JPMorgan NothingButNet 2011

Asia Pacific Equity Research
06 January 2011
Nothing But Net - Asia

2011 Internet Investment Guide
China Internet Dick Wei

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

AC
(81-3) 6736 8602 hiroshi.kamide@jpmorgan.com JPMorgan Securities Japan Co., Ltd.
Korea Internet Sungmin Chang, CFA

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

(1-212) 622-6693 imran.t.khan@jpmorgan.com J.P. Morgan Securities LLC
This report is an excerpt of Nothing But Net: 2011 Internet Investment Guide", published on Jan 3, 2011
See page 178 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com
Asia Pacific Equity Research 06 January 2011
Table of Contents
China: Top Predictions for 2011...................................................................... 5 China Internet Market Overview...................................................................... 6 Online Advertising ......................................................................................... 10 Display Advertising........................................................................................ 15 Online Search................................................................................................ 16 Online Video.................................................................................................. 25 Social Networking.......................................................................................... 30 Miniblog Platform........................................................................................... 33 eCommerce................................................................................................... 34 Online Gaming .............................................................................................. 44 Japan Internet Market Overview ................................................................... 57 Korea: Sector Summary................................................................................ 81
Companies
Alibaba.com Limited ...................................................................................... 85 Baidu.com ..................................................................................................... 89 China Finance Online.................................................................................... 95 Netease ......................................................................................................... 99 Shanda Games ........................................................................................... 103 Shanda Interactive Entertainment Ltd......................................................... 107 Sina Corp .................................................................................................... 111 Sohu.Com ................................................................................................... 115 Tencent ....................................................................................................... 119 The9 Limited................................................................................................ 123 DeNA (2432) ............................................................................................... 127 Gree (3632) ................................................................................................. 135 Mixi (2121)................................................................................................... 143 Rakuten (4755)............................................................................................ 149 Yahoo Japan (4689).................................................................................... 163 Daum........................................................................................................... 175 The authors acknowledge the contribution of Gon Suk Lee of J.P. Morgan Securities (Far East) Ltd, Seoul Branch,Ritesh Gupta of J.P. Morgan India Private Ltd, and Yusuke Maeda of J.P. Morgan Securities Japan Co., Ltd to this report .
Sector Overview
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Global Equity Research 03 January 2011
China
China Top Predictions for 2011

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

Internet penetration still low at 31% Chinas internet population grew at a rapid pace in 2010, increasing 24% Y/Y to 420M by June 2010, or at a penetration rate of 31.2%, according to China Internet Network Information Center (CNNIC). Since late 2008, China has the worlds largest internet user base. This strong growth in recent years has been driven by factors such as robust GDP growth, lower-priced computers, more affordable telecom connection fees, government support for internet usage, and low-cost entertainment aspects.
China Internet Users and Penetration Rate
600 500 400 300 200 100 0 Dec-10E Dec-11E Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11E 103 111 123 80 87 94 46 59 68 34 137 162 210 253 298 338 384 420 454 534 40% 35% 30% 25% 20% 15% 10% 5% 0%
494
Number of China Internet Users (Left, millions) Penetration Rate as % of Total Population (Right)
Source: CNNIC J.P. Morgan estimates.
Further, rural internet populations continued to adopt the internet in 1H10 with a 7.8% growth rate.
Rural Internet Penetration Reached 16.0% from 11.7% in One and a Half Years
60% 50% 40% 30% 20% 10% 0%
48.6% 35.2% 19.7% 11.7% 3.1% Dec-06 Dec-08 Jun-10 Penetration Rate (Rural Population) 16.0%
Penetration Rate (Urban Population)

Source: CNNIC.
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How much more growth? Despite this rapid growth, China's internet penetration rate of about 31% of the population is still well below that of developed markets like the US, Japan, and Korea (over 70%). We expect internet users to grow by around 17.7% Y/Y in 2011 to reach ~534MM, or the penetration rate to reach ~39% of the population by the end of 2011. We draw the parallel between internet penetration and mobile phone penetration in China. We observe that in recent years internet penetration has lagged mobile phone penetration by around four to five years. This gives us confidence that internet penetration will likely continue to grow in the future, with lower-cost connection fees and equipment costs.
China Internet and Mobile Phone Users
900 800 700 600 500 400 300 200 100 0 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14
90%
Mobile phone users (Mn)
Intenet users (Mn)
Mobile users shifted 4.5 years
Source: CNNIC, Ministry of Industry and Information Technology (MIIT), J.P. Morgan estimates.
Broadband and Mobile continue rapid growth According to CNNIC, the number of users with broadband internet access grew 28% Y/Y to 346M (90% of total users) by the end of 2009, and to 364MM (87% of total users) by June 2010.
Broadband Internet Users in China
400 300 200 100 0 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 77 91 122 163 270 214 319 346 364
Broadband Internet Users as % of Total Internet Users

100% 80% 60% 40% 20% 0% Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 66% 75% 78% 85% 91% 94% 87%
Broadband Users (Mn)
Broadband users as % of total Internet users
Source: CNNIC.
Source: CNNIC.
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Jun-15
According to the latest MIIT data, the number of broadband subscriber lines reached 123.2 million by October 2010.
Broadband Subscriber Penetration by Number of Broadband Lines
Broadband subscribers (MM) Population Penetration (%) Households Penetration (%) 2005 37.5 2.9% 9.1% 2006 51.9 4.0% 12.5% 2007 66.5 5.1% 16.1% 2008 83.4 6.4% 20.0% 2009 105.0 7.9% 24.0% 2010* 123.2 9.0% 28.2%
Source: CNNIC, Ministry of Industry and Information Technology (MIIT), J.P. Morgan estimates. Note: Data as of October 2010.
Internet access device The number of mobile internet users increased by 78% Y/Y to 277M by Jun-10, as per CNNIC. The number of mobile internet users was 66% of all internet users and 33% of all mobile users. We expect mobile internet usage to increase significantly once 3G penetration increases amongst consumers.
Methods of Accessing by Device
80% 70% 60% 50% 40% 30% 20% 10% 0% Desktop
Source: CNNIC (Jun-10).
73.6%
65.9%
36.8%
Laptop
Mobile Phone
Home has become preferred place to access the internet Given the increase in internet-accessible computers, broadband penetration, and per capita wealth, the home has become the preferred place for most users to access the internet, with more than four-fifths of all internet users accessing the internet from home. The number of people accessing the internet from the office also increased to 33% at the end of 1H10 from 30% in late 2009.
Main Access Locations
100% 80% 60% 40% 20% 0% Home
88.40%
33.60%
33.20%
Internet Caf
Company
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Average time spent online remains stable CNNICs Jun-10 survey showed users spent an average of 19.8 hours per week online. This was up from 18.7 hours per week six months earlier. While the overall average online time per user remains stable, we note old users likely spend more time online than new users. We also note that internet usage has more than doubled compared to the 9.8 hours per week spent online in December 2002.
Average Time Spent Online
Hours/week
25 20 15 10 5 0 9.8 13.0 13.4 12.3 13.2 14.0 15.9 16.5 16.9
18.6
16.2
19.0
18.7 19.8 16.6 18.0
Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10
Av erage Accessing Time Per Week

Media is the most popular internet use According to the Jun-10 CNNIC survey, online music is the most popular use of the internet, with 82.5% of internet users accessing online music. Online news is also popular, with 78.5% usage, while search engine use was 76.3%. Online payment and online shopping have seen fast growth with 36.2% and 31.4% user increases in six months by June 2010, respectively.
Internet Usage by Category
Service type Online Music/download News Search engine Instant messaging ( chat room, QQ, ICQ) Online Games Online movie (include download)/Video Email Blog Social Networking Online literature Online shopping BBS/forum Online payment Online banking Online stock trading Online travel reservation
% of surveyed use the service 82.5% 78.5% 76.3% 72.4% 70.5% 63.2% 56.5% 55.1% 50.1% 44.8% 33.8% 31.5% 30.5% 30.5% 15.0% 8.6%
Users in millions 346.5 329.7 320.5 304.1 296.1 265.4 237.3 231.4 210.4 188.2 142.0 132.3 128.1 128.1 63.0 36.1
Chinese mobile users cite chat as the most used function while accessing the internet with their phones. Mobile search is chosen by 48.4% of mobile users while listening/downloading music was the third most popular activity with 45.3% users.
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Chat Is the Most Used Application on Mobile

70% 60% 50% 40% 30% 20% 10% 0% 61.5% 48.4% 45.3% 43.3% 35.5% 21.1% 20.4% 16.0% 6.1%
Mobile Chat
Mobile Search
Online music listening or downloading
Mobile Literature
Mobile Online mobile Mobile Video Mobile email community game
Mobile Payment
Online Advertising
Maintain positive view on 2011 and longer-term online ad market growth We expect the rising number of internet users and increasing times spent on the internet will continue to drive online ad allocation. Lower computer prices, declining connection fees, higher influence of online media, and government support should continue to drive internet growth in China. Time spent on internet per users should accelerate from the increased penetration of smartphones and tablets.
Increasing Time Spent on Internet per User per Week
21 20 19 18 17 16 15 Dec-07 Dec-08 Jun-09 Dec-09 Jun-10 16.2 16.6 18 18.7 19.8
Time Spent Online (In Hr/Week)

Source: CNNIC.
The total online ad market still accounts for a relatively small portion of Chinas overall advertising market (expected to be around 15.8% in 2011). We forecast the online ad market to witness 23% YoY growth in 2011, to reach Rmb30B (or US$4.4B) and 31% YoY growth in 2012 to reach Rmb39.3B (US$5.8B).
China search ad is still ~50% of the total online ad market. This compares with around 67% in the US
Search ads continue to grow faster than brand ads We expect search advertising to continue to see stronger growth than brand advertising in 2011. From a top-down perspective, search ad is ~61% of the total online ad market in China in 2011E. This compares with ~70% in the US. As such, we still see room for growth. From a bottom-up perspective, we expect market drivers to be: 1) increasing user adoption of search, 2) higher SME advertisers adoption of pay-for-performance advertising, 3) search usage to increase with the growing eCommerce market, and 4) use of search ads as a brand advertising tool.
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China Online Advertising Market Forecast from 2006 to 2012E

Brand Advertising (RMB M) Search Advertising (RMB M) Other Online Format (RMB M) Total Online ad market (RMB M): Total Online ad market (US$M) Growth Rate (Rmb, %) Total China ad market (Rmb M) Growth Rate (Rmb, %) Ad market as % of GDP Online ad as % of Total ad market 2006 3,377 1,442 109 4,928 621 54.6% 105,712 16.5% 0.48% 4.7% 2007 4,559 2,851 122 7,533 999 60.8% 116,422 10.1% 0.44% 6.5% 2008 6,428 5,309 135 11,872 1,721 72.3% 139,707 20.0% 0.46% 8.5% 2009E 6,942 7,213 135 14,290 2,083 21.1% 142,501 2.0% 0.42% 10.0% 2010E 9,025 12,015 135 21,175 3,100 48.8% 165,301 16.0% 0.42% 12.8% 2011E 11,462 18,427 135 30,023 4,448 43.5% 190,096 15.0% 0.44% 15.8% 2012E 14,442 24,751 135 39,328 5,826 31.0% 216,709 14.0% 0.45% 18.1%
Source: iResearch, CNNIC, J.P. Morgan estimates. Note: Growth rates are in Rmb terms.
Online advertising: top-down perspective Internet usage growth same old story, but is that what is driving the online ad spending growth expected in 2011? We expect China's internet user base to grow around 20% CAGR (200911) to reach a penetration rate of 39% by the end of 2011, up from the current penetration rate of 31%. Drivers for the sector include lower-priced computers, more affordable telecom connection fees, government support of internet usage, and low-cost entertainment alternative. We believe if the number of internet users grows 20% Y/Y (or roughly equal to the increase in media consumption), a minimum of 20% Y/Y growth in online brand ad spending should be achievable, given: 1) higher number of hours spent online per user, 2) the internet can reach a broader audience in smaller cities in China, 3) more measurable and lower cost compared with traditional media like TV, 4) general inflation in advertising rates, and 5) GDP growth should also drive overall ad spending up. U.S. advertising spending = 2% of GDP vs. Chinas 0.5% Ad spend as a percentage of GDP in China is still below the US level; as such, we still believe advertising in China can grow at least in line with GDP. Online ads should grow even faster. Online advertising: bottom-up perspective The few sectors that we believe are likely to see fast growth next year are: autos, FMCG (Fast Moving Consumer Goods), and eCommerce. China Governments drive to push consumption in the country should continue to help drive retails sales. As a result, the advertising industry should benefit from this trend. Automobiles advertising outlook for 2011 Driver 1: Increased auto ad dollars In 2011, we believe the auto sales environment will become more competitive with less government subsidies and oversupply. Our China Autos Analyst Frank Li suggests that auto sales for personal vehicles will decline to 15% YoY in 2011 vs. 29% in 2010E. However, excess capacity build-up over the last few years will also lead to higher competition which, in turn, should help drive up marketing expenses by auto makers. Driver 2: Increased online allocation We believe that with an affluent internet population growing, more measurable results, and lower rates vs. TV, automobile companies will continue to increase
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budget allocations to online advertising. Currently ~7.3% of automobiles advertising budget is allocated online in China, according to iResearch. iResearch expects auto online advertising spending to increase to 10.9% by 2013. In addition, we believe more advertising budget will be directed to drive product sales (through advertising particular models, driving traffic for test drives) rather than general branding exercise. In our opinion, a product-specific campaign would be more effective over the internet as Chinese consumers tend to do a lot of their own research before their first car purchase. Driver 3: Geographic expansion in autos sales As we believe lower-tier cities will see faster autos sales in the next few years, we believe advertisers would also be well served by investing more on the internet for nationwide customer reach (rather than magazine and newspapers, which have limited geographic coverage). Real estate advertising Worst is over, 2011 to be a better year In 2010, the private real estate market was quite weak due to a series of restrictive measures to curb investment demand and housing price growth. Real estate advertising saw a big downturn in 1H10 as a result. We expect the reverse trend that begun in 2H10 to continue in 2011. Although we expect the government to maintain its tightening stance in 2011, the policy theme should shift from curbing demand to pushing out more housing supply while limiting price increases. We believe such a situation will benefit advertising demand. A geographic diversification story beyond Beijing, Shanghai All the major leading portals including Sohu, CRIC, and Baidu have been increasing their presence in Tier 2/Tier 3 cities, which should drive up the advertising allocation to internet from these cities. Currently, online ad spending in lower-tier cities is around 50% or less compared to Tier-1 cities. Online eCommerce advertising We believe the fast-growing eCommerce market will prompt eCommerce companies to increase spending online. In addition, with rising competition and fight for market share, eCommerce companies will be aggressive in online ad spending. In addition to general brand building through banner advertising, we expect eCommerce companies to increase spending on search as well. For eCommerce merchants, other attractive ad formats would be ads in social networking websites. Financial services advertising Investment funds increased their overall ad budgets in late 2007 and 2008; however, weve seen a significant pullback in 2009. With a better macro environment, we think these advertisers will likely come back in 2010 and 2011. These advertisers likely advertise with leading portals such as Sina and Sohu for stronger brand influence. We expect new drivers for the finance segment over the next few years could be insurance companies, personal banking, brokerage and wealth management advertisements.
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Fast-moving consumer goods Historically, these advertisers allocated less spending online. We expect the trend to continue to change with more allocation online, given a large internet population, a wider online demographic, and more integrated marketing campaign required to differentiate a brand. Furthermore, we believe with an increasing trend in luxury retailing, the internet would offer very cost-effective advertising. We note that brands like Cartier have begun advertising online.
China - Number of Households with Assets Above US$1 Million
800 600 400 200 0 2003 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 141 179 223 305 437 417 453 529 609 697
China - Number of households w ith assets abov e US$1 million

Source: ACMR.
Telecom sector spending We expect telcos will continue to invest in advertising in order to drive 3G adoption (government-mandated strategy) and higher competition in the space with operators trying to recoup their capex spending. Good growth in CCTV auctions Every year on November 18 (last year on November 8), CCTV (China Central Television) holds an advertising auction for the next years prime time ad resources on CCTV channels. This important event auctions off ~15% of the countrys total TV ad spending and sets the tone for ad growth in the coming year. In November 2010, CCTV reported prime time ad auction revenue of Rmb12.67B, up 15.52% Y/Y: This is slightly above industry expectations of around 15%. We see the following implications: (1) while advertisers are generally cautiously optimistic about 2011s outlook, the auction results suggest consensus (hundreds of advertisers participated) is more optimistic than cautious; (2) with the CCTV auction setting a positive tone, the online brand ad rate is likely to achieve >20% growth; (3) published rates for leading portals and other media are likely to increase good next year. We continue to expect the online branded ad segment to benefit from decent 2011 overall ad market growth as well as increased online ad allocation. Industry segments The top bidders were from the food and beverage sectors, home appliances, as well as finance and security. There was also an increased presence by the auto and tourism industries.
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We look at absolute dollar amounts of ads sold at the auction. The table below shows the auction results growth rate vs. online brand ad growth rate (in Rmb terms).
CCTV Auction Results vs. Online Brand Ad Growth

Year 2003 2004 2005 2006 2007 2008 2009 2010 2011E CCTV Prime time Auction Revenue (Rmb billion) 3.31 4.41 5.25 5.87 6.80 8.03 9.26 10.97 12.67 YoY Growth 26% 33% 19% 12% 16% 18% 15% 19% 16% Online Brand Ad Growth 102% 72% 37% 45% 35% 41% 8% 30% 27% Number of times (X): [Online Brand Ad Growth / CCTV Auction Growth Ratio] 3.9 2.2 2.0 3.8 2.2 2.3 0.5 1.6 1.7
Source: CCTV, Zenith Optimedia. Note: J. P. Morgan current estimates.
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Display Advertising
We forecast overall ad spending to see ~27% growth in 2011 For 2009, brand advertising growth was only around 8%, the lowest rate in the past few years. In 2010, the branded ad segment grew around 30%. For 2011, we expect the growth rate to be slightly lower than last year. Factors driving 2011 display ad spend include: On the positive side: 1) accelerated shift from offline to online given higher awareness in video sites and social network sites, 2) higher CCTV and satellite TV rates makes online ad a lower rate alternatives, and 3) improving ad serving technology in China. On the negative side: 1) lack of major events in 2011, 2) higher revenue base in 2010, and 3) higher competition among leading players. Longer term, we remain positive on the online display ad outlook, given the continuing increase in internet usage, higher cost effectiveness, and more measurable results for advertisers. Further, our China economics team expects consumer spending growth to accelerate in the next few years, which should also support the growth of branded advertising.
China Branded Ad Segment Forecast 2006 to 2012E
Branded Advertising (RMB M) Branded Advertising (US$ M) Growth rate (Rmb, %) Branded ad as % of ad market
Source: J.P. Morgan estimates.
2006 3,377 426 45% 3.2%
2007 4,559 605 35% 3.9%
2008 6,428 932 41% 4.6%
2009E 6,942 1,012 8% 4.9%
2010E 9,025 1,321 30% 5.5%
2011E 11,462 1698 27% 6.0%
2012E 14442 2140 26% 6.7%
Expect vertical sites to gain more market share Video and SNS portals such as Youku, and Tudou have gained significant traffic over the last few years. Additionally, industry-focused websites such as Soufun and CRIC are also gaining good traffic. While these sites have driven eyeballs and ad dollars away from traditional portals, we still expect leading portals to hold dominant user market share and to gain revenue market share, given: 1) Sina and Sohu are the leading news sites in China with strong brand awareness other news sites do not have a similar level of media influence; 2) portals are also aggressively expanding horizontally to offer SNS, blogs and video services.
Online Brand Ad Market Share Trend for Leading Portals
Year Market share of key portal players* (%) 2006 62% 2007 62% 2008 63% 2009E 58% 2010E 59% 2011E 60% 2012E 60%
Source: Company reports, Bloomberg estimates, J.P. Morgan estimates. * Includes: Sina, Sohu, NetEase, Tencent (Bloomberg estimates for Tencent).
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 online games, mobile blogs and Wireless Value Added Services. Online advertising is the most established online business in China (since the late 1990s), and regulations and boundaries are well understood by industry players.
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We believe the leading portals have strict internal compliance departments and automated content scans to ensure contents are in compliance with government standards. In addition, leading portals have gained trusts and have an existing relationship with the government. 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 still only a small portion of their revenues come from User Generated Contents, which could be subject to government regulation.
Online Search
Still in early high-growth stage The search advertising market in China is expected to grow 53% Y/Y in 2011, as per our estimates, to reach Rmb18.4B (US$2.7B). We believe search advertising is still in an early high-growth stage in China, driven by: 1) rising internet penetration, 2) significant growth in websites and pages, 3) higher search usage (due to greater mass of web content), and 4) large number of SMEs (with small ad budgets) turning to search advertising (due to the higher ROI).
China Search Market Forecast
Avg. Internet users (Mn) Number of search (Bn) Coverage Click through rate Price per click (Rmb) P4P Search Market (Rmb M) P4P Search Market (US$ M) Growth rate (Rmb, %) Total Search Market (Rmb M) Total Search Market (US$ M) Growth rate (Rmb, %) Search ad as % of total ad market 2006 123 81 17% 22% 0.34 1,062 134 110% 1,442 182 70% 1.4% 2007 162 116 21% 25% 0.42 2,472 328 133% 2,851 378 98% 2.4% 2008 253 181 24% 25% 0.45 4,945 717 100% 5,309 770 86% 3.8% 2009E 338 254 25% 24% 0.45 6,849 999 39% 7,213 1,052 36% 5.1% 2010E 420 334 32% 22% 0.50 11,644 1,705 70% 12,015 1,759 67% 7.3% 2011E 494 429 34% 22% 0.56 18,048 2,674 55% 18,427 2,730 53% 9.7% 2012E 577 521 35% 22% 0.60 24,364 3,610 35% 24,751 3,667 34% 11.4%
Source: CNNIC, J.P. Morgan estimates. Note: Excluding distributor discount.
How big can Chinas search market grow? Using various comparisons to the US and Korean search market, we estimate Chinas search market could reach US$3B-US$4.6B by 2013 This compares to our current 2013 forecast of US$3.4B and US search market 2009 size of US$15B. Please also refer to the chart below for analysis of market size comparison with the US and Korean markets. Other factors that could lead to positive surprise to our forecast include faster-thanexpected inflation and RMB appreciation. China search market size potential analysis If we use Korea and US as a proxy for online search market growth rate and growth potential, we see more upside possible upside to our base case forecast. We present five different scenarios for our forecast: Scenario 1: We compared search market size as a percentage of nominal GDP in China and the US. We shifted US search market size as a percentage of nominal GDP six years to estimate China search market size in 2010-2014. We think the market will reach US$3.0B and US$4.6B in 2011 and 2012, respectively.
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Scenario 2: We compared search market size as a percentage of nominal GDP in China and Korea. We shifted Korea search market size as a percentage of nominal GDP five years to estimate Chinas search market size in 2010-2014. We think the market will reach US$3.0B and US$4.5B in 2011 and 2012, respectively. Scenario 3: We compared search market growth rate in China and US. We shifted the US search market growth rate six years to estimate Chinas search market size in 2010-2014, and think the market will reach US$3.0B and US$4.3B in 2011 and 2012, respectively. Scenario 4: We compared search market growth in China and the US and shifted 2003-2008 CAGR of US search market growth six years to estimate Chinas search market size in 2010-2014. We think the market will reach US$2.3B and US$3.4B in 2011 and 2012, respectively. Scenario 5: We compared search market size as a percentage of personal consumption in China and the US. We shifted US search market size as a percentage of personal consumption five years to estimate Chinas search market size in 20102014. We think the market will reach US$2.1B and US$3.0B in 2011 and 2012, respectively.
Five Scenarios for Chinas Search Market Size Estimate
US$M
9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2008 2009 2010E 2011E 2012E 2013E 2014E
China Search Ad Market Size (US$ M) (Scenario 1) China Search Ad Market Size (US$ M) (Scenario 3) China Search Ad Market Size (US$ M) (Scenario 5)
Source: iResearch, World Bank, J.P. Morgan estimates.
China Search Ad Market Size (US$ M) (Scenario 2) China Search Ad Market Size (US$ M) (Scenario 4)
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Competitive landscape Baidu continued to gain more market share from Google China. Baidu market share reached 72.8% by revenue in 3Q10 vs.64.9% in 3Q09. Sogou and Soso both expanded markets here slightly to 1.2% and 1.0%, respectively. Googles market share declined to 24.6% in 3Q10 vs. 31.2% in 3Q09. Baidu has successfully expanded its search revenue market share by more than 10 percentage points since 1Q09. Google is still having trouble with its advertising agencies. We expect Baidu to at least continue to maintain its current share.
Baidu Gaining Market Share Consistently (by Revenues)
Baidu Google Sogou SoSo Others
Source: iResearch.
1Q09 62.3% 33.0% 1.2% 1.5% 2.0%
2Q09 63.6% 32.5% 0.9% 1.2% 1.8%
3Q09 64.9% 31.2% 1.0% 1.0% 1.8%
4Q09 64.0% 32.8% 1.2% 0.6% 1.3%
1Q10 67.8% 29.5% 1.0% 0.8% 0.9%
2Q10 70.8% 27.3% 0.8% 0.6% 0.5%
3Q10 72.9% 24.6% 1.2% 1.0% 0.4%
In addition to gaining search market share, the company significantly reduced the gap between its volume and search market share. We expect this to further reduce with time.
Baidu Search Market Share (by volume of search queries)
Baidu Google China Others Difference in marketshare* 1Q09 74.1% 20.9% 5.0% 15.1% 2Q09 75.7% 19.8% 4.5% 14.1% 3Q09 77.0% 17.9% 5.1% 13.1% 4Q09 77.1% 17.5% 5.4% 18.7% 1Q10 75.3% 18.4% 6.3% 11.3% 2Q10 80.2% 14.1% 5.7% 10.2% 3Q10 NA NA NA
Source: iResearch. * means difference in search volume and search revenue market share.
Soso and Sogou will take longer to become a challenge to Baidu Tencents Soso and Sohus Sogou have been working on developing their own search technologies. We believe they will not be a potential threat to Baidu for the medium term, as we believe the technology of these two search engines is still behind that of Baidu. Soso and Sogous total market share was 2.2% in 3Q10 as per iResearch. In mid-2010, Sogou and its related technology (pinyin, toolbar, etc) was spin off as a separate business entity. Alibaba Group and related persons invested in Sogou. Alibaba launches eCommerce search Alibaba joined with Microsoft to launch a beta version of search site Etao. Etao aims to drive traffic for Alibabas Taobao.com. The search results displayed in groups include Taobao listings, links to related online forums, information websites, and web search results provided by Microsofts Bing in the same order. While Etao has the potential to become a eCommerce focus search engine, we do not expect Etao to be successful as a general search engine. We note that in 2007, Baidu announced that it would introduce its own e-commerce platform called Youa to compete with Taobao. Taobao responded by blocking Baidu from searching goods on its website.
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Government-backed search team (1) During August 2010, Xinhua News Agency and China Mobile announced plans to set up a new search engine company. (2) Peoples Daily Newspaper group launched new search engine, goso.cn. The search engine is led by former Olympics Ping Pong Champion Deng Ya Ping. We do not expect these government-backed search companies to gain meaningful traction in the market. However, the move could lead to the governments closer monitoring of the search engine industry in China. Baidu Phoenix Nest latest update The full Phoenix Nest transition happened in December 2009. While the Phoenix Nest launch led to a significant revenue increase for Baidu in 1H10, we expect Phoenix Nest to continue to bring benefits to Baidu. One of Baidus key initiatives is to continue to improve Phoenix Nest performance in the long term. Baidu application platform: announced in September 2010 To enhance users search experience, Baidu launched an applications library which allows third-party offerings in the library to launch directly on Baidu rather than moving to another website. These third-party applications appear in search results when a user is looking for certain specific queries such as those related to games, music, etc. Baidu estimates that 30% of search queries in China are for applications rather than information.
Baidu estimates that 30% of search queries in China are for applications rather than information
The company currently has more than 400 applications under this library. Baidu and third-party application providers will split revenues in a ratio of 30:70. Baidus application will be based around music, e-books, games, and videos. Open platform strategy allows apps developers or book writers to submit content through open.baidu.com. This initiative is part of the larger box computing initiatives by the company. We believe this step could drive up search volumes in the future. Developers or book writers can get revenue from: 1) direct content purchase, 2) embedded ads. Currently Baidu has 400+ partners which give Baidu content, info and apps. Baidu is not specific about revenue sharing with apps developers. We think this will be one potential strategy. Searches that led to downloadable apps or content: This is the name of popular fiction. Users can buy e-books directly from results link. Publishers or writers can put their own books online. In the future, there is no need to go to Amazon or DangDang. A basic online game. Users can download this game or other games on the list of recommendations. Kingsoft anti-virus software. Links to download right away. Online radio station. Users can listen to radio directly on Baidus page.
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A popular soap opera. Video links have been verified by Baidu for highquality content. /126 NetEase mail box or SNS site. Users can directly login on Baidu page. Currently Tencent is not a partner with Baidu Open Platform. As such, users can't log in QQ mailbox QQ " directly from Baidu page. Aladdin: to search the hidden web As announced on the last conference call, there has been an ongoing R&D effort aimed at uncovering useful parts of the hidden web in order to enrich search results for Baidu users. This is an ongoing effort by the companys R&D team. The service was launched in mid-April. The site is: http://aladin.baidu.com/. As a part of Project Aladdin, Baidu launched the beta version of an open data sharing platform on April 15, 2010. The new platform allows webmasters and developers to submit data to Baidu in order to generate direct search results for dynamic information. Mobile search: Baidu still leads in market share Mobile search is still in an early growth phase. Google partners with China Mobile to be their default search engine on WAP website. We believe Baidus traffic from mobile devices is around 10% of its total traffic. However, revenue only accounts for 1-2%. We are encouraged to see Baidu demand leading market share in mobile search as well, according to Analysys. Baidu is also building more mobile search applications (e.g., Baidu Palm) to expand its usage. During 2010 Baidu World, Baidu showcased 3-D maps and various mobile features: voice search, map search new version of Baidu Palm and input method. While there were no discussions on Baidu mobile phone OS, Baidu discusses various potential applications to help search users obtain content easier on a large number of mobile phone platforms. Baidu also plans to work with web masters to help them make webpages more easily displayed on mobile phones.
Mobile Search Market Share by PV
Company Baidu Google China 3GYY YiCha.cn Others
Source: Analysys International.
Market share (%) 33.7% 19.5% 14.1% 14% 18.7%
Baidus brand zone Baidu provides additional marketing services to some of its key customers. Key customers can engage in integrated search marketing services across Baidu platform. Baidu charges extra fixed fee for an integrated campaign with Brand Zone. The company has reported strong growth from Brand Zone in 2010.
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For example, Meng Niu Milk product advertises across different properties on Baidu. We compared the search results between Meng Niu Milk that uses brand zone services and Wan Da Shan milk that is not using the services. When we search "Meng Niu Milk using Baidu Knows and Baidu Web Search, "Meng Niu brand zone comes first with detailed company information, such as the companys brand logo, weblink, recent events, etc. When we search Wan Da Shan Milk, the company related information is less. Meng Niu Milk also has banner advertise in Baidu News. Search usage vs. advertiser readiness vs. monetization To better understand the growth potential of Chinas Internet search market, we think it would be useful to look at the search space from three different perspectives: 1) search users, 2) advertisers, and 3) search monetization/market size. We view search usages and advertiser readiness as the two main drivers for the monetization of the online search market.
Search Monetization Driven by Both Search Usage and Advertising Readiness
Source: J.P. Morgan.
Search market outlook: usage Like the US, online search in China provides users with personalized information. As 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 non-entertainment related searches such as eCommerce and e-Government will continue to gain popularity. Growing usage in China The latest statistics from CNNIC show that the number of users in China has reached 420M as of June 2010. We expect usage in China to continue to grow, driven by such factors as: Entertainment tool. Digital entertainment, such as MP3, movies, etc., can be downloaded from the web virtually free of cost or at a very low cost. Online gamesLAN-based (local area network), MMORPG (massively multiplayer online role playing games), or casual board and chess gamesare also low-cost alternatives to offline entertainment. Internet in general is a low-cost form of entertainmentinternet caf access costs about Rmb2-3 per hour vs. Rmb40 for a movie. Communication tool. Migrant workers (about 10% of total population, or 140 million people in China, are floating population) as well as relocated white-collar workers visit internet cafs after work to use instant messenger and e-mail, or to
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play games or watch movies. Despite the government constantly monitoring these services, blogs and bulletin board services have also increased in popularity in Chinathey serve as channels for the Chinese to express their personal views and communicate with others. Information source. Most traditional media is still tightly controlled by the government. The Internet offers an alternative information source that users seem to find 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 boost internet usage. Apart from growth in the number of users, the time spent online per week as well as the number of days online per week is on the rise. Users turning to search in China With information on the internet ever expanding, it is natural that users turn to search engines to organize the high volume of information. As a result, the number of searches in China is expected to more than double from 2009 to 2012. According to the 2010 CNNIC report, more than 76% of internet users use search engines. Search market outlook: advertisers readiness 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. Hence, continuous education and marketing are required to drive market growth. 1. 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, there were 43 million SMEs in China. These SMEs are mainly 39 million individual businesses (small businesses registered with some government departments). Statistics from the State Administration for Industry & Commerce (SAIC) 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 the SAIC, there were 4.3 million larger-size SMEs (registered directly with the SAIC). The total number of websites in China is 2.8M (as of Jun 2010). 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 1.7M. We do not think the market is saturated Based on Baidus 3Q10 active marketing customers of 272,000, the companys penetration among larger SMEs is 6%. Hence, we believe the market is far from reaching a saturation point.
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Number of SMEs by Different Segments
Source: SAIC, J.P. Morgan estimates.
2. eCommerce should be another growth driver While C2C eCommerce has seen good adoption over the past few years, driven by factors such as: 1) better acceptance for mail order (Chinas catalogue sales are nonexistent, and most transactions are done face to face) through increased online and offline marketing, and larger product selection; 2) improved trust and safety features by eCommerce sites; and 3) more regulated online payment infrastructure. In the US, eCommerce companies are leading users for paid search advertising. We believe a similar trend will emerge in China too, as paid search is an effective method for targeting prospective buyers who already have items in mind. We expect paid search to benefit from eCommerce growth in the future. 3. 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 become more sophisticated. 4. IT outsourcing companies are the main educators for search usage The two types of companies that help drive paid search usage of SMEs are ad agencies and IT outsourcing companies. 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, or CE.Net) and Hichina (net.cn, acquired by Alibaba.com) provide one-stop services for SMEsdomain name registration, web hosting, website design, and promotions (mainly through search engine optimization, 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. 5. 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
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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, may simply 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 that of 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 users and advertisers growth. Higher search usage 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 will conduct more searches, thus leading to higher usage. This cycle should continue, and lead to market size expansion.
Monetization Increase Driven by Self-Fueling Cycle
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Traffic Breakdown in Baidu.com Domain

