J.880 95. and 3) availability of upgrade packs.000 9 79. Morgan estimates.440 47. we noted Mu.com Global Equity Research 03 January 2011 Estimated Gross Income of a MMORPG Under Various Concurrent Users Average concurrent users Active paying users ARPU per users (RMB): Revenue after distributor’s discount Number of servers Monthly server amortization & bandwidth cost Game masters and other labor cost Marketing and promotion Other operating expenses Gross Net Income Case 1 1.000 11.000 55.

x.wei@jpmorgan.Dick Wei (852) 2800-8535 dick.com Global Equity Research 03 January 2011 194 .

0 50.9 12. Morgan based on MIC's Survey of "Telecommunications Usage Trend Survey 2009" and "Number of Broadband Service Contracts. Internet User Population Trend via PC and Mobile million 80.6 73.0 80.6 7.com Global Equity Research 03 January 2011 Japan Japan Internet Market Overview Broadband the Norm – Mobile Surfing Taking Over Japan has enjoyed relatively high bandwidth availability since CY’02.8 64.2 17. and FWA. Internet Penetration Rate million.2 Apr-02 10.5 27.3 28.3 2.3 78.kamide@jpmorgan.0 75.0 20.4 24. Etc.1 26.P.0 40.8 25.0 30.6 Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 PC only PC & mobile Mobile only Apr-09 Apr-10 Source: J.0 70.8 Apr-00 4.0 70.0 70.0 8.9 26.2 35.0 60. this trend whereby mobile substitutes for PC usage will continue.1 23.8 26.2 30.0 10. 195 .9 31.0 Source: J. Since CY’00 we can see that users have become more accustomed to surfing the net via both PC and mobile.0 40.2 1.0 60. CATV.1 33.0 90.3 66.7 9. In April 2010 according to Nielsen Online.0 0.0 8. 46% of users accessed the net in this manner. Morgan based on Nielsen Online Internet Base Survey.8 5.0 0.2 12.5 11.1 31.4 22. We believe that with greater smartphone penetration going forward.8 72.4 23.0 20.3 Apr-08 33.3 57.0 100.0 30.Hiroshi Kamide (81-3) 6736 8602 hiroshi. DSL.2 18." Note: Broadband service is a sum of FTTH.0 10.2 Apr-01 14.P.0 50. back in April 2000 access via only PC stood at 84%.7 11. and with it high internet usage from both fixed line and mobile. % 120 100 80 60 40 20 0 CY'01 CY'02 CY'03 CY'04 CY'05 CY'06 CY'07 CY'08 CY'09 Internet subscribers (LHS) Mobile subscribers (LHS) Broadband service (LHS) Penetration rate (RHS) 46.7 21.

8 13. However.9 4.6 16.6 27% 4.9 Apr-02 27.6 23.0 26.8 5.4 3.9 58% 4.Hiroshi Kamide (81-3) 6736 8602 hiroshi.7 46% 1.0 0.6 46% 1.8 49% 2.4 8.0 20.0 10. Access Via PC at Home million 60. Internet Penetration by Age and Gender. The most active internet users are in the 30-to-44 age group.9 30.2 17.8 57% 25% 6.0 40.3 21.2 Apr-01 24.1 9.kamide@jpmorgan.4 Apr-00 6.7 27. we have also seen a gradual increase in the female user population for PC traffic.6 15. With regard to the gender split of internet users.8 71% 4.2 5.9 55% 6.7 23.4 62% 3.0 30.9 51.P. which is in line with the most active users on eCommerce sites.com Global Equity Research 03 January 2011 Internet User Population Trend.0 27.7 19. Morgan based on Nielsen Online NetView (Apr 2010).7 48.0 18.1 44.7 41.5 13. Advertising on major portals would be greatly influenced by this key demographic group.4 Apr-03 36.0 25.2 52% 3.0 50.1 70% 4.2 20.2 4.8 Apr-04 Apr-05 Apr-06 Male Female Apr-07 Apr-08 Apr-09 Apr-10 Source: J.1 11. internet penetration is currently fastest in the elderly population (aged 60 and over).1 18.3 68% 4. % 14.9 69% 4.0 15.6 21.6 58% 2.3 10. 196 .P.4 64% 4.4 58% 4.3 Female Population Penetration Male Population Penetration Source: J. Access via PC at Home million.2 48. Morgan based on Nielsen Online NetView.1 30% 37% 60 ov er 55-59 50-54 45-49 40-44 35-39 30-34 25-29 20-24 16-19 13-15 2-12 8% 20% 36% 52% 5.1 63% 3.5 3.

3% 60 ov er 5.4% 4. with the 16-to-24 age group being the main users.9 26% 4% 4.7% 2. unsurprisingly the core age category is younger than PC internet users. where penetration is almost 80%.4 3.P.0% 6.4% 4.0 44% 4.5% Total Source: J.3% 10.5% 13-15 16-19 20-24 25-29 30-34 35-39 Male 40-44 Female 45-49 50-54 2.2% 4. and females in their late 20s and early 30s.6 76% 1.1 4.9 8% 20% 24% 42% 55% 54% 60 ov er 55-59 50-54 45-49 40-44 35-39 30-34 25-29 20-24 16-19 13-15 2-12 4% 16% 27% 34% 5. Morgan based on Nielsen Online Internet Base Survey (June 2010).3% 8.2% 6.com Global Equity Research 03 January 2011 Internet Penetration by Age and Gender.4 58% 4.4% 7. 5.3% 4.4 3.1 70% 3.Hiroshi Kamide (81-3) 6736 8602 hiroshi.8 5.4% 9.P.7 75% 1.2 59% 3.2 4. Although smartphone penetration is still low (5.3 52% 4.9 4.3 Female Population Penetration 6.6 72% 2.9% according to Nielsen Online).4 4. When comparing user demographics for mobile internet users.1% 5.6% 6. usage rates are relatively high among men in their 30s.0% 55-59 5.8 60% 4. Morgan based on Nielsen Online NetView (Apr 2010).6% 11.2% 2. % 14.9 18.1 4.9% 197 .8 81% 2. Smartphone Penetration % 14% 12% 10% 8% 6% 4% 2% 0% 11. Access via Mobile million.8 48% 4% 6.1% 4.5% 8.4% 8.6 Male Population Penetration Source: J.kamide@jpmorgan.

6 107.0% Domestic internet advertising spend is expected to continue gaining market share against traditional mass media.6% 12.5 140.2 206.4 225.1 113.7 88.0 324.4 524.6% 100.3 17.0% -6.0 231.3 446. Internet Advertising Expenditure ¥ billion.9% of total ad spend in CY’09 We estimate that the online advertising market will resume a healthier growth profile Y/Y for CY’10 and CY’11.0% 15.2 8. as online media gains more share from traditional mass media and pricing rises.4 1.0 25.6% 31.1% 8.2% 8. % Internet ad expenditure PC Ad placements Search ads Mobile Ad placements Search ads Y/Y Internet ad expenditure PC Ad placements Search ads Mobile Ad placements Search ads Source: Dentsu.6 8.0 0.1 53.0% CY’11E 651.com Global Equity Research 03 January 2011 Internet Advertising Japan online ad spend 11.0% CY’09 544.0% CY’12E 705.0 103.5% 16.5 26.0 288.5 564.6 9.9% 8.0% 38.0 39.9% 11.3 74. this does bode positively for Yahoo Japan as the leading net property for advertising spend.P.1 397. CY’06 363.6 29.0 39.8 128.5 91.9% 47.7 270.4 33.8 293.8 9.9 339.2% 37.0 17. Although this is nothing new.3% 9. J.9 127.0% 10.0% 9.8% 59.Hiroshi Kamide (81-3) 6736 8602 hiroshi.4% -1.0 - CY’07 459. 198 .8% 8.5% 22.3 97.0% 15.0% 11.7 171.3% 9.3% 22.1 317. Morgan estimates.8% 7.kamide@jpmorgan.1 80.0% 12.3% 7.4% 37.0% 10.7 188.0% 12.0 268.5 481.7 22.3% 7.5% 10.8% CY’10E 595.5% 10.8 441.2 62.0% 10.4% 8.4% - CY’08 537.5 157.0 93. as seen with historic trends.

9% Satellite media 1.4% 28.4% 1.7% 1.8% -1. US online ad spend 14.Hiroshi Kamide (81-3) 6736 8602 hiroshi.4% 5.6% -11.6% -25.7B in CY’09.019 946 459 167 1.8% 3.7% -12.0% 10.9% - Domestic Advertising by Media (CY’05) News paper 15. Note: Internet advertising includes product expenditure.1% Radio 2.kamide@jpmorgan.9% Internet 5.2% -0. 199 .3% -5.3% -4.3% 28.8% 24.038 484 178 2.6% 39.940 999 478 174 2.3% -4.2% -11.4% 1.2% -4.0% -4.5% Satellite media 0. The US online market is three times the size of the Japanese market spend. CY’06 6.714 71 707 2.3% of total ad expenditure in CY’09 Comparison with US market The US market size for online advertising was $22.1% Radio 2.7% -3.1% 2.2% 7.3% of total advertising spend.8% CY’09 5.1% 0.693 828 408 155 1.9% 1.9% -1. larger than Japan at 11.9%.922 674 303 137 1.8% 6.9% 0.4% 39.5% -18.316 11.2% Sales promotion 38. Morgan based on Dentsu.4% 6.9% 10.0% CY’07 7.1% Sales promotion 39.3% TV 28.5% 29.9% 2. Morgan based on Dentsu.P.5% 0.6% Domestic Advertising by Media (CY’09) News paper Magazine 11.5% 6.6% -10.4% 6.3% 28.1% 2.9% Internet 11.7% TV 29.6% 29.5% 1.P.5% 38.5% 2. online advertising made up 14.2% 11.2% 4.656 15.com Global Equity Research 03 January 2011 Domestic Advertising Expenditure by Media Type ¥ billion.909 68 698 2.789 13. Morgan based on Dentsu.1% -7.7% 5.9% 39.1% -5.627 12.998 60 600 2.736 14.0% 39.1% 2.2% Source: J.4% 12. Source: J.9% CY’08 6. % CY’05 Value Total ad expenditure Newspapers Magazines Radio TV Satellite media Internet Sales promotion Composition Newspapers Magazines Radio TV Satellite media Internet Sales promotion Y/Y Total ad expenditure Newspapers Magazines Radio TV Satellite media Internet Sales promotion Source: J.1% -11.824 1.5% -11.3% -1.1% 16.P.7% 27.8% 7.041 49 378 2.9% 1.4% 5.9% Magazine 7.9% 8.016 54 483 2. according to the Interactive Advertising Bureau (IAB).2% 11.

9% 25.6% CY’08 68.6% 6.1% 20.9 12.0ppt 0.2% CY’06 72.0% 5.8 13.7 31.0% 10.0% Sector-wise spending is focused on retail.0ppt 1.7 12.0ppt - 22.0% 6.0% 6.4% 17. telecom and financial services – different from Yahoo Japan’s core exposure to financial services.6 39.4% 9.0% 10.0% 4.0% 14.8% 10.1% 9.3 46. PricewaterhouseCoopers.1 24.4% 12.1% 31.0% (2) . CY’09 (2) 20.0 25.0ppt 0.0% 12.0% 12. % TV Newspapers Internet Y/Y Radio Consumer magazines Others Composition (%) TV Newspapers Internet Radio Consumer magazines Others CY’04 49.2% 21.2% 7.5 29.7% 9.3 48.0% 100.8% 8. Advertising Expenditure by Media Type $ billion. auto.0% 6.0% 100.0% 11.0ppt -1.4 29.8% 5.9% 25.6 24. The IAB Internet Advertising Revenue Report shows that revenues were recovering +11.com Global Equity Research 03 January 2011 U.0% 6.0 10.9 70.6 22.3% 20.2 16.0% 3.9 47. Compared to the US and Japanese markets the size remains relatively small.6 32.9% 5. Internet Ad Revenues by Industry % CY’08 (1) Retail Telecom Financial services Automotive Computing Consumer packaged goods Leisure travel Entertainment Pharma & healthcare Media Others Total Source: IAB Internet Ad Revenue Report.4 63.1% 15.7 -3.2% CY’07 71.1% Source: IAB Internet Ad Revenue Report.5% 18.3% 8.4% 19.8 18.3% 16.4 10.S.0ppt -1.6% 21.6% CY’09 62.4 23.0% 4.0ppt 1.0 36.kamide@jpmorgan.5 24.0% 4.5% 14.5% CY’05 53.7 12.0ppt 2.2% 6. cosmetics/toiletries and real estate.8 24.(1) -2. growing about 21% Y/Y and making up 10% of total advertising spend.2 12.4% 22.0ppt 0. China online ad spending made up 10% of total ad expenditure in CY’09 Comparison with China market In CY’09 the China online ad market was US$2.0% 16.0% 4.9 36.0% 15.6 36.9% 4.1% 20.0% 4.8% 6.2 34.4 51.1B. 200 .0ppt 0. U.0ppt 0.6 62.1% 11.S.9% 32.0% 10.0% 13.3% 6.S. PricewaterhouseCoopers.Hiroshi Kamide (81-3) 6736 8602 hiroshi.0% 7.5% 9.8% 16.2 9.2 25.3% Y/Y in 1H CY’10 in the U.6 21.

com DeNA Gourmet Navigator Gree Dwango Yahoo Japan Cyber Agent Rakuten 2121 2193 2371 2432 2440 3632 3715 4689 4751 4755 Source: J.48 0.87 77.0 9.9 7. 30-to-40 age group). DeNA refers to Mobage mobile portal. with around 60% market share.S.0 2.0 10.e.S. and portal media). eCommerce The size of the Japanese B2C eCommerce market is estimated to be ¥4.0T.6 17.0 224.37 177. Japan and China $ billion 25.10 1. 2009.69 Mixi Cookpad Kakaku.11 132.kamide@jpmorgan.561.Hiroshi Kamide (81-3) 6736 8602 hiroshi.506.6 0.300. However. Internet shopping also now dominates the non-store retail channel (such as phone.81 65.05 1. Morgan Asia Research.0% 10. which is approximately 3.0 1. Dwango refers to Nico Nico Douga video site..1 20.0 6. sales refer to total net services (EC. in the core internet user demographic (i. and IAB “Internet Advertising Revenue Report”.47 104.0 3.9 7.04 Sales per visitors (month) (¥) 94.3% of the entire domestic retail market.0 41.2 0.4 27. Cyber Agent refers to Ameba business.4 7. travel..4 19.3 0.9 7.0% 20.0% 10.1 Sales (Apr-Jun 2010) PC (¥ M) 4.0 20.2 Monthly page views PC (B) 5.5T.02 0.1 9.com Global Equity Research 03 January 2011 Internet Advertising Expenditure CY’09 .7 0.34 0.0 5.0% Japan Internet Ads Spend (LHS) Y/Y (RHS) China Source: J.05 404. Rakuten visitors refers to both PC and mobile ads combined.P.4 Unique users (M) 14.207.11 2. television and catalog mail order). Comparison of Traffic and Sales for Key Domestic Internet Names Company Code Monthly visitors Registered users (M) 20.5 Mobile (B) 24. Note: Currency based on end-December. 1.931.0 70.940. Morgan based on companies’ data.63 98.0 20.60 0.6 35.0 15.0 -3.902. Data as of end-June 2010.8 0.93 43.940.4% 30.4 24.P.0% -10.0 0.4 2.0% U.013.9 41.0 Mobile (¥ M) 24.45 332.6 20. Dentsu.2% 0. Note: Unique users refer to the # of accessing users in a month. 201 .6 5.U. worth ¥135. eCommerce makes up a greater proportion of individual retail activity.3 40.0 Sales per PV (month) (¥) 0.1 71.193.

500 1.kamide@jpmorgan.P.000 1.4% 22.Hiroshi Kamide (81-3) 6736 8602 hiroshi. 2010.566. 2010.1% 80.000 2. Amazon Japan and Yahoo Japan.490. 15.2% 160% 140% 120% 80. Note: Rakuten and Amazon Japan data as of Oct. Number of Items for Sale Rakuten 65.681 stores Yahoo Shopping 17. Morgan assumption.295. LHS) Source: J.1% 20% 0% CY'09 CY'00 CY'01 CY'02 CY'03 CY'04 CY'05 CY'06 CY'07 CY'08 BtoC (retail & service.000 4. 28.com Global Equity Research 03 January 2011 Trend of Domestic BtoC ECommerce Market ¥ billion % 5. Morgan based on company data.4% 19.0% 60% 40% 13.407 items Yahoo Shopping 36.000 items Source: J.834 stores Yahoo Auction 17. and Yahoo Auction end-Sep. as seen by the number of merchants active on Rakuten and Yahoo Japan. The number of items for sale shows that the leaders have taken a long tail approach.1% 17.P. Number of Merchants Rakuten 35. Note: CY’00 to CY’04 are based on J.706. Yahoo Shopping Oct. 2010.8% 25.435 items Yahoo Auction 22.000 3.500 3. Yahoo Shopping and Yahoo Auction end-Sep. 15. Morgan based on METI Surveys on eCommerce Market Size. 202 . Morgan based on company data. The marketplace model (virtual shop tenants operating on a platform) has been very successful in Japan.9% 85.4% 100% 80% 64.254 items Amazon Japan 28.500 4.393 stores Source: J.P. Note: Rakuten data as of Oct. 2010. Y/Y(RHS) Online shopping is dominated by Rakuten.000 500 0 145.500 2.P.

203 .P. private brands).on select 'Rakuten 24' service None Yes .on select items Yes . Morgan based on company website.but not applicable to all items None None Lawson Available No Source: J. Comparisons of Rakuten and Amazon Japan Rakuten Characteristic Shopping model Third party sellers Own brands Free delivery Same-day delivery 24 hour delivery eBook sales Fulfillment services Point program Auction items Group buying Settlement and delivery at convenience store Gift card availability Credit card services All marketplace (online mall tenants) Mainly retailers and individuals None On select items and books None Yes . Morgan based on Fujitsu Research. Service comparisons between leader Rakuten and Amazon Japan We believe the key differences in the services offered by Rakuten and Amazon Japan are:  Amazon Japan has greater flexibility to offer customer experience improvements for shopping online (such as same-day delivery.  Rakuten’s strength lies in product selection and the ability to offer different online services within the group.P.com Global Equity Research 03 January 2011 Survey – Most Recent Online Shopping Site Used via PC Manufacturer direct sales 7% Niche e-tailer 8% Real w orld retailer net store 8% Other online mall operators 4% Catalogue sales companies 9% Amazon Japan 13% Yahoo! Shopping 8% Unknow n 4% Rakuten Books 9% Rakuten Mall 30% Source: J. with growing third party sellers Include manufacturers Javari Amazon Basic On all items Yes .on select 'Rakuten 24' service Rakuten Points Available Available None None Rakuten Point Club card Amazon Japan Primary retailer.pending stock availability Via Kindle eBook reader For in-house and third party sellers using Fulfillment services Amazon Points .kamide@jpmorgan. such as travel and financial services. given its key role as a retailer with the necessary infrastructure in place.Hiroshi Kamide (81-3) 6736 8602 hiroshi. in addition to auction.

The seller has the option for fulfillment to be carried out by Amazon Japan. as it aims to diversify its products on offer. which provides an incentive that attracts many mall operators.Hiroshi Kamide (81-3) 6736 8602 hiroshi. A comparison of marketplace fees highlights the following:  Rakuten has an initial fee and fixed monthly charge.  Amazon Japan has a smaller monthly fee for large sellers.com Global Equity Research 03 January 2011 There has been a growing emphasis by Amazon Japan on its third-party seller base. but its cost structure is more complex.kamide@jpmorgan. 204 . We think Rakuten’s brand and cost structure is likely to prove attractive to individuals and small businesses—especially for first timers.

0% of sale price (maximum charge $50.0% of sale price (maximum charge $50.0~4.00.P.000 No limit 2.50 Final value fee No fee 8~15% of the final sale price 8~15% of the initial $50.600 Light plan 41.00 $1.00.000 ¥ Item % ¥ Standard plan 52.00 .9% 1 yr 21.600 Mega-shop plan 105.000 Master plan 31.00 .790 200.290 200.5% 6 mos Payable at 1 mos.Final value fees Fixed price format listings -.01 or more Buy It Now price $0.00) 9.00 Final value fee No fee 9.Hiroshi Kamide (81-3) 6736 8602 hiroshi.0% 1 yr Once in 6 mos 33.00 or more Final sale price Item not sold $0.com Global Equity Research 03 January 2011 Participation Costs for Marketplace Sellers Rakuten Ichiba Monthly fixed fee Number of items registered for sale Variable commission Contract period Payment method Initial joining fee Yahoo! Shopping Store Monthly fixed fee Number of items registered for sale Variable commission Contract period Payment method Initial joining fee Amazon Market Place (Japan) Monthly fixed fee Basic contract System charge Number of items registered for sale Variable commission Per transaction sales fee (domestic sales) Initial joining fee eBay Auction-style format listings -.000 3.5~6.$0.790 5.99 .600 Ganbare! Plan 20.Insertion fees -.000 Royal plan 52.0~4.00 $2. 205 .$50.900 No limit.50 $0.000 2. plus 5~9% of the next $50.000.01 .99 or higher Final sale price Item not sold $0.000 3. 21. Note: Tax included.$199.5% 1 yr Yearly 33.000 3.1~3.99 $25.$49.000 2.kamide@jpmorgan.00 .99 $200. max ¥ 1 mn price tag 15 categories: 8~15% Others are un-registerable 15 categories: ¥30~140 Others are un-registerable ¥ Item % ¥ Regular plan 20.00 $1.75 $1.$9. plus 2% of the remaining final sale price balance ¥ ¥ % Item % ¥ ¥ Large plan 4.5~5.01 .500 20.7% 1 yr 21.00 .00 $50.Final value fees Source: J.600 -.000. plus 5~9% of the remaining final sale price balance 8~15% of the initial $50.$1.01 .000.99 $10.Insertion fees Starting or reserve price $0.0% 3 mos Once in 3 mos 33.00) Insertion fee $0.99 $1.0~4.01 or more Insertion fee Free (up to 100 listings) $0.000 1. Data as of end-Sept.0% 1 yr Once in 6 mos 33. All 21 categories 21 categories: 8~20% 4 categories: ¥30~140 Other categories: free Small plan ¥100 per transaction Category limits in place.475 5.$1. Morgan based on company websites.00) 9.0% of sale price (maximum charge $50.000.99 $50.00.$24.9~3.00 $50.25 $0. 2010.000.$50.01-$1.290 200.01 .

with a mobile service starting in September 2004. 30% of national population Estimated 50% .80% Predominantly virtual.41% .kamide@jpmorgan.20% Virtual goods and gaming content . but the two generalist sites that began to build major user bases were:  Mixi—Initially an online PC service with an invitation-only user registration format.P. making an impact as the concept of expansive online communities took hold. the same time as US/European counterparts Background Western social networking services such as Friendster and MySpace began in 2003.41% 30 years old and over Less than 5% of total user traffic Over 95% of total user traffic – driven by gaming content Mobile carrier settlement Virtual goods and gaming content . Mixi and Gree both began in February 2004 Mobile SNS and gaming content spurred user adoption Japan’s user-generated content sites were predominantly in the form of blogs (online diaries) and forums (such as 2Channel). Key characteristics The defining characteristics of Japanese SNS sites are as follows: Key Characteristics of Japanese SNS Potential user audience Current user penetration User growth Gender split User age group distribution Age group with highest ARPU PC SNS usage Mobile SNS usage Popular settlement method for virtual currency Mobile SNS sales split PC SNS sales split Social graph Source: Companies' data. in part due to the convenience factor offered by mobile access.60% of potential user audience 35% Y/Y (at Sept 2010) Dependent on site. launching a mobile service in December 2004 which became the mainstay service.Under 20 years old . overall evenly split between male and female .  Gree—Commenced as a PC service with open registration to users in February 2004. and with the more recent introduction of social gaming content. Began in February 2004.Hiroshi Kamide (81-3) 6736 8602 hiroshi. Morgan estimates.20% Advertising .80% Advertising .18% . real identification rarely used 206 . J.com Global Equity Research 03 January 2011 SNS in Japan Japanese SNS sites first appeared in 2003. User adoption of SNS however was relatively swift.30 years and above . Estimate 40M (50% of 15 to 64 age group).20 years to 30 years old . It was around the same time that numerous small special-interest SNS sites were emerging in Japan.

The leaning toward virtual social graphs and user behavior focused on gaming also limits its appeal as advertising media. a marked slowdown as both user numbers and ARPU growth domestically begin to flatten with market saturation. Social gaming Social games are simple-to-play titles that were inherently free to play. J.0% 20 to 30 41.P. We believe that the SNS market (both advertising and social gaming) is worth around ¥200B in CY’10 growing at 185% Y/Y.  The key earnings driver is virtual goods and gaming content.0% Over 30 41.0% Source: Company data. and introduced pay-to-play virtual items for sale to enhance game play experience – a common ‘freemium’ model whereby a basic web service is offered for free.0% Sales Split 20. although it remains a growth area.0% Traffic Per Platform PC SNS usage 5. encouraged user interaction.0% Mobile SNS sales split PC SNS sales split Vitual goods and gaming content Advertising Source: Company data. we believe there are two key issues that face the SNS industry:  The focus on the mobile platform means that the advertising market remains small.0% 80.kamide@jpmorgan. From the above. Gree (25%) and Mixi (5%) making up around 70% of total market share. Source: Company data. J. J.com Global Equity Research 03 January 2011 User Demographics Under 20 18. with DeNA (40%). Morgan estimates. We believe growth will slow drastically to 15% Y/Y in CY’11. Morgan estimates. Gree pioneered social gaming in 2007 207 . Mobile SNS usage 95. while charging for premium offerings.0% 20.0% 80.P. Gree was the first SNS to successfully pioneer the concept of mobile social gaming in 2007. Morgan estimates.P.Hiroshi Kamide (81-3) 6736 8602 hiroshi.

subscription fee service Prepaid currency to purchase virtual items. real name) or virtual (e. primarily for gaming content All uploaded by individual users for general consumption Uploading pictures Artist profiles and fan clubs Content generally found on a PC portal services Equivalent to ‘Wiki’ pages Additional services for PC site access.kamide@jpmorgan.g.Transport/access search . with the company launching its social gaming service in October 2009.Social games . Use of Flash and Java programming.Weather .Avatars Games .Groups/communities .Celebrities content Premium services Comments Mostly pet names and pseudonyms on domestic SNS sites Online diary entries List of users on your personal network Joining special interest forums Used as email/messaging service Virtual characters.Search . Morgan based on company data. Structure of SNS Services The basic structure of an SNS consists of the following:  User profile – either real (e.Blogs . which originally started as a standard publishing mobile gaming portal in February 2006. pet name) personal data  Posting diary entries/blog posts  Compile and share a list of contacts – allowing users to search and connect to each other  Joining specialist interest communities The key aim is to be able to stay in touch with your contacts and to allow for ease of communication as well as the ability to behave as a group in a virtual setting.News .P.Photos .Core gaming content Virtual currency User generated content . Staple basic puzzle games.g.Hiroshi Kamide (81-3) 6736 8602 hiroshi.User profiles . 208 .Horoscopes .Reference data . generally a free service Key earnings driver for DeNA and Gree More akin to traditional videogame titles.Friends/contacts .Mail function . such as additional data storage capabilities Source: J. which can be 'dressed up' usually for a fee In-house developed as well as third party. Service overview Domestic mobile SNS sites have evolved to become a generalist destination site like a portal.Music Entertainment and information content .Casual games . as they have expanded the services on offer: SNS Service Overview Service Social networking functionalities .com Global Equity Research 03 January 2011 Current market leader DeNA commenced social gaming in 2009 The latecomer to social gaming was DeNA’s ‘Mobage’ mobile site. The site changed into a SNS service later that year with the introduction of avatars.Novels .

whose net usage behavior was skewed to handset usage rather than PC. as users tend to reward for quality content after first being able to assess its worth via the free-to-play environment. Social Game Monetization Model SAP games User acquires ¥ x currency Purchase game items 30% Commissions recognized 70% paid to SAP In-house game application 10%~15% Carrier commissions All revenue recognized Source: J. 209 . or prepaid money available at convenience stores.kamide@jpmorgan. and the introduction of fixed pricing plans made heavy mobile usage more affordable.Hiroshi Kamide (81-3) 6736 8602 hiroshi.  Ease of purchase of virtual currency via carrier settlement made it more convenient to transact. Morgan assumption. Note: SAP stands for Social Application Provider. the key difference between Japanese and overseas SNS services is the focus on the mobile platform versus the PC. We believe this occurred due to the following factors:  Early adapters of mobile services were the younger under 30 demographic. thereby meeting their needs.com Global Equity Research 03 January 2011 Domestic SNS a de facto mobile service Apart from the wealth of content on offer. affordable data  The fall in pricing for packet download fees via carrier competition.  Games on offer can be in-house developed by the SNS operator.  Virtual currency is required to purchase game items—a common method to acquire currency is via carrier settlement. a developer of a social game application. Why social gaming can be highly profitable The success of social gaming comes from two key angles:  The relatively low barrier to entry into the market via low development costs. credit card. Fast. or by third-party developers. and replacing demand for mid-tier quality software from the traditional videogame industry.  Low priced download titles and free-to-play item sale titles are meeting the needs of gamers. Convenient carrier billing Social Gaming Primer Revenue structure Key points related to the revenue model for social gaming are as follows:  The ‘pay-to-play’ revenue model is a valid approach to online gaming.P. An open platform allows for greater product diversity.

¥6. However.P. apart from flagship titles that can use TV advertising Traditional Videogame Platforms—Illustrative Development Cost Estimates Game Platform Nintendo DS Sony PSP Wii PlayStation 3/Xbox 360 Source: J.090 210 .0M Upwards of ¥0. resulting in a potentially high margin earnings stream.000 . The key attractions here are that:  Marketing costs are relatively low.040 .P.0M .¥300 ¥1. Cost ¥10.800 . as internet content there is greater emphasis on viral marketing and user feedback  The ability to exceed breakeven point is relatively easy.0M ¥10.¥4. average 6 months ¥2.¥50. Social Gaming—Initial Cost Estimates Initial development costs Server costs Marketing costs Source: J. 10% for tuning) Usually low. social gaming titles involve a relatively small outlay of cost to start up and operate.0B We are making a generalization of development costs for traditional video gaming software. Morgan estimates.com Global Equity Research 03 January 2011  The launch of a social gaming title is the start of on ongoing development cycle.6% ¥50 .kamide@jpmorgan.4B Upwards of ¥1.¥75. Morgan estimates.¥30M Around 25% of revenue generated (15% for hardware. where the game can be fine-tuned and improved ‘on the go' with direct customer feedback. Range 2% .Hiroshi Kamide (81-3) 6736 8602 hiroshi. We set out the basic cost structure for developing and operating a social gaming title. J. The key variables in the revenue structure of a typical social game are as follows: Social Gaming Titles—Typical Factors Affecting Revenues Revenue Variables Participation rate of total registered user base Typical monthly ARPU range for registered users Monthly ARPPU (Average Revenue Per Paying User) range Game shelf life/lifetime value period For reference – typical pricing range of handheld software Nintendo DS software PSP software Source: Company data. Morgan estimates.800 ¥5. which can range significantly in scale and budget.¥5.0M . ¥10M .P.000 3 month to 12 months typically.

kamide@jpmorgan. Monthly User Acquisition Costs (UAC) Trends (CY’10) ¥/person 1. Also. traffic growth is limited and marketing costs are a necessary tool to encourage user activity. 211 . we can surmise that a simplified game title revenue model is: Gross revenue = Number of registered users × Participation rate × ARPU × Shelf life Less the following costs to derive profit:  Server fees and game tuning = gross revenue × around 25%  Marketing costs  Initial development fee  Carrier and platform provider commissions Therefore. it is possible to exceed the breakeven point in a comparatively short period of time and generate earnings over the longer term through this model. as well as keeping old ones active. Marketing is a user acquisition cost – must balance with ARPU Marketing costs in the early-to-mid cycle stages of a game title release can be viewed as a user acquisition cost—the cost and investment required to win new users. Cost drivers The initial cost driver for social gaming is staffing cost related to engineers and creators developing a game title.P. Note: Number of users is calculated by taking the average of the current and the last quarter end. and server costs as user traffic increases. with no negative residual issues such as reducing pricing or scrapping inventory. titles can be cancelled if proven to be unsuccessful. Monthly ARPU and Avg.200 1. Morgan based on company data.Hiroshi Kamide (81-3) 6736 8602 hiroshi. Despite growth in user traffic generated by gaming content. After release the key cost drivers are marketing spend to promote the title.000 800 600 400 200 0 Jan-Mar Apr-Jun mixi Jul-Sep Jan-Mar Apr-Jun 66 209 63 13 58 89 550 292 679 357 956 549 192 372 367 176 469 187 Jul-Sep Jan-Mar Apr-Jun GREE Jul-Sep DeNA ARPU UAC Source: J.com Global Equity Research 03 January 2011 From this.

unlike Japanese SNS sites Foreign SNS sites tend to focus on real social graphs. especially with the adoption of smartphones. Social application providers The SNS sites act as a platform for social network game developers (called Social Application Providers.1 58.  Facebook—The largest global SNS platform provided by Facebook Inc.9% UAC 209. or SAP) to plug in game applications on the sites.  Twitter—Twitter is a mini-blog service provided by Twitter Inc.6% Source: J. and other key players on the Facebook PC platform such as CrowdStar .com Global Equity Research 03 January 2011 ARPU and User Acquisition Cost—Y/Y Growth (CY’10) ¥/person Mixi DeNA Gree Jan-Mar Apr-Jun Jul-Sept Jan-Mar Apr-Jun Jul-Sept Jan-Mar Apr-Jun Jul-Sept ARPU 65. We view major PC browser-based game companies as a cluster of new entrants into the social gaming market—key players here are Germany's Bigpoint and Gameforge.4% 16.3 89. France’s Gameloft.9% 3555.1% 20. has established three dedicated subsidiaries to social gaming  KLab: IT services firm with social gaming content  Cave (3760): A PC online game operator branching out into smartphone social gaming Foreign SNS Presence in Japan Foreign SNS sites are not virtual communities.3 356.9 192.1% 100. RockYou!.1% 10.Hiroshi Kamide (81-3) 6736 8602 hiroshi. Electronic Art's subsidiary Playfish. The exception has been the social networking and microblogging service Twitter.8 186.4 Y/Y 2909.0 292.9% 186.5% 25.9 371. 212 . Nielsen Netview estimates that there are two million Facebook PC users in Japan as of September 2010. Major overseas players include Zynga. Key SAP companies in Japan are as follows:  CyberAgent (4751): A leading online advertising agency and blog site. Nielsen Netview estimates that there are 11.1 367. with the view of generating revenues either by virtual items sales or generating advertising income for traffic generated.3 13.6% 22.5 63.7% 284.7 549. and we believe this has been the overriding factor in their lack of popularity in Japan where users prefer greater privacy.8 956.8 175.4 550. Disney’s Playdom.9% 196.3 678. UK’s Mind Candy and Jagex.7% 0.P.7% 182.1M Twitter PC users in Japan as of September 2010. Morgan based on company data.6% 69.2 468. We believe that there is more user activity on the mobile platform.2 Y/Y 9.1% 211.6% 246.kamide@jpmorgan. and Digital Chocolate Inc.1% 234. 6 Waves (based in Hong Kong).

6 11.  Bargaining power of suppliers: Social gaming developers can choose to place their content on SNS platforms of choice.  Threat of new entrants: Substitution risk is high for social gaming developers as new entrants appear from PC browser-game market and the traditional videogaming players. With reference to Michael Porter’s Five Forces model to assess the competitive landscape of SNS and social gaming. Morgan estimates. Note: Reach is calculated as the number of monthly visitors divided by the potential domestic internet user audience.kamide@jpmorgan.1 2.4 Monthly Pageviews (M) 3. Morgan.Traditional video gaming companies adopting to social gaming Users can choose to ignore or embrace new games Switching costs are virtually zero Application developers choose the most successful SNS platform to provide content The lack of quality content results in quickly falling user traffic SNS sites spend user acquisition costs to attract new users Existing users need to be continually engaged to remain customers A highly competitive environment  Barriers to entry: Physically and technologically low barriers to build a SNS/social gaming applications.1 Reach (%) 15. Competitive Forces Analysis Competitive Forces Barriers to entry Threat of new entrants Bargaining power of buyers Bargaining power of suppliers Competitive rivalry Conclusion Source: J.com Global Equity Research 03 January 2011 Internet Usage Rates (September 2010) Monthly visitors (M) 9.369 841 119 Average pageviews (PV) 353 76 57 Average usage duration (minutes) 206 41 36 Mixi Twitter Facebook Source: Nielsen Netview .PC browser-game developers targeting smartphone market . and with self-publishing distribution channels such as the Apple App Store and Android Markets.P. Overseas Expansion—An Assessment of Growth Prospects Assessing competitive forces The SNS market is a developing growth business and is therefore a target of both start-ups and mature businesses aiming to take advantage of its user traffic growth. impacting future monetization. we conclude that despite the potential growth prospects. know-how over game development and tuning can be gained over time.  Bargaining power of buyers: End users can choose and decide whether a game is worth playing or not.8 18. J. Rating LOW HIGH HIGH MEDIUM HIGH Commentary Initial investment (time and cost) low for application development No technology barriers to develop social games/SNS .Individuals can easily develop content and self-publish . Less popular SNS sites are not seen as desirable given less user traffic generated.Hiroshi Kamide (81-3) 6736 8602 hiroshi.4 3. This has thrown the door wide open to new 213 .P. it is rapidly becoming an overcrowded and highly competitive space.  Competitive rivalry: It is much easier to make and release a game with available authoring tools.

we believe that operating a SNS with a real social graph will not be a conductive environment to really drive gaming behavior to the levels seen in Japan. we believe this will not be a major competitive advantage over the medium term. With overseas markets expected to be a new growth opportunity.g. 214 . as opposed to the PC. Morgan estimates. and virtual user interaction fosters gaming activity. Overseas M&A activity Domestic SNS players and leading social application developers are eager to explore and build overseas growth opportunities. The key difference between DeNA and other deals undertaken is that the company is acquiring firms with a focus on the smartphone platform e. Although this approach may buy time for DeNA versus competitors also diversifying into smartphones.com Global Equity Research 03 January 2011 entrants. Facebook and Zynga are PC-based with a real social graph. Japanese mobile user behavior is adapted to mobile gaming. DeNA estimates that its ARPU is 15 times higher.P. but there have been other transactions taking place. with a virtual community social graph.kamide@jpmorgan. and localized players are all beginning to look at the global picture for growth opportunities in the SNS market.com Unoh Acquirer/investor Disney Electronic Arts Electronic Arts DeNA DeNA DeNA DeNA Google Zynga Japan Price $563M + $200M earn-out $300M + $100M earn-out Less than $20M $303M + $100M earn-out NA NA NA $182M NA Date Jul-10 Jul-09 Oct-10 Oct-10 Sept-10 Sept-10 Oct-09 Aug-10 Aug-10 Daily Average Users 4. ARPU difference is significantly affected by the type of community (virtual or social).7M NA NA NA NA NA NA NA Source: Company reports and J. DeNA operates on a mobile platform. we believe that this view overlooks the intensifying competitive forces involved. content on iPhone and/or Android. DeNA estimates that its ARPU is 30 times higher and (2) compared to Zynga. DeNA acquired US company ngmoco in October 2010. Conversely. Recent M&A Activity in Social Gaming Space Company Playdom Playfish Chillingo ngmoco Astro Ape Gameview Studios IceBreaker US Inc Slide.Hiroshi Kamide (81-3) 6736 8602 hiroshi. Differences in ARPU DeNA has highlighted a major difference between social gaming markets in Japan and the West: (1) Compared to Facebook.6M 7.

30% 14.80% 43.90% 16.Hiroshi Kamide (81-3) 6736 8602 hiroshi.00% -3.  IDC expects that Symbian will be the leading operating system by 2014.90% 17. Mixi’s ARPU is lower than its peers due to:  Revenue driver remains advertising.30% 24.50% 2014E/2010E Change -18.50% 51. followed by Android.kamide@jpmorgan. This is a factor that would drive SNS and social gaming companies to see smartphones as new distribution systems for their services. Morgan based on company data. from 173. 372 157 58 DeNA GREE Domestically.5M units in CY’09 to 269.30% Source: IDC Worldwide Quarterly Mobile Phone Tracker. 215 .80% 4. as opposed to social gaming.30% 8. Smartphone Adoption—New Distribution Channels International Data Corporation (IDC) estimates that global smartphone shipments will grow 55.com Global Equity Research 03 January 2011 Monthly ARPU Comparison (July-September 2010E) ¥/person 400 350 300 250 200 150 100 50 0 mixi Source: J. Worldwide Converged Mobile Device Operating System Market Shares and 2010-2014 Growth Operating System Symbian BlackBerry OS Android IOS Windows Mobile Others 2010E Market Share 40.60% 10. September 7.80% 4. Growth is expected to continue at 24.10% 17.4% Y/Y in CY’10.20% -25.P. we are drawn to the competitive threats involved despite the Apple iOS and Android platforms being perceived as a ‘green-field’ site. 2010 While there is a positive outlook from a market growth perspective for smartphones.  Users on the Mixi SNS mostly go to the site for communication purposes.20% 2014E Market Share 32.70% 6.90% 9. which is the main draw for DeNA and Gree.5% Y/Y in CY’11.6M units. rather akin to video gaming software makers that took the 'multiplatform' approach for their game titles.

216 .kamide@jpmorgan.Namco Bandai .My Space phone SNS Traditional videogame companies . the following environment is necessary:  Social gaming content has high penetration rates in Japan.mix i Source: J.Hiroshi Kamide (81-3) 6736 8602 hiroshi.RockYou .KONAMI .Square Enix . We do however believe that social gaming will be appealing to a niche audience overseas.Cy ber Agent . offering a new service compared to real social graph SNS.GREE .DeNA .Tecmo Koei . virtual SNS sites need to be built with virtual communities.P. We feel that in order for smartphone penetration overseas to result in (1) a major hike in user activity on SNS sites and (2) widespread adoption of social gaming content.Play fish .Cav e iPhone Apple iOS / Android Domestic feature SNS platforms .Crow dStar Domestic social application profiders . Morgan based on company data.com Global Equity Research 03 January 2011 Competition in the Smartphone Game Application Market PC browser / SNS game developers .Play dom . or  With compelling content on offer.Zy nga .Facebook .Capcom . as the social graphs are virtual—overseas SNS sites which have real social graphs will have to replicate this level of activity. A current proxy would be Microsoft's Xbox Live online gaming service on the console. which in terms of scale may still present an attractive new market for Japanese companies to target.

5 million users Funded by European VCs Target Partners and Earlybird Operated by Aptocore founded in 2008 Platform devised by Chillingo. Android iOS. Morgan. Overseas Social Gaming Networks OpenFeint Plus+ Gameloft Live Score∞p AGON Online Crystal Social Gaming Network Source: J. Java.1. with DeNA as a passive investor ngmoco's social game platform Gameloft's mobile gaming network with 1. JavaScript FlashLite 1.0.000 20 Credit charge 30% 70% Android app Java Android Market App Store Apple Jul-08 iPhone OS 85.P. Java app WRT widget.com Global Equity Research 03 January 2011 Major Smartphone Platform Distribution Channels Android Market Google Oct-08 Android OS 55.Net Windows Mobile developer Center Ovi Store Nokia May-09 Symbian OS 10.000 41 Credit charge 20% 80% Java app Java BlackBerry Developer Zone Palm App Catalog Palm Jul-09 WebOS 1. Android iOS iOS iOS. 3.P. SMS charge carrier charge.kamide@jpmorgan. based on "Internet White Paper 2010" (Impress Japan).000 100 Credit charge 30% 70% iPhone app Objective-、 C/C++ iPhone Dev Center Windows Marketplace for Mobile Microsoft Sep-09 Windows OS 1.0 Forum Nokia BlackBerry App World Research In Motion Apr-09 BlackBerry OS 6.1. Morgan based on company data. soon Android 217 . 2.000 5 Credit charge 30% 70% WebOS app JavaScript/CSS/HT ML Palm Developer Network Operator Start date OS/Runtime Apps offered Users (M) Charge methods Revenue % (operator) Revenue % (developer) App name App development language Site name for developers Source: J. soon Android iOS. Android iOS. now acquired by Electronic Arts A game developer on iOS for multiplayer games Platform iOS. 2.000 NA Credit charge 30% 70% Windows Mobile app .000 Over 100 Credit charge. adding charge 30% 70% Symbian app.Hiroshi Kamide (81-3) 6736 8602 hiroshi. Description Social gaming platform.0. 1. Flash app C/C++.

2 12.7 18.1 16.1 28.0 11.1 1. CyberAgent.8 25.6 Source: Company data.6 Gourmet Navigator 2440 JPY 30.com Global Equity Research 03 January 2011 Valuation Table Company Code Currency Market cap Share price Liquidity (daily) P/E Div. Note: Yahoo Japan.6 37.1 9.9 29.1 0.0 3.8 43. com 2371 JPY 137. Rakuten.6 19.4 11.5 18. 20.0 7.9 14.0 1.1 4.5 2.1 -25.7 12.1 13.4 12.9 23.0 1.1 -40.3 8.069 56.0 11.2 18. Mixi.9 9. (¥B) (¥) ($M/day) (X) (X) (X) (%) (%) (%) (X) (X) (X) (X) (X) (X) (X) (%) (%) (%) (%) Yahoo Japan 4689 JPY 1.7 13.8 6.6 21.0 3.7 4.1 3.7 2.7 -1.7 11.7 56. Kakaku.7 Mixi 2121 JPY 68.4 4.com and Gourmet Navigator are based on Bloomberg consensus estimates.6 0. 218 .4 68. Morgan estimates.2 17.2 Kakaku.2 9.0 5.000 10. 2010. Morgan estimates.7 4.2 21.9 29.1 177.9 0.1 9.9 18.6 17.0 5.5 37. Bloomberg and J.8 6.5 55.5 0.200 27.7 5.1 10.3 0.2 3.6 45.0 0.Hiroshi Kamide (81-3) 6736 8602 hiroshi.6 6.3 17.9 1.1 7.7 4.0 102.954 113.4 3.9 118.6 0.7 11.853.0 -11.900 44.8 21.P.8 6.2 63. DeNA and Gree are based on J.8 -3.4 13.5 26.900 1.2 2.5 7.4 1.0 0.1 Rakuten 4755 JPY 893.8 6.1 1.kamide@jpmorgan.3 11.7 7.5 12.4 12.6 9.3 14.6 8.9 0.2 Gree 3632 JPY 243.4 5.4 0.4 16.4 24.8 2.8 1.500 9.1 -40.8 14.3 441.7 1.5 6.9 2.7 94.0 3.8 44.6 1.7 26.1 10.9 0.2 4.7 20.8 15.9 -22.8 1.1 8.P.8 14.8 2.950 33.5 1.0 0.6 9.8 6.3 31.0 11.6 13.2 6.3 23.0 11.2 -7.8 32.3 2.5 0.8 6.1 2.0 13.5 13.8 1.7 5.9 - F’10E F’11E F’12E F’10E F’11E F’12E F’10E F’11E F’12E F’10E F’11E F’12E F’09A 1 month 3 month 6 month 1 year Efficiency of capital ROE (%) ROA (%) ROCE (%) F’10E F’10E F’10E 26.4 1.9 29.5 9.4 4.3 474.7 1. Share prices as of December 29.3 5.6 6.0 6. yield EV/EBITDA EV/sales P/B Price movt.5 0.5 7.6 4.1 -0.1 0.8 2.0 7.7 3.1 CYBER AGENT 4751 JPY 115.4 2.5 38.8 0.1 0.1 9.1 4.6 1.7 DeNA 2432 JPY 420.9 23.7 13.1 19.0 4.2 16.7 2.9 31.4 7.7 12.7 0.2 Weighted avg.

which is a middleman between portals and advertisers. We believe Daum is currently oversold due to overblown concerns on the Overture impact as well as its small market cap. its view has changed to a more positive one recently based on interaction with resellers. we believe Daum’s growth momentum has more legs. despite the fact that it has a better growth outlook and its revenue consists of only search and display ad compared to NHN which generates about 30% of revenue from the lower multiple business of internet gaming. Daum is currently trading at a deep discount to market leader NHN. while it has been raising pricing for both search and display ad more aggressively than NHN on the back of a big pricing gap. Daum currently targets to increase its search market share to 30% by 2012 from the current 22%. This means overall pricing pressure may turn out to be substantially smaller than previous guidance suggested. Given basic traffic volume that amounts to over 70% of NHN’s. to internalize the intermediary platform business. Divergent Growth Momentum Daum has been gaining market share in both search and display from 2008 based on improved service quality and renewed focus on core businesses. CFA (82-2) 758-5719 sungmin. Daum faces potential losses in advertiser pool.com Global Equity Research 03 January 2011 Korea Korea Sector Summary We recommend investors switch from NHN to Daum for internet exposure based on Daum’s superior growth outlook and valuation merit. Search Ad Revenue Growth 110 90 70 50 30 10 (10) 1Q 06 2Q 06 3Q 06 4Q 06 1Q 07 2Q 07 3Q 07 4Q 07 1Q 08 3Q 08 2Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 NHN Daum % Display Ad Revenue Growth 120 100 80 60 40 20 0 (20) 3Q10 2Q10 1Q10 4Q09 3Q09 2Q09 1Q09 4Q08 3Q08 2Q08 1Q08 4Q07 3Q07 2Q07 1Q07 4Q06 3Q06 2Q06 1Q06 NHN Daum % Source: Company data.chang@jpmorgan. While Daum was guiding for a maximum 20% decline in pricing over the next two years. Such defection is seen as a threat. in which case there is room for positive earnings revisions from the Street over the next few months. As Overture concerns fade and Daum continues to generate superior earnings over the next few quarters. we believe the valuation discount will disappear and this will drive continued outperformance for Daum. Source: Company data. Overture Impact As NHN defects Overture. as it will likely lower clearing prices at Overture.Sungmin Chang. 219 . As a result.

com Global Equity Research 03 January 2011 Positive Mobile vs. CFA (82-2) 758-5719 sungmin. Mobile service. this should create additional demand for Internet portals down the road. however. the recent surge in popularity of SNS services such as Facebook and Twitter are negative developments for NHN and Daum in that they could lure away traffic in the longer term.Sungmin Chang. In this space. 220 . As consumers increasingly access web on the move. .chang@jpmorgan. For now. Daum is also leading NHN for now on the back of earlier investments in mobile content. on the other hand. As such. provides new growth momentum. as smartphone penetration is headed for over 30% in 2011E. Negative SNS Impact in 2011 The internet sector is a very dynamic space where consumer preferences can change on a whiff. we think the impact is limited due to a relatively small user base for these new services but the longer-term impact will depend on how NHN and Daum can protect their traffic base by offering their own SNS services to satisfy consumer needs.

the US (240M).P.3M users – 7th largest globally after China (420M). Morgan estimates.4 60 40 20 0 Germany 53. India (81M).9 31.com Global Equity Research 03 January 2011 Russia Russia Internet Industry Summary With over 53.5M) on the back of expected increases in PC. 221 . Brazil (76M) and Germany (64.gogolev@jpmorgan.6 20. We project that the Russian online advertising industry will expand at c29% CAGR during 2010-13 to reach $1. While the internet penetration in Russia has already reached relatively high levels – 37.1 28. . as when we consider the potential addressable market share. with 53. J. especially in the lower-income regions of Russia.4M).3M internet users at the end of 2009. Russia Is the Second-Largest Market in Europe by Users. The Russian IVAS market is expected to grow at an even faster pace – 33% CAGR during 2010-13E to reach $1. by 2013.65B. Social networking is by far the main driver of online engagement in Russia. .75B.6 out of 15 hours per visitor per month in social networks.9 10. expansion of private consumption and internet advertising budgets. We expect that internet penetration in Russia is likely to increase to c47% in 2012 (66.8% at the end of 2009 – we still believe that growth prospects for Russian internet companies remain high. reaching a total of over 68M users. 1Q’10 M internet users 80 64.3 51. We estimate that.7 Russia UK France Italy Spain Poland Ukraine Source: Internetworldstats. the Russian internet audience may surpass the German market. we should take into account not only the Russian population but also Russian speakers in the former Soviet Union and Russian communities in other countries across the globe. Russia is the second-largest internet market in Europe. We estimate that at the end of 2009 Russia had the second-largest internet audience in Europe.5 36.Alexei Gogolev (7-495) 967-1029 alexei. ITU. on the back of increasing purchasing power of the Russian population and mainly driven by social games and other paid services segments. as the average Russian spends 6. broadband reach and lack of entertainment. driven by Russian GDP growth. Russian Online Market Overview Russia – 2nd-largest European market by user . Japan (99M). The overall target audience of Russian-speaking potential internet users exceeds 250M.

Despite the relatively large size of the Russian internet market. 58% in Poland.P. ITU. . ITU. but still underpenetrated. . both in Europe and in Asia: we estimate internet penetration at roughly 37% in Russia vs. 20% 0% Internet Penetration as Percentage of Population (1Q’10) 100% 80% 60% 40% 20% 0% UK South Korea Source: Internetworldstats.P.Alexei Gogolev (7-495) 967-1029 alexei. J. This is explained by higher-thanaverage disposable incomes in those parts of the country. we believe it remains underpenetrated when compared to other markets. J. Morgan estimates. FOM. 64% 51% 33% 30% 35% 38% 32% 33% Central (ex North-West Southern Moscow ) Volga Urals Siberia Far-East 222 . Internet penetration of some parts of Russia (such as the city of Moscow or the North-West region) is significantly higher than the country average.com Global Equity Research 03 January 2011 Number of Internet Users in Russia vs.gogolev@jpmorgan. mn Internet penetration as % of population 100% 80% 60% 40% 25 0 2006 2007 2008 2009 2010E 2011E 2012E 2013E Source: J’Son & Partners (September 2010). 79% in Germany. Penetration lhs: M users. 83% 81% 79% 78% 78% 77% 69% 58% 45% 43% 38% 37% 32% 7% Germany Japan Canada US France Poland Turkey Iran Brazil Russia China India . Morgan estimates. which stimulate faster infrastructure development. Internet Penetration in the Federal Russian Districts (2H09) % 80% 60% 40% 20% 0% Moscow Source: GroupM. Internet penetration varies widely across Russian regions. 45% in Turkey and 38% in Brazil. rhs: % penetration 100 75 50 Number of internet users.

7 10.8 hours in July 2010 on social networking websites. FOM.307 pages per month in May 2009.5. Average Hours per Visitor per month 3.Alexei Gogolev (7-495) 967-1029 alexei. Internet Penetration by Age Group 18-24 25-34 35-44 45-54 55+ Source: GroupM.220 649 587 968 919 487 793 477 473 223 . Iks-consulting. with visitors spending an average of 10. roughly $3.0 pp 3.6 hours and viewing 1. by Region Moscow Central (without Moscow) North-West South Volga Urals Siberian Far East Source: GroupM. average price for connection 1000mbit/s (RuR) 106 489 584 896 320 321 546 1465 average price for connection 1000mbit/s ($) 3.2 48.3 5.5 29. Social Network Engagement Comparison by Country Country Worldwide Russia Brazil Canada Puerto Rico Spain Finland United Kingdom Germany United States Colombia Source: comScore (July 2009). This partially explains the growing popularity of mobile internet in the Russian regions as it becomes often cheaper than fixed line connection.9 10. Russia has the most engaged social networking audience in the world.7 18. However.6 5.5 16.307 1.com Global Equity Research 03 January 2011 We may see a considerable variation by internet connection price in different regions.0 pp 10. 2007 61% 44% 33% 16% 4% 2009 73% 58% 48% 26% 7% growth 12.3 19.0 pp 15.gogolev@jpmorgan.3 4.1 Average Pages per Visitor per month 525 1.0 pp 14.3 5.0 pp Russians are 50% more engaged in social networking than Germans. with visitors spending an average of 6.6 4.6 6. while in the Far-East Federal District of Russia this rises to $49. Price per Connection and Number of Web Domain Comparisons.5 4. FOM. Moscow has the cheapest average cost per connection. we believe.8 number of web domains per 1000 users 193 43 23 22 20 33 25 17 Age groups younger than 24 years of age already have the highest internet penetration in Russia (roughly 73% in 2009).7 4.2 4. User engagement of the social networking audience in Russia has increased since then. we note that the fastestgrowing segment of internet users has so far been the 35-44 segment and that this segment is likely to drive growth of penetration in the near future.7 6.

154 50 Y/Y 50.128 40 Jun-10 23 3. which is driving engagement (amounted to 25% in 1Q’10 on the daily basis vs. on average 50% 40% 30% 20% 10% 0% less then 1 e-mail 1-3 e-mails 4-10 e-mails 11-20 emails 21-50 emails more then 50 no answ er e-mails Source: MASMI. We also highlight that the gap between daily and monthly reach is diminishing. Most internet users go online for more than three hours a day and send up to three emails during that time.6 0 Russia US Global Av erage Source: MASMI. We believe that further growth of internet engagement in Russia will be driven by a number of cultural factors.0% 48. Source: comScore. including a high level of education (28% of employed Russians have a higher education degree). FOM. 10% in 1Q’07). Internet users in Russia are increasingly more active online.2% 25. FOM. Jun-09 15 2. Engagement % 40% 30% 20% 10% 10% 0% 1Q10 1Q08 1Q09 1Q10 Daily users. % Source: comScore (June 2010). July 2010. willingness to embrace technology as indicated by the level of PC penetration (39% of households in 2009).8M users in 2008) but also by the rising time spent by Russian users online. 224 . lack of entertainment and harsh climate conditions (stimulating indoor entertainment). % Monthly users. We highlight that growth of usage in Russia has been driven not only by a rising number of total internet users in Russia (53. Internet Usage in Russia Average hours per Internet user per month Average page views per Internet user per month Ratio of daily internet users to monthly users.8 8 4.3M users in 2009 vs.gogolev@jpmorgan.com Global Equity Research 03 January 2011 Engagement is growing.Alexei Gogolev (7-495) 967-1029 alexei.1% Frequency of internet use. % 31% 26% 22% 18% 14% 4 Time spent on social network hours per month 37% 25% 12 10. measured among daily internet users 40% 30% 20% 10% 0% less then 1 hour 1-2 hours 3-4 hours 4-6 hours more than 6 hours no answ er Daily Number of Emails %. Source: MASMI. FOM. mainly driven by social networking phenomenon. Reasons for further engagement growth. 44.7 4. Daily Time Spent on the internet (2009) %.

We estimate that.9 277.0 274.9% 31.0% 5.35% 36.9 5. while all other segments of the advertising industry declined by 18-43%. In 2010. We expect internet market breakdown between contextual (search) and display to remain unchanged for the next three years at a c40/60 split respectively.4 6. On our estimates.3 38% 827 20. $ M Net Internet. Although payment infrastructure is underdeveloped.855 142 13.3 5.6 16% 181. When looking at Russian internet market revenues. J.0% 31.6 -12% 600 15. expanding at a 2010E-13E CAGR of 29.1% Source: RACA.2% 29.0% 31. such as Qiwi. IVAS and Advertising Market Forecasts Nominal GDP ($ B) Population (M) GDP per capita ($) GDP deflator.0 361. 225 .034 464 570 2012E 1.724 0.35% 41.Alexei Gogolev (7-495) 967-1029 alexei.697 2.878 6.3 18.7 7.4% 15. both of those subsegments will be growing at roughly a similar pace – CAGR 29-30% during 2010E-13E.4 18% 199.0% 31. that show traction on revenue growth.089 142 14. Morgan estimates. we consider two key segments: online advertising and internet value-added services (IVAS) revenues. GroupM.753 45. Search/display breakdown to remain stable.070 27.739 18. 39% of revenues come from display and the rest from contextual.171 0.652 637 1015 CAGR 10E-13E 12.7 204.0% 15. We believe that internet advertising in Russia will be the fastest-growing segment of the advertising industry.0% 5.6 29% 1.472 142 10. IVAS segment to grow ahead of the internet industry.5 13% 686.232 140 8.408 8. $ M growth Y/Y Gross Internet.6 15% 238.699 0. Share of net internet revenues to reach 19% by 2013E.000 0. we note that there are solutions for online payments.4% 32.36% 47.0 315.3 29% 1.122 38% 42% 58% 153 134. RUB B* Net total advertising.0% 5.3% -7.7 27% 1. $ Net Internet share* Net Internet.095 27% 37% 63% 1.P.5 17% 1149. we expect those segments to grow ahead of the industry: the Russian internet valueadded services market is projected to grow at 32% CAGR for the 2010E-13E period. The two key subsegments of the IVAS market are MMO games and Community IVAS (social games and other paid services.0% 30.48% 56. Russian Macro. we expect each of those segments to contribute $670700 M. average Gross Total advertising market.3 19% 1454.5% 5. average Real GDP growth RUB/$.). * Not accounting for VAT and client discounts.37% 54.3 15% 888. display and contextual (search). (RUB B) growth Y/Y Net total advertising.9% in 2013E.4 237.8 15% 208.847 0.4% 21.35% 30. $ M 2008 1. partially due to a lack of reliable online payment systems but also due to lack of software. $ M Advertising spending (net)/GDP (%) Net Ad spend per capita. Russian internet advertising was the only segment that showed positive growth in 2009.9 4.347 562 786 2013E 2.636 29% 37% 63% 1.6 42% 708 14. as we do not expect a major shift by advertisers toward performance-based advertising forms. $ M MMO Games market.com Global Equity Research 03 January 2011 Russian Internet Revenue Breakdown Summary of online segment dynamics.537 32% 38% 62% 1.0% 14. On our estimates MMO games will expand at CAGR of 21% during 2010E13E.285 0.3% in 2010E to 18.4% in LC and increasing as a share of total net advertising from 13.828 32% 39% 61% 712 358 354 2011E 1.6 12% 498.6% 24. such as virtual gifts.5 2009 1. RUB M growth Y/Y Share of Display in total Share of Contextual in total Russian IVAS market.6% 5.1% 42.385 35.0 -26% 135.0 8.8 17% 156.4 7% 567. of the two subsegments of online advertising.782 6. etc. While online commerce remains undeveloped in Russia and still only a fraction of internet revenues.666 142 11. $ M Community IVAS market.gogolev@jpmorgan.178 6.662 142 11.809 12% 41% 59% 364 223 140 2010E 1. while Community IVAS will grow at 42% CAGR for the same period.

