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North America Equity Research

02 January 2008

Nothing But Net


2008 Internet Investment Guide
2007 saw Internet companies outperform the broader stock market, as the HHH rose ~14%, vs. a ~5% rise in the S&P 500. We believe some of the factors that drove F07 outperformance will persist into F08, and thus expect the sector to outperform the broader market. Expect 34% EPS Growth, vs. 8% for the S&P 500. We expect revenue growth to decelerate to 21.2% in F08, from 25.6% in F07. We are projecting 34% earnings growth for our coverage universe, compared to 8% for the S&P 500. Expect Blended CPM Pricing Growth Rate to Accelerate. We think blended CPM pricing bottomed out in F07. We expect tighter offline inventory and better monetization techniques will lead to a re-acceleration of growth in F08. We Project Global Search Revenue to Hit $60B by 2011. We are raising our F08 global search revenue estimate to $30.5B, from $26.2B, driven by strong volume trends, better-than-expected monetization, and continued robust growth in Continental Europe. We expect the global search market to reach $60B by 2011, growing at a 28% CAGR over the next four years. Global Consumer Growth Should Benefit Internet Companies. World GDP growth has outpaced US growth in recent years, and a projected 3-year CAGR of 6.5% for emerging economies means hundreds of millions of new consumers. We think large Internet companies global reach means theyll benefit from this rising tide. M&A Market Likely to Remain Healthy. The five biggest companies in our universe generated $8.8B in FCF in F07, a number we project will grow to $12.5B in F08. While some of that cash should continue to fund share repurchases, we think a significant portion of the incremental cash flow is likely to lead to continued M&A in the sector. Top Picks. The above trends translate into our top Overweight ideas going into the new year: GOOG, YHOO, EXPE, OMTR, SFLY and MNST.
www.morganmarkets.com J.P. Morgan Securities Inc.
Internet Imran Khan
AC

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

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

Lev Polinsky, CFA


(1-212) 622-8343 lev.x.polinsky@jpmchase.com

Joseph Boushelle, CFA


(1-212) 622-8523 joseph.d.boushelle@jpmchase.com

China Internet Dick WeiAC


(852) 2800 8535 dick.wei@jpmorgan.com

Please see our notes changing ratings for Priceline, and our note changing estimates for the remainder of our coverage released simultaneously.

All data and valuation in this report priced as of 26 Dec 2007.

See page 309 for analyst certification and important disclosures, including investment banking relationships.
JPMorgan 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. Customers of JPMorgan in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at www.morganmarkets.com or can call 1-800-477-0406 toll free to request a copy of this research.

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

North America Equity Research 02 January 2008

Table of Contents
Key Investment Themes ..........................................................5 Dot.Khans Top Ten for 2008 .................................................13 U.S. Sector Outlooks..............................................................15 China Outlook .........................................................................99 Amazon.com, Neutral ($92.85) ............................................121 Blue Nile, Neutral ($74.16) ...................................................129 CNET Networks, Neutral ($8.90) ..........................................136 eBay, Overweight ($34.49) ...................................................144 Expedia, Overweight ($32.56)..............................................154 Google, Overweight ($710.84) .............................................161 HouseValues, Underweight ($2.94) .....................................169 InfoSpace, Neutral ($18.96)..................................................177 InnerWorkings, Neutral ($18.40)..........................................183 Liberty Interactive, Neutral ($19.79) ....................................190 Mercadolibre, Overweight ($72.85) .....................................199 Monster Worldwide, Overweight ($33.91)...........................208 Move, Inc., Neutral ($2.70) ...................................................215 Omniture, Overweight ($34.95)............................................222 Priceline, Overweight ($118.23)...........................................229 Shutterfly, Overweight ($27.38) ...........................................239 ValueClick, Overweight ($23.39)..........................................247 Yahoo!, Overweight ($23.96) ...............................................255 Baidu, Overweight ($399.67)................................................267 China Finance Online, Overweight ($23.75) .......................272 NetEase, Neutral ($19.33).....................................................276 Ninetowns, Underweight ($3.45) .........................................281 Shanda, Overweight ($34.39)...............................................285 Sina, Neutral ($45.50) ...........................................................290 Sohu, Overweight ($56.58)...................................................294 The9, Overweight ($23.50) ...................................................299
The authors acknowledge the contribution of Deval Delivala and Rachna Srivastava of J.P. Morgan Services India Private Ltd., Mumbai, and John Ventimiglia of J.P. Morgan Securities Inc. to this report.
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Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com

North America Equity Research 02 January 2008

Figure 1: JPMorgan Internet Technology Universe


$ in millions, except per share data

JP Morgan Internet Technology Universe


Ticker Search/Advertising CNET Google Infospace ValueClick Yahoo* Group Average Leading e-Commerce brands Amazon Blue Nile Dice eBay Expedia InnerWorkings InterActive Corp Liberty Interactive Mercadolibre Monster.com Orbitz Worldwide Priceline.com Shutterfly Group Average Online Services Move.com HouseValues Group Average Enabling Platforms Akamai^ Omniture Salesforce.com^ Visual Sciences Websense^ Group Average Average AKAM OMTR CRM VSCN WBSN NR OW NR NR NR 36.80 34.95 63.87 19.31 17.16 6,590 2,248 7,682 369 777 5,859 2,270 7,176 394 496 1.29 0.20 0.13 0.59 0.90 1.66 0.39 0.32 0.75 1.13 2.01 0.70 0.65 0.74 1.35 28.6 NA NA 32.9 19.1 26.9 59.0 22.2 NM 199.4 25.6 15.1 65.6 55.7 18.3 49.8 98.9 26.1 12.8 41.2 42.8 25 35 40 20 15 1.1 NA NM 1.6 1.3 1.4 2.7 0.9 NM 5.0 1.3 1.0 2.0 2.1 0.7 1.4 2.5 1.3 0.9 1.4 3.2 275 22 38 15 53 368 37 77 21 47 469 71 NA NA 85 21.3 101.1 189.4 26.2 9.4 69.5 33.6 15.9 60.8 92.7 19.1 10.5 39.8 21.7 12.5 32.0 NA NA NA 22.2 14.0 628 141 741 82 226 805 213 1,030 90 309 994 309 1,372 NA 338 MOVE SOLD N UW 2.70 2.94 419 72 233 7 (0.05) (0.09) 0.03 0.02 0.05 0.07 NM NM NM 88.6 191.8 140.2 56.1 40.3 48.2 25 10 NM NM NM 3.5 NM 3.5 2.2 NM 2.2 29 3 42 7 49 8 8.1 2.2 5.1 5.6 1.0 3.3 4.8 0.9 2.8 294 60 320 49 349 54 AMZN NILE DHX EBAY EXPE INWK IACI LINTA MELI MNST OWW PCLN SFLY N N R OW OW N N N OW OW R OW OW 92.85 74.16 8.14 34.49 32.56 18.34 27.56 19.79 72.85 33.91 9.43 118.23 27.38 39,461 1,254 505 46,727 10,183 921 8,410 12,428 3,227 4,434 784 5,430 671 39,294 1,180 587 42,283 10,326 852 7,421 16,810 3,164 3,807 1,320 4,930 576 3.96 0.38 4.87 0.53 6.08 0.75 29.8 71.6 63.6 24.3 51.3 38.1 19.4 36.3 30.7 15 20 2.0 3.6 3.1 1.6 2.6 2.1 1.3 1.8 1.7 161 32 296 45 408 61 30.5 18.1 28.2 16.6 12.9 19.1 12.1 9.4 14.8 1,402 183 1,710 251 2,026 328 1.48 1.23 0.32 1.55 0.73 0.21 1.42 1.70 1.39 0.52 1.81 0.80 0.58 1.90 1.98 1.58 0.73 NA 0.89 0.86 2.27 23.3 26.5 57.3 17.8 27.1 354.1 23.9 20.3 23.4 35.1 15.2 24.8 126.2 17.8 17.4 20.6 25.1 NA 22.2 84.6 14.9 25 10 20 10 10 30 20 0.9 2.6 2.9 1.8 2.7 11.8 1.2 0.8 2.3 1.8 1.5 2.5 4.2 0.9 0.7 2.1 1.3 NA 2.2 2.8 0.7 2,863 725 27 867 1,707 24 301 3,337 808 46 958 1,766 43 441 3,754 887 65 NA 1,871 68 514 14.8 14.3 31.8 8.6 9.8 132.2 12.7 12.7 12.8 18.6 7.7 9.5 73.7 8.6 11.3 11.6 13.1 NA 9.0 46.3 7.4 7,685 2,643 288 6,352 7,721 84 1,350 9,007 3,006 472 6,897 8,094 134 1,519 10,506 3,318 641 NA 8,583 195 1,727 1.10 1.03 1.51 1.23 1.87 1.50 84.5 71.9 61.6 60.4 49.7 49.5 20 20 4.2 3.6 3.1 3.0 2.5 2.5 1,093 30 1,474 36 2,178 44 35.9 38.8 26.7 32.6 18.0 26.9 14,488 322 17,938 388 21,269 454 CNET GOOG INSP VCLK YHOO N OW N OW OW 8.90 710.84 18.96 23.39 23.96 1,350 225,035 629 2,343 33,426 1,364 211,948 54 2,092 25,615 NM 15.42 (1.49) 0.71 0.43 0.14 20.92 (0.88) 0.84 0.49 0.22 26.33 0.11 1.01 0.58 NM 46.1 NM 33.0 55.9 45.0 NM 34.0 NM 27.7 49.4 37.0 40.4 27.0 167.0 23.1 41.0 59.7 15 35 5 20 25 NM 1.3 NM 1.6 2.2 1.7 NM 1.0 NM 1.4 2.0 1.4 2.7 0.8 33.4 1.2 1.6 7.9 82 6,958 (9) 164 1,906 100 9,917 17 190 2,248 118 12,647 18 220 2,533 16.7 30.5 (5.8) 12.8 13.4 18.3 13.7 21.4 3.2 11.0 11.4 12.1 11.6 16.8 3.0 9.5 10.1 10.2 411 11,719 240 639 5,095 451 16,957 139 735 5,895 494 22,332 141 859 6,433 Rating Price Mkt Cap 12/26 12/26 Ent .Val. 12/26 2007E EPS 2008E 2009E 2007E Cal PE 2008E LT EPS 2009E Grth (%) 2007E PEG 2008E 2009E EBITDA ($M) 2007E 2008E 2009E Ent. Val/EBITDA 2007E 2008E 2009E 2007E Rev ($M) 2008E 2009E

Source: Company reports and JPMorgan estimates for JPMorgan rated companies. First Call consensus for non-covered companies. Note: Yahoo! EV assumes Yahoo! Japan is worth $26.9B. EBITDA Operating Income + D&A +/- extraordinary charges Data in this table and this report is priced as of December 26, 2007 close JPMorgan is currently subject to a research blackout period for Dice Holdings, Inc and Orbitz Worldwide, Inc. Company write-ups are omitted here in compliance with NYSE and NASD provisions relating to lock-up agreements. 3

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

North America Equity Research 02 January 2008

Table 1: JPMorgan Estimates vs. Consensus Estimates


$ in millions, except per share data Company Amazon.Com Inc CNET Networks Inc eBay Inc Expedia Inc Google Inc IAC/Interactivecorp Infospace Inc Innerworkings Inc Liberty Media Interactive Mercadolibre Inc Monster Worldwide Inc Move Inc Blue Nile Inc Omniture Inc Priceline.Com Inc Shutterfly Inc HouseValues Inc Valueclick Inc Yahoo Inc Ticker AMZN CNET EBAY EXPE GOOG IACI INSP INWK LINTA MELI MNST MOVE NILE OMTR PCLN SFLY SOLD VCLK YHOO FC 08 1.62 0.14 1.66 1.46 20.65 1.81 -0.29 0.52 0.79 0.53 1.83 0.04 1.32 0.41 4.78 0.57 -0.07 0.82 0.55 JPM 08 1.51 0.14 1.70 1.39 20.92 1.81 -0.88 0.52 0.80 0.58 1.90 0.03 1.23 0.39 4.87 0.53 0.02 0.84 0.49 EPS FC 09 2.41 0.20 1.94 1.74 25.89 2.06 -0.42 0.72 1.02 0.83 2.22 0.17 1.67 0.69 5.79 0.90 N/A 1.06 0.72 JPM 09 1.87 0.22 1.98 1.58 26.33 0.11 0.73 0.89 0.86 2.27 0.05 1.50 0.70 6.08 0.75 0.07 1.01 0.58 FC 08 18,256 450 9,031 3,008 16,547 6,862 137 468 8,156 131 1,561 318 394 220 1,690 252 46 741 5,954 Revenue JPM 08 FC 09 17,938 22,373 451 487 9,007 10,603 3,006 3,371 16,957 21,306 6,897 7,206 139 144 472 625 8,094 8,727 134 186 1,519 1,815 320 374 388 470 213 327 1,710 1,870 251 326 49 #N/A 735 869 5,895 6,833 JPM 09 21,269 494 10,506 3,318 22,332 141 641 8,583 195 1,727 349 454 309 2,026 328 54 859 6,433

Source: Company filings, First Call, and JPMorgan estimates

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

North America Equity Research 02 January 2008

Key Investment Themes


We Expect CPMs to Rise in 2008
While we think CPM growth was relatively muted in 2007, we expect 2008 will see it accelerate, driven by several factors, including easier comps, better inventory sellthrough, behavioral and geographic targeting, and ad exchanges. Tighter Offline Inventory Broadcast network total day ratings were ~8% lower in 2007, and we expect inventory is likely to continue shrinking further in 2008. Additionally, the reduced supply will face higher demand, as we believe as much as 6% of spot TV ads in 2008 may be taken up by political ads. We expect the inventory tightness will have a spillover effect online, as advertisers continue to shift a greater percentage of their spend away from traditional media. The Rise of Ad Networks More than 80% of online inventory currently sells for less than a $1 CPM. As such, we think ad networks present a significant opportunity for publishers to increase yield, and, given the low base, the CPM enhancement from using ad networks will not have to be very large, in absolute terms, to move the needle. Inventory Aggregation Many companies are aggregating traffic through partnerships and acquisitions. We think aggregation is likely to lead to a certain degree of pricing power for the aggregators. More importantly, we expect advertisers to be more willing to buy from aggregators that offer them sufficient scale. Easier Comps 2007 saw pressure on graphical ad CPMs, driven primarily by increases in nonpremium inventory, from sites such as MySpace and Facebook. We think the 2007 softness in the market is likely to set a lower base for 2008.

Free Cash Flow Likely to Drive M&A Activity


Large Internet companies are generating a significant amount of cash flow: looking at the five largest Internet-only companies in our coverage universe, we estimate they generated nearly $8.8B in FCF in F07, and are poised to produce $12.5B FCF in F08.
Table 2: Free Cash Flow Generation at 5 Large Internet Companies
$ in millions GOOG YHOO AMZN EBAY EXPE Top 5 Total
Source: Company reports, JPMorgan estimates

$ $ $ $ $ $

2007 3,490 1,307 1,351 2,067 566 8,781

$ $ $ $ $ $

2008 5,675 1,643 1,705 2,612 860 12,494

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

North America Equity Research 02 January 2008

While we believe some of these companies will use part of their income stream on share repurchases, we expect that a significant part will continue to spur increased M&A activity in the sector.
Table 3: Uses of Free Cash Flow at 5 Large Internet Companies, TTM
$ in million, 4Q06 3Q07 TTM FCF ($M) GOOG YHOO AMZN EBAY EXPE Top 5 Total
Source: Company reports, JPMorgan Estimates Note: Table does not include acquisitions made with stock, such as Googles YouTube acquisition

2,902 1,300 801 2,052 777 7,831

Cash Acquisitions/FCF 33.4% 33.6% 6.1% 15.5% 8.0% 23.4%

Buyback/FCF 0.0% 104.9% 31.0% 105.8% 179.8% 66.1%

In particular, we believe large companies will continue to seek out investments in social media, where sites often grow virally and the large-caps appear satisfied, for the most part, to let the public pick the winners out of a crowded field before making acquisitions. In the ad network and ad exchange space, we expect the need for scale to lead to continued consolidation and M&A activity, although perhaps not at the scale we have witnessed in F07, most sizably with the DoubleClick and aQuantive transactions. We expect continued M&A to be motivated by one or more of these key factors: Traffic. Developing high-traffic sites is difficult, and larger companies are often willing to pay for sites that have proven an ability to generate traffic. Technology. Companies that develop a technology that is difficult or uneconomical to replicate are often targets for acquisitions; such companies may also generate traffic, but the technology is a motivator for the buyer. Transactional. Companies with a proven track record of revenue and sales generation make attractive targets, as well; a recent example of a transactionalfocused acquisition is the 2007 purchase of Mezimedia by ValueClick.

Additionally, we continue to believe that there are synergies to be captured by a strategic partnership among large-cap Internet companies, due to (1) increased scale, (2) strengthened global footprint, (3) broadened user insights and (4) improved operational efficiencies. We believe continuing share gains and product introductions by Google may compel other large-cap Internet companies to explore strategic alliances.

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

North America Equity Research 02 January 2008

Table 4: Selected M&A Activity in the Internet Space, 2007 (Please see Appendix of this section for full list)
Ticker AMZN AMZN CNET CNET EBAY EBAY EBAY EBAY EBAY EBAY EXPE EXPE GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG IACI IACI IACI IACI IACI IACI IACI IACI IACI INSP LINTA MELI MELI MNST MSFT MSFT MSFT MSFT MSFT OMTR OMTR OMTR OMTR PCLN SFLY TFSM VCLK VCLK YHOO YHOO YHOO YHOO YHOO YHOO Date 5/14/2007 5/23/2007 10/25/2007 11/5/2007 1/10/2007 2/27/2007 5/3/2007 5/30/2007 10/4/2007 12/20/2007 2/28/2007 5/23/2007 10/31/2006 1/4/2007 3/16/2007 4/13/2007 4/17/2007 4/20/2007 5/29/2007 5/31/2007 6/1/2007 6/6/2007 6/20/2007 7/2/2007 7/9/2007 7/19/2007 9/28/2007 10/9/2007 12/18/2007 12/20/2006 2/27/2007 2/27/2007 3/1/2007 3/19/2007 4/19/2007 5/17/2007 5/24/2007 7/2/2007 9/17/2007 5/11/2007 10/1/2001 11/13/2005 1/17/2007 5/18/2007 8/30/2007 10/3/2007 10/7/2007 10/24/2007 1/18/2007 2/14/2007 9/7/2007 10/25/2007 11/8/2007 6/27/2007 5/17/2007 12/4/2006 7/16/2007 1/9/2007 4/30/2007 6/21/2007 9/4/2007 9/14/2007 9/17/2007 Target www.Dpreview.Com Brilliance Audio Inc Webshots Findarticles.Com Stubhub Beijing Union Mobile Pay Ltd Gittigidiyor.Com Stumbleupon Inc Via-Online Gmbh Tom Online Inc Smarter Travel Media Llc Independent Traveler Inc Jotspot Inc Shenzen Xunlei Netwk Tech Adscape Media Inc Doubleclick Tonic Systems Video Conf. Software Greenborder Tech Ltd Panoramio.Com Feedburner Inc Peakstream Inc Zenter Grandcentral Communicat. Postini Beijing Feixiangren Informat Zingku Jaiku Ltd Endoxon Ilike.Com Edodo.Com Netclub Insider Pages Echomusic Rqi Holdings Ltd Front Line Mgmt Emma Enterntainment Hold Paciolon Switchboard.Com Backcountry.Com Ibazar Com Br Ltd Deremate.Com Arbeidskamerater As Aquantive Screentonic Jellyfish.Com Newsvine Inc Facebook Inc Instadia Touch Clarity Offermatica Visual Sciences Inc Agoda Co Make It About Me! 24/7 Real Media Inc Shopping.Net Mezimedia Inc Mybloglog Right Media Inc Rivals.Com Bluelithium Inc Buzztracker.Com Zimra Inc Acquirer Amazon.com Inc Amazon.com Inc American Greetings Corp CNET Neworks eBay eBay eBay eBay eBay eBay Expedia Inc Expedia Inc Google Google Google Google Google Google Google Google Google Google Google Google Google Google Google Google Google IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp Idearc Inc Liberty Media Interactive MercadoLibre Inc MercadoLibre Inc Monster Worldwide Microsoft Microsoft Microsoft MULTIPLE ACQUIRERS Microsoft Omniture Inc Omniture Inc Omniture Inc Omniture Inc Priceline.com Inc Shutterfly WPP Group PLC ValueClick Inc ValueClick Inc Yahoo! Inc Yahoo! Inc Yahoo! Inc Yahoo! Inc Yahoo! Inc Yahoo! Inc Seller Cnet Networks Inc Looksmart Anncd Tot NA NA 45 20.5 310 105 NA 75 NA NA NA NA NA NA NA 3100 NA NA NA 7 NA NA NA NA 625 NA NA NA NA NA NA NA NA NA 109.12 NA NA NA 225 NA NA NA NA 5460.65 NA NA NA 240 14.41 48.5 65 390.27 NA NA 580.67 26.28 100 340 NA 300 Participate Media NA 350 Payment Undisclosed Cash Cash Cash Cash Cash Cash Cash Cash Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Cash Undisclosed Cash Undisclosed Cash Undisclosed Undisclosed Undisclosed Undisclosed Cash Undisclosed Undisclosed Undisclosed Undisclosed Status Complete Complete Complete Pending Complete Pending Complete Complete Complete Pending Complete Complete Complete Complete Complete Pending Complete Complete Complete Pending Complete Complete Complete Complete Pending Complete Complete Complete Complete Complete Complete Complete Pending Complete Complete Complete Complete Pending Pending Pending Complete Complete Complete Complete Complete Complete Complete Pending Complete Pending Pending Pending Complete Complete Complete Complete Pending Complete Complete Pending Complete Complete Pending

Multiple Sellers Marratech Ab

Gaylord Entertainment Co

Infospace Inc Ebay Inc

Cash Cash Stock Undisclosed Undisclosed Cash Undisclosed Undisclosed Undisclosed Cash Cash Cash Cash & Stock Cash & Stock Cash Undisclosed Cash Cash Cash Cash & Stock Undisclosed Cash Cash Undisclosed

Source: Bloomberg, company reports, news reports

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

North America Equity Research 02 January 2008

Worldwide Growth and Economic Prosperity Creating an Ever-Larger Consumer Base


JPMorgan estimates that GDP growth has been stronger outside the US than domestically in all but one year since 2000. At the same time, worldwide Internet penetration has been growing rapidly, as well. As such, we believe that, for larger Internet companies, the importance of the US, while remaining high, will continue to fade in relative terms in coming years.
Table 5: JPMorgans Global GDP growth projections
World Developed mkts G-7 Emerging Econ. Latin America Emerging Asia ex China China Emerging Eur. ex Russia Russia Developed Eur. World ex-US United States 2001 1.6% 1.2% 1.0% 3.0% 0.5% 5.1% 2.7% 8.3% 1.6% -0.6% 5.1% 1.9% 1.9% 0.7% 2002 1.9% 1.3% 1.2% 4.1% 0.1% 6.6% 4.8% 9.1% 4.5% 4.4% 4.7% 1.1% 2.0% 1.6% 2003 2.5% 1.8% 1.8% 5.0% 1.8% 7.2% 5.1% 10.0% 5.7% 4.7% 7.3% 1.1% 2.5% 2.5% 2004 3.8% 2.9% 2.8% 7.0% 6.2% 7.9% 6.3% 10.1% 6.8% 6.6% 7.2% 2.2% 3.8% 3.6% 2005 3.2% 2.4% 2.3% 6.3% 4.3% 7.8% 6.0% 10.4% 5.8% 5.5% 6.4% 1.8% 3.2% 3.1% 2006 3.6% 2.8% 2.7% 6.9% 5.3% 8.4% 6.5% 11.1% 6.4% 6.2% 6.7% 3.0% 4.0% 2.9% 2007E 3.4% 2.4% 2.2% 6.9% 5.1% 8.5% 6.3% 11.4% 6.3% 5.5% 7.5% 2.8% 3.9% 2.2% 2008E 3.0% 2.1% 2.1% 6.3% 4.5% 7.7% 5.8% 10.5% 5.8% 5.1% 6.8% 1.9% 3.2% 2.5% 2009E 3.4% 2.7% 2.7% 6.2% 4.4% 7.6% 5.9% 10.0% 5.7% 5.2% 6.3% 2.4% 3.5% 3.1%

Source: JPMorgan Economic and Policy Research

We believe the continued global GDP growth is creating an ever-expanding consumer class. Twinned with the trend of rising Internet penetration, we believe an ever-growing market opportunity exists outside the US for Internet companies, especially those with the scale to invest meaningfully in their international operations.
Internet companies are more internationally diversified: we estimate that ~64% of the revenue of S&P 500 companies is derived from US/North American sales, compared to less than 60% for large Internet firms.

Table 6: Revenue Mix Is Shifting Away from US at Large Ad-driven, eCommerce and Travel Sites
% of revenue derived from US Amazon (see note) eBay Expedia (see note) Google Priceline Yahoo! Total (revenue wtd) 2006 54.8% 52.1% 74.2% 57.0% 59.4% 75.0% 59.0% 2007E 55.0% 49.3% 70.0% 52.4% 44.9% 74.9% 55.8% 2008E 54.7% 47.5% 67.1% 50.6% 35.8% 73.5% 54.0% 2009E 54.0% 47.0% 64.6% 49.4% 29.8% 68.9% 52.4%

Source: Company reports, JPMorgan estimates Note: For Amazon and Expedia, the percentage given is North America revenue share, rather than US.

In this respect, we believe Internet companies are somewhat ahead of the broader market: based on FactSet data we estimate that ~64% of the revenue of S&P 500 companies is derived from US/North American sales. We see no reason for the shift away from the US to abate in the near future, and as such we believe that the large-cap companies in our coverage universe are likely to retain at least a somewhat firm footing even if the US economy and US consumer experience a slowdown. At the same time, given the significant exposure of these companies to the US, we believe it would be a mistake to think of them as recession-proof.
8

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

North America Equity Research 02 January 2008

Rising Broadband Penetration Remains Growth Catalyst


We believe faster Internet connections are necessary for a variety of online functions obvious ones such as media and gaming, but even eCommerce to achieve mainstream use. As such, we think rising broadband penetration across the world remains a key catalyst for the growth of the companies in our coverage universe. We note that, in the US, eCommerce spend as tracked by the Department of Commerce has increased at a similar pace as Broadband penetration. We believe this is not coincidental: speed is a key component of user experience, and a positive user experience is likely to drive greater use of eCommerce sites.
Figure 2: US eCommerce has grown hand-in-hand with Broadband penetration
$ in millions; eCommerce quarterly average spend

30% 30000 20000 10000 0 1H'02 2H'02 1H'03 2H'03 1H'04 eCommerce, $M
Source: Department of Commerce, OECD, JPMorgan estimates

25% 20% 15% 10% 5% 0% 2H'04 1H'05 2H'05 1H'06 2H'06 1H'07

Broadband Penetration, %

OECD data suggests many countries in Continental Europe remain 1-2 years behind the US and UK in terms of broadband penetration. As such, we think higher broadband usage is likely to be a growth catalyst in those countries as well as in the US in coming years. While eCommerce has grown in parallel with Broadband penetration, online ad spend, as measured by the IAB, has grown at a more rapid pace in recent years than Broadband adoption:
Figure 3: US Online ad spend rising faster than Broadband penetration
$ in millions; IAB quarterly average ad spend

5000

30% 25% 20% 15% 10% 5%

2500

0 1H'02 2H'02 1H'03 2H'03 1H'04 2H'04 1H'05 2H'05 1H'06 2H'06 1H'07

0%

Ad spend, $M
Source: OECD, IAB, JPMorgan estimates

Broadband Penetration, %

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

North America Equity Research 02 January 2008

We believe the faster rate of growth can be attributed in part to network effects: as more users have access to a faster, more complete Internet experience, a greater number of advertisers find it economical to direct part of their spend online. An additional factor is the ability of richer media ads which take advantage of higher bandwidth to command higher CPMs.

Newspaper Ad Spend Declining


Advertising spend at US newspapers is continuing to decline: 2007 saw an acceleration of newspaper ad spend declines, and we think this trend is likely to continue as time spent on newspapers declines in favor of time spent online. We expect a continuation of the shift away from newspapers to be a tailwind for Internet advertising in the coming year.
Figure 4: Newspaper Ad Spend Continues to Decline
$ in billions

3.9% 55.0 1.9% 1.5% -1.7% 45.0 44.9 35.0 2003


Source: NAA.org, JPMorgan estimates

4.0% 2.0% 0.0% -2.0% -8.6% -4.0% -6.0% 42.6 2007 -8.0% -10.0%

46.7

47.4

46.6

2004

2005

2006

Involvement of Regulatory Authorities Likely to Grow


As the industry grows and becomes entwined in more and more aspects of peoples lives, we think regulators are going to take more and more notice of Internet companies. Going forward, regulatory risk will likely grow, although we believe it will remain relatively small, compared to other industries. M&A in question 2007 saw several large mergers take place within the Internet space, most notably Googles purchase of DoubleClick and Microsofts acquisition of aQuantive. While the latter was able to achieve regulatory clearance, European authorities are still (as of mid-December) examining whether the Google DoubleClick merger will create a player in the online ad industry that is too dominant. We think such regulatory flare-ups are likely to reoccur. Further, as online advertising continues to take share away from traditional avenues, we expect the incumbent players to pursue a variety of approaches, including lobbying for regulatory/legislative intervention, to attempt to defend their position. Privacy concerns abound As search companies become larger and ad networks begin to capture more and more data about users, privacy concerns have become more common.

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North America Equity Research 02 January 2008

In response, several companies have made voluntary steps to lower the quantity of personalized data collection they do. For example, Google has said it will anonymize searcher data after 18 months, while Ask has given users the option of erasing their search history immediately. Social networking sites, which often collect more personal information than do search engines, have also faced attention in regards to their data practices. As we note in the Social Networks Primer, below, we think history indicates that users are willing to sacrifice incremental erosions of their privacy in exchange for features they find useful, especially if sites do not over-reach. Thus far, the desire of users to express themselves has been stronger than the desire to hide, and we think that is likely to continue. Internet Taxation: Likely Not on the Horizon in US Two key Internet tax issues exist in the US: an Internet access tax and a sales tax. A bill renewing the ban on an Internet access tax for seven years passed the US Congress in October 2007. As regards sales taxes on online retail sales, JPMorgans Senior Vice President for Government Relations, Tom Block, believes that a recently proposed bill, intended to allow states to implement an Internet sales tax under certain conditions, does not have a significant chance of passing in the foreseeable future. While offline retailers and state governors have lobbied for rules such as this, voting for this bill could be construed as a tax increase, and Tom Block thinks that makes passage of the bill a non-starter, especially in an election year.

Internet IPO Market Remains Healthy


2007 saw solid IPO activity in the Internet and online space, with deals in the double digits (please see chart below). We believe the trend is likely to continue in F08, as an ever-evolving marketplace gives rise to new opportunities.
Table 7: Selected Internet IPOs, F07
$ in millions except per-share amounts Pricing Date 06/26/07 10/02/07 07/17/07 03/21/07 11/16/07 06/07/07 08/09/07 07/19/07 07/25/07 02/15/07 05/16/07 02/08/07 03/08/07 Issuer Name Comscore Inc Constant Contact Dice Holdings Inc Glu Mobile Inc Internet Brands Inc Limelight Networks Inc MercadoLibre Inc Orbitz Worldwide Inc Perfect World Co Ltd Salary.com Inc TechTarget Inc U.S. Auto Parts Network Inc Xinhua Finance Media Ltd Symbol SCOR CTCT DHX GLUU INET LLNW MELI OWW PWRD SLRY TTGT PRTS XFML Amt ($mm) 101 123 221 86 48 276 333 510 217 69 115 115 300 Mkt cap ($mm) 457 433 805 327 334 1,192 752 1,244 894 158 508 298 883 % mcap 22% 28% 27% 26% 14% 23% 44% 41% 24% 44% 23% 39% 34% Offering Price 16.50 16.00 13.00 11.50 8.00 15.00 18.00 15.00 16.00 10.50 13.00 10.00 13.00 Price, 12/7 36.13 21.69 10.01 5.33 7.99 8.01 43.77 9.87 31.53 13.27 13.66 8.59 6.80 Performance 119% 36% -23% -54% 0% -47% 143% -34% 97% 26% 5% -14% -48%

Source: Company reports, FactSet, JPMorgan estimates

We see the Internet landscape continuing to undergo changes in F08. We expect several types of companies to start achieving a level of scale and operational visibility where a public offering makes sense. Particularly, we think the growing maturity of sectors of the Internet previously thought to be not yet mature, such as social networks, will spur deal activity.
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North America Equity Research 02 January 2008

We Think 2008 Could Bring Greater Profitability


In 2006, 12 of the Internet companies in our coverage universe saw EBITDA margins decline, and nine had increases. In F07, the numbers were reversed, with 12 risers and nine decliners. We think, as some of the companies in our universe reach greater maturity, profitability becomes a higher priority than growth, and more achievable, and are forecasting rising EBITDA margins at 16 of these companies in F08. At the same time, we do not believe that, given the scale of these firms, the leverage that can be achieved in the short term is significant: of the 16 companies whose margins we expect to improve, we are modeling greater than 100 bps EBITDA margin improvement at only eight. Finally, we would note that, should an economic downturn in F08 be more severe than currently expected, it is possible that our projected margin levels could see pressure.
Table 8: Change in EBITDA margins for the JPMorgan Internet Coverage Universe
2006 EBITDA mgn Y/Y change 6.6% -1.0% 20.8% 1.5% 35.0% -0.4% 34.4% -6.3% 27.3% -3.2% 63.2% -2.0% 15.2% 0.7% -7.5% -28.3% 9.0% 2.4% 36.3% 3.0% 14.2% 5.8% 25.1% 2.1% 8.4% 6.3% 8.9% -0.8% 10.1% 24.1% -8.3% -8.3% 9.5% 2.3% 16.8% -0.8% 8.3% -19.5% 26.6% -1.8% 41.8% -0.3% 2007E EBITDA mgn Y/Y change 7.5% 1.0% 19.9% -0.8% 41.4% 6.4% 33.1% -1.3% 27.4% 0.2% 59.4% -3.8% 13.6% -1.6% -3.9% 3.6% 9.3% 0.3% 35.2% -1.1% 28.3% 14.1% 22.3% -2.8% 9.8% 1.4% 9.5% 0.5% 16.0% 5.9% 11.6% 19.9% 11.5% 2.0% 17.4% 0.6% 5.7% -2.6% 25.6% -0.9% 37.4% -4.4% 2008E EBITDA mgn Y/Y change 8.2% 0.7% 22.1% 2.2% 41.5% 0.2% 33.3% 0.1% 26.9% -0.6% 58.5% -0.9% 13.9% 0.2% -11.2% -7.3% 9.7% 0.4% 34.8% -0.4% 32.1% 3.8% 29.0% 6.7% 13.0% 3.2% 9.3% -0.1% 17.5% 1.6% 16.8% 5.2% 17.3% 5.8% 17.8% 0.5% 15.1% 9.4% 25.8% 0.2% 38.1% 0.7%

AMZN CNET DHX EBAY EXPE GOOG IACI INSP INWK LINTA MELI MNST MOVE NILE OMTR OWW PCLN SFLY SOLD VCLK YHOO

Source: Company reports, JPMorgan estimates

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North America Equity Research 02 January 2008

Dot.Khans Top Ten for 2008


1. 2. 3. 4. 5. 6. 7. 8. 9. CPM growth rate will accelerate M&A market will remain robust Audience Fragmentation: Will the Ad Network strategy work? Domestic eCommerce growth will slow: Can Amazon continue to deliver abovemarket growth? Can Jerry Yang turn Yahoo! around? Mobile ads will be like video ads: A whole lot of talk, not a whole lot of $ Booking fees are not going away: consider that USAirways just introduced fees Economic slowdown may impact profitability somewhat, but we expect margins to stabilize Internet will continue to cannibalize Newspaper ad spend, which declined ~8% in F07

10. Battle of Facebook vs. MySpace: both will thrive, but we think Facebook will do better

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North America Equity Research 02 January 2008

14

U.S. Sector Outlooks

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

North America Equity Research 02 January 2008

2008 Search Advertising Outlook


Given a very strong 2007 performance, we are increasing our outlook for the global paid search market heading into 2008. We now believe global paid search revenues will reach $30.5B in 2008, up from our prior estimate of $26.2B. We believe that 2008 paid search growth will be driven by: International growth due to continued adoption of paid search as a marketing vehicle Keyword price inflation due to increased volume in advertisements Volume growth driven by increases in web usage CTR improvement driven by improvements in relevancy Within search, we continue to believe that Google will take volume market share from competitors as we have greater faith in the companys ability to execute relevancy enhancements and technological improvements and in its superior brand. However, we believe that on a dollar market share basis, Yahoo! will grow its share over Google due to the improved monetization from the global rollout of Project Panama.
Yahoo! will grow its share over Google due to the improved monetization from the global rollout of Project Panama.

We estimate that Google has a 73% dollar market share currently (including revenues from AOL, Ask, and other affiliates). We believe that this may decline to 71% by the end of 2008 as AOL and Ask have renegotiated their TAC rates and Yahoo! has improved its monetization. While Internet and broadband usage appears to be flattening out in developed countries, we believe that advertiser adoption of this welltargeted marketing vehicle is in its infancy and that there is still much room for monetization and click-through rate improvements.

Lessons Learned from 2007


In our Nothing but Net" preview and outlook for 2007, we stated that we preferred paid search to other Internet sub-sectors such as e-commerce, travel, and graphical advertising. Looking back on the year, paid search actually exceeded our expectations. Entering 2007, we expected the paid search market to grow 39% over 2006 (29% in the US and 52% internationally). However, due to better monetization by Google, Yahoo!, and MSN, as well as volume gains, we now expect global paid search revenues to grow 48% in 2007 (37% in the US and 64% internationally). We were surprised by how robust search volume growth was during F'07. At the beginning of the year we thought that much of F07s US search market growth would come from increases in coverage and were modeling a 190 bp improvement in coverage vs. 18% Y/Y growth in search volume. We now think that F07 US coverage will only improve 70 bps vs 25% growth in volume. We are encouraged by this trend as it demonstrates that the market is less mature than we thought and that search companies have not had to resort to increasing the number of ads on a page.

Global Search Overview: Global Search Expected to Grow 39% in F08


We believe 2008 will be another strong year for global paid search. On the back of 48.3% growth in 2007, we forecast that global paid search revenues will grow 38.7%
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North America Equity Research 02 January 2008

in 2008. From a metrics standpoint, we believe query volumes will grow 29.9% in F08, while RPS will grow 6.8%. We believe substantial monetization opportunities exist and we anticipate a climb in search usage. In 2008, we expect local search, personalized search and vertical search to be hot topics. Beyond 2008, we expect the global paid search market to grow at a 28.4% CAGR through 2011.
Table 9: JPMorgan's Global Search Advertising Revenue Forecast
Units as indicated Global Internet Population (M) Queries / Month / User Number of Queries (M) RPS (per 1,000 searches) % Coverage % Clickthrough Rate $ Revenue / Click Global Search Forecast ($M) Y/Y Growth 2002 593 12 83,030 $14.57 31.7% 15.1% $0.30 1,210 197.0% 2003 710 17 142,017 $19.04 35.3% 16.3% $0.33 2,704 123.4% 2004 820 22 220,128 $23.42 38.7% 17.3% $0.35 5,156 90.7% 2005 924 29 323,827 $28.17 41.7% 18.8% $0.36 9,121 76.9% 2006E 1,020 36 441,796 $33.58 43.9% 20.6% $0.37 14,835 62.6% 2007E 1,113 44 585,395 $37.58 44.5% 21.5% $0.39 21,999 48.3% 2008E 1,205 53 760,474 $40.12 44.5% 22.2% $0.41 30,511 38.7% 2009E 1,295 61 943,475 $41.98 45.2% 22.7% $0.41 39,606 29.8% 2010E 1,380 68 1,123,558 $44.75 45.6% 23.5% $0.42 50,275 26.9% 2011E 1,471 74 1,313,311 $45.59 47.1% 23.3% $0.42 59,868 19.1% 07-'11 CAGR 7.2% 14.2% 22.4% 4.9% 1.4% 2.0% 1.4% 28.4%

Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS

Increasing F08 US Search Growth Estimate: Now We Expect to Grow 32%


Based on out-performance in 2007, we are increasing our 2008 growth estimate for the domestic paid search market. We are now modeling 31.9% growth in 2008, up from our prior estimate of 19.9%. Broken down by metrics, we are modeling US query volume growth of 23.5% in 2008 (a very minor deceleration from the 25.4% we observed in 2007), driven by an increase in the number of searches conducted per user and a slight increase (3.0%) in the domestic Internet population.
We expect the domestic RPS to reach $87.21 in 2008, up from $81.65 in 2007 (6.8% Y/Y growth)

On the monetization front, we expect the domestic RPS to reach $87.21 in 2008, up from $81.65 in 2007 (6.8% Y/Y growth). We expect increases in RPS to be driven by advertiser demand for keywords as well as continued increases in sponsored-link relevancy.
Table 10: JPMorgan's US Search Advertising Revenue Forecast
Units as indicated United States Internet Population (M) Queries / Month / User Number of Queries (M) RPS (per 1,000 searches) % Coverage % Clickthrough Rate $ Revenue / Click US Search Forecast ($M) Y/Y Growth 2006 203 47 114,896 $74.86 62.8% 26.2% $0.46 8,602 47.2% 2007E 211 57 144,080 $81.65 63.5% 27.3% $0.47 11,764 36.8% 2008E 217 68 177,938 $87.21 64.2% 28.3% $0.48 15,518 31.9% 2009E 222 81 215,305 $88.73 64.3% 28.6% $0.48 19,104 23.1% 2010E 227 92 249,754 $94.62 64.3% 30.0% $0.49 23,631 23.7% 2011E 231 102 282,222 $94.91 64.5% 30.0% $0.49 26,786 13.4% 07-'11 CAGR 2.4% 15.6% 18.3% 3.8% 0.4% 2.4% 1.0% 22.8%

Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS

Our Proprietary Research Shows...


Market Share Shifts Are Likely to Continue In November, the JPMorgan Internet Team surveyed over 1,200 US residents to determine Internet usage behavior. Our market research found that Google is the dominant search engine with 54.6% of participants listing it as their most frequently used search engine. Yahoo! ranked second among participants with 21.8% of
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North America Equity Research 02 January 2008

participants using it most frequently. MSN and AOL trailed with 8.6% and 7.2% of participants using them most frequently, respectively.
Figure 5: Most Frequently Used Search Engine
% of participants

Don't use/Don't Other 3% Yahoo! 22% know 2% AOL 7% Ask 3%

MSN 9% Google 54%

Source: JPMorgan research

However, we note that while Google was the overwhelming favorite among participants, 38.5% of respondents use search engines other than their favorite at least 30% of the time. Thus, it appears that respondents are willing to try different search engines for better results.
44% of participants older than 42 used a search engine other than their favorite more than 30% of the time vs. only 32% of participants in the 18-41 age category.

Surprisingly, older participants were more likely to try different brand search engines than younger participants. 44% of participants older than 42 used a search engine other than their favorite more than 30% of the time vs. only 32% of participants in the 18-41 age category. This difference was statistically significant (t=-4.37, p<.05). 62% of Respondents Would Be Willing to Consider Switching Search Engines When asked what improvements by other search engines would cause you to switch from your preferred brand, only 38% of respondents stated that nothing would cause them to switch as they were satisfied with their current search engine. The most frequently selected improvement was results that better matched the search term, with 43% of respondents stating that this would cause them to switch search engines. Other factors that would cause respondents to consider switching search engines were the user-friendliness of the site (28% of participants) and search engine speed (28% of participants).
Table 11: Factors that Would Cause Search Engine Switching
Results that better match search term Results that include video, music, and other forms of information A more uncluttered easy to navigate site Ability to preview web content Faster response speed to searches Other Nothing, happy with current search engine
Source: JPMorgan research

% of Respondents 42.9% 14.2% 27.8% 22.5% 27.5% 1.7% 37.6%

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North America Equity Research 02 January 2008

What would make participants try a different search engine? Friend and family recommendations held the most weight, with 33.8% of respondents stating this as a driver to try a new search engine. 21.7% of respondents stated that the recommendation of a tech expert would influence them to try a new engine. Trailing in the rankings of persuasiveness were TV ads (11.3% of respondents), billboards (4.1% of respondents), newspapers and magazines (7.7% of respondents), and radio (3.5% of respondents). Over Half of Respondents Use Their Toolbar for Less than 40% of Searches Approximately 75% of respondents to our survey use a search toolbar. Google was the predominant choice of toolbars, with 40.7% of respondents having downloaded it. Yahoo! came in second with 24.1% of respondents having downloaded it. MSN, Ask, and AOL all had under 10% usage by respondents. Surprisingly, while almost three-fourths of our respondents had toolbars, their usage of them was infrequent. 42.4% of respondents who had toolbars used them less than 20% of the time.
Figure 6: Toolbar Usage Frequency
% of respondents

50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Less than 20%


Source: JPMorgan research

21-40%

41-60%

61-80%

81-100%

International Market to Top the US by F09


We continue to believe the opportunities for paid search in the international marketplace are even more significant than in the US. In our estimate, while the U.K. is at par or ahead of the US market, the overall international paid search market is still 2+ years behind the US in terms of development.
We expect the international market to reach $20.5B in F09 vs. the US market size of $19.1B.

However, we now believe that the international market will be larger than the domestic market in F09 with a market size of $20.5B vs. the US estimated market size of $19.1B. As such, we believe that the international markets will be a key growth driver in the upcoming year. We believe a key driver in the international markets will be query growth. While we expect the US to experience query growth of 23.5% Y/Y, we believe international markets will see a 32% Y/Y lift in the number of queries.

20

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

North America Equity Research 02 January 2008

Figure 7: US vs. International Query Volume


millions

200,000 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 3Q06 4Q06 U.S.
Source: comScore data and JPMorgan estimates

1Q07 International

2Q07

3Q07

We are modeling paid search revenues to grow 46.5% in F08, up from our prior estimate of 34.9% driven primarily by higher growth in queries and, to a lesser extent, monetization gains. Broken down by metrics, we are modeling international query volume growth of 32.0% in 2008 (a very minor deceleration from the 35.0% we observed in 2007), driven by an increase in the number of searches conducted per user and an increase (9.5%) in the domestic Internet population. On the monetization front, we expect the international RPS to reach $25.74 in 2008, up from $23.19 in 2007 (11.0% Y/Y growth). We expect increases in RPS to be sustainable as the international market RPS is significantly below US levels ($81.65 in F07). Gains will likely be driven by advertiser demand for keywords as well as continued increases in sponsored-link relevancy.
Table 12: JPMorgan's International Search Advertising Revenue Forecast
Units as indicated International Internet Population (M) Queries / Month / User Number of Queries (M) RPS (per 1,000 searches) % Coverage % Clickthrough Rate $ Revenue / Click Int'l Search Forecast ($M) Y/Y Growth 2006E 817 33 326,900 $19.07 37.2% 17.2% 0.30 6,233 90.1% 2007E 903 41 441,315 $23.19 38.3% 18.4% 0.33 10,235 64.2% 2008E 988 49 582,536 $25.74 38.5% 19.1% 0.35 14,993 46.5% 2009E 1,072 57 728,170 $28.16 39.5% 19.8% 0.36 20,502 36.7% 2010E 1,153 63 873,804 $30.49 40.2% 20.5% 0.37 26,644 30.0% 2011E 1,239 69 1,031,0 89 $32.08 42.3% 20.5% 0.37 33,082 24.2% 07-'11 CAGR 8.2% 14.2% 23.6% 8.5% 2.5% 2.8% 2.9% 34.1%

Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS

21

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

North America Equity Research 02 January 2008

2008 Graphical Advertising Outlook


After a difficult 2007 where CPMs were pressured from a non-premium inventory glut, we believe that 2008 will see stronger graphical advertising growth. Specifically, we think that 2008 growth will be driven by: Easier comps as growth will be computed off of this years depressed CPMs Improving CPMs as companies employ targeting techniques and use ad exchanges Improving RPMs due to higher sell-through and increased ads per page Increased advertiser interest due to the increased TV ad demand due to political campaigns Increased page views from rising broadband usage and social networking As a result, we are slightly increasing our F08 graphical advertising global growth estimate to 22.1% from 20.6% to reflect better monetization (CPMs) through the use of targeting and exchanges and expected growth from social networking sites and blogs. We favor web publishers who are organically growing their page views at a rapid pace and who have targeting capabilities.

Lessons Learned from 2007


In our Nothing but Net preview and outlook for 2007, we expressed our view that the US graphical advertising market was poised to grow 20% in 2007. Now that the year is almost complete, we have revised our F07 US growth estimate to 23.4%. We believe that we correctly recognized the audience fragmentation trend due to the rise of social networking and blog usage. We also forecasted the resulting depressed CPMs from the glut of non-premium inventory. However, we did overestimate the impact of video advertising. We thought that the increase in video inventory, coupled with lower CPMs, would cause many graphical advertisers to shift their advertising budgets toward video and away from more traditional graphical advertising. We now recognize that reaching revenue sharing agreements and developing unobtrusive video ads accepted by viewers will be a longer process than we first thought.

Global Graphical Advertising Overview: Expect to Grow 22.1% in F08


We believe that 2008 will be a strong year for graphical advertising publishers, particularly those with targeting capabilities. On the back of expected 23.4% growth in 2007, we believe global graphical advertising revenues will grow 22.1% in F08. From a metrics standpoint, we believe page views and RPMs will grow 11.1% and 9.9% in 2008, respectively. We expect the global Internet population to expand 8.3% to 1.2B in 2008 and web usage to expand by 2.7% per Internet user. We believe RPM growth will be driven by (1) improving CPMs as companies employ targeting techniques and use ad exchanges, (2) increased sell-through rates, and (3) increased ads per page. We expect the global graphical advertising market to grow at a 17.6% CAGR from 2007 through 2011.
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North America Equity Research 02 January 2008

Table 13: JPMorgan's Global Graphical Advertising Revenue Forecast


Units as indicated Global Internet Population (M) Pages Viewed / User / Day Total Pages Viewed (B) RPM (per 1,000 pages) Global Graphical Forecast ($M) Y/Y Growth 2002 593 33 7,209 $1.02 7,354 -19.6% 2003 710 34 8,897 $0.75 6,674 -9.2% 2004 820 36 10,724 $0.81 8,642 29.5% 2005 924 37 12,607 $0.87 10,984 27.1% 2006E 1,020 38 14,275 $0.97 13,829 25.9% 2007E 1,113 39 15,986 $1.07 17,068 23.4% 2008E 1,205 40 17,768 $1.17 20,846 22.1% 2009E 1,295 41 19,563 $1.26 24,561 17.8% 2010E 1,380 43 21,469 $1.33 28,573 16.3% 2011E 1,471 44 23,487 $1.39 32,685 14.4% 07-'11 CAGR 7.2% 2.7% 10.1% 6.8% 17.6%

Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS, IAB

We Think that US CPMs Will Rise in 2008


We expect the US graphical advertising market to grow 19.9% in 2008, slightly below our estimate from a year ago. We believe that page view growth will slow to 6.5% in 2008 (down from 8.0% in 2007) as social networking sites and blogs begin to mature and reach saturated penetration levels. In our estimate, page view growth will be driven by an increase of 3.0% in Internet users and an increase of 3.4% in usage per Internet user. We are modeling RPMs to grow 12.6% in 2008, driven by an 8.3% increase in the number of ad impressions per page view and a 3.9% increase in CPMs. We expect the US graphical advertising market to grow at a 14.2% CAGR from 2007 through 2011.
Table 14: JPMorgan'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 1,000 impressions) RPM (per 1,000 pages) US Graphical Forecast ($M) Y/Y Growth 2006 203 45 3,341 0.50 1,671 $3.50 $1.75 5,847 23.0% 2007E 211 47 3,608 0.60 2,165 $3.31 $1.99 7,166 22.6% 2008E 217 49 3,843 0.65 2,498 $3.44 $2.24 8,593 19.9% 2009E 222 50 4,093 0.68 2,783 $3.60 $2.45 10,019 16.6% 2010E 227 52 4,297 0.70 2,987 $3.76 $2.61 11,230 12.1% 2011E 231 53 4,512 0.70 3,158 $3.86 $2.70 12,192 8.6% 07-'11 CAGR 2.4% 3.3% 5.7% 3.9% 9.9% 3.9% 8.0% 14.2%

Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS, IAB

Political Advertising Likely to Drive Up Scatter Inventory


We estimate that political ad spend on TV will total approximately $2.2B in the 2008 political cycle, up about 38% from 2006 levels. We estimate that presidential TV ad spending alone should total over $600M in the 2008 election cycle. Since 1982, political advertising revenues have contributed about 34% of spot TV ad growth in even-numbered years.
Political advertising revenues have contributed about 34% of spot TV ad growth in evennumbered years.

Given the fixed quantity of available TV inventory and our expectation that political ads may account for 6% of 2008 spot TV ads, we think that it is likely that some advertisers will shift their ad spend to online display advertising.

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North America Equity Research 02 January 2008

Table 15: Political Ad Spending, 1992-2008E


$ in millions Presidential + Senate + House + Gubernatorial + Other = Total Political Dollars Raised x % $$ Spend = Total Political Dollars Spent x % Allocated to TV Advertising = Political TV Advertising % Change from Prior Election Year 1992 $331.1 $397.1 $530.7 $60.3 $263.7 $1,582.8 95.0% $1,503.7 35.6% $534.8 --1994 $480.8 $573.6 $423.0 $232.6 $1,710.0 95.0% $1,624.5 31.3% $508.3 (4.9)% 1996 $425.7 $435.8 $653.5 $68.6 $310.2 $1,893.8 95.0% $1,799.1 34.6% $621.9 22.4% 1998 $455.1 $677.9 $471.0 $273.7 $1,877.6 95.0% $1,783.7 40.1% $714.4 14.9% 2000 $528.9 $547.5 $691.3 $97.8 $364.9 $2,230.4 95.0% $2,118.9 41.0% $868.9 21.6% 2002 $458.8 $761.8 $833.3 $285.5 $2,339.5 95.0% $2,222.5 45.6% $1,013.0 16.6% 2004 $880.5 $573.1 $784.8 $112.6 $406.3 $2,757.3 95.0% $2,619.5 53.4% $1,400.0 38.2% 2006 $664.8 $1,012.2 $937.9 $252.0 $2,866.9 95.0% $2,723.6 58.7% $1,600.0 14.3% 2008E $1,454.4 $758.8 $1,160.5 $136.9 $447.0 $3,957.5 95.0% $3,759.6 58.7% $2,208.6 38.0%

Source: Opensecrets.org and JPMorgan estimates. Note: Other $$ includes funds raised by political parties, interest groups, etc.

Aggregators of Traffic Poised for Growth


While portals were once dominant, Yahoo!, AOL, and Microsoft only accounted for ~29% of minutes spent online in August 2007, down from 42% in August 2002.

Audience Fragmentation Creates Difficulty for Advertisers While portals were once dominant, Yahoo!, AOL, and Microsoft only accounted for ~29% of minutes spent online in August 2007, down from 42% in August 2002. Meanwhile, blogs, online gaming, and social networking websites have experienced double to triple digit Y/Y growth rates in page views. 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. We believe that companies that can aggregate traffic through the development of ad networks or partnerships will be more successful in driving growth in 2008. Please see the Ad Network section of this report for additional details. Targeting Capabilities Successful on Inventory with Overlapping User Base While increasing user reach is half the battle, we recognize that many page views are meaningless to advertisers unless user information can be gathered and ads are targeted. In order to most effectively target the ads, publishers need to have access to user behavior on multiple sites to collect data and to repeatedly show ads to the same user. We believe that companies with targeting capabilities will be able to command a premium CPM. Revenue Science estimates that there is a 15x CPM premium for behaviorally targeted ads.

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Figure 8: 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 ~$10.00 - 12.00

Average CPM Dollars

1000

800 600

6 4

400 200

Traditional optimized ad network $0.50 - 1.00

2 0
1 2

Exchange model potential benefits ~$0.75 - 1.50

20

40

60

80

Web impressions Percent

Source: Revenue Science Presentation

International Growth Is Still a Big Theme


International markets continue to benefit from increased broadband penetration and increased ad spend moving online. Even in markets where broadband is approaching saturation, such as in the UK, display ad prices are likely to rise as more advertisers compete for a more limited quantity of inventory. We estimate that international display advertising will grow at 23.8% in 2008 and at a 19.9% 2007-2011 CAGR.
We estimate that international display advertising will grow at 23.8% in 2008 and at a 19.9% 2007-2011 CAGR.

Table 16: JPMorgan's International Graphical Advertising Revenue Forecast


Units as indicated International Internet Population (M) Pages Viewed / User / Day Total Pages Viewed (B) RPM (per 1,000 pages) Int'l Graphical Forecast ($M) Y/Y Growth 2006E 817 37 10,934 $0.73 7,982 28.1% 2007E 903 38 12,378 $0.80 9,902 24.1% 2008E 988 39 13,925 $0.88 12,254 23.8% 2009E 1,072 40 15,470 $0.94 14,542 18.7% 2010E 1,153 41 17,172 $1.01 17,344 19.3% 2011E 1,239 42 18,975 $1.08 20,493 18.2% 07-'11 CAGR 8.2% 2.8% 11.3% 7.8% 19.9%

Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS, IAB

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Ad Networks on the Rise


What Are Ad Networks?
We see ad networks defined by the following: transacts, serves, tracks and reports the distribution of advertiser ads to publisher pages. enables marketers to advertise on multiple publisher sites through one central location publishers enjoy the benefit of advertising revenue without investing in a sales force or as a source to sell remnant inventory varies in the ability to target a specific audience and in methods of payment (CPM, CPC, and CPA) revenues are determined by revenue share agreements
Lead generation is more vertical specific and performance oriented than ad networks

The definition of ad networks is fuzzy with lead generation sometimes included. However, we are differentiating between the ad network and lead generation space. We are defining lead generation as much more targeted and deep into specific verticals. As a result, we believe that this commands much higher CPM's, in the $100-$150 range. While we believe that this is also an interesting ad model, we believe it deserves a more detailed consideration and will thus save it for a later note.

A Significant Market Opportunity


We estimate that the global graphical advertising market as a whole will grow over 22% through 2008. The sector should benefit from 1) increased online viewership as more people turn to the Internet as a source of content and 2) increased RPMs as audience targeting improves.
Int'l Ad Network penetration is so small that it is not yet tracked by ComScore. We expect that it is ~3-5 yrs developmentally behind the US and will be a significant future growth driver.

Additionally, increasing keyword prices and the ability of networks to provide response advertising in addition to branding campaigns will likely drive more marketers to ad networks. On the publisher side, as the long tail of information is increasing, more publishers are looking to monetize their content. We estimate that the top 20 ad networks will earn approximately $2B+ in revenue in 2007 (~14% of the display ad market) and are growing much faster than the general graphical advertising industry. We estimate ad networks to contribute ~17% of the total display ad market in 2010 (25% F08-F10 CAGR).

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Figure 9: Global Ad Network Market Forecast


$ in millions

6000 5000 4000 3000 2000 1000 0 2005 2006 2007E 2008E 2009E 2010E

Source: ComScore data, Company reports, and JPMorgan estimates

Table 17: Ad Networks by Page Views


millions Advertising.com AdBrite Traffic Marketplace ValueClick 24/7 Real Media Tribal Fusion CPX Interactive Casale Media Network Blue Lithium Specific Media Vibrant Media ContextWeb PrecisionClick Burst Media DRIVEpm Interclick Kontera adconion media group AdDynamix.com Undertone Networks Indieclick Rydium Network Total
Source: ComScore and JPMorgan estimates

August Page Views (M) 72,598.6 28,529.9 25,629.0 22,732.2 13,532.5 10,829.5 9,764.1 9,575.9 5,450.2 5,407.0 5,096.6 5,065.6 4,497.8 3,746.3 2,993.1 1,992.1 1,894.7 943.6 918.3 441.2 175.8 27.3 231,841.3

August Y/Y Growth 56% 901% 321% 64% 104% -4% N/A -59% 211% N/A 168% 122% -52% 26% 140% N/A N/A N/A 264% 734% N/A -52% 77%

The Future of Ad Networks


The ad network space is becoming increasingly competitive as new ventures are launched and as Google, Yahoo!, AOL, and Microsoft enter the space through acquisitions. We believe that differentiation will be key to success. Following are capabilities that we see important to market leadership. Behavioral Targeting We believe that advertisers used to pay for audiences on websites but will now start to pay for specific users. Marketers appear to value targeted advertising as evidenced by Googles well targeted search ads generating RPQs of more than double Yahoo!'s.

Behavioral targeting will increase CPMs and drive volume.

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We expect that this same principal will apply to graphical advertising and note that Revenue Science estimates a 15x CPM premium for behaviorally targeted ads.
Figure 10: 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 ~$10.00 - 12.00

Average CPM Dollars

1000

800 600

6 4

400 200

Traditional optimized ad network $0.50 - 1.00

2 0
1 2

Exchange model potential benefits ~$0.75 - 1.50

20

40

60

80

Web impressions Percent

Source: Revenue Science Presentation

We believe that the development of a non-intrusive video ad delivery system with contextual advertising capabilities will be valued by the ad network space.

Video Capabilities Googles $1.65B acquisition of video sharing site YouTube gives insight into the value placed on video property. Traditional media companies have also moved onto the Internet by offering TV episodes online and with Internet designed webisodes. However, monetization of Internet videos has trailed its growth. Various companies have experimented with pre-roll, post-roll and in-video ads. Google has experimented with in video ads on select YouTube videos in which the ad is overlaid on the bottom 20% of the video soon after it is launched. If the user does not click on it, it simply disappears. Mobile Ads An even younger industry is mobile phone advertising. The development of the iPhone and speculation of Google phone devices or services have placed a growing interest in the field. Performance-based Advertising While many graphical ads were originally used for branding purposes with less of a focus on conversion, the developments in behavioral and contextual advertising have put more pressure on ad networks to deliver conversions. Email Marketing Ad networks have entered the realm of email marketing by placing advertisements in emails sent by other companies to their customers. As in the other categories, ROI is enhanced by careful pairing of the ad with a related company or email content. Email marketing is a preferred method of advertising with its easy trackability and ROI calculation. Furthermore, unlike other advertisements, email is pushed to targeted customers rather than assuming that specific websites will pull these customers to the ad.

Success in mobile ads will be dependent on targeting, nonintrusiveness, and ability to load on slow-loading platforms.

We see payment structures shifting with objectives to include CPA models in addition to CPMs.

We believe marketers will turn to targeted email distribution given its high usage and push vs. pull ad model.

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Ultimately, we believe successful ad networks are going to need to be able to provide a diversity of advertising platforms to its marketers with clear targeting capabilities.

Dominant Portals Role in the Growing Ad Network Market


In our view, potential consolidation in the ad network space is strategically feasible. We believe that consolidation will occur throughout the industry as ad networks grow their user base and leverage user information through behavioral targeting across a larger audience base. We believe large portals are well positioned as it is easier for both advertisers and publishers to fulfill all of their needs on fewer platforms while a consolidated network yields greater leverage of technology and advertiser/publisher relationships. Creating Ad Networks Could be the Answer to an Ever-Fragmenting Audience While portals were once the dominant source of news and information, Yahoo!, AOL and Microsoft only accounted for ~27% of total minutes spent online in October vs. 42% in 2002. A similar trend can be seen in page views as October page views on the top 3 portals declined 22% from October 2004 vs. 22% total Internet growth in page views. We note that some of these losses can be attributed to losses in dial-up subs. We believe portals will become more significant players in ad networks as they turn to networks to grow their user reach, leverage user information through behavioral targeting, and leverage their existing capabilities to sell, place, and analyze display ads.
Figure 11: Total Minutes Spent on Portal in October 2002 and 2007
millions

Minutes spent on portals has declined over the last 5 years despite 37% growth in total minutes spent on the Internet.

60,000 50,000 40,000 30,000 20,000 10,000 0 Yahoo! Sites

43% decline 34% growth 21% decline

Time Warner Network Oct '02 Oct '07

Microsoft Sites

Source: ComScore data and JPMorgan estimates

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Figure 12: Total Page Views for Leading Portals, October 2004 and 2007
millions

45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0

7% decline 54% decline

4% growth

Yahoo! Sites

Time Warner Network Oct '04 Oct '07

Microsoft Sites

Source: comScore data and JPMorgan estimates

If a company had demographic, search query, and web navigation data on a user, we believe it could provide advertising that is more user relevant and could tailor the ads to the user as he/she navigates the web.

User Information Will Lead to Dominance Accurate and rich user information is among an Internet companys most valuable assets. Additionally, the ability to leverage accurate user information to deliver relevant content to users is the key to increasing conversion rates. We think large cap companies are particularly well suited to running ad networks as they can lever their user information with that of the publisher network to provide well targeted advertising. This should increase user conversion and monetization capabilities. A combination between any of the search players, a large publisher network, and a company with behavioral targeting capabilities would make sense, in our view. One Platform for Multiple Advertising Products=Higher Ad Dollar Allocation From the standpoint of an advertiser, advertising campaign management would be easier with a single ad firm offering multiple products (search, graphical, cost-perlead, cost-per-action, in-game advertising, mobile advertising, video). Publishers would benefit from the scale of various advertisers across verticals and the higher CPMs accompanying better targeted ads.

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Figure 13: Online Advertising Services by Company

Service
Search Ad Network Ad Serving*** Traffic Exchange*** Targeting Lead Generation Affiliate Marketing*** Rich Media Mobile Email

AOL

GOOG

MSN

YHOO

***Assumes DoubleClick/Performics acquisition Source: JPMorgan estimates, Company data

Cost Synergies Entering the ad network space would allow large cap Internet companies to lever their existing sales force, technology, and publisher relationships in expanding their product offering. The sales team could expand its offering of graphical advertising to include properties on the ad network. Technology used to place graphical ads on owned and operated properties and for behavioral targeting could be extended for use on network sites. Finally, search network relationships could be leveraged in building the ad network. Scale Is Critical to Build a Market-Leading Product While we have established that the goal of ad networks should be to increase their exposure to an overlapping user base across a variety of properties for targeting, such an undertaking requires scale. Small Companies must choose between generalization across a variety of publishers or going deep into a few verticals. Both options carry risk, as generalization limits targeting capabilities while focusing on limited verticals exposes companies to industry risk (for example, the current mortgage industry weakness). Large Cap Companies, however, have the resources to be both broad and deep, offering targeting capabilities while maintaining diversification of risk.

AOL
Advertising.com revenue growth is not dependent on AOL usage trends Advertising.com has been a major contributor to advertising revenue growth in the past 12 months, driving 43% of ad revenue increase at AOL while accounting for 27% of total advertising revenue. Because its revenue is derived from placing thirdparty advertising on third-party sites, Advertising.com grew mainly through acquisition of new customers rather than through improved monetization of AOL traffic.

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Figure 14: Advertising.com has contributed the largest portion of Y/Y advertising revenue increases
$ in millions

80.0 60.0 40.0 20.0 0.0 Q2-06A 39.0 50.0 40.0 38.0

63.0 50.0

60.0

75.0 51.8 34.0 55.7

74.0

29.0 9.0

35.0

Q3-06A Search

Q4-06A Graphical Ad.com

Q1-07A

Q2-07A

Source: Company reports and JPMorgan estimates.

We think that Advertising.com will continue to grow faster than AOLs search and graphical revenue streams, helped by an industry-wide shift to more targeted adverting, increased CPM due to behavioral targeting added through acquisition of TACODA as well as overall Internet advertising market growth.
Figure 15: We expect Advertising.com revenue to continue growing faster than search and graphical
%

40.0% 30.0% 20.0% 10.0% 0.0% 07E Search


Source: Company reports and JPMorgan estimates.

36.9% 20.1% 13.4% 15.4%

16.5%

18.0%

08E Graphical Adv ertising.com

Acquisition of TACODA Adds Behavioral Targeting Capability We believe that the acquisition of TACODA, a behavioral targeting network, completed by AOL on September 6, 07, makes sense strategically: The deals logic is consistent with our view that improved monetization of nonpremium inventory will continue to gain importance as premium inventory pricing growth is slowing industry-wide. We expect TACODA technology to improve targeting at advertising.com thus driving CPM and helping maintain revenue growth rates.

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Bringing behavioral targeting function in house is a prudent defensive move given recent consolidation, in our view. Recent M&A Activity Intensifies the Competitive Environment As discussed above, we see acquisition of TACODA as a positive strategic development that should help offset potential impact from the recent changes in the competitive landscape, two deals in particular: Acquisition of Blue Lithium by Yahoo! We believe that Yahoo! used advertising.com as well as other networks to monetize its non-premium inventory, relationships that maybe scaled down following the acquisition of Blue Lithium. Furthermore, we expect Yahoo! to combine Blue Lithium with a recently acquired ad exchange, Right Media, and pursue third-party business, thus competing with Advertising.com. Acquisition of Aptimus by The Apollo Group (University of Phoenix Online). The Apollo Group has been the single largest contributor to advertising.com growth. We estimate that it accounted for 73%, 60% and 62% of Y/Y revenue increase in Q3 06, Q4 06 and Q1 07, respectively. Although it's possible that The Apollo Group will re-direct some of the inventory from ad.com to Aptimus, we expect the gains from the integration of TACODA to at least offset any potential impact.

Google
Becoming More than Just a Search Engine and Search Network A latecomer to the display advertising field, Google has made recent strides to enter it and, in our view, would be a likely candidate for building its AdSense network to include display advertising. As the leader in search market share, Google has much information about user preferences for hosting behaviorally targeted ads.
Table 18: Search Market Share, October 2007
millions Core Search Google Sites Yahoo! Sites Microsoft Sites Ask Network Time Warner Network
Source: ComScore

Searches Oct-07 6,151 2,405 1,023 491 443

Search Market Share 59% 23% 10% 5% 4%

Strategic Acquisitions Provide Fast-Paced Industry Entrance Recent acquisitions have positioned it well to quickly gain market share. With the pending acquisition of DoubleClick, Google gains ownership of two key technologies: the DART suite: a comprehensive set of technologies that enable advertisers to effectively manage their online advertising campaigns while providing publishers with the ability to dynamically place ads on their sites. the DoubleClick Advertising Exchange: a platform for buyers to gain immediate access to inventory with goal-based bid rules, defined budgets,
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targeting, and frequency caps on inventory purchases, while sellers increase overall yield by reducing unsold and undervalued inventory DoubleClick has relationships with both publishers and advertisers that enable it to serve hundreds of billions of ad impressions per year. In 2004 (the most recent fullyear data available), DoubleClick served over 800 billion online ad impressions (we expect it will serve ~2 trillion impressions in F07). Beginning with display advertising tests within the AdSense for Content environment, Google has been exploring the serving of graphical advertisements for a couple of years. But we believe the acquisition of DoubleClick emphasizes the importance that Google places on entering the ad network market.
Figure 16: Graphical Ad Market Will Represent 36% of Total in 2010
% of industry revenues

Graphical Adv ertising 36%

Search Adv ertising 64%

Source: JPMorgan estimates, Company Reports, ComScore, Nielsen//NetRatings, IDC, IWS, IAB

MSN
Rich Targeting and Performance-based Advertising Capabilities With the acquisition of aQuantive, Microsoft obtained the DRIVE performance media platform, which provides premium advertising solutions to aQuantive advertisers and agencies. With a selective inventory from only the top 250 publishers, DRIVEpm offers brand protection to its advertisers. The collection of visitor data over several years and CPA payment options allows for behavioral targeting and performance-based capabilities. While the selectivity of the publisher network will likely limit its scale, this premium network will offer a point of differentiation from competitive networks.
Figure 17: DRIVEpm Ad Network
Behavioral Targeting CPA Solution

Top 250 Publishers

Remnant Inventory

DRIVEpm Network

Advertiser and Agency Clients

Source: aQuantive reports and JPMorgan estimates

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AdECN Should Improve Monetization In July, Microsoft announced its intention to acquire AdECN in 1H08. AdECN serves as a hub for ad networks to buy and sell display advertising in a real-time auction marketplace. Advertisers will get more access to inventory to enable better matching to their requirements and increasing ROI. Publishers should be able to increase their yield through increased volume of available inventory. With both parties benefiting, AdECN should provide better monetization through higher CPMs for Microsoft remnant and non-premium inventory. We believe this will be instrumental in monetizing inventory from the Facebook and Digg partnerships. Partnerships Are Growing MSNs Display Reach Outside Its O&O Properties Agreements to provide advertising on Facebook and Digg have expanded MSN's advertising network beyond its owned and operated properties and have allowed MSN to capitalize on the growing social networking trend. Facebook and Digg are two of the fastest growing social networks with Y/Y page view growth well in excess of 100%. The challenge that we believe Microsoft will face will be providing targeting capabilities sufficient to monetize such a diverse user and content base.
Table 19: Partner Page View Growth, August 2007
millions Total Internet FACEBOOK.COM DIGG.COM
Source: comScore data and JPMorgan estimates

Aug-2006 501,260 6,463 4

Aug-2007 474,003 15,260 24

Y/Y Growth -5% 136% 496%

Yahoo!
A Clear Fit in the Ad Network Space Yahoo! is particularly well positioned to provide targeted advertising to a network. As the top-ranked website by unique visitors (according to comScore), Yahoo! has a wealth of information about visitor habits and preferences.
Figure 18: Top Sites by Unique Visitors and % Reach, October 2007
thousands
160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 Yahoo! Sites Google Sites Time Warner Network Microsoft Sites Fox Interactive Media

75%

72%

66%

66% 46%

Source: ComScore data

Yahoo! has made strategic acquisitions to build off its existing assets and to gain dominance in this space.
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Its acquisition of Right Media, in addition to its owned and operated pages, has made it a destination for the buying and selling of inventory. The acquisition of Blue Lithium has provided Yahoo! with behavioral targeting technology, visitor information off its owned and operated sites, advanced analytic reporting, and a sales force more accustomed to direct response sales. These additions should have a smooth integration as Yahoo! already possesses a sales force accustomed to selling display and contextual advertising, has experience with behavioral targeting with SmartAds, and has entered the ad network arena with newspaper partnerships and agreements with eBay and Comcast. The acquisition of Blue Lithium builds on these earlier efforts and has now made it a significant player in the ad network space. Ad Network Growth Yields F08 Revenue Upside Yahoo! has made significant progress in developing its own display advertising partnerships. Most recently Yahoo! announced an agreement to collaborate with Bebo on display and video advertising on the company's U.K. and Ireland sites. Using a $1.00 CPM, 80% TAC and 50% Y/Y page view growth rate, we estimate Yahoo!s net take should be ~$16M. Given the high growth rate and the potential that this partnership could expand to other geographic regions, we think this agreement will yield additional long-term benefits.
Table 20: F'08E Partnership Revenue
$ in millions Company Category Partnership Date 4/30/2007 4/16/2007 4/16/2007 4/16/2007 4/16/2007 4/16/2007 11/20/2006 11/20/2006 11/20/2006 11/20/2006 11/20/2006 11/20/2006 11/20/2006 5/25/2006 9/12/2007 Ave. Monthly Unique Users (TTM) 17.8 6.2 NA 1.9 NA NA 4.0 3.4 16.1 7.2 NA 4.6 2.4 79.8 11.9 PV (last 12 Months through Apr.) 31,690 1,586 NA 288 NA NA 1,242 1,089 4,778 119 NA 1,099 442 129,421 84,012 Estimated Incremental YHOO Revenue 25.4 1.3 NA 0.2 NA NA 1.0 0.9 3.8 0.1 NA 0.9 0.4 59.6 16.4 109.8

Comcast The McClatchy Company Calkins Media, Inc. Media General, Inc. Morris Communications Paddock Publications, Inc. Belo Corp Cox Newspapers The E.W. Scripps Co Hearst Newspapers Journal Register Company Lee Enterprises MediaNews Group, Inc. eBay Bebo Total

Cable Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Online auctions Social Network

Source: ComScore, Company Reports, JPMorgan estimates

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Ad Exchanges: A New Marketplace


Ad Exchanges: A Response to Audience Fragmentation
One of the largest deterrents to the graphical advertising market has been the increase in the difficult to monetize non-premium inventory. Social networking, blogs, photo sharing, and email have all increased inventory levels but are difficult to monetize given their non-targeted user base and lack of focus on ads. Ad Exchanges focus on better monetizing this portion of inventory through aggregation and an open market. While portals were once the dominant source of news and information, page views on the top three portals declined 18% from August 2004 to August 2007 while the total Internet market experienced page view growth of 21% during the same time period. Much of this decline can be attributed to audience fragmentation, a result of increases in non-premium inventory. Blogs, online gaming and social networking websites like Facebook, MySpace and YouTube have been experiencing strong growth in page views, with double- to triple-digit Y/Y growth rates.
Figure 19: Non-Premium Inventory Growth
Billions

Facebook
15.26B Page views, Aug 136% Y/Y Growth

MySpace
45.24B Page views, Aug

YouTube
4.46B Page views, Aug >100% Y/Y Growth

38% Y/Y Growth

Blogs
17.44B Page views, Aug >100% Y/Y Growth
Source: comScore and JPMorgan estimates

Online Gaming
7.52B Page views, Aug 30% Y/Y Growth

We believe that this audience fragmentation hampered the development of the graphical advertising market as it resulted in the following challenges:

Audience fragmentation makes it difficult for advertisers to reach their target audience through only a few publishers Small publishers have difficulty attracting advertisers due to limited scale Monetization is limited due to the difficulty of attracting sufficient advertisers to cover available inventory (purchasing power)

Ad Exchanges have emerged as an efficient solution to these new challenges and are gaining traction to alter the landscape for selling and purchasing display advertising inventory.

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The Rise of the Ad Exchange


The ad exchange is a real time marketplace with an auction-based system where the participants - advertisers and publishers transact on a common platform to purchase and sell online graphical advertising. The publishers place remnant inventory on the exchange for the advertisers to purchase through bidding on a user-friendly interface. Network barriers are lowered and all participants interact on a common platform, while the outside relationships are not disturbed. Ad Exchanges do not compete with ad networks, targeting technologies, or publishers, but rather serve as a more efficient way for the exchange of inventory within these groups.
Figure 20: Ad Exchange Linkages
Bid Optimization Large Publishers Targeting Technologies

Contextual Networks

Ad Exchange

Rich Media Vendors

Agency Side Ad Servers

Display Networks

Other Ad Exchanges
Source: www.clickz.com (Article: Ad exchanges are the future)

Key features of ad exchanges: Transparent and dynamic pricing landscape due to open bidding process Reduced operational friction due to improved clarity of placement of ad serving on a website Enhanced efficiency due to simplification and standardization of business processes Improved liquidity of ad inventory Interests of smaller niche players safeguarded as existing relationships and budget sizes exert no influence and each bidder has equal access to the media Increased role of technology to automate and provide a common platform Elimination of intermediaries and their margins

The Value of an Ad Exchange


For Advertisers: An advertising exchange establishes a transparent and automated clearinghouse, easing pricing concerns. The advertiser can place different bids for each ad impression after evaluation of the perceived value against the buy criteria. Thus, the advertisers gain from:
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Smarter spending Better ROI Access for inventory for targeting purposes For Publishers: The ad exchange model will usher in more competition and enhanced technologies for targeting. This should drive the demand for inventory upwards, resulting in higher CPMs. The publisher can set a floor price for the impressions to be accepted by the exchange and will gain as yields optimize when highest bids win in a real-time auction. The benefits for the publishers are: Better targeting More valuable inventory Higher prices Better yield

Key Takeaways

Exchanges should increase CPMs for publishers as they provide an open auction market to a large population of advertisers Advertisers should gain easier access to a broad range of inventory, which can be used for targeted advertising

The major Internet players should become ad exchange operators as they strive to provide a one-stop solution to all of an advertisers needs

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North America Equity Research 02 January 2008

2008 eCommerce Outlook


2007 saw the standard-bearer of eCommerce, Amazon.com, accelerate revenue growth for a second straight year as the company extended its presence in a variety of categories and geographies. At the same time, we believe the online presence of brick-and-mortar retailers such as Walmart and Target has taken a step forward, with their sites growing penetration. Looking forward to 2008, we expect competition to continue to heat up between online and brick-and-mortar retailers. The biggest unknown is to what extent the US economy sees a slowdown in 08. Even in a slowdown, however, we think online retailers are likely to continue to gain market share from offline retail channels.

2008 eCommerce Forecast


We think US growth in eCommerce (including eBay GMV) could experience weaker Y/Y growth rates if economic conditions worsen. At the same time, we expect a greater proportion of retail sales to continue to shift online, driven by (1) increases in product selection, (2) continued Y/Y improvements for brick-and-mortar retailers and (3) further improved efficiencies from site optimization.
Table 21: 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
Note: includes eBay US GMV

2004 186 104 1.92 2,394 $39.50 94,581 10.0% 85,123

2005 195 117 1.99 2,788 $41.25 114,991 9.0% 104,642 22.9%

2006 203 130 2.08 3,241 $43.00 139,384 9.0% 126,839 21.2%

2007E 211 143 2.10 3,614 $45.50 164,431 8.0% 151,277 19.3%

2008E 217 152 2.23 4,074 $47.50 193,502 8.0% 178,022 17.7%

2009E 222 162 2.40 4,658 $ 48.80 227,321 8.0% 209,135 17.5%

2010E 227 173 2.59 5,363 $49.75 266,808 8.0% 245,463 17.4%

'07 - '10 CAGR 2.5% 6.3% 7.3% 14.1% 3.0% 17.5% 0.0% 17.5%

Source: Department of Commerce, Internet World Stats, company reports, JPMorgan estimates

Worldwide, we are projecting continued strong eCommerce growth. Note that, in 2007, the European growth rate had a ~10% impact from FX. Additionally, though we have assumed flat FX going forward, the projected 08 dollar-denominated growth rate sees a boost as the $/Euro exchange rate at year-end was above the fullyear average. For our international forecast, we expect the following drivers, some region-specific and some general: (1) continued rises in online shopping penetration in Western Europe, (2) continued investments by online retailers in broadening selection, (3) improvements in shipping infrastructure, (4) improved payment systems and (5) better fraud protection.

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

North America Equity Research 02 January 2008

Table 22: Global eCommerce Forecast


$ in millions Global eCommerce Forecast US Europe Asia ROW Total Y/Y Growth 2004 85,123 85,827 29,538 9,440 209,927 2005 104,642 112,139 39,685 13,216 269,681 28.5% 2006 126,839 139,126 50,556 18,502 335,024 24.2% 2007E 151,277 179,226 63,340 25,903 419,745 25.3% 2008E 178,022 224,911 77,899 36,265 517,096 23.2% 2009E 209,135 257,748 94,686 47,144 608,714 17.7% 2010E 245,463 289,966 114,673 61,287 711,390 16.9% '07 - '10 CAGR 17.5% 17.4% 21.9% 33.3% 19.2%

Source: Department of Commerce, Internet WorldStats, UK eStats, Forrester Research, Iresearch, Korea National Statistics Office, eMarketer, company reports, JPMorgan estimates

Large-Cap eCommerce Companies Growing Revenue Faster


Both Amazon and eBay grew revenue at a faster pace than the US eCommerce market as a whole. For eBay, international growth, as well as growth in PayPal, have been key drivers. At Amazon, US revenues have grown faster in the US than internationally, paced by growth in third-party sales and 50% growth in Electronics categories in the first three quarters of F07.
Table 23: eCommerce Industry Comparable Table -- Small and Large Cap Revenue Growth Rates
Market cap in $ millions Ticker ADBL AMZN DIET DSCM EBAY FLWS FTD MELI NAPS NFLX NILE OSTK SFLY STMP Rating NR N NR NR OW NR NR OW NR NR N NR OW NR Price 12/26 $9.02 $92.85 $5.90 $3.37 $34.49 $8.83 $13.30 $72.85 $1.95 $28.70 $74.16 $16.17 $27.38 $12.78 Mkt Cap 12/26 $220 $38,549 $147 $324 $46,683 $556 $383 $3,222 $90 $1,888 $1,190 $385 $675 $253 Y/Y Revenue Growth '04/'05 '05/'06 '06/'07E 84% 30% 32% 23% 26% 35% 18% -9% -40% 11% 4% 8% 39% 31% 29% 11% 17% 26% 10% 6% 39% 84% 62% -53% 103% 40% 35% 46% 21% 20% 24% 28% 63% -2% -1% 54% 47% 48% 62% 37% 3% 29% 32% 24% 31% 29% 32% 29% 32% 22% 22% 23% 20%

AUDIBLE INC AMAZON.COM INC EDIETS.COM INC DRUGSTORE.COM INC EBAY INC 1-800-FLOWERS.COM FTD GROUP INC MERCADOLIBRE INC NAPSTER INC NETFLIX INC BLUE NILE INC OVERSTOCK.COM INC SHUTTERFLY INC STAMPS.COM INC Group Average Large-cap Average Small-cap Average US E-commerce

Source: Department of Commerce, Company reports, Reuters, JPMorgan est. for rated companies, FactSet estimates for other companies. JPMorgan ratings: OW = Overweight; N = Neutral; UW = Underweight

Takeaways from the 2007 JPMorgan Internet Teams 2007 Consumer Survey
In the second half of November, we conducted a proprietary survey of US consumers. The survey had 1,261 participants, residents of the United States aged 18+. In addition to asking consumers about their shopping plans for the 2007 holiday season, we asked the respondents a variety of questions about their online shopping habits in general, and the key broad takeaways are summarized below: Price is biggest factor in choosing a site 63% of shoppers said price was the biggest factor in choosing an online store, with selection also important. Of the options we offered, the least popular one, by a wide margin, was recommendations from friends and relatives.
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Imran Khan (1-212) 622-6693 imran.t.khan@jpmorgan.com

North America Equity Research 02 January 2008

Table 24: Price is paramount: factors that influence buyers choices


% among respondents who indicated they shop online Factor Price Selection Customer service Promotions/Advertisements Payment options Familiarity/experience with store Name recognition Ability to purchase multiple items Access to customer reviews/product information Recommendations from friends/relatives
Source: JPMorgan Internet Team 2007 Consumer Survey

#1 factor 63.0% 11.8% 3.9% 2.2% 2.3% 5.7% 2.7% 4.1% 3.2% 1.3%

#2 factor 13.7% 36.5% 9.1% 7.3% 7.8% 6.2% 6.3% 5.0% 4.6% 3.6%

In top 5 87.1% 74.3% 48.0% 43.4% 42.0% 40.9% 40.0% 37.8% 33.7% 23.1%

Looking at the data on a site-by-site basis does not change the conclusion: price remains the top consideration for shoppers regardless of site, with 60-63% of shoppers at each of Amazon, eBay, Walmart.com and Target.com listing price as their top factor in choosing a site. Higher-income shoppers look for slightly different things in a site. More than 50% of shoppers with incomes over $100K listed familiarity/experience with store as one of their top five factors, compared to below 40% for those earning less than $100K. Selection and the ability to purchase multiple items were more important to those with incomes over $100K, while payment options were less important. Even for the >$100K-income shoppers, price is the biggest factor: fewer respondents in this income category chose it as their #1 factor, but approximately 86% listed it in their top five, in line with the sample as a whole.
Table 25: Familiarity and selection matter more to higher-income shoppers
% of online shoppers who indicated factor was one of their top 5 factors in choosing a site Factor Price Selection Customer service Promotions/Advertisements Payment options Familiarity/experience with store Name recognition Ability to purchase multiple items Access to customer reviews/product information Recommendations from friends/relatives
Source: JPMorgan Internet Team 2007 Consumer Survey

Income <$100K 87.2% 73.6% 48.0% 42.7% 43.7% 39.5% 40.8% 37.1% 34.1% 22.9%

Income >$100K 86.2% 79.7% 48.0% 48.0% 29.3% 50.4% 34.1% 43.1% 30.9% 24.4%

Difference -1.1% 6.1% -0.1% 5.3% -14.5% 10.9% -6.6% 6.0% -3.2% 1.5%

Walmart.com, Target.com catching up to large online sites Third-party metrics indicate eBay and Amazon are the two largest online-only stores in terms of unique users, whereas Walmart.com and Target.com are the two biggest sites belonging to brick-and-mortar retailers. In 06, only Amazon and eBay drew business from at least 30% of our respondents, more than any other sites. For the 07 holiday season, our survey shows no significant change in Amazons and eBays reach, but strong growth for the two largest brick-and-mortar retailers sites, with 20+% increases in respondents planning to use Walmart.com and Target.com. We also saw a significant increase in the number of users expecting to use Circuitcity.com.

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

North America Equity Research 02 January 2008

Table 26: Respondents who used (06) or plan to use (07) specific sites for holiday shopping
Site Amazon eBay Walmart.com Target.com Bestbuy.com Circuitcity.com QVC.com HSN.com 2006 36.9% 30.0% 22.9% 15.3% 17.9% 9.1% 6.3% 4.5% 2007 36.2% 28.4% 27.8% 19.9% 18.6% 12.0% 5.9% 4.7% Y/Y difference significant? No No Yes, up 21% Y/Y Yes, up 30% Y/Y No Yes, up 31% Y/Y No No

Source: JPMorgan Internet Team 2007 Consumer Survey. Statistical significance at a p<.01 level.

Media, Apparel top categories Books, music and video were the top category, with nearly 66% of online shoppers reporting they had bought such items online within the past year. Apparel and accessories, at 57% penetration, was second, tilted predominantly toward female shoppers. Unsurprisingly, men were much more likely to shop in both the Computers and VideoGames category and the Electronics category.
Table 27: Media items popular with both genders: Top five categories among men and women
%, among respondents who indicated they shop online, that indicated they had made purchases in category Men Books, music, videos and other media Computer and videogames software and hardware Apparel and accessories (includes shoes, handbags and jewelry) Electronics (includes television and stereo equipment) Health and beauty 63.7% 51.4% 46.5% 36.1% 24.3% Women Books, music, videos and other media Apparel and accessories (includes shoes, handbags and jewelry) Health and beauty Computer and videogames software and hardware Toys 67.0% 64.2% 38.2% 32.7% 32.2%

Source: JPMorgan Internet Team 2007 Consumer Survey

Younger users shop online more, and gap is widening Among online shoppers, 29% of those aged 18-41 did more than 40% of their holiday shopping online in 06, and 39% expected to do so this year. Among those aged 42+, the respective numbers were 17% and 20% for 06 and 07.
Figure 21: Expectation of money spent shopping online, holiday season 07 vs. 06
% among respondents who indicated they shop online

Ages 18-41
More, 43% About the same, 40% Less, 16%

More, 17%

Ages 42+

About the same, 51% Less, 31%

Source: JPMorgan Internet Team 2007 Consumer Survey

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

North America Equity Research 02 January 2008

Internet Sales Tax: Likely Not on the Horizon in the US


In May 2007, Senator Mike Enzi (R-WY) reintroduced a bill designed to allow states to collect sales tax from online sellers with revenues of $5M or more. The states must agree to certain terms to simplify their sales tax regulations in order to take advantage of the bill. JPMorgans Senior Vice President for Government Relations, Tom Block, believes that this bill does not have a significant chance of passing in the foreseeable future. While offline retailers and state governors have lobbied for rules such as this, voting for this bill could be construed as a tax increase, and Block thinks that makes passage of the bill a non-starter, especially in an election year.

Catalysts for International Growth


We believe the rising tide of increased Internet use across the world is likely to help lift eCommerce globally. However, we see three key challenges to overcome for eCommerce to fulfill its potential: Improvement of shipping infrastructure. Postal and parcel service in many parts of the world can be unreliable, and a reliable distribution channel is an essential prerequisite for the growth of eCommerce. Improved payment systems. This is not a world-wide challenge, but rather a slew of country-specific challenges related to the idiosyncrasies of different countries banking systems and conventions. Even in more developed countries, significant differences emerge: e.g., Germany and Austria have seen much lower rates of PayPal use than other eBay geographies due to the prevalence of bank transfers as a mode of payment there. We note the August 2007, announcement that Alibabas Alipay service will allow shoppers in China to buy products from non-China-based sellers in a variety of foreign currencies. We think such developments will eventually lead to a more fluid, interconnected global eCommerce market.