Domain Name Traffic breakdown
Image search is the third-largest search channel after web page and Tiebar. MP3 search continues to lose dominance
baidu.com tieba.baidu.com image.baidu.com zhidao.baidu.com hi.baidu.com mp3.baidu.com video.baidu.com baike.baidu.com zhangmen.baidu.com news.baidu.com
Source: Alexa.com. As of Oct 21, 2010.
44.5% 14.5% 13.5% 8.4% 3.5% 3.3% 2.8% 1.6% 1.6% 1.2%
Online Video
Online video has seen strong growth in China with the number of users growing to ~300M monthly users by end of September 2010, representing ~83% of total internet subscribers, according to CNNIC.
Growing Online Video Users in China (users in millions
300 250 202 200 150 100 Dec-07
Source: CNNIC.
265 222 161 180 240
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Driving factors for growth of China Online video services include: (1) Existing media companies are not commercially driven. Existing TV broadcaster or cable operators are tightly controlled by the government. Contents broadcast schedule many times are not commercially driven. As such, contents may not be tailor to viewers interests. As such, alternative online video would be well adopted by viewers. (2) Availability of large amounts of content were not broadcasted. There are large numbers of television stations and movie production companies across the country. Many of the content produced were not properly shown due to an under developed media distribution system in China. For example, out of approximately 12,000 television episodes produced each year, fewer than half are ultimately broadcast. Similarly, fewer than one-third of the approximately 450 movies produced in 2009 were released in theaters. (3) Multiple delivery platform enhances user experience. While Video Online Demand service has advantages over viewing scheduled TV programs, leading online video companies also make content available on different devices such as
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mobile devices (phones, tablets), and internet-enabled TV. The wider choice of device allows users to enjoy content anytime in different platforms.
Online Video Advertising Revenues in China
200% 150% 100% 50% 0% 2006 2007 2008 2009 2010E 2011E 2012E 2013E Online Video Adv ertising Rev enues (Rmb Bn, RHS)
Source: iResearch.
13.1 8.6 5.4 2.9 0.1 0.3 0.6 1.4
14 12 10 8 6 4 2 0
Grow th Rate (in %, LHS)
Industry outlook for 2011 Profitability still many quarters away In terms of content, most video portals in China operate on a mix of Youtube" (user generated content) and Netflix (professional content) in China. While US video portals which mostly have user generated content or news clips as their top content, Chinese video portals have more viewership of licensed content such as movies, drama, etc. As a result, Chinese companies often pay a high content licensing fee in order to procure premium content to retain users. Similar to the media market worldwide, both ad-supported and subscription-based models are used in China. The ad-supported model is by far more popular in China.
Similar to media market worldwide, both ad-supported and subscription-based models are used in China. The adsupported model is more popular by far in China
Most of the video sites in China monetize by 1) in-video advertisements, 2) program/channel sponsorship by brand advertisers, or 3) affiliate advertising from text-based ads by search engines. Some players such as Tudou have also launched premium content service for which users will have to pay a fixed subscription fee. Content costs on the rise From Youkus prospectus, the average license fee for television serial drama increased in 2009 by more than 200% vs. 2008, and such fees have increased in 9M10 by more than 100% as compared to 2009. The average license fee for movies has also increased in 9M10 by more than 90% vs. 2009. In-house produced contents also slightly help control content costs and build brand Youku and Tudou also have their own content development department creating popular movies and dramas. In addition, this content helps to further solidify branding of leading video sites. Industry still focused on land grabbing, profitability still quarters away As most of the online video players are focused on gaining market share rather than profitability, we believe content inflation will continue. However, this should be
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slightly eased by reduced demand for exclusivity of content from online video players. While advertisers are still gradually adopting online video advertising, with high content and bandwidth costs, we expect profitability in the sector could still be many quarters away. Online video should drive ad dollar shift from TV Television accounted for 39.1% of overall advertising expenditures in China, according to ZenithOptimedia. We expect that online video should accelerate TV ad spend to move toward brand advertising due to its similarity of format with television. In addition, online video offers attractive user profiles (from a higher income and young adults demographics perspective) and targeted advertising than TV. As per CR-Nielsen, in September 2009, Chinese online video users spent 23.4 hours per week on average watching online videos, which is approximately six hours more than they spent viewing television. Additionally, a CNNIC 2009 China Internet user video behavior study found that online video is the only media viewing choice for 16.4% of the total online population in China.
Thirty percent of online video viewers have a college degree or higher level of education, whereas only 14% of the television audience is similarly educated, according to CNNIC and CSM Media Research
Young demographics/more affluent population Chinas online video market offers more attractive and targeted user demographics vs. traditional television market in terms of users age, level of education and potential spending power. Online video viewers in China, on average, are younger than traditional television viewers, but slightly older than the overall internet population. According to iResearch, close to 80% of the online video viewers are between 18 and 40 years of age and only 8% of online video viewers are below the age of 18. Moreover, 30% of online video viewers have a college degree or higher level of education, whereas only 14% of the television audience is similarly educated, according to CNNIC and CSM Media Research. Cost-effective advertising SARFT (The State Administration of Radio, Film and Television) in 2009 published a new Act No. 61 which considerably limited the advertising inventory on TV especially on prime-time. This has also led to significant price rise by TV operators over last 2 years. The advertising rates for 2011 have gone up further by 20%-60% for CCTV and other satellite channels. In contrast, video advertising site has lower CPM, and offers more dispersed and targeted advertising options to brand advertisers in a similar format. Competitive landscape Video portals in China face stiff competition from both standalone video portals as well as integrated portals such as Baidu, Sina and Sohu. We profile some of the key players here. Youku Youku is the leading online video player in China. As per iResearch, it commands 40% (largest) share of time spent on watching videos online in 2Q10. As of September 30, 2010, their video content library contained more than 2,200 movie titles, 1,250 television serial drama titles, and over 231,000 hours of other professionally produced content, including 194 variety shows. The company had
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total revenues of Rmb153.6M in 2009, and Rmb234.6M in 9M10. Net losses were Rmb182.3M and Rmb167.0M in 2009 and 9M10, respectively. The company listed on Nasdaq in December 2010. Tudou Tudou is the second-largest online video portal in China. As of 3Q10 end, the company had a content library of more than 36.3M video clips. The company also started providing mobile video services channel on China Mobile. Tudou has been shrinking the losses. It had had total revenues of Rmb113.2M and Rmb224.8M in 2009 and 9M10, respectively. The company had total losses of Rmb144.8M and Rmb83.7M in 2009 and 9M10, respectively. Sohu video Sohu has a separate video channel on its website. This channel provides users free access to extensive and varied video content, including popular domestic and overseas movies and TV dramas, in-house produced online talk shows, exclusive celebrity interviews, live webcasts, on-demand sports games, and user-generated video clips. Sohu is the third largest player in terms of online video views in China, as per iResearch.
3Q10 Market Share Based on Total Effective Time Spent Watching Online Video in China
Pheonix , 1.0% Joy .cn, 1.0% CNTV, 2.5% Sina Video, 2.9% 56.com, 4.3% Ku6, 6.1% Xunlei Kankan, 5.8% Sohu Video, 9.0% Others, 5.1%
3Q10 Market Share Based on Revenue

Others, 16.9% Joy , 2.9% Xunlei Kankan, Youku, 22.5%
Youku, 39.6%
3.2% Sina Video, 3.5% PPLiv e, 5.3% Ku6, 5.6% CNTV, 6.1% Sohu Video, 6.4% PPStream, 8.9% Tudou, 18.5%
Toudu, 22.8%
Source: iResearch. Data as of 3Q10. Source: Analysys. Data as of 3Q10.
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China Video Portal Data (Monthly Data for Oct 2010)

Total Unique Visitors (000) YOUKU.COM Tudou Sites KU6.COM PPS.TV 56.COM SINA Video IFENG.COM SOHU.COM TV JOY.CN CNTV.CN QIYI.COM PPLIVE.COM SMGBB.CN IMGO.TV Average Daily Visitors (000) YOUKU.COM Tudou Sites KU6.COM PPS.TV 56.COM SINA Video IFENG.COM SOHU.COM TV JOY.CN CNTV.CN QIYI.COM PPLIVE.COM SMGBB.CN IMGO.TV
Source: Comscore.
77,439 65,817 62,719 49,406 35,702 30,760 30,417 24,487 16,646 13,298 12,780 2,934 2,594 1,216 9,538 7,762 6,482 12,363 2,857 2,875 4,809 2,444 1,570 1,055 862 202 162 80
Total Minutes (MM) YOUKU.COM Tudou Sites KU6.COM PPS.TV 56.COM SINA Video IFENG.COM SOHU.COM TV JOY.CN CNTV.CN QIYI.COM PPLIVE.COM SMGBB.CN IMGO.TV Average Minutes per Usage Day YOUKU.COM Tudou Sites KU6.COM PPS.TV 56.COM SINA Video IFENG.COM SOHU.COM TV JOY.CN CNTV.CN QIYI.COM PPLIVE.COM SMGBB.CN IMGO.TV
1,620 1,297 747 3,171 306 322 1,712 455 436 129 113 5 13 6 5.5 5.4 3.7 8.3 3.5 3.6 11.5 6.0 8.9 4.0 4.2 0.8 2.6 2.3
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Social Networking
Social networking has a long and successful presence in China, notably by the success of Tencent. The social networking trend in China is quite similar to that of the US. Companies earn their revenues through a mix of social games, selling virtual items as well as from brand advertising. Key trends for 2011: social commerce We expect social networking companies tobe a key beneficiary of the rising eCommerce trend in China. With increasing time spent on social networks connecting with friends, these sites would be increasingly important traffic generators for eCommerce companies. In addition to basic brand advertising and friends referrals, social network companies help promote products through integrated product marketing such as themed games to promote products or onsite avatars to build brand awareness. Revenue generation for SNS websites can be broken down into three types: (1) Banner advertising: Nearly half of the advertising revenues are generated from putting up banner advertisements on various locations on the site: e.g., profile pages of the users. (2) Integrated marketing: Many companies promote themselves by putting virtual items associated with their brands in game applications. (3) Fan pages: Another way of advertising on social networks is through fan pages. We estimate this accounts for nearly a quarter of social network advertising in China.
SNS Game Market Size
3000 2500 2000 1500 1000 500 0 2009 2010 2011E 2012E 2013E 240 420 780 1,632 2,850
SNS Games Market Size (Rmb Mn)

Source: Analysys.
SNS users already cross 200M mark As per CNNIC, the number of SNS users reached the 210 million mark (up 19.6% YoY) in Jun-2010. Currently 51% of China internet users are using social networks up from 46% users, a year ago. In 1H10, revenue for Chinas SNS market was RMB 489 million, with growth of 19.4% YoY. Favorable demographic distribution As per CNNIC, more than half of Chinese users spend around 1 hour on SNSs, 22.6% spend up to 2 hours per day, and 12.8% are logged on for more than 2 hours.
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59.1% of Chinese SNS users have a college degree and above, 34% higher than other Chinese internet users.
Frequency of Logging Onto Social Networking Websites

Not ev ery w eek 26% Once a w eek or less 40%
More than Once 16% Once per day 18%

Source: CNNIC.
Users by Access Method

Only using mobile 8%
Ov erlapping users 39%
Only using computer 53%
Source: CNNIC.
Competitive landscape The four major social networks in China are: Qzone: Qzone of Tencent is the largest social networking portal in China. Tencent's leadership in instant messaging and casual gaming helps Qzone capture a dominant share in the social networking market. The company reported 481M user accounts at the end of 3Q10. Qzone is perceived to be more popular among teenagers than college students and office-goers. However, we believe Qzone covers a wide range of users that resemble general internet users in China. The company earns most its revenues from fees charged to users for upgrading to premium features such as social games, avatars, etc. The company also launched a portal named Xiaoyou, which focuses on college students.. .
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51.com: 51.com has more users from lower-tier cities. By the end of 2009, the company had 178M registered users and 40M+ monthly unique users. In April 2010, 51.com achieved breakeven. Most of its revenues generate from revenue shares from 20+ SNS games. The second tranche of revenues are from users payments. The third tranche of revenues are from advertising. Giant Interactive has a 25% stake in 51.com. 2011 outlook Expect healthy growth from Advertising and Social Gaming We expect social networking websites to gain a greater more share of online brand advertising revenues. Social networking provides: (1) more innovative ways of brand promotions such as virtual items, fan pages, etc. (2) more targeted user base, which is young and has higher disposable incomes. Additionally, we expect SNS to be a key beneficiary of rising eCommerce spending. Social gaming should benefit as leading websites such as Qzone open. This should lead to a higher number of social applications on there portals, which would ultimately drive higher revenues. The number of users should also see healthy double-digit growth. Analysys Data forecasts the social gaming market to grow more than 86% YoY in 2011. We expect Tencent to be a key beneficiary of the rising social networking trend in China. With the traffic Tencent commands thanks to its QQ platform, we believe it can attract the best of the applications with even less revenue sharing.
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Miniblog Platform
Mini blog platform has added another dimension to social networking in China. Sina has seen a lot of success through its mini-blog. Miniblog registered users on Sinas platform were close to 50M at the end of 3Q10 compared with Twitter monthly unique users of 190 million in mid-2010, according to Twitter COO Dick Costolo. Sina has been witnessing an addition of 10M users every month. Netease also had close to 9M users at the end of 3Q10. Tencent, Sohu and other sites are catching up with their own mini-blogs. Easy access from mobile phones Miniblog platform should also see more popularity from users accessing the internet from mobile devices. Currently 45% of active mini-blogs on Sina platform are accessed through mobile devices. With strong growth in mobile internet usage, miniblog usage is likely to further increase. A celebrity broadcasting platform Microblog traffic in China is centered around VIP accounts. Sina currently has around 20,000 VIP accounts which are verified by Sina. Most of the traffic revolves around following favorite movie stars, business leaders, etc. Monetization model becomes visible Sina recently discussed various monetization methodologies during different phases of Weibo development. Direct monetization (CPM base model) from brand advertisers is expected to begin on a larger scale in late 2011. Indirect monetization or platform strategy to kick off in late 2011. Platform strategy refers to local SMEs open storefront on Weibo and revenue sharing with third-party apps developers.
Sinas Weibo Monetization Model
Brand Adv
Platform Model
Indirect Monetization Weibo.com Open API Rmb 200M fund to support third party developers
Brand Product Line Interaction with Weibo Integrate online and offline events
Source: Company data, J.P. Morgan.
Direct Monetization Internally developed apps SME marketing and services
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eCommerce
eCommerce is in fast growth stage in China eCommerce usage has seen rapid growth, but it still only penetrated 30.2% of total internet users in China with around 109M users in 2010, according to iResearch. We believe there is a high potential for further growth in eCommerce.
China eCommerce transaction value is estimated to account for 3.4% of total retail sales in 2010 and is expected to grow to 6.5% of total retail sales in 2013
The internet has become an emerging sales and marketing channel for retail sellers. The China eCommerce transaction value is estimated to account for 3.4% of total retail sales in 2010 and is expected to grow to 6.5% of total retail sales in 2013.
China eCommerce Market Size by GMV
Rmb B
1,400 1,200 1,000 800 600 400 200 0 476 5 2004 16 2005 26 2006 56 2007 128 263
1,269 994 723
7% 6% 5% 4% 3% 2% 1% 0%
2008
2009
2010E
2011E
2012E
2013E
B2C+C2C, ex cluding B2B (Rmb B)

Note: Transaction for virtual goods and online utility payment are not included. Source: iResearch (2010).
As a % of Total Retail Sales (%)
Factors driving growth of online shopping in china Large number of internet users: China now has the largest internet population in the world with a penetration rate of more than 30%. China already has the largest number of Internet users in the world. Additionally, increasing penetration of internet-enabled mobile phones is also driving up time spent on the internet. Rising trust in online transactions: (1) Credible eCommerce companies have helped to improve Chinas online shopping ecosystem and to decrease fraud and bad transactions in online shopping. (2) Well-known retail brands are starting to sell products online, with many users having good online purchasing experiences. (3) Well-developed payment alternatives. Chinese online shoppers have adopted online banking payment as well as third-party payments (such as Alipay and Tenpay) based on their good experiences. Rising disposable incomes: As per NBSC (National Bureau of Statistics of China), Chinas GDP per capita has grown at a CAGR of 15.4% from 2005 to 2009, reaching US$3,714.2 in 2009. We believe the rise in disposable income should continue in coming years. Additionally, with rapid urbanization and more people transitioning to an affluent class, online eCommerce should see faster growth. Government thrust on pushing consumption-led growth: Chins consumption is 34.5% of GDP vs. 70.1% of GDP in United States. With the Chinese government pushing the growth model to shift from investment and exports-led growth to consumption-driven growth, we expect it to take many structural steps to boost consumption.
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Fast Growth of China Online Shopping Users

300 250 200 150 100 50 0 2007 2008 2009 2010E 2011E 2012E 2013E 55 26.2% 26.8% 80 28.4% 109 30.2% 145 20.0% 10.0% 0.0% 32.4% 180 34.6% 213 36.2% 245 40.0% 30.0%
Online Shopping Users (M)

Source: iResearch (2010).
As a % of Totla Internet Users (%)
B2C eCommerce enjoys significant growth in 2010 Players converging to marketplace model B2C eCommerce in China can be categorized into B2C retailers and B2C marketplace operators by business model. In 2010, we have seen: (1) Leading C2C eCommerce operators expand and develop the B2C eCommerce marketplace (such as Taobao expanding to Taobao Mall), (2) B2C retailers began to introduce third-party merchants to their platform, (3) B2C sites emerge as a new sales and promotion channel for retail brands.
China B2C eCommerce Market Size by GMV
Rmb B
250 200 150 100 50 0 2009 15 31
110%
103% 118 62
201 90% 71%
120% 100% 80% 60% 40% 20% 0%
2010E
2011E
2012E YoY Grow th (%)
2013E
B2C eCommerce GMV (Rmb B)

Note: B2C marketplace is not included. Source: iResearch (2010).
China internet giants focus on developing B2C eCommerce marketplace (1) Taobao started B2C eCommerce in 2008. The company announced the independent domain name for Taobao Mall in Nov 2010, following with a series of promotion events. Since its launching, Taobao Mall has earned a high reputation and recorded the highest transaction value of Rmb1B on Nov 11 2010. (2) Tencent upgraded its QQ members store to QQ Mall in Mar 2010 to leverage its C2C Paipai experience to B2C eCommerce.
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(3) Baidu launched Lekutian," an online B2C marketplace, jointly with Japanese eCommerce leader Rakuten in June 2010. China portals entered B2C eCommerce market, still at an early stage (1) Sina started B2C eCommerce around 10 years ago, but Sina Mall is still struggling to attract customers under tough competition. (2) NetEase also started B2C eCommerce 10 years ago. NetEase started to focus more on its eCommerce sector this year and launched B2C marketplace in December 2010. B2C retailers start to mix B2C marketplace model with their online retailing model The leading B2C retailers such as Dangdang and Vancl have introduced third-party merchants to their B2C platform. 360Buy is also preparing to open its platform to third-party sellers. These companies have seen the demands from third-party merchants to use well-established B2C platforms as a sales and marketing channel. Self-established logistics B2C eCommerce companies have endeavored to build their own logistical systems, including warehouses and logistics centers. We believe well-built logistics is one of the key factors for further growth of B2C eCommerce. (1) B2C eCommerce operators can lower delivery cost, shorten delivery time and expand to tier-2 and tier3 cities. (2) B2C companies can shorten processing time on returned goods to improve user experiences. In addition, incumbent delivery companies and logistics services are not sophisticated. Popular online selling products are apparel, media products such as books and music, cosmetics and IT products. These are the products that B2C retailers are focusing on. We have seen: (1) Dangdang and Joyo-Amazon that are well-known for online books selling, (2) 360Buy that emphasizes online IT and electronics products selling, and (3)Vancl that is a well-recognized online apparel seller. Leading B2C players in China 360Buy, Dangdang, Joyo Amazon are the three leading B2C retailers, while Taobao Mall is the leading B2C marketplace operator in China. We have summarized some facts about these companies below.
China B2C Retailers Market Share by GMV in 3Q10
Coo8.com, 1.1% New 7, 1.3% Mecox Lane, 2.2% Redbaby , 2.3% icson.com, 3.1% New egg, 4.4% Vancl, 5.3% Joy o Amazon, 8.9% Dangdang, 8.9%
Others, 26.9%
360Buy , 35.6%
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Leading B2C Players in China (Taobao Mall, 360Buy and Joyo Amazon)
B2C Marketplace Taobao Mall 1. The largest B2C marketplace in China in terms of transaction value. 2. Around 15k merchants sell products with 20k brands. 3. Merchants need to pay gurantee money of Rmb 10,000 to open a store in Taobao Mall. Besides that, Taobao Mall charges annual service fee of Rmb 6,000 and online transaction technical fee of 1% ~ 5% as of transaction value per transaction. 170M in 2009 (Including Taobao C2C) Rmb 208.3B (GMV) 1. Alipay Katong payment: link with debit card, time saving for online payment 2. Credit card payment 3. Online banking Payment 4. Alipay 5. Consumer card payment 6. Cash-on-delivery Third-party logistics companies. Taobao started to establish its own distribution center and invested in one logistics company in 2010. B2C Retailers 360Buy Joyo Amazon 1. The third-largest B2C retailer in 1. The largest B2C retailer in China in China in terms of transaction value. terms of transaction value. 2. Supported by international B2C giant 2. Well-known for its 3C (computer, Amazon. communication, consumer electronics) 3. Well-known for its media products products. sales such as books and music. 3. Expand to sell various products, including books, cosmectics, household 4. Expand to sell software products, electronic goods, toys, household products and etc. products, cosmetics, jewelry, watches 4. Announce to offer group buying and baby products, etc. products from Dec 20, 2010. 14M+ in 2010 Rmb 10.2B (GMV) 1. Cash-on-delivery 2. Online Banking Payment 3. Credit card payment 4. Third-party payment: Alipay, Tenpay and 99Bill 5. Mobile payment 6. Installment payment 7. Remittance 8. Banking Account Transferring 1. Five logistics centers are in Beijing, Shanghai, Guangzhou, Chengdu and Wuhan. Self-established logistics networks reach 24 cities. 2. Cooperate with third-party logistics companies. Founded in 2004. n/a n/a 1. Cash-on-delivery and mobile POS payment 2. Online Banking Payment 3. Credit card payment 3. Third-party payment: Alipay and PayEase 7. Remittance 8. Banking Account Transferring 9. Amazon gift card payment 1. Nine self-established logistics centers in Beijing, Suzhou, Guangzhou, Chengdu, Wuhan, Shenyang, Xi'an, Xiamen. 2. Free of charge for delivery service. 3. Cooperate with third-party logistics companies. 1. Founded in 2000. 2. Acquired by Amazon in 2004.
Business Description
Registered Members Revenue/GMV (2009 estimated) Payment
Logistics
History
1. B2C marketplace started in2008. 2. Taobao Mall with independent domain name was launched in Nov 2010.
Source: Company reports, J.P. Morgan.
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Listed Leading B2C Players in China (Dangdang and Mecox Lane)