47% in Zynga and 5. including Mail. 1.000 17.ru Group s the largest site in the Russian internet space.5 15.7 25. Since the advent of the Russian internet. Yandex.com Global Equity Research 03 January 2011 Key Industry Players Having analyzed the traffic data. offering instant messaging. ICQ and Headhunter. Yandex is the leader in the Russian language search market.000 14.9 12.000 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Mail main Source: TNS. Yandex at the end of 2009 was the 7th-largest search property worldwide. In addition. *Mail. price comparison.Ru sites. VK.ru.ru as of Aug 2010). While Yandex’s website. maps.5 Source: TNS (October 2010).4% search engine traffic generated in Russia (LiveInternet.000 16.Alexei Gogolev (7-495) 967-1029 alexei. User Dynamics of Three Largest Russian Social Networks userM 22. the company has evolved from a simple web mailbox to an integrated communication and entertainment platform. OK. Yandex also provides a broad spectrum of other web services. Rambler.5 16. Today. including email. social networking services.000 19. engaging almost 70% of total Russian monthly unique users.ru Group data are net of duplications.6 16. Major shareholders include Baring Vostok Capital Partners.” was first launched in 1997 and the company was incorporated only in 2000.ru Group* VK Rambler RBC October 2009 21. Yandex is Russia’s leader in internet search and contextual advertising. and social networking. news. photo hosting.000 18. Source: TNS Yandex. with 1.1 18.000 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Vkontakte My World Odnoklassniki User Dynamics of Two Largest Russian Portals userM Yandex main 23.000 20.ru Group combines 30 projects. Google and RBC.13% in Groupon) that could provide balance sheet upside going forward. According to comScore. Tiger Global Management as well as the founders and management.gogolev@jpmorgan. Mail.5% stake in Russia’s largest social network and a 25% stake in payments business) and abroad (2.38% in Facebook. Mail. the technology development was launched in 1989. online payments.ru Group.9B searches.9 21. 226 . “yandex. with more than 80% of Yandex revenues coming from contextual advertising.000 21. we would highlight six top internet companies in the Russian internet space: Mail. multiplayer/casual games and other paid services.2 October 2010 26.9 20.000 12. the group has attractive portfolio investments in Russia (owns a 32. With 64. Top Five Russian Internet Companies (by monthly unique Russian visitors) M visitors Yandex Mail.

Ozon is Russia’s most popular internet shop operating in the Russian market (network covers 80% of Russian population) with over 600K of assorted goods (revenue breakdown: 30% books/CDs. printed media and information-services segments. VK was the first online social networking site in Russia to develop a contextual advertising system that allows users and advertisers to target advertisements to other users selectively based on information in user profiles. We believe strategically it would make sense for Mail. providing services to over 180K point-of-sale (POS) terminals (only owns a small number of terminals for replacement of terminals at agents).ru Group to either increase its stake to a controlling one or to fully consolidate the asset. eCommerce referral and product placement. Based on TNS Gallup data.ru. QIWI. in which Onexim is a blocking shareholder. Back in June 2010. The company generates revenues from advertising (banner ads. m. Mail.gogolev@jpmorgan. Mail. VK attracts a younger audience than Mail. Being an almost-pure software company. Ozon. The company also holds a 51% stake in contextual advertising business Begun.09% stake in the company in July 2007. It was delisted from the London Stock Exchange (AIM) in 2009 and is currently 100% owned by ProfMedia Group. In 2009 Ozon had roughly $100M of turnover. Petersburg. compared to 27% and 32% for OK and My World. Rambler is an internet search engine that was developed in 1996.5% is owned by Polyus Gold.8 cards per inhabitant). etc. Qiwi enjoys strong revenue growth without significant investments.5B). The company is the largest consumer payment processor in Russia.ru Group acquired a 25. – and will have enough capacity for the next 3 years. The popularity of POS cash collection points (used to pay bills. Ozon has 3. The website is the 6th most popular globally in terms of monthly page views (72.Alexei Gogolev (7-495) 967-1029 alexei.5B) and monthly minutes spent (25. of which c52% came from Moscow and 15. One key advantage enjoyed by Ozon is that it has its own courier company – distribution is very important in Russia.99% stake in the company back in 2007 (recently increased the stake to 32.8 M monthly unique visitors in Russia on average in 2Q’10. Founded in 2005. the blocking ownership stake makes sense as those systems will be the key channel for people inserting money into the system. interests.ru’s Odnasklasniki (OK) and My World websites.5M daily unique visitors.5%).5M registered visitors and 400K active customers. 30% small electronics – one of the largest retailers in Russia). geographies and education. bought a 51% stake in RBC for $80M.000 sq. Russia’s Onexim Group. RBC Group is a Russian media company (established in 1993) operating in the internet. 42% of VK’s user base as of July 2010 was in the under-25 age group.) is explained by consumers lacking credit/debt cards in Russia (payment card penetration is still only 0. the social network has become the #1 Russian language website and #1 social networking site (SNS).6% from St. while another 11. Founded in 1998 as one of the first eCommerce projects in the business-toconsumer (B2C) segment. owned by businessman Mikhail Prokhorov.com Global Equity Research 03 January 2011 VKontakte. TV.ru Group acquired a 24. the post is 227 . with over 70M registered users and 10. Strategically. The company competes both in the online advertising market and in instant messaging (QIP – 3rd largest instant messaging service in Russia. sponsored key word searches). the company had c13. respectively. The company has its own warehouse – 12. including gender. VK was also the first online social networking site in Russia to open an application programming interface (API) to third-party developers. The company expects 40-50% revenue growth in 2010. context ads.

35% of GDP in 2009 and is projected to grow to 0. but we expect growth to resume in 2010 (up 15. The listings are free of charge as the company is building up the brand in Russia. RUB bn grow th y oy 60% 40% 200 20% 0% -20% 100 0 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E -40% Source: RACA. rhs: % growth 300 Net adv ertising market. Morgan estimates. Avito.) has begun in 2010 and is expected to ramp up significantly during 2011. Russian Net Advertising Market lhs: RUB B.P. Founded in 2007.com Global Equity Research 03 January 2011 unreliable (only 10% of Ozon purchases are shipped via Russian post – to places that are difficult to reach otherwise). Consistent with J. etc. the company in the fall of 2010 began expanding to other Russian regions (targeting operations in 10+ large cities). Avito. driven by a growing share of ad spend as a percentage of GDP (net ad spend in Russia amounted to 0. GroupM. We highlight that. The Russian net advertising market saw a drop of 32% in 2009 in LC. 3M users at the end of 2009) and over 2M new listings per month.ru.Alexei Gogolev (7-495) 967-1029 alexei. as the Russian economy recovers. Russian Advertising Market Investments into Russian advertising dried up in 2009 due to falling consumer spending. we focus on revenues net of discounts (which have risen as high as 35% in favorable economic conditions).5%) and the net ad market to reach RUB226B by year-end 2013E. advertising in online advertising continued to expand. led by paid search.ru is currently Russia’s largest and fastest-growing online classified (consumer-to-consumer) trading business. instead of gross advertising. we project that the Russian net advertising market will grow 15% in RUB terms for the same period. with c11M unique visitors (vs. 228 . AdSense. however. Petersburg.37% by 2013). Leboncoin in France and Blocket in Sweden are its closest global peers with similar business models.P. Morgan’s Russian nominal GDP forecasts of 14% CAGR for the period 2009-13E. Craigslist in the US. J.ru’s successful operations in Moscow and St. Following Avito. but the monetization process (premium services.gogolev@jpmorgan. display.

Notably.3% 32.1% 2012E 55. We expect the share of internet advertising to grow. We expect support for online advertising mainly to come from growing broadband penetration and the redistribution of advertising budgets in favor of the cheaper internet. Prospects for broadband development in Russia are relatively attractive. despite relatively low penetration.0% In value terms.P. are both involved in FTTB rollout. with a growing number of users and improvements in infrastructure.7% 35. This is positive for usage/time spent on line.75B vs.1% 10. 2009 55. Forrester. 69% in the U. 9% in 2009). We thus believe that.).4% during 2010E-13E. Forrester. Over the next three years we believe the share of TV ad market will remain broadly flat.3B ($1.6% 2011E 55. while the share of gross internet revenues will expand to c14% (vs. As the economy matures and disposable incomes rise. it looks like Russia is shaping up as an attractive internet market. with consumer discretionary sectors such as finance.1% 13.Alexei Gogolev (7-495) 967-1029 alexei.7% 15. J’son & Partners. Share of Online Advertising in Total Gross Ad Revenues 2009. the top 2 mobile operators.6% 2013E 55. Despite its relatively low cost. c$600M in 2009).3% 34. J’son & Partners. Source: Screen Digest. growing mainly at the expense of press and radio segments of the industry.S. 2009 80% 60% 66% 69% 20% 9% 16% 14% 40% 20% 0% 24% 30% 10% 0% Russia China US UK China Russia UK US Source: Screen Digest. Compared to other countries. consumer discretionary sectors should increase their advertising budgets and explore new marketing channels. Euromonitor. TV advertising remains brand/image advertising by nature. 16% in China and 14% in the U.S.3% 29. in % terms 30% 27% Broadband Penetration Comparisons as % of households.3% 31. Zenith Optimedia. insurance and retail strongly under-represented. 229 . reaching RUB54. the internet market is expected to grow at CAGR of 29.6% 12. Even today we see that Russians can be considered heavy Internet users. including the internet. given the economics of FTTB/DOCSIS roll out (cheap compared to Western Europe). Morgan estimates.gogolev@jpmorgan. This is partially explained by a relatively low level of broadband penetration (30% in Russia vs. most TV advertising revenues in Russia are still derived from consumer staple sectors such as food and household products. Euromonitor.com Global Equity Research 03 January 2011 Russian Online Advertising Industry Share of online advertising relatively low.0% 9. Zenith Optimedia.3% 2010E 55. so VIP/MTS. the share of gross online advertising (does not account for discounts) in the total ad market is still relatively low in Russia: only 9% vs. in our view. internet advertising does not yet serve as a substitute for television advertising due to the relatively small audience size. Gross Ad Market Breakdown by Types % TV Other Internet Source: J.

408 29% 336 26% 38% 2012E 516 28% 13.414 6% 202 -17% 41% 2010E 321 32% 8. % Internet Growth. However.P.ru doesn’t have a single advertiser responsible for more than 5% of its display revenues. Radio Internet New spapers Magazines We expect the display ad segment to expand at a CAGR of 39% during 2010E-13E. we believe internet will soon begin offering low CPT. J.935 29% 2013E 199. should lead to the rapid development of the display ad industry.368 -41% 19. Online Display Advertising Attractive CPT.gogolev@jpmorgan. % 2009 113.654 15% 98.241 10% 42. Television is still the cheapest advertising medium in Russia on the basis of cost per thousand (CPT) – a commonly used measure to calculate the relative cost of an advertising campaign – as it offers the largest audience and greatest reach. investing $9. Most of the car advertisers doubled or even tripled their online display budgets during 2009.178 32% 2012E 174. which together with the growing online population that already exceeds that of some TV channels and flexible targeting and measurement capabilities. 230 .492 16% 81.094 32% 2011E 151. Mail. In 2009. telecom and FMCG) account for 64% of total display spend.806 27% 542 27% 37% CAGR 09-13E 38.584 10% 33. Display Advertising Revenues Gross Display advertising ($ M) growth Y/Y Net Display advertising (RUB M) growth Y/Y Net Display advertising ($ M) growth Y/Y Share of Display in total online advertising revenues Source: GroupM.Alexei Gogolev (7-495) 967-1029 alexei.7% 29. unless stated otherwise RUB M TV Growth. % Other Growth.P.332 27% CAGR 10E-13E 15.9% 38. while finance showed the highest decrease Y/Y due to the economic downturn in Russia.193 14% 25.com Global Equity Research 03 January 2011 Gross Ad Market by Types (RUB M) RUB M. 2009 244 -18% 6.095 26% 267 32% 39% 2011E 405 26% 10.979 15% 107.4% Source: Video International.2M for Megafon and $6.8% 37.9% Three leading categories (auto. Cost per Thousand in Russia in 2009: Relative Costs of Different Media USD 6 4 2 0 TV Source: CTC Media. Morgan estimates.026 8% 2010E 131.278 28% 428 28% 37% 2013E 653 27% 16.315 9% 54.873 16% 89. Morgan estimates. AKAR: Zenith Optimedia. comparable to TV’s.0% 9. Mobile TeleSystems was the biggest online spender.1M for Vimpelcom (source: consulting agency GroupM). J.655 -18% 71.7M compared to $7.

1% 20. auto 28% Top 10 Advertisers in Display Ad Market ($ ’000. 3) continued reallocation of budgets away from traditional (more expensive) advertising. preferring to focus on growing its own search engine. overtaking the share of display advertising. The share of contextual advertising in the Russian online market grew from 36% in 2004 to 59% in 2009.8% 9. 231 . this share will likely stabilize.gogolev@jpmorgan. according to Group M estimates.6% 7.3% 21. Going forward. 2) the growing number of small businesses that use mostly contextual rather than display advertising.1% 2. However. net) MTS Renault-Nissan Megafon Beeline PSA Peugeot Citroen Volkswagen Audi Group Toyota Motor Co. 2008 5950 4795 5790 4960 2315 1355 2085 3805 1985 3470 2009 9755 7275 7210 6120 5620 5355 4995 4630 4530 3970 Share in total Media budget of the brand in 2009 (%) 11.1% 12. contextual advertising continued to expand (up 17% in 2009). that the primary focus of Mail. (Ford only) Source: MindShare Interaction.Alexei Gogolev (7-495) 967-1029 alexei.1% 17. and we expect net contextual ad segment revenues to expand at a CAGR of 32. Over the past decade.9% Y/Y growth % 64% 52% 25% 23% 143% 295% 140% 22% 128% 14% Contextual Advertising Engine of growth. We note. Contextual advertising covers consumers’ immediate demands and provides higher measurability and cost-efficient transparent status.8% 13. During the crisis. contextual advertising has shown rapid growth levels and has been considered the financial engine of internet advertising.com Global Equity Research 03 January 2011 Most Active Categories in Internet Display (2009) other 14% IT 4% entertainment &media 6% retail 6% finance 6% telecom 18% FMCG 18% Source: GroupM. we expect continued transformation of search advertising toward more content-focused ads.8% 10.5% during 2009-13E on the back of: 1) online penetration growth resulting in an increasing number of search visitors and queries.ru Group is display advertising and that it does not plan to invest in contextual advertising agencies. Samsung Procter & Gamble Ford Motor Co. however.

4% Rambler 6. dominates search in all major internet markets. Mail.ru 9.084 63% CAGR 09-13E 32. Rambler. Search Engine Traffic Generation in Russia.359 31% 26. with its continued innovations. the number of portal page views reached 10. CNews.com Global Equity Research 03 January 2011 Contextual Advertising revenues Net Contextual advertising $ M growth Y/Y Gross Contextual advertising $ M Net Contextual advertising RUB M growth Y/Y Gross Contextual advertising RUB M Share of Contextual in total Source: AKAR. This contract is expected to be reviewed in January 2011.938 63% 2013E 913 27% 1.ru. However. 2009 296 -8% 356 9. having increased its search share from 56.4% in January 2009 to 64. lost market share.ru Group may continue with Google or switch to Yandex.099 28. Google receives a fee from the advertiser and shares a portion of that revenue with Mail.395 17% 11. China (led by home-grown player Baidu). local search engines globally have been able to defend their market share due to language and cultural barriers.gogolev@jpmorgan. including Google. In June 2010.6% in June 2010 (source: Liveinternet.288 59% 2010E 411 39% 495 12. Other 4% 232 . We highlight that during the period all major Yandex competitors. modern machine-learning techniques reduce language barriers quite dramatically. Jan 2009 % of Russian users coming to Russian sites via search Google 23. Mail. Morgan estimates.ru 7% Rambler 2% Yandex 65% Source: Livejurnal. the company generates revenue from its internally developed search engine services through context advertising furnished through Google’s AdWords technology. From the beginning of 2010.P.Alexei Gogolev (7-495) 967-1029 alexei.ru. The only exceptions are Russia (dominated by local player Yandex).733 36% 15.1% Search Engine Traffic Generation in Russia.5% 32. ZenithOptimedia.ru Group. J. the Yandex search engine has maintained its leading position in the Russian internet (Runet). RBC.ru Group has offered search services using internally developed search engine technology.1% Other 5. We think Yandex’s competitive strength lies in the area of technology and superiority in understanding of local culture and local user needs.ru). demonstrating growth of over 80% compared to June 2009. Over the past 18 months. This technology displays relevant ads using an auction-based program from Google in which advertisers bid to have their sponsored advertisements appear when specified search queries are entered.290 27% 34. Japan and South Korea.638 62% 2012E 721 31% 869 22. The monthly number of search result pages increased 50% Y/Y and was 220M pages as of June 2010.130 35% 20.7% 31. However. and Google.3% Source: Livejurnal.6% 31.8% Search Market In the past. Sept 2010 % of Russian users coming to Russian sites via search Google 22% Mail. When a customer clicks on a sponsored advertisement.2% Yandex 56.7B pages.341 61% 2011E 553 35% 666 17. when Mail.

0% 18-24 35. 12-17 20. Sociodemographic Categories of Online Game Users (2009) Game type ММО games Casual Social Network games Source: J’son & Partners.Alexei Gogolev (7-495) 967-1029 alexei.0% 48.6% Gender structure.0% 7.2% were playing MMO games.0% 26.4M users in 2009 vs.0% 62.0% 52.0% 40. 1.ru Rambler Other Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Russian Online Games Industry The average number of internet users reached almost 49M in 2009. MMO games typically have a free-to-play revenue model. both men and women in the highest age group (25-34) are equally engaged in the social network games.com Global Equity Research 03 January 2011 While Google has made a significant push to move more aggressively and has created its own Russian language ad agency. The highest share of MMO gamers are men in the 18-24 age group.0% 14. it was not able to retain its search engine traffic generation share.0% 70.7% were engaged in casual games and 17. % 25-34 29. Yandex Google Mail. % Women Men 38. of which 4. while the highest share of casual gamers are women in the 35-44 age group.0% 15.0% 19. or Browser games accessible via any internet browser.gogolev@jpmorgan.0% 5.0% 30. 233 . 2. however. but users can purchase in-game enhancements.1% >45 6. and the user base is dominated mostly by the so-called “hard-core” gamers (experienced and committed users).7% involved in social network games. MMO games are broken down by Client games installed on the users’ PCs. typically by short messaging service (SMS) or via online payment systems.5% 35-44 10. more than double the levels seen in China). the market is relatively young in Russia.0% 10.0% MMO Games Market The popularity of MMO games in Russia is growing quite rapidly (up to 3.8% Age categories.0% 32. in which basic game play is free of charge. Growth Rate in the Number of Queries of Key Russian Players Number of transitions to web-sites based on counters 50 40 30 20 10 0 Mar-08 Source: Liveinternet.0% 30.5M in 2008). which explains the high level of ARPU in Russia (c$38/month.

020 20.514 23. 2008 1.202 18.1% 47.4% 21. $ M Browser game revenue.623 31.8% 32.gogolev@jpmorgan.353 24.2 81 54 135 2009 2 1.5 1.3% 18.091 21.276 24.0% 1H09 17.197 27.6 31. with c10%.7% 2H09 17.1% 65.223 18. MMO Games Market in Russia Client games users.121 22. Having acquired Astrum Online. so far only Blizzard had a significant presence in Russia.4 210 140 350 Highly competitive market.686 23.4 28.ru Group managed to secure leading positions in the Russian MMO games market.915 25.com Global Equity Research 03 January 2011 MMO Paying Users at Mail. M Browser games users.553 25.729 18.8% 2Q10 19. community games (may cost up to $15M) and take longer to develop (up to 3 years). MMO Games Market Participants (2009) Mail.853 22.ru users Legend share of total active UU Allods Online share of total active UU Perfect World share of total active UU Source: Company data. Mail.5% 38.5% 2009 17.753 26. remains highly fragmented. The development of a new MMO title can cost as much as $10 million or more for a highly rated game that can compete globally. with c50% of the market taken up by a large number of small domestic players.6% 52. for example.9% MMO games usually have a long life cycle but are relatively more expensive to develop than.4% 1H10 18.819 19.Alexei Gogolev (7-495) 967-1029 alexei. Of the international players.3% 3Q09 17.038 25. Russia’s largest online gaming business.826 26. We note the market.2% 57.585 17.659 24.4% 2Q09 17.7% 31.791 20.2% 16.1% 4Q09 18.0% 1Q10 16. M Share of paying players among MMO game players Monthly ARPU Client games revenue.3% 44. $ M Source: J’Son & Partners (Sept 2010). $ M Total MMO market. however.225 19. 234 . in 2009.ru 29% Other 51% Blizzard 10% Innov a Group 10% Source: J’son & Partners.6% 42.5 1 19.4 134 89 223 2010E 2.7% 63.2% 68.2% 37.560 31.2% 19.7% 31. 1Q09 18.

Some of the most popular paid services enable users to limit the information shared about their profile. as in many CIS countries. In Russia. In Russia. M Share of paying social game players. $ M Social games revenues. The terminals may also be used for topping up mobile phones and making utility payments and money transfers. Social games are typically less expensive and faster to develop ($100-500K) than MMO games but also have a much lower ARPU (c$3).000 eCommerce Over the past year two years we have seen an increase of cards used for retail purchases of goods and services in Russia. $ M Source: J’Son & Partners (Sept 2010). the lack of card infrastructure is substituted by various electronic money solutions. The top three operators of payment terminals in Russia combined had over 600. with the lack of availability of payment methods affecting users’ willingness to pay for goods and services online. send virtual gifts to their friends and enhance their profile with additional graphical images.gogolev@jpmorgan. the share remains negligible compared to Europe’s and the US’s – only 3. $ Paid service revenues.8 77 28 2010E 37. % Share of paid services users.Alexei Gogolev (7-495) 967-1029 alexei. Social games target a broad audience and are easily accessible and engaging but are less likely to capture a user’s attention over longer periods of time. the majority of payments on social networks are still conducted through SMS.042 2Q10 168 1.ru MMO Games Community IVAS OK Source: Company data. This was the main reason for a slow development and lukewarm monetization of the IVAS industry in Russia.3 212 97 Monthly Paying Users '000 users Mail. Community IVAS Market in Russia Number of social network users. however.1 4. Another money solution is a network of payment terminals installed in convenient locations.010 957 1H10 167 965 1. Social games are linked within a social network environment and are usually less sophisticated games than MMO games that users may casually play without a strong commitment. 2008 22.8% of purchases made via cards in 2009.50% 2.60% 12% 3.5 n/a n/a n/a 0. The paid services market encompasses user payments for additional content and features on a social network.5 6 n/a 2009 31 6% 8.com Global Equity Research 03 January 2011 Community IVAS Community internet value-added services (IVAS) include social games as well as other paid services such as virtual gifts and avatars. % Monthly social games ARPU.9 2. 235 . $ Monthly paid service ARPU.5 7. 2008 29 232 1Q09 92 253 700 2Q09 101 245 696 1H09 96 249 698 3Q09 110 366 711 4Q09 145 635 868 2H09 127 501 790 2009 112 375 744 1Q10 167 919 1. including SMS-based billing systems.000 terminals and a turnover (total volume of payments processed) of approximately $15B in 2009.

16.4M UU.com Global Equity Research 03 January 2011 Instant Messaging (IM) Mail. had 5.000 per handset).gogolev@jpmorgan. This was partially due to the limited availability of 3G (has been introduced in many Russian cities throughout 2009 but was only launched in Moscow – the largest smartphone market – at the end of 2009). the main reason for limited use of mobile internet is a small share of smartphones (only about 6-7% by our estimates). we believe that this is likely to change once we see an inflow of affordable Korean and Chinese smartphones into the Russian market (expected in 2011).ru Agent and ICQ) is the leader in the Russian IM market – in December 2009 the company had c. Mobile Internet to Boost Usage The usage of cellphones to go online has not been widely used in Russia.ru Group with its two assets (Mail. However. while one of its closest competitors. We expect instant messaging to become more integrated in the social environment. enriching the consumer web experience through video applications and mobile devices.Alexei Gogolev (7-495) 967-1029 alexei. However. The reason for such a small number of smartphones in Russia is the lack of subsidies from mobile operators on the handset market (the cheapest iPhone 4 is worth more than $1. QIP. 236 .5M unique users (UU).

Company Outlooks .U.S.

Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Global Equity Research 03 January 2011 238 .

respectively.x.com Vasily Karasyov (1-212) 622-5401 vasily. Staples and others.0% Amazon. AMZN US Price: $183.t.com J. Through the first 9M’10.d.com Shelby Taffer (212) 622-6518 shelby.9% 3m 13. Morgan Securities LLC Price Performance 190 160 $ 130 100 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs 34. we expect tech and content to comprise ~4% of revenue in 2010. For example. including eBay (~11% of US market share). we believe Amazon’s strong free cash flow generation creates a large buyback opportunity.65 .  Structural margins should grow to the low double digits. Amazon currently holds ~14% of US eCommerce market share (on a gross revenue basis).35 Dec 455 199.45A 0.com (AMZN. we expect margin expansion to result from continued leverage in fulfillment and tech & content.karasyov@jpmorgan.x.78 0.com Bridget Weishaar (1-212) 622-5032 bridget. As Amazon builds out categories within EGM that go beyond electronics. we expect penetration to increase as broadband penetration improves and consumers grow more comfortable shopping online. Overweight AMZN. Additionally.433.93A 2.00 31 Dec 11 Source: Company data. we think margins can rise. and J. we estimate fulfillment is ~8% of revenue in 2010 compared to 12% in 2001. such as apparel and home furnishings.37 Price Target: $199. Target. US retail sales grew 7%. Therefore.45 0.  International eCommerce remains in a very early stage.32 0. We think the low need for investment.14 Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 183.  Amazon continues to gain market share.37 29 Dec 10 185.67 2012E 1. Additionally. Likewise. Note: The estimates above are GAAP estimates which include the impact of FAS123R. Bloomberg.Global Equity Research 03 January 2011 Amazon. Upside to Margins We are maintaining our Overweight rating on Amazon as we believe the company will see continued market share gains in the eCommerce market.AMZN US) 2009A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY 0.01 1.55A 2011E 0. We estimate Amazon will derive ~46% of F’10 revenue from its int’l business.P.74 0.com Further Market Share Gains Likely.P. coupled with long-term prospects for margin expansion. should allow Amazon stock to trade at attractive multiples through the medium-to-long term. Morgan estimates.polinsky@jpmorgan.a.00 Internet Imran Khan AC (1-212) 622-6693 imran. Though ecommerce represents an extremely small percentage of international retail. We think Amazon has benefited from the development of its third-party platform as well as from a broader secular shift toward multichannel selling. as a percentage of revenue. compared to 9% and 14% for Google and Yahoo!.taffer@jpmorgan.66A 0.03 2010E 0. . We expect capex at less than 3% of net revenue in F’10. down from 8% in 2001.03 1.com Lev Polinsky. CFA (1-212) 622-8343 lev. Electronics tend to carry very low gross margins (low teens) compared to Apparel (roughly 45%) and Home Furnishings (roughly 28%).105.99 5.weishaar@jpmorgan.4% 12m 30.51A 0. and we see more opportunity for the company to gain share from competitors.38 3.6% 1m 0.41 0.  Low capex drives strong FCF generation.85 2.11 1. US eCommerce grew 14% and Amazon North America retail revenue was up 46% Y/Y.khan@jpmorgan. we believe Amazon retains significant runway for revenue growth in the international markets.77 1.80 83. We also maintain our December 2011 price target of $199.

20B versus the eCommerce group at 14. we believe the stock has capacity to see further multiple expansion. $4.67 F’12E 56.23B.55 F’11E 44. Given the company’s rapid long-term revenue growth rate and superior industry position.397 4.293 2. and $5.Imran Khan (1-212) 622-6693 imran.P.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue.14.14 Source: Company reports and J.40B.904 3.4% 6. its peer group at 22%. Bloomberg. respectively.036 823 0. Investment Risks AMZN could underperform if it encounters difficulties in its international expansion. Key DCF Assumptions Equity beta Risk free rate (10yr yield) Risk premium Cost of Equity Cost of debt Final debt ratio Equity as a % Cap 1.0% Source: Company reports.khan@jpmorgan. Amazon may have difficulty growing revenues while maintaining its current operating margins.t.93 F’10E 34. EBITDA and EPS estimates of $44. we expect Amazon to grow EBITDA by 30% Y/Y in F’11 vs.20B and $3.04 2. Our F’12 estimates call for revenue. EBITDA and EPS of $56.202 3. Our price target is derived using a DCF analysis. hence our Overweight rating. our DCF analysis provides upside to the current price.9% 5. Amazon could suffer if consumer spending continues weakening or remains depressed longer than we expect. Morgan estimates.3x. We Maintain Our End-2011 Price Target of $199 We are maintaining our year-end 2011 price target of $199. and improved offerings from these competitors could hamper Amazon’s growth. J.458 2. respectively.0% 95. Morgan Estimates $ in millions except EPS Revenue EBITDA EPS 4Q’10E 13. $3. Amazon faces competition from a variety of online and offline retailers.P.67. with the parameters below.232 5. Valuation and Rating Analysis AMZN trades at a premium to its peers. Our F’11 assumptions yield a 2011E EV/EBITDA multiple of 24.90B. J.7x our F’11 EBITDA estimate of $3.5% 11.P.5% 8. Morgan estimates. However. In addition. including regulatory hurdles that make the business climate less hospitable or less profitable than those of the markets in which it currently operates. 240 .

Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 24.0 3Q10A 7.5% 17.t.6 6.366 1.603 253 902 442 2.627 1.67 56.370 2.0 0.14 Income Statement .2% 0.502 956 2.797 1.802 3.566 270 240 510 3 24 433 88 207 455 0.556 5.458 12 49 2.440 1.3% 0.609 3.131 394 206 600 4 3 514 100 299 454 0.0 72.161 456 2.467 2.3 2Q10A 6.466 3.581 13.03 FY09A 6.com Global Equity Research 03 January 2011 Amazon.950 2.081 4.khan@jpmorgan.0 0.7% 36.4% 0.6 FY10E FY11E FY12E 9.Imran Khan (1-212) 622-6693 imran. Morgan estimates.8% 25.913 (2.081 2.089 23.614 2.3% 44.5% 4.3% 0.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 7.293 1.651 (480) 4.919 (2.51 FY11E 30.93 FY12E 25.161 956 1.851 2 28 1.227 5.66 FY09A 27.813 1.202 32 0 2.0 0.4 7.701 996 1.701 463 3.3% 0.188 (545) 0 - Source: Company reports and J.192 8.918 10. Fiscal year ends Dec 241 .365) 223 13.257 902 721 1.336) (281) FY10E FY11E FY12E 34.390 11.733 (545) 5.3% 7. Note: $ in millions (except per-share data).508 1.6 6.808 537 1.0 0.9% 27.6% 3.963 1.397 3.206 996 3.826 766 2.179 18.232 40 0 3.0 35.560 268 257 525 2 22 425 79 231 456 0.999 30.425 1.157 26.036 570 253 823 3 713 149 424 458 0.904 2.P.2% 40.784 (871) 2.9% 30.0% 0.954 4.7% 0.935 3.0 4Q10E 13.633 1.130 721 1.6% 32.2% 16.45 FY10E 39.260 2.151 1.290 13.9% 32.085 416 1.0 50.390 13.8% 0.425 471 5.0 90.290 19.1% 17.2% 7.160 13.171 (480) 0 18.926 2.192 7.4% 7.55 44.443 1.045 1.2% 3.124 1.171 9.390 17.9% 18.1% 7.3 7.com: Summary of Financials Income Statement .1% 3.292 (373) 2.165 4.

com Global Equity Research 03 January 2011 242 .Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.

albeit at a slower pace.com J. AOL Inc.11 0. We believe that improved Y/Y pipeline as well as pricing should help recovery next year.30 (14. Our resulting ’11 graphical revenue forecast is $539M.3 million subscribers during ’10 and will lose 700K more next year. will drive another year of adjusted EBITDA decline.40A 2. Morgan Securities LLC Shelby Taffer (212) 622-6518 shelby.44A 0. We are currently modeling $780M in F’11 subscription revenue.09 29 Dec 10 29.com J. due to a large sales force restructuring the company undertook.r.22 1.84 0. .com J.67A 1.  Subscription revenue trajectory should continue to reflect subscriber base contraction. (AOL. Subscription and Investment in Patch Still a Headwind in '11 We expect AOL to start seeing recovery in graphical revenue in ’11 but think that continued loss. our 14. down from the 41.40B in ’11 as incremental investment in Patch almost entirely offsets the benefit of restructuring.9%.88) 1. Morgan estimates. Morgan Securities LLC Vasily Karasyov (1-212) 622-5401 vasily.x. Bloomberg.71 3.2% decline estimate for next year assumes a Y/Y benefit from a better user experience.khan@jpmorgan.taffer@jpmorgan.com J.P. We believe that starting in Q1 ’11 this trend should reverse and the pipeline will turn positive.P. respectively.86 1.47) 2009A 1. We forecast $360M in search revenue. We believe that AOL will lose 1. Morgan India Private Limited Bridget Weishaar (1-212) 622-5032 bridget.weishaar@jpmorgan. Morgan Securities LLC Lev Polinsky.  Display is likely to stabilize and return to growth next year.P.46A 0.karasyov@jpmorgan.com J. implying rates of decline of 26. Morgan Securities LLC Jigar Vakharia (91-22) 6157-3281 jigar.42 4.09 Price Target: $26.68 1. we are modeling full ’11 revenue growth of 5.P.16A 2011E 2012E Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 24.a.61 2. Graphical and Third-Party Revenue Trends to Improve.1% we expect for ’10.polinsky@jpmorgan. AOL entered every quarter of ’10 with the advertising sales pipeline down vs.56 1.96A 3.19.76 0. albeit at a slower pace than in ’10.6% decline we are likely to see in ’10.  We expect search revenue to continue declining in ’11. we are modeling it to decline 32. In addition.2% decline next year compared to the 30.584.6% Y/Y to $445M. we think that pricing will improve by 6% domestically.40 (2. AOL US Price: $24.40 0.Global Equity Research 03 January 2011 AOL Inc.P.P. CFA (1-212) 622-8343 lev.00 Internet Imran Khan AC (1-212) 622-6693 imran.x.P.com J. our gross margin assumption for next year is 35.45 .5%.d.86 Dec 107 26. But Search. we model cost of revenue to decline only $10M to $1.02 2010E 0.49 Source: Company data. a renegotiated GOOG deal and easier comps. J.01B estimate for full ’10. We expect ARPU to decline 4% in ’11 to $17. We estimate that in organic terms search revenue will be down ~20% in ’10.43. the previous year. Neutral AOL.vakharia@jpmorgan. combined with investment in patch. down from our $1. 'Bloomberg' above denotes Bloomberg consensus estimates.AOL US) 2008A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY Bloomberg EPS FY ($) 1.0%. of subscription and search revenue.00 31 Dec 11 0.t.0% and 18. Morgan Securities LLC  Cost of revenue likely to remain flattish due to reinvestment in Patch. a 14. Despite AOL’s significant cost cutting late in ’09 and early in ’10.

1 0.86 F’12E 2. EBITDA and pro forma EPS of $2. Morgan Estimates $ in millions Revenue EBITDA Adjusted EPS 4Q’10E 585.t.9 2. in line with our price target) and earnings expectations are also low and limit any potential downside. (3) Display advertising pricing may improve sooner than we expect and could drive upside to our revenue and EBITDA forecast.40 F’10E 2. $401.68. Our price target is based on the cash balance as of Q3 and doesn’t include potential proceeds from deals announced but not completed.00.P. Our F’12 estimates call for revenue.4 0. Armstrong and his team to AOL and believe that they are focused on the right challenges and opportunities.15B. We derived the multiple from the average trading multiples of UNTD. we think that the turnaround is likely to take time since the company has to catch up on a decade of insufficient innovation which we see as a headwind for the stock price in the midterm.Imran Khan (1-212) 622-6693 imran. we rate AOL stock Neutral. On the other hand. Morgan estimates.09 on December 29. respectively. ELNK and VCLK. Risks to the downside: (1) Display revenue growth potential may prove to be more limited than we estimate. we think the valuation (AOL shares closed at $24.68 Source: Company reports and J.6 146.5M and $0.388 662. $445. (4) The terms of the new search deal may be better than we anticipate.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 Our F’11 revenue.96 F’11E 2. Investment Risks Risks to the upside: (1) AOL subscriber base may erode at a slower pace than we estimate.khan@jpmorgan.P. J. Therefore. However. our current model.150 445.6 0. which we believe to be AOL’s closest comps. 2010. 244 . This would result in incremental operating profitability vs.07B. (2) Restructuring initiatives may take longer and require more resources to implement than we think. EBITDA and adjusted EPS estimates are $2. We Maintain Our End-2011 Price Target of $26 We use an EV/’10E EBITDA multiple of 5x to arrive at our end-2011 target price of $26. (2) We may be underestimating headroom left for cost cutting at AOL.072 401. (3) The terms of the new search deal may be worse than we anticipate.6M and $0. Valuation and Rating Analysis We are encouraged by the arrival of Mr. respectively.86.

1 3Q10A 4Q10E 564 81 70 158 0 14 94 (5) 172 107 1.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 655 76 116 216 0 (3) 73 35 35 107 0.219 503 3.4%) 29.1 (26.388 449 (1.963 42 900 3.308 48 954 2.0%) (36.9 35.5%) (20.khan@jpmorgan.P.8%) 0.67 FY10E (26.96 FY10E FY11E FY12E 667 316 235 1.150 150 295 445 (5) 4 159 64 95 110 0.42 FY09A 147 462 78 687 705 3.3%) (13.4% 0.0% 0.0 6.2%) (70.341) (269) (1. Fiscal year ends Dec 245 .8%) 20.102) 207 240 106 3.024 285 235 1.0 8.075 83 817 2.2%) 0.7% 4.9% 0.46 586 74 72 146 (1) (3) 71 28 43 107 0. Note: $ in millions (except per-share data).1 2.86 0.258 (891) 345 52 572 (100) 472 (5) (41) 1.106) 406 345 876 698 0 (0) (3) 4 446 (1.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A FY10E FY11E FY12E 2.2% (33.544 411 3.t.com Global Equity Research 03 January 2011 AOL Inc.0 27.68 Income Statement .0 7.4% 0.6 Source: Company reports and J.055) 107 0.336) 87 178 0 (4) (1.0% 7.: Summary of Financials Income Statement .248 2.063 248 406 189 908 (136) 772 (152) (750) (211) (806) 107 2.40 3. Morgan estimates.4%) 162.Imran Khan (1-212) 622-6693 imran.0 2Q10A 584 (1.7% 27.353 95 295 (43) 496 (103) 393 (103) (37) - FY11E FY12E (10.0%) (43.44 FY09A (22.

khan@jpmorgan.com Global Equity Research 03 January 2011 246 .t.Imran Khan (1-212) 622-6693 imran.

00 Previous: $39.12 0. Therefore. Blue Nile’s international revenue grew 6% Y/Y and represented ~14% of total revenues.93A 0. we believe the stabilization of diamond prices as well as an increase in purchasing power will help drive improvement in the international markets.39 Source: Company data.22 0.taffer@jpmorgan. As its revenue grows.19A 0.polinsky@jpmorgan. Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 58. in terms of both sales and traffic. we are slightly raising our 4Q revenue growth estimate to 9% from our prior estimate of 8%.1M and $0.33 0.com Shelby Taffer (212) 622-6518 shelby.42.20 0.05 29 Dec 10 65.27 0.59 1.x.2M.70 865.NILE US) 2010E (Old) 2010E (New) 2011E (Old) 2011E (New) 2012E (Old) 2012E (New) EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY 0.24 0.28 0.  International markets should see some improvement. CFA (1-212) 622-8343 lev.a.21 0. we expect Blue Nile to benefit from SG&A leverage. hence our Neutral rating. We are also raising estimates.1% in F’11 compared to our F’10 estimate of 9.49 1.P.4%  2011 drivers.7% 12m -9. While Blue Nile’s 3Q was below expectations.Global Equity Research 03 January 2011 ▲ Neutral Blue Nile Consumer Spending Rebounding. Blue Nile (NILE.com Lev Polinsky. respectively.51 1.05 ▲ Price Target: $49.20 0.41A 0.19A 0. driving a slight lift to EBITDA margins.  4Q trends appear to have picked up. In 3Q. Previous: Underweight NILE.48 . We now expect 4Q revenue. Morgan Securities LLC Price Performance 60 $ 50 40 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs -7. We are modeling an EBITDA margin of 10. The company saw international weakness over the past two quarters.94A 0.  Slight EBITDA margin lift.3M and $0.26 0.22 0. In our view. despite our increase in estimates. Upgrade to Neutral We are upgrading Blue Nile to Neutral as we expect the company to benefit from an increase in consumer spending and consolidation in the industry.8% 1m 20. However. especially in the international markets. (3) SG&A leverage. the following factors will drive NILE shares in 2011: (1) improved consumer discretionary spending. management commented that Blue Nile had a record Thanksgiving and Black Friday.  Raising estimates. NILE US Price: $58. $12. compared to our prior estimates of $111.khan@jpmorgan.00 Internet Imran Khan AC (1-212) 622-6693 imran. Additionally.P. J.com J.6%. we think the stock is still expensive.15 0.41.56 1.com Vasily Karasyov (1-212) 622-5401 vasily.t.19A 0. Bloomberg.x.d.00 31 Dec 11 .karasyov@jpmorgan.25 0.16A 0.com Bridget Weishaar (1-212) 622-5032 bridget. (2) diamond price trends.6% 3m 28.1M.40. Morgan estimates. on the earnings call the company noted acceleration in both traffic and sales growth thus far in 4Q.19A 0.weishaar@jpmorgan. $12. specifically in the UK and Europe. EBITDA and GAAP EPS of $112.22 0.28 0.16A 0. Looking ahead.42A 0.18 Dec 15 49. and our December 2011 price target goes to $49 from $39.

its peer group at 14x.7 43.7M and $1.0% Valuation and Rating Analysis On an EV/EBITDA basis.7 $1. we are raising our December 2011 price target to $49 from $39 previously.15 F’11E old 371. we do not think further multiple expansion is likely and thus rate the stock Neutral. walmart.com. amazon.P. Morgan Estimates $ in millions. EBITDA and EPS estimates of $380.9M. Raising Our End-2011 Price Target to $49 from $39 As a result of our newly increased estimates.7M.3 0.0M and $0. Our F’12E calls for revenue.93.1 $1.2 12. $42.2 38.7M and $1. EBITDA and EPS estimates of $330. our estimates could prove to be too conservative. $31. 2011 and 2012 We are now modeling F’10 revenue. respectively.41 F’10E new 330.94 compared to our previous estimates of $329.9 42.93 F’11E new 380.33. if the economy and consumer spending turn around more quickly than we expect.Imran Khan (1-212) 622-6693 imran.2M. 248 .1 12. Morgan estimates.com. $43.3M vs. respectively.0 $0. We are now modeling F’11 revenue.com. EBITDA and EPS of $435. and it would be difficult for the company’s business model to tolerate large fluctuations in the prices paid to acquire diamonds and jewelry.khan@jpmorgan. Online competitors include: diamond.com. which operate in different spaces in the jewelry market.9M.7 $0. If the company successfully executes its international business strategy or gains market share in the US from traditional retailers. Our price target is derived using a DCF model with the following parameters: Key DCF Assumptions Equity beta Risk free rate (10yr yield) Risk premium Cost of Equity Final debt ratio Equity as a % Cap Source: Company reports and J. Further. J.7M and $0. except per-share data 4Q’10E new 112.7 $1.12.P.42 4Q’10E old 111. Morgan estimates.39 F’12E old 413. $32. $37.1% 0. respectively. and Ashford. NILE trades at 21x our F’11 EBITDA estimate of $38.0% 100.39 compared to our previous estimates of $413.3 32. Investment Risks Blue Nile is highly dependent on its diamond and jewelry suppliers.43 3. mondera. the stock could outperform.3M. 1.94 F’10E old 329.3M. $38.3% 7.3 31.9 37.12 F’12E new 435.P. Although we expect the company to benefit from an increase in consumer spending and consolidation in the jewelry industry.1 0.1M and $1.15 compared to our previous estimates of $371.t. Blue Nile faces competition from both offline and online competitors.33 Revenue EBITDA GAAP EPS Source: J.6% 14.com Global Equity Research 03 January 2011 Raising Estimates and Outlook for 2010.3 $1.3M and $1.

6 FY10E FY11E FY12E 108 2 19 128 10 147 99 48 14 3 15 41 (2) 38 13 (24) 171 2 19 192 8 202 122 80 18 4 24 51 (3) 48 (3) 15 215 2 23 239 8 250 146 104 22 4 19 50 (4) 46 (4) (3) - Source: Company reports and J.19 FY11E 50.4 2Q10A 77 4 1 7 0 4 2 3 15 0.84 FY09A 93 2 21 116 7 130 87 43 12 3 16 39 (2) 37 (17) 2 FY10E FY11E FY12E 330 22 3 32 0 22 8 14 15 0.khan@jpmorgan.42 FY12E 41.8% 0.Imran Khan (1-212) 622-6693 imran.P.9% 12.1% 0.16 FY09A 2.9% 37.6% 3.6 4Q10E 112 10 1 12 0 10 3 6 15 0. Morgan estimates. Fiscal year ends Dec 249 .0 9.15 436 32 4 44 1 33 12 22 15 1.8% 11.0 0.0 0.0 69. Note: $ in millions (except per-share data).9% 9.com Global Equity Research 03 January 2011 Blue Nile: Summary of Financials Income Statement .6% 9.2% 0.3% 15.6% 31.5 3Q10A 67 4 1 7 0 4 1 3 15 0.3% 9.0 8.94 380 27 4 38 1 27 10 18 16 1.39 Income Statement .Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 74 4 1 6 0 4 1 2 15 0.0 61.3% 0.7% 4.19 FY10E 9.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 302 19 3 29 0 20 7 13 15 0.t.

t.Imran Khan (1-212) 622-6693 imran.khan@jpmorgan.com Global Equity Research 03 January 2011 250 .

assumes preferred stock converted to common stock. We believe Dice operates in an attractive recruitment vertical.00 Internet Imran Khan AC (1-212) 622-6693 imran.com Bridget Weishaar (1-212) 622-5032 bridget.05 0. Furthermore.09 0. We expect finance revenues to grow 23% Y/Y in F’11.com Shelby Taffer (212) 622-6518 shelby.08 29 Dec 10 14.taffer@jpmorgan.10A 0. In the US.55 951. For historical performance. With the acquisitions of WorldWideWorker and Rigzone in May and August of 2010. we believe the overall recruitment market remains tough and do not foresee a full recovery in the near future.  Tech & clearance should remain an attractive vertical. Inc. Full-year figures may not add due to rounding.khan@jpmorgan. yielding higher revenue per customer. (2) market share gains from Monster (rated Overweight by JPM internet software and services analyst Alexia Quadrani) and (3) the company’s ability to maintain EBITDA margins above 40%.15 0.05A 0. We are modeling energy revenues to exceed $13M in 2011.3%.d.26 Dec 68 11.3% 1m 19.8%.8% 3m 12m 66. specifically with increased spend in marketing and product development.x.P.13 0.08 Price Target: $11. In our view. Morgan Securities LLC Price Performance 12 $ 8 4 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs 111.polinsky@jpmorgan.12 0. CFA (1-212) 622-8343 lev.  Finance segment to benefit from increased penetration. above our F’10E 40.52 Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 14. we think eFinancialCareers will focus on leveraging its core markets as well as expanding into new regions.20 2010E 0. Therefore.5% 111.t. (DHX.04 0. Neutral DHX. We are maintaining our December 2011 price target of $11. Bloomberg.13 0.com Vasily Karasyov (1-212) 622-5401 vasily.com J. we think the tech & clearance segment will continue to benefit from an increase in new business as well as service-level upgrades.  We expect EBITDA margins of 40+% in 2011.  Building out energy vertical. J. we expect Dice to increase its presence in the energy sector. we believe continental Europe and the Middle East may see a slower pace of improvement.09A 0.06 0.weishaar@jpmorgan.5.29A 2011E 0.Global Equity Research 03 January 2011 Dice Holdings. However. We are modeling an F’11 EBITDA margin of 41. DHX US Price: $14. Increasing Recruitment Activity in Attractive Verticals Should Drive Growth in 2011 We are maintaining our Neutral rating on Dice.10 0. Inc. Though we have seen signs of improvement in the business and think management continues to execute well.41 2012E 0.x. with growth in all regions led by strong demand in Asia. . the following factors will drive DHX shares in 2011: (1) the employment outlook in the US and internationally.27 . we expect tech & clearance to grow 23% Y/Y in F’11. However.2%.a.P. as the unemployment rate for tech professionals (~4.  2011 drivers.0% Dice Holdings.00 31 Dec 11 Source: Company data.karasyov@jpmorgan.09 0.com Lev Polinsky.05A 0.3%) is below the overall national average of 9. we expect management to invest in the energy businesses.11 0.06 0. Morgan estimates. We believe margin expansion will be driven by continued cost efficiencies as well as a slight benefit from the higher-margin Rigzone business.DHX US) 2009A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY 0.

Despite the company’s strong free cash flow and international growth prospects.6 69.6% 10. we reiterate our Neutral rating. $82. EBITDA and EPS of $198.1M and $0. Morgan Estimates $ in millions.0% 75. EBITDA and EPS of $167.P.000 websites offering job postings. respectively.4 0.P. except per-share data Revenues EBITDA GAAP EPS 4Q’10E 36. 1.1 0.0% Valuation and Rating Analysis DHX trades at 14.P.41.41 2012E 198.6M. including some with significantly more financial resources than Dice.9% 25.52 Source: J.9 51.5 0. Key DCF Assumptions Equity beta Risk free rate (10yr yield) Risk premium Cost of Equity Cost of debt Final debt ratio Equity as a % Cap Source: Company reports. respectively. the company could outperform our estimates.3M.0x our F’11E EBITDA. results could exceed our expectations. Our price target is derived using a DCF analysis.10 2010E 127. We Maintain Our End-2011 Price Target of $11 We are maintaining our year-end 2011 price target of $11. with over 1. Our F’12 estimates call for revenue. the stock could see further weakness. Morgan estimates. $69. Morgan estimates. social networking sites have been generating significant traffic growth and are looking at job listings as a way to monetize traffic. the 14. 252 .com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11E revenue.3x peer group average. we believe a full recovery in the recruitment market will lag the broader economy. Should our expectations prove too pessimistic for the macroeconomy or for one of Dice’s specific verticals.6% 15.Imran Khan (1-212) 622-6693 imran.1M and $0. J.khan@jpmorgan. Bloomberg. Downside risks: Should the economic challenges persist longer than we expect. if the company is better able to retain clients than we expect in this environment.29 2011E 167.8 16. vs.3 82. Success of any of Dice’s competitors could negatively impact our growth expectations. J.25 2.52. Plus. Additionally. making multiple expansion unlikely in the near term. Investment Risks Upside risks: Our price target and Neutral thesis are predicated on prolonged economic challenges.8% 3. Additionally. Thus. Dice operates in a highly competitive landscape. with the parameters below.t.1 0.

3 3Q10A 4Q10E 34 9 4 14 (1) 7 (1) 6 68 0.Imran Khan (1-212) 622-6693 imran.1% 11.9 2Q10A 30 6 4 11 (1) 6 (2) 4 68 0.: Summary of Financials Income Statement .0 48.52 Income Statement .0% 104 16 4 123 5 362 52 162 199 28 17 13 63 (4) 59 (16) (1) 0.20 128 33 15 52 (4) 28 (8) 20 67 0.3% 1.2% 9.3% 3.khan@jpmorgan.com Global Equity Research 03 January 2011 Dice Holdings.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A FY10E FY11E FY12E 110 27 18 50 (7) 21 (8) 13 66 0.3% 15.41 198 59 18 82 (4) 54 (19) 35 68 0.0 5.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 27 6 3 10 (1) 5 (2) 3 67 0.1%) (11.t.0 68.00 0.00 0.0 0.6% 40.1 FY09A FY10E FY11E FY12E 49 11 2 63 6 262 50 113 148 13 18 (6) 25 (3) 22 (3) (31) 0.05 FY10E 16.6 37 12 4 16 (1) 11 (4) 7 68 0.1% 12. Note: $ in millions (except per-share data).P.1% 0.0%) (27.09 FY11E 34.1% 0.00 0.29 168 47 17 69 (4) 43 (15) 28 68 0. Inc.4% 1.0 6.9% 42.05 FY09A (29.0% Source: Company reports and J.10 FY12E 27.00 0.0% 58 13 2 73 5 324 53 147 177 20 15 16 52 (4) 47 (48) 5 0.9%) 45.0% 164 19 4 187 5 411 50 172 240 35 18 8 66 (4) 62 (4) (1) 0.0 0. Fiscal year ends Dec 253 . Morgan estimates.

com Global Equity Research 03 January 2011 254 .Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.

Out of PayPal’s two revenue streams. Morgan estimates.x. We continue to think PayPal is in an advantageous position in online payments and poised to grow rapidly.46 1.40 0.62 2.25 0.32A 1. (4) regulation in the payments space and (5) potential new competition in the payments business.85 1. (EBAY. We continue to expect the company to underperform the broader eCommerce market in the near term and think the stock is unlikely to work well until eBay’s market share losses stabilize.67. In the first nine months of 2010. Inc Market Share Losses Continue. .31A 0.33A 0.com Shelby Taffer (212) 622-6518 shelby.01. below 9% growth seen in the first half of the year (excludes Gmarket). Bloomberg.  eBay continues to lose domestic market share. Consequently. F'11.69A 2011E 0.82.polinsky@jpmorgan.06 37. Excluding FAS123R. EBAY US Price: $28.com Lev Polinsky. eBay’s US non-vehicles GMV grew 4%.19. the following factors will drive EBAY shares in 2011: (1) the turnaround of the marketplaces business. we think off-eBay TPV will experience robust growth.35 0.  Future in the international marketplaces looks shaky.37A 1. We think the growth lag is partly due to higher friction compared to other leading platforms as well as a weaker technology platform. much less gain market share. compared to 14% growth for the broader US eCommerce market.P.weishaar@jpmorgan.06 Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 28. We are maintaining our December 2011 price target of $25.taffer@jpmorgan.5% 12m 19.31A 0. J.36 Price Target: $25. We think the slowdown of international growth is cause for concern.36 0. we think the slower on-eBay TPV growth could offset PayPal’s total growth going forward.54 2010E 0.  PayPal is the biggest bright spot of the business.28 0.309 25.35 0.120.7% 1m -6.8% eBay. In our view. Inc.a. F'11. though PayPal Remains a Bright Spot We are maintaining our Neutral rating on eBay.com Bridget Weishaar (1-212) 622-5032 bridget. Furthermore.64 .06 Dec 1. and F'12 estimates include adjustments for FAS123R.Global Equity Research 03 January 2011 eBay.00 31 Dec 11 Source: Company data.karasyov@jpmorgan. $1.EBAY US) 2009A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY Bloomberg EPS FY ($) 0. YTD Abs 18. while the on-eBay portion (~40% of rev) will be more of a drag.36 29 Dec 10 31. and F'12 EPS estimates are $1. Morgan Securities LLC Price Performance 30 $ 26 22 18 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10  2011 drivers. Neutral EBAY.05 1.00 Internet Imran Khan AC (1-212) 622-6693 imran. 'Bloomberg' above denotes Bloomberg consensus nonGAAP EPS estimates. (3) take rate stabilization. CFA (1-212) 622-8343 lev.P. Note: F'10.2% 3m 13.41 1. International nonvehicles GMV growth ex FX grew 8% in 3Q’10.86 2012E 0.x.com J.com Vasily Karasyov (1-212) 622-5401 vasily. and $2. we believe there is much progress to be made before the eBay marketplace can grow in line with the industry.38 0. (2) PayPal’s on-eBay TPV growth.27 1. our F'10.47 1.39 0.t.khan@jpmorgan.d.

J.687 9. and thus we rate it Neutral. and valuation risks. Key DCF Assumptions Equity beta Risk free rate (10yr yield) Risk premium Cost of Equity Cost of debt Final debt ratio Equity as a % Cap WACC Source: Company reports.5% 8. International expansion is a concrete part of eBay’s growth strategy.45 2010E 61.0% 11.05 2.536 901 0.01.5% 6.827 2. Our price target is derived using a DCF analysis. Due to the challenges faced by the company’s businesses.82 2012E 70.20B. Morgan estimates. Bloomberg.0% 3. competition from sponsored search vendors. EBITDA and pro forma EPS estimates of $10.P. $3.606 10.813 2. risks related to the repositioning of eBay’s pricing structure.3% Valuation and Rating Analysis On a GAAP P/E basis.82. Investment Risks Downside risks: Barriers to international expansion.P.Imran Khan (1-212) 622-6693 imran. competition from hardline retailers.81B and $2.197 3.khan@jpmorgan.223 1. respectively.62B and $1. 256 .900 11.28B.197 3. respectively. As the company continues to grow outside the US.01 Source: Company reports and J. Our F’12 estimates call for revenue. Thus far. We Maintain Our End-2011 Price Target of $25 We are maintaining our year-end 2011 price target of $25. with the parameters below.47. it may face regulatory challenges and/or markets that make its business less profitable than it is in the US or other countries where it is already established. the company’s dependence on eBay Motors.0% 97. with each passing quarter.67 2011E 66. EBITDA and pro forma EPS of $11.P.624 1.275 3. Morgan Estimates $ in millions except EPS GMV Revenue EBITDA Pro forma EPS 4Q’10E 16. Although the bulk of eBay’s revenues come from the beginning and end of the retail life cycle. $3. J. risks associated with patent litigation. eBay also faces risks from hardline retailers. Morgan estimates. we believe eBay’s international expansion has been carried out in a strategic and timely manner.t.2x our F’11 estimate of $1.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue. we believe the stock is unlikely to significantly outperform its peer group in the coming months.6% 11. 1. eBay trades 19.

if the company takes steps that help the market value the separate parts of the enterprise more fully. the stock could outperform. Failure to meet these challenges could lead to relative stock price underperformance. Additionally.com Global Equity Research 03 January 2011 the percentage of revenue it earns from the in-season retail and fixed price sales continues to increase. Wal-Mart. Upside risks: Should the company be able to improve its search technology more rapidly than we expect. including Amazon.com. This puts the company in competition with traditional retailers and other eRetailers. BestBuy and Home Depot. 257 .Imran Khan (1-212) 622-6693 imran. this could result in an acceleration of trade on the platform.khan@jpmorgan.t.

Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 2.0 7.3% 0.t.241 1.0 21.460 1. Fiscal year ends Dec 258 .813 68 2.621 13.258 2.2% 0.314 18.8% 0.685 15.624 3.0% 5.9% 0.879 490 2.5% 0.601 559 2.663 1.788 2.0 0. Inc: Summary of Financials Income Statement .6% 35.281 3.42 FY09A 2.729 770 (449) 2.553 811 2.826 18.40 FY10E 5.408 0 4.7% 12.714 2.288 1.4 3Q10A 4Q10E 2.042 875 (22) 3.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 8.40 FY11E 11.275 11.422 2.0 19.0 13.153 9.197 2.416 1.45 FY12E 9.897 860 (27) 3.541) (946) (259) - Source: Company reports and J.486 8.5% 9.P.691 1.306 1.0 0.0% 18.3% 18.5% 27.01 Income Statement .536 750 200 901 20 620 133 487 1.2% 10.156 1.5% 9.310 0.304 0.4% 21.3% 10. Morgan estimates.2% 34.0% 5.0% 17.935 3.807 23.0% 35.944 408 2.644 21.0 8.416 519 1.351 5.290 1.908 (567) 2.0 17.4% 0.301 0.0 0.2% (15.4% 0. Note: $ in millions (except per-share data).268 1.Imran Khan (1-212) 622-6693 imran.832 (676) 2.0 15.5%) 30.042 1.860 (685) 0 2.190 770 860 875 3.727 2.4%) (7.9% 10.017 444 494 542 2.149) (1.976 3.376 0 0 0 4.249 645 194 778 27 517 85 432 1.0 7.3 2Q10A 2.1% 18.197 10.2 2.590 10.67 75 2.215 646 188 764 15 499 87 412 1.341 FY10E FY11E FY12E 9.196 673 188 779 6 495 97 398 1.131 403 1.363 13.004 (690) 0 - (1.897 1.545 (685) 2.726 17.com Global Equity Research 03 January 2011 eBay.013 12.5 FY10E FY11E FY12E 6.223 3.82 96 2.2% 0.khan@jpmorgan.729 1.389 1.081 20.389 811 37 2.309 0.719 (715) 3.981 5.995 27.58 FY09A 4.