Table 28: PayPal Penetration on select eBay country sites


% of listings that include PayPal Country Canada US UK Australia Spain Italy France Germany Austria Penetration 97.1% 95.5% 95.4% 72.1% 70.3% 67.8% 66.3% 33.5% 23.3%

Source: eBay.com (and country sites), JPMorgan estimates, data collected September - December, 2007

Better fraud protection. The promise of eCommerce has been one of lower prices and/or better selection, with the trade-off that many purchases must be made sight-unseen. 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. (An example is eBays PayPal, which provides up to $2K in fraud protection in the US to create

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North America Equity Research 02 January 2008

buyer confidence, with transaction loss rates for the PayPal unit of 25-33 bps, as denominated by total payment volume). 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.

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

North America Equity Research 02 January 2008

2008 Online Travel Outlook


In 2007, online travel agency companies continued to face slowing US growth due to a maturing market and increased competition from suppliers and have come to rely more heavily on growth from Europe. The companies in our coverage universe continue to pursue their international growth strategies and have begun to position themselves in the Asian market. Looking to 2008, we expect to see the following dynamics shape the online travel agency space: (1) acceleration of domestic growth as GDS air revenue declines are anniversaried, (2) increased dependence on international growth, (3) a focus on developing Asian markets as European markets mature, (4) higher sales and marketing costs due to keyword inflation, and (5) investment in customer service, technology and processes.

Online Travel Market Should Continue to Grow


US Online Travel Estimates We believe US online travel growth in 2008 will be driven by: (1) increased travel volume, (2) increased prices, particularly in hotel bookings where demand continues to exceed supply, and (3) to a lesser extent, increased online vs. offline travel booking. Our updated market forecast calls for F08 online travel gross bookings of $90.4B, representing Y/Y growth of 9.5%. We are estimating domestic online travel gross bookings to grow at a CAGR of approximately 7.5% through 2010.
Table 29: US Online Travel Market Projection
$ in millions Average Price Total Trips Total Travel Spend % online Online Travel Spend Average Price Growth Total Trips Growth Total Travel Spend Growth Online Travel Spend Growth 2004 272.6 1,953.3 532,400.0 9.8% 52,400.0 2005 287.1 1,992.4 572,100.0 11.0% 62,800.0 5.3% 2.0% 7.5% 19.8% 2006 302.2 2,032.2 614,200.0 12.0% 73,400.0 5.3% 2.0% 7.4% 16.9% 2007 317.3 2,072.9 657,808.2 12.6% 82,600.0 5.0% 2.0% 7.1% 12.5% 2008E 331.6 2,114.4 701,157.8 12.9% 90,449.4 4.5% 2.0% 6.6% 9.5% 2009E 343.2 2,146.1 736,583.8 13.2% 97,229.1 3.5% 1.5% 5.1% 7.5% 2010E 350.1 2,178.3 762,585.2 13.5% 102,949.0 2.0% 1.5% 3.5% 5.9% 2007-2010 CAGR 3.3% 1.6% 5.0% 2.4% 7.5%

Source: JPMorgan estimates, PhoCusWright, eMarketer, Jupiter, and TIA

International Online Travel Estimates Consistent with last year, many US companies are looking abroad to supplement slowing US growth. We believe international online travel growth in 2008 will be driven by (1) continued growth in online vs. offline bookings in Europe and Asia, (2) increased inventory placed online, (3) international acquisitions to facilitate market inroads, (4) continued investments in international operational infrastructure, (5) increased broadband penetration in Europe and Asia, and (6) increased prices and volumes.

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

North America Equity Research 02 January 2008

Our updated forecast calls for F08 European online travel gross bookings of $59.5B, representing Y/Y growth of 18%. We estimate that European online travel gross bookings will grow at a CAGR of approximately 16% through 2010.
Table 30: Europe Online Travel Forecast
$ in millions Average Price Total Trips Total Travel Spend % online Online Travel Spend Average Price Growth Total Trips Growth Total Travel Spend Growth Online Travel Spend Growth 2004 621.3 1,423.1 884,210.5 2.8% 25,100.0 2005 627.3 1,480.0 928,421.0 3.6% 33,500.0 1.0% 4.0% 5.0% 33.5% 2006 642.0 1,552.0 996,333.0 4.2% 41,900.0 2.3% 4.9% 7.3% 25.1% 2007 652.9 1,629.6 1,063,934.2 4.7% 50,300.0 1.7% 5.0% 6.8% 20.0% 2008E 662.0 1,694.8 1,121,982.4 5.3% 59,465.1 1.4% 4.0% 5.5% 18.2% 2009E 668.6 1,762.6 1,178,530.4 5.9% 69,533.3 1.0% 4.0% 5.0% 16.9% 2010E 675.3 1,833.1 1,237,928.3 6.3% 77,989.5 1.0% 4.0% 5.0% 12.2% 2007-2010 CAGR 1.1% 4.0% 5.1% 9.9% 15.6%

Source: JPMorgan estimates, PhoCusWright, eMarketer, Jupiter, and IPK International

Our updated Asian F08 forecast calls for online travel gross bookings of $43.6B, representing Y/Y growth of 35%. We estimate that Asian online travel gross bookings will grow at a CAGR of approximately 30% through 2010.
Table 31: Asia Online Travel Forecast
$ in millions 2004 Asia Online Travel Sales Y/Y Growth Rate 12,100.0 2005 15,900.0 31.4% 2006 22,300.0 40.3% 2007 32,300.0 44.8% 2008E 43,600.0 35.0% 2009E 56,600.0 29.8% 2010E 70,800.0 25.1% 2007-2010 CAGR 29.6%

Source: JPMorgan estimates, PhoCusWright, eMarketer, and Jupiter

This adds up to an F08 global online travel forecast of $193.5B, which is a 17% increase from 2007. Our forecasted CAGR through 2008 calls for 15% growth.
Table 32: Global Online Travel Forecast
$ in millions 2004 US Online Travel Sales Y/Y Growth Rate Europe Online Travel Sales Y/Y Growth Rate Asia Online Travel Sales Y/Y Growth Rate WW Online Travel Market Y/Y Growth Rate 52,400.0 2005 62,800.0 19.8% 25,100.0 33,500.0 33.5% 12,100.0 15,900.0 31.4% 89,600.0 112,200.0 25.2% 2006 73,400.0 16.9% 41,900.0 25.1% 22,300.0 40.3% 137,600.0 22.6% 2007 82,600.0 12.5% 50,300.0 20.0% 32,300.0 44.8% 165,200.0 20.1% 2008E 90,449.4 9.5% 59,465.1 18.2% 43,600.0 35.0% 193,514.4 17.1% 2009E 97,229.1 7.5% 69,533.3 16.9% 56,600.0 29.8% 223,362.3 15.4% 2010E 102,949.0 5.9% 77,989.5 12.2% 70,800.0 25.1% 251,738.5 12.7% 14.9% 29.6% 15.6% 2007-2010 CAGR 7.5%

Source: JPMorgan estimates, PhoCusWright, eMarketer, Jupiter, TIA.org, and IPK International

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

North America Equity Research 02 January 2008

Easing Domestic Comps but Keeping Market Share is Key


Air Monetization Should Stabilize Throughout 2006 and 2007, online travel agency domestic growth suffered as GDS renegotiations resulted in significantly lower commissions on air tickets. Early reports of negotiated agreements directly with suppliers indicated the establishment of variable compensation tied to the value delivered to the supplier. 2008 should bring the first year of flattish comparisons on this new compensation structure, resulting in slightly easier domestic comps. However, we note that intense competition from suppliers may put further pressure on pricing. Priceline has decided to completely eliminate its domestic booking fees on air tickets. While Expedia and Orbitz do not currently plan to follow suit, the increased competition may further pressure their future volume or pricing strategies.
Figure 22: Domestic Revenue as a Percent of Gross Bookings Trends at the Top 4 OTAs
14.5% 14.0% 13.5% 13.0% 12.5% 12.0% 11.5% 2004
Source: Company reports and JPMorgan estimates.

2005

2006

2007E

The effect of the air commission reduction can be seen by viewing trends in domestic revenue growth vs. gross bookings growth at the top 4 online travel agents. Note that in 2006 and 2007E, revenue as a percent of gross bookings declined 40 bps each year. For F08E, we are modeling more flattish revenue as a percent of gross bookings. Preserving Market Share Will be Key The domestic online travel market is entering maturity with the percent of bookings online expected to increase only 30 bps in 2008. As a result, domestic online travel growth should only slightly exceed the total travel market (6.6% Y/Y growth expected for the travel market, vs. 9.5% estimated Y/Y online travel growth). With this expected declining growth rate, market share would become key in determining company sales increases.

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

North America Equity Research 02 January 2008

Figure 23: Domestic Online Gross Bookings by Type

2006
Total OTA Gross NonOTA Gross Bookings 58% Bookings 42%

2008E

Total OTA Gross Bookings 40%

NonOTA Gross Bookings 60%

Source: PhoCusWright, Company Reports, and JPMorgan estimates

We believe that online travel agents will continue to lose market share to hotel and airline suppliers. As a result we are modeling OTA gross bookings growth of 7.8% in F08, slightly below the estimated 9.5% Y/Y growth for the online travel industry. We expect suppliers and other non-OTA sellers to grow 10.7% Y/Y in F08.

Our Proprietary Research Results


Price is King in Booking Decisions The JPMorgan Internet Team completed a survey of over 1,200 U.S. residents in November to determine Internet usage behavior. We discovered that, of the participants who book travel online, 81.9% listed price as the most important factor in making booking decisions. 94% of participants who book travel online listed price as the top 3 most important factors for deciding where to book travel. The second most important criteria in booking decisions was the number of hotel and airline options available (57.7% of participants who book travel online listed this option as one of their top 3 factors in deciding with whom to book travel). Least important factors in online booking decisions were customer service and the availability of a rewards program, which only 20.0% and 31.2% of participants who book online selected as one of their top 3 factors in deciding where to book their travel.

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

North America Equity Research 02 January 2008

Figure 24: Most Important Factor in Determining Where to Book Online Travel
% of participants who book travel online

7% 3% 2% 2% 4%

82% price av ailability of a rew ards program ease of use


Source: JPMorgan research

# of hotel/airline options customer serv ice customer rev iew s

Online Travel Sites are Used Extensively for Research Purposes 61% of respondents visit two or more travel websites to research prices and offerings before booking a trip. Of participants who book travel online, Expedia appears to be the most popular vendor with 37.8% of respondents having booked a trip through the company in the last 12 months. Combined with participants who booked trips on Hotels.com and Hotwire, 70.9% of participants who book trips online did so through Expedia properties. Travelocity came in second with 26.5% of participants who book trips online using them in the last 12 months. 23.0% of respondents who book online used Orbitz in the last 12 months.
Figure 25: Percent of Online Booking Respondents Who Have Made a Purchase on Site in Last 12 Months
Other Yahoo! Trav el Trav elzoo Trav elocity Priceline Orbitz Kay ak Hotw ire Hotels.com Ex pedia Cheap Tickets 0.0%
Source: JPMorgan Research

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

We Still See Much Room for Growth in Online Travel Surprisingly, over half of our respondents (55.1%) book less than 25% of their travel online. In fact, 34.6% of respondents do not book any of their travel online. Only 26.8% of respondents booked more than 75% of their travel online. We believe that this demonstrates additional room for growth for online travel companies from customers migrating online from offline sources in the U.S.

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

North America Equity Research 02 January 2008

However, our thesis that suppliers pose a threat to online travel agent market share seems to have been supported by our survey results. Of respondents who book trips online, 39.9% of respondents stated that they preferred to book flights directly from the airline while 45.3% of respondents stated that they preferred to book rooms directly from the hotel of their choice. 25% of respondents booking flights online and 23% of respondents booking hotels online stated that they had no preference in where they booked their trips. Given the stated priorities of our participants, we believe that pricing differences will be a key driver in their decision of where to book their trip. Package offerings do not appear to attract purchases with 38.1% of respondents who book online stating that they prefer to book hotel and air travel separately and 31.9% of respondents have no preference.

International Expansion Integral to OTA Growth


We expect this theme from 2007 to continue into 2008. As a result of GDS commission reductions and increased competitive pressure from suppliers on the domestic front, we believe that movement into international markets is critical to the success of OTAs in driving both top-line and bottom-line growth. We believe that international markets yield revenue as a percent of gross bookings margins almost double those of the US because the OTA services are more valued by suppliers abroad who find it difficult to market their inventory in multiple languages across Europe and Asia. Furthermore, we believe that international suppliers are less of a threat to OTAs as they tend to be smaller independent hotels that would have a difficult time achieving the scale necessary to move online booking in house. Europe is Starting to Mature; Companies Establish an Asia Presence While still a high-growth area, European online bookings growth is beginning to slow as the market enters maturity. For F08 we are projecting online bookings growth of 18.2% (vs. 20.0% in F'07) due to a 60 bp increase in online vs. offline bookings and a 5.5% increase in total European travel spend. Asia markets have become more attractive to OTAs. We are projecting F'08 Asia online bookings growth of 35% to $43.6B. We expect that many OTAs will grow faster than the market rates as they increase inventory on their sites, expand into new markets, and make strategic international acquisitions.
Figure 26: 2007 Estimated European Market Share
Ex pedia 17% Others 40% ebookers 7%

Lastminute (Trav elocity ) 17% Opodo 9%


Source: PhoCusWright, Company Reports, and JPMorgan estimates

Priceline 10%

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

North America Equity Research 02 January 2008

Rising Expenses Likely with Expansion and Market Share Retention Efforts
Sales & Marketing Spend Necessary to Support Market Share Retention We expect that sales and marketing expenses will increase as a percent of revenue as (1) online travel agents invest more heavily in offline marketing mediums such as TV and (2) as increased competition for online marketing inflates keyword pricing. We expect this to be especially prevalent with companies focused on international expansion as we believe online advertising is the key means of marketing. Using Nielsen adRelevance data, we believe that ad spend on domestic graphical ads increased approximately 48% over the last four quarters at the top four online travel agencies. During the same period, we note that the average revenue increase at these same four OTAs was only 10%.
Figure 27: Domestic Graphical Ad Spend vs. Revenue Growth at Top Four OTAs
millions

30 25 20 15 10 5 0 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 Total Rev enue 2Q07 3Q07 Graphical Ad Spend
Source: Nielsen//NetRatings and JPMorgan estimates

1,500 1,000 500 0

Expansion Efforts Likely to Be Supported by Technology Spend We think that global expansion efforts will likely result in companies investing more heavily in technology platforms to support growth. Additionally, companies may enhance their website and offer additional customer features or services in order to differentiate their product and grow market share. Orbitz Worldwide is in the process of rolling out Project Austin, which will provide a single, global, centrally managed platform. This should provide more scale for coding and consolidation of supply operations, accounting, customer service, and data center operations. Expedia has completed the first phase of a new platform that will allow the company to leverage the daily warehouse and make improvements in terms of merchandising, CRM, and segmentations. In 2008, the company plans to migrate different parts of sites onto the new platform and to enhance the data warehouse. We expect technology investment to be a theme in 2008.

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

North America Equity Research 02 January 2008

Table 33: Top Worldwide Travel Sites by Unique Visitors


thousands Total Internet : Total Audience Travel Expedia Inc Travelport Yahoo! Travel Priceline.com Incorporated Travel Ad Network TUI Group Travelocity Vueling Airlines ViaMichelin Lastminute.com Sites Southwest Airlines Co. SNCF InterContinental Hotels Group Hilton Hotels Deutsche Bahn About.com Travel Air France-KLM Group MSN Travel Kayak.com Network Marriott Aug-2007 791,338 301,118 62,427 28,038 24,901 19,743 11,561 14,384 13,313 8,782 13,178 14,770 9,104 6,191 7,408 6,991 5,563 5,996 5,452 4,589 6,662 7,094 Sep-2007 797,836 290,081 56,938 25,396 22,351 17,224 14,881 14,379 13,433 9,549 11,148 11,009 8,705 5,819 6,672 6,605 5,713 5,025 5,849 5,452 5,961 6,251 Oct-2007 804,546 293,713 56,228 25,525 23,223 16,571 15,344 14,214 13,263 10,432 10,052 9,972 9,419 7,381 6,765 6,670 6,649 6,563 6,519 6,422 6,268 6,264

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Source: comScore and JPMorgan estimates

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Online Photo Market Outlook


Digital Camera Penetration Continues to Grow
Digital camera penetration continues to grow at a strong rate. We estimate that 73% of American households now own a digital camera. This is up from IDCs estimate of 49% in 2005. We expect digital cameras to continue to increase penetration, although at a slower rate and we are currently forecasting 81% penetration by 2010.
Figure 28: Increasing Digital Camera Penetration
100% 80% 60% 40% 20% 0% 2005 2007 2010 49% 73% 81%

Source: Shutterfly, IDC, InfoTrends, JPMorgan Internet Team 2007 Consumer Survey, JPMorgan estimates

In addition to increasing digital camera penetration, we believe there are several key trends that will drive growth in the digital photo and online printing markets: (1) Digital camera owners take more photographs (2) Consumers purchase higher-quality digital cameras (3) Consumers upload more photographs on the web (4) Consumers seek more efficient and user-friendly photo printing technologies (5) Consumers will buy more personalized photo product, such as greeting cards, photo books and calendars.

As there is no cost associated with taking digital photographs, people are more apt to point and click with higher frequency.

People are taking more photographs and spending money to develop them
From 2003 to 2005, the average number of pictures taken per month by a digital camera owner nearly doubled. As there is no cost associated with taking digital photographs (unwanted photographs can be deleted to free up storage space), people are more apt to point and click with higher frequency (vs. the replacement and processing cost associated with traditional film).. According to our 2007 Consumer Survey, approximately 29% of digital camera users take more than 50 photographs in a month. People are also spending to print their photos, with 35% having spent over $50 in the past year developing their digital photos.

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Figure 29: Number of Pictures Taken by Digital Camera Users, per Month
%
101-125 3% 76-100 8% 51-75 11% 26-50 23% 126 + 7% 0-25 48%

Figure 30: Money Spent Developing Digital Prints, during the Past Year
%
50.0 40.0 30.0 20.0 10.0 0.0 $0-$24.99 $25-$49.99 $50-$74.99 $75-$99.99 $100$124.99 $125$149.99 $150+ 23.4 14.1 7.5 7.8 2.0 3.6 41.7

Source: JPMorgan Internet Team 2007 Consumer Survey Source: JPMorgan Internet Team 2007 Consumer Survey

People are buying higher-resolution cameras


Whereas, in 2005, cameras with resolutions of six megapixels (MP) or more accounted for less than a quarter of manufacturers shipments, by 2008, estimates indicate that 95% of units will have 6MP or greater. As camera quality improves further, we believe home printing solutions will continue to become less attractive to consumers, and commercial processes capable of presenting the quality of the digital image captured by better cameras will continue to grow in popularity. Additionally, as digital camera penetration grows, the devices will likely be in the hands of people who are less technology savvy than the earlier adopters. We believe these users will be attracted to commercial printing solutions, such as online photo providers and local merchants, because of their ease of use.
Table 34: Digital Camera Shipments Breakdown by Quality
Percent of shipments 5MP or fewer 6MP or more 2005 75.7% 24.3% 2006E 40.5% 59.5% 2007E 18.0% 82.0% 2008E 14.0% 86.0% 2009E 10.0% 90.0% 2010E 5.0% 95.0%

Source: IDC, 2005, NPD, JPMorgan Estimates

Digital camera owners use online photo services for sharing and storing photos
As broadband penetration continues to increase and online photo sharing becomes more mainstream, we expect the percentage of consumers uploading their photos to the Internet to increase. Additionally, we believe consumers will find online photo storage an attractive backup option for their photographs as the quality of digital cameras (and therefore photo quality and size) continues to increase. According to our Consumer survey, 31% of users with a digital camera downloaded their photos to an online photo service.

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Figure 31: Percentage of Digital Camera Owners Who...


%
Order prints o nline - have pho to s mailed Order prints o nline - pick up at sto re Emails pho to s directly to peo ple Do wnlo ad pho to s to an o nline pho to service

16.1% 21.0% 47.1% 31.0% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

Source: JPMorgan Internet Team 2007 Consumer Survey

We expect more people to develop photos outside the home


In addition to the old retail model of in-store drop-off and pickup, consumers also have the option of printing photos at home or uploading photos to online photo websites and ordering prints through the mail. As digital camera penetration increases, we believe online services, whether providing in-store pickup or mail order delivery, will prove to be the most convenient medium for people to store, enhance, print, and share their photographs.
PMA Marketing Research estimates indicate that by 2009 more than 70% of digital prints produced in the US will be printed outside the home.

Early on in the digital camera revolution, at-home printing was the printing format of choice. However, over the last few years, the introduction of self service retail kiosks and online photo websites has provided viable and less expensive alternatives. PMA Marketing Research estimates indicate that by 2009 more than 70% of digital prints produced in the US will be printed outside the home.
Figure 32: Digital Photo Printing Trends
Billions of prints

20 15 10 5 0 2.4 1.2 3.4 4.4 2005 4.6 4.9 2006 Home


Source: PMA Marketing Research

3.7 6.1 5.5 2007E Retail Online

4.7 6.9 5.5 2008E

5.5 7.5 5.4 2009E

Between 2004 and 2006, the percentage of people printing the photos they wanted to save nearly doubled, from 19% to 36% (InfoTrends). In 2006, the online share of total digital prints purchased was approximately 20.2% (including in-store pickup orders placed online), up from 13.3% in 2005. We expect online market share to continue to grow as more users share photos online.
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Figure 33: Number of Images Saved & Printed vs. Just Saved
Billions

35 30 25 20 15 10 5 0

9.5 5.5

11.8 7.4

13.7 9.5

15.9

18.0

10.7

11.6

2005

2006 Images Sav ed & Printed

2007E

2008E

2009E

Images Sav ed, but Not Printed

Source: PMA Marketing Research

Photo products create growth opportunity for online photo printers


We expect the personalized products category (personalized greeting cards, photo books, etc.) to be an area of growth for online photo providers during the next couple of years. Despite the strong trends we are seeing in digital camera penetration and the increase in photos printed using online sources, personalized photo product penetration remains low. According to our survey, only 11% of the respondents purchased photo greeting cards and only 8.2% purchased photo books. We expect penetration to improve during the next couple of years as users continue to shift to online photo services and new products become available to customers. According to PMA Marketing Research, spending on personalized photo products is expected to increase to $1,240M in 2008 from $694M in 2006.
Figure 34: Low Penetration Leaves Room for Growth in Personalized Photo Products
%
12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Photo Greeting Cards Photo Calenders Photo Books Personalized T-shirts 11.0% 7.6% 8.2% 7.5%

Figure 35: Growth in Spending on Photo Products/Gifts


$ in millions
1,400 1,200 1,000 800 600 400 200 0 2004 2005 2006 2007E 2008E 270 462 694 951 1,240

Source: JPMorgan Internet Team 2007 Consumer Survey

Source: PMA Marketing Research

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2008 Online Payment Outlook


2007 proved to be a strong year for online payment platforms. PayPal saw thirdquarter growth accelerate as the Merchant processing business saw particularly strong growth, Amazon entered the payment foray with its Amazon Payment offering and Google Checkout is still viable. Revolution Money is trying to revolutionize money management with its new money transfer service and credit card offering. In Latin America, Mercadolibre has seen strong growth in its payment business and is rolling out direct payment features starting in Chile. We expect trends to remain strong in 2008 helped by: Continued strength in global e-commerce growth, helped by increased global broadband penetration. The growing acceptance of payment solutions on third-party platforms, including travel sites. Increased P2P money transfers, driven by the growing remittance market and increased micro-lending. Increased use of mobile money transfer platforms should help drive revenues for those with a presence in the market, such as PayPal and Amazon Payment (through its relationship with Textpayme). Increased fee generation as platforms look at adding deferred payment plan options, which are particularly attractive in developing markets.

Key Highlights from 2007


This past year was a successful one for online payment companies. Both PayPal, which benefited from strength in its Merchants business, and MercadoPago, Mercadolibres Latin America Payment platform, saw growth accelerate in the third quarter of 2007. Some key events in 2007: PayPal launched a toolbar features that allows users to shop at any site that accepts MasterCard. The toolbar automatically populates the credit card information with a randomly generated credit card number. Amazon launched its Amazon Payment service and now requires all third-party sellers on its Marketplace and Auction platforms to offer it as a payment option. Steve Case entered the online payment business helping to fund Revolution Money, an online payment portal and credit card company. MercadoPago launched a direct payment version and began offering services to third-party sellers, beginning with a roll-out in Chili. Alipay began offering Chinese shoppers the ability to purchase merchandise from overseas web sites.

Global e-commerce growth expected to remain strong


We expect online payment portals to benefit from strong e-commerce growth in 2008 in both the U.S. and global markets. While we expect the overall retail environment
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in the U.S. to remain weak, we expect online retailers to benefit from the continued shift of retail dollars online, driven by (1) increases in product selection, (2) continued Y/Y online sales improvements for brick-and-mortar retailers and (3) further improved efficiencies from site optimization. Our international forecast is driven by (1) continued rises in online shopping penetration, especially Western Europe, (2) continued investments by online retailers in broadening selection, (3) improvements in shipping infrastructure, (4) improved payment systems and (5) better fraud protection.
Table 35: JPMorgan Global E-commerce Projections
$ in millions Global eCommerce Forecast US Europe Asia ROW Total
Source: JPMorgan estimates.

2004 94,581 85,827 29,538 9,440 219,385

2005 114,991 112,139 39,685 13,216 280,031

2006 139,384 139,126 50,556 18,502 347,568

2007E 164,431 179,226 63,340 25,903 432,900

2008E 193,502 224,911 77,899 36,265 532,577

2009E 227,321 257,748 94,686 47,144 626,899

2010E 266,808 289,966 114,673 61,287 732,735

'07 - '10 CAGR 17.5% 17.4% 21.9% 33.3% 19.2%

Global remittance market is expected to grow 10.9% in 2008


Celent estimates that over $311B in 2007 was transferred in the global remittance market, and global remittance is expected to grow at a 10.2% CAGR between 2000 and 2008. The mobile global population and the desire to send money back to family have led to the strong growth in remittance. The United Nation estimates that about 3% of the world's population, or roughly 175M people, is migrant, with the stock of immigrants to high-income countries growing at 3% per annum between 1980 and 2000. With about 31% of the population in developing countries under the age of 14, vs. 14% in developed countries, global migration is expected to remain robust. The World Bank highlights two drivers behind the expected strong migration trends through 2025. They include: 1. The labor force in high-income countries is expected to decline. The World Bank expects the labor force in high-income countries to peak near 500M in 2010, then fall to 475M by 2025. This would lead to 100 workers supporting 111 dependents, compared to less than 100 today. As a result, there would be greater demand for workers in the labor force. Developing countries can supply the needed labor. With a large population under the age of 14, and higher birth rates, the developing world is expected to supply 1B workers by 2025, many of whom would migrate to higher-income countries to meet their labor demands.

2.

These workers likely would continue to send money back to their country of origin. According to the World Bank's base-case scenario, new migrant workers could earn as much as $481B more in real (after-tax) income in high-income countries than they would have if they stayed in the developing countries. A large portion of this excess wealth would likely find its way back to the migrant worker's country of origin through remittance channels.

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Figure 36: Global Remittance Receive Trends


$ in billions

400 350 300 250 200 150 100 50 0 2000


Source: Celent

159

167

183

213

233

256

281

311

345

2001

2002

2003

2004

2005E

2006E

2007E

2008E

PayPal Remains the Dominant Player


According to our proprietary survey, 55% of online shoppers use PayPal, compared to 6% who use Google Checkout and 7% who use Amazon Payment. While the sample is small, 57% of those who used all three payment services preferred PayPal. Credit cards remain the preferred method for online shoppers with 83% stating that they use credit cards to make online purchases.
Table 36: Preferred Online Payment Providers for Users of PayPal, Google Checkout and Amazon Payments
Number of Respondents 16 21 39 2 Preferred Service GOOG AMZN Checkout Payments 2 3 4 8 2

Services Used PayPal, Checkout & Payments PayPal and Checkout PayPal and Payments Checkout & Payments
Note: Survey of 1,261 Internet Users

PayPal 9 16 30 -

Other 2 1 1 -

Source: JPMorgan Internet Team 2007 Consumer Survey

Figure 37: Payments Methods Used by Online Shoppers


% of respondents who stated they shop online

100.0% 80.0% 60.0% 40.0% 20.0% 0.0%

83.5% 54.8%

6.2%

7.0%

5.8%

Credit Card

Pay Pal

Google Checkout Amazon Pay ment

Other

Source: JPMorgan Internet Team 2007 Consumer Survey

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Online Payment Providers Offer a Viable Alternative to Other Payment Options


Users are still driven to online payment options despite strong satisfaction with credit cards PayPal, as well as Amazon Payment and Google Checkout, have been able to make inroads into the online retail business despite 89% of online shoppers who use credit cards rating their experience as either excellent or very good. Users of online payment services also seem to be content with credit cards with 92% of PayPal and Amazon Users rating their experience with credit cards as either excellent or very good and 91% of Google Checkout users experiencing the same level of contentment.
Figure 38: Online Shoppers' Satisfaction with Credit Cards for Users of Online Payment Services
% of online shoppers who use the selected payment option

70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0%

65.9% 47.6% 41.0% 50.1% 41.7% 25.0% 10.1% 1.3% Ov erall Ex cellent 7.5% 0.7% Pay Pal Very Good 9.1% 0.0% Google Checkout Satisfactory

61.9%

30.2% 4.8% 3.2% Amazon Pay ment

Needs Improv ement

Source: JPMorgan Internet Team 2007 Consumer Survey

Given the high level of satisfaction with credit cards, we find it remarkable that penetration of online payment services is so high. We believe that the online payment services offer users security and ease of use advantages over credit cards, including eliminating the need to enter credit card numbers. Extending beyond e-commerce shoppers, online retailers can benefit from lower total transaction costs and P2P users benefit from lower costs and the added security benefit from not having to share personal financial information, such as bank account numbers.
Figure 39: Online Payment Providers Simplify the Payment Process
Traditional payment structure Merchant Payment gateway provider Merchant bank
Source: JPMorgan.

PayPal payment structure Merchant Consumer

Consumer Card issuer processor Card-issuing bank

Merchant bank

Consumer bank

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The young and wealthy are more likely to use online payment providers
According to our proprietary survey, higher-income online shoppers, those earning more than $75K per year, are more likely to use both credit cards and online payment options. Almost 15% of those earning less than $25K/year selected other as the preferred choice, with most people in that group using money orders.
Figure 40: Online Payment Option Use by Income
% of respondents who stated they shop online

100.0% 80.0% 60.0% 40.0% 20.0% 0.0%

81.8% 54.6%

88.5% 55.2%

4.3% 6.0% 7.4% Less than $75K Credit Cards Pay Pal Google

11.5% 10.0%

1.1%

More than $75K Amazon Other

Source: JPMorgan Internet Team 2007 Consumer Survey

Younger users, those between 18 and 33 years old, were the most likely to use online payment methods, with 64% stating they use online payment services. However, usage by 34 to 49 year olds was also strong, at 61%, and 60% said they used PayPal, more than any other age group. Only 47% of those over 50 years old used online payment services, with 88% stating they used credit cards, higher than any other age group. We expect usage of online payment services to increase as younger people age and move to higher-earning income brackets.
Figure 41: Online Payment Option Use by Age Group
% of respondents who stated they shop online

100.0% 80.0% 60.0% 40.0% 20.0% 0.0% Credit Cards Pay Pal Google Checkout Amazon Pay ment 18-33
Source: JPMorgan Internet Team 2007 Consumer Survey

Other

34-49

50+

Key Features of Current U.S. Online Payment Providers


PayPal PayPal expanded its availability in 2007 to include airlines such as Southwest and Northwest, and is offered by thousands of merchants around the world. PayPal offers
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North America Equity Research 02 January 2008

a money market account for deposits, financing options and P2P money transfers. While a majority of PayPal's volume still takes place on eBay's site, its Merchant business is growing at a faster rate. We expect 2008 to be another strong year for PayPal as it grows its international and Merchants business and are forecasting transaction volume to increase 24.2% Y/Y to $61.36B.
Table 37: PayPal Fee Structure
Description Fee for a buyer to make a purchase Fees for specific actions Open an Account Send Money Withdraw Funds Add Funds Receive payments funded by PayPal Balance, PayPal Instant Transfer or PayPal eCheck Receive payments funded by Credit Card, Debit Card or Buyer Credit Personal Account Free Free Free Free for bank accounts in the US Free Free 4.9% + $0.30 USD (limit of 5 transactions per 12 month period) for domestic or U.S. transactions 2% + applicable Fees for cross border payments 4.9% plus $0.30 USD for card payments received using PayPal on Skype Exchange rate includes a 2.5% fee Free Free Free for bank accounts in the US Free 1.9% to 2.9% + $0.30 USD 1.9% to 2.9% + $0.30 USD Premier/Business Account

Multiple Currency Transactions


Source: www.paypal.com

Exchange rate includes a 2.5% fee

Amazon Payments Amazon rolled out its Amazon Payments Service in 2007 and now requires all thirdparty sellers on its Marketplace and Auctions platform to offer it as a payment option. Amazon Payments offers P2P money transfer options and has teamed up with Textpayme to offer mobile services. Amazon Payments is also integrated with Amazon Web Services to help developers create e-commerce sites.
Table 38: Amazon Payments Fees
Fees to send payments Sending Payments Fees to receive payments (by payment method) Bank Account Credit Card International Credit Card Amazon Payments stored funds
Source: payments.amazon.com

Fees No fees less than $0.05 2% of T V + $0.05 5% of T V + $0.05 6% of T V + $0.05 20% of T V, minimum fee of $0.0025 $0.05 to $9.99 2% of T V + $0.05 5% of T V + $0.05 6% of T V + $0.05 1.5% of T V + $0.01 $10.00 and more 2% of T V + $0.05 2.9% of T V + $0.30 3.9% of T V + $0.30 1.5% of T V + $0.01

Google Checkout Google Checkout is now available on hundreds of Internet retail sites. Google Adwords advertisers are offered discounted processing rates. Google Checkout does not currently offer P2P money transfer services.

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Table 39: Google Checkout Fees


Description Fees to use Google Checkout to process sales AdWords advertisers, will also be eligible for free transaction processing for some or all of the Google Checkout sales each month.
Source: www.google.com

Fee 2% + $0.20 per transaction. For every $1 spend on AdWords each month, advertiser can process $10 in sales the following month for free through Google Checkout.

Revolution Money Revolution Money was started in 2007 and offers a low fee credit card, Revolution Card, and a P2P money transfer platform, RevolutionMoney Exchange.
Table 40: Revolution Money Fees
RevolutionCard Transaction Description FEE Integrates credit, stored value, prepaid and loyalty card NO interchange fees functionality. Cardholders can activate RevolutionMoneyExchange functionality to their card account, which allows users to transfer money to other customers for free*. Cost to Accept RevolutionCard RevolutionCard only charges 0.50% (50 bps) of the transaction value per transaction for processing. Where is it accepted Currently being rolled out in the US, not available internationally Account registration Free Register for an Account Add Money electronically from Bank Account Send Money Receive Money Request Money Withdraw Money electronically to Bank Account Withdraw Money by Check Paper Statement Returned ACH Fee Overdraft Fee Stop Payment on a Check
Source: www.revolutionmoney.com

RevolutionMoney Exchange

Free Free Free Free Free Free $2.50 per check $5.00 per statement $35.00 per returned ACH $35.00 per overdraft $20.00 per check

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2008 Social Networks Primer


Key Takeaways
Runaway growth continued in 2007. Of the major sites, Facebook posted the most impressive growth, with user minutes worldwide multiplying more than six-fold, according to comScore data. Not a fad a technology that solves users problems. 2007 showed even the strongest doubters that there is very strong demand by users for the kind of interaction offered by social networks. We believe the sites gains in usage share, partly at the expense of email sites, demonstrate user needs are being better met. One question for 08: Will older users sign up? Our proprietary survey indicates 70% of users aged 18-41 use social network sites, and only 22% among those aged 42 or older. Privacy concerns overstated. Internet users have consistently demonstrated a willingness to trade information for features they find useful. So long as sites do not overreach, we expect this trend to continue, with yesterdays outrage becoming tomorrows hot feature (please see p. 68 for a more nuanced discussion).

Growth still very strong in 2007


The growth of social networks in 2007 was very strong, with Facebook in particular really coming into its own. For the three months ended October, US unique users to Facebooks site were up 125% Y/Y, while time spent on the site rose 157%. By October, 18% of all US Internet users visited Facebook, compared to less than 9% a year prior. Facebooks 18% penetration remained a far cry from MySpace, which saw almost 40% of US Internet users visit its site that month. Globally, the growth picture is even more drastic. In terms of growth in users worldwide, Facebook paced the competition with a 397% Y/Y growth rate. MySpace, Orkut, Bebo, Friendster and Hi5 all grew their unique users at least 35% Y/Y.
Table 41: Social Networks users are growing fast, and user time is growing even faster
Y/Y growth in August-October 07 vs 06; six largest sites worldwide in terms of minutes spent Worldwide Users, Y/Y Minutes, Y/Y 36% 33% 397% 558% 57% 65% 75% 160% 135% 276% 43% 187% Users, Y/Y 25% 125% 66% 56% 85% 4% US Minutes, Y/Y 17% 157% 95% 359% 198% 76%

Myspace Facebook Orkut Friendster Bebo Hi5

Source: comScore Networks, JPMorgan estimates

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Meet the big six


Based on minutes spent in the second half of the year (as measured by comScore), the following six sites are the largest social networking sites in the world: MySpace. Launched August 2003, the site was acquired by News Corporation in July 2005. MySpaces user base tends to tilt somewhat toward teens, and is more US-based than the audience for any of the other big six. Also popular with musicians and bands. Facebook. Launched February 2004, the site remains independent but in October 2007, drew a $240M investment from Microsoft, which acquired a 1.6% equity stake. Microsoft also sells ads on Facebook. The site became open to non-academic users in September 2006. Orkut. Launched by Google in January 2004. The site has not taken off significantly in the US, but is quite popular in Brazil as well as India and Pakistan. Friendster. Launched March 2003. In the US, the site has faded somewhat after being an early leader in the space, but it remains quite popular in Southeast Asia. Bebo. Launched January 2005. The site is popular in the UK and other English-speaking countries, including Ireland, as well as in Poland. In 4Q07, announced a partnership with AOL for integration of instantmessenger software. Hi5. Launched 2003. The site, though based out of the San Francisco Bay Area, maintains a base of popularity in Latin America, as well as some Asian countries.

Technology that fits a customer need


We think much of the success of social networks is attributable, at heart, to the fact that they provide a superior technology for filling users social needs more efficiently. In our 2007 Consumer survey, over 80% of social network users indicated that they use the sites to keep in touch with friends.
Table 42: Users overwhelmingly lean on social networks to keep in touch
% among users of social network sites; respondents could choose multiple answers Function Keep in touch with friends Reconnect with old friends Share photographs Meet new people with similar interests Share Music/Find new music To plan social events Play games Career networking
Source: JPMorgan Internet Team 2007 Consumer Survey

% choosing 80.1% 47.7% 36.8% 34.7% 17.8% 17.5% 11.6% 9.0%

When it comes to filling this user need, we believe social networks have two key competitive advantages over alternative methods of keeping in touch:
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News feeds. A news feed is a feature that enables users to see updates on their friends lives, and vice versa, without needing to specifically contact each other. As any social network user updates his/her profile, those updates become visible to that users circle of friends. Built-in spam filter. The promise of email is that anyone can contact you, and that has also become its curse. Many proposed spam solutions have focused on attempting to verify that the person contacting you is a friend, but social networks have a built-in verification system that allows one to ensure that the bulk of communication is from confirmed friends.

We think it is not coincidental that, at the same time that social networks have shown significant Y/Y usage growth, the number of minutes users devote to email has declined:
Table 43: comScore data indicates user time spent on email sites is declining Y/Y
Minutes of usage in millions Aug-Oct '06 47,132 32,862 13,150 4,179 113,241 Worldwide Aug-Oct '07 44,230 28,739 12,488 7,494 106,144 Y/Y -6% -13% -5% 79% -6% Aug-Oct '06 23,651 10,290 12,208 1,084 50,082 US Aug-Oct '07 20,828 8,786 11,796 2,136 46,481 Y/Y -12% -15% -3% 97% -7%

Yahoo! Mail Windows Live Hotmail AOL Email Google Gmail All email sites

Source: comScore Networks, JPMorgan estimates

High User Engagement


Social network sites excel in their ability to keep users on the site: comScore data indicates that, on the six biggest social networking sites in the world, users spend an average of 7 minutes per day, a number that has grown Y/Y.
Figure 42: Average time per user is growing on social networking sites even as it shrinks for email
Average minutes spent on site, per user per day

10.0 8.0 6.0 4.0 2.0 0.0

7.7 6.1 6.5

7.2

Aug-Oct '06 All email sites


Source: comScore Networks, JPMorgan estimates

Aug-Oct '07 Top six social netw orks

Survey results: older users remain on the sidelines


Our November 2007 proprietary survey of consumers Internet usage patterns reinforced the idea that social networking sites remain primarily the province of younger users. 89% of users aged 18-25 reported that they visited a social
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networking site at least once a month, while less than a quarter of users 42 or older went to such sites.
Figure 43: Younger users more likely to visit social network sites
% of users, in each age group, that reported visiting a social networking site at least once per month

100% 80% 60% 40% 20% 0%

89% 74% 53% 25% 20%

18-25

26-33

34-41 Age

42-49

50+

Source: JPMorgan Internet Team 2007 Consumer Survey

Further, we would note that our survey did not include users younger than 18, an age group that, on the whole, tends to be a very heavy user of social networking sites.

Privacy concerns overblown


Many social networking sites, especially Facebook, have faced public criticism for their use of user information. Whether or not these criticisms have merit, from an operational standpoint we believe concerns about privacy are unlikely to hamper the growth of sites. We think history suggests that users are willing to give up incremental information in exchange for features they find useful. Additionally, we think the history of the rollout of news feeds on Facebook is extremely instructive: In September 2006, when the feature was first introduced, it was met with an uproar from users who cited concerns about privacy. In response, Facebook emphasized that users have the ability to opt out of the feature. A year later, the news feed is one of the central aspects of the Facebook interface, and other sites, including MySpace and LinkedIn, have added similar features. We believe such flare-ups are likely to re-occur. Nevertheless, we believe the track record of social sites development suggests users have a strong desire for expression and for an avenue to share what is going on in their lives and the desire to share is stronger than the desire to hide. Features that meet users need for expression are likely to catch on, in our opinion, even if they carry with them an incremental erosion of users privacy.

Eventually, the CPMs will move up


Social networking sites, as a general rule, have not been able to command very high advertising rates for their page view inventory. Indeed, we believe the arrival of a significant quantity of bulk page-view inventory from social networks contributed to stagnant graphical ad CPMs for much of the last years. As time goes on, however, we believe social networks will develop better targeting and monetization of their page view inventory. Given the wealth of personalized
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information available to the sites, there are powerful avenues for improved monetization, although the technology remains fairly nascent. Large Internet and media companies have not been shy about making their presence felt in the social space, both through acquisitions and through advertising deals, such as Googles $900M partnership with MySpace and Microsofts relationship and small ownership stake in Facebook.
Table 44: Large Internet Companies Investments in and Partnerships with Social Sites
Date January, 2004 3/12/2005 5/18/2005 6/20/2005 7/19/2005 8/7/2006 8/23/2006 11/17/2006 12/20/2006 12/30/2006 1/9/2007 2/27/2007 2/27/2007 5/30/2007 6/1/2007 8/1/2007 9/14/2007 9/28/2007 10/4/2007 10/7/2007 10/9/2007 10/24/2007 Acquirer Google Yahoo! Inc Google Yahoo! Inc News Corp Google Microsoft Yahoo! Inc IAC/ Interactive corp Yahoo! Inc Yahoo! Inc IAC/ Interactive corp IAC/ Interactive corp eBay Google Disney Yahoo! Inc Google Time Waner GE and Microsoft Google Microsoft Target Launch of Orkut Ludicorp Research, the owner of Flickr ($40M) Dodgeball Yahoo! acquires Blo.gs. Intermix (including MySpace) ($580M) Fox Interactive Media Enters Into Agreement with Google Inc. Microsoft Signs Agreement to Show Ads on Facebook Bix.com Ilike.com del.icio.us Mybloglog Edodo.Com Netclub Stumbleupon Inc ($75M) Feedburner Inc ClubPenguin ($350M) Buzztracker.Com Zingku AOLs AIM and Bebo to offer seamless integration Newsvine Inc (acquired by MSNBC Interactive News) Jaiku Ltd Facebook (Microsoft acquired a 1.6% stake for $240M) Description Social Network site Photo-sharing site A social networking software provider for mobile devices. RSS aggregator Social Network site Advertising deal Advertising deal Interactive contests Music sharing for SN sites Website sharing blog communities service Dating site in China Dating site in France Website sharing RSS feed distribution. Virtual world Popularity-based news Photo sharing for mobile phones A global partnership to deliver AIM to Bebo users Popularity-based news Social Networking software for mobile phones

Source: Company reports, news reports

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2008 Virtual Online Worlds Primer


Key Takeaways
The market is in its infancy, so 08 should bring continued rapid growth. Due to increased awareness, continued product innovation, and faster Internet connections, we think the short-term portends significant usage growth for virtual worlds. We are bullish on sites for children. Virtual worlds present parents an opportunity to let their kids play online and interact in a closed environment that is perceived as safe, especially when sites are operated by companies with trusted brands. We think sites aimed at adults have yet to prove mainstream appeal. Adults have much more freedom than children to choose other avenues of social interaction. As such, while short-term growth should remain robust, we think that, in their current form, virtual worlds aimed at adults are unproven in their ability to achieve meaningful mainstream penetration over the long term.

Two Audiences, Two Differing Growth Curves


With investments by major media companies, virtual worlds have been making news for several years. Most recently, Disney purchased Club Penguin in July 07 for as much as $700M, and throughout the year there has been a steady flow of news stories, both positive and negative, regarding virtual world sites, primarily Second Life. We believe that virtual worlds are still in the very early stage of their growth, and as such have the capacity to grow very rapidly in the near future. However, we think the market is ultimately one that should be seen as consisting of two parts virtual worlds for children, and ones for adults with diverging longer-term growth prospects. We think virtual worlds for kids are a product with strong promise, and one that could achieve mainstream status in coming years. To the contrary, we think that virtual worlds aimed at adults face greater challenges. We think it is telling that virtual worlds have proven successful among kids, who have limited social options, and in places such as Finland, where external factors such as climate may limit users offline social options. As such, we think the ability of virtual worlds (as distinct from video games, which target a different, more male demographic) to achieve mainstream penetration has not yet been proven.

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Figure 44: In the US, virtual worlds for kids have a much bigger audience
Average monthly US unique users in millions, Aug-Oct '07

7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0

6.1

Virtual Worlds for kids 5.0 4.3

Virtual Worlds for Adults

2.0 0.5

WebKinz

ClubPenguin

Neopets

IMVU

SecondLife

Source: comScore Networks, JPMorgan estimates

Some Terms, Defined


What is a Virtual World? Two other definitions are important: Social Network: a site that allows users to form connections with others. Sites that are considered social networks will generally consist of profiles intended to represent the user more or less faithfully. Examples: MySpace, Facebook. MMORPG: (stands for Massively Multiplayer Online Role Playing Game) a game that creates an opportunity for users to interact with each other and with an immersive game environment. Prominent examples: World of Warcraft, EverQuest. Virtual world: these sites straddle a middle ground between social networks and MMORPGs, offering social functions in an immersive world. Some examples of virtual worlds include Second Life, Gaia Online, ClubPenguin and Neopets.

A virtual world creates an immersive environment for users to interact with each other, but the emphasis is not chiefly on gameplay, as in a MMORPG. Rather, the focus is on interaction with other users in a social way, and often on personalizing a users VW presence, called an avatar, or personalizing the avatars surroundings and possessions.

How Do They Make Money?


Most virtual worlds operate on one, or a combination, of three models: advertising, subscription revenue and the sale of virtual goods whether virtual currency to be used inside the world, or improvements to a users avatar. As the worlds mature, especially in those aimed at adults, advertising may play a larger role, although we think the exact look and feel of VW ads will likely change before we see a significant influx of revenue from external advertisers.

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Challenges to an advertising-supported virtual world model: Kids and pre-teens a key market. Although some childrens sites have used sponsorships and ads as a revenue stream, we believe parents who oversee their kids browsing may be leery of strongly commercial sites, especially for younger kids. Hard to control environment. The free nature of many virtual worlds means many sites have adult content that mainstream advertisers may not be comfortable appearing next to. Issues of scale. Some companies have set up a presence on Virtual Worlds, esp. Second Life, that must be continuously overseen by an employee whose avatar interacts with visitors. The investment of time may not pay off if traffic is too low, and such a presence does not scale well. High site engagement. If users are highly immersed in an online environment, their lower response to call-to-action advertisements is unlikely to generate attractive CPMs.

Virtual Worlds for Kids and Teens


Audience Is Growing eMarketer estimates that nearly 4 out of 5 US teens will be online in 2008, and projects a 25% 2007-2011 CAGR in the number of kids aged 3-17 visiting virtual world sites.
Figure 45: More than half of kids expected to visit Virtual Worlds in 2011
Users in millions

25 20 15 10 5 0 2006 2007 2008 2009 2010 2011

60% 50% 40% 30% 20% 10% 0%

Kids 3-17 Visiting VW sites


Source: eMarketer, September 2007

% of Kids 3-17 Visiting VW sites

We believe there is considerable cause for optimism in terms of kids adoption of these sites, for several reasons. Captive Audience One key reason, and a differentiating factor between kids worlds and ones for adults, is that kids entertainment options are severely constrained, compared to those of adults. The successful kids sites are those that can give children a degree of freedom and interactivity, while assuring parents that their kids are in a safe environment.
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Major Media Brands Are Investing Two major media companies, Walt Disney and Viacom, have made significant investments in the Virtual World space, exemplified most recently by Disneys purchase of Club Penguin.
Table 45: Major Media Companies' Forays into VW space
Company The Walt Disney Co. Viacom
Source: Company releases

Date June '03 July '07 June '05 Jan. '07

Event Launched Toontown Online Acquired ClubPenguin for $700M ($350M + $350M earnout) Acquired NeoPets for $160M Launched Nicktropolis

In the area of trust, we think the big media companies have an advantage, with established brands that parents are already familiar with. At the same time, any site aimed at kids is going to be subject to the whims of a fickle audience. As such, we think media companies are likely to remain open to acquiring sites that generate significant viral traffic.
Table 46: Summary of Virtual Worlds Aimed at Kids and Teens
Site BarbieGirls ClubPenguin CyWorld Gaia Online Habbo Hotel Millsberry NeoPets Webkinz Whyville Owner Mattel Disney SK Telecom Private Sulake (Finland) General Mills Viacom GANZ Private Target Audience Young Girls Kids Teens, 20's Pre-teens and teens Teens Kids Kids Kids Kids Business Model Toy Sales, Subscriptions Subscriptions Virtual Goods Virtual Goods, ads Ads and Virtual Currency Product Promotion Premium Memb., Ads, Virtual Items Toy Sales Ads Geographic Base US, WW US, WW Chiefly: Korea US, WW Europe, WW US WW US US Aug-Oct 07 avg. monthly UU 3.4M 10.3M 14.8M 2.0M 6.3M 2.4M 7.5M 5.9M 0.1M Y/Y User Growth N/A 152% N/A 195% 23% 11% 20% 545% 22%

Source: Company sites, comScore Networks, JPMorgan Estimates User statistics are based on worldwide usage as tracked by comScore.

Virtual Worlds for Adults


Whereas virtual world sites aimed at children are starting to gain significant traction, the marketplace of sites aimed at adults remains in a much earlier phase of development. E.g., Second Life, often touted as representative of the mainstreaming of virtual worlds, had 0.2% penetration of US Internet users in 10/07, according to comScore data. As such, the site could grow traffic five-fold or even ten-fold and still retain a somewhat limited reach.

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Table 47: Summary of Virtual Worlds Aimed at Adults


Site ActiveWorlds IMVU Kaneva SecondLife There.com Business Model Subscriptions, Hosting Premium Accounts, Ads Ads, Virtual Currency Subscriptions, Virtual Goods and Virtual Currency, Ads Premium Accounts Geographic Base US, WW US, WW 70+% US 75% Outside US US, WW Aug-Oct 07 avg. monthly UU 0.1M 4.9M 0.7M 2.3M 0.2M Y/Y User Growth 181% 71% 365% N/A 0%

Source: Company sites, comScore Networks, JPMorgan Estimates User statistics are based on worldwide usage as tracked by comScore.

Not Just a Toy for Men Virtual worlds interactivity and social aspect differentiates them from MMORPGs such as World of Warcraft, both in terms of usage and in terms of the demographics they attract. And while Second Life seems to attract more male users, a site like IMVU, with its focus on the social aspect, actually has a higher percentage of users who are female, according to comScore metrics.
Figure 46: While Warcraft attracts men, a site like IMVU tilts female.
100% 80% 60% 40% 20% 0% World of Warcraft Second Life Male
Source: comScore Networks, JPMorgan estimates comScore data for October 2007, Worldwide user base. Warcraft and Second Life based on application users.

26%

38%

54%

50%

74%

62%

46%

50%

IMVU Female

My Space

Challenges Second Life, in particular, has generated a significant amount of publicity over the past year, both positive and negative. The site has been very aggressive in signing up corporate sponsors, with companies such as IBM, Cisco, Toyota, Mazda and dozens of others setting up a presence in the world. The site has also generated negative attention due to gambling (banned after an FBI investigation) and adult content. While we do not believe these issues present an existential threat, we think they are unlikely to go away, as world designers must navigate a narrow path between a total free-for-all and a site where usage regulations become too restrictive, significantly affecting the site experience and user growth.

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The Mobile Ad Market


One-third of the Worlds Population Are Mobile Subscribers
The mobile market is a large and quickly growing industry with an estimated 2.2B mobile subscribers worldwide growing at an estimated pace of 23% Y/Y. Given this level of reach, we think this medium would be attractive to advertisers. A quick comparison to broadband penetration demonstrates this point. We estimate that 67% of Americans are mobile phone subscribers while only 57% have broadband subscriptions.
On a worldwide basis, 33% of the population has mobile subscriptions vs. 4% with broadband subscriptions

We believe that this disparity is even greater in developing countries. In China, for example, our estimates indicate there are approximately 30% mobile subscribers per 100 persons but only 4% broadband subscribers per 100 people. On a worldwide basis, 33% of the population has mobile subscriptions vs. 4% with broadband subscriptions. In short, this medium offers advertising brands very large reach in marketing their products. Please see Table 1 on the following page for a breakdown of subscription rates by country.

Mobile Ads Offer Targeting and Relationship Capabilities


Traditional advertising forms offered limited targeting capabilities. Advertisers would select specific television programs, newspaper sections, or magazines that attracted a certain demographic and then hope that some of those viewers were searching for their product. Targeting capabilities were much better with the Internet. Search marketing offered the opportunity to pair an advertisement with a person searching for information on that specific product. Display advertising is improving so that ads can now be targeted to consumers based on previous sites they have visited. In all cases, the ads were typically pushed onto the consumer.
Figure 47: Traditional Advertising Methods Consumer Behavior: Watch The Food Network
Consumer Behavior: Search for wine

Advertiser Response: Show ad for for general food products


Source: JPMorgan

Advertiser Response: Show ad for popular red wine brand

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Table 48: Mobile and Broadband Penetration by Country


millions Country
Egypt Morocco South Africa Africa China Hong Kong India Indonesia Japan Malaysia Pakistan Philippines South Korea Taiwan Thailand Vietnam Asia Pacific Austria Belgium Czech Republic Denmark Finland France Germany Greece Hungary Italy Netherlands Norway Poland Portugal Romania Russia Spain Sweden Switzerland Turkey Ukraine United Kingdom Europe Iran Israel Middle East Canada Mexico United States North America Australia New Zealand Oceania Argentina Brazil Chile Colombia Peru Venezuela South America World Wide

Population (M)
71.4 30.7 47.6 914.3 1,323.7 7.1 1,119.7 225.5 128.2 25.8 157.0 84.5 48.0 22.8 64.8 85.3 3,693.0 8.2 10.4 10.2 5.4 5.3 60.7 82.7 11.1 10.1 58.1 16.3 4.6 38.5 10.5 21.6 142.5 43.4 9.1 7.3 74.2 46.0 59.8 813.1 69.1 6.4 190.0 32.4 108.3 299.7 439.0 20.4 4.0 33.2 39.1 188.9 16.5 46.3 28.4 27.2 461.8 6,544.4

Broadband Subs BB Subs per 100 Mobile Subs per (M) Persons Mobile Subs (M) 100 Persons
0.1 0.3 0.2 2.9 47.0 1.5 2.0 0.5 24.2 0.7 0.1 0.1 12.8 4.4 0.3 0.3 99.6 1.5 2.0 1.0 1.6 1.3 11.1 12.4 0.3 0.8 8.0 4.7 1.1 2.0 1.4 0.4 2.1 5.9 2.1 2.0 2.1 0.1 11.6 72.4 NA 1.5 3.8 7.2 3.0 56.5 66.6 3.5 0.5 4.0 1.1 4.9 1.1 0.5 0.4 0.4 9.7 259.1 0.1 1.0 0.5 0.3 3.6 21.6 0.2 0.2 19.0 2.7 0.1 0.2 26.1 19.2 0.5 0.4 2.7 17.8 19.5 9.4 29.1 25.0 17.7 15.1 2.8 7.9 13.8 28.5 24.7 5.3 12.8 1.8 1.5 14.6 22.7 25.9 3.0 0.2 19.1 9.0 NA 23.5 2.0 21.5 2.7 18.8 15.2 17.3 11.7 11.8 2.7 2.6 6.8 1.1 1.5 1.6 2.6 3.9 13.6 16.0 39.7 193.8 461.1 9.4 166.1 63.8 101.7 19.5 34.5 42.9 40.2 23.2 40.8 15.5 1,073.3 9.3 9.7 12.1 5.8 5.7 51.7 84.3 11.1 10.0 71.5 15.8 5.0 36.7 12.2 17.4 150.0 46.2 9.6 7.4 52.7 49.1 69.7 797.6 13.7 8.4 63.6 17.0 57.0 201.7 275.7 19.8 3.5 24.1 31.5 99.9 12.5 29.8 8.5 18.8 282.3 2,710.4 19.1 52.1 83.3 21.2 34.8 131.5 14.8 28.3 79.3 75.5 22.0 50.8 83.8 102.0 63.0 18.2 29.1 112.8 92.6 119.0 107.3 107.8 85.1 101.9 99.6 99.0 123.1 97.2 108.6 95.5 116.0 80.5 105.2 106.4 105.9 102.1 71.0 106.7 116.4 98.1 19.4 122.7 33.5 52.5 52.6 67.3 62.8 97.0 87.6 72.6 80.5 52.9 75.6 64.3 30.0 69.0 61.1 41.4

Source: CIA Government Stats (http://www.cia.gov/cia/publications/factbook/index.html), International Telecommunications Union (http://www.itu.int/ITU-D/ict/statistics), JPMorgan estimates.

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Multimedia and interactivity create a relationship with the customer.

Mobile advertising has the potential to offer even more specific capabilities. Local search advertising overlaid on map applications could become key as users want information on the nearest restaurants, hotels, and entertainment. Application providers will likely amass much user information as cell phone owners download ringtones, games, and wallpaper, sign up for stock quotes and news headlines, and participate in social networking activities. Additionally, the ad format could move from a one-way message directed at the user to an interactive multimedia means of communicating with potential customers. Mobile advertising could eventually make use of the following tools: SMS MMS Web Search Game For example, a wine brand could create an interest group with a WAP site for viewing recipes and wine pairings, wine tasting dates, making purchases, and communicating with others connoisseurs.
Figure 48: Potential Mobile Ads for Customer Interested in Wine
Brands offer dinner music ringtone downloads and recipes with links to appropriate wine pairings

Applications Video Cell TV Broadcast TV

Invite friends to join club

Email questions about wine and food pairings

Wine store sends texts about local wine tastings


Source: JPMorgan

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Can Mobile Ads Achieve the Internet Ad Growth Curve?


While Internet ad spend growth rates remain very strong, they have begun to stabilize as the industry has become more established. Many Internet companies are now looking for the next medium to sustain their top-line growth.
We are estimating an ~80% 4year CAGR with mobile marketing spend reaching $13B by 2011, putting it in what we view as the very beginning stages of the Internet ad growth curve.

Strategy Analytics is forecasting that advertisers will spend $1.4B globally on mobile media this year. If mobile advertising follows a similar trajectory to Internet advertising, the medium could mean the next wave of growth to online ad companies. We estimate that Internet advertising has grown at a 25% CAGR over the past 5 years globally. Currently, we are estimating an ~80% 4-year CAGR with mobile marketing spend reaching $13B by 2011, putting it in what we view as the very beginning stages of the Internet ad growth curve.
Figure 49: Comparison of Global Search, Graphical, and Mobile Growth Curves
$ in millions

40000 35000 30000 25000 20000 15000 10000 5000 0 2001 2002 2003 2004 Search 2005 2006 Graphical 2007E 2008E 2009E 2010E

Mobile

Source: Company reports, JPMorgan estimates, Strategy Analytics, eMarketer, ComScore, Nielsen NetRatings, IDC, IWS, and IAB.

Table 49: A Comparison of Online and Mobile Advertising


Targeting User Information Format Bandwidth Standardization Online Advertising high targeting through search; less in graphical and video ads user information primarily obtained through cookies high text, video, and imaging capabilities high bandwidth available very standardized Mobile Advertising very targeted especially on a geographical basis great deal of user information direct from customer low formatting abilities given phone quality low; dependent on carrier dependent on phone and carrier

Source: JPMorgan research and company reports

Domestic Market Overview


While we believe the market is clearly attractive for its size, reach, targeting and multimedia capabilities, monetization of the space will likely be more difficult than the Internet. Following is a discussion of the key issues that we believe online advertising companies will face as they try to gain share in the space. Mobile Carrier Control Having learned a lesson from watching Internet service providers miss benefiting from online ads, we believe mobile operators will be careful to make sure that they
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get a good slice of the mobile advertising pie. As a result of this, they have created a somewhat walled garden in their mobile portals where operators have better control over the flow of mobile ads and the revenue they generate.
Mobile carriers control what software, services, and applications will be available on mobile phones.

Recently, we have seen Internet companies partner with operators in revenue sharing agreements. For example, Yahoo! and Rogers Communications just announced a partnership for Yahoo! to deliver their Go 2.0 and oneSearch products across wireless customers in Canada. Another notable partnership was the iPhone arrangement between Apple and AT&T. While AT&T allowed Apple to develop an ongoing relationship with customers through its iTunes platform, AT&T was named the exclusive domestic mobile provider of iPhones. We believe that more partnerships will be developed but that mobile carrier control has somewhat hindered mobile innovation due to the lack of scale developers can achieve. Google has approached the control issue differently with its entry into the 700 MHz spectrum auction. Partly as a result of Google's lobbying efforts, the FCC ruled that the C Block of spectrum would be limited open access (open devices and open applications) if a minimum bid of $4.6B was met. In December, Google officially announced its intention to participate in the FCC auction scheduled to start January 24th. If Google is successful, it is in the position to operate a wireless network itself or to help it build one and potentially resell wireless services. Device and Network Capabilities Until the advent of the iPhone, cellular devices were not well designed for web browsing and messaging use. Small screen size prevented easy viewing. Small keyboards demanding multiple taps to get the letter desired made messaging difficult.

Complex user-interfaces, small screens, and slow loading browsers have limited mobile feature use.

Navigation to various features required multiple clicks and complexity for many people. Slow-loading browsers and networks make mobile web navigation reminiscent of PC capabilities over a decade ago. As a result of this, US uptake of various features has been limited. In a survey by NPD Group, only 13% of Americans had mobile access to their email, 12% had mobile Internet access, and 39% used text messaging features.
Figure 50: U.S. Mobile Feature Usage
100% 80% 60% 40% 20% 0% Mobile email Internet access from handset Tex t Messaging Instant Messaging

Source: NPD Group and JPMorgan estimates

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User Reaction Consumers consider cell phones a highly personal device and it is not clear how they would react to having advertisements delivered through it. Some advertisers may fear reactions similar to those to email spam and telemarketer calls.
Consumers may have a negative reaction to mobile advertising.

We believe that in order for advertisers to successfully use this medium, they must deliver clear value to consumers. This could take many forms, including: Free or reduced-priced mobile service Additional services or applications provided by the advertiser Ads targeted to a specific and immediate need Opt-in/out features Whatever the method, we believe advertisers must be sure not to alienate the customer and his/her privacy in marketing endeavors.

International Markets Are More Attractive


While U.S. adoption of mobile services outside of phone use has been low, international users have embraced the technology.

The U.S. Trails International Markets in Mobile Services Adoption While U.S. adoption of mobile services outside of phone use has been low, international users have embraced the technology. In Japan, 85% of cellphone owners have mobile email and 78% access the Internet from their handset. Over 66% of Japanese mobile phone owners use PDA functions on the device.

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Figure 51: Mobile Feature Use in Japan and the U.S.


Watch TV on Mobile Phone Video Messaging Instant Messaging Digital Music Play er Tex t messaging Picture messaging Play mobile games Dow nload graphics/screensav ers PDA functions Dow nloading ringtones Internet access from handset Mobile email 0% 10% 20% 30% Japan
Source: NPD Group and JPMorgan estimates

40% US

50%

60%

70%

80%

90%

Although mobile feature usage in Europe is not as high as in Japan, Europeans, on average, still outpace Americans in mobile feature usage. The two countries are similar on SMS usage with 41% of Europeans using the technology vs. 39% of Americans. However, there are vast differences in multimedia messaging and mobile Internet access. In both cases, approximately 26% of Europeans use the technologies while only 12% of their American counterparts do.
Table 50: Mobile Feature Usage in Europe
SMS MMS Mobile Internet US 39% 12% 12% Europe 41% 26% 26%

Source: NPD, Gartner G2, M: Metrics, Forrester, comScore, and JPMorgan estimates

So why are American consumers trailing in mobile adoption? It doesnt appear to be due to lack of interest. In a Pew Research Center survey, the company found that 47% of Americans would like to have mobile maps, 38% were interested in IM services for their phone, and 24% wanted email access and search capabilities to find movie listings, weather reports, and stock quotes. Media-Screen surveys found that the reasons most cited for not using mobile Internet services were cost and connectivity issues.

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Figure 52: U.S. Survey Respondents Interested in Using the Following Mobile Services
50% 40% 30% 20% 10% 0% Maps IM Search for serv ices (mov ies, etc) Email Cameras

Source: Pew Research Centers and JPMorgan estimates

International Advertisers Have Begun to Enter the Market Due to these higher mobile services adoption levels, marketers have begun to experiment with mobile advertising in the international market.
Surveys of 50 brand name European companies revealed that 89% of brands plan to use text and multimedia messaging to reach their audience by 2008.

Surveys by Airwide Solutions of 50 brand name European companies revealed that 89% of brands plan to use text and multimedia messaging to reach their audience by 2008. Of these, one-third plan to spend over 10% of their marketing budget on the medium. In five years, 52% of the brands expect to spend between 5%-25% of their total marketing budget on mobile marketing. Currently, 40% of the brands have already initiated text messaging campaigns and 18% have launched MMS campaigns.
Figure 53: Global Mobile Ad Spend Forecast for 2011
2% 2% 3% 1% 10% 1% 1%

32%

48% SMS MMS Web Search Game Application Video Cell TV Bcast TV

Source: Strategy Analytics, eMarketer, and JPMorgan estimates

Challenges in the International Market


While the launch of mobile ad campaigns seems to have progressed further overseas than domestically, it is not without its weaknesses. For mobile advertising to maximize revenue streams, business models need to be established by carriers, advertisers, and marketing companies. Issues such as opting in or opting out of text advertisements and controlling the number of text ads received still need to be determined. Finally, each countrys privacy laws must be taken into consideration to determine how much information possessed by operators about their clients habits can be shared with advertisers and marketers to target ads.

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Conclusions
Attractive market size and reach The mobile market is a large and quickly growing industry with an estimated 2.2B mobile subscribers worldwide growing at an estimated pace of 23% Y/Y. On a worldwide basis, 33% of the population has mobile subscriptions vs. 4% with broadband subscriptions. In short, this medium offers advertising brands a very large reach in marketing their products. Strong targeting and relationship building capabilities Application providers will likely amass much user information as cell phone owners download ringtones, games, and wallpaper, sign up for stock quotes and news headlines, and participate in social networking activities. Additionally, the ad format could move from a one-way message directed at the user to an interactive multimedia means of communicating with potential customers including email, text messaging, web pages, applications, search, and MMS. Mobile ad growth could approximate that of the Internet We estimate that Internet advertising has grown at a 25% CAGR over the past 5 years globally. Currently, Strategy Analytics and eMarketer are estimating an ~80% 4-year CAGR with mobile marketing spend reaching $13B by 2011, putting it in what we view as the very beginning stages of the Internet ad growth curve. Barriers to entry could slow domestic adoption We believe that development of mobile ads has been inhibited primarily by three factors. First, mobile carrier control seems to have limited Internet entrants who need to make partnerships to have their services available on the phone. Second, devices have poor user interfaces, high costs, and slow connectivity times. Finally, users view their mobile phones as personal devices and reception to mobile marketing may be cool. International markets are in the early stages of development Use of mobile services and features is greater in Europe and Japan than in the U.S. As a result marketers have begun to test mobile advertising in these markets. Surveys by Airwide Solutions of 50 brand name European companies revealed that 89% of brands plan to use text and multimedia messaging to reach their audience by 2008. Of these, one-third plan to spend over 10% of their marketing budget on the medium.

Company Initiatives
Google Introduces Android Google decided to address distribution difficulties head-on with the creation of the Open Handset Alliance, composed of leading technology and wireless companies committed to the development of an open platform for mobile devices. The Android platform is a fully integrated mobile "software stack consisting of an operating system, middleware, user-friendly interface, and applications. The first phones based on Android are expected to debut in the second half of 2008. By bringing the Internet developer model to the mobile market, it is hoped that increased innovation will make the phone features more attractive, affordable, and user-friendly for the consumer.

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Despite speculation about the development of a Google Phone or GPhone, we believe that it is unlikely that Google will choose to enter the hardware business. First, none of Googles core competencies lie in this business and it would take much investment in technology, marketing, and people to ramp it up. Secondly, the handset business is a much lower-margin business than online advertising. We estimate that operating margins for handset makers range from 10%-20% and are skewed toward the lower end of the range. In contrast to this, we believe that Google will achieve an operating margin north of 50%. Instead, we believe that it is more likely that Google will pursue methods to increase the distribution of its products and services, so that they may later be monetized. If the Android open platform is widely rolled out, more consumers would have access to Google features. Google has introduced many mobile products, including search, Gmail, YouTube, Picassa, maps, and GOOG-411. We believe that Google is well positioned to capitalize on the mobile space with its search dominance. Currently, advertisers can elect to place mobile search or content ads through AdWords. Yahoo! Enters Carrier Partnerships Similar to Google, Yahoo! is focused on increasing the distribution of its mobile products. Yahoo! recently announced nine new partnerships with mobile operators across Asia Pacific, as well as the availability of Yahoo! Go 2.0 in Chinese language for Taiwan. These new partnerships bring the total distribution partnership count to 20, and include Rogers Communications, Telefonica, BPL Mobile, and 3 Group. We believe that these agreements, in addition to the companys leading email platform and content portal, will firmly establish Yahoo! in the mobile market. The Yahoo! Go 2.0 application allows consumers to personalize their mobile Internet experience with content across the Internet and access to oneSearch. Users are offered access to Yahoo! Go widgets, personal channels for email, local information, satellite and hybrid maps, news sports, finance, entertainment, weather, Flickr, search, and some GPS integration capabilities. On the advertising front, Yahoo! offers mobile display advertising in 19 countries with search marketing live in the U.S., the U.K., and Japan. Yahoo! is also the exclusive advertising partner for Vodafone in the U.K. Publishers can use Yahoo!'s Mobile Publisher Services to increase the discovery, distribution, and monetization of their content on mobile phones and to access the Yahoo! Mobile Ad Network, Mobile Content Engine, Mobile Media Directory, and Mobile Site Submit. MSN Updates Its Mobile Portal and Acquires Ad Firm Earlier this summer, Microsoft launched MSN Mobile, a redesigned portal providing customers with access to email, news, sports, entertainment, local movie listings, maps and directions, Windows Live Messenger, and Live Search. Like Yahoo!, Microsoft is pursuing alliances with operators to integrate MSN Mobile on WAP home pages. Microsoft now has a firm footing in the mobile advertising world with its May announcement of the acquisition of Screen Tonic, a Paris based company that specializes in delivering location-based ads to mobile devices. ScreenTonic's platform, called Stamp, enables delivery of text or banner links on portals, ads in SMS (Short Message Service) messages and ads in mobile Web pages that vary depending on where the reader is located.
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Mobile Payment Business Outlook


Mobile networks cover over 80% of the worlds population and over 2.7B people have access to mobile phones. Meanwhile the global remittance market is expected to grow at a 10.2% CAGR between 2000 and 2008 as the worlds population has become more mobile. In this section we analyze the impact of the growth in the global remittance market and mobile phone technology on the emerging payment portals designed to take advantage of this growth. Global remittance is expected to grow 10.9% in 2008. According to Celent, the global remittance market is expected to grow at a 10.2% CAGR between 2000 and 2008 as the global population becomes more mobile. Inexpensive methods for P2P money transfers do not exist, except in the most developed remittance corridors. Mobile money transfer solutions could provide an inexpensive solution for the 200M people who are involved in the global remittance trade. Increased utilization of mobile phones and broadband mobile networks provides opportunity for growth in mobile payments business. According to the CDMA Association, there are over 402B 3G subscribers around the world and according to JPMorgans estimates, global mobile phone penetration is expected to reach 68% by 2010. With lower infrastructure costs, we expect mobile Internet penetration growth to exceed land-based broadband penetration growth during the next five years. We believe increased mobile broadband penetration provides a robust platform for growth in both the mobile remittance and m-commerce business. M-commerce is expected to grow as mobile Internet usage increases. According to Jupiter Research, m-commerce was a $30B industry in 2006. While most m-commerce money was spent on phone features, the amount of money spent on physical purchases still remains relatively small. However, we expect this number to grow as broadband Internet connectivity increases and the difference between accessing the Internet from a mobile phone compared to a broadband connected PC is minimized. While we expect POS transactions to increase, we believe users will be slow to warm to NFC devices and bar-code displays will be limited to ticket purchases (both transportation and entertainment) and coupons. While a number of players are currently looking to enter the mobile payment business, we expect only a few to survive. In the U.S., PayPal Mobile and Textpayme both benefit from their relationships with the large online retailers, eBay and Amazon, respectively. We believe smaller players who enter the field will eventually need to team up with bigger operators, such as Obopays relationship with Citibank, in order to compete against the likes of Western Union, MasterCard, and major banks.

Background
Global Remittance Is a $311B Market Celent estimates that over $311B in 2007 was transferred in the global remittance market, and global remittance is expected to grow at a 10.2% CAGR between 2000 and 2008. The mobile global population and the desire to send money back to family have led to the strong growth in remittance. The United Nation estimates that about 3% of the world's population, or roughly 175M people, is migrant, with the stock of
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immigrants to high-income countries growing at 3% per annum between 1980 and 2000. With about 31% of the population in developing countries under the age of 14, vs. 14% in developed countries, global migration is expected to remain robust. The World Bank highlights two drivers behind the strong migration trends through 2025. They include: The labor force in high-income countries is expected to decline. The World Bank expects the labor force in high-income countries to peak near 500M in 2010, then fall to 475M by 2025. This would lead to 100 workers supporting 111 dependents, compared to less than 100 today. As a result, there could be greater demand for workers in the labor force. Developing countries can supply the needed labor. With a large population under the age of 14, and higher birth rates, the developing world is expected to supply 1B workers by 2025, many of whom will migrate to higher income countries to meet their labor demands. These workers likely would continue to send money back to their country of origin. According to the World Bank's base case scenario, new migrant workers could earn as much as $481B more in real (after-tax) income in high-income countries than they would have if they stayed in the developing countries. A large portion of this excess wealth would likely find its way back to the migrant worker's country of origin through remittance channels.
Figure 54: Global Remittance Receive Trends
$ in billions

400 350 300 250 200 150 100 50 0 2000


Source: Celent

159

167

183

213

233

256

281

311

345

2001

2002

2003

2004

2005E

2006E

2007E

2008E

Regulations and competition can have a major impact on remittance fees.

Inefficiencies and high costs still impact a large part of the remittance market Despite the robustness of the global remittance market, the cost of remitting remains high, except in the most developed and competitive markets. According to the World Bank, the cost to transfer $200 (the average remittance size), excluding foreign exchange fees, ranges as high as 17% between the United States and Columbia to as little as 0.4% between the U.S. and the Philippines. Fees are often impacted by regulation (see U.S. to Columbia example) and competition. We believe that there are 4 main reasons for high remittance fees:

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1. 2. 3. 4.

Lack of competition Lack of innovation Burdensome regulatory and compliance requirements Low remittance volume in certain markets.

Table 51: Approximate Cost of Remitting $200


% of principal amount Belgium to Nigeria* Belgium to Senegal* Hong Kong, China to the Philippines New Zealand to Tonga ($300) Russia to Ukraine South Africa to Mozambique Saudi Arabia to Pakistan United Arab Emirates to India United Kingdom to India United Kingdom to the Philippines United States to Columbia United States to Mexico United States to Philippines
Source: World Bank

Major MTOs 12.0 10.0 4.5 12.0 4.0 3.6 5.5 11.0 5.0 1.2-2.0

Banks 6.0 3.0 3.0 1.0 0.4 5.2 6.0 0.4-5.0 17.0 3.0 0.4-1.8

Other MTOs 9.8 6.4 8.8 2.5 2.3 10.0 4.7 -

Hawala 1-2 1-2 -

There are solutions to help drive down remittance costs The low cost of remittance in the Philippines is the result of utilizing new technologies and competitive pressures. Smart Communications, the largest mobile phone provider in the Philippines, has set up an SMS-based text messaging service to transfer money (see the SMS section below). Users can withdraw money using a debit card (see Obopay below) or through a number of stores that Smart has formed partnerships with, including McDonalds, gas stations and 7-11s. Smart has also formed partnerships with a number of remittance companies. The simple SMS technology helps keep costs down, and as a result, the Philippines have one of the lowest international remittance costs (see Table 1 above).
Figure 55: Barriers to Entry Cited by Remittance Providers
% of responding firms

Accessing U.S. financial Establishing commercial contacts Technology Acquiring know -how Building customer trust Getting licenses abroad Funding w orking capital Getting U.S. bond Getting bank account Building compliance sy stems Creating agent netw ork Getting U.S. Licenses 0
Source: World Bank

7 7

11

14

16

18.2 23 23 27 27

32 35

40 40 45

10

15

20

25

30

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Increased competition and use of new technologies can help lower remittance costs.

While there are a number of barriers to entry in the global remittance market, we believe there is ample room for new entrants to come into the market and provide lower cost solutions for most of the world's population. The growth of new money transfer options, from PayPal in the US, to Smart Communications in the Philippines, demonstrates that it is possible for new entrants to not only come into the market but also to thrive and make a meaningful impact; although many smaller operations may eventually be forced to team up with larger money transfer firms or banks.
Figure 56: Money Transfer Operating Margins
%

35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0%

31.0% 19.3% 18.7%

32.0% 18.6% 10.9%

29.1%

17.0%

15.7%

2004 Global Pay ments (Money Transfer)


Source: Company reports.

2005 Money Gram (Global Fund Transfer)

2006 Western Union (C2C)

We believe the growing mobile phone market provides a platform to grow lower cost remittance solutions
The mobile market is a large and quickly growing industry with an estimated 2.7B mobile subscribers worldwide growing at an estimated pace of 23% Y/Y. Given this level of reach, we believe mobile solutions provide an attractive method to send money around the world. We believe there are three key reasons that make the mobile market a viable solution to lower remittance costs. 1. 2. We estimate that 67% of Americans are mobile phone subscribers while only 57% have broadband subscriptions. We believe that this disparity is even greater in developing countries. In China, for example, our estimates indicate there are approximately 35 mobile subscribers per 100 persons but only 4 broadband subscribers per 100 people. On a worldwide basis, 41% of the population has mobile subscriptions vs. 4% with broadband subscriptions. JPMorgan's Wireless team expects mobile penetration to reach 68% by 2010.

On a worldwide basis, 41% of the population has mobile subscriptions vs. 4% with broadband subscriptions

3.

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Table 52: Mobile and Broadband Penetration by Country


millions Country Egypt Morocco South Africa Africa China Hong Kong India Indonesia Japan Malaysia Pakistan Philippines South Korea Taiwan Thailand Vietnam Asia Pacific Austria Belgium Czech Republic Denmark Finland France Germany Greece Hungary Italy Netherlands Norway Poland Portugal Romania Russia Spain Sweden Switzerland Turkey Ukraine United Kingdom Europe Iran Israel Middle East Canada Mexico United States North America Australia New Zealand Oceania Argentina Brazil Chile Colombia Peru Venezuela Latin America World Wide Population (M) 71.4 30.7 47.6 914.3 1,323.7 7.1 1,119.7 225.5 128.2 25.8 157.0 84.5 48.0 22.8 64.8 85.3 3,693.0 8.2 10.4 10.2 5.4 5.3 60.7 82.7 11.1 10.1 58.1 16.3 4.6 38.5 10.5 21.6 142.5 43.4 9.1 7.3 74.2 46.0 59.8 813.1 69.1 6.4 190.0 32.4 108.3 299.7 439.0 20.4 4.0 33.2 39.1 188.9 16.5 46.3 28.4 27.2 461.8 6,544.4 Broadband Subs (M) 0.1 0.3 0.2 2.9 47.0 1.5 2.0 0.5 24.2 0.7 0.1 0.1 12.8 4.4 0.3 0.3 99.6 1.5 2.0 1.0 1.6 1.3 11.1 12.4 0.3 0.8 8.0 4.7 1.1 2.0 1.4 0.4 2.1 5.9 2.1 2.0 2.1 0.1 11.6 72.4 NA 1.5 3.8 7.2 3.0 56.5 66.6 3.5 0.5 4.0 1.1 4.9 1.1 0.5 0.4 0.4 9.7 259.1 BB Subs per 100 Persons 0.1 1.0 0.5 0.3 3.6 21.6 0.2 0.2 19.0 2.7 0.1 0.2 26.1 19.2 0.5 0.4 2.7 17.8 19.5 9.4 29.1 25.0 17.7 15.1 2.8 7.9 13.8 28.5 24.7 5.3 12.8 1.8 1.5 14.6 22.7 25.9 3.0 0.2 19.1 9.0 NA 23.5 2.0 21.5 2.7 18.8 15.2 17.3 11.7 11.8 2.7 2.6 6.8 1.1 1.5 1.6 2.6 3.9 Mobile Subs (M) 13.6 16.0 39.7 193.8 461.1 9.4 166.1 63.8 101.7 19.5 34.5 42.9 40.2 23.2 40.8 15.5 1,073.3 9.3 9.7 12.1 5.8 5.7 51.7 84.3 11.1 10.0 71.5 15.8 5.0 36.7 12.2 17.4 150.0 46.2 9.6 7.4 52.7 49.1 69.7 797.6 13.7 8.4 63.6 17.0 57.0 201.7 275.7 19.8 3.5 24.1 31.5 99.9 12.5 29.8 8.5 18.8 282.3 2,710.4 Mobile Subs per 100 Persons 19.1 52.1 83.3 21.2 34.8 131.5 14.8 28.3 79.3 75.5 22.0 50.8 83.8 102.0 63.0 18.2 29.1 112.8 92.6 119.0 107.3 107.8 85.1 101.9 99.6 99.0 123.1 97.2 108.6 95.5 116.0 80.5 105.2 106.4 105.9 102.1 71.0 106.7 116.4 98.1 19.4 122.7 33.5 52.5 52.6 67.3 62.8 97.0 87.6 72.6 80.5 52.9 75.6 64.3 30.0 69.0 61.1 41.4

Source: CIA Government Stats (http://www.cia.gov/cia/publications/factbook/index.html), International Telecommunications Union (http://www.itu.int/ITU-D/ict/statistics), JPMorgan estimates.

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Developing payment processing solutions geared around mobile devices would greatly improve the reach of current remittance options, in our view. With the growing prevalence of mobile devices, someone in Ghana may some day be able to transfer money to someone in Northern Alaska without needing to visit a bank or Western Union. As the example of the Philippines demonstrates, this may even be at a lower cost than the options that are currently available.

Increased Mobile Internet Penetration Gives Users the Freedom to Access and Send Information from Almost Anywhere
U.S. mobile Internet usage has been slow to take off; the number of users with Internet capable phones and high-speed mobile data connections has remained small. However, that is changing as more users buy data-enabled phones, such as the iPhone, and access high-speed mobile data networks such as Sprints EVDO network and AT&Ts HSDPA network. According the Pew Internet & American Life Project report on mobile usage, only 14% of mobile subscribers use their phones to access the Internet, but 16% stated that they would like to have mobile Internet access. Despite a low penetration, mobile broadband access (defined as speeds of 200kps or more in at least one direction) continues to grow, increasing from 2,574 individual users in June 2005 to 2.4M individual users (21.9M if business devices are included) in Dec. 2006, according to the FCC. We expect mobile broadband growth to remain robust and to play a key role in the adaptation of m-commerce and mobile payment solutions.
Figure 57: U.S. Mobile Device Usage
%

According to the FCC, individuals in the U.S. with highspeed mobile access increased to 2.4M in Dec. 2006, from 2,574 in June 2005.

Trade instant messages Perform Internet searches Send/receiv e email Access the Internet Play games Take still pictures Send/receiv e tex t messages 0% 10% 20% Currently use
Source: Pew Internet & American Life Project

30%

40%

50%

60%

Would like to hav e

Mobile Users Are Adopting SMS as a Primary Way to Communicate


While mobile Internet growth has been slow, text messaging, or SMS, use has thrived, unencumbered by slow connections or text-heavy displays. According to the Pew Internet & American Life Project, over 35% of all cell phone users use textbased messaging, while 65% of those 18-29 use text messaging. SMS growth in the US has been robust during the past 2 years, growing 300%, according to the CTIA. SMS usage outside the US has also been strong, with 41% of Europeans using text messaging services. SMS, which doesnt require the latest mobile technology or high-priced cell phones, provides a low-cost method to grow the mobile remittance

In the U.S., 65% of 18-29 year olds use text messaging.

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market in developing countries and to attract the greatest user base in more developed markets like the U.S. and Europe.
Figure 58: US SMS Usage by Age Group
%

70% 60% 50% 40% 30% 20% 10% 0% Total 35%

65%

37%

13%

8%

18-29

30-49

50-64

65+

Source: Pew Internet & American Life Project

Figure 59: June Monthly SMS Usage in the US and UK


Billions of SMS Messages

35.0 30.0 25.0 20.0 15.0 10.0 5.0 -

28.8

12.5 7.2 2.6 3.4 4.4

2005

2006 US UK

2007

Source: CTIA, Test.it, JPMorgan Estimates

We Expect Mobile Commerce to be a Catalyst for Growth in Mobile Payment Platforms


According to Jupiter Research, mobile commerce was a $30B market in 2006. Most m-commerce has been, and continues to be, limited to the purchase of customizable ringers, downloadable games and screensavers, all features that are used on the phone. The use of a mobile phone to purchase physical merchandise has remained small. However, we expect m-commerce transactions to grow as more mobile users gain access broadband mobile networks and phones with improved display and Internet features. Jupiter Research expects m-commerce to reach $63B by 2010. As growth an e-commerce helped online payment providers, such as PayPal, grow its transaction volume, we expect strong growth in m-commerce to help grow mobile payment transaction volume and create an incentive for companies looking to enter the space.

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Figure 60: PayPal Transaction Volume Growth and eCommerce Penetration 2000-2007E
$ in millions

500,000 400,000 300,000 200,000 100,000 2000 2001 2002 2003 2004 2005 2006 2007E

12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%

eCommerce Sales

Pay Pal TPV

TPV as % eCommerce

Source: US Department of Commerce, JPMorgan estimates, Company data.

We expect point of sale transactions to have a limited impact on mobile commerce growth Companies such as Nokia and Samsung have looked at adding microchips to cell phones to drive mobile commerce growth at the retail store level. Using a chip embedded in their cell phone, a user can scan their phone near a reader and pay for merchandise at the store (point of sale) using funds from their credit card, bank account or other account, possibly set up through the cell phone provider. While companies focus on near field communication solution (NFC) to drive point of sale (POS) transactions, the marketplace for NFC solutions and the new technologies being tested are beyond the scope of this report. However, we are skeptical of the long-term viability of NFC solutions principally for four reasons 1. We believe most people are fairly happy with their current POS solutions NFC using credit cards, regular credit and debit cards and cash, and have little incentive to try something new. Security is an issue for many users who are concerned about not only extra phone charges when they lose their phone, but also someone purchasing items with it. Also, many people are concerned about accidental charges, since their phone only needs to pass in the vicinity of a reader. Having a chip embedded in the cell phone limits a customers choices and the ability to change phones, mobile providers or credit card companies easily. Transactions can require the cooperation of as many as seven separate parties: (1) consumer, (2) merchant, (3) the consumer's bank, (4) the merchant's bank, (5) the payment network, (6) mobile operator, and (7) merchant processor. All of these parties create additional transaction costs and make implementation more difficult.

2.

3.

4.

Bar codes are another payment option for POS transactions. Under this method, a mobile user purchases an item online, usually a ticket, and then receives a bar code verifying that the payment was made. When the user goes to use the ticket, or pick up the merchandise, the bar code on the phone is scanned. Mobilrelay (mbo.com) is one
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company that sells movie tickets online and sends users a bar code to confirm their purchase. In Belgian, users who purchase tickets for the De Lijn train line between Antwerp and Ghent can use SMS to receive rail tickets. Bar codes and SMS payment confirmations are essentially a replacement for the printed ticket. As a result, we expect usage will be primarily limited to entertainment and travel ticket purchases.

Current Mobile Payment Systems


SMS-Based Solutions With the popularity of SMS services on mobile networks, and helped by the fact that SMS-based services can operate independently of the users mobile service provider, SMS-based solutions are the most common option for mobile P2P money transfers. A typical P2P money transfer takes place in the following steps: 1. Send a text message to the Payment provider's number. Include the amount and phone number or email address (some providers, such as PayPal, allow transfers to PayPal members using an email address). Since the transaction occurs over an unsecured SMS channel, the payment processor will typically send a text message or make a phone call to confirm the payment. Once the payment is confirmed, the recipient receives a text or email notifying them that they have funds available in their account. If the recipient is not a current user of the payment service, they are invited to join, and typically cannot access their funds until they do so. Money that is not claimed is usually returned to the sender after a set period of time.

2.

3.

Users of SMS-based solutions can often use SMS messaging for other accountmanagement services. Some common features include: 1. 2. The ability to check your balance by sending a predetermined text message (ex. bal) to the service providers number. The ability to request money from other users. This can be done by sending a text message to the providers number with the users information and the amount requested. Funds are not deposited until the transfer is confirmed by the user sending the money. Users can also text to buy items using SMS payment solutions.