B2C Retailers Dangdang Mecox Lane 1. A B2C retailer to offer fashion products through its website 1. The second-largest B2C retailer in China in terms of and physical stores in China. transaction value. 2. The products include apparel and accessories, home 2. Well-known for its its media products sales such as books products, beauty and healthcare products and other products, and music. under its own brands of Euromoda and Rampage as well as 3. Expand to sell various products, including cosmetics, selected 3rd party brands. electronic goods, household products, baby products and etc. 3. Invite third-party merchants to sell products at its "plug-and4. Invite third-party merchants to sell general merchandize at play" platform. Dangdang platform under its marketplace program. 1. Active customers were 6.8M for the nine months ended Sep 30, 2010. 2. Average daily unique visitors were 1.6M in Sep 2010. Rmb 1.5B 1. Cash-on-delivery: cover 750+ cities and towns in China 2. Online Banking Payment 3. Credit card payment 4. Third-party payment: Alipay, Tenpay, 99Bill, PayEase and UnionPay 5. Remittance 6. Banking Account Transferring 7: Dangdang gift coupon payment 1. Ten self-established logistics centers: two central logistics centers in Beijing, eight regional logistics centers in five major cities outside Beijing. Warehouse space totals 180k square meters and can handle 165k+ orders per day. 2. Cooperate with 104 third-party inter-city transportation companies and courier companies. 1. Founded in 1999. 2. Listed on NYSE in Dec 2010. 1. Active online customers were 2.1M as of June 2010. 2. Average daily unique visitors of the companys website: 671k in June 2010. Rmb 1.2B 1. Cash-on-delivery: cover 100+ cities in China 2. Online Banking Payment 3. Third-party payment: Alipay, Tenpay, and 99Bill 4. Credit card payment 5. Remittance 6. Banking Account Transferring 1. Centralized logistics center in Shanghai, other three in Beijing, Chengdu and Guangzhou. Warehouse space totals around 58.7k square meters and can handle 50k orders per day. 2. Cooperate with third-party logistics companies. 1. Founded in 1996. 2. Listed on NASDAQ in Nov 2010.
Business Description
Registered Members Revenue (FY09) Payment
Logistics
History
B2C marketplace transaction service fees Third-party merchants at B2C marketplace need to pay: (1) guarantee money, (2) a percentage of sales per transaction as real-time technical service fee, and (3) annual technical service fee to B2C marketplace operators. We present the transaction service fees that the key B2C marketplace operators charge.
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B2C Marketplace Transaction Service Fees

Guarantee Money Real-time Technical Service Fee Ratio Fashion & Accessories Outdoors Home & Decor Water Heater Bathroom Warmer Shaving Razor Baby Infant Formula Children's Wear Intelligence Toys & Baby Carrier & Child Cot & Schoolbag Diapering Cosmetics Jewelry Gold Natural Jade Natural Pearls Natural Amber Electronics & Technology Electronics Parts Home Appliance Motors Foods & Health Care Products Tea Drink & Vegetable Drink Cooking Oil & Food Grains Books, Movies & Music Serivces, such as Tickets, Internet Serivces and etc. Virtual Recharge Annual Technical Service Fee Taobao Mall Rmb 10,000 5% 5% 5% 2% 2% 2% 2% 5% 5% 2% 4% 2% 1% 5% 5% 5% 2% nm nm 2% 2% 1% 1% 2% 2% nm Rmb 6,000 Lekutian Rmb 15,000 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 1.5% 4.5% 4.5% 1.5% 3.5% 1.5% 0.6% 4.5% 4.5% 4.5% 1.5% nm nm 1.5% 1.5% 0.6% 0.6% 1.5% 1.5% 0.6% 0 Dangdang Rmb 3,000 - Rmb 10,000 4% 4% 4% nm nm nm nm nm nm nm nm nm 2% nm nm nm nm 1-2% 4% 2% 2% nm nm nm nm nm nm 1) SKU<500, Rmb 300/month, 2) 500<SKU<1,000, Rmb 500/month 3) 1,000<SKU<2,000, Rmb 1,000/month 4) SKU>2,000, Rmb 2,000/month QQ Mall Rmb 20,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
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Group Buying: A Hot Trend in China Too

Group buying market size grows from zero to Rmb980M in one year The group buying eCommerce model originated from the U.S.'s GroupOn and became popularized in China in 2010. We have seen the emergence of hundreds of independent group buying sites, as well as sites launched by China's key internet players such as Tencent, Baidu, Sina, and Sohu. According to Analysys, a leading internet industry research firm in China, the group buying market size is around Rmb980M in 2010 and is expected to reach Rmb3,800M in 2013. Classification of group buying categories: Location-based Group Buying Sites and Products-based Nationwide Group Buying Sites Main customers: Young, white-collar workers and college students aged 20-35, who would like to try fresh things. Major products: Entertainment products such as movie tickets and karaoke coupons, restaurant coupons, beauty & hair salon coupons, travel & hotel coupons, etc. Major cities: Tier-1 cities, such as Beijing, Shanghai, Guangzhou, Shenzhen, Changsha, Xian, Hangzhou, Chengdu, Wuhan and Tianjin.
China Group Buying Market Size by Transaction Value
Rmb M
4,000 3,000 2,000 980 1,000 0 2010E 2011E 2012E 1,650 2,620
3,800
2013E
Group Buy ing Transaction Value (Rmb M)

Source: Analysys (2010).
Number of Group Buying Sites in China

Beijing Shanghai Guangzhou Shenzhen Changsha Xi'an Hangzhou Chengdu Wuhan Tianjin Others Total
# of Sites
473
183
77
75
65
56
53
52
49
44
537
1,664
Note: The statistics is as of Nov. 2010. Source: 2010 Group Buying Industry Credit Research Report, Internet Society of China.
Factors driving growth of group buying market in china 1. Cheap price. Many small- to medium-sized merchants use group buying sites as a promotion channel and offer high discount price to attract customers. The 60%-90% discount price is very attractive. 2. Attractive products. Group buying sites offer products that are attractive to young people with low prices, such as cake-making class coupons, laser gun game coupon, etc.
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3. Customers adoption of online payment method. Online banking payments and third-party online payments are the major payment methods for group buying sites. Chinese customers, especially the ones in tier-1 cities, have increased their trust in online payment with their online shopping experiences. 4. A new promotion channel for small- to medium-size merchants. With increasing internet usage, group buying sites can help small- to medium-size merchants to attract new customers from internet users. The promotion cost of using group buying sites is relatively smaller than that of print media. 2011 Outlook for group buying market 1. Consolidation. We believe we will see consolidation in the group buying sector. Because of low entry barriers, hundreds of group buying sites emerged in a short period of time. We observe that the group buying market is in disorder and the user experiences are poor. We think that the group buying sites serving low-quality products will be acquired by bigger sites or go bankrupt. 2. Combination with Portals, eCommerce Sites, Living Social Sites and SNS Sites. Group buying sites and other internet sites could complement each others advantage. Portals and SNS sites have large user basees. eCommerce sites can provide products for group buying. Living social sites have the networks of local merchants. Vise versa, group buying services can improve user experiences for the above sites.
Select Group Buying Sites in China
Lashou http://www.lashou.com/ Sep, 2009 100+ Cities 1. Lashou is the first and largest group buying site in China. It plans to expand to 200-300 cities by 2011. 2. Lashou is trying to add more functions to its group buying site, such as "Check-in" and SNS games. Meituan http://www.meituan.com/ Mar, 2010 12 Cities Meituan is the leading group buying site in China. Dingping Tuan http://t.dianping.com/ June, 2010 7 Cities Dingping Tuan is launched by Dingping.com, a wellknown living social site in China. QQ Tuan http://tuan.qq.com/ July, 2010 11 Cities QQ Tuan is launched by Tencent. QQ Tuan also offers group buying products only for QQ members with lower discount price. Juhuansuan http://ju.taobao.com/ Mar, 2010 Products based nationwide site Juhuansuan is launched by Taobao, Alibaba's subsidiary on eCommerce. It is a product based group buying site, covering across whole China rather than location based.
Launching Date Networks Business Description
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SNS and Microblogs: Help Drive Social eCommerce

We observe that social networking sites (SNS) and microblogs are the new channels to promote online shopping products and social living information. Click sharing to share the information of online shopping products Sharing links with SNS and microblogs labels are located under or above the product picture at online shopping malls and group buying sites. SNS and microblogs include the most popular ones,Tencent micro-blog and Sina microblog. Netizens can also click to copy the URL and paste it to MSN or QQ or their emails. Click forward to share social living information Same as the link at online shopping sites, the links to SNS and mirco-blogs are also located under or above the picture of social living information at social living site. It is generally straightforward for a user to forward a Cafes information at Dingping.com to a Sina Microblog. First step: the user selects the Cafe and clicks Sina Microblog label under the picture of the Cafe. Second step, at the pop-out webpage the user can log into Sina Microblog and click forward. Third step, the user can check that the Cafe information has been published on Sinas Microblog.
Leading C2C Players in China

Taobao, the eCommerce subsidiary of Alibaba, is the leading online marketplace operator in China. Taobao reached registered members of 170M by 2009 and is one of the worlds Top 20 most visited websites. Paipai is Tencents C2C marketplace and ranks second, leveraging Tencents large IM user base.
China C2C eCommerce Market Share by GMV in 3Q10
Eachnet, 3.6% Paipai, 11.6%
Taobao , 84.8%
Note: 1. Taobao includes GMV from both Taobao C2C shopping mall and Taobao Mall. 2. Paipai includes GMV from both C2C Paipai and QQ Mall. Source: iResearch (2010).
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Leading B2B Players in China

The B2B eCommerce sector has seen stable growth in 2010. Alibaba is still the leading player, with market share of 57% in 3Q10.
China B2B eCommerce Market Share by Revenue in 3Q10
Others, 16.2% Toocle, 1.0% DHgate.com, 1.8% My steel.com, 2.6% GlobalMarket, 3.3% Made-in-China.com, 3.4% HC360, 4.1% Global Resources, 10.7%
Alibaba, 57.0%
Chinas Leading B2B Players

Business Description Alibaba Alibaba operates the leading online B2B marketplace in China. 1. International marketplace, Chinese marketplace, Japanese marketplace, and global wholesale marketplace. 2. Ali loan: outstanding portfolio of Rmb 20BRmb 30B. 3. Acquisition: acquired AliSoft, HiChina, Vendio, Auctiva, and OneTouch as a part of "Work at Alibaba" strategy. 1. International marketplace: 15M - # of paying users of China Gold supplier members: 108.6k - # of paying users of Int'l Gold Suppliers: 11k 2. Chinese marketplace: 42M - # of China Trust Pass members: 631.3k 1. Generate revenue from (1) membership payment (2) value-added services - 2010E: Rmb 5,452M (US$801.8M) - 2009: Rmb 3,875M (US$569.9M) 2. Revenue breakdown (FY09) - International marketplace: 62.1% - Chinese marketplace: 36.5% - Others: 1.4% Global Resources Global Sources is a leading B2B media company and a primary facilitator of trade with Greater China. The company's principal business is to provide services that allow global buyers to identify suppliers and products, and enable suppliers to market their products to a large number of buyers. HC International HC International offers both online and offline B2B services in China. 1. Online marketplace: Mai-Mai-Tong ( 2. Offline marketing products: HC Trade Catalogues, HC Yellow Page Directory, Industrial Market Research
Registered Members
Mainland China registered online users and magazine readers: 2M+
Online marketplace Mai-Mai-Tong - Registered users (2009): 10M - Mai-Mai-Tong IM users: 7M
Revenue
1. Generate revenue from (1) online and other media services (2) exhibitions - 2009: US$174.5M 2. Revenue breakdown (FY09) - Online and other media services: 66.1% a) Online services: 48.9% b) Print services: 17.2% - Exhibitions: 31.6%
Margin (FY09) History
- Gross Margin: 86.2% - Operating Margin: 26.6% - Profit Margin: 26.1% Founded in 1999.
- Gross Margin: 36.7% - Operating Margin: 9.2% - Profit Margin: 9.2% Founded in 1971.
1. Generate revenue from (1) subscription fee from online services (2) advertising income from industry portals, trade catalogues, yellow page directories and printed periodicals (3) hosting of trade exhibitions and business seminars (4) customer-specific market research reports - 2009: Rmb 317.7M (US$46.7M) 2. Revenue breakdown (FY09) - Online services: 40% - Trade catalogues and yellow page directories: 36% - Market research and analysis: 16% - Seminars and other services: 8.1% - Gross Margin: 52.5% - Operating Margin: 0.56% - Profit Margin: 0.67% Founded in 1992.
Source: Company reports, Bloomberg, J.P. Morgan.
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Online Gaming
Growth outlook remains robust The online gaming sector continued to see good growth in 2011, with ~23% Y/Y growth to reach Rmb35.9B (~US$5.3B), as per our estimates. The MMORPG segment (~84% of total gaming market) expected to growth ~21% Y/Y in 2011 to reach ~US$4.4B, as per our estimates, with the launch of few key games next year with different genre, such Final Fahe. The casual and social game segments are likely to benefit from SNS sites opening up their platforms for new social games. Overall for 2011, we expect companies with strong operating and marketing capabilities and healthy game pipelines to continue to benefit from the markets growth.
China MMORPG Market Forecast
MMORPG gamers (million) Game users penetration Average ARPU per month (Rmb) Market size (Rmb million) MMORPG Market size (US$M) Growth Rate:
2006 25.5 18.6% 19.7 6,043 762 27%
2007 37.0 17.6% 21.3 9,463 1,255 65%
2008 53.3 17.9% 23.7 15,125 2,192 75%
2009 66.6 18.1% 25.8 20,608 3,005 37%
2010E 77.7 18.5% 26.6 24,767 3,626 21%
2011E 91.5 18.5% 27.1 29,738 4,406 21%
2012E 106.7 18.5% 27.6 35,380 5,242 19%
China Casual and Social Game Market Forecast

Casual game players (million) Casual players penetration APRU per month (Rmb) Market size (Rmb million) Casual Market size (US$M) Growth Rate:
2006 32.6 23.8% 2.7 1,044 132 52%
2007 47.3 22.5% 2.9 1,634 217 65%
2008 68.1 22.8% 3.2 2,589 375 73%
2009 88.5 24.0% 3.5 3,669 535 43%
2010E 102.9 24.5% 3.8 4,694 687 28%
2011E 122.8 24.8% 4.2 6,158 912 33%
2012E 145.1 25.2% 4.6 8,005 1,186 30%
China Total Game Market Forecast

Total Game Market size (Rmb million) Total Game Market size (US$M) Growth Rate:
2006 7,086 893 30%
2007 11,097 1,472 65%
2008 17,714 2,568 74%
2009 24,277 3,539 38%
2010E 29,460 4,313 22%
2011E 35,896 5,318 23%
2012E 43,386 6,428 21%
Key industry drivers We expect continued robust growth of online gaming in China to be driven by: 1) Continued strong internet user growth in China (2009-12E CAGR of 17%). 2) Upside in gamer penetration, which is still less than one-third of Koreas penetration (also below HK and Taiwan), with additional gamers coming particularly from lower-tier cities. 3) Increasing broadband penetration, with 364MM broadband internet users as of Jun-10, or 87% of total internet users; CAGR of ~47% over the last five years. 4) Efforts of game companies new genre, better quality, more innovative games and more effective promotions to continue to attract players; also, success of the freeto-play (item-based sales) model (contributing ~79.4% of industry revenues in 2009, up from ~76.2% in 2008, as per IDC estimates).
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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. 2011 -- Look for companies with product specific drivers With market growth slowing down from the high double-digit level a few years ago, we expect more intense competition among leading game companies. We look for companies with game-specific drivers going into 2011. Key MMORPG Games in 2011 We expect new games launching in 2011 to lead industry growth. In 2010, we think only Dragon Nest, launched by Shanda Games in late July, performed well with PCU of 700k+. In 2011, a few key games we will watch for are Changyou and Giant Interactive to release Duke of Mountain Deer and ZT Online II in 1H11, respectively. Netease may launch Blizzards WoW: The Catastrophe as well as Starcraft II, but it still depends on the approval procedures of China-related bureaus. Final Fantasy XIV will also be a game to watch which will be launched by Shanda Games.
Key MMORPG New Games in 2010 and 2011
Game Dragon Nest Duke of Mountain Deer Chinese Title Genre Action Martial arts adventure Visual Dimensions 3D 3D Game Operator Shanda Games Sohu Changyou Game Developer Eyedentity Games (acquired by Shanda Games in 2010) Sohu Changyou Launch Date Jul-10 1. Expect to be launched in 1H11 2. Started closed beta testing in Dec10. 1. Expect to be launched in 1H11 2. Started unlimited closed beta testing in Nov-10. Shanda Games announced the acquisition of an exclusive license for the game in Sep-10. The new version has been launched in other countries except mainland China in Dec-10.
ZT Online II
Martial arts adventure
2D
Giant Interactive
Giant Interactive
Final Fantasy XIV
14
Fantasy
3D
Shanda Games
Square-Enix
World of Warcraft: The Catastrophe
Fantasy
3D
NetEase
Blizzard
Source: Company reports, J.P. Morgan estimates.
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Comparison of Leading Games and Game Companies

Market Share of Leading Online Gaming Companies by Revenue
2007 Tencent Shanda NetEase Sohu Changyou Perfect World Giant Interactive Kingsoft NetDragon The9 Others 6% 17% 14% 2% 5% 12% 3% 5% 10% 25% 2008 11% 16% 12% 7% 7% 8% 3% 3% 8% 23% 2009 20% 18% 12% 7% 8% 5% 3% 2% 3% 21% First Nine Months of 2010 29% 14% 15% 7% 8% 4% 2% 2% 0.3% 18%
Source: Company reports, iResearch, J.P. Morgan estimates.
Leaders in MMOG Quarterly Active Paying Accounts (Free-to-Play Model)

(In '000s) Tencent Sequential growth Shanda Sequential growth Sohu Changyou Sequential growth Perfect World Sequential growth Giant Interactive Sequential growth 1Q08 921 4,110 1,514 1,701 1,447 2Q08 2,713 194.7% 4,239 3.1% 1,807 19.4% 1,530 -10.1% 1,760 21.6% 3Q08 3,684 35.8% 5,189 22.4% 2,006 11.0% 1,610 5.2% 937 -46.8% 4Q08 5,024 36.4% 5,889 13.5% 1,981 -1.2% 1,546 -4.0% 1,290 37.7% 1Q09 5,960 18.6% 7,189 22.1% 2,270 14.6% 1,464 -5.3% 1,236 -4.2% 2Q09 6,919 16.1% 8,580 19.3% 2,390 5.3% 1,877 28.2% 1,204 -2.6% 3Q09 8,377 21.1% 9,060 5.6% 2,400 0.4% 1,643 -12.5% 1,108 -8.0% 4Q09 8,304 -0.9% 9,420 4.0% 2,400 0.0% 2,188 33.2% 1,138 2.7% 1Q10 8,518 2.6% 9,620 2.1% 2,400 0.0% 1,670 -23.7% 1,373 20.7% 2Q10 8,526 0.1% 9,640 0.2% 2,790 16.3% 1,433 -14.2% 1,435 4.5% 3Q10 9,243 8.4% 9,190 -4.7% 2,610 -6.5% 1,274 -11.1% 1,497 4.3%
Leaders in MMOG Quarterly ARPU per Active Paying Accounts (Free-to-play Model)
(In Rmb) Tencent Sequential growth Shanda Sequential growth Sohu Changyou Sequential growth Perfect World Sequential growth Giant Interactive Sequential growth 1Q08 68 156 192 151 325.1 2Q08 33 -51.0% 164 5.4% 176 -8.3% 188 24.5% 285.9 -12.1% 3Q08 33 -0.3% 149 -9.3% 177 0.8% 196 4.3% 282.1 -1.3% 4Q08 78 136.3% 149 0.4% 194 9.6% 225 14.8% 272.7 -3.3% 1Q09 81 3.3% 132 -11.8% 179 -7.9% 244 8.4% 299.7 9.9% 2Q09 83 2.6% 126 -4.5% 186 3.9% 237 -2.9% 300 0.1% 3Q09 88 5.5% 130 3.6% 190 2.2% 266 12.2% 259.4 -13.5% 4Q09 90 2.3% 135 3.5% 196 3.2% 223 -16.2% 240.5 -7.3% 1Q10 98 9.7% 106 -21.1% 201 2.6% 306 37.2% 220 -8.5% 2Q10 99 0.1% 105 -0.9% 184 -8.5% 292 -4.6% 223 1.4% 3Q10 101 2.5% 106 0.4% 214 16.3% 323 10.6% 225 0.9%
Game software industry typically not correlated with macroeconomic growth; thus, should be less vulnerable in an economic slowdown Historically, the game software industry has not been significantly correlated with macroeconomic growth. For instance, in developed markets such as the US, the videogame software industry has historically exhibited cyclicality driven by game hardware launches (consoles, handheld devices). These, in turn, result from technological advances by the hardware manufacturers in terms of faster processing devices with superior graphics and game play capabilities typically every four to five years, which creates the need for newer software and also drives consumer demand. As a result, the game software industry is relatively less vulnerable in an economic slowdown, compared to other industries and software segments.
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US Game Software Leading Companies Revenue Growth vs. US GDP (Nominal) Growth
70% 60% 50% 40% 30% 20% 10% 0% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Game Company Rev enues US GDP grow th rate 7% 6% 5% 4% 3% 2% 1% 0%
Source: DataStream. Note: Correlation coefficient: -0.19 (weak correlation). 1) Leading US game software companies revenue growth based on total revenue of Electronic Arts, Activision, THQ and Take Two. 2) Prior game platform cycles were 1995-2000 and 2000-05; current console cycle started in 2005 (Xbox 360 launch).
In addition to the above, in recent times, other aspects contributing to potentially greater resilience of the gaming sector have been: 1) the increasing acceptance of gaming among a wider demographic (e.g., games being seen as a family entertainment avenue, including women and children); 2) increasing penetration of the internet and more broadband connections driving online gaming; 3) emergence of innovative business models such as free-to-play online games and in-game advertising making gaming more affordable for consumers; and 4) greater variety of games (e.g., casual games such as music and dancing games) to appeal to diverse tastes.
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The Rise of Social Gaming

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

3,000 2,500 2,000 1,500 1,000 500 0 2009 2010E 2011E 2012E YoY Grow th (%) 2013E 240 420 75.0% 85.7% 1,632 780 74.6% 109.2% 2,850 1 0.8 0.6 0.4 0.2 0
SNS Game Market Size (Rmb M)

Source: Analysys.
Social gaming proves to be a goldmine for Tencent With the rising popularity of social games on Facebook and other Chinese websites, Tencent introduced many new social gaming applications with more interactive functionalities such as farming, aquarium, etc. to increase user stickiness. The company has adopted a mixed content sourcing strategy where it is sourcing the popular games like social farm from third-party vendors while also working in-house to keep the game launch pipeline green. As social games are simple, they are expected to have smaller life cycles and continuous churn of new games becomes necessary. The success of social games on Qzone led to a rise in the number of users from 150M in 4Q08 to 481M in 3Q10. The revenues have also gone up to 35.1% YoY in 3Q10 to reach Rmb580M. We estimate daily active users on Chinese SNS websites playing social games to be comparable to the number of active users on Facebook (500M+ active users).
Qzone Continues Stable Growth
500 400 300 200 100 0 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 115 131 138 150 183 228 305 388 428 459 481
Qzone Activ e Users (M)

Source: Company reports.
Social gaming a big opportunity for China game publishers China internet companies focus on an open platform strategy, which should help developers publish their social games. Tencent announced its open platform strategy after QQ vs. 360 war. Tencents SNS open platform is still in open beta testing, but it already becomes a popular
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channel for third-party application developers to publish their SNS games at Qzone. Skyscraper, a popular third-party game at Qzone developed by Kingnet, recorded 70M game users, according to Kingnets CEO. The9 invested in Openfeint, a mobile game platform developer and operator, in July 2010. In December 2010, The9 signed a five-year license to use OpenFeint's mobile social gaming network software in China. The OpenFeint software is one of the most successful mobile social gaming network software for iOS and Android devices in the US. More than 13,000 mobile game developers are registered to integrate OpenFeint's SDK into their games and there are over 50 million registered users and approximately 4,000 games in the Apple App Store and Google Market running on OpenFeint's platform. We believe Chinese social game developers will grow fast with the popularity of SNS and social games in China as in other countries. In the US, key social game developers such as Zynga and Playfish have been attracting large numbers of players to their games. Zynga has more than 320M registered users, according to an article by GamesBeat. Playfish was acquired by Electronic Arts for approximately US$275M in cash and approximately $US25 M in equity retention arrangements. In addition, Playfish will receive additional variable cash consideration, up to a maximum of US$100M, contingent upon the achievement of certain performance milestones through December 31, 2011.
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Summary of Gaming Regulations in China

Summary of historical gaming regulations The General Administration of Press and Publication (GAPP) has been the key regulatory body since online games were introduced 10 years ago. This is because online games were assumed to be publications by online game companies, and, as such, they turn to GAPP for approvals. On July 11, 2008, the State Council issued Three Regulations outlining responsibilities of various government bodies (including Ministry of Culture [MoC] and GAPP) in the regulation of animation, online gaming, and the cultural market in general. Even after this regulation, GAPP and the MoC both conduct their own approval process independently. On September 7, 2009, China's State Commission Office for Public Sector Reform issued a notice clarifying responsibilities of various government bodies in the regulation of animation, online gaming, and the cultural market in general. According to this notice, MoC is the key regulatory body, responsible for market planning, management of the industry, project development, conferences, and market oversight for the animation and online gaming industries. By the end of 2009, all the transition in responsibility should be complete. MoC gets involved - released Interim Measures for Online Games in 2010 In late September 2009, MoC held a meeting with leading games companies stating that MoC will be the key regulatory body. MoC released Interim Measures for Online Games on June 3, 2010, after about two years of preparation. The implementation of Interim Measures began on August 1, 2010. News about the rules was reported on Sina.com on June 22, 2010. The key points are: - Detailed the requirements (registered capitals of no less than Rmb10M, etc.) for online game companies to obtain Online Culture Operating Permit. MoC is responsible for reviewing online game content. However, games have already been approved by other departments (GAPP), no separate review is required by MoC. - Application process: If there is a change in operator for imported games in China, the game needs to be re-approved. For domestic developed games, the game needs to be filed with MoC within 30 days of operation. If game content is substantially changed, the game needs to be re-filed with MoC. - No illegal game content which are considered as negative to Chinese culture, society, etc. Games should include details for suitable age groups. No gambling items in game allowed. - Real name registration for players. Online game companies are required to implement anti-addiction system (time limits) for minors. - Virtual game currencies: (1) cannot be used for payment, other physical product purchases, or other non-game product purchases, (2) game operators to keep record
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of game currencies trading for at least 180 days, (3) data for game currencies types/prices/total amount issued to be filed with MoC. - If a game ceased to operate for 30 days, operators will return money to gamers. There are fines for non-compliance, and potential criminal charges. Regulations on virtual currency and virtual items trading platform Separation of online game operators that issue virtual currencies and online game items trading platform MoC and the Ministry of Commerce (MOFCOM) jointly issued a notice regarding strengthening the administration of online game virtual currency on June 4, 2009. The notice prohibits businesses that issue online game virtual currency from providing services that would enable the trading of such virtual currency. Interim Measures regulates virtual game currency and virtual currency trading platform - Virtual game currencies cannot be used for other payments instead of online game products and services. Virtual game currency issuers cannot issue virtual currencies for the purpose of occupying the prepaid capital. The record of purchasing virtual game currencies should be kept for at least 180 days. Data for virtual game currency types/price/total amount issued should be filed with MoC-related bureaus. - Virtual online game currency trading platform cannot provide trading service for: 1) minors, and 2) online games that are not approved or filed with MoC. The trading platform should require real name registration for buying/selling parties and the registration information should match bank account information. The trading and account information should be kept for at least 180 days.
Online Gaming Primer