50.com Vasily Karasyov (1-212) 622-5401 vasily. J.27 Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 25. We expect G&A leverage and further operational efficiencies to offset the increased investments.323.40 0.98 2. Bloomberg. we are concerned that hotel inventory levels may fall as suppliers lower the portion of inventory sold to online travel agencies. 3) rising average daily rates (ADRs) and 4) an easier comp from lapping the volcano impact in 2Q’10. .18.EXPE US) 2009A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY Bloomberg EPS FY ($) 0.t.22 0. (2) sales and marketing trends and (3) ADR and air capacity trends. our F'09.26.38.khan@jpmorgan.53A 1.com Bridget Weishaar (1-212) 622-5032 bridget.06 and $2.54 0.com Lev Polinsky.8%.d.0% 1m -4. Neutral EXPE. 2) continued expansion of TripAdvisor. We expect Expedia’s international business to see healthy growth in 2011 driven by: 1) increased penetration in the APAC region.50 Internet Imran Khan AC (1-212) 622-6693 imran.9%  2011 drivers.14 0. However. we think Expedia will continue to increase its spending on the newer European and Asia Pacific markets as well as continue its investments to expand TripAdvisor.35 1. Expedia has benefited from healthy domestic room night growth. $2.73. our F’10 estimate of 16% growth.58 29 Dec 10 29.44 1.58 Price Target: $31.  US growth moderating. EXPE US Price: $25. and are thus modeling an F’11 OIBA margin of 25. However. Expedia.30 7.2% 12m -5. we expect spending to pick up in order to support growth. CFA (1-212) 622-8343 lev.x. Morgan Securities LLC Price Performance 30 26 $ 22 18 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs -1. Expedia cut back on its selling and marketing expense due to the weak macro environment in Europe. looking ahead. F'10. $1. Inc. Domestic Moderating We are maintaining our Neutral rating on Expedia. We are modeling domestic growth bookings growth of 5% Y/Y in F’11 vs.P.20A 0.62A 0.03 1.65 0. up only slightly from 25.  We expect selling and marketing spend to pick up in 2011. 'Bloomberg' above denotes Bloomberg consensus estimates. reflective of increased inventory and promotional activity during a period of macroeconomic uncertainty.40A 0.4% in F’10E.48 0. the following factors will drive EXPE shares in 2011: (1) revenue margin trends.polinsky@jpmorgan. Furthermore. We are maintaining our December 2011 price target of $31.taffer@jpmorgan. Excluding FAS123R.weishaar@jpmorgan.com Shelby Taffer (212) 622-6518 shelby.72A 2011E 0. International Outlook Strong.a.71 0.00 2012E 0.P. In our view.24 0.  International growth should remain healthy. as the economy continues to improve in 2011.14 0.com J. While we think the company will see healthy international growth as well as continued strength from TripAdvisor.9% 3m -12. In the first half of 2010.85 .Global Equity Research 03 January 2011 Expedia. Estimates reflect impact of FAS 123R.37 2010E 0. (EXPE.karasyov@jpmorgan.48 1. F'11 and F'12 EPS estimates are $1.79 2. Inc. We are modeling F’11 international gross bookings to grow 18% Y/Y. Morgan estimates.31A 1.x.14 Dec 286 31.50 31 Dec 11 Source: Company data. we believe cyclical challenges and new pricing pressure in the industry could create headwinds.

As we see better upside opportunities in other stocks in our coverage universe.2 1.0% 13.50 Valuation and Rating Analysis On EV/EBITDA.06 2012E 3. (3) achieve strong gross bookings growth in a weak economy and/or (4) achieve further expansion into international markets.896 3. Morgan estimates.043 286.222 5.06. except per-share data Revenues EBITDA Pro Forma EPS 4Q’10E 796. Investment Risks Upside risks: The company (1) achieves significant market share gains to offset pricing decreases.7 221.3 $31.896 $9.50 We are maintaining our year-end 2011 price target of $31.09B and $2. We think this valuation accurately reflects the cyclical challenges the company faces in addition to new pricing pressure in the industry.9 4. Downside risks: The company is unable to (1) withstand the competitive threat that the travel suppliers and travel search engines pose.P. respectively.t.P.50.710. respectively. we rate Expedia Neutral. with the parameters below. J.6 2. $1.37 2010E 3. Morgan Estimates $ in millions.71B.16B and $2.4 0.26 Source: Company reports and J.032. Morgan estimates.158. (2) eliminates pricing promotions and/or (3) makes significant market share gains in the international markets.1 1.97B.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue. 260 . Bloomberg.3 2.165 5. Our price target is derived using a DCF analysis. Parameters for Our DCF Price Target Derivation Base FCF Terminal Growth Rate Terminal WACC Terminal Multiple Terminal Value PV of terminal value Firm value NPV year 2011-2015 PV of terminal value Enterprise value Plus Net Cash Equity value Shares outstanding Equity Value Per Share Source: Company reports. J.62% 10 11.118 (75) $9. EBITDA and pro forma EPS of $3. EBITDA and pro forma EPS estimates of $3. Our F’12 estimates call for revenue. Expedia trades at 7x our F’11 EBITDA estimate versus its peers at 14x.093. $1.73 2011E 3.P.5 962.8 1.Imran Khan (1-212) 622-6693 imran.khan@jpmorgan.336. (2) achieve a high ROI on selling and marketing investments. We Maintain Our End-2011 Price Target of $31.967.26. 1.

40 FY10E 12.8 988 277 31 329 (25) (14) 239 (61) 177 286 0.com Global Equity Research 03 January 2011 Expedia.790 1. Morgan estimates.0 0.0 0.0 16.271 1.354 255 7.645 4.645 4.300 247 8. Fiscal year ends Dec 261 .6% 10.955 571 103 876 (78) (35) 458 (154) 300 292 1.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A FY10E FY11E FY12E 2. Note: $ in millions (except per-share data).0 24.98 Income Statement .9% 28.3% 1.210 1.645 3.t.khan@jpmorgan.53 3.750 304 103 207 676 (92) 584 (48) (660) 1.303 338 216 1.6% 13.31 FY12E 12.134 4.9 834 194 30 247 (19) 1 176 (60) 114 289 0.03 3.158 (124) 0 778 (241) 537 271 1.728 380 246 2.967 902 136 1.336 748 118 963 (95) (12) 641 (198) 439 288 1.9% 13.79 3.9% 48.9 FY09A FY10E FY11E FY12E 702 308 215 1.: Summary of Financials Income Statement .834 443 118 87 769 (154) 616 (889) 183 1.1% 12.20 FY09A 0.856 271 6.5% 15.225 237 5. Inc.9% 9.956 2.602 422 276 3.076 537 136 27 835 (128) 707 (128) 168 - Source: Company reports and J.1% (111.710 838 136 1.937 895 3.9% 0.0 5.3 797 165 31 221 (31) 134 (46) 89 283 0.187 2.7%) 29.3% 1.237 492 136 7 770 (120) 650 (120) (232) 2.Imran Khan (1-212) 622-6693 imran.035 3.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 2Q10A 3Q10A 4Q10E 718 112 26 166 (21) 1 92 (32) 59 295 0.0% 0.P.7 6.62 FY11E 14.094 (124) 0 714 (221) 492 276 1.

Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 262 .t.khan@jpmorgan.

32. and mobile.taffer@jpmorgan.72 28.com Shelby Taffer (212) 622-6518 shelby.P.433.88 6.85 .Global Equity Research 03 January 2011 Google Search Remains Robust. In our view. we note the display business margins are significantly lower than the company’s overall margins.40A 2011E 6.00 7.2% 3m 13.  Risk to market share and increased government scrutiny. Over the past two years.00 Internet Imran Khan AC (1-212) 622-6693 imran. We think Google has done an impressive job in growing its display business.1% 1m 3.  2011 drivers. $32. (2) growth of non-search ad products.com Vasily Karasyov (1-212) 622-5401 vasily. we are maintaining our December 2011 price target of $625.d.41 2010E 6. However. with social networking sites emerging as a big threat to Google’s traffic and mobile applications letting users bypass search.com Lev Polinsky. and $37. and F'12 are $28. Google (GOOG.13 6.72A 6.khan@jpmorgan.08 8. our pro forma EPS estimates for F'10. etc. we think the margins will come under pressure as the newer revenue stream has incrementally lower margins.32 2012E 8. management indicated that mobile advertising is contributing $1B (~3% of gross revenue) in annualized run-rate revenue.karasyov@jpmorgan.com Bridget Weishaar (1-212) 622-5032 bridget.2B. Morgan Securities LLC Price Performance 600 $ 500 400 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs -4.  Display offers a strong opportunity.77 32.91A 25. including YouTube.com J. as the company now earns a ~$2.x.a.63 193. an accelerated pace.65. search queries from mobile have grown 5x.81 6.x.polinsky@jpmorgan.98 8. Apple.13 20.t.00 29 Dec 10 630.77. because of its leadership position in search volume share.35 EPS for the company. display.5B run rate in gross revenue on non-text display products including YouTube and DoubleClick.49 4. We think Google is facing an increasing amount of competition. On Google’s 3Q earnings call. J.0% 2011: (1) improved international online and ad spend penetration. We are modeling Google search gross revenue to grow ~12% in 2011.71A 6.00 31 Dec 11 Source: Company data. (3) increasing competition from Facebook.9% 12m -3. Moreover. Note: Excluding the impact of FAS 123R. Therefore. However.  Mobile will drive search usage. despite increasing competition.GOOG US) 2009A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY 4. we think mobile search will be incremental to Google’s business.58 Dec 322 625. we believe Google will continue to face more scrutiny from the government with regard to future acquisitions and business practices. Morgan estimates. GOOG US Price: $601. or 4 points of the growth.  Search is still the biggest EPS driver. Display Offers a Strong Opportunity We are maintaining our Overweight rating on Google as we believe the company will benefit from strong search revenue growth as well as likely incremental revenue from display and mobile. We believe search and AdSense for content are the most profitable business segments for the company. F'11. our estimates suggest that 1% net revenue growth in Google’s search revenue generates $0.748. As worldwide smartphone penetration continues to grow.66 5.92 7.00 Price Target: $625. .weishaar@jpmorgan. We think the overall display business will contribute an incremental ~$1. the following factors will drive GOOG shares in Overweight GOOG. CFA (1-212) 622-8343 lev.06A 5. Bloomberg.82 Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 601. Additionally.P.

we think this discount is unjustified.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 net revenue.32 Source: Company reports and J. Google trades at 21x its F’11E EPS vs. Given Google’s growth rate. If content publishers such as Yahoo! and Microsoft are able to gain market share through user defection from Google’s user base. except per-share data Base FCF Terminal Growth Rate Terminal WACC Terminal Multiple Terminal Value PV of terminal value Firm value NPV year 2012-2016 PV of terminal value Enterprise value Plus Net Cash Equity value Shares outstanding Equity Value Per Share Source: J. respectively.116 28. EBITDA and pro forma EPS estimates of $26.77 F’11E 26. Hence our Overweight rating. Google remains an Overweight pick. Morgan estimates.P.512. our price target and rating could be too optimistic. Our F’12 estimates call for net revenue. $15.P.021 123. EBITDA and pro forma EPS of $29. except per-share data Net Revenue EBITDA ProForma EPS 4Q’10E 6. Investment Risks Google has experienced fast revenue growth over the past few years.514 $171. Our price target is derived using a DCF analysis.5 $625. $17.514 48. J.208 17. 15.10B.100 15. its large-cap internet peers at 28x. 264 .65 F’12E 29.16% 13 209.00 Valuation and Rating Analysis We believe GOOG shares are fundamentally attractive due to secular industry growth trends and expansion of new product categories such as contextual ads and local search.P. Our price target and Overweight rating are based on the assumption that Google will continue to be the market leader in the paid search space and will continue to enjoy strong revenue growth.626 123.234 3.7 3.059 $201. We Maintain Our End-2011 Price Target of $625 We are maintaining our year-end 2011 price target of $625.khan@jpmorgan.787 37. Key DCF Assumptions $ in millions.48B and $32.t.536 30.32. Morgan estimates.Imran Khan (1-212) 622-6693 imran. respectively.21B.594 322.866 13.721 7.92 F’10E 21. Morgan Estimates $ in millions.485 32.65. with the parameters below.79B and $37.5% 11.

com Global Equity Research 03 January 2011 Our price target and Overweight rating are also predicated on the company’s success in the international market. 265 . it may face regulatory hurdles that make the business climate less hospitable and potentially less profitable than those of the markets in which it currently operates. as Google continues to expand its business internationally.khan@jpmorgan.t. If it cannot successfully build out a larger international advertising base. Additionally.Imran Khan (1-212) 622-6693 imran. the company will not be able to increase its monetization rate abroad.

316 (810) 8.110 18 2.520 1.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 17.240 486 9.631) 1.336 1.com Global Equity Research 03 January 2011 Google: Summary of Financials Income Statement .506 551 1.408 (3.485 0 12.520 319 20.72 FY11E 21.925 9.840 322 5.200) 0 - Source: Company reports and J.308 15.171 57.0 29.366 2.117 3.004 6.194 323 25.955 323 6.139 39.khan@jpmorgan.091 2.684 (2.819 8.381 1.178 1.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 5.064 (2.71 FY10E 25.0 15.0% 0.9% 37.547 257 3.406 45.488 264 3.4 2Q10A 5.721 0 2.240 11.2 6.477 8.037 1.493 36.936 277 3.096 7.921 65.397 8.037 2.32 32.232 323 6.1% 19.608 (3.590 2.40 FY10E 33.100 12.269 167 2.861 6.866 10.319 49.0 16.91 FY12E 18.308 212 12.485 3.029 53.2% 24.064 13.234 2.7 3Q10A 4Q10E 5.3 FY11E FY12E 43.116 254 10.7% 53.P.272) 6.148 323 28.5% 0.3% 62.845 40. Fiscal year ends Dec 266 .756 2.936 705 2.4% 20.001 69 8. Note: $ in millions (except per-share data).1% 20. Morgan estimates.192 7.t.Imran Khan (1-212) 622-6693 imran.200) 9.2% 17.167 4.504 29.298 FY11E FY12E 26.714 547 2.365 266 3.226 7.016 69 2.3% 0.3% 0.41 FY09A 24.497 4.213) 8.148 1.481 2.167 322 6.019) 233 FY10E 21.889 9.194 1.060 2.434 594 1.214 6.0% 37.82 Income Statement .709 3.0 23.506 (8.4% 60.06 FY09A 10.312 1.412 (8.

39 0. ServiceMagic revenue grew 19% Y/Y.IACI US) 2009A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY Bloomberg EPS FY ($) (0. we think the Ask.com. Additionally.x.7M and $122. the following factors could drive IACI shares in 2011: (1) growth of Match.54 0. However.44 2012E 0.a.khan@jpmorgan. we think the Match business will be the largest driver of the stock. Morgan Securities LLC Price Performance 32 28 $ 24 20 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs 45.com to Remain the Key Driver. we believe the market will remain competitive for Ask.25 1. (2) trend in the search space and (3) possible share buybacks. We are maintaining our December 2011 price target of $35.36 1. we think margins will begin to stabilize as investment levels become steadier next year.x.71 Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 30.com and believe the company will continue to expand its subscriber base.32 1. CFA (1-212) 622-8343 lev.36 1.96 .188.02 29 Dec 10 30.com.9M. Now comprising 25% of revenue and 71% of OIBA.00A 0.  Although a smaller component of the company. For the first nine months of 2010.2% 3m 10. Note: FY EPS estimates may differ from quarterly summed estimates due to rounding 'Bloomberg' above denotes Bloomberg consensus estimates.weishaar@jpmorgan.00 31 Dec 11 Source: Company data. J. Match. While Search Faces Some Challenges We are maintaining our Neutral rating on IAC. We are modeling F’11 revenue and OIBA of $428. (IACI.21 0. We think investments in the search business will be de-emphasized as the company focuses on better-performing properties such as Zwinky.20.7M. In our view.00 Internet Imran Khan AC (1-212) 622-6693 imran.Global Equity Research 03 January 2011 IAC/InterActive Corp.20 0. We expect growth to be primarily driven by continued healthy subscriber growth as well as the new Yahoo! arrangement. respectively. IAC/InterActive Corp.32 0.  Match.41 2010E 0. IACI US Price: $30. driven by an increase in service requests.31A 0.polinsky@jpmorgan. as large search players continue to make innovations to the space.02 0.com business will remain challenged and will become less of a focus for management.24A 0.02 Price Target: $35.02) 0.P.com Lev Polinsky.com will be less of a priority to management.96 Dec 106 35. We are encouraged by the growth of Match. Morgan estimates.com J.d.89A 2011E 0.P.com Bridget Weishaar (1-212) 622-5032 bridget.com Vasily Karasyov (1-212) 622-5401 vasily.87A 0. compared to 18% growth in F’10E.5% 12m 46. We expect search revenue growth to decelerate and are modeling ~8% Y/Y search rev growth in F’11.9%  2011 drivers. We are modeling F’11 revenue and OIBA of $195. respectively. We expect the business to benefit from improving macroeconomic conditions in 2011.com Shelby Taffer (212) 622-6518 shelby.taffer@jpmorgan. Additionally.36 0.24 0. Estimates in this table are pro forma.32A 0.  We think Ask. ServiceMagic should continue to shine.karasyov@jpmorgan.t.9M and $16.34 0. Bloomberg. Neutral IACI. .34 0.01 3.8% 1m 5.com will likely be the major property.

EV/EBITDA Multiple Analysis $ in millions except multiple.Debt Market Value Share count 2011 Price Target Source: Company reports and J.4 95.9M and $1.25 F’12E 1854.0 1.7 208. Strategic acquisitions could also weigh on the company’s performance.P.00 Valuation and Rating Analysis On an EV/EBITDA basis.Imran Khan (1-212) 622-6693 imran.77B. We Maintain Our End-2011 Price Target of $35 We are maintaining our year-end 2011 price target of $35. except per-share data Revenue OIBA Pro forma EPS 4Q’10E 432. 280. respectively.8 3. Our price target is derived using a DCF analysis. with the parameters below. 268 . We maintain our Neutral rating.1 0. J.khan@jpmorgan.87 F’11E 1770. Morgan estimates. $216. OIBA and pro forma EPS estimates of $1.5 101. Our F’12 estimates call for revenue. its peer group which trades at 14.t.3 2328.3x our $281M FY’11 EBITDA estimate. Downside risks: The company is unable to achieve higher query volumes from Ask.5 0. OIBA and pro forma EPS of $1.3x.3 189.7 216. Investment Risks Upside risks: The company is able to sustain growth in its media & advertising business and in the personals business despite a competitive search market and international pressures and/or introduces a large share-buyback program.8 54.com.31 F’10E 1643. macroeconomic pressures impact ServiceMagic more than expected.32. $208. and/or international weakness weighs on Personals.0 35. respectively.606. Morgan estimates. vs.9 1. Morgan Estimates $ in millions.0M and $1.6 8.P.32 Source: J.25. share count and price target EV/EBITDA Multiple Analysis 2011 EBITDA Peer Group EV/EBITDA Multiple Implied Enterprise Value + Cash .P.9 1.85B. IACI trades at 6.373.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue.

263 113 145 1.87 1.016 96 888 3.376 (1.466 96 961 2.P.6% 59. Fiscal year ends Dec 269 .5% 15.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A FY10E FY11E FY12E 1. Note: $ in millions (except per-share data).4% 34.000 297 4.4% 52.7 FY09A FY10E FY11E FY12E 1.54 1.Imran Khan (1-212) 622-6693 imran.8%) (1.4%) 0.00) FY09A (4.4 1.5%) (69.521 246 3.7%) 12.058) 222 169 91 (968) 1 (979) 142 0.128 (969) 222 130 332 (38) 294 (427) (406) 1. Morgan estimates.734 102 165 2.1% 1.3% (70.32 Income Statement .32 FY11E 24.khan@jpmorgan.3 2Q10A 403 24 22 67 (4) 20 5 14 115 0.7 3Q10A 4Q10E 422 36 18 71 0 36 15 18 108 0.t.360 113 145 1.7% 2.24 FY10E 19.: Summary of Financials Income Statement .643 94 81 257 (21) 73 33 32 111 0.31 FY12E 22.com Global Equity Research 03 January 2011 IAC/InterActive Corp.771 115 82 281 0 115 46 69 101 1.587 96 961 2.626 40 81 35 269 (40) 229 (36) (589) 1.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 386 4 21 47 (17) (14) 4 (19) 116 (0.4% 0.6 (24.1 433 31 20 72 0 31 9 19 106 0.618 270 3.25 1.1%) (25.7%) 55.505 69 82 0 237 (47) 190 (47) (286) - Source: Company reports and J.

khan@jpmorgan.com Global Equity Research 03 January 2011 270 .Imran Khan (1-212) 622-6693 imran.t.

Global Equity Research
03 January 2011

Liberty Interactive
Internet Sales Growing at QVC; Strong International Outlook
We are maintaining our Overweight rating on LINTA as we believe the company will see a strong domestic QVC performance and robust international growth. We are maintaining our December 2011 price target of $19.  Domestic QVC growth likely to be driven by internet usage. We think that internet sales will be a significant driver for growth as existing customers embrace use of the vehicle to order or reorder items not currently aired on TV and as non-QVC customers discover the website though product searches on search engines. In the first nine months of 2010, internet penetration grew to 32% of purchases from 28% in the year-ago period. We are modeling this penetration rate to reach 35% in F’11 and 37% in F’12.  We think international revenue growth will outpace that of the US. International markets will likely be aided by the following factors: 1) improved subscriber penetration, 2) improved product mix, 3) contributions from QVC Italy. We are estimating international QVC rev of $2.9B in F’11, which includes $120M from QVC Italy.  Many headwinds will be comped. F’10 OIBDA was negatively impacted by the following factors: 1) the loss of the eCommerce commission-related businesses which contributed ~$32M to F’09 revenue; 2) the refinancing of the GE bank credit agreement; which would have negatively impacted OIBDA by ~$20-25M in F’09; 3) investment in QVC Italy, which we think will negatively impact OIBDA by ~$30-40M. If our estimates are adjusted for these events, we think F’10 OIBDA growth would be closer to ~11% Y/Y vs. our currently modeled 6% growth. Thus, we feel comfortable with our F’11 OIBDA growth estimate of 8% Y/Y.  LINTA should benefit from being a stand-alone company. We think LINTA’s tracking stock discount should disappear, new investors could be attracted to this asset-backed stock, there is additional clarity to the story, and the company has greater options in capital raising and acquisitions.  2011 drivers. In our view, the following factors will drive LINTA shares in 2011: (1) new customer growth at QVC, (2) performance of QVC Italy and (3) OIBDA expansion.
Liberty Media Holding Corp. Interactive (LINTA;LINTA US) 2009A 2010E EPS Reported ($) Q1 (Mar) (0.10) 0.52A Q2 (Jun) 0.21 0.10A Q3 (Sep) (0.01) 0.17A Q4 (Dec) 0.32 0.23A FY 0.43 1.02A Bloomberg EPS FY ($) 0.35 1.01A

Overweight
LINTA, LINTA US Price: $15.59 Price Target: $19.00

Cable TV, Entertainment Bridget Weishaar
AC

(1-212) 622-5032 bridget.a.weishaar@jpmorgan.com

Imran Khan
(1-212) 622-6693 imran.t.khan@jpmorgan.com J.P. Morgan Securities LLC
Price Performance
16 $ 14 12 10
Dec-09 Mar-10 Jun-10 Sep-10 Dec-10

YTD Abs 39.7%

1m -1.1%

3m 12.6%

12m 42.8%

2011E 0.11 0.18 0.12 0.32 0.73 0.74

2012E 0.14 0.20 0.15 0.35 0.83 0.95

Source: Company reports, Bloomberg, J.P. Morgan estimates. 'Bloomberg' above denotes Bloomberg consensus estimates.

Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date

15.59 29 Dec 10 16.80 - 10.07 9,416.36 Dec 604 19.00 31 Dec 11

Bridget Weishaar (1-212) 622-5032 bridget.a.weishaar@jpmorgan.com

Global Equity Research 03 January 2011

Our Estimates and Outlook for 2011 and 2012
We are maintaining our F’11 revenue, OCF and pro forma EPS estimates of $9.65B, $1.89B and $0.73, respectively. Our F’12 estimates call for revenue, OCF and pro forma EPS of $10.35B, $2.01B and $0.83, respectively.
J.P. Morgan Estimates
$ in millions, except per-share data Revenue OCF Pro forma EPS 4Q’10E 2,852.7 568.1 $0.23 F’10E 8,898.7 1,750.1 $1.02 F’11E 9,650.6 1,894.1 $0.73 F’12E 10,353.6 2,008.6 $0.83

Source: Company reports and J.P. Morgan estimates.

We Maintain Our End-2011 Price Target of $19
We are maintaining our year-end 2011 price target of $19. Our price target is derived using a DCF analysis, with the parameters below.
Key DCF Assumptions
Equity beta Risk free rate (10yr yield) Risk premium Cost of Equity Cost of debt Final debt ratio Equity as a % Cap 1.04 2.5% 8.5% 11.4% 6.9% 5.0% 95.0%

Source: Company reports, Bloomberg, J.P. Morgan estimates.

Valuation and Rating Analysis
LINTA is trading at 6.2x our F’11E EBITDA vs. the peer group average of 7.9x. We do not think that this discount is justified given QVC growth prospects in existing and new markets. We rate the stock Overweight.

Investment Risks
Downside risks: QVC could underperform our expectations if QVC.com does not continue to outperform the domestic TV shopping business. Underperformance could also occur if the other eCommerce holdings do not outperform brick-and-mortar retail. Margins could be weaker than expected if production and broadcasting costs increase. Finally, given QVC’s exposure to international markets, we are assuming that there are no changes in the regulations governing its business in foreign countries.

272

Bridget Weishaar (1-212) 622-5032 bridget.a.weishaar@jpmorgan.com

Global Equity Research 03 January 2011

Liberty Interactive: Summary of Financials
Income Statement - Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares EPS - GAAP Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Levered free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 8,305 1,041 566 1,654 (590) 451 (154) 258 595 0.43 FY09A 884 1,250 1,245 3,379 1,030 17,343 6,073 10,420 6,923 258 566 147 1,087 (208) 879 FY10E FY11E FY12E Income Statement - Quarterly 8,899 1,120 566 1,750 (213) 907 (251) 613 602 1.02 9,651 1,222 600 1,894 (424) 798 (319) 440 604 0.73 Revenues Operating Income D&A EBITDA 1Q10A 2,025 218 141 381 239 457 (137) 310 595 0.52 FY09A 2Q10A 3Q10A 4Q10E 2,053 274 139 428 (140) 134 (69) 58 605 0.10 FY10E 1,968 220 141 373 (155) 65 55 105 604 0.17 2,853 408 145 568 (157) 251 (100) 140 604 0.23

- Net interest income / (expense) - Other income / (expense) - Pretax income - Income taxes - Net income - Weighted average diluted shares 0.83 EPS - GAAP

FY10E FY11E FY12E Ratio Analysis 1,347 2,283 685 734 1,231 1,240 3,263 4,257 1,037 1,077 16,590 17,427 5,415 9,976 6,613 645 566 388 1,416 (229) 1,187 4,972 9,576 7,851 440 600 97 1,216 (280) 936 (280) 0 Sales growth EBITDA growth EPS growth EBITDA margin Net margin

FY11E FY12E 21.4 18.7

2.8% 7.1% 6.4% 5.8% (133.0%) 134.7% 19.9% 3.1% 3.7 1.5% 3.9% 0.0 0.0 36.0 19.7% 7.2% 3.1 3.9% 9.5% 0.0 0.0 15.3

- Debt / EBITDA - Return on assets (ROA) Return on equity (ROE) - FV / EBITDA - FV / Unlevered free cash flow - P/E -

48 961 (1,066) (1,923) -

Source: Company reports and J.P. Morgan estimates. Note: $ in millions (except per-share data). Fiscal year ends Dec Note: EBITDA excludes stock compensation expense

273

Bridget Weishaar (1-212) 622-5032 bridget.a.weishaar@jpmorgan.com

Global Equity Research 03 January 2011

274

Global Equity Research
03 January 2011

MediaMind
Increasing Demand for New Products Should Help Drive Healthy Top-Line Growth
We are maintaining our Overweight rating on MediaMind as we believe the company provides a critical solution for digital ad campaign management across a broad global reach. We are maintaining our December 2011 price target of $18.  Critical solution for digital ad campaign management. Global internet advertising is expected to be a ~$67B market in 2010, representing ~14% of total ad spend. Given that the consumption of online media continues to grow, IDC estimates that online ad spend will be ~$100B in 2013. However, the process of executing a digital ad campaign is becoming increasingly complex as the internet fragments further. Additionally, consumer banner blindness and the difficulty of interpreting performance data create challenges for advertisers. Because MediaMind addresses these challenges and provides a comprehensive solution for advertisers and ad agencies, we think the company will experience strong revenue growth.  Publisher-neutral platform is appealing to customers. Despite the fact that MediaMind’s largest competitors are parts of large advertising players such as Google and Microsoft, MediaMind grew its revenue 29% in the first nine months of 2010. We think many agencies are looking for an independent, publisher-neutral platform as they believe it will more likely serve ads without any bias toward channels, formats or specific websites.  Highly scalable business model. MediaMind’s business uses low capex (~4% of revenue in F’10E) and thus offers a strong margin-expansion opportunity. MediaMind has been profitable since 2002. As the revenue grows, we believe the company will see leverage from sales and marketing and R&D, and we expect operating margins to be 21.4% and 22.5% in F’11 and F’12, respectively, up from 16.9% in F’10E.  Platform customers to comprise over half of F’11E revenues. We believe MediaMind will generate more revenue per customer as it transitions clients to use more of the platform’s capabilities. By the end of 2011, we expect more than half of its total revenue to come from platform customers that adopt MediaMind as an end-to-end solution for all their ad campaigns.  2011 drivers. In our view, the following factors will drive MDMD shares in 2011: (1) further recovery of the advertising market, (2) new capabilities of the MediaMind platform and (3) sales and marketing leverage.
MediaMind Technologies (MDMD;MDMD US) 2009A EPS Reported ($) Q1 (Mar) (0.01) Q2 (Jun) 0.14 Q3 (Sep) 0.12 Q4 (Dec) 0.31 FY 0.58
Source: Company data, Bloomberg, J.P. Morgan estimates. Note: Pro forma EPS estimates used.

Overweight
MDMD, MDMD US Price: $13.71 Price Target: $18.00

Internet Imran Khan
AC

(1-212) 622-6693 imran.t.khan@jpmorgan.com

Shelby Taffer
(212) 622-6518 shelby.x.taffer@jpmorgan.com

Lev Polinsky, CFA
(1-212) 622-8343 lev.x.polinsky@jpmorgan.com

Bridget Weishaar
(1-212) 622-5032 bridget.a.weishaar@jpmorgan.com

Vasily Karasyov
(1-212) 622-5401 vasily.d.karasyov@jpmorgan.com J.P. Morgan Securities LLC
Price Performance
16 14 $ 12 10
Aug-10 Nov-10

YTD Abs 19.2%

1m 3.1%

3m -3.0%

12m 19.2%

2010E 0.06A 0.17A 0.10A 0.28A 0.61A

2011E 0.09 0.22 0.14 0.37 0.81

2012E 0.11 0.26 0.16 0.42 0.96

Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date

13.71 29 Dec 10 16.11 - 10.50 297.51 Dec 22 18.00 31 Dec 11

Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com

Global Equity Research 03 January 2011

Our Estimates and Outlook for 2011 and 2012
We are maintaining our F’11 revenue, EBITDA and EPS estimates of $95.3M, $26.4M and $0.68, respectively. Our F’12 estimates call for revenue, EBITDA and EPS of $111.9M, $31.2M and $0.83, respectively.
J.P. Morgan Estimates
$ in millions, except per-share data Revenues EBITDA Diluted EPS Pro forma EPS 4Q’10E 25.5 9.0 0.25 0.28 2010E 80.4 19.9 0.54 0.61 2011E 95.3 26.4 0.68 0.81 2012E 111.9 31.2 0.83 0.96

Source: Company reports and J.P. Morgan estimates. Note: Diluted EPS are calculated assuming no accretion of preferred stock dividend. Pro forma EPS adds back stock-based comp. and uses full post-offering share count in all time periods.

We Are Maintaining Our End-2011 Price Target of $18
We are maintaining our year-end 2011 price target of $18. Our price target is derived using a DCF analysis, with the parameters below.
Key DCF Assumptions
Equity beta Risk free rate Risk premium Cost of equity Cost of debt Final debt ratio Equity as a % cap WACC
Source: J.P. Morgan estimates, Bloomberg.

1.00 2.6% 8.4% 11.0% 8.0% 0.0% 100.0% 11.0%

Valuation and Rating Analysis
MediaMind trades at 7.7x our F’11 EBITDA estimate of $26M vs. its peer group at 13.6x. We believe the company’s growth prospects do not merit this discount and thus rate MDMD Overweight.

Investment Risks
The company is unable to compete successfully with Google and Microsoft; it loses a major customer - such as Microsoft, which is also a competitor – or faces a reduction in its customers’ advertising budgets; consolidation of internet advertising networks impairs MediaMind’s ability to serve advertisements and collect campaign data; the company either does not continue to innovate and provide high-quality solutions and services or does not do so as quickly as its competitors; the internet advertising market deteriorates or develops more slowly than expected; there is an extended downturn in the US, European or worldwide economy, driving weakness in ad spend; and/or fluctuations in currency exchange rates have a negative impact on the company’s operating results.

276

Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com

Global Equity Research 03 January 2011

MediaMind: Summary of Financials
Income Statement - Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 65 12 1 17 0 (50) 12 (2) 10 13 0.76 FY09A 15 24 19 59 2 67 12 55 10 1 (4) 10 (1) 9 (22) 0 FY10E FY11E FY12E 80 14 2 20 0 (63) 14 (4) 10 18 0.54 95 20 2 26 1 (70) 21 (6) 15 22 0.68 112 25 2 31 1 (81) 26 (8) 18 22 0.83 Income Statement - Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 16 1 0 2 0 (14) 1 (0) 1 16 0.04 FY09A 2.0% 46.7% 48.6% 25.7% 15.1% 14.7% 72.2% 23.7 2Q10A 21 4 0 6 (1) (16) 4 (1) 3 16 0.18 FY10E 23.6% 19.1% 6.1% 24.7% 12.1% 6.8% 63.1% 22.4 3Q10A 18 1 1 3 1 (16) 1 (0) 1 19 0.05 FY11E 18.5% 32.8% 32.5% 27.7% 15.6% 9.0% 74.3% 16.9 4Q10E 25 8 0 9 0 (17) 8 (2) 5 22 0.25 FY12E 17.4% 18.3% 18.5% 27.9% 16.3% 9.7% 83.5% 14.2

FY10E FY11E FY12E 53 32 47 132 5 143 17 126 10 2 (4) 11 (4) 8 (30) 56 66 40 47 153 5 164 21 143 15 2 (4) 17 (4) 13 (4) 0 83 47 47 176 5 188 24 164 18 2 (4) 21 (4) 17 (4) 0 -

Source: Company reports and J.P. Morgan estimates.

Note: $ in millions (except per-share data). Fiscal year ends Dec

277

Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com

Global Equity Research 03 January 2011

278

7M.P.48 0.54 0. Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 69.50.com Bridget Weishaar (1-212) 622-5032 bridget.14 Dec 44 82.96.43A 0.43A 0. As this impact dissipates. MercadoLibre.t.40 0.52 1.41 0.63. We think significant additional penetration gains are possible and model TPV to reach 25% of GMV by the end of F’11.  Pago 3. (3) TPV growth and (4) take rate trends. Inc.56 0.  Raising estimates.d. We think MELI is well-positioned to capitalize on economic growth.0 rollout should help drive TPV growth. MELI US Price: $69.x. and $1.64 0. Long-Term Outlook Remains Strong.37 0.0 Should Drive TPV Growth.1% 12m 33.karasyov@jpmorgan. and we see upside to GMV growth.22A 0.081. We are raising our F’11 revenue.35A 1.47 1.0% 1m 6.35. $110M. higher broadband expansion and the growth of eCommerce in Latin America. Morgan estimates.82 29 Dec 10 76. J.polinsky@jpmorgan.1M and $1.P.  Very bullish on long-term outlook.28 0.27A 0. $119M and $1. We believe the rollout of MercadoPago 3. (2) MercadoPago penetration.48 0.20 2. we think the take rate could be pressured by the expansion of free listings on the site.com Vasily Karasyov (1-212) 622-5401 vasily. Upgrade to Overweight We are upgrading MELI to Overweight from Neutral.81 . 'Bloomberg' above denotes Bloomberg consensus estimates. In the near term. we expect revenue. respectively.67 2. We expect GMV growth to remain healthy as eCommerce penetration in Latin America is below 2%.3% 3m -7. EBITDA and EPS of $392M.35A 1.45 0.26A 0.com J. EBITDA and EPS estimates to $296M.a.weishaar@jpmorgan.2% (1) GMV growth. from $282M. We are raising our end-2011 price target to $82 from $65. Inc.26A 1.khan@jpmorgan.50 3. 3Q saw average selling prices (ASPs) decline due to the appreciation of the Brazilian real last year and the follow-up lag in seller price adjustments. with growth accelerating in 2H’11.00 31 Dec 11 . CFA (1-212) 622-8343 lev. We expect MELI to manage take rates to maintain growth and minimize margin erosion.00 Internet Imran Khan AC (1-212) 622-6693 imran. $142.22A 0.60 1.00 Previous: $65.com Shelby Taffer (212) 622-6518 shelby. TPV was 21.Global Equity Research 03 January 2011 ▲ Overweight MercadoLibre. We believe the company is well-positioned to take advantage of eCommerce growth in Latin America. crossing the 20% mark for the first time. For F’12. However.50 0. driven by a 34% rise in successful items. Bloomberg. We also think broader integration of Pago should reduce friction and help drive GMV growth. (MELI.26A 0.17 Source: Company data.82 ▲ Price Target: $82.63 1. Pago 3. longer term we believe there is plenty of upside to the take rate as the Latin America eCommerce market is still in the early stages of development.  2011 drivers.com Lev Polinsky.96 0. our prior respective estimates of $357.MELI US) 2010E (Old) 2010E (New) 2011E (Old) 2011E (New) 2012E (Old) 2012E (New) EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY Bloomberg EPS FY ($) 0. In our view.x.29 0. GMV grew 23% in 9M’10 in dollar terms.35 0.34 0. the following factors will drive MELI shares in 2011: Previous: Neutral MELI.  ASPs should begin to improve in 1Q’11.26A 0.taffer@jpmorgan. we expect ASPs to rise beginning in 1Q’11.  Managing business for growth.0 should rapidly grow use of the payments solution and boost TPV. $158M and $2.4% of GMV in 3Q.20 vs. Morgan Securities LLC Price Performance 80 65 $ 50 35 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs 38.

4 85.7 142.6 109. respectively. (4) Creating an online marketplace requires little capital.9 84. $142. could negatively impact our estimates for eCommerce growth in the region and therefore growth for MercadoLibre.26 3. MELI trades at 43x our F’11 estimate of $1. Our new F’12 estimates call for revenue. Morgan Estimates $ in millions except EPS 4Q’10E new 62. (3) MELI has grown through a number of acquisitions since its inception in 1999. Google. Yahoo! or Amazon. EBITDA and EPS of $295.9 118. its peer group at 37x. respectively.9 1.6% 12. Regional or global economic weakness. we are raising our year-end 2011 price target to $82.t.26 F’10E old 215. governments may limit internet or eCommerce activities.0% 12. EBITDA and EPS of $392.0 25. Our price target is derived using a DCF analysis.khan@jpmorgan. J.0 157.96 Revenue EBITDA EPS Source: Company reports and J. Morgan estimates. In addition.P.8 0.96. $109. Political instability could affect customers’ confidence and therefore their willingness to purchase goods online.20.3% 7.7M.20 F’12E old 357. from $65 previously.9 2.0M.9 1. We believe the company’s strong fundamentals and free cash flow generation justify a premium valuation and thus rate the stock Overweight. Investment Risks Downside risks: (1) Several of MELI’s core markets have a history of economic turmoil and financial crises.63 vs.0 1. Bloomberg.9M and $2. $118. 280 . As the company looks to grow into new product offerings and markets.35 F’10E new 216. $157.9M and $1. DCF Valuation Equity beta Risk free rate (10yr yield) Risk premium Cost of Equity Equity as a % Cap WACC Source: J.1 1.63 F’11E old 281.1M and $1. (2) MELI operates in many countries with a history of political instability.35 4Q’10E old 61.com Global Equity Research 03 January 2011 Raising Estimates and Outlook for 2010.6M. such as eBay.50.9% Valuation and Rating Analysis On a P/E basis. Also. 1.26 F’11E new 295. which have deeper pockets than MELI’s.50 F’12E new 392. or an economic upheaval. since the owner does not need to stock merchandise and fulfill orders. Either event could stress its financial resources.0 0. Morgan estimates.P. it may look to acquire other companies or be forced to spend substantial cash to develop its own products.9M and $1. We Are Raising Our End-2011 Price Target to $82 from $65 After flowing through our newly increased estimates.P. up from our prior estimates of $281.63. 2011 and 2012 We are now modeling F’11 revenue. above our prior estimates of $357.9 1. with the parameters below.6 24.Imran Khan (1-212) 622-6693 imran. Latin American eCommerce growth might attract the interest of larger players.9M.9% 100.

26 296 107 7 119 (1) (2) 104 (31) 73 44 1.4% 32.7 2Q10A 49 19 1 21 (2) (0) 16 (5) 12 44 0.9% 0.: Summary of Financials Income Statement . Morgan estimates.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 159 43 4 48 (11) (3) 29 (10) 20 44 0. Inc.75 FY09A 64 5 13 82 6 183 68 114 20 4 12 38 (4) 34 (4) 0 FY10E FY11E FY12E 216 76 5 85 (4) (0) 72 (16) 56 44 1.Imran Khan (1-212) 622-6693 imran.6% 0.2% 0.5 3Q10A 56 19 1 22 1 (0) 20 (1) 19 44 0.4% 25.9% 34.4% 12.63 392 143 9 158 (1) (2) 141 (42) 99 45 2.8% 30.0 42.0 55.4% 40.P.2% 24.4% 0.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 43 16 1 17 (2) 0 14 (4) 10 44 0.7% 0.8% 15.0 19.3% 25.8% 75.t.3% 25.5% 66.0 21.0% 0.35 FY12E 32.0 19.43 FY11E 36.8% 17.2% 30.26 FY10E 35.22 FY09A 21.9% 39.5% 32.8 FY10E FY11E FY12E 74 9 21 104 19 259 88 171 56 5 11 75 (13) 63 (13) 0 168 15 31 214 20 370 120 250 73 7 14 102 (8) 94 (8) 0 290 20 41 350 21 507 150 357 99 9 14 131 (9) 122 (9) 0 - Source: Company reports and J.0 10.7% 39.20 Income Statement .0 0. Fiscal year ends Dec 281 .khan@jpmorgan.9% 77.0% 40.3% 0. Note: $ in millions (except per-share data).0 0.com Global Equity Research 03 January 2011 MercadoLibre.0 92.0 0.7 4Q10E 62 22 1 25 (0) (0) 22 (6) 15 44 0.0 31.5% 0.7% 29.0 0.

Imran Khan (1-212) 622-6693 imran.khan@jpmorgan.com Global Equity Research 03 January 2011 282 .t.

While we expect Netflix to increase its content costs.6% at the end of 4Q’11.53 1.64 and $6.27 Price Target: $186. 'Bloomberg' above denotes Bloomberg consensus estimates.P.P. Morgan estimates.  Churn should see further declines.10.04A 2011E 0. Therefore. which carries a much higher cost of delivery (due to postage) than the streaming product. We think overall churn will decline as streaming subscribers increase and as the overall business matures.9% at the end of 4Q’09. We expect further subscriber growth to be driven by: 1) continued retail store closures.52 0.NFLX US) 2009A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY Bloomberg EPS FY ($) 0.27 29 Dec 10 209.95 1. F'11 and F'12 EPS estimates are $3. we think content delivery costs will grow at a significantly slower pace than revenue growth.78 Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 180.00 Internet Imran Khan AC (1-212) 622-6693 imran. Morgan Securities LLC Price Performance 220 160 $ 100 40 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs 237.taffer@jpmorgan. Netflix grew its subscriber base 43% Y/Y in the first nine months of 2010.52 9.com Lev Polinsky.  Expect strong subscriber growth in F’11.6% 216.14 Dec 54 186. International Offers a Strong Opportunity We are maintaining our Overweight rating on Netflix as we believe the company is poised for additional subscriber growth while being able to manage its rising content costs.722.99 2.6% in F’11. NFLX US Price: $180.  Content costs are manageable.x. we think there is a lot of local long-tail content internationally that Netflix could successfully monetize. (2) gross margins. The company has indicated that international expansion could happen as early as 2H’11. $4.00 2010E 0.com Bridget Weishaar (1-212) 622-5032 bridget. Moreover. .a.  International market offers a strong opportunity. our F'10. We believe international expansion would be a key growth opportunity for Netflix as it would contribute to robust subscriber growth.23 1.48. the following factors will drive NFLX shares in 2011: (1) subscriber growth.com Shelby Taffer (212) 622-6518 shelby.weishaar@jpmorgan.59A 0. CFA (1-212) 622-8343 lev.karasyov@jpmorgan.com J.72A 2.polinsky@jpmorgan.4% 3m 12m 5.khan@jpmorgan.8% toward the end of 2010 and 3.07 2012E 1. Excluding FAS123R.d. We are maintaining our December 2011 price target of $186. which we view as a potential low-risk investment. (4) content deals and (5) free cash flow.11 4.37 0.com Vasily Karasyov (1-212) 622-5401 vasily.42 1.12. down from 3. and 2) international expansion.t.24 .Global Equity Research 03 January 2011 Netflix Inc Subscriber Growth to Remain Healthy. We are modeling a gross margin of 36.15 1.54 0. we think rising costs are manageable.12 1.70A 0. (3) operating margins.80A 0.54 5. We are modeling an average monthly churn of 3. In our view.x. Netflix Inc (NFLX.00 31 Dec 11 Source: Company data and J.33 4.4%  2011 drivers. Overweight NFLX.56 1.1% 1m -9. which we estimate put ~$1B in rental revenue up for grabs in 2010. partially driven by lower utilization of DVD by mail. and we are projecting the company to exceed 26M subscribers by the end of 2011.82A 3.72 5.

with the parameters below.79 F’10E 19.3M and $4. we believe it deserves a premium.8x. 0. respectively. Bloomberg.5% 10. 4Q’10E 19.0% 7.Imran Khan (1-212) 622-6693 imran. are able to offer more attractive customer offerings and thus take market share.7% 149 $0. Investment Risks Downside risks: The company is not able to manage future postal price increases effectively. $853.64 F’12E 32. The company is not able to strike deals with content owners to continue to expand its streaming catalog.5M and $6. Key DCF Assumptions Equity beta Risk free rate (10yr yield) Risk premium Cost of Equity Cost of debt Final debt ratio Equity as a % Cap WACC Source: Company reports.12.9% 587 $3.6 3004 14.85 2.P. or sites such as YouTube. J.10 F’11E 26.khan@jpmorgan.12 We Maintain Our End-2011 Price Target of $186 We are maintaining our year-end 2011 price target of $186.64. EBITDA and pro forma EPS of $3.8% Valuation and Rating Analysis Given the result of the DCF analysis above and our belief that Netflix is well positioned to benefit from trends in the movie rental industry.P.7% 854 $6. the peer group average of 7. we rate the company Overweight. On an EV/EBITDA basis. Our F’12 estimates call for revenue.3% 712 $4. Given that NFLX is growing EBITDA at 21% Y/Y compared to a 7% average for the peer group. Morgan estimates. respectively. 284 . Morgan Estimates units as indicated Qtr-End Subs (M) Revenue ($M) Pro Forma Operating Margin EBITDA ($M) Pro forma EPS Source: Company reports and J.5 594 12. Morgan estimates.3x our F’11E EBITDA vs. Competitors such as Redbox.5% 8.0% 90. EBITDA and pro forma EPS estimates of $3.76B. $712.7% 8. Netflix trades at 13.5 2161 13.t. Amazon or Apple. Our price target is derived using a DCF analysis.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue.00B.6% 7.4 3758 14. J.P.

com Global Equity Research 03 January 2011 Netflix Inc: Summary of Financials Income Statement .6 2Q10A 520 77 9 152 1 (5) 73 30 44 54 0.t.0% 0.1 90.59 FY09A 22.7% 8.9% 6.33 3.1% 19. Note: $ in millions (except per-share data).P.0% 26.004 402 37 712 7 (20) 389 160 230 53 4.99 FY09A 320 91 411 132 680 37 481 199 116 38 18 325 (228) 86 (246) (85) FY10E FY11E FY12E 2.7% 41.670 192 38 449 7 (6) 192 76 116 58 1. Fiscal year ends Dec 285 .3% 53.7 4Q10E 594 69 9 149 1 (5) 65 27 39 53 0.2% 7.7% 7.8% 32.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 1.khan@jpmorgan.0 41.161 275 38 587 4 (20) 259 106 152 54 2.0 31.1% 0.5 FY10E FY11E FY12E 268 210 478 125 756 35 571 185 152 38 108 262 (73) 98 (108) (165) 238 251 489 125 767 35 687 80 230 37 76 265 0 95 (156) (139) 265 282 546 125 824 35 774 50 302 38 56 310 0 138 (157) (126) - Source: Company reports and J.0 3Q10A 553 70 9 155 1 (5) 65 27 38 54 0.72 FY12E 25.9% 0.4% 23.4% 30.Imran Khan (1-212) 622-6693 imran.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 494 58 11 131 1 (5) 54 22 32 55 0.6% 50.2% 22.72 Income Statement .80 FY10E 29.6% 0.82 3.5% 23.1 64.6% 27. Morgan estimates.70 FY11E 39.0% 21.758 516 38 854 7 (20) 504 201 302 53 5.

Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com Global Equity Research 03 January 2011 286 .

12 0. YTD Abs -28. (2) growth of its hotel business and (3) increased investments.polinsky@jpmorgan.34 2012E (0. We are maintaining our December 2011 price target of $8.53 Dec 105 8.12 Q3 (Sep) 0. Neutral OWW.14 (0.10 0. International gross bookings grew 29% Y/Y in the first nine months of 2010. We think margins may be pressured next year from increased marketing spend due to a likely rise in cost per click (CPC) as well as efforts to strengthen the Orbitz brand.karasyov@jpmorgan.34 2010E (0.03) 0. Bloomberg. the following factors will drive OWW shares in 2011: (1) cash balance and leverage ratios. 'Bloomberg' above denotes Bloomberg consensus estimates. partly driven by a strong performance from ebookers.22) FY (4. Morgan estimates.  Hotel room night sales will remain an area of focus in 2011. We expect marketing as a percentage of revenue to be 29.3.com Lev Polinsky. OWW US Price: $5.02) Q2 (Jun) 0.00 Internet Imran Khan AC (1-212) 622-6693 imran.09)A 0. Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 5.09A 0. Morgan Securities LLC Price Performance 7 $ 5 3 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10  2011 drivers.26A 2011E (0.com Vasily Karasyov (1-212) 622-5401 vasily.  Margins may be pressured by a continued investment phase. We are pleased with the progress Orbitz has made from its global technology platform for its US businesses and are encouraged by the upcoming migration of HotelClub to the global platform. While we are encouraged by the company’s focus on growing its hotel business.OWW US) 2009A EPS Reported ($) Q1 (Mar) (4.0% in F’11.15 (0. We believe the ebookers business will continue to post healthy transaction and room night growth in 2011.com Bridget Weishaar (1-212) 622-5032 bridget. slightly above our 29.00 31 Dec 11 .t.a.7% 3m -11. But Challenges from Competitors Persist We are maintaining our Neutral rating on Orbitz. CFA (1-212) 622-8343 lev.P. Inc.86 . Inc.41 Source: Company data.56 582. (OWW. In our view.15 0.1% Orbitz Worldwide.com Shelby Taffer (212) 622-6518 shelby.08 Q4 (Dec) (0. We are modeling international gross bookings growth of 15.8% 12m -26. ebookers Should Help International Growth.16 0.2% estimate in 2010.05)A 0. we believe it will face challenges reaching the brand identity and inventory scale of Expedia and Priceline.04) Bloomberg EPS FY ($) 0.06) 0.09A 0.08) 0.P.taffer@jpmorgan.6%. we remain cautious about the challenges to be overcome before reaching the brand identity and inventory scale of Expedia and Priceline.03) 0. We expect Orbitz to continue its investment mode to achieve its goal of increasing hotel sales.53 29 Dec 10 7. We expect management to continue its focus on building the company’s hotel business.Global Equity Research 03 January 2011 Orbitz Worldwide.d.khan@jpmorgan.15A (0. However.8% 1m 1.  International growth will be supported by ebookers. J.com J.3% in 2011.weishaar@jpmorgan. aiding Orbitz’s international performance.x.53 Price Target: $8.x. and a revenue margin of 9.

15 2012E 850 179 0.15. and/or 4) the online travel market achieves penetration levels beyond our current expectations. Morgan Estimates $ in millions.09 2011E 802 165 0. respectively. Investment Risks Upside risks: 1) Hotel product sales and international sales exceed our expectations. 125. 2) further acquisitions are made in the international space.P.Imran Khan (1-212) 622-6693 imran. with the parameters below.0% 10.P. $165M and $0. 2) maintain its domestic leadership position.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue. and/or 5) meet debt covenants that could also hinder operational strategies. we think further multiple expansion unlikely and reiterate our Neutral rating. Our F’12E revenue. respectively. below the peer group average of 14x. 3) the company gains market share against its existing online travel agent competitors. EBITDA and EPS estimates of $802M. 3) grow the top line due to economic conditions. EBITDA and EPS are $850M.8 0.P. Downside risks: The company is unable to 1) withstand the competitive threat that the travel suppliers and travel search engines pose. We Maintain Our End-2011 Price Target of $8 We are maintaining our year-end 2011 price target of $8. J.249 773 458 773 $1.16 Source: Company reports and J. Morgan estimates.07% 10 1.09) 2010E 752 151 0. Morgan estimates. Our price target is derived using a DCF analysis.khan@jpmorgan. DCF Analysis Base FCF Terminal Growth Rate Terminal WACC Terminal Multiple Terminal Value PV of terminal value Firm value NPV year 2012-2016 PV of terminal value Enterprise value Plus Net Cash Equity value Shares outstanding Equity Value Per Share Source: J.00 Valuation and Rating Analysis Orbitz trades at 6x our pro forma F’11E EBITDA. $179M and $0. 288 .3 $8. 4) successfully expand into the international market or increase hotel sales. Given the difficult comps of the air product and company-specific headwinds.t.231 (345) $ 887 105. except per-share data Revenues EBITDA EPS 4Q’10E 177 25 (0.16.

Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 187 7 19 31 (12) (5) 0 (5) 97 (0.294 556 1.09) FY09A FY10E FY11E FY12E 89 55 25 169 181 1.16 Income Statement .09 802 59 86 165 (40) 19 4 15 421 0.Imran Khan (1-212) 622-6693 imran.1% 1.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A FY10E FY11E FY12E 738 (274) 69 143 (55) (329) 9 (338) 339 (4.15 0. Note: $ in millions (except per-share data).9 (26. Inc.t.8%) 3.4% 3.1%) (118.09 194 28 18 47 (11) 16 1 15 105 0.9 34. Fiscal year ends Dec 289 .5% 60.P.7% 5. Morgan estimates.3%) 20.157 332 15 86 27 168 (44) 124 (44) 0 - FY10E FY11E FY12E 2.2%) 7.489 484 1.04) 752 56 76 151 (43) 13 3 10 413 0.127 238 10 76 31 151 (40) 112 (40) (44) 279 55 45 380 170 1.0% 6.8% 19.: Summary of Financials Income Statement .3% (45.15 177 0 20 25 (10) (10) 0 (10) 105 (0.2% (102.2 0.khan@jpmorgan.05) FY09A (15.8 Source: Company reports and J.8%) NM 2Q10A 3Q10A 4Q10E 193 22 20 48 (11) 11 1 10 106 0.3% 12.365 484 1.com Global Equity Research 03 January 2011 Orbitz Worldwide.164 130 (338) 69 9 104 (43) 61 (43) (6) 155 52 42 249 176 1.1 37.

khan@jpmorgan.Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 290 .t.

up from 28.32 20.com We Expect Further Market Share Gains in the US and in International Markets We are maintaining our Overweight rating on Priceline as we believe the company will continue to gain market share both domestically and internationally. PCLN US Price: $405. Morgan Securities LLC Price Performance 450 350 $ 250 150 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs 81.86 7.x.d.0%.45 1. 'Bloomberg' above denotes Bloomberg consensus estimates.com in the US.a.87 8.P.6%  2011 drivers. In our view.com (PCLN. 2) new market entrance for booking.com Bridget Weishaar (1-212) 622-5032 bridget. leaving more room for growth).Global Equity Research 03 January 2011 Priceline. We are encouraged by the large portion of gross profit dollars coming from Priceline’s international business (80%) as we believe this growth is more sustainable than the company’s domestic growth.29 2010E 1. EPS est.PCLN US) 2009A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY Bloomberg EPS FY ($) 1.1% in F’10E and 23. in table are on a pro forma basis. CFA (1-212) 622-8343 lev..14 3. Africa.1% 1m 0. While the primary focus remains on European travelers.30 Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 405. etc.10 . Brazil. We are modeling an F’11 pro forma operating margin of 31.P.21 4. We expect Priceline to benefit from continued international growth driven by: 1) secular internet penetration growth (40% in the US vs.  International offers a secular growth opportunity. Gross profit growth has outpaced advertising expense growth in the last two quarters. Overweight PCLN.12A 13.com including the US.3% in F’09.511.com Lev Polinsky.weishaar@jpmorgan. We think Priceline's domestic hotel business will benefit from the continued development of booking.com Vasily Karasyov (1-212) 622-5401 vasily.79 Dec 51 484. 3) continued ADR recovery.173.taffer@jpmorgan.00 31 Dec 11 Source: Company data.31 17.16A 2011E 2.18 21. Furthermore.  booking. Priceline.com in the US offers market share gains.karasyov@jpmorgan.t.09A 5. (2) volume growth and (3) Euro currency rates. and we expect Priceline to continue to benefit from improved advertising efficiency. 4) greater exposure to more fragmented markets that favor aggregators. We model international gross bookings to grow 39% Y/Y in F’11. we think higher ADRs and increased brand awareness (better organic traffic) will help moderate ad expense growth.56 2012E 2.02 3.70 29 Dec 10 428. we are maintaining our December 2011 price target of $484. .70A 3.x.10 17.52 8.5% 12m 80.70 Price Target: $484. 35% in Europe and 24% in Asia. with the hotel market having even lower penetration rates. we think there is a significant opportunity to expand coverage and build out inventory in the US.khan@jpmorgan.00A 13.56 4. Additionally.09 2. J.polinsky@jpmorgan.97 21. Bloomberg. We are modeling domestic gross bookings to grow 7% Y/Y in F’11.3% 3m 16.99 8. the following factors will drive PCLN shares in 2011: (1) ADR trends.00 Internet Imran Khan AC (1-212) 622-6693 imran.78 4.com Shelby Taffer (212) 622-6518 shelby.  Margins should expand. Additionally.33A 3. Morgan est. we expect Priceline to see further domestic market share gains in 2011. 5) modest take rate increases as emerging markets develop.com J.