3.

Adding and withdrawing money is usually done online, through a web-based interface, or sometimes through the use of a specially branded credit/debit card. Web Interface and Software-Based Solutions Slow speeds and difficult to read text displays have kept many away from web interface solutions. However, as newer mobile broadband technologies (3G, etc) and better graphical interfaces (i.e. Apple iPhone) are rolled out, we expect cell phone Internet usage to grow. Web-based interface has the benefit of operability on most service provider networks (at least those that offer advanced Internet capabilities) and eliminates the need to download software on the users phone. It also creates a more secure transmission environment; the sender usually must log in with a user
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name and password prior to sending money, and can enter a PIN number through the web interface, eliminating the need to receive a callback and/or text message verifying the senders information.
Figure 61: How KushCash Works

Source: www.kushcash.com

Software-based applications, offered by firms such as KushCash and retail banks (such as Bank of America, Citibank and Wachovia), offer another secure solution. The drawback to using software-based applications is that their usage is limited to certain carrier networks, which often depend more on relationships than the size of the network, and model of cell phones, although this limitation also exists for both SMS-based and web-based services. The advantage of software solutions is usually a more secure environment, as transfer requests are encrypted, and increased functionality over SMS-based solutions.

Conclusions
Global migration has created a large market opportunity in remittance The increase in global migration has created a global remittance market that is expected to reach $345B by 2008, according to Celent. According to the World Bank remittance options for many people still remain high, with some people paying fees of 10% or more, before foreign currency exchange costs. We believe there is room for new competitors, other than the existing money transfer companies, to provide lower cost solutions, such as Smart Communications does in the Philippines. The growth in mobile penetration creates an attractive vehicle to transfer funds. With over 68% of the world expected to have a mobile phone by 2010, we believe that mobile technology offers a viable and low-cost solution in the global remittance market. The attractiveness of this market has not been lost on the big players in the space as Western Union and MasterCard have teamed up with the GSM Association and Citibank has teamed with Obopay to offer mobile money transfer solutions.

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M-commerce is still in its early stages but should grow with high-speed connections We believe that m-commerce is still in its early stages, as users mostly limit their purchases to cell phone features, such as ring tones, games and screensavers. We expect this to change as more mobile users gain access to high-speed mobile connections on 3G and later mobile devices and viewing screens continue to improve, as on Apple's iPhone. POS m-commerce solutions are not expected to take off We believe that mobile phone subscribers will be slow to adopt near field communication solutions (NFC) as they already have a number of viable payment options. Since a significant amount of capital needs to be spent developing an NFC infrastructure, including readers, we believe usage will be limited to wealthier countries and usage will be more prominent among those who do not have other viable payment alternatives, such as teenagers. We expect bar code POS solutions to be an attractive alternative to paper ticket sales, for entertainment events and travel, however, usage should be limited to more developed markets. SMS and web-based solutions are expected to remain the main portals for mobile money transfers We expect SMS and web-based solutions to be the most successful mobile payment solutions. SMS service is widely available and used by a large portion of young mobile subscribers. The service does not require advanced broadband technology or expensive hardware and is relatively inexpensive to implement, which should help drive its usage. However, security is a concern, as most SMS messages are unencrypted, and a user most give a PIN number or password in response to a text message or voice call. Web-based solutions offer a more secure alternative for those with a broadband mobile Internet connection and Internet-capable phone.

Current Providers
KushCash KushCash is a software-based money transfer solution based in Southern California. Its user base is currently small and the company is focused on growing in its core California market. The application is available on select phones that operate on the Boost, Cingular and Sprint networks and through a web-based interface. A user can access its KushCash account through 1) the mobile application or 2) an Internet or mobile Internet browser. In addition users can send, receive and borrow money from KushCash members using the KushCash application.
Table 53: KushCash
Fees to: Open an Account Add Money Send Money Withdraw to Bank Receive Money How it works Install KushCash directly to your supported phone. 1. Register an account online. 2. Follow the download instructions. 3. Instantly install KushCash.
Source: www.kushcash.com.

FREE 2.80% + $0.30 FREE 0.5 0.5

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Obopay Obopay was launched in 2005 and some of its investors include ONSET Ventures, Qualcomm, Redpoint Ventures and Richmond Management. The service operates on any SMS or web-enabled phone device. Obopay works primarily as a P2P service, however, it was teamed up with Verizon to offer the Verizon Get It Now Catalog, that allows the purchase of digital downloads and physical goods. Users can use credit cards, bank accounts and even an Obopay-branded ATM card to deposit and withdraw funds. Obopay founded BillMonk, which allows users to lend and borrow money from friends and to keep track of and settle expenses. BillMonk users can use Obopay to settle and collect their debts. Other Obopay partners include Citibank and AIM, which offers an Obopay plug-in.
Table 54: Obopay
Fees to: Sign up for Obopay Receive money Receive money as a merchant (get paid) Withdraw money to your bank account Send money (or accept a request for money) Add money from your credit or debit card (standard) Add money from your bank account (economy) Mobile Operators Verizon Wireless' HELIO Cellular South Merchants RIPmobile Online Partners AIM
Source: www.obopay.com.

FEE Free Free Free Free $0.10 1.50% Fee is waived

PayPal Mobile PayPal Mobile is the mobile version of PayPals payment processing platform. The platform can work either via SMS, with users receiving a callback or text message to verify their PIN, or through a web based interface. There are no extra fees for sending money via PayPal Mobile as opposed to using the regular PayPal service. In order to purchase items on eBay, users must first download an application to their cell phone. Users can also buy merchandise from other vendors on web-enabled phones or by sending a text message to a number on a Text to Buy ad. Users can even use SMS messaging to change currencies.

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North America Equity Research 02 January 2008

Table 55: PayPal Mobile


Fees to Open an Account Send Money Withdraw Funds Add Funds Receive payments funded by PayPal Balance, PayPal Instant Transfer or PayPal eCheck Receive payments funded by Credit Card, Debit Card or Buyer Credit Multiple Currency Transactions Personal Account Free Free Free for banks in the U.S. Fees for other banks Free Free 4.9% + $0.30 (in U.S.)** Additional fees for cross border payments Exchange rate includes a 2.5% fee** Additional fees for cross border payments Premier/Business Account Free Free Free for banks in the U.S. Fees for other banks Free 1.9-%-2.9% + 0.30 USD (in U.S.) 1.9-%-2.9% + 0.30 USD (in U.S.) Additional fees for cross border payments Exchange rate includes a 2.5% fee Additional fees for cross border payments

Supported Carriers Alltel AT&T Cincinnati Bell Midwest Wireless Sprint T-Mobile T-Mobile (prepaid) Verizon Virgin Mobile
Source: www.paypal.com/mobile. Note: Personal accounts may not receive payments funded by credit card, debit card or buyer credit for sales on eBay. Users who would like to receive these payments must upgrade to a premier or business account.

Textpayme Textpayme is an SMS-based money transfer solution that recently moved out of its beta testing phase and is linked to Amazon's Payment Services. In order to create a Textpayme account, users must first create, or already have, an Amazon account. In addition to being able to transfer money, users can also use Textpayme to purchase items on Amazon.com. In order to encourage users to try its service, the company is currently offering $5 to new members and since it is SMS-based, the service is accessible to subscribers on any mobile network that offers text messaging. Fees are only charged when money is added via credit card. Bank deposits and withdrawals are free, and users can choose to receive their money in the form of Amazon gift certificates.

97

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North America Equity Research 02 January 2008

Table 56: Textpayme


Fees to: Signup for a TextPayMe Account Send Money Receive Money Deposit Funds through Bank Account Withdraw Funds to Bank Account Auto Debit from Credit Card Supported Carriers AT&T Alltel Boost Midwest Wireless Nextel Communications Sprint PCS T-Mobile Verizon Wireless
Source: www.Textpayme.com.

Free Free Free Free Free Free for first $200 ($0.15 + 1.35% after)

98

China Sector Outlook

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

North America Equity Research 02 January 2008

Strong Internet User Growth Continues


Chinas Internet users continue to swell, and have crossed 162 million as of Jun-07, compared to 137 million as of Dec-06 and 123 million as of Jun-06 (or up ~32% Y/Y), as per CNNIC (China Internet Network Information Center). This makes Chinas Internet population second only to the US (~212M). However, Chinas population penetration is still only 12%, versus 65%+ in more developed Internet markets like Japan, Korea and the US. We expect the Internet population in China to continue to grow robustly and reach ~239 million by 2010 (06-10E CAGR of 15%).
Figure 62: China Internet Users and Penetration Forecast
250 200 162 150 100 50 0 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07E Dec-08E Dec-09E Dec-10E
101

175

189

200

212

221

230 239

20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

23 27

34

46

59

68

80

87 94

103

111

123

137

Jun-08E

Jun-09E

Number of China Internet Users (Left, millions)


Source: CNNIC, JPMorgan estimates.

Penetration Rate as % of Total Population (Right)

Besides the typical benefits of Internet access (information, communication, etc.), we believe a few China-specific reasons still continue to drive Internet usage: 1) relatively low-cost entertainment source (Internet cafe access fee of ~US$0.30 per hour to enjoy online games, online music, movie downloads), 2) community tools for the large floating population in China (eg. workers moving from rural to urban areas), 3) alternative news source (due to few media with nationwide coverage).
Table 57: Common Applications of Internet in China
% of Users Information News Search engine Communication IM E-mail Entertainment Online music Online video Internet games
Source: CNNIC Survey (Jun-07).

% of Users Life Assistance Look for jobs Online education Online shopping Online banking Stock 15.2% 24.0% 25.5% 20.9% 14.1%

77.3% 74.8% 69.8% 55.4% 68.5% 61.1% 47.0%

Jun-10E

Jun-01

Jun-02

Jun-03

Jun-04

Jun-05

Jun-06

Jun-07

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North America Equity Research 02 January 2008

Figure 63: Broadband Internet Users in China


140 120 100 80 60 40 20 0 Jun02 Dec- Jun02 03 Dec- Jun03 04 Dec- Jun- Dec- Jun- Dec- Jun04 05 05 06 06 07 2 7 10 31 17 43 53 77 64 91 122

Figure 64: Broadband Internet Users as % of Total Internet Users


100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun02 02 03 03 04 04 05 05 06 06 07 4% 11% 22% 14% 36% 46% 51% 58% 63% 66% 75%

Broadband Internet Users (millions)

Broadband users as % of total Internet users

Figure 65: China Internet Users by Age Group


40.0% 30.0% 20.0% 10.0% 0.0% Under 18 18 24 25 30 31 35 36 40 41 50 51 60 Abov e 60 18% 19% 10% 8% 7% 3% 1% 34%

Figure 66: Main Locations of Internet Access in China


80% 70% 60% 50% 40% 30% 20% 10% 0% Home Internet Caf Workplace School 37% 31% 12% 74%

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North America Equity Research 02 January 2008

Online Advertising
Remain positive on the secular high growth online advertising sector
Online advertising (display and search advertising) in China continued to see strong growth in 2007, with ~50% YoY growth, as per our estimates. Online advertising thus accounted for ~6.7% of the total advertising market in China in 2007 (as per our estimates), up from ~5.2% in 2006. We remain positive on the online advertising sector in China and forecast 50% growth in 2008. We expect the 2008 Beijing Olympics to act as a significant growth driver in the near to medium term, as advertisers try to take advantage of this key event (a source of great national pride) to build and strengthen their brand awareness among consumers.
Table 58: China Online Advertising Forecast
Branded Advertising Market (US$M) Email Advertising Market (US$M) PPC Search Market (US$M) Fixed Price Ranking (US$M) Total Online Ad Market (US$M) Growth (%) China overall ad market (US$M) Online as % of total China ad market
Source: CNNIC, JPMorgan estimates.

2004 205 8 37 37 287 97% 8,449 3.4%

2005 287 11 67 42 407 42% 10,184 4.0%

2006 425 14 140 48 626 54% 12,051 5.2%

2007E 586 16 309 50 961 53% 14,236 6.7%

2008E 809 17 562 53 1,441 50% 17,479 8.2%

2009E 970 19 911 55 1,956 36% 19,588 10.0%

2010E 1,213 21 1,384 58 2,677 37% 22,918 11.7%

2011E 1,431 23 2,046 61 3,561 33% 26,356 13.5%

2012E 1,689 25 2,748 64 4,527 27% 30,309 14.9%

2013E 1,993 28 3,507 68 5,596 24% 34,855 16.1%

2014E 2,352 31 4,310 71 6,764 21% 40,084 16.9%

2015E 2,775 34 5,196 75 8,080 19% 46,096 17.5%

The key drivers for the continued momentum in online advertising remain: (1) strong economic growth across sectors, (2) continued increase in disposable income and consumer spending, (3) competitive business environment and increasing brand investments across sectors and (4) secular growth in advertising dollars moving online (from more traditional media, as users spend more time online).
Figure 67: Nominal GDP Growth in China
Units: RMB Bn (Y-axis)
25,000 20,000 15,000 10,000 5,000 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Figure 68: Ad Spending as % of GDP


0.5% 0.4% 0.3% 0.2% 0.1% 0.0%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

1992-2006 CAGR of 16%

0.47% 0.34% 0.25% 0.27% 0.38% 0.39%

0.45% 0.46%

Source: CEIC/SAIC.

Source: CEIC/SAIC.

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North America Equity Research 02 January 2008

Figure 69: Growth in Urban Disposal Income per Capita


Units: RMB
14,000 12,000 10,000 8,000 6,000 4,000 2,000 0

Figure 70: Growth in Retail Sales of Consumer Goods


Units: RMB Bn
8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

1992-2006 CAGR of 13%

1992-2006 CAGR of 15%

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Source: CEIC.

Source: CEIC.

Figure 71: Average Weekly Online Time


20 18 16 14 12 10 8 6 4 2 0

Figure 72: China Online Ad Market as % of Total Ad Market


15.9 16.5 16.9 18.6

Average Access Time Per Week (Left, hours)


13.0 8.7 8.5 8.3 9.8 13.4 12.3 13.2 14.0

4,000 3,500 3,000 2,500 2,000 1,500 1,000

13.5% 11.7% 10.0% 8.2% 6.7% 5.2% 3.4% 4.0%

16% 14% 12% 10% 8% 6% 4% 2% 0%

Jun-01 Dec- Jun-02 Dec- Jun-03 Dec- Jun-04 Dec- Jun-05 Dec- Jun-06 Dec- Jun-07 01 02 03 04 05 06
Average Access Time Per Week (Left, hours)

500 2004 2005 2006 2007E 2008E 2009E 2010E 2011E

Source: CNNIC.

Online ad market size (US$m,left) As % of total ad market (% , Right)


Source: JPMorgan estimates.

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North America Equity Research 02 January 2008

Branded Advertising Segment


Branded advertising strength should continue; Olympics should give a boost in 2008
The branded advertising segment grew ~38% in 2007 to reach US$586 million, as per our estimates. In terms of the advertiser sectors, automobiles, real estate and IT remained the largest, (together accounting for 40%-50% of branded ad spend on top portals), while financial services, FMCG and online games were among the fastest growing (with 100%+ YoY growth in branded ad spend on top portals). For 2008, we forecast the branded advertising segment to witness ~38% YoY growth to reach US$809 million, with the Olympics being a key driver for the segment. We expect listed portals such as Sina, Sohu, Tencent and NetEase to remain the market leaders and be the key beneficiaries of the segment growth due to their strong brand names, superior content offering and proven execution ability.
Figure 73: China Branded Advertising Forecast
1,600 72% 1,200 800 400 0 2004 2005 2006 2007E 2008E 2009E 2010E 2011E

40% 287

48% 38% 425 586

1,213 38% 809 20% 970 25%

1,431

75% 60% 45%

205

18%

30% 15% 0%

Branded Advertising Market (US$M,left)


Source: JPMorgan estimates.

YoY growth (% , Right)

Internet users online time continuing its up-trend


The duration of time spent online by users continues to increase in China. The average weekly online time has increased to 18.6 hours for Chinese Internet users as of June 2007 (as per CNNIC survey), up from 16.9 hours as of December 2006; the average weekly online time has thus more than doubled over the last 5 years in China (from 8.3 hours in June 2002). The factors that have contributed to the up-trend include: (a) major portals have been increasing their content investments over the past few years to make more information and differentiated content (such as the NBA, European soccer leagues, Asian Games, Olympics lead-up, etc.) available to users, and (b) the Internet is viewed in China as an alternative information source that is more friendly and entertaining to use (as most traditional media remains tightly controlled by the government).

105

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North America Equity Research 02 January 2008

Figure 74: Internet User Online Time Trend


20 18 16 14 12 10 8 6 4 2 0 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Av erage Access Time Per Week (Left, hours) 8.7 8.5 9.8 8.3

Average Access Time Per Week (Left, hours)


15.9 13.0 13.4 12.3 13.2 14.0

18.6 16.5 16.9

Source: CNNIC.

Olympics should be a key driver in 2008


The 2008 Beijing Olympics should be a key driver for the overall advertising industry in China, as well as for the online advertising sector. As a historical event for China, and a matter of great national pride, advertisers will try to take advantage of the Olympics to build and strengthen their brand awareness among consumers. In terms of impact on leading players, we forecast both Sina and Sohu to experience nearly 50% YoY growth in their branded advertising segments in 2008, up from ~40% YoY growth in 2007.
Figure 75: Sina Branded Ad Revenue Growth
350 300 250 200 150 100 50 0

Figure 76: Sohu Branded Ad Revenue Growth


310 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 200 150 100 50 0 2006 2007E 2008E 2009E YoY grth (%, right)

49.9% 41.3%
120

40.4%
169

253

48.4% 35.1%
79

188

60.0% 50.0% 40.0% 30.0%

40.0%
111

164

22.9%

14.7%

20.0% 10.0% 0.0%

2006

2007E

2008E

2009E YoY grth (%, right)

Sina Branded Ad Rev enue (US$M, left)


Source: Company, JPMorgan estimates.

Sohu Branded Ad Rev enue (US$M, left)


Source: Company, JPMorgan estimates.

Sohu, being the official Beijing Olympics Internet content sponsor, has already begun to see some benefits of ad spending by Olympics partners and sponsors Olympics sponsors as a group increased ad spending on Sohu by 60% YoY in 3Q07 and by 80% YoY in 2Q07 (These sponsors/partners include Coca Cola, Lenovo, Adidas, Yili, Bank of China, Volkswagen, et al). Sohu believes that the larger Olympics ad spending is yet to come, and the spending is likely to be in three phases:

106

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North America Equity Research 02 January 2008

(1) 4Q07 until early May: Advertisers likely will still be relatively slow in Olympicsrelated spending. (2) From May until early August: The Olympics torch relay will begin in May, and advertisers likely will increase their ad spending. (3) During the month of August: The largest ad spending likely will take place during the actual Olympics event. Growth after the Olympics We expect online ad spending to continue to grow after 2008, on the back of: (1) strong domestic consumer growth and high industry competition should continue even after Olympics, (2) while a portion of Olympics-related ad spend may come from international companies targeting international visitors (buying ads in China during Olympics to show their presence there) and will not come back postOlympics, we believe these international companies likely weill not use Chinese Internet portals to advertise in the first place, (3) accelerated Internet usage likely in China after Olympics as Olympics are held during daytime, office workers likely turn to Internet for updates, (4) various industries, such as FMCG, will likely increase their percentage of online spending after the Olympics - as they are likely to see good ROI during Olympics advertising, and (5) the 2010 World Expo in Shanghai is another highly anticipated international event, and would provide advertisers another opportunity to associate their products / brands with a highprofile international event that demonstrates the success of China.

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, such as WVAS, online music or online games. Online advertising is the most established online business in China (since the late 90s), and regulations and boundaries are well-understood by industry players. We believe the leading portals have strict internal compliance departments and automated content scans to ensure content is in compliance with government standards. While Web 2.0 content such as music, video, and blogs has come to the governments attention, we believe if there is further regulatory tightening for Web 2.0 content, leading portals should be less impacted than pure Web 2.0 companies. Leading portals are the most trusted by the government among Internet companies and have the best compliance procedures; further, the financial impact would be less significant because only a small portion of their revenues is likely to be from Web 2.0 content.

107

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North America Equity Research 02 January 2008

Online Search
Online search advertising still in early high-growth stage
The online search segment in China was up ~120% YoY in 2007 to reach US$309 million, as per our estimates. We believe online search advertising is still in an early high-growth stage in China, and forecast search revenues to experience 56% CAGR over 07-'11, driven by: (1) rising Internet penetration in China, (2) significant growth in websites and pages, (3) higher search usage (due to greater mass of web content), and (4) large number of SMEs (with small ad budgets) turning to search advertising (due to higher ROI). For 2008, we expect the search advertising segment in China to witness ~82% YoY growth to reach US$562 million. We expect Baidu to remain the dominant player in China in the near to medium term and be the key beneficiary of the industry growth. (Baidus market share is around 65%-70%, with nearest rivals Google and Yahoo! together having around 25%-30% market share).
Table 59: China Paid Search Forecast
Avg Internet users (millions) Number of search (billions) Coverage Click through rate Price per click (RMB) Market size (US$M) YoY Growth (%) 2004 94 51 12% 20% 0.25 37 83% 2005 111 67 14% 21% 0.29 67 82% 2006 130 86 17% 22% 0.34 140 109% 2007E 168 119 21% 24% 0.40 309 120% 2008E 195 145 25% 26% 0.47 562 82% 2009E 217 169 29% 27% 0.55 911 62% 2010E 234 190 33% 28% 0.62 1,384 52% 2011E 253 214 38% 28% 0.69 2,046 48%

Source: CNNIC, JPMorgan estimates. Note: Excluding distributor discount.

Search market outlook: Usage


As Internet users become more experienced, they look for information on the Internet beyond the major portals. Entertainment-related content, such as pictures and music, have always been popular in China. Going forward, we believe the nonentertainment-related searches, such as eCommerce, e-Government will continue to gain popularity. Growing usage in China Latest statistics from CNNIC show that the number of users in China has reached 162 million (Jun-07). We expect usage to continue to grow driven by such factors as: Entertainment tool. Digital entertainment (MP3, movies, etc.), can be downloaded from the web virtually free of cost or at a very low cost. Online gamesLAN-based, MMORPG, or casual board and chess gamesare also low-cost alternatives to offline entertainment. Internet is a low cost form of entertainmentInternet caf access is about Rmb2-4 / hr vs. Rmb40 for a movie. Communication tool. Migrant workers (~10% of total population, or 140M people in China are floating population) as well as relocated white-collar workers visit Internet cafs after work to use instant messenger and email, or to play games or watch movies. Despite the government constantly monitoring these services, blogs and bulletin board services have also increased in popularity in China (as channels to express personal views and communicate with others).

Table 60: Entertainment comparison


Entertainment option Webcafes with online games Movie Big Mac meal Karaoke Beijing subway fee (one way) Fee Rmb2-4 per hour Rmb30 - 60 Rmb20 Starting Rmb30 per hour Rmb2-5

Source: JPMorgan estimates.

108

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North America Equity Research 02 January 2008

Information source. Most traditional media is still tightly controlled by the government. Internet offers an alternative information source that is more friendly and entertaining to use. Major portals have also been increasing their content over the past few years to make more information available to users. Other government initiatives, such as electronic tax filing, customer clearing, and government agency websites, also help in improving Internet usage. Surge in websites and webpages in China China is no exception to the information boom. As of December 2006, there were around 4.4 billion webpages, up from 650 million in December 2004 (CNNIC, excludes 217 million overlapped pages). The number of websites (located in China) is also rapidly growing. According to CNNIC, the number reached 1.3 million by July 2007, up from 669k by end-2004. Despite the recent stricter registration requirements, we believe the government strongly supports healthy websites. The amount of information per page (in terms of number of bytes) is also on the rise.
Figure 77: Number of websites in China
Number of w ebsites in China 1,400,000 1,200,000 1,000,000 800,000 600,000 400,000 200,000 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07

Figure 78: Number of webpages in China


Webpages (millions) 5,000 4,000 3,000 2,000 1,000 0 2002
Source: CNNIC. Note: Includes static and dynamic pages, excludes overlapped pages.

CAGR (02-06): 26%

CAGR (02-06): 131%

2003

2004

2005

2006

Source: CNNIC.

Users turning to searches in China With information on the Internet ever expanding, it is natural that users turn to search engines to get organized information on the Internet. As a result, the number of searches in China is expected to increase by more than 4-fold from 2003 to 2008. According to the 2006 CNNIC report, more than 80% of Internet users perform a search every time they get on line.

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North America Equity Research 02 January 2008

Figure 79: Number of searches per day in China


400 350 300 250 200 150 100 50 0 2002 2003 2004 2005 2006 2007E 2008E 24 96 136 177 236 295 357

Figure 80: Number of searches per user daily


2.5 2.0 1.5 1.0 0.5 0.5 0.0 2002 2003 1.3 1.5 1.8 1.9 2.0

1.7

Number of search per day (million, Left)


Source: I Research, JPMorgan estimates. Note: Includes traffic form toolbar and address bar.

2004 2005E 2006E 2007E 2008E Search per Internet user per day (Left)

Source: I Research, JPMorgan estimates. Note: Includes traffic form toolbar and address bar.

Search market outlook: Advertisers readiness


Online advertising accounts for only ~7% of the total ad spending in China in 2007. The search revenue is even smaller, at approximately 37% of the online ad market. As in the US, we believe the paid search ad is particularly well-suited for small and medium enterprises (SME) in generating sales leads. Yet, as with the low Internet adoption rate in China, paid search is still a new advertising concept for these advertisers. Continuous education/marketing are required to drive market growth. Large available SME market for search advertising but low Internet usage According to the National Development and Reform Commission, Department of Small and Medium-Sized Enterprises figures, as of end 2005, there were 43 million SMEs in China. These SMEs are mainly 39 million individual businesses (these are small businesses registered with some government departments). Statistics from SAIC (State Administration for Industry & Commerce) suggest that the number of SMEs in China is roughly 24 million. Despite the discrepancies, we believe the overall number of SMEs is large. According to SAIC, as of end of 2005, there were 4.3 million larger-size SMEs (that are registered directly with SAIC). The total number of websites in China is 843,000 (as of December 2006). We estimate 60% of the websites are corporate (excluding personal sites, bulletin boards, and inactive sites). Therefore, the number of corporate websites in China is roughly 506,000. The Internet penetration rate among larger SMEs is 12%, roughly in line with personal Internet penetration rate of 12.2% (or 162 million). We do not think the market is saturated Based on Baidus 2Q07 active marketing customers of 128,000, the companys penetration among larger SMEs is 2.9%. Hence, we believe the market is far from reaching saturation point.

110

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North America Equity Research 02 January 2008

50% of corporate websites get fewer than 50 page views per day According to the CNNIC survey, about 50% of all corporate websites in China have fewer than 50 page views per day. With a low hit rate, we believe corporates would use the search engine market (both search engine optimization and paid search) to increase traffic to their sites and as a result generate new business leads.
Figure 81: ChinaNumber of SMEs by different segments

500 k

SME with websites

4.3 million

Larger-size SME

20 - 42 million

Individual businesses

Source: SAIC, JPMorgan estimates.

Ecommerce should be another growth driver We expect C-C eCommerce to see better adoption in the next few years driven by factors such as: (1) better acceptance for mail order (Chinas catalogue sales are non-existent, and most transactions are done faceto-face) through increased marketing, more variety, and increased adoption of home TV shopping networks, (2) improved trust and safety features by eCommerce sites, and (3) more regulated online payment infrastructure. In the US, eCommerce companies are leading users of paid search advertising. We believe a similar trend will emerge in China, too, as paid search is an effective method to target prospective buyers who already have items in mind. Currently, leading online search advertisers in China include Alibaba, Taobao, Dangdang, Joyo, Ctrip, and eLong. Given the expected higher growth in eCommerce, we expect paid search to benefit from this growth. Local search: Another promising area Similar to the US, we believe there is a large commercial potential for local search in China. Particularly, there are a large number of households/individual businesses eager to promote their local businesses. In addition, IP address assignment is quite well organized in China. We expect IP-based marketing to be more popular going forward as online advertisers are more sophisticated.

111

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North America Equity Research 02 January 2008

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. While ad agencies mainly focus on companies that already have websites, IT outsourcing companies target SMEs that are less sophisticated in IT infrastructure. IT outsourcing companies such as Sino-I (250.HK), and Hichina (net.cn), provide one-stop services for SMEsdomain name registration, web hosting, website design, promotions (mainly through search engine optimization (SEO), paid search, directory listing). We believe the IT outsourcing companies will be key players in the future to drive Internet adoption growth and search usage for SMEs. China Enterprise (ce.net) (fully owned by Sino-I) is one of the first official agents for Google in China. It has approximately 220,000 customers. The company is a dedicated educator for IT services in China with each of its 77 offices conducting regular meetings for entrepreneurs and SMEs. We believe this kind of education will help expand the number of advertisers for online search services. Ad agencies would have to drive search market growth Paid search marketing campaigns are usually more involved than display ads. Advertisers need to decide on what keywords to use, the number of keywords, bidding strategy and bidding period. In addition, more sophisticated advertisers also pay attention to competitors strategy, lead quality and ROI. 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. Furthermore, budgets for search campaigns are more difficult to manage as spending is based on the number of clicks, which non-experienced advertisers do not have control over. The ad spending amount essentially has no limit. Hence, advertisers are generally quite cautious about the initial spending and only allocate a small daily budget for trial, or even worse, just give up on paid search campaigns. We believe education by agents and distributors can eventually help advertisers overcome these barriers, and advertisers will thus increase their budgets on search campaigns.

Search market outlook: Monetization


We expect monetization of the paid search market to grow quickly driven by both higher search usage by users and better adoption by advertisers. The coverage ratio is low compared with the US, and we expect it to increase and drive monetization of the market. Self-fueling cycle to expand monetization We view the market as a self-fueling cycle driven by user and advertiser growth. Higher search usage typically leads to a higher number of sales leads for advertisers. With more high-quality leads coming from paid search, advertisers would place more keywords in more search engines. As users find more relevant product information by advertisers, they likely will conduct more searches, thus leading to higher usage. This cycle should continue and lead to market-size expansion.

112

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North America Equity Research 02 January 2008

Selling channel comparison Baidu: Mixed distribution strategy In top cities, such as Beijing, Shanghai, and in the Dongguan/Guandong province area, Baidu builds up its in-house sales force to distribute its own products. In most other cities, it uses distributors to sell products. The company has a mixed strategy in Shenzhen, where it has its own sales office and distributor. Typically, Baidu only grants exclusive rights to one distributor in each geographic area. Distributor discount We believe Baidu gives distributors discounts of around 30%-40%, lower than other search engines (such as Sogou and Zhongsou), which give discounts of 40%-50%. We believe agents accept this lower discount because Baidu generates a higher number of clicks, and as such higher absolute revenue. Google: Distribution strategy still uncertain From mid-2005 to late-2006, Google has signed roughly 20 authorized resellers in China. However, we believe that some of these distributors have ended their partnerships with Google. The main reason is the low distributor discount. We believe Google only offers less than 10% of profits to distributors vs. roughly 30% by Baidu. Google, in our opinion, faces a dilemma. If the company offers larger discounts in China, advertisers in other countries may place their ads through distributors in China, and potentially obtain a discount, therefore, impacting Googles revenue. We also believe that Googles distribution is still significantly behind Baidu in terms of penetration. Yahoo! While the Alibaba group has an internal sales force of over 3,500 across the country, Yahoo! search mainly relies on third-party distributors. Sohu Sohu also uses distributors for its search products. Distributors are typically exclusive for each region.

Search market outlook: Key Issues with segment growth


Fraudulent clicks and trust issue to weigh on industry growth Although not addressed in detail by industry players, we believe fraudulent clicks are a significant problem. Parties that could benefit from fraudulent clicks are value chain playerssearch engine companies, search partner sites, distributors, and agencies -- as more clicks could translate into more commissions or advertising fees.
Table 61: Search ad buyers attitude to invalid clicks (click-fraud + accidental clicks) issue
Issues Invalid click issue is not a significant concern Invalid click rate is within acceptable limit It's OK if ROI is OK Invalid click rate is too high and discouraging I am not aware of invalid clicks Sum
Source: China IntelliConsulting (CIC).

% of Respondents 3% 28% 23% 39% 6% 100%

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Unethical practices by ad agencies remain a risk As most search advertisers turn to agents to manage their ad campaigns, agents have full access to advertisers accounts. It is not uncommon for some ad agencies to deceive advertiser clients (as per search ad buyer surveys) by, for example, increasing the bid price for keywords or adding some unrelated high-price keywords (and receiving monetary benefits from search partner sites or search engines), or even colluding in fraudulent clicks (as previously mentioned). Despite this industrywide issue, advertisers continue to place ads on search sites, which we believe demonstrates that search advertising provides a reasonable ROI (return on investment) despite fraudulent click issues. Nonetheless, we believe unethical practices by ad agencies remain a risk to healthy long-term growth of the search advertising market in China. Regulatory Risks Search companies are in an interesting position. On one hand, search engines try to index as much information as possible, on the other hand, some of these materials may be deemed to be politically sensitive. We believe Chinese Internet companies in general are cautious about the issue, and avoid keywords/results content that could be sensitive. We believe this political risk has existed since the beginning of the Internet in China 10 years ago, and none of the major websites were closed because of it (the only widely mentioned incident was the Google site being blocked in China in 2002). Hence, we do not believe the political risk is high. We also do not expect search companies revenue growth to be affected by politically sensitive content, as they are difficult to commercialize, and we believe search companies have no interest in including them in search results.

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Online Gaming
Robust growth outlook for online gaming
The online gaming sector witnessed revenue acceleration in 2007, with 55% YoY growth, and reached ~US$1.33 billion, as per our estimates. The MMORPG segment (~85% of total gaming market) grew 54% YoY to reach ~US$1.12 billion in 2007, as per our estimates, with the success of the free-to-play (item-based sales) model being among the key factors. The casual game segment, meanwhile, grew 56% YoY to reach ~US$206 million in 2007. For 2008, we forecast ~37% YoY growth in the MMORPG segment and ~43% YoY growth in casual games. With more game companies having listed in 2H07, we expect leaders and laggards to emerge. We maintain Shanda (leading free-to-play game operator, strong operating and marketing capabilities and healthy game pipeline) as our top pick in the gaming sector.
Table 62: China MMORPG Market Forecast
MMORPG gamers (million) Internet users (million) Game users penetration Average ARPU per month (RMB) Market size (RMB million) MMORPG Market size (US$M) Growth Rate:
Source: iResearch, JPMorgan estimates.

2005 18.9 111.0 17.0% 21.7 4,918 592 35%

2006 24.6 137.0 17.9% 20.5 6,043 728 23%

2007E 34.4 175.0 19.7% 20.7 8,544 1,124 54%

2008E 44.7 200.3 22.3% 21.7 11,663 1,535 37%

2009E 55.9 220.8 25.3% 22.4 15,016 1,976 29%

2010E 66.0 238.8 27.6% 22.8 18,073 2,378 20%

2011E 75.9 258.3 29.4% 23.3 21,200 2,789 17%

Table 63: China Casual Game Market Forecast


Casual game players (million) Internet Users (million) Casual players penetration Assumed Ratio of paying users APRU per month (Rmb) Market size (RMB million) Casual Market size (US$M) Growth Rate:
Source: iResearch, JPMorgan estimates.

2005 24.4 111.0 22.0% 22% 11.0 708 85 82%

2006 32.6 137.0 23.8% 23% 11.6 1,044 132 54%

2007E 42.4 175.0 24.2% 25% 12.2 1,563 206 56%

2008E 50.9 200.3 25.4% 27% 13.5 2,227 293 43%

2009E 59.0 220.8 26.7% 29% 14.5 2,996 394 35%

2010E 66.1 238.8 27.7% 30% 15.6 3,714 489 24%

2011E 71.4 258.3 27.6% 31% 16.7 4,435 584 19%

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 (06-10E CAGR of 15%). (2) Upside in gamer penetration, which is still <25% (as % of Internet users); less than half of Koreas (also below HK and Taiwan); additional gamers particularly from lower-tier cities. (3) Increasing broadband penetration, with 122 million broadband Internet users as of Jun-07, or 75% of total Internet users; CAGR of ~100% over last 5 years. (4) Efforts of game companies - better quality, innovative games and more effective promotions to continue to attract players; also, success of the free-to-play (item115

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based sales) model (contributing ~63% of industry revenues in 2007, up from ~52% in 2006, as per IDC estimates). (5) Limited leisure alternatives - teenagers in first-tier China cities spending more on entertainment like Internet/games, with the trend being replicated in smaller cities.

Good understanding of gamers needs will be a key success factor for companies
Competition within the online gaming industry increased in 2007, with more free games, more competitors, and further public listings (significant capital raised via IPOs in 2H07). With the continuing popularity of the free-to-play model, we believe game companies can continue to generate revenue growth as long as gamers believe it is really worth it. Thus, we expect game companies that continue to maintain a good understanding of what gamers will pay for (or strong marketing capabilities), and respond accordingly, to see greater success going forward. Hence, in our view, companies like Shanda (leading free-to-play game operator with strong operating and marketing capabilities) are more likely to capitalize on the robust industry growth.

Comparison of leading games and game companies


Table 64: Leading MMORPG Companies by Revenue Market Share
Shanda NetEase Giant Interactive The9 Perfect World CDC Games Kingsoft Others
Source: Company reports, JPMorgan estimates.

2006 22% 31% 7% 17% 2% 4% 3% 14%

9M07 24% 23% 18% 14% 6% 4% 4% 8%

Table 65: Leading MMORPGs by PCU (Peak Concurrent Users)


(PCU in 000s) Fantasy WWJ (NetEase) Sequential growth ZT Online (Giant) Sequential growth WoW (The9) Sequential growth WWJ2 (NetEase) Sequential growth Eudemons Online (NetDragon) Sequential growth Yulgang (CDC Games) Sequential growth
Source: Company reports.

1Q06 1,236 18.5% 120 610 15.1% 581 4.8% 26 330 26.9%

2Q06 1,313 6.2% 320 166.7% 630 3.3% 562 -3.3% 50 92.3% 348 5.5%

3Q06 1,223 -6.9% 558 74.4% 595 -5.6% 593 5.5% 128 156.0% 331 -4.9%

4Q06 1,335 9.2% 755 35.3% 680 14.3% 603 1.7% 325 153.9% 333 0.5%

1Q07 1,503 12.5% 874 15.8% 680 0.0% 480 -20.4% 438 34.8% 343 3.2%

2Q07 1,472 -2.1% 1,073 22.7% 665 -2.2% 505 5.3% 496 13.2% na

3Q07 1,443 -1.9% 888 -17.2% 809 21.7% 305 -39.7% 527 6.3% na

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Table 66: Leaders in MMOG Active Paying Accounts (Free-to-play Model)


(In 000s) Shanda Sequential growth Giant Interactive Sequential growth Perfect World Sequential growth Sohu Sequential growth The9 Sequential growth 1Q06 2,470 143 2Q06 2,230 -9.7% 602 321.0% 3Q06 2,140 -4.0% 698 15.9% 26 4Q06 2,290 7.0% 787 12.8% 602 2215% 1Q07 2,340 2.2% 986 25.3% 695 15.4% 4 2Q07 2,720 16.2% 1,248 26.6% 1,040 49.6% 209 194 4995% 3Q07 3,080 13.2% 1,318 5.6% 1,390 33.7% 690 230.1% 183 -5.3%

Source: Company reports, JPMorgan estimates. Note: Perfect World: based on item-based games; Sohu: based on TLBB; The9: based on SUN and JJW.

Table 67: Leaders in MMOG Quarterly ARPU per Active Paying Account (Free-to-play Model)
(In Rmb) Giant Interactive Sequential growth Shanda Sequential growth Perfect World Sequential growth Sohu Sequential growth The9 Sequential growth 1Q06 84 91 2Q06 117 39.3% 137 49.7% 3Q06 220 88.0% 155 13.4% 12 4Q06 220 0.0% 165 6.8% 76 544.9% 1Q07 320 45.5% 177 7.1% 95 25.2% 88 2Q07 295 -7.8% 174 -1.9% 98 2.8% 171 85 -3.4% 3Q07 305 3.5% 179 3.1% 136 38.8% 118 -30.8% 175 105.4%

Source: Company reports, JPMorgan estimates. Note: Perfect World: based on item-based games; Sohu: based on TLBB; The9: based on SUN and JJW.

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U.S. Company Previews

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Amazon.com, Neutral ($92.85)


We are maintaining our Neutral rating on Amazon. Although we have been impressed with the companys ability to generate above-market revenue growth despite its size, we believe the stocks valuation leaves limited room for upside. Third-party sales growth to offset margin pressure from pricing. As a percentage of units, the company saw third-party sales increase more than 200 bps Y/Y in the first three quarters of 07. We believe third-party as a % of sales is likely to continue growing in F08. Further, we believe the platform helps Amazon expand selection, which ranked as the #2 factor influencing shoppers site choices in our proprietary survey. We think the more profitable 3P business should help offset margin pressure resulting from the sites continued competitiveness in the #1 factor, price. As such, we are modeling flat gross margins in F08, at 22.9%. Slight improvement in operating margins. We are modeling F08 operating margin improvement of ~30 bps and F09 improvement of ~20 bps, partly due to our expectation of increased leverage in expense lines such as tech & content as the company grows. We do not expect any leverage on gross margins, as we expect Amazon will continue to offer discounts to spur continued US sales growth. Additionally, we do not expect material leverage from fulfillment, as the company invests to support sales growth. 2008 drivers. In our view, the following factors will drive the stock in 2008: (1) Amazons continued ability to outperform the eCommerce markets growth rate; (2) the competitiveness of online offerings from brick-and-mortar retailers; (3) third-party sales mix; (4) potential for tech & content leverage. Additionally, the broader state of consumer spending is likely to have a continued impact on Amazon. Maintaining 4Q and 2007 estimates. We remain comfortable with our 4Q revenue, GAAP operating income and EPS estimates of $5.3B, $273M and $0.46. For the full year, we expect revenue, GAAP operating income and EPS of $14.5B, $657M, and $1.10.

Table 68: Amazon Estimates Snapshot


$ in millions, except per share data AMZN 4Q'07E JPM Revenue EBITDA EPS Consensus Revenue EBITDA EPS 5,325 392 0.46 5,360 393 0.48 F'07E 14,488 1,093 $1.10 14,504 1,080 1.12 F'08E 17,938 1,474 $1.51 18,256 1,446 1.61 F'09E 21,269 2,178 $1.87 22,373 1,884 2.41 F'07E 35.3% 84.0% 144.2% 35.4% 81.8% 148.6% Y/Y F'08E 23.8% 34.8% 37.2% 25.9% 33.9% 44.2% F'09E 18.6% 47.8% 23.8% 22.5% 30.3% 49.2%

Source: Company reports, FactSet, JPMorgan estimates

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We See Slight Margin Expansion in F08 and F'09


We think Amazon is poised to continue to benefit from improved leverage across its operating expense lines in the coming years. We think increased scale is likely to help the company boost its operating margins, up 30 bps in F08 and up ~20 bps in F09, to 6.3%.
Table 69: Key Expense metrics for Amazon.com
Fulfillment Marketing Technology and content General and administrative Y/Y Change in: Revenue growth Fulfillment Marketing Technology and content General and administrative Operating Margin (pro forma)
Source: Company reports, JPMorgan estimates

2006 8.5% 2.4% 5.7% 1.6% 26% 5 bps -14 bps -88 bps 8 bps -204 bps

2007E 8.4% 2.2% 5.0% 1.4% 35% 8 bps 19 bps 69 bps 27 bps 123 bps

2008E 8.3% 2.2% 4.8% 1.4% 24% 11 bps 1 bps 16 bps 2 bps 30 bps

2009E 8.2% 2.2% 4.7% 1.3% 19% 11 bps 3 bps 8 bps 2 bps 18 bps

Our Estimates and Outlook for 2008


We believe Amazons F08 North America sales are likely to slow their pace of growth from the rapid growth exhibited in F07, with a slightly softer economic outlook likely to cut into retail sales, as well as tougher comps due to the absence of Harry Potter. We are modeling 23% NA sales growth in F08. Internationally, we expect the company to grow slightly faster, at 25%. International sales should continue to benefit from favorable Y/Y FX rates (even assuming no further weakening of the dollar). We now expect Amazon F08 revenue of $17.9B, up from $17.4B previously, and we continue to project a 22.9% gross margin. We expect gross margins to see roughly offsetting impact from higher third-party sales on the one hand and more aggressive product pricing, on the other. We are projecting GAAP operating income of $881M, from $844M previously, and EPS of $1.51, up from $1.45, with the upside driven by our higher revenue projections, as we continue to expect the company to post a 6.1% pro forma operating margin.

Our Estimates and Outlook for 2009


For F09, we expect revenue growth to continue to moderate somewhat, as the company drives benefits from better scale and slight improvements in profitability. We are forecasting 19% overall revenue growth, to $21.3B, and slight Y/Y erosion in gross margin, to 22.8%. We are modeling F09 GAAP operating income of $1.1B, and EPS of $1.87.

Valuation and Rating Analysis


AMZN trades at a premium to its peers. Our F07 assumptions yield a 2007 EV/EBITDA multiple of 35.9x our F07 EBITDA estimate of $1,093M, versus the ecommerce group at 28.2x. AMZN trades at 26.7x our F08 EBITDA estimate of $1,437M, versus the ecommerce group at 19.1x. Despite strong EBITDA growth in both F'07 and F'08, we believe that AMZN shares are fully valued.

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Risks to Our Rating


AMZN could outperform if the company is able to successfully expand its third-party relationships faster than we are forecasting, in which case our margin assumptions could be too conservative. Additionally, an ever-growing portion of Amazons revenue is from its international business, exposing the company to foreign currency fluctuations. AMZN could underperform if it encounters difficulties in its international expansion, including regulatory hurdles that make the business climate less hospitable and potentially less profitable than the markets where it currently operates. Amazon may have difficulty growing revenues while maintaining its current operating margins.

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Table 70: AMZN Annual Income Statement


$ in millions, except per share data FY 2006 10,711 8,256 2,455 22.9% 912 259 607 176 10 101 2,065 1,964 390 491 3.6% 4.6% 702 491 60 (80) (3) (23) 468 468 377 49.6% 187 281 10 10 190 $0.45 425 8.5% 2.4% 5.7% 1.6% FY 2007E 14,488 11,172 3,316 22.9% 1,223 323 721 198 9 185 2,659 2,474 657 842 4.5% 5.8% 1,093 842 81 (75) (2) 4 846 846 652 29.0% 189 657 (9) (9) 463 $1.10 423 8.4% 2.2% 5.0% 1.4% FY 2008E 17,938 13,826 4,111 22.9% 1,473 399 873 254 16 216 3,231 3,015 881 1,097 4.9% 6.1% 1,474 1,097 89 (64) 25 1,122 1,122 906 29.0% 263 859 643 $1.51 426 8.2% 2.2% 4.9% 1.4% FY 2009E 21,269 16,410 4,859 22.8% 1,747 466 1,007 284 16 240 3,760 3,520 1,099 1,339 5.2% 6.3% 2,178 1,339 89 (64) 25 1,364 1,364 1,124 29.0% 326 1,038 798 $1.87 428 8.2% 2.2% 4.7% 1.3%

Net sales Cost of sales Gross profit Gross Margins Fulfillment Marketing Technology and content General and administrative Other operating expense (income) Stock-based compensation (1) Amortization of other intangibles Restructuring-related and other Total operating expenses Total recurring operating expenses Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma) EBITDA Income (loss) from continuing operations Interest Income Interest Expense Other Income, net Total non-operating expenses, net Income (loss) before equity in losses of equity-method investees Income (loss) before change in accounting principle (reported) Cumulative effect of change in accounting principle GAAP Income before taxes Tax Rate Provision (benefit) for taxes Net income (loss) Remeasurement of 6.875% PEACS and other Other gains (losses), net Total Extraordinary Items Net income (loss) Reported GAAP EPS Shares Outstanding % Of Revenue Fulfillment Marketing Technology and content General and administrative Y/Y Change Revenue Fulfillment Marketing Technology and content General and administrative PF Operating Income
Source: Company reports and JPMorgan estimates.

26% 25% 34% 50% 21% -13%

35% 34% 25% 19% 13% 72%

24% 20% 23% 21% 28% 30%

19% 19% 17% 15% 12% 22%

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Table 71: AMZN Quarterly Income Statement


$ in millions, except per share data Q1-06 2,279 1,732 547 24.0% 190 54 138 45 3 11 441 430 106 117 4.7% 5.1% 160 117 15 (21) (1) (7) 110 110 96 46.9% 45 65 (3) (3) 51 $0.12 FY 2006 Q2-06 Q3-06 2,139 2,307 1,630 1,758 509 549 23.8% 23.8% 182 52 151 44 3 30 462 432 47 77 2.2% 3.6% 123 77 13 (19) 1 (5) 72 72 54 59.3% 32 40 12 12 22 $0.05 209 63 156 49 2 30 509 479 40 70 1.7% 3.0% 133 70 14 (21) 4 (3) 67 67 38 49.6% 19 48 1 1 19 0.05 Q4-06 3,986 3,136 850 21.3% 331 90 162 38 2 30 653 623 197 227 4.9% 5.7% 286 227 18 (19) (7) (8) 219 219 189 48.1% 91 128 98 $0.23 Q1-07 3,015 2,296 719 23.8% 253 71 167 49 34 574 540 145 179 4.8% 5.9% 241 179 20 (19) 1 180 180 144 22.9% 33 147 (2) (2) 111 $0.26 FY 2007E Q2-07 Q3-07 2,886 3,262 2,185 2,500 701 762 24.3% 23.4% 248 63 176 49 3 46 585 539 116 162 4.0% 5.6% 225 162 20 (19) (1) 162 162 111 29.7% 33 129 (5) (5) 78 $0.19 285 72 181 47 3 51 639 588 123 174 3.8% 5.3% 235 174 23 (19) (1) 3 177 177 124 35.5% 44 133 (2) (2) 80 $0.19 Q4-07E 5,325 4,191 1,134 21.3% 437 117 197 53 3 54 861 807 273 327 5.1% 6.1% 392 327 18 (18) 327 327 273 29.0% 79 248 194 $0.46 Q1-08E 3,864 2,944 920 23.8% 313 89 205 62 4 54 726 672 193 247 5.0% 6.4% 193 247 20 (16) 4 251 251 197 29.0% 57 194 140 $0.33 FY 2008E Q2-08E Q3-08E 3,601 3,910 2,726 2,971 875 938 24.3% 24.0% 299 82 216 58 4 54 712 658 163 217 4.5% 6.0% 433 217 20 (16) 4 221 221 167 29.0% 48 172 118 $0.28 336 90 223 59 4 54 766 712 173 227 4.4% 5.8% 329 227 29 (16) 13 240 240 186 29.0% 54 186 132 $0.31 Q4-08E 6,563 5,185 1,378 21.0% 525 138 230 75 4 54 1,026 972 352 406 5.4% 6.2% 518 406 20 (16) 4 410 410 356 29.0% 103 307 253 $0.59

Net sales Cost of sales Gross profit Gross Margins Fulfillment Marketing Technology and content General and administrative Other operating expense (income) Stock-based compensation (1) Amortization of other intangibles Restructuring-related and other Total operating expenses Total recurring operating expenses Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma) EBITDA Income (loss) from continuing operations Interest Income Interest Expense Other Income, net Total non-operating expenses, net Income (loss) before equity in losses of equity-method investees Income (loss) before change in accounting principle (reported) Cumulative effect of change in accounting principle GAAP Income before taxes Tax Rate Provision (benefit) for taxes Net income (loss) Remeasurement of 6.875% PEACS and other Other gains (losses), net Total Extraordinary Items Net income (loss) Reported GAAP EPS

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Shares Outstanding % Of Revenue Fulfillment Marketing Technology and content General and administrative Q/Q Change Revenue Fulfillment Marketing Technology and content General and administrative PF Operating Income PF Net Income Y/Y Change Revenue Fulfillment Marketing Technology and content General and administrative PF Operating Income Additional Revenue Operating profit Contribution Margins
Source: Company reports and JPMorgan estimates.

Q1-06 426 8.3% 2.4% 6.1% 2.0% -23% -23% -19% 12% -2% -35% -69% 20% 17% 23% 68% 7% -9% 377 (11) -3%

FY 2006 Q2-06 Q3-06 426 424 8.5% 2.4% 7.1% 2.1% -6% -4% -4% 9% -2% -34% -38% 22% 19% 30% 62% 38% -42% 386 (55) -14% 9.1% 2.7% 6.8% 2.1% 8% 15% 21% 3% 11% -9% 21% 24% 26% 50% 44% 88% -42% 449 (51) -11%

Q4-06 422 8.3% 2.3% 4.1% 1.0% 73% 58% 43% 4% -22% 224% 165% 34% 35% 34% 32% -17% 25% 1,009 46 5%

Q1-07 420 8.4% 2.4% 5.5% 1.6% -24% -24% -21% 3% 29% -21% 15% 32% 33% 31% 21% 9% 53% 736 62 8%

FY 2007E Q2-07 Q3-07 423 425 8.6% 2.2% 6.1% 1.7% -4% -2% -11% 5% 0% -9% -12% 35% 36% 21% 17% 11% 110% 747 85 11% 8.7% 2.2% 5.5% 1.4% 13% 15% 14% 3% -4% 7% 3% 41% 36% 14% 16% -4% 149% 955 104 11%

Q4-07E 425 8.2% 2.2% 3.7% 1.0% 63% 53% 63% 9% 13% 88% 86% 34% 32% 30% 22% 40% 44% 1,339 100 7%

Q1-08E 426 8.1% 2.3% 5.3% 1.6% -27% -28% -24% 4% 16% -24% -22% 28% 24% 25% 23% 26% 38% 849 68 8%

FY 2008E Q2-08E Q3-08E 426 426 8.3% 2.3% 6.0% 1.6% -7% -5% -8% 5% -7% -12% -11% 25% 21% 30% 23% 18% 34% 715 55 8% 8.6% 2.3% 5.7% 1.5% 9% 13% 10% 3% 2% 5% 8% 20% 18% 25% 23% 25% 30% 648 53 8%

Q4-08E 427 8.0% 2.1% 3.5% 1.2% 68% 56% 53% 3% 29% 79% 65% 23% 20% 18% 17% 42% 24% 1,238 79 6%

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Table 72: AMZN Annual Balance Sheet


$ in millions FY-06 ASSETS: Cash/Equivalents ST Investments Inventories A/R, net and other current Total Current Assets Equipment, Net Other LT Assets L.T. Investments Goodwill/Intang. Goodwill Total Other Assets Total Assets LIABILITIES: Accounts Payable Accrued Expense Unearned Revenue Oth. Curr. Liab. Curr.Port.LT Debt Advertising Total Current Liabs Long Term Debt Capital Leases Total Long Term Debt Total Liabilities SHAREHOLDER EQUITY: Total Equity Liabilities + Equity
Source: Company reports and JPMorgan estimates.

FY-07E 2610.3 543.0 1224.8 639.0 5017.1 510.0 254.0 218.0 0.0 231.0 1213.0 6230.1 2396.4 798.8 0.0 0.0 0.0 3195.2 1538.0 1538.0 4733.2 1497.0 6230.1

FY-08E 4315.2 543.0 1575.2 787.6 7221.0 584.0 254.0 218.0 0.0 231.0 1287.0 8508.0 2953.5 984.5 0.0 0.0 0.0 0.0 3938.0 1538.0 0.0 1538.0 5476.0 3032.0 8508.0

FY-09E 6396.9 543.0 1861.6 930.8 9732.3 682.0 254.0 218.0 0.0 231.0 1385.0 11117.3 3490.6 1163.5 0.0 0.0 0.0 0.0 4654.1 1538.0 0.0 1538.0 6192.1 4925.3 11117.3

1022.0 997.0 877.0 477.0 3373.0 457.0 139.0 199.0 0.0 195.0 990.0 4363.0 1816.0 716.0 0.0 0.0 0.0 2532.0 1400.0 1400.0 3932.0 431.0 4363.0

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North America Equity Research 02 January 2008

Table 73: AMZN Annual Cash Flow Statement


$ in millions FY-06 OPERATING CASH FLOWS Net Income Depreciation and amortization Stock-Based Amort. Other operating expense Excess tax benefit on stock awards Equity in Loss Amort. Intangibles Merger/Acquisition Mrktbl.Secs. Remeasurement and other Investment Inc/Loss Interest Expense Accounting Change Deferred Taxes Changes current assets Inventories Prepaid Exp./Other Accounts Payable Accrued Expense Other Operating Non-Cash Items Interest Payable Cash From Operations FCF Y/Y Growth INVESTING CASH FLOWS Mat./ST Investments Purch./ST Investment Capital Expenditures Sale of Subsidiary Invst. in Affiliates Acquisitions Cash From Investing FINANCING CASH FLOWS Options Exercised Tax benefit of stock awards Issuance of Common Options/Common Issue Proceeds/LT Debt Repay. LTD Repayment of Debt Financing Costs Purch./Sale of Stock Long Term Debt Cash From Financing Foreign Exch Effects Net Change In Cash Beginning Cash Ending Cash
Source: Company reports and JPMorgan estimates.

FY-07E 190.3 205.0 101.0 2.0 6.0 (4.0) 462.9 248.0 185.0 3.0 (2.0) 755.9 (213.0) 62.9 582.8 297.3 121.0 (95.0) 1573.9 1350.9 178.4% 1,155.0 (777.0) (223.0) (47.0) 108.0

FY-08E 643.0 300.0 216.0 835.9 (347.8) 153.9 769.5 260.4 1994.9 1704.9 26.2% (290.0) (290.0)

FY-09E 798.2 338.0 232.0 1,043.6 (350.4) 182.6 904.0 307.3 2411.7 2081.7 22.1% (330.0) (330.0)

3.0 3.0 23.0 245.0 -282.0 -103.0 402.0 203.0 158.0 (133.0) 701.3 485.3 -8.5% 1,844.0 (1,929.0) (216.00) (32.0) (333.0)

36.0 99.0 (70.0) (313.0) (252.0) (399.0) 40.0 9.3 1,013.1 1,022.4

79.0 33.0 (58.0) (17.0) (248.0) (118.0) 24.0 1,587.9 1,022.4 2,610.3

1,704.9 2,610.3 4,315.2

2,081.7 4,315.2 6,396.9

128

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

North America Equity Research 02 January 2008

Blue Nile, Neutral ($74.16)


We think that NILE will continue to experience both strong revenue growth and margin expansion in F08. We believe that engagement products are less discretionary than other jewelry purchases and that the companys value-driven model will be attractive to customers in a weak economy. However, we think that, at the stocks current valuation, NILE will likely trade in line with its peer group. Hence, we reiterate our Neutral rating. Gains in traffic and number of purchases likely to continue. Traffic growth accelerated to 20% Y/Y in 3Q07, the highest third-quarter traffic growth since 2004. We believe that traffic gains are sustainable as the company pursues efficient and targeted marketing, as online shopping penetration rises, and as consumers become more value-oriented in a weak economy. Furthermore, we believe that repeat business accounts for only slightly over 20% of revenue and non-diamond jewelry for ~10%. Given NILEs high customer satisfaction levels, we believe repeat purchases will continue to climb. We think international market development will be a priority. At the end of 3Q07, intl revenues were only ~7% of total revenue. This is markedly lower than other e-commerce companies such as Amazon and eBay where intl revenue accounts for ~45% and ~51%, respectively. With the opening of the Ireland operations center, the launch of localized websites in Canada and the UK, planned product introductions, and a more integrated marketing program within the next 1-2 years, we believe int'l markets will be a large growth driver in 2008 and 2009. 2008 Drivers. In our view, the following factors will drive NILE shares in 2008: (1) top-line strength from discounted diamond pricing, (2) increased focus on intl markets, and (3) operating margin expansion from increased leverage. Maintaining 4Q'07 estimates. We maintain our 4Q07 revenue, EBITDA, and EPS estimates of $114.3M, $12.8M, and $0.44 (Y/Y growth of 26%, 32%, and 27% respectively). Our current and newly introduced 2009 estimates are in the table below:
Table 74: Blue Nile Estimates Snapshot
$ in millions, except per share data Blue Nile JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07E 114.32 12.80 0.44 113.52 12.53 0.44 F'07E 321.68 30.42 1.03 321.10 29.27 1.04 F'08E 388.45 36.20 1.23 391.43 36.25 1.30 F'09E 453.79 43.83 1.50 464.01 45.70 1.63 F'07E Y/Y 27.9% 35.7% 14.1% F'08E Y/Y 20.8% 19.0% 19.0% 21.9% 23.8% 25.0% F'09E Y/Y 16.8% 21.1% 22.1% 18.5% 26.1% 25.4%

Source: JPMorgan estimates, Company data, and Bloomberg

129

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


Our updated 2008 estimates call for Y/Y revenue, EBITDA, and EPS growth of 20.8%, 19.0%, and 19.0%, respectively. Specifically, we are modeling 2008 revenues, EBITDA, and GAAP EPS of $388.5M, $36.2M, and $1.23 (from $384.0M, $36.8M, and $1.22). We believe that the company will intensify its focus on international efforts in 2008, with an emphasis on its UK and Canadian websites. We believe that management has been encouraged with the early response to the sites and will now invest more heavily in growing these ventures. With the opening of the Ireland operations center, the launch of localized websites in Canada and the UK, planned product introductions, and a more integrated marketing program within the next 1-2 years, we believe int'l markets will be a more significant growth driver in 2008.

Our Estimates and Outlook for 2009


Our newly introduced 2009 estimates call for revenue, EBITDA, and EPS growth of 16.8%, 21.1%, and 22.1%, respectively. Specifically, we are modeling 2009 revenues, EBITDA, and GAAP EPS of $453.8M, $43.8M, and $1.50. We expect top-line growth to continue to be driven by international expansion and believe that the company might start to look at markets outside the UK and Canada. In addition, we expect operating margins to continue to expand due to increased leverage as we believe many of the existing assets can be used to support international expansion.

Valuation and Rating Analysis


On a P/E basis, NILE trades at 60.4x our F08 GAAP EPS estimate of $1.22 vs. its ecommerce peers, which trade at 38.1x F08 estimates. We do not think there is additional multiple expansion opportunity at this time and we maintain our Neutral rating.

Risks to Our Rating


Blue Nile is highly dependent on its diamond and jewelry suppliers, and it would be difficult for the companys business model to tolerate large price fluctuations in the price to acquire diamonds and jewelry. Blue Nile faces competition from both offline and online competitors, who operate in different spaces in the jewelry market. Online competitors include: diamond.com, amazon.com, walmart.com, mondera.com, and Ashford. Changes to Internet regulations regarding the collection of state and local taxes could negatively impact Blue Niles business, as consumers save a significant amount of money by purchasing jewelry over the Internet. A substantial number of Blue Niles shares are owned by insiders, giving NILE management significant voting leverage. Additionally, if the management decided to sell the stock then it could create selling pressure on the stock. If the company successfully executes its international business strategy or gains market share in the US from traditional retailers, our estimate could prove to be too conservative.

130

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

North America Equity Research 02 January 2008

Table 75: NILE Annual Income Statement


$ in millions, except per share data 2006 Total Revenue Cost of Revenue Pro forma FAS123R adjustment Pro forma Cost of Revs Gross Profit (Rpt) Gross Profit (Pforma) Gross Margin (Rpt) Gross Margins (PF) SG&A Restructuring FAS 123R Stock based compensation Total Expenses Total Recurring Expenses Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma) EBITDA EBITDA Margin Y/Y EBITDA Growth Other Income (Expense) Total Other Income Before Taxes (Reported) Income Before Taxes (Pro Forma) Income Taxes (Rpt) Income Taxes (Pforma) Tax Rate Pforma Tax Rate Inc From Ops After Taxes (Rpt) Inc From Ops After Taxes (PF) Extraordinary Item Reported Net Income Pro Forma Net Income Reported EPS Pro Forma EPS Diluted Shares % of Total Revenue Cost of Revenue Gross Profit SG&A Y/Y Change Total Revenue Cost of Revenue SG&A
Source: Company reports and JPMorgan estimates.

2007E 321.7 256.2 256.2 65.4 65.4 20.3% 20.3% 42.7 5.9 42.7 36.8 22.7 28.6 7.1% 8.9% 30.4 9.5% 35.7% 3.9 3.9 26.6 32.5 9.3 11.4 35.1% 17.3 21.1 17.3 21.1 1.03 1.26 16.7 0.23 36% 79.7% 20.3% 13.3%

2008E 388.4 309.0 309.0 79.4 79.4 20.4% 20.4% 52.0 6.3 52.0 45.7 27.4 33.7 7.1% 8.7% 36.2 9.3% 19.0% 4.4 4.4 31.8 38.1 11.2 13.4 35.2% 20.6 24.7

2009E 453.8 360.4 360.4 93.4 93.4 20.6% 20.6% 60.8 7.1 60.8 53.7 32.6 39.7 7.2% 8.8% 43.8 9.7% 21.1% 6.0 6.0 38.6 45.7 13.6 16.1 35.2% 25.0 29.6

251.6 200.7 200.7 50.9 50.9 20.2% 20.2% 34.3 4.0 34.3 30.3 16.6 20.6 6.6% 8.2% 22.4 8.9% 13.4% 3.4 3.4 20.0 24.1 6.9 8.4 34.5% 13.1 15.7 13.1 15.7 0.76 0.90 17.3 0.14 15% 79.8% 20.2% 13.6%

20.6 24.7 1.23 1.47 16.8 0.24 19% 79.6% 20.4% 13.4%

25.0 29.6 1.50 1.78 16.7 0.28 22% 79.4% 20.6% 13.4%

23.8% 27.0% 26.6%

27.9% 27.6% 24.5%

20.8% 20.6% 21.8%

16.8% 16.6% 16.9%

131

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

North America Equity Research 02 January 2008

Table 76: NILE Quarterly Income Statement


$ in millions, except per share data Q1-06 Total Revenue Cost of Revenue Pro forma FAS123R adjustment Pro forma Cost of Revs Gross Profit (Rpt) Gross Profit (Pforma) Gross Margin (Rpt) Gross Margins (PF) SG&A Restructuring FAS 123R Stock based compensation Total Expenses Total Recurring Expenses Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma) EBITDA EBITDA Margin Y/Y EBITDA Growth Other Income (Expense) Total Other Income Before Taxes (Reported) Income Before Taxes (Pro Forma) Income Taxes (Rpt) Income Taxes (Pforma) Tax Rate Pforma Tax Rate Inc From Ops After Taxes (Rpt) Inc From Ops After Taxes (PF) Extraordinary Item Reported Net Income
132

Q2-06 56.9 45.6 0.0 45.6 11.3 11.4 19.9% 20.0% 7.7 0.9 7.7 6.9 3.6 4.5 6.3% 7.9% 5.0 8.7% 17.5% 1.0 1.0 4.6 5.5 1.5 1.8 31.7% 32.3% 3.1 3.7

FY 2006 Q3-06 53.2 42.8 0.0 42.8 10.4 10.5 19.6% 19.6% 8.3 1.2 8.3 7.1 2.2 3.4 4.1% 6.3% 3.8 7.2% 5.2% 0.7 0.7 2.8 4.0 1.0 1.4 35.6% 35.6% 1.8 2.6

Q4-06 90.7 72.0 0.0 72.0 18.7 18.7 20.6% 20.6% 10.6 1.2 10.6 9.4 8.1 9.3 9.0% 10.3% 9.7 10.7% 22.4% 0.8 0.8 8.9 10.1 3.2 3.6 35.5% 35.5% 5.8 6.5

Q1-07 67.9 54.7 54.7 13.2 13.2 19.5% 19.5% 9.6 1.3 9.6 8.3 3.7 5.0 5.4% 7.3% 5.4 7.9% 36.9% 1.2 1.2 4.9 6.2 1.7 2.2 34.9% 34.9% 3.2 4.0

FY 2007E Q2-07 Q3-07 72.1 57.2 57.2 14.9 14.9 20.7% 20.7% 9.9 1.4 9.9 8.5 5.0 6.4 7.0% 8.9% 6.8 9.5% 37.4% 0.8 0.8 5.8 7.2 2.1 2.6 35.4% 35.4% 3.8 4.7 67.4 54.0 54.0 13.4 13.4 19.8% 19.8% 9.7 1.4 9.7 8.3 3.6 5.0 5.4% 7.4% 5.4 8.0% 41.9% 1.0 1.0 4.6 6.0 1.6 2.1 35.0% 35.0% 3.0 3.9

Q4-07E 114.3 90.4 90.4 23.9 23.9 20.9% 20.9% 13.5 1.8 13.5 11.7 10.4 12.2 9.1% 10.7% 12.8 11.2% 31.9% 1.0 1.0 11.4 13.2 4.0 4.6 35.0% 35.0% 7.4 8.6

Q1-08E 83.5 66.6 66.6 17.0 17.0 20.3% 20.3% 11.7 1.3 11.7 10.4 5.3 6.6 6.3% 7.9% 7.2 8.6% 33.1% 1.1 1.1 6.4 7.7 2.2 2.7 35.2% 35.2% 4.1 5.0

FY 2008E Q2-08E Q3-08E 88.0 70.0 70.0 17.9 17.9 20.4% 20.4% 12.0 1.4 12.0 10.6 6.0 7.4 6.8% 8.4% 8.0 9.1% 17.0% 1.1 1.1 7.1 8.5 2.5 3.0 35.2% 35.2% 4.6 5.5 81.5 65.0 65.0 16.5 16.5 20.2% 20.2% 12.6 1.6 12.6 11.0 3.8 5.4 4.7% 6.7% 6.0 7.4% 11.2% 1.1 1.1 4.9 6.5 1.7 2.3 35.2% 35.2% 3.2 4.2

Q4-08E 135.5 107.4 107.4 28.0 28.0 20.7% 20.7% 15.7 2.0 15.7 13.7 12.3 14.3 9.1% 10.6% 15.0 11.1% 17.4% 1.1 1.1 13.4 15.4 4.7 5.4 35.2% 35.2% 8.7 10.0

50.7 40.3 0.0 40.3 10.4 10.4 20.5% 20.5% 7.7 0.8 7.7 6.9 2.7 3.5 5.3% 6.9% 3.9 7.8% -1.2% 1.0 1.0 3.7 4.5 1.3 1.6 35.5% 35.6% 2.4 2.9

2.4

3.1

1.8

5.8

3.2

3.8

3.0

7.4

4.1

4.6

3.2

8.7

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

North America Equity Research 02 January 2008

Pro Forma Net Income Reported EPS Pro Forma EPS Diluted Shares % of Total Revenue Cost of Revenue Gross Profit SG&A Q/Q change Total Revenue Cost of Revenue SG&A Y/Y Change Total Revenue Cost of Revenue SG&A
Source: Company reports and JPMorgan estimates.

Q1-06 2.9 0.13 0.16 18.2 79.5% 20.5% 15.2% -30.8% -29.3% -11.8% 14.9% 17.1% 25.8%

Q2-06 3.7 0.18 0.21 17.6 80.1% 19.9% 13.6% 12.3% 13.0% 0.5% 29.9% 34.7% 25.3%

FY 2006 Q3-06 2.6 0.11 0.16 16.7 80.4% 19.6% 15.5% -6.4% -6.0% 6.8% 26.8% 30.7% 36.7%

Q4-06 6.5 0.34 0.39 16.8 79.4% 20.6% 11.7% 70.4% 68.2% 27.9% 23.9% 26.3% 21.0%

Q1-07 4.0 0.19 0.24 16.5 80.5% 19.5% 14.1% -25.2% -24.1% -9.6% 34.0% 35.6% 24.1%

FY 2007E Q2-07 Q3-07 4.7 3.9 0.23 0.28 16.6 79.3% 20.7% 13.7% 6.2% 4.6% 3.6% 26.7% 25.4% 27.9% 0.18 0.23 16.9 80.2% 19.8% 14.5% -6.6% -5.5% -1.7% 26.5% 26.1% 17.8%

Q4-07E 8.6 0.44 0.51 16.9 79.1% 20.9% 11.8% 69.7% 67.5% 38.4% 26.0% 25.5% 27.6%

Q1-08E 5.0 0.24 0.29 16.9 79.7% 20.3% 14.0% -26.9% -26.4% -13.3% 23.0% 21.8% 22.3%

FY 2008E Q2-08E Q3-08E 5.5 4.2 0.27 0.33 16.9 79.6% 20.4% 13.6% 5.3% 5.2% 2.3% 22.0% 22.5% 20.7% 0.19 0.25 16.7 79.8% 20.2% 15.5% -7.3% -7.1% 5.6% 21.0% 20.4% 29.6%

Q4-08E 10.0 0.52 0.60 16.7 79.3% 20.7% 11.6% 66.2% 65.2% 24.4% 18.5% 18.8% 16.5%

133

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

North America Equity Research 02 January 2008

Table 77: NILE Annual Balance Sheet


$ in millions 2006 Assets Cash and cash equivalents Restricted cash Marketable securities Accounts receivable Inventories Deferred income taxes Prepaids and other current assets Total Current Assets Property and equipment, net Intangible assets, net Deferred income taxes, net Other assets Total Long Term Assets Total Assets Liabilities Accounts payable Accrued liabilities Accrued marketing Current portion of deferred rent Current portion of note payable to related party Current portion of subordinated notes payable Current portion of capital lease obligations Total Current Liabilities Deferred rent, less current portion Note payable to related party, less current portion Capital lease obligations, less current portion Redeemable convertible preferred stock Total Long Term Liabilities Total Liabilities Shareholder Equity Preferred stock Common Stock Additional Paid in Capital Deferred compensation Accumulated deficit Treasury stock Total Equity Total Liabilities + Equity
Source: Company reports and JPMorgan estimates.

2007E 135.3 2.2 18.3 0.7 4.1 160.7 6.8 0.3 3.0 0.1 10.1 170.8

2008E 192.0 2.1 18.6 0.7 2.2 215.6 8.3 0.3 2.0 0.1 10.6 226.3

2009E 246.5 2.0 19.0 0.7 (0.1) 268.2 6.6 0.3 2.0 0.1 9.0 277.2

78.5 0.1 19.8 1.6 14.6 0.6 0.7 116.0 3.4 0.3 2.0 0.1 5.8 121.8

66.6 7.5 0.2 74.3 0.7 0.7 74.9 0.0 115.8 (0.2) 6.7 (75.4) 46.9 121.8

74.3 8.0 0.2 82.6 0.6 0.6 83.2 87.6 170.8

100.2 13.1 (0.1) 113.1 0.6 0.6 113.7 112.6 226.3

122.2 17.9 (0.6) 139.6 0.6 0.6 140.2 136.9 277.2

134

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

North America Equity Research 02 January 2008

Table 78: NILE Annual Cash Flow


$ in millions 2006 Operating Cash Flows Net income Depreciation and amortization Loss on asset retirement Stock-based compensation expense Warrant based interest expense Restructuring charges Deferred income taxes Tax benefit from exercise of stock options Excess tax benefit from exercise of stock options Changes in working capital Receivables, net Inventories Prepaid expenses and other assets Accounts payable Accrued liabilities Deferred rent Cash From Operations FCF Investing Cash Flows Purchases of property and equipment Proceeds from sales of property and equipment Transfers to restricted cash Purchase/Sale of marketable securities Cash From Investing Financing Cash Flows Proceeds from sale of common stock, net of issuance costs Proceeds from sale of mandatorily redeemable convertible preferred stock, net of issuance costs Repurchase of restricted and common stock Proceeds from stock option exercises Excess tax benefit from exercise of stock options Net repayments on line of credit Payments on subordinated notes payable Payments on capital lease obligations Payments on note payable to related party Payment on note payable Proceeds from warrant and stock option exercises Cash From Financing Net Increase (decrease) in cash Beginning Cash Ending Cash
Source: Company reports and JPMorgan estimates.

2007E 17.3 1.8 (0.0) 5.9 (1.1) 6.2 (1.6) 20.0 (0.6) (1.8) (2.8) 21.7 3.5 (0.1) 48.5 43.5 12.6% (5.1) 0.0 0.1 19.8 14.8 (13.5) 5.4 1.6 0 0 0 0 (6.6) 56.8 78.6 135.3

2008E 20.6 2.5 6.3 (1.0) 32.2 0.1 (0.3) 1.9 25.9 5.1 (0.4) 60.7 56.7 30.4% (4.0) (4.0) 56.7 135.3 192.0

2009E 25.0 2.9 7.1 (1.0) 28.5 0.1 (0.4) 2.3 22.1 4.9 (0.5) 62.5 54.5 -3.7% (8.0) (8.0) 54.5 192.0 246.5

13.1 1.9 0.0 4.4 2.7 2.7 (0.2) 15.9 0.2 (2.9) 0.1 16.5 2.2 (0.2) 40.5 38.6 27.8% (1.9) 0.0 0.0 23.0 21.1 (57.4) 2.3 0.2 -

(55.0) 6.6 72.0 78.6

135

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

North America Equity Research 02 January 2008

CNET Networks, Neutral ($8.90)


While we believe the CPM growth rate will accelerate in F08 after a soft F07, we expect some of the challenges CNET faced in F07 to persist in the coming year. Core audience unlikely to grow. We continue to believe that much of the audience for CNETs core tech vertical is tech savvy and thus already online. As such, the rising tide of continued growth in Internet penetration is not likely to significantly raise the tech sites audience. comScore data suggests US users for CNETs core sites are growing at half the pace of overall US Internet users. (See Figure on next page). Non-tech verticals outpacing core CNET. Third-party metrics suggest growth at sites such as GameSpot is significantly exceeding that of the core tech vertical. However, we believe it will take time for CNET to drive CPMs at non-tech sites to levels similar to those of core CNET, as the company builds out ad sales forces familiar with those verticals. Sale of WebShots removes a growth drag. CNETs sale of WebShots to American Greetings was a positive step, allowing the company to focus on creating and nourishing successful brands. We expect the company to continue to reevaluate its brands and sites going forward. CPMs appear poised to rise. On a positive note, we think that, after an influx of inventory pressured CPMs in F07, ad pricing for graphical ads is likely to start growing at a faster pace in F08 than it has in the past year. 2008 Drivers. In our view, the following factors will drive the stock in 2008: (1) CPM pricing trends for graphical ads; (2) usage trends at CNETs core sites; (3) usage uptake at newer CNET verticals; (4) CNETs ability to monetize non-tech sites; and (5) CNETs ability to monetize its non-US traffic. Maintaining Q407 and F07 estimates. We continue to expect CNET to post revenue, EBITDA and EPS of $122M, $36M and $1.29, respectively, in 4Q, and $411M, $82M and $1.12, respectively, for the full year.

Table 79: CNET Estimates Snapshot


$ in millions, except per share data CNET 4Q'07E JPM Revenue EBITDA EPS Consensus Revenue EBITDA EPS 122.1 36.3 1.29 122.5 33.3 1.29 F'07E 410.9 81.9 1.12 410.8 70.1 1.12 F'08E 450.8 99.6 0.14 449.4 91.5 0.14 F'09E 494.0 117.7 0.22 486.0 96.8 0.21 F'07E 5.9% 86.1% NM 5.9% 59.4% NM Y/Y F'08E 9.7% 21.7% NM 9.4% 30.5% NM F'09E 9.6% 18.1% 57.1% 8.2% 5.8% 56.6%

Source: Company reports, FactSet, JPMorgan estimates.

136

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


We expect F08 to see a continuation of many of the trends that CNET encountered in F07: User growth at core site is slowing The core, tech-focused CNET brand attracts an audience that is tech-savvy, and as such we continue to believe that this core audience has long been online and increased secular Internet use is unlikely to translate into rapid user growth for the core site. ComScore data for the last two years supports this view:
Figure 82: Core CNET user growth below Internet usage growth
CAGR, 4Q'05 - 4Q'07

4% 3% 2% 1% 0% CNET
Source: comScore Networks, JPMorgan Estimates

4%

2%

US Internet

Non-tech sites still in early stages Aside from GameSpot, we believe CNETs non-tech verticals are still in the early stages of their growth. As such, while we think there is significant promise from these sites, we do not expect significant monetization from them in the near term. Slightly adjusting estimates We think the sale of WebShots suggests CNET is willing to look critically at all of the parts of its portfolio of sites. Further, we are encouraged by the companys efforts to build relationships with advertisers in non-tech areas and the investments CNET is making outside the US. Additionally, we are more positive on broader CPM growth in the graphical ad market than we were coming into F07. As such, we now expect F08 revenue of $451M, up from $444M previously, representing 12% Y/Y growth after adjusting for the sale of WebShots. At the same time, we think higher investment in new products will lead to somewhat lower profitability we now estimate EBITDA of $100M, from $103M previously. We see F07 EPS of $0.14, compared to our previous $0.16 estimate.

Our Estimates and Outlook for 2009


We are introducing our F09 estimates for CNET, as follows: we expect 11% revenue growth in F09, to $494M. We believe profitability will improve due to increased scale and improved pricing, with operating margins rising to 23.8%, from 22.1% in F08. As such, we are projecting EBITDA of $118M, up 18% Y/Y, and EPS of $0.22.

137

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

North America Equity Research 02 January 2008

By F09, we think some of CNETs non-tech verticals will likely be able to contribute more meaningfully, although we think it is likely that there will be some misses in addition to the hits. Further, as online advertising matures in markets outside the US and UK, we think F09 could be the year when monetization at the companys international sites improves, although we think it is unlikely to reach parity with US and UK monetization in the foreseeable future.

Valuation and Rating Analysis


On an EV/EBITDA basis, CNET trades at 13.7x our F08 EBITDA estimate of $99.6M, in line with a 12.1x for its peer group. Given the secular challenges, we think multiple expansion is unlikely, and as such, we maintain our Neutral rating.

Risks to Our Rating


CNET is highly dependent on the performance of the online advertising industry. During the recent quarter, the majority of CNETs revenues came from its Marketing Services business segment. The advertising industry is very susceptible to overarching economic conditions, making a large portion of CNETs revenues vulnerable to general economic risk. Changes in the competitive landscape or new regulations could also significantly impact CNETs main revenue stream, presenting a downside risk to our rating. On the contrary, should CNET grow at a faster rate than the online industry or further improve its contribution margins, our outlook could prove to be too conservative. Also, if the company further improves its operating margins, the stock could outperform its peers.

138

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

North America Equity Research 02 January 2008

Table 80: CNET Annual Income Statement


$ in millions, except per share data FY-06 Marketing services Licensing Total Revenue Cost of Revenue Gross Profit Gross Margin Sales and Marketing General and Administrative Unusual Inc./Expense Depreciation Amort.Intangibles Asset Impairment Stock Compensation Total Expenses Total Recurring Expenses Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma) EBITDA Realized gain on sale of investments Interest Income Interest Expense Other, Net Total Other, Reported Total Other, Pro Forma Income Before Taxes Income Taxes Tax Rate Income After Taxes Extraordinary Item Reported Net Income Reported EPS Diluted Shares % of Total Revenue Marketing services Licensing Sales and Marketing G&A Q/Q change Marketing services Licensing G&A Y/Y Change Marketing services Licensing Total Revenue Sales and Marketing G&A
Source: Company reports and JPMorgan estimates.

FY-07E 337.3 50.3 387.7 162.2 225.5 58.2% 94.7 50.3 13.7 22.8 11.9 2.8 19.8 216.1 145.0 9.4 80.5 2.4% 20.8% 80.5 0.6 4.9 (5.0) (0.5) (0.1) (0.6) 9.3 1.5 15.7% 7.9 (0.0) 7.8 0.05 152.3 87.0% 13.0% 24.4% 13.0% 363.2 47.6 410.9 166.0 244.9 59.6% 106.2 56.8 7.8 28.4 12.4 19.0 19.9 250.4 162.9 (5.6) 81.9 -1.4% 19.9% 81.9 2.2 3.3 (5.3) 2.4 2.7 0.5 (2.9) (175.8) nm 172.9 172.9 1.12 153.3 88.4% 11.6% 25.8% 13.8%

FY-08E 405.3 45.5 450.8 170.9 279.9 62.1% 117.7 62.6 36.7 12.8 23.3 253.1 180.3 26.8 99.6 6.0% 22.1% 99.6 2.0 (5.6) (3.6) (3.6) 23.2 1.5 6.4% 21.7 21.7 0.14 154.7 89.9% 10.1% 26.1% 13.9%

FY-09E 450.4 43.7 494.0 180.5 313.5 63.5% 126.7 69.1 40.8 12.8 24.0 273.4 195.8 40.1 117.7 8.1% 23.8% 117.7 2.0 (5.6) (3.6) (3.6) 36.5 2.1 5.7% 34.4 34.4 0.22 155.9 91.2% 8.8% 25.7% 14.0%

15% 21% 14%

8% -5% 6% 12% 13%

12% -4% 10% 11% 10%

11% -4% 10% 8% 10%

139

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Table 81: CNET Quarterly Income Statement


$ in millions, except per share data 1Q'06 71.2 12.4 83.7 39.5 44.2 52.8% 22.1 12.1 4.8 2.7 4.8 46.5 34.2 (2.3) 10.0 -3% 11.9% 10.0 0.5 1.2 (0.7) 0.1 1.1 0.6 (1.2) 0.1 -6% (1.3) (0.0) (1.3) $ (0.01) FY 2006 2Q'06 3Q'06 79.8 80.7 12.6 12.6 92.4 93.3 38.6 53.8 58.2% 23.8 11.1 1.4 5.3 2.7 4.6 49.0 35.0 4.8 18.8 5.2% 20.4% 18.8 1.3 (0.7) (0.1) 0.5 0.5 5.4 0.2 4% 5.2 5.2 $ 0.03 40.1 53.2 57.0% 22.3 12.4 5.8 5.9 3.2 1.4 5.0 56.0 34.7 (2.8) 18.5 -3.0% 19.8% 18.5 0.1 1.6 (0.7) (0.0) 0.9 0.9 (1.9) 0.4 -22% (2.3) (2.3) $ (0.02) 4Q'06 105.7 12.7 118.4 44.0 74.3 62.8% 26.5 14.7 6.5 6.9 3.2 1.4 5.4 64.6 41.2 9.7 33.1 8.2% 28.0% 33.1 0.9 (3.0) (0.5) (2.7) (2.7) 7.1 0.8 11% 6.3 6.3 $ 0.04 1Q'07 80.1 12.0 92.1 41.7 50.4 54.7% 25.1 13.5 4.4 7.5 3.2 5.2 58.9 38.6 (8.5) 11.8 -9% 12.8% 11.8 0.6 (1.3) 0.3 (0.4) (0.4) (8.9) 0.2 nm (9.1) (9.1) $ (0.06) FY 2007E 2Q'07 3Q'07 85.5 87.6 11.7 11.9 97.2 99.5 40.5 56.7 58.3% 26.8 13.7 2.9 7.0 3.2 4.1 57.6 40.5 (1.0) 16.2 -1.0% 16.6% 16.2 1.6 0.9 (1.3) (0.2) 1.0 (0.6) 0.0 0.1 nm (0.1) (0.1) $ (0.00) 40.9 58.6 58.9% 26.8 14.1 0.4 6.8 3.3 19.0 4.7 75.1 40.9 (16.5) 17.7 -16.5% 17.8% 17.7 0.6 1.0 (1.2) 0.9 1.2 0.7 (15.2) 1.4 nm (16.6) (16.6) $ (0.11) 4Q'07E 110.0 12.1 122.1 42.8 79.2 64.9% 27.5 15.5 0.1 7.2 2.7 6.0 58.8 43.0 20.4 36.3 16.7% 29.7% 36.3 0.7 (1.4) 1.5 0.8 0.8 21.2 (177.5) nm 198.7 198.7 $ 1.29 1Q'08E 87.3 11.4 98.7 42.3 56.4 57.1% 27.8 14.8 8.5 3.2 5.7 60.0 42.6 (3.7) 13.7 -3.7% 13.9% 13.7 0.5 (1.4) (0.9) (0.9) (4.6) 0.1 5% (4.7) (4.7) $ (0.03) FY 2008E 2Q'08E 3Q'08E 94.9 95.4 11.1 11.3 106.0 106.8 42.0 64.0 60.4% 29.9 14.9 8.9 3.2 5.4 62.3 44.8 1.7 19.2 1.6% 18.1% 19.2 0.5 (1.4) (0.9) (0.9) 0.8 0.0 5% 0.7 0.7 $ 0.00 41.4 65.4 61.2% 28.6 15.7 9.4 3.2 6.1 63.0 44.3 2.3 21.0 2.2% 19.7% 21.0 0.5 (1.4) (0.9) (0.9) 1.4 0.1 5% 1.4 1.4 $ 0.01 4Q'08E 127.6 11.7 139.3 45.1 94.2 67.6% 31.3 17.1 9.9 3.2 6.1 67.7 48.5 26.5 45.7 19.0% 32.8% 45.7 0.5 (1.4) (0.9) (0.9) 25.6 1.3 5% 24.3 24.3 $ 0.16

Marketing services Licensing Total Revenue Cost of Revenue Gross Profit Gross Margin Sales and Marketing General and Administrative Unusual Inc./Expense Depreciation Amort.Intangibles Asset Impairment Stock Compensation Total Expenses Total Recurring Expenses Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma) EBITDA Realized gain on sale of investments Interest Income Interest Expense Other, Net Total Other, Reported Total Other, Pro Forma Income Before Taxes Income Taxes Tax Rate Income After Taxes Extraordinary Item Reported Net Income Reported EPS
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Diluted Shares % of Total Revenue Marketing services Licensing Sales and Marketing G&A Q/Q change Marketing services Licensing G&A Y/Y Change Marketing services Licensing Total Revenue Sales and Marketing G&A
Source: Company reports and JPMorgan estimates.

148.7 85.2% 14.8% 26.4% 14.5% #DIV/0! #DIV/0! -1.7% 19% 7% 17% 19% 12%

152.8 86.4% 13.6% 25.8% 12.1% 12.0% 1.3% -8.1% 14% 15% 14% 21% -8%

149.8 86.4% 13.6% 23.9% 13.3% 1.1% 0.5% 11.0% 13% 14% 13% 14% 1%

152.6 89.3% 10.7% 22.4% 12.4% 31.0% 0.5% 18.7% n/a n/a 14% 26% 19%

150.4 87.0% 13.0% 27.2% 14.7% -24.2% -5.7% -7.9% 12% -4% 10% 14% 11%

151.3 88.0% 12.0% 27.6% 14.1% 6.7% -2.6% 1.1% 7% -7% 5% 13% 23%

151.7 88.0% 12.0% 26.9% 14.1% 2.4% 2.4% 3.0% 9% -6% 7% 20% 14%

154.0 90.1% 9.9% 22.5% 12.7% 25.6% 1.0% 10.1% 4% -5% 3% 4% 6%

154.3 88.5% 11.5% 28.2% 15.0% -20.6% -5.7% -4.5% 9% -5% 7% 11% 9%

154.6 89.5% 10.5% 28.2% 14.1% 8.7% -2.6% 1.0% 11% -5% 9% 11% 9%

154.9 89.4% 10.6% 26.8% 14.7% 0.5% 2.4% 5.0% 9% -5% 7% 7% 11%

155.2 91.6% 8.4% 22.5% 12.3% 33.7% 3.2% 9.2% 16% -3% 14% 14% 11%

141

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Table 82: CNET Annual Balance Sheet


$ in millions FY-06 Assets Cash/Equivalents Marketable Debt Sec. Marketable Equity Acct. Receivable Other Current Dfrd. Income Tax Total Current Assets Restricted Cash Debt Sec. Investment Equity Invest. Prop. & Equip., Net Other Assets Dfrd. Income Taxes Intangibles, Net Goodwill Total Assets Liabilities Accounts Payable Line of Credit Accrued Liabilities Cur. Port. LT Debt Tax Related Dfrd. Tax Liabs. Bank Overdraft Total Current Liabs LTD Total Long Term Debt Other Liabilities Total Liabilities Shareholder Equity Common Stock Paid in Capital Other Equity Conv. Pref. Stock & Deferred Stock Comp Accumulated Deficit Treasury Stock Total Equity Total Liabilities + Equity
Source: Company reports and JPMorgan estimates.