What are online games? Broadly speaking, we can separate online games into two segments: 1) casual games, and 2) serious games/MMORPG. Causal games are easy to play and only require brief tutorials. Some examples are puzzles, board games, and some old arcade games. Demographics for casual games are diverse: they cut across age groups (from young children to senior citizens) and are equally split across genders. Very often, these games are free. What is a MMORPG online game? These are more complex games with a large number of scenes, multiple players and characters. Serious game players are also more committed to the games than casual players. They usually comprise young adults or teens who spend more than 10 hours per week on online games. The most popular games that account for most of Chinas online game revenues (~84% of total online gaming market, as per our estimates) are Massively Multiplayer Online Role Playing Games (MMORPG). These games are not simply about shooting and killing or finding treasures and saving the princess, as in some other games. MMORPG are community-based and players can interact with other players, form coalitions with acquaintances to fight battles, make villages more livable, and even have virtual marriages.
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MMORPG games are very dynamic; game developers and operators always extend the map, create new weapons and run special virtual events. Typically, operators have a new release every month and a major upgrade once a yearand users can download them free of cost. What is a casual game? Casual games are online games that are typically less evolving compared with MMORPG games. Players typically only spend less than 30 minutes per game session. The content and depth is much simpler, and requires fewer skills or less training to play the games. Casual games can be broadly classified into 1) board and chess games, and 2) advanced casual games. Board and chess games, as the name suggests, are board games, chess, different types of card games, and other traditional games put online. These are viewed more as commodity products, and difficult to differentiate from competitors. As such, monetization is typically lower. Advanced casual games are online games that have more depth and content compared with board and chess games. However, they are not as involved as MMORPG. Gamers spend less than an hour per game session. Successful advanced casual games are typically more innovative, and bring in new ideas to the market space. The popular advanced casual games include: Cross Fire, QQ Speed, QQ Dancer, Audition, Crazy Racing, CSOnline, AVA, etc. Successful casual games generate more revenue compared to board and chess games. The revenue model for casual games is in-game item sales. Typical game items are: avatars (virtual clothing, accessories, and decorative products), tools (i.e., virtual golf clubs to play golf), weapons, special features (i.e., ability to see competitors cards in card games), and membership (priority access to game servers, and members only games). Casual and MMORPG are complementary rather than competing products We believe casual games and MMOPRG satisfy needs of players at different times. For example, if a player has 15 minutes to kill, they likely would turn to casual games, but if a player has a few hours everyday, playing a simple casual game is likely to become too boring. Therefore, this same player could play both types of games at different times, depending on his or her availability and needs. We believe new innovative advanced casual games attract non-game players to online games and further expand the gamer base. We observe this from the demographic differences between casual games and MMORPG games. These additional players could perhaps become MMORPG gamers down the road, if they find online gaming interesting.
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Gender Breakout of Online Gamers in China

Female, 14.6%
Age Breakout of Online Gamers in China

Abov e 50, 7.1% 41-50, 12.1% Below 11, 0.7% 11-20, 24.8%
31-40, 14.2%
Male, 85.4%
Source: IDC (2009). Source: IDC (2010).
21-30, 41.2%
Do gamers have time to play both advanced casual and MMORPG? In China, the market trend is to develop advanced casual games that are more complex and involved, and, as such, these casual games consume more time compared with before. Investors are concerned that this would reduce spending on MMORPG games. We believe this may be true, but the effects on MMORPG should be minimal, in our opinion. First, it is not uncommon for users to play multiple games, so users can play both MMORPG and casual games during the same day. Second, an expanded casual game user base should also bring new users to MMORPG. Online gamesa sticky business In online games, players build a strong community with other game players. They communicate through instant messengers in the game. Once players have been playing for a certain period, they start building their seniority and respect within the gaming community, as well as their stock of accumulated weapons. As such, fair play becomes very important. Hacking not only demoralizes players but also seems to cause community unrest and to threaten the social order in the game space. Game operators hire game masters or GMs who patrol the game space to check for unfair practices, and remove those users who violate the rules. Leaving the game means severing ties with the community, as well as giving up weapons and armors accumulated over time. As such, players have proved to be quite loyal to the games. A well-run game is therefore very sticky, and the operators goal is to make their game stickier. To further increase user loyalty, game operators organize special events in the virtual space, as well as organize offline promotions and parties. One good example is Lineage in Korea, which was launched in Korea about six years ago and remains one of the top games in the country. Any piracy issues in online games? Online games are designed to get around the piracy issue. There are two sets of software server software and client software. Server software is installed inside game companies servers. The game server is designed to protect against hackers trying to copy or alter the server software. Client software is distributed free of charge and can be downloaded from a game operator's site at any time. Since client
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software is free, unlike game consoles where game software is charged a fee, there is no reason to make pirated copies. As such, piracy problems are very limited. What are pirated servers? This refers to the situation where the main server software is stolen from game companies or the server software is being reverse-engineered. In this situation, criminals put stolen/pirated server codes on home-run servers and charge users a lower fee than authentic servers to play the game on their servers. These are referred to as pirated servers. Games that are operated widely across the globe are more prone to being pirated. This is because game developers need to distribute a source code to outside game local operators, and as such, there is a higher chance of the source code being leaked out. For example, Mir2, Aion, and Lineage are well known for having pirated servers in China. NetEase, which develops its games in-house, has not seen any pirated server issues. Also, new games have more security features to protect the server software from being pirated. For example, we have not noted any pirated servers for World of Warcraft. What are hacking tools software? Hacking in online games typically refers to special (purchased or self-written) programs that run on players PCs. With these special hacking tools, game players can, for example, get infinite lives, nuke all the adjacent players, or take tools from others. Hacking demoralizes other players and results in their leaving the game. To tackle the issue, online game operators can: 1) amend the actual game software, 2) hire more game masters to patrol the virtual community, and 3) bar hacking players from playing the game. The first option is the most effective way to deal with the problem. However, as many online game operators only purchase games from other developers and do not have access to the source code, there could be a time delay in addressing a particular hacking issue. In fact, this is a fairly frequent issue raised by operators in China, and has led to the decline of some early online games. Economy of games We believe the required number of concurrent users is low for a MMORPG game to break even. Excluding development costs or licensing fees, a game can achieve an operational breakeven at 4,000-5,000 average concurrent users. With relatively low breakeven user numbers, we believe the number of MMORPG game titles will continue to grow. However, many of these will likely be small-scale games that we expect will target niche audiences, much like different types of movies: action-adventure, science-fiction, martial arts, war, mystery, medieval, etc.
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Estimated Gross Income of a MMORPG Under Various Concurrent Users

Average concurrent users Active paying users ARPU per users (RMB): Revenue after distributors discount Number of servers Monthly server amortization & bandwidth cost Game masters and other labor cost Marketing and promotion Other operating expenses Gross Net Income Case 1 1,000 11,000 9 79,200 3 16,375 48,000 55,440 47,520 (88,135) Case 2 4,000 44,000 9 316,800 4 21,833 64,000 110,880 95,040 25,047 Case 3 10,000 110,000 9 792,000 9 49,125 144,000 158,400 158,400 282,075
Source: J.P. Morgan estimates. Note: Excluding development cost, amortization of licensing fee or revenue sharing with game developer.
How fast would a game decline from its peak? As a rule of thumb, typical popular MMOPRG games reach their peak in around three years. The rate of decline from the peak varies depending on different factors. Some games decline at a faster rate compared with others. For example, we noted Mu, operated by 9Webzen, experienced a step function (around 50% drop each step) type of sharp fall, mainly due to hacking and cheating tools, while Mir 2 declined 30% Q/Q in 3Q05, mainly due to pirated servers. We believe the rate of decline from the peak varies, depending mainly on these factors: 1) hacking or pirated server issues, 2) ongoing promotion and user activities, and 3) availability of upgrade packs. Some of the Korean games have still maintained a high level of usage for over 10 years.
Revenues for Long-Running Korean Online Games (In KRW M)
60,000 50,000 40,000 30,000 20,000 10,000 0
1Q 05 3Q 05 1Q 07 1Q 06 3Q 07 3Q 06 1Q 08 3Q 08 3Q 04 1Q 09 3Q 09 1Q 10 3Q 10
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Lineage 1
Source: Company reports.
Lineage 2
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Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com
Japan
Japan Internet Market Overview

Broadband the Norm Mobile Surfing Taking Over
Japan has enjoyed relatively high bandwidth availability since CY02, and with it high internet usage from both fixed line and mobile.
Internet Penetration Rate
million, %
120 100 80 60 40 20 0 CY'01 CY'02 CY'03 CY'04 CY'05 CY'06 CY'07 CY'08 CY'09 Internet subscribers (LHS) Mobile subscribers (LHS) Broadband service (LHS) Penetration rate (RHS) 46.3 57.8 64.3 66.0 70.8 72.6 73.0 75.3 78.0
100.0 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0
Source: J.P. Morgan based on MIC's Survey of "Telecommunications Usage Trend Survey 2009" and "Number of Broadband Service Contracts, Etc." Note: Broadband service is a sum of FTTH, DSL, CATV, and FWA.
Since CY00 we can see that users have become more accustomed to surfing the net via both PC and mobile. In April 2010 according to Nielsen Online, 46% of users accessed the net in this manner; back in April 2000 access via only PC stood at 84%. We believe that with greater smartphone penetration going forward, this trend whereby mobile substitutes for PC usage will continue.
Internet User Population Trend via PC and Mobile
million
80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0
8.2 1.3 2.2 18.8 Apr-00 4.8 5.7 21.2 Apr-01 14.1 26.2 Apr-02
10.2 17.8 25.9
12.4 22.4 24.2
12.4 23.1 23.7
11.3 28.5
11.2 30.7
9.2 35.6
7.9 31.0
8.1 33.8
26.5
27.9
26.3 Apr-08
33.1
31.6
Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 PC only PC & mobile Mobile only
Apr-09
Apr-10
Source: J.P. Morgan based on Nielsen Online Internet Base Survey.
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Internet User Population Trend, Access Via PC at Home

million
60.0 50.0 40.0 30.0 20.0 10.0 0.0 15.4 8.5 3.2 5.4 Apr-00 6.1 9.2 Apr-01 24.3 10.5 13.9 Apr-02 27.1 11.6 15.4 Apr-03 36.9 30.8 13.2 17.6 16.2 20.7 41.1 18.1 44.7 19.7 48.3 21.2
48.6 21.9
51.6 23.7
23.0
25.0
27.0
26.7
27.8
Apr-04 Apr-05 Apr-06 Male Female
Apr-07
Apr-08
Apr-09
Apr-10
Source: J.P. Morgan based on Nielsen Online NetView.
With regard to the gender split of internet users, we have also seen a gradual increase in the female user population for PC traffic.
Internet Penetration by Age and Gender, Access via PC at Home
million, %
14.8 5.1
30% 37%
60 ov er 55-59 50-54 45-49 40-44 35-39 30-34 25-29 20-24 16-19 13-15 2-12
8% 20% 36% 52% 5.2 4.4 3.9 4.0
18.4
62% 3.9 69% 4.1 70% 4.4 58% 4.9 58% 4.2 52% 3.8 49% 2.7 46% 1.9 55% 6.6 27%
4.4
64%
4.3 68% 4.8 71% 4.1 63% 3.6 58% 2.6 46% 1.8 57% 25% 6.3 Female Population Penetration
Male Population Penetration

Source: J.P. Morgan based on Nielsen Online NetView (Apr 2010).
The most active internet users are in the 30-to-44 age group, which is in line with the most active users on eCommerce sites. Advertising on major portals would be greatly influenced by this key demographic group. However, internet penetration is currently fastest in the elderly population (aged 60 and over).
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Internet Penetration by Age and Gender, Access via Mobile

million, %
14.8 5.1 4.4 3.9 4.1 4.4 4.9
8% 20% 24% 42% 55% 54%
60 ov er 55-59 50-54 45-49 40-44 35-39 30-34 25-29 20-24 16-19 13-15 2-12
4% 16% 27% 34% 5.2 4.4 3.9
18.4
58% 4.2 59% 3.8 81% 2.7 75% 1.9 26% 4%
4.0 44% 4.3 52% 4.8 60% 4.1 70% 3.6 72% 2.6 76% 1.8 48% 4% 6.3 Female Population Penetration
6.6
Male Population Penetration

Source: J.P. Morgan based on Nielsen Online NetView (Apr 2010).
When comparing user demographics for mobile internet users, unsurprisingly the core age category is younger than PC internet users, with the 16-to-24 age group being the main users, where penetration is almost 80%.
Smartphone Penetration
%
14% 12% 10% 8% 6% 4% 2% 0%
11.4% 9.6%
11.5%
8.0% 6.3%
8.6% 6.4%
8.3%
10.2%
6.4%
7.1%
4.2% 2.4%
4.7% 2.5%
13-15
16-19
20-24
25-29 30-34
35-39 Male
40-44 Female
45-49 50-54
2.4%
4.1% 5.0%
55-59
5.3% 4.3% 60 ov er
5.2% 4.5%
Total
Source: J.P. Morgan based on Nielsen Online Internet Base Survey (June 2010).
Although smartphone penetration is still low (5.9% according to Nielsen Online), usage rates are relatively high among men in their 30s, and females in their late 20s and early 30s.
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5.9%
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Internet Advertising
Japan online ad spend 11.9% of total ad spend in CY09
We estimate that the online advertising market will resume a healthier growth profile Y/Y for CY10 and CY11, as online media gains more share from traditional mass media and pricing rises. Although this is nothing new, this does bode positively for Yahoo Japan as the leading net property for advertising spend.
Internet Advertising Expenditure

billion, % Internet ad expenditure PC Ad placements Search ads Mobile Ad placements Search ads Y/Y Internet ad expenditure PC Ad placements Search ads Mobile Ad placements Search ads
Source: Dentsu, J.P. Morgan estimates.
CY06 363.0 324.0 231.0 93.0 39.0 39.0 0.0 -
CY07 459.1 397.0 268.8 128.2 62.1 53.6 8.5 26.5% 22.5% 16.4% 37.8% 59.2% 37.4% -
CY08 537.3 446.0 288.5 157.5 91.3 74.3 17.0 17.0% 12.3% 7.3% 22.9% 47.0% 38.6% 100.0%
CY09 544.8 441.7 270.7 171.0 103.1 80.7 22.4 1.4% -1.0% -6.2% 8.6% 12.9% 8.6% 31.8%
CY10E 595.5 481.8 293.7 188.1 113.7 88.0 25.8 9.3% 9.1% 8.5% 10.0% 10.3% 9.0% 15.0%
CY11E 651.4 524.1 317.2 206.9 127.3 97.6 29.6 9.4% 8.8% 8.0% 10.0% 11.9% 11.0% 15.0%
CY12E 705.5 564.9 339.4 225.5 140.6 107.4 33.2 8.3% 7.8% 7.0% 9.0% 10.5% 10.0% 12.0%
Domestic internet advertising spend is expected to continue gaining market share against traditional mass media, as seen with historic trends.
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Domestic Advertising Expenditure by Media Type

billion, % CY05 Value Total ad expenditure Newspapers Magazines Radio TV Satellite media Internet Sales promotion Composition Newspapers Magazines Radio TV Satellite media Internet Sales promotion Y/Y Total ad expenditure Newspapers Magazines Radio TV Satellite media Internet Sales promotion
Source: J.P. Morgan based on Dentsu. Note: Internet advertising includes product expenditure.
CY06 6,940 999 478 174 2,016 54 483 2,736 14.4% 6.9% 2.5% 29.1% 0.8% 7.0% 39.4% 1.7% -3.8% -1.3% -1.9% -1.2% 11.7% 27.8% 3.0%
CY07 7,019 946 459 167 1,998 60 600 2,789 13.5% 6.5% 2.4% 28.5% 0.9% 8.6% 39.7% 1.1% -5.2% -4.0% -4.2% -0.9% 10.8% 24.4% 1.9%
CY08 6,693 828 408 155 1,909 68 698 2,627 12.4% 6.1% 2.3% 28.5% 1.0% 10.4% 39.3% -4.7% -12.5% -11.1% -7.3% -4.4% 12.1% 16.3% -5.8%
CY09 5,922 674 303 137 1,714 71 707 2,316 11.4% 5.1% 2.3% 28.9% 1.2% 11.9% 39.1% -11.5% -18.6% -25.6% -11.6% -10.2% 4.9% 1.2% -11.8%
6,824 1,038 484 178 2,041 49 378 2,656 15.2% 7.1% 2.6% 29.9% 0.7% 5.5% 38.9% -
Domestic Advertising by Media (CY05)

News paper 15.2% Sales promotion 38.9% Magazine 7.1% Radio 2.6%
Domestic Advertising by Media (CY09)

News paper Magazine 11.4% 5.1% Sales promotion 39.1% Radio 2.3% TV 28.9% Internet 11.9%
Internet 5.5% Satellite media 0.7% TV 29.9%
Satellite media 1.2%
Source: J.P. Morgan based on Dentsu.
Source: J.P. Morgan based on Dentsu.
US online ad spend 14.3% of total ad expenditure in CY09
Comparison with US market The US market size for online advertising was $22.7B in CY09, according to the Interactive Advertising Bureau (IAB). The US online market is three times the size of the Japanese market spend, online advertising made up 14.3% of total advertising spend, larger than Japan at 11.9%.
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U.S. Advertising Expenditure by Media Type

$ billion, % TV Newspapers Internet Y/Y Radio Consumer magazines Others Composition (%) TV Newspapers Internet Radio Consumer magazines Others CY04 49.3 46.2 9.6 32.1% 20.7 12.4 63.5 24.4% 22.9% 4.8% 10.3% 6.1% 31.5% CY05 53.9 47.9 12.4 29.2% 21.7 12.9 70.6 24.6% 21.8% 5.7% 9.9% 5.9% 32.2% CY06 72.4 51.2 16.9 36.3% 20.8 24.6 62.5 29.1% 20.6% 6.8% 8.4% 9.9% 25.2% CY07 71.3 48.6 21.2 25.4% 19.8 13.8 18.6 36.9% 25.1% 11.0% 10.2% 7.1% 9.6% CY08 68.2 34.4 23.4 10.4% 17.2 12.7 31.0 36.5% 18.4% 12.5% 9.2% 6.8% 16.6% CY09 62.1 24.6 22.7 -3.0% 14.0 10.0 25.6 39.1% 15.5% 14.3% 8.8% 6.3% 16.1%
Source: IAB Internet Ad Revenue Report; PricewaterhouseCoopers.
U.S. Internet Ad Revenues by Industry

% CY08 (1) Retail Telecom Financial services Automotive Computing Consumer packaged goods Leisure travel Entertainment Pharma & healthcare Media Others Total
Source: IAB Internet Ad Revenue Report; PricewaterhouseCoopers.
CY09 (2) 20.0% 16.0% 12.0% 11.0% 10.0% 6.0% 6.0% 4.0% 4.0% 4.0% 7.0% 100.0%
(2) - (1) -2.0ppt 1.0ppt -1.0ppt -1.0ppt 0.0ppt 0.0ppt 0.0ppt 0.0ppt 0.0ppt 1.0ppt 2.0ppt -
22.0% 15.0% 13.0% 12.0% 10.0% 6.0% 6.0% 4.0% 4.0% 3.0% 5.0% 100.0%
Sector-wise spending is focused on retail, telecom and financial services different from Yahoo Japans core exposure to financial services, auto, cosmetics/toiletries and real estate. The IAB Internet Advertising Revenue Report shows that revenues were recovering +11.3% Y/Y in 1H CY10 in the U.S.
China online ad spending made up 10% of total ad expenditure in CY09
Comparison with China market In CY09 the China online ad market was US$2.1B, growing about 21% Y/Y and making up 10% of total advertising spend. Compared to the US and Japanese markets the size remains relatively small.
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Internet Advertising Expenditure CY09 - U.S., Japan and China

$ billion
25.0 20.0 15.0 20.4%
30.0% 20.0% 10.0%
10.0 5.0 0.0 -3.0% U.S. 1.2% 0.0% -10.0% Japan Internet Ads Spend (LHS) Y/Y (RHS) China
Source: J.P. Morgan Asia Research, Dentsu, and IAB Internet Advertising Revenue Report. Note: Currency based on end-December, 2009.
Comparison of Traffic and Sales for Key Domestic Internet Names

Company Code Monthly visitors Registered users (M) 20.7 0.4 19.9 7.1 20.6 17.4 24.0 9.9 41.4 Unique users (M) 14.1 9.4 27.6 20.0 224.2 Monthly page views PC (B) 5.2 0.6 0.8 0.4 2.3 40.9 7.5 Mobile (B) 24.3 0.1 71.6 35.4 7.9 7.1 Sales (Apr-Jun 2010) PC ( M) 4,013.0 2,207.0 3,561.6 5,902.0 6,931.0 70,506.0 1,940.0 41,300.0 Mobile ( M) 24,193.0 10,940.0 Sales per PV (month) () 0.05 1.60 0.11 2.34 0.10 1.02 0.48 0.04 Sales per visitors (month) () 94.87 77.93 43.05 404.63 98.37 177.11 132.47 104.81 65.45 332.69
Mixi Cookpad Kakaku.com DeNA Gourmet Navigator Gree Dwango Yahoo Japan Cyber Agent Rakuten
2121 2193 2371 2432 2440 3632 3715 4689 4751 4755
Source: J.P. Morgan based on companies data. Note: Unique users refer to the # of accessing users in a month. Rakuten visitors refers to both PC and mobile ads combined; sales refer to total net services (EC, travel, and portal media). Cyber Agent refers to Ameba business. DeNA refers to Mobage mobile portal. Dwango refers to Nico Nico Douga video site. Data as of end-June 2010.
eCommerce
The size of the Japanese B2C eCommerce market is estimated to be 4.5T, which is approximately 3.3% of the entire domestic retail market, worth 135.0T. However, in the core internet user demographic (i.e., 30-to-40 age group), eCommerce makes up a greater proportion of individual retail activity. Internet shopping also now dominates the non-store retail channel (such as phone, television and catalog mail order), with around 60% market share.
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Trend of Domestic BtoC ECommerce Market

billion %
5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0
145.2%
160% 140% 120% 80.1% 80.9% 85.4% 100% 80% 64.8% 25.4% 19.4% 22.1% 17.0% 60% 40% 13.1% 20% 0% CY'09
CY'00
CY'01
CY'02
CY'03
CY'04
CY'05
CY'06
CY'07
CY'08
BtoC (retail & service, LHS)

Source: J.P. Morgan based on METI Surveys on eCommerce Market Size. Note: CY00 to CY04 are based on J.P. Morgan assumption.
Y/Y(RHS)
Online shopping is dominated by Rakuten, Amazon Japan and Yahoo Japan. The number of items for sale shows that the leaders have taken a long tail approach.
Number of Items for Sale
Rakuten 65,706,254 items Amazon Japan 28,566,407 items Yahoo Shopping 36,295,435 items Yahoo Auction 22,490,000 items
Source: J.P. Morgan based on company data. Note: Rakuten and Amazon Japan data as of Oct. 15, 2010, Yahoo Shopping Oct. 28, and Yahoo Auction end-Sep. 2010.
The marketplace model (virtual shop tenants operating on a platform) has been very successful in Japan, as seen by the number of merchants active on Rakuten and Yahoo Japan.
Number of Merchants
Rakuten 35,681 stores Yahoo Shopping 17,834 stores Yahoo Auction 17,393 stores
Source: J.P. Morgan based on company data. Note: Rakuten data as of Oct. 15, 2010; Yahoo Shopping and Yahoo Auction end-Sep. 2010.
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Survey Most Recent Online Shopping Site Used via PC

Manufacturer direct sales 7% Niche e-tailer 8% Real w orld retailer net store 8% Other online mall operators 4% Catalogue sales companies 9% Amazon Japan 13% Yahoo! Shopping 8% Unknow n 4% Rakuten Books 9%
Rakuten Mall 30%
Source: J.P. Morgan based on Fujitsu Research.
Service comparisons between leader Rakuten and Amazon Japan We believe the key differences in the services offered by Rakuten and Amazon Japan are: Amazon Japan has greater flexibility to offer customer experience improvements for shopping online (such as same-day delivery, private brands), given its key role as a retailer with the necessary infrastructure in place. Rakutens strength lies in product selection and the ability to offer different online services within the group, such as travel and financial services, in addition to auction.
Comparisons of Rakuten and Amazon Japan
Rakuten Characteristic Shopping model Third party sellers Own brands Free delivery Same-day delivery 24 hour delivery eBook sales Fulfillment services Point program Auction items Group buying Settlement and delivery at convenience store Gift card availability Credit card services All marketplace (online mall tenants) Mainly retailers and individuals None On select items and books None Yes - on select 'Rakuten 24' service None Yes - on select 'Rakuten 24' service Rakuten Points Available Available None None Rakuten Point Club card Amazon Japan Primary retailer, with growing third party sellers Include manufacturers Javari Amazon Basic On all items Yes - on select items Yes - pending stock availability Via Kindle eBook reader For in-house and third party sellers using Fulfillment services Amazon Points - but not applicable to all items None None Lawson Available No
Source: J.P. Morgan based on company website.
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There has been a growing emphasis by Amazon Japan on its third-party seller base, as it aims to diversify its products on offer. A comparison of marketplace fees highlights the following: Rakuten has an initial fee and fixed monthly charge, which provides an incentive that attracts many mall operators. Amazon Japan has a smaller monthly fee for large sellers, but its cost structure is more complex. The seller has the option for fulfillment to be carried out by Amazon Japan. We think Rakutens brand and cost structure is likely to prove attractive to individuals and small businessesespecially for first timers.
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Participation Costs for Marketplace Sellers

Rakuten Ichiba Monthly fixed fee Number of items registered for sale Variable commission Contract period Payment method Initial joining fee Yahoo! Shopping Store Monthly fixed fee Number of items registered for sale Variable commission Contract period Payment method Initial joining fee Amazon Market Place (Japan) Monthly fixed fee Basic contract System charge Number of items registered for sale Variable commission Per transaction sales fee (domestic sales) Initial joining fee eBay Auction-style format listings -- Insertion fees Starting or reserve price $0.01 - $0.99 $1.00 - $9.99 $10.00 - $24.99 $25.00 - $49.99 $50.00 - $199.99 $200.00 or more Final sale price Item not sold $0.01 - $50.00 $50.01 - $1,000.00 $1,000.01 or more Buy It Now price $0.99 or higher Final sale price Item not sold $0.99 - $50.00 $50.01 - $1,000.00 $1,000.01 or more Insertion fee Free (up to 100 listings) $0.25 $0.50 $0.75 $1.00 $2.00 Final value fee No fee 9.0% of sale price (maximum charge $50.00) 9.0% of sale price (maximum charge $50.00) 9.0% of sale price (maximum charge $50.00) Insertion fee $0.50 Final value fee No fee 8~15% of the final sale price 8~15% of the initial $50.00, plus 5~9% of the remaining final sale price balance 8~15% of the initial $50.00, plus 5~9% of the next $50.01-$1,000.00, plus 2% of the remaining final sale price balance % Item % Large plan 4,900 No limit, All 21 categories 21 categories: 8~20% 4 categories: 30~140 Other categories: free Small plan 100 per transaction Category limits in place, max 1 mn price tag 15 categories: 8~15% Others are un-registerable 15 categories: 30~140 Others are un-registerable Item % Regular plan 20,790 200,000 3.0~4.5% 6 mos Payable at 1 mos. 21,000 Master plan 31,290 200,000 2.1~3.9% 1 yr 21,000 Royal plan 52,290 200,000 1.9~3.7% 1 yr 21,000 Item % Standard plan 52,500 20,000 2.0~4.0% 1 yr Once in 6 mos 33,600 Ganbare! Plan 20,475 5,000 3.5~6.5% 1 yr Yearly 33,600 Light plan 41,790 5,000 3.5~5.0% 3 mos Once in 3 mos 33,600 Mega-shop plan 105,000 No limit 2.0~4.0% 1 yr Once in 6 mos 33,600
-- Final value fees
Fixed price format listings -- Insertion fees -- Final value fees
Source: J.P. Morgan based on company websites. Note: Tax included. Data as of end-Sept. 2010.
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SNS in Japan
Japanese SNS sites first appeared in 2003, the same time as US/European counterparts
Background Western social networking services such as Friendster and MySpace began in 2003, making an impact as the concept of expansive online communities took hold. It was around the same time that numerous small special-interest SNS sites were emerging in Japan, but the two generalist sites that began to build major user bases were: MixiInitially an online PC service with an invitation-only user registration format. Began in February 2004, with a mobile service starting in September 2004. GreeCommenced as a PC service with open registration to users in February 2004, launching a mobile service in December 2004 which became the mainstay service.
Mixi and Gree both began in February 2004
Mobile SNS and gaming content spurred user adoption
Japans user-generated content sites were predominantly in the form of blogs (online diaries) and forums (such as 2Channel). User adoption of SNS however was relatively swift, in part due to the convenience factor offered by mobile access, and with the more recent introduction of social gaming content. Key characteristics The defining characteristics of Japanese SNS sites are as follows:
Key Characteristics of Japanese SNS
Potential user audience Current user penetration User growth Gender split User age group distribution Age group with highest ARPU PC SNS usage Mobile SNS usage Popular settlement method for virtual currency Mobile SNS sales split PC SNS sales split Social graph
Source: Companies' data, J.P. Morgan estimates.
Estimate 40M (50% of 15 to 64 age group), 30% of national population Estimated 50% - 60% of potential user audience 35% Y/Y (at Sept 2010) Dependent on site, overall evenly split between male and female - Under 20 years old - 18% - 20 years to 30 years old - 41% - 30 years and above - 41% 30 years old and over Less than 5% of total user traffic Over 95% of total user traffic driven by gaming content Mobile carrier settlement Virtual goods and gaming content - 80% Advertising - 20% Virtual goods and gaming content - 20% Advertising - 80% Predominantly virtual; real identification rarely used
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User Demographics
Under 20 18.0% Over 30 41.0%
Traffic Per Platform