292 .P. We Maintain Our End-2011 Price Target of $484 We are maintaining our year-end 2011 price target of $484. Our F’12 estimates call for revenue. 1.4 884. respectively. $1. As we are modeling 32% Y/Y EPS growth (in line with the peer group average at 32%).12 F’11E 3.khan@jpmorgan. Morgan estimates.Imran Khan (1-212) 622-6693 imran.46B and $21.4 $21.8 205.18. the peer group average of 38.31 F’12E 4.868.082. and/or if sales and marketing and technology expenses increase significantly.20B and $17.005 5.4x vs.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue. DCF Analysis Base FCF Terminal Growth Rate Terminal WACC Terminal Multiple Terminal Value PV of terminal value Firm value NPV year 2012-2016 PV of terminal value Enterprise value Plus Net Cash Equity value Shares outstanding Equity Value Per Share Source: J.461 1.73B.456 18. if macroeconomic weakness hinders top-line growth. Morgan Estimates Revenue EBITDA EPS (Pro forma) 4Q’10E 728.00 F’10E 3.713 18.18 Source: Company reports and J. if it experiences increased competition in the international market. with the parameters below.P. EBITDA and pro forma EPS estimates of $3. EBITDA and pro forma EPS of $4.460. if ADRs and exchange rates fall further than expected.30B.299. if it has difficulty obtaining merchant inventory.0% 10. Morgan estimates.7 $17.1x.0 4.201. Our price target is derived using a DCF analysis. Thus we rate the stock Overweight.466 50.8 1. respectively. Investment Risks Priceline shares could underperform those of other companies in our coverage universe if PCLN’s domestic growth is pressured by competition from other online travel agencies or suppliers. $1.31.6 1.P.005 $23.00 Valuation and Rating Analysis Priceline currently trades at 23. we think such a discount is unjustified.54% 15 29.0 $13.t. J.731.6 $484.005 $24.6 $3.

087 46 1.00 FY12E 19.8% 61.18 Income Statement .4% 20.115 1.698 201 105 2.338 471 39 548 (22) (29) 442 47 489 50 8.com Global Equity Research 03 January 2011 Priceline.887 551 1.322 489 39 68 510 (15) 495 (501) (169) FY10E FY11E FY12E 3.12 3.2% 43.0% 23.732 1.1% 45.33 FY11E 23.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 2.9% 28.09 FY10E 31.097 (318) 779 51 17.202 10 10 1.com: Summary of Financials Income Statement .5% 0. Morgan estimates. Note: $ in millions (except per-share data).4% 0.6 17.7% 16.khan@jpmorgan.2 FY10E FY11E FY12E 1.834 196 513 1.9 3Q10A 1.9% 33.t.808 779 46 0 941 (32) 909 (917) 0 - Source: Company reports and J. Fiscal year ends Dec 293 .772 516 49 114 826 (20) 806 (481) 175 1.7% 0.4% 53.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 584 88 10 112 (4) (7) 81 (27) 54 51 1.4 26.P.923 551 1.023 30 1.0 47.Imran Khan (1-212) 622-6693 imran.6 2Q10A 767 173 12 204 (8) (7) 166 (51) 115 51 3.31 21.082 778 49 884 (20) (39) 739 (223) 516 51 13.673 201 105 1.0 30.979 37 2.4 4Q10E 729 180 13 206 0 (6) 173 (50) 123 51 3.002 337 15 363 (7) (18) 319 (94) 225 51 5.70 FY09A 24.003 49 2.9% 0.7% 48.115 1.52 FY09A 801 119 103 1.

khan@jpmorgan.Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 294 .t.

com Shelby Taffer (212) 622-6518 shelby.a.14A 0.taffer@jpmorgan. QuinStreet.x. respectively.9. Management has consistently targeted a 20% annual EBITDA margin. While regulatory changes in the education vertical will reduce spending on lead generation.1% 3m 38. In our view.  Other verticals a longer-term catalyst. 2) continued shift of marketing spend to online and 3) additional acquisitions in the space. Additionally.  2011 drivers. (QNST. GAAP F'10 EPS as reported by the company was $0.P. Financial Services Offers a Large Opportunity.48 Price Target: $24. profitability.karasyov@jpmorgan.00 Internet Imran Khan AC (1-212) 622-6693 imran.05A 0. Inc. We expect education revenue growth to accelerate in the back half of FY’11 once the company has anniversaried the reduction of spend from DeVry. we model education revenue to grow 6% Y/Y in FY’11 and 9% in FY’12.Global Equity Research 03 January 2011 QuinStreet.38 . We believe continued growth will be driven by: 1) expansion of its customer base.79 917.khan@jpmorgan.44A 2011E 0. Note: F'10 EPS numbers are calculated based on post-offering share count.t.13 0.17 0.P. (2) the education regulatory environment and (3) growth from other noncore verticals.63 Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 19.2% 1m -0. Financial services revenue grew 68% in the first nine months of CY’10 and has been the largest client vertical for the past three quarters. roughly 5x the size of the education market (~$3B).15 0.14A 0.17 0.com Lev Polinsky. QNST US Price: $19.8% 12m 30.57A 2012E 0. Furthermore. Morgan Securities LLC Price Performance 22 18 $ 14 10 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs 30.00 31 Dec 11 Source: Company data.2% 2011: (1) expansion of the FS vertical. . QuinStreet’s other verticals grew 71% in the first nine months of CY’10 and represent a ~$20B market in North America. Morgan estimates.15A 0.com Bridget Weishaar (1-212) 622-5032 bridget. we think QuinStreet’s education revenue growth rate will accelerate as the company laps the reduction of spend from DeVry.50.48 29 Dec 10 21. J. We are modeling F’11 and F’12 EBITDA margins of 21% and 20%. the following factors will drive QNST shares in Overweight QNST. We are modeling FS revenue to grow 45% in FY’11.weishaar@jpmorgan. We expect future results to hew fairly close to this level as the company uses the target to benchmark its decisions of investing in growth vs. QuinStreet’s financial services vertical represents a ~$15B market.QNST US) 2010A EPS Reported ($) Q1 (Sep) Q2 (Dec) Q3 (Mar) Q4 (Jun) FY 0. Education revenue was roughly flat in the first nine months of CY’10. Inc.polinsky@jpmorgan. Bloomberg. medical and B2B) through the organic development of sites as well as strategic acquisitions.  Education revenue growth to accelerate due to easier comps.com J.com Vasily Karasyov (1-212) 622-5401 vasily. We are maintaining our $24 December 2011 price target. Education Growth to Accelerate We are maintaining our Overweight rating on QuinStreet as we believe the company will continue to see healthy growth in its financial services vertical.11A 0.74 Jun 47 24. we expect QuinStreet to build out depth within these other verticals (including home services.x.d. we think QNST will benefit as education companies consolidate their spend with more reputable vendors that can provide higher-quality leads.14A 0. As the economy improves and the company focuses more on execution. CFA (1-212) 622-8343 lev.  20% EBITDA margin is sustainable.  Financial services vertical a large market opportunity.11A 0.17A 0.

0M.96.94 F’12E 505. Our price target is derived using a DCF model with the parameters below. EBITDA and pro forma EPS estimates of $420. $93.0% 7.0 100.00 2.19 F’11E 420.2M. $100.0M.0% 10. Key DCF Assumptions $ in millions except as indicated Equity beta Risk free rate Risk premium Cost of equity Cost of debt Final debt ratio Equity as a % cap WACC Source: Bloomberg.5% 10.2M and $1.94.7 89. Morgan Estimates Revenue EBITDA EPS (pro forma) FY 2Q’11E 97. J. J. thereby adversely affecting the company’s financial results. respectively.3M and $0.6% 8. $89.Imran Khan (1-212) 622-6693 imran.01 Source: Company reports and J. 1. the company is not able to identify and complete strategic acquisitions at attractive prices or is unable to successfully integrate the acquisitions it does make.3 $0. EBITDA and pro forma EPS estimates of $505.7M. $111. especially in education.0M and $0. respectively.5% 11.P. Our CY’12 estimates call for revenue. the company’s reputation is harmed due to improper actions of third-party publishers which drive the majority of QuinStreet’s traffic but over whose operations QuinStreet has limited oversight and control. its peer group at 12. Investment Risks Downside risks: Changes in regulations or government actions negatively impact QuinStreet clients’ marketing practices and budgets.0% 90.P. given that a limited number of clients account for a large proportion of revenue.4% Valuation and Rating Analysis QuinStreet trades at 9. EBITDA and pro forma EPS of $463.khan@jpmorgan.P.5x our CY’11 EBITDA estimate of $93M vs.t. We believe the company’s growth prospects do not merit this discount and thus rate QNST Overweight.11. a rapid decline in revenue from a major client.01.3M and $1.3 $1. Morgan estimates.6x. 296 .com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our FY’11 revenue.9 19. Our CY’11 estimates call for revenue.3 $0. Morgan estimates. We Maintain Our $24 End-2011 Price Target We are maintaining our December 2011 price target of $24. EBITDA and pro forma EPS of $537. We are maintaining our FY’12 revenue.

4 3Q11E 112 13 5 23 (1) 0 12 5 7 50 0.24 FY12E 31.Debt / EBITDA .94 505 53 22 100 (3) 0 50 21 29 50 1.t. Note: $ in millions (except per-share data).Quarterly 335 39 19 71 (2) 37 16 21 28 0.Return on assets (ROA) Return on equity (ROE) . Morgan estimates.77 421 49 22 89 (3) 46 20 26 196 0.01 573 68 115 Revenues Operating Income D&A EBITDA 1Q11A 2Q11E 104 15 6 25 (1) 0 14 7 8 47 0.P/E - Source: Company reports and J.1 4Q11E 107 12 5 22 (1) 0 11 5 6 50 0.Enterprise value / Free cash flow . Fiscal year ends Jun 297 . Inc.com Global Equity Research 03 January 2011 QuinStreet.Enterprise value / EBITDA .P.19 FY11E 34.23 FY13E 24.29 FY10A 44.: Summary of Financials Income Statement .12 Diluted EPS FY10A FY11E FY12E FY13E Ratio Analysis 156 51 12 219 5 435 94 145 290 21 19 (5) 39 (3) 35 (72) 164 153 53 18 224 5 411 88 139 272 26 22 (8) 56 (5) 51 (44) (15) 209 62 20 292 5 480 88 148 332 29 22 (3) 68 (5) 63 (5) (7) Sales growth EBITDA growth EPS growth EBITDA margin Net margin .4 (3) Net interest income / (expense) 0 Other income / (expense) 65 Pretax income 27 Income taxes 37 Net income 51 Weighted average diluted shares 1.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY10A FY11E FY12E FY13E Income Statement .Imran Khan (1-212) 622-6693 imran.khan@jpmorgan.4 98 9 5 19 (1) 0 8 4 5 49 0.

khan@jpmorgan.t.Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 298 .

10 0. We believe the increasing fragmentation of the internet. we believe there is significant room for ReachLocal to expand margins in the medium-to-long term. driving revenue growth.14) (0.com Lev Polinsky.P. CFA (1-212) 622-8343 lev. ReachLocal. (2) continued product development and (3) the maturation of the sales force. display.09)A (0.khan@jpmorgan.4% Source: Company data.  2011 drivers. the company began rolling out ReachCast.11. RLOC US Price: $19.80 540.RLOC US) 2009A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY (0.com Shelby Taffer (212) 622-6518 shelby.18) (0. compared to only 16% growth in underclassmen expense.42 Price Target: $23. which we believe presents a key barrier to entry. from expanding its product offering and from the maturation of its sales force.. During 4Q. ReachLocal is in the very early stages of its growth curve.08) (0. We are maintaining our $23 end-2011 price target. Thus.  Sales force maturation should increase productivity.11) (0.weishaar@jpmorgan. J.7% 12m 49. Morgan Securities LLC Price Performance 20 $ 16 12 May-10 Aug-10 Nov-10 YTD Abs 49.06) (0. and even its longer-tenure IMCs are relatively new. We think ReachLocal can continue to innovate and expand its product portfolio. gradually building an even broader suite of digital marketing products for small to medium-size businesses (SMBs) that encompass search. In our view. we are modeling 40% revenue growth in F’11. Morgan estimates. its new digital presence.00 Internet Imran Khan AC (1-212) 622-6693 imran.48)A 2011E (0.00 31 Dec 11 .Global Equity Research 03 January 2011 ReachLocal Multiple Growth Levers Playing Out.  Product expansion drives cross-sell opportunities.taffer@jpmorgan. Reiterate Overweight We are maintaining our Overweight rating on ReachLocal as we believe the company will benefit from adding new markets and internet marketing consultants (IMCs).18 Overweight RLOC.81 Dec 28 23.d. Bloomberg. social media and reputation management platform.06) (0.g.P.42 29 Dec 10 21.x.10)A (0. As the average tenure improves. the cost of the company’s investment in training its underclassmen should grow less rapidly than revenue growth. we expect ReachLocal to continue to expand its IMC sales force (currently at nearly 700). Additionally. with 7 markets added in the last two quarters alone. We believe the company retains significant runway to build its presence across new markets both in the US and internationally. Inc.t.a. ReachLocal operates in 45 markets worldwide.com J. As the ratio of experienced IMCs to underclassmen increases.10)A (0.03) 0. online presence and social solutions.com Vasily Karasyov (1-212) 622-5401 vasily. Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 19. the following factors will drive RLOC shares in 2011: (1) expansion into new markets. will drive demand for this product.com Bridget Weishaar (1-212) 622-5032 bridget.03) (0.18)A (0.x.karasyov@jpmorgan.14 .27) 2010E (0.07 0.polinsky@jpmorgan.  Margins should benefit from scale in underclassman expense.  Increased penetration into new markets.46) 2012E (0. along with the growth of social media. (RLOC.06) (0. e. productivity per IMC should go up.4% 1m 12.03 0.6% 3m 40. We are modeling revenue to grow 40% in 2011 and 38% in 2012.

to a lesser extent.6x.3 43.9 0. $12.0% Valuation and Rating Analysis ReachLocal currently trades at ~10.t. train and retain its internet marketing consultants.6 0. agencies or resellers. take actions that are adverse to the company’s interests. its peer group at ~12.P.9M and $0.5x our F’12 EBITDA estimate of $44M vs.00 2. putting pressure on profitability.3% 11.4 -0. J. The company fails to increase the number of its clients or to retain existing SMB clients. J. respectively.0% 6. Our price target is derived using a DCF analysis. Morgan estimates. jeopardizing the ability of ReachLocal’s clients to increase or maintain advertising spend. respectively.66 Source: Company reports and J.16 F’11E 407. Morgan estimates.66. SMBs increasingly opt to perform advertising tasks on their own or go directly to internet search engines and publishers. Our F’12 estimates call for revenue.Imran Khan (1-212) 622-6693 imran. Key DCF Assumptions $ in millions.0% 100. EBITDA and pro forma EPS of $561.3M.3 -0.3 -0. with the parameters below.P. MSN et al.06.7% 8. The company is unable to maintain relationships with its national brands. Investment Risks Downside risks: The company fails to adequately recruit.5 0.06 F’12E 561. 300 . We believe the company’s growth prospects do not merit this discount and thus rate RLOC Overweight. Google and.0% 11. 1.6M and $0.P. EBITDA and pro forma EPS estimates of $407.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue.9% 0. Morgan Estimates Revenue EBITDA Pro forma EPS 4Q’10E 80.8 12.8M.khan@jpmorgan.07 F’10E 291. The cost of the advertising media that the company purchases on behalf of its clients rises faster than expected. Key executives leave the company (four of ReachLocal’s founders are still with the company – the departure of any could create risk). The economic situation worsens. Yahoo!. We Maintain Our End-2011 Price Target of $23 We are maintaining our year-end 2011 price target of $23. except as indicated Equity beta Risk free rate (10yr yield) Risk premium Cost of Equity Cost of debt Final debt ratio Equity as a % Cap WACC Source: Bloomberg. $43.

18 Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS 1Q10A 64 (3) 1 (0) (0) (3) 1 (2) 24 (0.Quarterly 213 (6) 3 1 0 (6) (0) (6) 23 (0.5% 37.9% 2.1% (118.0%) 0.2 FY09A FY10E FY11E FY12E Ratio Analysis 43 3 2 48 5 98 60 42 10 3 14 14 (6) 9 (17) (1) 82 3 3 88 8 146 64 82 (13) 7 14 14 (11) 3 (20) 43 103 3 2 108 9 171 90 81 (13) 12 26 37 (16) 21 (16) 0 164 3 2 169 10 232 128 104 6 15 37 76 (16) 61 (16) 0 Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 38.t.6% 248.0% 2.09) FY10E 3Q10A 77 (3) 2 1 0 (3) (0) (3) 28 (0.10) FY11E 39.0%) 7.3%) (52.com Global Equity Research 03 January 2011 ReachLocal: Summary of Financials Income Statement . Morgan estimates.5% (5.8% 1.4%) (48.7%) (43.1%) (7. Note: $ in millions (except per-share data).7%) (27. Fiscal year ends Dec 301 .46) 561 11 15 44 0 11 (5) 6 33 0.48) 408 (12) 12 13 0 (12) (1) (13) 28 (0.2%) 3.2%) 77.27) 291 (13) 7 0 0 (13) 0 (13) 26 (0.4%) (61.5% 19.khan@jpmorgan.8% 0.2% 109.10) FY09A 2Q10A 70 (3) 1 0 0 (3) (0) (2) 26 (0.3%) - (6.Imran Khan (1-212) 622-6693 imran.7%) NM NM Source: Company reports and J.18) FY12E 37.4%) NM 4Q10E 80 (5) 2 (0) (5) (0) (5) 28 (0.P.829.1% (4.5% (3.6% (139.4%) (8.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A FY10E FY11E FY12E Income Statement .1% (3.

khan@jpmorgan.t.com Global Equity Research 03 January 2011 302 .Imran Khan (1-212) 622-6693 imran.

We believe the WMSG acquisition.com Shelby Taffer (212) 622-6518 shelby. we think the expansion of its commercial print business will provide an important use for its non-seasonal manufacturing capacity. but also increased awareness and demand for the company’s other products.25) (0. In our view. Furthermore.18)A (0.24) (0. As consumers are taking pictures via multiple devices and sharing their photos on many sites. J.00 Internet Imran Khan AC (1-212) 622-6693 imran.30) 1.17 0.t.13 0. SFLY US Price: $34. Additionally.93A 0.17)A 0.92A 0.00 31 Dec 11 .  Continued growth of PP&S business.karasyov@jpmorgan.6%  2011 drivers.20) (0.20) (0.65 Source: Company data.9M in the first nine months of 2010.33 0.8% 12m 93. comprising ~73% of total revenues.SFLY US) 2010E (New) 2010E (Old) 2011E (New) 2011E (Old) 2012E (New) 2012E (Old) EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY (0. We expect Shutterfly’s non-print revenue to grow 30% in F’10.17)A 0.89 ▲ Price Target: $39.com Lev Polinsky.8M in revenues in 2009 and $2.  Growth of social media makes Shutterfly a more utilized tool. the following factors will drive SFLY shares in 2011: (1) continued mix shift trend from print to non-print products. Morgan estimates.18)A (0. We are now modeling 20% PP&S growth in F’11.com Bridget Weishaar (1-212) 622-5032 bridget.x. Inc.22)A (0. Shutterfly announced a partnership with CVS/pharmacy and Walgreens.polinsky@jpmorgan.weishaar@jpmorgan. Shutterfly.5% 1m 5.23) (0.22)A (0.89 29 Dec 10 36. Bloomberg.15.d. which we believe is very conservative.com Vasily Karasyov (1-212) 622-5401 vasily. giving Shutterfly customers an in-store pickup option at any CVS/pharmacy or Walgreens US store location with a photo center.45 (0. Raising Estimates and Price Target We are maintaining our Overweight rating on Shutterfly as we believe the company will continue to benefit from strong growth in its personalized products and services (PP&S) business.42A (0. We expect Shutterfly to take advantage of the growth of social media sites. announced in November 2010.00 Previous: $32.23) (0. This adds to the company’s existing retail partnership with Target.29) 1.68 (0. we think Shutterfly will achieve better printing facility utilization via the development of its commercial print business. We are raising our end-2011 price target to $39 from $32. We are modeling commercial print revenue of ~$11M in F’12.5% 3m 31.x.  Commercial print business an attractive opportunity.40 0.21) (0.40A (0. (2) development of commercial print business and (3) margin expansion.69 .22 Dec 27 39. Overweight SFLY.  Retail partnerships could help boost print revenue. We believe increased penetration of photobooks and continued product development will drive growth in Shutterfly’s personalized products & services business. Shutterfly’s commercial print business contributed $3.a. representing 71% of total revenues.P.taffer@jpmorgan.29) 1.48 (0. Increased Confidence in the Business.Global Equity Research 03 January 2011 Shutterfly. we think Shutterfly will become a more utilized tool. announced in May 2007.khan@jpmorgan. Morgan Securities LLC Price Performance 35 $ 25 15 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs 93. Inc. Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 34.P.46 952. We think Shutterfly’s expanded retail presence could drive not only print volume growth. will help Shutterfly expand its presence in the commercial print market. (SFLY.com J. as it reduces friction. Note: Diluted EPS estimates.21) (0. In October 2010. CFA (1-212) 622-8343 lev.30) 1.

P. Our price target is derived using a DCF model with the following parameters: Key DCF Assumptions Equity beta Risk free rate (10yr yield) Risk premium Cost of Equity Final debt ratio Equity as a % Cap Source: Company reports and J. EBITDA and EPS estimates of $296.com Global Equity Research 03 January 2011 Raising Estimates and Outlook for 2010. $71. SFLY trades at 11. Given SFLY’s strong growth prospects. we believe there is opportunity for multiple expansion and thus rate the stock Overweight. We are now modeling F’11 revenue. Morgan estimates. and there could be downside risk to the stock.92 F’10E new 296.9 $0.4M and $0.1x our F’11 EBITDA estimate of $71. the company may have difficulty meeting our revenue estimates.1M.2 0. Morgan Estimates $ in millions.2M vs. Our F’12 estimates call for revenue.48 compared to our previous estimates of $337. $83. Morgan estimates.P. If the company were unable to deliver customer orders during the holiday season. EBITDA and EPS of $412.1M.65 Revenue EBITDA GAAP EPS Source: J.40.6M and $0. EBITDA and EPS estimates of $347. there would be downside risk. respectively.6% 12.3x. $85.6 54.45 F’12E new 412. its peer group at 14.3 85. we are raising our December 2011 price target to $39 from $32 previously.4 83. causing the company to look for growth in other product segments.khan@jpmorgan. respectively.65. $61.68 F’12E old 391.1% 0.42 F’10E old 294.1 60.17 3. J.4 69. 1. Investment Risks Downside risks: (1) Currently. $60. Should other product segments experience similar pricing pressure.0% 100.6 0. Raising Our End-2011 Price Target to $39 from $32 As a result of our newly increased estimates.68 compared to our previous estimates of $391. (2) Pricing on 4X6 prints has come down over the last few years.t.7 $0. 2011 and 2012 We are now modeling F’10 revenue.3M. $69.1 71.0% Valuation and Rating Analysis SFLY trades at a discount to its peers.42 compared to our previous estimates of $294.9 $0.48 F’11E old 337.4M.8 61. 304 . (3) If consumer spending slows more rapidly than we currently expect.9M and $0.9M and $0. On an EV/EBITDA basis. Shutterfly’s business is very seasonal.3 54. our estimates could be at risk.2M and $0.Imran Khan (1-212) 622-6693 imran.0 $0. except per-share data 4Q’10E new 155.4 0.8 0.40 F’11E new 347.8M.3% 7. with approximately 50% of revenues earned in the fourth quarter.4M.7M and $0.45.P.93 4Q’10E old 152.

0 0.1% 0.0 159.4% 29.7% 4.2% 20.8% 4.1% 36. Fiscal year ends Dec 305 .5% 4.93 FY12E 20.0 3.0 0.42 347 23 26 71 1 25 (10) 14 30 0.9% 0.t.0 4.0 0.6% 20.com Global Equity Research 03 January 2011 Shutterfly.0 3.7% 0.4% 22.0 51.0 4Q10E 155 43 6 55 0 44 (16) 28 30 0.17) FY11E 20.4% 2.: Summary of Financials Income Statement .5% 4.7% 5.khan@jpmorgan.Imran Khan (1-212) 622-6693 imran.0 0.22) FY10E 20.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 246 9 25 50 1 9 (4) 6 27 0.1% 0.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 46 (8) 6 3 0 (8) 3 (5) 26 (0.2% 2.22 FY09A 133 5 10 196 42 271 56 215 6 25 7 54 (18) 38 (14) 5 FY10E FY11E FY12E 297 18 25 62 1 18 (6) 12 29 0.48 412 34 26 85 1 35 (14) 21 30 0.1% 0.P.4 3Q10A 49 (8) 6 2 0 (8) 3 (5) 27 (0.68 Income Statement .0 73.18) FY09A 15.4% 0.0 2. Inc. Note: $ in millions (except per-share data).7% 6.8 2Q10A 47 (10) 6 1 0 (10) 4 (6) 27 (0.8% 91.2% 0.7% 0.0 83. Morgan estimates.0 FY10E FY11E FY12E 222 12 34 268 39 342 84 258 12 25 (1) 51 (23) 30 25 14 262 15 36 313 40 387 94 294 14 26 5 67 (27) 40 (27) (0) 319 15 32 367 45 446 107 339 21 26 17 88 (31) 57 (31) (0) - Source: Company reports and J.

khan@jpmorgan.Imran Khan (1-212) 622-6693 imran.t.com Global Equity Research 03 January 2011 306 .

19 0.22 0.23 0. Yahoo! has $2. Furthermore.22A 0. Further.weishaar@jpmorgan.15A 0.com J.P.YHOO US) 2009A EPS Reported ($) Q1 (Mar) Q2 (Jun) Q3 (Sep) Q4 (Dec) FY 0.79 Dec 1.x.taffer@jpmorgan.61 29 Dec 10 19. equivalents and marketable securities on its balance sheet.4B ($5. if AOL improves its market share going forward. owned by Alibaba Group. We believe there is significant value in Yahoo!’s private assets as well as the company’s Asian assets.82B in cash. We are maintaining our December 2011 price target of $20.89A 2011E 0. we think the current share price does not fully reflect upside from Asian assets.19 0. (2) monetization/valuation revision of Asian assets.com Lev Polinsky. we think Yahoo!’s growth rate significantly underperformed that of Google and Facebook. In the first half of 2010. above the display market growth rate of ~16%. .11 0.19 0.d.khan@jpmorgan. despite getting into the business much later than Yahoo!.  However.a.08 0.com Shelby Taffer (212) 622-6518 shelby.12.x. representing an additional $2. Yahoo Inc (YHOO. Morgan Securities LLC Price Performance 19 17 $ 15 13 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 YTD Abs -2. Note: Est's include FAS 123R adjustment.13 0. J. which we believe are undervalued by the Street.00 31 Dec 11 Source: Company data.61 Price Target: $20. In our view.P.22 0. search comps will be easier once Yahoo! laps the discontinuation of paid inclusion (in 1Q’11). FY total may not add up due to rounding. Yahoo! grew its O&O graphical revenue 19% Y/Y. Overweight YHOO. Additionally. However.10 0.79 2012E 0.51/share) in value from Yahoo! Japan and Alibaba. CFA (1-212) 622-8343 lev.polinsky@jpmorgan.42 2010E 0. we think such gains could come from the slowdown of Yahoo!’s growth.22 0. which does not include any contribution from the value of TaoBao. We think Yahoo! will see an uplift in RPS from the Microsoft search alliance. we are maintaining our Overweight rating on Yahoo! as we believe the company will benefit from continued margin expansion.25 0.94 22. we believe Google and Facebook will have display market share similar to YHOO’s by 2011.  Benefits from the completion of the Microsoft search deal. Additionally. part of which can be attributed to the Microsoft search deal. the following factors will drive YHOO shares in 2010: (1) display ad growth.  Display growing faster than market but may not be sustainable going forward. YHOO US Price: $16.00 Internet Imran Khan AC (1-212) 622-6693 imran. We see at least ~$7.com Bridget Weishaar (1-212) 622-5032 bridget.343 20. Morgan estimates.8% 12m -1.Global Equity Research 03 January 2011 Yahoo Inc Increased Competition Could Pressure Display.10/share in value. Additionally.12 . Bloomberg.karasyov@jpmorgan.4% 3m 15. (3) margin trends and (4) search market share trends.308.8%  2011 drivers.t.9% 1m 1.29A 0.22A 0.92 Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 16. But Valuation Remains Attractive Despite its poor execution and some structural challenges.com Vasily Karasyov (1-212) 622-5401 vasily. current share price does not reflect the full asset value. We note that Yahoo!’s 3Q O&O search revenue would have been up 1% Y/Y excluding the removal of paid inclusion (compared to a 7% nominal decline).

respectively.6 3.1 20.47B. EBITDA and EPS of $4.039 1. Yahoo! trades at 7.470.599.79.89 F’11E 4. respectively.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue. $1.92.khan@jpmorgan.4 1. 308 .P.455 20.174.1 430. Morgan estimates. We Maintain Our End-2011 Price Target of $20 We are maintaining our year-end 2011 price target of $20. EBITDA and EPS estimates of $4.7 0.22 F’10E 4.0 0.373 12. Morgan estimates.89B and $0.1 0.5 0. DCF Analysis Base FCF Terminal Growth Rate Terminal WACC Terminal Multiple Terminal Value PV of terminal value Firm value NPV year 2012-2016 PV of terminal value Enterprise value Plus Net Cash Equity value Shares outstanding Adjusted equity value (+strike price) Yahoo Japan Other Investment Nols Total Value Total shares o/s for stock price calc Equity Value Per Share Source: J. its large cap peers at an average 12.893. J.557. Our price target is derived using a DCF analysis. $1. Investment Risks Yahoo! is heavily dependent on the performance of the online advertising industry. Yahoo! generates the majority of its net revenues from its marketing services revenue unit.627.416 27. Morgan Estimates $ in millions.211 16.92 Source: Company reports and J. On an EV/EBITDA basis.79 F’12E 4. Our F’12 estimates call for revenue.Imran Khan (1-212) 622-6693 imran.69B and $0.983 2.692. making a large portion of Yahoo!’s revenues vulnerable to general economic risk.8x F’11 estimates.583 3.P.437 1.514 12.1 1.0% 10. 1.2 1.67B.343.039 4. with the parameters below.211 4. we rate the stock Overweight.P.t.343 20.00 $ $ $ $ $ $ $ $ $ Valuation and Rating Analysis Given our belief that the management is effectively implementing a turnaround and asset value limits downside.93% 13 20.1x our F’11 EBITDA estimate vs. The advertising industry is susceptible to overarching economic conditions. except per-share data Net Revenue ($M) EBITDA ($M) GAAP EPS 4Q’10E 1.670.

259 2.221 635 (367) 1.573 981 1.427 14.934 3.3% 18.9% 0.579 1.124 189 162 402 191 381 86 396 1.343 0.1% 39.130 188 165 375 86 274 49 310 1. Morgan estimates.564) - Source: Company reports and J.066 580 (7) 1.42 FY09A 3.020 357 371 4. Note: $ in millions (except per-share data).271 4.5% 8.085 253 1.t.1 FY10E FY11E FY12E 2.595 1.79 Income Statement .174 236 150 431 7 243 49 294 1.599 297 1.22 FY09A (13.7 1.Annual Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Balance Sheet and Cash Flow Data Cash and cash equivalents Accounts receivable Other current assets Current assets PP&E Total assets Total debt Total liabilities Shareholders' equity Net Income (including charges) D&A Change in working capital Other Cash flow from operations Capex Free cash flow Cash flow from investing activities Cash flow from financing activities Dividends Dividend yield FY09A 4.964 1.2%) 110.519 604 740 85 1.com Global Equity Research 03 January 2011 Yahoo Inc: Summary of Financials Income Statement .682 387 740 1.250 0 0 2.P.0 8.310 (434) 957 FY10E FY11E FY12E 4.413 0.8% 0.0 4.722 188 574 219 598 1.932 1.0%) 41.1% 35.416 0.291 1.343 0.Quarterly Revenues Operating Income D&A EBITDA Net interest income / (expense) Other income / (expense) Pretax income Income taxes Net income Weighted average diluted shares Diluted EPS Ratio Analysis Sales growth EBITDA growth EPS growth EBITDA margin Net margin Debt / EBITDA Return on assets (ROA) Return on equity (ROE) Enterprise value / EBITDA Enterprise value / Free cash flow P/E 1Q10A 1.Imran Khan (1-212) 622-6693 imran.003 300 4.7%) (7.318 12.024 359 1.159 12.390 0.343 0.128 175 158 391 13 188 69 213 1.131 (647) 555 1.22 FY12E 18.khan@jpmorgan.557 788 635 1.417 15.89 4.1% 26.1% 36.372 0.359 (720) 639 (720) 0 - (2.8% 12.719 14.066 1.4 2Q10A 3Q10A 4Q10E 1.692 32 1.470 992 580 1.9 1.214 1.0% 5. Fiscal year ends Dec 309 .29 FY11E 20.417 12.419) 895 35 (1.15 FY10E (2.936 0 2.3%) (5.

t.com Global Equity Research 03 January 2011 310 .khan@jpmorgan.Imran Khan (1-212) 622-6693 imran.

International Company Outlooks .

Imran Khan (1-212) 622-6693 imran.com Global Equity Research 03 January 2011 312 .khan@jpmorgan.t.

6% -27. the international marketplace expected growth rate of 20% YoY in 2011.4 0.05 0.875 5.06 0.  Company to execute “Work at Alibaba” strategy in 2011.6Mn US$21. (%) 43.43 0.10 12M -23. VAS for keywords.34 0.06 0.3 18. Bloomberg: 1688 HK Rmb in millions.07 0.4 17.24 0.8% -26.0 Equity (Rmb M) 0. 2010 Source: Company reports.53 Absolute perf.com Ritesh Gupta (91-22) 6157 3307 ritesh.28 0.280 2.x.013 1. We forecast around 4K quarterly net-adds in 2011.3% 3m -13. International expansion is still in the early stages. Value-added services should also continue to gain more revenue share in 2011. Bloomberg and J. AliLoan could start monetization as soon as 1H10. and Alibaba’s plan to slow down new customer net adds. Morgan estimates.0 0.  2011 drivers: (1) Increasing monetization of value-added services.696 Neutral 1688.P.6 5.4 35.8 20.05 0.002 2.452 6.gupta@jpmorgan.0 -14.2 8.365 2.  International marketplace net-adds to continue to be slow: With higher fee Rmb30K annual fee package launch next year.41 1. 2011 membership net-adds are likely to see slow growth.0 Cash (Rmb M) 12.8 7. India and Turkey are the key potential target markets for the company.2 20.0% 1m 2. Alibaba offers SMEs access to Alibaba’s marketing services (annual fee to marketplace.989 EPS FY09 1.7% FY12E 21.8% 12m -24.6 28.  Future monetization potential on Alibaba platform: AliExpress (international transaction base platform) saw GMV (gross merchandise volume) up 3 times QoQ in 3Q10.05 0. .933 2.770 7.09 3M -12.00 Price Target: HK$16.10 52-week range Shares outstg Avg daily volume Avg daily value Index (HSI) Free float Dividend yld Market cap Price target 23. (%) 50. etc.HK share price (HK$ MSCI-Cnx (rebased) YTD Abs Rel -24.20 0. EPS (RMB) 1.423 1.253 FY11E 22.00 China Internet Dick Wei AC (852) 2800-8535 dick.9% 5.86 2.501 Date of price 16. Morgan Securities (Asia Pacific) Limited Price Performance 20 HK$ 16 12 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 1688.4% -12.z.216 5.5 3Q 0.732 2.073 1.98 1. We expect China’s marketplace to grow at a faster rate than the international marketplace in 2011.535 HK$12.761 8. Reuters: 1688. “Meet at Alibaba” has been the company strategy for many years.969 19% 0% US$8. The newly added “Work at Alibaba” strategy will help SMEs to reduce operating costs by offering them more value-added services.HK.08 1M 0.124 2.1 4Q 0.602 3.com Limited Slowdown in Customer Growth Limits Near-term Stock Upside We remain Neutral on Alibaba with a Dec-11 PT of HK$16.3-19.561 2.2 14.269 GAAP dil.HK. AliLoan program cumulative loan amounts reached Rmb20 M.674 ROIC (%) 1. * Note: Adj.46 EPS FY11E 60.3 43. 1688 HK Price: HK$15.176 1.37 0.039Mn 9.6 6.9Bn HK$16 Dec 29.07 0.com J. Both could lead to longer-term monetization potential. year-end December Net sales Operating profit EBITDA Pre-tax profit Net profit Diluted EPS (Rmb) P/E (x) Adjusted EPS (Rmb) Adjusted P/E (x) EV/EBITDA P/B (x) Y/E BPS (Rmb) FY09 FY10E FY11E FY12E 3.4Mn 22.42 FY09 20.8 21.wei@jpmorgan. (2) Good growth in China marketplace from growth of local eCommerce market.) in order to meet with potential buyers.302 ROE (%) 1.0 1Q 0.Global Equity Research 03 January 2011 Alibaba.7 10. (3) Improvement in operating margins from leverage over SG&A expenses. We currently expect China’s marketplace to grow 36% YoY vs.4 19.444 EPS FY10E 0. We expect China marketplace’s share to increase with the increase in the domestic eCommerce market.5 27.5 5.018 FY10E 23.0 22.4 -30.07 0. China marketplace revenues accounted for ~34% of total revenues in 2010. EPS excludes share-based compensation expense.P.3 32.9 26.9 2Q 0.6 Relative perf.376 9.

(4) share buybacks.2 FY12E diluted adjusted EPS. Risks to Our Rating and PT Downside risks include (1) slowdown in Gold Supplier and China Trustpass customer growth. with terminal growth of 0%). At HK$16.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue and adjusted EPS estimates of Rmb6.x.1x FY11E. and 26. 314 . (2) new “Work at Alibaba” pricing strategy could be risky.3 B and Rmb0.43. given the high valuation and high volatility of the stock. and (3) upside in earnings from new initiatives and currently free VAS. To date. Dec-11 Price Target of HK$16 Our price target is based on DCF valuation of HK$16 (WACC = 12%.Dick Wei (852) 2800-8535 dick.1x PEG (based on 2011E P/E and 2012E EPS growth). respectively. the company has not traded below a forward P/E of 20x even during market lows. Our PT of HK$16 implies 32. We note that on a forward P/E basis. and 30. and (3) global macro fundamentals turn negative. such as Baidu. (2) strong cash position to get through current downturn and use cash to gain market share. We believe a higher multiple for Alibaba can be justified. Maintain Neutral While the company has a strong platform for future growth and monetization. in line with the current valuation of other China Internet market leaders.wei@jpmorgan. respectively. (3) new VAS such as Aliloan. Upside risks include (1) better-than-expected Gold Supplier and China Trustpass customer growth due to the company’s strong execution and strong export market growth. given: (1) Alibaba’s leadership in the China B2B market (60% market share). Alibaba has historically traded at high multiples since its IPO. We also use P/FCF ratio as a reference to set our Dec-11 price target. We maintain our N.53. and (5) RMB appreciation. Our F’12 estimates call for revenue and adjusted EPS estimates of Rmb8.6x FY12E diluted reported EPS. or 38. Tencent. (2) VAS penetration rate grew faster than expected.4x FY11E.1x 2012E P/FCF. we believe there could be near-term downside risks from: (1) slowdown in China’s exports.8 B and Rmb0. (2) VAS does not gain good traction as expected in both marketplaces. Alibaba trades at 19. Our PT implies 1.

3% 7.0% 14.6% 24.0% WACC Source: J.P.9 20.5 9.7% (1.3% 7.7% 6.0 12.6% 26.7 20.8 15.0% 15.0% (1.3) 41.0% 11.3) 22.3) 40.6% 26.74) FY12E 22.04 (1.1 12.50 (1.2% 25.64) FY20E 11.5 13.0 5% 24.0% 13.4% 26.0 17.51 21.7 7% 27.95) FY11E 24.0 17.1% 7. 315 .6% 22.8 6% 25.2 Terminal Growth (%) 2% 3% 4% 23.0% (1.3 14.P.6 17.0 14.0% 33.00 20.7 20. Morgan estimates.77 21.6 20.5% (1.9 20.0% 12.0% (1.2% 30.3) 34.2 1% 22.7 14.5 13.7% 28.64) DCF Sensitivity Analysis 0% 22.1 13.2% 31.65) FY16E 18.75) FY13E 23. Morgan estimates.20 21.6% 6.70) FY14E 22.3 17.50 (1.8 15.com Global Equity Research 03 January 2011 Alibaba—DCF Model (base-case scenario) Sales growth EBIT margin NOPAT margin Year end net fixed assets turns Year end net working capital turns Year end net other assets turns Cash operating taxes as % of EBIT Year end Invested Capital turns Source: J.3) 40.8 16.98 (1.8 15.19 (1.3 13.68) FY15E 21.47 (1.9% (1.00 20.2 12.3) 40.5% (1.8 17.54 21.1 20.2% 32.4% 33.5% (1.74 (1. FY10E 40.2 13.6% 26.0 12.2 20.8 16.3% 7.0% 10.2% 7.9 15.6 14.1 23.00 20.4) 14.5% 7.8 15.4% 24.wei@jpmorgan.6% (1.8 12.3 12.95 20.64) FY19E 13.50 (1.4 17.1% 33.04 21.50 (1.4 14.3) 40.8 17.6 11.50 (1.3) 40.8 14.8% 32.7 11.0 12.x.00 20.64) FY18E 15.3) 28.Dick Wei (852) 2800-8535 dick.5 13.0% 31.77 (1.2 12.00 20.9 15.3) 18.9% 7.8 17.1% 33.6% 25.64) FY17E 18.0% 33.0 14.3% 8.9% 7.9 11.0% (1.5% 26.9 21.6% 26.4 23.0% (1.

2 32.37 0.27 0.732 309 1.612 7.216 10.241 141 0 -37 0 1.404 210 1.392 6.176 163 1.00 5.P.x.6 26.8 31.569 -267 -2.1 -133.5 -47.9 0.5 47.213 0.3 17.064 309 2.947 0 38 6.6 8.5 31.302 -79 0 12 0 -67 -1.9 26.2 -144.8 -148.452 907 4.360 FY12E 18.302 1.4 -144.8 23.272 FY11E 14.616 582 3.9 -133.770 14.766 171 0 1 0 172 3.357 0 46 8.553 0 7.018 FY10E 5.9 20.770 0 0 944 11.989 545 2.3 -148.769 FY11E 1.761 1.5 40.46 0.5 39.42 0.444 2.8 -143.8 41.536 241 0 0 0 2.805 -406 33 -373 3.5 -148.801 0 451 7.253 FY11E 6.8 23.7 45.24 0.0 24.133 8.883 0 30 5.193 1.2 38.933 2.8 46.216 0 0 926 8.893 0 16 2.4 28.840 -2 1. *Note: Adjusted earnings exclude share-based compensation expense.126 414 4.4 35.457 0 24 4. & amortization Change in working capital Other Cash flow from operations Capex Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash F/X & term deposits change Beginning total cash Ending total cash FY08A 1.145 5.00 5.00 5.193 76.274 6.234 -411 -261 -671 1.) Non-operating income (exp.5 24.264 -498 33 -465 3.929 177 0 -6 0 1.178 0 451 8.375 FY12E 2.124 2.423 151 1.2 38.439 5.1 9.733 0.271 0.491 19.600 2.6 Balance sheet Total cash Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity Cash flow statement Net income Depr.6 32.0 46.3 -143.3 39.86 0.149 5.9 39.180 1.7 26.5 44.859 0.4 28.376 18.604 0 10.3 18.947 -209 204 -5 2.116 FY10E 10.1 38.616 -2 969 365 16.738 171 0 440 0 611 3.630 7.013 1.com Global Equity Research 03 January 2011 Alibaba.002 391 2.0 23.9 22.045 -135 2.561 1.835 -3.349 0 0 1.258 239 0 -16 0 1.9 -52.28 0.34 1.910 706 3.8 19.1 -15.1 -15.1 FY09A 86.18 5.4 40. Morgan estimates.8 25.8 27.373 0.097 0 342 4.696 -166 2.0 27.98 0.9 0.925 4.41 0.8 20.2 -148.803 2.1 35.) Earnings before tax Tax Net income (reported) Net income (adjusted) Rmb EPS (Reported) EPS (Adjusted) BPS DPS Diluted shares outstanding (MM) FY08A 3.98 0.53 2.674 3.696 FY12E 8.43 1.wei@jpmorgan. year-end December Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC ROIC (net of cash) FY08A 87.532 -92 1.3 1.6 431 -132 1.3 -64.102 1.416 -178 1.423 1.013 119 926 175 2.762 6.365 433 1.818 0 106 2.1 FY11E 83.933 209 1.073 4.0 36.612 FY09A 1.034 -151 1.143 4 783 527 9.823 -70 0 0 -888 -958 604 0 6.251 9.6 45.0 0.340 384 2.939 5.5 42.0 FY10E 83.972 0 14.0 41.2 29.546 544 2.2 20.1 37.444 280 1.9 52.0 0.714 -2 806 365 12.073 1.1 10.612 0 0 508 7.203 315 0 0 0 2.0 -53.875 534 3.24 0.240 15.399 171 0 1 0 172 3.629 12.068 FY09A 7.7 6.5 29.326 337 3.1 -9.Dick Wei (852) 2800-8535 dick.055 FY08A 6.8 21.154 365 21.728 Ratio analysis %.216 FY10E 1. 316 .4 8. year-end December Income statement Revenues Cost of goods sold Gross profit R&D expenses SG&A expenses Others Operating profit (EBIT) EBITDA Interest income Interest expense Investment income (exp.2 38.179 0 451 5.com: Summary of financials Rmb in millions.121 32 376 365 7.348 Source: Company data and J.5 22.7 FY12E 83.376 0 0 1.968 FY09A 3.6 -46.612 194 1.00 5.20 0.3 39.

P/E (x) 149.21 P/E (x) 158.01 Price Target: $120.2 3. Positive on market potential: Using various references to the US and Korea search markets.7 -3.64 Free float 1M 3M 12M Dividend Yld (%) -9.278 US$38. Perf.5-115.7% 126. and leverage over bandwidth and operating expenses. (3) growth in eCommerce–related advertising.7 Adj.2 348Mn US$996M 10.83B in FY’11.1 FY12E 2. However.4% 136.5 27.168.828.35 0.(%) Cash Equity FY09 FY10E FY11E FY12E 40 53 48 40 52-Week range 39 53 47 39 Shares Outstg 1Q 2Q 3Q 4Q Avg daily value 0.7 2.Global Equity Research 03 January 2011 Baidu. As a result. we estimate China’s search market size could reach US$3B-US$4.6B by 2013.117 3.16 0.com J.khan@jpmorgan.6 1. J.1 Reported EPS (US$) 0.  Rising eCommerce trend may add upside: Baidu should also benefit from the growing B2C eCommerce market in China. Perf.9 -15. Reuters: BIDU.5 9.08 0.9 66.0% in FY09 driven by lower TAC.5B US$120 Dec 29.250.42 0.0 3.t. or 1. EPS * 0.5 115. (4) increasing mobile search usage.4B and US search market 2009 size of US$15B.98 33. year-end December US$MM.6 68.7Mn 2.7x FY12E diluted adjusted EPS. 38.45 0.3% 3m 12m -4. We expect the company to be able to maintain this margin level in 2011.(%) Rel. Morgan Securities (Asia Pacific) Limited Ritesh Gupta (91-22) 6157 3307 ritesh. respectively.00 Internet Dick Wei AC (852) 2800-8535 dick.18 Avg dly volume 0.0 910. Morgan estimates.z.2% -16.073.2 Price Target 671 1. Baidu reported the number of online retail advertisers doubled Y/Y.6 6.514.7 Operating Profit (EBIT) 235.0 993.3 132.172 2.P.7 44. * Note: Excluding share-based compensation expense.4 Pre Tax Profit 246.wei@jpmorgan. Increasing competition among B2C eCommerce companies and strong growth in eCommerce sales volume should help drive search ad demand on Baidu’s platform.0 EV/EBITDA 115. Pricing data as of 29 December 2010. Bloomberg: BIDU US US$ in millions.3 EBITDA 296.45 2.9 887.com J. and 39.gupta@jpmorgan. We believe medium-term revenue drivers are: (1) continued gradual improvement in monetization from Phoenix Nest. we believe ARPU growth will be faster than advertiser number growth.x.  Maintain OW with Dec-11 PT of US$120: Our price target implies 53.243 2.66 1.com J. .7 16.P.4 Overweight BIDU.350.6 Market Cap -14.5 507.49 2.1 573. Morgan India Private Limited Imran Khan (1-212) 622-6693 imran. Risks to our PT include slower-than-expected revenue growth and a potential macro slowdown.com 2011 To Be Another Year of Solid Growth  2011 to be another year of solid growth: We expect Baidu’s revenues to see 57% Y/Y growth to reach $1.667 75% 0% US$34.P.62 0.6% 119.45 Index (NASD) 0.3x PEG (based on 2012E P/E and long-term growth of 30%).0 1. 2010 Source: Company data.3 52.62 1.7% ROE (%) ROIC (%) Qtr GAAP EPS (US$) EPS FY09 EPS FY10E EPS FY11E Abs.3%.4 1.25 Adj.3% vs.02 32. Morgan Securities LLC Price Performance 110 $ 70 30 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 BIDU share price ($) NASDAQ Composite (rebased) YTD Abs Rel 141. BIDU US Price: $100.2 34.0 654.4 790. Bloomberg.7% -13.2 1.2% 1m -7.1 Reported Net profit 217. Baidu has already seen fast growth in eCommerce–related search demand – during 3Q10.101 3.53 0.21 0.212.4 P/B (x) 49.315 Price Date 696 1.3x FY11E. YE-Dec FY09 FY10E FY11E Net Sales 651.8 1. This compares to our current 2013 forecast of US$3. Our 2011 operating margin forecast is 50.8 25.7 1. P.5 44. further expansion will be limited with the potential increase in contextual search advertising.20 0. and (5) upside from contextual advertising.  FY’10 margin expansion to remain intact in FY’11: Baidu’s operating margins expanded in 2010 to 50.3 Y/E BPS (US$) 2.3 10.5 585. on the back of 53% and 35% EPS growth for FY11E and FY12E. (2) secular trend in growth of search usage and search advertising in China.

and as a result an increase in advertising spending on search. eBooks. As such. Cost side Baidu Union optimization: The company’s new revenue-sharing policy has been effective in enhancing Baidu Union's traffic quality and lowering traffic acquisition costs in 2010. We believe improvements in search quality should further increase the number of search queries per user. large numbers of customers will also lead to keyword pricing increase. driven by better quality ads being served in more search results. Contextual ads to increase TAC in 2011: However. The company has been investing its R&D capability to improve its contextual search technology. we believe the company is likely to see higher revenue per search next year. with online B2C retailers offering a wide selection of good-quality products at low prices. software. Contextual advertisements will create a win-win situation for Baidu as well as content providers who have not been able to monetize their content properly. (2) increasing amount of Chinese content is available online. (3) Contextual advertisements are likely to be another growth driver in the medium term. Indeed.wei@jpmorgan. We expect competition among eCommerce merchants likely to increase. We note that a significant portion of Google China’s revenue comes from contextual search. We believe both click through and coverage ratios will gradually increase. To further enhance users’ search experience. (1) Open Data platform (Aladdin) providing users with more dynamic and comprehensive information. (2) Upside from eCommerce advertisers: eCommerce in China is expected to experience strong growth over the next few years. etc. Logistics.x. We believe the eCommerce segment could account for a double-digit percentage of revenues for Baidu in 2011. (3) higher reliance on search in daily life. as well as trust and safety. If contextual becomes very successful. TAC could move up 318 . the company focuses on box computing initiatives. a decrease in TAC from currently search box-related traffic would be balanced by a rise in payouts related to contextual advertising.Dick Wei (852) 2800-8535 dick. On search queries side We believe the search market in China is still in the early stages of growth as (1) internet penetration still has good upside. Baidu has already seen the number of eCommerce advertisers double Y/Y during 3Q10. (2) Open Application platform to provide users with their more common application–related needs such as web-based games. Contextual advertising usually has higher payout ratios for third-party websites. Thirty percent of general search queries on Baidu are applications related. In addition.com Global Equity Research 03 January 2011 Key Drivers for 2011 On the monetization side We expect three major revenue drivers: (1) Continued improvement in Phoenix Nest algorithm will likely increase Baidu’s search monetization potential. have improved significantly over the past year.

Dick Wei (852) 2800-8535 dick.000 12.wei@jpmorgan.7% 8. We believe the company could make more acquisitions over the next two to three years.6% 41.000 -0.7% 18% 16% 14% 10. J.000 8.557 -3.1% 14. (%) Avg Qtly Spending / Customer (Rmb) QoQ Chg.000 100.541 3.000 4.com Global Equity Research 03 January 2011 back to the low teens level as a percentage of revenue.0% 15.3% 5.1% 40.9% 3Q09 216.2% 5.3% 9. (%) 1Q08 161.0% 26.000 6.1% 25.5% 5.918 9.000 0 12.P.2% 5.000 1.652 -4.1% Source: Company reports.000 10.3% 15.4% 41. We currently forecast TAC at 10% of revenues in 2011.000 150.9% 43.1% 4Q10E 282.x. Customers QoQ Chg. Source: Company reports.3% 11.6% 33.5% 1Q10 221. %) 2009 2010E 2011E Total Rev enue (Left. Active Online Marketing Customers and Average Quarterly Spending Trend Active Online Mktg.7% 12% 10% 8% 6% 4% 2% 0% 13.2% 35. J.2% 9.1% 2Q08 181.1% Long-term TAC as % of Total Revenue 18% 16% 14% 12% 10% 8% 6% 4% 2% 250.000 -6.379 -4.4% 11.6% 2Q10 254.5% 23.852 3.5% 25.9% 19.8% 36.292 10. J.1% 4.2% 13.000 50.000 3.1% 15.000 3.3% 23.5% 27.1% 2Q09 203.9% 25.1% 7. Quarterly TAC Trend 16.4% 21.P.0% 16.0% 11. Morgan estimates.2% 200.733 6.7% 4.402 23. when the revenue growth rate slows.5% 2Q09 185.3% 24.000 7.7% 9. Morgan estimates.000 13.0% 51.880 4. Morgan estimates.P.000 6.2% 45.9% 8.9% 4. New Businesses The Video and eCommerce businesses are still in the early stages of growth.000 12.576 -3.533 28.000 0 2005 2006 2007 2008 6.0% 4Q09 223.4% 4Q08 197. RMB millions) TAC as % of total rev enue (Right) Source: Company reports.5% 3Q10 272. We believe the company could maintain its strategy of taking a minority stake in new businesses by providing traffic. Rmb '000s) TAC as % of rev enue (RHS.9% 0% 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10E TAC (LHS.000 2.3% 14. 319 .9% 8.7% 12.8% 14.5% 13.8% 3. (%) YoY Chg.432 24.5% 9. (%) YoY Chg.7% 39.6% 3Q08 194.000 9.4% 4.000 7.000 14.

6% 18.1 89. We maintain our Dec 2011 price target of US$120.9% 6.P.8 91. our DCF valuation is US$120.2% 39.0% 45.7% 7.0 14.2% 49.4 78.8% 30.6 Terminal growth (%) 2% 3% 4% 185.3 131.8 105.4% 46.0 14.5 35. .3x PEG (based on 2012 P/E and long-term growth of 30%).2 141. Google’s potential exit from China is likely to be beneficial to Baidu as well.8% 30.2% 41.1 207.5 5% 239.0 -7.3x FY11E.9% 45.0% 13.4 128.0 30.x.0% 45.7 93.6 91. on the back of 53% and 35% EPS growth for FY11E and FY12E respectively.0% 12.7% 9.8% 30. (1) DCF valuation We use a 15-year DCF valuation for Baidu.3% 7.5 123.7 FY13E 33.0 -7. with a terminal growth rate at 3% Baidu—DCF Model Sales growth EBIT margin NOPAT margin Year-end net fixed assets turns Year-end net working capital turns Year-end net other assets turns Cash operating taxes as % of EBIT Year-end Invested capital turns Source: J.8 10.0 FY16E 22.0% 45.7 96.0 30.0 -7.0 14.4% 38.8 153.0 141.0 30.5% 7.5% 48.Dick Wei (852) 2800-8535 dick.0 14. Our price target implies 53.9 150.0% 14.0 14. with an estimated 17% long-term growth rate from 2020E-25E.2 1% 175.1% 42.2% 38.3x PEG (based on 2012 P/E and long-term growth of 30%).2% 38.0 112.9% 39.wei@jpmorgan.8% 30.0 FY20E 20.4% 5.com Global Equity Research 03 January 2011 Rating and Price Target We maintain our Overweight rating on Baidu as it remains one of the dominant market leaders in China’s online search market.8% 30.0 -7.2 85.6 103. (2) PEG ratio analysis At our PT of US$120.4.1% 7.0 FY18E 20.7x FY12E diluted adjusted EPS.9 186.0 DCF Sensitivity Analysis 0% 167.2% 38.2 161.0 -7. which is still in an early high-growth stage.5 FY11E 55.0 95.1% 6.9 -7.2 108.5% 41. we believe the risks are on the upside that the search ad market could develop at a faster pace.8% 30.7 81.3 83.4 115.6 49.8% 30. or 1. Morgan estimates.3 237.2% 38. Baidu trades at 1.4 179. We also performed some near-term revenue growth sensitivity analysis on a potential growth slowdown. Our current forecast implies 2012-2015E CAGR to be 30%.5% 7.9 117.P.8% 30.0 30.4 99.0 14.0 -7.6 172.2% 38.6 13.0 -7.2 FY12E 37.6 7% 336.0 FY17E 21.8% 30.6 140.0 FY14E 31. Morgan estimates.0 14.2 22.0 FY19E 20.0% 320 WACC Source: J.5% 7.4 134. or 1.2 6% 276.0 30.1 162.0% 45.5x PEG (based on 2011E P/E and 2012E EPS growth of 35%).1 109.7 198.0 FY15E 25.3 -7.6 88.0% 15.5 13.0 -7.6 146.0 -7.5% 7.0 30. and 39.4 79. Our nominal case DCF valuation is based on a WACC of 12% and 0% terminal growth. with lack of other well-established offline SME marketing platforms and the network of distributors and sales agencies.2% 48.9 103. If we assume near-term growth to slow down to 25%.5% 7. With China’s search market around five to six years behind the US in terms of monetization.2 123.0 14.0% 45.6 215.0 14. Based on the assumptions.9 119. FY10E 77.0% 45.0 30.0 30.0% 11. our DCF valuation is US$120.

Dick Wei (852) 2800-8535 dick. 321 .7x. and higher R&D could lead to a margin decline. the S&P 500 currently trades at 12x forward P/E with the next threeyear CAGR of 7%. government policy changes. the share price could be impacted in the near term due to lower earnings. The company also invested in a video site (Qiyi.wei@jpmorgan. • Unsuccessful new initiatives: Baidu began investments in Japan in 2007 with US$15million in expenses. upside surprise to TAC could come from a ramp-up of contextual search on affiliate sites and partnerships with new affiliate members. • Potential margin decline: While we expect Baidu to see a slight increase in TAC. we estimate China’s search market size could reach US$3B-US$4. Baidu could take an investment loss. Please also refer to the chart below for analysis of market size comparison with US/Korea market.com) and eCommerce site (JV with Rakuten). This compares to our current 2013 forecast of US$3. or a PEG of 1. economic slowdown.6B by 2013. fraudulent clicks causing a general decline in ROI. Baidu could invest in servers and bandwidths more significantly than we forecast. While this would be a positive in the long term.x.4B and US search market 2009 size of US$15B. In addition. (3) Market size potential Using various references to the US and Korea search markets.com Global Equity Research 03 January 2011 As a reference. Risks to Our Rating and Price Target Downside risks to our rating and price target include: • Slower-than-expected online search growth: This would be due to Baidu’s execution. Other factors that could lead to positive surprises to our forecast include faster-thanexpected inflation and RMB appreciation. and availability of an alternative more effective advertising form. higher bandwidth cost increases. If these ventures were unsuccessful or required additional financing. higher marketing expenses. • Large infrastructure-related expense: During the early phase of search advertising growth.