FY-07E 31.3 30.4 90.4 10.4 162.6 2.2 13.9 72.6 15.6 34.8 133.2 434.9 10.1 60.0 80.4 13.8 164.2 4.5 4.5 0.7 169.4 125.4 16.0 97.7 12.2 251.2 1.6 0.5 71.8 14.2 37.6 101.5 478.3 11.0 60.0 79.3 3.3 153.7 2.8 2.8 4.1 160.6 317.7 478.3

FY-08E 178.7 16.0 111.4 13.9 320.0 1.6 0.5 71.8 14.2 37.6 101.5 547.1 12.5 60.0 90.5 3.3 166.4 2.8 2.8 4.1 173.4 0.0 0.0 0.0 0.0 0.0 0.0 373.8 547.1

FY-09E 241.1 16.0 121.3 15.2 393.5 1.6 0.5 71.8 14.2 37.6 101.5 620.7 13.6 60.0 98.5 3.3 175.5 2.8 2.8 4.1 182.5 0.0 0.0 0.0 0.0 0.0 0.0 438.2 620.7

0.0 2,857.2 (11.4) (2,550.1) (30.5) 265.3 434.9

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Table 83: CNET Annual Cash Flow Statement


$ in millions FY-06 Operating Cash Flows Net Income Depreciation & Amort Stock compensation expense Deferred Taxes Fair Value Remeasurement Non-Cash Items Noncash Interest Goodwill Impairment Loss-Sale of Assets Debt Retirement Extraordinary Loss Doubtful Accounts Gain on Sale of Business Investment Sales & Equity Loss Working Capital Cash From Operations FCF Investing Cash Flows Purch.-Mktbl. Secs. Purch.- Mktbl. Debt Proc. Mktbl. Debt Proc. Mktbl. Equity Release of restrictions on cash Other Investing Capital Expenditures Cash Acq. & Asset Sales, Net Cash From Investing Financing Cash Flows Pmt from Sharehold notes Net borrowing on credit facility Pmt from Employee stk plan Purch./Sale of Stock Payments-Cap. Leases Debt, Net Common/Options/ESOP Cash From Financing Net Increase (decrease) in cash Foreign Exch Effects Beginning Cash Ending Cash
Source: Company reports and JPMorgan estimates.

FY-07E 7.8 34.7 19.8 (0.6) 2.8 0.3 2.5 (0.3) (0.6) (4.6) 61.8 29.0 (45.5) 57.6 0.1 3.1 (32.8) (14.5) (32.1) (62.9) 7.3 (55.7) (25.9) 1.4 55.9 31.3 172.9 40.8 19.9 (177.5) (0.1) (0.1) 19.0 1.6 (2.2) 0.1 73.7 42.7 (9.4) 38.7 1.6 0.6 2.5 (31.0) 5.4 8.5 (0.0) (0.0) 11.7 11.6 93.8 0.2 31.3 125.4

FY-08E 21.7 49.5 23.3 94.5 48.5 (46.0) (46.0) 4.7 4.7 53.3 125.4 178.7

FY-09E 34.4 53.6 24.0 112.0 57.7 (54.3) (54.3) 4.7 4.7 62.5 178.7 186.5

143

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eBay, Overweight ($34.49)


After Y/Y listings declines in the first nine months of F07, 4Q07 saw reaccelerated listings growth, and the company has made several incremental structure and pricing changes intended to strengthen the core site. We maintain our optimistic outlook as we see continued RPL and listings growth in F08 and F09, and believe the PayPal franchises increasing off-eBay penetration remains a growth driver for the company. PayPal is a catalyst for growth. PayPal is no longer just a lubricant for the eBay marketplace; in the first three quarters of 07, 41.5% of PayPal TPV was off-eBay, a rise of over 650 bps Y/Y. We think this trend is likely to continue, and thus we are projecting PayPal revenue to grow 25% in F08 and 23% in F09, even as eBay GMV rises 10% in both years. Will eBay experiment with site structure? The company has made public statements suggesting alternative fee schedules for the core site may be considered, possibly shifting toward lower listing fees and higher finalvalue fees. We believe the 06 shift in Stores listings has ensured that eBay will make changes very tentatively and after experimentation. Additionally, we expect revenue loss from the introduction of lower listing fees will be offset by higher final value fees and faster listings growth. As such, we expect neutral near-term impact from site structure changes. Strong growth from StubHub!, ad revenues and classifieds. We believe eBays businesses outside the core marketplace are poised for continued strength in F08. We think the international expansion of StubHub! presents a significant growth opportunity, and we believe eBay is likely to start reaping increased rewards as its advertising deal with Google matures. 2008 Drivers. In our view, the following factors will drive the stock in 2008: (1) RPL improvements; (2) impact of promotions and price changes on marketplace ecosystem; (3) growth in non-GMV businesses; (4) improved intl PayPal penetration; (5) growing PayPal presence off-eBay. Maintaining 4Q07 and F07 estimates. Our listings tracking and conversations with sellers give us confidence in our 4Q07 revenue, EBITDA and pro forma EPS estimates of $2.19B, $726M and $0.40. For the full year, we expect $7.68B, $2.55B and $1.48, respectively.

Table 84: eBay Consensus Snapshot


$ in millions, except per share data EBAY JPM Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07E 2,193 811 0.40 2,136 823 0.40 F'07E 7,685 2,863 1.48 7,632 2,915 1.49 F'08E 9,007 3,337 1.70 9,031 3,392 1.66 F'09E 10,506 3,754 1.98 10,603 3,848 1.94 F'07E 28.7% 1.6% 41.2% 27.8% 16.4% 41.8% Y/Y F'08E 17.2% 17.7% 14.6% 18.3% 16.4% 11.6% F'09E 16.6% 13.9% 16.7% 17.4% 13.5% 16.9%

Source: Company reports, FactSet, JPMorgan estimates.

144

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North America Equity Research 02 January 2008

Key Financial Metrics and Forecasts


The following tables summarize our revenue forecast by business segment as well as our estimate for Y/Y growth in key auction metrics.
Table 85: eBay Revenue Forecast by Segment
$ in millions Gross Merchandise Volume (GMV) % change Y/Y Payment revenue eBay online revenue Total Transaction revenue 3rd party advertising revenue Skype Total Online Revenue
Source: Company reports and JPMorgan estimates

2006A 52,473 18% 1,402 4,203 5,605 172 193 5,970

2007E 59,384 13% 1,817 5,206 7,023 294 368 7,685

2008E 65,362 10% 2,278 5,795 8,073 424 510 9,007

2009E 71,573 10% 2,805 6,439 9,244 572 690 10,506

Table 86: eBay Auction Metrics forecasts


Auctions in millions Auctions (M) % change Y/Y GMV/Auction % change Y/Y eBay Online Revenue / Auction % change Y/Y
Source: Company reports and JPMorgan estimates

2006A 2,366 $ 22.17 $ 1.78

2007E 2,374 0.4% $ 25.06 13.1% $ 2.19 23.5%

2008E 2,499 5.3% $ 26.18 4.4% $ 2.32 5.7%

2009E 2,670 6.8% $ 26.83 2.5% $ 2.41 4.0%

Our Estimates and Outlook for 2008


With the marketplace changes resulting from the August 2006 price rebalancing fully anniversaried, we think eBay is poised to follow roughly flat F07 Y/Y listings growth with 5% Y/Y listings growth in F08. At the same time, we think the company can improve revenue per listing 6% Y/Y in F08. We think PayPal revenues can grow 25% Y/Y (after a projected 30% Y/Y growth rate in F07). As such, we are now modeling F08 revenue of $9.0B, up ~$10M from our previous estimate. We are projecting ~36 bps operating margin erosion, to 31.9%, and EBITDA of $3.0B, up from $2.97B. We are raising our pro forma F08 EPS estimate for eBay to $1.70, from $1.68 previously.

Our Estimates and Outlook for 2009


For F09, we expect eBays marketplace improvements to help generate a healthier buyer-seller ecosystem, driving a slight acceleration in listings growth, to 7% Y/Y. At the same time, we think RPL growth is likely to slow somewhat, and we are projecting RPL up 4% Y/Y in F09. In part, we expect slower RPL growth as the rate of increase moderates at non-GMV businesses such as StubHub! as they reach greater size. Likewise, we expect PayPal revenue growth to slow slightly in F09, to 23%. Our forecast calls for F09 revenue of $10.5B, EBITDA of $3.41B and pro forma EPS of $1.98. We expect operating margin erosion of ~60 bps, driven by gross
145

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North America Equity Research 02 January 2008

margin pressure from a revenue mix that tilts more heavily toward lower-grossmargin PayPal revenue.

Valuation and Rating Analysis


On an EV/EBITDA basis, eBay trades 12.7x our F08 estimate, compared to its peers at 18.0x F08 estimates. We think such a discount is unwarranted.. We thus reiterate our Overweight rating.

Risks to Our Rating


Risks associated with our Overweight rating include: barriers to international expansion, competition from sponsored search vendors, the companys dependence on eBay Motors, competition from hardline retailers, risks associated with patent litigation, and valuation risks. International expansion is a concrete part of eBays growth strategy. As the company continues to grow outside the U.S., it may face regulatory challenges and/or markets that make its business less profitable than it is in the U.S. or other countries where it is already established. Thus far, we believe eBays international expansion has been carried out in a strategic and timely manner. eBay also faces risks from hardline retailers. Although the bulk of eBays revenues come from the beginning and end of the retail life cycle, with each passing quarter, the percentage of revenue it earns from the in-season retail and fixed price sales continues to increase. This puts the company in competition with traditional retailers and other e-tailers, including Amazon.com, Wal-Mart, BestBuy, and Home Depot. Failure to meet these challenges could lead to relative stock price underperformance.

146

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Table 87: EBAY Annual Income Statement


$ in millions, except per share data FY 2006A $52,473.0 18% 1,401.8 4,203.3 5,605.2 171.8 192.8 5,970 5,969.7 1243.1 -11.3 4726.7 4759.6 79.7% 1654.7 494.7 941.2 213.1 3303.7 (96.55) (81.49) (106.39) (5.32) (214.9) (504.68) 2799.0 1423.0 23.8% 1960.6 32.8% 130.0 (5.9) 124.1 124.1 2,284.9 23% 1,547.1 2,084.7 421.4 591.5 (0.0) FY 2007E $59,383.5 13% 1,817.1 5,206.0 7,023.0 293.7 368.0 7,684.7 7,684.7 1,770.0 (27.5) 5,914.6 5,942.2 77.3% 1,958.9 641.2 1,162.9 1,598.7 5,361.7 (64.49) (56.77) (83.39) (5.36) (1,557.1) (1,895) 3,466.6 552.9 7.2% 2475.5 32.2% 137.4 (13.0) 124.3 124.3 2,862.9 25% 677.3 2,599.9 405.5 116.6 558.6 FY 2008E $65,361.8 10% $2,278.4 $5,794.5 $8,073.0 $424.3 $510.0 $9,007.3 9,007.3 2,164.9 $6,842.4 $6,842.4 76.0% 2,232.0 807.7 1,217.3 228.0 4,485.1 (512) 3,973.1 2,357.3 26.2% 2869.3 31.9% 165.0 (14.0) 151.0 151.0 3,337.3 27% 2,508.3 3,020.3 591.5 724.9 147

Gross Merchandise Volume (GMV) % Change Y-Y % Change Q-Q Payment revenue eBay online revenue Total transactions 3rd party advertising revenue Skype End-to-end Services Total Online Revenue Offline revenue Total revenue Cost of revenue COGS pro forma adjustment Gross Profit Gross Profit (pro forma) Pro Forma Gross Margin Sales and Marketing Product Development General and Admin. Amort., Payroll Taxes, merger other Total Operating Expenses Pro forma op ex adjustments: Sales & marketing Product development G&A Payroll exp on empl stock options Amort of acq'd assets Total Pro forma operating expenses Operating Profit (reported) Operating Margin (reported) Operating Profit (pro forma) Operating Margin (pro forma) Interest and other income, net Interest Expense Net Interest Income Pro forma adjustment Pro forma interest Impairment of Equity Investments EBITDA Y/Y Growth IBT(reported) IBT(pro forma) Income Taxes Pro forma adjustment Pro forma tax Minority Interest Pro forma entry Pro forma minority interest Charitable contribution Other non-cash charges

FY 2009E $71,573.3 10% $2,805.0 $6,438.6 $9,243.7 $572.1 $690.0 $10,505.8 10,505.8 2,637.4 $7,868.4 $7,868.4 74.9% 2,550.9 921.1 1,394.2 228.0 5,094.2 (512) 4,582.2 2,774.2 26.4% 3286.2 31.3% 195.0 (14.0) 181.0 181.0 3,754.2 12% 2,955.2 3,467.2 679.7 832.1

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North America Equity Research 02 January 2008

Net Income (reported) Net Income (pro forma) FASB Adjustment net of Taxes Reported Net Income Adj. for FASB123 Pro Forma NI Adj. for FASB 123 EPS (reported) EPS (pro forma) Reported EPS Adj. for FASB123 EPS (pro forma) y/y GAAP Diluted Share count Pro Forma Diluted Outstanding Shares 2 As a % of Revenue Payment revenue eBay online revenue Third Party Advertising revenue Skype Revenue Total online revenue Offline Revenue Cost of goods sold Sales & marketing Product development G&A Total operating expenses Operating income (reported) Operating income (pro forma) Net income (reported) Net income (pro forma) Tax Rate Pro forma tax rate Year-Over-Year Growth Payment revenue eBay online revenue Third Party Advertising revenue End-to-end services revenue Communications Revenue Total online revenue Offline Revenue Sales & marketing Product development G&A Total operating expenses Operating income (pro forma)
Source: Company reports and JPMorgan estimates.

FY 2006A 1,125.6 1,493.3 1,125.6 1,493.3 0.79 1.05 0.79 22% 1,425.5 1,425.5 23.5% 70.4% 2.9% 3.2% 100.0% 0.0% 20.8% 27.7% 8.3% 15.8% 55.3% 23.8% 32.8% 18.9% 25.0% 27.2% 28.4% 39.9% 23.5% 39.3% NM 31.1% 34.4% 50.7% 59.1% 21.4%

FY 2007E 271.8 2,041.3 271.8 2,041.3 0.19 1.48 0.19 41% 1,373.0 1,377.6 23.6% 67.7% 3.8% 4.8% 100.0% 0.0% 23.0% 25.5% 8.3% 15.1% 69.8% 7.2% 32.2% 3.5% 26.6% 59.9% 21.5% 29.6% 23.9% 70.9% NM 90.9% 28.7% 18.4% 29.6% 23.6% 26.3%

FY 2008E 1,916.8 2,295.4 1,916.8 2,295.4 1.42 1.70 1.42 15% 1,352.0 1,352.0 25.3% 64.3% 4.7% 5.7% 100.0% 0.0% 24.0% 24.8% 9.0% 13.5% 49.8% 26.2% 31.9% 21.3% 25.5% 23.6% 24.0% 25.4% 11.3% 44.5% NM 38.6% 17.2% 13.9% 26.0% 4.7% 15.9%

FY 2009E 2,275.5 2,635.0 2,275.5 2,635.0 1.71 1.98 1.71 17% 1,330.0 1,330.0 26.7% 61.3% 5.4% 6.6% 100.0% 0.0% 25.1% 24.3% 8.8% 13.3% 48.5% 26.4% 31.3% 21.7% 25.1% 23.0% 24.0% 23.1% 11.1% 34.8% NM 35.3% 16.6% 14.3% 14.0% 14.5% 14.5%

148

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North America Equity Research 02 January 2008

Table 88: EBAY Quarterly Income Statement


$ in millions, except per share data Q1-06 $12,504.0 17.9% 4.1% 328.2 990.5 1,318.7 36.6 35.2 1,390.4 $1,390.4 278.6 (9.5) 1,111.9 1,121.3 80.6% 400.6 119.1 215.4 54.25 789.2 (24.72) (20.70) (28.92) (2.32) (51.92) (128.59) 660.6 322.6 23.2% 460.7 33.1% 25.8 (0.7) FY 2006 Q2-06 Q3-06 $12,896.0 $12,639.0 18.5% 17.0% 3% -2% 330.7 997.1 1,327.8 38.8 44.2 1,410.8 $1,410.8 292.5 (7.6) 1118.3 1125.9 79.8% 398.0 124.0 222.9 62.00 806.9 (27.06) (22.99) (27.72) (1.61) (62.00) (141.38) 665.5 311.4 22.1% 460.4 32.6% 25.6 (0.9) 340.0 1,017.3 1,357.3 41.3 50.0 1,448.6 1,448.6 315.7 (8.0) 1132.9 1140.9 78.8% 394.8 120.4 227.2 51.47 793.9 (23.15) (19.01) (23.36) (0.47) (51.47) (117.46) 676.4 339.0 23.4% 464.493 32.1% 41.2 (0.6) Q4-06 $14,434.0 20.2% 14% 403.0 1,198.4 1,601.4 55.1 63.4 1,719.9 $1,719.9 356.3 (7.9) 1,363.6 1,371.5 79.7% 461.3 131.2 275.7 45.40 913.7 (21.61) (18.79) (26.39) (0.92) (49.54) (117.25) 796.5 449.9 26.2% 575.0 33.4% 37.4 (3.7) Q1-07 $14,281.0 14.2% -1% 419.0 1,211.5 1,630.5 60.5 77.1 1,768.1 $1,768.1 393.7 (8.8) 1,374.4 1,383.2 78.2% 443.3 137.6 278.4 47.35 906.6 (19.20) (16.00) (28.00) (1.78) (51.89) (116.87) 789.7 467.8 26.5% 593.5 33.6% 30.0 (4.5) FY 2007E Q2-07 Q3-07 $14,464.0 $14,395.0 12.2% 13.9% 1% 0% 432.3 1,236.8 1,669.1 76.2 89.1 1,834.43 $1,834.4 416.8 (9.6) 1,417.6 1,427.2 77.8% 477.8 147.9 283.5 51.55 960.7 (23.1) (19.4) (27.5) (1.3) (56.9) (128.20) 832.5 456.9 24.9% 594.7 32.4% 34.0 (2.7) 448.0 1,267.5 1,715.4 77.0 96.8 1,889.2 $1,889.2 446.5 (9.1) 1,442.7 1,451.8 76.8% 485.2 164.9 287.4 1,442.8 2380.4 (22.19) (21.37) (27.89) (2.28) (1,448.3) (1,522.0) 858.4 -937.7 -49.6% 593.4 31.4% 38.4 (2.7) Q4-07E $16,243.5 12.5% 13% 517.8 1,490.1 2,007.9 80.0 105.0 2,192.9 $2,192.9 513.0 1,679.9 1,679.9 76.6% 552.6 190.8 313.6 57.0 1114.0 (128.00) 986.0 565.9 25.8% 693.9 31.6% 35.0 (3.0) Q1-08E $15,754.4 10.3% -3% 541.7 1,402.5 1,944.1 90.1 115.0 2,149.2 $2,149.2 512.3 1,636.9 1,636.9 76.2% 533.0 191.3 298.7 57.0 1080.0 (128.00) 952.0 556.9 25.9% 684.9 31.9% 40.0 (3.5) FY 2008E Q2-08E Q3-08E $15,913.1 $15,649.5 10.0% 8.7% 1% -2% 538.3 1,387.9 1,926.3 108.9 125.0 2,160.2 $2,160.2 517.4 1,642.8 1,642.8 76.0% 555.2 196.6 295.9 57.0 1104.7 (128.00) 976.7 538.1 24.9% 666.1 30.8% 40.0 (3.5) 553.9 1,360.6 1,914.5 111.7 130.0 2,156.2 $2,156.2 525.9 1,630.3 1,630.3 75.6% 554.1 196.2 284.6 57.0 1092.0 (128.00) 964.0 538.4 25.0% 666.4 30.9% 40.0 (3.5) Q4-08E $18,044.8 11.1% 15% 644.5 1,643.6 2,288.1 113.6 140.0 2,541.7 $2,541.7 609.4 1,932.4 1,932.4 76.0% 589.7 223.7 338.0 57.0 1208.4 (128.00) 1080.4 724.0 28.5% 852.0 33.5% 45.0 (3.5)
149

Gross Merchandise Volume (GMV) % Change Y-Y % Change Q-Q Payment revenue eBay online revenue Total transactions 3rd party advertising revenue Skype End-to-end Services Total Online Revenue Offline revenue Total revenue Cost of revenue COGS pro forma adjustment Gross Profit Gross Profit (pro forma) Pro Forma Gross Margin Sales and Marketing Product Development General and Admin. Amort., Payroll Taxes, merger other Total Operating Expenses Pro forma op ex adjustments: Sales & marketing Product development G&A Payroll exp on empl stock options Amort of acq'd assets Total Pro forma operating expenses Operating Profit (reported) Operating Margin (reported) Operating Profit (pro forma) Operating Margin (pro forma) Interest and other income, net Interest Expense

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

North America Equity Research 02 January 2008

Net Interest Income Pro forma adjustment Pro forma interest Impairment of Equity Investments EBITDA Y/Y Growth IBT(reported) IBT(pro forma) Income Taxes Pro forma adjustment Pro forma tax Minority Interest Pro forma entry Pro forma minority interest Charitable contribution Other non-cash charges Net Income (reported) Net Income (pro forma) FASB Adjustment net of Taxes Reported Net Income Adj. for FASB123 Pro Forma NI Adj. for FASB 123 EPS (reported) EPS (pro forma) Reported EPS Adj. for FASB123 EPS (pro forma) y/y GAAP Diluted Share count Pro Forma Diluted Outstanding Shares 2 As a % of Revenue Payment revenue eBay online revenue Third Party Advertising revenue Skype Revenue Total online revenue Offline Revenue Cost of goods sold Sales & marketing Product development G&A Total operating expenses Operating income (reported)
150

25.0 25.0 529.7 26% $347.6 $485.7 99.4 43.4 142.8 (0.00) 248.3 342.9 248.3 342.9 0.17 0.24 0.17 20% 1,437.6 1,437.6 23.6% 71.2% 2.6% 2.5% 100.0% 0.0% 20.0% 28.8% 8.6% 15.5% 56.8% 23.2%

24.7 24.7 539.2 16% $336.1 $485.1 86.1 48.3 134.4 (0.00) 250.0 350.7 250.0 350.7 0.17 0.24 0.17 10% 1,435.8 1,435.8 23.4% 70.7% 2.8% 3.1% 100.0% 0.0% 20.7% 28.2% 8.8% 15.8% 57.2% 22.1%

40.7 40.7 547.8 21% $379.7 $505.2 98.8 38.9 137.8 (0.00) 280.9 367.4 280.9 367.4 0.20 0.26 0.20 28% 1,426.1 1,426.1 23.5% 70.2% 2.9% 3.5% 100.0% 0.0% 21.8% 27.3% 8.3% 15.7% 54.8% 23.4%

33.7 33.7 668.2 30% $483.6 $608.7 137.1 41.0 176.5 (0.00) 346.5 432.2 346.5 432.2 0.25 0.31 0.25 29% 1,402.7 1,402.7 23.4% 69.7% 3.2% 3.7% 100.0% 0.0% 20.7% 26.8% 7.6% 16.0% 53.1% 26.2%

25.5 25.5 683.2 29% $493.3 $619.0 116.1 42.3 158.4 377.2 460.5 377.2 460.5 0.27 0.33 0.27 39% 1,384.3 1,384.3 23.7% 68.5% 3.4% 4.4% 100.0% 0.0% 22.3% 25.1% 7.8% 15.7% 51.3% 26.5%

31.2 31.2 683.2 27% $488.1 $625.9 112.3 42.5 154.8 375.8 471.1 375.8 471.1 0.27 0.34 0.27 40% 1,379.7 1,379.7 23.6% 67.4% 4.2% 4.9% 100.0% 0.0% 22.7% 26.0% 8.1% 15.5% 52.4% 24.9%

35.6 35.6 685.6 25% ($902.1) $629.1 33.6 31.7 65.3 (935.6) 563.8 (935.6) 563.8 (0.69) 0.41 (0.69) 59% 1,354.8 1,373.3 23.7% 67.1% 4.1% 5.1% 100.0% 0.0% 23.6% 25.7% 8.7% 15.2% 126.0% -49.6%

32.0 32.0 810.9 21% $597.9 $725.9 143.5 180.0 454.4 545.9 454.4 545.9 0.33 0.40 0.33 29% 1,373.3 1,373.3 23.6% 68.0% 3.6% 4.8% 100.0% 0.0% 23.4% 25.2% 8.7% 14.3% 50.8% 25.8%

36.5 36.5 801.9 17% $593.4 $721.4 142.4 173.1 451.0 548.3 451.0 548.3 0.33 0.40 0.33 20% 1,370.0 1,370.0 25.2% 65.3% 4.2% 5.4% 100.0% 0.0% 23.8% 24.8% 8.9% 13.9% 50.3% 25.9%

36.5 36.5 783.1 15% $574.6 $702.6 137.9 168.6 436.7 534.0 436.7 534.0 0.32 0.40 0.32 16% 1,350.0 1,350.0 24.9% 64.2% 5.0% 5.8% 100.0% 0.0% 24.0% 25.7% 9.1% 13.7% 51.1% 24.9%

36.5 36.5 783.4 14% $574.9 $702.9 135.1 168.7 439.8 534.2 439.8 534.2 0.33 0.40 0.33 -3% 1,348.0 1,348.0 25.7% 63.1% 5.2% 6.0% 100.0% 0.0% 24.4% 25.7% 9.1% 13.2% 50.6% 25.0%

41.5 41.5 969.0 19% $765.5 $893.5 176.1 214.4 589.4 679.0 589.4 679.0 0.44 0.51 0.44 27% 1,340.0 1,340.0 25.4% 64.7% 4.5% 5.5% 100.0% 0.0% 24.0% 23.2% 8.8% 13.3% 47.5% 28.5%

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

North America Equity Research 02 January 2008

Operating income (pro forma) Net income (reported) Net income (pro forma) Tax Rate Pro forma tax rate Year-Over-Year Growth Payment revenue eBay online revenue Third Party Advertising revenue End-to-end services revenue Communications Revenue Total online revenue Offline Revenue Sales & marketing Product development G&A Total operating expenses Operating income (pro forma)
Source: Company reports and JPMorgan estimates.

33.1% 17.9% 24.7% 28.6% 29.4% 44.5% 27.7% 27.5% 34.8% NM 47.6% 61.4% 57.9% NM 25.4%

32.6% 17.7% 24.9% 25.6% 27.7% 39.4% 21.6% 34.0% 29.9% NM 38.6% 73.1% 72.4% NM 13.3%

32.1% 19.4% 25.4% 26.0% 27.3% 41.7% 21.6% 43.6% 31.0% NM 34.4% 52.6% 57.5% NM 18.0%

33.4% 20.1% 25.1% 28.4% 29.0% 35.4% 23.6% 49.1% 29.4% NM 21.9% 26.3% 51.7% NM 28.3%

33.6% 21.3% 26.0% 23.5% 25.6% 27.7% 22.3% 65.3% 27.2% NM 10.7% 15.6% 29.3% NM 28.8%

32.4% 20.5% 25.7% 23.0% 24.7% 30.7% 24.0% 96.2% 30.0% NM 20.0% 19.3% 27.2% NM 29.2%

31.4% -49.5% 29.8% -3.7% 10.4% 31.7% 24.6% 86.5% 30.4% NM 22.9% 36.9% 26.5% NM 27.8%

31.6% 20.7% 24.9% 24.0% 24.8% 28.5% 24.3% 45.2% 27.5% NM 19.8% 45.4% 13.7% NM 20.7%

31.9% 21.0% 25.5% 24.0% 24.0% 29.3% 15.8% 49.0% 21.6% NM 20.2% 39.0% 7.3% NM 15.4%

30.8% 20.2% 24.7% 24.0% 24.0% 24.5% 12.2% 43.0% 17.8% NM 16.2% 32.9% 4.4% NM 12.0%

30.9% 20.4% 24.8% 23.5% 24.0% 23.7% 7.3% 45.0% 14.1% NM 14.2% 19.0% -1.0% NM 12.3%

33.5% 23.2% 26.7% 23.0% 24.0% 24.5% 10.3% 42.0% 15.9% NM 6.7% 17.2% 7.8% NM 22.8%

151

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

North America Equity Research 02 January 2008

Table 89: EBAY Annual Balance Sheet


$ in millions FY 2006 Assets Cash and cash equivalents ST investments in marketable securities Accounts receivable, net Funds receivable Other assets Total current assets Investments Property and equipment, net Intangible assets, net Other assets, net Total assets Liabilities and stockholders' equity Accounts payable Funds payable Deferred Revenue Short term debt Taxes payable Other current liabilities Total current liabilities Debt Deferred taxes Other long term Total liabilities Stockholders' equity: Common stock Accumulated deficit Other equity Total stockholders' equity Total L&S
Source: Company reports and JPMorgan estimates.

FY 2007E 3,927.5 (453.9) 482.4 614.0 1,396.4 5,966.5 455.3 1,069.6 6,822.9 87.3 14,401.6 131.6 1,535.1 153.5 101.2 1,319.6 3,241.0 592.4 48.9 3,882.2 10,519.3 14,401.6

FY 2008E 6,939.4 (453.9) 559.2 711.7 1,396.4 9,152.8 455.3 909.6 6,822.9 87.3 17,427.9 152.5 1,779.2 177.9 101.2 1,319.6 3,530.4 592.4 48.9 4,171.7 13,256.2 17,427.9

FY 2009E 10,330.7 (453.9) 649.7 826.9 1,396.4 12,749.9 455.3 749.6 6,822.9 87.3 20,865.0 177.2 2,067.3 206.7 101.2 1,319.6 3,872.1 592.4 48.9 4,513.3 16,351.6 20,865.0

2,662.8 542.1 393.2 399.3 973.2 4,970.6 277.9 998.2 7,227.3 20.1 13,494.0 83.4 1,160.0 129.0 464.4 681.7 2,518.4 31.8 39.2 2,589.4

10,904.6 13,494.0

152

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

North America Equity Research 02 January 2008

Table 90: EBAY Annual Cash Flow Statement


$ in millions FY 2006A OPERATING CASH FLOWS Net Income Depreciation Amortization Stock based comp expense related to stock options and purchases Tax Benefit Excess tax benefit from stock-based compensation Impairment Minority Interest Doubtful Accounts/Losses Other Changes in Working Capital Accounts Receivable Fund Receivable Other Deferred Tax Accounts Payable Funds Payable Accrued Charges Deferred Revenue Income Taxes Cash From Operations % Chg Y-Y FCF % Chg Y-Y INVESTING CASH FLOWS Capital Expenditures Net Investment ST Investment Purch. ST Investments Mat. Acquisitions Purchase of intangibles and other non current assets Cash From Investing FINANCING CASH FLOWS Common Stock Issued Excess tax benefit from stock-based compensation Shares Repurchased Payment of headquarters facility lease obligation Long Term Debt Cash From Financing Foreign Exch Effects Net Change In Cash Cash at Beginning Cash at End
Source: Company reports and JPMorgan estimates.

FY 2007E 271.8 601.9 317.2 192.9 257.7 1,390.9 (399.8) (157.60) (212.32) (516.08) (68.93) 45.57 358.72 2.97 24.80 123.08 2,563.5 14.0% 2,067.5 19.3%

FY 2008E 1,916.8 640.0 340.0 120.0 200.0 (34.9) (76.73) (97.66) 20.93 94.14 24.41 3,181.9 24.1% 2,611.9 26.3%

FY 2009E 2,275.5 640.0 340.0 120.0 200.0 (14.2) (90.56) (115.26) 24.70 138.14 28.81 3,561.3 11.9% 3,001.3 14.9%

1,125.6 544.6 317.4 148.6 (161.4) 0.0 227.2 (23.2) (169.8) (146.9) (433.4) (181.1) 33.0 575.1 (31.0) 47.9 283.0 2,247.8 11.8% 1,732.3 3.6%

(515.4) 797.0 (43.9) (8.8) 228.9

(496.0) 48.5 (320.2) 5.5 (762.2)

(570.0) (570.0)

(560.0) (560.0)

313.5 (1,666.5) (1,260.7) 133.3 1,349.2 1,313.5 2,662.7

365.2 (1,170.7) (736.5) 199.9 1,264.8 2,662.7 3,927.5

2,611.9 3,927.5 6,539.4

3,001.3 6,539.4 9,540.7

153

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

North America Equity Research 02 January 2008

Expedia, Overweight ($32.56)


We are maintaining our Overweight rating on Expedia. We continue to see mid-teen revenue growth in F08 as the company benefits from its customer rewards program, entrance into new international markets, and growth of its media and advertising arm. As the business is somewhat counter-cyclical, we believe EXPE will benefit from the increased available inventory and discounted pricing in a weakening US economy. We expect 2008 revenue growth to be driven by international market expansion. We expect F08 European gross bookings to grow 26% Y/Y to $5.2B on top of F07E growth of 38%. We believe that the company will focus on expanding inventory into secondary and tertiary markets as well as on expansion into Asia. We also believe as the company increases selection, it may enjoy improved conversion rates. The Media and Advertising arm will become a more significant growth driver. We see TripAdvisor and its related properties (BookingBuddy and SmarterTravel) benefiting the company two-fold. First, the business will contribute to top-line growth as TripAdvisor organic growth rates are currently over 60% Y/Y. Secondly, the businesses serve as a hedge to increasing online marketing costs and Expedia is now able to share in the upside of this. We expect OIBA margins to decline 70 bps in F08. We believe management will increase selling and marketing spend to increase its share. Technology and content spend will also likely increase as the company protects its market share through innovation. Finally, facilities expense is expected by the company to increase by $16M in F08 due to relocation expenses. 2008 Drivers. In our view, the following factors will drive EXPE shares in 2008: (1) first full year of comping lower air revenues as a result of GDS renegotiations, (2) increased intl inventory, which should drive conversion and market share gains, and (3) rising travel marketing spend on media and advertising unit. Maintaining 4Q'07 estimates. We maintain our 4Q07 revenue, EBITDA, and EPS estimates of $642.8M, $177.0M, and $0.24 (Y/Y growth of 21%, 11%, and 21% respectively). Our current and newly introduced 2009 estimates are in the table below:
Table 91: Expedia Financial Snapshot
$ in millions, except per share data Expedia JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07E 642.76 176.98 0.24 642.86 182.09 0.24 F'07E 2,642.77 724.63 0.96 2,646.54 719.62 0.96 F'08E 3,006.30 807.71 1.17 3,019.64 820.34 1.19 F'09E 3,317.53 887.16 1.36 3,367.52 945.01 1.55 F'07E Y/Y 18.1% 18.8% 38.0% F'08E Y/Y 13.8% 11.5% 21.4% 14.1% 14.0% 24.0% F'09E Y/Y 10.4% 9.8% 16.1% 11.5% 15.2% 30.3%

Source: JPMorgan estimates, Company data, and Bloomberg

154

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


We are adjusting our F08 revenue estimate to $3.01B and our full-year EPS estimate to $1.17, representing Y/Y revenue and EPS growth of 14% and 21%. We expect most of the revenue growth to be driven by the international market where we see gross bookings growth of 26% Y/Y. Furthermore, we note that this is the first year that the company is fully comping air revenue declines as a result of GDS renegotiations. Thus, the company faces easy domestic comparisons with 1H07 gross bookings growth of only 4.5% Y/Y vs. 3Q07 growth of 13.4%. We expect OIBA margins to decline 70 bps in F'08 due to increased selling and marketing and technology and content expenses and a one-time expense associated with relocation.
Figure 83: Domestic Unique Visitor Trends on EXPE Properties
thousands

21,500 16,500 11,500 6,500 1,500 Sep- Oct- Nov - Dec- Jan- Feb- Mar- Apr- May - JunJul- Aug- Sep- Oct- Nov 2006 2006 2006 2006 2007 2007 2007 2007 2007 2007 2007 2007 2007 2007 2007 EXPEDIA.COM* HOTELS.COM
Source: comScore and JPMorgan estimates

Tripadv isor Sites HOTWIRE.COM

Our Estimates and Outlook for 2009


We are introducing F09 revenue and EPS estimates of $3.32B and $1.36, which represents 10% and 16% Y/Y growth, respectively. Again, we expect much of the revenue growth to stem from European gross booking increases, which we model as slowing to 18% on a Y/Y basis due to maturation of the market and increased competition. Domestically, we expect Y/Y gross booking growth to slow to 5% from 8% in the prior year, due to lower growth in shifts from offline spend and increased competition. We expect OIBA margins to decrease another 10 bps Y/Y as selling and marketing expenses rise.

Valuation and Rating Analysis


We believe Expedia is undervalued given the potential for international growth, signs of a successful domestic turnaround, and increased advertising revenue opportunities. On an EV/EBITDA basis, Expedia trades at 12.8x our F08 EBITDA estimate of $808 million, versus its peers at 19.1x. As such, we rate the stock Overweight.

Risks to Our Rating


The companys shares could underperform if the company is unable to (1) withstand the competitive threat that the travel suppliers and travel search engines pose, (2) achieve a high ROI on selling and marketing investments, (3) successfully complete the turnaround of the core Expedia brand, and (4) achieve further expansion into international markets.

155

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

North America Equity Research 02 January 2008

Table 92: EXPE Annual Income Statement


$ in millions, except per share data INCOME STATEMENT North America Europe Other Total Gross Bookings % North America % Europe % Other Y/Y Growth North America Europe Other Total GB Total Revenue Revenue as a % GB Cost of Revenues Gross Profit Gross Margin Selling and Marketing expense General and Administrative expense Technology and Content Amortization of non-cash distributing & mktg Amortization of non-cash compensation expense Amortization of intangibles Stock Based Compensation Depreciation expense Extraordinary Items Total Operating Expenses Total Operating Expenses (Pro forma) Operating Profit Operating Profit (Pro forma) Operating Margin Operating Margin (Pro forma) EBITDA OIBA OIBA Margin Net Interest Income Write-off of long-term investment Other Equity Income of Unconsolidated Affiliates EBT (Earnings Before Taxes) EBT (Earnings Before Taxes - Pro forma) Minority Interest Income Income Tax Expense Tax Rate Net Income (Reported) Net Income (Pro Forma) EPS (Reported) EPS (Pro Forma) Sharecount
Source: Company reports and JPMorgan estimates.

2006 12,737 3,001 1,424 17,162 74% 17% 8% 5.6% 19.3% 46.5% 10.4% 2,237.6 13.0% 494.2 1,743.3 78% 770.3 252.8 121.3 9.6 110.8 80.3 9.0 47.0 1,392.0 1,144.3 351.3 599.0 15.7% 26.8% 609.8 599.0 26.8% 14.8 18.8 384.9 613.8 (0.5) (139.5) 35% 244.9 388.5 0.70 1.10 352.2

2007E 13,814 4,130 1,786 19,730 70% 21% 9% 8.5% 37.6% 25.4% 15.0% 2,642.8 13.4% 548.9 2,093.9 79.2% 973.7 293.3 160.7 77.9 62.2 1,567.8 1,427.6 526.1 666.2 19.9% 25.2% 724.6 666.2 25.2% (6.3) (13.5) 506.3 659.9 1.3 (202.6) 40% 305.0 395.6 0.96 1.23 317.7

2008E 14,887 5,205 2,101 22,194 67% 23% 9% 7.8% 26.0% 17.6% 12.5% 3,006.3 13.5% 623.7 2,382.6 79.3% 1,116.5 331.3 197.1 64.0 65.0 1,773.9 1,644.9 608.7 737.7 20.2% 24.5% 807.7 737.7 24.5% 608.7 737.7 2.0 (243.5) 40% 367.2 442.6 1.17 1.39 314.0

2009E 15,632 6,163 2,398 24,192 65% 25% 10% 5.0% 18.4% 14.1% 9.0% 3,317.5 13.7% 682.7 2,634.8 79.4% 1,242.3 360.9 222.5 60.0 65.0 1,950.7 1,825.7 684.2 809.2 20.6% 24.4% 887.2 809.2 24.4% 684.2 809.2 2.0 (260.0) 38% 426.2 501.7 1.36 1.58 314.0

156

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

North America Equity Research 02 January 2008

Table 93: EXPE Quarterly Income Statement


$ in millions, except per share data North America Europe Other Total Gross Bookings % North America % Europe % Other Y/Y Growth North America Europe Other Total GB Total Revenue Revenue as a % GB Cost of Revenues Gross Profit Gross Margin Selling and Marketing expense General and Administrative expense Technology and Content Amortization of non-cash distributing & mktg Amortization of non-cash compensation expense Amortization of intangibles Stock Based Compensation Depreciation expense Extraordinary Items Total Operating Expenses Total Operating Expenses (Pro forma) Operating Profit Operating Profit (Pro forma) Operating Margin Operating Margin (Pro forma) EBITDA OIBA OIBA Margin Net Interest Income Write-off of long-term investment 1Q'06 3,522 780 347 4,649 76% 17% 7% 10.3% 12.7% 72.6% 13.8% 493.9 10.6% 116.1 377.8 76.5% 195.8 63.7 29.8 8.2 30.2 23.9 9.0 351.6 289.3 26.2 88.5 5.3% 17.9% 108.6 88.5 17.9% 1.7 2Q'06 3,445 752 368 4,565 75% 16% 8% 7.5% 12.4% 41.5% 10.5% 598.5 13.1% 126.9 471.6 78.8% 195.2 62.3 29.9 0.6 30.1 17.2 335.3 287.4 136.3 184.2 22.8% 30.8% 195.8 184.2 30.8% 6.6 3Q'06 3,104 792 365 4,261 73% 19% 9% 2.0% 23.0% 46.6% 8.2% 613.9 14.4% 131.3 482.7 78.6% 212.1 59.1 31.4 0.7 26.6 16.4 47.0 393.4 302.7 89.3 180.0 14.5% 29.3% 146.2 180.0 29.3% 4.8 4Q'06 2,666 677 344 3,687 72% 18% 9% 1.6% 32.7% 31.3% 8.6% 531.3 14.4% 120.0 411.3 77.4% 167.2 67.7 30.2 0.1 23.9 22.7 311.7 265.0 99.5 146.2 18.7% 27.5% 159.2 146.2 27.5% 1.7 1Q'07 3,559 1,032 425 5,016 71% 21% 8% 1.1% 32.3% 22.5% 7.9% 550.5 11.0% 120.4 430.1 78.1% 219.0 68.5 38.2 21.2 15.9 362.8 325.7 67.3 104.4 12.2% 19.0% 118.8 104.4 19.0% (3.9) 2Q'07 3,723 1,035 466 5,224 71% 20% 9% 8.1% 37.6% 26.6% 14.4% 689.9 13.2% 143.0 546.9 79.3% 253.1 68.7 38.0 19.5 14.0 393.3 359.8 153.6 187.1 22.3% 27.1% 200.7 187.1 27.1% 0.7 3Q'07 3,519 1,163 465 5,147 68% 23% 9% 13.4% 46.8% 27.4% 20.8% 759.6 14.8% 150.5 609.1 80.2% 276.6 75.7 44.0 18.6 14.4 429.3 396.3 179.8 212.8 23.7% 28.0% 228.1 212.8 28.0% (1.1) 4Q'07E 3,013 900 430 4,343 69% 21% 10% 13.0% 33.0% 25.0% 17.8% 642.8 14.8% 135.0 507.8 79.0% 225.0 80.3 40.5 18.6 18.0 382.4 345.8 125.4 162.0 19.5% 25.2% 177.0 162.0 25.2% (2.0) 1Q'08E 3,915 1,334 507 5,756 68% 23% 9% 10.0% 29.3% 19.2% 14.8% 644.7 11.2% 141.2 503.5 78.1% 256.6 79.3 48.3 16.0 16.0 416.2 384.2 87.3 119.3 13.5% 18.5% 136.3 119.3 18.5% 2Q'08E 3,984 1,306 550 5,840 68% 22% 9% 7.0% 26.2% 18.1% 11.8% 782.6 13.4% 161.2 621.4 79.4% 287.2 78.3 47.0 16.0 15.0 443.4 412.4 177.9 208.9 22.7% 26.7% 225.9 208.9 26.7% 3Q'08E 3,765 1,457 545 5,768 65% 25% 9% 7.0% 25.3% 17.3% 12.1% 859.4 14.9% 170.2 689.3 80.2% 313.7 85.9 55.0 16.0 15.0 485.6 454.6 203.6 234.6 23.7% 27.3% 252.6 234.6 27.3% 4Q'08E 3,223 1,108 499 4,830 67% 23% 10% 7.0% 23.0% 16.0% 11.2% 719.6 14.9% 151.1 568.5 79.0% 259.1 87.8 46.8 16.0 19.0 428.6 393.6 139.9 174.9 19.4% 24.3% 192.9 174.9 24.3% -

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North America Equity Research 02 January 2008

Other Equity Income of Unconsolidated Affiliates EBT (Earnings Before Taxes) EBT (Earnings Before Taxes - Pro forma) Minority Interest Income Income Tax Expense Tax Rate Net Income (Reported) Net Income (Pro Forma) EPS (Reported) EPS (Pro Forma) Sharecount
Source: JPMorgan estimates and Company report

1Q'06 3.7 31.6 90.2 1.4 (9.7) 31% 23.3 57.0 0.06 0.15 365.2

2Q'06 10.5 153.3 190.8 (1.6) (56.2) 37% 95.5 118.2 0.27 0.32 359.1

3Q'06 2.9 97.1 184.9 (0.4) (37.7) 39% 59.0 117.2 0.17 0.34 341.1

4Q'06 1.7 103.0 147.9 0.1 (35.9) 35% 67.1 96.2 0.20 0.28 343.6

1Q'07 (5.5) 57.9 100.5 0.5 (23.6) 41% 34.8 59.3 0.11 0.18 323.7

2Q'07 5.9 160.2 187.7 0.0 (64.1) 40% 96.1 114.0 0.30 0.35 320.2

3Q'07 (13.9) 164.8 211.8 0.3 (65.5) 40% 99.6 123.1 0.32 0.39 312.8

4Q'07E

1Q'08E

2Q'08E

3Q'08E

4Q'08E

123.4 160.0 0.5 (49.3) 40% 74.5 99.2 0.24 0.31 314.0

87.3 119.3 0.5 (34.9) 40% 52.9 71.6 0.17 0.23 314.0

177.9 208.9 0.5 (71.2) 40% 107.3 125.4 0.34 0.39 314.0

203.6 234.6 0.5 (81.5) 40% 122.7 140.8 0.39 0.44 314.0

139.9 174.9 0.5 (55.9) 40% 84.4 104.9 0.27 0.33 314.0

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North America Equity Research 02 January 2008

Table 94: EXPE Annual Balance Sheet


$ in millions 2006 ASSETS Cash and Cash Equivalents Restricted Cash and Cash Equivalents Marketable Securities Accounts and Notes Receivable Receivables from IAC and Subsidiaries Deferred Income Taxes Other Current Assets Total Current Assets Goodwill Intangible Assets, Net Long-Term Investments and Other Property, Plant and Equipment, Net Total Assets LIABILITIES Accounts Payable, Trade Deferred Merchant Bookings Deferred Revenue Income Tax Payable Deferred income taxes Short term borrowings Other Current Liabilities Total Current Liabilities Long Term Debt Credit Facility Other Long-Term Liabilities Deferred Income Taxes Derivative liabilities Minority Interest Total Liabilities INVESTED EQUITY Invested Capital Accumulated Other Comprehensive Income Total Invested Equity LIABILITIES AND INVESTED EQUITY
Source: Company reports and JPMorgan estimates.

2007E 501.4 20.7 317.9 0.3 143.3 983.6 5,912.9 988.5 89.0 152.9 8,127.0 849.0 549.5 13.8 52.5 196.9 1,661.6 500.0 500.0 104.1 362.4 62.6 3,190.6 4,936.3 8,127.0

2008E 1,361.2 23.0 417.9 0.3 183.3 1,985.7 5,912.9 988.5 89.0 189.2 9,165.4 1,219.0 719.5 13.8 52.5 196.9 2,201.6 500.0 500.0 104.1 362.4 62.6 3,730.6 5,434.7 9,165.4

2009E 2,306.4 23.0 509.9 0.3 223.3 3,062.9 5,912.9 988.5 89.0 228.1 10,281.5 1,629.0 874.5 13.8 52.5 196.9 2,766.6 500.0 500.0 104.1 362.4 62.6 4,295.6 5,985.9 10,281.5

853.3 11.1 211.4 4.9 102.0 1,182.7 5,861.3 1,028.8 59.3 137.1 8,269.2 720.7 466.5 10.3 30.9 171.7 1,400.1 500.0 4.7 369.3 29.0 61.8 1,864.9 5,904.3 8,269.2

159

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North America Equity Research 02 January 2008

Table 95: EXPE Annual Cash Flow Statement


$ in millions 2006 CASH FLOW FROM OPERATIONS Net Income Adjustments to Reconcile Cash to Income Depreciation and Amortization Amortization of non-cash distributing & mktg Amortization of non-cash compensation expense Amortization of intangibles & stock-based comp Deferred Income Taxes Unrealized gain on derivative instrument Equity in Losses of Unconsolidated Affiliates Minority Interest in Income of Subsidiaries Other Impairment of Intangible Asset Foreign exchange gain/loss Changes in Current Assets and Current Liabilities Accounts and Notes Receivable Prepaids and Other Assets Accounts Payable and Accrued Liabilities Accounts Payable, merchants Deferred Revenue Deferred Merchant Bookings Other, Net Net Cash Provided by Operating Activities Free Cash Flow (FCF) CASH FLOW FROM INVESTING Acquisitions, Net of Cash Required Capital Expenditures Purchase of Marketable Securities Proceeds from Sale of Marketable Securities Increase in Long-Term Investments & Notes Rec. Proceeds from Sale of Business Other, Net Net Cash Provided by Investing Activities CASH FLOW FROM FINANCING Transfers to IAC Short term borrowings Proceeds from issuance of long term debt Proceeds from Sale of Subsidiary Stock, inc. Options Changes in Restricted Cash Principal payments on long term obligations Treasury stock activity Other, Net Net Cash Provided by Investing Activities Effect of FX on Cash & Equivalents Net Increase in Cash & Equivalents Cash & Equivalents at Beginning of Period Cash & Equivalents at End of Period
Source: Company reports and JPMorgan estimates.

2007E 305.0 58.4 140.2 (3.3) 5.9 4.1 (1.1) 3.4 (18.7) (94.4) (38.7) (6.1) 221.1 3.4 83.0 662.2 565.6 (59.6) (96.6) (29.7) (185.9) 500.0 48.1 (10.6) (1,396.0) (0.8) (859.4) 31.2 (351.9) 853.3 501.4

2008E 367.2 70.0 129.0 1.2 (1.2) (100.0) (40.0) 140.0 230.0 170.0 966.2 859.9 (106.3) (106.3) 859.9 501.4 1,361.2

2009E 426.2 78.0 125.0 1.2 (1.2) (92.0) (40.0) 160.0 250.0 155.0 1,062.1 945.2 (116.9) (116.9) 945.2 1,361.2 2,306.4

244.9 48.8 200.7 (10.7) (8.1) (2.5) 0.5 1.1 47.0 (37.2) (32.1) (20.7) 59.9 63.2 3.2 59.5 617.4 524.8 (32.5) (92.6) (1.5) 13.2 (113.5) (231.0) 495.3 36.6 4.6 (295.7) 9.8 42.1 555.9 297.4 853.3

160

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North America Equity Research 02 January 2008

Google, Overweight ($710.84)


We believe Google will continue to innovate at an industry-leading pace, which should spur continued market share gains. Additionally, international, which we are modeling to be up 42% in 2008, will continue to be an important theme. At 37.7x our F08 GAAP EPS estimate of $18.94, we find Googles valuation attractive. As such, we maintain our Overweight rating. Volume growth and market share gains are likely. We think that paid clicks will grow 30% Y/Y as search volume increases and as Google continues to take market share. In addition to market share gain, coverage is expected to be up slightly (~40 bps) and relevancy is expected to be up high single digits. International will be a more significant contributor in 2008. We believe Googles vast international presence will enable the company to maintain industry-leading growth rates in 2008. We expect international gross revenues to reach almost 50% of total revenues in 2008, growing 42% Y/Y. We believe Western Europe will continue to outpace domestic growth. We believe monetization will be a key catalyst for international growth in 2008, as advertisers increasingly adopt paid search as a marketing vehicle. Google apps will begin to ramp. We think web-based cloud computing will become more widely adopted in F08 as it gains more mainstream appeal. Additionally, Google's introduction of a complete services package, including word processing, spreadsheets, and presentation capabilities for free, will likely appeal to customers. We estimate that the office productivity software market is ~$10.3B. Even a 10% market share would mean an additional $1B in revenue to Google. 2008 Drivers. In our view, the following factors will drive GOOG shares in 2008: (1) continued monetization enhancements of search & contextual advertising platforms, (2) increased search market share, and (3) outsized growth in Western Europe and emerging markets. Maintaining 4Q'07 estimates. We maintain our 4Q07 revenue, EBITDA, and EPS estimates of $3.45B, $2.01B, and $3.82 (Y/Y growth of 55%, 45%, and 16%, respectively). Our current and newly introduced 2009 estimates are in the table below:
Table 96: GOOG Estimates Snapshot
$ in millions, except per share data Google JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07E 3,447.35 2,013.12 3.82 3,453.65 2,039.15 3.84 F'07E 11,718.63 6,957.86 13.33 11,649.28 6,997.77 13.36 F'08E 16,957.04 9,917.13 18.94 16,406.75 9,684.73 17.97 F'09E 22,332.26 12,646.53 24.38 21,279.55 12,522.79 22.75 F'07E Y/Y 60.6% 50.9% 34.0% F'08E Y/Y 44.7% 42.5% 42.1% 40.8% 38.4% 34.5% F'09E Y/Y 31.7% 27.5% 28.7% 29.7% 29.3% 26.6%

Source: JPMorgan estimates, Company reports, and Bloomberg

161

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North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


We are raising our 2008 net revenue, EBITDA, and GAAP EPS estimates to $16.96B, $9.92B, and $18.94 from $16.30B, $9.58B, and $18.18. Our new estimates call for Y/Y revenue, EBITDA, and EPS growth of 45%, 43%, and 42%, respectively. In 2008, we are expecting Google to continue to make progress on the international front, both through search volume growth and increasing advertiser demand. We are modeling international gross revenue growth of 42% Y/Y to $11.1B in 2008. As we believe international growth will outpace domestic growth, we see international revenues representing ~49.4% of gross revenues in 2008, up from ~47.6% of gross revenue in 2007. We believe usage will be the most meaningful catalyst for international growth in 2008, as consumers in emerging markets continue to leverage the Internet at an accelerating pace Beyond international, we believe Google will generate above-average market share growth through continued volume share gains from its domestic competitors. We continue to believe that Google has the strongest brand in search. Googles rapid innovation of new web offerings should lead to increased attention from consumers, which should contribute to sustained volume share growth in 2008. We think that paid clicks will grow 30% Y/Y as search volume increases and as Google continues to take market share. We believe that Googles attempts to show meaningful revenue diversification are starting to come to fruition. We think web-based cloud computing will become more widely adopted in F08 as it gains more mainstream appeal. Additionally, Google's introduction of a complete services package, including word processing, spreadsheets, and presentation capabilities for free, will likely appeal to customers. The product has become even more marketable to enterprise clients through the acquisition of Postini, an on-demand security and compliance solution. We estimate that the office productivity software market is ~$10.3B. Even a 10% market share would mean an additional $1B in revenue to Google.

Our Estimates and Outlook for 2009


We are introducing above consensus 2009 estimates, which call for Y/Y revenue, EBITDA, and EPS growth of 32%, 27.5%, and 29%, respectively. Specifically, our F09 revenue, EBITDA, and EPS estimates are $22.3B, $12.6B, and $24.38, respectively. In 2009, we are expecting search revenues to continue to show strong growth, despite decelerating from 2008 levels. We are modeling Google.com search volumes to grow ~25% in 2009, with RPM growth contributing an additional 8%. We believe international search revenues will make up 51% of total company revenues in 2009.

Valuation and Rating Analysis


We believe GOOG shares are fundamentally attractive due to secular industry growth trends, improving fundamentals in the international market, and expansion of new product categories, such as contextual ad and local search. Google remains an Overweight pick. Google trades at 21.4x its F08E EBITDA vs. its large cap Internet

162

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North America Equity Research 02 January 2008

peers at 18.0x. Given Google's higher growth rate, we think it deserves a premium. Hence, our OW rating.

Risks to Our Rating


Google has experienced very fast revenue growth over the past few years. Our Overweight rating is 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. If the content publishers like Yahoo! and Microsoft are able to gain market share through user defection from Googles user base, then our rating could be too optimistic. However, we have not seen any trends that would support this argument thus far. Our Overweight rating is also predicated on the companys success in the international market. If the company cannot successfully build out a larger international advertising base, it will not be able to increase its monetization rate abroad. Additionally, as Google continues to expand its business internationally, it may face regulatory hurdles that make the business climate less hospitable and potentially less profitable than the markets in which it currently operates.

163

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North America Equity Research 02 January 2008

Table 97: GOOG Annual Income Statement


$ in millions, except per share data FY 2006 10,604.9 3,308.8 79.5% 6,332.8 851.1 112.3 7,296.1 81.3% 898.6 6,397.5 87.7% FY 2007E 16,455.1 4,736.5 84.6% 10,709.2 861.4 148.0 11,718.6 60.6% 1,722.4 9,996.2 85.3% FY 2008E 22,479.5 5,522.5 85.9% 15,840.7 906.4 210.0 16,957.0 44.7% 2,800.2 14,156.9 83.5% FY 2009E 28,531.9 6,199.7 86.2% 21,040.7 996.6 295.0 22,332.3 31.7% 3,822.7 18,509.6 82.9%

Gross Revenue TAC TAC % Google websites Google Network websites Licensing and other Revenues Net Revenues Y/Y growth Q/Q growth Cost of Revenues Gross Profit Gross Margins Contribution GM R&D Sales & Marketing General & Administrative Cost of revenues Research and development Sales and marketing General and administrative In process R&D charge Stock based compensation Settlement Attorney Fees (Lane's Gift) Contribution to Google Foundation Total Expenses Operating Income Pro Forma Operating Income Operating Margins Pro Forma Operating Margins Interest Income (Expense) EBT Less Taxes Tax Rate EBITDA Margins EAT Tax Benefit --> Stock Comp & Foundation Pro forma EAT GAAP EPS Pro forma EPS Diluted Sharecount
Source: Company reports and JPMorgan estimates.

941.1 790.1 628.2 458.1 30.0 3,746.1 3,550.0 4,008.1 48.7% 54.9% 461.0 4,011.0 933.6 23% 4,610.0 63.2% 3077.4 225.3 3278.9 9.94 10.59 309.5

1,542.7 1,331.5 1,127.9

2,220.2 1,831.4 1,572.2 880.0 9,303.9 7,653.1 8,533.1 45.1% 50.3% 740.0 8,393 2,182 26.0% 9,917.1 58.5% 6,210.9 228.8 6,862.1 18.94 20.92 328.0

2,924.5 2,411.9 2,070.7 880.0 12,109.7 10,222.5 11,102.5 45.8% 49.7% 740.0 10,963 2,850 26.0% 12,646.5 56.6% 8,112.3 228.8 8,763.5 24.38 26.33 332.8

818.3 6,542.8 5,175.8 5,994.1 44.2% 51.2% 582.3 5,758 1,534 27% 6,957.9 59.4% 4,224.1 154.4 4,888.0 13.33 15.42 317.0

164

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

North America Equity Research 02 January 2008

Table 98: GOOG Quarterly Income Statement


$ in millions, except per share data Q1 -06 2,253.8 722.7 77.8% 1,297.3 205.6 28.1 1,531.0 92.7% 18.7% 179.1 1,351.9 88.3% 87.0% 173.5 175.0 116.0 FY2006 Q2-06 Q3-06 2,456.0 2,689.7 785.2 825.3 78.8% 79.6% 1,432.5 211.4 27.0 1,670.8 87.6% 9.1% 201.6 1,469.3 87.9% 87.4% 212.0 182.1 150.7 1,626.0 211.8 26.7 1,864.4 77.8% 11.6% 221.3 1,643.1 88.1% 88.1% 250.9 192.3 168.7 Q4-06 3,205.5 975.6 81.4% 1,977.0 222.2 30.6 2,229.9 72.8% 19.6% 296.7 1,933.2 86.7% 84.0% 304.7 240.7 192.8 Q1 -07 3,664.0 1,125.0 83.6% 2,282.1 220.3 36.5 2,538.9 65.8% 13.9% 341.0 2,197.9 86.6% 83.9% 287.6 275.3 230.0 FY2007E Q2-07 Q3-07 3,872.0 4,231.4 1,150.0 1,221.0 85.1% 83.9% 2,486.3 202.1 33.6 2,722.0 62.9% 7.2% 402.6 2,319.4 85.2% 80.9% 375.1 319.2 278.9 2,734.8 233.7 41.9 3,010.4 61.5% 10.6% 437.5 2,572.8 85.5% 81.1% 418.1 350.9 288.0 Q4-07E 4,687.8 1,240.4 85.8% 3,206.1 205.3 36.0 3,447.4 54.6% 14.5% 541.2 2,906.1 84.3% 79.9% 461.9 386.1 330.9 Q1 -08E 5,229.3 1,355.5 85.8% 3,604.4 224.3 45.0 3,873.8 52.6% 12.4% 627.6 3,246.2 83.8% 78.5% 511.3 418.4 360.3 FY 2008E Q2-08E Q3-08E 5,366.3 5,615.3 1,355.0 1,358.2 85.8% 86.0% 3,737.0 224.3 50.0 4,011.3 47.4% 3.5% 661.9 3,349.4 83.5% 79.9% 529.5 433.2 373.1 3,981.1 221.1 55.0 4,257.2 41.4% 6.1% 706.7 3,550.5 83.4% 78.4% 553.4 459.8 395.9 Q4-08E 6,268.5 1,453.8 86.0% 4,518.1 236.7 60.0 4,814.8 39.7% 13.1% 804.1 4,010.7 83.3% 80.8% 625.9 520.0 443.0

Gross Revenue TAC TAC % Google websites Google Network websites Licensing and other Revenues Net Revenues Y/Y growth Q/Q growth Cost of Revenues Gross Profit Gross Margins Contribution GM R&D Sales & Marketing General & Administrative Cost of revenues Research and development Sales and marketing General and administrative In process R&D charge Stock based compensation Settlement Attorney Fees (Lane's Gift) Contribution to Google Foundation Total Expenses Operating Income Pro Forma Operating Income Operating Margins Pro Forma Operating Margins Interest Income (Expense) EBT Less Taxes Tax Rate EBITDA Margins

114.7 30.0 788.3 742.7 887.4 49% 58% 67.9 811 218 27% 998.5 65.2%

109.1 855.5 815.4 924.5 49% 55% 160.8 976 255 26% 1,050.7 62.9%

99.9 933.1 931.3 1,031.2 50% 55% 108.2 1,040 306 29% 1,176.5 63.1%

134.4 1,169.3 1,060.6 1,195.0 48% 54% 124.1 1,185 154 13% 1,384.3 62.1%

183.9 1,317.7 1,221.2 1,405.1 48% 55% 130.7 1,352 350 26% 1,610.1 63.4%

241.5 1,617.3 1,104.6 1,346.1 41% 49.5% 137.1 1,242 317 25% 1,569.5 57.7%

198.0 1,692.5 1,317.8 1,515.8 44% 50.4% 154.4 1,472 402 27% 1,765.2 58.6%

195.0 1,915.2 1,532.1 1,727.1 44% 50% 160.0 1,692 465 28% 2,013.1 58.4%

205.0 2,122.5 1,751.3 1,956.3 45% 51% 170.0 1,921 500 26% 2,266.3 58.5%

215.0 2,212.6 1,798.7 2,013.7 45% 50% 180.0 1,979 514 26% 2,347.7 58.5%

225.0 2,340.8 1,916.4 2,141.4 45% 50% 190.0 2,106 548 26% 2,499.4 58.7%

235.0 2,627.9 2,186.8 2,421.8 45% 50% 200.0 2,387 621 26% 2,803.8 58.2%

165

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North America Equity Research 02 January 2008

EAT Tax Benefit --> Stock Comp & Foundation Pro forma EAT GAAP EPS Pro forma EPS Diluted Sharecount % of Revenue Google website Network Partners R&D Sales & Marketing General & Administrative Q/Q Growth R&D Sales & Marketing General & Administrative Y/Y Growth R&D Sales & Marketing General & Administrative Total Expenses Contribution Margins
Source: Company reports and JPMorgan estimates.

Q1 -06 592.3 39.8 697.2 1.95 2.29 304.1 85% 13% 11.3% 11.4% 7.6% 10% 13% 2% 218% 211% 203% 124% 54%

Q2-06 721.1 (3.2) 772.1 2.33 2.49 310.0 86% 13% 12.7% 10.9% 9.0% 22% 4% 30% 221% 188% 211% 106% 51%

FY2006

Q3-06 733.4 20.9 812.3 2.36 2.62 310.6 87% 11% 13.5% 10.3% 9.0% 18% 6% 12% 192% 183% 182% 80% 53%

Q4-06 1,030.7 167.8 997.3 3.29 3.18 313.5 89% 10% 13.7% 10.8% 8.6% 21% 25% 14% 194% 156% 169% 62% 51%

Q1 -07 1,002.2 26.8 1,159.3 3.18 3.68 314.9 90% 9% 11.3% 10.8% 9.1% -6% 14% 19% 166% 157% 198% 67% 51%

FY2007E Q2-07 Q3-07 925.1 1,070.0 43.0 31.0 1,123.6 1,236.9 2.93 3.56 315.5 91% 7% 13.8% 11.7% 10.2% 30% 16% 21% 177% 175% 185% 89% 40% 3.38 3.91 316.6 91% 8% 13.9% 11.7% 9.6% 11% 10% 3% 167% 182% 171% 81% 42%

Q4-07E 1,226.8 53.6 1,368.2 3.82 4.26 321.0 93% 6% 13.4% 11.2% 9.6% 10% 10% 15% 152% 160% 172% 64% 44%

Q1 -08E 1,421.7 53.3 1,573.4 4.37 4.84 325.0 93% 6% 13.2% 10.8% 9.3% 11% 8% 9% 178% 152% 157% 61% 41%

FY 2008E Q2-08E Q3-08E 1,464.2 1,558.7 55.9 58.5 1,623.3 1,725.2 4.48 4.96 327.0 93% 6% 13.2% 10.8% 9.3% 4% 4% 4% 141% 136% 134% 37% 52% 4.74 5.24 329.0 94% 5% 13.0% 10.8% 9.3% 5% 6% 6% 132% 131% 137% 38% 50%

Q4-08E 1,766.3 61.1 1,940.2 5.34 5.86 331.0 94% 5% 13.0% 10.8% 9.2% 13% 13% 12% 135% 135% 134% 37% 51%

166

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

North America Equity Research 02 January 2008

Table 99: GOOG Annual Balance Sheet


$ in millions FY 2006E 3,544.7 7,699.2 1,322.3 29.7 443.9 13,039.8 1,031.9 2,395.2 1,545.1 346.8 114.5 18,473.4 211.2 351.7 265.9 370.4 105.1 0.4 1,304.6 20.0 40.4 68.5 128.9 0.3 11,882.9 23.3 5,133.3 17,039.8 18,473.4 FY 2007E 6,239.2 7,980.9 2,068.4 88.0 689.5 17,066.0 1,048.1 3,923.8 2,277.4 485.3 170.1 24,970.7 265.5 568.1 459.1 581.4 167.3 2,041.5 23.7 91.0 114.7 22,814.5 24,970.7 FY 2008E 11,914.1 7,980.9 2,888.9 88.0 963.0 23,834.8 1,048.1 5,563.8 2,277.4 485.3 170.1 33,379.5 529.6 553.7 553.7 812.0 233.7 2,682.7 23.7 91.0 114.7 0 0 0 0 0 0 0 30,582.1 33,379.5 FY 2009E 19,650.4 7,980.9 3,702.0 88.0 1,234.0 32,655.2 1,048.1 7,043.8 2,277.4 485.3 170.1 43,679.9 678.7 709.5 709.5 1,040.6 299.5 3,437.8 23.7 91.0 114.7 40,127.4 43,679.9

Cash and Cash Equivalents Short term investments Accounts Receivable Income taxes receivable Deferred Income Tax Prepaid revenue share,expenses and other assets Total Current Assets Non-marketable equity securities Property, Plant, and Equipment Goodwill Intangible Assets Deferred income taxes, net Prepaid revenue share, expenses and other non current assets Total Assets Accounts Payable Accrued Compensation and benefits Accrued Expenses and other current liabilities Accrued revenue share Deferred revenue Income taxes payable Current portion of equipment leases Total Current Liabilities Long term portion of equipment leases Deferred revenue, long term Liability for stock options exercised early, long term Deferred income taxes Income taxes payable, long-term Other long term liabilities Total Long Term Liabilities Redeemable convertible, preferred stock warrant Common stock Preferred stock Additional Paid in capital Note receivable from office/stockholder Deferred stock based compensation Accumulated other comprehensive income Retained Earnings Total Stockholders' equity Total Liabilities & Equity
Source: Company reports and JPMorgan estimates.

167

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

North America Equity Research 02 January 2008

Table 100: GOOG Annual Cash Flow Statement


$ in millions FY 2006E Operating Activities Net income Depreciation and Amortization Amortization of Warrants Amortization of Intangibles In process R&D Stock based compensation Excess tax benefit from stock-based award activity Other Changes in WC Accounts Receivables Income taxes Prepaid revenue share,expenses and other assets Accounts Payable Accrued Expenses and other liabilities Accrued revenue share Deferred revenue Tax Benefit from exercise Option Non Recurring Portion Net Cash provided by Operating Activities FCF Investing Activities Purchase of PP&E Purchase of short term investments Maturities and sale of short term investments Investments in non-marketable equity securities Acquisitions, net of cash acquired Change in other assets Net Cash used in Investing Activities Financing Activities Proceeds from issuance of convertible preference stock Proceeds from IPO/Public Offering Proceeds from exercise of stock options Proceeds from exercise of warrants Payments of notes receivables from shareholders Excess tax benefits from stock-based award activity Payment of Principal on capital leases and eqpt loans Net Cash provided by Financing Activities Effect of Exchange rate changes Net Increase (Decrease) in Cash & Equivalents Cash and Cash Equivalents - Beginning Cash and Cash Equivalents - Ending
Source: Company reports and JPMorgan estimates.

FY 2007E 4,224.1 805.8 157.9 818.3 (238.6) (7.2) (559.4) 431.0 (237.3) 20.2 206.5 136.4 32.1 5,790.0 3,490.3 (2,299.6) (11,756.1) 11,519.0 (21.3) (823.1) (3,381.2) 19.1 238.6 257.7 28.1 2,694.5 3,544.9 6,239.4

FY 2008E 6,210.9 1,160.0 224.0 880.0 8,474.9 5,674.9 (2,800.0) (2,800.0) 5,674.9 6,239.4 11,914.3

FY 2009E 8,112.3 1,320.0 224.0 880.0 10,536.3 7,736.3 (2,800.0) (2,800.0) 7,736.3 11,914.3 19,650.6

3,077.4 494.4 77.5 10.8 458.1 (581.7) 1.7 (624.0) 398.4 (289.2) 95.4 291.5 139.3 30.8 3,580.5 1,677.7 (1,902.8) (26,681.9) 23,107.1 (1,019.1) (402.4) (6,899.2) 2,063.5 321.1 581.7 2,966.4 19.7 (332.5) 3,877.4 3,544.9

168

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

North America Equity Research 02 January 2008

HouseValues, Underweight ($2.94)


As HouseValues businesses continue to be in transition, we believe it is strategically disadvantaged to weather the ongoing downturn in the real estate market. Despite a strong balance sheet ($74.5M net cash at the end of 3Q07), we believe the company will continue to be impacted by weakness in the housing market and therefore maintain our Underweight rating. Lead generation business we expect ARPC to stabilize. As a result of the housing slowdown, SOLD has been shedding costumers at a rapid clip, losing 1,559 customers in 3Q07 alone. We believe that a large number of customers lost were lower value customers. As a result, we expect ARPC to stabilize in 2008, at $410, from $403 in 2007. Acquisition of Realty Generator could provide some upside to our F'08 estimates. SOLD announced the acquisition of Realty Generator, a provider of
marketing and technology solutions to real estate brokerage companies, in November 07. While the acquisition was small, ~$10M, we expect it to be accretive to EBITDA in F08 and the acquisition demonstrates that management is looking to diversify its product mix.

Acquisitions could continue. With $74.5M in cash at the end of 3Q'07, and slow real estate markets depressing valuations in the space, we expect HouseValues to actively pursue acquisitions. 2008 share price catalysts. We will look for the following as signs of an improving business model in 2008: (1) stabilization in ARPC, and (2) revenue generation of the Realty Generator acquisition. We would be concerned if we saw the following trends develop in 2008: (1) continued declines in ARPC, (2) accelerating customer losses, and (3) continued declines in U.S. home sales. Tweaking 4Q estimates. We are maintaining our 4Q07 revenue and EBITDA estimates of $12.3M and $1.6M, and modifying our 4Q07 EPS estimate from ($0.01) to $0.00. The table below outlines our current estimates, including our newly introduced 2009 estimates.
Table 101: HouseValues Estimate Snapshot
$ in millions HouseValues JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07 12.3 1.6 0.00 11.8 1.6 (0.02) F'07 59.9 3.4 (0.09) 59.5 3.4 (0.10) F'08 49.3 7.4 0.02 46.2 7.4 (0.07) F'09 54.0 8.1 0.07 F'07 Y/Y -36.7% -56.7% NM -37.1% -56.6% NM F'08 Y/Y -17.7% 118.6% NM -22.4% 117.6% NM F'09 Y/Y 9.6% 9.6% 376.1% NM NM NM

Source: Company reports, FactSet and JPMorgan estimates.

169

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

North America Equity Research 02 January 2008

Key Financial Metrics & Forecasts


The following table summarizes our estimates for HouseValues customer additions and average revenue per real estate customer through 2008.
Table 102: SOLD Customer Metrics and ARPC Forecast
Real Estate Customers Net Customer Additions Y/Y growth Average Revenue per Real Estate Customer ARPC Growth Y/Y
Source: Company Reports and JPMorgan estimates

2005 15,700 5,068 46.1% 489.25 10.4%

2006 14,596 (375) -2.3% 446.5 -8.7%

2007E 9,948 (5,745) -36.6% 402.8 -9.8%

2008E 10,448 500 5.0% 410 1.7%

2009E 11,648 1,200 11.5% 408 -0.5%

Our Estimates and Outlook for 2008


Our updated 2008 estimates call for a Y/Y decline in revenues, down 17.7%, and Y/Y improvements in EBITDA, up 118.6%, as a result of cost savings initiatives, including the closing of a call center. Specifically, we are modeling 2008 revenues, EBITDA, and EPS of $49.3M, $7.4M, and $0.02.

Our Estimates and Outlook for 2009


We are introducing 2009 estimates calling for revenue, EBITDA, and earnings of $54M, $8.1M, and $0.07. These estimates incorporate the following assumptions: (1) revenue per real estate subscriber will decline slightly in 2009, (2) a marginal revenue impact from the acquisition of Realty Generator, and (3) sustained margin improvements despite continued softness in the real estate market.

Valuation and Rating Analysis


On an EV/EBITDA basis, SOLD trades at 1.0x our F08 EBITDA estimate of $7.4M, vs. peers at 20.5x. Despite this discount, we remain very concerned about SOLDs longer-term growth outlook for two main reasons: Even as the real estate market faces significant headwinds, the online real estate sector continues to become more competitive, with current players upgrading current offerings and new players entering the space. Additionally, other players in the space with multiple product offerings have introduced lead-generation products that supplement other real estate offerings such as listing enhancement products. The company is likely to face increased competition from players such as Move, Inc., Homegain, LendingTree, ZipRealty, and Zillow as more advertising dollars shift online.

Therefore, we believe the current discount is justified and SOLD could continue to face continued pressure on its cash balance and therefore, we maintain our Underweight rating.

170

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

North America Equity Research 02 January 2008

Risks to Our Rating


Our current estimates are based on the assumption that difficult real estate market conditions will persist during 2007 and 2008, which could impact HouseValues top and bottom lines. Inherent in our assumptions are continued customer churn and limited upside potential in revenue per customer. Should market conditions improve sooner than we anticipate, our estimates could prove to be too conservative.

171

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

North America Equity Research 02 January 2008

Table 103: SOLD Annual Income Statement


$ in millions, except per share data FY 2006 Revenues House Values/Just Listed Other Sales & Marketing Technology and Product Development General & Admin Restruc. / Impair't of goodwill + intang. assts Depreciation Amortization Stock based compensation Total Expenses Total Recurring Expenses Income from Operations Pro Forma Operating Income Operating Margins Pro Forma Operating Margins EBITDA EBITDA Margins Y/Y EBITDA Growth Interest Income, Net EBT Tax EAT (Continuing Operations) Pro Forma EAT (excludes FAS) Income/loss from Discontinued Ops Income tax benefit from discontinued Loss on discontinued ops Net income - adj for discontinued Weighted Average No of shares (diluted) Pro Forma EPS GAAP EPS
Source: Company reports and JPMorgan estimates.

FY 2007E 59.9 59.9 38.7 8.7 9.1 5.3 0.7 3.2 67.0 56.5 (7.1) 3.4 -11.8% 5.7% 3.4 5.7% -56.7% 2.9 (4.2) (1.8) (2.3) 4.1 0.2 0.1 0.2 (2.2) 24.5 0.17 (0.09)

FY 2008E 49.3 49.3 30.3 6.0 5.5 6.0 1.6 2.1 51.6 41.9 (2.3) 7.4 -4.6% 15.1% 7.4 15.1% 118.6% 2.8 0.5 0.1 0.4 6.6 0.4 25.7 0.26 0.02

FY 2009E 54.0 54.0 33.2 6.6 6.1 3.6 2.0 3.2 54.6 45.9 (0.6) 8.1 -1.1% 15.1% 8.1 15.1% 9.6% 3.1 2.5 0.6 1.9 7.3 1.9 25.8 0.28 0.07

94.6 62.2 12.3 61.8 13.0 12.0 5.2 1.1 4.0 97.0 86.8 (2.4) 7.8 -2.6% 8.3% 7.8 8.3% -67.5% 2.7 (6.0) (3.1) (2.9) 6.8 (0.4) (0.1) (0.3) (3.1) 26.1 0.25 (0.14)

172

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

North America Equity Research 02 January 2008

Table 104: SOLD Quarterly Income Statement


$ in millions, except per share data Q1-06 Revenues House Values/Just Listed Other Sales & Marketing Technology and Product Development General & Admin Restruc. / Impair't of goodwill + intang. assts Depreciation Amortization Stock based compensation Total Expenses Total Recurring Expenses Income from Operations Pro Forma Operating Income Operating Margins Pro Forma Operating Margins EBITDA EBITDA Margins Y/Y EBITDA Growth Interest Income, Net EBT Tax EAT (Continuing Operations) Pro Forma EAT (excludes FAS) Income/loss from Discontinued Ops Income tax benefit from discontinued Loss on discontinued ops Net income - adj for discontinued Weighted Average No of shares (diluted) Pro Forma EPS GAAP EPS
Source: Company reports and JPMorgan estimates.

FY2006 Q2-06 Q3-06 25.9 22.4 3.5 15.9 3.4 3.0 1.1 0.4 1.1 25.0 22.4 0.9 3.5 3.3% 13.5% 3.5 13% -38% 0.7 1.6 (0.3) 1.9 2.7 24.0 20.6 2.9 17.1 3.2 3.3 1.6 0.3 1.0 26.3 23.5 (2.3) 0.4 -9.7% 1.8% 0.4 2% -94% 0.7 (1.6) (0.2) (1.5) 0.7

Q4-06 21.5 19.2 2.3 15.3 3.6 3.1 6.2 1.5 0.2 1.0 30.9 22.0 (9.4) (0.5) -43.5% -2.3% (0.5) -2% -107% 0.6 (8.7) (3.4) (5.3) 0.1

Q1-07 17.8 17.8 12.2 2.7 2.7 1.4 0.4 1.2 20.5 17.5 (2.7) 0.3 -15% 2% 0.3 2% -92% 0.6 (2.1) (0.9) (1.2) 0.6 (0.1) (0.0) (0.0) (1.2) 24.4 0.02 (0.05)

FY2007E Q2-07 Q3-07 16.0 16.0 10.1 2.4 2.6 1.4 0.0 0.7 17.1 15.0 (1.1) 0.9 -7% 6% 0.9 6% -73% 0.8 (0.4) (0.1) (0.3) 1.1 0.2 0.1 0.1 (0.2) 24.6 0.04 (0.01) 13.8 13.8 8.8 2.1 2.4 1.2 1.3 0.0 0.6 16.4 13.3 (2.6) 0.5 -19% 4% 0.5 4% 17% 0.9 (1.7) (0.8) (0.9) 0.9 0.1 0.0 0.1 (0.9) 24.5 0.04 (0.04)

Q4-07E 12.3 12.3 7.6 1.6 1.5 1.3 0.3 0.6 12.9 10.7 (0.6) 1.6 -5% 13% 1.6 13% -425% 0.7 0.1 0.0 0.1 1.5

Q1-08E 12.1 12.1 7.5 1.5 1.3 1.4 0.4 0.6 12.7 10.3 (0.7) 1.7 -5% 15% 1.7 15% 410% 0.7 0.0 0.0 0.0 1.6

FY2008E Q2-08E Q3-08E 12.2 12.2 7.6 1.5 1.3 1.5 0.4 0.5 12.8 10.4 (0.6) 1.8 -5% 15% 1.8 15% 94% 0.7 0.1 0.0 0.1 1.6 12.5 12.5 7.6 1.5 1.5 1.5 0.4 0.5 13.0 10.6 (0.5) 1.9 -4% 15% 1.9 15% 268% 0.7 0.2 0.0 0.1 1.7

Q4-08E 12.5 12.5 7.7 1.5 1.4 1.6 0.4 0.5 13.1 10.6 (0.5) 2.0 -4% 16% 2.0 16% 23% 0.7 0.2 0.0 0.1 1.7

23.2 3.6 13.5 2.7 2.6 1.0 0.2 1.0 21.0 18.8 2.2 4.4 9.6% 19.0% 4.4 19% -12% 0.6 2.8 0.8 2.0 3.3 (0.4) (0.1) (0.3) 1.8 27.4 0.12 0.06

1.9 27.3 0.10 0.07

(1.5) 25.4 0.03 (0.06)

(5.3) 24.4 0.00 (0.22)

0.1 24.5 0.06 0.00

0.0 25.6 0.06 0.00

0.1 25.6 0.06 0.00

0.1 25.7 0.07 0.01

0.13 25.7 0.07 0.00

173

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

North America Equity Research 02 January 2008

Table 105: SOLD Quarterly Income Statement


$ in millions, except per share data Q1-06 Total Customers Real Estate customers (QE) Real Estate customers (Avg.) Net Customer Additions Sequential Growth Y/Y growth Average Reve/Sub ARPC Growth Y/Y ARPC Growth Q/Q Churn Lifetime Value of Customer SAC Total Sales and Marketing Dept Expenses as % of Revenue Sales & Marketing Technology and Product Development General & Admin Depreciation Amortization Y/Y Change Revenue Growth Sales & Marketing Technology and Product Development General & Admin Depreciation Amortization Total Expenses Total Recurring Expenses GAAP EPS Sequential Change Revenue Growth Sales & Marketing Technology and Product Development General & Admin Depreciation Amortization
Source: Company reports and JPMorgan estimates.

Q2-06

FY2006 Q3-06 17,281 16,184 16,089 191 1% 9% 427 -15.3% -7.4% 7.6% 5618 450 71.2% 13.4% 13.6% 6.5% 1.1% 3% 49% 86% 0% 208% 71% 51.2% 42.9%

Q4-06 15,693 14,596 15,390 (1,588) -9.19% -2.33% 406 -18.47% -4.92% 9.3% 4,366

Q1-07 14,593 13,508 14,052 (1,100) -7.01% -13.76% 415 -15.65% 2.22% 10.4% 3,990 379

FY2007E Q2-07 Q3-07 13,304 12,207 12,858 (1,289) -8.83% -22.15% 405 -12.15% -2.41% 9.1% 4,451 368 63.3% 14.8% 16.0% 8.5% 0.1% -38% -36% -31% -16% 21% -96% -31.5% -32.8% 10,648 10,648 11,428 (1,559) -19.96% -38.38% 393 -7.96% -2.96% 9.5% 4,137 240 63.8% 15.0% 17.5% 9.3% 0.1% -42% -49% -35% -26% -18% -94% -37.6% -43.6%

Q4-07E 9,948 9,948 10,298 (700) -6.57% -36.61% 398 -1.97% 1.27%

Q1-08E 9,848 9,848 9,898 (100) -1.01% -32.52% 406 -2.17% 2.01%

FY2008E Q2-08E Q3-08E 9,948 9,948 9,898 100 1.02% -25.23% 411 1.48% 1.23% 10,148 10,148 10,048 200 2.01% -4.70% 415 5.60% 0.97%

Q4-08E 10,448 10,448 10,298 300 2.96% 5.03% 406 2.01% -2.17%

16,922 15,825 15,763 854 5% 30% 492 5.4% -1.2% 6.6% 7,455 389 58.2% 11.6% 11.2% 4.4% 0.9% 32% 57% 118% -6% 186% 40% 56.4% 49.0%

17,090 15,993 16,197 168 1% 22% 461 -5.5% -6.3% 7.4% 6,230 427 61.5% 13.3% 11.8% 4.3% 1.6% 26% 55% 114% 0% 178% 168% 58.9% 50.0%

71.1% 16.9% 14.4% 6.9% 0.9% -15% 12% 47% 25% 137% -39% 56.2% 18.6%

68.2% 15.0% 14.9% 7.9% 2.2% -23% -10% -1% 2% 39% 85% -2.2% -7.0%

62.0% 13.0% 12.0% 10.6% 2.4% -43% -50% -56% -52% -13% 53% -58.2% -51.4%

62.0% 12.5% 11.0% 11.6% 3.3% -32% -39% -44% -50% -1% 1% -38.1% -41.1%

62.0% 12.5% 10.5% 12.3% 3.3% -24% -25% -35% -50% 11% 2400% -25.4% -31.0%

61.0% 12.0% 12.0% 12.0% 3.2% -9% -13% -28% -38% 17% 2400% -20.7% -20.0%

61.0% 12.0% 11.3% 12.8% 3.2% 2% 0% -6% -4% 23% 33% 1.4% -1.2%

-7.7% -0.6% 9.1% 5.2% 61.2% -33.9%

11.3% 17.6% 27.3% 17.2% 10.1% 89.7%

-7.3% 7.4% -6.4% 6.7% 39.7% -36.1%

-10.3% -10.5% 13.0% -4.9% -4.6% -24.0%

-17.1% -20.5% -26.3% -13.8% -5.0% 101.5%

-10.4% -16.8% -11.8% -3.9% -4.2% -95.9%

-13.7% -13.1% -12.1% -5.6% -5.5% 0.0%

-10.9% -13.3% -22.9% -39.0% 1.6% 1775.0%

-2.0% -2.0% -5.7% -10.1% 7.7% 33.3%

1.2% 1.2% 1.2% -3.4% 7.1% 0.0%

2.5% 0.9% -1.6% 17.1% 0.0% 0.0%

0.3% 0.3% 0.3% -5.6% 6.7% 0.0%

174

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

North America Equity Research 02 January 2008

Table 106: SOLD Annual Balance Sheet


$ in millions FY 2006 ASSETS Current assets: Cash and cash equivalents Short-term investments Accounts receivable, net Income taxes Receivable Prepaid advertising Prepaid expenses and other assets Deferred income taxes Prepaid income taxes Other current assets Total current assets Property and equipment, net Goodwill Intangible assets, net Restricted cash Other assets Deferred income taxes Total assets LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable Accrued compensation and benefits Accrued expenses and other current liabilities Deferred rent, current portion Deferred revenue Income taxes payable Total Current Liabilities Deferred income taxes Deferred rent, less current portion Note payable Redeemable convertible preferred Series A Redeemable convertible preferred Series B Total Liabilities Shareholders Equity: Common stock Deferred stock-based compensation Notes receivable from officers/shareholders Retained earnings Total shareholders equity Total Liabilities and shareholders equity
Source: Company reports and JPMorgan estimates.

FY 2007E

FY 2008E

FY 2009E

49.4 28.4 0.4 1.7 1.6 2.3 83.8 11.5 3.6 0.6 1.8 101.4

26.4 40.3 0.0 1.9 2.0 0.9 71.4 8.0 3.6 0.2 2.6 85.9

34.6 40.3 0.0 1.4 1.9 0.9 79.1 6.4 3.6 0.2 2.6 91.9

42.9 40.3 0.0 1.4 1.9 0.9 87.4 5.3 3.6 0.2 2.6 99.1

3.2 3.2 5.1 1.1 12.9 1.1 1.7 15.7 63.2 22.4 85.7 101.4

1.0 1.9 2.5 0.3 0.8 6.5 0.8 1.8 9.1 56.5 20.3 76.8 85.9

0.8 2.4 3.5 0.3 0.9 7.9 0.8 1.8 10.5 60.7 20.7 81.4 91.9

0.8 2.4 3.5 0.3 0.9 7.9 0.8 1.8 10.5 66.1 22.5 88.6 99.1

175

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

North America Equity Research 02 January 2008

Table 107: SOLD Annual Statement of Cash Flows


$ in millions FY 2006 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) Operating activities: Depreciation and amortization of property and equipment Amortization of intangible assets Stock-based compensation Deferred income tax expense (benefit) Impairment of goodwill and intangible assets Tax benefit from exercise of stock option Changes in certain assets and liabilities, net of Soar Solutions, Inc acquisition Accounts receivable Prepaid advertising Prepaid expenses and other assets Prepaid income taxes Other current assets Income taxes receivable Accounts payable Accrued compensation and benefits Accrued expenses and other current liabilities Deferred rent Deferred revenue Income taxes payable Net cash provided by operating activities Y/Y Growth in OCF FCF Y/Y FCF Growth Y/Y Capex Growth CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of short-term investments Sales of short-term investments Change in restricted cash Purchases of property and equipment Purchases of intangible assets Acquisition of the Loan Page, net of cash acquired Acquisitions, net of cash acquired Net cash provided by (used in) investing activities CASH FLOWS FROM FINANCING ACTIVITIES: Issuance costs related to the sale of common stock Repayment of note payable Cash held for third party common stock transaction Cash paid to third party common stock transaction Net proceeds from issuance of redeemable convertible preferred stock, Series B Purchase and retirement of common stock Proceeds from exercises of stock options and warrants Tax benefit from exercise of stock options Proceeds from repayment of note receivable from officer/stockholder Convertible preferred stock dividend Common stock dividend Deferred initial public offering costs Proceeds from IPO Net cash provided by (used in) financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period
Source: Company reports and JPMorgan estimates.