PC SNS usage 5.0%
20 to 30 41.0%
Source: Company data, J.P. Morgan estimates. Source: Company data, J.P. Morgan estimates.
Mobile SNS usage 95.0%
Sales Split
20.0%
80.0% 80.0%
20.0% Mobile SNS sales split PC SNS sales split Vitual goods and gaming content Advertising
Source: Company data, J.P. Morgan estimates.
From the above, we believe there are two key issues that face the SNS industry: The focus on the mobile platform means that the advertising market remains small, although it remains a growth area. The leaning toward virtual social graphs and user behavior focused on gaming also limits its appeal as advertising media. The key earnings driver is virtual goods and gaming content. We believe that the SNS market (both advertising and social gaming) is worth around 200B in CY10 growing at 185% Y/Y, with DeNA (40%), Gree (25%) and Mixi (5%) making up around 70% of total market share. We believe growth will slow drastically to 15% Y/Y in CY11, a marked slowdown as both user numbers and ARPU growth domestically begin to flatten with market saturation. Social gaming Social games are simple-to-play titles that were inherently free to play, encouraged user interaction, and introduced pay-to-play virtual items for sale to enhance game play experience a common freemium model whereby a basic web service is offered for free, while charging for premium offerings. Gree was the first SNS to successfully pioneer the concept of mobile social gaming in 2007.
Gree pioneered social gaming in 2007
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Current market leader DeNA commenced social gaming in 2009
The latecomer to social gaming was DeNAs Mobage mobile site, which originally started as a standard publishing mobile gaming portal in February 2006. The site changed into a SNS service later that year with the introduction of avatars, with the company launching its social gaming service in October 2009.
Structure of SNS Services

The basic structure of an SNS consists of the following: User profile either real (e.g. real name) or virtual (e.g. pet name) personal data Posting diary entries/blog posts Compile and share a list of contacts allowing users to search and connect to each other Joining specialist interest communities The key aim is to be able to stay in touch with your contacts and to allow for ease of communication as well as the ability to behave as a group in a virtual setting. Service overview Domestic mobile SNS sites have evolved to become a generalist destination site like a portal, as they have expanded the services on offer:
SNS Service Overview
Service Social networking functionalities - User profiles - Blogs - Friends/contacts - Groups/communities - Mail function - Avatars Games - Casual games - Social games - Core gaming content Virtual currency User generated content - Photos - Novels - Music Entertainment and information content - News - Weather - Transport/access search - Search - Reference data - Horoscopes - Celebrities content Premium services Comments Mostly pet names and pseudonyms on domestic SNS sites Online diary entries List of users on your personal network Joining special interest forums Used as email/messaging service Virtual characters, which can be 'dressed up' usually for a fee In-house developed as well as third party. Use of Flash and Java programming. Staple basic puzzle games, generally a free service Key earnings driver for DeNA and Gree More akin to traditional videogame titles, subscription fee service Prepaid currency to purchase virtual items, primarily for gaming content All uploaded by individual users for general consumption Uploading pictures Artist profiles and fan clubs Content generally found on a PC portal services
Equivalent to Wiki pages Additional services for PC site access, such as additional data storage capabilities
Source: J.P. Morgan based on company data.
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Domestic SNS a de facto mobile service
Apart from the wealth of content on offer, the key difference between Japanese and overseas SNS services is the focus on the mobile platform versus the PC. We believe this occurred due to the following factors: Early adapters of mobile services were the younger under 30 demographic, whose net usage behavior was skewed to handset usage rather than PC, thereby meeting their needs.
Fast, affordable data
The fall in pricing for packet download fees via carrier competition, and the introduction of fixed pricing plans made heavy mobile usage more affordable. Ease of purchase of virtual currency via carrier settlement made it more convenient to transact.
Convenient carrier billing
Social Gaming Primer

Revenue structure Key points related to the revenue model for social gaming are as follows: The pay-to-play revenue model is a valid approach to online gaming, as users tend to reward for quality content after first being able to assess its worth via the free-to-play environment. Games on offer can be in-house developed by the SNS operator, or by third-party developers. An open platform allows for greater product diversity. Virtual currency is required to purchase game itemsa common method to acquire currency is via carrier settlement, credit card, or prepaid money available at convenience stores.
Social Game Monetization Model

SAP games User acquires x currency Purchase game items 30% Commissions recognized 70% paid to SAP
In-house game application 10%~15% Carrier commissions All revenue recognized
Source: J.P. Morgan assumption. Note: SAP stands for Social Application Provider, a developer of a social game application.
Why social gaming can be highly profitable The success of social gaming comes from two key angles: The relatively low barrier to entry into the market via low development costs. Low priced download titles and free-to-play item sale titles are meeting the needs of gamers, and replacing demand for mid-tier quality software from the traditional videogame industry.
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The launch of a social gaming title is the start of on ongoing development cycle, where the game can be fine-tuned and improved on the go' with direct customer feedback.
We set out the basic cost structure for developing and operating a social gaming title.
Social GamingInitial Cost Estimates
Initial development costs Server costs Marketing costs
10M - 30M Around 25% of revenue generated (15% for hardware, 10% for tuning) Usually low, apart from flagship titles that can use TV advertising
Traditional Videogame PlatformsIllustrative Development Cost Estimates

Game Platform Nintendo DS Sony PSP Wii PlayStation 3/Xbox 360
Cost 10.0M - 50.0M 10.0M - 75.0M Upwards of 0.4B Upwards of 1.0B
We are making a generalization of development costs for traditional video gaming software, which can range significantly in scale and budget. However, social gaming titles involve a relatively small outlay of cost to start up and operate. The key attractions here are that: Marketing costs are relatively low, as internet content there is greater emphasis on viral marketing and user feedback The ability to exceed breakeven point is relatively easy, resulting in a potentially high margin earnings stream. The key variables in the revenue structure of a typical social game are as follows:
Social Gaming TitlesTypical Factors Affecting Revenues
Revenue Variables Participation rate of total registered user base Typical monthly ARPU range for registered users Monthly ARPPU (Average Revenue Per Paying User) range Game shelf life/lifetime value period For reference typical pricing range of handheld software Nintendo DS software PSP software
Range 2% - 6% 50 - 300 1,000 - 5,000 3 month to 12 months typically; average 6 months
2,800 - 4,800 5,040 - 6,090
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From this, we can surmise that a simplified game title revenue model is: Gross revenue = Number of registered users Participation rate ARPU Shelf life Less the following costs to derive profit: Server fees and game tuning = gross revenue around 25% Marketing costs Initial development fee Carrier and platform provider commissions Therefore, it is possible to exceed the breakeven point in a comparatively short period of time and generate earnings over the longer term through this model. Also, titles can be cancelled if proven to be unsuccessful, with no negative residual issues such as reducing pricing or scrapping inventory. Cost drivers The initial cost driver for social gaming is staffing cost related to engineers and creators developing a game title. After release the key cost drivers are marketing spend to promote the title, and server costs as user traffic increases.
Marketing is a user acquisition cost must balance with ARPU
Marketing costs in the early-to-mid cycle stages of a game title release can be viewed as a user acquisition costthe cost and investment required to win new users, as well as keeping old ones active. Despite growth in user traffic generated by gaming content, traffic growth is limited and marketing costs are a necessary tool to encourage user activity.
Monthly ARPU and Avg. Monthly User Acquisition Costs (UAC) Trends (CY10)
/person
1,200 1,000 800 600 400 200 0 Jan-Mar Apr-Jun mixi Jul-Sep Jan-Mar Apr-Jun 66 209 63 13 58 89 550 292 679 357
956 549 192
372
367 176
469 187
Jul-Sep
Jan-Mar
Apr-Jun GREE
Jul-Sep
DeNA ARPU UAC
Source: J.P. Morgan based on company data. Note: Number of users is calculated by taking the average of the current and the last quarter end.
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ARPU and User Acquisition CostY/Y Growth (CY10)

/person Mixi DeNA Gree Jan-Mar Apr-Jun Jul-Sept Jan-Mar Apr-Jun Jul-Sept Jan-Mar Apr-Jun Jul-Sept ARPU 65.5 63.1 58.0 292.3 356.9 371.8 175.8 186.9 192.2 Y/Y 9.1% 10.7% 0.6% 69.9% 186.1% 234.1% 20.6% 22.4% 16.9% UAC 209.3 13.3 89.4 550.3 678.8 956.1 367.2 468.7 549.4 Y/Y 2909.1% 100.9% 3555.5% 25.9% 196.1% 211.6% 246.7% 182.7% 284.6%
Social application providers The SNS sites act as a platform for social network game developers (called Social Application Providers, or SAP) to plug in game applications on the sites, with the view of generating revenues either by virtual items sales or generating advertising income for traffic generated. Major overseas players include Zynga, Electronic Art's subsidiary Playfish, Disneys Playdom, RockYou!, and other key players on the Facebook PC platform such as CrowdStar , 6 Waves (based in Hong Kong), and Digital Chocolate Inc. We view major PC browser-based game companies as a cluster of new entrants into the social gaming marketkey players here are Germany's Bigpoint and Gameforge, Frances Gameloft, UKs Mind Candy and Jagex. Key SAP companies in Japan are as follows: CyberAgent (4751): A leading online advertising agency and blog site, has established three dedicated subsidiaries to social gaming KLab: IT services firm with social gaming content Cave (3760): A PC online game operator branching out into smartphone social gaming
Foreign SNS Presence in Japan

Foreign SNS sites are not virtual communities, unlike Japanese SNS sites
Foreign SNS sites tend to focus on real social graphs, and we believe this has been the overriding factor in their lack of popularity in Japan where users prefer greater privacy. The exception has been the social networking and microblogging service Twitter. FacebookThe largest global SNS platform provided by Facebook Inc. Nielsen Netview estimates that there are two million Facebook PC users in Japan as of September 2010. TwitterTwitter is a mini-blog service provided by Twitter Inc. Nielsen Netview estimates that there are 11.1M Twitter PC users in Japan as of September 2010. We believe that there is more user activity on the mobile platform, especially with the adoption of smartphones.
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Internet Usage Rates (September 2010)

Monthly visitors (M) 9.6 11.1 2.1 Reach (%) 15.8 18.4 3.4 Monthly Pageviews (M) 3,369 841 119 Average pageviews (PV) 353 76 57 Average usage duration (minutes) 206 41 36
Mixi Twitter Facebook
Source: Nielsen Netview , J.P. Morgan. Note: Reach is calculated as the number of monthly visitors divided by the potential domestic internet user audience.
Overseas ExpansionAn Assessment of Growth Prospects

Assessing competitive forces The SNS market is a developing growth business and is therefore a target of both start-ups and mature businesses aiming to take advantage of its user traffic growth. With reference to Michael Porters Five Forces model to assess the competitive landscape of SNS and social gaming, we conclude that despite the potential growth prospects, it is rapidly becoming an overcrowded and highly competitive space.
Competitive Forces Analysis
Competitive Forces Barriers to entry Threat of new entrants Bargaining power of buyers Bargaining power of suppliers Competitive rivalry Conclusion
Rating LOW HIGH HIGH MEDIUM HIGH
Commentary Initial investment (time and cost) low for application development No technology barriers to develop social games/SNS - Individuals can easily develop content and self-publish - PC browser-game developers targeting smartphone market - Traditional video gaming companies adopting to social gaming Users can choose to ignore or embrace new games Switching costs are virtually zero Application developers choose the most successful SNS platform to provide content The lack of quality content results in quickly falling user traffic SNS sites spend user acquisition costs to attract new users Existing users need to be continually engaged to remain customers A highly competitive environment
Barriers to entry: Physically and technologically low barriers to build a SNS/social gaming applications; know-how over game development and tuning can be gained over time. Threat of new entrants: Substitution risk is high for social gaming developers as new entrants appear from PC browser-game market and the traditional videogaming players. Bargaining power of buyers: End users can choose and decide whether a game is worth playing or not, impacting future monetization. Bargaining power of suppliers: Social gaming developers can choose to place their content on SNS platforms of choice. Less popular SNS sites are not seen as desirable given less user traffic generated. Competitive rivalry: It is much easier to make and release a game with available authoring tools, and with self-publishing distribution channels such as the Apple App Store and Android Markets. This has thrown the door wide open to new
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entrants, and localized players are all beginning to look at the global picture for growth opportunities in the SNS market. With overseas markets expected to be a new growth opportunity, we believe that this view overlooks the intensifying competitive forces involved. Overseas M&A activity Domestic SNS players and leading social application developers are eager to explore and build overseas growth opportunities. DeNA acquired US company ngmoco in October 2010, but there have been other transactions taking place.
Recent M&A Activity in Social Gaming Space
Company Playdom Playfish Chillingo ngmoco Astro Ape Gameview Studios IceBreaker US Inc Slide.com Unoh Acquirer/investor Disney Electronic Arts Electronic Arts DeNA DeNA DeNA DeNA Google Zynga Japan Price $563M + $200M earn-out $300M + $100M earn-out Less than $20M $303M + $100M earn-out NA NA NA $182M NA Date Jul-10 Jul-09 Oct-10 Oct-10 Sept-10 Sept-10 Oct-09 Aug-10 Aug-10 Daily Average Users 4.6M 7.7M NA NA NA NA NA NA NA
Source: Company reports and J.P. Morgan estimates.
The key difference between DeNA and other deals undertaken is that the company is acquiring firms with a focus on the smartphone platform e.g. content on iPhone and/or Android, as opposed to the PC. Although this approach may buy time for DeNA versus competitors also diversifying into smartphones, we believe this will not be a major competitive advantage over the medium term.
Differences in ARPU
DeNA has highlighted a major difference between social gaming markets in Japan and the West: (1) Compared to Facebook, DeNA estimates that its ARPU is 30 times higher and (2) compared to Zynga, DeNA estimates that its ARPU is 15 times higher. ARPU difference is significantly affected by the type of community (virtual or social). DeNA operates on a mobile platform, with a virtual community social graph; Facebook and Zynga are PC-based with a real social graph. Japanese mobile user behavior is adapted to mobile gaming, and virtual user interaction fosters gaming activity. Conversely, we believe that operating a SNS with a real social graph will not be a conductive environment to really drive gaming behavior to the levels seen in Japan.
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Monthly ARPU Comparison (July-September 2010E)

/person
400 350 300 250 200 150 100 50 0 mixi

372
157 58
DeNA
GREE
Domestically, Mixis ARPU is lower than its peers due to: Revenue driver remains advertising. Users on the Mixi SNS mostly go to the site for communication purposes, as opposed to social gaming, which is the main draw for DeNA and Gree.
Smartphone AdoptionNew Distribution Channels International Data Corporation (IDC) estimates that global smartphone shipments will grow 55.4% Y/Y in CY10, from 173.5M units in CY09 to 269.6M units. Growth is expected to continue at 24.5% Y/Y in CY11. This is a factor that would drive SNS and social gaming companies to see smartphones as new distribution systems for their services, rather akin to video gaming software makers that took the 'multiplatform' approach for their game titles. IDC expects that Symbian will be the leading operating system by 2014, followed by Android.
Worldwide Converged Mobile Device Operating System Market Shares and 2010-2014 Growth
Operating System Symbian BlackBerry OS Android IOS Windows Mobile Others 2010E Market Share 40.10% 17.90% 16.30% 14.70% 6.80% 4.20% 2014E Market Share 32.90% 17.30% 24.60% 10.90% 9.80% 4.50% 2014E/2010E Change -18.00% -3.50% 51.20% -25.80% 43.30% 8.30%
Source: IDC Worldwide Quarterly Mobile Phone Tracker, September 7, 2010
While there is a positive outlook from a market growth perspective for smartphones, we are drawn to the competitive threats involved despite the Apple iOS and Android platforms being perceived as a green-field site.
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Competition in the Smartphone Game Application Market
PC browser / SNS game developers - Zy nga - Play dom - Play fish - RockYou - Crow dStar Domestic social application profiders - Cy ber Agent - Cav e
iPhone Apple iOS / Android
Domestic feature SNS platforms - Facebook - My Space phone SNS Traditional videogame companies - Capcom - KONAMI - Square Enix - Tecmo Koei - Namco Bandai - DeNA - GREE - mix i
We feel that in order for smartphone penetration overseas to result in (1) a major hike in user activity on SNS sites and (2) widespread adoption of social gaming content, the following environment is necessary: Social gaming content has high penetration rates in Japan, as the social graphs are virtualoverseas SNS sites which have real social graphs will have to replicate this level of activity, or With compelling content on offer, virtual SNS sites need to be built with virtual communities, offering a new service compared to real social graph SNS. A current proxy would be Microsoft's Xbox Live online gaming service on the console. We do however believe that social gaming will be appealing to a niche audience overseas, which in terms of scale may still present an attractive new market for Japanese companies to target.
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Major Smartphone Platform Distribution Channels

Android Market Google Oct-08 Android OS 55,000 20 Credit charge 30% 70% Android app Java Android Market App Store Apple Jul-08 iPhone OS 85,000 100 Credit charge 30% 70% iPhone app Objective- C/C++ iPhone Dev Center Windows Marketplace for Mobile Microsoft Sep-09 Windows OS 1,000 NA Credit charge 30% 70% Windows Mobile app .Net Windows Mobile developer Center Ovi Store Nokia May-09 Symbian OS 10,000 Over 100 Credit charge, SMS charge carrier charge, adding charge 30% 70% Symbian app, Java app WRT widget, Flash app C/C++, Java, JavaScript FlashLite 1.0, 1.1, 2.0, 2.1, 3.0 Forum Nokia BlackBerry App World Research In Motion Apr-09 BlackBerry OS 6,000 41 Credit charge 20% 80% Java app Java BlackBerry Developer Zone Palm App Catalog Palm Jul-09 WebOS 1,000 5 Credit charge 30% 70% WebOS app JavaScript/CSS/HT ML Palm Developer Network
Operator Start date OS/Runtime Apps offered Users (M) Charge methods Revenue % (operator) Revenue % (developer) App name App development language Site name for developers
Source: J.P. Morgan, based on "Internet White Paper 2010" (Impress Japan).
Overseas Social Gaming Networks

OpenFeint Plus+ Gameloft Live Scorep AGON Online Crystal Social Gaming Network
Description Social gaming platform, with DeNA as a passive investor ngmoco's social game platform Gameloft's mobile gaming network with 1.5 million users Funded by European VCs Target Partners and Earlybird Operated by Aptocore founded in 2008 Platform devised by Chillingo, now acquired by Electronic Arts A game developer on iOS for multiplayer games
Platform iOS, Android iOS, soon Android iOS, Android iOS, Android iOS iOS iOS, soon Android
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Valuation Table
Company Code Currency Market cap Share price Liquidity (daily) P/E Div. yield EV/EBITDA EV/sales P/B Price movt. (B) () ($M/day) (X) (X) (X) (%) (%) (%) (X) (X) (X) (X) (X) (X) (X) (%) (%) (%) (%) Yahoo Japan 4689 JPY 1,853.3 31,950 33.1 19.9 18.2 16.9 1.0 1.4 1.5 9.3 8.6 8.0 5.4 5.1 4.8 6.0 6.2 9.0 -11.8 14.1 Rakuten 4755 JPY 893.4 68,200 27.4 24.8 21.6 19.4 0.1 0.1 0.1 13.7 12.3 11.2 3.1 2.8 2.7 4.4 7.1 7.6 9.8 -3.7 Mixi 2121 JPY 68.3 441,500 9.5 37.1 28.6 21.9 0.0 0.0 0.0 11.1 9.5 7.7 3.3 2.7 2.2 4.7 4.1 -0.5 2.1 -40.7 DeNA 2432 JPY 420.7 2,954 113.4 12.7 11.0 11.4 1.6 1.8 1.8 6.7 5.8 6.0 3.4 2.8 2.7 12.2 21.1 9.3 14.7 56.2 Gree 3632 JPY 243.1 1,069 56.8 14.4 12.7 11.5 0.5 0.5 0.5 7.5 6.6 6.0 4.0 3.4 3.0 11.8 6.9 -22.1 -25.2 -7.1 CYBER AGENT 4751 JPY 115.1 177,900 44.3 17.9 14.5 13.1 1.5 1.8 2.0 7.2 6.0 5.3 0.9 0.8 0.7 4.5 12.7 18.5 38.8 6.2 Kakaku. com 2371 JPY 137.3 474,000 10.9 29.9 23.7 20.1 0.6 0.7 0.8 15.2 12.1 10.0 7.6 6.3 5.4 13.7 13.1 3.5 26.8 32.6 Gourmet Navigator 2440 JPY 30.9 118,900 1.6 17.7 13.6 13.8 1.7 1.7 1.7 5.1 4.6 4.6 1.0 0.9 0.9 2.7 -1.7 7.6 9.1 -40.2 Weighted avg. 20.5 18.1 16.6 0.8 1.0 1.1 10.1 9.1 8.4 4.4 4.0 3.8 6.9 -
F10E F11E F12E F10E F11E F12E F10E F11E F12E F10E F11E F12E F09A 1 month 3 month 6 month 1 year
Efficiency of capital ROE (%) ROA (%) ROCE (%)
F10E F10E F10E
26.2 18.8 43.4
16.2 2.0 11.4
11.9 9.3 23.2
63.9 29.0 102.5
55.9 31.7 94.2
17.9 23.6
37.7 26.6 45.0
13.8 25.9
29.8 44.6
Source: Company data, Bloomberg and J.P. Morgan estimates. Note: Yahoo Japan, Rakuten, Mixi, DeNA and Gree are based on J.P. Morgan estimates. CyberAgent, Kakaku.com and Gourmet Navigator are based on Bloomberg consensus estimates. Share prices as of December 29, 2010.
80 218
Sungmin Chang, CFA (82-2) 758-5719 sungmin.chang@jpmorgan.com
Korea
Korea Sector Summary

We recommend investors switch from NHN to Daum for internet exposure based on Daums superior growth outlook and valuation merit. We believe Daum is currently oversold due to overblown concerns on the Overture impact as well as its small market cap. As a result, Daum is currently trading at a deep discount to market leader NHN, despite the fact that it has a better growth outlook and its revenue consists of only search and display ad compared to NHN which generates about 30% of revenue from the lower multiple business of internet gaming. As Overture concerns fade and Daum continues to generate superior earnings over the next few quarters, we believe the valuation discount will disappear and this will drive continued outperformance for Daum.
Divergent Growth Momentum

Daum has been gaining market share in both search and display from 2008 based on improved service quality and renewed focus on core businesses. Given basic traffic volume that amounts to over 70% of NHNs, we believe Daums growth momentum has more legs. Daum currently targets to increase its search market share to 30% by 2012 from the current 22%, while it has been raising pricing for both search and display ad more aggressively than NHN on the back of a big pricing gap.
Search Ad Revenue Growth
110 90 70 50 30 10 (10) 1Q 06 2Q 06 3Q 06 4Q 06 1Q 07 2Q 07 3Q 07 4Q 07 1Q 08 3Q 08 2Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 NHN Daum %
Display Ad Revenue Growth

120 100 80 60 40 20 0 (20) 3Q10 2Q10 1Q10 4Q09 3Q09 2Q09 1Q09 4Q08 3Q08 2Q08 1Q08 4Q07 3Q07 2Q07 1Q07 4Q06 3Q06 2Q06 1Q06 NHN Daum %
Source: Company data.
Source: Company data.
Overture Impact
As NHN defects Overture, which is a middleman between portals and advertisers, to internalize the intermediary platform business, Daum faces potential losses in advertiser pool. Such defection is seen as a threat, as it will likely lower clearing prices at Overture. While Daum was guiding for a maximum 20% decline in pricing over the next two years, its view has changed to a more positive one recently based on interaction with resellers. This means overall pricing pressure may turn out to be substantially smaller than previous guidance suggested, in which case there is room for positive earnings revisions from the Street over the next few months.
81
219
Positive Mobile vs. Negative SNS Impact in 2011

The internet sector is a very dynamic space where consumer preferences can change on a whiff. As such, the recent surge in popularity of SNS services such as Facebook and Twitter are negative developments for NHN and Daum in that they could lure away traffic in the longer term. For now, however, we think the impact is limited due to a relatively small user base for these new services but the longer-term impact will depend on how NHN and Daum can protect their traffic base by offering their own SNS services to satisfy consumer needs. Mobile service, on the other hand, provides new growth momentum, as smartphone penetration is headed for over 30% in 2011E. As consumers increasingly access web on the move, this should create additional demand for Internet portals down the road. In this space, Daum is also leading NHN for now on the back of earlier investments in mobile content.
.
82 220
83
Companies
84 2
Global Equity Research

03 January 2011
Alibaba.com Limited
Slowdown in Customer Growth Limits Near-term Stock Upside
We remain Neutral on Alibaba with a Dec-11 PT of HK$16. We expect Chinas marketplace to grow at a faster rate than the international marketplace in 2011. Value-added services should also continue to gain more revenue share in 2011. International marketplace net-adds to continue to be slow: With higher fee Rmb30K annual fee package launch next year, and Alibabas plan to slow down new customer net adds, 2011 membership net-adds are likely to see slow growth. We forecast around 4K quarterly net-adds in 2011. China marketplace revenues accounted for ~34% of total revenues in 2010. We expect China marketplaces share to increase with the increase in the domestic eCommerce market. We currently expect Chinas marketplace to grow 36% YoY vs. the international marketplace expected growth rate of 20% YoY in 2011. Future monetization potential on Alibaba platform: AliExpress (international transaction base platform) saw GMV (gross merchandise volume) up 3 times QoQ in 3Q10. AliLoan program cumulative loan amounts reached Rmb20 M. Both could lead to longer-term monetization potential. AliLoan could start monetization as soon as 1H10. International expansion is still in the early stages. India and Turkey are the key potential target markets for the company. Company to execute Work at Alibaba strategy in 2011. Meet at Alibaba has been the company strategy for many years. Alibaba offers SMEs access to Alibabas marketing services (annual fee to marketplace, VAS for keywords, etc.) in order to meet with potential buyers. The newly added Work at Alibaba strategy will help SMEs to reduce operating costs by offering them more value-added services. 2011 drivers: (1) Increasing monetization of value-added services, (2) Good growth in China marketplace from growth of local eCommerce market, (3) Improvement in operating margins from leverage over SG&A expenses.
Reuters: 1688.HK; Bloomberg: 1688 HK
Rmb in millions, year-end December Net sales Operating profit EBITDA Pre-tax profit Net profit Diluted EPS (Rmb) P/E (x) Adjusted EPS (Rmb) Adjusted P/E (x) EV/EBITDA P/B (x) Y/E BPS (Rmb) FY09 FY10E FY11E FY12E 3,875 5,452 6,761 8,302 ROE (%) 1,073 1,561 2,124 2,674 ROIC (%) 1,280 2,002 2,602 3,269 GAAP dil. EPS (RMB) 1,176 1,732 2,365 2,989 EPS FY09 1,013 1,423 1,933 2,444 EPS FY10E 0.20 0.28 0.37 0.46 EPS FY11E 60.3 43.3 32.9 26.4 0.24 0.34 0.43 0.53 Absolute perf. (%) 50.4 35.6 28.0 22.6 Relative perf. (%) 43.5 27.8 21.4 17.0 Cash (Rmb M) 12.2 8.6 6.5 5.0 Equity (Rmb M) 0.98 1.41 1.86 2.42 FY09 20.3 18.0 1Q 0.05 0.06 0.08 1M 0.0 0.8 7,216 5,018 FY10E 23.2 20.9 2Q 0.05 0.07 0.09 3M -12.0 -14.7 10,770 7,253 FY11E 22.8 20.5 3Q 0.05 0.07 0.10 12M -23.4 -30.2 14,376 9,696
Neutral
1688.HK, 1688 HK Price: HK$15.00 Price Target: HK$16.00
China
Internet Dick Wei