7 246.172 39 0 48 1.4 8.0 77.058 57 0 69 2.2 159.4 847.7 1.7 53. *Note: Excluding share-based compensation expenses.6 -101.6 1.7 507.828.3 42.3 39.4 36.9 152.829 0 270 347 617 0 1 618 3.4 6.172 FY11E 790 91 110 13 1.4 22.3 32.1 0.2 37.3 72.058 3.0 FY12E 71.7 Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC -86.528 0 194 260 454 0 1 455 2.7 37.5 FY09 63.6 56.1 1.6 42.9 2.6 910.6 14.800.49 3.62 0.8 -96.0 790.3 13.wei@jpmorgan.3 144.5 29.514.330 -191 0 -191 1. 322 .5 230.0 0.1 33.7 82. year-end December Net Income Depr.9 0.139 72 0 0 0 72 1.8 0.25 6.3 75.184 7 286 50 2.) Other Income (Exp.2 1. year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Other LT assets Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY08 388 14 0 14 415 2 129 28 573 0 62 62 124 0 0 124 450 FY09 671 24 0 15 709 2 146 44 902 0 110 95 205 0 1 206 696 FY10E 1.4 520.5 164.6 55.0 0.243 FY11E 2.0 6.9 12.9 112.6 1.2 90.8 19.44 0.0 45.6 53.9 1.4 54.3 42.7 46.8 887.189 2.350.0 49.6 54.3 131.4 8.9 47.0 12.0 350 FY11E 1.1 296.3 573.3 993.1 120.0 357 FY12E 2.3 1.6 0.4 -96.8 415.7 1.0 36.98 3.0 217. year-end December FY08 Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Share-based Expense Operating Profit (EBIT) EBITDA Interest Income.4 1.21 2.212.416 7 355 50 3.7 504.1 40.7 -99.5 167.P.248 76 0 93 3.4 72.3 100.0 348 FY09 651.1 133.6 53.8 177.4 -94.7 FY11E 72.073.250.9 34.248 Source: Company data and J.com Global Equity Research 03 January 2011 Baidu: Summary of financials Income statement US$ in millions.6 235.9 79.1 44.6 97.087.5 36.0 348 FY10E 1.1 43. Morgan estimates.6 40.6 55.3 216. net Investment Income (Exp.x.3 1.2 42.5 43.8 7.47 1.0 9.2 81.4 34.0 320.2 39.7 1.1 65.4 235.2 2.45 1.9 654.259 8 233 52 1.8 45.168.3 0.4 16.9 169.02 9.6 17.1 585. year-end December FY08 64.211 Cash flow statement US$ in millions.7 35.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) * US$ Diluted EPS (GAAP) Adj.2 0.0 2.074 121 121 14 1.6 56.3 357.8 0.074 FY12E 3.0 0.2 -86.5 52.551 0 128 179 307 0 1 308 1.4 1.2 266.3 48.9 13.1 12.0 4.2 14.005 -147 0 -147 858 59 0 0 0 59 886 1.3 1.172 2.1 1.7 8.3 -94.1 39.3 157.4 FY10E 72.6 1.2 8. & Amortisation Change in working capital Other Cash flow from operations Capex / Investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08 153 40 24 38 254 -59 -34 -93 195 -9 0 4 0 -5 176 211 388 FY09 218 48 70 13 348 -82 0 -82 267 17 0 -3 0 14 283 388 671 FY10E 507 67 51 13 638 -159 -5 -164 480 18 0 1 0 19 501 671 1.5 298.9 119.3 -99.0 2.2 713.2 Balance sheet US$ in millions.324.058 FY12E 1.0 2.6 82.66 2.6 211.1 -101.1 803.4 47.7 48. Diluted EPS * BPS DPS Shares Outstanding (Mn) 465.5 162.1 1.Dick Wei (852) 2800-8535 dick.0 360 Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth Diluted EPS growth Ratio analysis %.6 14.

3 Dec 29.8-9. In addition.8 161. Morgan Securities Inc. Morgan India Private Limited Imran Khan (1-212) 622-6693 imran.5 6.(%) Rel.com J.7 59.3 Neutral JRJC.6 1.6 0.05 0.8 1Q -0.5% -27. While the company has been working on a few new products.2 36. Bloomberg: JRJC US US$MM.4 Qtr GAAP EPS(US$) 0. Excluding net cash of US$4.3 6.1 3.30 Internet Dick Wei AC (852) 2800-8535 dick.53 per diluted share. Morgan Securities (Asia Pacific) Limited Ritesh Gupta (91-22) 6157 3307 ritesh.2 5.4 6.4 5. Upside risks include: (1) the government announcing new policies or innovative products that could lead to higher spot/futures market activity.6 1. Profit * GAAP Net Profit Adj.7x 2011E/2012E adjusted diluted P/E. net profit * Reported EPS (US$) P/E (x) Adj.05Mn 0.6 0.5% -28.P.t.Global Equity Research 03 January 2011 China Finance Online Remain Neutral on Lack of Near-term Price Drivers  While the company has established good checks on its operating expenses to reduce losses.4 EPS FY09 -0.2 1.26 25.4 -0.30 0. We recently revised down our 2011 revenue estimate by 19% and adjusted our EPS estimate (ex sharebased expenses) by 40%.0 4.0% 3m -6.01 3M -6.com J.01 0. Bloomberg.06 0.7 ROIC (%) -6. Reuters: JRJC.0 0. P/E (x) * EV/EBITDA (x) P/B (x) Y/E BPS (US$) FY09 FY10E FY11E FY12E 53.4 4. * Note: Adjusted figures exclude share-based comps & one-off expenses.01 FY10E 6.(%) Cash (US$m) Equity (US$m) FY09 0.0 $ 7.  Weaker 2011 Outlook: JRJC still lacks new revenue drivers in the near term. existing products are also negatively impacted due to rising competition and the IPO of its competitor in the A-share market (Grand Wisdom).5 97.2 2.7x 2011E/2012E adjusted diluted P/E.3 52-Week range Shares Outstg Avg daily volume Avg daily value Index (NASD) Free float Dividend Yld (%) Market Cap Price Target Price Date US$6.28 23.64 Price Target: $8.2 -31.6 1.3: Our DCF-based Dec-11 price target implies 67.8 134.04 0. these new products are yet to be introduced to the market place.5 33.13 0.1 4.3 3Q -0.P.0 2Q -0.8 EPS FY11 E 0. EPS (US$) Adj.3 5.4% -22. Perf. 2010 107.2 Abs.3x/31. we believe the company still lacks a product that could strengthen its revenue quality in the medium term. our PT implies 67.6 3.8 13.P. J. Downside risks to our PT include: (1) deterioration in domestic stock market activity.4 6.0 6. reducing demand for JRJC products. We are now also forecasting increased sales and marketing and research and development expenses.3x/31.2 ROE (%) -1.01 0.8 FY11E 2.0% FY12E 5.6 130. Op. Price Performance 9.3 105.  Dec-11 PT of US$8. Y/E Dec Net Revenue Adj.11 0. .9 107.0% 1m -16.wei@jpmorgan.  Business Still Lacks New Drivers: We believe China Finance Online is still lacking a product that could drive their revenues.z.8 3.2 -22.7 4Q -0.gupta@jpmorgan.com J.1 1.9% 12m -11.667 52% 0% US$146M US$ 8.P.12 53.khan@jpmorgan.6 59.9 112.4Mn 2.x.02 0.1 22Mn 0.01 12M -14.4 119.1 6. JRJC US Price: $6.02 371.7% -18. and (2) the company diversifying into other brokerage–related businesses.01 1M -17. Morgan estimates. A decline in cash revenues for 3Q10 and a muted outlook for next quarter would mean weaker revenue recognition until 2Q11 due to amortization of subscription revenues.0 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 JRJC share price ($) NASDAQ Composite (rebased) YTD Abs Rel -11.18 EPS FY10 E nm 71. and (2) higher-than-expected product development expenses.7 -18.09 0.3 1.01 0.2 1. Perf.4 Source: Company reports.2 54.

7% 11.0% 16.5% 4.5 9.7 (4.6% 10.7 (4.3 7.7% 14.5 10.P.1 2013E 9.6 8.1 7.5 25.0) 4.3x/31.7% 14.0) 3.1 7.7 (4.0% 12.6% 10.4 10.3% 4.5 8.0) 4.8% 8.8% 8.26 (up 112.0% 11.2% 10. terminal growth of 0%) of US$8.7% 14.2 8.1 7.9 7% 11.3% 8.8 8.0) 4.7% 14.6% 10.1) 3.8 8.2% Y/Y).8 7.7M (down 7.3) 3.0% 15.7 7.7% 11.0% 14.8 8.3 8.6% 10.9 8.0) 4.3 9.6% 10.8% 8.0% Source: J.7% 11.6% Y/Y) and adjusted EPS (excluding share-based expenses) of US$0.6 9.0) 4.5 25.5 2011E -7.3% Y/Y) and adjusted EPS of US$0.2 -33.4 7.7% 11.8 8.5 2020E 11.5 2019E 11.0 5% 10.5 25.7x 2011E/2012E adjusted diluted P/E. Morgan estimates.8 7.4 (4.5% 3.0) 4.4 7.6% 10.7% Y/Y).5 25.53 per diluted share.5% 8.0) 4.5 25.3 25.0 -33. Our DCF-based PT (WACC of 13%.5 2014E 11.5 25.7 (4.7% 14.4 7.7% 6.8 7.7 (4.2 7.6 7.7% 11.2 7.7 7.0 6% 11.5 25.7% 11. 2010E 10.9 10.6 9.8% 8.2 6.6% -1.5 2015E 11.0x 2011E/2012E adjusted diluted P/E.8 8.3 7. Excluding net cash of US$4.1 9. our PT implies 65.9% 7.1 1% 10.5 DCF Sensitivity Analysis 0% 10.7x/20.3.7% 11.1 7. Price Target.3 7.7% 14.0% 3.12 (down 56.7% 11.5 2018E 11.4 (5.5 8.4% -1.8 8.8 7. Risks to Our Rating and Price Target Key downside risks include: (1) deterioration in domestic stock market activity (negatively affecting demand for JRJC’s products).5 7.8% 8. (2) increase in competition in financial analysis software.7% 14.1 Terminal Growth (%) 2% 3% 4% 10.7 2012E 8. 324 WACC .7 9.7 8.8% 8.7 (4.0) 4.4 9.5 25. Our 2012 revenue estimates are US$59.0% 13.2 6. DCF Model (Base case scenario) Sales growth EBIT margin NOPAT margin Year end net fixed assets turns Year end net working capital turns Year end net other assets turns Cash operating taxes as % of EBIT Year end Invested Capital turns Source: J.x.6 7.Dick Wei (852) 2800-8535 dick.0% 8.4% -1.8 8. Valuation and Rating Analysis Maintain Neutral with our Dec-11 PT of US$8.7 (4. Morgan estimates.8 8.8% 8.P.7 (4.5 2017E 11.7% -2.3 7.3% 7.8 8.7 (4.9 9.2% 10.com Global Equity Research 03 January 2011 2011 and 2012 Outlook We expect 2011 revenues of US$54.2M (up 8.3 implies 67. and (3) larger-than-expected in-house investment in product development and database.5 2016E 11.wei@jpmorgan.

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

China Finance Online: Summary of financials
Income statement
USD in millions, year-end December FY08 Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.) Non-Operating Income (Exp.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) USD: EPS (Reported) EPS (Adjusted) * BPS DPS ADS Outstanding (Diluted, Mn) 56.2 9.4 46.9 5.6 28.5 12.8 22.5 1.6 0.0 0.0 1.8 16.2 2.6 19.0 26.6 0.84 1.18 4.9 0.0 19.8 FY09 53.6 8.1 45.5 10.7 43.1 -8.4 1.3 1.4 0.0 0.0 0.4 -6.7 0.4 -6.2 0.4 -0.30 0.02 4.6 0.0 21.0 FY10E 59.2 8.3 50.9 12.7 39.0 -0.8 7.1 1.5 0.0 0.0 1.6 2.2 -0.3 2.1 6.6 0.09 0.28 5.0 0.0 21.5 FY11E 54.7 8.5 46.2 12.9 34.3 -0.9 3.2 1.6 0.0 0.0 0.4 1.1 -0.3 1.0 3.0 0.04 0.12 5.6 0.0 21.4 FY12E 59.2 9.0 50.3 13.0 34.6 2.7 6.9 1.8 0.0 0.0 0.4 4.9 -0.7 4.4 6.4 0.18 0.26 6.2 0.0 21.5 Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth

Ratio analysis

%, year-end December FY08 83.3 40.1 22.8 33.8 9.9 50.6 117.1 185.0 560.9 -491.0 FY09 84.8 2.5 -15.6 -11.6 20.0 80.5 -4.7 -165.3 -132.7 -135.1 FY10E 86.0 12.0 -1.4 3.6 21.5 65.9 10.4 89.9 134.3 -131.2 FY11E 84.4 5.9 -1.7 1.8 23.5 62.6 -7.6 -9.8 -53.2 -55.4 FY12E 84.9 11.7 4.5 7.5 22.0 58.4 8.3 387.2 342.1 338.1

Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC

-101.1 -101.1 39.8 0.9 32.5 30.5

-110.3 -110.3 32.4 0.7 0.4 -0.8

-98.3 -98.3 34.7 0.7 6.4 5.0

-94.2 -94.2 31.6 0.6 2.6 1.3

-97.4 -97.4 30.5 0.6 5.1 3.7

Balance sheet

USD in millions, year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY08 97.5 2.9 0.0 12.7 113.1 1.5 8.6 18.0 141.2 0.0 7.0 28.3 35.4 0.0 9.4 44.8 96.5 FY09 107.5 5.4 0.0 20.8 133.7 1.5 10.3 20.2 165.6 0.0 21.7 30.7 52.4 0.0 15.8 68.2 97.4 FY10E 105.9 16.1 0.0 20.6 142.6 1.5 8.0 18.6 170.8 0.0 24.8 28.5 53.3 0.0 9.7 63.0 107.8 FY11E 112.4 15.7 0.0 18.0 146.1 1.5 7.4 18.2 173.2 0.0 19.3 27.8 47.1 0.0 6.8 53.9 119.3 FY12E 130.8 17.6 0.0 20.1 168.5 1.5 6.8 17.7 194.5 0.0 20.8 34.7 55.5 0.0 4.7 60.2 134.3

Cash flow statement

USD in millions, year-end December Net Income Depreciation & Amortization Change in working capital Other Cash flow from operations Capex/investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08 19.0 2.1 -1.1 7.3 27.3 -11.2 0.0 -11.2 16.1 2.5 0.0 4.2 0.0 6.7 22.8 74.7 97.5 FY09 -6.2 3.1 6.4 6.6 9.9 -6.9 0.0 -6.9 3.0 0.6 0.0 6.4 0.0 6.9 9.9 97.5 107.5 FY10E 2.1 3.5 -9.6 4.2 0.2 0.3 0.0 0.3 0.5 3.8 0.0 -5.9 0.0 -2.0 -1.5 107.5 105.9 FY11E 1.0 2.2 -3.2 1.8 1.7 -1.1 0.0 -1.1 0.6 8.5 0.0 -2.7 0.0 5.9 6.5 105.9 112.4 FY12E 4.4 2.3 4.4 1.8 12.9 -1.2 0.0 -1.2 11.6 8.5 0.0 -1.8 0.0 6.7 18.3 112.4 130.8

Source: Company data and J.P. Morgan estimates. * Note: We have included 123R share-based compensation adjustments starting in 2006.

325

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

326

Global Equity Research
03 January 2011

Netease
Leading Game Developer in China. Starcraft 2, WoW Upgrade to Provide Growth in F'11
We see Netease as the top online game developer and operator in China, and expect the company to see ~20% gaming revenue growth in 2011. Success of Starcraft 2, WoW Cataclysm, and other in-house games could drive the stock higher.  WoW and Fantasy WWJ to remain strong: Online games saw healthy growth over the last two quarters for Netease. New "Perfect Beauty" and having Jay Chou as spokesperson helped Fantasy WWJ drive good growth in 2Q11 and 3Q11. WoW also saw good sequential growth with the launch of new expansion pack “Wrath of Lich King” in 2011. We believe these games should continue to maintain their franchise with the launch of promotion events and new expansion packs.  Starcraft 2 may be launched in 2011: Netease has already submitted information and materials related to the game to relevant government authorities and the game is undergoing the review process. We expect that Starcraft 2 may be launched in 2011.  Online advertising to benefit from new advertising placement system: We expect Netease to see healthy portal revenue growth of 26% next year. We believe the company should benefit from improved awareness amongst advertisers from: (1) sponsorship of Asian Games in Guangzhou, and (2) launch of a new ad placement system which provides analytics for effectiveness of advertisements placed on Netease portal. Portal traffic on Netease is up 40% YTD as of the end of 3Q10.  2011 outlook: We expect 2011 revenues to see 19.7% growth YoY to reach US$947M. We expect gross margins to remain intact with slight improvement in operating margins on lower marketing expenses. Online Games should see 19.2% growth YoY in 2011 from continued performance of WoW and Fantasy WWJ. Launch of Starcraft 2 should be a key revenue driver for 2011, in our view. Netease has one of the strongest R&D teams and we expect the company to maintain its strength as a gaming franchise.
Reuters: NTES; Bloomberg: NTES US
(US$MM, Y/E Dec) Net Sales Operating Profit EBITDA Pre Tax Profit Net Profit Reported EPS (US$) Reported P/E (x) Adj. EPS (US$) Adj. P/E (x) EV/EBITDA P/B (x) Y/E BPS (US$) FY09 550.2 296.3 322.0 314.9 269.0 2.07 17.6 2.11 17.3 12.6 4.1 8.8 FY10E 789.7 359.3 409.2 368.2 311.8 2.39 15.3 2.51 14.5 9.9 3.2 11.4 FY11E FY12E 946.6 1,055.7 ROE (%) 441.8 496.5 ROIC (%) 506.0 570.5 GAAP Qtr EPS (US$) 472.4 536.2 EPS FY09 393.3 441.0 EPS FY10E 2.94 3.22 EPS FY11E 12.4 11.3 3.10 3.40 Abs. Perf.(%) 11.8 10.7 Rel. Perf.(%) 8.0 7.1 2.5 2.0 Cash (US$MM) 14.7 18.3 Equity (US$MM)

Overweight
NTES, NTES US Price: $36.07 Price Target: $45.00

Internet Dick Wei
AC

(852) 2800-8535 dick.x.wei@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited

Ritesh Gupta
(91-22) 6157 3307 ritesh.z.gupta@jpmorgan.com J.P. Morgan India Private Limited

Imran Khan
(1-212) 622-6693 imran.t.khan@jpmorgan.com J.P. Morgan Securities LLC
Price Performance
40 $ 34 28
Dec-09 Mar-10 Jun-10 Sep-10 Dec-10

NTES share price ($) NASDAQ Composite (rebased)

YTD Abs Rel -12.5% -28.0%

1m -5.6% -11.2%

3m -8.2% -20.4%

12m -2.9% -19.4%

FY09 FY10E FY11E FY12E 28.9 26.0 25.0 21.6 52-Week range (US$) 27.3 24.7 23.5 20.1 Shares Outstg (MM) 1Q 2Q 3Q 4Q Avg daily volume 0.47 0.53 0.44 0.64 Avg daily value 0.51 0.55 0.66 0.68 Index (NASD) 0.68 0.72 0.76 0.78 Free float (%) 1M 3M 12M Dividend yld (%) -6.7 -8.7 -2.8 Market Cap -11.9 -20.9 -20.3 Price target (US$) Price Date 1,046 1,519 2,004 2,544 1,087 1,429 1,891 2,404

26.2-43.7 130M 0.9M US$31.4M 2,667 ~50% 0% US$4.7B US$45 Dec 29, 2010

Source: Company reports, Bloomberg, J.P. Morgan estimates. Note: We have included 123R share-based expense adjustments starting in 2006.

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

2011 and 2012 Outlook
We expect 2011 revenues of US$946.6M (up 19% Y/Y) and adjusted EPS (excluding share based expenses) of US$3.10 (up 23.4% Y/Y). We expect 2012 revenues of US$1,055.7M and adjusted EPS of US$3.40.

Rating and Price Target
OW with Dec-11 price target of US$45 We maintain our OW rating on Netease and recently rolled over our PT time frame to Dec-11 from Dec-10. Our PT is US$45 based on DCF valuation of US$45 (assuming WACC of 12.9% and 0% terminal growth). Our price target of US$45 implies 17.9x ’10, 14.5x ’11E, and 13.2x ‘12E diluted adjusted EPS. If we exclude cash of US$9.9 per share, our price target of US$45 implies 14.0x ’10, 11.3x ’11E, and 10.3x ‘12E ex-cash P/E. The company has a strong cash position of US$1.29B (US$9.9 per diluted share).

Share Price Drivers
We expect new game launches such as Starcraft 2 and WoW upgrade to Cataclys will be share price drivers for NetEase

Risks to Our Rating and Price Target
Downside risks to our price target include: intense competition resulting in a negative industry environment, delays in game launches, hacking or pirated server issues limiting user growth, and risks of losing operating rights for licensed games (such as WoW).

NTES—DCF model (base case scenario)
Sales growth EBIT margin NOPAT margin Year-end net fixed assets turns Year-end net working capital turns Year-end net other assets turns Cash operating taxes as % of EBIT Year-end Invested capital turns
Source: J.P. Morgan estimates.

FY10E 42.8% 45.5% 38.2% 7.8 (4.4) 24.3 16.0% (17.1)

FY11E 19.7% 46.7% 38.0% 9.3 (4.8) 29.1 18.6% (15.1)

FY12E 11.5% 47.0% 37.6% 10.4 (4.9) 32.5 20.0% (12.7)

FY13E 10.1% 46.0% 36.8% 12.0 (4.9) 22.0 20.0% (13.0)

FY14E 10.8% 45.4% 36.3% 12.0 (4.9) 22.0 20.0% (13.0)

FY15E 10.0% 42.0% 33.6% 12.0 (4.9) 22.0 20.0% (13.0)

FY16E 10.0% 40.0% 32.0% 12.0 (4.9) 22.0 20.0% (13.0)

FY17E 10.0% 38.0% 30.4% 12.0 (4.9) 22.0 20.0% (13.0)

FY18E 10.0% 36.0% 28.8% 12.0 (4.9) 22.0 20.0% (13.0)

FY19E 10.0% 36.0% 28.8% 12.0 (4.9) 22.0 20.0% (13.0)

FY20E 10.0% 36.0% 28.8% 12.0 (4.9) 22.0 20.0% (13.0)

DCF sensitivity analysis
0% 57.3 52.3 48.2 44.8 41.9 39.4 37.2 1% 59.3 53.8 49.3 45.6 42.5 39.8 37.6 Terminal growth (%) 2% 3% 4% 61.8 64.9 69.2 55.5 57.7 60.5 50.5 52.1 54.0 46.5 47.6 49.0 43.2 44.0 45.0 40.4 41.0 41.7 38.0 38.5 39.0 5% 75.2 64.3 56.5 50.7 46.2 42.6 39.7 6% 84.3 69.6 59.9 52.9 47.7 43.7 40.4 7% 99.6 77.6 64.6 55.9 49.7 45.0 41.4

9.9% 10.9% 11.9% 12.9% 13.9% 14.9% 15.9%

328

WACC

Source: J.P. Morgan estimates.

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

Netease: Summary of financials
Income statement
Rmb in millions, year-end December Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.) Non-Operating Income (Exp.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) * RMB EPS (Reported) EPS (Adjusted) * BPS DPS Shares outstanding (MM)

Ratio analysis
FY08 2,938 546 2,392 185 439 1,768 1859 144.8 0 1.5 -163.5 1,751 -264 1,487 1,555 11.53 12.05 45.90 0.00 125 FY09 3,757 943 2,814 220 570 2,023 2167 128.2 0 0.4 -1.3 2,151 -314 1,837 1,869 14.17 14.41 60.36 0.00 129 FY10E 5,364 1,707 3,657 280 936 2,441 2682 139.5 0 0.2 -79.0 2,501 -383 2,118 2,230 16.22 17.07 77.14 0.00 129 FY11E 6,420 2,044 4,375 356 1,023 2,996 3282 207.5 0 0.0 0.0 3,203 -536 2,667 2,816 19.92 21.03 99.81 0.00 127 FY12E 7,159 2,261 4,899 394 1,138 3,367 3706 269.4 0 0.0 0.0 3,636 -646 2,991 3,153 21.87 23.06 124.21 0.00 130

%, year-end December Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC

FY08 81.4 63.3 60.2 50.6 6.3 14.9 32.7 46.6 17.6 20.2 -101.8 -101.8 46.3 0.7 34.9 30.1

FY09 74.9 57.7 53.9 48.9 5.9 15.2 27.9 14.5 24.5 22.9 -96.2 -96.2 42.7 0.6 28.9 27.3

FY10E 68.2 50.0 45.5 39.5 5.2 17.5 42.8 20.6 15.1 14.5 -106.3 -106.3 45.2 0.7 26.0 24.7

FY11E 68.2 51.1 46.7 41.5 5.5 15.9 19.7 22.7 25.2 22.9 -106.0 -106.0 42.1 0.6 25.0 23.5

FY12E 68.4 51.8 47.0 41.8 5.5 15.9 11.5 12.4 12.1 9.8 -105.8 -105.8 37.7 0.5 21.6 20.1

Balance sheet

Rmb in millions, year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity

Cash flow statement
FY08 5,613 231 0 129 5,974 0 259 113 6,346 0 320 510 829 0 0 829 5,516 FY09 7,141 187 0 645 7,973 0 558 273 8,803 0 582 796 1378 0 0 1,378 7,425 FY10E 10,316 408 0 224 10,949 0 691 220 11,860 0 1,132 993 2125 0 25 2,151 9,709 FY11E 13,615 465 0 264 14,344 0 693 220 15,258 0 1,257 1,132 2389 0 25 2,415 12,843 FY12E 17,278 514 0 292 18,085 0 686 220 18,991 0 1,385 1,251 2636 0 25 2,661 16,330

Rmb in millions, year-end December Net Income Depr. & Amortization Change in working capital Other Cash flow from operations Capex / investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash

FY08 1,487 91 111 68 1,757 -214 0 -214 1,543 453 -642 100 0 -88 1,455 4,159 5,613

FY09 1,837 144 77 18 2,076 -602 0 -602 1,473 40 0 0 0 40 1,513 5,613 7,141

FY10E 2,118 242 947 100 3,407 -322 0 -322 3,085 54 0 25 0 79 3,164 7,141 10,316

FY11E 2,667 286 167 149 3,269 -289 0 -289 2,980 318 0 0 0 318 3,298 10,316 13,615

FY12E 2,991 339 170 163 3,662 -332 0 -332 3,330 334 0 0 0 334 3,664 13,615 17,278

Source: Company data, J.P. Morgan estimates. * Adjusted EPS excludes share-based compensation expense.

329

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

330

Global Equity Research
03 January 2011

Shanda Games
2011 Could Mark a Turnaround
 2011 outlook: Shanda Games currently guides 4Q10 revenues to be 3% to 5% higher sequentially in 4Q10. We expect Shanda Games could return to growth in 2011, particularly if Dragon Nest can continue to gain traction in 2011. F’11 could well mark the turnaround for Shanda Games: We expect the company to see double-digit growth on the top line. Dragon Nest has gotten a good response from gamers. Another promising game in the F’11 pipeline is Final Fantasy XIV.  Dragon Nest could be the second-largest game next year: Dragon Nest PCUs have already touched 700K levels. We believe by next year the game could reach 10% of total revenues for Shanda Games, or become the second-largest game after Mir2, and to surpass Woool. We believe the revenues from new games could ease the pressure from the potential decline in legacy games.  Acquisition of Eyedentity: The company acquired Eyedentity games for US$95M, which will save the company from paying royalties on Dragon Nest. Additionally, this will also contribute some international revenues to Shanda Games.  2011 pipeline healthy: Shanda Games maintains a healthy pipeline of 5 MMORPG games and one casual game for next year. We believe Final Fantasy XIV could be a popular game for Shanda. The game is licensed from Square Enix and has seen good response from gamers internationally.  We believe the company could also benefit from Final Fantasy XIV and other in-house games.
Reuters: GAME, Bloomberg: GAME US
US$ in millions, year-end December US$MM, YE-Dec FY09 FY10E Net Sales 703.3 655.8 Operating Profit (EBIT) 253.8 193.7 EBITDA 298.1 234.8 Pre Tax Profit 282.4 229.5 Reported Net profit 212.6 180.6 Reported EPS (US$) 0.75 0.62 P/E (x) 8.4 10.2 Adj. EPS * 0.82 0.68 Adj. P/E (x) 7.7 9.4 EV/EBITDA 5.7 7.3 P/B (x) 4.4 3.0 Y/E BPS (US$) 1.4 2.1

Overweight
GAME, GAME US Price: $6.33 Price Target: $8.00

Internet Dick Wei
AC

(852) 2800-8535 dick.x.wei@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited
Price Performance
11 $ 8 5
Dec-09 Mar-10 Jun-10 Sep-10 Dec-10

GAME share price ($) NASDAQ Composite (rebased)

YTD Abs Rel -40.6% -56.1%

1m 11.2% 5.6%

3m 19.4% 7.2%

12m -38.4% -54.9%

FY11E 727.8 217.1 261.9 251.2 187.2 0.62 10.2 0.66 9.6 6.5 2.3 2.8

FY12E 825.4 253.6 305.5 294.6 220.0 0.72 8.8 0.77 8.3 5.6 1.8 3.6

ROE (%) ROIC (%) Qtr GAAP EPS (US$) EPS FY09 EPS FY10E EPS FY11E Abs. Perf.(%) Rel. Perf.(%) Cash Equity

FY09 FY10E FY11E FY12E 81 38 28 26 52-Week range 82 37 28 25 Shares Outstg 1Q 2Q 3Q 4Q Avg daily value 1.13 1.33 1.58 1.54 Avg dly volume 1.19 1.22 1.10 1.11 Index (NASD) 1.08 1.11 1.14 1.20 Free float 1M 3M 12M Dividend Yld (%) 11.1 13.7 -38.2 Market Cap 6.0 1.5 -55.7 Price Target 374 545 732 940 Price Date 413 616 803 1,023

US$5.0-11.0 288Mn US$ 6Mn 1.0Mn 2,667 ~29% 0% US$1.82B US$8 Dec 29, 2010

Source: Company reports, Bloomberg, J. P. Morgan estimates, Bloomberg. * Note: Excluding share-based compensation expense.

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

2011 and 2012 Outlook
We expect Shanda Games to register US$727.8M (up 11.0% Y/Y) in revenues in 2011 while adjusted EPS (excluding share-based expenses) to be US$0.66 (down 1.8% Y/Y). 2012 revenues are expected to be US$825.4M (up 13.4% Y/Y) while adjusted EPS are expected to be US$0.77 (up 15.8% Y/Y).

Rating, Price Target and Valuation
Maintain OW with Dec-11 PT of US$8 Our PT is based on the historical 12-month midpoint of forward P/E of 10x. Our Dec-11 PT implies 12.1x 11E and 10.4x 12E diluted adjusted P/E. Excluding US$1.8 per share (or US$500M of cash), our PT implies 10.0x 11E and 8.7x 12E. We believe the stock is undervalued given its leading position in China online game space. As such, we maintain our OW rating on Shanda Games. We expect share price drivers to be few months away, with (1) stabilization of Mir 2 revenue, (2) upside from Dragon Nest and other new games. DCF valuation Our DCF valuation assumes 10-year revenue growth and 0% terminal growth. At a WACC of 12.1%, our DCF valuation is US$9. We believe DCF is a good reference to value the company. However, with risks in the game pipeline, we believe Shanda Games may not be able to trade at its DCF valuation.

Risks to Our Rating and Price Target
Risk to our price target include: (1) slower-than-expected revenue growth due to an aging game portfolio and Shanda Games fails to launch successful new games or new upgrade packs, (2) increased competition in the game industry, (3) larger-thanexpected spending in marketing, overseas expansion or game sourcing, (4) disruption in the distribution contract with Shanda Interactive, and (5) regulatory changes that could impact the operation of existing games or delay new game launches.

DCF model (base case scenario)
Sales growth EBIT margin NOPAT margin Year-end net fixed assets turns Year-end net working capital turns Year-end net other assets turns Cash operating taxes as % of EBIT Year-end Invested capital turns
Source: J.P. Morgan estimates.

FY10E -6.8% 29.5% 22.6% 21.9 (79.9) 6.0 23.4% 5.0

FY11E 11.0% 29.8% 21.8% 16.9 (68.0) 6.7 26.8% 5.2

FY12E 13.4% 28.7% 22.5% 13.0 (78.2) 7.6 26.7% 5.1

FY13E 12.0% 28.4% 22.4% 10.2 (76.9) 8.5 26.5% 4.9

FY14E 12.3% 29.3% 22.4% 8.8 (82.0) 9.5 26.2% 4.9

FY15E 11.7% 29.4% 22.4% 8.1 (86.5) 10.6 26.2% 4.8

FY16E 10.0% 29.4% 21.7% 7.80 (82.5) 10.6 26.2% 4.8

FY17E 10.0% 28.9% 21.3% 7.80 (82.5) 10.6 26.2% 4.8

FY18E 10.0% 28.9% 21.3% 7.80 (82.50) 10.64 26.2% 4.8

FY19E 10.0% 28.9% 21.3% 7.80 (82.50) 10.64 26.2% 4.8

FY20E 10.0% 28.9% 21.3% 7.80 (82.50) 10.64 26.2% 4.8

332

1 8.11% 13.P.0 13.2 Terminal growth (%) 2% 3% 4% 13. 333 .0 8.8 12.5 5% 17.0 9.3 9.2 10.11% 15.1 9.7 14.3 7.1 9.x.2 7.2 8.7 7.6 14.6 8.3 12.wei@jpmorgan.4 7.11% 12.8 18.1 11.2 7.1 9.9 11.11% WACC Source: J.7 10.4 13.4 9.7 8.0 8.7 16.0 8.11% 10.7 7.9 8.7 6% 20.0 7.3 8.8 9.4 9.4 7.1 10.8 11.4 15.5 10.1 1% 12. Morgan estimates.6 7.3 11.9 7% 26.com Global Equity Research 03 January 2011 DCF sensitivity analysis 0% 12.5 12.9 9.3 10.5 9.5 14.11% 14.0 10.Dick Wei (852) 2800-8535 dick.4 7.11% 11.7 11.

4 1.7 10.048 FY12E 940 116 0 62 1.5 81.9 -89.9 19.7 10.8 0.67 2.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) * US$ Diluted EPS (GAAP) Adj.6 24.294 Cash flow statement US$ in millions.wei@jpmorgan.4 1. 334 .9 80.0 282 FY10E 656 270 386 66 126 15 194 235 8 0 28 230 45 181 196 0.75 0.6 0.1 3.7 7.2 10.0 303 FY12E 825 325 500 90 157 14 254 305 16 0 25 295 68 220 234 0.com Global Equity Research 03 January 2011 Shanda Games: Summary of financials Income statement US$ in millions.9 FY09 59. *Note: Excluding share-based compensation expenses.1 30.7 -91.6 0.P.0 56.7 -78.5 27.66 2.2 109.8 FY12E 60.9 36.8 25.4 16.8 1.5 16.0 25.6 -88. year-end December Net Income Depr.) Other Income (Exp.9 39.4 51.9 17.023 37 1. & Amortisation Change in working capital Other Cash flow from operations Capex / Investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08 136 23 15 -7 166 -18 -3 -21 148 -52 0 -63 0 -115 39 87 125 FY09 213 26 7 25 271 -61 2 -59 210 168 2 -65 -78 28 249 125 374 FY10E 181 26 -33 19 192 -8 -2 -10 184 9 -2 -10 0 -4 171 374 545 FY11E 187 31 6 19 244 -44 0 -44 199 -14 0 1 0 -12 187 545 732 FY12E 220 38 5 20 283 -59 0 -59 225 -14 0 -3 0 -17 208 732 940 Source: Company data and J.2 7.5 10.4 FY11E 59.9 63.1 102.0 12. year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Other LT assets Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity Minority interests Total Liabilities and Equity FY08 125 64 0 40 230 3 14 108 355 0 14 157 171 0 4 176 159 20 355 FY09 374 62 0 46 482 1 28 129 641 2 14 168 185 0 6 190 413 30 633 FY10E 545 91 0 48 684 3 30 109 826 0 14 165 180 0 4 184 616 26 826 FY11E 732 105 0 56 893 3 43 109 1.9 19.6 34.8 -23.2 69.5 -88.294 0 18 213 230 0 4 234 1.62 0.0 -17.8 29.3 27.2 11.4 0. Diluted EPS * BPS DPS Shares Outstanding (Mn) 491 216 274 35 71 3 168 194 5 0 1 174 36 136 139 0.50 0.9 72.9 Balance sheet US$ in millions.3 85. year-end December FY08 55.62 0. year-end December FY08 Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Share-based Expense Operating Profit (EBIT) EBITDA Interest Income.7 -90.0 91. Morgan estimates.1 16.Dick Wei (852) 2800-8535 dick.82 1.0 304 Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth Diluted EPS growth Ratio analysis %.0 13.7 -15.2 -91.4 54.4 -91.8 3.9 35.7 138.7 26.8 42.x.6 59.6 38.6 37.6 72.6 43.9 -91.0 29.2 -6.1 14.1 0.72 0.048 0 16 191 208 0 4 212 803 33 1.77 3.5 79.118 3 63 109 1.2 28.0 290 FY11E 728 291 436 79 140 14 217 262 12 0 22 251 58 187 201 0.0 279 FY09 703 283 420 50 117 18 254 298 4 0 25 282 63 213 231 0.6 -0.1 37.49 0.9 Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC -78.4 36. net Investment Income (Exp.1 19.9 FY10E 58.3 27.0 30.

and customer relationship management.6% 3m 2.64 52-week range Shares outstg.690 FY10E 8. (%) 1. Still.5% -9.5 1Q 1. * Note: We have included share-based compensation adjustments starting in 2006. Y/E . Avg daily vol. generating additional sources of revenues.790 FY11E 8. Morgan estimates. preferences.1 233.7 3. P/E (x) EV/EBITDA P/B (x) Y/E BPS (US$) FY09 767.wei@jpmorgan.4% -39.53 EPS FY10E 30.8 ROE (%) 155.60 1M 0.khan@jpmorgan.0 Qtr GAAP Dil EPS (US$) 92.8 1.60 3M 3.6 10.83 21.1 22.446 Price date: 2. Shanda Online is also working to include the systematic integration of users’ personal information.5 1. We expect the segment to see good traction in 2011.6 ROIC (%) 246.com J.8 109.63 12M -23.1 3. J.56 0.9% FY11E 8. EPS (US$) P/E (x) Adj.02 0. relationships. and (3) the company continues to make synergetic investments to become a leading interactive entertainment provider in China.6 1.40 0. We maintain our view that: (1) Shanda Games’ potential success is in its new games. In addition.4 180.3-59.6 226. Ku6 and other new ventures.31 1. promotion & payment.  2011 outlook: We maintain our Overweight rating on Shanda. we think the stock price will largely depend on the performance of its gaming business.  Good Shanda Online outlook: Shanda Online is an integrated service platform providing total solutions to all kinds of accounts and application developers.0% -6.918 Overweight SNDA.6 3Q 1.9 Absolute perf. Shanda Literature (SDL) recently unveiled its Cloudary initiative.912 1.2 EPS FY09 1.5 1.gupta@jpmorgan.7B US$47 Dec 29. SDL currently works with more than 100 publishers for its Cloudary initiatives.P.0 287.6% -46.2 1.6 FY11E FY12E 937.9 69M 0.18 0. There are a total of 72 third-party providers working with Shanda Online.7 8. (2) potentials exist in Shanda Online.27 0.com J.7% 12m -23. Bambook has also been a decent success for SDL.227 1. combining Shanda Literature's rich IP library with the content from external parties.P. EPS (US$) * Adj.030 1.2 7.5 20. (US$ M) 27.36 29.4 -4.2M 2.P.6 -8.74 10. Morgan India Private Limited Imran Khan (1-212) 622-6693 imran. messages. Bloomberg: SNDA US (US$MM.9 141. SNDA US Price: $39. It brings together over 70 billion Chinese characters of literary content. Morgan Securities Inc.5 367.23M US$9.4 Cash & Equiv.7 8.6 24. Shanda Games.4 Relative perf. Morgan Securities (Asia Pacific) Limited Ritesh Gupta (91-22) 6157 3307 ritesh.1 4Q 1.t.1 28. as Shanda continues to improve its presence in this area.061 US$36.5 26.Dec) Net Sales Operating profit EBITDA Net Profit Reprtd.60 Price Target: $47.2 91. Reuters: SNDA.8 Equity (US$ M) FY09 25.53 0.6 6.90 23. given its lowvaluation and high cash level.667 49% 0% US$2.com J. Bloomberg.1% 1m -1.074. 3 million copyrighted books and more than 1000 electronic magazines and periodical publications.2 298.7 2Q 1. 2010 Source: Company data.00 Internet Dick Wei AC (852) 2800-8535 dick.Global Equity Research 03 January 2011 Shanda Interactive Entertainment Ltd New Businesses Shaping Up Well But Stock Price Still Hinges On Online Games  We expect Shanda Interactive to continue investing in its Shanda Online and Shanda Literature businesses in 2011. Avg daily value Index (NASD) Free float Div yield (%) Market Cap Price target 2. (%) 9.P. The three core service modules are content delivery.4 -40.6 7.38 11. The Cloudary offers a massive online collection of literary works. Price Performance 65 $ 50 35 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 SNDA share price ($) NASDAQ Composite (rebased) YTD Abs Rel -30.  Shanda Literature continues to see good traction: The Literature business achieved solid sequential growth in 3Q10 by implementing its core strategy of establishing a complete copyright operation platform.9 EPS FY11E 1.8 2.90 0.5 FY10E 807.51 0.5 1.68 1.z.x.8 1.7 2. .2 25.

0x 2011E and 18.Dick Wei (852) 2800-8535 dick.6% Y/Y) and adjusted EPS of US$1.412 (153) 3.2 per share). DCF valuation of US$56.8x 2012E diluted adjusted EPS.68 for 2011. Price Target and Valuation Remain Overweight on Shanda We maintain our Overweight rating on Shanda. our PT implies 22. which is based on our Shanda Games PT of US$8 ).613 1.9%. we believe these new initiatives would create value in the longer term.4B (excluding Game cash and net of debt). (2) Other non-game business (SDO. and others) of US$740M.com Global Equity Research 03 January 2011 2011 and 2012 Outlook We expect Shanda Interactive to generate US$937.8x 2012E P/E.1% Y/Y) in revenues for F’11 and adjusted EPS (exc. given its low valuation and high cash levels.6 assumes a WACC of 11. We believe DCF is a good tool to value the company. Our PT of US$47 is based on SOTP valuation. However.3 1.29B (given the large 70% stake Shanda owns.8x 2011E and 30.wei@jpmorgan. We do not apply any discount to the cash level.P.287 46. Rating.V.90 (up 16. We maintain our view that: (1) Shanda Games’s potential success is in its new games.61 B.013 42. 336 .5% Y/Y).5 Source: J.259B (or US$18. generating additional sources of revenues.074. Share-based expenses) of US$1. Ku6 and other new ventures. a 10-year revenue growth and 0% terminal growth. We assume: (1) Value of Shanda Game of US$1.290 738 1. While the company will likely invest its cash in new non-game businesses and as such reduce its cash level.8M (up 16. (2) potentials exist in Shanda Online. We assume an 8x forward P/E multiple for the group of businesses.270 1.412 (153) 3. with risks in the game pipeline. Morgan. Our price target of US$47 implies 35. after applying 20% holding company discount: Value of non-game initiatives: Cash & ST investment at SNDA(excluding GAME cash)* Debt at SNDA Sum: Value per diluted share (US$): At current GAME share price of US$6. Dec-11 price target of US$47 Our Dec-11 PT of US$47 is based on SOTP valuation. Shanda has net cash (excluding Shanda Games cash) of US$1. Excluding cash.6 At current GAME TP of US$8 1. We expect F’12 revenues of US$1.x. Shanda: SOTP Valuation Table SOTP valuation (US$M) Market value of Shanda Games (70% of GAME) M. and (3) the company continues to make synergetic investments to become a leading interactive entertainment provider in China.016 738 1. we believe Shanda Games may not be able to trade at its DCF valuation. SDL. (3) Net cash level of US$1. we believe it is reasonable to assume a liquidity discount of 20% from US$1.8M (up 14.

5 24.9 69.0) 2.0 FY12E 14.5 24.6 Terminal growth (%) 2% 3% 4% 73.3 47.0) 2.4 68.5 24.0) 2.0% 4.9 50. Morgan estimates.1 56.0 (4.9% 14.0) 2.0 (4.0 (4.0 FY14E 12.0% 18.8 6% 105.7 97.2 55.5 24.1 44.92% Source: J.3% 10.9 7% 126.5 24.2 45.1 1% 70.9 47.0% 4.com Global Equity Research 03 January 2011 Near-term share price drivers We expect the share price could still trade sideways.1 64.0 FY20E 12.0% 4.9 48.4 80.0 (4.5 57.0% 4.6 78.0 73.3% 14.3 46.9% 14.0) 2.3% 21.3% 10. Morgan estimates. with (1) better performance of Shanda Games.1 65.0 FY17E 12.9% 14.Dick Wei (852) 2800-8535 dick.3 64.1 53.P.4% 14.0) 2.9 55.5 24.9 48.0 (4.0% 18.0 FY11E 16.92% 13. (3) large investment do not provide near-term profitability.92% 14.8 54.5 61.0 (4.6% 11.x.9% 14.2% 18.1 63.0% 4.P.0 FY19E 12.7 51. (2) new.0 45.0% 18.0% 4.2 47.7% 10.7 51.5 24.4 56.3% 10.0 (4.3% 10.7% 18.0% 4.0% 18.0% 4.4 9.0 FY13E 13.9% 14.1% 19. J.0) 2.0 (4.9% 18.0 73.2 52.0) 2.9 50.92% 15.4 53.9% 14.5 24. (2) non game initiatives see stronger-than-expected growth.5 78. DCF Model (Base Case Scenario) Sales growth EBIT margin NOPAT margin Year-end net fixed assets turns Year-end net working capital turns Year-end net other assets turns Cash operating taxes as % of EBIT Year-end Invested capital turns Source: Company data.0% 4.8 5% 92. WACC 337 .7 50.0 FY15E 11.6 49.0) 2.0 FY18E 12.8% 14.0% 4.0 FY16E 12.5 24.6% 10.3 61.92% 11.0% 18.6% 19.9 62.3% 10.4 58.5 24.8 60. FY10E 5.0 (4.6 52.9 52.3% 10. (3) further synergetic investments to lead to higher value of Shanda Group.1 84.0 DCF Sensitivity Analysis 0% 67.1 68.0% 4.92% 10.0) 2.3% 10.7 58.5 24. and (4) new investments fail to generate expected value.5 44.7% 10.9 46.0 (4. given lack of strong guidance from Shanda Games and new initiatives We expect share price drivers to be a few quarters away.0) 2.9% 14.3% 10. Risks to Our Rating and Price Target Downside risks include: (1) Existing games experiencing a significant decline from lack of new content or promotion.0 59. big titles MMORPG seeing lower-thanexpected gamer interest.0 (4.92% 12.wei@jpmorgan.2 86.

8 328 -71 233 258 3.2 11.574 12 95 290 2.051 1.9 -95.31 1.5 8.9 29.53 1.6 -60.492 0 24 265 288 151 35 474 1.030 19 9 68 2.59 7. 338 .48 2.4 36.8 0.4 0.9 38.x.366 2 15 261 279 151 11 441 1.912 17 7 58 1.790 227 2.1 1.0 0.912 2.7 47.0 0.0 14.1 169 -43 93 119 1.36 1.1 FY09 71.5 0.0 67 FY10E 808 308 500 91 267 142 226 3.7 16.6 0.3 -84. *Note: Excluding share-based compensation expenses.8 41.4 -3.446 Source: Company data and J.8 26.68 27.8 -105.2 3.5 0.5 -96.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) US$ EPS (Reported) EPS (Adjusted) BPS DPS Shares Outstanding (Mn) 519 146 374 40 124 210 251 10.1 5. year-end December FY08 71.0 16.3 11.) Non-Operating Income (Exp.722 FY12E 2.0 16.5 7.0 -8.3 40.2 29.4 8.6 9.1 197 -49 109 136 1.4 0.8 44.5 11.2 36.0 14.1 9.0 69 Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth Ratio analysis %.227 2.0 0.0 32.971 Cash flow statement US$ in millions.2 6.0 18.3 FY12E 61.7 23.6 16.2 7.0 24.3 17.7 -100.4 29.7 16.wei@jpmorgan.5 8.4 0.227 FY12E 109 80 26 65 280 -94 0 -94 186 8 0 25 0 33 219 2.8 10.6 26.5 -4.030 FY11E 93 64 32 60 250 -82 0 -82 168 8 0 21 0 29 197 2.5 8.3 34.0 72 FY09 767 217 550 61 191 299 367 2.993 12 70 289 2.0 0.74 24.4 -11.5 164 -47 91 124 1.0 34.6 7.1 0.8 -59.90 28.9 28.7 43.227 22 11 80 2.061 346 2.290 622 1.3 34.722 0 28 310 338 151 35 523 1.0 34.5 Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC -67.4 34.8 46. year-end December Net Income Depr.971 0 30 348 379 151 35 564 2.2 1.446 24 12 91 2. & Amortisation Change in working capital Other Cash flow from operations Capex/investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08 179 33 39 10 261 -33 -11 -44 228 27 146 -175 0 -2 215 404 619 FY09 233 44 59 49 384 -148 2 -146 236 923 7 122 0 1.7 1.Dick Wei (852) 2800-8535 dick.126 12 64 290 2.2 0.8 FY11E 61.339 12 81 290 2. Morgan estimates.0 65 FY11E 938 360 577 103 319 155 246 0.0 69 FY12E 1.030 2.4 -108.9 48.1 22.9 30.4 FY10E 61.075 411 664 118 365 181 287 0.2 33.918 282 2.7 -2.3 -52.0 0.7 8.1 32.7 25.9 221 -40 179 187 2.9 11.com Global Equity Research 03 January 2011 Shanda: Summary of financials Income statement US$ in millions.8 -111.2 16.0 17.690 234 2.38 3.8 55.492 FY11E 2.4 -104.6 -103. year-end December FY08 Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.1 Balance sheet US$ in millions.366 FY10E 2.7 0. year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans and payables Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shanda Shareholders' equity MI Total liabilities and Equity FY08 619 5 0 49 673 14 45 209 941 0 8 182 190 146 6 342 557 42 941 FY09 1.P.912 FY10E 91 52 -2 58 199 -46 0 -46 153 -24 -2 -9 0 -35 118 1.83 26.

9% 23.7 ROE (%) ROIC (%) Qtr GAAP EPS ($) EPS FY09 EPS FY10E EPS FY11E Abs.663 Source: Company data.35 P/E (x) 10. .23 1M 13.0 2.P.2 9.7 2. and (2) revenue share from applications built around microblog platform.1 26. 20M last quarter. Morgan India Private Limited Imran Khan (1-212) 622-6693 imran.95 0.wei@jpmorgan. and to help maintain long-term advertising revenue growth across both PC and mobile platforms.9 102.17 0.36 3M 35.7 EBITDA 81.361 Neutral SINA. P/E (x) 9.9 382.4 7.2 FY11E 467. In terms of monetization. Sina has set up an Rmb200M Miniblog fund with venture capital from Sequoia.9 169.5 104.44 12M 57.9% 2. while the growth rate should moderate due to a higher base effect. SINA US Price: $70. and social network sites.9 32. Morgan estimates.3 22.5Mn US$105M 2.2B US$68 Dec 29.5 23.00 Internet Dick Wei AC (852) 2800-8535 dick.00 35.8 8.56 27.t. daily value Index (NASD) Free float Dividend Yld (%) Market Cap Price Target Price date US$32. Bloomberg: SINA US US$ in millions.3 Pre Tax Profit 415.5 Operating Profit (EBIT) 27. The company expects healthy growth in advertising from growing eCommerce activities in China.P.com J.0 6.1 EV/EBITDA 45. 2010 784 1. However.6 129.34 0. Avg. daily vol.0-76. In addition.5 2. NBA games are a popular sports event amongst Chinese youth and should enhance the portal traffic from young users.7 99. Avg.8 42.4 89. year-end December FY09 FY10E Sales 353.9 24.7% 12m 57.3 140.z. J. we do not see much direct contribution from microblogs till end of next year. Bloomberg.1 693 1.7 Reported Net profit 407.4 67Mn 1.  2011 outlook: We expect a healthy online advertising growth rate of 28% for 2011.30 0.2% 40. Note: We have excluded quarterly revenue of US$4.2 143.  Sina to maintain leadership in microblogging: Sina continued to maintain its leadership in microblogging with the number of miniblog users surpassing 50M in 3Q10 vs.667 73% 0% US$4.khan@jpmorgan.3 2.4 21.0 1. FMCG and luxury goodsrelated advertising should also gain traction.  Platform strategy playing out well: We believe video and microblogs should continue to help maintain traffic share at Sina's portal.7% FY11E 8.31 Price Target: $68.  Sina expects to monetize Miniblog through: (1) brand advertising and SME advertising.(%) Cash Equity FY09 47. Morgan Securities LLC Price Performance 70 $ 50 30 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 SINA share price ($) NASDAQ Composite (rebased) YTD Abs Rel 53.7M related to CRIC IPO starting 4Q09.0 Reported EPS (US$) 6. IDG.26 1. Reuters: SINA.3% 3m 35.8 77. Remain Neutral on Valuation  Sina to remain as the leading portal in China: We maintain our view that Sina should continue to be the leading portal in China. we also note media segregation leading to market share loss to other verticals.9 173.6 1Q 0.51 52-Week range Shares Outstg. Perf.com J. We expect Sina Miniblog to further solidify Sina’s media influences.1 Adjusted EPS 7.1 FY12E 585. Sina brand advertising should also benefit from increased traffic generation from video (includes NBA video) and some contribution from microblogs in 2H11.5 3Q 0.11 33.7 41.2 Y/E BPS (US$) 20.3 615 1.491 FY12E 10.7 123. targeted by 2012.6 40.64 1.2% 1m 7.9 2Q 0.31 0.29 0. The company has been adding more than 10M users during the last two months. Secular online advertising growth and Sina’s leadership position should be positive drivers in the long run. Perf.com J.(%) Rel.23 0.222 FY10E 8.Global Equity Research 03 January 2011 Sina Corp Miniblog and Video Portal to Expand Portal Leadership.  Video strategy: Sina won live broadcasting rights to NBA matches for the next three years.6 26. online videos.6 52.55 45.gupta@jpmorgan.7% 38.9 P/B (x) 3.5 3. Morgan Securities (Asia Pacific) Limited Ritesh Gupta (91-22) 6157 3307 ritesh.7 746 1. Auto is expected to be strong. and DFJ to support third-party developers to develop applications on SINA’s Miniblog platform. targeted by 2H11.71 Adj.P.40 0.6 2.P.2 4Q 5.9 114. The company also plans to add more licensed content in Video for next year.x.

2012 revenues are expected to be US$585.2% Y/Y) and adjusted EPS of US$2. we also include small revenue from revenue-sharing of third-party apps and other VAS to small to medium-sized enterprises.9x ’12E diluted adjusted P/E.00 (up 16.5x 11/12 P/E.9% Y/Y).1 per Sina share (with a 15% holding discount). this implies Sina’s core business (excluding Weibo) is valued at 34. as dilution impacts from convertible debt has already been reflected in diluted share counts. we value this part of the business at US$6.3% Y/Y) and adjusted EPS (excluding share based expenses) of US$2. respectively. or at a share price of US$52.x. but we believe looking at gross cash is more relevant.6M (up 25. We value Sina’s 33% holding in CRIC based on the share price of US$10.9M (up 22. At our PT of US$68. share price of US$39 implies Sina’s organic business is valued at 25. We assign a 25x P/E.2% Y/Y).com Global Equity Research 03 January 2011 2011 and 2012 Outlook We expect 2011 revenues to be US$467. Excluding values of Weibo and CRIC. Maintain our Neutral rating We maintain our Neutral rating on Sina due to: (1) high expected 2011 ad growth. Value Weibo at US$664M We value Weibo based on 80M active Weibo users in 2012. 340 .1. The company has convertible debt of US$100M. or at excash 30. which will likely not contribute meaningful earnings until 2012 — such assigned value is likely to change at high beta. and (3) cautious in assigning a large value to Miniblog.5x 11E/12E diluted adjusted P/E.9x ’11E and 18. Excluding equity income from CRIC.wei@jpmorgan. and gross cash of US$13.0x/23.0x/26. or a value of US$664M. values of Weibo and CRIC. Excluding gross cash of US$13.51 and US$2. we value Sina business based on SOTP valuation (see table below). 11E/12E adjusted diluted EPS are US$1. The mid-range of SOTP valuation is US$62. Excluding equity earnings from CRIC and excluding interest income. In addition page view.07. We estimate the business to generate net income of US$27M. Our PT is based on SOTP valuation of Sina’s organic business (valued at US$39. given a CAGR growth rate of roughly 25% over the next few years. As such. Weibo (valued at US$10).6x ’12E diluted adjusted P/E.6x ’11E and 24.8).56 (up 28. 33% holding in CRIC (valued at US$6). this implies 34. or PEG ratio of around 1x. This represents US$405M or US$6. Rating and Price Target Remain Overweight with Dec-11 PT of US$68 We remain Overweight with Dec-11 PT of US$68. We believe this is a fair P/E multiple. (2) newly listed vertical sites and video sites could compete with Sina (and may limit revenue upside).Dick Wei (852) 2800-8535 dick.

Note: * Exclude earnings contribution from CRIC.4 2011E 22.P.5% 21.0 2.2 1.5 50. Earnings (US$M)* 108.8% 1.2 2017E 16.1 49.2 41.3 14.8% 18.2% 21. In addition.2 2019E 15.0 4.2% 20.0 13.723. Morgan estimates.5 182.9% 21.3 104.0 4.3 53.7 71.0 64. 2011 Sum-of-the-parts valuation (2012E) Business lines Advertising WVAS Others Weibo Gross cash and investments Total value* Price per dil.7 22.5% 23.7 43.0 13.8% 25.6% 15.8% 15.2 2015E 18.6 46. Secular online advertising growth and Sina’s leadership position should be positive drivers in the long run.5 13.5 78. Morgan estimates.5% 15.2 58.3 48.8% 1.6 36.0 2.8% 22.1% 23.8% 1. online videos.0 63.2 2013E 22.2% 21.0 3.5% 22.P.0 2. as well as further declines in wireless-related revenue due to strong competition and regulatory changes are downside risks.9 2.449.0 13.7% 22.9 12.6 41. and social network sites.0 4.0 13.6% 15.9 36.5 50.1 37.1 40.2 DCF sensitivity analysis 0% 9% 10% 11% 12% 13% 14% 15% 1% Terminal Growth (%) 2% 3% 4% 5% 6% 7% 60.9 35.wei@jpmorgan.0 13.4 44.0 13.5 857.1 48.6% 25.0 2.8% 1.2 39.1% 21.0 34.0 2.6 92.9% 17.0 13.0 2.3 46.0 4.2 35.5 4.2 47.End Hi -End 2.6 45.9 38.6% 15.2% 21. lowerthan-expected growth in advertising spending in China. we also note media segregation leading to market share loss to other verticals.4 0.7% 19. WACC 341 .0 13.0 2.3 53.836.8% 15.7 70.com Global Equity Research 03 January 2011 Sina to remain the leading portal in China We maintain our view that Sina should continue to be the leading portal in China.0 4.4 39.8% 1.2 2020E 15.0 857.5 52.0 1.8% 0.2 78.1 137.6 63.2 2014E 20.8% 1.6% 15. changes in regulations in wireless value-added space.8% 1.0 38.6 38.5 34.1 66. and competition with other Internet vertical sites.0 55.0 13.2% 25.0% 15.0 2012E 25. 2010E 8.6 121.2 2016E 17.P.0 44.0 4.0 2.0 4.4 1.3 66.8% 1.6% 25.178. However.End Hi -End 20 25 10 15 10 15 Value (US$M) Low.7 87.7% 19.0 37.7% 19.2 37.2 2018E 15.8% 1.6 4.x.5 Multiple (x) Low.0 4.7% 15. Risks to Our Rating and Price Target Upside risks to our price target include better-than-expected online advertising growth and better-than-expected performance for Weibo.3 60.1 Source: J.2 41.5% 27. Downside risks to our price target include a decline in online ad gross margin.0 2.7 42.5 664.0 13.0 4.8% 15.9 70.2 61.3 43.Dick Wei (852) 2800-8535 dick. share (US$) Average Price (US$) Source: J.5 34.6 57.5 55.5 57.8% 1.0 664.7 SINA—DCF model (base case scenario) Sales growth EBIT margin NOPAT margin Year end net fixed assets turns Year end net working capital turns Year end net other assets turns Cash operating taxes as % of EBIT Year end Invested Capital turns Source: J. Morgan.3% 24.4 57.