FY 2007E (2.2) 5.3 0.7 3.2 (1.1) (5.3) 0.4 (0.9) 1.0 (0.0) (1.4) (1.3) (2.4) (0.3) (0.3) 1.9 -83.0% (1.2) -134.6% -60.2% (22.6) 10.8 (3.1) (0.0) (9.8) (24.8)

FY 2008E 0.4 6.0 1.6 2.1 1.9 0.5 (0.2) 0.5 1.0 0.1 12.0 533.7% 7.6 -743.8% 42.9% (4.4) (4.4) 0.5 0.1 0.6 8.2 26.4 34.6

FY 2009E 1.9 5.9 1.6 3.2 12.6 4.6% 7.2 -5.2% 10.2% (4.9) (4.5) 0.5 0.1 0.6 8.3 34.6 42.9

(3.1) 5.2 1.3 4.1 (3.5) 1.1 0.2 0.8 0.2 1.4 (1.1) 1.5 (0.6) 0.1 11.2 -53.5% 3.4 -79.2% 3.2% (5.0) 2.2 0.3 (7.7) (0.0) (1.3) (11.5)

1.4 (9.5) (9.9) 59.2 49.4

0.8 (0.1) (23.0) 49.4 26.4

176

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

North America Equity Research 02 January 2008

InfoSpace, Neutral ($18.96)


As a second-tier player in the online search business, we believe InfoSpace will continue to lose market share to the larger players. As such, we believe there is little opportunity to accelerate its anemic growth, and thus maintain our Neutral rating. Sale of directory and mobile businesses allows INSP to capture value NOLs. With declining earnings, InfoSpace turned to selling its online directory, for $225M, and mobile services businesses, for $135M, in order to capture the value of $380M in NOLs the company was carrying. As a result of the sales, INSP plans to return $300M, or $9 per share, to shareholders in the form of a special dividend in Jan. 08. Search Share Dwindling. According to our estimates, InfoSpace will see its query volumes decline in 2007, as larger players continue to gain market share. We now believe InfoSpace controls less than 0.5% of the US search market, down from 1.4% just three years ago. Slowing RPS growth has also had a negative impact on earnings, and we do not expect a material improvement in 2008. 2008 Drivers. In our view, the following factors will drive the stock in 2008: (1) search market share declines, (2) the return of cash to shareholders from the divesture of the mobile business in January 2008, and (3) improving EBITDA margins as a result of the divesture of the mobile businesses. Maintaining 4Q07 Estimates. We are maintaining our 4Q revenue, EBITDA and EPS estimates of $34.3M, $0.9M and ($0.24), respectively However, we believe there is the potential for some additional upside to margins following the divesture of its lower-margin mobile business. Our current and newly introduced 2009 estimates are in the table below.

Table 108: InfoSpace Estimate Highlights


$ in millions InfoSpace JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07 34.3 0.9 (0.24) 34.5 1.7 0.17 F'07 240.2 (9.4) (1.49) 240.4 NA (1.44) F'08 138.9 (15.5) (0.88) 137.8 17.7 (0.27) F'09 140.6 18.1 0.11 143.9 21.2 (0.58) F'07 Y/Y -35.4% NM NM -35.3% NM NM F'08 Y/Y -42.2% NM NM -42.7% NM NM F'09 Y/Y 1.3% NM NM 4.4% NM NM

Source: Company reports, FactSet and JPMorgan estimates.

Our Estimates and Outlook for 2008


In order to account for the $300M special dividend, we are adjusting our F08 revenue, EBITDA and EPS estimates to $138.9M, ($15.5M), and ($0.88), from $138.9M, $16.6M and $0.07, respectively.

177

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

North America Equity Research 02 January 2008

In search, we believe InfoSpace will continue to lose search market share due to its lack of brand awareness. In addition, we believe the companys RPS will remain flat in F08. As a result, we are modeling Search & Directory revenues of $138.9M, down 9.2% Y/Y. During 2H'07, InfoSpace announced the sale of its mobile operations. Given that the company no longer plans to support large investments in mobile-media content, we believe that margin expansion is likely in 2008.

Our Estimates and Outlook for 2009


We are introducing our 2009 revenue, EBITDA and EPS estimates of $141M, $18M and $0.11, respectively, suggesting Y/Y growth (excluding the impact of the 1x special dividend) of 1%, 9%and 57%, respectively. In 2009, we expect InfoSpace to continue to face difficulties growing its search business as it continues to lose market share. As such, we are modeling Search & Directory revenues to grow 1% in 2009 to $140.6M. However, we expect margins to continue to improve from the divesture of lower-margin mobile businesses. As such, we are modeling F09 EBITDA margins of 12.9%, up from 11.9% in F08 (excluding the impact of the special dividend).

Valuation and Rating Analysis


On an EV/EBITDA basis, INSP trades at 3.2x our calendar F08 pro forma EBITDA estimate of $16.6M, compared with its peers, which trade at an average of 12.1x F08E EV/EBITDA. Although many investors may find the valuation compelling, we believe the stock will trade in line unless the company demonstrates improving fundamentals. Consequently, we maintain our Neutral rating.

Risks to Our Rating


Among the risks to our rating are INSPs dependence on the online advertising industry, integration risks associated with recent acquisitions, and competition from larger portal players. Additionally, if the company is unable to renew any of its search distribution partnerships, INSPs Search and Directory revenue may decline. We believe that most of the contracts with the distribution partners are 2-3 years in length. Finally, if Google, Yahoo! and InfoSpace are not able to increase search RPMs, our estimates could prove to be too aggressive.

178

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

North America Equity Research 02 January 2008

Table 109: INSP Annual Income Statement


$ in millions, except per share data FY 2006 Online Mobile Revenues Ex Payment Content and Distribution Costs System and Network Operation Product Development Sales and Marketing G&A Depreciation Amortization of Intangibles Restructuring Charges Impairment of other intangible Expense related to Spec. Div. Stock-based Comp (FAS 123R) Total Expenses Operating Profit (Reported) Operating Profit (Pro forma) Operating Margins (Reported) Operating Margins (Pro Forma) EBITDA EBITDA % Gain on Investments Other, Net Income Before Taxes Income Taxes Income From Disc. Ops Income After Taxes Accounting Change EPS (GAAP) Shares Outstanding % Of Revenue Content and Distribution Costs System and Network Operation Product Development Sales and Marketing G&A
Source: Company reports and JPMorgan estimates.

FY 2007E 152.9 87.3 240.2 102.0 21.3 39.7 23.0 41.5 17.2 3.8 (1.9) 21.8 39.5 286.0 (67.7) (4.4) -28.2% -1.8% (9.4) -3.9% 15.3 (52.4) (0.4) 3.1 (52.0) (1.49) 32.7 42.5% 8.9% 16.5% 9.6% 17.3%

FY 2008E 138.9 138.9 58.0 12.0 19.0 12.6 20.7 8.0 0.4 32.1 16.0 178.8 (39.9) 8.6 -28.8% 6.2% (15.5) -11.2% 10.3 (29.6) (29.6) (0.88) 34.1 41.8% 8.7% 13.7% 9.0% 14.9%

FY 2009E 140.6 140.6 57.4 12.2 19.2 12.7 21.0 8.0 0.4 16.0 146.9 (6.3) 10.1 -4.5% 7.2% 18.1 12.9% 10.3 4.0 4.0 0.11 35.3 40.8% 8.7% 13.7% 9.0% 14.9%

186.9 184.8 371.7 178.3 29.6 43.7 41.7 43.9 16.1 12.2 62.3 16.9 444.7 (73.0) 18.4 -19.6% 4.9% (27.8) -7.5% 19.4 (53.6) (40.9) (12.7) (0.46) 32.6 48.0% 8.0% 11.7% 11.2% 11.8%

179

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

North America Equity Research 02 January 2008

Table 110: INSP Quarterly Income Statement


$ in millions, except per share data 1Q'06 Online Mobile Revenues Ex Payment Content and Distribution Costs System and Network Operation Product Development Sales and Marketing G&A Depreciation Amortization of Intangibles Restructuring Charges Impairment of other intangible Expense related to Spec. Div. Stock-based Comp (FAS 123R) Total Expenses Operating Profit (Reported) Operating Profit (Pro forma) Operating Margins (Reported) Operating Margins (Pro Forma) EBITDA EBITDA % Gain on Investments Other, Net Income Before Taxes Income Taxes Income From Disc. Ops Income After Taxes Accounting Change EPS (GAAP) Shares Outstanding
Source: Company reports and JPMorgan estimates.

2Q'06 50.4 45.5 95.8 46.1 7.4 11.8 11.1 10.6 3.5 3.6 4.6 98.7 (2.8) 5.4 -2.9% 5.7% 8.9 9.3% 4.7 1.9 0.9 1.0 0.03 32.9

FY 2006

3Q'06 48.6 47.7 96.3 47.7 7.9 11.3 11.5 11.4 4.6 3.0 57.8 4.8 160.1

4Q'06 41.8 47.5 89.3 42.9 7.3 11.7 10.6 10.4 4.7 1.8 4.5 3.3 97.3 (8.0) 1.7 -8.9% 1.9% 1.9 2.1% 5.4 (2.6) (32.6) 30.0 0.91 33.1

1Q'07 45.0 41.6 86.6 41.6 6.2 13.1 6.9 10.7 4.6 1.8 (0.8) 7.3 91.3 (4.6) 3.6 -5.4% 4.2% 9.0 10.4% 5.2 0.5 1.1 (0.5) (0.02) 31.5

2Q'07 39.7 30.8 70.5 28.9 6.2 12.3 6.4 13.6 4.8 1.7 (1.7) 22.3 8.8 103.3

FY 2007

3Q'07 33.9 14.9 48.7 17.0 5.7 9.0 5.7 10.7 4.3 0.2 0.6 (0.4) 13.0 65.8

4Q'07E 34.3 34.3 14.5 3.2 5.2 4.0 6.5 3.5 0.2 10.4 47.5 (13.2) (2.6) -38.4% -7.5% 0.9 2.7% 3.0 (10.2) (0.5) 1.7 (8.0) (0.24) 33.4

1Q'08E 35.6 35.6 15.0 3.1 4.9 3.2 6.1 2.2 0.1 32.1 4.0 70.8 (35.2) 1.0 -99.1% 2.8% (28.9) -81.3% 2.5 (32.7) (32.7) (0.97) 33.7

FY 2008E 2Q'08E 3Q'08E 35.1 35.1 14.7 3.1 4.8 3.2 5.3 2.1 0.1 4.0 37.3 (2.2) 1.9 -6.4% 5.3% 4.0 11.3% 2.6 0.3 0.3 0.01 34.0 33.5 33.5 13.9 2.9 4.6 3.1 4.6 1.9 0.1 3.8 34.9 (1.4) 2.5 -4.2% 7.4% 4.4 13.1% 2.6 1.2 1.2 0.03 34.3

4Q'08E 34.7 34.7 14.4 3.0 4.6 3.1 4.7 1.8 0.1 4.2 35.8 (1.1) 3.2 -3.1% 9.3% 5.0 14.5% 2.7 1.6 1.6 0.05 34.6

46.1 44.1 90.3 41.6 6.9 8.9 8.5 11.6 3.3 3.7 4.1 88.7 1.6 9.4 1.7% 10.4% 12.7 14.1% 3.9 5.4 2.4 3.0 0.09 32.9

(63.8) 1.8 -66.3% 1.9% (51.3) -53.3% 5.4 (58.4) (11.7) (46.7) (1.49) 31.3

(32.8) (1.7) -46.5% -2.4% (17.5) -24.8% 4.4 (28.4) (0.3) (28.1) (0.86) 32.6

(17.0) (3.7) -35.0% -7.6% (1.8) -3.7% 2.7 (14.3) (0.7) 1.4 (12.3) (0.37) 33.2

180

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

North America Equity Research 02 January 2008

Table 111: INSP Annual Balance Sheet


$ in millions FY 2006 ASSETS Cash/Equivalents ST Investments Accounts Rcvbl.,Net Payroll Tax Rcvbl Notes and other Rcvbl Prepayments Other Total Current Assets Prop./Equip., Net LT Investments Other Investments Goodwill Goodwill/Intang. Deferred tax asset, net Other LT Assets Total Assets LIABILITIES Accounts Payable Accrued Expenses Deferred Revenue Other Current Liabs. Total Current Liabs Other LT Liabs. Deferred Taxes Total Liabilities SHAREHOLDER EQUITY Total Equity Total Liabilities & Equity
Source: Company reports and JPMorgan estimates.

FY 2007E 474.3 101.1 24.0 10.2 609.7 33.5 44.2 8.9 696.3 4.1 20.6 8.8 33.5 0.7 34.2 662.0 696.3

FY 2008E 158.1 101.1 24.3 5.0 10.2 298.7 33.5 44.2 8.9 385.3 4.2 20.8 8.8 33.8 0.7 34.5 350.8 385.3

FY 2009E 175.5 101.1 24.6 5.0 10.2 316.5 33.5 44.2 8.9 403.1 4.2 21.1 8.8 34.2 0.7 34.8 368.2 403.1

163.5 238.4 78.7 3.4 14.8 498.8 33.2 104.4 19.6 101.6 8.2 765.8 13.0 61.2 6.7 80.9 0.9 5.5 87.3 678.6 765.8

181

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

North America Equity Research 02 January 2008

Table 112: INSP Annual Statement of Cash Flows


$ in millions FY 2006 OPERATING CF's Net Income D&A Impair. of Intang. Warrant Income Income from discontinued ops Warrants Expense Stock-based Compen. Option Tax Benefits Bad Debt Expense Gain on Investments Other Charges Minority Interest Non-Cash Items Deferred Taxes Changes in Working Capital Amort. Trademark Write-off R&D Cash From Operations FCF INVESTING CF's Capital Expenditures Business Acquisition Increase in other long-term assets Asset Sale Proceeds Proceeds from sale of disc. Ops Other Investing Purchase Intangible Cash From Investing FINANCING CF's Proceeds from IPO Issuance of Common Stock to Employees Exercise of Options Debt, Net Purch./Sale of Stock Other Financing Repayment of Notes Cash From Financing Discontinued Operations Net cash provided by disc. Ops Net cash used by disc. Ops Net cash provided Foreign Exch/Other Adj Net Change In Cash Beginning Cash Ending Cash
Source: Company reports and JPMorgan estimates.

FY 2007E (48.9) 19.8 (6.2) 38.5 (3.1) 1.6 0.4 13.2 15.2 (10.7) (26.0) 3.0 360.0 135.4 472.4 1.4 12.9 (208.2) (193.9) 17.3 (0.3) 17.1 310.8 163.5 474.3

FY 2008E (29.6) 8.4 16.0 (5.2) (16.2) (11.0) (11.0) (300.0) (300.0) (316.2) 474.3 158.1

FY 2009E 4.0 8.4 16.0 28.4 17.4 (11.0) (11.0) 17.4 158.1 175.5

(12.7) 28.3 16.9 0.2 62.3 (41.3) (10.2) 43.5 20.9 (22.6) 0.0 (15.6) (0.3) (38.5) 1.8 3.6 5.4 10.5 153.0 163.5

182

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

North America Equity Research 02 January 2008

InnerWorkings, Neutral ($18.40)


InnerWorkings has continued to post rapid revenue growth in F07, with both acquisitions and organic growth accounting for the rise. We think the speed with which the company can achieve its long-run profitability profile remains the key unknown going forward. Several major acquisitions in F07. InnerWorkings made five notable acquisitions in F07, with the most significant being the acquisition of NYbased Corporate Edge in 4Q; Corporate Edge had revenue of approximately $60M in F06. The price was ~$33M in cash, with $18M due immediately and $15M available as earnouts over three years. At its 4Q investor day, InnerWorkings noted that all previous acquisition earnouts have been achieved, and the company has ~$25M in earnouts outstanding going forward. Revenue growth to remain strong. At just above the midpoint of F08 guidance, we are projecting 64% revenue growth in F08, and just over 40% revenue growth excluding the impact of the Corporate Edge acquisition. Speed of profitability improvements will be key catalyst. The first three quarters of F07 saw nearly 400 bps in Y/Y gross margin improvement, while operating margins over the same period were flat Y/Y. We believe the speed with which InnerWorkings is able to ramp profitability and cash flow generation remains the key area of focus: since F04, the company has generated $475M in revenue, but less than $1M in operating cash flows and negative free cash flow. 2008 Drivers. In our view, the following factors will drive the stock in 2008: (1) Profitability and cash flow generation; (2) integration of acquired companies; (3) pace of revenue growth. Raising 4Q07 and F07 estimates. In view of the Corporate Edge acquisition, we are raising our revenue, EBITDA and EPS estimates to $89.7M, $9.3M and $0.11, respectively, from $84.6M, $8.8M and $0.10. We are raising our F07 estimates to $288M, $26.8M and $0.32, respectively, from $283M, $26.3M and $0.31.

Table 113: InnerWorkings Consensus Snapshot


$ in millions, except per-share data INWK JPM Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07E 90 9 $0.11 87 9 0.11 F'07E 288 27 $0.32 286 26 0.32 F'08E 472 46 $0.52 467 45 0.51 F'09E 641 65 $0.73 625 61 0.72 F'07E 78.9% 91.5% 52.5% 77.7% 84.8% 54.0% Y/Y F'08E 63.8% 70.7% 63.3% 63.4% 72.4% 59.1% F'09E 35.9% 42.3% 39.4% 33.8% 36.6% 39.5%

Source: Company reports, FactSet, JPMorgan estimates. 183

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


Taking into account the Corporate Edge acquisition, we now project InnerWorkings to achieve F08 revenue of $472M, just above the midpoint of company guidance. We note that any further significant acquisitions may push F08 revenue higher. We now expect F08 EBITDA of $45.8M, and EPS of $0.52. The company has stated it expects to grow operating margins ~50-60 bps per year, and our F08 projections imply a Y/Y 55 bps improvement in operating margin Y/Y. Previously, we had modeled revenue, EBITDA and EPS of $414M, $40.9M and $0.50, respectively.

Our Estimates and Outlook for 2009


We think the company can draw a slightly higher percentage of business from Enterprise clients in F09, at 64.3%, up from 61.6% in F08. We are modeling 36% Y/Y revenue growth, to $641M, and projecting ~50 bps operating margin expansion, leading to $65.1M in EBITDA and EPS of $0.73.

Valuation and Rating Analysis


INWK is trading at a 18.6x EV/EBITDA multiple based on our F08 estimate, a premium to the peer group avg. of 19.1x. While INWK is growing revenue at a faster
rate than peers, we believe that multiple expansion is unlikely. As a result, we are maintaining our Neutral rating.

Risks to Our Rating


The company may outperform our expectations if it is able to grow its sales force organically or through acquisitions faster than expected, if operational leverage is higher than modeled, or if it is able to negotiate better gross margins with its clients. The company may underperform our expectations as revenue generation is currently concentrated among a few key clients. Additionally, concentration among a group of key suppliers means that a loss of any of these printers from the supplier network could have a significant impact on the depth of printing orders offered, the ability to fulfill orders, the cost savings obtained, and margins. Finally, margin expansion, sales force growth, and client penetration may be slower than expected if competition increases, skilled salesman are difficult to obtain and train, or no viable acquisitions are available.

184

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

North America Equity Research 02 January 2008

Table 114: INWK Annual Income Statement


$ in millions, except per share data FY 2006 160.5 124.0 36.5 22.8% 248 8.8 13.3 0.6 1.0 23.7 12.8 8.0% 201 14.4 0.9 (0.1) (0.0) 0.8 FY 2007E 288.1 214.9 73.2 25.4% 264 17.9 28.5 1.0 2.3 49.7 23.5 8.2% 16 26.8 2.5 (0.0) 0.4 2.9 FY 2008E 471.8 350.8 121.0 25.6% 24 30.0 45.3 1.4 3.3 79.9 41.1 8.7% 55 45.8 2.0 (0.0) 0.6 2.6 FY 2009E 641.0 475.5 165.5 25.8% 17 40.1 60.3 2.1 4.3 106.7 58.8 9.2% 47 65.1 2.4 (0.0) 0.6 3.0

Revenue Cost of goods sold Gross profit Gross margin Y/Y Improvement (bps) Operating Expenses Commission expense General and Administrative Expense Stock-based compensation Depreciation and amortization Total operating expenses Income from operations Operating Margin Y/Y Improvement (bps) EBITDA Other income Interest income Interest expense Minority interest Other, net Total other income

Income before taxes Income tax expense Tax Rate Net income Dividends on preferred shares Net income applicable to common shareholders Pro Forma Net Income Diluted EPS Pro Forma Diluted EPS Shares outstanding % Y/Y growth Revenue EBITDA Operating income EPS % of Revenue COGS Commission expense General and Administrative Stock Based compensation
Source: Company reports and JPMorgan estimates.

13.6 (5.3) 39.2% 8.3 8.3 8.3 $0.20 $0.20 39.5 108.8% 184.2% 178.9% 221.4% 77.2% 5.5% 8.3% 0.3%

26.4 (10.3) 39.1% 16.0 16.0 16.0 $0.32 $0.32 50.0 79.5% 85.8% 83.0% 59.2% 74.6% 6.2% 9.9% 0.4%

43.6 (17.0) 38.9% 26.6 26.6 26.6 $0.52 $0.52 50.9 63.8% 70.7% 74.8% 63.3% 74.4% 6.4% 9.6% 0.3%

61.8 (24.0) 38.9% 37.7 37.7 37.7 $0.73 $0.73 51.7 35.9% 42.3% 43.2% 39.4% 74.2% 6.3% 9.4% 0.3%

185

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

North America Equity Research 02 January 2008

Table 115: INWK Quarterly Income Statement


$ in millions, except per share data 1Q06 22.4 17.9 4.5 20.1% (16) 0.9 2.1 0.1 3.1 1.4 6.1% 161 1.5 0.1 (0.1) (0.0) 0.0 2Q06 35.1 28.1 7.1 20.1% (94) 1.7 2.3 0.1 0.2 4.3 2.8 7.9% 180 3.1 0.1 (0.0) 0.0 0.0 FY06 3Q06 41.8 32.2 9.5 22.8% 240 2.3 3.2 0.2 0.2 5.9 3.6 8.7% 191 4.1 0.3 (0.1) (0.0) 0.2 4Q06 61.2 45.7 15.4 25.2% 573 3.9 5.8 0.3 0.5 10.4 5.1 8.3% 239 5.8 0.4 (0.0) 0.4 1Q07 58.9 44.5 14.4 24.4% 433 3.9 6.0 0.3 0.4 10.6 3.8 6.4% 34 4.5 0.6 (0.0) 0.6 FY07E 2Q07 3Q07 67.3 72.1 50.1 53.8 17.2 18.3 25.6% 25.4% 546 258 4.2 6.7 0.2 0.5 11.6 5.6 8.3% 37 6.3 0.6 (0.0) 0.1 0.7 4.0 7.6 0.2 0.6 12.5 5.8 8.1% (64) 6.7 0.6 (0.0) 0.1 0.8 4Q07E 89.7 66.5 23.2 25.9% 68 5.8 8.2 0.3 0.7 14.9 8.3 9.3% 100 9.3 0.7 (0.0) 0.1 0.8 1Q08E 95.8 71.3 24.4 25.5% 108 6.2 9.5 0.3 0.8 16.7 7.7 8.1% 166 8.8 0.5 (0.0) 0.1 0.6 FY08E 2Q08E 3Q08E 110.2 119.7 82.2 89.1 28.0 30.7 25.4% 25.6% (16) 18 6.9 10.5 0.3 0.8 18.5 9.6 8.7% 37 10.7 0.5 (0.0) 0.1 0.6 7.5 11.7 0.4 0.8 20.4 10.3 8.6% 51 11.5 0.5 (0.0) 0.1 0.6 4Q08E 146.1 108.2 37.9 25.9% 3 9.5 13.6 0.4 0.9 24.4 13.5 9.2% (2) 14.8 0.5 (0.0) 0.1 0.6

Revenue Cost of goods sold Gross profit Gross margin Y/Y Improvement (bps) Operating Expenses Commission expense General and Administrative Expense Stock-based compensation Depreciation and amortization Total operating expenses Income from operations Operating Margin Y/Y Improvement (bps) EBITDA Other income Interest income Interest expense Minority interest Other, net Total other income

Income before taxes Income tax expense Tax Rate Net income Dividends on preferred shares Net income applicable to common shareholders Pro Forma Net Income Diluted EPS Pro Forma Diluted EPS Shares outstanding % Q/Q growth Revenue EBITDA Operating income
186

1.4 (0.6) 41.4% 0.8 0.8 0.8 $0.02 $0.02 33.1 0.9% 5.2% 4.6%

2.8 (1.1) 39.2% 1.7 1.7 1.7 $0.05 $0.05 33.1 56.6% 104.1% 104.0%

3.9 (1.5) 39.1% 2.4 2.4 2.4 $0.05 $0.05 43.6 18.9% 32.2% 30.7%

5.5 (2.1) 38.6% 3.4 3.4 3.4 $0.07 $0.07 48.1 46.4% 41.2% 38.8%

4.3 (1.7) 38.6% 2.7 2.7 2.7 $0.05 $0.05 49.3 -3.6% -22.0% -25.1%

6.3 (2.5) 39.1% 3.8 3.8 3.8 $0.08 $0.08 50.1 14.2% 40.8% 47.6%

6.6 (2.6) 39.0% 4.0 4.0 4.0 $0.08 $0.08 50.2 7.2% 6.1% 4.3%

9.1 (3.6) 39.5% 5.5 5.5 5.5 $0.11 $0.11 50.4 24.3% 38.1% 42.5%

8.4 (3.2) 38.6% 5.1 5.1 5.1 $0.10 $0.10 50.6 6.8% -5.2% -6.7%

10.2 (4.0) 39.0% 6.2 6.2 6.2 $0.12 $0.12 50.8 15.0% 21.5% 23.4%

10.9 (4.3) 39.0% 6.7 6.7 6.7 $0.13 $0.13 51.0 8.7% 7.4% 7.6%

14.1 (5.5) 39.0% 8.6 8.6 8.6 $0.17 $0.17 51.2 22.0% 29.1% 31.4%

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

North America Equity Research 02 January 2008

EPS % Y/Y growth Revenue EBITDA Operating income EPS % of Revenue COGS Commission expense General and Administrative Stock Based compensation
Source: Company reports and JPMorgan estimates.

80.6% 127.4% 145.9%

87.5% 141.7% 142.5%

78.1% 139.8% 128.2%

174.9% 300.6% 287.2%

162.7% 197.3% 177.2%

91.5% 105.1% 100.5%

72.7% 64.7% 60.0%

46.6% 61.1% 64.3%

62.5% 95.7% 104.6%

63.7% 68.8% 71.0%

66.0% 70.8% 76.3%

62.9% 59.7% 62.6%

79.9% 4.0% 9.3% 0.0%

79.9% 4.9% 6.5% 0.3%

77.2% 5.5% 7.6% 0.5%

74.8% 6.4% 9.4% 0.4%

75.6% 6.6% 10.2% 0.5%

74.4% 6.3% 9.9% 0.4%

74.6% 5.5% 10.6% 0.3%

74.1% 6.4% 9.1% 0.3%

74.5% 6.4% 9.9% 0.3%

74.6% 6.2% 9.5% 0.3%

74.4% 6.2% 9.8% 0.3%

74.1% 6.5% 9.3% 0.3%

187

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

North America Equity Research 02 January 2008

Table 116: INWK Annual Balance Sheet


$ in millions FY 2006 Assets Current Assets: Cash and cash equivalents Marketable securities Accounts receivable Unbilled revenue Inventories Prepaid expenses Advances to related parties Deferred income taxes Other current assets Total current assets Property and equipment, net Intangibles and other assets: Goodwill Intangible assets Deposits Investment Deferred income taxes Other assets Total intangibles and other assets Total assets Liabilities and stockholders' deficit/members equity Current liabilities: Accounts payable - trade Advances from related parties Due to seller Distribution payable Outstanding line of credit Current maturities of capital lease obligations Customer deposits Other liabilities Deferred revenue Accrued expenses Total current liabilities Capital lease obligations, less current maturities Mandatorily redeemable preferred stock - Class D Total liabilities Class C, Convertible redeemable preferred shares Class D, Convertible redeemable preferred shares Class E, Convertible redeemable preferred shares Stockholders' deficit/member's equity: Total stockholders' equity Total liabilities and stockholders' deficit/members' equity
Source: Company reports and JPMorgan estimates.

FY 2007E 20.6 10.0 45.0 4.7 2.1 5.5 0.1 0.3 1.3 89.5 2.8 9.7 6.5 0.2 0.1 4.5 0.0 21.2 113.5 24.0 0.2 1.6 0.1 1.9 0.8 0.2 3.0 31.8 0.2 32.1 81.5 113.5 26.2 16.0 69.7 9.8 4.3 0.1 0.8 2.0 128.8 3.6 15.6 8.0 0.2 0.1 4.1 0.0 28.1 160.5 38.2 0.6 0.1 2.3 1.2 3.5 45.9 0.2 0.0 46.1 114.4 160.5

FY 2008E 35.6 16.0 113.5 9.8 4.3 0.1 0.8 2.0 182.0 3.6 15.6 8.0 0.2 0.1 4.1 0.0 28.1 213.7 62.2 0.6 0.1 2.3 1.2 3.5 70.0 0.2 0.0 70.1 143.6 213.7

FY 2009E 61.4 16.0 148.3 9.8 4.3 0.1 0.8 2.0 242.6 3.6 15.6 8.0 0.2 0.1 4.1 0.0 28.1 274.3 81.0 0.6 0.1 2.3 1.2 3.5 88.8 0.2 0.0 88.9 185.3 274.3

188

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

North America Equity Research 02 January 2008

Table 117: INWK Annual Cash Flow Statement


$ in millions FY 2006 Cash flows from operating activities Net income Adjustments to reconcile NI to Net Cash by operating activities: Minority interest Deferred income taxes Noncash stock compensation expense Depreciation and amortization Bad debt provision Deferred financing expense Advances to related parties Change in assets: Accounts receivable Unbilled revenue Inventory Prepaid expenses and other Change in liabilities: Accounts payable Customer deposits Taxes payable Accrued expenses and other Net cash provided by operating activities Cash flows from investing activities Purchases of property and equipment Sale/(Purchase) of marketable securities Investment in Echo Purchase of customer list Purchase of Ocular Purchase of Graphography Other purchases Purchase of AppliedGraphics Net cash used in investing activities Cash flows from financing activities Net repayments of note payable, bank Repayment of memer receivable Payment of deferred financing fees Principal payments on capital lease obligations Tax benefit of stock options exercised Payments of distributions Payment of dividends on preferred shares Preference payments on preferred shares Issuance of shares Payment of issuance costs Payments for share repurchase Net cash provided by financing activities Increase in cash and cash equivalents Cash and cash equivalents, beginning of period Cash and cash equivalents, end of period FCF
Source: Company reports and JPMorgan estimates.

FY 2007E 16.0 (0.2) 1.0 2.3 0.3 0.0 (0.1) (21.2) (4.1) 0.8 10.5 0.2 (2.0) 2.8 (1.8) (5.9) (1.2) (30.2) (39.0) (0.1) 4.2 37.7 41.8 5.6 20.6 26.2 1.0

FY 2008E 26.6 (0.5) 1.4 3.3 0.3 0.0 (43.8) 24.0 11.3 (1.8) (1.8) (0.1) (0.1) 9.4 26.2 35.6 9.5

FY 2009E 37.7 (0.5) 2.1 4.3 0.3 0.0 (34.8) 18.8 27.8 (2.0) (2.0) (0.1) (0.1) 25.8 35.6 61.4 25.8

8.3 0.9 0.6 1.0 0.3 0.0 0.2 (21.7) (1.2) (1.2) 4.5 (2.9) 0.4 1.5 (9.7) (1.4) (10.0) (3.3) (0.3) (7.2) (22.1) (7.0) (0.1) 0.4 (3.3) (1.6) (5.5) 109.1 (2.6) (40.0) 49.5 17.7 3.0 20.6 (11.1)

189

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

North America Equity Research 02 January 2008

Liberty Interactive, Neutral ($19.79)


We are maintaining our Neutral rating on the Liberty Interactive tracking stock because we believe that the company will face challenging growth in F08 as the domestic arm of QVC faces a difficult retail environment in a tightening economy and as turnaround efforts at QVC Germany may last longer. Additionally, we note that QVC Japan will not completely comp health and beauty declines until 4Q'08. Domestic QVC growth slowing amongst increased competition and a tightening economy. We are modeling F08 Y/Y growth of 3% following F'07E's growth of 4%. We are concerned with recent domestic performance weakness due to slowing consumer spending and see this continuing as the consumer weathers the sub-prime lending fallout. We also believe that competition for nationally branded merchandise has become stiffer with HSNs re-merchandising strategy and that this may further pressure margins. We believe intl expansion efforts will be put on hold until current problems are addressed. At the beginning of 2007, the int'l markets could not have looked brighter with QVC Japan revenues growing 20% Y/Y in F'06, total int'l revenue growth of 12%, and the company positioning itself for entry into the China market. However, this year we expect F08 int'l revenue growth of only 1% as the company struggles to perfect its merchandising strategy in Germany and as Japan health and beauty sales (~21% of business a year ago) plummet due to increased regulatory scrutiny. We now think that the company will put further expansion efforts on hold until these weaknesses are addressed. QVC margin pressure likely. We expect intl margins to continue to be pressured as investments are made to drive the Germany and Japan turnarounds. Furthermore, we believe domestic margins might be pressured due to possible inventory buildup in the slowing sales economy and pricing pressure from increased HSN competition. As such, we are modeling F08 QVC operating cash flow margins as remaining roughly flat with F07E's depressed levels. 2008 Drivers. In our view, the following factors will drive LINTA shares in 2008: (1) clearance of old inventory in Germany, (2) comping Japan health and beauty losses, and (3) improved US economic conditions. Maintaining 4Q'07 estimates. We maintain our 4Q07 revenue, EBITDA, and EPS estimates of $2.40B, $569M, and $0.32 (Y/Y growth of 3.8%, 0.7%, and (26%) respectively). Our current and newly introduced 2009 estimates are in the table below:
Table 118: Liberty Interactive Financial Snapshot
$ in millions, except per share data Liberty Interactive JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07E 2,398.82 569.09 0.32 2,417.00 575.00 0.30 F'07E 7,720.82 1,707.09 0.74 7,734.00 1,667.00 0.72 F'08E 8,094.31 1,765.73 0.80 8,156.00 1,775.00 0.79 F'09E 8,583.14 1,871.07 0.89 8,727.00 1,952.00 1.02 F'07E Y/Y 5.39% 1.61% 0.91% F'08E Y/Y 4.84% 3.43% 8.57% 5.46% 6.48% 9.72% F'09E Y/Y 6.04% 5.97% 11.52% 7.00% 9.97% 29.11%

Source: JPMorgan estimates, Company data, and Factset 190

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


We are maintaining our F08 revenue estimate of $8.09B and our full year EBITDA estimate of $1.77B, representing Y/Y revenue and EBITDA growth of 5% and 3%, respectively. Domestically, we believe that the tightening economic conditions we currently see will persist into F08. JPMorgans most recent US economic outlook calls for only an average real GDP growth (SAAR) of 2% in 1H08. As a result of this, we see consumer discretionary spending tightening up. During the 3Q conference call, Liberty Media management noted that domestic QVC sales grew only 2% Y/Y vs. 6% growth in 1H'07 due to a difficult retail environment.
Table 119: JPMorgan US Economic Outlook
percent Economic Outlook Real GDP IP CPI PPI
Source: JPMorgan economic analysis

%ch saar %oya %ch saar %oya %ch saar %oya %oya

07Q2 3.8 1.9 4.3 1.9 6.0 2.7 3.4

07Q3 4.9 2.8 4.1 1.9 1.9 2.4 3.5

07Q4 0.5 2.4 1.5 2.7 4.1 3.9 5.0

08Q1 1.5 2.7 2.0 3.0 3.2 3.8 3.8

08Q2 2.5 2.3 3.0 2.7 1.6 2.7 1.8

08Q3 3.5 2.0 4.0 2.6 1.9 2.7 1.9

08Q4 3.0 2.6 3.0 3.0 2.4 2.3 1.6

We also see domestic growth pressured by increased competition from HSN. With HSNs new management team in place and inventory levels more under control, we believe that their focus has shifted to better merchandising and growing nationally branded product offerings. This could lead to increased competition between HSN and QVC for the same brands and could pressure margins. As a result, we are now modeling F08 Y/Y growth of 3% following F'07E's growth of 4%. International weakness is expected to persist into F08. In F07, QVC Germany sales were hurt by efforts to reduce reliance on a small number of core brands that had been over rotated, and ASPs and margins were impacted by markdowns needed to clear underperforming inventory. QVC Japan saw sales growth plummet in F07 as health and beauty regulatory changes had the health product category fall from 21% of the business a year ago to less than 9% this year. Offsetting this, other product categories are experiencing growth in the 20-40% range. However, we now believe that the impact of regulatory changes will not be comped until 4Q08. As we believe regulatory and operational problems will persist longer than expected, we are now modeling QVC international revenue growth of only 1.3% in F08.

Our Estimates and Outlook for 2009


We are introducing F09 revenue, EBITDA, and EPS estimates of $8.58B, $1.87B, and $0.89, which represents Y/Y growth of 6%, 6%, and 12%, respectively. We believe that much of the revenue growth will be driven by international markets where Germany and Japan will see easing comps given their expected weakness in F08. We believe that QVC Japan will continue to post strong growth as product lines outside of health and beauty have not shown any weakness.

191

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

North America Equity Research 02 January 2008

Valuation and Rating Analysis


LINTA is trading at a 10x EV/EBITDA multiple on our F08 EBITDA estimate of $1.77B, which is a discount to the peer group average of 19x EBITDA in F08E. Given that we expect F08 EBITDA growth of only 3% vs. the peer group average of 36%, we believe that this discount is justified and that the stock will trade in line with its peers.

Risks to Our Rating


QVC could outperform our estimates if German operational difficulties are turned around faster than expected, the Japan regulatory environment shifts, or domestic economic conditions recover. Outperformance might also occur if strategic acquisitions are made in the e-commerce space. QVC growth could slow if increased competition from HSN and Shop NBC decreases domestic market share, weakness in jewelry persists, or if increased programming costs hinder margin growth. Furthermore, QVC Japan could encounter additional difficulties if more product lines come under regulatory scrutiny.

192

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

North America Equity Research 02 January 2008

Table 120: LINTA Annual Income Statement


$ in millions, except per share data FY-06 Net Sales QVC Other Total Sales Cost of Sales QVC Other Total Cost of Sales Gross Profit Gross Margin Operating Costs Operating Expenses SG&A Expenses Stock Based Compensation Depreciation and Amortization Total Operating Cost & Expenses Total Operating Expenses (less Cost of Sales) Operating Cash Flow QVC Other Total Operating Cash Flow Operating Margin Leverage Operating Income (Loss) QVC Other Total Operating Income (Loss) Operating Margin Other Income : Interest Expense Dividend and interest income Share of earnings of affiliates Realized and Unrealized gains on derivative instruments net Gains losses on other instruments, net Other,net Total Other Income Earnings from continuing operations before income tax and minority interests Income Tax Expense Tax Rate Minority Interests in earnings of subsidiaries Cumulative effect of accounting change, net of taxes EBITDA GAAP Net Earnings Pro Forma Net Earnings Net Margin GAAP Earnings Per Share Basic Diluted Pro Forma Earnings Per Share Basic Diluted Shares Outstanding Basic 7,074.00 252.00 7,326.00 4,426.04 138.96 4,565.00 2,761.00 37.7% 596.00 485.00 59.00 491.00 6,196.00 1,631.00 1,656.00 24.00 1,680.00 22.9% 3.23 1,130.00 0.00 1,130.00 15.4% (417.00) 40.00 47.00 20.00 0.00 23.00 (287.00) 843.00 (210.00) 24.9% (35.00) 0.00 1,680.00 511.00 598.00 8.2% 0.73 0.73 0.89 0.89 670.00 FY-07E 7,351.41 369.41 7,720.82 4,635.34 224.33 4,859.67 2,861.14 37.1% 624.71 529.34 52.99 534.27 6,600.98 1,741.31 1,675.25 31.85 1,707.09 22.1% 3.72 1,112.10 7.74 1,119.84 14.5% (449.02) 46.00 80.00 2.00 12.00 12.00 (297.02) 822.82 (330.33) 40.1% (26.00) 1,707.09 0.22 466.49 466.49 6.0% 0.74 0.74 0.73 0.73 637.03 FY-08E 7,540.19 554.12 8,094.31 4,753.04 365.72 5,118.75 2,975.55 36.8% 654.78 555.05 73.58 549.10 6,951.26 1,832.50 1,730.23 35.50 1,765.73 21.8% 3.62 1,105.73 37.32 1,143.05 14.1% (436.08) 49.00 55.00 8.00 0.00 16.00 (308.08) 834.96 (333.99) 40.0% (24.00) 1,765.73 0.22 476.98 476.98 5.9% 0.80 0.80 0.80 0.80 597.50 FY-09E 7,862.79 720.35 8,583.14 4,960.99 482.64 5,443.63 3,139.51 36.6% 687.71 580.73 78.01 572.58 7,362.66 1,919.03 1,794.55 76.52 1,871.07 21.8% 3.02 1,143.34 77.15 1,220.49 14.2% (436.08) 52.00 55.00 8.00 0.00 16.00 (305.08) 915.40 (366.16) 40.0% (24.00) 1,871.07 0.22 525.24 525.24 6.1% 0.89 0.89 0.89 0.89 590.00
193

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

North America Equity Research 02 January 2008

Diluted As a % of Net Sales Other Cost of Sales Cost of Sales Operating Expenses SG&A Expenses Y/Y Change Net Sales QVC Sales Other Sales Cost of Sales SG&A Expenses Depreciation and Amortization Stock Based Compensation Operating Cash Flow Operating Income
Source: Company reports and JPMorgan estimates.

FY-06 670.00 62.3% 8.1% 6.6% 12.7% 8.8% 11.0% 20.6% 844.2% -86.9% 18.7% 23.4%

FY-07E 638.28 62.9% 8.1% 6.9% 5.4% 3.9% 46.6% 6.5% 9.1% 8.8% -10.2% 1.6% -0.9%

FY-08E 597.50 63.2% 8.1% 6.9% 4.8% 2.6% 50.0% 5.3% 4.9% 2.8% 38.9% 3.4% 2.1%

FY-09E 590.00 63.4% 8.0% 6.8% 6.0% 4.3% 30.0% 6.3% 4.6% 4.3% 6.0% 6.0% 6.8%

194

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

North America Equity Research 02 January 2008

Table 121: LINTA Quarterly Income Statement


$ in millions, except per share data 31-Mar Q1-06A Net Sales QVC Other Total Sales Cost of Sales QVC Other Total Cost of Sales Gross Profit Gross Margin Operating Costs Operating Expenses SG&A Expenses Stock Based Compensation Depreciation and Amortization Total Operating Cost & Expenses Total Operating Expenses (less Cost of Sales) Operating Cash Flow QVC Other Total Operating Cash Flow Operating Margin Leverage Operating Income (Loss) QVC Other Total Operating Income (Loss) Operating Margin Other Income : Interest Expense Dividend and interest income Share of earnings of affiliates Realized and Unrealized gains on derivative instruments net Gains losses on other instruments, net Other,net Total Other Income 1,555.00 53.00 1,608.00 971.71 28.29 1,000.00 608.00 37.8% 132.00 111.00 27.00 120.00 1,390.00 390.00 355.00 10.00 365.00 22.7% 212.00 6.00 218.00 13.6% (93.00) 9.00 4.00 20.00 0.00 1.00 (59.00) FY-2006 30-Jun 30-Sep Q2-06A Q3-06A 1,630.00 85.00 1,715.00 1,006.68 47.32 1,054.00 661.00 38.5% 141.00 135.00 17.00 125.00 1,472.00 418.00 378.00 7.00 385.00 22.4% 242.00 1.00 243.00 14.2% (97.00) 10.00 17.00 (3.00) 0.00 12.00 (61.00) 1,653.00 40.00 1,693.00 1,040.39 22.61 1,063.00 630.00 37.2% 142.00 123.00 -7.00 122.00 1,443.00 380.00 366.00 (1.00) 365.00 21.6% 257.00 (7.00) 250.00 14.8% (108.00) 10.00 8.00 5.00 0.00 2.00 (83.00) 31-Dec Q4-06 2,236.00 74.00 2,310.00 1,407.27 40.73 1,448.00 862.00 37.3% 181.00 116.00 22.00 124.00 1,891.00 443.00 557.00 8.00 565.00 24.5% 419.00 0.00 419.00 18.1% (119.00) 11.00 18.00 (2.00) 0.00 8.00 (84.00) 31-Mar Q1-07 1,684.59 86.41 1,771.00 1,060.57 49.43 1,110.00 661.00 37.3% 144.00 135.00 13.00 125.00 1,527.00 417.00 374.00 8.00 382.00 21.6% 243.00 1.00 244.00 13.8% (114.00) 11.00 15.00 2.00 0.00 0.00 (86.00) FY-2007E 30-Jun 30-Sep Q2-07 Q3-07 1,693.00 98.00 1,791.00 1,056.94 55.06 1,112.00 679.00 37.9% 148.00 138.00 9.00 137.00 1,544.00 432.00 383.00 10.00 393.00 21.9% 244.00 3.00 247.00 13.8% (105.00) 12.00 24.00 (4.00) 12.00 4.00 (57.00) 1,686.00 74.00 1,760.00 1,068.41 46.59 1,115.00 645.00 36.6% 148.00 134.00 7.00 135.00 1,539.00 424.00 364.00 (1.00) 363.00 20.6% 231.00 (10.00) 221.00 12.6% (121.00) 11.00 22.00 2.00 0.00 4.00 (82.00) 31-Dec Q4-07E 2,287.82 111.00 2,398.82 1,449.41 73.26 1,522.67 876.14 36.5% 184.71 122.34 23.99 137.27 1,990.98 468.31 554.25 14.85 569.09 23.7% 394.10 13.74 407.84 17.0% (109.02) 12.00 19.00 2.00 0.00 4.00 (72.02) 31-Mar Q1-08E 1,728.45 129.62 1,858.07 1,089.77 85.55 1,175.31 682.76 36.7% 152.36 141.21 18.58 136.55 1,624.02 448.70 382.43 6.75 389.18 20.9% 228.60 5.46 234.05 12.6% (109.02) 12.00 6.00 2.00 0.00 4.00 (85.02) FY-2008E 30-Jun 30-Sep Q2-08E Q3-08E 1,721.94 147.00 1,868.94 1,076.51 97.02 1,173.53 695.41 37.2% 153.25 145.78 18.69 136.03 1,627.29 453.75 389.98 6.40 396.38 21.2% 236.72 4.93 241.66 12.9% (109.02) 12.00 19.00 2.00 0.00 4.00 (72.02) 1,729.39 111.00 1,840.39 1,095.91 73.26 1,169.17 671.21 36.5% 154.59 141.71 11.04 134.89 1,611.41 442.24 380.34 (5.43) 374.91 20.4% 228.16 0.82 228.98 12.4% (109.02) 12.00 10.00 2.00 0.00 4.00 (81.02) 31-Dec Q4-08E 2,360.41 166.50 2,526.91 1,490.84 109.89 1,600.73 926.17 36.7% 194.57 126.35 25.27 141.62 2,088.55 487.81 577.48 27.77 605.26 24.0% 412.25 26.11 438.36 17.3% (109.02) 13.00 20.00 2.00 0.00 4.00 (70.02)

195

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

North America Equity Research 02 January 2008

Earnings from continuing operations before income tax and minority interests Income Tax Expense Tax Rate Minority Interests in earnings of subsidiaries Cumulative effect of accounting change, net of taxes EBITDA GAAP Net Earnings Pro Forma Net Earnings Net Margin GAAP Earnings Per Share Basic Diluted Pro Forma Earnings Per Share Basic Diluted Shares Outstanding Basic Diluted As a % of Net Sales Other Cost of Sales Cost of Sales Operating Expenses SG&A Expenses Y/Y Change Net Sales QVC Sales Other Sales Cost of Sales SG&A Expenses Depreciation and Amortization Stock Based Compensation Operating Cash Flow Operating Income
Source: Company reports and JPMorgan estimates.

31-Mar Q1-06A 159.00 (76.00) 47.8% (8.00) 365.00 (11.00) 75.00 4.7% 0.00 0.00 0.11 0.11 703.000 703.000 53.4% 62.2% 8.2% 6.9% 9.8% 6.2% 9.4% 10.4% 823.1% -75.9% 14.6% 9.6%

FY-2006 30-Jun 30-Sep Q2-06A Q3-06A 182.00 167.00 (46.00) 25.3% (10.00) 385.00 125.00 126.00 7.3% 0.13 0.13 0.18 0.18 687.30 687.30 55.7% 61.5% 8.2% 7.9% 16.0% 10.2% 14.2% 34.3% 861.5% -84.9% 18.6% 26.6% (45.00) 26.9% (8.00) 365.00 114.00 114.00 6.7% 0.17 0.17 0.17 0.17 671.00 671.00 56.5% 62.8% 8.4% 7.3% 14.8% 12.1% 12.9% 22.4% 838.5% -106.2% 21.0% 40.5%

31-Dec Q4-06 335.00 (43.00) 12.8% (9.00) 565.00 283.00 283.00 12.3% 0.43 0.43 0.43 0.43 660.00 660.00 55.0% 62.7% 7.8% 5.0% 10.9% 7.3% 8.5% 15.4% 853.8% -80.4% 19.9% 20.7%

31-Mar Q1-07 158.00 (60.00) 38.0% (7.00) 382.00 91.00 91.00 5.1% 0.14 0.14 0.14 0.14 652.10 652.10 57.2% 62.7% 8.1% 7.6% 10.1% 8.3% 63.0% 11.0% 21.6% 4.2% -51.9% 4.7% 11.9%

FY-2007E 30-Jun 30-Sep Q2-07 Q3-07 190.00 139.00 (81.00) 42.6% (7.00) 393.00 102.00 102.00 5.7% 0.16 0.16 0.16 0.16 648.00 652.00 56.2% 62.1% 8.3% 7.7% 4.4% 3.9% 15.3% 5.5% 2.2% 9.6% -47.1% 2.1% 1.6% (55.00) 39.6% (6.00) 363.00 78.00 78.00 4.4% 0.12 0.12 0.12 0.12 628.00 629.00 63.0% 63.4% 8.4% 7.6% 4.0% 2.0% 85.0% 4.9% 8.9% 10.7% -200.0% -0.5% -11.6%

31-Dec Q4-07E 335.82 (134.33) 40.0% (6.00) 569.09 195.49 195.49 8.1% 0.32 0.32 0.32 0.32 620.00 620.00 66.0% 63.5% 7.7% 5.1% 3.8% 2.3% 50.0% 5.2% 5.5% 10.7% 9.0% 0.7% -2.7%

31-Mar Q1-08E 149.03 (59.61) 40.0% (6.00) 389.18 83.42 83.42 4.5% 0.14 0.14 0.14 0.14 610.00 610.00 66.0% 63.3% 8.2% 7.6% 4.9% 2.6% 50.0% 5.9% 4.6% 9.2% 42.9% 1.9% -4.1%

FY-2008E 30-Jun 30-Sep Q2-08E Q3-08E 169.64 147.96 (67.85) 40.0% (6.00) 396.38 95.78 95.78 5.1% 0.16 0.16 0.16 0.16 600.00 600.00 66.0% 62.8% 8.2% 7.8% 4.4% 1.7% 50.0% 5.5% 5.6% -0.7% 107.7% 0.9% -2.2% (59.18) 40.0% (6.00) 374.91 82.77 82.77 4.5% 0.14 0.14 0.14 0.14 590.00 590.00 66.0% 63.5% 8.4% 7.7% 4.6% 2.6% 50.0% 4.9% 5.8% -0.1% 57.7% 3.3% 3.6%

31-Dec Q4-08E 368.34 (147.34) 40.0% (6.00) 605.26 215.00 215.00 8.5% 0.36 0.36 0.36 0.36 590.00 590.00 66.0% 63.3% 7.7% 5.0% 5.3% 3.2% 50.0% 5.1% 3.3% 3.2% 5.3% 6.4% 7.5%

196

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

North America Equity Research 02 January 2008

Table 122: LINTA Annual Balance Sheet


$ in millions FY-06 FY-07E FY-08E FY-09E

Assets Current Assets : Cash and cash equivalents Trade and other recievables Inventory, net Derivative instruments Current deferred tax asset Other current assets Total current assets Working Capital Current Assets Investments in available-for-sale-securities and other cost investments Long term derivative instruments Investments in affiliates, accounted for using equity method Property and equipment, net Goodwill Trademarks Intangible assets subject to amortization, net Other assets (at cost) net of accumulated amortization Assets of discontinued operations Total assets Liabilities and Equity Current Liabilities : Accounts payable Accrued liabilities Intergroup payable receivable Accrued stock compensation Derivative instruments Current portion of long term debt Current deferred tax liabilities Other current liabilities Total current liabilities Long-term debt Long-term derivative instruments Deferred income tax liabilities Other liabilities Liabilities of discontinued operations Total liabilities Minority interests in equity of subsidiaries Equity attributed net assets Total liabilities and equity
Source: Company reports and JPMorgan estimates.

946.0 977.0 831.0 12.0 159.0 59.0 2,984.0 2,038.0 2,572.0 2.0 1,358.0 912.0 5,755.0 2,450.0 3,756.0 31.0 0.0 19,820.0

797.8 1,127.4 863.6 0.0 124.0 76.3 2,989.1 2,191.3 2,300.0 18.0 1,312.0 1,110.9 5,854.0 2,470.0 3,484.9 44.0 0.0 19,582.9

956.4 1,162.4 833.9 0.0 124.0 80.4 3,157.1 2,200.7 2,300.0 18.0 1,312.0 1,350.3 5,854.0 2,470.0 3,214.3 44.0 0.0 19,719.7

1,691.6 1,231.8 883.7 0.0 124.0 85.2 4,016.4 2,200.8 2,300.0 18.0 1,312.0 1,641.3 5,854.0 2,470.0 2,964.8 44.0 0.0 20,620.5

475.0 136.0 663.0 81.0 0.0 11.0 0.0 91.0 1,457.0 6,372.0 9.0 3,115.0 210.0 0.0 11,163.0 96.0 8,561.0 19,820.0

502.5 609.1 121.8 0.0 5.0 24.0 0.0 25.0 1,287.4 7,143.0 29.0 2,790.0 268.0 0.0 11,517.4 96.0 7,969.5 19,582.9

528.2 640.3 121.8 0.0 5.0 24.0 0.0 25.0 1,344.4 7,343.0 29.0 2,790.0 268.0 0.0 11,774.4 96.0 7,849.4 19,719.7

561.6 851.0 121.8 0.0 5.0 24.0 0.0 25.0 1,588.4 7,343.0 29.0 2,790.0 268.0 0.0 12,018.4 96.0 8,506.1 20,620.5

197

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

North America Equity Research 02 January 2008

Table 123: LINTA Annual Cash Flow Statement


$ in millions LINT Cash Flow in millions FY-06 Cash Flow From Operating Activities Net Earnings (loss) Adjustments to reconcile net earnings (loss) to net cash provided by operating activities : Cumulative effect of accounting change Depreciation and amortization Stock based compensation Payments of stock based compensation Noncash interest expense Share of losses (earnings) of affiliates, net Realized and unrealized losses( gains) of financial instruments, net Losses (gains) on disposition of assets, net Minority interests in earnings (losses) of subsidiaries Intergroup transfers Deferred income tax benefit Other non cash charges (credits), net Changes in operating assets and liabilities, net of the effects of acquisitions : Current Assets Inventory Accounts Receivable Current Liabilities Accounts Payable Accrued Liabilities Implied cash from operating activities Adjustment Net cash from operating activities Cash Flow from Investing Activities: Cash proceeds from dispositions Net proceeds from settlement of derivatives Capital expended for property and equipment Net purchases of short term investments Cash paid for acquisitions, net cash acquired Investment in and loans to cost and equity investees Other investing activities, net Repurchases of subsidiary common stock Net cash provided (used) by investing activities Cash Flow from Financing Activities : Borrowing of debt Repayments of debt Repurchase of Liberty common stock Intergroup cash transfers, net Repurchases of subsidiary common stock Other financing activities, net Net cash used by financing activities Effect of foreign currency rates on cash Net increase in cash and cash equivalents Cash and Cash equivalents at the beginning of year Cash and Cash equivalents at end of year
Source: Company reports and JPMorgan estimates.

FY-07E 466.5 0.0 534.3 53.0 (35.0) 5.0 (80.0) (2.0) (12.0) 26.0 (263.0) (162.0) (8.0) 0.0 0.0 0.0 0.0 0.0 0.0 578.7 0.0 578.7 12.0 0.0 (336.0) 0.0 (120.0) (11.0) (29.0) 0.0 (484.0) 960.0 (187.0) (1,021.0) 0.0 0.0 (5.0) (253.0) 10.0 (148.2) 946.0 797.8

FY-08E 477.0 0.0 549.1 73.6 0.0 3.0 (55.0) (8.0) 0.0 24.0 0.0 (223.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 888.3 0.0 888.3 0.0 0.0 (309.7) 0.0 0.0 0.0 (20.0) 0.0 (329.7) 200.0 0.0 (600.0) 0.0 0.0 0.0 (400.0) 0.0 158.6 797.8 956.4

FY-09E 525.2 0.0 572.6 78.0 0.0 3.0 (55.0) (8.0) 0.0 24.0 0.0 (223.0) 0.0 (124.1) 0.0 0.0 244.1 0.0 0.0 1,036.8 0.0 1,036.8 0.0 0.0 (281.6) 0.0 0.0 0.0 (20.0) 0.0 (301.6) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 735.2 956.4 1,092.1

511.0 87.0 491.0 59.0 (111.0) 4.0 (47.0) (20.0) 0.0 35.0 (262.0) (13.0) 89.0 (18.0) 107.0 13.0 (60.0) 73.0 553.0 0.0 553.0 0.0 0.0 (259.0) 23.0 (436.0) (5.0) (8.0) (331.0) (1,016.0) 3,227.0 (2,188.0) (954.0) 293.0 0.0 68.0 446.0 18.0 1.0 945.0 946.0

198

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

North America Equity Research 02 January 2008

Mercadolibre, Overweight ($72.85)


We believe that the rollout of the new payment system and improving take rates will continue to drive strong growth in 2008 and 2009. We are forecasting growth in both the marketplace and payments take rate, acceleration in high-margin advertising and classified revenues, which positively impact the marketplace take rate, and growth in total payment volume. Despite the fact that Mercadolibre trades at a premium to its peers, we continue to believe the secular Latin America e-commerce growth story remains intact and Mercadolibre is well positioned to take advantage of this trend. As such, we reiterate our Overweight rating. Improving take rates and strong GMV growth should drive Marketplace revenues. E-commerce growth in Latin America is expected to remain strong in 2008 and 2009 as broadband penetration and comfort with online transactions continue to improve. We expect Mercadolibre to continue to maintain market share and are forecasting GMV growth of 42% in 2008 and 31% in 2009. We expect the take rate to improve to 5.1% in 2008 and 5.8% in 2009, up from 4.6% in 2007, as the company continues to optimize its fee structure and non-GMV revenue grows faster than GMV. As a result, we are estimating Marketplace revenue Y/Y growth of 58.3% in 2008 and 47.8% in 2009. Rollout of direct payment version of MercadoPago should drive Payments growth. Mercadolibre finished the rollout of the new direct payment version of MercadoPago in Chili and Columbia and we expect the new system is to be implemented through all of Mercadolibre's markets by the end of 2008. We expect both the Marketplace, where the system is expected to spur increased transaction growth, and the Payments segment to benefit from the rollout. We are modeling TPV growth of 66% in 2008 and 38% in 2009 and a take rate of 9% in both 2008 and 2009, lower than the 9.5% in 2007. As a result, we are estimating Payments revenue Y/Y growth 58.1% in 2008 and 38.9% in 2009. Increasing scale and higher-margin advertising and classifieds sales should lead to improving margins. With a significant portion of its costs fixed and no requirements to stock merchandise, we expect Mercadolibre to continue to benefit from increasing scale. In addition, we expect growth in high-margin advertising and classified sales to help offset growth in lowermargin payments revenue. As a result, we are estimating a 2008 EBITDA margin improvement of ~380bps and a 2009 EBITDA margin improvement of ~290bps. 2008 Drivers. In our view, the following factors will drive Mercadolibre shares in 2008: (1) strong Latin America e-commerce growth, (2) the rollout of the new MercadoPago system across the marketplace platform and to third-party sellers, (3) take rate improvement in the marketplace, and (4) the continued success of high-margin deferred payment plans. Maintaining 4Q estimates. We are maintaining our 4Q07 revenue, EBITDA, and EPS estimates of $26.2M, $8.6M, and $0.11 (Y/Y growth of
199

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

North America Equity Research 02 January 2008

69.8%, 237.3%, and 0% respectively). For 2007, we are modeling revenue, EBITDA, and EPS growth of 62.3%, 223.3%, and 820.4%, respectively. The table below outlines our current estimates:
Table 124: Mercadolibre Estimate Highlights
$ in millions Mercadolibre JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07 26.2 8.6 0.11 27.0 8.0 0.10 F'07 84.5 23.9 0.21 85.1 22.8 0.21 F'08 133.7 42.9 0.58 131.3 39.7 0.53 F'09 195.5 68.4 0.86 185.8 61.4 0.82 F'07 Y/Y 62.3% 223.3% 820.5% 63.5% 207.8% 839.5% F'08 Y/Y 58.3% 79.3% 180.7% 54.3% 74.1% 152.4% F'09 Y/Y 46.2% 59.2% 49.0% 41.5% 54.7% 54.7%

Source: Company reports, FactSet, and JPMorgan estimates.

Key Financial Metrics & Forecasts


The following tables summarize our revenue forecast by business segment and our estimates for Y/Y growth in the marketplace and payments segments through 2009.
Table 125: Mercadolibre Marketplace Forecasts
US$ in Millions, unless otherwise noted Gross Merchandise Volume (GMV) % Change Y-Y Take Rate Marketplace Revenues GMV per successful item (US$) Revenue per successful item (US$) Successful items sold (millions)
Source: Company reports and JPMorgan estimates

2006 1,075.1 76.9% 4.2% 44.7 77.9 3.24 13.8

2007E 1,508.2 40.3% 4.6% 69.7 84.1 3.89 17.9

2008E 2,147.9 42.4% 5.1% 110.4 92.8 4.77 23.1

2009E 2,818.3 31.2% 5.8% 163.1 97.7 5.66 28.8

Table 126: MercadoPago Operating Metrics


US$ in Millions, unless otherwise noted Total Payment Volume (TPV) % Change Y-Y % of GMV Take Rate Payments Revenues
Source: Company reports and JPMorgan estimates

2006 89.0 131.2% 8.3% 8.2% 7.3

2007E 155.7 74.9% 10.3% 9.5% 14.7

2008E 258.7 66.2% 12.0% 9.0% 23.3

2009E 358.1 38.4% 12.7% 9.0% 32.3

200

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


Our 2008 estimates call for Y/Y revenue, EBITDA, and earnings growth of 58.3%, 79.3%, and 180.7% respectively. Specifically, we are modeling 2008 revenues, EBITDA, and EPS of $133.7M, $42.9M and $0.58, respectively. We are modeling 42.4% growth in marketplace GMV for 2008, with 10.4% growth in GMV per successful item and 29% growth in successful items sold. We expect marketplace take rates to increase throughout the year and we are modeling a take rate of 5.1% for the year. On the payments side, we are forecasting 66.2% growth in TPV and a decline in payments take rate to 9%, as the use of MercadoPago begins to accelerate growth beyond the deferred payments platform. Additionally, we are forecasting 58.3% growth in payments revenue for 2008.

Our Estimates and Outlook for 2009


We are maintaining our 2009 estimates, calling for revenue, EBITDA, and earnings growth of 46.2%, 59.2%, and 49.0%, respectively. Specifically, we are modeling 2009 revenues, EBITDA and EPS of $195.5M, $68.4M, and $0.86. We are modeling 31.2% growth in marketplace GMV for 2009. Consistent with our expectations for 2008, we expect take rates to improve throughout the year as MELI benefits from strong growth in its advertising and classifieds business. As such, we are modeling a take rate of 5.8%, up from 5.1% in F08. On the payments side, we are forecasting 38.4% growth in TPV. We expect payments to continue to benefit from high take rates and are forecasting a payments take rate of 9.0% in F09. Additionally, we are forecasting 38.9% growth in payments revenue for 2009.

Valuation and Rating Analysis


On an EV/EBITDA basis, MELI trades at 73.9x our F08 estimate of $42.9M, vs. our peer group at 44.8x, and 46.3x our F'09 estimate of $68.4, vs. our peer group at 29.5x. Given MELIs strong EBITDA growth prospects, 79% EBITDA growth in F'08 vs. the peer group at 66% and 59% EBITDA growth in F09 vs. the peer group at 33%, as well as strong free cash flow generation (60% EBITDA conversion in F08), we believe such a premium is warranted.

Risks to Our Rating


We believe there are four primary risks to our Overweight rating on Mercadolibre: Economic conditions: While economic conditions recently have been healthy in many Latin American markets, in particular Mercadolibre's core markets, the region has a history of economic turmoil and financial crises. An economic slowdown, brought on by regional or global economic weakness, or an economic upheaval, could negatively impact our estimates for e-commerce growth in the region and therefore growth for Mercadolibre. Political environment and sovereign issues: Mercadolibre operates in many countries with a history of political instability. Political instability could affect customers confidence and therefore their willingness to purchase goods online. In addition, governments may limit Internet or
201

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

North America Equity Research 02 January 2008

commerce activities. We believe that Mercadolibres close work with local governments to monitor sales practices and the ability to track cash flows with MercadoPago mitigate some of this risk. Expansion plans could stress resources: Mercadolibre has grown through a number of acquisitions since its inception in 1999. As MELI looks to grow into new product offerings and markets, it may look to acquire other companies or be forced to spend substantial cash to develop its own products. Either event could stress the company's financial resources. Low cost of entry business model. Creating an online marketplace requires little capital, since the owner does not need to stock merchandise and fulfill orders. In addition, if Latin American e-commerce growth proves to be as attractive as some projections estimate, it might attract the interest of larger players, such as eBay, Google and Yahoo, who have greater resources available to them than Mercadolibre. However, we believe that the first-mover advantage and marketplace scale that Mercadolibre has achieved act as barriers to entry for even deep-pocketed competitors.

202

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

North America Equity Research 02 January 2008

Table 127: MELI Annual Income Statement


$ in millions, except per share data FY 2006 Merchandise GMV Payment GMV Auction Revenues Payment Revenues Total Revenues Blended Take rate Total Cost of Sales Gross Profit Gross Margin Product & Technology Development Sales and Marketing General and Administrative Total Operating Expenses Income From Operations Operating Margin Depreciation and amortization EBITDA EBITDA Margins Y/Y Growth Interest income Interest expense Exchange gains (losses) Other income, net Other income (expense) Income Before Income Taxes Tax Rate Income/ asset tax benefit (expense) Net Income before disc. Discontinued Operations Cumulative effect change in account. princ. Net income (loss) Add back non-cash effect of warrants Pro forma Net Income Accredition of preferred stock Net income (loss) available to common Pro Forma Net Income to common Net Attributable to preferred Net income ex. attributable to preferred EPS ex. Attributable to preferred Pro Forma EPS Sharecount
Source: Company reports and JPMorgan estimates.

FY 2007E 1,508.2 155.7 69.7 14.7 84.5 5.1% 18.4 66.1 78.3% 4.5 27.8 12.6 44.9 21.2 25.2% 2.7 23.9 28.3% 223.3% 1.5 (1.2) (2.7) (3.0) (5.5) 15.8 35.0% (6.7) 9.1 9.1 2.0 11.1 (0.3) 8.8 10.8 1.8 7.0 0.21 0.43 24.8

FY 2008E 2,147.9 258.7 110.4 23.3 133.7 5.6% 27.8 105.9 79.2% 6.1 44.3 18.0 68.4 37.6 28.1% 5.3 42.9 32.1% 79.3% 2.0 2.0 39.6 35.0% (13.9) 25.7 25.7 25.7 25.7 25.7 25.7 0.58 0.58 44.7

FY 2009E 2,818.3 358.1 163.1 32.3 195.5 6.2% 39.4 156.1 79.8% 8.9 64.7 25.9 99.5 56.6 29.0% 11.7 68.4 35.0% 59.2% 3.0 3.0 59.6 35.0% (20.8) 38.7 38.7 38.7 38.7 38.7 38.7 0.86 0.87 44.7

1,075.1 89.0 44.7 7.3 52.1 4.5% 12.1 40.0 76.8% 3.1 23.4 8.1 34.6 5.4 10.4% 2.0 7.4 14.2% 212.0% 0.5 (1.7) (0.4) (1.5) (3.1) 2.3 35.0% (1.2) 1.1 1.1 1.0 2.0 (0.5) 0.6 1.5 0.3 0.3 0.02 0.12 13.1

203

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

North America Equity Research 02 January 2008

Table 128: MELI Quarterly Income Statement


$ in millions, except per share data 1Q'06 Merchandise GMV Payment GMV Auction Revenues Payment Revenues Total Revenues Blended Take rate Total Cost of Sales Gross Profit Gross Margin Product & Technology Development Sales and Marketing General and Administrative Total Operating Expenses Income From Operations Operating Margin Depreciation and amortization EBITDA EBITDA Margins Y/Y Growth Interest income Interest expense Exchange gains (losses) Other income, net Other income (expense) Income Before Income Taxes Tax Rate Income/ asset tax benefit (expense) Net Income before disc. Discontinued Operations Cumulative effect change in account. princ. Net income (loss) Add back non-cash effect of warrants Pro forma Net Income Accredition of preferred stock Net income (loss) available to common
204

2Q'06 244.8 19.1 10.8 1.6 12.4 4.7% 2.7 9.6 77.8% 0.8 5.5 1.9 8.2 1.4 11.6% 0.5 1.9 15.7% 645.1% 0.1 (0.4) (0.2) (1.0) (1.6)

FY06

3Q'06 283.7 23.1 11.3 1.9 13.2 4.3% 3.2 10.1 76.1% 0.8 6.1 2.1 8.9 1.1 8.7% 0.5 1.7 12.5% 98.1% 0.1 (0.5) (0.1) (0.2) (0.7) 0.5 92.0% (0.4) 0.0 0.0 0.2 0.2 (0.1) (0.1)

4Q'06 328.8 30.4 13.1 2.4 15.5 4.3% 3.7 11.8 76.4% 0.8 6.7 2.2 9.8 2.0 13.1% 0.5 2.6 16.5% 44.7% 0.3 (0.5) (0.3) (0.1) (0.5) 1.5 -23.4% 0.4 1.9 1.9 0.1 1.9 (0.1) 1.7

1Q'07 312.6 26.4 14.2 2.3 16.5 4.9% 3.6 12.9 78.3% 1.0 6.3 2.7 10.0 2.9 17.7% 0.5 3.5 21.0% 175.2% 0.1 (0.4) (0.4) (0.3) (1.0) 1.9 47.1% (0.9) 1.0 1.0 0.2 1.2 (0.1) 0.9

2Q'07 343.0 31.0 16.1 2.9 19.0 5.1% 4.1 14.9 78.5% 1.0 6.3 2.8 10.2 4.7 24.9%

FY07E 3Q'07 394.9 43.6 18.1 4.7 22.8 5.2% 5.2 17.6 77.2% 1.2 7.0 3.5 11.6 6.0 26.3% 0.6 6.6 28.8% 297.7% 0.4 (0.4) (0.8) (1.0) (1.8) 4.2 33.5% (1.4) 2.8 2.8 0.6 3.4 (0.1) 2.7

4Q'07E 457.6 54.7 21.3 4.9 26.2 5.1% 5.5 20.7 79.0% 1.3 8.1 3.6 13.1 7.6 29.0% 1.0 8.6 32.8% 237.3% 0.6 (0.9) (0.3) 7.3 35.0% (2.6) 4.8 4.8 4.8 4.8

1Q'08E 425.2 46.1 20.8 4.2 25.0 5.3% 5.2 19.8 79.2% 1.2 8.5 3.7 13.4 6.4 25.6% 1.0 7.4 29.6% 114.1% 0.4 0.4 6.8 35.0% (2.4) 4.4 4.4 4.4 4.4

FY08E 2Q'08E 3Q'08E 466.8 54.2 24.3 4.9 29.2 5.6% 6.0 23.2 79.4% 1.4 9.9 4.0 15.3 7.8 26.9% 1.2 9.0 30.9% 70.0% 0.5 0.5 8.3 35.0% (2.9) 5.4 5.4 5.4 5.4 576.6 76.3 30.0 6.9 36.8 5.6% 7.8 29.0 78.8% 1.7 11.8 5.1 18.5 10.5 28.5% 1.5 12.0 32.5% 82.6% 0.5 0.5 11.0 35.0% (3.9) 7.2 7.2 7.2 7.2

4Q'08E 679.3 82.1 35.3 7.4 42.7 5.6% 8.8 34.0 79.5% 1.9 14.1 5.1 21.1 12.8 30.0% 1.7 14.5 34.0% 68.6% 0.6 0.6 13.4 35.0% (4.7) 8.7 8.7 8.7 8.7

217.8 16.5 9.6 1.4 11.0 4.7% 2.5 8.5 77.1% 0.7 5.1 1.9 7.7 0.8 7.2% 0.5 1.3 11.4% NM 0.0 (0.4) 0.1 (0.1) (0.3) 0.5 76.1% (0.4) 0.1 0.1 0.1 0.2 (0.1) (0.0)

0.6 5.3 28.0% 172.8% 0.4 (0.4) (0.6) (1.8) (2.3) 2.4 75.5% (1.8) 0.6 0.6 1.1 1.7 (0.1) 0.5

(0.1) -688.2% (0.8) (0.9) (0.9) 0.7 (0.3) (0.1) (1.0)

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

North America Equity Research 02 January 2008

Pro Forma Net Income to common Net Attributable to preferred Net income ex. attributable to preferred EPS ex. Attributable to preferred Pro Forma EPS Sharecount
Source: Company reports and JPMorgan estimates.

1Q'06 0.0 (0.0) (0.00) 0.00 13.14

2Q'06 (0.4) (1.0) (0.08) (0.03) 13.14

FY06

3Q'06 0.1 (0.1) (0.01) 0.01 13.1

4Q'06 1.8 0.3 1.5 0.11 0.12 13.4

1Q'07 1.1 0.6 0.3 0.02 0.04 13.4

2Q'07 1.6 0.3 0.2 0.01 0.09 14.0

FY07E 3Q'07 3.3 0.9 1.8 0.07 0.09 27.5

4Q'07E 4.8 4.8 0.11 0.11 44.3

1Q'08E 4.4 4.4 0.10 0.10 44.4

FY08E 2Q'08E 3Q'08E 5.4 7.2 5.4 0.12 0.12 44.5 7.2 0.16 0.16 44.6

4Q'08E 8.7 8.7 0.19 0.19 44.7

205

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

North America Equity Research 02 January 2008

Table 129: MELI Annual Balance Sheet


$ in millions FY 2006 Assets Current assets Cash and cash equivalents Short-term investments Accounts receivable Funds receivable from customers Prepaid expenses Deferred tax assets Other current assets Total Current Assets Non-current assets Long-term investments Property & equipment, net Gooodwill & intangibles, net Deferred tax assets Other assets Total Non-Current Assets Total Assets Current liabilities Accounts payable and accrued expenses Funds payable to customers Social security payable Taxes payable Loans payable Other liabilities Provisions Total Current Liabilities Non-current liabilities Loans payable Other liabilities Total non-current liabilities Total Liabilities Mandatorily Redeemable conv. preferred stock Shareholders equity Common stock Additional paid-in capital Accumulated deficit Accumulated other comprehensive income Total shareholders' equity (deficit) Total Liabilities and shareholders' equity
Source: Company reports and JPMorgan estimates.

FY 2007E

FY 2008E

FY 2009E

7.1 6.3 2.0 10.2 0.3 2.9 0.2 29.1 2.9 21.3 0.4 0.0 24.7 53.8 5.7 9.1 2.7 1.7 0.1 0.3 19.7 9.0 1.8 10.8 30.5 64.1 0.1 2.7 (44.1) 0.5 (40.7) 53.8

20.2 48.4 2.6 18.4 0.8 4.7 0.5 95.6 1.5 4.4 23.0 0.6 0.2 29.6 125.2 9.4 13.9 3.9 2.4 3.1 0.0 32.7 1.2 1.2 34.0 0.0 122.9 (35.0) 3.2 91.2 125.2

45.9 48.4 3.0 29.9 1.3 7.7 0.9 137.0 1.5 5.2 23.0 0.6 0.2 30.4 167.4 16.2 23.9 6.3 3.8 3.1 0.0 53.4 2.4 2.4 55.8 0.0 117.5 (9.3) 3.2 111.5 167.4

88.6 48.4 3.7 41.7 1.8 11.0 1.2 196.4 1.5 6.0 23.0 0.6 0.2 31.2 227.6 23.3 34.9 9.0 5.4 3.1 0.0 75.8 3.6 3.6 79.4 0.0 115.4 29.5 3.2 148.2 227.6

206

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

North America Equity Research 02 January 2008

Table 130: MELI Annual Statement of Cash Flows


$ in millions FY 2006 Cash flows from operations Net income Depreciation & amortization Interest expense (income) Realized gains on investments Unrealized gains on investments Stock-based compensation expense Cumulative effect of change in accounting Change in fair value of warrants Deferred income taxes Changes in working capital Accounts receivable Funds receivable from customers Prepaid expenses Other assets Accounts payable Funds payable to customers Provisions Other liabilities Net cash provided by operating activities FCF = Operating Cash Flow - Capex FCF, % of EBITDA Cash flows from investing activities Purchase of investments Proceeds from sale of investments Payment for purchase of DeRemate, net of cash required Purchase of intangible assets Purchase of property and equipment Net cash provided by investing activities Cash flows from financing activities Increase in short term debt Decrease in short term debt Loans received Loans paid Proceeds from stock issuance Stock options and warrants exercised Net cash provided by investing activities Effects of exchange rates on cash Cash and equivalents, beginning of year Net increase (decrease) in cash Cash and equivalents, end of year
Source: Company reports and JPMorgan estimates.

FY 2007E 9.1 2.7 (0.4) (0.2) 0.0 3.0 0.5 0.7 (0.6) (8.2) (0.5) (0.4) 4.9 4.8 (0.3) 0.9 15.5 11.3 47.2% (49.9) 6.9 (0.0) (4.2) (47.2) 3.0 (9.0) 49.6 0.8 44.4 0.4 7.1 13.1 20.2

FY 2008E 25.7 5.3 0.0 5.3 (0.4) (11.5) (0.5) (0.3) 6.8 10.0 1.2 36.4 25.7 59.9% (10.7) (10.7) 20.2 25.7 45.9

FY 2009E 38.7 11.7 (3.0) 0.0 5.9 (0.7) (11.8) (0.6) (0.4) 7.1 11.0 1.2 53.4 39.7 58.1%

1.1 2.0 0.1 (0.2) (0.0) 0.0 1.3 (1.3) 3.2 0.4 (6.0) (0.2) 0.2 4.7 4.7 (0.6) 0.1 6.2 4.1 54.8% (4.9) 2.2 (0.3) (2.1) (5.2) (0.0) (3.0) 0.0 (3.0) 0.2 9.0 (1.8) 7.1

(13.7) (13.7) 45.9 39.7 85.6

207

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

North America Equity Research 02 January 2008

Monster Worldwide, Overweight ($33.91)


We believe that the market has already priced a U.S. recession in MNSTs current stock price. Despite market skepticism, we continue to see upside potential from Monsters international business and cost savings initiatives that began in 2007. Monster Worldwide remains our top mid-cap pick in our Internet Coverage universe and we reiterate our OW rating. International should continue to drive growth in 2008 and 2009. We are modeling 2008 and 2009 Monster Careers International revenue growth of 28.8% and 22.6%, respectively. Additionally, we are modeling corresponding International 08 and 09 OIBDA margins of 24.9% and 28.0%, respectively, up from our 2007 estimate of 14.7%. Additionally, we continue to believe the company has incremental margin opportunity in its NA Monster Careers segment as the company completes its cost cutting initiative and improves its local penetration. North American revenue growth is expected to slow as U.S. economy weakens. We believe the market is pricing in a decline in U.S. revenues of almost 20%, in line with the last recession. However, we believe that this scenario is too pessimistic. While we believe there will be some serious headwinds, we are modeling 4.5% and 8.9% Y/Y revenue growth for Monster Careers North America in 2008 and 2009, as we believe MNST will benefit from share gains from offline dollars shifting online and a restructured MNST will begin to recapture market share in 2009 from competitors. 2008 Drivers. In our view, the following factors will drive the stock in 2008: (1) continued strength in International markets as online penetration continues to grow, (2) continued margin improvement in International markets as Monster benefits from increased scale and lower sales and marketing costs, (3) margin improvement potential from cost savings initiatives that began in 2007, and (4) execution of the remaining share buyback program. Maintaining 4Q estimates. We are modeling revenue, OIBDA, and pro forma EPS of $353M, $92M, and $0.40, (Y/Y growth of 18%, 33%, and 1% respectively). For F'07, we expect revenue and pro forma EPS growth of 20.9% and 10%, and we are modeling MNST OIBDA margins of 22.3%, down from 25.1% in F'06. The table below outlines our current estimates, including our newly introduced 2009 estimates.
Table 131: Monster Worldwide Estimate Highlights
$ in millions Monster WW JPMorgan Revenue OIBDA EPS Consensus Revenue EBITDA EPS 4Q'07 353 92 $0.40 353 90 0.38 F'07 1,350 301 $1.42 1,351 328 1.40 F'08 1,519 441 $1.90 1,558 419 1.84 F'09 1,727 514 $2.27 1,812 503 2.24 F'07 Y/Y 20.9% 7.3% 9.8% 21.0% 16.9% 8.2% F'08 Y/Y 12.5% 46.5% 34.0% 15.3% 27.7% 31.4% F'09 Y/Y 13.7% 16.6% 19.5% 16.3% 20.0% 21.7%

Source: Company reports, FactSet and JPMorgan estimates. 208

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

North America Equity Research 02 January 2008

Key Financial Metrics & Forecasts


The following table summarizes our revenue and margin assumptions by business segment and geography through 2009.
Table 132: Monster Worldwide Revenue Estimates by Business Segment
Segment Revenue: Monster Careers - North America Monster Careers - International Monster Careers Total Revenue Monser Careers NA Y/Y Growth Monster Careers Intl Y/Y Growth Monster Careers Blended Y/Y Growth Monster Careers % North America Monster Careers % International Internet Advertising & Fees Revenue IA&F Y/Y Growth Total Monster Revenue Total Monster Revenue Y/Y Growth
Source: Company reports and JPMorgan estimates

2006 658.1 306.3 964.3 26.2% 63.7% 36.1% 68.2% 31.8% 152.3 39.1% 1,116.7 36.5%

2007E 711.0 480.6 1,191.6 8.0% 56.9% 23.6% 59.7% 40.3% 158.5 4.0% 1,350.0 20.9%

2008E 743.3 618.8 1,362.0 4.5% 28.8% 14.3% 54.6% 45.4% 157.3 -0.7% 1,519.4 12.5%

2009E 809.3 758.7 1,568.0 8.9% 22.6% 15.1% 51.6% 48.4% 158.9 1.0% 1,726.9 13.7%

Table 133: Monster Worldwide OIBDA Margin Estimates by Business Segment


NA OIBDA Margin Intl OIBDA Margin Monster Careers OIBDA Margin % Careers OIBDA from NA % Careers OIBDA from Intl IA&F OIBDA Margin
Source: Company reports and JPMorgan estimates

2006 37.5% 10.8% 29.0% 88.2% 11.8% 34.3%

2007E 36.2% 14.7% 27.6% 78.5% 21.5% 16.8%

2008E 38.5% 24.9% 32.3% 65.0% 35.0% 20.1%

2009E 38.5% 28.0% 33.4% 59.4% 40.6% 20.4%

Our Estimates and Outlook for 2008


Our 2008 estimates call for Y/Y revenue, OIBDA, and pro forma EPS growth of 12.5%, 46.5%, and 34.0%, respectively. Specifically, we are modeling 2008 revenues, OIBDA, and pro forma EPS of $1.519B, $440.8M, and $1.90. The online recruitment market in Europe is fractionalized along national boundaries. Monster is focused on building its brand across Europe, while at the same time driving efficiencies through centralized call center and sales operations. Monster has introduced its eCommerce product to the European market earlier than it did domestically, which we believe will drive margin in step with online adoption. We are modeling International OIBDA margin expansion to 24.9% and 28.0% in 2008 and 2009, respectively, from 14.7% in 2007. We believe Monsters North American OIBDA margins will be bolstered by the local newspaper deals MNST is signing as these partnerships will help the company increase local penetration at a relatively low cost. Additionally, we believe MNST will continue to sell through its ecommerce product. We are modeling NA OIBDA margins of 38.5%, up from 36.2% in 2007.

209

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

North America Equity Research 02 January 2008

We expect IA&F revenues to decline in 2008 as MNST focuses on revamping its site and removes lower quality advertisers. For F08, we are modeling IA&F revenues of $157M, down from $159M in F07.

Our Estimates and Outlook for 2009


We are introducing 2009 estimates calling for Y/Y revenue, OIBDA, and pro forma EPS growth of 13.7%, 16.6%, and 19%, respectively. Specifically, we are modeling 2009 revenues, OIBDA, and pro forma EPS of $1.727B, $514M, and $2.27. By 2009, we expect weakness in the U.S. recruiting markets to subside. In addition, we expect the company to benefit from an increased focus on its customers' experience and efforts to recapture market share from CareerBuilder. As such, we expect Monster Careers- North America to see revenue growth accelerate to 8.9% in F09, up from 4.5% in F08. We expect the strong International growth trends to continue, as we expect MNST to benefit from the continued shift of recruiting dollars online, since we believe online penetration in International markets still remains below that of the U.S., and stronger employment markets. In addition, we expect MNST to continue to focus on improving its International operations and margins.

Valuation and Rating Analysis


On a P/E basis, MNST trades 17.8x our F08 pro-forma EPS estimate of $1.90, vs. ecommerce peers at 30.8x, a 42% discount. In addition, on an EV/EBITDA basis, Monster trades 8.6x our 2008 EBITDA estimate of $441M, vs. its ecommerce peers which trade at 19.2x 2008 estimates, a 55% discount. Despite current US macro conditions, we believe such a discount is unwarranted. We reiterate our Overweight rating.

Risks to Our Rating


Monster Worldwides business model is highly dependent on the macroeconomic environment, as well as trends in the labor market. As a result, material negative changes in the overall economy could have an impact on our revenue and earnings estimates and could cause shares to underperform its peer group. Our Overweight rating is largely predicated on the continued shift of classified advertising dollars from offline media to online. As such, should this shift not materialize to the extent we are forecasting, our estimates could be impacted to the downside.

210

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

North America Equity Research 02 January 2008

Table 134: MNST Annual Income Statement


$ in millions, except per share data FY 2006 Revenues: Monster Careers Internet Advertising & Fees Total Revenues Q/Q Revenue Growth Y/Y Revenue Growth Salaries and Costs Office and General Marketing and Promotion Unusual Inc./Expense Amort./Intangibles Depreciation Non-cash stock option expense Amortization of stock based comp Total Operating Expenses Pro Forma Operating Expenses Operating Profit (Reported) OIBDA Adj Segment OIBDA Operating Margins (Reported) OIBDA Margins OIBDA Growth Y/Y Interest and Other Income Pretax Income Tax Benefit (Exp) Losses in equity interest Minority Interest Income from Continuing Operations Income from Discontinued Oper'ns Net Income--Inc. Discon'd Business Cumulative effect of accounting change, net of tax benefit 1x time legal / Severance Net Income - Reported Pro Forma Net Income GAAP EPS Pro Forma EPS Diluted Shares Outstanding
Source: Company reports and JPMorgan estimates.

FY 2007E 1,191.6 158.5 1,350.0 20.9% 501.0 230.4 306.5 11.2 5.2 41.0 27.0 1,122.6 1,079.0 227.4 300.9 355.1 16.8% 22.3% 7.3% 26.2 253.6 (90.0) (10.2) 153.4 (0.5) 152.9 152.9 186.4 $1.17 $1.42 131.3

FY 2008E 1,362.0 157.3 1,519.4 12.5% 550.7 199.3 328.5 57.0 32.0 1,167.6 1,135.6 351.8 440.8 471.9 23.2% 29.0% 46.5% 28.7 380.5 (133.2) (4.0) 243.3 243.3 243.3 243.3 $1.90 $1.90 127.8

FY 2009E 1,568.0 158.9 1,726.9 13.7% 626.0 211.5 375.6 57.0 32.0 1,302.1 1,270.1 424.8 513.8 556.5 24.6% 29.8% 16.6% 29.6 454.4 (159.0) (4.0) 291.4 291.4 291.4 291.4 $2.27 $2.27 127.5

964.3 152.3 1,116.7 36.5% 401.0 161.7 273.5 8.9 30.9 10.8 886.8 867.1 229.9 280.5 332.3 20.6% 25.1% 48.6% 22.91 252.8 (87.7) (9.5) 155.6 (116.5) 39.1 39.1 169.7 $0.30 $1.29 131.2

211

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

North America Equity Research 02 January 2008

Table 135: MNST Quarterly Income Statement


$ in millions, except per share data Q1-06 Revenues: Monster Careers Internet Advertising & Fees Total Revenues Q/Q Revenue Growth Y/Y Revenue Growth Salaries and Costs Office and General Marketing and Promotion Unusual Inc./Expense Amort./Intangibles Depreciation Non-cash stock option expense Amortization of stock based comp Total Operating Expenses Pro Forma Operating Expenses Operating Profit (Reported) OIBDA Adj Segment OIBDA Operating Margins (Reported) OIBDA Margins OIBDA Growth Y/Y Interest and Other Income Pretax Income Tax Benefit (Exp) Losses in equity interest Minority Interest Income from Continuing Operations Income from Discontinued Oper'ns Net Income--Inc. Discon'd Business Cumulative effect of accounting change, net of tax benefit 1x time legal / Severance Net Income - Reported Pro Forma Net Income GAAP EPS Pro Forma EPS Diluted Shares Outstanding
Source: Company reports and JPMorgan estimates. 212

FY 2006 Q2-06 Q3-06 237.2 38.0 275.2 7% 39% 95.4 32.7 73.2 2.6 8.6 3.4 215.9 209.9 59.3 73.8 82.6 21.5% 26.8% 66.4% 5.5 64.8 (22.1) (2.0) 40.7 0.8 41.5 41.5 40.7 $0.31 0.31 132.0 244.3 41.6 285.9 4% 38% 103.9 42.0 68.1 1.8 7.3 2.9 226.0 221.3 59.8 71.9 83.9 20.9% 25.1% 43.4% 5.0 64.8 (22.7) (2.0) 40.1 (123.9) (83.8) 2.7 (83.8) 42.8 ($0.64) 0.33 130.8

Q4-06 258.3 40.4 298.6 4% 33% 112.2 50.0 66.4 1.9 7.9 2.4 240.8 236.5 57.8 70.0 90.8 19.4% 23.4% 32.2% 6.4 64.2 (22.5) (1.5) 40.2 (1.2) 39.1 11.4 39.1 51.7 $0.30 0.39 131.2

Q1-07 290.2 38.8 329.0 10% 28% 118.0 60.4 78.1 1.7 8.3 0.2 4.2 270.8 264.8 58.2 72.5 90.2 17.7% 22.0% 12.0% 5.3 63.5 (22.4) (1.4) 39.7 (0.2) 39.5 6.4 39.5 46.1 $0.30 $0.35 132.5

FY 2007E Q2-07 Q3-07 291.3 39.8 331.1 1% 20% 129.0 53.0 78.0 1.7 9.8 0.0 17.1 288.8 269.9 42.4 71.0 86.0 12.8% 21.5% -3.8% 6.9 49.3 (17.4) (3.0) 28.9 (0.3) 28.6 13.7 28.6 42.6 $0.22 $0.32 133.0 297.0 40.1 337.1 2% 18% 125.3 58.8 76.3 11.2 1.7 10.9 0.1 2.9 287.1 271.3 50.0 65.6 75.5 14.8% 19.5% -8.7% 6.3 56.3 (20.0) (3.1) 33.2 0.1 33.3 12.9 33.3 46.2 $0.25 $0.35 130.8

Q4-07E 313.0 39.7 352.7 5% 18% 128.7 58.2 74.1 12.0 2.9 275.9 273.0 76.8 91.7 103.5 21.8% 26.0% 31.0% 7.7 84.5 (30.3) (2.8) 51.5 51.5 51.5 51.5 $0.40 $0.40 129.1

Q1-08E 339.3 37.6 376.9 7% 15% 135.7 52.8 82.9 13.0 8.0 292.4 284.4 84.5 105.5 112.3 22.4% 28.0% 45.5% 7.5 92.0 (32.2) (1.0) 58.8 58.8 58.8 58.8 $0.46 $0.46 129.1

FY 2008E Q2-08E Q3-08E 337.4 39.0 376.4 0% 14% 137.4 48.9 82.8 13.8 8.0 290.9 282.9 85.5 107.3 115.0 22.7% 28.5% 51.0% 7.2 92.7 (32.4) (1.0) 59.2 59.2 59.2 59.2 $0.46 $0.46 128.1 336.9 40.5 377.4 0% 12% 137.8 49.1 81.1 14.7 8.0 290.7 282.7 86.7 109.4 118.0 23.0% 29.0% 66.8% 7.0 93.7 (32.8) (1.0) 59.9 59.9 59.9 59.9 $0.47 $0.47 127.1

Q4-08E 348.6 40.1 388.7 3% 10% 139.9 48.6 81.6 15.5 8.0 293.6 285.6 95.0 118.5 126.6 24.5% 30.5% 29.3% 7.0 102.0 (35.7) (1.0) 65.3 65.3 65.3 65.3 $0.51 $0.51 127.1

224.6 32.4 257.0 15% 36% 89.5 37.0 65.8 2.7 7.1 2.0 204.1 199.4 52.9 64.7 75.0 20.6% 25.2% 57.0% 6.0 58.9 (20.4) (4.0) 34.5 7.8 42.4 42.4 34.5 $0.32 0.26 130.6

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

North America Equity Research 02 January 2008

Table 136: MNST Annual Balance Sheet


$ in millions FY 2006 Assets Cash/Equivalents Marketable securities Accounts Receivable Prepaids/Others Assets Discont. Ops. Work in Progress Total current assets Prop. & Equip., Net Goodwill Intangibles, Net Investment in unconsolidated affiliate Other Assets Assets Discont. Ops. Total assets Liabilities and stockholders' equity Accounts Payable and accrued expenses Deferred Revenues Cur.Port.LT Debt Current liabilities of discontinued operations Oth. Curr. Liab. Total current liabilities Long term debt, less current portion Deferred income taxes Other LT Liabs. Long term liabilities of discontinued operations Total Long Term Liabilities Minority Interests Total Liabilities Stockholders' equity: Common Stock Other Equity Paid in Capital Accumulated other comprehensive income Unamortized stock based compensation Treasury Stock Accummulated Deficit Total stockholders' equity Total L&S
Source: Company reports and JPMorgan estimates.