AC
(852) 2800-8535 dick.x.wei@jpmorgan.com
Ritesh Gupta
(91-22) 6157 3307 ritesh.z.gupta@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited
Price Performance
20 HK$ 16 12
Dec-09 Mar-10 Jun-10 Sep-10 Dec-10
1688.HK share price (HK$ MSCI-Cnx (rebased)
YTD Abs Rel -24.8% -26.0%
1m 2.9% 5.3%
3m -13.4% -12.8%
12m -24.6% -27.7%
FY12E 21.4 19.1 4Q 0.06 0.07 0.10
52-week range Shares outstg Avg daily volume Avg daily value Index (HSI) Free float Dividend yld Market cap Price target 23,501 Date of price 16,535
HK$12.3-19.6 5,039Mn 9.6Mn US$21.4Mn 22,969 19% 0% US$8.9Bn HK$16 Dec 29, 2010
Source: Company reports, Bloomberg and J.P. Morgan estimates. * Note: Adj. EPS excludes share-based compensation expense.
Our Estimates and Outlook for 2011 and 2012

We are maintaining our F11 revenue and adjusted EPS estimates of Rmb6.8 B and Rmb0.43, respectively. Our F12 estimates call for revenue and adjusted EPS estimates of Rmb8.3 B and Rmb0.53, respectively.
Dec-11 Price Target of HK$16

Our price target is based on DCF valuation of HK$16 (WACC = 12%, with terminal growth of 0%). Our PT of HK$16 implies 32.4x FY11E, and 26.2 FY12E diluted adjusted EPS, or 38.1x FY11E, and 30.6x FY12E diluted reported EPS. Our PT implies 1.1x PEG (based on 2011E P/E and 2012E EPS growth). We note that on a forward P/E basis, Alibaba has historically traded at high multiples since its IPO. To date, the company has not traded below a forward P/E of 20x even during market lows. We also use P/FCF ratio as a reference to set our Dec-11 price target. At HK$16, Alibaba trades at 19.1x 2012E P/FCF, in line with the current valuation of other China Internet market leaders, such as Baidu, Tencent. We believe a higher multiple for Alibaba can be justified, given: (1) Alibabas leadership in the China B2B market (60% market share); (2) strong cash position to get through current downturn and use cash to gain market share; and (3) upside in earnings from new initiatives and currently free VAS.
Maintain Neutral
While the company has a strong platform for future growth and monetization, we believe there could be near-term downside risks from: (1) slowdown in Chinas exports, (2) new Work at Alibaba pricing strategy could be risky. We maintain our N, given the high valuation and high volatility of the stock.
Risks to Our Rating and PT

Downside risks include (1) slowdown in Gold Supplier and China Trustpass customer growth, (2) VAS does not gain good traction as expected in both marketplaces, and (3) global macro fundamentals turn negative. Upside risks include (1) better-than-expected Gold Supplier and China Trustpass customer growth due to the companys strong execution and strong export market growth, (2) VAS penetration rate grew faster than expected, (3) new VAS such as Aliloan, (4) share buybacks, and (5) RMB appreciation.
86 314
AlibabaDCF Model (base-case scenario)

Sales growth EBIT margin NOPAT margin Year end net fixed assets turns Year end net working capital turns Year end net other assets turns Cash operating taxes as % of EBIT Year end Invested Capital turns
FY10E 40.7% 28.6% 22.6% 6.77 (1.4) 14.95 20.9% (1.95)
FY11E 24.0% 31.4% 24.7% 6.98 (1.3) 18.54 21.5% (1.74)
FY12E 22.8% 32.2% 25.3% 7.19 (1.3) 22.77 21.5% (1.75)
FY13E 23.1% 33.4% 26.2% 7.47 (1.3) 28.04 21.5% (1.70)
FY14E 22.0% 33.5% 26.3% 7.74 (1.3) 34.20 21.6% (1.68)
FY15E 21.4% 33.6% 26.3% 8.04 (1.3) 41.51 21.7% (1.65)
FY16E 18.0% 33.6% 26.9% 7.50 (1.3) 40.00 20.0% (1.64)
FY17E 18.1% 33.6% 26.9% 7.50 (1.3) 40.00 20.0% (1.64)
FY18E 15.2% 32.6% 26.1% 7.50 (1.3) 40.00 20.0% (1.64)
FY19E 13.2% 31.6% 25.3% 7.50 (1.3) 40.00 20.0% (1.64)
FY20E 11.2% 30.6% 24.5% 7.50 (1.3) 40.00 20.0% (1.64)
DCF Sensitivity Analysis

0% 22.7 20.0 17.8 16.0 14.5 13.3 12.2 1% 22.9 20.0 17.8 16.0 14.5 13.2 12.2 Terminal Growth (%) 2% 3% 4% 23.1 23.4 23.9 20.1 20.2 20.4 17.8 17.8 17.8 15.9 15.9 15.8 14.4 14.3 14.3 13.2 13.1 13.0 12.1 12.0 12.0 5% 24.6 20.6 17.8 15.7 14.2 12.9 11.8 6% 25.7 20.8 17.8 15.6 14.0 12.7 11.7 7% 27.9 21.3 17.8 15.5 13.8 12.6 11.5
9.0% 10.0% 11.0% 12.0% 13.0% 14.0% 15.0%
87
WACC
315
Alibaba.com: Summary of financials

Rmb in millions, year-end December
Income statement
Revenues Cost of goods sold Gross profit R&D expenses SG&A expenses Others Operating profit (EBIT) EBITDA Interest income Interest expense Investment income (exp.) Non-operating income (exp.) Earnings before tax Tax Net income (reported) Net income (adjusted) Rmb EPS (Reported) EPS (Adjusted) BPS DPS Diluted shares outstanding (MM)
FY08A 3,002 391 2,612 194 1,416 -178 1,180 1,258 239 0 -16 0 1,404 210 1,193 1,373 0.24 0.27 0.98 0.00 5,055 FY08A 6,612 0 0 508 7,121 32 376 365 7,893 0 16 2,803 2,818 0 106 2,925 4,968
FY09A 3,875 534 3,340 384 2,034 -151 1,073 1,241 141 0 -37 0 1,176 163 1,013 1,213 0.20 0.24 0.98 0.18 5,068 FY09A 7,216 0 0 926 8,143 4 783 527 9,457 0 24 4,073 4,097 0 342 4,439 5,018
FY10E 5,452 907 4,546 544 2,532 -92 1,561 1,929 177 0 -6 0 1,732 309 1,423 1,733 0.28 0.34 1.41 0.00 5,116 FY10E 10,770 0 0 944 11,714 -2 806 365 12,883 0 30 5,149 5,179 0 451 5,630 7,253
FY11E 6,761 1,145 5,616 582 3,045 -135 2,124 2,536 241 0 0 0 2,365 433 1,933 2,271 0.37 0.43 1.86 0.00 5,272 FY11E 14,376 0 0 1,240 15,616 -2 969 365 16,947 0 38 6,762 6,801 0 451 7,251 9,696
FY12E 8,302 1,392 6,910 706 3,696 -166 2,674 3,203 315 0 0 0 2,989 545 2,444 2,859 0.46 0.53 2.42 0.00 5,360 FY12E 18,349 0 0 1,491 19,840 -2 1,154 365 21,357 0 46 8,133 8,178 0 451 8,629 12,728
Ratio analysis
%, year-end December Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC ROIC (net of cash)
FY08A 87.0 41.9 39.3 39.7 6.5 47.2 38.8 46.8 23.3 17.9 -133.1 -133.1 38.0 0.8 27.8 23.3 -64.1
FY09A 86.2 32.0 27.7 26.1 9.9 52.5 29.1 -9.1 -15.1 -15.3 -143.8 -143.8 41.0 0.9 20.3 18.0 -53.0
FY10E 83.4 35.4 28.6 26.1 10.0 46.4 40.7 45.5 40.5 39.2 -148.5 -148.5 42.3 1.0 23.2 20.9 -52.1
FY11E 83.1 37.5 31.4 28.6 8.6 45.0 24.0 36.1 35.8 31.8 -148.3 -148.3 39.9 0.9 22.8 20.5 -47.7
FY12E 83.2 38.6 32.2 29.4 8.5 44.5 22.8 25.9 26.5 24.4 -144.2 -144.2 38.9 0.8 21.8 19.6 -46.6
Balance sheet
Total cash Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity
Cash flow statement

Net income Depr. & amortization Change in working capital Other Cash flow from operations Capex Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash F/X & term deposits change Beginning total cash Ending total cash
FY08A 1,193 76.6 431 -132 1,569 -267 -2,835 -3,102 1,302 -79 0 12 0 -67 -1,600 2,939 5,274 6,612
FY09A 1,013 119 926 175 2,234 -411 -261 -671 1,823 -70 0 0 -888 -958 604 0 6,612 7,216
FY10E 1,423 151 1,064 309 2,947 -209 204 -5 2,738 171 0 440 0 611 3,553 0 7,216 10,769
FY11E 1,933 209 1,326 337 3,805 -406 33 -373 3,399 171 0 1 0 172 3,604 0 10,770 14,375
FY12E 2,444 280 1,126 414 4,264 -498 33 -465 3,766 171 0 1 0 172 3,972 0 14,376 18,348
Source: Company data and J.P. Morgan estimates. *Note: Adjusted earnings exclude share-based compensation expense.
88 316

03 January 2011
Baidu.com
2011 To Be Another Year of Solid Growth
2011 to be another year of solid growth: We expect Baidus revenues to see 57% Y/Y growth to reach $1.83B in FY11. We believe medium-term revenue drivers are: (1) continued gradual improvement in monetization from Phoenix Nest, (2) secular trend in growth of search usage and search advertising in China, (3) growth in eCommercerelated advertising, (4) increasing mobile search usage, and (5) upside from contextual advertising. As a result, we believe ARPU growth will be faster than advertiser number growth. FY10 margin expansion to remain intact in FY11: Baidus operating margins expanded in 2010 to 50.3% vs. 38.0% in FY09 driven by lower TAC, and leverage over bandwidth and operating expenses. We expect the company to be able to maintain this margin level in 2011. However, further expansion will be limited with the potential increase in contextual search advertising. Our 2011 operating margin forecast is 50.3%. Rising eCommerce trend may add upside: Baidu should also benefit from the growing B2C eCommerce market in China. Increasing competition among B2C eCommerce companies and strong growth in eCommerce sales volume should help drive search ad demand on Baidus platform. Baidu has already seen fast growth in eCommercerelated search demand during 3Q10, Baidu reported the number of online retail advertisers doubled Y/Y. Maintain OW with Dec-11 PT of US$120: Our price target implies 53.3x FY11E, and 39.7x FY12E diluted adjusted EPS, on the back of 53% and 35% EPS growth for FY11E and FY12E, respectively, or 1.3x PEG (based on 2012E P/E and long-term growth of 30%). Risks to our PT include slower-than-expected revenue growth and a potential macro slowdown. Positive on market potential: Using various references to the US and Korea search markets, we estimate Chinas search market size could reach US$3B-US$4.6B by 2013. This compares to our current 2013 forecast of US$3.4B and US search market 2009 size of US$15B.
Reuters: BIDU, Bloomberg: BIDU US
US$ in millions, year-end December US$MM, YE-Dec FY09 FY10E FY11E Net Sales 651.4 1,168.0 1,828.7 Operating Profit (EBIT) 235.1 573.9 887.3 EBITDA 296.0 654.0 993.4 Pre Tax Profit 246.5 585.0 910.1 Reported Net profit 217.5 507.4 790.1 Reported EPS (US$) 0.62 1.45 2.21 P/E (x) 158.6 68.5 44.7 Adj. EPS * 0.66 1.49 2.25 Adj. P/E (x) 149.9 66.7 44.0 EV/EBITDA 115.3 52.2 34.4 P/B (x) 49.5 27.7 16.3 Y/E BPS (US$) 2.0 3.6 6.1 FY12E 2,514.2 1,212.6 1,350.7 1,250.8 1,073.7 2.98 33.2 3.02 32.8 25.3 10.5 9.4
Overweight
BIDU, BIDU US Price: $100.01 Price Target: $120.00
Internet Dick Wei

AC
Ritesh Gupta
(91-22) 6157 3307 ritesh.z.gupta@jpmorgan.com J.P. Morgan India Private Limited
Imran Khan
Price Performance
110 $ 70 30
BIDU share price ($) NASDAQ Composite (rebased)
YTD Abs Rel 141.7% 126.2%
1m -7.7% -13.3%
3m
12m
-4.4% 136.2% -16.6% 119.7%
ROE (%) ROIC (%) Qtr GAAP EPS (US$) EPS FY09 EPS FY10E EPS FY11E Abs. Perf.(%) Rel. Perf.(%) Cash Equity
FY09 FY10E FY11E FY12E 40 53 48 40 52-Week range 39 53 47 39 Shares Outstg 1Q 2Q 3Q 4Q Avg daily value 0.08 0.16 0.21 0.18 Avg dly volume 0.20 0.35 0.45 0.45 Index (NASD) 0.42 0.53 0.62 0.64 Free float 1M 3M 12M Dividend Yld (%) -9.7 -3.3 132.6 Market Cap -14.9 -15.5 115.2 Price Target 671 1,172 2,101 3,315 Price Date 696 1,243 2,117 3,278
US$38.5-115.2 348Mn US$996M 10.7Mn 2,667 75% 0% US$34.5B US$120 Dec 29, 2010
Source: Company data, J. P. Morgan estimates, Bloomberg. * Note: Excluding share-based compensation expense. Pricing data as of 29 December 2010.
Key Drivers for 2011

On the monetization side We expect three major revenue drivers: (1) Continued improvement in Phoenix Nest algorithm will likely increase Baidus search monetization potential. We believe both click through and coverage ratios will gradually increase, driven by better quality ads being served in more search results. In addition, large numbers of customers will also lead to keyword pricing increase. As such, we believe the company is likely to see higher revenue per search next year. (2) Upside from eCommerce advertisers: eCommerce in China is expected to experience strong growth over the next few years, with online B2C retailers offering a wide selection of good-quality products at low prices. Logistics, as well as trust and safety, have improved significantly over the past year. We expect competition among eCommerce merchants likely to increase, and as a result an increase in advertising spending on search. Indeed, Baidu has already seen the number of eCommerce advertisers double Y/Y during 3Q10. We believe the eCommerce segment could account for a double-digit percentage of revenues for Baidu in 2011. (3) Contextual advertisements are likely to be another growth driver in the medium term. The company has been investing its R&D capability to improve its contextual search technology. We note that a significant portion of Google Chinas revenue comes from contextual search. Contextual advertisements will create a win-win situation for Baidu as well as content providers who have not been able to monetize their content properly. On search queries side We believe the search market in China is still in the early stages of growth as (1) internet penetration still has good upside, (2) increasing amount of Chinese content is available online, (3) higher reliance on search in daily life. To further enhance users search experience, the company focuses on box computing initiatives. (1) Open Data platform (Aladdin) providing users with more dynamic and comprehensive information. (2) Open Application platform to provide users with their more common applicationrelated needs such as web-based games, eBooks, software, etc. Thirty percent of general search queries on Baidu are applications related. We believe improvements in search quality should further increase the number of search queries per user. Cost side Baidu Union optimization: The companys new revenue-sharing policy has been effective in enhancing Baidu Union's traffic quality and lowering traffic acquisition costs in 2010. Contextual ads to increase TAC in 2011: However, a decrease in TAC from currently search box-related traffic would be balanced by a rise in payouts related to contextual advertising. Contextual advertising usually has higher payout ratios for third-party websites. If contextual becomes very successful, TAC could move up
90 318
back to the low teens level as a percentage of revenue. We currently forecast TAC at 10% of revenues in 2011.
New Businesses
The Video and eCommerce businesses are still in the early stages of growth. We believe the company could maintain its strategy of taking a minority stake in new businesses by providing traffic. We believe the company could make more acquisitions over the next two to three years, when the revenue growth rate slows.
Active Online Marketing Customers and Average Quarterly Spending Trend
Active Online Mktg. Customers QoQ Chg. (%) YoY Chg. (%) Avg Qtly Spending / Customer (Rmb) QoQ Chg. (%) YoY Chg. (%) 1Q08 161,000 3.9% 43.8% 3,557 -3.2% 45.1% 2Q08 181,000 12.4% 41.4% 4,432 24.6% 41.6% 3Q08 194,000 7.2% 35.7% 4,733 6.8% 36.4% 4Q08 197,000 1.5% 27.1% 4,576 -3.3% 24.5% 2Q09 185,000 -6.1% 14.9% 4,379 -4.3% 23.1% 2Q09 203,000 9.7% 12.2% 5,402 23.4% 21.9% 3Q09 216,000 6.4% 11.3% 5,918 9.5% 25.0% 4Q09 223,000 3.2% 13.2% 5,652 -4.5% 23.5% 1Q10 221,000 -0.9% 19.5% 5,852 3.6% 33.6% 2Q10 254,000 14.9% 25.1% 7,533 28.7% 39.5% 3Q10 272,000 7.1% 25.9% 8,292 10.1% 40.1% 4Q10E 282,880 4.0% 26.9% 8,541 3.0% 51.1%
Quarterly TAC Trend

16.0% 16.0% 15.3% 15.3% 14.5% 9.1%
Long-term TAC as % of Total Revenue

18% 16% 14% 12% 10% 8% 6% 4% 2%
250,000
13.3% 11.8%
14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 2005 2006 2007 2008 6.3% 9.0% 11.5% 13.1%
15.7%
18% 16% 14% 10.2% 9.7% 12% 10% 8% 6% 4% 2% 0%
13.2%
200,000 150,000 100,000 50,000 0
12.7%
9.7%
8.9%
0%
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10E
TAC (LHS, Rmb '000s)
TAC as % of rev enue (RHS, %)
2009
2010E
2011E
Total Rev enue (Left, RMB millions) TAC as % of total rev enue (Right)
Source: Company reports, J.P. Morgan estimates. Source: Company reports, J.P. Morgan estimates.
91
319
Rating and Price Target

We maintain our Overweight rating on Baidu as it remains one of the dominant market leaders in Chinas online search market, which is still in an early high-growth stage. Googles potential exit from China is likely to be beneficial to Baidu as well. With Chinas search market around five to six years behind the US in terms of monetization, we believe the risks are on the upside that the search ad market could develop at a faster pace, with lack of other well-established offline SME marketing platforms and the network of distributors and sales agencies. We maintain our Dec 2011 price target of US$120. Our price target implies 53.3x FY11E, and 39.7x FY12E diluted adjusted EPS, on the back of 53% and 35% EPS growth for FY11E and FY12E respectively, or 1.3x PEG (based on 2012 P/E and long-term growth of 30%). (1) DCF valuation We use a 15-year DCF valuation for Baidu, with an estimated 17% long-term growth rate from 2020E-25E. Our nominal case DCF valuation is based on a WACC of 12% and 0% terminal growth. Based on the assumptions, our DCF valuation is US$120.4. We also performed some near-term revenue growth sensitivity analysis on a potential growth slowdown. Our current forecast implies 2012-2015E CAGR to be 30%. If we assume near-term growth to slow down to 25%, our DCF valuation is US$120, with a terminal growth rate at 3%
BaiduDCF Model
Sales growth EBIT margin NOPAT margin Year-end net fixed assets turns Year-end net working capital turns Year-end net other assets turns Cash operating taxes as % of EBIT Year-end Invested capital turns
FY10E 77.2% 49.1% 42.4% 5.0 -7.2 22.5 13.7% 9.5
FY11E 55.2% 48.5% 41.9% 6.3 -7.5 35.6 13.6% 18.2
FY12E 37.5% 48.2% 41.1% 6.9 -7.6 49.0 14.8% 30.7
FY13E 33.4% 46.2% 39.3% 7.0 -7.0 30.0 14.8% 30.0
FY14E 31.0% 45.9% 39.1% 7.0 -7.0 30.0 14.8% 30.0
FY15E 25.9% 45.4% 38.7% 7.0 -7.0 30.0 14.8% 30.0
FY16E 22.0% 45.2% 38.5% 7.0 -7.0 30.0 14.8% 30.0
FY17E 21.0% 45.2% 38.5% 7.0 -7.0 30.0 14.8% 30.0
FY18E 20.0% 45.2% 38.5% 7.0 -7.0 30.0 14.8% 30.0
FY19E 20.0% 45.2% 38.5% 7.0 -7.0 30.0 14.8% 30.0
FY20E 20.0% 45.2% 38.5% 7.0 -7.0 30.0 14.8% 30.0

0% 167.6 140.9 119.9 103.1 89.4 78.2 1% 175.6 146.5 123.8 105.8 91.4 79.6 Terminal growth (%) 2% 3% 4% 185.7 198.6 215.8 153.2 161.6 172.4 128.4 134.0 141.1 109.0 112.9 117.7 93.7 96.4 99.7 81.3 83.2 85.5 5% 239.9 186.9 150.2 123.6 103.6 88.2 6% 276.1 207.1 162.3 131.2 108.6 91.6 7% 336.3 237.4 179.2 141.4 115.0 95.8
10.0% 11.0% 12.0% 13.0% 14.0% 15.0%
92 320
WACC
(2) PEG ratio analysis At our PT of US$120, Baidu trades at 1.3x PEG (based on 2012 P/E and long-term growth of 30%), or 1.5x PEG (based on 2011E P/E and 2012E EPS growth of 35%).
As a reference, the S&P 500 currently trades at 12x forward P/E with the next threeyear CAGR of 7%, or a PEG of 1.7x. (3) Market size potential Using various references to the US and Korea search markets, we estimate Chinas search market size could reach US$3B-US$4.6B by 2013. This compares to our current 2013 forecast of US$3.4B and US search market 2009 size of US$15B. Please also refer to the chart below for analysis of market size comparison with US/Korea market. Other factors that could lead to positive surprises to our forecast include faster-thanexpected inflation and RMB appreciation.
Risks to Our Rating and Price Target

Downside risks to our rating and price target include: Slower-than-expected online search growth: This would be due to Baidus execution, economic slowdown, government policy changes, fraudulent clicks causing a general decline in ROI, and availability of an alternative more effective advertising form. Potential margin decline: While we expect Baidu to see a slight increase in TAC, upside surprise to TAC could come from a ramp-up of contextual search on affiliate sites and partnerships with new affiliate members. In addition, higher bandwidth cost increases, higher marketing expenses, and higher R&D could lead to a margin decline. Large infrastructure-related expense: During the early phase of search advertising growth, Baidu could invest in servers and bandwidths more significantly than we forecast. While this would be a positive in the long term, the share price could be impacted in the near term due to lower earnings. Unsuccessful new initiatives: Baidu began investments in Japan in 2007 with US$15million in expenses. The company also invested in a video site (Qiyi.com) and eCommerce site (JV with Rakuten). If these ventures were unsuccessful or required additional financing, Baidu could take an investment loss.
93
321
Baidu: Summary of financials

Income statement
US$ in millions, year-end December FY08 Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Share-based Expense Operating Profit (EBIT) EBITDA Interest Income, net Investment Income (Exp.) Other Income (Exp.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) * US$ Diluted EPS (GAAP) Adj. Diluted EPS * BPS DPS Shares Outstanding (Mn) 465.5 167.5 298.0 36.2 90.0 12.2 159.6 211.4 6.9 0.0 2.9 169.4 16.9 152.5 164.8 0.44 0.47 1.3 0.0 348 FY09 651.4 235.8 415.6 55.9 112.1 12.6 235.1 296.0 4.8 0.0 6.7 246.5 29.0 217.5 230.2 0.62 0.66 2.0 0.0 348 FY10E 1,168.0 320.4 847.6 97.5 162.9 13.3 573.9 654.0 9.1 0.0 2.1 585.0 77.7 507.4 520.7 1.45 1.49 3.6 0.0 350 FY11E 1,828.7 504.4 1,324.3 157.2 266.9 12.8 887.3 993.4 22.3 1.0 0.6 910.1 120.0 790.1 803.0 2.21 2.25 6.1 1.0 357 FY12E 2,514.2 713.9 1,800.3 216.3 357.2 14.1 1,212.6 1,350.7 37.6 1.0 0.6 1,250.8 177.1 1,073.7 1,087.9 2.98 3.02 9.4 1.0 360 Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth Diluted EPS growth
Ratio analysis
%, year-end December FY08 64.0 45.4 34.3 32.8 7.8 19.3 100.9 119.7 82.6 82.5 FY09 63.8 45.4 36.1 33.4 8.6 17.2 39.9 47.3 42.6 42.4 FY10E 72.6 56.0 49.1 43.4 8.3 13.9 79.3 144.1 133.3 131.7 FY11E 72.4 54.3 48.5 43.2 8.6 14.6 56.6 54.6 55.7 53.0 FY12E 71.6 53.7 48.2 42.7 8.6 14.2 37.5 36.7 35.9 34.7
Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC
-86.2 -86.2 81.2 2.1 44.3 42.8
-96.4 -96.4 72.2 1.6 40.1 39.4
-94.3 -94.3 75.3 1.6 53.5 52.7
-99.3 -99.3 72.3 1.4 47.7 46.6
-101.1 -101.1 65.7 1.1 40.3 39.2
Balance sheet
US$ in millions, year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Other LT assets Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY08 388 14 0 14 415 2 129 28 573 0 62 62 124 0 0 124 450 FY09 671 24 0 15 709 2 146 44 902 0 110 95 205 0 1 206 696 FY10E 1,172 39 0 48 1,259 8 233 52 1,551 0 128 179 307 0 1 308 1,243 FY11E 2,058 57 0 69 2,184 7 286 50 2,528 0 194 260 454 0 1 455 2,074 FY12E 3,248 76 0 93 3,416 7 355 50 3,829 0 270 347 617 0 1 618 3,211
Cash flow statement
US$ in millions, year-end December Net Income Depr. & Amortisation Change in working capital Other Cash flow from operations Capex / Investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08 153 40 24 38 254 -59 -34 -93 195 -9 0 4 0 -5 176 211 388 FY09 218 48 70 13 348 -82 0 -82 267 17 0 -3 0 14 283 388 671 FY10E 507 67 51 13 638 -159 -5 -164 480 18 0 1 0 19 501 671 1,172 FY11E 790 91 110 13 1,005 -147 0 -147 858 59 0 0 0 59 886 1,172 2,058 FY12E 1,074 121 121 14 1,330 -191 0 -191 1,139 72 0 0 0 72 1,189 2,058 3,248
Source: Company data and J.P. Morgan estimates. *Note: Excluding share-based compensation expenses.
94 322

03 January 2011
China Finance Online

Remain Neutral on Lack of Near-term Price Drivers
While the company has established good checks on its operating expenses to reduce losses, we believe the company still lacks a product that could strengthen its revenue quality in the medium term. Business Still Lacks New Drivers: We believe China Finance Online is still lacking a product that could drive their revenues. While the company has been working on a few new products, these new products are yet to be introduced to the market place. In addition, existing products are also negatively impacted due to rising competition and the IPO of its competitor in the A-share market (Grand Wisdom). Weaker 2011 Outlook: JRJC still lacks new revenue drivers in the near term. A decline in cash revenues for 3Q10 and a muted outlook for next quarter would mean weaker revenue recognition until 2Q11 due to amortization of subscription revenues. We recently revised down our 2011 revenue estimate by 19% and adjusted our EPS estimate (ex sharebased expenses) by 40%. We are now also forecasting increased sales and marketing and research and development expenses. Dec-11 PT of US$8.3: Our DCF-based Dec-11 price target implies 67.3x/31.7x 2011E/2012E adjusted diluted P/E. Excluding net cash of US$4.53 per diluted share, our PT implies 67.3x/31.7x 2011E/2012E adjusted diluted P/E. Downside risks to our PT include: (1) deterioration in domestic stock market activity, reducing demand for JRJC products, and (2) higher-than-expected product development expenses. Upside risks include: (1) the government announcing new policies or innovative products that could lead to higher spot/futures market activity, and (2) the company diversifying into other brokeragerelated businesses.
Reuters: JRJC; Bloomberg: JRJC US
US$MM, Y/E Dec Net Revenue Adj. Op. Profit * GAAP Net Profit Adj. net profit * Reported EPS (US$) P/E (x) Adj. EPS (US$) Adj. P/E (x) * EV/EBITDA (x) P/B (x) Y/E BPS (US$) FY09 FY10E FY11E FY12E 53.6 59.2 54.7 59.2 ROE (%) -1.8 3.6 1.1 4.7 ROIC (%) -6.2 2.1 1.0 4.4 Qtr GAAP EPS(US$) 0.4 6.6 3.0 6.4 EPS FY09 -0.30 0.09 0.04 0.18 EPS FY10 E nm 71.8 161.2 36.8 EPS FY11 E 0.02 371.5 33.2 1.4 4.6 0.28 23.3 6.2 1.3 5.0 0.12 53.8 13.6 1.2 5.6 0.26 25.4 6.3 1.1 6.2 Abs. Perf.(%) Rel. Perf.(%) Cash (US$m) Equity (US$m) FY09 0.4 -0.8 1Q -0.01 0.01 0.01 FY10E 6.4 5.0 2Q -0.11 0.02 0.01 1M -17.2 -22.3 105.9 107.8 FY11E 2.6 1.3 3Q -0.05 0.06 0.01 3M -6.7 -18.9 112.4 119.3
Neutral
JRJC, JRJC US Price: $6.64 Price Target: $8.30
Internet Dick Wei

AC
Ritesh Gupta
Imran Khan
(1-212) 622-6693 imran.t.khan@jpmorgan.com J.P. Morgan Securities Inc.
Price Performance
9.0 $ 7.5 6.0
JRJC share price ($) NASDAQ Composite (rebased)
YTD Abs Rel -11.5% -27.0%
1m -16.4% -22.0%
3m -6.7% -18.9%
12m -11.5% -28.0%
FY12E 5.1 3.7 4Q -0.13 0.01 0.01 12M -14.2 -31.6 130.8 134.3
52-Week range Shares Outstg Avg daily volume Avg daily value Index (NASD) Free float Dividend Yld (%) Market Cap Price Target Price Date
US$6.8-9.1 22Mn 0.05Mn 0.4Mn 2,667 52% 0% US$146M US$ 8.3 Dec 29, 2010
107.5 97.4
Source: Company reports, Bloomberg, J.P. Morgan estimates. * Note: Adjusted figures exclude share-based comps & one-off expenses.
2011 and 2012 Outlook

We expect 2011 revenues of US$54.7M (down 7.6% Y/Y) and adjusted EPS (excluding share-based expenses) of US$0.12 (down 56.7% Y/Y). Our 2012 revenue estimates are US$59.2M (up 8.3% Y/Y) and adjusted EPS of US$0.26 (up 112.2% Y/Y).
Price Target, Valuation and Rating Analysis

Maintain Neutral with our Dec-11 PT of US$8.3. Our DCF-based PT (WACC of 13%, terminal growth of 0%) of US$8.3 implies 67.3x/31.7x 2011E/2012E adjusted diluted P/E. Excluding net cash of US$4.53 per diluted share, our PT implies 65.7x/20.0x 2011E/2012E adjusted diluted P/E.