6 22.7 #DIV/0! -35.3 24.5 Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC ROIC (net of cash) Cash flow statement US$ in millions.8 14.6 0 29.) Non-Operating Income (Exp.2 14.5 -45. year-end Dec Net Income Depr.2 0.5 #DIV/0! -38.6 16.6 10.2 39.2 24.00 56 FY09A 354 153 201 30 135 33 53 8.0 -78.7 27.5 47.2 24.1 FY11E 57. year-end Dec Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.0 0 14.4 95 -14 81 94 1. & Amortisation Change in working capital Other Cash flow from operations Capex/investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08A 81 17 5 14 117 -29 -14 -43 88 10 0 27 0 37 112 272 383 FY09A 407 21 22 33 483 -5 -435 -440 478 -33 0 353 0 320 363 383 746 FY10E 89 23 -51 14 75 -12 -213 -225 63 -3 0 21 0 18 -132 746 615 FY11E 104 22 -7 16 136 -20 -28 -48 116 10 0 -19 0 -9 79 615 693 FY12E 143 26 -6 18 181 -23 -60 -82 158 11 0 -19 0 -8 90 693 784 0 1 94 95 99 8 202 621 0 2 123 125 99 168 392 1222 0 6 78 85 99 149 333 1361 0 8 101 110 99 130 339 1491 0 10 124 134 99 112 345 1663 Source: Company data.3 8. Morgan estimates.9 #DIV/0! -39.6 22.0 375.11 2.830 FY12E 784 126 236 44 1.5 11.56 26.9 25.2 7.16 0.7 21. 342 .2 FY09A 56.0 50.4 7.7 37.0 6.x.4 -39.9 0.2 29.8 44.3 0 13.0 169 -26 143 174 2.7 0 0.1 9.5 #DIV/0! -37.6 0.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) * US$ EPS (Reported) EPS (Adjusted) * BPS DPS Shares Outstanding (Mn) Balance sheet US$ in millions.1 416 -8 407 445 6.2 28.12 0.4 38. year-end Dec Cash and cash equivalents Accounts receivable Short-term investments Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY08A 383 79 221 9 692 0 34 96 822 FY09A 746 75 75 22 919 581 23 91 1.2 27.0 -53.4 8.1 8.8 42.2 46.0 21.8 15.33 1.1 139.0 26.9 -41.72 0. * Note: We have included share-based compensation adjustments starting 2006.00 62 Ratio Analysis %.6 0.9 11.9 0.5 8.2 115.00 24.26 20.8 7.0 100 -11 89 113 1. J.8 0.35 1.00 62 FY12E 586 250 335 47 157 130 156 9.7 32.3 -37.0 123 -20 104 134 1.9 20.4 405.9 22.2 0.3 26.694 FY11E 693 103 236 36 1.3 31.2 21.wei@jpmorgan.P.7 0.3 FY12E 57.1 0 0.29 0.56 11.2 397.9 FY10E 57.2 26.3 20.5 8.0 37.2 -56.10 0.0 8.71 22.007 FY08A 370 147 223 28 118 75 92 17. year-end Dec Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth FY08A 60.6 36.55 2.00 61 FY11E 468 199 268 36 129 102 125 7.2 9.0 2.7 17.9 22.4 26.0 12.64 7.Dick Wei (852) 2800-8535 dick.189 721 10 87 2.2 -79.00 54 FY10E 383 163 219 31 107 78 101 8.068 661 12 88 1.9 25.3 23.8 #DIV/0! -49.com Global Equity Research 03 January 2011 Sina Corp: Summary of financials Income statement US$ in millions.614 FY10E 615 80 236 28 958 633 14 89 1.6 79.1 -4.

9% -2.Global Equity Research 03 January 2011 Sohu.P. Reuters: SOHU. * Note: We have included share-based compensation expense adjustments starting in 2006.1-80.6 6.30 Free float 1M 3M 12M Dividend Yld (%) -12. We believe Sohu could see more margin leverage in 2011.P.0% 1m -10.01 0.khan@jpmorgan.3x ’12 P/E.  Upside to come from online game business: Based on Street consensus.0 ROE (%) ROIC (%) Qtr GAAP EPS (US$) EPS FY09 EPS FY10E EPS FY11E Abs. We expect autos.15 1.x. Sohu’s game division (Changyou) currently trades at 8.2 US$40.49 18. Increased video monetization should help overall brand advertising revenues for Sohu. we assume the game segment trades at 8.341.1% 12m 14.  2011 stock price drivers: Earning upgrades potential may come from: (1) stronger trend in online video monetization.6 197. fast-moving consumer goods.t.6 226. Bloomberg: SOHU US US$MM.1 322.(%) Rel.5 FY12E 877.gupta@jpmorgan.88 0.9 38M US$55M 1.8 3.7 5.5 237.41B US$89 Dec 29. We expect earnings upside could come from the launch of DMD (likely 1H’11).75 Avg dly volume 0. EPS * Adj.7% 3m 8. Morgan Securities (Asia Pacific) Limited Ritesh Gupta (91-22) 6157 3307 ritesh.79 0.4 337.0 1.82 1.8 3.163.  2011 to experience margin expansion in online advertising: With a positive macro environment.4 52-Week range 38. while multiple expansion could come from re-rating of leading game companies given sustained long-term growth.57 17.com J.0 4.P.97 1.6 327.39 11.8 651. P/E (x) EV/EBITDA P/B (x) FY09 515.28 10.76 Price Target: $89.3 3.64 13.3 Price Target 563.5 5.4% -6.9 31.0 4.15 0. SOHU US Price: $65.9 12. in over view.8 26.5% -4.5% in 2010E.00 Internet Dick Wei AC (852) 2800-8535 dick.com J. (2) launch of Duke of Mountain deer generates strong interest amongst online gamers.5 268.667 45% 0% US$2.4 -5.1 279.7 28.23 1.3x ‘11 and 7.5 1.6 223.4 Shares Outstg 1Q 2Q 3Q 4Q Avg daily value 1.51 11. and eCommerce to be key segments to watch.com J.1 FY10E 606.9% -17.5 2.4 6.94 Index (NASD) 0.2M 2. Morgan estimates. J.2 4. as the company plans to reduce spending on video and begin to get more traction from video advertising. While real estate revenues should continue to be affected by new government policies and regulations.7 387. 2010 Source: Company data.2 147.  Expect Sohu to maintain brand advertising market share: We expect Sohu 2011 brand revenue to grow by 19%.wei@jpmorgan.8 3.3 889. At our PT.5 1.0 210.8 7.7 27.8 6.7 Price Date 609.2 29.1 5.5 2. We expect online advertising margins in 2011 to expand to 61. Morgan India Private Limited Imran Khan (1-212) 622-6693 imran.5x ‘11/’12 P/E.2 Market Cap -18.0 313. . We expect advertising margin expansion and upside from DMD to be share price drivers for the stock in 2011.2 FY11E 736.P. Bloomberg. Perf. Re-rating could happen from the multiple expansion of the online gaming sector through sustained solid growth by online gaming companies in 2011.z. Perf.4 144. Morgan Securities LLC Price Performance 80 $ 60 40 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 SOHU share price ($) NASDAQ Composite (rebased) YTD Abs Rel 13.13 15.0 -4.Com Potential Upside from Ad Margin and Games to Drive Share Price We maintain our Overweight rating on Sohu with a Dec-11 PT of US$89.8 799.5% FY09 FY10E FY11E FY12E 38.4 238.99 16. penetration into second-tier cities is likely to drive growth.1% from 60.048.0 9.2 204. YE-Dec Net Sales Operating Profit (EBIT) EBITDA Pre Tax Profit Reported Net profit Reported EPS (US$) P/E (x) Adj. we believe Sohu should see margin expansion on the back of fixed portal costs.73 0.1 30.(%) Cash Equity Overweight SOHU.

Sogou value at US$200 M Based on Alibaba’s investment amount. respectively. portal is valued at US$1. or 25. Sohu has cash of US$609. Given Sohu’s brand name and content investment. Our F’12 estimates call for revenue and adjusted EPS estimates of $877. or an implied value of US$1. but not a dominant player).com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue and adjusted EPS estimates of $736.5B and Soufun at US$1. WACC of 12%. Rating and Price Target We maintain our Dec-11 PT of US$89. On a consolidated basis.5x 2010E.wei@jpmorgan. and 16. Sohu has net cash of US$510M or net cash of US$13. we take a more optimistic view that with Alibaba's investment.3x P/E 2011E.x. If we assume Sogou were also profitable with similar margins. we believe Sohu’s portal could see a higher valuation.6B (including Sohu’s claim on Changyou cash). respectively.4. it currently has ~1% market share. For Sogou. The US$50M value difference causes ~US$1 share price impact in our SOTP analysis.4B. 344 . or US$15. then Sogou probably can only trade at 20x (given high growth end market. we assume game segment to trade at 8. We have assumed a higher value. Online games Based on Street consensus. At our PT. Our price target is based on the midpoint of our sum-of-the-parts valuation of US$78-US$99. and terminal growth rate of 0%. From this calculation. In other words. based on a 10-year DCF forecast. Making a direct comparison. post money valuation for Sogou is US$150M. Baidu has ~80% market search share in China with ~US$40B market cap.2 per diluted share (excluding Changyou’s claim cash). Baidu is currently trading at 40. our Dec-11 DCF value for Sohu is US$81.2x 2011E GAAP P/E.39. this implies Sogou value of US$500M.3B. we believe Sohu's portal cannot demand a higher value in the near term. Our PT implies 21.5M and $5. Sogou can have a higher value in the future. 16. 19. due to Sohu’s portal recent content investments. However. Sohu’s game division (Changyou) trades at 8.28. we estimate Sogou’s valuation to be US$200M. which we think is relatively low.8x ‘11 and 8x ’12 PE. Sohu’s portal At the mid-point of our SOTP valuation. As a reference.9 per diluted share. compared with Sina at US$2.2x 2011E.2x 2012E diluted adjusted P/E. We expect earnings upside could come from the launch of DMD (likely 1H’11).5x 2010E.Dick Wei (852) 2800-8535 dick.5x 11/12 P/E.1M and $6.5x 2011E and 14. while multiples expansion could come from re-rating of sustained solid growth for leading game companies. as we believe Alibaba’s cooperation will create value to Sogou.3M as of 3Q10.

9 57.00% 16.0) 3.8 8.3 68.2 (8.9% 23. significant market share loss in online advertising to other websites.9 2020E 13. 2010E 17.0% 27.0 79.1 3059.5 64.5% 26.1 113. J.0 317.5% 29.0 317.3 83.0 Multiple (x) 20 10 10 nm Value (US$M) 1496.6 1% 113.1 73.0 59.2 (8.2 56.0) 3.0 15.4% 3.4 50.0 15.00% 14.3 1680.0 88.1 108. For online games business.P.9 75.0 15.0% 1.8 168.0 15.0) 3.0% 1.5% 3. Morgan estimates.wei@jpmorgan.0 70.7% 31.9 55.com net cash and other Claim on Changyou cash (66.5 Branded ads WVAS Games profit (after 66% of MI) Sogou (53% holdings) Sohu.9 2019E 13.2 (8.2 84.7% 24.6 1176.6 92.7 71.3 192.2 (8.5 87.0 81.0 15.0) 3. J. Sohu DCF Model (base case scenario) Sales growth EBIT margin NOPAT margin Year end net fixed assets turns Year end net working capital turns Year end net other assets turns Cash operating taxes as % of EBIT Year end Invested Capital turns Source: Company data.0) 3.6 78.P.3 63.9 2018E 13.6 106.1% 30.2 (8. delays in upgrade and new game launches.0% 1.1 71.8 69.3% 25.1% 3.0% 27.0 97.2 127.3 116.2 (8.0 102.1 71.5% 3.7 10.2 (8.9 94.1 3880.0) 3.2 (8.com Global Equity Research 03 January 2011 Risks to Our Rating and Price Target Risks to our price target include a slowdown in the Chinese economy that could result in lower online advertising revenue growth.0 15.4% 31.8% 3.9 2014E 16.1 65.9 2016E 15.0 84.1 66.7 142. 345 . and regulatory changes also add to downside risks.00% 11.5% 3.1 -10.6 Multiple (x) 16 8 7 nm Value (US$M) 1197.4 87.5% 25.0 164.8 62.7% 23.1% 26.0 15.3% 28.4 97.0% 1.9 2011E 21.6% 27.1 104.7% of Changyou cash) Total equity value Value per diluted share Mean value per share (US$) Source: Company data.8 99.9 2013E 15.9 2017E 13.4 5% 159.0) 3. and volatility in wireless revenue due to policy change at mobile operators.00% 13.3 192.5% 3.6 Terminal Growth (%) 2% 3% 4% 120.0) 3.7% 23.8 59.0% 27.9 2012E 19.00% 12.0% 1.0) 3.3 88.0 102.0% 1.8% 3.0% 1.x.0% 1.0) 3.9 DCF Sensitivity Analysis 0% 107.0% 27.1 6% 185.0 15.5 129.7 127.7% 3.7% 23.0% 1. Morgan estimates.6 53.P.9 2015E 15. Sohu Sum-of-the-Parts Valuation 2011E Net profit (US$M) 74.2 7% 228.0) 3.1 57.9 106.0% 1.00% 15.7% 23.2 (8.1 79.2 (8.0 142. Morgan estimates.0 15.4% 3.0 15.00% WACC Source: J.5 76.6 93.2 (8.6 51.5% 3.Dick Wei (852) 2800-8535 dick.7 61.7% 23.1 60.7 52.0% 27.0 15.0% 1.

49 4.0 -1.5 -81.8 51.0 27.048 0 9 245 254 0 115 369 1.Dick Wei (852) 2800-8535 dick.5 55.1 20.9 FY12E 73.341 Source: Company data.7 36.2 37.0 280 -37 197 216 4.5 19.6 18.1 -2.14 0.13 20.5 62.293 0 189 228 1.9 127.89 0.99 15.51 6.30 10.x.) Non-Operating Income (Exp.3 1.8 -86.4 27.0 51.00 41 Ratio Analysis % Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth FY08A 75.0 0 0.3 0 0.5 -92.4 38.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted)* USD EPS (Reported) EPS (Adjusted)* BPS DPS Diluted Shares (Mn) Balance sheet Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY08A 314 37 0 28 379 0 76 67 522 FY09A 564 47 0 11 621 0 115 92 828 FY10E 651 51 0 42 744 0 125 228 1.6 56.7 28.8 -86.13 0.1 345.1 26.8 27.0 38.5 -81.0 0 0. year-end December Income statement FY08A Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.5 168 -9 159 169 4.com Global Equity Research 03 January 2011 Sohu.00 39 FY11E 737 198 539 67 203 269 327 11.001 0 154 228 1.2 39.1 27.7 9. Morgan estimates.1 29.3 46.48 0.57 3.0 54. & Amortisation Change in working capital Other Cash flow from operations Capex Disposal/ (purchase) Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08A 159 14 29 11 213 -24 0 -24 189 -2 0 5 0 3 192 123 314 FY09A 148 16 27 46 237 -80 0 -80 156 59 0 34 0 93 249 314 564 FY10E 144 63 -4 76 280 -209 0 -209 71 18 0 -1 0 17 87 564 651 FY11E 197 26 18 78 318 -55 0 -55 263 19 0 -45 0 -26 238 651 889 FY12E 238 30 17 90 375 -66 0 -66 309 21 0 -55 0 -34 275 889 1.2 36.7 9.6 FY09A 76.0 26.164 71 0 58 1.2 20.9 38.3 44.3 FY11E 73.04 4.64 5.0 0.0 0.8 -11.7 28.8 53.1 24.164 0 4 126 131 0 5 136 386 0 5 146 150 0 68 218 610 0 7 176 182 0 115 297 799 0 8 211 218 0 115 334 1.2 31.097 FY11E 889 61 0 50 1.2 27.00 40 FY12E 877 233 644 89 233 323 387 14.4 -2.7 FY10E 74.0 0.5 82.2 2.7 -6.00 39 FY09A 515 122 393 48 140 204 238 5.7 9.4 26.wei@jpmorgan.68 0.1 10.8 23.1 400.6 Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC -81.5 26.39 25.382 FY12E 1.0 17.4 36.4 Cash flow statement Net Income Depr.5 21. * Adjustments: excluding stock based compensation expense 346 .9 354.8 210 -34 148 162 3.2 1.3 1.0 10. J.3 226 -34 144 160 3.7 -84.2 20.1 44.4 20.2 30.3 1.8 -92.4 44.8 0 0.5 32.0 -0.8 10.7 0 0.com: Summary of financials US$ in millions.8 -84.0 337 -45 238 256 5.1 -81.00 39 FY10E 607 158 449 62 164 223 314 4.4 36.P.28 32.710 429 106 323 43 115 164 189 4.

3 34.46 1.489 16.3 Overweight 0700. Mobile games and mobile social games will increase loyalty to Tencent’s platform and help Mobile VAS revenue. Tencent plans to upgrade “Xiaoyou” to “PengYou” with better open-platform support. 2010 Source: Company data.62 5.97 4.130 10.00 Price Target: HK$205. • 2011 earnings drivers to come from: (1) potential upside in gaming revenue.3 -0.156 8.018 31.37 5. (2) better-than-expected ad growth with macro pick-up and improving brand image.069 13.HK.1 24.479 EPS FY09 5.6% FY09 FY10E FY11E FY12E 54 51 43 37 52-week range 56 47 37 33 Shares outstg 1Q 2Q 3Q 4Q Avg daily value 0.com J.0 1. mobile platform launch.54 Free float 1M 3M 12M Dividend yld (%) 0. * Note: Excluding share-based compensation expenses.020 9.9 21.179 19. Net Profit Reported EPS (Rmb) P/E (x) Adj.3 23. • Online games Should Continue to Be Strong: We expect game segment growth to continue to be driven by Cross Fire and Dungeon & Fighter upgrades and new unannounced titles launch (both in-house and licensed games). .com Ritesh Gupta (91-22) 6157 3307 ritesh.7 26. We remain Overweight with a Dec-11 PT of HK$205.79 4.57 0.3% US$41.589 13. Bloomberg.65 0.839 Qtr GAAP EPS (Rmb) 5. Reuters: 0700. The strategy is to increase user loyalty to Tencent’s community and eventually increase monetization.803 12.16 1.7 16. Perf.36 1. Morgan estimates. • Open Platform to Be a Key Focus: The company has already created open platform interfaces for four key products: (1) social networks.63 7. online search. social eCommerce. and (3) new growth potential in SNS (third party apps.96 1. New revenue from open platform applications. eCommerce and others). Perf.440 19.950 EPS FY10E 2. driven by the launch of multiple games in 2011.840 13.429 ROE (%) 6.094 15. (3) Paipai. P/E (x) EV/EBITDA P/BV (x) YE BPS (Rmb) FY09 FY10E FY11E FY12E 12. and.HK. instant messaging.066 30.497 HK$120. • Expect Tencent to Maintain its Leadership in China internet: Tencent has established itself as a leading internet platform in China with its leadership in social networking. to a certain extent.801 10.212 Date of price 12.5% 1.4% 0.5% 1m 0.00 Internet Dick Wei AC (852) 2800-8535 dick.22 Index (HSI) 1.77 0.4 Equity 6.7 15. YE December Net sales Operating profit (EBIT) EBITDA Net Profit Adj. third-party apps.5 19.2 10.34 Abs.HK share price (HK$) HSI (rebased) YTD Abs Rel 2.z.81 Avg dly volume 0. online gaming.x.8 Cash 25.8 20. 700 HK Price: HK$178.8 Price target 11. and (4) Tenpay.8% -2.7 Market cap 1. and online and wireless portal.4% 3m 2.1 32.7 10.Global Equity Research 03 January 2011 Tencent To Maintain Its Leadership Position in China Internet Space We expect Tencent to continue maintaining its leadership position in China’s internet space in 2011.88 7. As a well-executed leader in China’s internet space.270 44.P.P.5 2.6 7.851MM US$ 114MM 4.(%) 39.6 Rel.1% 12m 7.540 25. mobile internet.477 8. Bloomberg: 700 HK Rmb MM.1 0.473 30.03 1.10 EPS FY11E 54.601 11.5MM 22.8 25.4 2.149 43.2B HK$205 Dec 29. Morgan Securities (Asia Pacific) Limited P r ic e P e r fo r m a n c e 180 HK$ 150 120 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 0700.(%) 51.gupta@jpmorgan.27 1.5 7.4-193.354 19. EPS (Rmb) * Adj. Tencent is likely to remain a key beneficiary of rising disposable incomes and increasing internet penetration in China.969 ~50% 0.wei@jpmorgan.6 16. J. (2) SoSo. and a new game pipeline could be some of the drivers for 2011.5% -0.246 ROIC (%) 6. and (4) early signs of the success of mobile internet products. We expect Tencent to further leverage and monetize its platform in 2011 through new ventures in eCommerce.

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

Launch of Open Platforms to Be Next Growth Driver
The company plans to expand Qzone and Tenpay into open platforms with the flexibility to host more third-party applications. By leveraging strong Qzone/QQ user base, the company creates a strong ecosystem with third-party content.
By leveraging its strong Qzone/QQ user base, the company creates a strong ecosystem with third-party content.

The company is increasingly open to the idea of investing in small third-party developers focusing on developing applications for Qzone platform. In addition, Tencent has been expanding its technology infrastructure to host more social applications to integrate Qzone with other content websites. For Tenpay, the company has been allowing other applications with payment needs to be integrated with its platform. The company has already been working with close to 100 applications. Tencent has been also working on developing a strategy to attract more applications with strong user interest on Tenpay.

Our Estimates and Outlook for 2011 and 2012
We are maintaining our F’11 revenue and adjusted EPS estimates of Rmb25.0B and Rmb5.88, respectively. Our F’12 estimates call for revenue and adjusted EPS of Rmb31.4B and Rmb7.34, respectively.

Valuation, Rating Analysis and Risks
DCF valuation Our 10-year DCF-based valuation (assuming a WACC of 12% and a terminal growth rate of zero) yields a PT of HK$205. We expect Tencent to post a revenue CAGR of >20% from 2010 to 2015, and subsequently mid-teen growth from 2015 to 2021. We maintain our long-term growth forecast and DCF assumptions. We maintain our DCF-based Dec-11 PT of HK$205. Remain Overweight with a Dec-11 price target of HK$205 Our DCF-based Dec-11 price target of HK$205 implies 41.2x FY10E, 32.0x FY11E, and 25.3x FY12E reported EPS, or 38.9x FY10E, 30.6x FY11E, and 24.5x FY12E adjusted EPS, on the back of 41%/26% FY11E/12E EPS growth. The company has around HK$10.7 cash per share, after DST investments. We expect potential earnings upside to drive its share price further: (1) potential upside in gaming revenue, with new title and upgrade launches; (2) launch of new open-platform applications across QQ products, which also creates synergy in the QQ ecosystem, (3) better-than-expected ad growth with macro pick-up and improving brand image. Share price risks, in our view, include: tightened content censorship in China, revenue volatility of short-life cycle SNS applications, faster-than-expected decline in game revenue, and regulatory risks.

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Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

Tencent: Summary of financials
Rmb in millions, year-end December

Income statement
Revenues Cost of goods sold Gross profit R&D expenses SG&A expenses Others Operating profit (EBIT) EBITDA Interest income Investment income (exp.) Non-operating income (exp.) Earnings before tax Tax Net income (reported) Net income (adjusted) Rmb EPS (Reported) EPS (Adjusted) BPS DPS Diluted shares outstanding (MM)

FY08 7,155 2,170 4,984 518 1,332 0 3,134 3,654 112 0.0 -140.7 3,105 -289 2,785 2,945 1.51 1.60 3.88 0.14 1,841

FY09 12,440 3,889 8,550 581 2,026 0 5,943 6,801 78 0.0 -2.0 6,019 -819 5,156 5,477 2.79 2.97 6.73 0.35 1,845

FY10E 19,540 6,205 13,335 914 2,809 0 9,612 10,840 278 0.0 -1.1 9,889 -1,742 8,130 8,601 4.37 4.62 10.65 0.45 1,861

FY11E 25,018 7,892 17,126 1,001 4,031 0 12,094 13,489 468 0.0 0.0 12,562 -1,956 10,589 11,069 5.63 5.88 16.30 0.58 1,882

FY12E 31,429 9,860 21,568 1,257 5,065 0 15,246 16,839 714 0.0 0.0 15,961 -2,465 13,479 13,950 7.10 7.34 23.27 0.73 1,900

Ratio analysis

%, year-end December Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC

FY08 69.7 51.1 43.8 38.9 7.2 18.6 87.2 100.1 77.8 77.1 -73.0 -73.0 72.6 1.9 45.6 45.6

FY09 68.7 54.7 47.8 41.4 4.7 16.3 73.9 89.6 85.2 84.8 -90.1 -91.6 71.1 1.9 53.7 55.8

FY10E 68.2 55.5 49.2 41.6 4.7 14.4 57.1 61.7 57.7 56.3 -65.3 -78.2 63.6 1.9 51.4 46.9

FY11E 68.5 53.9 48.3 42.3 4.0 16.1 28.0 25.8 30.3 28.8 -77.8 -87.7 58.0 1.5 42.7 37.2

FY12E 68.6 53.6 48.5 42.9 4.0 16.1 25.6 26.1 27.3 26.1 -85.3 -92.8 53.6 1.1 36.6 32.8

Balance sheet
Total cash Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity

FY08 5,129 983 5 378 6,496 389 2,041 930 9,856 0 245 1,847 2,092 0 743 2,835 7,021

FY09 11,354 1,229 0 574 13,157 972 2,623 753 17,506 202 697 3,664 4,563 0 764 5,327 12,179

FY10E 19,066 1,910 0 1,465 22,440 3,246 3,480 1,577 30,744 3,838 1,318 5,418 10,574 0 697 11,271 19,473

FY11E 30,270 2,401 0 1,817 34,488 3,246 3,837 1,577 43,148 3,838 1,652 6,813 12,303 0 697 13,000 30,149

FY12E 44,212 3,001 0 2,274 49,486 3,246 4,283 1,577 58,593 3,838 2,048 8,514 14,400 0 697 15,096 43,497

Cash flow statement
Net income Depr. & amortization Change in working capital Other Cash flow from operations Capex Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash F/X & term deposits change Beginning total cash Ending total cash

FY08 2,785 360 202 233 3,580 -1,705 -810 -2,515 1,875 -301 -292 -19 -258 -870 -76 119 1,190 3,820 5,129

FY09 5,156 537 1,833 365 7,891 -943 -584 -1,526 6,949 255 202 43 -639 -140 0 6,225 0 5,129 11,354

FY10E 8,130 756 804 490 10,180 -2,437 -2,274 -4,711 7,742 124 3,636 -704 -813 2,243 0 7,712 0 11,354 19,066

FY11E 10,589 915 885 497 12,885 -1,272 0 -1,272 11,614 666 0 -17 -1,059 -410 0 11,204 0 19,066 30,270

FY12E 13,479 1,121 1,041 488 16,129 -1,568 0 -1,568 14,561 746 0 -17 -1,348 -619 0 13,942 0 30,270 44,212

Source: Company data and J.P. Morgan estimates. *Note: Adjusted earnings exclude share-based compensation expense (non-cash) and one-time items.

349

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

350

Global Equity Research
03 January 2011

The9 Limited
New Three-legged Strategy But Still Lacks a Strong Game
We expect weak operating performance for the company to continue in 2011. Our Dec-11 PT of US$6.1 is at a 20% discount to year-end 2011 estimated cash per share.
 Company has restructured into three divisions: (1) Global strategy: Mainly based on R&D capability of Red 5 studio and other future investments. Red 5 studio is led by an ex-World of Warcraft developer from Blizzard. (2) Domestic strategy: Maintain in-house and licensing strategy. Currently, the company has an R&D staff of 300 for in-house development. (3) Alternative platform strategy: Mobile game/mobile game platform. The acquisition of minority stakes in Aurora Feint (an iPhone game platform with 28M registered users and 2,220 games) to help jump-start The9’s mobile game business in China.  Mobile gaming platform: The company has been trying to develop a mobile gaming platform along with three telco carriers in China. The company has tie-ups with Aurora Fient which runs the biggest game platform on iPhone in the US. The company also invested US$4 M in Openfeint previously for a 13% stake.  Disclosed game pipeline includes: (1) 1Q11: Shen Xian Zhuan (in-house game from Hang Zhou studio), (2) Free Realms (a cartoon-style MMORPG licensed from Sony) to be launched in 2H11, and (3) Red 5, a subsidiary of The9 is also releasing a FPS game named Firefall in October 2011. The company terminated its online game FIFA Online from EA Sports recently. The game was generating losses for the company.  Expect losses to continue and the stock to trade below cash: With a small revenue base, while maintaining company headcount of 800 to support potential future growth, we forecast losses to continue in the medium term. The company currently has net cash of US$9.0 per share. We do not expect strong results from Shen Xian Zhuan launch by the end of 2010. As such, we believe the company still lacks share price drivers. Potential drivers could come from successes in handset games and Red 5 game.
Reuters: NCTY; Bloomberg: NCTY US
(US$ MM, Y/E-Dec) Sales Operating profit EBITDA Pre-tax profit Reported Net Profit GAAP EPS (US$) P/E (x) Adj. EPS (US$) Adj. P/E (x) EV/EBITDA P/B (x) Y/E BPS (US$) FY08 249.1 19.6 60.7 24.7 14.1 0.51 13.5 0.78 8.7 -1.2 0.5 14.3 FY09 FY10E FY11E 111.5 15.5 19.7 ROE (%) -70.8 -42.7 -37.9 ROIC (%) -33.1 -27.4 -22.7 Qtr Diluted EPS (US$) -57.6 -41.0 -35.5 EPS FY09 -59.4 -38.8 -35.5 EPS FY10E -2.34 -1.53 -1.38 EPS FY11E nm nm nm -1.99 -1.33 -1.21 Abs. Perf.(%) nm nm nm Rel. Perf.(%) 2.3 2.7 3.3 0.6 0.7 0.7 Cash (US$ MM) 11.8 10.4 9.2 Equity (US$ MM) FY08 6.3 4.5 1Q -0.26 -0.44 -0.35 1M -1.7 -6.9 323.2 395.8 FY09 -13.9 -14.4 2Q -0.46 -0.38 -0.35 3M 35.5 23.3 245.5 294.8 FY10E -12.9 -13.0 3Q -0.43 -0.36 -0.34 12M -2.8 -20.3 215.4 261.5 FY11E -12.6 -11.9 4Q -1.20 -0.35 -0.34

Neutral
NCTY, NCTY US Price: $5.05 Price Target: $6.10

Internet Dick Wei
AC

(852) 2800-8535 dick.x.wei@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited

Ritesh Gupta
(91-22) 6157 3307 ritesh.z.gupta@jpmorgan.com J.P. Morgan India Private Limited

Imran Khan
(1-212) 622-6693 imran.t.khan@jpmorgan.com J.P. Morgan Securities Inc.
Price Performance
9 $ 6 3
Dec-09 Mar-10 Jun-10 Sep-10 Dec-10

NCTY share price ($) NASDAQ Composite (rebased)

YTD Abs Rel -9.8% -27.3%

1m 1.1% -5.7%

3m 24.0% 9.5%

12m -7.7% -25.1%

52-wk range (US$) Shares outstg (MM) Avg daily volume Avg daily value Index (NASD) Free float (%) Dividend yld (%) Market cap (US$) Price target (US$) Price Date

3.7-8.7 25Mn 0.1Mn US$0.4Mn 2,667 25% 0% 0.17B US$6.1 Dec 29, 2010

192.8 232.5

Source: Bloomberg, Company and J.P.Morgan estimates. Note: We have included share-based compensation adjustments starting 2006.

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

Our Estimates and Outlook for 2011 and 2012
We are maintaining our F’11 revenue and adjusted EPS estimates of $15.5M and $(1.33), respectively. Our F’12 estimates call for revenue and adjusted EPS estimates of $19.7M and $1.21, respectively.

Rating and Valuation
Our Dec-11 price target is US$6.1 We recently rolled over our Dec-10 PT of US$6.1 to Dec-11. The company had total cash of US$226M at the end of 1H10 with zero debt. We expect 2011-end cash to fall to US$192.5M. At 2011-end, the company is expected to have US$7.7 per ADS in cash. We keep our 2011-end PT at a 20% discount to estimated 2011-end cash. We remain Neutral on The9 due to low revenue visibility and earnings decline from operating losses and R&D investments. However, we believe the share price will be supported by the current cash level of US$9.0 per ADS. The stock has been trading in the range of a 20%-30% discount to net cash over the past few quarters. We expect The9 to continue to trade within this range. The company could trade closer to a 20% discount to its net cash, given the potential success of some of its new game launches. Share price drivers We believe drivers will come from strong gamer response from newly launched games and alternative platform strategy.

Risks to Our Price Target and Rating

Downside risks to our price target and rating include: (1) larger-than-expected investments in game titles and studios, (2) new game launches that disappoint. We expect positive share price drivers/risks to be: (1) Better-than-expected performance of The9’s new game launches, and (2) the company being an acquisition target (due to its high cash).

352

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

The9: Summary of financials
Income statement
Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.) Non-Operating Income (Exp.) Earnings before tax Tax Net Income (Reported) Adj. Net Income (ex-123R exp.) RMB: Diluted EPS (Reported) Adj. EPS (ex-123R exp.) BPS DPS Shares outstanding (MM) Rmb in millions, year-end December FY07 1,280 700 580 41 284 236 448 50.7 0.0 -5.7 -30.1 251 -9 241 289 8.71 10.44 97.56 0.00 27 FY08 1,711 998 714 74 423 135 365 56.7 0.0 -2.2 -19.0 170 -48 97 149 3.50 5.38 98.42 0.00 28 FY09 761 712 48 114 338 -483 -308 30.5 0.0 -2.6 61.8 -393 6 -405 -346 -15.95 -13.61 80.33 0.00 26 FY10E 106 108 -2 121 169 -291 -222 24.7 0.0 -8.2 -5.0 -280 0 -265 -230 -10.45 -9.08 71.01 0.00 25 FY11E 134 120 14 104 168 -258 -185 23.8 0.0 -3.6 -4.0 -242 0 -242 -212 -9.41 -8.22 62.95 0.00 25

Ratio analysis
Gross Margin EBITDA margin

%, year-end December FY07 45.3 35.0 18.4 18.8 3.2 22.2 29.8 -12.7 -22.9 -31.8 FY08 41.7 21.3 7.9 5.7 4.3 24.7 33.8 -43.0 -59.8 -60.2 FY09 6.3 -40.6 -63.5 -53.3 15.0 44.4 -55.6 -458.9 -518.4 -556.1 FY10E -1.6 -209.2 -274.5 -249.8 113.6 159.3 -86.1 39.7 34.6 32.1 FY11E 10.2 -138.1 -192.6 -180.6 77.5 125.4 26.5 11.3 8.6 11.0

Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth

Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC ROIC (net of cash)

-72.4 -75.1 39.4 0.9 14.0 11.6 44.0

-73.4 -76.9 52.5 0.9 6.3 4.5 19.4

-79.6 -81.2 32.7 0.4 -13.9 -14.4 -69.9

-60.0 -68.4 4.4 0.1 -12.9 -13.0 -54.9

-58.1 -67.2 6.0 0.1 -12.6 -11.9 -41.0

Balance sheet

Rmb in millions, year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY07 2,215 27 101 72 2,415 179 344 307 3,246 107 285 48 440 0 0 440 2,806 FY08 2,221 9 126 139 2,494 403 200 166 3,263 129 345 69 544 0 0 544 2,719 FY09 1,675 2 126 0 1,803 395 76 52 2,325 41 22 248 312 0 2 314 2,011 FY10E 1,469 2 182 0 1,653 408 60 269 2,390 0 30 307 337 249 20 607 1,784 FY11E 1,315 3 208 0 1,526 404 35 277 2,242 0 35 352 387 249 20 656 1,586

Cash flow statement

Rmb in millions, year-end December Net Income Depr. & Amortization Change in working capital Other Cash flow from operations Capex / investment Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY07 241 212 31 49 533 -362 -144 -506 171 1,229 70 -49 0 1,250 1,277 938 2,215 FY08 97 230 7 77 412 -46 -122 -168 365 -138 23 -123 0 -238 5 2,215 2,221 FY09 -405 174 1 160 -69 -71 60 -11 -140 -115 -88 -262 0 -466 -546 2,221 1,675 FY10E -265 69 11 20 -165 -271 -13 -284 -435 3 208 32 0 243 -206 1,675 1,469 FY11E -242 73 23 31 -116 -56 4 -53 -172 14 0 0 0 14 -154 1,469 1,315

Source: Company data and J.P.Morgan estimates.

353

Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com

Global Equity Research 03 January 2011

354

Japan Equity Research
03 January 2011

DeNA (2432)
Domestic Growth Peaking, Competitive Pressures Overseas
We are maintaining our Underweight rating on DeNA, with a target price of ¥2,200 to November 2011. We believe domestic growth prospects have peaked, and consequently we expect returns to fall due to greater competition and pressure to spend on marketing to keep market share. We have low expectations for DeNA’s plans for overseas expansion and believe that these efforts will not offset the declining domestic growth profile.  We maintain our Underweight rating. We view DeNA as being in the 'early glory' phase of the mobile social gaming market cycle, as it dominates the domestic market (we estimate a 40% share in CY’10). We believe Y/Y growth rates have peaked, and although short-term earnings visibility is high the decelerating Y/Y growth profile looks unattractive. Overseas expansion via M&A does position the company strongly versus domestic peers, but we believe competitive threats are also high as the market overcrowds. Overall, we believe medium-term growth prospects are muted as domestic demand enters a declining profile, with measured advances to be gained overseas. With the business exiting a high-growth phase and entering a flattening growth profile in our view, we rate the shares Underweight.  Domestic prospects diminishing, overseas competitive threats. Mobile social gaming is a new developing market, and the supply/demand balance is still in favor of early movers with hit content. Social gaming content has the advantage of being able to be changed and adjusted 'on the go' in order to meet user needs and can have a long shelf life compared with traditional package software. However, with more games on the market we think the business model will become more reliant on winning new users and keeping them active—we believe marketing costs will rise, resulting in lower returns. As we think the domestic market is unlikely to see a reacceleration of demand, positioning in the overseas markets becomes important for DeNA. However, competitive threats are significantly higher, and we envisage that replicating the success seen domestically will be very difficult to execute overseas. Despite acquiring US app maker ngmoco and having access to overseas resources and the virtual social gaming network 'Plus+', we believe it will become a niche service given the preference of overseas users to operate with real social graphs.

Underweight
2432.T, 2432 JT Price: ¥2,954 Price Target: ¥2,200

Japan

Internet Hiroshi Kamide
AC

(81-3) 6736 8602 hiroshi.kamide@jpmorgan.com

Yusuke Maeda
(81-3) 6736-8654 yusuke.x.maeda@jpmorgan.com JPMorgan Securities Japan Co., Ltd.
Price Performance
2,800 Y 2,200 1,600
Dec-09 Mar-10 Jun-10 Sep-10 Dec-10

2432.T share price (Y TOPIX (rebased)

Company Data
Price Price date Market capitalization Shares outstanding 52-week range TOPIX Dividend (F’10E) Dividend yield (F’10E) ROE (F’10E) ¥2,954 Dec. 29, 2010 ¥420.7B 142.4M ¥3,105– 1,680 908.01 ¥46.5 1.6% 63.9%

Source: Bloomberg, J.P. Morgan estimates.

 Valuation and risks. The shares are trading at 11.0x our F’11 EPS forecast,
which is not a demanding valuation in our opinion. On our medium-term forecasts with decelerating earnings growth that turns negative, we believe the shares offer little upside, and hence our Underweight rating. Risks to our price target include a reaccelerating growth profile in the domestic market and speedy and pronounced earnings generation from overseas expansion.
Consolidated Y/E Mar 2009 2010 2011E 2012E 2013E Sales (¥B) 37.6 48.1 113.3 140.1 141.3 Y/Y (%) 26.5 27.9 135.5 23.7 0.9 OP (¥B) 15.8 21.3 55.5 64.0 61.8 Y/Y (%) 25.1 34.2 160.8 15.3 -3.3 RP (¥B) 16.1 21.5 55.7 64.2 62.1 Y/Y (%) 25.6 33.7 158.9 15.2 -3.3 NP (¥B) 8.0 11.4 33.1 38.1 36.9 Y/Y (%) 17.4 42.9 191.0 15.2 -3.3 EPS (¥) 55.1 79.8 232.4 267.7 258.9 P/E (x) 53.7 37.0 12.7 11.0 11.4 P/B (x) 17.5 12.2 6.1 4.0 3.0 EV/EBITDA (x) 22.5 17.1 6.7 5.8 6.0

Source: Company data and J.P. Morgan estimates. Note: The company had not disclosed its earnings forecasts as of Dec. 29, 2010.

0B.Hiroshi Kamide (81-3) 6736 8602 hiroshi. • Monthly ARPU per registered user —We believe annualized monthly ARPU will decline 4.3% Y/Y to 24. Our Estimates and Outlook for F’12 We are maintaining our F’12 estimates for DeNA. • Overseas expansion places the company in a relatively strong position compared to domestic peers. Competitive threats are rising in a rapidly overcrowding market.3M in F’11. and we believe DeNA will not be able to replicate the level of overseas success seen in Japan. With registered user growth slowing Y/Y. Overseas expansion . Our key assumptions are as follows: • Average registered monthly users—We estimate the number of annual average registered users will grow 3.kamide@jpmorgan.1% Y/Y to 25.4. a marked slowdown from the estimated 38. we believe the company faces the following challenges: Growth in domestic market has peaked Cost increases via marketing lowering margins. 2011 Price Target of ¥2.2% Y/Y to ¥389.6 in F’11. free cash flow conversion is high and hence we have used DCF as our valuation method to derive a fair value for the stock. • Domestic ARPU levels are currently high. there is pressure on sales volume expansion and associated marketing costs (user acquisition costs) to maintain user activity on the site.com Global Equity Research 03 January 2011 Our Estimates and Outlook for F’11 We are maintaining our F’11 estimates for DeNA.1B and operating profit of ¥64. • Monthly ARPU per registered user —We believe annualized monthly ARPU will peak at ¥406. and we believe they are overreaching realistic levels of sustainability. With a reaccelerating growth profile unlikely to occur in the medium term. we rate the shares Underweight. Our key assumptions are as follows: • Average registered monthly users—We estimate the number of annual average registered users will grow 12. with revenue of ¥140. We expect operating margins to continue declining Y/Y as the decline in earnings from the domestic social gaming business is not offset by overseas expansion.200 DeNA is the dominant player in mobile SNS social gaming services in Japan (40% share in CY’10 based on our estimates) and is conducting M&A for overseas market expansion. with revenue of ¥141.limitations via intense competition Valuation and Rating Analysis Despite the volatility in growth rates at the company.9% Y/Y growth for F'10. in order to maintain sales volume • We believe growth rates for their domestic SNS operation has peaked. with marketing cost increases and margin dilution from the consolidation of overseas acquisitions. Despite the high earnings visibility in the short term. We expect operating margins to decline Y/Y. and with a domestic business that looks to have peaked.3B and operating profit of ¥61.0M in F’12. We Are Maintaining Our Nov.8B. and unlikely to reaccelerate hereon in. 356 .

3B. we derive a net present value of ¥273.200 per share. producing a fair value of around ¥2. and the resultant fair value equity is ¥319.5% and generating an average annual ¥33.8B.9B of free cash flow into perpetuity (with a zero terminal growth rate).Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan. and 1. For the number of shares outstanding. We then add back ¥46.26M shares (includes the forthcoming third-party equity issuance for the acquisition of ngmoco—pending dilution from 1.5B net cash and equivalents.0% dilution from the earn-out clause have been excluded).0% warrants issued. Investment Risks We view the risks to our investment thesis as follows: Upside risk • Growth reaccelerating in the domestic market • Overseas earnings growth more pronounced than expected into F’11 • Major M&A activity to raise market position and scale of operations Downside risk • Growth decelerating faster than expected in the domestic market • Overseas expansion failing to produce results in the expected timeframe • Major equity financing for M&A activity resulting in dilution 357 . we have used 147.com Global Equity Research 03 January 2011 Our basic premise is that on a WACC of 10.

Morgan based on company data ‘Kaitou Royale’ is a mafia/gang category game. game ad sales.com Global Equity Research 03 January 2011 Key Assumptions DeNA’s mainstay business is social media.5 5.4 1.P.0% 51. DeNA has been active in overseas M&A. 358 . with the objective to become a successful thief—a similar overseas equivalent title is 'Mafia Wars' from Zynga. This title was initially exclusive to ‘MobageTown’.1% 3. In the social media business. affiliate ads Avatar item sales and affiliate ad sales Display.8 69. mixiAppli sales (ad and fee).0% 0. We believe that in the short term this situation will not change dramatically.8 -33.8% 9.0% 14. and Mixi 5%. The company up until then was in decelerating in growth.6% 209.1% 0.6% -26. and had the following impact to user ARPU traffic.6 70.3 -10.8 94.1 -1.9 3.9% 136.5% 12. tie-up.3 3. GREE 25%. as its online avatar service was experiencing a slowdown. and earnings growth: Impact of Social Gaming Content Introduced in 3Q F’09 on ARPU.8 4. content matched and affiliate ad program sales Overseas sales.1% 282. which accounts for the vast majority (8090%) of its earnings.5% 35.2% 49. 'Everystar' mobile portal.0 22.2 55.8 87.1 186.6 2Q 371. social gaming is the primary earnings source and is exhibiting dominant strength. most recently acquiring ngmoco in October 2010.8 50. We believe financing requirements are low for DeNA as it has completed a major deal with ngmoco.8 -27.5 F’10 1Q 356.3% 5.3% 1.2 234.2% 248.0% NA Description Comprises of the following service divisions Item sales.1 -24. Business Lines Business segment Social Media Game related Avatar Ad sales Other ngmoco Commerce Other Sales split 86. Pageviews and OP F’09 Monthly ARPU Q/Q Y/Y User pageviews Q/Q Y/Y OP Q/Q Y/Y OPM ¥/user % % B % % ¥B % % % 1Q 124.6% 2Q 111. Morgan based on company data Recent History—Impact of ‘Kaitou Royale’ DeNA experienced its turning point in terms of raising its market positioning in the mobile social gaming market in October 2009 (3Q F’09).1 184.3 49.3 75.9 158. SAP ad sales.1 52. specializing in smartphone apps Mobile and PC auction and shopping sites Travel and insurance agency operations Source: J.6 67. its mobile SNS gaming portal site and decided to follow GREE's success in social gaming content and developed its first breakthrough title called 'Kaitou Royale'. which signaled a major expansion into overseas markets.P.8% 6. others 100% US subsidiary.5% 102.5 -35.6% 9.kamide@jpmorgan.1 NA NA NA 13.2 69.8 4Q 292.7% -10.6 13. search.0 3Q 166.3% 14. The company operated ‘MobageTown’.3 16.Hiroshi Kamide (81-3) 6736 8602 hiroshi.4% 31. We believe the current market share in terms of revenues generated by item sales including social gaming and advertising are as follows: DeNA 40%.9 22.6 341.0% 68.6% 36.9% 44.6 Source: J.

8 44.4 0.2 2.3 F’11 Q1 E 33.7 29.2 0.6 15.6 24.6 0.8 46.5 20.2 -3.0 13.8 403.3 4.4 216.0 10.2 20.3 27.3 5.0 10.9 43.5 16.4 400.0 25.1 64.0 25.5 57.1 21.3 0.5 13.2 -4.0 -0.5 3.4 33.7 % % % % % % % % % % 49.2 5.2 24.5 395.0 -0.7 0.0 0.5 40.5 13.3 69.6 Q2 27.1 0.3 16.3 15.7 46.4 0.4 29.2 Source: Company data.6 289.7 12.6 0.6 371.8 6.2 34.9 22.6 6.1 389.6 174.6 230.5 3.2 34.0 -0.4 3.1 23.0 10.6 2.4 50.7 15.2 43.9 24.3 -0. such as 'Sengoku Royale' (the same game in a samurai historical setting) in April 2010.3 406.1 31.0 1.1 1.0 10.4 15.8 1. J.0 23.6 38.4 6.8 4.0 10.0 3.4 50.9 0. Morgan estimates Our earnings forecasts are based on the following key variable factors for the Social Media business: 359 .kamide@jpmorgan.2 0.3 34.1 0.8 0.7 24.9 31.5 3.7 44.0 2.8 9.1 9. Other in-house social gaming titles are: • ‘Setururin’: A pet sim • ‘Nouen Hokorina’: A gardening sim • ‘Aqua Square': A fish/aquarium sim.1 Q4 E 37.1 0.3 0.0 15.8 15.2 0.9 -1.5 16.3 55.7 -4.4 0.1 186.5 14.0 135.9 F’10E 113.0 10.0 -7.3 15.0 154.6 28.2 4.4 -4.2 0.1 -0.0 1.9 24.4 12.1 -0.5 196.8 -3.2 24.4 87.3 1.4 -7.2 369.1 2.0 -29.0 -8.8 51.8 6.3 42.3 -0.5 28.8 3.0 F’12E 141.travel and insurance agencies Operating profit Social media ngmoco eCommerce Other .2 -1.3 97.0 14.7 25.3 1.0 61.5 420.8 2.9 44.4 16.5 25.6 0.5 15.7 0.4 13.0 -0.0 -5.6 34.3 -14.4 0.7 40.7 Q2 E 33.5 53.4 4.6 0.7 1.0 0.0 10.1 53.9 38.2 Q3 E 35.5 31.P.8 4.7 10.0 -0.0 5.1 -0.8 0.0 Q4 E 32.0 1.2 3.2 1.1 43.9 31.5 2.0 33.3 12.5 1.3 14.1 22.0 Sales Social media ngmoco eCommerce Other .4 -7.0 62.3 116.0 38.8 12.6 20.0 0.8 59.9 2.0 6.5 14.1 -2.0 12.5 15.0 10.7 33.) Q/Q Y/Y Monthly ARPU Q/Q Y/Y M % % ¥/user % % 19.0 1.0 -0.1 0.9 3.0 43.5 25.3 55.2 0.0 5.9 31. the company has rolled out spinoff versions of the title.2 25.5 0.6 1.6 0.0 5.7 14.9 34.0 -2.2 0.7 0.3 4.0 16.2 4.0 28.travel and insurance agencies Eliminations OPM Social media ngmoco eCommerce Other .5 15.7 Q3 E 35. and another PC browser game version ‘Kaitou Royale ZERO’ on Yahoo Japan’s ‘Yahoo! Mobage’ service in from September 2010.7 7.0 0.6 -3.0 -0.6 1.0 0.0 32.8 -13.9 33.7 34.0 -4.7 16.0 19.4 402. similar to Zynga’s 'Fishville’ Quarterly Earnings Estimates ¥ billion F’10 Q1 24.1 -1. Since 3Q F’09.6 56.6 51.9 379.7 403.4 3.5 2.1 20.4 -7.6 3.4 7.0 3.1 3. DeNA also released ‘Kaitou Royale’ on the Mixi mobile platform in December 2009.1 118.0 -5.0 -0.6 9.6 46.3 0.7 0.9 Q4 E 36.0 14.0 15.travel and insurance agencies Sales growth Y/Y Social media ngmoco eCommerce Other .6 F’12 Q1 E 35.4 Q3 E 29.0 -0.8 1.8 47.4 15.9 373.3 34.0 -1.5 398.2 -0.0 10.8 1.8 5.4 30.0 52.0 36.4 0.6 Q2 E 34.5 -5.4 0.8 15.0 12.0 -2.1 53.7 22.0 11.8 27.0 45.0 4.4 34.travel and insurance agencies Social media Users (quarterly avg.4 23.6 51.4 35.4 0.1 -7.9 25.5 4.4 4.2 234.6 64.0 385.6 48.3 79.6 13.9 2.1 25.1 -2.0 -1.1 50.6 54.Hiroshi Kamide (81-3) 6736 8602 hiroshi.3 1.6 1.4 0.0 23.0 3.3 0.6 1.3 3.1 -7.0 0.3 25.8 13.7 52.4 44.1 356.2 55.8 9.0 128.0 F’11E 140.9 2.2 3.5 4.1 1.1 32.2 370.8 53.3 2.9 52.1 118.2 55.com Global Equity Research 03 January 2011 which is very popular on Facebook.5 0.

Corporate History and Basic Information DeNA – Corporate History Year 1999 2004 2005 2006 2007 2009 2010 Summary Established in Tokyo. as an online PC auction site “Bidders” Open's "Mobaoku" mobile auction site Tie-up with KDDI as their official auction service Lists on TSE Mothers Open's "Mobage Town" mobile game portal and social network service with avatar content Lists on TSE 1st section Launches social gaming on "Mobage Town" Launches "Mobile Game" open platform Launches "Game Community" globally to iPhone and iPod touch Acquires US iPhone app company ngmoco Launches "Yahoo! Mobage" with Yahoo Japan Source: J. Morgan based on company report. 2010. Acquisition of ngmoco DeNA announced the 100% acquisition of US based smartphone game application developer ngmoco on October 12. Morgan based on company data Note: Data as March 2010 DeNA’s shareholder structure shows management (CEO Namba) and So-net Entertainment as core shareholders.Hiroshi Kamide (81-3) 6736 8602 hiroshi.P. despite the tendency for the over 30s demographic to be high spenders.P.4% as of March 2010. with the ceiling of around 25M users • Monthly ARPU per registered users —we believe that ARPU is nearing its ceiling limit as well.com Global Equity Research 03 January 2011 • Average registered monthly users—we expect a gradual slowdown trend to continue into F’12. DeNA – Shareholder Structure Tomoko Namba 15% Others 48% Sonet Entertainment 14% Trustee Accounts 23% Source: J. The key details are as follows: 360 . The free float is estimated to be 6.kamide@jpmorgan.

361 . The company now releases registered user numbers at quarter end at quarterly financial reporting. but nothing on pageview statistics.0 146. CEO Namba commented at the 2Q F’10 analyst meeting that ngmoco is growing so that its profits will offset any annual goodwill amortization charge arising in F’11.0 56. Although we agree that mobile ecommerce operations have little bearing on earnings visibility now. as well as data from its mobile ecommerce operations (shopping transaction volume and subscription customers) from August 2010.5 -10.7 100.5 3. Morgan based on company data Note: ngmoco’s F’08 was a seven month reporting period.P.kamide@jpmorgan.0 12.0 Nov-10 Dec-11 From F’11 San Francisco Neil Young* June 25 2008 0. Company Disclosure DeNA has ceased to release monthly data regarding user registration numbers and pageview traffic for its ‘MobageTown’ service.4 1.3 8. the company felt that disclosure was no longer required as these monthly data was not related to actual recent trading.com Global Equity Research 03 January 2011 ngmoco—Basic Financial Outline and Transaction Details Purchase price ($M) Final price Equity finance Options Cash Earn-out phase Equity finance Options Cash Closing phase Earn-out phase 303. the data supplied for ‘MobageTown' are useful indicators of user activity.0 31.0 27.2 -2. We have asked the company about the amortization schedule and was told it was over around a 10-year period.0 23.Hiroshi Kamide (81-3) 6736 8602 hiroshi. given the major shift in business model.0 Completion dates Consolidation date Company location CEO Incorporated Financials Sales ($M) OP ($M) Total assets ($M) Estimate goodwill ($M) Estimate goodwill (¥B) DeNA equity dilution (%) F’08* F’09 F’08* F’09 F’08 F’09 Closing phase Earn-out phase Closing phase Earn-out phase Closing phase Stock options exercised from closing phase Earn-out phase Source: J.9 3. * The founder and CEO of ngmoco.5 3.3 28.0 128. The reason given by the company was that.3 274. Forex rate is $1=¥85. not the Canadian singer/songwriter.0 1.0 100.

3 18.1 -0.0 -2.3 -1.4 -0.0 46.1 0.3 8.0 F’12E 0.8 15.0 62.8 24.9 31.0 55.7 45. Stock price as of Dec.3 2.3 80.1 0.7 0.2 55.0 12. 29. Morgan estimates.5 1.4 0.1 0.5 20.7 49.0 33.1 0.0 33.8 6.5 38.1 14.1 33.1 35.5 68.3 0.7 25.7 5.3 0.4 160.6 2.9 31.0 18.8 20.0 Source: Company data.5 123.6 25.2 6.4 484.5 -3.com Global Equity Research 03 January 2011 Financial Statement – DeNA (2432) ¥ billion Income Statement .3 15.7 7.0 23.3 116.0 14.6 3Q F’10E 29.2 10.9 77.0 5.0 64.9 ¥ ¥ ¥ % Balance Sheet and Cash Flow <Balance sheet> Current assets Cash and cash equivalents Accounts receivable Other current assets Tangible fixed assets Intangible fixed assets Investments and other assets Total assets Current liabilities Long term liabilities Total liabilities Shareholders' equity Minority interest Total net assets Total liabilities and net assets <Cash Flow> Cash flow from operating activities Cash flow from investing activities Cash flow from financial activities Gross change in cash/cash equivalents Cash and cash equivalents at the beginning of the year Effect of change in consolidated companies Cash/ cash equivalents at FY end Free cash flow Free cash flow conversion Free cash flow yield % % F’08A 32.0 64.2 33.5 95.8 141.6 3.3 27.3 F’09A 48.2 369.6 2.0 12.0 -1.8 5.5 5.4 17.4 12.3 0.2 15.5 81.9 4.9 971.8 0.3 9.0 154.1 21.7 37.5 10.9 33.0 1.1 36.8 13.7 21.0 13.8 0.5 51.4 0.4 3.6 15.7 3.7 15.4 24.8 49.3 22.3 3.7 Segment Statement .3 2.7 6.0 55.8 2.6 34.6 9.5 24.0 -7.7 743.1 47.6 0.4 0.2 24.0 -7.5 8.3 0.8 F’12E 141.8 158.0 55.1 -25.0 3.4 15.4 51.8 9.4 79.Hiroshi Kamide (81-3) 6736 8602 hiroshi.7 0.1 % % % % % % % % x x % x x x F’08A 37.2 -26.4 52.4 216.9 71.8 61.0 0.6 3.7 114.3 -3.4 F’10E 84.1 38.9 34.3 2.9 F’12E 156.5 0.4 0.3 0.2 14.3 0.4 55.7 11.6 48.9 6.9 22.4 114.3 55.5 53.0 -0.6 42.2 19.1 33.9 2.8 0.0 1.8 62.1 2.8 45.4 0.6 13.5 -1.0 1.6 102.2 28.2 80.1 0.0 57.2 4.5 -2.2 45.1 0.0 52.1 124.4 7.1 53.6 160.5 0.7 -22.4 13.0 -0.9 21.4 0.9 3.0 0.0 0.6 6.5 58.3 11.4 3.4 2.1 118.3 97.0 1.7 33.8 71.5 60.5 10.2 0.1 23.7 24.7 12.9 29.7 10.9 105.1 1.1 64.2 68.0 F’11E 23.4 87.0 42.0 71.4 78.5 3.0 45.0 4.1 42.4 F’11E 140.2 2Q F’10A 27.3 13.0 20.1 0.1 0.1 -0.4 6.9 191.1 0.7 55.0 23.2 5.0 15.8 243.5 0.5 50.3 F’11E 127. earning results and J.7 -0.7 0.P.9 -3.8 1.2 11.0 36.1 -4.8 6.0 F’09A 27.8 6.7 20.4 9.2 -1.0 15.8 43.7 0.0 16. Note: Fiscal year ends March.7 17.4 37.8 53.2 20.8 44.2 -5.6 289. 2010.5 0.2 -3.0 0.8 8.0 1Q F’10A 24.1 169.3 68.0 11.8 40.3 43.7 37.5 22.5 160.7 9.6 174.0 61.6 30.0 11.1 -6.2 40.3 51.0 42.8 44.1 -0.1 0.5 1.2 44.9 258.3 138.1 F’10E 113.9 F’08A 26.9 40.5 25.6 56.8 108.1 1.4 76.0 -0.6 0.0 43.6 1.5 14.4 0.0 10.8 47.0 43.0 0.6 10.Annual Revenues Social media ngmoco eCommerce Others Operating profit Social media ngmoco eCommerce Others Eliminations Non operating income Non operating expense Recurring profit Extraordinary income Extraordinary expense Pre-tax profit Tax Minority interests Net profit EPS BPS DPS Payout ratio Ratio Analysis <Y/Y growth> Sales Operating profit Recurring profit Net profit <Margins> GPM OPM RPM Effective tax rate <Valuations> P/E P/B Dividend yield EV/EBITDA EV/EBIT EV/Sales <Profitability> ROCE ROE ROA % % % 68.5 20.4 -7.0 62.0 4.0 13.8 13.6 0.2 0.0 10.8 0.1 232.2 1.9 31.6 23.0 53.0 4Q F'10E 32.3 0.0 1.3 5.4 14.0 58.1 0.6 11.0 1.5 3.7 42.6 0. 362 .6 24.0 F’10E 135.1 18.0 3.4 193.6 18.2 22.1 37.3 32.1 11.0 72.9 3.0 21.2 3.kamide@jpmorgan.4 2.7 42.1 267.3 0.5 1.1 25.0 68.6 230.1 0.0 62.3 -3.7 F’09A 49.2 49.1 9.6 54.0 5.4 10.1 193.9 2.9 1.1 1.0 6.0 10.2 0.7 -8.3 18.0 0.1 32.5 0.3 69.8 7.9 1.3 0.7 -0.6 17.0 4.4 3.7 55.0 51.1 1.7 11.2 4.8 0.3 67.1 27.5 13.8 0.8 9.1 -4.9 -4.5 0.1 2.8 -4.2 1.5 63.0 80.0 23.Quarterly Revenues Social media eCommerce Others Operating profit Social media eCommerce Others Eliminations OPM Social media eCommerce Others Revenue growth Y/Y Social media eCommerce Others % % % % % % % % 4Q F'09A 19.