FY 2007E 54.2 511.7 493.8 1,059.8 115.8 662.7 206.2 2,044.5 299.8 511.4 811.3 1.9 124.2 126.2 937.4 0.1 1,455.4 115.8 (464.3) 1,107.0 2,044.5

FY 2008E 113.0 511.7 544.1 1,168.9 98.1 662.7 206.2 2,135.9 326.5 563.6 890.1 1.9 124.2 126.2 1,016.2 0.1 1,224.7 115.8 (221.0) 1,119.7 2,135.9

FY 2009E 415.7 511.7 617.9 1,545.3 81.3 662.7 206.2 2,495.5 364.1 640.0 1,004.1 1.9 124.2 126.2 1,130.3 0.1 1,178.9 115.8 70.4 1,200.7 2,261.9

58.7 537.9 444.7 82.5 1,123.8 102.4 589.0 51.7 43.2 1,969.8 358.9 444.1 23.2 826.2 0.4 33.5 33.9 860.1 0.1 1,636.0 87.6 (614.1) 1,109.7 1,969.8

213

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

North America Equity Research 02 January 2008

Table 137: MNST Annual Statement of Cash Flows


$ in millions FY 2006 OPERATING CASH FLOWS Net Income Loss from Discont. Depreciation and amortization Accounting Change Prov./Doubtful Acct. Tax Effect Options Excess benefit from stock option exercises Special Compensation Disposal of Fixed Common stock issue for 401k plan and other Deferred Income Tax Minority Interests Write-Off Oth. Asset Other Operating Changes in Working Capital Accounts Receivable Prepaid and Other Deferred Revenue Accounts payable, accrued expenses and other liabilities Net cash provided by (used for) op activities of disc. Ops Cash From Operations FCF INVESTING CASH FLOWS Capital Expenditures Purchase of marketable securities Sale and maturities of marketable securities Payments for acq and intang assets, net of cash acq Inv in unconsolidated affiliate Cash funded for sale of subsidiaries Sale of long term investment Proceeds from sale of business, net of professional fees Net cash used for investing activities in discountinued ops Purch. of Invest. Other Investing Cash From Investing FINANCING CASH FLOWS Net repayments under line of credit and capital lease obligations Payments on acquisition of debt Purch./Sale of Stock Stock Options Excess tax benefit from stock option exercises Repurchase of common stock Structured stock repurchase Cash funded to Hudson Highland Group Net cash used for financing activities for discountinued ops Repay Long Term Debt Cap. Lease Payments Other Financing Cash From Financing Foreign Exch Effects Net Change In Cash Cash at Beginning Cash at End
Source: Company reports and JPMorgan estimates.

FY 2007E 152.9 0.5 46.1 0.0 10.5 0.0 24.5 0.0 0.0 (2.7) 10.2 (0.6) 0.0 18.6 (57.8) (12.2) 67.3 26.5 (5.3) 260.0 194.2 (65.8) (1.9) 0.0 (10.0) 0.0 0.0 0.0 0.0 0.0 (51.6) (0.1) 0.0 54.1 (264.7) 0.0 0.0 0.0 0.0 0.0 (218.6) 5.8 (4.5) 0.0 58.7 54.2

FY 2008E 243.3 0.0 57.0 0.0 8.0 0.0 0.0 0.0 0.0 0.0 0.0 4.0 0.0 0.0 28.5 (50.3) 0.0 52.1 26.7 0.0 340.8 248.8 (92.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (92.0) 0.0 0.0 0.0 0.0 (190.0) 0.0 0.0 0.0 0.0 0.0 0.0 (190.0) 0.0 58.8 0.0 54.2 113.0

FY 2009E 291.4 0.0 57.0 0.0 8.0 0.0 0.0 0.0 0.0 0.0 0.0 4.0 0.0 0.0 40.3 (73.8) 0.0 76.4 37.6 0.0 400.6 302.6 (98.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (98.0) 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 0.0 302.6 0.0 113.0 415.7

37.1 116.5 39.8 0.0 9.1 0.0 0.0 10.8 0.0 10.8 7.1 0.0 0.0 35.2 (171.3) (21.8) 116.6 94.0 17.8 268.2 212.6 (55.6) (19.6) (10.0) 69.2 0.0 0.0 (453.1) (0.2) 0.0 92.3

0.0 0.0 0.0 43.3 3.6 (137.9) 0.0 196.6 58.7

214

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

North America Equity Research 02 January 2008

Move, Inc., Neutral ($2.70)


Move has not escaped the doldrums of the real estate market in 2007, and we expect F07 Y/Y revenue growth to be ~1%. We see positives in the measures the company has undertaken to streamline operations, led by new President Lorna Borenstein, hired in May 07, who brings Internet experience from her time at Yahoo! and eBay. As market conditions are likely to remain challenging for the foreseeable future, we reiterate our Neutral rating. Real estate market environment remains challenging. We believe the state of the real estate market continues to present a near-term headwind, both operationally and due to headline risk. As such, we think it may be difficult for Move to achieve significant revenue growth in F08, and are modeling only 9% revenue growth Y/Y. Site improvements a step in the right direction. We believe management is taking appropriate measures to modernize the site and run the business as an Internet company. We were very encouraged by progress made in 3Q to improve site speed (such as a 60% improvement in front page load time) and search-engine friendliness, allowing search engines to index its pages. Maintaining traffic remains a key challenge. Move has a significant traffic advantage as the #1 site in the real estate space. When real estate market conditions improve, we think a significant opportunity exists for revenue growth, both in the current realtor-targeted products and through ads and lead-generation. However, there is no guarantee of continued traffic leadership, as competition in the online real estate market increases. 2008 Drivers. In our view, the following factors will drive the stock in 2008: (1) Real estate market conditions; (2) the extent to which Moves realtor clients shift their spend online; (3) the companys new venture, being developed by Allen Dalton; and (4) the competitive landscape of RE sites. Maintaining 4Q07 and F07 estimates. We think the company can achieve 3% revenue growth in 4Q, and are maintaining our revenue, EBITDA and EPS estimates of $74M, $7.8M and $0.00, respectively, and our F07 estimates of $294M, $28.8M and $(0.05), respectively.

Table 138: Move Consensus Snapshot


$ in millions, except per-share data MOVE JPM Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07E 74.0 7.8 (0.00) 72.0 10.2 -0.01 F'07E 294.2 28.8 (0.05) 292.6 28.2 -0.04 F'08E 319.9 41.6 0.03 318.3 37.6 0.04 F'09E 349.1 48.7 0.05 373.7 N/A 0.17 F'07E 0.4% 60.1% -149.5% -0.1% 56.4% -144.3% Y/Y F'08E 8.7% 44.4% -161.6% 8.8% 33.6% -196.0% F'09E 9.1% 17.2% 57.8% 17.4% NM 300.0%

Source: Company reports, FactSet, JPMorgan estimates.

215

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


Although we think real estate market conditions are likely to remain challenging in F08, we expect a slight improvement to Moves operating results in the coming year, as we think initiatives the company is undertaking to make the site more efficient may start to pay off. As such, we are maintaining our F08 revenue, EBITDA and EPS estimates of $320M, $41.6M and $0.03. Our revenue forecast implies 9% Y/Y growth, coming on the heels of projected 1% revenue growth in F07. We think Realtor.com revenue can grow 10% Y/Y, and are forecasting Welcome Wagon revenue growth of 2% in F08.

Our Estimates and Outlook for 2009


We do not, alas, have a crystal ball to predict whether F09 will see a significant turnaround in the fortunes of the US real estate market. At the same time, we think that, independent of the timing of such a turnaround, the challenging conditions we are currently seeing are likely to force the industry to more critically evaluate its approaches to marketing. We believe such a re-examination can only benefit a company like Move, the current traffic leader in the online real estate space. As such we think our F09 projection of a second consecutive year of 9% revenue growth is fairly conservative. For F09, our projections call for revenue of $349M, EBITDA of $48.7M and EPS of $0.05. We note that neither our F08 nor our F09 projections include any impact from the project, thus far kept under tight wraps by the company, spearheaded by Allen Dalton. While we think its likely the project will not have an immediate material impact, near-term profitability may be affected if the project requires significant up-front investment.

Valuation and Rating Analysis


On an EV/EBITDA basis, MOVE trades 5.6x our F08 EBITDA estimate of $42M, versus the Internet real estate group at 5.5x. We believe that current real estate market conditions make significant multiple expansion unlikely at this time.

Risks to Our Rating


Moves revenues and earnings are highly dependent on the health of the real estate market, which is impacted by macroeconomic conditions outside of Moves immediate control. If the real estate market rebounds sooner than we are estimating, there could be upside to our current estimates. If it takes MOVE longer to realign the Welcome Wagon business than we are estimating, or the real estate market deteriorates beyond current expectations, there could be downside to our current estimates.

216

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

North America Equity Research 02 January 2008

Table 139: MOVE Annual Income Statement


$ in millions, except per share data 2006 Revenue Related party revenue Total Revenue Cost of Revenue Gross Profit Gross Margin Sales and Marketing Product and website development General and administrative Amortization of intangible assets Acquisition and restructuring charges Impairment of long-lived assets Litigation settlement Stock based compensation Total Expenses Total Recurring Expenses Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma) EBITDA EBITDA margin Y/Y EBITDA Growth Interest Income Convertible preferred stock dividends Other, Net Gain on settlement of distrib agreement Total Other, Reported Total Other, Pro Forma Income Before Taxes Income Taxes Tax Rate Inc From Cont Ops After Taxes Gain from discontinued operations Extraordinary Item Reported Net Income FAS 123 Adjustment Reported Net Income W/ FAS 123 Reported EPS Diluted Shares % of Total Revenue Cost of Revenue Sales and Marketing Product and website development General and administrative Y/Y Change Revenue Sales and Marketing Product and website development General and administrative
Source: Company reports and JPMorgan estimates.

2007E 290.4 0.0 290.4 65.1 225.3 77.6% 108.6 32.4 69.3 2.3 (0.3) 15.4 211.0 204.0 (2.4) 15.0 -0.8% 5.2% 294.2 0.0 294.2 61.1 233.1 79.2% 111.7 34.7 69.8 2.2 3.9 24.5 246.9 216.2 (13.7) 16.9 -4.7% 5.7% 28.8 9.8% 17.9% 10.0 (5.0) 1.2 6.2 6.2 (7.6) 0.6 (8.2) (8.2) (8.2) (0.05) 166 20.8% 38.0% 11.8% 23.7% 1% 3% 7% 1%

2008E 319.9 0.0 319.9 64.4 255.5 79.9% 122.0 36.3 70.6 3.2 23.2 255.4 228.9 0.2 26.6 0.1% 8.3% 41.6 13.0% 44.4% 10.6 (5.0) 5.6 5.6 5.8 1.0 0 4.8 4.8 4.8 0.03 157 20.1% 38.1% 11.3% 22.1% 9% 9% 5% 1%

2009E 349.1 0.0 349.1 69.5 279.5 80.1% 133.1 39.6 77.0 3.8 23.2 276.8 249.8 2.7 29.7 0.8% 8.5% 48.7 14.0% 17.2% 10.9 (5.0) 5.9 5.9 8.6 1.0 0% 7.6 7.6 7.6 0.05 159 19.9% 38.1% 11.3% 22.1% 9% 9% 9% 9%

24.5 8.4% 357.8% 7.3 (3.6) 17.4 21.1 21.1 18.7 0.1 18.5 18.5 18.5 0.12 161 22.4% 37.4% 11.2% 23.9% 15% 19% 47% -16%

217

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

North America Equity Research 02 January 2008

Table 140: MOVE Quarterly Income Statement


$ in millions, except per share data FY 2006 Q1-06 69.0 69.0 16.3 52.7 76.4% 24.9 7.9 18.7 0.7 3.4 55.5 51.4 (2.8) 1.3 -4.1% 1.8% 3.9 5.6% 57.7% 1.6 (0.9) 0.1 0.8 0.8 (2.0) 0% (2.0) Q2-06 73.9 73.9 16.4 57.5 77.8% 28.0 8.5 17.5 0.6 2.5 57.1 54.0 0.4 3.5 0.5% 4.8% 4.7 6.4% 64.4% 1.8 (0.9) 0.4 1.3 1.3 1.7 0% 1.7 Q3-06 75.7 75.7 16.9 58.7 77.6% 28.6 8.2 17.3 0.5 (0.3) 4.2 58.6 54.2 0.2 4.5 0.2% 6.0% 7.4 9.8% 160.0% 1.9 (0.9) 0.1 1.1 1.1 1.3 0% 1.3 Q4-06 71.8 71.8 15.5 56.4 78.5% 27.1 7.9 15.7 0.5 5.3 56.5 50.7 (0.1) 5.7 -0.2% 7.9% 8.5 11.8% NA 1.9 (0.9) 16.8 17.9 17.9 17.7 0.1 17.6 FY 2007E Q1-07 71.0 71.0 14.7 56.4 79.4% 27.4 8.5 16.1 0.5 0.0 0.0 0.0 5.4 58.0 52.0 (1.6) 4.3 -2.2% 6.1% 7.1 10.0% 84.7% 2.3 (1.2) 0.8 1.8 1.8 0.2 0.1 0% 0.2 Q2-07 73.6 73.6 15.3 58.4 79.3% 27.3 9.0 17.9 0.5 0.0 0.0 0.0 7.8 62.6 54.3 (4.2) 4.1 -5.7% 5.6% 6.9 9.4% 46.5% 2.5 (1.2) (0.4) 0.9 0.9 (3.3) 0.2 0% (3.5) Q3-07 75.6 75.6 16.0 59.6 78.9% 28.3 8.3 19.1 0.5 0.0 0.0 3.9 5.9 66.0 55.7 (6.4) 3.9 -8.5% 5.2% 7.0 9.2% -6.2% 2.6 (1.2) 0.7 2.0 2.0 (4.4) 0.2 0% (4.6) Q4-07E 74.0 74.0 15.2 58.8 79.4% 28.8 8.8 16.7 0.7 0.0 0.0 0.0 5.3 60.3 54.3 (1.5) 4.5 -2.1% 6.1% 7.8 10.6% -7.5% 2.6 (1.2) 0.1 1.4 1.4 (0.1) 0.2 0% -0.3 FY 2008E Q1-08E 76.0 76.0 15.2 60.8 80.0% 29.3 8.9 17.2 0.8 0.0 0.0 0.0 5.6 61.8 55.4 (1.0) 5.4 -1.4% 7.1% 8.9 11.7% 24.8% 2.6 (1.2) 1.4 1.4 0.3 0.3 0% (0.0) Q2-08E 81.1 81.1 16.5 64.6 79.7% 31.2 9.3 18.3 0.8 0.0 0.0 0.0 5.6 65.2 58.8 (0.6) 5.8 -0.8% 7.1% 9.3 11.4% 33.8% 2.6 (1.2) 1.4 1.4 0.8 0.2 0% 0.6 Q3-08E 82.5 82.5 16.7 65.8 79.8% 31.3 9.2 18.1 0.8 0.0 0.0 0.0 5.7 65.1 58.6 0.7 7.2 0.8% 8.7% 11.2 13.5% 60.4% 2.7 (1.2) 1.4 1.4 2.1 0.2 0% 1.9 Q4-08E 80.4 80.4 16.1 64.3 80.0% 30.2 8.8 17.1 0.8 0.0 0.0 0.0 6.3 63.2 56.1 1.2 8.3 1.5% 10.3% 12.3 15.3% 57.2% 2.7 (1.2) 1.4 1.4 2.6 0.3 0% 2.4 -

Revenue Related party revenue Total Revenue Cost of Revenue Gross Profit Gross Margin Sales and Marketing Product and website development General and administrative Amortization of intangible assets Acquisition and restructuring charges Impairment of long-lived assets Litigation settlement Stock based compensation Total Expenses Total Recurring Expenses Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma) EBITDA EBITDA margin Y/Y EBITDA Growth Interest Income Convertible preferred stock dividends Other, Net Gain on settlement of distrib agreement Total Other, Reported Total Other, Pro Forma Income Before Taxes Income Taxes Tax Rate Inc From Cont Ops After Taxes Gain from discontinued operations Extraordinary Item
218

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North America Equity Research 02 January 2008

Reported Net Income FAS 123 Adjustment Reported Net Income W/ FAS 123 Reported EPS Diluted Shares % of Total Revenue Cost of Revenue Sales and Marketing Product and website development General and administrative Y/Y Change Revenue Sales and Marketing Product and website development General and administrative Q/Q change Revenue Sales and Marketing Product and website development General and administrative
Source: Company reports and JPMorgan estimates.

(2.0) (2.0) (0.01) 149.0 23.6% 36.0% 11.4% 27.1% 22% 11% 79% 14% 3.6% 5.4% 16.0% -23.0%

1.7 1.7 0.01 165.1 22.2% 37.9% 11.4% 23.7% 17% 23% 67% -11% 7.1% 12.7% 7.6% -6.5%

1.3 1.3 0.01 164.4 22.4% 37.9% 10.8% 22.9% 14% 28% 40% -22% 2.4% 2.3% -3.1% -0.9%

17.6 17.6 0.09 165.7 21.5% 37.7% 11.0% 21.9% 8% 15% 17% -35% -5.1% -5.5% -3.1% -9.5%

0.2 0.2 0.00 167.4 20.6% 38.6% 12.0% 22.7% 3% 10% 9% -14% -1.1% 1.3% 7.7% 2.5%

(3.5) (3.5) (0.02) 154.9 20.7% 37.1% 12.3% 24.4% 0% -3% 7% 3% 3.7% -0.5% 5.7% 11.5%

(4.6) (4.6) (0.03) 155.0 21.1% 37.4% 11.0% 25.3% 0% -1% 2% 10% 2.6% 3.6% -7.8% 6.4%

(0.3) (0.3) (0.00) 155.5 20.6% 38.9% 11.9% 22.5% 3% 6% 11% 6% -2.1% 1.9% 5.7% -12.8%

(0.0) (0.0) (0.00) 156.0 20.0% 38.6% 11.7% 22.6% 7% 7% 4% 7% 2.6% 1.8% 0.9% 3.1%

0.6 0.6 0.00 156.5 20.3% 38.5% 11.5% 22.6% 10% 14% 3% 2% 6.7% 6.4% 4.9% 6.7%

1.9 1.9 0.01 157.0 20.2% 38.0% 11.2% 21.9% 9% 11% 11% -5% 1.8% 0.4% -0.9% -1.4%

2.4 2.4 0.01 157.5 20.0% 37.5% 11.0% 21.2% 9% 5% 0% 2% -2.5% -3.8% -4.2% -5.6%

219

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North America Equity Research 02 January 2008

Table 141: MOVE Annual Balance Sheet


$ in millions FY-06E Assets Cash and cash equivalents Restricted cash Short term investments Marketable securities Accounts receivable, net Current portion of distribution expense Assets of discontinued operations Other current assets Total Current Assets Prepaid distribution expense, net of current portion Property and equipment, net Goodwill, net Intangible assets, net Restricted cash Other assets Total Long Term Assets Total Assets Liabilities Accounts payable Accrued expenses Accrued litigation settlement Accrued distribution obligation Obligation under capital leases Deferred revenue Deferred revenue from related parties Liabilities of discontinued operations Total Current Liabilities Distribution obligation, net of current portion Obligation under capital leases Deferred revenue Deferred revenue from related parties Other non-current liabilities Total Long Term Liabilities Total Liabilities Convertible preferred stock Shareholder Equity Total Equity Total Liabilities + Equity
Source: Company reports and JPMorgan estimates.

FY-07E 28.1 165.1 18.5 18.5 230.2 36.2 23.9 15.8 3.3 1.6 80.8 311.0 5.2 25.9 2.0 51.8 84.9 0.7 1.9 2.5 87.4 99.9 123.7 311.0

FY-08E 63.3 165.1 20.1 20.1 268.6 34.2 23.9 15.8 3.3 1.6 78.8 347.4 5.6 28.2 2.0 56.3 92.1 0.7 1.9 2.5 94.6 99.9 152.8 347.4

FY-09E 104.9 165.1 22.0 22.0 313.9 31.6 23.9 15.8 3.3 1.6 76.2 390.1 6.2 30.8 2.0 61.5 100.4 0.7 1.9 2.5 102.9 99.9 187.2 390.1

14.9 143.0 18.3 34.5 210.6 29.2 23.9 16.7 4.3 1.2 75.4 285.9

4.9 26.7 1.9 50.1 83.6 2.2 2.5 4.7 88.3 96.2 101.5 285.9

220

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

North America Equity Research 02 January 2008

Table 142: MOVE Annual Cash Flow Statement


$ in millions 2006 Operating Cash Flows Net income Depreciation Amortization of intangibles Gain on sales of ppe Accretion of distribution agreement Imrairment of long-lived assets Provision for doubtful accounts Acquisition and restructuring charges Stock-based charges Gain on settlement of distribution agreement Write down of investments Realized loss on sale of marketable securities Non-cash convertible preferred stock dividends Write off of capitalized software Change in market value of embedded derivative liab Other non-cash items Changes in working capital Accounts receivable Prepaid distribution expense Restricted cash Other assets Accounts payable and accrued expenses Accrued distribution agreement Deferred revenue Deferred revenue from related parties Cash From Operations FCF Investing Cash Flows Purchases of property and equipment Proceeds from the surrender of life insurance Purchases of short term investments Maturities of short-term investments Proceeds from sale of marketable equity securities Purchase of intangible assets Proceeds from sale of assets Other assets Acquisitions, net of cash acquired Cash From Investing Financing Cash Flows Proceeds from payment of stockholders' notes Proceeds from exercise of stock options, warrants and shares issuances under employee stock purchase plan Proceeds from the sale of convertible preferred stock Payments on capital leases Restricted Cash Repayment of notes payable Issuance of notes receivable Repurchase of common stock Settlement of a stock issuance obligation Transfer to restricted cash Cash From Financing Net Cash provided by discontinued operations Net Increase (decrease) in cash Foreign Exch Effects Beginning Cash Ending Cash
Source: Company reports and JPMorgan estimates.

2007E (4.5) 11.5 2.2 (0.3) 1.0 24.9 (0.7) (0.1) (3.5) (0.9) (3.3) 8.2 (7.6) 30.6 12.6 (18.0) 5.2 (87.3) 65.2 15.7 0.3 (19.5) 3.1 (1.9) 2.1 13.3 14.9 28.1

2008E 4.8 15.0 3.2 0.9 23.2 1.5 (3.3) 5.0 (0.2) 48.7 35.7 (13.0) (13.0) 1.4 (1.9) (0.5) 35.2 28.1 63.3

2009E 7.6 19.0 3.8 0.9 25.5 1.6 (3.6) 5.5 (0.2) 58.5 42.1 (16.4) (16.4) 1.4 (1.9) (0.5) 41.6 63.3 104.9

22.1 10.5 2.3 2.2 15.7 (0.3) (29.1) (3.0) (14.7) (17.1) 5.8 23.4 10.5 (12.9) 26.3 (30.3) (9.6) (26.7) 6.9 (2.7) 4.9 1.6 13.3 14.9

221

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

North America Equity Research 02 January 2008

Omniture, Overweight ($34.95)


F07 has seen Omniture further its lead in the Web Analytics space, most notably through the acquisition of Visual Sciences, announced in 4Q and expected to be completed in 1Q08. The companys prospects for customer additions, higher ASPs and improved profitability give us continued confidence in our Overweight thesis. Three levers for growth. With the Visual Sciences acquisition, we believe Omniture could achieve a customer count in excess of 5,000 by the middle of F08. As products such as SearchCenter, TouchClarity and Offermatica get sold across a larger customer base, we think ASPs could begin to rise. Finally, we expect increased scale to pay off in the form of improved profitability. Acquisition integration will be key. The Visual Sciences deal is Omnitures biggest to date, and we believe navigating the integration is a near-term risk factor. However, we think management is highly cognizant of the challenges in bringing together two firms, and do not think executive focus on a successful integration is in short supply. Additionally, we think the rapid DOJ approval for the acquisition was a positive, as it minimized the period of time when Visual Sciences operations were in regulatory limbo. 2008 Drivers. In our view, the following factors will drive the stock in 2008: (1) Integration of Visual Sciences; (2) impact from changes in competitive environment, including both paid competitors and free analytics offerings from Google and Microsoft; (3) pace of customer adds; (4) international growth; (5) ability to raise ASP through up-sell and cross-sell; and (6) profitability improvements. Maintaining 4Q07 and F07 estimates. We are maintaining our 4Q revenue, EBITDA and pro forma EPS estimates of $40.7M, $7.3M and $0.08, respectively, and our F07 revenue, EBITDA and pro forma EPS estimates of $140.7M, $22.4M and $0.20, respectively.

Table 143: Omniture Consensus Snapshot


$ in millions, except per-share data OMTR 4Q'07E JPM Revenue EBITDA EPS Consensus Revenue EBITDA EPS 41 7 0.08 42 7 0.08 F'07E 141 22 0.20 143 22 0.20 F'08E 213 37 0.39 216 38 0.41 F'09E 309 71 0.70 314 73 0.69 Y/Y F'07E 75.8% 180.6% -349.6% 78.2% 177.1% -348.3% F'08E 51.2% 66.3% 95.0% 51.6% 70.6% 108.2% F'09E 45.0% 90.1% 80.2% 45.2% 91.8% 67.4%

Source: Company reports, FactSet, JPMorgan estimates.

222

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

North America Equity Research 02 January 2008

The Growth Trajectory


Our Overweight thesis for Omniture is based on three key points: Customer additions. The company estimates that, even after the Visual Sciences acquisition is completed, its penetration among the top 10,000 Internet sites will be just north of 10%. As such, there remains significant room for customer growth, with much of the customer base still a greenfield opportunity. ASP growth. Omniture had made two acquisitions, TouchClarity and Offermatica, which gave it access to products with higher ASPs than the core SiteCatalyst product. The two acquired companies did not have the sales force scale that Omniture has. As such, we believe adding such products gives Omnitures sales force a significant opportunity to sell these high-ASP products across a much wider customer base. We note that SearchCenter, another higher-ASP product, has reached ~18%-20% penetration among the companys customer base, less than two years after its initial introduction. We believe the availability of additional products for cross-selling gives Omniture the ability to drive higher ASPs going forward:

Table 144: TouchClarity and Offermatica ASP, compared to SiteCatalyst


TouchClarity Offermatica Announced 2/14/2007 9/7/2007 Completion 3/1/2007 12/13/07 ASP estimate 1x-2x SiteCatalyst ASP .75x-1x SiteCatalyst ASP

Source: Company Reports, JPMorgan estimates

Scale to drive profitability. As the company scales its technology and sales force, we believe improved efficiencies are likely to drive profitability. The company has noted it expects to expand non-GAAP operating margins roughly 1% per quarter in F08.

Our Estimates and Outlook for 2008


As the Visual Sciences acquisition has not yet been finalized, we note that our projections for F08 and F09 do not include any impact from that acquisition. We are maintaining our F08 revenue, EBITDA and pro forma EPS estimates of $213M, $37.3M and $0.39. We expect subscription revenue per customer to begin rising on a Y/Y basis in the second half of the year as product cross-selling gains momentum.

Our Estimates and Outlook for 2009


We expect Omniture to grow revenue 45% Y/Y in F09, to $309M. We are modeling $70.9M in EBITDA, implying 5.5% Y/Y EBITDA margin improvement, and $0.70 pro forma EPS.

Valuation and Rating Analysis


Given Omnitures continued market share gains and strong operating leverage, we are maintaining our Overweight rating. On an EV/EBITDA basis, Omniture trades at 60.8x our F08 EBITDA estimate of $37M, vs. its peers at 39.8x F08 estimates. However, we believe Omnitures rapid growth deserves a higher premium.
223

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

North America Equity Research 02 January 2008

Risks to Our Rating


Omniture derives more than 90% of its revenue from subscription revenues. If the company undergoes a precipitous rise in churn rates, the companys revenue growth could be impacted. The web analytics space is extremely competitive with over 20 companies providing analytics solutions. Should Omnitures proposed acquisition of Visual Sciences not go through, or go through slower than expected, the stock could underperform. Googles acquisition of Urchin and subsequent announcement of free analytics may entice some mid-market customers to discontinue paying for web analytics, or may pressure Omnitures existing pricing dynamics. Also, if Omniture fails to gain market share as we anticipate, our revenue estimates could prove optimistic. Omnitures numerous enterprise customers could choose to build analytics solutions in-house, which could negatively impact the companys growth rates. Finally, should recent acquisitions be more difficult to integrate than we expect, Omnitures future performance could suffer as a result.

224

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

North America Equity Research 02 January 2008

Table 145: OMTR Annual Income Statement


$ in millions, except per share data 2006 Subscription Professional services and other Total Revenues Cost of Revenues Gross Profit Gross Margin Sales & marketing Research & development General and administrative Litigation settlement Total Operating Expenses Operating Profit (Loss) Operating Margin EBITDA EBITDA Margin Other Income (Expense) Profit (Loss) before provision for income taxes Provision for income taxes Net Income (Loss) - GAAP Net Income (Loss) - Pro forma EPS - GAAP (w/FAS123R) EPS - Pro forma (ex-FAS123R) Basic Shares Outstanding Diluted Shares Outstanding % of Revenue Sales & marketing Research & development General and administrative Growth Y/Y Subscription Professional services and other Total Revenues Sales & marketing Research & development General and administrative Total Expenses
Source: Company reports and JPMorgan estimates.

2007E 74.6 5.2 79.7 31.8 47.9 60.1% 35.2 8.7 12.1 56.1 129.8 10.9 140.7 51.6 89.0 63.3% 61.5 16.5 23.1 101.1 (12.0) -8.6% 22.4 16.0% 179.0% 3.7 (8.4) 0.3 (8.7) 12.4 $ $ (0.17) 0.20 53.4 59.9 43.7% 11.7% 16.4%

2008E 198.1 14.6 212.8 71.7 141.1 66.3% 96.4 22.2 24.7 143.3 (2.3) -1.1% 37.3 17.5% 66.3% 4.1 1.8 0.4 1.4 25.6 $ $ 0.02 0.39 59.3 65.7 45.3% 10.4% 11.6%

2009E 288.3 20.3 308.6 95.3 213.3 69.1% 125.3 29.1 30.4 184.7 28.5 9.2% 70.9 23.0% 90.1% 5.1 33.6 11.8 21.9 47.3 $ $ 0.36 0.70 60.9 67.3 40.6% 9.4% 9.8%

(8.1) -10.2% 8.0 10.1% 0.6 (7.5) 0.2 (7.7) (2.4) $ $ (0.45) (0.22) 35.8 39.8 44.2% 10.9% 15.2%

81.6% 197.4% 86.3% 45.2% 31.4% 94.6% 41.1%

74.0% 110.3% 76.4% 74.5% 88.5% 91.0% 80.3%

52.7% 34.5% 51.2% 56.8% 34.9% 7.0% 41.8%

45.5% 38.9% 45.0% 30.0% 31.1% 22.7% 28.9%

225

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

North America Equity Research 02 January 2008

Table 146: OMTR Quarterly Income Statement


$ in millions, except per share data 1Q'06 15.5 0.9 16.4 6.8 9.7 58.8% 8.2 2.0 2.9 13.0 (3.3) -20.4% (0.1) -0.3% (0.0) (3.4) 0.0 (3.4) (2.4) $ (0.24) $ (0.17) 14.0 14.0 49.8% 12.0% 17.3% 100.2% 223.5% 104.4% 69.1% 71.2% 198.4% 87.3% FY 2006 2Q'06 3Q'06 17.6 19.5 1.2 1.5 18.8 21.0 7.6 11.3 59.8% 8.6 2.1 2.6 13.2 (2.0) -10.6% 1.8 9.8% (0.3) (2.3) 0.0 (2.3) (1.0) $ (0.16) $ (0.07) 14.2 14.2 45.7% 11.0% 13.6% 91.0% 322.8% 98.1% 44.9% 28.8% 79.3% 47.5% 8.5 12.5 59.6% 8.8 2.3 3.1 14.2 (1.7) -8.0% 2.7 13.0% 0.5 (1.2) 0.1 (1.3) 0.2 $ (0.03) $ 0.00 45.9 52.1 42.1% 10.9% 14.6% 75.4% 295.0% 82.6% 35.2% 13.8% 67.2% 36.8% 4Q'06 21.9 1.6 23.5 9.0 14.5 61.7% 9.6 2.4 3.6 15.6 (1.1) -4.8% 3.5 15.1% 0.4 (0.7) 0.1 (0.8) 0.9 $ (0.02) $ 0.02 47.3 53.0 40.9% 10.2% 15.4% 69.1% 96.0% 70.7% 38.2% 27.9% 81.3% 16.3% 1Q'07 27.3 1.8 29.2 10.7 18.4 63.2% 13.3 3.1 4.4 20.9 (2.4) -8.4% 4.0 13.6% 0.0 (2.4) 0.0 (2.4) 0.9 $ (0.05) $ 0.02 47.8 54.4 45.7% 10.8% 15.0% 75.8% 104.6% 77.4% 62.9% 59.4% 53.9% 60.4% FY 2007 2Q'07 3Q'07 30.6 34.4 2.9 3.0 33.5 37.4 12.7 20.7 61.9% 15.3 4.0 5.9 25.2 (4.5) -13.3% 5.1 15.1% 0.5 (4.0) 0.1 (4.1) 1.9 $ (0.08) $ 0.03 49.8 56.1 45.8% 11.9% 17.5% 73.9% 134.5% 77.9% 78.3% 91.2% 128.7% 90.1% 13.8 23.5 63.0% 15.7 4.7 6.4 26.8 (3.2) -8.6% 6.1 16.4% 2.2 (1.0) 0.1 (1.1) 4.4 $ (0.02) $ 0.07 57.9 64.3 42.0% 12.5% 17.1% 75.9% 102.5% 77.8% 77.6% 103.9% 107.4% 88.3% 4Q'07E 37.5 3.1 40.7 14.3 26.3 64.8% 17.1 4.7 6.5 28.3 (1.9) -4.7% 7.3 17.9% 1.0 (1.0) 0.1 (1.1) 5.2 $ (0.02) $ 0.08 58.3 64.7 42.1% 11.6% 16.0% 71.3% 101.9% 73.3% 78.2% 95.7% 79.6% 81.2% 1Q'08E 43.9 3.2 47.2 16.4 30.8 65.2% 21.7 5.3 5.9 32.9 (2.2) -4.6% 7.4 15.7% 0.9 (1.2) 0.1 (1.3) 4.6 $ (0.02) $ 0.07 58.7 65.1 46.1% 11.2% 12.5% 60.8% 77.2% 61.8% 63.2% 68.1% 34.4% 57.9% FY 2008 2Q'08E 3Q'08E 46.8 51.8 3.6 3.8 50.4 55.5 17.1 33.3 66.0% 23.0 5.3 5.9 34.2 (0.9) -1.8% 8.9 17.6% 1.0 0.1 0.1 0.0 6.0 $ 0.00 $ 0.09 59.1 65.5 45.6% 10.5% 11.7% 52.9% 24.8% 50.5% 49.7% 33.3% 0.4% 35.6% 18.8 36.8 66.2% 25.1 5.7 6.4 37.1 (0.3) -0.6% 9.7 17.4% 1.0 0.7 0.1 0.6 6.7 $ 0.01 $ 0.10 59.5 65.9 45.1% 10.2% 11.5% 50.7% 24.9% 48.6% 59.4% 21.7% 0.1% 38.7% 4Q'08E 55.7 4.0 59.7 19.4 40.3 67.5% 26.6 6.0 6.6 39.1 1.1 1.9% 11.3 19.0% 1.1 2.3 0.1 2.2 8.4 $ 0.04 $ 0.13 59.9 66.3 44.6% 10.0% 11.0% 48.3% 27.7% 46.7% 55.6% 27.0% 1.2% 38.4%

Subscription Professional services and other Total Revenues Cost of Revenues Gross Profit Gross Margin Sales & marketing Research & development General and administrative Litigation settlement Total Operating Expenses Operating Profit (Loss) Operating Margin EBITDA EBITDA Margin Other Income (Expense) Profit (Loss) before provision for income taxes Provision for income taxes Net Income (Loss) - GAAP Net Income (Loss) - Pro forma EPS - GAAP (w/FAS123R) EPS - Pro forma (ex-FAS123R) Basic Shares Outstanding Diluted Shares Outstanding % of Revenue Sales & marketing Research & development General and administrative Growth Y/Y Subscription Professional services and other Total Revenues Sales & marketing Research & development General and administrative Total Expenses
Source: Company reports and JPMorgan estimates. 226

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

North America Equity Research 02 January 2008

Table 147: OMTR Annual Balance Sheet


$ in millions 2006 ASSETS Cash & cash equivalents Short-term investments Accounts receivable, net Prepaid expenses & other current assets Total Current Assets Property and equipment, net Intangible assets, net Goodwill Other assets Total Non-Current Assets Total Assets LIABILITIES Accounts Payable Accrued Liabilities Deferred Revenues Current notes payable, capital lease obligations Deferred Consideration related to business acq Total Current Liabilities Deferred revenues, less current Notes payable, less current portion Capital lease obligations, less current portion Other liabilities Total LT Liabilities Total Liabilities Convertible preferred stock STOCKHOLDERS' DEFICIT Common Stock Additional paid-in capital Deferred stock-based compensation Accumulated other comprehensive income Accumulated Deficit Total Stockholders Equity Total Liabilities & Owners Equity
Source: Company reports and JPMorgan estimates.

2007E 68.3 24.1 1.6 94.0 31.1 9.8 0.3 41.2 135.2 61.8 117.0 38.6 3.8 221.2 32.5 32.2 48.0 0.6 113.4 334.6

2008E 87.0 123.0 56.7 4.2 270.8 41.7 25.8 48.0 0.9 116.4 387.1

2009E 131.1 129.2 81.8 6.0 348.2 57.2 19.4 48.0 1.3 126.0 474.1

2.6 11.4 21.9 6.1 42.0 2.2 4.1 0.0 0.5 6.8 48.8 0.1 263.1 (10.3) 0.0 (148.2) 86.4 135.2

8.0 15.2 37.8 4.7 65.8 1.4 2.1 0.2 6.8 10.6 76.4 0.1 593.9 (3.1) (0.6) (91.8) 258.2 334.6

11.7 22.4 53.7 6.9 94.7 2.1 3.1 0.4 10.0 15.6 110.3 276.9 387.1

16.9 32.3 77.5 10.0 136.7 2.5 4.5 0.5 14.4 22.5 159.2 315.0 474.1

227

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

North America Equity Research 02 January 2008

Table 148: OMTR Annual Cash Flow Statement


$ in millions 2006 OPERATING ACTIVITIES Net Income (Loss) Depreciation Amortization Stock-based compensation Loss on disposal of property and equipment Patent license and litigation settlement costs Loss on foreign currency forward contract Changes in Working Capital Accounts receivable, net Prepaid expenses and other assets Account payable Accrued and other liabilities Deferred revenue Deferred gain on extinguishment of debt Net Cash Provided by Operating Activities Free Cash Flow (FCF) INVESTING ACTIVITIES Purchases of short-term investments, net Purchases of property and equipment (CAPX) Purchase of intangible assets Payment related to foreign currency forward contract Business acquisitions, net of cash Net Cash Provided by Investing Activities FINANCING ACTIVITIES Proceeds from exercise of stock options Proceeds from employee SPP Proceeds from issuance of preferred stock, net Repurchase of preferred stock Repurchase of preferred warrants Proceeds from issuance of notes payable, capital leases Issuance of common stock through IPO Principal payments on notes payable, capital leases Net Cash Provided by Financing Activities Effect of FX on Cash & Equivalents Net Increase in Cash & Equivalents Cash & Equivalents at Beginning of Period Cash & Equivalents at End of Period
Source: Company reports and JPMorgan estimates.

2007E (8.7) 13.4 5.7 13.4 (0.0) 0.2 (12.8) (0.6) 5.0 2.1 12.0 29.8 15.9 (114.8) (13.9) (3.6) (0.3) (44.2) (176.8) 2.6 0.2 142.2 (4.6) 140.4 (6.5) 68.3 61.8

2008E 1.4 15.4 6.4 17.8 (18.0) (0.7) 3.7 7.1 16.6 49.7 25.2 (24.5) (24.5) 25.2 61.8 87.0

2009E 21.9 17.0 6.4 19.0 (25.1) (2.3) 5.2 9.9 24.7 76.7 44.1 (32.6) (32.6) 44.1 87.0 131.1

(7.7) 11.4 1.6 3.2 (11.8) (1.0) (1.5) 1.1 9.9 5.2 (9.7) (14.9) (7.9) (22.8) 0.2 9.6 59.2 (5.4) 63.7 46.1 22.2 68.3

228

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

North America Equity Research 02 January 2008

Priceline, Overweight ($118.23)


We are upgrading PCLN to Overweight from Neutral Current Street models dont appreciate the growth available internationally. Ownership of Active Hotels and Bookings gives PCLN revenue opportunities through international sales, cross selling with the domestic market, and through affiliate partnerships. International performance accounts for ~57% of gross bookings, one-third of revenue and almost two-thirds (64%) of gross profit, thereby limiting the impact of GDS negotiations and airline revenue tightening. We expect international gross bookings to contribute $1.6B or 88% of growth in FY08. Priceline appears well positioned to take domestic market share. We believe that domestic top-line growth will remain strong with the positive customer response to the removal of airline booking fees and momentum in merchant products. We expect this momentum in higher-margin merchant revenue to continue in F'08 as we see more inventory becoming available in a weak economy and as consumers become more price conscious. We are modeling Y/Y merchant gross bookings growth of 7.7% and total domestic gross bookings growth of 10.6% for F08 (9.0% and 8.2% in F07E). Margin expansion is likely given leverage and expense control. We believe that the company operates a highly scalable business model that allows for international expansion with few additional costs. Additionally, the domestic business is benefiting from expense discipline programs implemented approximately a year ago that have given the US business even more operating leverage than the European business. We are modeling 210 bps of pro forma operating margin expansion to 16.8%in F08, which we note is still well below Expedia's pro forma F'08E margin of 24.5%. 2008 Drivers. In our view, the following factors will drive PCLN shares in 2008: (1) comping the airline no booking fee policy, (2) expanding international business to new markets, and (3) benefiting from the Agoda acquisition and synergy opportunities. Maintaining 4Q'07 estimates. We maintain our 4Q07 revenue, EBITDA, and EPS estimates of $327.4M, $48.4M, and $0.59 (Y/Y growth of 26%, 85%, and 68% respectively). Our current and newly introduced 2009 estimates are in the table below:
Table 149: Priceline Financial Snapshot
$ in millions, except per share data Priceline JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07E 327.43 48.36 0.59 324.29 49.07 0.56 F'07E 1,401.99 161.41 3.22 1388.98 218.14 3.21 F'08E 1,709.79 296.46 3.92 1689.9 299.02 3.92 F'09E 2,026.34 407.63 5.10 1889.47 364.23 4.82 F'07E Y/Y 24.83% 50.77% 98.33% F'08E Y/Y 21.95% 83.67% 21.90% 21.66% 37.08% 22.12% F'09E Y/Y 18.51% 37.50% 29.94% 11.81% 21.81% 22.96%

Source: JPMorgan estimates, Company data, and Bloomberg 229

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


We are adjusting our F08 revenue estimate to $1.71B and our full-year EBITDA estimate to $296.5M, representing Y/Y revenue and EBITDA growth of 22% and 84%, respectively. Current Street models dont appreciate the growth available internationally. We expect international revenue to grow 62% Y/Y in F08 as a result of the following factors: Expansion into new regions Priceline has significant opportunities to expand throughout Europe. Many European countries are earlier in the online retailing adoption process thereby offering growth not only through increasing market share but also from a growing market size. The company estimates that Europe Internet penetration is only at 38.9% of the population vs. 69.9% in the US.. Additionally, the introduction of offices in Ireland, Vienna, and Portugal further rolls out the supply and distribution function to new European locations, providing both long- (Eastern Europe) and short-term (Western Europe) opportunities.
Figure 84: Geographic Presence

Source: Company Reports

In 3Q07, Priceline announced its acquisition of Bangkok-and Singapore-based Agoda. The company is an OTA specializing in merchant hotel discount bookings throughout Asia. We believe that this is a valuable acquisition for entry into a developing market and that clear synergies can be achieved operationally and with inventory. We estimate that Agoda will contribute ~$76M to gross bookings in F08 and be slightly accretive to pro forma earnings. Cross-sales with the domestic market Access to the more than 24,000 hotel options available at Active Hotels and Bookings has allowed Priceline to create European vacation packages and hotel opportunities on the domestic website, further driving international revenues and differentiating itself from competitors with its broad overseas offering.

230

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

North America Equity Research 02 January 2008

Affiliate partnerships yield additional income Active Hotels promotes its offerings across 1,500 websites and Booking.com supplements this with additional affiliates. Through profitable revenue sharing agreements, this allows the large hotel inventories to be marketed on a much broader scale. International hotel business growth limits the impact of airline revenue tightness and unfavorable GDS negotiations International performance accounts for approximately one-third of revenue and almost two-thirds gross profit, thereby limiting the impact of GDS negotiations and airline revenue tightening as these areas become a smaller proportion of income. We expect international gross bookings to contribute $1.6B or 88% of growth in FY08, continuing this trend.
Figure 85: International Gross Bookings Growth
$ in thousands
$2,500,000 $2,000,000 185.0% $1,500,000 $1,000,000 $500,000 $0 2003
Source: Company data

94.1%

625.2% NM 603.9% 2004 2005 2006 YTD06 YTD07

Domestic growth looks promising. We believe that domestic top-line growth will remain strong with the positive customer response to the removal of airline booking fees and momentum in merchant products. We expect this momentum in higher-margin merchant revenue to continue in F'08 as we see more inventory becoming available in a weak economy and as consumers become more price conscious. Furthermore, low-margin airline travel is accounting for a smaller proportion of sales with hotels and car rentals growing at a much faster pace. Hotel room bookings now compose the majority of sales and are expected to grow at the fastest pace. We are modeling Y/Y merchant gross bookings growth of 7.7% and total domestic gross bookings growth of 10.6% for F08 (9.0% and 8.2% in F07E).

231

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

North America Equity Research 02 January 2008

Figure 86: Units Sold by Type of Product


15,000 10,000 5,000 Q1-05 Q2-05 Q3-05 Q4-05 Q1-06 Q2-06 Q3-06 Q4-06 Q1-07 Q2-07 Q3-07 Air - Total Airline Tickets (000's) Car - Total Rental Car Day s (000's)
Source: Company reports and JPMorgan estimates.

Hotel - Total Room Nights (000's)

Margin expansion is likely given leverage and expense control We believe that the company operates a highly scalable business model that allows for international expansion with few additional costs. Additionally, the domestic business is benefiting from expense discipline programs implemented approximately a year ago that have given the US business even more operating leverage than the European business. We are modeling 210 bps of pro forma operating margin expansion to 16.8%, which we note is still well below Expedia's pro forma F'08E margin of 24.5%.
Table 150: Historical Operating Margin Trends
$ in millions Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma)
Source: JPMorgan estimates and Company data

F'05 35.9 60.4 3.7% 6.3%

F'06 62.0 98.8 5.5% 8.8%

F'07E 128.2 206.3 9.1% 14.7%

F'08E 254.5 286.5 14.9% 16.8%

F'09E 360.6 393.6 17.8% 19.4%

Our Estimates and Outlook for 2009


We are introducing F09 revenue, EBITDA, and EPS estimates of $2.03B, $407.6M, and $5.10, which represents 19%, 38%, and 30% Y/Y growth, respectively. Again, growth should be mostly supported by the international market where we see gross bookings increases of 39% Y/Y, moving the international market to account for an expected 70% of gross bookings. We expect the company to strategically support the international market by concentrating on developing its presence in Eastern Europe and Asia as the Western European market matures. We see an additional 260 bps of pro forma operating margin expansion due to leverage of the business and increases in merchant revenues.

Valuation and Rating Analysis


On a price/non-GAAP FCF basis, PCLN shares are trading at 19x our F08 nonGAAP FCF estimate of $281M versus its peer group, which is trading at 24x F08 estimates. We believe that this discount is unjustified given its high F08 non-GAAP FCF estimated growth rate of 90% vs. the peer group average of 32%. As such, we rate this stock Overweight.

232

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

North America Equity Research 02 January 2008

Risks to Our Rating


Priceline shares could underperform other companies in our coverage universe if its domestic growth is pressured by competition from other OTA's or suppliers, if it has difficulty obtaining merchant inventory, if it experiences increased competition in the international market, or if sales and marketing and technology expenses increase significantly.

233

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

North America Equity Research 02 January 2008

Table 151: PCLN Annual Income Statement


$ in millions, except per share data FY-06 Merchant Revenues Agency Revenues Other Revenues Total Revenue Pro Forma Revenue Cost of Revenue (Reported) Cost of Revenue (Pro Forma) Gross Profit (Reported) Gross Profit (Pro Forma) Gross Margin Pro Forma) Advertising Sales & Marketing Personnel General and Administrative Information Technology Depreciation & Amortization Unusual Expenses FAS123R Adjustments to Operating Exp Total Operating Exp (Reported) Total Operating Exp (Pro Forma) Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma) EBITDA Y/Y change Interest (Inc & Exp) Other Adjustments to Other Income Total Other (Reported) Total Other (Pro Forma) EBT (Reported) EBT (Pro Forma) Income Tax, Reported Income Tax Pro forma Equity in income (loss) of minority interest Equity in income of minority int. (Pro Forma) Net Income (Reported) Net Income w/ FAS 123R Adjustment Net Income (Pro Forma) Preferred Stock Dividend EPS (Reported) EPS (Pro Forma) Shares Outstanding (Basic) Shares Outstanding (Diluted GAAP) Shares Outstanding (Diluted Pro Forma)
Source: Company reports and JPMorgan estimates.

FY-07E 1,005.9 389.0 7.0 1,402.0 1,383.4 772.9 772.9 629.1 610.5 43.5% 209.7 48.5 84.3 93.0 13.6 35.8 16.1 (80.6) 500.9 404.2 128.2 206.3 9.1% 14.7% 161.4 50.8% 15.8 (3.4) 12.5 9.3 140.6 215.6 15.3 (35.2) (3.9) (4.5) 152.0 152.0 176.0 $3.22 $3.96 37.6 42.6 42.6

FY-08E 1,088.0 615.9 5.9 1,709.8 1,709.8 931.6 931.6 778.2 778.2 45.5% 259.9 59.6 101.1 44.1 17.1 38.0 18.0 (28.0) 523.7 491.7 254.5 286.5 14.9% 16.8% 296.5 83.7% 18.8 0.4 19.2 19.2 273.7 305.7 (76.6) (61.1) 197.0 197.0 244.5 $3.92 $4.87 38.2 50.0 50.0

FY-09E 1,164.4 846.0 16.0 2,026.3 2,026.3 1,044.8 1,044.8 981.5 981.5 48.4% 314.1 70.5 117.1 48.8 23.4 42.0 20.0 (28.0) 620.9 587.9 360.6 393.6 17.8% 19.4% 407.6 37.5% 20.0 20.0 20.0 380.7 413.7 (106.6) (86.9) 274.1 274.1 326.8 $5.10 $6.08 40.1 53.6 53.6

904.2 213.9 5.0 1,123.1 1,123.1 722.0 721.0 401.1 401.0 35.7% 145.7 42.1 68.0 28.4 9.7 33.4 0.1 15.1 (26.5) 339.1 302.1 62.0 98.8 5.5% 8.8% 107.1 54.7% 4.3 (0.6) 3.6 3.6 65.6 102.5 12.4 (15.7) (3.6) (3.7) 74.5 74.5 83.1 (1.9) $1.62 $2.03 38.7 44.7 40.9

234

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

North America Equity Research 02 January 2008

Table 152: PCLN Quarterly Income Statement


$ in millions, except per share data FY-2006 Q1-06 Q2-06 Merchant Revenues Agency Revenues Other Revenues Total Revenue Pro Forma Revenue Cost of Revenue (Reported) Cost of Revenue (Pro Forma) Gross Profit (Reported) Gross Profit (Pro Forma) Gross Margin Pro Forma) Advertising Sales & Marketing Personnel General and Administrative Information Technology Depreciation & Amortization Unusual Expenses FAS123R Adjustments to Operating Exp Total Operating Exp (Reported) Total Operating Exp (Pro Forma) Operating Profit (Reported) Operating Profit (Pro Forma) Operating Margin (Reported) Operating Margin (Pro Forma) EBITDA Y/Y change Interest (Inc & Exp) Other Adjustments to Other Income Total Other (Reported) Total Other (Pro Forma) 210.4 30.4 1.1 241.9 241.9 169.7 169.3 72.2 72.6 30.0% 31.3 9.6 13.4 5.6 2.3 7.9 0.1 3.1 -5.7 73.5 64.7 -1.2 7.9 -0.5% 3.3% 10.3 250.5 55.9 1.2 307.7 307.7 201.8 201.5 105.8 106.1 34.5% 39.4 10.7 15.0 7.1 2.3 8.4 3.8 -5.8 86.8 77.1 19.0 29.0 6.2% 9.4% 31.6 Q3-06 238.6 73.3 1.6 313.5 313.5 189.9 189.5 123.5 122.3 39.0% 41.2 11.2 21.7 6.6 2.6 8.7 3.5 (4.4) 91.9 84.0 31.6 38.3 10.1% 12.2% 39.0 Q4-06 204.6 54.3 1.1 260.1 260.1 160.6 160.6 99.5 99.9 38.4% 33.8 10.6 17.9 9.0 2.6 8.5 4.7 (10.6) 86.9 76.3 12.6 23.6 4.8% 9.1% 26.1 69.6% 2.53 -0.45 2.08 2.08 FY-2007E Q1-07 Q2-07 246.0 54.5 0.9 301.4 285.5 181.7 181.7 119.7 103.8 36.4% 43.3 11.4 18.3 63.9 2.9 8.5 3.2 (61.2) 151.5 87.1 (31.7) 16.8 -10.5% 5.6% -35.9 -449.0% 5.73 -0.21 -2.79 5.52 2.73 254.9 98.3 2.6 355.9 353.6 198.7 198.7 157.2 154.9 43.8% 52.8 11.5 20.0 9.7 3.2 9.0 3.6 (6.2) 109.6 99.9 47.6 55.0 13.4% 15.5% 57.8 83.0% 3.63 -0.33 -0.26 3.30 3.03 Q3-07 275.2 139.6 2.5 417.3 416.9 215.0 215.0 202.3 201.9 48.4% 62.3 13.1 23.1 9.0 3.3 9.1 4.4 (6.2) 124.2 113.6 78.1 88.3 18.7% 21.2% 91.2 133.5% 3.46 -1.32 -0.08 2.14 2.06 Q4-07E 229.8 96.5 1.1 327.4 327.4 177.6 177.6 149.8 149.8 45.8% 51.4 12.4 22.9 10.5 4.2 9.1 5.0 (7.0) 115.6 103.6 34.2 46.2 10.5% 14.1% 48.4 85.1% 3.00 -1.50 1.50 1.50 FY-2008E Q1-08E Q2-08E 264.4 95.7 1.1 361.2 361.2 225.8 225.8 135.4 135.4 37.5% 54.9 14.1 22.8 8.7 3.6 9.5 4.0 (7.0) 117.5 106.5 17.9 28.9 4.9% 8.0% 31.4 -187.2% 3.72 0.11 3.83 3.83 278.7 168.8 2.6 450.1 450.1 241.2 241.2 208.8 208.8 46.4% 68.4 14.9 25.0 10.8 4.5 9.5 4.0 (7.0) 133.0 126.0 75.8 82.8 16.8% 18.4% 85.3 47.5% 3.16 0.11 3.27 3.27 Q3-08E 297.2 206.3 1.1 504.6 504.6 253.7 253.7 250.8 250.8 49.7% 76.7 15.6 27.8 11.6 5.0 9.5 5.0 (7.0) 146.2 139.2 104.6 111.6 20.7% 22.1% 114.1 25.2% 4.79 0.11 4.90 4.90 Q4-08E 247.7 145.1 1.1 393.9 393.9 210.8 210.8 183.1 183.1 46.5% 59.9 15.0 25.6 13.0 3.9 9.5 5.0 (7.0) 126.9 119.9 56.2 63.2 14.3% 16.0% 65.7 35.9% 7.09 0.11 7.20 7.20

0.1 0.1 0.2 0.2

0.6 -0.6 (0.06) (0.06)

1.08 0.35 1.43 1.43

235

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

North America Equity Research 02 January 2008

EBT (Reported) EBT (Pro Forma) Income Tax, Reported Income Tax Pro forma Equity in income (loss) of minority interest Equity in income of minority int. (Pro Forma) Net Income (Reported) FAS 123R Adjustment Net Income w/ FAS 123R Adjustment Net Income (Pro Forma) Net Income (Pro Forma) W/FAS 123 Preferred Stock Dividend EPS (Reported) EPS (Pro Forma) Shares Outstanding (Basic) Shares Outstanding (Diluted GAAP) Shares Outstanding (Diluted Pro Forma) % of Total Revenue Operating Expenses Cost of Revenue (Pro Forma) Advertising Sales & Marketing Personnel General and Administrative Information Technology Depreciation & Amortization Y/Y Change Total Revenue Merchant Rev. Agency Rev. Cost of Revenue (Pro Forma) Gross Profit Advertising Sales & Marketing Personnel General and Administrative Information Technology Depreciation & Amortization
Source: Company reports and JPMorgan estimates.

FY-2006 Q1-06 Q2-06 (1.0) 19.0 8.1 28.9 0.7 (5.6) (0.3) (4.7) 0.2 (0.9) (0.2) (1.3) (0.1) 12.5 (0.1) 7.6 7.6 -0.9 (0.02) $0.19 39.4 39.4 40.9 26.7% 70.0% 12.9% 4.0% 5.6% 2.3% 1.0% 3.3% 3.7% -3.0% 103.6% -3.4% 25.0% 49.0% 16.7% 19.7% 33.3% -15.8% 45.4% 12.5 23.0 23.0 0.0 $0.28 $0.55 39.5 47.0 41.8 25.1% 65.5% 12.8% 3.5% 4.9% 2.3% 0.8% 2.7% 15.4% 1.6% 196.4% 0.3% 61.9% 93.9% 5.9% 54.1% 30.7% -16.0% 65.6%

Q3-06 33.03 39.71 18.11 (7.98) (2.33) (1.58) 48.8 48.8 30.2 30.2 (1.06) $1.05 $0.72 39.6 46.4 42.0 26.8% 60.5% 13.2% 3.6% 6.9% 2.1% 0.8% 2.8% 21.1% 7.4% 106.6% 6.5% 51.3% 51.6% 16.2% 56.7% 38.0% 1.7% 21.4%

Q4-06 14.66 25.73 (0.89) (2.66) (0.54) (0.64) 13.2 13.2 22.4 22.4 0.00 $0.35 $0.58 36.2 40.9 38.9 29.3% 61.7% 13.0% 4.1% 6.9% 3.4% 1.0% 3.3% 27.5% 18.1% 82.4% 15.9% 53.0% 60.8% 67.9% 20.5% 40.3% -1.5% 9.9%

FY-2007E Q1-07 Q2-07 (26.22) 50.87 19.49 58.04 11.59 (14.96) (1.71) (9.36) (0.09) (1.33) (0.40) (1.33) (14.7) 34.6 (14.7) 17.4 17.4 (1.56) -$0.44 $0.43 37.2 37.2 40.2 28.9% 60.3% 15.2% 4.0% 6.4% 22.4% 1.0% 2.8% 24.6% 16.9% 79.4% 7.3% 43.1% 38.2% 19.1% 36.4% 1030.9% 26.2% 7.0% 34.6 47.3 47.3 0.00 $0.79 $1.11 37.6 43.7 42.7 28.1% 55.8% 14.9% 3.3% 5.6% 2.7% 0.9% 2.5% 15.7% 1.8% 76.0% -1.4% 45.9% 34.0% 7.6% 32.8% 35.9% 35.2% 7.6%

Q3-07 80.22 90.35 26.66 (16.09) (2.52) (2.72) 104.4 104.4 71.5 71.5 0.00 $2.27 $1.58 37.8 45.9 45.4 27.2% 51.5% 14.9% 3.1% 5.5% 2.2% 0.8% 2.2% 33.1% 15.4% 90.4% 13.4% 65.1% 51.0% 16.9% 6.5% 35.7% 31.0% 5.4%

Q4-07E 35.73 47.73 (8.00) (8.00) 27.7 27.7 39.7 39.7 0.00 $0.59 $0.85 38.0 47.0 47.0 31.6% 54.2% 15.7% 3.8% 7.0% 3.2% 1.3% 2.8% 25.9% 12.3% 77.8% 10.6% 49.9% 52.2% 17.1% 28.0% 17.1% 63.8% 7.7%

FY-2008E Q1-08E Q2-08E 21.69 79.06 32.69 86.06 (6.07) (22.14) (6.54) (17.21) 15.6 15.6 26.2 26.2 0.00 $0.32 $0.53 38.2 49.0 49.0 29.5% 62.5% 15.2% 3.9% 6.3% 2.4% 1.0% 2.6% 19.8% 7.5% 75.6% 24.3% 30.4% 26.9% 23.5% 24.2% -86.4% 24.1% 11.7% 56.9 56.9 68.8 68.8 0.00 $1.16 $1.41 38.2 49.0 49.0 28.0% 53.6% 15.2% 3.3% 5.6% 2.4% 1.0% 2.1% 26.5% 9.3% 71.6% 21.4% 34.8% 29.7% 28.9% 25.1% 11.6% 42.8% 5.6%

Q3-08E 109.51 116.51 (30.66) (23.30) 78.8 78.8 93.2 93.2 0.00 $1.55 $1.83 38.2 51.0 51.0 27.6% 50.3% 15.2% 3.1% 5.5% 2.3% 1.0% 1.9% 20.9% 8.0% 47.8% 18.0% 24.2% 23.2% 19.5% 20.4% 28.8% 50.9% 4.0%

Q4-08E 63.41 70.41 (17.75) (14.08) 45.7 45.7 56.3 56.3 0.00 $0.90 $1.10 38.2 51.0 51.0 30.4% 53.5% 15.2% 3.8% 6.5% 3.3% 1.0% 2.4% 20.3% 7.8% 50.3% 18.7% 22.2% 16.5% 20.3% 11.7% 24.1% -6.0% 4.0%

236

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

North America Equity Research 02 January 2008

Table 153: PCLN Annual Balance Sheet


$ in millions FY-06 Cash and cash equivalents Restricted cash Short-term investments Accounts receivable Prepaid expenses and other current assets Total current assets Property and equipment, net Intangible assets, net Goodwill Deferred Taxes Other assets Total assets Accounts payable Accrued expenses Deferred merchant bookings Other current liabilities Total current liabilities Deferred Taxes Other long-term liabilities Minority Interest Long-term debt Total liabilities Series B Mandatorily Redeemable Preferred Stock Common stock, $0.008 par value per share, Treasury stock, 2,496,326 shares and 2,496,326 Additional paid-in capital Deferred compensation Accumulated deficit Accumulated other comprehensive income Total stockholders equity Total liabilities and stockholders equity
Source: Company reports and JPMorgan estimates.

FY-07E 438.1 2.7 73.0 62.2 26.2 602.3 28.0 182.4 270.8 222.8 39.8 1,346.1 58.9 58.9 7.7 569.5 695.0 47.2 12.5 15.1 0.0 769.8 0.0 0.0 0.3 (488.7) 2,154.4 0.0 (1,139.4) 49.6 576.3 1,346.1

FY-08E 674.9 2.7 73.0 91.2 26.2 868.1 31.6 182.4 270.8 222.8 39.8 1,615.5 78.9 58.9 7.7 569.5 715.0 47.2 12.5 15.1 0.0 789.8 0.0 0.0 0.3 (488.7) 2,403.8 0.0 (1,139.4) 49.6 825.7 1,615.5

FY-09E 983.8 2.7 73.0 124.3 28.9 1,212.8 35.6 182.4 270.8 222.8 39.8 1,964.2 98.9 58.9 7.7 569.5 735.0 47.2 12.5 15.1 0.0 809.8 0.0 0.0 0.3 (488.7) 2,732.5 0.0 (1,139.4) 49.6 1,154.4 1,964.2

423.6 2.5 8.0 48.5 20.5 503.1 21.7 152.9 226.7 179.4 21.8 1,105.6 49.0 46.9 4.8 0.0 100.7 39.7 11.9 22.5 568.9 743.6 13.5 0.0 0.3 (486.5) 2,070.4 0.0 (1,262.0) 26.3 348.6 1,105.6

237

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

North America Equity Research 02 January 2008

Table 154: PCLN Annual Cash Flow Statement


$ in millions FY-06 Net income (loss) Depreciation Amortization Provision for uncollectible accounts Deferred Income Tax Restructuring charge, net Warrant costs Equity in loss of investees, net Impairments of investments in licensees Net gain on disposal of property and equipment Compensation expense arising from restricted stock awards Amortization of debt issuance costs Changes in assets and liabilities: Accounts receivable Prepaid expenses and other current assets Accounts payable and accrued expenses Other Cash Flow from Operations FCF Additions to property and equipment Purchase of short-term investments Maturing of Investments (investing) (Funding)Return of restricted cash and bank certificate of deposit Equity investment and other acquisitions Cash flow from Investing Activities Proceeds from sale of common stock Proceeds from issuance of convertible senior notes Proceeds from exercise of stock options/warrants Proceeds from sale of minority interest in subsidiary Purchase of conversion spread hedges Additional debt issuance costs Excess tax benefit from stock based comp Repurchase of stock Cash flow from Financing Activites Effect of exchange rate changes on cash Net Change in Cash Cash at the Beginning of period Cash at the End of Period
Source: Company reports and JPMorgan estimates.

FY - 07E 152.0 5.3 18.5 4.0 (7.2) 1.4 11.5 1.6 (37.5) 12.6 (2.5) (48.4) 0.8 106.9 92.9 (14.0) (22.4) 8.0 (0.2) (59.2) (87.8) 9.65 (0.12) 0.57 (16.64) (6.54) 0 1.984 14.5 423.6 438.1

FY - 08E 197.0 12.4 25.6 10.4 16.4 (9.0) (29.0) 20.0 252.8 236.8 (16.0) (16.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 236.8 438.1 674.9

FY - 09E 274.1 16.0 26.0 11.6 17.0 (15.8) (33.1) (2.7) 20.0 328.9 308.9 (20.0) (20.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 308.9 674.9 983.8

74.5 10.1 24.8 5.1 (27.8) 0.1 3.6 14.9 1.9 4.9 (21.2) (2.6) 27.4 1.3 112.1 99.2 (12.9) (112.0) 176.8 19.9 (3.1) 68.8 345.00 14.13 (19.83) (37.40) (9.05) 0.28 (135.84) 157.3 338.2 73.1 423.6

238

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

North America Equity Research 02 January 2008

Shutterfly, Overweight ($27.38)


Shutterflys efforts to diversify its business away from traditional photo prints and into higher ASP products will help drive revenue growth in 2008 and 2009, in our view. We also believe strong customer metrics in conjunction with continued digital camera adoption will drive revenue growth. We reiterate our Overweight rating. Shutterflys diversified product offering should drive revenue metrics. With the purchase of Make It about Me! and branding arrangements with companies such as Nickelodeon and Martha Stewart in 2007, we believe Shutterfly is committed to its expansion into personalized products and higher ASP photo merchandise. In 2008 and 2009, we believe Shutterfly will enjoy strong growth in higher ASP product categories, which will drive stronger overall revenue growth. We expect F08 customer growth, order growth, and AOV growth of 28.3%, 29.1%, and 6.2%, respectively. Completion of Charlotte facility should positively impact margins in 2008. While the Charlotte facility began operations in 2007, we think the margin impact will be felt in 2008,, once the facility has worked out any operational kinks and begins to run near full capacity. We are forecasting F08 margins to improve ~110bps to 6.9% from 5.8% in F'07. International expansion is not likely until 2009. Currently, over 98% of SFLYs revenue comes from the U.S. and the company remains focused on bolstering its platform and infrastructure to support US growth. However, we believe SFLY will begin to look for international opportunities in F'09. 2008 Drivers. We believe the following factors will drive Shutterflys share price in 2008: (1) continued creative marketing efforts with fast ROI (e.g., marketing arrangements with Target and David's Bridal), (2) introduction of new products and/or partnerships that decrease the seasonality of the business (e.g., the acquisition of Make It About Me! and book licensing arrangements with Nickelodeon), and (3) print price stability. Maintaining estimates. We are maintaining our 4Q07 revenue, EBITDA, and adjusted EPS estimates of $93.8M, $32.0M, and $0.64 (representing Y/Y growth of 43%, 34.1%, and 31.2% respectively). For 2007, we are modeling revenues, EBITDA, and adjusted EPS of $183.0M, $31.8M, and $0.36.

The table below outlines our current estimates, including our newly introduced 2008 estimates.
Table 155: Shutterfly Estimate Highlights
$ in millions Shutterfly JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07 93.8 32.0 0.64 93.7 32.3 0.65 F'07 183.0 31.8 0.38 182.9 31.3 0.40 F'08 251.0 44.8 0.53 252.2 44.3 0.57 F'09 328.1 61.5 0.75 325.6 68.5 0.90 F'07 Y/Y 48.3% 53.6% -31.7% 48.3% 51.1% -28.6% F'08 Y/Y 37.2% 40.7% 39.6% 37.9% 41.5% 42.5% F'09 Y/Y 30.7% 37.3% 41.3% 29.1% 54.6% 57.9%

Source: Company reports, FactSet and JPMorgan estimates.

239

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

North America Equity Research 02 January 2008

Key Financial Metrics & Forecasts


The following table summarizes our Y/Y growth assumptions by business segment through 2009. Detailed description of our forecast is in the following two sections.
Table 156: Shutterfly Operating Metrics
Customers Y/Y Growth Orders Y/Y Growth Average orders per customer Y/Y Growth Average Order Size Y/Y Growth As % of total revenues Print Revenue Personalized Products Revenue
Source: Company reports and JPMorgan estimates.

2006A 1,734,780 42.3% 5,104,859 39.8% 1.95 -1.4% $24.16 5.1% 49% 51%

2007E 2,329,545 34.3% 6,842,183 34.0% 1.94 -0.7% $26.74 10.7% 40% 60%

2008E 2,987,472 28.2% 8,834,439 29.1% 1.95 0.6% $28.41 6.2% 35% 65%

2009E 3,682,144 23.3% 11,074,806 25.4% 1.98 1.7% $29.62 4.3% 31% 69%

Our Estimates and Outlook for 2008


We are maintaining our 2008 estimates, which call for Y/Y revenue, EBITDA, and earnings growth of 37.2%, 40.7%, and 38.8%, respectively. Specifically, we are modeling 2008 revenues, EBITDA, and adjusted EPS of $251.0M, $44.8M, and $0.49. We are modeling Y/Y growth in customers, orders, and AOV of 28.2%, 29.1, and 6.2%, respectively. As photo prints have become increasingly commoditized, Shutterfly has pursued a strategic move away from a print-focused approach. We estimate photo print revenues will represent 40% and 35% of revenues in F07 and F08, respectively (from 49% in F06). At the same time, growth in non-print revenues, such as greeting cards, photobooks, and calendars has increased. For F08, we estimate Y/Y growth rates for personalized products of 48% and photo prints of 21%.

Our Estimates and Outlook for 2009


We are introducing our 2009 estimates and are calling for revenue, EBITDA, and earnings growth of 30.7%, 37.3%, and 44.3%, respectively. Specifically, we are modeling 2009 revenues, EBITDA and adjusted EPS of $328.1M, $61.5M, and $0.71. We are modeling Y/Y growth in customers, orders, and AOV of 23.3%, 25.4%, and 4.3%, respectively.

Valuation and Rating Analysis


We believe Shutterfly should be valued relative to companies with the following attributes: (1) online commerce business models, (2) subscription driven business models, (3) 25%+ top-line growth potential, (4) exposure to the online printing market, and (5) a data hosting offering. SFLY trades at a discount to its peers. On an EV/EBITDA basis, SFLY trades at 13x our F08 EBITDA estimate of $44.8M, vs. its peer group at 19X and as such, we believe there is opportunity for multiple expansion.
240

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

North America Equity Research 02 January 2008

Risks to Our Rating


We believe there are three primary risks to our Overweight rating on Shutterfly: Seasonality: Currently, Shutterflys business is very seasonal, with approximately 50% of revenues earned in the fourth quarter. If the company is unable to deliver customer orders during the holiday season, there would be downside risk to our rating. Product pricing: Pricing on 4X6 prints has come down over the last few years, causing the company to look for growth in other product segments. Should other product segments experience similar pricing pressure, our Overweight rating could be at risk. Paper costs: Shutterfly purchases paper from Fuji Film, with whom it also competes in this space. This contract is up for renewal in September 2007, and should renewal terms be less favorable than its current contract, the company could see margin pressure.

241

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

North America Equity Research 02 January 2008

Table 157: SFLY Annual Income Statement


$ in millions, except per share data FY 2006 Revenues Product Revenue (80%) Shipping Revenue (20%) Cost of revenues Pro forma adj for SBC Gross Profit Pro forma Gross Profit Gross Margins Technology and Development Sales and Marketing General and Administrative Total Operating Expenses Total SBC adjustments Total pro forma operating expenses Income from Operations PF Income from Operations Operating Margins EBITDA EBITDA Margins EBITDA Growth Y/Y Interest Expense Interest Income EBT and accounting change Tax benefit (provision) Assumed Tax Rate EAT and before accounting change Cumulative effect of change in acct principle Net income EPS - basic EPS - diluted Adjusted EPS (diluted) Pro Forma Diluted Sharecount Shares outstanding - basic Shares outstanding - diluted Customers Y/Y Growth Orders Y/Y Growth Average order per customer Y/Y Growth Average Order Size Y/Y Growth
Source: Company reports and JPMorgan estimates.

FY 2007E 183.0 146.4 36.6 82.4 0.1 100.5 100.4 54.9% 29.7 31.3 28.9 89.9 3.5 86.4 10.6 14.0 5.8% 31.8 17.4% 53.6% (0.2) 5.8 16.2 (5.9) 37% 10.2 10.2 0.42 0.38 0.36 28.8 24.3 26.8 2,329,545 34.3% 6,842,183 34.0% 1.94 -0.7% $26.74 10.7%

FY 2008E 251.0 200.8 50.2 112.7 138.2 138.2 55.1% 38.3 44.5 38.0 120.9 2.9 118.0 17.3 20.2 6.9% 44.8 17.8% 40.7% (0.2) 6.2 23.3 (8.6) 37% 14.7 14.7 0.56 0.53 0.49 29.7 25.3 27.5 2,987,472 28.2% 8,834,439 29.1% 1.95 0.6% $28.41 6.2%

FY 2009E 328.1 262.5 65.6 146.9 181.2 181.2 55.2% 49.0 56.4 47.6 153.0 4.2 148.8 28.1 32.3 8.6% 61.5 18.7% 37.3% (0.2) 6.6 34.5 (12.8) 37% 21.7 21.7 0.79 0.75 0.71 30.5 25.6 28.8 3,682,144 23.3% 11,074,806 25.4% 1.98 1.7% $29.62 4.3%

123.4 98.7 24.7 55.4 0.1 67.9 67.8 55.1% 19.1 21.9 19.2 60.2 2.204 58.0 7.7 9.8 6.2% 20.7 16.8% 40.6% (0.3) 2.3 9.7 (3.9) 40% 5.8 5.8 (1.11) 0.56 0.12 20.8 8.6 10.3 1,734,780 42.3% 5,104,859 39.8% 1.95 -1.4% $24.16 5.1%

242

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

North America Equity Research 02 January 2008

Table 158: SFLY Quarterly Income Statement


$ in millions, except per share data Q1-06 Revenues Product Revenue (80%) Shipping Revenue (20%) Cost of revenues Pro forma adj for SBC Gross Profit Pro forma Gross Profit Gross Margins Technology and Development Sales and Marketing General and Administrative Total Operating Expenses Total SBC adjustments Total pro forma operating expenses Income from Operations PF Income from Operations Operating Margins EBITDA EBITDA Margins EBITDA Growth Y/Y Interest Expense Interest Income EBT and accounting change Tax benefit (provision) Assumed Tax Rate EAT and before accounting change Cumulative effect of change in acct principle Net income EPS - basic EPS - diluted Adjusted EPS (diluted) Pro Forma Dilluted Sharecount Shares outstanding - basic Shares outstanding - diluted
Source: Company reports and JPMorgan estimates. 243

FY2006 Q2-06 Q3-06 19.6 15.7 3.9 9.8 0.0 9.9 9.9 50.3% 4.3 4.5 4.3 13.1 0.4 12.6 (3.2) (2.8) -16.3% (0.3) -1.4% (0.1) 0.0 (3.2) 1.1 (2.1) (2.1) (0.54) (0.54) (0.12) 17.7 3.9 3.9 21.2 16.9 4.2 10.9 0.0 10.3 10.3 48.6% 5.0 5.4 5.1 15.4 0.6 14.8 (5.1) (4.5) -24.2% (1.6) -7.7% (0.1) 0.5 (4.7) 1.9 (2.7) (2.7) (0.70) (0.70) (0.15) 17.8 4.0 4.0

Q4-06 65.7 52.5 13.1 26.1 0.0 39.6 39.6 60.3% 5.9 8.3 6.5 20.7 0.7 20.0 18.9 19.6 28.8% 22.9 34.9% (0.1) 1.3 20.2 (8.0) 12.2 12.2 0.53 0.50 0.49 25.1 22.8 24.5

Q1-07 26.7 21.4 5.3 13.0 0.0 13.7 13.6 51.2% 5.8 5.2 6.0 17.0 0.8 16.1 (3.3) (2.5) -12.3% 1.1 4.1% (0.1) 1.5 (1.9) 0.8 (1.1) (1.1) (0.04) (0.04) (0.04) 23.9 23.9 23.9

FY2007E Q2-07 Q3-07 29.9 23.9 6.0 14.8 0.0 15.0 15.0 50.4% 6.6 7.2 6.7 20.6 0.9 19.7 (5.5) (4.7) -18.5% (0.6) -2.0% (0.0) 1.4 (4.2) 1.7 41% (2.4) (2.4) (0.10) (0.10) (0.10) 24.1 24.1 24.1 32.6 26.1 6.5 17.2 0.0 15.4 15.3 47.1% 7.6 7.0 7.4 22.0 1.0 21.0 (6.6) (5.7) -20.3% (0.70) -2.1% (0.1) 1.4 (5.3) 2.0 38% (3.3) (3.3) (0.14) (0.14) (0.14) 24.5 24.5 24.5

Q4-07E 93.8 75.0 18.8 37.3 56.5 56.5 60.2% 9.7 11.9 8.8 30.4 0.8 29.6 26.1 26.9 27.8% 32.0 34.1% (0.1) 1.5 27.5 (10.5) 38% 17.1 17.1 0.70 0.64 0.64 26.8 24.5 26.8

Q1-08E 36.3 29.0 7.3 18.0 18.3 18.3 50.5% 8.6 8.3 8.0 24.9 0.6 24.3 (6.6) (6.0) -18.1% (0.1) -0.4% (0.1) 1.5 (5.1) 1.9 37% (3.2) (3.2) (0.13) (0.13) (0.13) 24.8 24.8 24.8

FY2008E Q2-08E Q3-08E 41.6 33.3 8.3 20.6 21.0 21.0 50.5% 9.2 9.6 9.3 28.0 0.7 27.3 (7.0) (6.3) -16.8% (0.2) -0.4% (0.1) 1.5 (5.5) 2.1 37% (3.5) (3.5) (0.14) (0.14) (0.14) 25.1 25.1 25.1 45.0 36.0 9.0 23.0 22.1 22.1 49.0% 10.4 11.3 9.9 31.5 0.7 30.8 (9.5) (8.8) -21.0% (2.5) -5.6% (0.1) 1.6 (7.9) 2.9 37% (5.0) (5.0) (0.20) (0.20) (0.20) 25.4 25.4 25.4

Q4-08E 128.0 102.4 25.6 51.2 76.8 76.8 60.0% 10.2 15.4 10.9 36.5 0.9 35.6 40.3 41.2 31.5% 47.6 37.2% (0.1) 1.6 41.9 (15.5) 37% 26.4 26.4 1.03 0.96 0.96 27.5 25.7 27.5

16.9 13.5 3.4 8.7 0.0 8.1 8.1 48.2% 4.0 3.7 3.4 11.1 0.4 10.7 (2.9) (2.6) -17.4% (0.3) -1.6% (0.1) 0.5 (2.5) 1.0 (1.6) (1.6) (0.41) (0.41) (0.09) 17.6 3.8 3.8

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

North America Equity Research 02 January 2008

Table 159: SFLY Quarterly Income Statement


$ in millions, except per share data Q1-06 Customers Y/Y Growth Orders Y/Y Growth Average order per customer Y/Y Growth Average Order Size Y/Y Growth Print Revenue (% of total revenue) Non-Print Revenue (% of total revenue) Print Revenue Non-print revenue Expenses as % of Revenue Cost of revenues Technology and Development Sales and Marketing General and Administrative Y/Y Change Revenue Growth Cost of revenues Technology and Development Sales and Marketing General and Administrative Sequential Change Revenue Growth 523,896 40.6% 980,798 33.7% 1.87 -4.9% $17.21 -4.1% 62% 38% 10.5 6.4 51.8% 23.6% 21.9% 20.1% 28% 36% 72% 62% 21% -58.8% Q2-06 517,518 35.5% 1,041,129 33.9% 2.01 -1.2% $18.86 3.9% 58% 42% 11.4 8.2 49.7% 21.7% 22.9% 21.9% 39% 43% 55% 56% 81% 16.3% FY2006 Q3-06 623,000 39.6% 1,244,000 42.5% 2.00 2.1% $17.00 -5.2% 61% 39% 12.9 8.3 51.4% 23.4% 25.5% 23.9% 36% 60% 34% 44% 80% 7.7% Q4-06 955,104 47.4% 1,838,932 45.3% 1.93 -1.5% $35.72 10.2% 40% 60% 26.1 39.5 39.7% 8.9% 12.7% 9.8% 60% 54% 34% 32% 14% 210.5% Q1-07 693,092 32.3% 1,288,471 31.4% 1.86 -0.7% $20.73 20.5% 51% 49% 13.6 13.1 48.8% 21.8% 19.4% 22.3% 58% 49% 46% 40% 76% -59.3% Q2-07 FY2007E Q3-07 Q4-07E 1,260,737 32.0% 2,431,068 32.2% 1.93 0.2% $38.58 8.0% 30% 70% 28.1 65.6 39.8% 10.3% 12.7% 9.4% 43% 43% 64% 43% 36% 187.7% Q1-08E 901,020 30.0% 1,675,012 30.0% 1.86 0.0% $21.66 4.5% 45% 55% 16.3 20.0 49.5% 23.6% 23.0% 22.0% 36% 38% 47% 61% 34% -61.3% FY2008E Q2-08E Q3-08E 943,485 29.0% 1,885,727 29.0% 2.00 0.0% $22.08 8.0% 43% 57% 17.9 23.7 49.5% 22.0% 23.0% 22.3% 39% 39% 38% 33% 38% 14.7% 1,080,832 28.0% 2,142,484 29.0% 1.98 0.8% $21.00 7.0% 45% 55% 20.3 24.8 51.0% 23.0% 25.0% 22.0% 38% 33% 37% 60% 35% 8.1% Q4-08E 1,601,136 27.0% 3,131,216 28.8% 1.96 1.4% $40.89 6.0% 26% 74% 33.3 94.8 40.0% 8.0% 12.0% 8.5% 37% 37% 6% 29% 23% 184.5%

731,384 41.3% 1,461,804 40.4% 2.00 -0.7% $20.44 8.4% 48% 52% 14.3 15.5 49.9% 22.2% 24.1% 22.6% 52% 52% 55% 60% 57% 11.9%

844,400 35.5% 1,660,840 33.5% 1.97 -1.5% $19.63 15.5% 51% 49% 16.6 16.0 51.1% 23.2% 21.6% 22.6% 54% 59% 53% 30% 45% 9.1%

Cost of revenues Technology and Development Sales and Marketing General and Administrative
Source: Company reports and JPMorgan estimates.

-48.2% -9.0% -41.8% -40.0%

11.5% 7.2% 22.0% 26.6%

11.4% 16.1% 19.9% 17.6%

139.9% 18.5% 54.6% 27.8%

-50.0% -1.0% -37.9% -7.7%

13.8% 14.2% 39.0% 13.0%

16.2% 14.1% -2.2% 9.1%

116.5% 27.5% 69.1% 19.9%

-51.9% -11.4% -29.9% -9.4%

14.7% 6.9% 14.7% 16.3%

11.4% 13.0% 17.5% 6.6%

123.2% -1.0% 36.6% 9.9%

244

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

North America Equity Research 02 January 2008

Table 160: SFLY Annual Balance Sheet


$ in millions FY 2006 ASSETS Cash and cash equivalents Short-term investments Accounts receivable Net inventory Deferred tax asset - current Other current Total current assets Net fixed assets Acquisition cost Intangible assets, net Deferred tax asset Other assets Total assets LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable Accrued liabilities Litigation settlement Deferred revenue Lease obligation - current Note payable - current Total Current Liabilities Lease obligations Other liabilities Note payable Litigation settlement Preferred stock warrant liability Total Liabilities Series A-F preferred stock Common stock at par Additional paid in capital Accumulated other comprehensive income Deferred stock-based comp Retained earnings Total stockholder equity Total Liabilities and shareholders equity
Source: Company reports and JPMorgan estimates.

FY 2007E 107.0 3.0 2.8 2.8 1.7 3.7 121.0 48.5 3.9 23.7 2.2 199.3 8.4 11.3 8.4 1.3 29.5 1.0 0.5 31.0 188.3 (20.1) 168.2 199.3

FY 2008E 115.9 3.0 3.8 3.8 1.7 3.7 132.1 58.5 3.9 23.7 2.2 220.3 10.2 14.1 9.0 1.3 34.6 1.0 0.5 36.2 189.5 (5.4) 184.1 220.3

FY 2009E 134.5 3.0 5.0 5.0 1.7 3.7 152.9 69.3 3.9 23.7 2.2 251.9 12.5 16.6 11.6 1.3 42.0 1.0 0.5 43.6 192.0 16.3 208.3 251.9

119.1 2.2 2.5 2.1 2.8 128.6 30.9 1.4 18.8 0.5 180.2 9.4 8.8 6.3 2.0 26.4 1.7 0.7 28.8 0.0 182.0 (0.2) (30.3) 151.4 180.2

245

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

North America Equity Research 02 January 2008

Table 161: SFLY Annual Statement of Cash Flows


$ in millions FY 2006 OPERATING ACTIVITIES: Net income (loss) Depreciation and amortization Amortization of intangible assets Amortization of stock-based compensation, net of cancellation Amortization of warrants Change in carrying value of preferred stock warrant liability Gain/loss on disposal of fixed assets Deferred income taxes Charitable contribution expense for shares issued to charitable foundation Changes in operating assets and liabilities: Inventories Accounts receivable Prepaid expenses & other current assets Deferred tax asset Other assets Accounts payable Accrued liabilities Preferred stock warrant liability Deferred revenue Deferred rent Net cash provided by operating activities FCF INVESTING ACTIVITIES: Purchase of property & equipment Cash acquired from acquisition of business Proceeds from sale of property and equipment Net cash provided by (used in) investing activities FINANCING ACTIVITIES: Principal payments of capital lease obligation Proceeds from loan from a related party Repayment of loan from a related party Proceeds from loan Repayment of loan Principal payment of note payable obligation Proceeds from issuance of redeemable conv. pref stock, net of issuance cost Payment of IPO related costs Proceeds from issuance of common stock Proceeds from exercise of unvested options Other Repurchase of common stock Net cash provided by (used in) financing activities Net change in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period
Source: Company reports and JPMorgan estimates.