Key downside risks include: (1) deterioration in domestic stock market activity (negatively affecting demand for JRJCs products), (2) increase in competition in financial analysis software, and (3) larger-than-expected in-house investment in product development and database.
DCF Model (Base case scenario)
2010E 10.4% -1.4% -1.9% 7.4 (4.3) 3.2 -33.5% 4.5
2011E -7.6% -1.7% -2.3% 7.4 (5.1) 3.0 -33.0% 3.7
2012E 8.3% 4.5% 3.3% 8.7 (4.0) 3.3 25.7% 6.1
2013E 9.2% 10.8% 8.0% 8.7 (4.0) 4.5 25.7% 11.5
2014E 11.7% 14.2% 10.5% 8.7 (4.0) 4.5 25.7% 11.5
2015E 11.7% 14.6% 10.8% 8.7 (4.0) 4.5 25.7% 11.5
2016E 11.7% 14.6% 10.8% 8.7 (4.0) 4.5 25.7% 11.5
2017E 11.7% 14.6% 10.8% 8.7 (4.0) 4.5 25.7% 11.5
2018E 11.7% 14.6% 10.8% 8.7 (4.0) 4.5 25.7% 11.5
2019E 11.7% 14.6% 10.8% 8.7 (4.0) 4.5 25.7% 11.5
2020E 11.7% 14.6% 10.8% 8.7 (4.0) 4.5 25.7% 11.5

0% 10.3 9.5 8.8 8.3 7.8 7.5 7.1 1% 10.4 9.5 8.8 8.3 7.8 7.4 7.1 Terminal Growth (%) 2% 3% 4% 10.4 10.5 10.7 9.5 9.6 9.6 8.8 8.8 8.8 8.3 8.2 8.2 7.8 7.8 7.7 7.4 7.4 7.3 7.1 7.1 7.0 5% 10.9 9.7 8.8 8.2 7.7 7.3 7.0 6% 11.1 9.8 8.8 8.1 7.6 7.2 6.9 7% 11.6 9.9 8.8 8.1 7.6 7.2 6.9
10.0% 11.0% 12.0% 13.0% 14.0% 15.0% 16.0%
96 324
WACC
China Finance Online: Summary of financials

Income statement
USD in millions, year-end December FY08 Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.) Non-Operating Income (Exp.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) USD: EPS (Reported) EPS (Adjusted) * BPS DPS ADS Outstanding (Diluted, Mn) 56.2 9.4 46.9 5.6 28.5 12.8 22.5 1.6 0.0 0.0 1.8 16.2 2.6 19.0 26.6 0.84 1.18 4.9 0.0 19.8 FY09 53.6 8.1 45.5 10.7 43.1 -8.4 1.3 1.4 0.0 0.0 0.4 -6.7 0.4 -6.2 0.4 -0.30 0.02 4.6 0.0 21.0 FY10E 59.2 8.3 50.9 12.7 39.0 -0.8 7.1 1.5 0.0 0.0 1.6 2.2 -0.3 2.1 6.6 0.09 0.28 5.0 0.0 21.5 FY11E 54.7 8.5 46.2 12.9 34.3 -0.9 3.2 1.6 0.0 0.0 0.4 1.1 -0.3 1.0 3.0 0.04 0.12 5.6 0.0 21.4 FY12E 59.2 9.0 50.3 13.0 34.6 2.7 6.9 1.8 0.0 0.0 0.4 4.9 -0.7 4.4 6.4 0.18 0.26 6.2 0.0 21.5 Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth
Ratio analysis
%, year-end December FY08 83.3 40.1 22.8 33.8 9.9 50.6 117.1 185.0 560.9 -491.0 FY09 84.8 2.5 -15.6 -11.6 20.0 80.5 -4.7 -165.3 -132.7 -135.1 FY10E 86.0 12.0 -1.4 3.6 21.5 65.9 10.4 89.9 134.3 -131.2 FY11E 84.4 5.9 -1.7 1.8 23.5 62.6 -7.6 -9.8 -53.2 -55.4 FY12E 84.9 11.7 4.5 7.5 22.0 58.4 8.3 387.2 342.1 338.1
-101.1 -101.1 39.8 0.9 32.5 30.5
-110.3 -110.3 32.4 0.7 0.4 -0.8
-98.3 -98.3 34.7 0.7 6.4 5.0
-94.2 -94.2 31.6 0.6 2.6 1.3
-97.4 -97.4 30.5 0.6 5.1 3.7
Balance sheet
USD in millions, year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY08 97.5 2.9 0.0 12.7 113.1 1.5 8.6 18.0 141.2 0.0 7.0 28.3 35.4 0.0 9.4 44.8 96.5 FY09 107.5 5.4 0.0 20.8 133.7 1.5 10.3 20.2 165.6 0.0 21.7 30.7 52.4 0.0 15.8 68.2 97.4 FY10E 105.9 16.1 0.0 20.6 142.6 1.5 8.0 18.6 170.8 0.0 24.8 28.5 53.3 0.0 9.7 63.0 107.8 FY11E 112.4 15.7 0.0 18.0 146.1 1.5 7.4 18.2 173.2 0.0 19.3 27.8 47.1 0.0 6.8 53.9 119.3 FY12E 130.8 17.6 0.0 20.1 168.5 1.5 6.8 17.7 194.5 0.0 20.8 34.7 55.5 0.0 4.7 60.2 134.3
Cash flow statement
USD in millions, year-end December Net Income Depreciation & Amortization Change in working capital Other Cash flow from operations Capex/investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08 19.0 2.1 -1.1 7.3 27.3 -11.2 0.0 -11.2 16.1 2.5 0.0 4.2 0.0 6.7 22.8 74.7 97.5 FY09 -6.2 3.1 6.4 6.6 9.9 -6.9 0.0 -6.9 3.0 0.6 0.0 6.4 0.0 6.9 9.9 97.5 107.5 FY10E 2.1 3.5 -9.6 4.2 0.2 0.3 0.0 0.3 0.5 3.8 0.0 -5.9 0.0 -2.0 -1.5 107.5 105.9 FY11E 1.0 2.2 -3.2 1.8 1.7 -1.1 0.0 -1.1 0.6 8.5 0.0 -2.7 0.0 5.9 6.5 105.9 112.4 FY12E 4.4 2.3 4.4 1.8 12.9 -1.2 0.0 -1.2 11.6 8.5 0.0 -1.8 0.0 6.7 18.3 112.4 130.8
Source: Company data and J.P. Morgan estimates. * Note: We have included 123R share-based compensation adjustments starting in 2006.
97
325
98 326

03 January 2011
Netease
Leading Game Developer in China. Starcraft 2, WoW Upgrade to Provide Growth in F'11
We see Netease as the top online game developer and operator in China, and expect the company to see ~20% gaming revenue growth in 2011. Success of Starcraft 2, WoW Cataclysm, and other in-house games could drive the stock higher. WoW and Fantasy WWJ to remain strong: Online games saw healthy growth over the last two quarters for Netease. New "Perfect Beauty" and having Jay Chou as spokesperson helped Fantasy WWJ drive good growth in 2Q11 and 3Q11. WoW also saw good sequential growth with the launch of new expansion pack Wrath of Lich King in 2011. We believe these games should continue to maintain their franchise with the launch of promotion events and new expansion packs. Starcraft 2 may be launched in 2011: Netease has already submitted information and materials related to the game to relevant government authorities and the game is undergoing the review process. We expect that Starcraft 2 may be launched in 2011. Online advertising to benefit from new advertising placement system: We expect Netease to see healthy portal revenue growth of 26% next year. We believe the company should benefit from improved awareness amongst advertisers from: (1) sponsorship of Asian Games in Guangzhou, and (2) launch of a new ad placement system which provides analytics for effectiveness of advertisements placed on Netease portal. Portal traffic on Netease is up 40% YTD as of the end of 3Q10. 2011 outlook: We expect 2011 revenues to see 19.7% growth YoY to reach US$947M. We expect gross margins to remain intact with slight improvement in operating margins on lower marketing expenses. Online Games should see 19.2% growth YoY in 2011 from continued performance of WoW and Fantasy WWJ. Launch of Starcraft 2 should be a key revenue driver for 2011, in our view. Netease has one of the strongest R&D teams and we expect the company to maintain its strength as a gaming franchise.
Reuters: NTES; Bloomberg: NTES US
(US$MM, Y/E Dec) Net Sales Operating Profit EBITDA Pre Tax Profit Net Profit Reported EPS (US$) Reported P/E (x) Adj. EPS (US$) Adj. P/E (x) EV/EBITDA P/B (x) Y/E BPS (US$) FY09 550.2 296.3 322.0 314.9 269.0 2.07 17.6 2.11 17.3 12.6 4.1 8.8 FY10E 789.7 359.3 409.2 368.2 311.8 2.39 15.3 2.51 14.5 9.9 3.2 11.4 FY11E FY12E 946.6 1,055.7 ROE (%) 441.8 496.5 ROIC (%) 506.0 570.5 GAAP Qtr EPS (US$) 472.4 536.2 EPS FY09 393.3 441.0 EPS FY10E 2.94 3.22 EPS FY11E 12.4 11.3 3.10 3.40 Abs. Perf.(%) 11.8 10.7 Rel. Perf.(%) 8.0 7.1 2.5 2.0 Cash (US$MM) 14.7 18.3 Equity (US$MM)
Overweight
NTES, NTES US Price: $36.07 Price Target: $45.00
Internet Dick Wei

AC
Ritesh Gupta
Imran Khan
Price Performance
40 $ 34 28
NTES share price ($) NASDAQ Composite (rebased)
YTD Abs Rel -12.5% -28.0%
1m -5.6% -11.2%
3m -8.2% -20.4%
12m -2.9% -19.4%
FY09 FY10E FY11E FY12E 28.9 26.0 25.0 21.6 52-Week range (US$) 27.3 24.7 23.5 20.1 Shares Outstg (MM) 1Q 2Q 3Q 4Q Avg daily volume 0.47 0.53 0.44 0.64 Avg daily value 0.51 0.55 0.66 0.68 Index (NASD) 0.68 0.72 0.76 0.78 Free float (%) 1M 3M 12M Dividend yld (%) -6.7 -8.7 -2.8 Market Cap -11.9 -20.9 -20.3 Price target (US$) Price Date 1,046 1,519 2,004 2,544 1,087 1,429 1,891 2,404
26.2-43.7 130M 0.9M US$31.4M 2,667 ~50% 0% US$4.7B US$45 Dec 29, 2010
Source: Company reports, Bloomberg, J.P. Morgan estimates. Note: We have included 123R share-based expense adjustments starting in 2006.

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

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

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

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

FY10E 42.8% 45.5% 38.2% 7.8 (4.4) 24.3 16.0% (17.1)
FY11E 19.7% 46.7% 38.0% 9.3 (4.8) 29.1 18.6% (15.1)
FY12E 11.5% 47.0% 37.6% 10.4 (4.9) 32.5 20.0% (12.7)
FY13E 10.1% 46.0% 36.8% 12.0 (4.9) 22.0 20.0% (13.0)
FY14E 10.8% 45.4% 36.3% 12.0 (4.9) 22.0 20.0% (13.0)
FY15E 10.0% 42.0% 33.6% 12.0 (4.9) 22.0 20.0% (13.0)
FY16E 10.0% 40.0% 32.0% 12.0 (4.9) 22.0 20.0% (13.0)
FY17E 10.0% 38.0% 30.4% 12.0 (4.9) 22.0 20.0% (13.0)
FY18E 10.0% 36.0% 28.8% 12.0 (4.9) 22.0 20.0% (13.0)
FY19E 10.0% 36.0% 28.8% 12.0 (4.9) 22.0 20.0% (13.0)
FY20E 10.0% 36.0% 28.8% 12.0 (4.9) 22.0 20.0% (13.0)
DCF sensitivity analysis

0% 57.3 52.3 48.2 44.8 41.9 39.4 37.2 1% 59.3 53.8 49.3 45.6 42.5 39.8 37.6 Terminal growth (%) 2% 3% 4% 61.8 64.9 69.2 55.5 57.7 60.5 50.5 52.1 54.0 46.5 47.6 49.0 43.2 44.0 45.0 40.4 41.0 41.7 38.0 38.5 39.0 5% 75.2 64.3 56.5 50.7 46.2 42.6 39.7 6% 84.3 69.6 59.9 52.9 47.7 43.7 40.4 7% 99.6 77.6 64.6 55.9 49.7 45.0 41.4
9.9% 10.9% 11.9% 12.9% 13.9% 14.9% 15.9%
100 328
WACC
Netease: Summary of financials

Income statement
Rmb in millions, year-end December Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.) Non-Operating Income (Exp.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) * RMB EPS (Reported) EPS (Adjusted) * BPS DPS Shares outstanding (MM)
Ratio analysis
FY08 2,938 546 2,392 185 439 1,768 1859 144.8 0 1.5 -163.5 1,751 -264 1,487 1,555 11.53 12.05 45.90 0.00 125 FY09 3,757 943 2,814 220 570 2,023 2167 128.2 0 0.4 -1.3 2,151 -314 1,837 1,869 14.17 14.41 60.36 0.00 129 FY10E 5,364 1,707 3,657 280 936 2,441 2682 139.5 0 0.2 -79.0 2,501 -383 2,118 2,230 16.22 17.07 77.14 0.00 129 FY11E 6,420 2,044 4,375 356 1,023 2,996 3282 207.5 0 0.0 0.0 3,203 -536 2,667 2,816 19.92 21.03 99.81 0.00 127 FY12E 7,159 2,261 4,899 394 1,138 3,367 3706 269.4 0 0.0 0.0 3,636 -646 2,991 3,153 21.87 23.06 124.21 0.00 130
%, year-end December Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC
FY08 81.4 63.3 60.2 50.6 6.3 14.9 32.7 46.6 17.6 20.2 -101.8 -101.8 46.3 0.7 34.9 30.1
FY09 74.9 57.7 53.9 48.9 5.9 15.2 27.9 14.5 24.5 22.9 -96.2 -96.2 42.7 0.6 28.9 27.3
FY10E 68.2 50.0 45.5 39.5 5.2 17.5 42.8 20.6 15.1 14.5 -106.3 -106.3 45.2 0.7 26.0 24.7
FY11E 68.2 51.1 46.7 41.5 5.5 15.9 19.7 22.7 25.2 22.9 -106.0 -106.0 42.1 0.6 25.0 23.5
FY12E 68.4 51.8 47.0 41.8 5.5 15.9 11.5 12.4 12.1 9.8 -105.8 -105.8 37.7 0.5 21.6 20.1
Balance sheet
Rmb in millions, year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity
Cash flow statement

FY08 5,613 231 0 129 5,974 0 259 113 6,346 0 320 510 829 0 0 829 5,516 FY09 7,141 187 0 645 7,973 0 558 273 8,803 0 582 796 1378 0 0 1,378 7,425 FY10E 10,316 408 0 224 10,949 0 691 220 11,860 0 1,132 993 2125 0 25 2,151 9,709 FY11E 13,615 465 0 264 14,344 0 693 220 15,258 0 1,257 1,132 2389 0 25 2,415 12,843 FY12E 17,278 514 0 292 18,085 0 686 220 18,991 0 1,385 1,251 2636 0 25 2,661 16,330
Rmb in millions, year-end December Net Income Depr. & Amortization Change in working capital Other Cash flow from operations Capex / investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash
FY08 1,487 91 111 68 1,757 -214 0 -214 1,543 453 -642 100 0 -88 1,455 4,159 5,613
FY09 1,837 144 77 18 2,076 -602 0 -602 1,473 40 0 0 0 40 1,513 5,613 7,141
FY10E 2,118 242 947 100 3,407 -322 0 -322 3,085 54 0 25 0 79 3,164 7,141 10,316
FY11E 2,667 286 167 149 3,269 -289 0 -289 2,980 318 0 0 0 318 3,298 10,316 13,615
FY12E 2,991 339 170 163 3,662 -332 0 -332 3,330 334 0 0 0 334 3,664 13,615 17,278
Source: Company data, J.P. Morgan estimates. * Adjusted EPS excludes share-based compensation expense.
101
329
102 330

03 January 2011
Shanda Games
2011 Could Mark a Turnaround
2011 outlook: Shanda Games currently guides 4Q10 revenues to be 3% to 5% higher sequentially in 4Q10. We expect Shanda Games could return to growth in 2011, particularly if Dragon Nest can continue to gain traction in 2011. F11 could well mark the turnaround for Shanda Games: We expect the company to see double-digit growth on the top line. Dragon Nest has gotten a good response from gamers. Another promising game in the F11 pipeline is Final Fantasy XIV. Dragon Nest could be the second-largest game next year: Dragon Nest PCUs have already touched 700K levels. We believe by next year the game could reach 10% of total revenues for Shanda Games, or become the second-largest game after Mir2, and to surpass Woool. We believe the revenues from new games could ease the pressure from the potential decline in legacy games. Acquisition of Eyedentity: The company acquired Eyedentity games for US$95M, which will save the company from paying royalties on Dragon Nest. Additionally, this will also contribute some international revenues to Shanda Games. 2011 pipeline healthy: Shanda Games maintains a healthy pipeline of 5 MMORPG games and one casual game for next year. We believe Final Fantasy XIV could be a popular game for Shanda. The game is licensed from Square Enix and has seen good response from gamers internationally. We believe the company could also benefit from Final Fantasy XIV and other in-house games.
Reuters: GAME, Bloomberg: GAME US
US$ in millions, year-end December US$MM, YE-Dec FY09 FY10E Net Sales 703.3 655.8 Operating Profit (EBIT) 253.8 193.7 EBITDA 298.1 234.8 Pre Tax Profit 282.4 229.5 Reported Net profit 212.6 180.6 Reported EPS (US$) 0.75 0.62 P/E (x) 8.4 10.2 Adj. EPS * 0.82 0.68 Adj. P/E (x) 7.7 9.4 EV/EBITDA 5.7 7.3 P/B (x) 4.4 3.0 Y/E BPS (US$) 1.4 2.1
Overweight
GAME, GAME US Price: $6.33 Price Target: $8.00
Internet Dick Wei

AC

Price Performance
11 $ 8 5
GAME share price ($) NASDAQ Composite (rebased)
YTD Abs Rel -40.6% -56.1%
1m 11.2% 5.6%
3m 19.4% 7.2%
12m -38.4% -54.9%
FY11E 727.8 217.1 261.9 251.2 187.2 0.62 10.2 0.66 9.6 6.5 2.3 2.8
FY12E 825.4 253.6 305.5 294.6 220.0 0.72 8.8 0.77 8.3 5.6 1.8 3.6
ROE (%) ROIC (%) Qtr GAAP EPS (US$) EPS FY09 EPS FY10E EPS FY11E Abs. Perf.(%) Rel. Perf.(%) Cash Equity
FY09 FY10E FY11E FY12E 81 38 28 26 52-Week range 82 37 28 25 Shares Outstg 1Q 2Q 3Q 4Q Avg daily value 1.13 1.33 1.58 1.54 Avg dly volume 1.19 1.22 1.10 1.11 Index (NASD) 1.08 1.11 1.14 1.20 Free float 1M 3M 12M Dividend Yld (%) 11.1 13.7 -38.2 Market Cap 6.0 1.5 -55.7 Price Target 374 545 732 940 Price Date 413 616 803 1,023
US$5.0-11.0 288Mn US$ 6Mn 1.0Mn 2,667 ~29% 0% US$1.82B US$8 Dec 29, 2010
Source: Company reports, Bloomberg, J. P. Morgan estimates, Bloomberg. * Note: Excluding share-based compensation expense.

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

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

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

FY10E -6.8% 29.5% 22.6% 21.9 (79.9) 6.0 23.4% 5.0
FY11E 11.0% 29.8% 21.8% 16.9 (68.0) 6.7 26.8% 5.2
FY12E 13.4% 28.7% 22.5% 13.0 (78.2) 7.6 26.7% 5.1
FY13E 12.0% 28.4% 22.4% 10.2 (76.9) 8.5 26.5% 4.9
FY14E 12.3% 29.3% 22.4% 8.8 (82.0) 9.5 26.2% 4.9
FY15E 11.7% 29.4% 22.4% 8.1 (86.5) 10.6 26.2% 4.8
FY16E 10.0% 29.4% 21.7% 7.80 (82.5) 10.6 26.2% 4.8
FY17E 10.0% 28.9% 21.3% 7.80 (82.5) 10.6 26.2% 4.8
FY18E 10.0% 28.9% 21.3% 7.80 (82.50) 10.64 26.2% 4.8
FY19E 10.0% 28.9% 21.3% 7.80 (82.50) 10.64 26.2% 4.8
FY20E 10.0% 28.9% 21.3% 7.80 (82.50) 10.64 26.2% 4.8
104 332

0% 12.3 11.0 9.9 9.0 8.2 7.6 7.1 1% 12.8 11.3 10.1 9.2 8.4 7.7 7.2 Terminal growth (%) 2% 3% 4% 13.5 14.4 15.7 11.8 12.4 13.2 10.5 10.9 11.4 9.4 9.7 10.1 8.6 8.8 9.0 7.9 8.0 8.2 7.3 7.4 7.5 5% 17.6 14.3 12.1 10.5 9.3 8.4 7.7 6% 20.7 16.0 13.1 11.1 9.7 8.7 7.9 7% 26.8 18.7 14.5 12.0 10.3 9.0 8.1
9.11% 10.11% 11.11% 12.11% 13.11% 14.11% 15.11%
105
WACC
333
Shanda Games: Summary of financials

Income statement
US$ in millions, year-end December FY08 Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Share-based Expense Operating Profit (EBIT) EBITDA Interest Income, net Investment Income (Exp.) Other Income (Exp.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) * US$ Diluted EPS (GAAP) Adj. Diluted EPS * BPS DPS Shares Outstanding (Mn) 491 216 274 35 71 3 168 194 5 0 1 174 36 136 139 0.49 0.50 0.6 0.0 279 FY09 703 283 420 50 117 18 254 298 4 0 25 282 63 213 231 0.75 0.82 1.4 0.0 282 FY10E 656 270 386 66 126 15 194 235 8 0 28 230 45 181 196 0.62 0.67 2.1 0.0 290 FY11E 728 291 436 79 140 14 217 262 12 0 22 251 58 187 201 0.62 0.66 2.8 0.0 303 FY12E 825 325 500 90 157 14 254 305 16 0 25 295 68 220 234 0.72 0.77 3.6 0.0 304 Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth Diluted EPS growth
Ratio analysis
%, year-end December FY08 55.9 39.6 34.3 27.7 7.1 14.6 59.1 102.6 72.9 72.9 FY09 59.8 42.4 36.1 30.2 7.1 16.6 43.4 51.0 56.4 54.9 FY10E 58.9 35.8 29.5 27.5 10.1 19.2 -6.8 -23.7 -15.0 -17.4 FY11E 59.9 36.0 29.8 25.7 10.9 19.2 11.0 12.1 3.6 -0.8 FY12E 60.6 37.0 30.7 26.7 10.9 19.0 13.4 16.9 17.5 16.9
-78.7 -78.7 138.2 10.0 91.3 85.9
-89.7 -90.2 109.8 3.9 80.5 81.6
-88.5 -88.5 79.4 1.6 38.1 37.4
-91.2 -91.2 69.4 1.2 28.3 27.7
-91.9 -91.9 63.8 1.0 25.6 24.9
Balance sheet
US$ in millions, year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Other LT assets Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity Minority interests Total Liabilities and Equity FY08 125 64 0 40 230 3 14 108 355 0 14 157 171 0 4 176 159 20 355 FY09 374 62 0 46 482 1 28 129 641 2 14 168 185 0 6 190 413 30 633 FY10E 545 91 0 48 684 3 30 109 826 0 14 165 180 0 4 184 616 26 826 FY11E 732 105 0 56 893 3 43 109 1,048 0 16 191 208 0 4 212 803 33 1,048 FY12E 940 116 0 62 1,118 3 63 109 1,294 0 18 213 230 0 4 234 1,023 37 1,294
Cash flow statement
US$ in millions, year-end December Net Income Depr. & Amortisation Change in working capital Other Cash flow from operations Capex / Investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08 136 23 15 -7 166 -18 -3 -21 148 -52 0 -63 0 -115 39 87 125 FY09 213 26 7 25 271 -61 2 -59 210 168 2 -65 -78 28 249 125 374 FY10E 181 26 -33 19 192 -8 -2 -10 184 9 -2 -10 0 -4 171 374 545 FY11E 187 31 6 19 244 -44 0 -44 199 -14 0 1 0 -12 187 545 732 FY12E 220 38 5 20 283 -59 0 -59 225 -14 0 -3 0 -17 208 732 940
106 334

03 January 2011
Shanda Interactive Entertainment Ltd

New Businesses Shaping Up Well But Stock Price Still Hinges On Online Games
We expect Shanda Interactive to continue investing in its Shanda Online and Shanda Literature businesses in 2011. Still, we think the stock price will largely depend on the performance of its gaming business, Shanda Games. Good Shanda Online outlook: Shanda Online is an integrated service platform providing total solutions to all kinds of accounts and application developers. The three core service modules are content delivery, promotion & payment, and customer relationship management. Shanda Online is also working to include the systematic integration of users personal information, preferences, messages, relationships. There are a total of 72 third-party providers working with Shanda Online. We expect the segment to see good traction in 2011, as Shanda continues to improve its presence in this area. Shanda Literature continues to see good traction: The Literature business achieved solid sequential growth in 3Q10 by implementing its core strategy of establishing a complete copyright operation platform. In addition, Shanda Literature (SDL) recently unveiled its Cloudary initiative, combining Shanda Literature's rich IP library with the content from external parties. The Cloudary offers a massive online collection of literary works. It brings together over 70 billion Chinese characters of literary content, 3 million copyrighted books and more than 1000 electronic magazines and periodical publications. SDL currently works with more than 100 publishers for its Cloudary initiatives. Bambook has also been a decent success for SDL. 2011 outlook: We maintain our Overweight rating on Shanda, given its lowvaluation and high cash level. We maintain our view that: (1) Shanda Games potential success is in its new games, (2) potentials exist in Shanda Online, Ku6 and other new ventures, and (3) the company continues to make synergetic investments to become a leading interactive entertainment provider in China, generating additional sources of revenues.
Reuters: SNDA, Bloomberg: SNDA US
(US$MM, Y/E - Dec) Net Sales Operating profit EBITDA Net Profit Reprtd. EPS (US$) P/E (x) Adj. EPS (US$) * Adj. P/E (x) EV/EBITDA P/B (x) Y/E BPS (US$) FY09 767.2 298.5 367.1 233.1 3.38 11.7 3.74 10.6 6.5 1.6 24.5 FY10E 807.9 141.6 226.2 91.5 1.36 29.2 1.83 21.6 10.6 1.5 26.6 FY11E FY12E 937.8 1,074.8 ROE (%) 155.4 180.6 ROIC (%) 246.0 287.0 Qtr GAAP Dil EPS (US$) 92.8 109.2 EPS FY09 1.31 1.53 EPS FY10E 30.2 25.9 EPS FY11E 1.68 1.90 23.5 20.9 Absolute perf. (%) 9.7 8.4 Relative perf. (%) 1.5 1.4 Cash & Equiv. (US$ M) 27.1 28.8 Equity (US$ M) FY09 25.1 22.5 1Q 1.02 0.90 0.60 1M 0.4 -4.8 1,912 1,690 FY10E 8.6 7.7 2Q 1.18 0.56 0.60 3M 3.6 -8.7 2,030 1,790 FY11E 8.2 7.6 3Q 1.27 0.51 0.63 12M -23.4 -40.8 2,227 1,918
Overweight
SNDA, SNDA US Price: $39.60 Price Target: $47.00
Internet Dick Wei

AC
Ritesh Gupta
Imran Khan
Price Performance
65 $ 50 35
SNDA share price ($) NASDAQ Composite (rebased)
YTD Abs Rel -30.6% -46.1%
1m -1.0% -6.6%
3m 2.5% -9.7%
12m -23.4% -39.9%
FY11E 8.7 8.1 4Q 1.40 0.53 0.64
52-week range Shares outstg. Avg daily vol. Avg daily value Index (NASD) Free float Div yield (%) Market Cap Price target 2,446 Price date: 2,061
US$36.3-59.9 69M 0.23M US$9.2M 2,667 49% 0% US$2.7B US$47 Dec 29, 2010
Source: Company data, Bloomberg, J.P. Morgan estimates. * Note: We have included share-based compensation adjustments starting in 2006.