8 Y/Y (%) 134. 29.3 7.3 44.4M ¥1.0 OP (¥B) 19.7 74. which we do not think is demanding considering our 45% Y/Y OP growth forecast.T share price (Y TOPIX (rebased) Company Data Price Price date Market capitalization Shares outstanding 52-week range TOPIX Dividend (F’10E) Dividend yield (F’10E) ROE (F’10E) ¥1. User Acquisition Costs Rising We are maintaining our Neutral rating on GREE.7 10.0 ~ 77.kamide@jpmorgan.9 NP (¥B) 11.0 54.0 70.1 21.0 EV/EBITDA (x) 11.5 12.0 Source: Company data and J.4 27.2 93.0 ~ 30.8 15.3 35.9 ~ 53.  Marketing cost increases heighten our concern.8 ~ 53. we think that GREE will struggle to surprise on the upside with limited resources. As of December 29. Short-term earnings visibility is fair but not one denoting a reacceleration of growth.2 56.1 13.8 Y/Y (%) 135.0 3. a casual fishing game in May 2007.9 ~ 17.7 10. We think recent performance metrics have given rise to concern.6 28.000 through November 2011. marketing spend.580– 875 908.7x our F’11 EPS forecast.. with 1Q’10 showing 2. . We believe much of these negatives have been priced into the stock. Price Performance 1. Neutral 3632.6 6.0 Y/Y (%) 152. Morgan estimates. Downside risk factors include declining profitability through increasing marketing expenditure.6 46. However.9 37.01 ¥5.9 RP (¥B) 19.5% 55.x.com JPMorgan Securities Japan Co. Average monthly ARPU growth has visibly slowed.1 44.6 28.069 Dec. and we believe the structural negatives (increasing competition.8 53.8 13. With more social gaming content available compared to three years ago.3 38. Parent Y/E June 2010 2011E 2011Co.3 16.P.0 ~ 60.6 58. The company pioneered mobile social gaming in Japan with “Tsuri-Sta!”. with a target price of ¥1. we believe GREE is finding it difficult to construct winning titles as the SNS platform becomes more competitive and hit driven.3% Q/Q (monthly ¥549 spend per user).9 EPS (¥) 50.3 ~ 70.com Yusuke Maeda (81-3) 6736-8654 yusuke.069 Price Target: ¥1. but as this is in line with expectations we believe the shares are fairly valued. J.7 11. 3632 JT Price: ¥1. We conclude that users activity is waning as the games on offer are entering the latter stages of their product cycle and replacements have yet to construct a recovery.2 ~ 53.4 12. At the same time. but with sluggish earnings growth and no positive catalysts in sight we rate the shares Neutral. 2010 ¥243.7 19.3 35. Upside risk factors include ARPU growth via strong title releases.T.1 4.0 0.5 6.2 73.2 Y/Y (%) 157. Source: Bloomberg.P. The situation today is in stark contrast.3 P/E (x) 21.2 13.8 6.Global Equity Research 03 January 2011 Gree (3632) ARPU Growth Slowing.9 37.1 14. Morgan estimates.5 16. as DeNA has become the market leader and GREE is struggling to compete in terms of content offering. We believe the shares have corrected to reflect the competitive pressures and structural issues regarding peaked demand in the domestic market.4 27. the shares have fallen 32% from their 52-week high in June 2010.0 32.5% growth Q/Q (ARPU ¥192 per month) despite the launch of the platform business in June 2010 and the release of two new in-house game titles (“Columbus” and “Monster Planet”).  We maintain our Neutral rating.9%  Valuation and risks. Ltd.0 65.0 32.400 Y 1.100 800 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 3632.maeda@jpmorgan.0 ~ 30. The shares are currently trading on a P/E of 12.E 2012E 2013E Revenue (¥B) 35.9 84. marketing spend has increased 22.7 10. and user monetization.000 Internet Hiroshi Kamide AC (81-3) 6736 8602 hiroshi. rising costs) have been priced in.1B 227.5 P/B (x) 11.

free cash flow conversion is high and hence we have used DCF as our valuation method to derive a fair value.3. 364 . We believe that operating margins will stabilize. as it has a more mature growth profile compared to DeNA in social gaming.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 We are maintaining our F’11 estimates for GREE. proactive marketing and staff increases. with revenue of ¥73. • We believe much of these negative factors have been priced into the stock. • Monthly ARPU per registered user —Y/Y we expect monthly ARPU to grow by 4% on an annualized basis to ¥213. we believe the company will perform in line with our expectations. We believe these issues are more pronounced at GREE.Hiroshi Kamide (81-3) 6736 8602 hiroshi.0 and operating profit of ¥35. We Are Maintaining Our Nov. with revenue of ¥65. The key points to make are: • We believe growth rates for their domestic SNS operations has peaked and unlikely to reaccelerate hereon in. reaching 27M users in 4Q’11. Y/Y we expect monthly ARPU to grow by 5% on an annualized basis to ¥206.kamide@jpmorgan.1. Our key assumptions are as follows: • Average registered monthly users—We expect a gradual slowdown in user growth into F’11. • We think operating costs are likely to increase in order for the company to remain competitive—new game developments. We rate the shares Neutral. We expect operating margins to decline slightly Y/Y.000 The challenges faced by DeNA are not dissimilar to GREE—slowing domestic growth prospects and execution risks over expansion into the heavily contested overseas market. This is slightly higher than DeNA (25M) given the more casual nature of the platform. GREE has a more mature growth profile compared to its peer group. 2011 Price Target of ¥1. but with no major improvement as the business needs to invest in order to maintain its growth profile. • Monthly ARPU per registered user —We believe ARPU will remain in the ¥190-210 zone. with marketing costs growing faster than topline growth. GREE’s most successful fishing game was released in May 2007—DeNA's core game “Kaitou Royale” was released in October 2009. Our key assumptions are as follows: • Average registered monthly users—We expect registered user numbers to reach 29M. Although we think a reaccelerating growth profile is unlikely in the medium term.3B.2B and operating profit of ¥32. Valuation and Rating Analysis Despite the volatility in growth rates at the company. Our Estimates and Outlook for 2012 We are maintaining our F’12 estimates for GREE.8B.

4B in net cash and equivalents. we derive a net present value of ¥209. leading to drops in ARPU • Major hikes in marketing spend to compete with peers • Increasing development costs of new games. as more resources are required to create competitive titles 365 .8B in free cash flow into perpetuity (with a zero terminal growth rate).000 per share. We then add back ¥21. resulting in ARPU increases • Major influx of advertising demand on the SNS site • Inactive users are recaptured Downside risks • Faster-than-expected decline in user activity.6B.kamide@jpmorgan.5% and generating an average annual ¥18. producing a fair value of around ¥1.Hiroshi Kamide (81-3) 6736 8602 hiroshi.com Global Equity Research 03 January 2011 Our basic premise is that on a WACC of 10.0B. Investment Risks We view the risks to our investment thesis as follows: Upside risks • New game releases that reignite user activity. and the resultant fair value equity is ¥231.

9 24.000 per purchase) Banner and listings ads.2 2.9 2. J.5 12.5 7.2 210.4 205.9 12.9 50.5 10.1 12. finance Advertising 18% Source: J.6 2. behind DeNA.3 6.7 28.3 6.2 10.6 7.0 7.1 8.7 50.0 0.0 4.5 27.0 13.5 38.0 11.4 2. 366 .1 2.0 50.9 23.7 F’12E 73. primarily for mobile content providers.5 15.7 7.1 81.2 2.3 3. With an estimated market share of 25% in CY’10.7 46.0 Q2 E 16.0 1.1 5.7 0. 2 spot in sales among domestic SNS companies.8 26.4 10.1 2.7 -14.P.8 51.7 58.0 F’11 Q1 E 15.4 11.9 17. GREE holds the No.0 40.4 54.0 1.3 55.6 4.0 47.7 2.6 9.5 16.8 6.1 F’10E 56.0 12.9 M % % ¥/user % % 21.7 50.1 12.0 69.6 25.0 1. Morgan estimates.4 195.8 10.000 per purchase) Discretionary user spend on virtual currency (¥300 to ¥5.3 29. and hence its financing requirements are low.kamide@jpmorgan.1 2.3 192.0 10.0 28.6 5.7 8.6 32.9 60.5 60.1 9.0 7.2 215.0 5.0 8.4 23.7 5.0 4.0 57.7 6.6 2.0 -1.2 Q2 E 17.5 37.2 0.4 28.0 16.5 16.0 Q3 E 16.0 2.4 28.0 2.6 11.4 50. Business Lines Business segment Item sales Sales split 82% Description Premium service subscriptions (¥300 per month) Monthly user defined virtual currency purchases (¥300 to ¥5.0 19.3 49.8 206.5 12.7 4.1 50.6 7.8 11.0 3.2 4. We believe that in the short term this situation will not change dramatically.4 4.0 Q3 E 14.6 198.8 5.1 202.0 Q4 E 15.1 26.8 29.7 50.0 Q3 E 18.5 47.0 2.6 54.5 Source: Company data.3 25. completing a small transaction to acquire a minority stake in countries such as South Africa and Indonesia.0 8.6 50.3 50.2 48.000 to ¥10.0 F’12 Q1 E 17.0 13. internet services.000 per purchase) Discretionary user spend on avatar items (¥1.Hiroshi Kamide (81-3) 6736 8602 hiroshi.0 8.0 45.0 4. Morgan based on company data Quarterly Earnings Estimates ¥ billion F’10 Q1 Revenue Item sales Advertising Operating profit OPM Sales growth Y/Y Item sales Advertising Sales assumptions Average registered monthly users Q/Q Y/Y Monthly total ARPU per user Q/Q Y/Y % % % % 12.0 Q4 E 17.5 59.2 35. We believe GREE is not prioritizing M&A strategy.9 50.0 8.0 8.4 8.5 7.5 27.0 4.0 24.2 3.5 196.8 2.4 51.0 0.P.1 2.3 Q2 E 13.0 2.2 210.5 25.2 50.0 10.7 35.9 3.0 2.1 8.8 16.5 8.5 91.0 71.0 28.0 210.0 -2.0 8.1 4.7 201.8 48.3 50.1 213.5 11.2 218.5 13.2 207.5 5.6 Q4 E 18.6 4.8 60.9 F’11E 65.8 49.1 60.0 2.0 0.4 50.7 76.1 13.2 8.2 48.6 51.4 2.8 12. GREE is taking a longer-term view on overseas expansion.com Global Equity Research 03 January 2011 Key Assumptions GREE’s mainstay business is item sales through the sales of social games and avatars and accounts for 80-90% of total revenues.1 26.8 8.

We make no earnings assumptions for overseas expansion plans.P.P. Note: Data as of June 2010. 367 . given that the tie-up with Project Goth Inc. leading to mobile "EZ GREE" site Launches social games on GREE SNS Lists on Mothers Lists on TSE 1st Section Starts GREE Platform – third party application developers selected to bolt on gaming content Announces capital tie-up with Project Goth Inc. GREE – Shareholder Structure Others 25% Trustee Accounts 18% KDDI 7% Yoshikazu Tanaka 50% Source: J.com Global Equity Research 03 January 2011 Corporate History and Basic Information GREE – Corporate History Year 2004 2006 2007 2008 2010 2010 2010 Summary Establishes GREE PC social networking site Business and capital tie-up with KDDI.Hiroshi Kamide (81-3) 6736 8602 hiroshi. Morgan based on company report.kamide@jpmorgan. involves little capital (less than ¥0.5B) and planned to be a long-term relationship aimed at emerging market opportunities. Morgan based on company report.. operator of SNS platform ‘Mig33” Source: J.

P. recent title releases have performed poorly. While this is a testament to the longevity of social gaming applications. 368 . Morgan based on company report GREE’s core title “Tsuri Sta!” has been active since May 2007. and that GREE’s client base may be shifting between titles thereby not creating incremental growth via item sales.kamide@jpmorgan.Hiroshi Kamide (81-3) 6736 8602 hiroshi. We believe that increasing competition from DeNA and other social application providers are giving GREE a run for their money.com Global Equity Research 03 January 2011 Key Game Titles GREE’s in-house social gaming titles are as follows: In-house Social Gaming Titles Title Tsuri-Sta! Clinoppe Dorirando Hakoniwa Monster Planet Columbus Service start May-07 Jul-07 Aug-09 Sep-08 Jun-10 Aug-10 Category Fishing game Pet sim Excavation game Gardening sim Monster sim/battle game Pirate game Source: J.

1 0.0 45.3 157.7 0.0 13.6 134.1 0.5 38.2 93.0 9.8 0.6 6.9 31.6 21.2 60.5 49.9 0.2 19.7 -0.5 6.2 50.1 92.0 60.8 94.9 10.1 0.2 0.5 -40.2 0.3 0.4 26.0 2.0 19.0 25.1 98.0 24.0 4Q F’10E 15.0 13.2 29.0 59.3 0.7 F’11E 65.0 50.4 F’12E 12.9 76.9 10.1 5.2 67.4 0.8 -0.6 5.2 15.9 17.6 32.0 15.0 6.2 11.3 0.6 20. Morgan estimates Note: Fiscal year ends June.0 11.7 F’12E 73.1 55.6 -40.7 8.2 267.0 3Q F’10E 14.6 8.0 6.8 0.6 11.2 1.4 11.6 4.0 57.4 0.0 53. 2010.0 0.9 0.3 667.3 6.8 60.5 3.1 0.6 2.5 0.7 1.7 -2.3 14.0 4.6 0.1 13.2 -1.6 0.5 8.2 10.9 F’10E 51.3 48.7 -46.3 6.2 5.6 6.0 0.4 9.0 Balance Sheet and Cash Flow <Balance sheet> Current assets Cash and cash equivalents Accounts receivable Other current assets Tangible fixed assets Intangible fixed assets Investments and other assets Total assets Current liabilities Long term liabilities Total liabilities Shareholders' equity Minority interest Total net assets Total liabilities and net assets <Cash Flow> Cash flow from operating activities Cash flow from investing activities Cash flow from financial activities Gross change in cash/cash equivalents Cash and cash equivalents at the beginning of the year Effect of change in consolidated companies Cash and cash equivalents at FY end Free cash flow Free cash flow conversion Free cash flow yield F’08A 15.3 14.0 0.Quarterly Revenues Item sales Advertising Operating profit OPM Revenue growth Y/Y Item sales Advertising % % % % 4Q F’09A 10.4 112.com Global Equity Research 03 January 2011 Financial Statement – GREE (3632) ¥ billion Income Statement Annual Revenues Item sales Advertising Operating profit Non operating income Non operating expense Recurring profit Extraordinary income Extraordinary expense Pre-tax profit Tax charge Minority interests Net profit EPS BPS DPS Payout ratio Ratio Analysis <Y/Y growth> Sales Operating profit Recurring profit Net profit <Margins> GPM OPM RPM Effective tax rate <Valuations> P/E P/B Dividend yield EV/EBITDA EV/EBIT EV/Sales <Profitability> ROCE ROE ROA % % % 166.9 46.0 11.0 11.3 359.0 32.1 12.0 17.0 47.6 26.9 2.4 1.8 15.7 696.0 0.7 98.3 25.7 126.0 35.0 21.1 135.0 2.2 28.1 54.5 49.5 50.4 -2.0 13.7 53.3 0.0 19.6 50.7 35.8 -14.0 -40.8 0.6 0.7 28.6 3.2 0.6 0.8 5.9 F’11E 16.5 9.1 84.4 0.0 5.0 77.5 F’08A 13.0 88.9 0.2 7.0 16.2 11.6 55. 29.7 0.8 4.0 20.1 3.8 0.0 0.6 -10.7 0.8 11.3 -13.0 40.0 0.0 0.6 % % Source: Company data.8 F’10E 58.7 17.3 -3.9 9.2 -1.7 13.0 39.P.9 10.1 38.1 19.0 12.5 7.9 74.1 81.0 10.4 F’09A 35.3 -2.1 0.9 0.1 11.4 0.3 15.8 2.0 0.8 74.7 91.6 92.6 0.0 32.9 0.4 692.0 174.3 2Q F’10E 13.5 0.6 32.0 35.9 49.4 39.9 44.4 0.2 0.0 71.5 47.4 51.4 11.7 28.0 9.5 60.8 0.0 0.5 11.0 81.3 11.5 6.0 10.4 19.6 0.8 6.5 16.0 11.3 0.7 7.1 5.9 F’09A 152.2 3.6 0.5 35.5 1.0 28.5 5.3 1Q F’10A 12.1 0.9 91.1 2.7 2.0 32.7 -40.7 F’12E 96.0 8.7 64.7 Segment Statement .4 -7.2 35.5 6.5 6.4 10.4 6.3 92.8 10.6 132.5 7.5 0. earning results and J.0 6.2 3.9 5.5 3.6 0.4 0.9 21.4 -11.9 3.8 44.1 F’08A % % % % % % % % 374.5 3.0 49.8 51.1 2.4 7.0 5.Hiroshi Kamide (81-3) 6736 8602 hiroshi.6 37.0 5.7 50.5 59.5 13.8 5.0 0.7 13.5 15.0 0.9 F’09A 30.7 9.0 20.1 81.0 ¥ ¥ ¥ % x x % x x x 53.0 0.0 28.7 4.2 48.3 0.7 90.3 10.3 50.5 0.0 69.5 20.8 21.1 15.9 50.3 0.0 15.2 -1.7 0.1 2. 369 .5 1.6 5.3 1.2 55.3 1.7 F’10E 56.9 50.0 7.0 8.4 16.0 0.kamide@jpmorgan.1 76. Stock price as of Dec.9 21.5 26.0 -0.0 F’11E 75.5 91.

kamide@jpmorgan.com Global Equity Research 03 January 2011 370 .Hiroshi Kamide (81-3) 6736 8602 hiroshi.

8 4. Neutral 2121.2 RP (¥B) 2. Consolidated Y/E Mar 2010 2011E 2011Co. we believe Mixi has interesting prospects longer term.7 25. The focus on advertising as the key revenue driver should see improving prospects with smartphone penetration.5 0.000 Internet Hiroshi Kamide AC (81-3) 6736 8602 hiroshi. Downside risks include unplanned investment into new services and further marketing activities to boost user activity.4 2.0 29.5 7.4 3. The shares are currently trading at 28.0 0.0 Y/Y (%) 12. focusing on developing new services and improving user experience. However.kamide@jpmorgan.500 Dec.3 EPS (¥) 8. but as we understand management takes user satisfaction as its key objective.1 28. Online advertising demand continues to grow albeit at a relatively modest pace.6 3.4 5. Source: Bloomberg.T.9%  Valuation and risks.7 11. the shares have consistently traded at high levels.x.6 16.1 9.1 49. as we think ‘feature phone’ mobile media remains high maintenance and unwieldy for most advertisers.6 21.7 4.000 to November 2011.000 908.6 24.8 3.01 ¥0.143 P/E (x) 52. Morgan estimates.300 for PC).000 for mobile SNS.6 20.000 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 2121.  We maintain our Neutral rating.6x our F’11 EPS forecast.000 300.2 24. with their focus on providing well thought out services and a deep user experience. Monetizing user traffic is a core activity. Mixi continues to roll out new services and functions to improve the site.155M ¥777.Global Equity Research 03 January 2011 Mixi (2121) Obstacles Remain on the Road to Monetization We are maintaining our Neutral rating on Mixi.1 37.maeda@jpmorgan. which will likely grow as users adapt to new services.4 20.8 23. Ltd.6 23. We believe management is taking a long-term view of the business.911 8.7 3..000– 383. . Item sales from the various applications available on Mixi’s platform are beginning to gain traction. and a current TV advertising campaign is under way aimed at raising brand awareness. 2121 JT Price: ¥441.500 Price Target: ¥425. thinking long term.T share price (Y TOPIX (rebased) Company Data Price Price date Market capitalization Shares outstanding 52-week range TOPIX Dividend (F’10E) Dividend yield (F’10E) ROE (F’10E) ¥441. with a target price of ¥425.000 Y 600.4 5.8 17. Price Performance 900.6 30.4 27.8 Y/Y (%) -27. 1. J.6 2. While valuations are not inexpensive. but this will still take over a year to materialize in our opinion.7 30.8 1. and hence we do not see this as being a major mispricing.5 OP (¥B) 2.3B 0.8 Y/Y (%) -29. More applications are available on the platform now (around 1.457 20.985 15.6 6.com JPMorgan Securities Japan Co.3 NP (¥B) 1. which is a high valuation multiple.P. 2010 ¥68.7 Source: Company data and J.1 Y/Y (%) -33.3 1.1 EV/EBITDA (x) 17.6 2.4 32.9 P/B (x) 4.com Yusuke Maeda (81-3) 6736-8654 yusuke. We believe this is the core strength of Mixi’s management.P.E 2012E 2013E Sales (¥B) 13. We think advertising demand should benefit from smartphone penetration.  Keeping users satisfied.0% 11.2 3. Morgan estimates.8 30.0 40. Upside risks include major application hit services resulting in major item sales.476 11. 29. The release of functions such as ‘Mixi Check’ (a sharing function similar to Twitter and Facebook share/like icons) and ‘Mixi Voice’ (an updated version of their microblogging service) continue to keep the user community involved.8 3.8 4.2 29. but management's emphasis on providing useful utility-type services cannot compete in terms of generating user ARPU available from social gaming in our opinion.

but in the medium term we expect steady progress as opposed to a major ramp up in earnings growth. we derive a net present value of ¥53.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 We are maintaining our F'11 revenue forecast of ¥20. Our basic premise is that on a WACC of 10. respectively.8B. Our Estimates and Outlook for 2012 We are maintaining our F'11 revenue forecast of ¥25.6B in net cash and equivalents. User monetization with social applications limited • • Valuation and Rating Analysis Despite the volatility in growth rates at the company. representing Y/Y growth of 24% and 25%. as opposed to a virtual one. Investment Risks We view the risks to our investment thesis as follows: 372 . We Are Maintaining Our Nov. 2011 Price Target of ¥425.1B.4B. The focus on social utility applications being made available on the Mixi platform delivers some potential for user monetization by item sales.7B. representing Y/Y growth of 21% and 30%. but compared to social gaming applications its impact is limited. In F'12 we believe that demand for mobile advertising will benefit from smartphone penetration.000 Mixi is the leading SNS operating with a real user community. opportunities for margin improvement are likely to be limited as the company invests in new service development as well as marketing costs. and the resultant fair value equity is ¥65. as the media itself remains high maintenance and cumbersome for the majority of advertisers.0B and operating profit forecast of ¥5.5% and generating an average annual ¥4.7B and operating profit forecast of ¥4. and Mixi's ability to raise pricing. However. We estimate that top-line growth will remain stable and high as the company improves its media power and makes more inroads into winning new customer accounts. respectively. The company has no direct domestic competitor and is hence strongly positioned as an internet media company with potential for longevity and a loyal user base.6B free cash flow into perpetuity (with a zero terminal growth rate).000 per share. producing a fair value of around ¥425. we believe it faces the following challenges: Mobile advertising demand still hampered by technology • The dominance of mobile advertising revenue (63% of total ad revenue in 1Q F’11) limits short-term growth potential. However. free cash flow conversion is high and hence we have used DCF as our valuation method to derive a fair value for the stock. We believe the site is yet to clearly show its monetization potential.kamide@jpmorgan. greater adoption by major advertisers.Hiroshi Kamide (81-3) 6736 8602 hiroshi. a greater range of advertising products. We then add back ¥12.

Hiroshi Kamide (81-3) 6736 8602 hiroshi. contractor fees 373 . resulting in strong reacceleration of item sales • Major adoption of smartphones.kamide@jpmorgan. e. leading to more mobile advertising clients and greater demand for advertising Downside risk • Ineffective but expensive marketing campaigns that deteriorate margins • Major upfront investment costs for new developments.g.com Global Equity Research 03 January 2011 Upside risk • Major hit services on the Mixi platform.

Morgan estimates.4 15.1 67.0 1.6 -7.1 12.0 -0. provided by third parties Job listings site for IT specialists Includes China star-up operations Source: J.2 6.9 3.8 0.6 24.2 1.1 0.5 21.0 24.0 - % % % % % % % % M % % ¥/user % % 20.0 80.6 6.0 8.7 23.2 10.4 26.0 Q4 E 4.kamide@jpmorgan.2 -0.5 1.4 1. Mixi . hence financing requirements are low.7 21.5 12.0 10.6 29.1 5.1 -0.0 79.7 5.0 6.2 2.1 35.4 5.1 0.5 6.4 0.8 Q3 E 4.9 80.9 5.0 Q3 E 5.0 28.0 23.0 -0.0 17.4 21.2 0.7 75.0 7.1 -0.7 3.6 84.0 F’10E 16.2 -0.5 0.7 10.2 33.5 5.9 4.0 21.5 10.5 9.9 20.8 Q2 3.0 0.0 25.4 26.0 23.5 2.5 31.9 26.8 0.0 -0.7 23.0 Q4 E 5.0 0.0 10. Gree 25%.2 1.6 21.9 1.0 0.0 0.7 0.5 70.0 Q2 E 4.3 0.0 0.0 80.2 0.0 21.6 80.0 F’12E 25.7 22.7 12. although driven by mobile advertising demand increasing with smartphone adoption.1 2.5 13. Mixi has operations in China.4 63.9 0.0 23. listings and search ads on PC and mobile sites Sale of virtual currency to use application services.1 -1.4 31.2 23.4 12.0 5.6 -7.2 73.0 23.0 Q2 E 5.2 0.3 1.6 2.2 0.7 0.5 0.7 30.7 4.3 29.4 21.0 21.0 3.0 23.2 0.3 4.0 19.7 F’11 Q1 E 5.2 31.2 14.6 0.3 10. Business Lines Business segment Internet media Advertising Item sales Recruitment Other Sales split 80% 16% 4% Description Sales of banners. and advertising revenue accounts for 8090% of its earnings.3 6.1 1.2 11.7 0.3 1.0 33.0 1.2 0.7 25.0 -0.3 1.8 23.5 10.6 75. We do not think Mixi is prioritizing M&A strategy.4 10.P.0 1.com Global Equity Research 03 January 2011 Key Assumptions Mixi’s mainstay business is internet media.6 4.4 70.8 80.8 4.0 80.P.0 18.2 1.1 0.4 2.2 0.2 0.6 5.5 10.1 66.6 -0.0 0.6 31.6 -0.8 0.3 68.2 -2.7 0.9 2. Our earnings forecasts are based on the following assumptions: 374 .5 0.6 22. We think that this situation will not change dramatically in the short term.2 -0.0 23.0 80.3 31.1 31. J.6 23.2 10.6 20.2 1.1 0.7 21.2 1.5 21.0 2.7 36.2 0. tie-ups.6 21.6 63. Morgan based on company data.Quarterly Earnings Estimates ¥ billion Sales Internet media Recruitment listings Other Operating profit Internet media Recruitment listings Other Eliminations OPM Internet media Recruitment listings Other Sales growth Y/Y Internet media Recruitment listings Other Sales assumptions Average registered monthly users Q/Q Y/Y Monthly total ARPU per user Q/Q Y/Y F’10 Q1 4.7 6.5 16.0 20.8 16.0 -0.7 18.1 -0.9 0.6 2.1 -3.9 10.4 27.0 F’12 Q1 E 6.2 1. we think Mixi will increase its market share over the medium term.1 10.1 33.1 79.3 13.0 32.2 1. but we believe management is prioritizing organic growth.1 25.5 24.1 27.4 6.1 0.1 24.0 80.0 80.0 Q4 E 6.1 -0.5 58.3 2.0 12.3 5.0 19.1 5.9 5.2 -2.7 11.0 -0.2 27. and Mixi 5%.0 Q3 E 6.0 80.9 2.8 8.4 22.3 30.7 24.8 25.0 21.5 0.1 -0.4 1.0 -8.0 F’11E 20.6 20.9 20.2 21.2 1.7 22.7 2.5 20.9 1.7 31.8 0.7 19.5 30.3 0.0 -0.5 61.2 18.5 8.0 -0.2 1.7 -0.7 26.6 8. We believe current market share in terms of revenues generated by item sales including social gaming and advertising are as follows: DeNA 40%.2 1.7 65.2 30.2 Source: Company data.5 34.3 30.4 23.0 80.3 0.7 5.4 77.8 24.6 26.9 5.1 1.Hiroshi Kamide (81-3) 6736 8602 hiroshi.0 85.0 81.2 1.0 0.8 35.5 19.6 18.1 0.3 0.0 20.2 4.

Hiroshi Kamide (81-3) 6736 8602 hiroshi. However. Hence.8%. Note: Data as March 2010. • Monthly ARPU—We believe monthly ARPU trends will see a slow but steady climb. as it continues to attract users with real identities that want to use it as a communication tool.P. primarily driven by item sales demand. it will remain considerably low compared to social gaming peers. Morgan based on company report. the market Mixi caters to is broader than that of social gaming sites. Corporate History and Basic Information Mixi – Corporate History Year 1997 2004 2006 2007 2009 2010 Summary Commences "Find Job!" job listings site Launches "Mixi" SNS Lists on TSE Mothers Releases the mobile service Launches "Mixi Appli" – the open platform service based on Google’s OpenSocial API standard Membership policy changes from invitation only to an open registration Announce business alliance with China's Renren and Korea's Cyworld SNS sites Facebook offers export tool to Mixi users Source: J.com Global Equity Research 03 January 2011 • Average registered monthly users—We believe a steady increase of 2.kamide@jpmorgan. The free float is estimated to be 14. Morgan based on company report. 375 .5% Q/Q for the medium term is realistic for Mixi. Mixi – Shareholder Structure Others 28% ngi group 1% Trustee Accounts 13% Kenji Kasahara 58% Source: J. with legacy investor ngi group as a minority shareholder with about 1%.P. CEO Kasahara is the largest shareholder.

4 28.8 0.9 24.0 22.1 21.9 4.3 1.1 11.6 0.0 0.2 0.7 3.0 0.3 74.0 0.8 3.8 -2.4 16.0 2.1 0.2 0.7 0.0 2.0 0.0 3.1 12.1 2.8 2.Quarterly Revenues Internet media Recruitment listings Others Operating profit Internet media Recruitment listings Others OPM Internet media Recruitment listings Others Revenue growth Y/Y Internet media Recruitment listings Others 4Q F'09A 3.741 85.1 79.9 3.2 0.6 7.2 1.1 2.2 0.7 0.com Global Equity Research 03 January 2011 Financial Statement – Mixi (2121) ¥ billion Income Statement Annual Revenues Internet media Recruitment listings Others Operating profit Internet media Recruitment listings Others Non operating income Non operating expense Recurring profit Extraordinary income Extraordinary expense Pre-tax profit Tax charge Minority interests Net profit EPS BPS DPS Payout ratio <Y/Y growth> Sales Operating profit Recurring profit Net profit <Margins> GPM OPM RPM Effective tax rate <Valuations> P/E P/B Dividend yield EV/EBITDA EV/EBIT EV/Sales <Profitability> ROCE ROE ROA % % % 31.0 -0.1 Source: Company data.5 17.0 21.4 -48.0 0.2 11.0 37.1 0.2 F’09A 15.1 0.5 23.4 0.0 3.0 2.7 30.4 1.3 1.0 0.2 30.2 71.861 121.2 0.1 5.3 52.1 1.0 20.4 0.3 93.0 0.2 0.6 84.0 1.6 24.2 1.7 0.9 27.7 5.6 0.8 24.0 14.8 0.5 0.457 20.0 0.7 25.8 2.4 26.8 19.3 0.0 2.6 3.8 20.0 28.4 -46.5 40.3 31.5 7.2 0.0 0.4 19.2 14.0 0.3 0.6 4.9 F’11E 20.1 12.8 0.kamide@jpmorgan.4 5.9 0.5 32.0 21.2 1.0 20.0 -29.7 2.2 0.2 -0.0 26.0 3.0 -0.0 2.0 2.2 -0.6 23.0 -2.8 0.9 0.2 2.2 16.2 0.143 93.5 4.4 -33.3 14.0 0.2 18.6 80.4 0.8 3.0 19.0 14.8 -0.3 23.0 0.318 141.0 1.2 11.3 25.5 31.1 81.4 5.0 0.0 -0.8 0.0 0.8 0.2 0. Stock price as of Dec.4 2.7 0.9 0.0 4.4 3.0 -2.2 0.6 3.2 % % % % % % % % % % % % % % % % x x % x x x Balance Sheet and Cash Flow <Balance sheet> Current assets Cash and cash equivalents Accounts receivable Other current assets Tangible fixed assets Intangible fixed assets Investments and other assets Total assets Current liabilities Long term liabilities Total liabilities Shareholders' equity Minority interest Total net assets Total liabilities and net assets <Cash Flow> Cash flow from operating activities Cash flow from investing activities Cash flow from financial activities Effect of exchange rate change on cash/cash equivalents Gross change in cash/cash equivalents Cash and cash equivalents at the beginning of the year Effect of change in consolidated companies Cash and cash equivalents at FY end Free cash flow Free cash flow conversion Free cash flow yield % % F’08A 13.1 17.0 0.6 75.1 23.1 35.2 1.0 4.8 -1.2 -46.1 -46.1 15.0 0.0 1.0 16.8 4.7 20.0 0.6 -2.P.4 4.6 F’08A 12.7 F’09A F’10E F’11E F’12E Segment Statement .2 4.0 7.2 2.0 0.0 85.0 13.2 16.5 12.1 0.0 0. 2010.9 0.6 21.0 0. Note: Fiscal year ends March.2 0.9 9.4 19.2 34.7 10.1 15.0 0.1 0.7 9.0 21.0 15.0 0.4 11.8 3.8 6.4 0.2 3.4 13.0 17.2 0.6 0.6 0.0 21.0 13.1 -0.9 3.0 19.4 1.6 0.7 0.1 23.7 4.3 30.8 0.3 -1.7 -0.5 0.4 0.0 16.7 0.2 21. earning results and J.7 29.3 1.9 0.8 -27.5 0.9 3.8 0.2 19.3 1.1 0.0 0.0 4Q F'10E 4.0 2.8 23.1 4.0 5.6 16.2 0.0 3.3 30.0 0.6 4.0 18.8 6.0 17.8 0.0 0.8 0. 29.8 40.0 0.0 0.8 F’10E 17.8 35.0 2Q F’10A 3.0 11.2 0.7 15.2 1.5 34.5 21.0 6.8 0.Hiroshi Kamide (81-3) 6736 8602 hiroshi.3 11.8 -0.0 0.1 0.6 0.0 0.4 0.0 21.8 3.0 ¥ ¥ ¥ 13.1 8.7 2.6 10.0 0.0 12.1 -0.1 0.0 3.1 4.4 29.7 20.0 0.4 2.6 -0.5 20.7 1.4 3.6 1.2 0.6 0.0 74.0 10.0 1Q F’10A 4.6 74.7 0.6 15.8 74.476 11.1 0.9 19.2 8.0 9.7 -49.0 3.4 1.5 23.0 25.3 0.8 0.0 2.0 0.9 70.2 4.4 21.2 31.0 31.8 -1.5 0.0 2.1 0.8 4.2 0.9 1. Morgan estimates.2 0.9 4.6 0.6 24.0 1.911 15.9 14.9 10.2 14.5 -0.0 5.0 0. 376 .0 0.0 0.5 3.9 27.6 0.871 105.4 77.0 3.0 0.4 4.0 3Q F’10E 4.0 13.9 31.0 3.8 3.6 29.9 0.5 30.9 0.0 2.2 1.0 13.5 21.2 0.0 11.0 9.6 9.461 F’09A F’10E F’11E F’12E 12.0 F’12E 23.2 9.4 0.626 F’08A 19.4 5.7 0.

and we estimate that generating material earnings here will take time due to strong local competition.5 54.P.000 55. Whilst these are positive traits.8 11. and ad-hoc business diversification.1 69. The consensus view is that this is a positive development. 29. a drop in growth in online consumer activity.6x.5 15.1 10.512.7 12.1 41.1mn ¥74.com in China commenced in October 2010. upside risks to our price target include positive news flow regarding speedy and solid execution of overseas expansion. Rakuten’s business model is idiosyncratic.9 79.1 76.000 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 4755.6 36. The joint venture with Baidu.01 ¥100 0.200 908. and J.300–56.7 3.2 2.1% 16.4 3. Consolidating its operations after the consumer finance ‘crash’ of F’07.9 13.160. We are maintaining our ¥63.4 46.8 19.7 3. However.000 price target to November 2011. Ltd.0 4.4 P/B (x) 6.7 Y/Y (%) 20.0 11.9 60. we believe the business is not economy-sensitive enough to benefit from an economic upturn. we believe they are well-acknowledged themes and in themselves provide little catalyst for the shares. 4755 JQ Price: ¥68. and we think overseas expansion plans for eCommerce operations are unlikely to yield material results in the medium term. We take a more balanced view.3 9.2 NP (¥B) -55.x.8 21.6 62. with business activities ranging from eCommerce to financial services.9 385. We view the business as a stable domestic eCommerce growth story but believe this has already been priced in. Although online shopping is defensive in a downturn.7 EV/EBITDA (x) 16. We believe the company’s growth prospects are acknowledged and unlikely to yield major positive surprises.kamide@jpmorgan. We believe the shares are fairly valued on a F’11 P/E of 21.4 402.8 14. Its core activities remain online shopping and travel. EPS (¥) -4.3 11.9 4.8 RP (¥B) 44.. Consolidated Y/E Dec 2008 2009 2010E 2011E 2012E Sales (¥B) 249.200 Price Target: ¥63.4 4.000 Y 65.8 3.4 16.0 Y/Y (%) -32.1 P/E (x) 16. We believe the shares are fairly valued.com JPMorgan Securities Japan Co.8 Y/Y (%) 16. Morgan estimates.1 Neutral 4755. Downside risks include higher operating costs due to overseas expansion. earnings results. The domestic eCommerce market remains firm and is expected to maintain a steady yet unspectacular medium-term growth profile.5 OP (¥B) 47.0 11.9 298.OS. Morgan estimates . as we estimate that overseas operations made up around 2-3% of 3Q F’10 total sales.4bn 13.2 Source: Company data.000 Internet Hiroshi Kamide AC (81-3) 6736 8602 hiroshi.  We maintain our Neutral rating.7 24.  Valuation and risks.8 71. 2010 ¥ 893.9 13.3 2. Rakuten has recently begun to expand into niche eCommerce operations overseas via M&A and partnerships.Global Equity Research 03 January 2011 Rakuten (4755) Steady Domestic Prospects We are maintaining our Neutral rating on Rakuten.  Overseas expansion: Managing expectations.  Dominant market position in a growth market: Well-known themes.2 56.5 10.3 345.752.6 19.092.OS share price (Y TOPIX (rebased) Company Data Price Price date Market capitalization Shares outstanding 52-week range TOPIX Dividend (F’10E) Dividend yield (F’10E) RoE (FY’10E) ¥68.maeda@jpmorgan. highlighting the progress required to meaningfully impact earnings.0 53.203.P.9 Y/Y (%) 23. An upturn in activity at the financial operations (brokerage and credit) would also boost earnings visibility. J.2% Source: Bloomberg.7 14. Price Performance 75. having major domestic market shares with strong track records.com Yusuke Maeda (81-3) 6736-8654 yusuke.200 Dec.

with revenue of ¥385.9B.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 We are maintaining our F’11 estimates for Rakuten. We rate the shares Neutral for the following reasons: Rakuten’s market dominance and growth prospects priced in • Rakuten’s dominant domestic market position in eCommerce and its growth prospects are understood. The travel business should see stable growth Y/Y as leisure travel demand increases on the site. We Are Maintaining Our Nov.8B and operating profit of ¥79. Overseas expansion unlikely to be material in the medium term Valuation and Rating Analysis Historically Rakuten has had an inconsistent record of generating free cash flow. • As things currently stand. The credit card operation should have grown significantly over the period. However. These core businesses have been the central hub around which the company has diversified its activities into financial services. as overseas operations are likely to remain dilutive to the sales mix.Hiroshi Kamide (81-3) 6736 8602 hiroshi. We estimate the financial operations will remain stable yet generate little in terms of earnings for the group. We estimate that the eCommerce operation will see a marked slowdown in growth (up 7% Y/Y) as hurdles become higher and domestic operations begin to experience growth limitations. which we believe is symptomatic of the company’s firm but unspectacular long-term domestic growth prospects. 378 . We estimate the financial operations will remain stable but continue to generate little in terms of earnings for the group.000 Rakuten is a major online shopping mall operator and travel service in Japan. and it is sensitive to an economic upturn. which are unlikely to decline significantly over time. Recent plans for overseas expansion of its eCommerce operations have been met with a relatively muted response by the market. we estimate it will contribute only 16% of total F'11 operating profit.kamide@jpmorgan. telecommunications and other net media. Using DCF may not be best suited to ascertaining fair value for the company.com in China will be a lengthy process before material earnings are generated.4B and operating profit of ¥71. 2011 Price Target of ¥63.7B. Rakuten is targeting small niche markets in Asia. we do not believe that plans for overseas expansion will yield material results in the medium term. but with a stabilized financial operation we believe there are sufficient grounds to estimate that free cash flow will be a more regular occurrence going forward. Our Estimates and Outlook for 2012 We are maintaining our F’12 estimates for Rakuten. with revenue of ¥402. and we believe the joint venture with Baidu. We believe that the core eCommerce operation will see a decline in growth Y/Y post acquisitions (up 20% Y/Y versus 25% Y/Y in F’10) and experience margin dilution as a result. but earnings are highly dependent on marketing costs. Margins are unlikely to improve significantly. This well-known theme provides little upside risk for the shares.

3% and generating an average around ¥60. terminal growth rate 0.0B annual free cash flow into perpetuity (with 0.5% terminal growth). WACC 7. such as further indebtedness or margin dilution 379 . Investment Risks We view the risks to our investment thesis as follows: Upside risk • Positive news flow regarding speedy and solid execution of overseas expansion • Improving market conditions for financial services. chiefly increased activity in the online brokerage and a rising loan book at consumer credit services Downside risk • Bigger-than-anticipated increase in operating costs as a result of overseas expansion • An unexpected slowdown in online user activity • Ad-hoc business diversification that might impair fundamentals.3B in investments. and add ¥59.1B.com Global Equity Research 03 January 2011 We use a synthetic free cash flow.3%.5% Our basic premise is that on a WACC of 7.000 per share. We then subtract net debt of ¥141. bank and brokerage assets and liabilities distort what we deem to be a more useful picture of Rakuten’s free cash flow. net capex and working capital adjustments.3B. we derive an enterprise value of ¥908.Hiroshi Kamide (81-3) 6736 8602 hiroshi.5B. We omit changes in financial-related working capital. The resultant market value of equity is ¥826. Changes in credit. as we believe Rakuten’s core activity remains eCommerce. as the normal cash flow statement does not give us a relevant figure to work with—EBITDA less adjusted taxes. being the indebtedness of the Rakuten parent company and ignoring financial services liabilities. and this produces a fair value of ¥63.kamide@jpmorgan.

0% 4.4% 28.5% 10. but no major growth factors are expected.5% 16.0% 43.0% 20.6B.0% -10.0% 2.0% 7.9% - Key assumptions for our earnings forecasts are as follows: Sales growth • Shopping – After high Y/Y growth in F’10 partly fueled by acquisitions. Morgan estimates F'10E 25.9% 3.0% 5. We estimate high single-digit growth in F'12.0% 15. • Bank and eMoney – A gradual profile.0% -15.0% 43. • Credit – No major changes in annual OPM. We have flat growth forecasts.0% -9.0% 15. • Portal/media – Scale of operations remain small.8% CAGR F'10E-12E 13.0% 10.0% 4. when sales should reach ¥184.5% 29. although quaterly fluctuations are expected given securitization revenues.0% -9. • Credit – We expect little change in sales volume.0% 10.0% 20.0% 7.0% 3.5% 3.0% -10.5% 45. • Broker – No major changes expected.7% F'12E 7.0% 5.1% F'11E 20.0% -10. • Broker – Dependent on market conditions and consequent trading volume.0% 27.0% 2. enabling CAGR F’10E-12E of 10%Y/Y.0% 3.0% 28.3% 2.0% 11.0% 10.5% 5. • Portal/media – No major changes expected.2% 18.0% 9.0% 3.0% 19.0% 10.com Global Equity Research 03 January 2011 Key Assumptions Earnings Forecasts by Business Segment Sales growth Y/Y eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Total sales growth OPM estimates eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Total OPM Source: J.Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.5% 10.5% 9. • Sports and Telco – We see no major growth prospects. we estimate the pace of growth will slow as hurdles become higher Y/Y.0% 18. as the growth in credit card receivables is offset by the continued decline in the ‘grey zone’ loan book.0% 19.0% 5.0% 5. 380 .0% 20.0% 10.P.0% 10.5% -12.0% 5. OPM estimates • Shopping – Acquisitions and the Chinese joint venture operating at a loss should mean that opportunities for operational leverage will be limited going forward.

relying on a B2B2C business model – connecting 'brick and mortar' retailers to consumers online. Morgan based on company data.Hiroshi Kamide (81-3) 6736 8602 hiroshi. International shipping has been available to overseas customers since 2008. and we estimate they contributed less than 1% of gross merchandising volume in 2Q F’10. Since the beginning of 2010 with the agreement with Baidu. These points can be converted to other point programs. We assess these opportunities in turn. Although the business priority remains in domestic operations.com and Europe with PriceMinister. albeit a limited service. CEO Hiroshi Mikitani has made it plain that overseas expansion is required in order to generate growth. Rakuten has a dominant position as an online shopping mall without a major warehousing function.com to jointly operate online shopping mall in China (Rakuten stake 51%) Signs joint venture agreement with PT Global Mediacom in Indonesia. The attractions of Rakuten's model to potential tenants of virtual shop fronts are:  Access to an active user base of 41. including his stated goal of doing business in 27 countries. To date overseas shopping sales less than 1% of total group sales Initial forays overseas appeared focused on niche geographies such as Taiwan and Thailand.price euro 180M 41M active users 65M items listed for sale Reward points scheme in place Source: J. The immediate impact on gross merchandising volume will be around ¥2. such as ANA mileage and T-Points program from CCC.price $256M Acquires 100% PriceMinister . Company Overview Dominant B2B2C domestic business Assessing overseas growth potential A household name in Japan. making up around 1% of the total. Rakuten has made tentative moves into the US with Buy.com Global Equity Research 03 January 2011  Sports and Telco – We see no major growth prospects. which can be effective in encouraging user loyalty and activity (although pricing remains the biggest draw for online consumerism). Progress to date has been relatively slow compared to US counterparts but has recently speeded up: Overseas Expansion Milestones to Date Date Sep-05 Feb-08 Sep-09 Jan-10 May-10 Jul-10 Event Acquires 100% LinkShare US.38M members within the Rakuten group.com.  Access to Rakuten’s reward points scheme.com in China. to set up Rakuten Ichiba Taiwan Acquires 67% stake in TARAD Dot Com in Thailand Reaches agreement to set up joint venture with Baidu. For group sales we estimate overseas operations will make up 2% to 3% of total sales in 3Q F’10. There are currently 65M items listed for sale on the site (although this includes same items from multiple shops).kamide@jpmorgan. to set up Rakuten Ichiba Indonesia (Rakuten stake 51%) Acquires 100% Buy. an affiliate marketing company Signs joint venture agreement with President Store Chain in Taiwan.5B during 3Q F’10 from overseas markets. overseas sales grow to 2% to 3% of total group sales 381 .com Inc .  Bank and eMoney – We estimate better cost control should lead to gradual improvements in profitability.  A business that caters to ‘long tail’ demand – the site is aimed at selling any conceivable item. On consolidation of PriceMinister and Buy.P.

com Baidu.P.com is the premier search engine in China and therefore a formidable local partner to operate online shopping.com factsheet Established Location Prior contact with Japan IPO Sales in F’09 Geographic reach Business model Number of members Number of products for sale Holding in joint venture 2000 Beijing HQ.P. Morgan based on company data Market Share of C2C Market (CY’08) in China (by Transaction Volume) Tencent Paipai 7% eBay 7% Others (including Baidu) 0% Taobao 86% Source: J. individually it has had little success in online shopping with its 'Youa' site. Morgan based on Analysys International Pros and Cons of JV with Baidu.3B ($50M) in capital in the first three years. Despite Baidu.com have announced plans to invest ¥4. Morgan assumptions. Baidu.Hiroshi Kamide (81-3) 6736 8602 hiroshi.com Global Equity Research 03 January 2011 Baidu. If we assume Rakuten were aiming to take away 25% of this user base: 382 .P.com Positives Footprint in a major growth market Partnering with a local player Access to major online traffic Source: J.com Baidu. China Commenced online search service in 2008 2005 N/A Shopping in China Commenced online shopping site 'Youa' in 2008 N/A N/A 51% Source: J.com’s success in its core field of search and pay for placement advertising. We compare this amount to efforts made by eBay and its Chinese acquisition EachNet to develop its business in 2002-2003: • Acquisition costs totaling $180M for 100% stake • An additional $100M budget We assume that there are 120M users on competitor TaoBao's site.kamide@jpmorgan. Negatives Dominant local competition in place Partner's track record patchy User traffic not all with shopping intent Rakuten and Baidu.

The next two years are likely to see major market growth especially in B2C sites (as opposed to auctions or B2B) and will also be a crucial period that decides which companies succeed and which do not.P.com operates a mall-type operation similar to Rakuten. However. eBay) Patchy track record Business model is marketplace – similar to Rakuten Buy. Morgan based on company data.com Global Equity Research 03 January 2011 $50M capital commitment is on the low side Great opportunity in China. We therefore believe medium-term prospects for this joint venture have potential.5M (March 2010) $256M (¥20. connecting shoppers with distributors and retailers. Total goodwill arising is J. Head of Internet and Media for Asia Research.com Buy.4M (¥0. 25.OPM 7. where users are looking for a greater sense of security about purchasing online.com factsheet Established Location Prior contact with Japan IPO Sales in F’98 Sales in F’09 OP in F’09 Geographic reach Business model Number of members Number of products for sale Deal value Book value Total goodwill arising estimate 1997 California. next two years the crucial period • Aim to gain 30M users over three years • This would equate to user acquisition costs of $0.Hiroshi Kamide (81-3) 6736 8602 hiroshi. but meaningful earnings remain difficult to ascertain. we feel that the swift execution of this project is promising for the future. “We don't expect this venture to have much impact on Baidu. Note: Forex rate: $1 = ¥92. It is similar to Rakuten's business model as it holds no inventory. Italy. taken private November 2001 $125M $62M (¥5. 383 . According to J.P.55 per user over the period. Germany.P. Pros and Cons of Buy. logistics and customer services—areas where it has expertise in Japan. Morgan assumptions.com is a survivor of the dotcom era. 2010] Buy. having listed in 1999 and being taken private in 2001. which does not strike us as being very high We believe there is an opportunity in the China eCommerce market.kamide@jpmorgan. major seller on eBay 14M 11. France. Spain Marketplace.com’s earnings in the near future.7B) $4.com in the near future Source: J.com do not seem very large when considering the challenges being faced. Rakuten has a chance of performing if executing well on its services regarding settlements.8B ¥17.7B) ¥2.” [Regional Internet Newsflow: Oct.0% Canada. Morgan estimate.P. Morgan analyst Dick Wei.com Buy. USA Softbank invested in 1998 and 1999 pre-IPO October 1999 on NASDAQ. With such a strong market tailwind. Negatives Crowded market with two dominant players (Amazon. Buy. and outsources distribution and fulfillment.4B) .com Acquisition Positives Footprint in the developed US eCommerce market Learn new online shopping model Source: J. The costs budgeted by Rakuten and Baidu.9B Joint venture not expected to make a major impact at Baidu.

Morgan estimate. This implies that late movers such as Rakuten have an opportunity to catch up with established global peers such as Amazon and eBay.P.9B Source: J.6B) Euro 6. France N/A N/A Euro 40.P. Negatives Small niche player A small footprint in Europe is unlikely to materially affect Rakuten's earnings visibility in our view.5B) ¥3. However. most auction and shopping sites operate with payment on delivery and have reimbursement policies. The challenge for Rakuten will be to operate a profitable business whilst aiming for market share gains in a very competitive market. Rakuten guarantees reimbursement for undelivered goods up to ¥500. and to take on strong local players in China such as the Alibaba group’s Taobao. Spain C2C. although historically its strength has been in sales of technology and consumer electronics—very unlike sales at Rakuten where sales rankings are dominated by cosmetics and toiletries. as switching costs for online consumers as well as barriers to entry for new entrants are both low.com's operations in the past have focused on cost leadership and undercutting competitors to win business—this has not been Rakuten’s focus to date.P. 384 .4% France. Key selling point is security – but this is an industry norm • There is emphasis on security.6B ¥16.0M (¥3. PriceMinister PriceMinister factsheet Established Location Prior contact with Japan IPO Sales in F’09 OP in F’09 Geographic reach Business model Number of members Number of products for sale Deal value Book value Total goodwill arising estimate 2000 Paris. PriceMinister The key selling points of PriceMinister’s online shopping model are: • Empowering the individual—the site is designed for individual sellers and buyers. online real estate 11M 150M Euro 180M (¥20. Note: Forex rate: Euro1 = ¥112. Buy. Late movers can make an impact in eCommerce… Conclusion We believe first-mover advantage in the internet economy is exaggerated.6M (¥0.7B) – OPM 19. foodstuffs and fashion items. Total goodwill arising is J. Pros and Cons of PriceMinister Acquisition Positives Footprint in Europe Source: J.com Global Equity Research 03 January 2011 Business strategy has centered on cost leadership The company has a loyal following. at a fixed price/slight negotiation but not auction-based. online travel. Morgan assumptions. Morgan based on company data.000. UK.kamide@jpmorgan.Hiroshi Kamide (81-3) 6736 8602 hiroshi.

Rakuten will have to be aggressive and persevering in order to make its mark overseas. and the number of products offered.Hiroshi Kamide (81-3) 6736 8602 hiroshi.com Global Equity Research 03 January 2011 …but dominant players have consolidated their market position On the other hand. We believe this is due to wellexecuted online businesses being able to scale at a rapid pace. In online shopping and auction. enabling them to cement their market position. Key competitive strength is size and scale of service on offer 385 . instances whereby new entrants have cracked markets with established dominant players in place have been rare. As market leaders consolidate their market position. the key competitive strength is the size of the network of buyers and sellers.kamide@jpmorgan. Instances whereby latecomers beat established competition—for example Taobao besting eBay in China on transaction volume— involved competition over pricing and as well as the ability to deliver well designed localized services.

3 2.3 3.2 0.0% 8.1 -0.5% -21.2% 0.0% 5.5 8.9 22.5 8.2 0.4 172.3 -0.9 6.4% 8.7% 29.0 0.3% 25.7% -10.9% -13.7% -12.4 1.0 6.1% 0.3% 24.1 39.0% 29.4 22.6 14.3 0.2 0.0 21.2% -14.0% 27.0% -10.3 6.5% 9.3 41.0% 10.8% 23.6 23.0% 7.0% 27.4% 19.5 1.4 0.3 0.5% 10.5 2.5% 20.1 5.0 18.3% -7.1 0.2% 1.7 -0.6 6.0% 4.0 11.2 2.7 8.0% 110.2 4.0% 10.3% F’10 E 345.3 4.5 1.4 23.1% -21.0 0.0% 10.0 2.2 0.2 8.3% 27.1% 6.4 0.4% 21.Hiroshi Kamide (81-3) 6736 8602 hiroshi.2 5.3 2.9 6.9 0.9% 41.0 19.6% -8.4% 8.1 0.0% 3.4 23.0% -9.2 0.8 3.2 -1.7% 60.0% 13.5% 1.0% -10.0% 1.0% 9.0 16.3 4.6 3.0 27.6 0.4 15.2% 6.2 0.1% 26.0 0.3% 55.4% 19. J.5% 15.4% 20.7% 24.3 28.0% 19.8 15.2 33.6 8.4 4.4% 7.0 8.2 5.7% Q4 81.2 0.4 7.4 1.0% 2.6 0.5 1.0% -35.2 -0.9% 48.5% 31.7% 8.3 0.2 14.9% 31.5% 19.0% 10.2 6.3 16.3 0.1% 18.2 35.2 -0.5% 1.3 9.6 5.0% 2.0% 11.5 1.1% 0.0 1.1 -0.4 0.4 25.4% 5.7 5.2% 16.0% 2.1% -15.4 0.4 23.0 5.8% 29.6% 22.1 15.2% 18.6 5.0% 2.0% 20.7 0.0% 43.7 6.5 5.6 8.5 0.kamide@jpmorgan.0 2.3 14.0% 5.3% -25.5 3.9 6.8 0.9% -23.9% 43.7 0.0% 2.8% 6.6% 43.8% 6.3% 31.6% 16.3 15.7% 1.3 2.3 -0.0% 15.6% 49.9% 25.2 0.2 7.5% F’10 Q1 79.2% -27.8 2.8 6.7 -0.2 62.0 9.9 0.8 0.5 6.1 11.0% 27.0 -0.2% 47.8 1.7 53.1 5.5 18.0% 10.7 5.9% 10.1 0.7% -2.0% 10.4% Q3 77.0% 27.3 2.4% 10.8% -35.5% Q4 E 93.9 6.1% 28.2 31.9% 3.P.7% -12.0% Q4 E 106.4 71.5 5.5% 10.3 1.4% 10.0% 43.1 1.7% 27.8 15.0 5.0 24.5% 26.4 26.7 6.7% 28.4% 39.1% 24.1 0.5 0.1% 31.0% 10.0% -10.1 23.0% 25.8 -0.5% 25.5% -18.7% 7.5% 4.9 8.1% -0.5% -16.0% 10.3 0.0% -15.0% F’12 E 402.8 62.4 1.0% -9.5 -0.7 0.0% 11.4% 1.2% 8.9 48.1 28.4 15.0% -10.4 43.8 41.1 1.7% 6.2% -1.0 5.8 -0.0 1.6% 13.9% 13.8 0.9 5.3 2.8 0.5% 5.9 0.5% 5.8 0.0 18.5 3.1 1.1 0.2% 15.7 9.0% Q3 E 96.6 0.8% 6.3 4.2 0.3 0.9% -135.7% 4.0% 40.4% -8.0% 10.5 35.0% -10.2 13.9 5.7 1.5 0.6 0.4 1.2% 26.0 3.4 1.2% 46.1% 17.5 0.7% 12.5 -0.5% 5.0% 2.2 -0.0% 5.0% Q2 E 94.2 0.3 16.7 -0.9% 24.5 5.3 1.7 5.8 7.3 0.0 0.2 14.8 5.5 5.5 0.9 5.0% 10.9 14.6 66.0 -0.0 18.4 4.5 7.5% -16.2 3.4 0.6% -12.4 19.2 35.1 5.1 1.2% 1.com Global Equity Research 03 January 2011 Quarterly Earnings Forecast F’09 Q1 Sales (¥B) eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Operating profit (¥B) eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Intercompany OPM (%) eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Sales growth Y/Y (%) eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money 66.2% 17.2 0.5% 21.5 2.0 16.5 66.5% 21.4 -0.8 7.6% 20.9 43.0% 15.5 18.5 5.0% 4.6 0.5% Q2 73.6 6.7 8.5 11.8 -0.5 5.0% 10.6% 9.1 14.6 3.4% 28.8 18.1 0.0 2.0% 25.1 5.2 34.7 6.5 8.7% 26.4% -135.9 6.5% F’11 E 385.5% 11.4% -12.0 1.5% -0.0 13.0% 9.0 0.4% 18.6% 12.2% 6.6 13.5 0.6% 24.5% 9.9 5.2 6.0% -10.9 2.0 0.7 0.0 0.6% 23.8% 24.5 0.0% 10.0% 10.8 0.0 1.2% -19.0% -9.5% 9.0% 43.2 1.1 1.3 1.6 -1.1 19.0% 5.0% 10.2 1.5 5.0% 29.1 18. Morgan estimates 386 .0% 5.4% 20.0% 43.6% 8.4 4.5 18.7 1.1% 18.9 143.5% 17.5% Q2 84.1 0.7 -0.0% -12.0% -5.8 22.2 17.5% -12.9 5.0 5.9 10.9% 15.9 6.5 7.1 0.6 26.1% Q3 88.1% 25.2 11.0% 15.8 0.0 0.6% 18.0% 15.0% Source: Company data.7 -0.7 12.0% 5.1% 9.0 8.9 1.7% 8.3% -3.4% 139.2 18.8 184.0% 25.2% 5.6 0.3 1.9 33.0% -10.0 0.2 0.4 -1.5% -166.9% 16.3% 20.9 0.0% 3.6% 8.6% 31.5 8.8% 30.3 2.0% 20.0 0.2% 9.7 79.0% 11.3 10.1% 5.1 10.6% 47.5% 3.5% 45.0% 14.3 18.0% 10.9 2.6% 6.9 15.1 0.9% 2.4 23.5 14.4 23.2 15.3 19.7 1.8 1.0% 43.0% 20.0 8.5 2.2% 34.5% 1.4% -10.0% 10.1 48.3% 26.6 8.1% 6.3 1.8% F’11 Q1 E 88.0% 3.5% 7.

com Global Equity Research 03 January 2011 Business Segment Outline (as of 3Q F’10) Main services 1.com.goods 9. Telecommunication Business Provide IP telephony service.kamide@jpmorgan. PriceMinister. Banking Business Internet banking services 5. Travel Business Booking rooms through internet. Group company Rakuten Rakuten Auction Rakuten Rakuten Rakuten Rakuten Rakuten LinkShare Corporation Rakuten Rakuten Rakuten KC BitWallet eBANK Rakuten Rakuten Rakuten Research O-net Showtime Rakuten Travel Rakuten Securities Rakuten Baseball Club Fusion Communications 387 .) Rakuten GORA (golf course reservation through internet) Online DVE / CD rentals Performance marketing Logistics service Rakuten business (business services) 2. E-Money Business Planning and operating pre-paid money (Edy) 4.P. telephone exchanging services Source: J. Morgan based on annual financial report.Hiroshi Kamide (81-3) 6736 8602 hiroshi. Credit Card Business Issues and services on credit cards (Rakuten Card) 3. total traveling web-site (Rakuten Travel) 7. Portal Media Business Portal sites (Infoseek) Internet advertising internet marketing Marriage consultancy (O-net) Delivering movie contents 6. Securities Business Provide services for online securities dealing 8. eCommerce Business Rakuten Ichiba (internet shopping mall) Auction Consulting for eCommerce Rakuten Books (book selling) Foreign eCommerce site (Buy. Professional Sports Business Operating Tohoku Rakuten Golden Eagles and planning/merchandising of related. etc.