FY 2007E 10.2 17.2 0.4 3.6 0.2 (4.5) 0.4 (0.3) (0.6) (0.9) (1.7) (0.9) 2.8 2.2 27.5 (7.4) (34.9) (3.0) (40.6) (2.4) 3.4 1.0 (12.1) 119.1 107.0

FY 2008E 14.7 24.0 0.6 2.9 3.1 (1.0) (1.0) 1.8 2.8 0.5 45.2 11.2 (34.0) (34.0) (2.3) (2.3) 9.0 107.0 115.9

FY 2009E 21.7 28.6 0.6 4.2 5.1 (1.1) (1.1) 2.2 2.5 2.7 60.2 20.8 (39.4) (39.4) (2.3) (2.3) 18.6 115.9 134.5

5.8 10.6 0.2 2.3 (0.2) (0.0) 3.2 (0.5) (1.4) (1.2) (1.2) (0.1) 5.5 (3.8) 1.7 22.3 1.6 (20.7) (20.7) (1.3) 80.2 (0.0) 78.3 79.9 39.2 119.1

246

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

North America Equity Research 02 January 2008

ValueClick, Overweight ($23.39)


We are maintaining our Overweight rating on VCLK. We believe that 2008 prospects for growth look good given rising online advertising trends. We also see meaningful margin expansion opportunities in 2008 from the acquisition of MeziMedia. Finally, we think that the Street overreacted to the promotional lead-gen investigation given settlement agreements of comparable investigations. VCLK is trading at an EV/EBITDA multiple of 11.0x our F'08 EBITDA estimate vs. the peer group average of 14.4x, as such, we rate the stock Overweight. MeziMedia will likely boost top- and bottom-line growth. We expect MeziMedia to grow 59% Y/Y organically in 2008, bringing total comparison shopping growth to 109% Y/Y. Furthermore, we believe that the SEO technology of MeziMedia is a strong margin driver that can also be leveraged by the Pricerunner platform. Thus, we are modeling EBITDA margins expanding 20 bps Y/Y in F08. Upside to lead gen estimates possible. Since the announcement of the promotional lead-gen investigation, Adteractive, a close promotional lead-gen competitor, settled its FTC investigation with a $650,000 fine and an agreement to conspicuously disclose payments or obligations of consumers to obtain gifts and prizes. Although we are still modeling F'08 promotional lead-gen revenues disappearing to be conservative, we think that there may be upside to this estimate if the FTC allows the business to continue with disclosures. 2008 Drivers. In our view, the following factors will drive VCLK shares in 2008: (1) settlement of the FTC investigation, (2) leverage of MeziMedia technology by other business lines, and (3) affiliate marketing strength from increased online ad spend and market share gains. Maintaining 4Q'07 estimates. We maintain our 4Q07 revenue, EBITDA, and EPS estimates of $176.3M, $44.0M, and $0.18 (Y/Y growth of 10%, (5%), and (14%) respectively). Our current and newly introduced 2009 estimates are in the table below:
Table 162: ValueClick Financial Snapshot
$ in millions, except per share data ValueClick JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07E 176.25 44.00 0.18 175.98 43.68 0.18 F'07E 638.75 163.80 0.71 639.25 164.10 0.71 F'08E 735.00 189.65 0.84 740.77 191.31 0.82 F'09E 858.97 220.26 1.01 856.30 227.09 1.06 F'07E Y/Y 17.1% 13.0% 15.4% F'08E Y/Y 15.1% 15.8% 18.9% 15.9% 16.6% 15.5% F'09E Y/Y 16.9% 16.1% 19.8% 15.6% 18.7% 29.3%

Source: JPMorgan estimates, Company data, and Bloomberg

247

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


We are revising our F08 revenue estimate to $735M and our full-year EPS estimate to $0.84 (from $731M and $0.83), representing Y/Y revenue and EPS growth of 15% and 19%, respectively. We expect the media segment to contribute $352M of revenue, representing an 8% Y/Y decline in growth. We believe that lead-gen losses will drive down growth levels until the losses begin to be comped in 2Q08. However, we are very tentatively optimistic that there may be upside to our modeled losses if the FTC settlement allows for the continuation of the business with disclosures. We expect the display advertising business to remain strong as money shifts from lead-gen to display and as dollars shift to the online graphical ad market. We expect comparison shopping to contribute $187M of revenue, representing 109% Y/Y growth. Much of this growth, we believe, will be driven by the MeziMedia acquisition, which we see growing ~59% organically Y/Y. Furthermore, we believe that the SEO technology of MeziMedia is a strong margin driver that can also be leveraged by the Pricerunner platform. Thus, we are modeling EBITDA margins expanding 20 bps Y/Y in F08. We see affiliate marketing achieving revenues of $162M, representing 18% Y/Y growth, a very modest deceleration from F07Es 22% Y/Y growth. We believe that this segment will continue to benefit from shifts towards online spending and will continue to gain market share as the leading affiliate network. We believe that the technology segment will experience 13% Y/Y growth, yielding revenues of $36.8M, a significant deceleration from F07Es 26% Y/Y growth. We believe that growth will be hindered by increased competition from MSN due to its recent acquisition of aQuantive and Google with its planned DoubleClick acquisition.

Our Estimates and Outlook for 2009


We are introducing F09 revenue and EPS estimates of $859M and $1.01, which represent 17% and 20% Y/Y growth, respectively. While revenue is effectively in line with consensus of $856M, our EPS estimate is lower than consensus of $1.06 as we believe that shifts to display advertisements from lead-gen business and increased pricing pressure from competition will begin to offset margin gains from MeziMedia. We are modeling a 20 bp Y/Y decline in EBITDA margin. We believe that much of the growth will be driven by international revenue across all segments and that domestic growth will be supported by further shifts toward online advertising and the demand for increased customer targeting and rich media services. However, we believe that competition will intensify as large, capital-rich Internet companies are attracted to the growing market.

Valuation and Rating Analysis


On an EV/EBITDA basis, ValueClick trades at 11.0x our F' 08 EBITDA estimate of $189.6M, vs. its peers which trade at 14.4x. We believe that the market has overreacted to the announced FTC investigation and market conditions. Hence, our Overweight rating.
248

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

North America Equity Research 02 January 2008

Risks to Our Rating


ValueClick shares may underperform other companies in our coverage universe if 1) the online advertising market weakens and advertisers limit their expenditures to toptier properties/networks, such as Google, Yahoo! and MSN, 2) the company loses share to large online networks, such as Google, Yahoo and MSN, or if smaller online advertising players create stronger offerings, 3) the company is unable to increase its presence in international markets, including Europe and China and 4) if FTC investigations have a larger-than-projected impact on growth.

249

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

North America Equity Research 02 January 2008

Table 163: VCLK Annual Income Statement


$ in millions, except per share data FY 2006 Revenues Media Comparison Shopping Affiliate Marketing Technology Intercompany eliminations and others Cost of Revenues Media Comparison Shopping Affiliate Marketing Technology Intercompany eliminations and others Gross Profit Media Gross Margin Comparison Shopping Gross Margin Affiliate Marketing Gross Margin Technology Gross Margin Gross Profit Margin Operating Cost Sales and marketing General and administrative Product development Stock-based compensation Amortization of intangibles and acquired software Merger Related Costs Restructuring Charges Income (loss) from operations Operating Margin Equity in loss of ValueClick Japan Interest income, net Gain on the sale of ValueClick Japan stock Other Income Income (loss) before income taxes and minority interest Provision for income taxes Tax Rate Income (loss) before minority interest Minority interest in ValueClick Japan Net income (loss) FASB 123 Adjustment Net Income Adjusted for FASB123 EPS (Diluted) - Ex FAS 123R EPS (Diluted) w/ FAS 123R
Source: Company reports and JPMorgan estimates.

F2007E 638.7 381.4 89.5 137.2 32.5 (1.8) 202.8 149.8 21.3 27.8 5.7 (1.8) 435.9 60.7% 76.2% 79.7% 82.4% 68.2% 324.8 185.5 62.8 33.4 18.2 25.0 0.0 0.0 111.1 17.4% 0.0 11.8 0.0 0.0 122.8 51.3 41.8% 71.5 0.0 71.5 71.5 0.89 0.71

F2008E 735.0 352.0 186.7 161.5 36.8 (1.9) 239.6 155.0 46.7 32.7 6.4 (1.2) 495.4 56.0% 75.0% 79.7% 82.6% 67.4% 332.1 207.9 73.5 36.7 20.0 21.2 0.0 0.0 136.0 18.5% 0.0 12.0 0.0 0.0 148.0 63.7 43.0% 84.4 0.0 84.4 84.4 1.04 0.84

F2009E 859.0 403.6 232.1 185.7 39.5 (1.9) 281.3 177.7 58.0 39.5 7.3 (1.2) 577.7 56.0% 75.0% 78.7% 81.6% 67.3% 412.6 249.1 75.1 47.2 20.0 21.2 0.0 0.0 165.1 19.2% 0.0 14.0 0.0 0.0 179.1 77.9 43.5% 101.1 0.0 101.1 101.1 1.21 1.01

545.6 383.0 26.2 112.2 25.7 (1.4) 167.9 141.5 2.2 19.8 5.4 (0.9) 377.8 63.1% 91.7% 82.4% 79.0% 69% 275.6 158.5 52.9 30.5 11.9 21.8 0.0 0.0 102.1 18.7% 0.0 8.0 0.0 0.0 110.1 47.6 43.2% 62.6 0.0 62.6 62.6 0.73 0.62

250

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

North America Equity Research 02 January 2008

Table 164: VCLK Quarterly Income Statement


$ in millions, except per share data 1Q 2006 Revenues Media Comparison Shopping Affiliate Marketing Technology Intercompany eliminations and others Cost of Revenues Media Comparison Shopping Affiliate Marketing Technology Intercompany eliminations and others Gross Profit Media Gross Margin Comparison Shopping Gross Margin Affiliate Marketing Gross Margin Technology Gross Margin Gross Profit Margin Operating Cost Sales and marketing General and administrative Product development Stock-based compensation Amortization of intangibles and acquired software Merger Related Costs Restructuring Charges Income (loss) from operations Operating Margin Equity in loss of ValueClick Japan Interest income, net Gain on the sale of ValueClick Japan stock Other Income Income (loss) before income taxes and minority interest Provision for income taxes Tax Rate 117.3 79.4 5.5 26.9 5.8 (0.3) 39.2 33.7 0.3 4.1 1.3 (0.2) 78.1 57.5% 94.7% 84.7% 77.1% 67% 61.9 30.1 15.5 7.4 3.3 5.7 16.14 13.8% 1.9 2Q 2006 130.0 93.5 5.9 25.2 5.7 (0.4) 42.1 36.2 0.5 4.3 1.3 (0.2) 87.9 61.3% 92.3% 82.8% 76.9% 68% 62.7 36.5 10.0 7.6 3.2 5.5 25.2 19.4% 2.0 3Q 2006 137.9 98.4 5.9 27.4 6.5 (0.3) 38.7 31.7 0.5 5.3 1.4 (0.2) 99.2 67.8% 91.3% 80.7% 78.9% 72% 74.4 45.1 13.1 7.7 3.0 5.5 24.8 18.0% 1.6 4Q 2006 160.4 111.6 8.8 32.7 7.7 (0.5) 47.8 39.8 0.9 6.0 1.4 (0.3) 112.6 64.4% 89.8% 81.5% 82.1% 70% 76.6 46.8 14.4 7.8 2.4 5.2 36.0 22.4% 2.4 1Q 2007 156.9 108.4 8.6 32.8 7.5 (0.4) 47.0 38.5 1.3 6.0 1.5 (0.2) 109.9 64.5% 84.3% 81.8% 80.6% 70% 80.7 47.4 15.5 8.4 3.6 5.8 29.2 18.6% 2.9 2Q 2007 148.7 100.9 8.2 32.3 7.8 (0.5) 49.1 39.9 1.8 6.7 1.4 (0.8) 99.6 60.5% 77.8% 79.2% 81.5% 67% 73.6 40.9 14.2 8.1 4.9 5.5 26.0 17.5% 3.4 3Q 2007 156.9 85.6 29.4 34.1 8.2 (0.5) 50.5 35.1 7.3 7.2 1.4 (0.5) 106.4 59.0% 75.2% 78.9% 83.0% 68% 80.1 45.2 15.5 8.1 4.6 6.7 26.3 16.8% 2.9 4Q 2007E 176.3 86.4 43.3 38.0 9.1 (0.5) 56.2 36.3 10.8 8.0 1.5 (0.3) 120.0 58.0% 75.0% 79.0% 84.0% 68% 90.4 52.0 17.6 8.8 5.0 7.0 29.6 16.8% 2.5 1Q 2008E 176.4 86.5 43.3 38.7 8.4 (0.5) 56.3 37.2 10.8 7.0 1.6 (0.3) 120.2 57.0% 75.0% 82.0% 81.0% 68% 87.9 51.2 17.6 8.8 5.0 5.3 32.2 18.3% 3.0 2Q 2008E 175.3 89.1 39.8 38.1 8.8 (0.5) 58.4 39.2 10.0 8.0 1.6 (0.3) 116.8 56.0% 75.0% 79.0% 82.0% 67% 83.9 47.3 17.5 8.8 5.0 5.3 32.9 18.8% 3.0 3Q 2008E 173.1 82.2 41.9 40.3 9.3 (0.5) 56.4 36.2 10.5 8.5 1.6 (0.3) 116.8 56.0% 75.0% 79.0% 83.0% 67% 84.7 48.5 17.3 8.7 5.0 5.3 32.0 18.5% 3.0 4Q 2008E 210.2 94.3 61.7 44.4 10.2 (0.5) 68.5 42.4 15.4 9.3 1.6 (0.3) 141.7 55.0% 75.0% 79.0% 84.0% 67% 102.8 61.0 21.0 10.5 5.0 5.3 38.9 18.5% 3.0

18.1 8.3 45.8%

27.2 12.7 46.8%

26.4 9.6 36.5%

38.5 16.9 44.0%

32.1 13.5 42.0%

29.4 11.8 40.1%

29.2 12.4 42.5%

32.1 13.6 42.5%

35.2 15.1 43.0%

35.9 15.4 43.0%

35.0 15.1 43.0%

41.9 18.0 43.0%


251

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

North America Equity Research 02 January 2008

1Q 2006 Income (loss) before minority interest Minority interest in ValueClick Japan Net income (loss) FASB 123 Adjustment Net Income Adjusted for FASB123 EPS (Diluted) - Ex FAS 123R EPS (Diluted) w/ FAS 123R
Source: Company reports and JPMorgan estimates.

2Q 2006 14.4

3Q 2006 16.8

4Q 2006 21.6

1Q 2007 18.6

2Q 2007 17.6

3Q 2007 16.8

4Q 2007E 18.4

1Q 2008E 20.1

2Q 2008E 20.5

3Q 2008E 20.0

4Q 2008E 23.9

9.8

9.8 9.8 0.13 0.09

14.4 14.4 0.17 0.14

16.8 16.8 0.20 0.17

21.6 21.6 0.24 0.22

18.6 18.6 0.22 0.18

17.6 17.6 0.22 0.17

16.8 16.8 0.21 0.17

18.4 18.4 0.23 0.18

20.1 20.1 0.25 0.20

20.5 20.5 0.25 0.20

20.0 20.0 0.25 0.20

23.9 23.9 0.29 0.24

252

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

North America Equity Research 02 January 2008

Table 165: VCLK Annual Balance Sheet


$ in millions FY 2006 Cash and cash equivalents Investment in marketable securities, at market value Pledged marketable securites, at fair value Accounts receivable, net Inventories Prepaid expenses and other current assets Deferred tax assets IPO proceeds receivable Income taxes receivable Total Current Assets Property and equipment, net Marketable Securities, at fair value Intangibles, net Goodwill Deferred income taxes Other assets Total Assets Accounts payable and accrued expenses Income taxes payable Deferred revenue Short-term debt Other current liabilities Total current liabilities Capital lease obligation, less current portions Income taxes payable, less current portion Deferred Tax Liabilities Other non-current long-term liabilities Total Liabilities Minority Interest In Valueclick Japan Preferred stock Common stock Additional paid-in capital Treasury stock, at cost Deferred stock compensation Retained Earnings/Accumulated deficit Accumulated other comprehensive loss Total stockholders' equity Total Liabilities and Stockholders' Equity
Source: Company reports and JPMorgan estimates.

FY 2007E 151.1 188.4 111.8 1.6 9.0 461.9 18.0 4.0 63.9 273.0 0.0 1.5 822.3 54.0 3.2 0.5 0.0 0.2 58.0 0.1 2.9 1.2 0.0 62.2 0.0 0.0 0.1 630.0 0.0 3.8 127.5 2.7 760.1 822.3

FY 2008E 301.9 192.2 111.8 1.6 9.0 616.5 19.6 4.0 63.9 273.0 0.0 1.5 978.5 54.0 3.2 0.5 0.0 0.2 58.0 0.1 2.9 1.2 0.0 62.2 0.0 0.0 0.1 630.0 0.0 0.0 283.4 3.0 916.3 978.5

FY 2009E 482.6 196.1 111.8 1.6 9.0 801.1 22.4 4.0 63.9 273.0 0.0 1.5 1165.9 54.0 3.2 0.5 0.0 0.2 58.0 0.1 2.9 1.2 0.0 62.2 0.0 0.0 0.1 630.0 0.0 0.0 470.8 3.0 1103.7 1165.9

76.8 204.8 107.8 2.6 4.3 6.6 403.0 19.0 0.0 91.4 278.1 0.5 1.4 793.3 83.8 2.5 1.1 0.0 0.0 87.4 0.0 44.5 14.4 3.3 149.6 0.0 0.0 0.1 632.9 0.0 0.0 5.5 5.2 643.7 793.3

253

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

North America Equity Research 02 January 2008

Table 166: VCLK Annual Cash Flow Statement


$ in millions FY 2006 Net Income Depreciation and amortization Cumulative effect of change in accounting principal Restructuring charge (reversal) Provision for doubtful accounts Inventory write-down Stock-based compensation Tax benefit from stock option exercises Gain (loss) on sale of marketable securities Minority interest in ValueClick Japan Gain on ValueClick Japan stock issuance Provision (benefit from) for deferred taxes Changes in operating assets and liabilities: Accounts receivable Prepaid expenses and other assets Accounts payable and accrued liabilities Income tax receivable/payable Deferred revenue Other non-current liablities Net cash from operating activities FCF Cash flows from investing activities: Proceeds from the sale of marketable securities Purchase of marketable debt securities Purchase of equity securities Acquistion of businesses, net of cash acquired Purchases of property and equipment Sale of equity interest in Japan subsidiary Purchases of intangible assets Net cash used in investing activities Cash flows from financing activities: Purchase of Treasury Stock Repayments on notes payable and capital leases Net proceeds from exercises of options and warrants Proceeds from short-term debt, net of payments of capital lease Net cash provided by financing activities Effect of currency translations Net increase in cash and cash equivalents Cash and cash equivalents, beginning of period Cash and cash equivalents, end of period
Source: Company reports and JPMorgan estimates.

FY 2007E 71.5 32.0 0.0 0.0 1.1 0.0 17.9 7.0 0.0 0.0 0.0 (5.1) 24.5 0.0 0.0 0.0 0.0 0.0 0.0 148.9 138.5 114.5 (192.8) 0.0 0.0 (10.4) 0.0 (1.9) (90.6) 0.0 0.0 15.3 0.0 15.3 0.6 74.3 76.8 151.1

FY 2008E 84.4 33.6 0.0 0.0 0.8 0.0 20.0 10.4 0.0 0.0 0.0 1.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 150.8 138.8 0.0 0.0 0.0 0.0 (12.0) 0.0 0.0 (12.0) 0.0 0.0 12.0 0.0 12.0 0.0 150.8 151.1 301.9

FY 2009E 101.1 35.2 0.0 0.0 0.8 0.0 20.0 16.0 0.0 0.0 0.0 1.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 174.7 160.7 0.0 0.0 0.0 0.0 (14.0) 0.0 0.0 (14.0) 0.0 0.0 20.0 0.0 20.0 0.0 180.7 301.9 482.6

62.6 31.1 0.0 0.0 4.8 0.0 10.4 (0.1) 0.0 0.0 0.0 (5.7) 11.1 0.0 0.0 0.0 0.0 0.0 0.0 114.2 104.0 228.8 (238.9) 0.0 (12.1) (10.2) 0.0 0.0 (32.5) (103.4) (0.2) 49.0 0.0 (54.6) 2.8 29.9 46.9 76.8

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

North America Equity Research 02 January 2008

Yahoo!, Overweight ($23.96)


In 2008, we expect Yahoo!s growth to be driven by the Owned and Operated business, led by monetization improvements in both search and graphical advertising. While we think organic network revenues will continue to decline, we see total network revenue bolstered by newspaper partnerships and the Blue Lithium acquisition. As such, we maintain our Overweight rating. Graphical advertising is poised for a turnaround. We believe that graphical advertising monetization will improve with use of behavioral targeting and ad exchanges. Furthermore, YHOO will face easing comps in 2008 with 2007Es Y/Y growth of only 19.6% (down from 36% in 2006). As such, we are modeling 18% Y/Y growth for F08. We think that O&O search will grow 29% Y/Y in F08. Since the company will not fully start to comp Project Panama's rollout until the second half of the year, we are modeling 36% Y/Y growth in 1H08 due to expected monetization gains. Additionally, we think that the rollout of Project Panama in the intl market will be a strong growth driver. As such, we are still modeling ~23% Y/Y growth due to increased paid click volume and higher CPCs. We expect partnerships to ramp in F08. In F07, Yahoo! entered into a number of strategic partnerships, including the newspaper consortium, Bebo, WebMD, and Cars.com. We believe that Yahoo! will focus on monetizing these relationships, which we estimate could add ~$100M to F08 network revenue. 2008 Drivers. In our view, the following factors will drive YHOO shares in 2008: (1) continued search monetization increases from Project Panama, (2) leverage of the Right Media exchange and behavioral targeting to increase graphical ad monetization, and (3) monetization of partnership agreements. Maintaining 4Q'07 estimates. We maintain our 4Q07 revenue, EBITDA, and EPS estimates of $1.39B, $506.4M, and $0.11 (Y/Y growth of 13%, (6%), and (44%), respectively). Our current and newly introduced 2009 estimates are in the table below:
Table 167: YHOO Estimates Snapshot
$ in millions, except per share data Yahoo! JPMorgan Revenue EBITDA EPS Consensus Revenue EBITDA EPS 4Q'07E 1,385.71 506.37 0.11 1,408.18 524.62 0.11 F'07E 5,095.15 1,906.34 0.43 5,117.69 1,922.14 0.44 F'08E 5,894.51 2,248.29 0.49 5,953.57 2,273.54 0.54 F'09E 6,433.21 2,533.17 0.58 6,719.19 2,671.11 0.69 F'07E Y/Y 11.7% 0.0% -17.2% F'08E Y/Y 15.7% 17.9% 13.3% 16.3% 18.3% 21.6% F'09E Y/Y 9.1% 12.7% 20.4% 12.9% 17.5% 28.0%

Source: JPMorgan estimates, company data, and Bloomberg

255

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


We are maintaining our F08 revenue and GAAP EPS estimates of $5.89B and $0.49, which represent Y/Y growth of 16% and 13%, respectively. In 2008, we are expecting a turnaround of the graphical advertising segments, which we believe will play out via improved CPM growth and demand. We believe that blended CPM growth will track close to mid-single digits as behavioral targeting and ad exchanges better monetize the channel. Furthermore, we see increased demand for the advertising form as presidential campaign volume and the writers strike drive marketing dollars from TV to display advertising. As such, we are modeling graphical advertising Y/Y growth of 18% to $2.0B. We believe that Yahoo! will continue to benefit materially through higher search monetization as a result of Project Panama. The company began to roll out the new search platform in 1Q'07, with much of the international rollout occurring during 2H'07. Thus, we think that O&O search growth rates will accelerate to 29% Y/Y from 27% in F'07E. Another key component of Yahoo!s 2008 performance will be its ability to monetize its graphical affiliate partnerships. In 2007, Yahoo! was able to sign numerous partnerships, including the newspaper consortium, Bebo, Cars.com, and WebMD. In 2008, we look for the company to begin to generate revenue from these relationships, which we think can approach ~$100M.

256

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

North America Equity Research 02 January 2008

Table 168: Yahoo! Partnership Estimates


$ in millions Company Category Partership Date 9/12/2007 4/30/2007 4/16/2007 4/16/2007 4/16/2007 4/16/2007 4/16/2007 11/20/2006 11/20/2006 11/20/2006 11/20/2006 11/20/2006 11/20/2006 11/20/2006 5/25/2006 Ave. Monthly Unique Users (TTM) 3.6 20.7 6.5 NA 2.0 NA NA 4.4 3.4 16.7 6.4 1.1 5.3 3.5 80.2 PV (last 12 Months through Nov.) 28,469 39,890 1,524 NA 298 NA NA 1,057 1,088 5,049 105 110 1,137 624 112,806 Estimated Incremental YHOO Revenue 5.6 31.9 1.2 NA 0.2 NA NA 0.8 0.9 4.0 0.1 0.1 0.9 0.5 53.6 99.9

Bebo Comcast The McClatchy Company Calkins Media, Inc. Media General, Inc. Morris Communication s, Inc. Paddock Publications, Inc. Belo Corp Cox Newspapers The E.W. Scripps Company Hearst Newspapers Journal Register Company Lee Enterprises MediaNews Group, Inc. eBay Total

Social Network Cable, entertainment Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Newspapers Online auctions site

Source: comScore and JPMorgan estimates

Our Estimates and Outlook for 2009


We are introducing 2009 revenue, EBITDA, and EPS estimates of $6.43B, $2.53B, and $0.58. Our newly introduced F09 revenue, EBITDA, and EPS estimates call for Y/Y growth of 9%, 13%, and 20%, respectively. We expect roughly sustained graphical advertising growth of 17% Y/Y as we believe targeting capabilities will drive both monetization and demands. We expect O&O search growth to decline to the high teens from the high twenties as the company monetizes its gains and as we believe that it will continue to lose market share to Google. Finally, we think network revenue will decline 3% as the company focuses on it O&O businesses.

Valuation and Rating Analysis


Given our belief that the company has begun to address softness in the graphical advertising market, that there is further upside potential to Project Panama than currently expected, and that asset value limits downside, we rate the stock Overweight. On an EV/EBITDA basis, Yahoo! trades at 11.4x our F08 EBITDA estimate of $2.25B vs. its peers at 18.0x F08 estimates.

257

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

North America Equity Research 02 January 2008

Risks to Our Rating


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. The advertising industry is susceptible to overarching economic conditions, making a large portion of Yahoo!s revenues vulnerable to general economic risk. Changes in competition (e.g., mergers/acquisitions) and new regulations could also impact Yahoo!s main revenue stream.

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

North America Equity Research 02 January 2008

Table 169: YHOO Annual Income Statement


$ in millions, except per share data Marketing Services Fees Listing Total Revenue Cost of Revenue Gross Profit Gross Margin Sales and Marketing Product Development G&A Amortization & stock comp FAS123 Adjustment Other Adjustment Total Expenses Total Expenses (ex-FAS123R) Operating Profit Operating Margin (Reported) EBITDA EBITDA Margin Interest Income Investment gains (losses) Contract termination fees Other Other income, net IBT & Minority Interest Margins Income Taxes Tax Rate IAT Earnings in Equity Interest Minority Interest IAT & Minority Interest Accounting Changes Reported Net Income Reported EPS GAAP (inc. FAS 123R) Diluted Shares % of Total Revenue Marketing Services Fees Sales and Marketing Product Development G&A Y/Y Change Marketing Services Fees Revenue Sales and Marketing Product Development G&A
Source: Company reports and JPMorgan estimates.

FY-06 3,761.3 798.5 4,559.8 804.9 3,754.9 82.3% 1,167.2 688.3 410.4 124.8 423.3 2,814.0 2,390.7 940.9 20.6% 1,905.9 41.8% 157.0 1,098.0 24% 458.0 42% 639.9 112.1 (0.7) 751.3 751.3 0.52 1,492 82% 18% 26% 15% 9% 24% 20% 23% 26% 26% 28%

FY-07E 4,231.1 864.0 5,095.2 975.1 4,120.1 80.9% 1,342.5 873.4 532.0 117.3 589.3 3,454.5 2,865.2 665.5 13.1% 1,906.3 37.4% 144.9 810.5 16% 343.2 42% 467.3 132.8 1.1 601.2 601.2 0.43 1,403 83% 17% 26% 17% 10% 12% 8% 12% 27% 27% 30%

FY-08E 4,993.1 901.4 5,894.5 1,165.9 4,728.6 80.2% 1,461.7 1,014.1 681.4 123.0 765.0 4,045.3 3,280.3 683.3 11.6% 2,248.3 38.1%

FY-09E 5,681.2 752.0 6,433.2 1,288.6 5,144.6 80.0% 1,579.9 1,087.7 730.9 123.0 780.0 4,301.5 3,521.5 843.2 13.1% 2,533.2 39.4%

160.0 843.3 14% 354.2 42% 489.1 175.0 664.1 664.1 0.49 1,370 85% 15% 25% 17% 12% 18% 4% 16% 16% 16% 28%

160.0 1,003.2 16% 421.3 42% 581.8 210.0 791.8 791.8 0.58 1,355 88% 12% 25% 17% 11% 14% -17% 9% 7% 7% 7%

259

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

North America Equity Research 02 January 2008

Table 170: YHOO Quarterly Income Statement


$ in millions, except per share data Q1-06 901.5 186.2 1,087.7 178.6 909.1 83.6% 292.3 179.9 97.9 30.9 107.0 707.9 600.9 201.2 18.5% 434.9 40.0% 35.4 236.6 22% 102.9 44% 133.7 26.4 (0.3) 159.8 FY-2006 Q2-06 Q3-06 933.0 911.5 189.6 209.9 1,122.7 191.0 931.7 83.0% 287.4 172.6 108.4 34.0 99.7 702.1 602.4 229.6 20.5% 456.9 40.7% 36.1 265.7 24% 122.7 46% 143.0 21.6 (0.3) 164.3 1,121.5 220.6 900.9 80.3% 288.6 163.8 91.9 32.8 121.5 698.6 577.1 202.3 18.0% 473.7 42.2% 50.3 252.6 23% 124.4 49% 128.2 30.2 0.1 158.5 Q4-06 1,015.2 212.7 1,227.9 214.7 1013.2 82.5% 299.0 172.1 112.1 27.2 95.1 705.4 610.3 307.8 25.1% 540.4 44.0% 35.2 343.1 28% 108.0 31% 235.1 33.9 (0.2) 268.7 Q1-07 979.8 203.2 1,183.1 222.9 960.2 81.2% 317.2 191.2 115.7 27.1 140.0 791.2 651.2 169.0 14.3% 460.0 38.9% 35.5 204.5 17% 92.4 45% 112.1 29.1 1.2 142.4 FY-2007E Q2-07 Q3-07 1,031.9 1,058.7 211.9 223.9 1,243.8 226.5 1017.3 81.8% 338.3 216.6 123.4 25.2 128.8 832.3 703.5 185.0 14.9% 473.6 38.1% 30.7 215.7 17% 87.7 41% 128.0 32.1 0.5 160.6 1,282.6 252.7 1029.9 80.3% 340.6 223.1 140.5 30.0 145.5 879.7 734.1 150.2 11.7% 466.3 36.4% 43.7 193.9 15% 78.7 41% 115.3 36.5 (0.5) 151.3 Q4-07E 1,160.7 225.0 1,385.7 273.0 1112.7 80.3% 346.4 242.5 152.4 35.0 175.0 951.4 776.4 161.4 11.6% 506.4 36.5% 35.0 196.4 14% 84.4 43% 111.9 35.0 146.9 Q1-08E 1,146.1 221.2 1,367.3 269.4 1097.9 80.3% 348.7 252.9 161.3 30.0 185.0 977.9 792.9 120.0 8.8% 490.0 35.8% FY 2008E Q2-08E Q3-08E 1,229.3 1,267.9 226.3 227.0 1,455.6 283.8 1171.7 80.5% 362.4 254.7 171.8 30.0 190.0 1008.9 818.9 162.8 11.2% 547.8 37.6% 1,494.9 299.0 1196.0 80.0% 372.2 254.1 174.9 31.0 195.0 1027.3 832.3 168.7 11.3% 568.7 38.0% Q4-08E 1,349.7 227.0 1,576.7 313.8 1263.0 80.1% 378.4 252.3 173.4 32.0 195.0 1031.1 836.1 231.8 14.7% 641.8 40.7%

Marketing Services Fees Listing Total Revenue Cost of Revenue Gross Profit Gross Margin Sales and Marketing Product Development G&A Amortization & stock comp FAS123 Adjustment Other Adjustment Total Expenses Total Expenses (ex-FAS123R) Operating Profit Operating Margin (Reported) EBITDA EBITDA Margin Interest Income Investment gains (losses) Contract termination fees Other Other income, net IBT & Minority Interest Margins Income Taxes Tax Rate IAT Earnings in Equity Interest Minority Interest IAT & Minority Interest Accounting Changes

40.0 160.0 12% 67.2 42% 92.8 40.0 132.8 -

40.0 202.8 14% 85.2 42% 117.6 42.0 159.6 -

40.0 208.7 14% 87.6 42% 121.0 45.0 166.0 -

40.0 271.8 17% 114.2 42% 157.7 48.0 205.7 -

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North America Equity Research 02 January 2008

Reported Net Income Reported EPS GAAP (inc. FAS 123R) Diluted Shares % of Total Revenue Marketing Services Fees Sales and Marketing Product Development G&A Q/Q change Marketing Services Fees Sales and Marketing Product Development G&A Y/Y Change Marketing Services Fees Revenue Sales and Marketing Product Development G&A
Source: Company reports and JPMorgan estimates.

Q1-06 159.8 0.11 1,493

FY-2006 Q2-06 Q3-06 164.3 158.5 0.11 0.11 1,477 1,442

Q4-06 268.7 0.19 1,419

Q1-07 142.4 0.10 1,418

FY-2007E Q2-07 Q3-07 160.6 151.3 0.11 0.11 1,404 1,395

Q4-07E 146.9 0.11 1,395

Q1-08E 132.8 0.10 1,385

FY 2008E Q2-08E Q3-08E 159.6 166.0 0.12 0.12 1,375 1,365

Q4-08E 205.7 0.15 1,355

83% 17% 26.9% 16.5% 9.0% 2% 0% 3% 12% 3% 34% 25% 33% 27% 51% 33%

83% 17% 25.6% 15.4% 9.7% 3% 2% -2% -4% -2% 30% 19% 28% 17% 37% 33%

81% 19% 25.7% 14.6% 8.2% -2% 11% 0% -5% 0% 20% 23% 20% 9% 16% 18%

83% 17% 24.3% 14.0% 9.1% 11% 1% 4% 5% 4% 15% 15% 15% 6% 7% 29%

83% 17% 26.8% 16.2% 9.8% -3% -4% 6% 11% 6% 9% 9% 9% 9% 6% 18%

83% 17% 27.2% 17.4% 9.9% 5% 4% 7% 13% 7% 11% 12% 11% 18% 26% 14%

83% 17% 26.6% 17.4% 11.0% 3% 6% 1% 3% 1% 16% 7% 14% 18% 36% 53%

84% 16% 25.0% 17.5% 11.0% 10% 0% 2% 9% 2% 14% 6% 13% 16% 41% 36%

84% 16% 25.5% 18.5% 11.8% -1% -2% 1% 4% 1% 17% 9% 16% 10% 32% 39%

84% 16% 24.9% 17.5% 11.8% 7% 2% 4% 1% 4% 19% 7% 17% 7% 18% 39%

85% 15% 24.9% 17.0% 11.7% 3% 0% 3% 0% 3% 20% 1% 17% 9% 14% 25%

86% 14% 24.0% 16.0% 11.0% 6% 0% 2% -1% 2% 16% 1% 14% 9% 4% 14%

261

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North America Equity Research 02 January 2008

Table 171: YHOO Annual Balance Sheet


$ in millions FY-06 Assets Cash and cash equivalents Restricted cash ST investments in marketable securities Restricted short-term investments Accounts receivable, net Prepaid expenses and other current assets Total current assets LT investments in marketable securities Restricted long-term investments Property and equipment, net Goodwill Intangible assets, net Other assets, net Investments in equity interests Total assets Liabilities and stockholders' equity Accounts payable Accrued expenses and other current liabilities Deferred revenue Short term debt Total current liabilities Long Term Deferred Other liabilities Minority interests in consolidated subsidiaries Convertible debt Total liabilities Total stockholders' equity Total Liabilities and Shareholders' Equity
Source: Company reports and JPMorgan estimates.

FY-07E 1,813.3 684.2 1,025.4 401.9 3,924.8 550.6 1,270.3 3,532.3 517.4 529.5 1,989.3 12,314.2 166.3 1,039.3 374.1 749.6 2,329.3 59.0 309.3 8.3 2,705.9 9,608.3 12,314.2

FY-08E 3,456.3 684.2 1,182.5 457.2 5,780.2 550.6 1,270.3 3,532.3 517.4 529.5 1,989.3 14,169.6 189.2 1,182.5 425.7 749.6 2,547.1 59.0 309.3 8.3 2,923.7 11,246.0 14,169.6

FY-09E 5,191.9 684.2 1,287.3 497.8 7,661.1 550.6 1,160.3 3,532.3 517.4 529.5 1,989.3 15,940.5 206.0 1,287.3 463.4 749.6 2,706.3 59.0 309.3 8.3 3,082.9 12,857.7 15,940.5

1,569.9 1,031.5 931.0 217.8 3,750.1 935.9 1,101.4 2,992.1 405.8 460.0 1,891.8 11,537.2 109.1 1,048.2 318.0 1,475.3 64.9 50.5 8.1 749.9 2,348.8 9,188.4 11,537.2

262

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

North America Equity Research 02 January 2008

Table 172: YHOO Cash Flow Statement


$ in millions FY-06 751.3 540.0 529.7 (112.1) 6.3 424.9 (7.8) (163.7) 1,431.4 1,279.5 (689.1) 536.8 (334.8) 436.0 (142.6) (193.7) 318.1 (1,782.1) (227.7) 537.3 (1,154.5) 56.9 140.1 1,429.8 1,569.9 FY-07E 601.2 651.5 103.3 (134.3) 14.0 589.3 (56.5) 148.4 1,668.9 1,307.0 (609.8) 246.0 (112.0) 510.7 (355.5) (320.7) 243.9 (1,363.2) (250.0) 247.9 (15.9) (1,137.3) 32.5 243.5 1,569.9 1,813.4 FY-08E 664.1 800.0 360.0 (146.2) 765.0 2,442.9 1,642.9 (800.0) (800.0) 1,642.9 1,813.3 3,456.3 FY-09E 791.8 910.0 200.0 (146.2) 780.0 2,535.7 1,735.7 (800.0) (800.0) 1,735.7 3,456.3 5,191.9

Net Income D&A Tax Benefit Excess Tax Benefit from SBC Equity Minority Interests Stock Based Compensation Other Non-Cash Items Changes in Working Capital Accounts Receivable Prepaid Expenses Accounts Payable Accrued Charges Deferred Revenue Other Operating Cash From Operations FCF INVESTING CASH FLOWS Capital Expenditures Net Investment ST Investment Purch. ST Investments Mat. Acquisitions Cash From Investing FINANCING CASH FLOWS Common Stock Issued Shares Repurchased Structured stock repurchase Excess Tax Benefit from SBC Other financing activities, net Long Term Debt Cash From Financing Foreign Exch Effects Net Change In Cash Cash at Beginning Cash at End
Source: Company reports and JPMorgan estimates.

263

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North America Equity Research 02 January 2008

264

China Company Previews

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

North America Equity Research 02 January 2008

Baidu, Overweight ($399.67)


We maintain our Overweight rating on Baidu, the dominant market leader in China's online search market, which is still in an early high-growth stage. We expect the paid search market in China to experience ~55% CAGR over 2007-2012, driven by: (1) rising Internet penetration in China, (2) significant growth in websites and pages, (3) higher search usage, and (4) increased SME search marketing due to relatively higher ROI. Baidus search market share is around 60%-70% (as per different market research firms) and it also now has the top Internet traffic in China (as per Alexa). Baidus fundamentals continue to remain strong. In 3Q07, active online marketing customers were ~143K, up 12% Q/Q and up 40% Y/Y. Revenue per online marketing customer was Rmb3,469 (~US$467), up 11% Q/Q and up 49%Y/Y. Going forward, we expect customer numbers to grow at a faster rate than revenue per customer. Also, by end-3Q07, customer deposits were at Rmb 229M, up 27% Q/Q; we believe the good customer deposit growth sets a good stage for future revenue growth. We expect Baidu to maintain its leading search engine position in China due to: (1) its products are tailored better to local needs (eg. music search and Baidu Knows - community Q&A site), (2) its strong local brand name, (3) good relationship with the Chinese government, and (4) its good Chinese search technology. Baidu also has one of the widest distribution networks in China (a key to driving sales), and remains well ahead of competitors in this regard. As per management, the company has 60 first-level/large distributors; we believe there are also more than a thousand second-tier distributors / agents across China. A wide distribution network remains crucial as the paid search market in China is still in an early phase of development, and many SME advertisers still need advice and services from ad agencies. In our view, positive share price drivers include: (1) potential upside from new revenue sources, such as display ads and Baidu TV, as a majority of its current traffic is now on non-search properties; (2) continued strong fundamentals in paid search (still in early high-growth stage), including margin expansion; (3) potential from long-term strategic investments, such as the Japanese site and C2C e-commerce platform; and (4) QDII funds showing strong interest in leading US-listed Chinese names. For 4Q07, we estimate total revenue of US$76.2M, up 15% Q/Q and 119% Y/Y, and GAAP-diluted EPS of US$0.60, down 14% Q/Q and up 33% Y/Y, with the Shenzhen distributor transition and Internet Data Center shut-down issues leading to slightly slower growth in the quarter (we believe these are short-lived issues, while the longer-term fundamental outlook remains strong).

267

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

North America Equity Research 02 January 2008

Table 173: Baidu Financial Snapshot


US$ millions, except per share data 4Q07E 3Q07A 4Q06A JPMorgan Revenue EBITDA EPS (GAAP) EPS (Adj.) * Consensus Revenue EBITDA EPS (GAAP) 76.2 29.0 0.60 0.66 76.0 0.72 66.3 29.2 0.70 0.72 66.3 29.2 0.70 34.8 16.9 0.45 0.48 34.8 16.9 0.45 Y/Y Q/Q 119% 72% 33% 37% 15% -1% -14% -9% F'07E 230.1 96.1 2.15 2.31 226.7 2.30 F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y 451.0 196.9 4.42 4.65 418.1 4.07 716.5 315.7 6.99 7.21 666.0 6.33 118% 100% 99% 83% 115% 112% 96% 105% 106% 101% 84% 77% 59% 60% 58% 55% 59% 56%

119% 15% 59% 3%

Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.

Our Estimates and Outlook for 2008


We forecast 2008 total revenue at US$451M, up 96% Y/Y, and GAAP-diluted EPS of US$4.42, up 106% Y/Y. We expect active online marketing customers to grow at ~42% Y/Y in 2008 to reach ~220K in 4Q08, and revenue per customer to reach Rmb 4,811 in 4Q08, up 31% Y/Y. In respect of margins, we forecast gross margin at 63.9% for 2008, or relatively stable vs. 63.7% for 2007; adjusted operating margin (ex-share-based expense) of 35.2% for 2008, up from 32.1% for 2007 (due to better leverage in SG&A expenses), and adjusted net margin (ex-share-based expense) of 36.7% for 2008, up from 35% for 2007. Also, Baidus Japan search service is set to launch in 4Q07 (with full-year 2007 expense of ~US$15M); however, revenue will likely not come in until late 2008 or 2009. In respect of C2C e-commerce, the business model will be similar to C2C market leader Taobao (keyword ranking with free store front offered) and is scheduled to launch in 2008. The company expects spending on the C2C service will be significantly less than the Japan investment. We are not modeling any revenue contribution as yet. Also, we do not expect any significant negative revenue impact from Baidus C2C competitors (Taobao and eBay Eachnet), which are still Baidus customers.

Our Estimates and Outlook for 2009


For 2009, we forecast total revenue at US$716.5M, up 59% Y/Y, and GAAP-diluted EPS of US$6.99, up 58% Y/Y. We forecast active online marketing customers to reach ~282K in 4Q09, up 28% Y/Y, and revenue per customer to reach Rmb 5,556 in 4Q09, up 15% Y/Y. We forecast gross margin at 62.7% for 2009 (slightly lower Y/Y); adjusted operating margin (ex-share-based expense) of 35.3% (stable from prior year) and adjusted net margin (ex-share-based expense) of 36.4% (stable).

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North America Equity Research 02 January 2008

Rating and Price Target


We maintain our OW rating on Baidu. Our Dec-08 price target is US$400, based on a PEG ratio of 1.9x (based on 2009E PE, divided by 2011 estimated earnings growth), or 1.1x (based on 2009E PE, divided by 2010E earnings growth), largely in line with valuation on Chinas Internet names. The PT implies 90.5x 2008E, 57.2x 2009E, and 38.1x 2010E diluted GAAP P/E (or 86.1x 2008E, 55.5x 2009E, and 37.3x 2010E diluted adjusted P/E). We believe Baidus current valuation can be sustained at least until end-2008 due to: (1) Internet growth outlook will likely remain unchanged, and Internet penetration in China is still below 20% vs. the US level of 65%+; also, the number of SMEs using search is still low, roughly 240k out of around 4 million relatively larger SMEs in China. (2) Potential pickup in eCommerce after 2008. (3) New revenue sources, such as Baidu TV and display ads, to provide upside surprise. (4) Investments from domestic Chinese investors. In addition, we believe that earnings upside could come from the expansion in Japan, Baidu TV, banner advertising, C2C e-commerce services and potential margin expansion. As with other growth stocks, we believe Baidus shares may continue to be volatile. However, from a 12-month perspective, we expect Baidu to further consolidate its leading position and increase its monetization rate from growing traffic.

Risks to Our Rating and Price Target


Downside risks to our rating and price target include: (1) Slower-than-expected online search spending. (2) Large infrastructure-related (servers and bandwidth) spending. (3) Near-term distributor transition (Baidu is transitioning its sales channel from distributor sales to direct sales in Shenzhen). (4) Unsuccessful Japan and ecommerce initiatives. (5) Potential margin decline (from bandwidth cost increases, tax rate increases and significant labor cost increases).

269

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

North America Equity Research 02 January 2008

Table 174: Baidu Income statement


US$ in millions, except per share data, year-end December Total Revenue Online marketing services Other services COGS Gross Profit Operating Expense SG&A expenses R&D expenses Share-based comps expenses EBIT Adj. EBIT (ex-share-based exp.) EBITDA Net Interest Income Net Other Income Pre Tax Profit Tax Expense/(Credit) Net Profit Adj. Net Profit (ex-share-based exp) Diluted EPS (US$) Adj. Diluted EPS (US$, ex-sharebased exp.) Margins (%) Gross Margin Adj. OPM (ex-share-based exp.) EBITDA Margin Net Margin Adj. Net Margin (ex-share-based) Sequential Growth (%) Revenue Gross Profit EBIT Net Profit Adj. Net Profit Diluted EPS Adj. Diluted EPS
Source: Company, JPMorgan estimates.

1Q06 16.9 16.5 0.4 -5.3 11.6 -8.3 -5.1 -1.5 -1.6 3.4 5.0 6.6 1.1 0.1 4.6 0.7 4.4 6.0 0.13 0.17 68.7 29.3 39.0 26.0 35.4 18.8 20.1 90.6 44.5 38.2 45.0 38.7

2Q06 24.0 23.6 0.3 -7.0 16.9 -9.7 -6.4 -1.8 -1.5 7.3 8.7 10.7 1.3 0.1 8.6 1.3 7.3 8.8 0.21 0.25 70.6 36.4 44.6 30.5 36.6 41.7 45.8 116.0 66.4 46.5 65.8 46.0

3Q06 30.3 30.1 0.2 -8.6 21.7 -12.1 -7.6 -2.4 -2.1 9.6 11.7 14.1 1.4 0.0 11.0 0.3 10.8 12.9 0.31 0.37 71.7 38.7 46.7 35.6 42.5 26.3 28.2 33.0 47.5 46.4 47.3 46.3

4Q06 34.8 34.6 0.2 -9.9 24.8 -11.8 -8.3 -2.6 -0.9 13.0 14.0 16.9 1.5 0.4 15.0 -0.8 15.7 16.7 0.45 0.48 71.4 40.2 48.5 45.3 48.0 14.8 14.5 35.2 45.9 29.7 45.5 29.4

1Q07 35.7 35.6 0.1 -13.2 22.5 -13.0 -8.6 -2.8 -1.6 9.6 11.1 14.9 1.5 0.2 11.3 -0.2 11.1 12.7 0.32 0.36 63.1 31.2 41.6 31.0 35.5 2.6 -9.3 -26.7 -29.6 -24.1 -29.6 -24.0

2Q07 52.7 52.6 0.1 -19.2 33.5 -16.5 -11.9 -3.5 -1.2 16.9 18.1 23.3 1.5 0.4 18.9 -0.2 18.6 19.8 0.54 0.57 63.5 34.4 44.2 35.4 37.6 47.7 48.7 77.2 68.4 56.6 68.2 56.4

3Q07 66.3 66.2 0.1 -24.1 42.2 -19.8 -14.7 -4.3 -0.7 22.4 23.2 29.2 1.6 0.5 24.6 -0.3 24.3 25.0 0.70 0.72 63.7 35.0 44.1 36.6 37.7 25.7 26.1 32.4 30.1 26.1 29.9 25.9

4Q07E 76.2 76.2 0.1 -27.2 49.0 -29.2 -21.9 -5.3 -2.0 19.8 21.8 29.0 1.9 0.0 21.7 -0.5 21.2 23.2 0.60 0.66 64.3 28.6 38.0 27.9 30.5 15.0 16.1 -11.8 -12.5 -7.0 -13.9 -8.5

1Q08E 76.2 76.1 0.1 -29.1 47.1 -26.1 -18.8 -5.3 -2.0 21.0 23.0 30.4 2.3 0.0 23.3 -0.8 22.5 24.5 0.64 0.69 61.8 30.1 39.9 29.6 32.2 0.0 -3.9 5.9 6.2 5.7 5.8 5.3

2Q08E 104.2 104.1 0.1 -37.9 66.3 -32.1 -22.8 -7.3 -2.0 34.2 36.2 45.0 2.5 0.0 36.8 -1.2 35.6 37.6 1.00 1.06 63.6 34.8 43.2 34.2 36.1 36.8 40.8 63.2 57.8 53.1 57.3 52.6

3Q08E 129.4 129.3 0.1 -45.5 83.9 -38.1 -27.1 -9.1 -2.0 45.8 47.8 58.0 3.1 0.0 48.9 -1.5 47.4 49.4 1.33 1.38 64.9 36.9 44.8 36.6 38.2 24.2 26.6 33.9 33.1 31.3 32.7 30.9

4Q08E 141.3 141.2 0.1 -50.3 90.9 -41.0 -29.1 -9.9 -2.0 50.0 52.0 63.5 3.7 0.0 53.7 -1.7 52.0 54.0 1.45 1.51 64.4 36.8 44.9 36.8 38.3 9.2 8.4 9.1 9.9 9.5 9.5 9.1

FY06 105.7 104.5 1.2 -30.8 74.9 -41.7 -27.4 -8.2 -6.1 33.2 39.2 48.1 5.4 0.5 39.0 -1.5 38.1 43.6 1.08 1.26 70.9 37.1 45.6 36.0 41.2 170.7 183.8 656.5 553.8 338.9 543.5 338.7

FY07E 230.1 229.8 0.3 -83.4 146.7 -78.2 -56.8 -15.9 -5.5 68.5 74.0 96.1 6.6 1.1 76.2 -1.2 75.0 80.4 2.15 2.31 63.7 32.1 41.7 32.6 35.0 117.8 95.9 106.6 97.0 84.7 98.5 83.2

FY08E 451.0 450.8 0.2 -162.8 288.2 -137.3 -97.7 -31.6 -8.0 150.9 158.9 196.9 11.7 0.0 162.7 -5.1 157.6 165.6 4.42 4.65 63.9 35.2 43.7 34.9 36.7 96.0 96.5 120.4 110.2 105.8 105.7 101.4

FY09E 716.5 716.3 0.2 -267.4 449.0 -203.8 -142.1 -53.7 -8.0 245.2 253.2 315.7 21.0 0.0 266.2 -13.7 252.5 260.5 6.99 7.21 62.7 35.3 44.1 35.2 36.4 58.9 55.8 62.5 60.3 57.4 58.1 55.3

270

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

North America Equity Research 02 January 2008

Table 175: Baidu Annual Balance Sheet


US$ in millions, year-end December Cash & Cash Equivalents Account Receivables Other Current Assets Total Current Assets Net Fixed Assets LT Investments Other LT Assets Total Long Term Assets Total Assets ST Debt Accrued Expenses and Payables Other Current Liabilities Total Current Liabilities LT Debt Other LT Liabilities Total Liabilities Share Capital Additional Paid-in Capital Other Reserves Retained Earnings Preferred Stock Total Equity Total Liabilities and Equity
Source: Company reports, JPMorgan estimates.

FY06 154 3 4 161 36 13 49 210 19 19 38 1 39 0 137 (4) 38 171 210

FY07E 232 8 14 254 75 1 19 96 349 44 43 87 0 88 0 155 (9) 115 262 349

FY08E 436 15 26 477 114 1 18 134 611 86 81 166 0 167 0 179 (9) 274 444 611

FY09E 652 23 38 713 241 1 17 259 972 130 120 250 0 250 0 204 (9) 526 721 972

Table 176: Baidu Annual Cash Flow Statement


US$ in millions, year-end December Net Income Add Non cash Expenses/(income) Depreciation and Amortization Extra-ordinaries Other Non-Cash Items Changes in Working Capital: (Increase)/Decrease Receivables (Increase)/Decrease Inventories (Increase)/Decrease Other Current Assets Increase/(Decrease) Payables Increase/(Decrease) Other Current Liabilities Net Cash from Operations Cash Flow from Investing Purchase of Property, Plant & Equipment Purchase / Sale of Other LT Assets Purchase / Sale of Investments Net Cash from Investing Activities Cash Flow from Financing Issuance/Repayment of Debt Change in other LT liabilities Change in Common Equity - net Payment of Cash Dividends Other Financing Charges, Net Net Cash from Financing Activities Net Change in Cash & Cash Equivalents Cash & Cash Equivalents at end of period
Source: Company reports, JPMorgan estimates.

FY06 38 9 (1) 6 (0) (3) 13 9 71 (22) (11) 0 (33) 1 0 1 2 44 154

FY07E 75 22 5 (5) (9) 24 24 135 (59) (7) (1) (66) (1) 2 (0) 2 78 232

FY08E 158 38 8 (7) (12) 41 37 263 (75) (75) 14 (0) 14 204 436

FY09E 253 62 8 (7) (12) 44 39 386 (187) (187) 17 17 216 652

271

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

North America Equity Research 02 January 2008

China Finance Online, Overweight ($23.75)


We maintain our Overweight rating on China Finance Online (JRJC). We remain positive on the current management team's execution capability, and expect continued business momentum through a significant scaling up of the companys core subscriptions business in 2008 and beyond. JRJCs execution capability has significantly improved over the last year, particularly in its core individual subscription business, where the company has delivered four back-to-back quarters of record cash inflows. In 3Q07, individual subscriber cash inflows were a record-high US$11.06M, up 35% Q/Q and 465% Y/Y; deferred revenue reached US$18.8M, up 31% Q/Q and 563% Y/Y. Signaling greater business confidence, JRJC also raised its 2008 guidance at the 3Q07 results announcement. JRJC now expects 2008 revenue of US$50-$60M (up 113% Y/Y at the mid-point) and adj. net income of US$22-$28M (up 150% Y/Y at the mid-point), driven by continuing strength in its core subscription business. Although a prolonged downturn (lasting for several quarters) in Chinas domestic stock market may have an adverse effect on demand for JRJCs offerings, we believe the company is now significantly better positioned than in the past to continue on a strong growth path. JRJC has expanded its tele-sales force from ~90 at the end of 2006 to around 260 as of 3Q07, and is preparing for a 500-seat call center by mid-2008; we expect this to be a key component of the companys subscriber acquisition / up-selling strategy, which should help to drive significant scaling up of revenues and earnings. Also, the companys fundamental analysis product series Value Engine remains a differentiated offering for consumers. We believe the key share price drivers include: (1) continued strong performance in its core subscriptions business, (2) further strategic acquisitions to expand its core business, and (3) potentially acquiring an A-share brokerage license, after having acquired a small HK broker. The key downside risk remains: a prolonged slow-down in domestic stock market activities. For 4Q07, we estimate net revenues at US$8.8M, up 20% Q/Q and 249% Y/Y, and GAAP EPS of US$0.11, up 36% Q/Q (and vs. loss of US$0.08 in 4Q06). Our top-line estimate is 2% above the mid-point of company guidance (US$8.2$9.0M). With the projected strong top-line growth, we expect adjusted operating margin (ex-share-based expense) to expand to 38.5% in 4Q07, up from 34.5% in 3Q07.

272

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

North America Equity Research 02 January 2008

Table 177: JRJC Financial Snapshot


US$ millions, except per share data 4Q07E JPMorgan Revenue 8.8 EBITDA 3.7 EPS (GAAP) 0.11 EPS (Adj.) * 0.16 Consensus Revenue 8.6 EBITDA EPS (GAAP) 0.11 3Q07A 4Q06A 7.3 2.8 0.08 0.13 7.3 2.8 0.08 2.5 -0.3 -0.08 -0.01 2.5 -0.3 -0.08 Y/Y Q/Q 249% n.m. n.m. n.m. 20% 33% 36% 22% F'07E 25.8 9.3 0.32 0.46 25.7 0.32 F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y 56.5 28.4 0.92 1.11 56.5 0.92 106.9 55.2 1.82 2.01 106.0 1.82 262% 1006% n.m. 1529% 261% n.m. 119% 206% 189% 139% 120% 188% 89% 94% 98% 81% 88% 98%

241% 18% n.m. 30%

Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.

Our Estimates and Outlook for 2008


We forecast 2008 net revenue at US$56.5M, up 119% Y/Y, and GAAP-diluted EPS of US$0.92, up 189% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.11, up 139% Y/Y. We expect JRJCs core subscription business to remain the key driver on the back of continued solid execution, particularly with the planned tripling of its tele-sales team by mid-08 (to reach ~760). In respect of margins, we forecast gross margin at 83.4% for 2008, up slightly from 82.6% for 2007; adjusted operating margin (ex-share-based expense) of 46.9% for 2008, expanding from 32.2% for 2007 (due to better leverage in operating expenses), and adjusted net margin (ex-sharebased expense) of 44.8% for 2008, up from 38.8% for 2007.

Our Estimates and Outlook for 2009


For 2009, we forecast net revenue at US$106.9M, up 89% Y/Y, and GAAP-diluted EPS of US$1.82, up 98% Y/Y, or adjusted EPS (ex-share-based expense) of US$2.01, up 81% Y/Y. We forecast gross margin at 84.0% for 2009 (up slightly Y/Y); adjusted operating margin (ex-share-based expense) of 48.2% (slight expansion) and adjusted net margin (ex-share-based expense) of 43.2% (down slightly due to slightly higher tax rate assumption).

Rating and Price Target


We maintain our Overweight rating on JRJC. Our Dec-08 price target is US$36, which implies 08 / 09 PE of 32x / 18x on our adjusted diluted EPS estimates (or GAAP PE of 39x /20x), on the back of 08E / 09E / 10E adjusted diluted EPS growth of 139% / 81% / 22%. The price target is slightly above our DCF valuation of ~US$33 (based on WACC of 14% & terminal growth of 0%) due to the strong growth prospects.

Risks to Our Rating and Price Target


Downside risks to our rating and price target are: (1) prolonged slowdown in domestic stock market activities (which have historically impacted demand for JRJCs products), (2) increased competition in financial analysis software, (3) management bandwidth in managing the expanding business scale (core business) and wider portfolio (institutional subscriptions, HK brokerage, advertising).

273

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

North America Equity Research 02 January 2008

Table 178: China Finance Online Income statement


US$ in millions, except per share data, year-end December Revenue Subscriptions Online Ads Wireless / Stockstar / Others COGS Gross Profit Operating Expenses Sales & Mktg. expenses G&A expenses R&D expenses Other expenses Share-based comp. expense (123R) EBITDA EBIT Adj. EBIT (ex-123R expense) Net Interest Income Net Other Income Pre Tax Profit Tax Expense/(Credit) Net Profit (GAAP Reported) Adj. Net Profit (ex-123R exp.) Pre Tax EPS (US$) EPS (US$) Diluted EPS (Reported, US$) Adj. Diluted EPS (ex-123R exp., US$) Margins (%) Gross Margin Operating Margin (ex-123R exp.) EBITDA Margin Net Margin Adj. Net Margin (ex-123R exp.) Sequential Growth (%) Revenue Gross Profit Adj. EBIT (ex-123R exp.) Pre Tax Profit Adj. Net Profit (ex-123R exp.) Adj. Diluted EPS (ex-123R exp.) 1Q06 1.41 0.87 0.54 0.00 -0.17 1.23 -1.48 -0.68 -0.76 -0.05 0.00 0.44 0.23 -0.25 0.19 0.26 0.09 0.11 0.01 0.10 0.54 0.01 0.01 0.00 0.03 87.6 13.5 16.7 6.9 38.1 -26.1 -29.8 -73.7 -90.6 -49.7 -50.5 2Q06 1.47 0.96 0.51 0.00 -0.28 1.19 -1.15 -0.35 -0.66 -0.14 0.00 0.23 0.31 0.04 0.26 0.26 0.15 0.45 0.01 0.44 0.67 0.02 0.02 0.02 0.03 80.9 18.0 21.3 30.1 45.5 4.3 -3.7 38.9 315.7 24.4 21.7 3Q06 1.73 1.38 0.35 0.00 -0.30 1.44 -1.19 -0.30 -0.77 -0.12 0.00 0.30 0.62 0.25 0.54 0.27 0.06 0.58 0.02 0.56 0.85 0.03 0.03 0.03 0.04 82.8 31.3 35.5 32.1 49.2 18.1 20.9 105.7 28.1 27.9 31.2 4Q06 2.52 2.03 0.19 0.30 -0.60 1.92 -2.66 -1.23 -0.90 -0.31 0.00 -0.23 -0.30 -0.74 -0.52 0.21 -1.24 -1.77 -0.08 -1.70 -0.15 -0.09 -0.09 -0.08 -0.01 76.1 -20.5 -11.8 -67.2 -5.9 45.5 33.7 -195.0 -408.3 n.m. n.m. 1Q07 4.00 3.39 0.25 0.36 -0.82 3.18 -2.81 -1.22 -0.87 -0.32 0.00 -0.39 0.94 0.37 0.77 0.25 0.06 0.69 -0.09 0.78 1.17 0.04 0.04 0.04 0.06 79.6 19.2 23.5 19.4 29.2 58.4 65.7 -248.6 -138.9 n.m. n.m. 2Q07 5.72 4.93 0.40 0.40 -1.08 4.64 -3.59 -1.33 -1.25 -0.42 0.00 -0.60 1.87 1.05 1.65 0.25 0.11 1.41 -0.15 1.56 2.16 0.07 0.08 0.08 0.11 81.1 28.8 32.6 27.3 37.7 43.2 46.1 115.0 104.6 84.8 85.1 3Q07 7.30 6.38 0.50 0.42 -1.19 6.11 -4.67 -1.85 -1.16 -0.58 0.00 -1.08 2.78 1.44 2.52 0.24 0.04 1.73 -0.18 1.90 2.98 0.09 0.10 0.08 0.13 83.7 34.5 38.0 26.0 40.8 27.6 31.6 52.9 22.2 38.2 25.0 4Q07E 8.79 7.92 0.45 0.42 -1.41 7.39 -5.08 -2.02 -1.32 -0.66 0.00 -1.08 3.69 2.31 3.39 0.32 0.00 2.63 0.00 2.63 3.71 0.14 0.14 0.11 0.16 84.0 38.5 42.0 29.9 42.2 20.4 20.9 34.3 52.1 24.3 22.2 1Q08E 10.18 8.88 0.47 0.83 -1.77 8.40 -5.56 -2.34 -1.42 -0.71 0.00 -1.08 4.27 2.84 3.93 0.37 0.00 3.21 0.43 2.77 3.85 0.17 0.15 0.12 0.17 82.6 38.6 41.9 27.2 37.9 15.8 13.8 15.9 22.3 4.0 4.6 2Q08E 12.10 10.74 0.48 0.88 -2.06 10.04 -6.04 -2.54 -1.57 -0.85 0.00 -1.08 5.51 4.00 5.08 0.39 0.00 4.39 0.55 3.83 4.91 0.23 0.20 0.17 0.22 83.0 42.0 45.5 31.7 40.6 18.8 19.5 29.4 36.6 27.4 27.2 3Q08E 14.96 13.55 0.50 0.92 -2.47 12.49 -6.47 -2.84 -1.65 -0.90 0.00 -1.08 7.62 6.02 7.10 0.44 0.00 6.46 0.75 5.69 6.77 0.34 0.30 0.25 0.30 83.5 47.5 50.9 38.0 45.3 23.7 24.4 39.8 47.2 37.9 37.7 4Q08E 19.30 17.83 0.51 0.95 -3.10 16.20 -6.87 -3.09 -1.74 -0.96 0.00 -1.08 11.01 9.33 10.41 0.50 0.00 9.84 1.09 8.73 9.81 0.52 0.46 0.38 0.43 84.0 54.0 57.1 45.3 50.9 29.0 29.8 46.6 52.3 44.9 44.6 FY06 7.13 5.24 1.59 0.30 -1.36 5.77 -6.48 -2.56 -2.12 -0.61 0.00 -1.19 0.84 -0.70 0.48 1.00 -0.94 -0.64 -0.04 -0.60 0.59 -0.03 -0.03 -0.03 0.03 81.0 6.7 11.8 -8.4 8.2 -4.7 -17.6 -85.1 nm -87.3 -87.1 FY07E 25.81 22.62 1.60 1.59 -4.49 21.32 -16.15 -6.42 -4.60 -1.97 0.00 -3.15 9.28 5.17 8.32 1.07 0.21 6.45 -0.41 6.86 10.02 0.34 0.36 0.32 0.46 82.6 32.2 36.0 26.6 38.8 262.1 269.4 1,630.6 nm 1,612.3 1,529.3 FY08E 56.53 51.00 1.95 3.58 -9.40 47.13 -24.94 -10.81 -6.38 -3.42 0.00 -4.32 28.40 22.20 26.52 1.69 0.00 23.89 2.82 21.03 25.35 1.26 1.11 0.92 1.11 83.4 46.9 50.2 37.2 44.8 119.0 121.1 218.6 270.2 153.1 138.9 FY09E 106.89 100.56 2.20 4.13 -17.14 89.75 -42.55 -19.92 -11.29 -7.02 0.00 -4.32 55.21 47.20 51.52 2.92 0.00 50.12 8.17 41.91 46.23 2.62 2.19 1.82 2.01 84.0 48.2 51.7 39.2 43.2 89.1 90.4 94.3 109.8 82.3 81.1

Source: Company, JPMorgan estimates. Note: We have included 123R share-based compensation adjustments starting 2006.

274

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

North America Equity Research 02 January 2008

Table 179: JRJC Annual Balance Sheet


US$ in millions, year-end December Cash & Cash Equivalents Accounts Receivable Inventory Total Other Current Assets Total Current Assets Gross Fixed Assets Accumulated Depreciation Net Fixed Assets Other Long Term Assets Long Term Investments and Associates Total Long Term Assets Total Assets ST Debt and Current Portion of LT Debt Accounts Payable (Accrued expenses, etc.) Other Current Liabilities Total Current Liabilities Long Term Debt Other Long Term Liabilities Total Long Term Liabilities Share Capital Share Premium Other Reserves Retained Earnings Preferred Stock Total Equity Total Liabilities and Equity
Source: Company reports, JPMorgan estimates.

FY06 45.0 0.5 1.1 46.5 2.3 (0.6) 1.7 10.3 12.6 24.6 71.1 2.1 6.4 8.5 0.1 0.1 0.0 52.6 1.6 8.2 62.5 71.1

FY07E 66.8 1.7 2.9 71.4 5.4 (1.3) 4.2 13.6 12.6 30.4 101.9 3.8 17.6 21.4 2.1 2.1 0.0 59.7 3.5 15.1 78.3 101.9

FY08E 108.4 3.8 6.0 118.2 12.2 (2.9) 9.4 13.6 12.6 35.6 153.8 8.4 30.9 39.3 1.5 1.5 0.0 73.4 3.5 36.1 113.0 153.8

FY09E 163.9 5.5 11.3 180.8 25.1 (6.3) 18.8 13.6 12.6 45.0 225.8 11.2 44.9 56.1 1.0 1.0 0.0 87.1 3.5 78.0 168.6 225.8

Table 180: JRJC Annual Cash Flow Statement


US$ in millions, year-end December Net Income Non cash Expenses/(income) Depreciation and Amortization Extraordinaries Other Non-Cash Items Changes in Working Capital: (Increase)/Decrease Receivables (Increase)/Decrease Inventories (Increase)/Decrease Other Current Assets Increase/(Decrease) Payables Increase/(Decrease) Other Current Liabilities Net Cash from Operations Purchase of Property, Plant & Equipment Purchase/Sale of Other LT assets Purchase/Sale of Investments Net Cash from Investing Activities Issuance/Repayment of Debt Change in other LT liabilities Change in Common Equity - net Payment of Cash Dividends Other Financing Charges, Net Net Cash from Financing Activities Net Effect of Exchange Rate Changes Net Change in Cash and Cash Equivalents Cash & CE at End of Period
Source: Company reports, JPMorgan estimates.

FY06 (0.6) 0.4 1.2 (0.3) 0.1 1.7 4.5 6.9 (1.4) (10.3) 2.4 (9.3) 0.1 1.0 0.0 1.2 (1.2) 45.0

FY07E 6.9 1.0 3.2 (1.3) (1.8) 1.8 11.2 20.8 (3.1) (3.6) (0.0) (6.8) 2.0 5.8 (0.0) 7.8 21.8 66.8

FY08E 21.0 1.9 0.0 4.3 (2.1) (3.1) 4.6 13.3 40.0 (6.8) (0.3) (7.1) (0.6) 9.4 (0.0) 8.7 41.6 108.4

FY09E 41.9 3.7 0.0 4.3 (1.7) (5.3) 2.8 14.0 59.7 (12.8) (0.3) (13.1) (0.4) 9.4 (0.0) 8.9 55.5 163.9

275

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

North America Equity Research 02 January 2008

NetEase, Neutral ($19.33)


We maintain our Neutral rating on NetEase. Although the stocks valuation is relatively low, we believe NetEase still lacks revenue drivers in the near to medium term, or the next big game to drive earnings growth. While WWJ3 has commercialized, and the results are respectable, we believe investors will wait for the next games: we expect TianXia 2 and Datang free-model to launch in 2Q08. However, we believe investors will not get excited easily (or pay high valuation), given limited success in the first versions of Datang and TianXia2. NetEase remains in a period of transition in its online games business, in our view. While we expect its online game revenue to register ~7% growth in 4Q07 (with WWJ3 to offset the decline in WWJ2), NetEase currently lacks a successful new game for sustainable growth. TianXia2 launch in 1Q08 is closedbeta, with commercialization at the very earliest in mid-2Q08. Datangs itembased model launch is also delayed to around mid-08. In respect of Fantasy WWJ (still the flagship game), we expect the game to see flattish growth in 4Q07, due to seasonally flat Q4. We expect FWJ to peak out in 3Q08; and to observe a single-digit quarterly decline going forward. Despite the near-term transition, we remain positive on NetEase in the long run. As a leading online game developer in China, with proven game operating capability, we believe the company is well positioned to capture growth in Chinas online games industry in the long run. In addition, NetEase has the largest free email user base in China. We believe NetEase can leverage this user base and its portal traffic to monetize through online advertising and search services. The share price drivers over the next six months include: (1) news on WWJ3 progress, (2) FWJ anniversary activities in Jan, and (3) TianXia2 closed beta in 1Q08. Upside risks include: upside from future licensed games or existing games, better-than-expected advertising growth. Downside risks include: future delay in game launches, unsuccessful new licensed games. For 4Q07, we estimate net revenue of US$78.0M, up 7% Q/Q and up 17% Y/Y, and GAAP diluted EPS of US$0.30, up 12% Q/Q as well as Y/Y. For online games, we expect net revenue of US$64.6M, up 7% Q/Q and 15% Y/Y, with flattish growth for FWJ and WWJ3 offsetting the decline in WWJ2.

276

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

North America Equity Research 02 January 2008

Table 181: NetEase Financial Snapshot


US$ millions, except per share data 4Q07E 3Q07A 4Q06A JPMorgan Revenue EBITDA EPS (GAAP) EPS (Adj.) * Consensus Revenue EBITDA EPS (GAAP) 78.0 49.9 0.30 0.33 76.0 0.30 73.1 41.8 0.27 0.29 73.1 41.8 0.27 66.5 44.4 0.27 0.29 66.5 44.4 0.27 Y/Y Q/Q 17% 12% 12% 13% 7% 19% 12% 11% F'07E 290.4 183.4 1.17 1.26 289.0 1.18 F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y 326.5 203.5 1.24 1.35 326.9 1.25 374.0 225.2 1.32 1.43 380.9 1.39 8% 2% 7% 7% 8% 8% 12% 11% 6% 7% 13% 6% 15% 11% 7% 6% 17% 11%

14% 4% 12% 12%

Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.

Our Estimates and Outlook for 2008


For 2008, we forecast net revenue at US$326.5M, up 12% Y/Y, and GAAP-diluted EPS of US$1.24, up 6% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.35, up 7% Y/Y. We expect new versions of TianXia 2, Datang (item-based model), and FlyFF to be launched in 1H08; we have also modeled in one new licensed game to be commercialized in May 2008. Overall, we forecast online game revenues of US$263.9M, up 7% Y/Y, with a slight decline in FWJ revenue and continued decline in WWJ2, to be offset by contribution from WWJ3, and other games. After a flattish year for online ad revenue, we expect NetEase to achieve industry growth of ~50% in 2008. In order to drive online ad revenue growth, we expect NetEase to continue to focus on improving its content in news, entertainment, sports, female, and finance channels. In addition, the company plans to improve its email services in order to further expand available ad inventory. In respect of margins, we expect NetEase to see a slight decline in 2008.

Our Estimates and Outlook for 2009


For 2009, we forecast net revenue at US$374.0M, up 15% Y/Y, and GAAP diluted EPS of US$1.32, up 7% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.43, up 6% Y/Y. For online games, we forecast revenue of US$295.3M, up 12% Y/Y; we expect the company to in-house develop 1 to 2 games during 2009. In respect of margins, we estimate gross margin at 77.6% for 2009 (down slightly Y/Y); adjusted operating margin (ex-share-based expense) of 54.6% (down slightly Y/Y) and adjusted net margin (ex-share-based expense) of 50.9% (also down Y/Y).

Rating and Price Target


We maintain our Neutral rating on NetEase. We believe NetEase still lacks revenue drivers in the near to medium term, or the next big game to drive earnings growth. Our Dec-08 price target of US$18 implies 14.5x 2008E and 13.6x 2009E GAAP P/E, (or 13.4x 2008E and 12.6x 2009E adj. diluted P/E). Our price target is slightly below our DCF valuation of ~US$22. We note that NetEase traded at around 12x forward P/E at the last trough, which would suggest a potential share price bottom of around US$16.

277

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

North America Equity Research 02 January 2008

Risks to Our Rating and Price Target


Downside risks to our rating and price target include: intense competition resulting in negative industry environment, hacking or pirated server issues limiting user growth, delays in game launches, and significant increase in R&D expenses. Upside risks include: better-than-expected acceptance of its new games, extended life cycle of existing games on the back of new upgrade packs, and upside in online advertising.

278

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

North America Equity Research 02 January 2008

Table 182: NetEase Income Statement


US$ in millions, except per share data, year-end December Revenue Wireless & other Advertising Online Games COGS Gross Profit Operating Expense Sales & Mktg. expenses G&A expenses R&D expenses Other expenses Share-based compensation EBIT Adj. EBIT (ex-123R expense) EBITDA Net Interest Income Net Other Income Pre Tax Profit Tax Expense/(Credit) Net Profit Adj. Net Profit (ex-123R exp.) Pre Tax EPS (US$) After Tax EPS (US$) Diluted EPS (US$) Adj. Diluted EPS (US$, ex-123R exp.) Margins (%) Gross Margin Operating Margin (ex-123R exp.) EBITDA Margin Net Margin Adj. Net Margin (ex-123R exp.) Sequential Growth (%) Revenue Gross Profit Adj. EBIT Pre Tax Profit Net Profit (ex-123R exp.) Diluted EPS Adj. Diluted EPS (ex-123R exp.)
Source: Company, JPMorgan estimates.

1Q06 63.5 2.1 7.0 54.3 -10.4 53.0 -14.7 -4.7 -3.8 -3.0 0.0 -3.2 38.3 41.6 43.4 2.8 -0.3 40.9 4.3 36.6 39.9 0.31 0.28 0.26 0.28 83.6 65.5 68.4 57.7 62.8 9.6 10.9 15.2 6.8 16.3 7.9 17.4

2Q06 69.1 2.5 7.9 58.8 -11.4 57.8 -17.3 -4.9 -4.3 -4.9 0.0 -3.3 40.4 43.7 45.8 3.0 0.0 43.4 4.1 39.3 42.6 0.33 0.30 0.28 0.30 83.5 63.2 66.3 56.8 61.6 8.9 8.9 5.1 6.1 6.8 7.5 7.0

3Q06 69.4 2.5 9.7 57.2 -12.2 57.2 -17.2 -5.1 -4.7 -4.0 0.0 -3.3 40.1 43.4 45.9 3.1 0.2 43.4 3.6 39.8 43.1 0.34 0.31 0.29 0.31 82.5 62.5 66.1 57.4 62.1 0.4 -0.9 -0.8 0.0 1.3 2.9 2.8

4Q06 66.5 2.1 8.5 56.0 -12.0 54.4 -16.3 -4.1 -5.3 -4.0 0.0 -3.0 38.1 41.1 44.4 2.9 0.2 41.2 4.7 36.5 39.4 0.32 0.29 0.27 0.29 81.9 61.8 66.8 54.9 59.3 -4.3 -4.9 -5.3 -5.1 -8.5 -6.7 -6.9

1Q07 69.1 2.1 6.7 60.3 -13.0 56.1 -15.6 -5.1 -3.5 -4.4 0.0 -2.6 40.5 43.1 46.2 3.0 -0.1 43.4 4.4 39.0 41.7 0.34 0.31 0.29 0.31 81.2 62.4 66.9 56.5 60.3 3.9 3.0 4.9 5.4 5.6 7.4 6.1

2Q07 70.4 2.2 7.9 60.4 -12.4 58.1 -19.3 -5.9 -5.1 -4.7 0.0 -3.6 38.8 42.3 45.5 3.7 -1.2 41.3 0.3 41.1 44.6 0.33 0.33 0.31 0.34 82.5 60.1 64.6 58.3 63.4 2.0 3.5 -1.8 -4.7 7.1 8.1 10.1

3Q07 73.1 2.2 10.4 60.5 -13.6 59.5 -24.4 -10.6 -5.3 -5.1 0.0 -3.5 35.1 38.6 41.8 3.9 -1.6 37.4 2.7 34.7 38.2 0.31 0.28 0.27 0.29 81.4 52.8 57.2 47.5 52.3 3.8 2.5 -8.8 -9.5 -14.4 -13.9 -12.8

4Q07E 78.0 2.2 11.2 64.6 -14.5 63.5 -20.7 -6.7 -5.5 -5.1 0.0 -3.5 42.8 46.3 49.9 3.3 0.0 46.1 6.2 39.9 43.4 0.38 0.33 0.30 0.33 81.4 59.3 64.0 51.2 55.7 6.7 6.7 19.9 23.3 13.6 12.1 10.8

1Q08E 76.5 2.2 10.6 63.7 -14.7 61.8 -21.1 -6.5 -5.4 -5.7 0.0 -3.5 40.7 44.2 47.9 3.4 0.0 44.1 6.0 38.2 41.7 0.37 0.32 0.29 0.32 80.8 57.8 62.6 49.9 54.4 -1.9 -2.6 -4.4 -4.3 -4.0 -3.2 -2.9

2Q08E 78.1 2.3 13.3 62.6 -15.2 62.9 -21.1 -6.2 -5.5 -5.9 0.0 -3.5 41.9 45.4 49.2 3.4 0.0 45.3 6.1 39.2 42.7 0.38 0.33 0.30 0.33 80.6 58.1 62.9 50.2 54.7 2.1 1.8 2.6 2.7 2.5 3.9 3.7

3Q08E 86.0 2.3 14.5 69.3 -17.7 68.3 -22.9 -6.9 -6.0 -6.5 0.0 -3.5 45.5 49.0 53.4 3.7 0.0 49.2 6.6 42.6 46.1 0.41 0.36 0.33 0.35 79.5 57.0 62.1 49.6 53.6 10.1 8.6 8.0 8.7 8.0 8.1 7.4

4Q08E 85.8 2.3 15.2 68.3 -18.0 67.8 -22.8 -6.9 -6.0 -6.4 0.0 -3.5 45.0 48.5 53.0 4.1 0.0 49.1 6.6 42.5 46.0 0.41 0.35 0.32 0.35 79.0 56.5 61.8 49.6 53.6 -0.2 -0.8 -1.0 -0.2 -0.2 -0.7 -0.7

FY06 268.5 9.2 33.0 226.3 -46.0 222.5 -65.6 -18.8 -18.0 -16.0 0.0 -12.8 156.9 169.7 179.6 11.9 0.1 168.9 -16.7 152.2 165.0 1.31 1.18 1.09 1.18 82.9 63.2 66.9 56.7 61.4 36.2 36.1 42.1 34.5 44.8 36.3 47.7

FY07E 290.4 8.6 36.0 245.7 -53.3 237.1 -80.0 -28.3 -19.3 -19.2 0.0 -13.1 157.1 170.2 183.4 14.0 -2.8 168.2 -13.5 154.8 167.9 1.36 1.25 1.17 1.26 81.6 58.6 63.1 53.3 57.8 8.2 6.6 0.3 -0.4 1.8 6.7 6.8

FY08E 326.5 9.1 53.5 263.9 -65.6 260.9 -87.8 -26.5 -22.9 -24.5 0.0 -14.0 173.1 187.1 203.5 14.6 0.0 187.7 -25.2 162.5 176.5 1.56 1.35 1.24 1.35 79.9 57.3 62.3 49.8 54.1 12.4 10.1 9.9 11.6 5.1 6.5 6.6

FY09E 374.0 9.8 68.9 295.3 -83.7 290.3 -100.0 -31.8 -26.2 -28.0 0.0 -14.0 190.3 204.3 225.2 19.7 0.0 210.0 -33.6 176.4 190.4 1.72 1.44 1.32 1.43 77.6 54.6 60.2 47.2 50.9 14.6 11.3 9.2 11.9 7.9 6.6 6.0

279

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

North America Equity Research 02 January 2008

Table 183: NetEase Annual Balance Sheet


US$ in millions, year-end December Cash and Cash Equivalents Account Receivables Inventory Total Other Current Assets Total Current Assets Gross Fixed Assets Accumulated Depreciation Net Fixed Assets Other Long Term Assets Long Term Investments and Associates Total Long Term Assets Total Assets ST Debt and Current Portion of LT Debt Accounts Payable Other Current Liabilities Total Current Liabilities Long Term Debt Other Long Term Liabilities Total Long Term Liabilities Share Capital Share Premium Other Reserves Retained Earnings Preferred Stock Total Equity Total Liabilities and Equity
Source: Company reports, JPMorgan estimates.

FY06 496.6 16.6 0.0 7.5 520.7 53.0 (24.7) 28.3 2.6 0.0 30.8 551.6 0.0 32.3 53.0 85.3 98.4 1.4 99.8 0.3 50.7 20.6 294.9 0.0 366.4 551.6

FY07E 516.5 15.2 0.0 11.6 543.3 67.8 (40.9) 26.9 6.8 0.0 33.7 576.9 87.7 29.4 51.4 168.5 0.0 1.3 1.3 0.3 22.8 (79.3) 463.2 0.0 407.1 576.9

FY08E 680.3 16.9 0.0 13.8 711.0 98.6 (57.8) 40.8 6.8 0.0 47.7 758.7 88.7 37.0 57.2 183.0 0.0 1.4 1.4 0.4 23.0 (80.2) 631.1 0.0 574.3 758.7

FY09E 897.7 19.5 0.0 15.3 932.6 133.6 (78.7) 54.9 6.8 0.0 61.7 994.3 88.7 46.2 66.0 201.0 0.0 1.4 1.4 0.4 64.3 (80.2) 807.5 0.0 792.0 994.3

Table 184: NetEase Annual Cash Flow Statement


US$ in millions, year-end December Net Income Add Non cash Expenses/(income) Depreciation and Amortization Extraordinaries Other Non-Cash Items Changes in Working Capital: (Increase)/Decrease Receivables (Increase)/Decrease Inventories (Increase)/Decrease Other Current Assets Increase/(Decrease) Payables Increase/(Decrease) Other Current Liabilities Net Cash from Operations Purchase of Property, Plant & Equipment Purchase/Sale of Other LT assets Purchase/Sale of Investments Net Cash from Investing Activities Issuance/Repayment of Debt Change in other LT liabilities Change in Common Equity - net Payment of Cash Dividends Other Financing Charges, Net Net Cash from Financing Activities Net Effect of Exchange Rate Changes Net Change in Cash and Cash Equivalents Cash at End of Period
Source: Company reports, JPMorgan estimates.

FY06 152.2 0.0 9.9 (0.1) 12.8 0.0 (7.8) 0.0 (1.2) 12.2 20.7 198.7 (22.2) (2.4) 0.0 (24.6) (4.8) 1.4 (101.1) 0.0 1.0 (103.5) 0.0 70.6 496.6

FY07E 154.8 0.0 13.1 0.0 13.1 0.0 2.2 0.0 (3.7) (4.4) (4.1) 171.0 (10.5) (4.1) 0.0 (14.5) (15.2) (0.2) (144.1) 0.0 0.0 (159.5) 0.0 (3.0) 516.5

FY08E 162.5 0.0 16.4 0.0 14.0 0.0 (1.6) 0.0 (2.1) 7.3 5.3 201.8 (30.0) 0.0 0.0 (30.0) 0.0 0.0 (14.1) 0.0 0.0 (14.1) 0.0 157.8 680.3

FY09E 176.4 0.0 20.9 0.0 14.0 0.0 (2.6) 0.0 (1.6) 9.2 8.8 225.2 (35.0) 0.0 0.0 (35.0) 0.0 0.0 27.2 0.0 (0.0) 27.2 0.0 217.4 897.7

280

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

North America Equity Research 02 January 2008

Ninetowns, Underweight ($3.45)


We maintain our Underweight rating on Ninetowns (NINE). NINEs core B2G (business-to-government) e-filings business continues to face a tough environment due to the availability of a free substitute. Further, its new B2B segment is likely to remain in investment / development phase at least till the end of 2007, with limited visibility on prospects over the coming year. NINEs core iDeclare.CIQ software sales continue to face a challenging business environment due to the free alternative distributed by the government. Further, paid service contract renewals remain muted and the transitioning of free users to paid ones through such service contracts is yet to be seen. In respect of the NINEs B2B initiatives, visibility into prospects of the companys B2B platform (in a highly competitive space) and size of potential revenue streams remains low. Also, we believe NINE will need to spend significantly on marketing its B2B services over the next year (around its official launch), leading to margin pressures over the next several quarters. With the core B2G business also facing a tough environment, we expect NINE to witness further operating losses in the near term (after recording losses in 4Q06 and 1Q07). We do not expect any near-term share price drivers for NINE, given that any meaningful improvement in overall business performance may require at least a few more quarters. The key upside risk is if NINE becomes a potential acquisition or partnership prospect: NINE has a customer list of ~132K importers & exporters (installed base of iDeclare users), implying an enterprise value/customer of only ~US$130. For 2Q07 (still to be reported), we forecast net revenue of US$3.1M, up 10% Q/Q but down 38% Y/Y, and a loss of US$0.04 as GAAP diluted EPS (vs. a loss of US$0.02 in 1Q07 and a profit of US$0.06 per diluted share in 2Q06).

Table 185: Ninetowns Financial Snapshot


US$ millions, except per share data 2Q07E JPMorgan Revenue 3.1 EBITDA -1.3 EPS (GAAP) -0.04 EPS (Adj.) * -0.03 Consensus Revenue na EBITDA na EPS (Adj.) * na 1Q07A 2Q06A 2.8 -0.9 -0.02 -0.02 2.8 -0.9 -0.02 5.0 2.3 0.06 0.07 5.0 2.3 0.07 Y/Y Q/Q -38% n.m. n.m. n.m. 10% n.m. n.m. n.m. F'06 19.3 5.9 0.16 0.20 19.3 5.9 0.20 F'07E F'08E 13.0 -3.9 -0.12 -0.09 na na na 15.0 0.8 -0.01 0.01 na na na F'06 Y/Y F'07E Y/Y F'08E Y/Y -34% -65% -69% -61% -34% -65% -61% -33% n.m. n.m. n.m. 15% n.m. n.m. n.m. -

Source: JPMorgan estimates. *Note: Adjusted EPS excludes share-based compensation expense.

281

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


For 2008, we forecast net revenues of US$15.0M, up 15% Y/Y, and a GAAP loss of US$0.01 per share (vs. GAAP loss of US$0.12 per share for 2007), or adjusted EPS (ex-share-based expense) of US$0.01 (vs. GAAP loss of US$0.09 per share for 2007). In respect of margins, we forecast gross margin at 87.5% for 2008, down slightly from 89.0% for 2007; adjusted operating loss margin (ex-share-based expense) of 10.5% (operating loss) for 2008, narrowing from operating loss margin of 44.3% for 2007, and adjusted net margin (ex-share-based expense) of 3.0% for 2008, vs. net loss margin of 25.3% for 2007. Our top-line estimate calls for 7% Y/Y increase in enterprise software revenue (74% of total revenues in 2008E) and 26% Y/Y increase in software development service revenue (22% of total revenues). We also forecast the B2B business to begin contributing to revenues, although very modestly (4% of total revenues). We believe the potential for upside surprise in company performance would be dependent on NINEs success in its B2B initiatives and the company's execution on paid service contracts (new and renewal contracts) in the B2G segment.

Rating and Price Target


We maintain our Underweight rating on NINE, given: (1) NINEs core iDeclare.CIQ software sales remain challenged due to availability of a free alternative (from the government); (2) Paid service contract renewals remain muted and the transitioning of free software users to paid ones through such service contracts is yet to be seen; (3) Visibility on the prospects of NINE's B2B platform remains low; (4) NINE will incur significant operating expenses on its B2B services (marketing, etc.) leading to margin pressures over the next several quarters. Our DCF-based Dec-07 price target is US$3.2, which implies 251x on our 2008E adjusted EPS. (The implied EV at our target price is ~US$26M) Overall, we believe a turnaround for the company is still at least a few quarters away, and the share price performance is likely to remain weak in the interim. (We also expect the total cash balance to be down to ~US$2.5 per share at end-4Q07, compared to US$3.3 per share as of 1Q07).

Risks to Our Rating and Price Target


Upside risks to our rating and price target include: 1) Possibility of NINE becoming a target for acquisition or strategic partnership (with current EV/customer of only ~US$130); 2) Earlier-than-expected progress on business transition to B2B; 3) Significant conversions from free e-filing software to NINEs paid software / service contracts. Downside risks to our estimates include: 1) Accelerated decline in existing core revenue base; 2) Larger-than-expected investments in the new B2B business; 3) Disruption in the working relationship between the PRC Inspections Administration and the company.

282

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

North America Equity Research 02 January 2008

Table 186: Ninetowns Income Statement


US$ in millions, except per share data, year-end December Revenue Enterprise software Software development service Other COGS Gross profit Operating expense Sales & mktg. expenses G&A expenses R&D expenses Other expenses Share-based compensation EBIT Adj. EBIT (ex-123R expense) EBITDA Net interest income Net other income Pre-tax profit Tax expense/(credit) Net profit Adj. Net profit (ex-123R exp.) Pre-tax EPS (US$) After-tax EPS (US$) Diluted EPS (US$) Adj. Diluted EPS (ex-123R exp., US$) Margins (%) GPM OPM (ex-123R exp.) EBITDA margin Net margin Adj. Net margin (ex-123R exp.) Sequential growth (%) Revenue Gross profit Adj. EBIT Pre-tax profit Net profit (ex-123R exp.) Diluted EPS Adj. Diluted EPS (ex-123R exp.)
Source: Company, JPMorgan estimates.