8 58.1 2.3 298.P.9 76.1 23.1 65.5 12.3 35.5 174.6 4.5 5.2 4.1 10.2 -99.2 36.6 0.5 10.7 296.0 54.1 10.8 4.4 47. earnings results and J.4 23.4 -80.9 -55.4 20.5 0.0 2.9 44.5 11.4 4.0 -4.8 62.0 228.4 23.1 16.8 0.2 7.0 57.1 23.4 3.6 0.5 1.5 -0.6 16.0 2.8 9.8 11.P.7 77.2 77.7 -0.2 24.4 26.8 8.1 0.2 33.0 10.2 3.2 35.5 2.3 194.4 56.0 5.0 0.7 16.5 Actual F’08 91.1 81.4 36.7 -0.8 0.5 26.4 53.9 -40.5 8.7 12.4 4.6 9.9 30.7 172.4 -40.8 -0.2 36.1 50.1 -29.753 100 3.8 19.0 14.0 69.5 15.8 48.7 <Sales> eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Total sales COGS Gross profit <Operating profit> eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Total operating profit Dividend income Net interest income Gains on securities Other gains Other losses Recurring profit Extraordinary gains Extraordinary losses Pre-tax profit Tax Minorities Net profit Per share EPS (¥) DPS (¥) Effective payout ratio (%) Y/Y % Sales (%) Operating profit (%) Recurring profit (%) Net profit (%) NAV (%) Operating performance GPM (%) OPM (%) RPM (%) Effective tax rate (%) Source: Company data.4 -88.1 -1.5 3.0 1.1 -1.2 7.0 18.5 8.6 79.4 23.9 -2.5 -0.1 -1.5 70.0 -20.6 -55.1 69.4 30.5 8.5 19.9 5.9 17.4 0.7 17.2 35.9 -79.9 18.6 23.4 23.5 -32.6 266.1 0.0 27.5 -25.6 -1.0 18.2 -2.4 0.8 -22.2 8.6 0.4 6.8 62.4 41.Hiroshi Kamide (81-3) 6736 8602 hiroshi.9 -35.1 0.1 -28.2 345.2 -0.7 -0.6 0.2 11.5 5.4 385.7 0.2 -2.3 0.8 0.5 0.2 -2.2 249.4 16.2 11.7 17.1 -40.6 -92.4 -9.9 -0.4 14.9 22.0 76.4 2.6 -1.0 24.4 -7.com Global Equity Research 03 January 2011 Consolidated Profit and Loss Statement ¥ billion F’07 75.4 23.092 100 2.0 34.5 0.9 2.3 0.1 28.2 -70.1 -24.3 2.6 19.512 100 2.7 F’12E 184.7 77.7 -0.0 2.1 1.8 17.1 0.9 F’09 115.161 100 3.6 7.0 3.4 46.3 -0.3 77.3 1.2 J.4 0.6 26.7 213.9 -1.6 310.5 66.0 60.2 -5.6 66.0 18.5 19.3 23.7 402.8 52.9 5.0 19.9 9.4 1.2 1.9 76. Morgan estimates.2 53.2 2.3 2.8 4.8 3.204 100 -2.2 5.4 -0.5 71.4 57.8 0.kamide@jpmorgan.4 19.4 41.826 100 3.5 8.8 -92.5 5. 388 .5 1.9 0.7 -15. Morgan Estimates F’10E F’11E 143.7 17.9 -39.8 1.7 -0.1 60.2 -2.2 0.9 -31.1 17.

853.5 19.0 1.1 1.6 142.0 674.7 1.1 142.1 2.9 333.Hiroshi Kamide (81-3) 6736 8602 hiroshi.0 33.7 120.1 1.6 65.389.2 589.8 1.2 150.6 46 143 13.5 88.7 8.0 142.1 2.1 1.0 89.9 138.5 15.1 203.1 1.1 93.8 159.367.6 203.6 342.2 13.9 20.1 89.9 194.1 156.0 193.0 37.6 185.0 288.382.0 F’10E 99. F’07 57.7 741.8 142.7 30.9 26.1 2.2 122.1 19.807.7 235.5 39.086.0 44 138 11.0 14.6 344.8 195.0 18.5 148.3 3.3 1.4 64.1 123.5 164.0 93.9 45 139 12.7 290. Morgan estimates.6 44.5 105.0 33.5 87.4 1.0 282.2 642.158.5 568.4 27.8 38 106 0.7 1.9 4.6 15.0 -5.0 89.2 2.0 726.7 312.1 850.4 712.0 157.1 0.3 661.1 1.4 154.4 16.1 139.3 101.2 15.9 965.759.5 141.6 2.2 28.4 105.0 78.7 1.8 18.4 389 .3 44 122 7.514.4 61.5 120.4 151.7 39.7 2.573.807.667. earnings results and J.5 105.8 698.6 32.7 548.7 1.1 190.4 1.8 45.0 296.6 68.3 65.7 243.6 43 126 9.7 0.6 186.3 207.7 104.3 89.1 263.3 89.0 105.6 1.5 28.9 2.5 170.409.916.4 181.1 15.3 13.2 F’08 88.5 167.6 62.0 -14.P.2 172.7 218.3 428.8 244.9 121.7 1.1 18.3 21.3 1.9 14.6 2.7 50.0 1.5 19.1 3.9 750.7 1.3 183.2 928.556.2 24.8 611.8 2.4 307.8 13.158.kamide@jpmorgan.1 28.6 104.6 1.5 -4.1 28.0 255.1 2.0 13.1 199.7 210.6 3.5 87.com Global Equity Research 03 January 2011 Consolidated Balance Sheet ¥ billion <Assets> Cash and cash equivalents Accounts receivables Marketable securities Inventories Deferred tax Non-bank related assets Securities related assets Bank related assets Other Current assets Tangible fixed assets Intangible fixed assets Goodwill Other Investments and other assets Total assets <Liabilities> Accounts payable Short term debt Cash deposits in escrow Margin trading liabilities Guarantees receivables Credit guarantees (KC) eBank deposits Other Current liabilities Long term debt Other Long term liabilities Reserves under special laws Total liabilities <Net assets> Shareholder's equity Valuation and translation adjustments Minority interest Total net assets Total liabilities and net assets Net debt Capital employed Net debt/equity (%) Debtor days Inventory days Creditor days ROCE (%) ROE (%) ROA (%) Source: Company data.086.0 648.1 35.853.5 114.6 59.2 37.0 14.562.4 18.7 3.1 206.8 31.2 289.0 295.8 387.5 161.4 19.540.7 629.0 1.3 182.8 617.4 903.3 148.759.0 111.1 13.1 13.606.2 1.1 222.4 1.7 82.7 3.2 F’12E 157.552.6 53.5 137.1 F’09 96.3 142.2 2.1 3.7 236.0 14.6 12.2 262.2 215.4 15.9 16.5 15.7 -32.9 702.7 1.9 392.4 52.5 252.1 29.916.7 1.5 18.0 342.5 -9.9 20.8 158.4 174.0 F’11E 118.

6 4.8 60.9 3.1 -24.6 0.0 -1.2 -1.4 -2. 2010 F’08 -35.0 9.3 34.3 50.8 4.P.4 -7.8 38.5 -41.7 50.4 19.5 -60.6 -11.5 55.7 -11.6 103.7 153.8 6.831.3 -2.4 89.5 -0.0 -22.7 -38.0 -82.8 F’09 52.8 -1.1 2.5 -60.9 -11.1 -0.1 -5.8 3.0 3.9 0.729.6 -1.5 62.7 -0.0 0.306.2 3.3 153.3 87.7 -11.1 5.1 -15.0 -2.4 -113.2 -8.0 64. Morgan estimates.3 15.0 -22.9 -21.0 -14.Hiroshi Kamide (81-3) 6736 8602 hiroshi.7 -1.5 14.kamide@jpmorgan.4 7.3 62.4 16.0 -1.1 -114.6 0.2 F’12E 76.0 217.2 43.0 -12.8 103.3 4.1 F’11E 69.3 1.8 107.6 -4.5 -1.1 114.7 F’10E 60.4 -18.659.3 -4.7 -20.7 -22.9 -31.8 -22.5 -14.0 48.4 -0.2 -1.2 -0.9 7. Note: Share price as of December 29.7 -15.4 -174.6 12.8 65.1 15.5 61.3 -2.3 0.2 -163.6 1.0 -2.1 -11.6 0.1 -28.1 73.9 -7.0 57.6 4.2 73.2 -15. net interest and provisioning Cash flow from operating activities Capital expenditure Net sale/purchase of securities Other Cash flow from investing activities Change in debt Dividends paid Net buybacks Equity issued Other Cash flow from financial activities Effect of exchange rate change on cash and cash equivalents Gross change in cash and cash equivalents Cash and cash equivalents at the beginning of the year Effect of Change in Consolidated Companies Cash and cash equivalents at FY end FCF per share (¥) FCF yield (%) FCF conversion (%) Source: Company data.7 -15.9 -3. earnings results and J.8 -31.0 -55.0 -1.8 114.5 -15.7 191.736.3 -2.3 2.8 92.1 10. equity income.com Global Equity Research 03 January 2011 Consolidated Cash Flow Statement ¥ billion F’07 Pre-tax profit Tax paid Depreciation and amortization Changes in working capital Changes in financial working capital Other Revaluation/sale of asset.3 81.2 -12.7 -50.7 91.2 -0.4 -13.3 -1.0 -2.3 81.4 -18.4 390 .7 -118.

J.3 6.2 1.3 Y/Y (%) 9.6 143.8 10. such as social gaming and eCommerce partnerships with leading players.com Yusuke Maeda (81-3) 6736-8654 yusuke.000 26.8 9.9 328.T share price (Y TOPIX (rebased) Company Data Price Price date Market capitalization Shares outstanding 52-week range TOPIX Dividend (F’10E) Dividend yield (F’10E) RoE (FY’10E) ¥31. Ltd.0 Y/Y (%) 19. Risks to our price target include a slower-than-anticipated recovery in ad demand and a potentially disruptive cutover to Google’s search engine in January 2011.9 18.950 Price Target: ¥35.5 9.000 Internet Hiroshi Kamide AC (81-3) 6736 8602 hiroshi.3 3.8 157.7 185. with a price target of ¥35.4 157. 29. 2010 ¥ 1. The shares are trading at 18.6 8.7 OP (¥B) 134.9 110.7 1.230 908.8 185.5 Y/Y (%) 1. We believe the company is geared for a recovery in online advertising.4 171.maeda@jpmorgan. as high cash generation is put to good use. 4689 JT Price: ¥31.0 307.9 6.8 11.P. we believe this is a key swing factor regarding the company's prospects going forward.0mn ¥38.9 9.01 ¥322 1. with display ad sales showing Y/Y growth since 4Q F’09 and listings showing reaccelerating growth from 2Q F’09.x.P. EPS (¥) 1. We believe Yahoo Japan will continue to benefit from a recovery in ad demand as the premier player in Japan’s net media space.1 7.T.5 93.000 to November 2011.2 19. The company sharply reduced operating costs in F’09 and is continuing to cut costs. With around 60% of total sales derived from advertising. We believe these are incremental positives that raise earnings visibility at the company. Developing a digital content platform heralds a new approach to improve the sales mix. The company has consistently improved free cash flow generation and has more ‘cash cow’ characteristics than a high-growth company. Morgan estimates .  The advertising recovery is gaining pace.Global Equity Research 03 January 2011 Yahoo Japan (4689) Cash Cow Geared for Recovery in Advertising We are maintaining our Overweight rating on Yahoo Japan.9 1.9 NP (¥B) 74.com JPMorgan Securities Japan Co.0 4. Concerns remain over visibility for online advertising expenditure in 2H F’10.4 11.255.9 RP (¥B) 132.8 289. Consolidated Y/E Mar 2009 2010 2011E 2012E 2013E Sales (¥B) 265.9 143.9 P/B (x) 7.853bn 58.439.4 7. earnings results.000 Y 32.4 22.000 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 4689.8 9. We expect medium-term margin expansion through effective cost management and scaling of recent business initiatives.2 16. However.9 Overweight 4689.3 Y/Y (%) 7.0% 26. which we believe is undervalued for a geared recovery story.1 7.950 Dec.kamide@jpmorgan.. Morgan estimates.9 6.6 3.6 P/E (x) 25.8 9.4 101. We view improving fundamentals as a precursor to changes in corporate governance.  Valuation and risks.3 8.0 EV/EBITDA (x) 10. and J.0 Source: Company data. We think this will result in improved corporate governance via dividend hikes over the medium term.2x our F’11 EPS forecast.756.1 7.895.4 5. We think the divesture of the online market research business and the license renegotiations carried out in 2Q F’10 were practical measures to maximize margin growth.7 3.5 171.  Cost reductions and digital content are incremental positives.7 83.2 9.  We expect fundamentals to continue improving in 2011.2% Source: Bloomberg. we believe a recovery profile is gaining pace at Yahoo Japan. with effective cost control resulting in pronounced margin expansion. Price Performance 38.8 279.500–27.609.5 6.5 1.

8% from 54.5% terminal growth rate).2B.3B.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 We are maintaining our F’11 estimates for Yahoo Japan. with revenue of ¥328. Continued recovery in ad demand would result in margin expansion with increasing sales volume.5%.6%. We calculate that annual free cash flow generation has consistently grown every year since then. with revenue of ¥307. We believe some new business initiatives that commenced in F'10. We believe that in a sustained economic recovery scenario. and free cash flow conversion remain high.9B and operating profit of ¥171. resulting in marked increases in profitability during 1H F’10.kamide@jpmorgan.6% and generating an average annual ¥116B free cash flow into perpetuity (with a 0.5B and operating profit of ¥185. will be feeding material earnings for the business. As free cash flow remains steady. We then add back ¥136.7B.000 Yahoo Japan is the domestic market leader in internet media. WACC 7. with advertising demand at stable growth rates Y/Y resulting in margin expansion. Cost reduction efforts also allow for increase in profitability We expect a dividend hike from this cash cow Valuation and Rating Analysis Yahoo Japan has been free cash flow generative since F’01. The 392 . driven primarily by the rebound in advertising demand. we derive a net present value of ¥1. we believe corporate governance will improve via dividend hikes in the medium term.3B in net cash. and ¥167. as it maintains its market leader status as an online ‘go to’ destination for domestic internet users.755. eCommerce collaborations and smartphone content. We believe that Yahoo Japan is a geared play on a sustained recovery in online advertising demand.Hiroshi Kamide (81-3) 6736 8602 hiroshi. We believe continued cost management and business expansion into digital content will lead to a further increase in profitability. such as social gaming. The scenario we are modeling is similar to F'11. We Are Maintaining Our Nov. 0. Our model calls for a stable operating profit margin improvement Y/Y to 55. although we expect the consumer business (eCommerce . but its growth has flattened somewhat since F’08 (F’09 being an exception due to a low tax payment). Demand has begun to stabilize Y/Y. its key earnings driver being advertising demand. with both listings and banner display advertising showing continued growth since 2Q F’09. Yahoo Japan will benefit from operational gearing based on the following factors: Ad demand recovery drive operational gearing • We estimate advertising makes up approximately 60% of total sales. Our Estimates and Outlook for 2012 We are maintaining our F’12 estimates for Yahoo Japan. • With the company’s ‘cash cow’ status.shopping and auction) to post a growth profile.5% terminal rate Our basic premise is that on a WACC of 7. • The company conducted cost reductions in F’09. we have used DCF as our valuation method to derive fair value for the stock. 2011 Price Target of ¥35.5B in investments and land (including ¥120B in preferred shares in Softbank). as sales volume expansion drives operational gearing. when it was experiencing a high growth profile.

059B. • Digital content sales from online gaming operations experiences significant growth.Hiroshi Kamide (81-3) 6736 8602 hiroshi. • Cutover to new Google search technology is disruptive and results in advertising client loss. Investment Risks We view the risks to our investment thesis as follows: Upside risks • Banner display advertising demand picks up faster than expected in 2H F’10. 393 . • Management undertakes price hikes for advertising and eCommerce services. • New business developments lead to higher than expected costs. and this produces a fair value of ¥35.com Global Equity Research 03 January 2011 resultant Market Value of Equity is ¥2.kamide@jpmorgan. Downside risks • Ad demand recovery slower than anticipated.000 per share.

Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com

Global Equity Research 03 January 2011

Advertising—The Swing Factor
Yahoo Japan's core earnings driver is advertising, with the company's unrivalled media power in the online market. Advertising takes broadly two forms: • Display advertising – panels of advertising space on a webpage, primarily for brand advertising • Listings – text-based advertising, which can be driven by search queries, standard listings or by targeting The company says profitability is similar for both products, although this is dependent on utilization rates (the amount of ad space inventory being sold) for banners, and pricing.
Advertising Sales Breakdown by Product – 2Q F’10
30% Display 70% Listing

9% Targeting

21% Brand panel, prime display

65% Search, tex t-based ads

5% Interest match

Source: J.P. Morgan based on company interview.

• Display ads demand fell significantly in 1H F’09, as demand from financial, real estate and recruitment sectors dropped. However, spending bottomed in 3Q F’09, and has been recovering Y/Y since 4Q F’09. • Listings ads have maintained a resilient Y/Y growth profile throughout the economic downturn. Demand reaccelerated in 2Q F’10, and demand from the weak sectors such as finance has begun to bottom.

394

Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com

Global Equity Research 03 January 2011

Yahoo Japan’s Display Advertising Revenue by Industry
Industry Finance/Insurance/Securities Autos (Transport Equipment) Cosmetics/Toiletries Real Estate/Construction Transportation/Leisure Foodstuffs Beverages/Cigarettes internet Information Site/Email service Fashion/Accessories Medicament/Pharmaceuticals Mobile Communications Service Entertainment Related Software Others Total
Source: J.P. Morgan based on company data.

2Q F’08 (1) 18.9% 10.7% 10.2% 11.5% 7.9% 3.4% 3.9% 3.4% 3.3% 3.1% 23.7% 100.0%

2Q F’10 (2) 16.8% 13.3% 9.3% 9.3% 7.2% 4.5% 4.1% 3.7% 3.6% 3.3% 3.1% 2.9% 18.9% 100.0%

(2) - (1) -2.1ppt 2.6ppt -0.9ppt -2.2ppt -0.7ppt 1.1ppt 0.2ppt 0.2ppt -0.2ppt -0.2ppt -

Yahoo Japan has managed to increase operating margins over the last year and a half, through a combination of cost reductions and the ongoing recovery in advertising spending: • Cost cutting measures in F’09 focused on reducing contractor costs, administrative expenses and IT costs. • During 2Q F’10, the divesture of Yahoo Value Insight (online market research), the termination of search services with Yahoo! Inc. and renegotiating a contract with an advertising partner reduced COGS.
Quarterly Sales and OPM Trend
¥ million

76,000 72,000 68,000 64,000 1Q 2Q FY'08 3Q 4Q

Bottoming of listings demand

Continued margin expansion

56% 54% 52%

Bottoming of display ad demand

50% 48% 46%

1Q

2Q FY'09

3Q

4Q

1Q FY'10

2Q

Sales (LHS)

OPM (RHS)

Source: J.P. Morgan based on company data.

395

Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com

Global Equity Research 03 January 2011

Quarterly Advertising Sales Trends
% Display ads sales growth Y/Y F’09 1Q 2Q 3Q 4Q F’10 1Q 2Q -10% -10% -3% 15% 7%-8% less than 10% Listings ads (including search and Interest Match) sales growth Y/Y 2%-3% Flat → positive 2%-3% 7%-8% 7%-8% Plus 10% Total sales growth Y/Y 3.2% 2.8% 5.6% 8.9% 4.2% 4.6% Total OPM 50.4% 50.8% 51.5% 52.9% 53.3% 54.2% Notes

M&A growth impact Y/Y: Softbank IDC and Gyao Corp. Bottom of listings decline. 1Q-2Q Major cost cutting exercise – contractor and administration costs Bottoming of banner ad demand Major display ad recovery Y/Y Pullback Q/Q for display ads, listings ads demand steady OPM continue to improve via cost reductions: - Sale of Yahoo Value Insight - Renegotiate license contract w/ ad partners - Renegotiate search license fee with Yahoo! Inc..

Source: J.P. Morgan based on company data.

Key Assumptions
J.P. Morgan Assumptions for Domestic Sales and OPM
F’10E Sales growth Y/Y Media Business services Consumer Total sales growth OPM estimates Media Business services Consumer Total OPM
Source: J.P. Morgan estimates.

F’11E 8.7% 7.3% 3.9% 6.5%

F’12E 9.0% 8.8% 2.7% 6.7%

CAGR 10E-12E 8.8% 8.0% 3.3% 6.6%

4.7% 7.5% -0.7% 3.3%

53.0% 49.7% 66.6% 54.5%

54.4% 50.3% 67.9% 55.8%

55.2% 50.8% 68.6% 56.4%

-

The three business segments refer to the following: • Media – all display advertising sales, listings advertising sales via advertising agency • Business services – listings advertisings sold direct (search and targeted), listings advertising sold in ‘Yahoo! Real Estate’, ‘Yahoo! Rikunavi’ (recruitment) and ‘Yahoo! Motor’. Also sales of data center operations • Consumer – income from auction site (fixed tenancy fees and variable commission/system fees), income from shopping site (fixed tenancy fee and variable commission), premium user id monthly fee, digital content sales, and legacy ISP fees

396

Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com

Global Equity Research 03 January 2011

Key assumptions for our earnings forecasts are as follows: Sales growth • Media – online ad likely demand to maintain a steady growth trajectory, from both display and listings. • Business services – dependent on listings, ad demand from finance, real estate and recruitment to recover, but starting from a low base. • Consumer – a bottoming in online auction activity, with growth stemming from the company's efforts to drive shopping volume at the marketplace operation. Small impact from digital content sales. OPM estimates • Media - steady margin expansion Y/Y through sales volume hikes and controlled costs. • Business services - no major hikes in margins, although with ad demand returning, some scope for margin expansion through sales volume growth. • Consumer - stability in the auction business and an improving sales mix from digital content sales with very high margins.

397

Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com

Global Equity Research 03 January 2011

Quarterly Earnings Forecasts
(¥ billion) Sales Media Business services Consumer Adjustments Operating profit Media Business services Consumer Adjustments OPM Media Business services Consumer Adjustments Sales growth Y/Y Media Business services Consumer Adjustments F’09 Q1 67.6 23.6 17.5 26.4 0.2 34.3 11.0 7.4 18.1 -2.2 50.7% 46.7% 42.7% 68.4% 3.2% 3.2% 3.2% 3.2% 3.2% Q2 68.0 24.6 17.5 25.7 0.2 34.4 11.4 7.7 17.2 -1.9 50.6% 46.4% 43.7% 67.0% 3.1% 7.2% 3.1% -0.3% -5.9% Q3 70.9 25.9 17.7 27.2 0.2 36.4 12.4 8.0 17.9 -1.9 51.4% 48.1% 45.2% 65.9% 5.9% 10.8% 2.4% 4.0% -6.8% Q4 73.2 28.2 18.7 26.1 0.2 38.7 14.7 9.2 16.9 -2.1 52.9% 52.2% 49.2% 64.7% 9.1% 20.8% 8.0% -0.6% 1.2% F’10 Q1 70.5 25.6 18.4 26.3 0.2 37.6 13.1 8.9 17.6 -2.1 53.3% 51.3% 48.5% 66.9% 4.2% 8.7% 5.7% -0.5% -19.8% Q2 70.9 26.4 19.0 25.4 0.1 38.4 13.9 9.4 16.8 -1.7 54.2% 52.7% 49.5% 66.1% 4.2% 7.2% 8.3% -1.1% -47.4% Q3 E 72.7 27.1 19.5 26.0 0.1 39.9 14.5 9.8 17.3 -1.7 54.9% 53.5% 50.2% 66.5% 2.6% 5.0% 10.1% -4.3% -47.6% Q4 E 74.9 28.0 19.9 26.9 0.1 41.5 15.2 10.0 18.1 -1.7 55.5% 54.2% 50.5% 67.0% 2.2% -1.0% 6.1% 3.4% -51.9% F’11 Q1 E 75.5 28.2 20.1 27.1 0.1 41.9 15.2 10.0 18.3 -1.7 55.5% 54.0% 50.0% 67.5% 7.1% 10.3% 8.8% 3.2% -39.8% Q2 E 76.2 28.7 20.3 27.1 0.1 42.4 15.5 10.1 18.5 -1.7 55.6% 54.0% 50.0% 68.0% 7.4% 8.5% 6.7% 6.8% 0.0% Q3 E 77.2 29.2 20.8 27.1 0.1 43.2 15.9 10.5 18.5 -1.7 55.9% 54.5% 50.5% 68.0% 6.2% 7.7% 6.7% 4.2% 0.0% Q4 E 79.0 30.3 21.3 27.3 0.1 44.3 16.6 10.8 18.6 -1.7 56.1% 55.0% 50.5% 68.0% 5.5% 8.2% 7.2% 1.4% 0.0% F’09 279.8 102.3 71.4 105.4 0.8 143.8 49.6 32.3 70.1 -8.1 51.4% 48.5% 45.3% 66.5% 5.3% 10.5% 4.2% 1.5% -2.1% F’10 E 289.0 107.1 76.8 104.7 0.5 157.4 56.7 38.2 69.8 -7.2 54.5% 53.0% 49.7% 66.6% 3.3% 4.7% 7.5% -0.7% -41.5% F’11 E 307.9 116.4 82.4 108.7 0.4 171.7 63.3 41.4 73.8 -6.8 55.8% 54.4% 50.3% 67.9% 6.5% 8.7% 7.3% 3.9% -14.2%

Source: Company data, J.P. Morgan estimates.

398

Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com

Global Equity Research 03 January 2011

Consolidated Profit and Loss Statement
¥ billion F’07 91.3 67.6 102.4 0.8 262.0 -28.3 233.8 38.3 27.0 68.6 -9.1 124.8 -3.1 0.0 -0.3 0.5 -0.5 121.5 0.0 -7.5 114.0 -50.7 -0.7 62.6 1,035.3 104.0 10.0 23.3 17.5 18.2 8.0 29.0 89.2 47.6 46.4 -44.5 Actual F’08 92.5 68.6 103.8 0.8 265.8 -27.8 237.9 43.5 29.5 71.2 -9.6 134.6 -1.1 0.1 -0.2 1.3 -1.8 132.9 1.6 -8.1 126.4 -51.1 -0.6 74.7 1,255.9 130.0 10.4 1.4 7.9 9.4 19.4 -1.7 89.5 50.7 50.0 -40.4 F’09 102.3 71.4 105.4 0.8 279.8 -32.6 247.2 49.6 32.3 70.1 -8.1 143.8 -0.2 0.1 -0.1 0.0 -0.4 143.4 0.4 -3.1 140.7 -56.8 -0.4 83.5 1,439.7 288.0 20.0 5.3 6.8 7.8 11.8 32.5 88.4 51.4 51.2 -40.4 J.P. Morgan Estimates F’10E F’11E 107.1 76.8 104.7 0.5 289.0 -30.3 258.7 56.7 38.2 69.8 -7.2 157.4 0.1 -0.1 0.0 -0.4 157.5 157.5 -63.6 -0.5 93.4 1,609.5 321.9 20.0 3.3 9.5 9.9 11.8 29.5 89.5 54.5 54.5 -40.4 116.4 82.4 108.7 0.4 307.9 -30.8 277.1 63.3 41.4 73.8 -6.8 171.7 0.1 -0.1 0.0 -0.4 171.8 171.8 -69.4 -0.5 101.9 1,756.2 439.1 25.0 6.5 9.1 9.1 9.1 25.4 90.0 55.8 55.8 -40.4 F’12E 126.9 89.6 111.6 0.4 328.5 -31.2 297.3 70.0 45.5 76.6 -6.8 185.3 0.1 -0.1 0.0 -0.4 185.3 185.3 -74.9 -0.5 110.0 1,895.6 473.9 25.0 6.7 7.9 7.9 7.9 21.8 90.5 56.4 56.4 -40.4

<Sales> Media Business services Consumer Adjustments Total sales COGS Gross profit <Operating profit> Media Business services Consumer Adjustments Total operating profit Affiliate income Dividend income Net interest income Gains on securities Other gains Other losses Recurring profit Extraordinary gains Extraordinary losses Pre-tax profit Tax Minorities Net profit Per share EPS (¥) DPS (¥) Effective payout ratio (%) Y/Y % Sales (%) Operating profit (%) Recurring profit (%) Net profit (%) NAV (%) Operating performance GPM (%) OPM (%) RPM (%) Effective tax rate (%)

Source: Company data, earnings results and J.P. Morgan estimates.

399

Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com

Global Equity Research 03 January 2011

Consolidated Balance Sheet
¥ billion <Assets> Cash and cash equivalents Accounts receivables Marketable securities Inventories Deferred tax Other Current assets Tangible fixed assets Intangible fixed assets Goodwill Other Investments and other assets Total assets <Liabilities> Accounts payable Short term debt Other Current liabilities Long-term debt Other Long-term liabilities Total liabilities <Net assets> Shareholders’ equity Valuation and translation adjustments Minority interest Total net assets Total liabilities and net assets Net debt Capital employed Net debt/equity(%) Debtor days Inventory days Creditor days ROCE (%) ROE (%) ROA (%)
Source: Company data, J.P. Morgan estimates. Note: Net debt/equity: net cash position.

F’07 113.0 34.7 0.2 4.3 12.0 164.3 16.6 13.8 2.5 11.3 174.9 369.7 6.6 20.0 62.4 89.0 30.0 0.0 30.0 119.0 246.5 1.7 2.4 250.7 369.7 -63.0 300.7 -25.4 6 -3 -49 43.4 28.4 16.9

F’08 37.0 33.4 0.3 3.6 17.2 91.4 29.2 18.7 6.4 12.3 172.3 311.5 5.3 20.0 39.4 64.7 10.0 0.4 10.4 75.1 234.2 0.2 2.1 236.5 311.5 -7.0 266.5 -3.0 47 -3 -78 47.2 31.0 24.0

F’09 139.2 35.9 0.0 0.2 6.7 21.3 203.3 27.1 15.0 4.9 10.1 172.8 418.3 7.5 10.0 88.1 105.6 0.0 0.4 0.4 106.0 308.0 2.0 2.3 312.3 418.3 -129.2 322.3 -41.7 45 -3 -72 48.8 30.7 20.0

F’10E 209.4 38.8 0.0 0.3 6.7 23.1 278.3 27.4 15.1 4.9 10.2 174.6 495.4 7.6 0.0 83.5 91.0 0.0 0.4 0.4 91.5 401.4 0.0 2.5 403.9 495.4 -209.4 403.9 -52.2 47 -3 -91 43.4 26.2 18.8

F’11E 306.3 41.4 0.0 0.3 6.7 24.6 379.4 27.7 15.3 4.9 10.4 176.3 598.6 7.7 0.0 84.7 92.4 0.0 0.4 0.4 92.8 503.3 0.0 2.5 505.8 598.6 -306.3 505.8 -60.9 48 -4 -91 37.8 22.5 17.0

F’12E 409.5 44.2 0.0 0.3 6.7 26.3 487.0 27.9 15.4 4.8 10.6 179.8 710.1 8.1 0.0 85.8 93.9 0.0 0.4 0.4 94.4 613.2 0.0 2.5 615.7 710.1 -409.5 615.7 -66.8 48 -4 -92 33.1 19.7 15.5

400

Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com

Global Equity Research 03 January 2011

Consolidated Cash Flow Statement
¥ billion F’07 Pre-tax profit Tax paid Depreciation Changes in working capital Other Gain/loss on asset sale/valuation Cash flow from operating activities Capital expenditure Net sale/purchase of securities Other Cash flow from investing activities Change in debt Dividends paid Net buybacks Equity issued Other Cash flow from financial activities Gross change in cash and cash equivalents Cash and cash equivalents at the beginning of the year Effect of Change in Consolidated Companies Cash and cash equivalents at FY end FCF per share (¥) FCF yield (%) FCF conversion (%)
Source: Company data, J.P. Morgan estimates. Note: Share prices as of December 29, 2010.

F’08 126.4 -55.4 12.7 4.1 -4.2 4.3 87.8 -11.1 -43.6 0.8 -53.9 -20.0 -6.3 -82.0 0.2 -1.8 -109.9 -76.1 113.0 0.0 37.0 1,337.1 4.2 59.1

F’09 140.7 -15.8 11.1 0.6 0.4 3.1 140.1 -6.7 -1.6 0.9 -7.4 -20.4 -7.5 -3.1 0.2 -0.5 -31.4 101.4 37.0 -0.1 138.3 2,274.3 7.1 91.7

F’10E 157.5 -63.6 10.9 -3.1 -6.6 95.1 -3.6 -2.0 -5.6 -20.0 -18.7 -38.7 50.8 138.3 -1.8 187.3 1,577.0 4.9 58.1

F’11E 171.8 -69.4 11.0 -2.6 -0.4 110.4 -3.6 -2.0 -5.6 -25.5 -25.5 79.3 187.3 266.6 1,840.8 5.8 62.2

F’12E 185.3 -74.9 11.1 -2.5 -0.6 118.4 -3.6 -2.0 -5.6 -27.5 -27.5 85.3 266.6 352.0 1,979.5 6.2 62.0

114.0 -51.1 13.6 1.6 -1.0 4.5 81.5 -11.2 -6.6 0.9 -17.0 -20.1 -5.8 0.4 -0.6 -26.2 38.3 75.2 -0.5 113.0 1,209.4 3.8 58.6

401

Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com Global Equity Research 03 January 2011 402 .

Daum has been gaining market share in both the search and display market recently and this has led to 43% yoy revenue growth compared to 15% for NHN in 3Q10.6 110.02 8. Bloomberg: 035720 KQ) W in mn. respectively.5 -1.Average daily Value (W mn) 42.8% 3mth Avg daily volume 33.s. 035720 KQ Price: W76. Seoul Branch  Daum provides pure exposure to internet portal.0x 2011E P/E.chang@jpmorgan.9% Free float (%) 263.6 Market cap ($ mn) 8.0% 13 1. Our Jun-11 price target is W100. which generates one-third of revenue from internet games. We are maintaining our 4Q’10 revenue.9% 29.1 2.  We believe the overall growth momentum for Daum will continue to be better than the industry and NHN over the next couple of years.0 Exchange Rate -1.619. it is currently trading at some 42% discount to NHN on 2011E P/E. innovative marketing efforts.300 Price Target: W100.0% -25. James R.22 8. J. Overweight 035720. Morgan Securities (Far East) Ltd.0% 0.P.1 KOSPI 3. CFA (65) 6882-2374 james. EBITDA.3% 22.795.427.5x.Global Equity Research 03 January 2011 Daum The Little Engine That Could We maintain our Overweight rating on Daum.  While Daum is a pure portal that is accorded higher multiples than game companies.0% 14. and W1.com J.P.1% Average 3m Daily Turnover ($ mn) 8.70 6.4% 12.38 2.9% 24. Daum controls the search query market in Korea with a share of 23% and the display ad market with a share of 25%.017.KQ.8 Fiscal Year End 0. and differentiated customer profile from NHN.043 1. Morgan estimates. Morgan Securities Singapore Private Limited Daum (Reuters: 035720.KQ.442.643.6% 3M .5% 30.485. our target translates to only 9.000. the second-largest search portal in Korea.4 2. year-end Dec Revenue (W bn) Net Profit (W bn) EPS (W) DPS (W) Revenue growth (%) EPS growth (%) ROCE ROE P/E (x) P/BV (x) EV/EBITDA (x) Dividend Yie ld Source: Company data.0% 0.300 29 Dec 10 122. communities and news. messaging service.7% 30. and EPS estimates of W99B.537 886 76. as the company focuses on search and display ads only compared to NHN.5 84. FY10E FY11E FY12E Shares O/S (mn) 345 394 445 Market cap (W mn) 113.7 -1. Furthermore.90 Dec .com J.00 9. Currently.lee@jpmorgan.P. It was founded in 1995 as a provider of various types of web service including free web-based e-mail. based on a 2011E P/E of 15. CFA AC (82-2) 758-5719 sungmin.  2011 drivers: We believe Daum will continue to gain market share in both search and display ads based on improved search quality.8 9.000 Korea Internet Sungmin Chang.r.com J.12 Price (W) 0 0 0 Date Of Price 41.147.  Maintaining 4Q’10 estimates. Sullivan.8 11.sullivan@jpmorgan.P.  Daum is the second-largest search portal in Korea. Seoul Branch Gon Suk Lee (82-2) 758 5710 gon. Morgan Securities (Far East) Ltd. On a cash-adjusted basis. Bloomber g. W33B.

We note Daum is spearheading the entry into the corporate sector through multiple innovative programs with large corporates lately and this should turn into a new and meaningful revenue source for Daum by 2012. which is an 8% discount to our target multiple for NHN and a 0 to 6% discount to current multiples of global peers such as Google. The EPS decline owes to a one-off gain from Lycos sales in 2010.h there is a good possibility that search ad revenue will turn out better than our estimates. as suc. However. Our Estimates and Outlook for 2012 We expect revenue to grow another 13% to W445B and EPS by 31% to W8.442. up from 27. and Yahoo Japan. we believe there is also room for positive earnings revisions. while display ads will continue to narrow the gap with NHN. This implies an operating margin of 30.000. up 14% Y/Y.000 We are maintaining a Jun-2011 price target of W100.5% for 2011E.427 on ongoing growth in both the search and display businesses. CFA (82-2) 758-5719 sungmin. 404 . So the number to focus on in 2011 is operating profit rather than EPS.chang@jpmorgan. we believe the valuation discount on Daum will quickly disappear beginning in 1Q11. we note that our estimates are based on very conservative price decline assumptions and.5% in 2010E and net margin of 23.Sungmin Chang. Investment Risks The key risk is a larger-than-expected price decline due to Overture’s loss of pricing power in the search-ad market. We currently estimate operating profit will grow by 16% to W110B in 2011 based on 14% revenue growth to W394B. and EPS of W6. Valuation and Rating Analysis We believe the main discount factor for Daum is uncertainty on the Overture issue.5x. Yahoo.9% for 2011E. On the display ad side. We Are Maintaining Our Price Target of W100. Once this clarifies as having less impact than bears think. We expect Daum to continue to gain market share in search. Our PT is based on a 2011E P/E of 15. given the material price hike in October 2010 and growing corporate interest in display ads for their brand building efforts.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 We forecast revenue of W394B in 2011. down 26%Y/Y. We believe revenue growth will slow down in 2011 on anticipated negative impact from NHN’s departure from Overture.

1 na -59% -59% 73% 120% 24% 18% Source: Company. J.427 13% 28% 25% 31% Cash flow statement Net Income Depreciation & amortization Other non-cash items Change in working capital Cash flow from operations Purchase of PP&E Other assets disposal/ (purchase) Cash flow from investing Equity raised/(repaid) Debt raised/(repaid) Other charges Cash dividends Cash flow from Financing Net Effect of FX rate changes Net Changes in Cash Beginning cash Ending cash DPS (Won) Ratio Analysis EBIT Margin (%) EBITDA margin (%) Net profit margin (%) Operating cost/sales (%) Sales per share growth (%) Sales growth (%) EBIT growth (%) Net profit growth (%) EPS growth (%) Interest Coverage (x) Inventory Turnover (x) Net Debt (cash) to total Capital (%) Net debt (cash) to equity (%) Sales/Assets (%) Assets/Equity (%) ROE (%) ROA (%) FY09 31 23 4 -2 56 15 -17 -14 0 -16 12 0 -12 0 30 40 69 0 FY10E 113 25 -17 30 151 -14 -12 -26 0 -20 6 0 -13 0 112 69 181 0 FY11E 85 30 -13 2 101 -25 -18 -43 0 0 2 0 2 0 60 181 241 0 FY12E 111 29 -25 -15 115 -25 -15 -40 0 0 -15 0 -15 0 60 241 301 0 FY09 69 46 0 45 160 56 61 26 297 20 16 42 78 0 10 88 210 297 16.7 na -22% -24% 82% 142% 16% 10% FY10E 27% 35% 33% 15% 40% 41% 112% 265% 263% 243. & Equity BVPS (Won) FY10E 345 190 138 251 51 61 94 119 120 113 113 8.Reported 31 Net income .Sungmin Chang.427 8.Reported 2.894 FY11E 241 69 0 18 328 62 72 50 512 0 24 62 86 0 14 100 411 512 31. 405 . year-end December Profit & loss statement FY09 Revenues 245 Search ad 125 Display ad 105 Operating cost 200 Labor 41 Commission 53 Operating profit 45 EBITDA 67 Pre-tax Profit 38 Net Income .442 14% 16% -6% -25% FY12E 445 243 180 305 71 64 140 169 141 111 111 8.chang@jpmorgan.2 na -55% -55% 82% 128% 42% 27% FY11E 28% 35% 21% 16% 14% 14% 16% -25% -25% n.442 6.P.Adjusted 31 EPS .m na -59% -59% 77% 124% 23% 17% FY12E 32% 38% 25% 16% 13% 13% 28% 31% 31% 35.336 FY12E 301 79 0 24 403 62 78 65 608 0 24 62 86 0 15 101 507 608 38.050 FY10E 181 64 0 19 264 61 62 33 419 0 24 56 80 0 13 93 327 419 24.644 8.381 EPS .605 FY09 18% 27% 13% 17% 4% 5% -3% -32% 50% 24.644 41% 112% 219% 263% FY11E 394 217 158 285 64 62 110 139 113 85 85 6. Morgan estimates. CFA (82-2) 758-5719 sungmin.Adjusted 50% Balance sheet Cash and Cash Equivalents Accounts receivable Inventories Others current assets Current assets LT investments Net fixed assets Other long term assets Total Assets ST Debt and CPLTD Account Payables Other current liabilities Total current liabilities Long term debt Other Long term liabilities Total liabilities Shareholder's equity Total Liab.381 Growth Revenues 5% Operating profit -3% Pre-tax Profit -45% EPS .Adjusted 2.com Global Equity Research 03 January 2011 Daum: Summary of financials Won in billions.

com Global Equity Research 03 January 2011 406 .chang@jpmorgan. CFA (82-2) 758-5719 sungmin.Sungmin Chang.

.com J. The low base translates into strong growth.ru Group Ltd.72 31 Dec 11 43. The company is debt free. Overweight MAILRq.7/GDR. and a 25% stake in a leading payments business) and abroad (2. but its penetration is only 37% vs. The company is integrating its diversified portfolio and could benefit from cost synergies as well as from high operating leverage (over 70% fixed costs): we project 53% EBITDA CAGR during 2010E-13E.P.gogolev@jpmorgan.05 . and penetration is adding 1pp per month.38% in Facebook.1% 2013E 1.5x 2012E P/E. Morgan Bank International LLC Imran Khan (1-212) 622-6693 imran. Mail.1% 12m 26.27 Price Target: $51.34 304 123 73 3.7/GDR is based on SOTP and discounted terminal value calculation.L. multiplayer/casual games and other paid services.) in a growing advertising market (15-20% total ad growth expected in 2011). EPS FY ($) 0.1% OpFCF FY ($ mn) 59 FCF Yield FY -2.ru Group Strongly Positioned for Fast-Growing Russian Internet  Russia’s Tencent? Mail.t. VKontakte.5% stake in Russia’s largest social network.  A large and growing market. and an option for 7.S. the group has attractive strategic investments in Russia (32.ru aims at emulating in Russia the success experienced by Tencent in China.L. however.P. social networking services. Morgan Securities LLC Jean-Charles Lemardeley. risks are significant and center on disruptive competition.5% more.com J. Mail. PT of $51.0% 2012E 1. 77% in the U.70 8. etc.com J. (MAILRq.  Overweight rating. including fair value of international assets (Facebook.1% 1m -7.4% 2010E 0. engaging about 70% of total Russian monthly unique users with instant messaging.MAIL LI) FYE Dec 2009A Adj.47% in Zynga and 5. Our end-2011 price target of $51. Russia is the 2nd-largest internet market in Europe.1% 17.27.13% in Groupon) that could provide balance sheet upside.) based on “second market” estimates. EBITDA 2012E P/E 2010-13E revenue CAGR 2010-13E EPS CAGR Source: J.1% Risk: Competition from Facebook Catalyst: Raising VK stake to blocking or controlling Valuation and Growth Metrics 2012E EV/Prop. the rollout of a strong broadband infrastructure.27 14 Dec 10 51.0% 2011E 0. Price Performance 44 38 $ 32 26 Nov-10 YTD Abs 26. CFA (44-20) 7325-5763 jean-charles.47 723 435 315 10.lemardeley@jpmorgan.05 552 321 225 8.ru Group is the leading integrated content and communications platform in the Russian internet space. 1.9% 377 3. Additionally. an increasing share of online (9% of total gross advertising vs.ru Group is well positioned to face potential threats.20 Revenue FY ($ mn) 199 Adj EBITDA FY ($ mn) 64 Net Income FY ($ mn) 44 ROE FY 2.P. Morgan estimates.P. J. Supported by a joint shareholder in Naspers. and we estimate FCF of $170M in 2012E. profitability and the scarcity of quality growth stories in Russia.  We expect 33% core revenue CAGR from ’10 to ’13. a 10% premium to peers.S. Bloomberg. and 83% in the UK.6% 183 0.8x 27.9% 3m 26. but we believe Mail.72 Russia Russian Internet Alexei Gogolev AC (7-495) 967-1029 alexei.P. Morgan estimates. Mail.4 214 Source: Company data.5x 33% 63% Company Data Price ($) Date Of Price Price Target ($) Price Target End Date 52-week Range ($) Mkt Cap ($ bn) Shares O/S (mn) 39. market position. Given the fast-moving nature of the internet. 16% in China and 14% in the U.ru is strongly positioned to benefit from high internet user engagement in games and social networks. MAIL LI Price: $39.4% 271 2.6% 90 -6. we think this could be justified by Mail’s growth prospects.Global Equity Research 03 January 2011 Mail. Mail trades at 27.71 415 225 153 4. This is equally driven by advertising revenue CAGR of 33% and internet value-added services (IVAS) revenue growth of 34% for the period. Morgan Securities Ltd.khan@jpmorgan.

05 EPS. We note the multiple we are using for the terminal value at year-end 2015E.ru Group’s international investments in global internet players (Facebook. The international investment valuation is based on the “second market” valuation (used for employees of private companies to sell their shares) and recent press reports (Bloomberg on December 1. a 10% premium to peers that we think is justified by growth prospects (33% revenue CAGR ’10E-’13E). Zynga and Groupon). 2010. which at our PT implies 2012E EV/EBITDA and P/E of 29. available upon request). and up 30% Y/Y in Mail. expensive acquisitions are a risk – acquisition of a blocking stake in VK (natural acquisition target for the group).ru community base reaching 1.9x. 46% in 2011). Our Estimates and Outlook for 2012 We expect F’12 revenue of $552M. though 2010 EBITDA was impacted by $20M IPO-related costs). Investment Risks Downside risks: (1) Mail. 408 . For profitability we project a substantial EBITDA margin improvement to 46% (vs.ru Group management is not able to maintain its leading position (mitigated by the likely significant stickiness of the mail/instant messaging/social network service platforms). up 25% Y/Y in Mail. We also believe that Mail will benefit from faster recovery in the Russian advertising segment. profitability (63% EPS CAGR ’10E-’13E) and the scarcity of quality growth stories in Russia. Our model calls for $191M of EBITDA and $0. We believe a 21x P/E multiple is reasonable in light of longer-term growth prospects for Mail and current internet sector valuation. (4) High reliance on MMO games (1/3 of revenues). valuing it at $6B [not confirmed by either party]). respectively.5% Y/Y.3x and 43. Valuation and Rating Analysis Our sum-of-parts valuation is derived by combining the discounted terminal value with independently derived equity values of Mail. Our model calls for $273M of EBITDA and $1. up 36.3% in 2010. When setting our PT we are using a forward P/E multiple of 21x at the end of 2015E (please see our full model. although our projected EPS growth rate at 2015 is actually higher than what JPM projects for Tencent. market positioning.Alexei Gogolev (7-495) 967-1029 alexei.com Global Equity Research 03 January 2011 Our Estimates and Outlook for 2011 We expect F’11 revenue of $415M.4% (vs. We are projecting a 340 bps EBITDA margin improvement to 49.ru community). Currently Mail trades at 27. 34. (3) Given Mail’s acquisitive business model.8M subs). three popular games accounted for 2/3 of MMO revenues in 2009. within MMO. (2) Facebook strengthens its position in Russia. 21x. Mail should continue benefiting from growth of Internet advertising market (29% Y/Y growth in 2012). reported that Google offered to buy a stake in Groupon. is significantly lower than the current year-out multiple of Tencent of 27x. We believe the pace of paying customer additions is likely to accelerate somewhat in 2011 (up 59% Y/Y to 360K in massively multiplayer online [MMO] games. up an estimated 33% Y/Y.5x 2012E P/E. We Maintain Our End-2011 Price Target of $51.gogolev@jpmorgan.71 EPS. The pace of paying customer additions is likely to accelerate further in 2012 (up 51% Y/Y to 545K in MMO.7/GDR is based on a sum of the parts and discounted terminal value calculation.7/GDR Our end-2011 PT of $51.

0% FY12E 49.3) (1.PPE) 1. year end Dec 467 EBITDA margin 81 EBIT Margin 1 Net profit margin 34 Capex/sales 583 Depreciation/Sales 442 .0% 36.5) (1.9% 24.190 EFCF pre Div.9% 0 88 57.4% Net investments (11) CF from investments 351 Dividends 38.1% Cash flow from operations 335 36.160 FY09 199 26.34 66.3% 109.8% 47. year end Dec 723 Cash EBITDA 30.951 FY12E 461 62 1 27 550 442 2.00 FY12E 552 33.47 40.5% 83.8% 28.4% (2) 56 103. year end Dec Cash and cash equivalents Accounts Receivables ST financial assets Others Current assets LT investments Net fixed assets Total assets ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY09 148 22 1 13 184 442 1.0% FY13E 51.9% Interest 370 Tax 35.7% 214.685 0 9 44 53 0 155 208 1.3% 246 44.20 182.3% 44. year end Dec Revenues % Change Y/Y EBITDA % Change Y/Y EBITDA Margin EBIT % Change Y/Y EBIT Margin Net Interest PBT % change Y/Y Net Income (clean) % change Y/Y Average Shares Clean EPS % change Y/Y DPS Balance sheet $ in millions.9% 214.00 FY10E 304 52.5% 66.05 47.43 0.PPE) 2.Revenue growth 2.5% 34.43 1.2% 88 66.7% 73 66.43 0.17 EFCF pre Div.1% 0.2% 44 182.6% 8.8% 153 109.6% 9.0% (2) 176 99. PPE Ratio Analysis FY13E $ in millions. Morgan estimates.5% 191 83.8% 49.gogolev@jpmorgan.5% 104 63.1% 42.9% 2.1% 33.1% 273 42.7% 182. 409 .1) 26.0% 59 90 183 271 377 (5) -226 (226) (33) -603 (603) (42) -154 (154) (50) -50 (50) (58) -58 (58) FY09 (2) 2 93 FY10E 0 0 122 FY11E (2) 0 197 FY12E (3) 0 282 FY13E (11) 0 380 Source: Company reports and J.3% 46.7% 0.5% 64 74.9% 0.43 FCF to debt 1.5% 26.0% FY11E 46.0% 30.0% 170 93.116 0 22 103 126 0 249 (44) 2.com Global Equity Research 03 January 2011 Mail. PPE 59 90 183 271 377 (2.9% 26.6% Other 51.175 EBITDA Growth 0 EPS Growth 29 126 Net debt/EBITDA 154 CF to Shareholders 0 FCF to debt 295 (15) OpFCF (EBITDA .0% 0.4% FY10E 34.2% 28.0% 11.3% CF to Shareholders 214.6% Share (buybacks)/ issue 315 40.00 FY11E 415 36.3% 225 47.1% 214.3) (0.5% 74.891 0 17 84 101 0 213 (60) 1.4% 44.5% Capex PPE 46.3% FY09 31.7% 31.5% 63.0% 214.1% 46.8% 10.ru Group: Summary of Financials Profit and Loss Statement $ in millions.71 109.P.477 FY10E 59 34 1 16 110 442 1.629 0 12 70 82 0 183 (60) 1.9% 35.9% 53 78.9% 36.7% 52.43 0.689 FY11E 282 47 1 21 350 442 1.5% 41.5% (3) 253 44.6% 40.5% 40.4% 43.Alexei Gogolev (7-495) 967-1029 alexei.00 Cash flow statement FY13E $ in millions.4% 21.4) (1.0% 41.3% OpFCF (EBITDA .

khan@jpmorgan.t.com Global Equity Research 03 January 2011 410 .Imran Khan (1-212) 622-6693 imran.

63/Overweight) Visa (V/$70.29/Overweight) MasterCard (MA/$225. (AAPL/$325. 2010) Apple Inc.60/Overweight) 411 .t.46/Overweight) Microsoft (MSFT/$27.com Global Equity Research 03 January 2011 Other companies recommended in this report (and priced as of December 29.97/Neutral) Monster Worldwide (MWW/$23.khan@jpmorgan.Imran Khan (1-212) 622-6693 imran.

Shanda Interactive Entertainment Ltd (SNDA). Rostelecom (RTKM.OS).HK). Morgan’s website https://mm.P.RTS). Inc.KS). News Corporation. each stock’s expected total return is compared to the expected total return of the FTSE All Share Index. (DHX). Blue Nile (NILE). eBay. The9 Limited (NCTY). (095660. compensation for investment banking services from NHN. we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.Imran Khan (1-212) 622-6693 imran.KS). Expedia. Mail. Dalsvyaz (ESPK. Alibaba.com/disclosures/company or by calling this U. Viacom Inc (VIAb).P. Netflix Inc (NFLX). (DISCA). Southern Telecom (KUBN.] Underweight [Over the next six to twelve months. is. (QNST). Shutterfly. Inc. and (2) no part of any of the research analyst’s compensation was. LG Uplus Corp (032640. Investment Banking (next 3 months): J. we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe. during the past 12 months. Sibir Telecom (ENCO. Inc.KS). Inc. VanceInfo Technologies Inc.RTS). (MELI). Morgan beneficially owns 1% or more of a class of common equity securities of DeNA (2432).T). Inc. See below for the specific stocks in the certifying analyst(s) coverage universe.OS).L). Important Disclosures for Korea and Japan     Beneficial Ownership (1% or more): J. Morgan uses the following rating system: Overweight [Over the next six to twelve months. The Walt Disney Co. in the past 12 months. (DIS).L). Uralsvyazinform (URSI.T) Sungmin Chang.Com (SOHU). JPM provided to the company investment banking services.com Global Equity Research 03 January 2011 Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or. Morgan received.P.] Neutral [Over the next six to twelve months. Client of the Firm: NHN is or was in the past 12 months a client of JPM. Shanda Games (GAME). Rakuten (4755) is or was in the past 12 months a client of JPM. (OWW). however. (030200. Inc. Mixi (2121) (2121.RTS).KS) Alexei Gogolev: AFK Sistema (SSAq.com (AMZN).] J.P.P. Coverage Universe: Imran Khan: AOL Inc. or intends to seek. (AOL).P. (VIT). Center telecom (ESMO.RTS) 412 . NorthWest Telecom (SPTL. (SFLY). (NWSA). MercadoLibre.S. (IACI). Investment Banking (past 12 months): J. Discovery Communications. Priceline. Google (GOOG). Netease (NTES). not to those analysts’ coverage universe. IAC/InterActive Corp. Orbitz Worldwide. NHN (035420. Sina Corp (SINA).RTS). Morgan expects to receive. are available through the search function on J. Morgan Cazenove’s UK Small/Mid-Cap dedicated research analysts use the same rating categories. Inc. where multiple research analysts are primarily responsible for this report. VisionChina (VISN) Hiroshi Kamide: DeNA (2432) (2432. Yahoo Inc (YHOO). Time Warner (TWX). including price charts for all companies under coverage for at least one year.L). Inc. The analyst or analyst’s team’s coverage universe is the sector and/or country shown on the cover of each publication. (RHIEQ). Rakuten (4755) (4755. Tencent (0700. toll-free number (1-800-477-0406) Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: J. Inc. KT Corp. Sohu. we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.KS). A list of these analysts is available on request.com (PCLN). China Finance Online (JRJC).T). ReachLocal (RLOC). Nintendo (7974) (7974.RTS).khan@jpmorgan. (EXPE). Yahoo Japan (4689) (4689. Tivo (TIVO) Dick Wei: AirMedia (AMCN). Ambow Education (AMBO). Important Disclosures for Equity Research Compendium Reports: Important disclosures. Baidu.RTS). Focus Media (FMCN). RHI Entertainment.t. Liberty Interactive (LINTA). with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers. CFA: Daum (035720. Amazon.RTS).ru Group (MAILRq. Inc (EBAY) Bridget Weishaar: Liberty Capital (A) (LCAPA). Rostelecom (Preferred) (RTKM_p. Volga Telecom (NNSI.jpmorgan. Comstar UTS (CMSTq. Dice Holdings.KQ).T). MediaMind (MDMD). Gree (3632) (3632.HK). Neowiz Games Corp. QuinStreet.com (BIDU). the research analyst denoted by an “AC” on the cover or within the document individually certifies. compensation for investment banking services in the next three months from NHN. or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.com Limited (1688. SK Telecom (017670.RTS).

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Morgan internet. Ms. Mr. Hiroshi joined Cazenove Japan in 2002 and moved to KBC Securities Japan in 2003. media and entertainment team in 2006.Imran Khan (1-212) 622-6693 imran. Prior to J. He was also a design engineer at Quantum Corporation (acquired by Maxtor). Morgan internet. Khan has been ranked one of the top 3 internet analysts by major third-party surveys such as the Institutional Investors All-America Research Poll and Greenwich Research Survey every year since 2005.S. media & entertainment analyst. Morgan internet. Mr. Polinsky was a trader at Susquehanna Investment Group. NHN.P. Taffer was at National Cable Communications. Morgan in 2002. corporate development. Mr. he is a graduate of Edinburgh University. Prior to joining J. Khan is the author of some of the most widely read research reports in the industry. including: Nothing But Net. In the Starmine Thomson Reuters rankings for stock-picking performance.B.P. Hiroshi Kamide Hiroshi Kamide graduated with a B. degree from the University of Notre Dame. Khan resides in New York City and serves on the board of the Make-A-Wish foundation’s metro New York chapter.P.A.khan@jpmorgan. Mr. Bridget Weishaar Bridget Weishaar joined the J. Ms. Alexei Gogolev Alexei Gogolev joined J. Vasily Karasyov Vasily Karasyov joined the J. KT Corp. Morgan. Prior to joining J. home entertainment and new media.com Global Equity Research 03 January 2011 Imran Khan and the J. He is an associate member of the Institute of Chartered Accountants of England and Wales. Wei graduated with an MBA from the Wharton School and obtained his M. LG Uplus Corp. Ms. in Economics from Harvard University.P. degree in mechanical engineering from Stanford University. where she oversaw the company’s human resources initiatives.Sc. Dick Wei Dick Wei’s primary research focus is on China internet. Khan has been with the firm since 2004 and was elected managing director in 2007 at the age of 29. he is responsible for global technology research. Shelby Taffer Shelby Taffer joined the J. Gogolev worked in equity research at MDM Bank (Moscow) and at UBS for two years. Polinsky is a CFA charterholder and received an A. University of Pennsylvania. Wei worked with Merrill Lynch in the Hong Kong and New York offices. He joined J.P. in human psychology from Aston University in 1994 and joined KPMG in London as an accountant.P. Morgan in September 2010 as an internet and game sector analyst. Weishaar obtained her MBA at the Wharton School. covering a variety of industries. Mr.P. from the University of Wisconsin – Madison..P. media and entertainment team in 2006. Morgan’s head of global internet research and U.Sc. Chang is a CFA charterholder. at Sony Pictures. SK Telecom and Neowitz Games Corp. Hiroshi was ranked fifth in 2010 and third in 2009 among all Japanese analysts.P. media and entertainment team in 2006. Mr. Morgan. Prior to J.P.P. Prior to J. ranked #1 in the Institutional Investor All-America Research Poll. The Rise of Ad Networks. Mr. Prior to this. Mr. television.P. Mr. Mr. Media and Entertainment Team Imran Khan Imran Khan is J.t. Morgan Internet. media and entertainment team in 2008. Morgan. Lev Polinsky Lev Polinsky joined the J. Mr. Mr. Khan is a frequent speaker at leading industry conferences and different corporate board/leadership meetings. and Large Cap Courtship and Consolidation. 415 . Taffer holds a B. Ms. Morgan equity research in Moscow in 2007. Morgan. Sungmin Chang Sungmin Chang covers the Korea internet and telecommunications sectors for J. Morgan. and holds a B.S. In addition. Morgan internet. Chang’s coverage includes Daum. A Russian national. where he worked on M&A and financing transactions as well as strategic planning in film. Karasyov holds an MBA from INSEAD.P. he was an executive director. Weishaar was an associate analyst on the retail team at Bear Stearns.P. Mr. focusing on media and entertainment companies.

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