1Q06 6.1 5.0 1.1 0.0 -0.3 5.8 -3.3 -0.9 -1.9 -0.6 0.0 -0.5 2.4 2.9 3.1 0.6 0.0 3.0 0.1 2.9 3.3 0.08 0.08 0.08 0.09 94.6 47.1 50.8 47.1 54.6 -6.4 -3.9 9.7 -12.5 -1.3 -15.0 -1.6

2Q06 5.0 4.0 1.0 0.0 -0.4 4.6 -2.9 -0.3 -1.9 -0.6 0.0 -0.3 1.8 2.0 2.3 0.6 0.0 2.3 0.1 2.3 2.6 0.07 0.07 0.06 0.07 92.4 40.7 45.9 45.3 50.9 -17.3 -19.3 -28.5 -20.8 -22.9 -20.1 -22.6

3Q06 3.7 3.2 0.5 0.0 -0.2 3.5 -2.8 -0.2 -1.7 -0.9 0.1 -0.3 0.8 1.1 1.4 0.6 0.0 1.4 0.0 1.4 1.7 0.04 0.04 0.04 0.05 95.1 28.6 36.6 37.2 45.3 -26.6 -24.5 -48.5 -40.5 -34.7 -39.8 -34.6

4Q06 4.5 2.5 2.0 0.0 -1.3 3.2 -4.7 -0.3 -2.7 -1.7 0.0 -0.3 -1.5 -1.3 -1.0 0.7 0.0 -0.8 -0.1 -0.8 -0.5 -0.02 -0.02 -0.02 -0.01 72.0 -27.9 -21.3 -17.5 -11.6 21.6 -8.0 -218.5 -160.3 -131.1 -157.4 -131.2

1Q07 2.8 2.4 0.5 0.0 -0.3 2.5 -4.0 -1.0 -2.1 -1.0 0.0 -0.2 -1.5 -1.3 -0.9 0.6 0.1 -0.8 0.0 -0.8 -0.6 -0.02 -0.02 -0.02 -0.02 88.3 -45.0 -30.3 -28.4 -21.3 -37.1 -22.9 1.5 -7.0 15.2 3.4 17.0

2Q07E 3.1 2.6 0.5 0.0 -0.3 2.8 -4.8 -1.5 -2.4 -1.0 0.0 -0.2 -2.0 -1.8 -1.3 0.7 0.0 -1.3 -0.1 -1.2 -1.0 -0.04 -0.04 -0.04 -0.03 91.7 -57.3 -43.0 -39.9 -33.4 10.1 14.3 40.4 65.2 73.1 54.1 72.4

3Q07E 3.5 2.7 0.8 0.0 -0.4 3.1 -4.8 -1.8 -2.1 -0.9 0.0 -0.2 -1.7 -1.5 -1.0 0.5 0.0 -1.1 0.0 -1.1 -0.9 -0.03 -0.03 -0.03 -0.03 88.0 -42.0 -28.4 -30.8 -25.1 12.8 8.3 -17.3 -12.9 -15.2 -12.9 -15.3

4Q07E 3.6 2.7 0.8 0.0 -0.4 3.2 -4.6 -1.8 -2.0 -0.8 0.0 -0.2 -1.4 -1.2 -0.7 0.4 0.0 -1.0 0.0 -1.0 -0.8 -0.03 -0.03 -0.03 -0.02 88.2 -34.8 -20.6 -27.0 -21.4 2.0 2.2 -15.6 -10.8 -13.1 -10.8 -13.3

1Q08E 3.7 2.7 0.8 0.1 -0.5 3.2 -4.2 -1.5 -2.0 -0.7 0.0 -0.2 -1.0 -0.8 -0.2 0.5 0.0 -0.4 0.0 -0.4 -0.2 -0.01 -0.01 -0.01 -0.01 87.4 -20.6 -6.1 -11.6 -6.2 3.1 2.1 -38.9 -56.1 -70.0 -55.6 -70.0

2Q08E 3.7 2.7 0.8 0.1 -0.5 3.3 -3.9 -1.2 -2.0 -0.7 0.0 -0.2 -0.6 -0.4 0.1 0.5 0.0 -0.1 0.0 -0.1 0.1 0.00 0.00 0.00 0.00 87.4 -11.6 3.7 -3.2 2.1 1.1 1.1 -43.3 -73.8 -134.6 -72.1 -134.5

3Q08E 3.8 2.8 0.8 0.1 -0.5 3.3 -3.7 -1.1 -1.9 -0.8 0.0 -0.2 -0.4 -0.2 0.4 0.5 0.0 0.1 0.0 0.0 0.2 0.00 0.00 0.00 0.01 87.5 -6.5 9.4 1.3 6.6 1.1 1.1 -43.1 -154.5 213.3 -141.5 212.7

4Q08E 3.8 2.8 0.8 0.2 -0.5 3.3 -3.7 -1.0 -1.9 -0.8 0.0 -0.2 -0.3 -0.1 0.5 0.5 0.0 0.2 0.0 0.2 0.4 0.00 0.00 0.00 0.01 87.5 -3.5 13.1 4.0 9.2 1.0 1.1 -46.2 171.4 41.1 205.2 40.9

FY05 29.3 24.9 4.4 0.1 -2.3 27.0 -10.6 -3.2 -6.0 -1.4 -0.1 0.0 16.4 16.4 17.1 2.2 0.1 18.6 -0.1 18.5 18.5 0.54 0.53 0.52 0.52 92.0 55.9 58.1 63.2 63.2 20.5 13.4 -2.7 6.5 14.6 -9.4

FY06 19.3 14.7 4.6 0.0 -2.1 17.2 -13.7 -1.7 -8.3 -3.8 1.4 -1.3 3.5 4.8 5.9 2.4 0.0 5.9 -0.1 5.8 7.1 0.17 0.17 0.16 0.20 88.9 24.7 30.7 30.0 36.7 -34.1 -36.3 -70.9 -68.2 -61.8 -68.6 -61.4

FY07E 13.0 10.3 2.7 0.0 -1.4 11.6 -18.1 -6.0 -8.6 -3.6 0.8 -0.8 -6.6 -5.8 -3.9 2.3 0.1 -4.2 0.1 -4.1 -3.3 -0.12 -0.12 -0.12 -0.09 89.0 -44.3 -30.2 -31.4 -25.3 -32.7 -32.6 n.m. n.m. n.m. n.m. n.m.

FY08E 15.0 11.0 3.4 0.6 -1.9 13.1 -15.5 -4.7 -7.8 -3.0 0.8 -0.8 -2.4 -1.6 0.8 2.0 0.0 -0.3 0.0 -0.3 0.5 -0.01 -0.01 -0.01 0.01 87.5 -10.5 5.1 -2.3 3.0 15.2 13.2 n.m. n.m. n.m. n.m. n.m.

283

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

North America Equity Research 02 January 2008

Table 187: Ninetowns Annual Balance Sheet


US$ in millions, year-end December Cash, cash equivalents and term deposits Account receivables Inventory Total other current assets Total current assets Gross fixed assets Accumulated depreciation Net fixed assets Other long term assets Long term investments and associates Total long term assets Total assets ST debt and current portion of LT debt Accounts payable Other current liabilities Total current liabilities Long term debt Other long term liabilities Total long term liabilities Share capital Share premium Other reserves Retained earnings Preferred stock Total equity Total liabilities and equity
Source: Company reports, JPMorgan estimates.

FY05 114.8 5.8 0.9 5.4 126.8 5.0 (0.9) 4.1 33.6 37.7 164.6 3.8 8.3 12.1 0.1 0.1 0.1 104.3 48.0 152.4 164.6

FY06 114.2 2.8 0.9 7.0 124.8 7.5 (1.6) 5.9 41.4 47.3 172.2 4.3 3.3 7.6 0.1 109.8 54.7 164.6 172.2

FY07E 86.3 3.9 1.0 4.4 95.6 11.7 (2.8) 8.9 70.0 78.8 174.5 2.7 4.1 6.8 0.2 0.2 0.1 114.4 52.9 167.5 174.5

FY08E 82.9 4.2 1.0 5.0 93.2 15.9 (4.4) 11.4 70.0 81.4 174.5 0.8 4.3 5.2 0.2 0.2 0.1 116.5 52.6 169.2 174.5

Table 188: Ninetowns Annual Cash Flow Statement


US$ in millions, year-end December Net income Add non cash expenses/(income) Depreciation and amortization Extraordinaries Other non-cash items Changes in working capital: (Increase)/decrease receivables (Increase)/decrease inventories (Increase)/decrease other current assets Increase/(decrease) payables Increase/(decrease) other current liabilities Net cash from operations Purchase of property, plant & equipment Purchase/sale of other LT assets Purchase/sale of investments Net cash from investing activities Issuance/repayment of debt Change in other LT liabilities Change in common equity - net Payment of cash dividends Other financing charges, net Net cash from financing activities Net effect of exchange rate changes Net change in cash and cash equivalents Net change in term deposits Total cash balance at beginning of period Total cash balance at end of period
Source: Company reports, JPMorgan estimates.

FY05 18.5 0.6 0.1 2.6 0.0 (0.8) (0.9) (2.4) 17.9 (6.7) (6.9) (13.6) (0.7) 0.9 0.2 (0.4) 4.2 6.9 102.4 114.8

FY06 5.8 1.2 1.2 3.8 0.1 (1.6) 0.0 (5.4) 5.1 (2.5) (2.2) (17.5) (22.3) (0.1) 0.9 0.8 (0.4) (16.8) 12.6 114.8 114.2

FY07E (4.1) 1.8 0.8 (1.1) (0.1) 2.8 (1.7) 0.7 (0.8) (3.9) (28.1) (32.1) 0.2 0.9 0.8 1.9 (30.9) 114.2 86.3

FY08E (0.3) 2.3 0.8 (0.3) (0.1) (0.6) (1.9) 0.3 0.2 (4.1) (0.7) (4.9) 1.3 0.0 1.3 (3.4) 86.3 82.9

284

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

North America Equity Research 02 January 2008

Shanda, Overweight ($34.39)


We maintain our Overweight rating on Shanda, which also remains our top pick in the China online games sector. We maintain our view that: (1) Industry-wide online gamers shift from pay-to-play paying model to free-to-play (item sales) paying model will benefit Shanda, the largest free-to-play online game operator in China. (2) Shandas strong marketing capability and operating platform should enable it to further monetize its aging, but very well known games Mir2 and Woool. Shanda continues to execute in a consistently solid vein. In 3Q07, the strong execution drove record-high active paying accounts (APA) of 3.08 million (in the MMORPG segment), up 13%Q/Q; growth came mainly from existing game titles (such as Woool and Mir2), with small contributions from new game Feng Yun Online (acquired in July). The solid 3Q07 result again gives us confidence that Shanda can maintain good growth on its existing games by providing quality upgrades and ongoing promotions through its game platform. Further, we believe the companys focus on expanding APA (as against ARPU) should be positive for Shanda in the long run. We also maintain our view that Shandas strong marketing capability and proven operating platform should enable it to further monetize its aging, but still popular games Mir2 and Woool. We believe new gamers in lower-tier cities are likely to continue adopting them (due to their famous brand name); further, upgrade packs should continue to draw old gamers back. Shanda currently operates around 20 games, and also has a very healthy game pipeline with around 9 MMOGS (including several 2.75D / 3D games) and 9 casual games for 4Q07/2008. Shanda targets launching 1 or 2 big hit titles each year, and we expect the next big game to be Changchun Online to be launched in 1H08. In our view, share price drivers in the near to medium term include: (1) operating results of new games such as Changchun Online (testing) and DDO in 4Q07; (2) continued good execution likely to lead to earnings upside. For 4Q07, we forecast net revenue at US$92.3M, up 6% Q/Q and 53% Y/Y, and GAAP diluted EPS of US$0.44, down 1% Q/Q but up 41% Y/Y, or adjusted EPS (ex-share-based expense) of US$0.46, down 1% Q/Q but up 41% Y/Y. Sequential revenue growth is in the mid-range of company guidance of 4% - 7% Q/Q growth. We expect MMORGP revenue to be up ~6.5% Q/Q, on the back of momentum of new game Feng Yun Online and other game updates. For casual games, we forecast revenue growth of ~3.4% QoQ (on weak 4Q seasonality).

285

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

North America Equity Research 02 January 2008

Table 189: Shanda Financial Snapshot


US$ millions, except per share data 4Q07E 3Q07A 4Q06A JPMorgan Revenue EBITDA EPS (GAAP) EPS (Adj.) * Consensus Revenue EBITDA EPS (GAAP) 92.3 45.3 0.44 0.46 89.1 0.46 87.4 44.1 0.44 0.46 87.4 44.1 0.44 60.3 25.9 0.31 0.33 60.3 25.9 0.31 Y/Y Q/Q 53% 75% 41% 41% 6% 3% -1% -1% F'07E 322.2 164.3 1.66 1.76 318.9 1.77 F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y 399.9 197.3 1.76 1.85 393.3 1.93 483.6 242.1 2.12 2.21 447.6 2.26 54% 133% 80% 101% 53% 92% 24% 20% 6% 5% 23% 9% 21% 23% 20% 19% 14% 17%

48% 2% 48% 5%

Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense. 4Q06A EPS figures also exclude gain from sale of Sina shares.

Our Estimates and Outlook for 2008


We forecast 2008 net revenue of US$399.9M, up 24% Y/Y, and GAAP-diluted EPS of US$1.76, up 6% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.85, up 5% Y/Y (lower earnings growth on account of higher operating expenses and higher tax rate assumption) . We expect the top line to be driven by 27% Y/Y growth in MMORPG revenue (~85% of total revenues) and 13% Y/Y growth in casual games revenue. In respect of the new in-game advertising business, we believe it is still in the phase of technology development for ad placement solutions; some revenue contribution may start in mid-2008, probably around the Olympics with ads on sports casual games. On margins, we forecast gross margin at 66.3% for 2008, down modestly from 67.6% for 2007; adjusted operating margin (ex-share-based expense) of 39.0% for 2008, down from 42.9% for 2007 (due to higher SG&A and R&D expenses), and adjusted net margin (ex-share-based expense) of 35.0% for 2008, down from 40.2% for 2007 (partially due to slightly higher tax rate assumption for 2008).

Our Estimates and Outlook for 2009


For 2009, we forecast net revenue at US$483.6M, up 21% Y/Y, and GAAP diluted EPS of US$2.12, up 20% Y/Y, or adjusted EPS (ex-share-based expense) of US$2.21, up 19% Y/Y. We forecast 21% Y/Y revenue growth for MMORPG and 20% Y/Y growth for casual games. We forecast gross margin at 65.7% for 2009 (stable Y/Y); adjusted operating margin (ex-share-based expense) of 39.1% (stable Y/Y) and adjusted net margin of 34.8% (also stable).

Rating and Price Target


We maintain our Overweight stance on Shanda, on the back of: (1) Industry-wide online gamers shift to free-to-play (item sales) model will benefit Shanda, the largest free-to-play online game operator in China. (2) Shandas strong marketing capability and operating platform will enable it to further monetize its aging, but very well known games Mir2 and Woool, (3) consistent solid execution, and (4) Shanda continues to expand its game pipeline and diversifies game-specific risks. Our Dec-08 price target is US$43, which implies 24.4x 2008E and 20.3x 2009E diluted GAAP EPS, or 23.2x 2008E and 19.5x 2009E adjusted diluted EPS (ex-

286

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

North America Equity Research 02 January 2008

share-based expense). The price target is in line with our DCF valuation of ~US$45 (12% WACC, 0% terminal growth).

Risks to Our Rating and Price Target


Upside risks include: (1) New games such as DDO and Changchun attracting greaterthan-expected user traction; (2) better-than-expected casual game revenue in 2008; and (3) in-game advertising ahead of our expectations in 2008. On the other hand, key downside risks include: (1) Existing games seeing a significant decline from lack of new content or promotion; (2) new big titles in MMORPG seeing lower-thanexpected gamer interest.

287

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

North America Equity Research 02 January 2008

Table 190: Shanda Income Statement


US$ in millions, except per share data, year-end December Revenue MMORPG Casual games EZ hardware EZ subscription Others COGS Gross Profit Operating Expense Sales & Mktg. expenses G&A expenses R&D expenses Other expenses 123R share-based comps. EBIT Adj. EBIT (ex-123R expense) EBITDA Net Interest Income Net Other Income Pre Tax Profit Tax Expense/(Credit) Net Profit (Reported) Adj. Net Profit (ex-123R exp.) * Pre Tax EPS (US$) After Tax EPS (US$) Diluted EPS (Reported, US$) Adj. Diluted EPS (US$, ex-123R) Margins (%) Gross Margin Operating Margin (ex-123R exp.) EBITDA Margin Net Margin Adj. Net Margin (ex-123R exp.) Sequential Growth (%) Revenue Gross Profit Adj. EBIT Pre Tax Profit Net Profit (ex-123R exp.) Diluted EPS Adj. Diluted EPS (ex-123R exp.)
Source: Company, JPMorgan estimates.

1Q06 42.6 28.1 10.5 1.4 0.0 2.6 -18.4 24.2 -21.9 -8.0 -7.3 -6.6 0.0 -1.5 2.3 3.8 8.6 0.1 1.4 3.7 1.1 1.5 3.0 0.05 0.02 0.02 0.04 56.8 8.9 20.1 3.5 7.0 -4.7 -9.7 n.m. 56.6 n.m. n.m. n.m.

2Q06 50.7 38.1 8.7 1.1 0.0 2.8 -22.1 28.7 -17.2 -4.9 -6.5 -5.9 0.0 -0.8 11.4 12.2 16.3 0.1 6.3 17.9 0.3 16.7 17.5 0.25 0.23 0.23 0.24 56.5 24.0 32.1 32.9 34.4 19.1 18.6 221.0 377.4 489.0 1,036.0 489.1

3Q06 55.2 42.0 9.7 0.9 0.0 2.6 -24.2 31.0 -16.8 -4.0 -8.2 -4.5 0.0 -1.4 14.2 15.6 20.0 0.2 6.1 20.5 2.0 18.1 19.5 0.29 0.25 0.25 0.27 56.2 28.3 36.2 32.9 35.4 8.8 8.2 28.2 14.6 11.8 8.2 11.4

4Q06 60.3 48.4 9.2 0.0 0.0 2.6 -22.3 37.9 -18.1 -5.8 -8.1 -4.1 0.0 -1.4 19.9 21.3 25.9 0.5 12.4 32.8 1.3 30.8 23.6 0.46 0.43 0.42 0.33 62.9 35.3 43.0 51.1 39.2 9.1 22.2 36.2 59.9 21.0 69.0 20.6

1Q07 68.8 53.5 11.8 0.9 0.0 2.6 -24.0 44.9 -15.8 -3.8 -8.4 -3.6 0.0 -1.5 29.0 30.5 36.0 0.9 33.3 63.2 3.1 58.0 27.8 0.88 0.81 0.79 0.38 65.2 44.3 52.3 84.3 40.5 14.2 18.3 43.3 92.7 17.9 87.5 17.2

2Q07 74.1 62.1 9.3 0.0 0.0 2.7 -24.3 49.8 -17.8 -5.0 -8.7 -4.0 0.0 -2.0 32.1 34.1 39.4 1.1 26.4 59.6 5.0 54.6 33.3 0.84 0.76 0.74 0.46 67.2 46.0 53.2 73.7 44.9 7.7 11.1 11.7 -5.7 19.5 -5.7 19.8

3Q07 87.4 73.4 10.9 0.1 0.0 3.0 -26.4 61.0 -26.6 -8.1 -11.9 -6.6 0.0 -2.0 34.3 36.3 44.1 2.0 2.7 39.1 6.4 31.8 33.8 0.55 0.44 0.44 0.46 69.8 41.6 50.5 36.4 38.7 17.9 22.3 6.7 -34.4 1.6 -40.5 1.1

4Q07E 92.3 78.2 11.3 0.1 0.0 2.7 -29.9 62.3 -26.8 -7.4 -12.0 -7.4 0.0 -1.7 35.6 37.3 45.3 3.6 0.9 40.1 6.3 32.8 34.5 0.55 0.45 0.44 0.46 67.6 40.4 49.1 35.5 37.4 5.6 2.2 2.6 2.4 2.1 -1.0 -0.7

1Q08E 95.9 81.3 11.8 0.1 0.0 2.7 -31.2 64.7 -27.8 -7.7 -12.5 -7.7 0.0 -1.7 36.9 38.6 47.1 1.9 1.0 39.8 6.2 32.5 34.3 0.55 0.45 0.43 0.46 67.5 40.3 49.1 33.9 35.7 4.0 3.8 3.6 -0.7 -0.7 -0.6 -0.5

2Q08E 98.6 83.6 12.0 0.1 0.0 3.0 -32.9 65.7 -28.6 -7.9 -12.8 -7.9 0.0 -1.7 37.1 38.8 48.6 2.2 1.0 40.3 6.3 33.0 34.7 0.56 0.46 0.44 0.46 66.6 39.4 49.3 33.4 35.2 2.8 1.5 0.6 1.3 1.3 1.0 1.0

3Q08E 101.4 85.8 12.4 0.1 0.0 3.2 -35.1 66.4 -29.4 -8.1 -13.2 -8.1 0.0 -1.7 36.9 38.7 50.2 2.4 1.0 40.4 6.3 33.1 34.8 0.56 0.46 0.44 0.46 65.4 38.1 49.4 32.6 34.3 2.9 1.0 -0.5 0.3 0.3 0.0 0.0

4Q08E 103.9 87.9 12.8 0.1 0.0 3.2 -35.7 68.2 -30.1 -8.3 -13.5 -8.3 0.0 -1.7 38.1 39.8 51.5 2.7 1.0 41.8 6.5 34.3 36.0 0.58 0.47 0.45 0.48 65.6 38.3 49.6 33.0 34.7 2.5 2.8 3.0 3.6 3.5 3.4 3.2

FY06 208.6 156.3 38.2 3.5 0.0 10.6 -87.0 121.6 -74.0 -22.8 -30.0 -21.2 0.0 -5.0 47.6 52.6 70.5 0.9 26.0 74.5 -4.6 66.7 63.3 1.05 0.94 0.92 0.88 58.3 25.2 33.8 32.0 30.4 -10.1 -22.4 -30.8 -23.9 213.4 232.0 215.2

FY07E 322.2 266.8 43.3 1.1 0.0 11.0 -104.5 217.7 -86.8 -24.2 -41.0 -21.6 0.0 -7.2 130.9 138.1 164.3 7.6 64.0 202.4 -20.7 177.8 129.3 2.82 2.48 2.42 1.76 67.6 42.9 51.0 55.2 40.2 54.5 79.0 162.3 171.6 104.2 161.8 100.7

FY08E 399.9 338.6 49.0 0.2 0.0 12.1 -134.9 265.0 -116.0 -32.0 -52.0 -32.0 0.0 -6.9 149.0 156.0 197.3 9.2 4.0 162.2 -25.4 132.9 139.8 2.25 1.84 1.76 1.85 66.3 39.0 49.3 33.2 35.0 24.1 21.8 12.9 -19.9 8.1 -27.1 5.4

FY09E 483.6 410.4 59.0 0.3 0.0 13.9 -166.1 317.5 -135.4 -38.7 -58.0 -38.7 0.0 -6.9 182.1 189.0 242.1 13.8 4.8 200.7 -31.1 161.6 168.5 2.76 2.22 2.12 2.21 65.7 39.1 50.1 33.4 34.8 20.9 19.8 21.2 23.7 20.5 20.2 19.2

* Note: Adjusted net profit for 4Q06, 1Q07 and 2Q07 also excludes gain from Sina stake sale.

288

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

North America Equity Research 02 January 2008

Table 191: Shanda Annual Balance Sheet


US$ in millions, year-end December Cash and Cash Equivalents Account Receivables Inventory Total Other Current Assets Total Current Assets Gross Fixed Assets Accumulated Depreciation Net Fixed Assets Other Long Term Assets Long Term Investments and Associates Total Long Term Assets Total Assets ST Debt and Current Portion of LT Debt Accounts Payable Other Current Liabilities Total Current Liabilities Long Term Debt Other Long Term Liabilities Total Long Term Liabilities Share Capital Share Premium Other Reserves Retained Earnings Preferred Stock Total Equity Total Liabilities and Equity
Source: Company reports, JPMorgan estimates.

FY06 162.9 4.0 1.1 12.2 180.2 63.8 (19.8) 44.0 98.3 326.1 468.5 648.6 270.7 11.5 61.3 343.5 0.4 0.4 1.5 185.2 43.8 74.3 304.8 648.6

FY07E 250.7 6.0 0.5 18.2 275.4 81.2 (40.8) 40.4 187.9 119.9 348.2 623.6 8.5 121.7 130.2 24.9 24.9 1.6 204.3 22.2 240.5 468.5 623.6

FY08E 390.0 6.8 0.6 21.4 418.7 115.4 (60.2) 55.2 190.0 121.2 366.4 785.2 10.0 138.6 148.6 17.6 17.6 1.6 219.0 22.4 376.0 619.0 785.2

FY09E 575.2 8.5 0.7 26.1 610.6 155.4 (86.3) 69.1 190.0 121.2 380.3 990.8 12.2 173.3 185.5 12.3 12.3 1.6 231.5 22.4 537.5 793.0 990.8

Table 192: Shanda Annual Cash Flow Statement


US$ in millions, year-end December Net Income Add Non cash Expenses/(income) Depreciation and Amortization Extraordinaries Other Non-Cash Items Changes in Working Capital: (Increase)/Decrease Receivables (Increase)/Decrease Inventories (Increase)/Decrease Other Current Assets Increase/(Decrease) Payables Increase/(Decrease) Other Current Liabilities Net Cash from Operations Purchase of Property, Plant & Equipment Purchase/Sale of Other LT assets Purchase/Sale of Investments Net Cash from Investing Activities Issuance/Repayment of Debt Change in other LT liabilities Change in Common Equity - net Payment of Cash Dividends Other Financing Charges, Net Net Cash from Financing Activities Net Effect of Exchange Rate Changes Net Change in Cash and Cash Equivalents Cash at End of Period
Source: Company reports, JPMorgan estimates.

FY06 66.7 17.8 3.2 5.0 6.2 2.5 (1.8) 3.3 (7.3) 95.6 (18.6) (42.1) (25.0) (85.7) (9.1) (0.1) 33.4 (10.1) 14.2 24.1 162.9

FY07E 177.8 26.2 3.9 7.2 (1.8) 0.7 (5.5) (3.5) 57.6 262.7 (8.4) (97.5) 220.8 114.9 (282.8) 24.5 (19.9) (18.9) (297.1) 80.5 250.7

FY08E 132.9 41.4 4.0 6.9 (0.8) (0.1) (3.0) 1.4 15.6 198.3 (33.3) (22.5) (55.7) (7.5) 5.6 (4.0) (6.0) 136.6 390.0

FY09E 161.6 53.0 8.0 6.9 (1.7) (0.1) (4.8) 2.3 34.7 259.8 (39.9) (27.0) (66.9) (5.3) 5.6 (8.0) (7.7) 185.2 575.2

289

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

North America Equity Research 02 January 2008

Sina, Neutral ($45.50)


While we maintain our view that Sina is likely to remain the leading portal in China, we remain Neutral on the stock. We believe most of the near-term positives have been factored in the share price, and it will be difficult for the stock to see further multiple expansion in the near term. In addition, the outlook for the wireless segment (26% of total revenues in 3Q07) remains relatively uncertain. Sina remains the leader in Chinas branded advertising market and its online ad revenue has continued to show strong growth over the last year (with 40% or higher growth for ad revenue in each of the last 6 quarters). We believe Sina continues to be seen by advertisers as the leading online media company in terms of media influence. As such, leading advertisers generally allocate the largest portion of their online budget to Sina. We expect the display ad market in China to grow around 50% Y/Y in 2008 (due to Olympics boost for the ad market), and we expect Sina to register similar ~ 50% Y/Y growth in its branded ad segment. However, we maintain our Neutral rating on Sina due to valuation. We believe most of the near-term positives have been factored in the share price, and it will be difficult for the stock to see further multiple expansion in the near term. We would revisit our thesis if there is more clarity on potential for higher-thanexpected online ad (and video ad / blog formats) revenue growth in 2009 and we get more comfortable with the longer-term ad gross margin level. In addition, the outlook for the wireless segment (26% of total revenues in 3Q07) currently remains relatively uncertain. We believe potential positive drivers include: (1) stronger-than-expected Olympics ad growth, (2) upside from blogs, games, finance, or search channel. For 4Q07, we are forecasting net revenue of US$69.3M, up 8% Q/Q and 23% Y/Y (vs. guidance of US$68-$70M), and GAAP EPS of US$0.28, down 2% Q/Q and up 38% Y/Y, or adjusted EPS (ex-share-based expense) of US$0.31, down 2% Q/Q and up 21% Y/Y. We estimate advertising revenue of US$49.7M in 4Q07, up 9% Q/Q and 39% Y/Y (at the top end of guidance of US$49-$50M).

Table 193: Sina Financial Snapshot


US$ millions, except per share data 4Q07E 3Q07A 4Q06A JPMorgan Revenue EBITDA EPS (GAAP) EPS (Adj.) * Consensus Revenue EBITDA EPS (Adj.) * 69.3 22.1 0.28 0.31 69.1 0.33 64.3 20.7 0.28 0.32 64.3 20.7 0.32 56.4 15.5 0.20 0.26 56.4 15.5 0.26 Y/Y Q/Q 23% 42% 38% 21% 8% 7% -2% -2% F'07E 244.7 74.2 0.96 1.09 244.8 1.09 F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y 339.3 102.0 1.28 1.43 333.4 1.50 406.8 130.3 1.65 1.80 420.1 1.87 15% 32% 38% 24% 15% 24% 39% 38% 33% 31% 36% 38% 20% 28% 29% 26% 26% 25%

23% 7% 28% 4%

Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.

290

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

North America Equity Research 02 January 2008

Our Estimates and Outlook for 2008


We forecast 2008 net revenue at US$339.3M, up 39% Y/Y, and GAAP diluted EPS of US$1.28, up 33% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.43, up 31% Y/Y. We expect the top line to be driven by 50% Y/Y growth in advertising segment revenues (74% of total 2008E revenues), with an expected Olympics boost for the ad market in China. In terms of major advertising sectors, automobiles, real estate and IT should remain among the largest, while the financial industry (banks, insurance companies, etc.) could become one of the top 3 largest ad sectors by mid2008. For the wireless related segment (22% of total 2008E revenues), we are modeling a modest 7% Y/Y (following a 20% decline in 2007). Among other revenue (~4% of total 2008E revenues), we currently expect ~US$9M in Googlesearch revenue in 2008. In terms of margins, we forecast gross margin at 61.9% for 2008, stable from 62.1% for 2007; adjusted operating margin (ex-share-based expense) of 24.5% for 2008, also flattish from 24.2% for 2007, and adjusted net margin (ex-share-based expense) of 25.4% for 2008, slightly lower than 26.7% for 2007.

Our Estimates and Outlook for 2009


For 2009, we forecast net revenue at US$406.8M, up 20% Y/Y, and GAAP-diluted EPS of US$1.65, up 29% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.80, up 26% Y/Y. We forecast 23% Y/Y growth in advertising segment (76% of total 2009E revenues) and 11% growth in wireless segment (20% of total 2009E revenues). We forecast gross margin at 62.2% for 2009 (stable); adjusted operating margin (ex-share-based expense) of 26.1% (slight expansion) and adjusted net margin of 26.8% (slight expansion).

Rating and Price Target


We maintain our Neutral rating on Sina, with a Dec-08 price target of US$48, which implies 38x 2008E and 29x 2009E GAAP PE, or 34x 2008E and 27x 2009 adjusted P/E. This is above our DCF valuation of US$32. We believe Sina can trade at this valuation, given its longer-term earnings growth of around 30% and historical trading range of 25x-40x forward PE. Our sum-of-the-parts valuation points to a range of US$44 US$53; our price target is close to the mid-point of the estimates. We believe at the current level, the stock may find it difficult to see further multiple expansion. We would revisit our thesis if we get more clarity on potential for higherthan-expected online ad (and video ad / blog formats) revenue growth in 2009, and get more comfortable with longer-term ad gross margin level.

Risks to Our Rating and Price Target


Upside risks to our rating and price target include: better-than-expected online advertising growth, further partnerships formed, and upside from Google-Sina search partnership. Downside risks include: decline in online ad gross margin, slowdown in advertising spending in China, competition with other Internet portals, and changes in regulations in wireless value-added space, as well as further decline in wirelessrelated revenue due to strong competition.

291

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

North America Equity Research 02 January 2008

Table 194: Sina Income Statement


US$ in millions, except per share data, year-end December Revenue Mobile related Advertising Others COGS Gross Profit Operating Expense Sales & Mktg. expenses G&A expenses R&D expenses Other expenses Share-based compensation EBIT Adjusted EBIT (ex- 123R exp.) EBITDA Net Interest Income Net Other Income Pre Tax Profit Tax Expense/(Credit) Reported Net Profit Adj. Net Profit * Reported Diluted EPS (US$) Adj. Diluted EPS (US$) * Margins (%) Gross Margin Adj. Operating Margin * EBITDA Margin Net Margin Adj. Net Margin * Sequential Growth (%) Revenue Gross Profit Adj. EBIT (ex-123R) EBITDA Reported Diluted EPS Adj. Diluted EPS * 1Q06 46.7 22.7 22.2 1.8 -17.7 29.0 22.4 -11.5 -4.6 -4.3 -0.5 -1.5 6.6 8.1 10.9 1.8 -0.6 7.8 0.8 7.0 9.6 0.12 0.16 62.1 17.4 23.4 15.1 20.5 -10.1 -0.4 -15.1 -23 -48 2Q06 53.7 22.4 29.5 1.8 -19.3 34.4 26.7 -13.1 -5.5 -4.6 -0.5 -3.0 7.6 10.7 13.5 1.8 1.8 11.3 0.9 10.4 12.3 0.18 0.21 64.0 19.8 25.1 19.4 22.9 14.9 18.4 30.8 23.6 47.7 28.5 3Q06 56.1 21.8 32.7 1.6 -19.5 36.6 26.2 -11.7 -6.8 -4.5 -0.5 -2.7 10.4 13.1 13.6 2.0 -0.6 11.8 1.1 10.7 14.7 0.19 0.25 65.3 23.4 24.2 19.1 26.1 4.4 6.4 23.2 0.7 2.7 19.4 4Q06 56.4 19.3 35.7 1.4 -21.2 35.2 25.0 -12.1 -5.9 -4.4 -0.4 -2.2 10.2 12.5 12.9 2.3 0.5 13.0 1.3 11.7 15.2 0.20 0.26 62.4 22.1 22.8 20.8 26.9 0.6 -3.7 -5.1 -20.2 8.5 2.8 1Q07 51.3 18.2 31.8 1.3 -20.4 30.9 23.4 -10.7 -5.8 -4.3 -0.4 -2.2 7.5 9.7 13.1 2.5 0.0 10.0 1.4 8.6 11.4 0.15 0.19 60.2 18.9 25.6 16.8 22.1 -9.1 -3.7 -12.3 -15.6 -26.8 -25.7 2Q07 59.8 17.0 41.2 1.6 -22.2 37.6 24.9 -11.7 -6.0 -4.9 -0.3 -2.1 12.7 14.7 18.3 2.4 0.8 15.9 1.5 14.5 16.1 0.25 0.27 62.9 24.6 30.6 24.2 26.9 16.6 21.8 52.3 39.4 65.5 40.9 3Q07 64.3 16.6 45.8 1.9 -24.1 40.2 25.1 -12.1 -5.5 -5.5 -0.3 -1.7 15.2 16.9 20.7 3.7 0.0 18.9 1.7 17.2 19.1 0.28 0.32 62.5 26.2 32.1 26.7 29.7 7.6 6.9 14.5 13.1 16.2 17.7 4Q07E 69.3 17.1 49.7 2.4 -26.0 43.3 26.8 -13.2 -6.2 -5.5 -0.3 -1.6 16.4 18.0 22.1 2.5 0.0 18.9 2.1 16.9 18.8 0.28 0.31 62.5 26.0 31.9 24.4 27.1 7.7 7.6 6.8 6.9 -1.9 -2.1 1Q08E 65.1 17.7 44.3 3.2 -26.5 38.7 26.4 -13.0 -5.9 -5.2 -0.3 -2.0 12.3 14.3 18.6 2.7 0.0 15.0 1.7 13.3 15.6 0.22 0.26 59.4 22.0 28.5 20.4 23.9 -6.0 1.7 -10.7 -16.0 -21.2 -17.1 2Q08E 83.8 18.1 62.4 3.2 -31.5 52.3 33.9 -17.6 -7.5 -6.5 -0.3 -2.0 18.4 20.4 25.0 2.8 0.0 21.2 2.3 18.9 21.1 0.31 0.35 62.4 24.4 29.8 22.6 25.3 28.6 35.2 42.6 34.5 41.7 35.7 3Q08E 103.0 18.6 81.1 3.3 -38.4 64.6 41.2 -21.6 -9.3 -8.0 -0.3 -2.0 23.4 25.4 30.3 2.9 0.0 26.4 2.8 23.5 25.8 0.39 0.43 62.7 24.7 29.4 22.8 25.0 23.0 23.6 24.7 21.4 24.5 21.9 4Q08E 87.4 19.1 64.9 3.4 -32.9 54.5 33.5 -16.6 -7.9 -6.8 -0.3 -2.0 21.0 23.0 28.2 3.1 0.0 24.1 2.6 21.5 23.8 0.35 0.39 62.4 26.3 32.3 24.6 27.2 -15.2 -15.6 -9.5 -7.0 -8.8 -8.0 FY06 212.9 86.3 120.1 6.5 -77.7 135.2 -100.3 -48.5 -22.8 -17.8 -1.8 -9.5 34.9 44.4 56.1 7.9 1.2 44.0 -4.1 39.9 51.7 0.69 0.88 63.5 20.9 26.4 18.8 24.3 10.0 3.6 6.9 3.4 -7.1 18.3 FY07E 244.7 69.0 168.5 7.2 -92.7 152.0 -100.2 -47.6 -23.5 -20.3 -1.2 -7.6 51.8 59.3 74.2 11.1 0.8 63.7 -6.6 57.1 65.4 0.96 1.09 62.1 24.2 30.3 23.3 26.7 15.0 12.4 33.7 32.2 38.4 23.6 FY08E 339.3 73.5 252.7 13.1 -129.3 210.1 -134.9 -68.9 -30.5 -26.5 -1.0 -8.0 75.2 83.2 102.0 11.6 0.0 86.7 -9.5 77.3 86.3 1.28 1.43 61.9 24.5 30.1 22.8 25.4 38.7 38.2 40.2 37.5 33.1 30.7 FY09E 406.8 81.7 310.5 14.6 -153.8 252.9 -154.7 -78.1 -36.6 -30.9 -1.0 -8.0 98.2 106.2 130.3 13.9 0.0 112.2 -12.0 100.2 109.2 1.65 1.80 62.2 26.1 32.0 24.6 26.8 19.9 20.4 27.7 27.7 29.1 26.0

Source: Company and JPMorgan estimates. * Note: Adjusted for 123R share based compensation expense and other non-cash & non-recurring items.

292

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

North America Equity Research 02 January 2008

Table 195: Sina Annual Balance Sheet


US$ in millions, year-end December Cash and Cash Equivalents Account Receivables Inventory Total Other Current Assets Total Current Assets Gross Fixed Assets Accumulated Depreciation Net Fixed Assets Other Long Term Assets Long Term Investments and Associates Total Long Term Assets Total Assets ST Debt and Current Portion of LT Debt Accounts Payable Other Current Liabilities Total Current Liabilities Long Term Debt Other Long Term Liabilities Total Long Term Liabilities Share Capital Share Premium Other Reserves Retained Earnings Preferred Stock Total Equity Total Liabilities and Equity
Source: Company reports, JPMorgan estimates.

FY06 163.2 45.0 199.6 10.3 418.1 64.0 -36.9 27.1 92.4 1.2 120.7 538.8 0.0 1.6 49.4 51.0 100.0 0.0 100.0 7.2 303.9 0.0 76.7 0.0 387.8 538.8

FY07E 234.2 41.8 199.6 18.5 494.0 84.0 -53.1 30.9 91.2 1.2 123.3 617.3 0.0 3.7 52.3 55.9 100.0 0.0 100.0 7.3 320.2 0.0 133.8 0.0 461.3 617.3

FY08E 320.8 52.7 199.6 23.3 596.4 110.0 -71.0 39.1 90.2 1.2 130.4 726.8 0.0 4.6 66.0 70.6 100.0 0.0 100.0 7.3 337.9 0.0 211.1 0.0 556.3 726.8

FY09E 431.8 68.3 199.6 30.2 730.0 140.0 -94.0 46.0 89.1 1.2 136.4 866.3 0.0 5.9 85.5 91.4 100.0 0.0 100.0 7.4 356.3 0.0 311.2 0.0 674.9 866.3

Table 196: Sina Annual Cash Flow Statement


US$ in millions, year-end December Net Income Add Non cash Expenses/(income) Depreciation and Amortization Extraordinaries Other Non-Cash Items Changes in Working Capital: (Increase)/Decrease Receivables (Increase)/Decrease Inventories (Increase)/Decrease Other Current Assets Increase/(Decrease) Payables Increase/(Decrease) Other Current Liabilities Net Cash from Operations Purchase of Property, Plant & Equipment Purchase/Sale of Other LT assets Purchase/Sale of Investments Net Cash from Investing Activities Issuance/Repayment of Debt Change in other LT liabilities Change in Common Equity - net Payment of Cash Dividends Other Financing Charges, Net Net Cash from Financing Activities Net Effect of Exchange Rate Changes Net Change in Cash and Cash Equivalents Cash at End of Period
Source: Company reports, JPMorgan estimates.

FY06 39.9 11.7 0.0 9.5 -11.1 0.0 2.1 0.0 1.9 54.0 -14.8 1.3 15.5 2.0 0.0 0.0 10.0 0.0 8.8 18.8 74.8 163.2

FY07E 57.1 14.9 0.0 7.6 3.3 0.0 -8.1 2.0 2.9 79.6 -17.4 0.0 0.0 -17.4 0.0 0.0 8.9 0.0 0.0 8.9 71.0 234.2

FY08E 77.3 18.9 0.0 8.0 -10.9 0.0 -4.8 0.9 13.7 103.0 -26.0 0.0 0.0 -26.0 0.0 0.0 9.7 0.0 0.0 9.7 86.6 320.8

FY09E 100.2 24.1 0.0 8.0 -15.6 0.0 -6.9 1.3 19.6 130.5 -30.0 0.0 0.0 -30.0 0.0 0.0 10.5 0.0 0.0 10.5 111.0 431.8

293

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

North America Equity Research 02 January 2008

Sohu, Overweight ($56.58)


We maintain our Overweight rating on Sohu, which also remains our top pick in the brand advertising sector in China. With strong secular growth of online advertising in China, benefits from Olympics (near term on content due to official Internet sponsorship, longer term on brand awareness and improved execution), and bonus from online gaming, we maintain Sohu as our top pick. As the official 2008 Beijing Olympics Internet content sponsor, Sohus brand awareness continues to strengthen among Internet users, advertisers and also the government. Sohu is also a strategic partner for China Interactive Sports (Sohu builds and hosts their sports site; most of Chinas athletes belong to CI Sports and will host their blogs on Sohu) and an exclusive sponsor for Chinas National Team, or Team China (athletes in Chinas national teams in international events such as the Olympics belong to Team China). Through such sponsorships, Sohu will have access to first interview rights to Chinese athletes after each Olympics event, and can carry official news for the athletes, during and around the Olympics time. We expect this to help drive traffic before / during the Olympics. On the back of such content strength and consistent execution, we forecast Sohu's branded ad revenue to grow at ~48% Y/Y in 2008 (after 40% Y/Y in 2007) and ~15% in 2009 (conservative estimate). Sohus success in online gaming with its game TLBB (launched in May-07) is an added bonus (for revenues and margins) going forward. In 3Q07, the game saw average paying accounts of 690K, up from 209K in 2Q07; while peak concurrent users hit 500K in November. We expect TLBB to see sustained growth in 2008 as well. We believe the strong TLBB result is due to the teams deep experience and good understanding of Chinese gamers, and TLBB's strong brand name. Sohu has also signed another game naming right from TLBBs novelist, Jinyong: The Duke of Mount Deer will likely be the title of Sohus next in-house game (likely to be launched in late 2008). Positive share price drivers include: 1) As the Olympics draw nearer, Sohu is likely to benefit from Olympics-related advertising and stronger branding effects; (2) positive revenue/margin impact from its successful game TLBB; (3) potential upside from next game The Duke of Mount Deer to be launched in late-08; (4) strong growth in video-related traffic should provide benefit from increasing ad rates, offsetting higher content costs; and (5) potential upside from monetization of its social networks. For 4Q07, our revenue forecast is US$55.9M, up 8% Q/Q and 63% Y/Y, and GAAP EPS of US$0.30, up 20% Q/Q and 89% Y/Y, or adjusted EPS (ex-sharebased expense) of US$0.35, up 15% Q/Q and 66% Y/Y. (Note: Sohu has increased its 4Q07 revenue guidance to US$55.5$57.5M, up $2M vs. prior guidance US$53.5-$55.5M, due to strength in online game TLBB. Adjusted EPS guidance is US$0.36-$0.38, vs. prior US$0.33-$0.35. We are reviewing our numbers. )

294

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

North America Equity Research 02 January 2008

Table 197: Sohu Financial Snapshot


US$ millions, except per share data 4Q07E 3Q07A 4Q06A JPMorgan Revenue EBITDA EPS (GAAP) EPS (Adj.) * Consensus Revenue EBITDA EPS (GAAP) 55.9 16.2 0.30 0.35 54.7 0.29 51.5 13.2 0.25 0.31 51.5 13.2 0.25 34.4 10.0 0.16 0.21 34.4 10.0 0.16 Y/Y Q/Q 63% 8% 61% 22% 89% 20% 66% 15% 59% 6% 80% 14% F'07E 179.5 48.5 0.82 1.05 179.4 0.83 F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y 281.0 319.8 92.3 109.2 1.78 2.17 2.00 2.40 271.6 341.2 1.52 2.03 33% 23% 22% 23% 34% 22% 57% 90% 116% 90% 51% 83% 14% 18% 22% 20% 26% 34%

Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.

Our Estimates and Outlook for 2008


Our forecast for 2008 net revenue is US$281.0M, up 57% Y/Y, and GAAP-diluted EPS of US$1.78, up 116% Y/Y, or adjusted EPS (ex-share-based expense) of US$2.00, up 90% Y/Y. We forecast 2008 brand advertising revenue of US$164.1M (58% of total revenues), up 48% Y/Y, and online game revenue of US$78.2M (28% of total revenues), up 129% Y/Y. In terms of Olympics advertising, Sohu expects the spending pattern in three phases: (1) 4Q07 till early May - advertisers likely will still be relatively slow in Olympics-related spending; (2) From May until early August the Olympics torch relay will begin in May, and advertisers will likely increase their ad spending; (3) During the month of August - the largest ad spending should take place during the actual Olympics event. On margins, we forecast gross margin at 69.6% for 2008, expanding from 65.5% for 2007 (boosted by higher-margin online games segment); adjusted operating margin (ex-share-based expense) of 28.6% for 2008, expanding from 21.3% for 2007, and adjusted net margin (ex-share-based expense) of 27.7% for 2008, up from 22.5% for 2007.

Our Estimates and Outlook for 2009


For 2009, we forecast net revenue at US$319.8M, up 14% Y/Y, and GAAP-diluted EPS of US$2.17, up 22% Y/Y, or adjusted EPS (ex-share-based expense) of US$2.40, up 20% Y/Y. We forecast gross margin at 70.3% for 2009 (up slightly Y/Y); adjusted operating margin of 30.2% (slight expansion) and adjusted net margin of 29.8% (slight expansion).

Rating and Price Target


We maintain our OW stance on Sohu, which is also on the LONG side of our Analyst Focus List. Our Dec-08 price target of US$69 implies 39x 08E and 32x 09E GAAP EPS, or 35x 08E and 29x 09E adjusted diluted EPS (ex-share-based expense); the price target is based on mid-point of our sum-of-parts valuation of US$63 US$75. We believe Sohu would likely see multiple expansion due to: (1) As we approach the 2008 Olympics, Sohu is likely to benefit from Olympics-related advertising and stronger branding effects. (2) Strong growth in video-related traffic should benefit Sohu from increasing ad rates, which help offset an increase in content costs. (3) Positive financial impact (revenue & margins) from online game TLBB. (4) Sohu
295

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

North America Equity Research 02 January 2008

may begin to see meaningful monetization from its social networks (China Ren alumni site, bulletin boards, etc.).

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, significant market share loss in online advertising to other portals, and uncertainty in wireless revenue due to policy change by mobile operators.

296

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

North America Equity Research 02 January 2008

Table 198: Sohu Income Statement


US$ in millions, except per share data, year-end December Revenue Advertising Brand advertising Paid search Mobile related Online games (breakout from 1Q07) Others COGS Gross Profit Operating Expense Sales & Mktg. expenses G&A expenses R&D expenses Other expenses Share-based compensation EBIT Adj. EBIT (ex- 123R expense) EBITDA Net Interest Income Net Other Income Pre Tax Profit Tax Expense/(Credit) Net Profit (after MI) Adj. Net Profit (ex- 123R exp.) Diluted EPS (US$) Adj. Diluted EPS (US$, ex- 123R exp.) Margins (%) Gross Margin Operating Margin (ex- 123R exp.) EBITDA Margin Net Margin Adj. Net Margin (ex- 123R exp.) Sequential Growth (%) Revenue Gross Profit EBIT EBITDA Diluted EPS Adj. Diluted EPS 1Q06 31.3 20.1 16.7 3.5 8.0 3.1 -10.5 20.8 -14.7 -6.1 -2.7 -3.8 -0.5 -1.7 6.0 7.8 9.6 0.5 -0.1 6.5 0.4 6.0 7.8 0.16 0.20 66.4 24.8 30.6 19.3 24.9 2.6 3.5 33.4 32.8 -32.2 -13.4 2Q06 34.1 22.8 19.3 3.5 9.0 2.3 -12.2 21.9 -15.3 -6.7 -2.9 -3.9 -0.5 -1.3 6.6 7.8 9.7 0.8 0.1 7.5 0.3 7.2 8.4 0.19 0.22 64.3 23.0 28.5 21.0 24.8 9.0 5.6 1.1 1.7 18.9 9.1 3Q06 35.4 23.9 21.0 2.9 8.8 2.7 -12.0 23.4 -17.3 -6.8 -3.5 -4.5 -0.5 -1.9 6.1 8.0 10.0 1.0 -0.1 7.0 0.4 6.6 8.5 0.17 0.22 66.1 22.7 28.4 18.6 24.1 3.9 6.8 2.6 3.3 -7.0 2.1 4Q06 34.4 24.9 22.0 2.9 6.8 2.7 -12.1 22.2 -16.5 -7.4 -2.1 -4.4 -0.5 -2.0 5.7 7.7 10.0 0.9 -0.1 6.5 0.5 6.1 8.1 0.16 0.21 64.7 22.6 29.2 17.7 23.5 -3.0 -5.1 -3.7 -0.2 -6.9 -4.6 1Q07 33.1 25.6 23.5 2.1 5.6 1.6 0.3 -12.8 20.2 -16.2 -6.8 -2.6 -3.9 -0.4 -2.5 4.1 6.6 9.1 0.8 -0.1 4.7 0.3 4.5 7.0 0.12 0.18 61.2 19.8 27.6 13.5 21.0 -3.7 -8.9 -15.3 -9.1 -27.1 -14.8 2Q07 39.0 28.4 26.6 1.7 6.6 3.8 0.2 -14.9 24.1 -19.1 -9.0 -2.7 -4.8 -0.3 -2.4 4.9 7.3 9.6 1.1 -0.1 5.9 0.2 5.7 8.1 0.15 0.21 61.7 18.8 24.6 14.6 20.8 17.8 18.9 11.7 5.1 26.6 15.9 3Q07 51.5 31.5 29.8 1.7 6.8 12.7 0.5 -16.8 34.8 -25.9 -13.2 -4.3 -6.2 -0.2 -2.0 8.8 10.8 13.2 0.6 0.6 10.0 0.3 9.7 11.7 0.25 0.31 67.5 21.0 25.7 18.8 22.7 32.1 44.5 47.9 32.4 70.9 46.1 4Q07E 55.9 32.3 30.7 1.7 7.5 16.0 0.1 -17.4 38.5 -26.9 -14.2 -3.6 -6.7 -0.4 -1.9 11.6 13.5 16.2 0.5 0.0 12.1 0.4 11.7 13.6 0.30 0.35 68.9 24.2 29.0 20.9 24.3 8.4 10.8 24.9 22.4 19.6 15.1 1Q08E 59.4 33.9 32.2 1.7 7.6 17.8 0.1 -18.3 41.1 -27.1 -13.4 -4.2 -7.1 -0.4 -2.1 13.9 16.0 18.8 0.6 0.0 14.5 1.2 13.4 15.5 0.35 0.40 69.1 27.0 31.6 22.5 26.0 6.3 6.6 18.4 16.1 13.8 13.3 2Q08E 73.9 46.8 45.1 1.7 7.8 19.2 0.1 -22.5 51.4 -33.0 -16.6 -5.2 -8.9 -0.3 -2.1 18.4 20.5 23.7 0.7 0.0 19.1 1.5 17.6 19.7 0.45 0.51 69.6 27.7 32.0 23.8 26.7 24.4 25.2 27.6 25.9 30.7 26.5 3Q08E 79.6 51.3 49.6 1.7 8.0 20.2 0.1 -24.2 55.4 -34.0 -16.7 -5.6 -9.6 -0.1 -2.1 21.4 23.5 26.7 0.9 0.0 22.3 1.7 20.6 22.7 0.53 0.58 69.6 29.5 33.6 25.8 28.5 7.8 7.8 14.8 12.9 16.2 14.5 4Q08E 68.1 39.0 37.2 1.8 8.1 21.0 0.1 -20.4 47.8 -29.5 -14.3 -4.8 -8.2 -0.1 -2.1 18.3 20.4 23.2 1.1 0.0 19.4 1.5 17.9 20.0 0.46 0.51 70.1 30.0 34.0 26.3 29.3 -14.4 -13.8 -13.1 -13.3 -13.4 -12.3 FY06 135.1 91.8 79.0 12.8 32.6 10.7 -46.8 88.3 -63.9 -27.1 -11.2 -16.7 -2.0 -6.9 24.4 31.4 39.3 3.2 -0.2 27.5 -1.6 25.9 32.8 0.68 0.86 65.4 23.2 29.1 19.2 24.3 24.7 22.6 25.9 24.0 -11.9 11.1 FY07E 179.5 117.9 110.6 7.2 26.5 34.1 1.0 -61.9 117.6 -88.1 -43.3 -13.1 -21.6 -1.3 -8.8 29.5 38.3 48.5 2.9 0.3 32.7 -1.2 31.5 40.3 0.82 1.05 65.5 21.3 27.0 17.6 22.5 32.9 33.1 22.0 23.3 21.6 22.9 FY08E 281.0 171.0 164.1 6.8 31.5 78.2 0.3 -85.3 195.6 -123.7 -61.0 -19.7 -33.7 -0.9 -8.4 72.0 80.4 92.3 3.3 0.0 75.3 -5.9 69.4 77.8 1.78 2.00 69.6 28.6 32.9 24.7 27.7 56.6 66.4 110.0 90.4 116.3 90.0 FY09E 319.8 195.8 188.1 7.7 34.3 89.4 0.3 -95.0 224.8 -137.4 -67.2 -22.4 -38.4 -0.3 -9.2 87.4 96.6 109.2 6.0 0.0 93.4 -7.2 86.2 95.4 2.17 2.40 70.3 30.2 34.2 27.0 29.8 13.8 14.9 20.2 18.3 21.5 20.0

Source: Company and JPMorgan estimates. * Adjustments: excluding share-based compensation expense.

297

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

North America Equity Research 02 January 2008

Table 199: Sohu Annual Balance Sheet


US$ in millions, year-end December Cash and Cash Equivalents Account Receivables Inventory Total Other Current Assets Total Current Assets Gross Fixed Assets Accumulated Depreciation Net Fixed Assets Other Long Term Assets Long Term Investments and Associates Total Long Term Assets Total Assets ST Debt and Current Portion of LT Debt Accounts Payable Other Current Liabilities Total Current Liabilities Long Term Debt Other Long Term Liabilities Total Long Term Liabilities Share Capital Share Premium Other Reserves Retained Earnings Preferred Stock Total Equity Total Liabilities and Equity
Source: Company reports, JPMorgan estimates.

FY06 124.8 23.8 0.0 10.9 159.5 41.4 -19.9 21.5 71.4 1.3 94.1 253.6 59.8 1.2 36.6 97.6 0.0 0.1 0.1 0.0 111.4 0.0 44.5 0.0 156.0 253.6

FY07E 80.3 33.7 0.0 22.3 136.4 91.9 -28.9 63.0 69.5 0.0 132.5 268.9 0.0 2.0 55.9 57.9 1.3 0.0 1.3 0.0 133.7 0.0 76.0 0.0 209.8 268.9

FY08E 165.2 41.1 0.0 27.3 233.6 111.9 -40.0 71.9 68.6 0.0 140.5 374.1 0.0 2.3 68.1 70.5 1.3 0.0 1.3 0.0 156.9 0.0 145.4 0.0 302.4 374.1

FY09E 264.3 52.4 0.0 34.8 351.4 137.9 -52.3 85.6 68.3 0.0 153.9 505.3 0.0 3.0 86.9 89.9 1.3 0.0 1.3 0.0 182.5 0.0 231.6 0.0 414.2 505.3

Table 200: Sohu Annual Cash Flow Statement


US$ in millions, year-end December Net Income Add Non cash Expenses/(income) Depreciation and Amortization Extraordinaries Other Non-Cash Items Changes in Working Capital: (Increase)/Decrease Receivables (Increase)/Decrease Inventories (Increase)/Decrease Other Current Assets Increase/(Decrease) Payables Increase/(Decrease) Other Current Liabilities Net Cash from Operations Purchase of Property, Plant & Equipment Purchase/Sale of Other LT assets Purchase/Sale of Investments Net Cash from Investing Activities Issuance/Repayment of Debt Change in other LT liabilities Change in Common Equity - net Payment of Cash Dividends Other Financing Charges, Net Net Cash from Financing Activities Net Change in Cash and Cash Equivalents Cash at End of Period
Source: Company reports, JPMorgan estimates.

FY06 25.9 8.0 0.0 6.9 0.0 -4.5 0.0 2.7 -0.5 3.2 41.7 -11.7 -7.5 4.7 -14.4 -15.0 0.1 -6.7 0.0 0.0 -21.6 5.7 124.8

FY07E 31.5 10.2 0.0 8.8 0.0 -9.8 0.0 -11.4 0.8 19.2 49.3 -50.5 0.6 1.3 -48.6 -58.5 -0.1 13.5 0.0 0.0 -45.1 -44.4 80.3

FY08E 69.4 12.0 0.0 8.4 0.0 -7.4 0.0 -4.9 0.3 12.3 90.1 -20.0 0.0 0.0 -20.0 0.0 0.0 14.8 0.0 0.0 14.8 84.9 165.2

FY09E 86.2 12.6 0.0 9.2 0.0 -11.3 0.0 -7.5 0.6 18.8 108.6 -26.0 0.0 0.0 -26.0 0.0 0.0 16.4 0.0 0.0 16.4 99.0 264.3

298

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

North America Equity Research 02 January 2008

The9, Overweight ($23.50)


We maintain Overweight on The9, as the company has one of the most diversified game pipelines, and we believe the risk is on the upside for the company to operate these games well, despite muted success in the recent two game launches. In addition, the company is trading at a relatively lower valuation compared with other online game companies. However, shares could trade flattish in the near term, on the back of increasing costs and uncertainties (timing, upfront fee, royalty payment) in WoW (World of Warcraft) renewal terms. We expect WoW to see solid revenue growth in 4Q07 (full quarter impact of Burning Crusade expansion pack launch) and continue with healthy growth over the next few quarters, driven by further penetration to lower-tier cities (as more PCs in lower-tier cities are upgraded with more 3D games in the market). However, The9 may continue to see more margin pressure going forward, mainly due to: (1) Loose control on marketing spending in recent times; (2) year-end bonus and professional fees; (3) The9 may see a slightly higher tax rate in 2008 and beyond; and (4) second-term WoW license renewal (current license expires in June 2009) will likely cause reduction in gross margin (from both amortization of upfront licensing fee and increased ongoing royalty). The9 still has one of the most diversified game pipelines in China online gaming: 3D games GE and Guild Wars (likely commercialization 1Q08), EAs casual soccer game FIFA Online (likely commercialization 3Q08), Hellgate: London (likely commercialization 1H08) and several others likely in 2H08 (inhouse games FM Online and MJSG, dancing game Audition 2, first-personshooting game Huxley). We believe the risk is on the upside for the company to operate these games well, despite muted success in the last two game launches (SUN commercialization and Guild Wars beta testing). We believe positive share price drivers could come around mid-2008 with: (1) FIFA Online launch; and (2) confirmation of WoW license renewal (current license expires in June 2009). We do note that with a new corporate structure at Activision-Blizzard (following the recent merger announcement), there could be delays in the license renewal process. As such, this could be a drag on The9's share price. However, we maintain that The9 is the most likely candidate for the renewal contract, as it has already invested more than US$60 million in WoW servers - a high entry barrier for other potential licensees. For 4Q07, we forecast net revenue of US$50.9M, up 21% Q/Q and 40% Y/Y, and GAAP EPS of US$0.18, up 6% Q/Q and down 67% Y/Y, or adjusted EPS (ex-share-based expense) of US$0.27, up 7% Q/Q and down 54% Y/Y. In addition to a full quarter of Burning Crusade revenue impact, WoW plans to launch version 2.3 upgrade during 4Q07 and also launch a new fee-based character transfer feature that should lead to additional monetization (we expect these drivers to lead to 4Q07 WoW ACU of 417k and PCU of 910k). However, margins will likely remain under pressure on higher operating expenses.

299

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

North America Equity Research 02 January 2008

Table 201: The9 Financial Snapshot


US$ millions, except per share data 4Q07E 3Q07A 4Q06A JPMorgan Revenue EBITDA EPS (GAAP) EPS (Adj.) * Consensus Revenue EBITDA EPS (GAAP) 50.9 16.4 0.18 0.27 50.3 0.28 42.2 15.6 0.17 0.25 42.2 15.6 0.17 36.2 16.5 0.54 0.58 36.2 16.5 0.54 Y/Y Q/Q 40% -1% -67% -54% 21% 5% 6% 7% F'07E 163.2 61.7 0.93 1.17 163.1 1.05 F'08E F'09E F'07E Y/Y F'08E Y/Y F'09E Y/Y 248.9 100.0 1.26 1.60 255.7 1.64 318.8 139.1 1.84 2.18 312.5 2.26 31% 7% -42% -31% 31% -35% 53% 62% 35% 36% 57% 56% 28% 39% 47% 37% 22% 38%

39% 19% -49% 63%

Source: JPMorgan, First Call estimates. *Note: Adjusted EPS excludes share-based compensation expense.

Our Estimates and Outlook for 2008


For 2008, we forecast net revenue of US$248.9M, up 53% Y/Y, and GAAP-diluted EPS of US$1.26, up 35% Y/Y, or adjusted EPS (ex-share-based expense) of US$1.60, up 36% Y/Y. We forecast WoW revenue of US$197.2M (79% of total revenues), up 31% Y/Y, while we expect revenue contribution to begin from several other games (GE, Guild Wars, Hellgate: London, etc.), which should help to diversify The9s revenue streams (even if they do not become huge hits). In respect of margins, we forecast gross margin at 45.8% for 2008, up slightly from 44.4% for 2007; adjusted operating margin (ex-share-based expense) of 22.1% for 2008, up slightly from 20.5% for 2007, and adjusted net margin (ex-share-based expense) of 19.0% for 2008, down slightly from 19.9% for 2007 (due to increase in effective tax rate in 2008).

Our Estimates and Outlook for 2009


For 2009, we forecast net revenue at US$318.8M, up 28% Y/Y, and GAAP-diluted EPS of US$1.84, up 47% Y/Y, or adjusted EPS (ex-share-based expense) of US$2.18, up 37% Y/Y. We forecast gross margin at 48.6% for 2009 (Y/Y expansion); adjusted operating margin (ex-share-based expense) of 24.2% (Y/Y expansion) and adjusted net margin of 20.5% (slight Y/Y expansion).

Rating and Price Target


We retain our Overweight rating on the stock, as The9 has one of the most diversified pipelines, and we believe the risk is on the upside for the company to operate these games well, despite muted success in the recent two launches. In addition, the company is trading at a relatively lower valuation compared with other online game companies. Our Dec-08 price target is US$34, implying 27.0x 2008E, or 18.4x2009E GAAP EPS, and 21.3x 2008E, or 15.6x2009E adjusted EPS. The price target is also in line with our DCF valuation. We believe the company will trade at the low end of its historical trading range due to uncertainty in WoW license renewal and increasing costs.

Risks to Our Rating and Price Target


Risks to our rating and price target include: (1) lower-than-expected WoW revenue growth, (2) if The9 is unable to obtain 2nd-term WoW license or is required to pay a
300

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

North America Equity Research 02 January 2008

significant fee, (3) loose control on marketing spending, and (4) lower-than-expected acceptance in upcoming titles. Positive risks to our target price are additional license games to The9s pipeline.

301

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

North America Equity Research 02 January 2008

Table 202: The9Income statement


US$ in millions, except per share data, year-end December Revenue Online games services Game operation support SMS services Other revenue COGS Gross Profit Operating Expenses Sales & Mktg. expenses G&A expenses R&D expenses Other expenses Share-based compensation (123R) EBIT Adj. EBIT (ex-123R expense) EBITDA Equity earnings in affiliates Net Other Income Pre Tax Profit Tax Expense/(Credit) Net Profit Adj. Net Profit (ex-123R exp.) Pre Tax EPS (US$) After Tax EPS (US$) Diluted EPS (US$) Adj. Diluted EPS (US$, ex-123R) Margins (%) Gross Margin Operating Margin (ex-123R exp.) EBITDA Margin Net Margin Adj. Net Margin (ex-123R exp.) Sequential Growth (%) Revenue Gross Profit Adj. EBIT Pre Tax Profit Net Profit Diluted EPS Adj. Diluted EPS (ex-123R exp.) 1Q06 26.5 26.1 0.1 0.0 0.2 -14.6 11.9 -4.8 -1.4 -2.3 -1.1 0.0 -0.6 7.1 7.7 12.8 0.1 0.1 7.3 0.0 7.3 7.9 0.29 0.29 0.30 0.33 44.8 28.9 48.2 27.7 29.9 0.0 -2.2 16.6 -3.7 -13.9 -14.2 -7.6 2Q06 32.2 32.0 0.1 0.0 0.1 -16.7 15.5 -6.8 -2.4 -3.3 -1.1 0.0 -0.6 8.8 9.4 14.5 0.0 1.7 10.5 -0.1 10.5 11.1 0.41 0.42 0.43 0.45 48.2 29.0 45.0 32.7 34.6 21.4 30.5 21.8 42.6 43.3 41.3 38.7 3Q06 29.5 29.0 0.3 0.0 0.2 -15.9 13.6 -5.6 -1.5 -3.2 -1.0 0.0 -0.6 8.0 8.6 13.9 -0.2 0.2 8.0 -0.1 8.1 8.7 0.33 0.33 0.33 0.35 46.2 29.1 47.0 27.6 29.5 -9.4 -13.1 -9.3 -24.0 -23.7 -23.6 -22.6 4Q06 36.2 36.1 0.1 0.0 0.1 -19.0 17.3 -7.0 -2.3 -4.0 -0.7 0.0 -0.8 10.3 11.1 16.5 -0.1 2.8 12.9 -0.1 13.5 14.3 0.53 0.55 0.54 0.58 47.7 30.5 45.6 37.2 39.4 22.7 26.5 28.9 61.1 65.4 64.8 63.1 1Q07 35.0 34.5 0.3 0.0 0.1 -18.1 16.9 -7.5 -2.1 -4.2 -1.2 0.0 -0.8 9.3 10.1 15.8 -0.2 0.5 9.6 1.0 8.6 9.4 0.39 0.35 0.34 0.37 48.2 29.0 45.1 24.5 26.8 -3.5 -2.3 -8.3 -25.8 -36.4 -37.1 -35.1 2Q07 35.5 34.5 0.9 0.0 0.1 -20.4 15.1 -9.8 -3.0 -5.3 -1.5 0.0 -1.2 5.3 6.5 14.0 -0.3 1.8 6.8 0.1 6.6 7.9 0.26 0.25 0.25 0.29 42.4 18.3 39.3 18.7 22.2 1.5 -10.7 -36.1 -29.2 -22.3 -27.2 -21.4 3Q07 42.2 41.5 0.3 0.0 1.2 -24.5 17.6 -11.8 -4.3 -6.5 -1.1 0.0 -2.3 5.8 8.1 15.6 -0.1 0.3 6.0 0.9 5.1 7.4 0.20 0.17 0.17 0.25 41.8 19.3 37.0 12.1 17.5 18.9 17.2 25.5 -11.6 -23.3 -31.0 -15.3 4Q07E 50.9 50.7 0.0 0.0 0.1 -27.8 23.0 -16.8 -6.4 -8.6 -1.8 0.0 -2.5 6.2 8.7 16.4 -0.1 0.4 6.5 1.1 5.4 7.9 0.22 0.18 0.18 0.27 45.2 17.2 32.2 10.6 15.5 20.6 30.4 7.3 8.0 5.6 5.9 6.9 1Q08E 53.2 53.1 0.0 0.0 0.1 -30.0 23.2 -14.9 -5.3 -8.0 -1.6 0.0 -2.5 8.3 10.8 20.3 -0.1 0.3 8.5 1.4 7.0 9.5 0.29 0.24 0.24 0.32 43.7 20.4 38.2 13.2 17.9 4.6 0.9 24.1 30.8 30.8 30.5 20.8 2Q08E 57.3 57.2 0.0 0.0 0.1 -31.9 25.4 -16.0 -5.7 -8.6 -1.7 0.0 -2.5 9.4 11.9 22.0 -0.1 0.2 9.4 1.6 7.8 10.3 0.32 0.27 0.26 0.35 44.4 20.7 38.3 13.7 18.1 7.7 9.5 9.7 11.3 11.3 11.1 8.1 3Q08E 65.8 65.7 0.0 0.0 0.1 -35.4 30.4 -18.1 -6.6 -9.9 -1.6 0.0 -2.5 12.3 14.8 26.9 -0.1 0.1 12.2 2.1 10.2 12.7 0.42 0.35 0.34 0.43 46.2 22.5 40.9 15.4 19.2 14.9 19.6 24.7 29.7 29.7 29.4 22.2 4Q08E 72.7 72.6 0.0 0.0 0.1 -37.6 35.1 -20.0 -7.3 -10.9 -1.8 0.0 -2.5 15.1 17.6 30.8 -0.1 -0.1 14.9 2.5 12.4 14.9 0.51 0.42 0.41 0.50 48.2 24.2 42.4 17.0 20.4 10.5 15.3 18.7 21.6 21.6 21.3 17.0 FY06 124.3 123.2 0.6 0.0 0.6 -66.1 58.2 -24.2 -7.5 -12.8 -3.9 0.0 -2.5 34.1 36.6 57.6 -0.1 4.7 38.7 -0.3 39.4 41.9 1.58 1.61 1.60 1.71 46.8 29.4 46.3 31.7 33.7 118.8 112.2 401.6 349.3 345.0 339.2 367.4 FY07E 163.2 161.2 1.5 0.0 1.5 -90.7 72.5 -45.8 -15.6 -24.6 -5.6 0.0 -6.8 26.7 33.5 61.7 -0.7 2.9 29.0 3.2 25.8 32.5 1.05 0.94 0.93 1.17 44.4 20.5 37.8 15.8 19.9 31.3 24.5 -8.5 -25.2 -34.6 -42.0 -31.2 FY08E 248.9 248.5 0.1 0.0 0.3 -134.8 114.1 -69.0 -24.9 -37.3 -6.8 0.0 -10.0 45.1 55.1 100.0 -0.5 0.4 45.1 7.7 37.4 47.4 1.53 1.27 1.26 1.60 45.8 22.1 40.2 15.0 19.0 52.5 57.4 64.5 55.6 45.2 35.4 35.9 FY09E 318.8 318.4 0.0 0.0 0.4 -163.9 154.9 -87.7 -31.9 -47.8 -8.0 0.0 -10.0 67.2 77.2 139.1 -0.5 -0.1 66.7 11.3 55.3 65.3 2.26 1.88 1.84 2.18 48.6 24.2 43.6 17.4 20.5 28.1 35.8 40.2 47.9 47.9 46.5 36.5

Source: Company and JPMorgan estimates. Note: We have included 123R share-based compensation adjustments starting 2006.

302

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

North America Equity Research 02 January 2008

Table 203: The9 Annual Balance Sheet


US$ in millions, year-end December Cash and Cash Equivalents Account Receivables Inventory Total Other Current Assets Total Current Assets Gross Fixed Assets Accumulated Depreciation Net Fixed Assets Other Long Term Assets Long Term Investments and Associates Total Long Term Assets Total Assets ST Debt and Current Portion of LT Debt Accounts Payable Other Current Liabilities Total Current Liabilities Long Term Debt Other Long Term Liabilities Total Long Term Liabilities Share Capital Share Premium Other Reserves Retained Earnings Preferred Stock Total Equity Total Liabilities and Equity
Source: Company reports, JPMorgan estimates.

FY06 118.3 1.3 14.1 3.5 137.1 44.8 (16.2) 28.7 34.6 4.5 67.8 204.9 4.6 25.1 6.6 36.4 0.3 118.8 2.6 46.9 168.5 204.9

FY07E 263.2 3.9 11.0 13.3 291.4 94.8 (33.8) 61.0 40.9 19.7 121.5 412.9 27.5 8.0 35.6 0.3 299.5 2.7 74.8 377.3 412.9

FY08E 293.0 5.6 15.9 13.4 327.9 146.0 (62.4) 83.6 51.0 19.4 154.0 482.0 39.8 11.6 51.5 0.3 314.4 2.8 113.0 430.5 482.0

FY09E 357.9 6.3 18.0 13.4 395.6 206.0 (105.7) 100.3 40.6 19.0 159.8 555.4 45.0 13.1 58.2 0.3 325.8 2.8 168.4 497.3 555.4

Table 204: The9 Annual Cash Flow Statement


US$ in millions, year-end December Net Income Add Non cash Expenses/(income) Depreciation and Amortization Extraordinaries Other Non-Cash Items Changes in Working Capital: (Increase)/Decrease Receivables (Increase)/Decrease Inventories (Increase)/Decrease Other Current Assets Increase/(Decrease) Payables Increase/(Decrease) Other Current Liabilities Net Cash from Operations Purchase of Property, Plant & Equipment Purchase/Sale of Other LT assets Purchase/Sale of Investments Net Cash from Investing Activities Issuance/Repayment of Debt Change in other LT liabilities Change in Common Equity - net Payment of Cash Dividends Other Financing Charges, Net Net Cash from Financing Activities Net Change in Cash and Cash Equivalents Cash at End of Period
Source: Company reports, JPMorgan estimates.

FY06 39.4 21.0 (0.4) 2.5 1.6 (6.9) 1.9 7.7 (6.8) 60.1 (9.1) (5.7) 2.1 (12.8) 1.2 10.4 (2.2) 9.3 56.7 118.3

FY07E 25.8 28.2 6.8 (2.5) 3.7 (9.6) 1.2 1.1 54.7 (47.5) (16.3) (15.0) (78.8) (4.8) 168.5 0.0 163.7 139.5 263.2

FY08E 37.4 44.9 10.0 (1.7) (4.8) 12.0 3.5 101.3 (50.1) (26.4) 0.5 (76.0) 1.4 0.0 1.4 26.7 293.0

FY09E 55.3 61.9 10.0 (0.7) (2.1) 5.2 1.5 131.1 (60.0) (8.1) 0.5 (67.6) 1.4 0.0 1.4 64.9 357.9

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Table 205: M&A Activity in the Internet Space, 2007


Ticker AMZN AMZN CNET CNET DRIV EBAY EBAY EBAY EBAY EBAY EBAY ELNK EXPE EXPE EXPE EXPE GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG GOOG IACI IACI IACI IACI IACI IACI IACI IACI IACI IACI INCX INSP INSP INSP INWK INWK INWK INWK INWK JUPM JUPM JUPM JUPM JUPM JUPM LINTA LINTA LINTA LINTA LINTA Date 5/14/2007 5/23/2007 10/25/2007 11/5/2007 9/5/2007 1/10/2007 2/27/2007 5/3/2007 5/30/2007 10/4/2007 12/20/2007 3/7/2007 12/8/2006 2/28/2007 5/23/2007 6/19/2007 10/31/2006 1/4/2007 3/16/2007 4/13/2007 4/17/2007 4/20/2007 5/29/2007 5/31/2007 6/1/2007 6/6/2007 6/20/2007 7/2/2007 7/9/2007 7/19/2007 9/28/2007 10/9/2007 10/26/2007 12/18/2007 12/20/2006 2/27/2007 2/27/2007 3/1/2007 3/19/2007 4/19/2007 5/9/2007 5/17/2007 5/24/2007 7/2/2007 7/19/2007 1/25/2007 9/17/2007 10/15/2007 10/11/2006 3/8/2007 7/9/2007 11/12/2007 11/12/2007 12/28/2006 1/18/2007 1/30/2007 1/30/2007 6/6/2007 7/18/2007 12/22/2006 2/13/2007 5/9/2007 5/11/2007 8/15/2007 Target www.Dpreview.Com Brilliance Audio Inc Webshots Findarticles.Com Netgiro Systems Ab Stubhub Beijing Union Mobile Pay Ltd Gittigidiyor.Com Stumbleupon Inc Via-Online Gmbh Tom Online Inc Wifi Network Expedia Inc Smarter Travel Media Llc Independent Traveler Inc Expedia Inc Jotspot Inc Shenzen Xunlei Netwk Tech Adscape Media Inc Doubleclick Tonic Systems Video Conf. Software Greenborder Tech Ltd Panoramio.Com Feedburner Inc Peakstream Inc Zenter Grandcentral Communicat. Postini Beijing Feixiangren Informat Zingku Jaiku Ltd Web Search Patent Endoxon Ilike.Com Edodo.Com Netclub Insider Pages Echomusic Rqi Holdings Ltd Home Shopping Eur. Gmbh Front Line Mgmt Emma Enterntainment Hold Paciolon Permierguide Inc Atlas Mobile Inc Switchboard.Com Mobile Services Business About Applied Graphics Inc Spectrum Printing Systems Brown Partners Data Flow Media Sys, LP Graphic Resource Group Justtechjobs.Com Studiocutz.Com Ispcon Trade Shows Inbox Trade Shows Multiple Targets Mediabistro.Com Inc News Corp Cl A Unnamed Target Liberty Media Interactive A Backcountry.Com Borba Llc Acquirer Amazon.com Inc Amazon.com Inc American Greetings Corp CNET Neworks Digital River Inc eBay eBay eBay eBay eBay eBay Earth Link Expedia Inc Expedia Inc Expedia Inc Expedia Inc Google Google Google Google Google Google Google Google Google Google Google Google Google Google Google Google Google Google IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp Arcandor AG IAC/ Interactive corp IAC/ Interactive corp IAC/ Interactive corp LOCAL.COM Corp Twistbox Entertainment Inc Idearc Inc Motricity Inc Innerworkings Inc Innerworkings Inc Innerworkings Inc Innerworkings Inc Innerworkings Inc Jupiter Media Corp Jupiter Media Corp Jupiter Media Corp Jupiter Media Corp Jupiter Media Corp Jupiter Media Corp News Corp L A Liberty Media Interactive A Liberty Media Interactive A Liberty Media Interactive A Liberty Media Interactive A Seller Announced Total NA NA 45 20.5 27 310 105 NA 75 NA NA NA 660 NA NA 725 NA NA NA 3100 NA NA NA 7 NA NA NA NA 625 NA NA NA 2 NA NA NA NA NA NA 109.12 196.47 NA NA NA 2 NA 225 135 NA 3.35 NA NA NA NA NA NA NA NA 20 550 68.09 484.47 NA NA Payment Type Undisclosed Cash Cash Cash Cash Cash Cash Cash Cash Cash Undisclosed Cash Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Cash Undisclosed Cash Undisclosed Cash Undisclosed Undisclosed Undisclosed Undisclosed Cash Undisclosed Undisclosed Undisclosed Cash Undisclosed Deal Status Complete Complete Complete Pending Complete Complete Pending Complete Complete Complete Pending Pending Complete Complete Complete Complete Complete Complete Complete Pending Complete Complete Complete Pending Complete Complete Complete Complete Pending Complete Complete Complete Pending Complete Complete Complete Complete Pending Complete Complete Complete Complete Complete Pending Complete Pending Pending Pending Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Complete Pending Complete Complete Pending Complete
307

Cnet Networks Inc Looksmart Netgiro International Ab

City Of Corpus Christi Tx Shareholders Shareholders

Multiple Sellers Marratech Ab

Invenda Corp Reg

Gaylord Entertainment Co Iac/ Interactive Corp

Infospace Inc Infospace Inc Infospace Inc

Mediatone Music Inc Golden Group Inc Golden Group Inc Liberty Media Interactive A Cbs Corp Class B Shareholders

Cash Undisclosed Cash Cash Undisclosed Cash Undisclosed Undisclosed Undisclosed Cash Cash Cash Cash Cash Cash Cash Stock Cash Undisclosed

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MCHX MELI MELI MNST MSFT MSFT MSFT MSFT MSFT MSFT OMTR OMTR OMTR OMTR OSTK PCLN RNWK RNWK RNWK SFLY SOLD TFSM TOMO TOMO VCLK VCLK YHOO YHOO YHOO YHOO YHOO YHOO YHOO YHOO

8/9/2007 10/1/2001 11/13/2005 1/17/2007 5/18/2007 8/30/2007 10/3/2007 10/7/2007 10/24/2007 11/12/2007 1/18/2007 2/14/2007 9/7/2007 10/25/2007 4/25/2007 11/8/2007 5/16/2007 8/21/2007 9/27/2007 6/27/2007 11/5/2007 5/17/2007 3/12/2007 12/20/2007 12/4/2006 7/16/2007 1/9/2007 4/24/2007 4/30/2007 6/21/2007 9/4/2007 9/12/2007 9/14/2007 9/17/2007

Voicestar Ibazar Com Br Ltda Deremate.Com Arbeidskamerater As Aquantive Screentonic Jellyfish.Com Newsvine Inc Facebook Inc Musicwave Instadia Touch Clarity Offermatica Visual Sciences Inc Otravel.Com Inc Agoda Co Sony Netservices Gmbh Viacom Inc Class B Game Trust Inc Make It About Me! Realty Generator 24/7 Real Media Inc Tom Online Inc Tom Online Inc Shopping.Net Mezimedia Inc Mybloglog Overture Kk Right Media Inc Rivals.Com Bluelithium Inc Speedcast Holdings Ltd Buzztracker.Com Zimra Inc

Marchex INC CLASS B MercadoLibre Inc MercadoLibre Inc Monster Worldwide Microsoft Microsoft Microsoft MULTIPLE ACQUIRERS Microsoft Microsoft Omniture Inc Omniture Inc Omniture Inc Omniture Inc MULTIPLE ACQUIRERS Priceline.com Inc Real Networks Inc Real Networks Inc Real Networks Inc Shutterfly Housevalues WPP Group PLC Tom Group Online eBay ValueClick Inc ValueClick Inc Yahoo! Inc YAHOO! JAPAN CORP Yahoo! Inc Yahoo! Inc Yahoo! Inc Asia Satellite Telecom Hldg Yahoo! Inc Yahoo! Inc

21.82 Ebay Inc NA NA NA 5460.65 NA NA NA Openwave Systems 240 50 14.41 48.5 65 390.27 17 NA NA NA NA NA NA 580.67 283.94 NA 26.28 100 Yahoo! Inc NA 340 NA Multiple Sellers Participate Media 300 2.96 NA 350

Overstock.Com Inc Sony Corp

Cash & Stock Stock Undisclosed Undisclosed Cash Undisclosed Undisclosed Undisclosed Cash Cash Cash Cash Cash & Stock Cash & Stock Cash Cash Undisclosed Undisclosed Undisclosed Undisclosed Undisclosed Cash Cash Undisclosed Cash Cash Undisclosed Cash & Stock Undisclosed Cash Cash Cash Undisclosed

Complete Complete Complete Complete Complete Complete Complete Complete Pending Pending Complete Pending Pending Pending Complete Complete Pending Pending Pending Complete Complete Complete Complete Pending Complete Pending Complete Pending Complete Pending Complete Complete Complete Pending

Source: Bloomberg, company reports, news reports.

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Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, 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; and (2) no part of any of the research analysts compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.

Important Disclosures for Asian Companies


Market Maker: JPMSI makes a market in the stock of Baidu.com, China Finance Online, Netease, Ninetowns Internet Technology Group Co. Ltd., Shanda Interactive Entertainment Ltd, Sina Corp, Sohu.Com, The9 Limited. Market Maker/ Liquidity Provider: JPMSL and/or an affiliate is a market maker and/or liquidity provider in Sina Corp, Sohu.Com. Lead or Co-manager: JPMSI or its affiliates acted as lead or co-manager in a public offering of equity and/or debt securities for Ninetowns Internet Technology Group Co. Ltd. within the past 12 months. Client of the Firm: China Finance Online is or was in the past 12 months a client of JPMSI. Netease is or was in the past 12 months a client of JPMSI. Ninetowns Internet Technology Group Co. Ltd. is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services. Shanda Interactive Entertainment Ltd is or was in the past 12 months a client of JPMSI. Sohu.Com is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-investment banking securities-related service and non-securities-related services. Investment Banking (past 12 months): JPMSI or its affiliates received in the past 12 months compensation for investment banking services from Ninetowns Internet Technology Group Co. Ltd.. Investment Banking (next 3 months): JPMSI or its affiliates expect to receive, or intend to seek, compensation for investment banking services in the next three months from China Finance Online, Ninetowns Internet Technology Group Co. Ltd.. Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services other than investment banking from Sohu.Com. An affiliate of JPMSI has received compensation in the past 12 months for products or services other than investment banking from China Finance Online, Ninetowns Internet Technology Group Co. Ltd., Shanda Interactive Entertainment Ltd, Sohu.Com.

Important Disclosures for US Equity Research Compendium Reports: Important disclosures, including price charts for all companies under coverage for at least one year, are available through the search function on JP Morgans website https://mm.jpmorgan.com/disclosures/company or by calling this U.S. toll-free number (1-800-477-0406). Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: JPMorgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analysts (or the analysts teams) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analysts (or the analysts teams) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analysts (or the analysts teams) coverage universe.] The analyst or analysts teams coverage universe is the sector and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.

Coverage Universe: Imran Khan: Amazon.com (AMZN), Blue Nile (NILE), CNET Networks (CNET), Dice Holdings, Inc. (DHX), Expedia, Inc. (EXPE), Google (GOOG), HouseValues, Inc (SOLD), InfoSpace Inc (INSP), InnerWorkings (INWK), InterActiveCorp (IACI), Liberty Interactive (LINTA), Mercadolibre, Inc. (MELI), Monster Worldwide Inc (MNST), Move (MOVE), News Corporation, Inc. (NWSa), Omniture, Inc. (OMTR), Orbitz Worldwide, Inc. (OWW), Priceline.com (PCLN), Shutterfly, Inc. (SFLY), The Walt Disney Co. (DIS), Time Warner (TWX), ValueClick (VCLK), Viacom Inc (VIAb), Xinhua Finance Media (XFML), Yahoo Inc (YHOO), eBay, Inc (EBAY) Dick Wei: Baidu.com (BIDU), China Finance Online (JRJC), Netease (NTES), Ninetowns Internet Technology Group Co. Ltd. (NINE), Shanda Interactive Entertainment Ltd (SNDA), Sina Corp (SINA), Sohu.Com (SOHU), The9 Limited (NCTY)

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JPMorgan Equity Research Ratings Distribution, as of September 28, 2007 Overweight (buy) 46% 51% 42% 70% Neutral (hold) 40% 50% 46% 63% Underweight (sell) 14% 38% 12% 49%

JPM Global Equity Research Coverage IB clients* JPMSI Equity Research Coverage IB clients*

*Percentage of investment banking clients in each rating category. For purposes only of NASD/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category.

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Imran Khan and the JPMorgan Internet, Media and Entertainment team
Imran Khan Imran Khan is a Managing Director and the Senior Internet, Media and Entertainment Analyst at JPMorgan. Mr. Khan ranked #2 for Internet in the Institutional Investor All America Research Poll in 2005, 2006, and 2007. Additionally, he has been consistently recognized as one of the top Internet analysts in the Greenwich Research Poll since 2005. Mr. Khan has authored several widely read research reports, including past editions of the Nothing But Net report, as well as The Rise of Ad Networks and Large Cap Courtship and Consolidation. Mr. Khan is a sought-after speaker and has presented at leading industry conferences such as Ad-Tech, Red Herring, AlwaysOn, and Young & Rubicam Digital Day. Mr. Khan has also received invitations as a guest speaker at multiple universities. Mr. Khan came to JPMorgan in 2004 after three years at Fulcrum Global Partners, where he was a Managing Director in Equity Research covering Internet and Software. Prior to Fulcrum, Mr. Khan worked as an investment banker at ING, covering Telecom. Before ING, he worked for Wild Blue, a satellite start-up company. Bridget Weishaar Bridget Weishaar joined the JPMorgan Internet, Media and Entertainment team in 2006. Prior to JPMorgan, Ms. Weishaar was a member of the Retail team at Bear Stearns, which ranked #1 in the Institutional Investor All America Research Poll in 2005. Ms. Weishaar obtained her MBA at the Wharton School, University of Pennsylvania, and holds a B.S. from the University of Notre Dame. Joseph Boushelle Joe Boushelle joined the JPMorgan Internet, Media and Entertainment team in 2007. Previously, Mr. Boushelle covered the oil and gas sector for a credit trading group. Mr. Boushelle is a CFA charterholder, and received an M.B.A. with distinction from Cornell University and a B.A. in Economics from the University of Chicago. Lev Polinsky Lev Polinsky joined the JPMorgan Internet, Media and Entertainment team in 2006. Prior to JPMorgan, Mr. Polinsky was a trader at Susquehanna Investment Group, covering a variety of industries. Mr. Polinsky is a CFA charterholder, and received an A.B. in Economics from Harvard University. Vasily Karasyov Vasily Karasyov joined the JPMorgan Internet, Media and Entertainment team in 2006, focusing on Media and Entertainment companies. Prior to JPMorgan, he was an Executive Director, Corporate Development at Sony Pictures, where he worked on M&A and financing transactions, as well as strategic planning in film, television, home entertainment and new media. Mr. Karasyov holds an MBA from INSEAD. Dick Wei Dick Weis primary research focus is on China Internet. In addition, he is also responsible for global technology research. Prior to joining JPMorgan in 2002, Mr. Wei worked with Merrill Lynch in the Hong Kong and New York offices. He was also a design engineer at Quantum Corporation (acquired by Maxtor). Mr. Wei graduated with an MBA from the Wharton School and obtained his M.Sc. degree in mechanical engineering from Stanford University.