We expect Shanda Interactive to generate US$937.8M (up 16.1% Y/Y) in revenues for F11 and adjusted EPS (exc. Share-based expenses) of US$1.68 for 2011. We expect F12 revenues of US$1,074.8M (up 14.6% Y/Y) and adjusted EPS of US$1.90 (up 16.5% Y/Y).
Rating, Price Target and Valuation

Remain Overweight on Shanda We maintain our Overweight rating on Shanda, given its low valuation and high cash levels. We maintain our view that: (1) Shanda Gamess potential success is in its new games, (2) potentials exist in Shanda Online, Ku6 and other new ventures, and (3) the company continues to make synergetic investments to become a leading interactive entertainment provider in China, generating additional sources of revenues. Dec-11 price target of US$47 Our Dec-11 PT of US$47 is based on SOTP valuation. Our price target of US$47 implies 35.8x 2011E and 30.8x 2012E diluted adjusted EPS. Shanda has net cash (excluding Shanda Games cash) of US$1.259B (or US$18.2 per share). Excluding cash, our PT implies 22.0x 2011E and 18.8x 2012E P/E. Our PT of US$47 is based on SOTP valuation. We assume: (1) Value of Shanda Game of US$1.29B (given the large 70% stake Shanda owns, we believe it is reasonable to assume a liquidity discount of 20% from US$1.61 B, which is based on our Shanda Games PT of US$8 ). (2) Other non-game business (SDO, SDL, and others) of US$740M. We assume an 8x forward P/E multiple for the group of businesses. (3) Net cash level of US$1.4B (excluding Game cash and net of debt). We do not apply any discount to the cash level. While the company will likely invest its cash in new non-game businesses and as such reduce its cash level, we believe these new initiatives would create value in the longer term. DCF valuation of US$56.6 assumes a WACC of 11.9%, a 10-year revenue growth and 0% terminal growth. We believe DCF is a good tool to value the company. However, with risks in the game pipeline, we believe Shanda Games may not be able to trade at its DCF valuation.
Shanda: SOTP Valuation Table
SOTP valuation (US$M) Market value of Shanda Games (70% of GAME) M.V. after applying 20% holding company discount: Value of non-game initiatives: Cash & ST investment at SNDA(excluding GAME cash)* Debt at SNDA Sum: Value per diluted share (US$): At current GAME share price of US$6.3 1,270 1,016 738 1,412 (153) 3,013 42.6 At current GAME TP of US$8 1,613 1,290 738 1,412 (153) 3,287 46.5
108 336
Near-term share price drivers We expect the share price could still trade sideways, given lack of strong guidance from Shanda Games and new initiatives We expect share price drivers to be a few quarters away, with (1) better performance of Shanda Games, (2) non game initiatives see stronger-than-expected growth, (3) further synergetic investments to lead to higher value of Shanda Group.

Downside risks include: (1) Existing games experiencing a significant decline from lack of new content or promotion; (2) new, big titles MMORPG seeing lower-thanexpected gamer interest; (3) large investment do not provide near-term profitability, and (4) new investments fail to generate expected value.
DCF Model (Base Case Scenario)
FY10E 5.3% 21.6% 11.7% 10.0 (4.0) 2.5 24.0% 4.0
FY11E 16.1% 19.4% 14.7% 10.0 (4.0) 2.5 24.0% 4.0
FY12E 14.6% 19.3% 14.6% 10.0 (4.0) 2.5 24.0% 4.0
FY13E 13.2% 18.9% 14.3% 10.0 (4.0) 2.5 24.0% 4.0
FY14E 12.7% 18.8% 14.3% 10.0 (4.0) 2.5 24.0% 4.0
FY15E 11.9% 18.9% 14.3% 10.0 (4.0) 2.5 24.0% 4.0
FY16E 12.0% 18.9% 14.3% 10.0 (4.0) 2.5 24.0% 4.0
FY17E 12.0% 18.9% 14.3% 10.0 (4.0) 2.5 24.0% 4.0
FY18E 12.0% 18.9% 14.3% 10.0 (4.0) 2.5 24.0% 4.0
FY19E 12.0% 18.9% 14.3% 10.0 (4.0) 2.5 24.0% 4.0
FY20E 12.0% 18.9% 14.3% 10.0 (4.0) 2.5 24.0% 4.0

0% 67.3 61.4 56.6 52.6 49.3 46.5 44.1 1% 70.1 63.4 58.1 53.7 50.2 47.1 44.6 Terminal growth (%) 2% 3% 4% 73.6 78.1 84.1 65.9 69.0 73.0 59.9 62.1 64.9 55.1 56.7 58.7 51.2 52.4 53.9 47.9 48.9 50.0 45.2 45.9 46.8 5% 92.5 78.4 68.5 61.2 55.7 51.3 47.8 6% 105.2 86.0 73.3 64.5 57.9 52.9 48.9 7% 126.7 97.4 80.1 68.8 60.8 54.9 50.4
9.92% 10.92% 11.92% 12.92% 13.92% 14.92% 15.92%
109
WACC
337
Shanda: Summary of financials

Income statement
US$ in millions, year-end December FY08 Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.) Non-Operating Income (Exp.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) US$ EPS (Reported) EPS (Adjusted) BPS DPS Shares Outstanding (Mn) 519 146 374 40 124 210 251 10.5 -4.1 1.2 3.9 221 -40 179 187 2.48 2.59 7.7 0.0 72 FY09 767 217 550 61 191 299 367 2.0 -8.2 6.2 29.8 328 -71 233 258 3.38 3.74 24.5 0.0 67 FY10E 808 308 500 91 267 142 226 3.5 0.0 0.0 18.5 164 -47 91 124 1.36 1.83 26.6 0.0 65 FY11E 938 360 577 103 319 155 246 0.0 0.0 0.0 14.1 169 -43 93 119 1.31 1.68 27.1 0.0 69 FY12E 1,075 411 664 118 365 181 287 0.0 0.0 0.0 16.1 197 -49 109 136 1.53 1.90 28.8 0.0 69 Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth
Ratio analysis
%, year-end December FY08 71.9 48.3 40.4 34.5 7.7 23.8 44.7 43.4 -11.7 -2.1 FY09 71.7 47.9 38.9 30.4 8.0 24.8 46.8 41.4 29.2 36.4 FY10E 61.9 28.0 17.5 11.3 11.2 33.1 5.3 -52.6 -60.8 -59.8 FY11E 61.6 26.2 16.6 9.9 11.0 34.0 16.1 9.7 1.4 -3.3 FY12E 61.8 26.7 16.8 10.2 11.0 34.0 14.6 16.3 17.7 16.5
-67.3 -84.8 55.2 1.3 34.9 29.9
-95.4 -104.1 32.4 0.7 25.1 22.5
-96.8 -105.0 32.4 0.5 8.6 7.7
-100.4 -108.3 34.4 0.5 8.2 7.6
-103.8 -111.4 36.2 0.5 8.7 8.1
Balance sheet
US$ in millions, year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans and payables Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shanda Shareholders' equity MI Total liabilities and Equity FY08 619 5 0 49 673 14 45 209 941 0 8 182 190 146 6 342 557 42 941 FY09 1,912 17 7 58 1,993 12 70 289 2,366 2 15 261 279 151 11 441 1,690 234 2,366 FY10E 2,030 19 9 68 2,126 12 64 290 2,492 0 24 265 288 151 35 474 1,790 227 2,492 FY11E 2,227 22 11 80 2,339 12 81 290 2,722 0 28 310 338 151 35 523 1,918 282 2,722 FY12E 2,446 24 12 91 2,574 12 95 290 2,971 0 30 348 379 151 35 564 2,061 346 2,971
Cash flow statement
US$ in millions, year-end December Net Income Depr. & Amortisation Change in working capital Other Cash flow from operations Capex/investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08 179 33 39 10 261 -33 -11 -44 228 27 146 -175 0 -2 215 404 619 FY09 233 44 59 49 384 -148 2 -146 236 923 7 122 0 1,051 1,290 622 1,912 FY10E 91 52 -2 58 199 -46 0 -46 153 -24 -2 -9 0 -35 118 1,912 2,030 FY11E 93 64 32 60 250 -82 0 -82 168 8 0 21 0 29 197 2,030 2,227 FY12E 109 80 26 65 280 -94 0 -94 186 8 0 25 0 33 219 2,227 2,446
110 338

03 January 2011
Sina Corp
Miniblog and Video Portal to Expand Portal Leadership. Remain Neutral on Valuation
Sina to remain as the leading portal in China: We maintain our view that Sina should continue to be the leading portal in China. Secular online advertising growth and Sinas leadership position should be positive drivers in the long run. However, we also note media segregation leading to market share loss to other verticals, online videos, and social network sites. Platform strategy playing out well: We believe video and microblogs should continue to help maintain traffic share at Sina's portal. In terms of monetization, we do not see much direct contribution from microblogs till end of next year. Sina to maintain leadership in microblogging: Sina continued to maintain its leadership in microblogging with the number of miniblog users surpassing 50M in 3Q10 vs. 20M last quarter. The company has been adding more than 10M users during the last two months. We expect Sina Miniblog to further solidify Sinas media influences, and to help maintain long-term advertising revenue growth across both PC and mobile platforms. Sina expects to monetize Miniblog through: (1) brand advertising and SME advertising, targeted by 2H11, and (2) revenue share from applications built around microblog platform, targeted by 2012. Sina has set up an Rmb200M Miniblog fund with venture capital from Sequoia, IDG, and DFJ to support third-party developers to develop applications on SINAs Miniblog platform. Video strategy: Sina won live broadcasting rights to NBA matches for the next three years. NBA games are a popular sports event amongst Chinese youth and should enhance the portal traffic from young users. The company also plans to add more licensed content in Video for next year. 2011 outlook: We expect a healthy online advertising growth rate of 28% for 2011. Auto is expected to be strong, while the growth rate should moderate due to a higher base effect. The company expects healthy growth in advertising from growing eCommerce activities in China. In addition, FMCG and luxury goodsrelated advertising should also gain traction. Sina brand advertising should also benefit from increased traffic generation from video (includes NBA video) and some contribution from microblogs in 2H11.
Reuters: SINA, Bloomberg: SINA US
US$ in millions, year-end December FY09 FY10E Sales 353.9 382.5 Operating Profit (EBIT) 27.8 77.7 EBITDA 81.9 114.3 Pre Tax Profit 415.7 99.7 Reported Net profit 407.4 89.0 Reported EPS (US$) 6.64 1.35 P/E (x) 10.6 52.1 Adjusted EPS 7.26 1.71 Adj. P/E (x) 9.7 41.1 EV/EBITDA 45.9 32.9 P/B (x) 3.5 3.2 Y/E BPS (US$) 20.3 22.2 FY11E 467.9 102.3 140.7 123.5 104.0 1.55 45.5 2.00 35.1 26.7 2.9 24.1 FY12E 585.6 129.9 173.9 169.2 143.0 2.11 33.3 2.56 27.4 21.6 2.6 26.7 ROE (%) ROIC (%) Qtr GAAP EPS ($) EPS FY09 EPS FY10E EPS FY11E Abs. Perf.(%) Rel. Perf.(%) Cash Equity FY09 47.8 42.6 1Q 0.17 0.30 0.23 1M 13.8 8.7 746 1,222 FY10E 8.0 6.9 2Q 0.23 0.31 0.36 3M 35.5 23.3 615 1,361
Neutral
SINA, SINA US Price: $70.31 Price Target: $68.00
Internet Dick Wei

AC
Ritesh Gupta
Imran Khan
Price Performance
70 $ 50 30
SINA share price ($) NASDAQ Composite (rebased)
YTD Abs Rel 53.7% 38.2%
1m 7.9% 2.3%
3m 35.9% 23.7%
12m 57.2% 40.7%
FY11E 8.4 7.5 3Q 0.29 0.40 0.44 12M 57.6 40.1 693 1,491
FY12E 10.2 9.2 4Q 5.95 0.34 0.51
52-Week range Shares Outstg. Avg. daily vol. Avg. daily value Index (NASD) Free float Dividend Yld (%) Market Cap Price Target Price date
US$32.0-76.4 67Mn 1.5Mn US$105M 2,667 73% 0% US$4.2B US$68 Dec 29, 2010
784 1,663
Source: Company data, Bloomberg, J.P. Morgan estimates. Note: We have excluded quarterly revenue of US$4.7M related to CRIC IPO starting 4Q09.

We expect 2011 revenues to be US$467.9M (up 22.3% Y/Y) and adjusted EPS (excluding share based expenses) of US$2.00 (up 16.9% Y/Y). 2012 revenues are expected to be US$585.6M (up 25.2% Y/Y) and adjusted EPS of US$2.56 (up 28.2% Y/Y).

Remain Overweight with Dec-11 PT of US$68 We remain Overweight with Dec-11 PT of US$68. Our PT is based on SOTP valuation of Sinas organic business (valued at US$39.8), Weibo (valued at US$10), 33% holding in CRIC (valued at US$6), and gross cash of US$13. Value Weibo at US$664M We value Weibo based on 80M active Weibo users in 2012. In addition page view, we also include small revenue from revenue-sharing of third-party apps and other VAS to small to medium-sized enterprises. We estimate the business to generate net income of US$27M. We assign a 25x P/E, or a value of US$664M. Excluding equity income from CRIC, we value Sina business based on SOTP valuation (see table below). The mid-range of SOTP valuation is US$62. Excluding equity earnings from CRIC and excluding interest income, 11E/12E adjusted diluted EPS are US$1.51 and US$2.07, respectively. Excluding values of Weibo and CRIC, or at a share price of US$52, this implies Sinas core business (excluding Weibo) is valued at 34.6x 11E and 24.9x 12E diluted adjusted P/E. Excluding gross cash of US$13, values of Weibo and CRIC, share price of US$39 implies Sinas organic business is valued at 25.9x 11E and 18.6x 12E diluted adjusted P/E. We believe this is a fair P/E multiple, given a CAGR growth rate of roughly 25% over the next few years, or PEG ratio of around 1x. We value Sinas 33% holding in CRIC based on the share price of US$10. This represents US$405M or US$6.1 per Sina share (with a 15% holding discount). As such, we value this part of the business at US$6.1. At our PT of US$68, this implies 34.0x/26.5x 11E/12E diluted adjusted P/E, or at excash 30.0x/23.5x 11/12 P/E. The company has convertible debt of US$100M, but we believe looking at gross cash is more relevant, as dilution impacts from convertible debt has already been reflected in diluted share counts. Maintain our Neutral rating We maintain our Neutral rating on Sina due to: (1) high expected 2011 ad growth, (2) newly listed vertical sites and video sites could compete with Sina (and may limit revenue upside), and (3) cautious in assigning a large value to Miniblog, which will likely not contribute meaningful earnings until 2012 such assigned value is likely to change at high beta.
112 340
Sina to remain the leading portal in China We maintain our view that Sina should continue to be the leading portal in China. Secular online advertising growth and Sinas leadership position should be positive drivers in the long run. However, we also note media segregation leading to market share loss to other verticals, online videos, and social network sites.

Upside risks to our price target include better-than-expected online advertising growth and better-than-expected performance for Weibo. Downside risks to our price target include a decline in online ad gross margin, lowerthan-expected growth in advertising spending in China, and competition with other Internet vertical sites. In addition, changes in regulations in wireless value-added space, as well as further declines in wireless-related revenue due to strong competition and regulatory changes are downside risks.
2011 Sum-of-the-parts valuation (2012E)
Business lines Advertising WVAS Others Weibo Gross cash and investments Total value* Price per dil. share (US$) Average Price (US$)
Source: J.P. Morgan. Note: * Exclude earnings contribution from CRIC.
Earnings (US$M)* 108.9 12.2 1.5
Multiple (x) Low- End Hi -End 20 25 10 15 10 15
Value (US$M) Low- End Hi -End 2,178.9 2,723.6 121.5 182.3 14.7 22.0 664.5 664.5 857.0 857.0 3,836.6 4,449.4 57.1 66.2 61.7
SINADCF model (base case scenario)

2010E 8.1% 23.9% 17.5% 27.4 1.4 0.5 13.8% 0.4
2011E 22.3% 24.9% 21.5% 15.0 1.5 4.0 13.8% 1.0
2012E 25.2% 25.1% 21.6% 15.0 2.0 4.0 13.8% 1.2
2013E 22.6% 25.2% 21.7% 15.0 2.0 4.0 13.8% 1.2
2014E 20.6% 25.2% 21.8% 15.0 2.0 4.0 13.8% 1.2
2015E 18.8% 25.2% 21.8% 15.0 2.0 4.0 13.8% 1.2
2016E 17.5% 23.2% 20.0% 15.0 2.0 4.0 13.8% 1.2
2017E 16.7% 22.7% 19.6% 15.0 2.0 4.0 13.8% 1.2
2018E 15.8% 22.7% 19.6% 15.0 2.0 4.0 13.8% 1.2
2019E 15.5% 22.7% 19.6% 15.0 2.0 4.0 13.8% 1.2
2020E 15.5% 21.8% 18.8% 15.0 2.0 4.0 13.8% 1.2

0% 9% 10% 11% 12% 13% 14% 15% 1% Terminal Growth (%) 2% 3% 4% 5% 6% 7%
60.3
53.2 47.7 43.2 39.6 36.5 34.0
63.0
55.1 49.0 44.1 40.2 37.0 34.3
66.6
57.5 50.6 45.2 41.0 37.5 34.7
71.3
60.5 52.6 46.6 41.9 38.2 35.2
78.0
64.5 55.1 48.3 43.0 38.9 35.7
87.9
70.2 58.5 50.4 44.4 39.9 36.3
104.5
78.6 63.3 53.3 46.2 41.1 37.1
137.6
92.7 70.5 57.3 48.7 42.6 38.1
113
WACC
341
Sina Corp: Summary of financials

Income statement US$ in millions, year-end Dec Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.) Non-Operating Income (Exp.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted) * US$ EPS (Reported) EPS (Adjusted) * BPS DPS Shares Outstanding (Mn) Balance sheet US$ in millions, year-end Dec Cash and cash equivalents Accounts receivable Short-term investments Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY08A 383 79 221 9 692 0 34 96 822 FY09A 746 75 75 22 919 581 23 91 1,614 FY10E 615 80 236 28 958 633 14 89 1,694 FY11E 693 103 236 36 1,068 661 12 88 1,830 FY12E 784 126 236 44 1,189 721 10 87 2,007 FY08A 370 147 223 28 118 75 92 17.7 0 0.0 2.4 95 -14 81 94 1.33 1.56 11.10 0.00 56 FY09A 354 153 201 30 135 33 53 8.1 0 0.0 375.1 416 -8 407 445 6.64 7.26 20.29 0.00 54 FY10E 383 163 219 31 107 78 101 8.3 0 13.7 0.0 100 -11 89 113 1.35 1.71 22.16 0.00 61 FY11E 468 199 268 36 129 102 125 7.0 0 14.2 0.0 123 -20 104 134 1.55 2.00 24.12 0.00 62 FY12E 586 250 335 47 157 130 156 9.6 0 29.8 0.0 169 -26 143 174 2.11 2.56 26.72 0.00 62 Ratio Analysis %, year-end Dec Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth FY08A 60.2 24.9 20.2 21.8 7.7 32.0 50.2 46.2 39.7 37.9 #DIV/0! -39.5 -45.8 44.9 0.7 17.0 12.3 24.2 FY09A 56.8 15.1 9.2 115.1 8.4 38.1 -4.2 -56.4 405.2 397.8 #DIV/0! -49.0 -53.0 21.9 0.5 47.8 42.6 79.9 FY10E 57.3 26.3 20.3 23.3 8.2 28.0 8.1 139.0 -78.2 -79.7 #DIV/0! -35.3 -37.9 22.6 0.5 8.0 6.9 11.1 FY11E 57.4 26.7 21.9 22.2 7.7 27.6 22.3 31.6 16.8 14.5 #DIV/0! -37.4 -39.9 25.6 0.5 8.4 7.5 11.3 FY12E 57.2 26.6 22.2 24.4 8.0 26.9 25.2 27.0 37.6 36.5 #DIV/0! -38.9 -41.2 29.2 0.6 10.2 9.2 14.5
Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC ROIC (net of cash) Cash flow statement US$ in millions, year-end Dec Net Income Depr. & Amortisation Change in working capital Other Cash flow from operations Capex/investments Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash
FY08A 81 17 5 14 117 -29 -14 -43 88 10 0 27 0 37 112 272 383
FY09A 407 21 22 33 483 -5 -435 -440 478 -33 0 353 0 320 363 383 746
FY10E 89 23 -51 14 75 -12 -213 -225 63 -3 0 21 0 18 -132 746 615
FY11E 104 22 -7 16 136 -20 -28 -48 116 10 0 -19 0 -9 79 615 693
FY12E 143 26 -6 18 181 -23 -60 -82 158 11 0 -19 0 -8 90 693 784
0 1 94 95 99 8 202 621
0 2 123 125 99 168 392 1222
0 6 78 85 99 149 333 1361
0 8 101 110 99 130 339 1491
0 10 124 134 99 112 345 1663
Source: Company data, J.P. Morgan estimates. * Note: We have included share-based compensation adjustments starting 2006.
114 342

03 January 2011
Sohu.Com
Potential Upside from Ad Margin and Games to Drive Share Price
We maintain our Overweight rating on Sohu with a Dec-11 PT of US$89. We expect advertising margin expansion and upside from DMD to be share price drivers for the stock in 2011. Expect Sohu to maintain brand advertising market share: We expect Sohu 2011 brand revenue to grow by 19%. Increased video monetization should help overall brand advertising revenues for Sohu, in over view. We expect autos, fast-moving consumer goods, and eCommerce to be key segments to watch. While real estate revenues should continue to be affected by new government policies and regulations, penetration into second-tier cities is likely to drive growth. 2011 to experience margin expansion in online advertising: With a positive macro environment, we believe Sohu should see margin expansion on the back of fixed portal costs. We expect online advertising margins in 2011 to expand to 61.1% from 60.5% in 2010E. We believe Sohu could see more margin leverage in 2011, as the company plans to reduce spending on video and begin to get more traction from video advertising. Upside to come from online game business: Based on Street consensus, Sohus game division (Changyou) currently trades at 8.3x 11 and 7.3x 12 P/E. We expect earnings upside could come from the launch of DMD (likely 1H11), while multiple expansion could come from re-rating of leading game companies given sustained long-term growth. At our PT, we assume the game segment trades at 8.5x 11/12 P/E. 2011 stock price drivers: Earning upgrades potential may come from: (1) stronger trend in online video monetization; (2) launch of Duke of Mountain deer generates strong interest amongst online gamers. Re-rating could happen from the multiple expansion of the online gaming sector through sustained solid growth by online gaming companies in 2011.
Reuters: SOHU, Bloomberg: SOHU US
US$MM, YE-Dec Net Sales Operating Profit (EBIT) EBITDA Pre Tax Profit Reported Net profit Reported EPS (US$) P/E (x) Adj. EPS * Adj. P/E (x) EV/EBITDA P/B (x) FY09 515.2 204.4 238.0 210.2 147.8 3.57 17.8 3.99 16.0 9.0 4.1 FY10E 606.6 223.0 313.6 226.4 144.3 3.49 18.2 4.13 15.4 6.8 3.2 FY11E 736.5 268.6 327.1 279.6 197.0 4.64 13.7 5.39 11.8 6.5 2.5 FY12E 877.1 322.7 387.4 337.5 237.5 5.51 11.6 6.28 10.1 5.5 2.0 ROE (%) ROIC (%) Qtr GAAP EPS (US$) EPS FY09 EPS FY10E EPS FY11E Abs. Perf.(%) Rel. Perf.(%) Cash Equity
Overweight
SOHU, SOHU US Price: $65.76 Price Target: $89.00
Internet Dick Wei

AC
Ritesh Gupta
Imran Khan
Price Performance
80 $ 60 40
SOHU share price ($) NASDAQ Composite (rebased)
YTD Abs Rel 13.5% -4.0%
1m -10.9% -17.7%
3m 8.4% -6.1%
12m 14.9% -2.5%
FY09 FY10E FY11E FY12E 38.9 31.2 29.7 27.4 52-Week range 38.1 30.7 28.8 26.4 Shares Outstg 1Q 2Q 3Q 4Q Avg daily value 1.15 0.79 0.88 0.75 Avg dly volume 0.73 0.82 1.01 0.94 Index (NASD) 0.97 1.15 1.23 1.30 Free float 1M 3M 12M Dividend Yld (%) -12.8 7.9 12.2 Market Cap -18.0 -4.4 -5.3 Price Target 563.8 651.3 889.0 1,163.7 Price Date 609.8 799.5 1,048.5 1,341.2
US$40.1-80.9 38M US$55M 1.2M 2,667 45% 0% US$2.41B US$89 Dec 29, 2010
Source: Company data, Bloomberg, J.P. Morgan estimates. * Note: We have included share-based compensation expense adjustments starting in 2006.

We are maintaining our F11 revenue and adjusted EPS estimates of $736.5M and $5.39, respectively. Our F12 estimates call for revenue and adjusted EPS estimates of $877.1M and $6.28, respectively.

We maintain our Dec-11 PT of US$89. Our PT implies 21.5x 2010E, 16.5x 2011E and 14.2x 2012E diluted adjusted P/E, or 25.5x 2010E, 19.2x 2011E, and 16.2x 2011E GAAP P/E. Our price target is based on the midpoint of our sum-of-the-parts valuation of US$78-US$99.4. As a reference, our Dec-11 DCF value for Sohu is US$81, based on a 10-year DCF forecast, WACC of 12%, and terminal growth rate of 0%. Sohus portal At the mid-point of our SOTP valuation, portal is valued at US$1.3B, which we think is relatively low, compared with Sina at US$2.5B and Soufun at US$1.4B. Given Sohus brand name and content investment, we believe Sohus portal could see a higher valuation. However, due to Sohus portal recent content investments, we believe Sohu's portal cannot demand a higher value in the near term. Online games Based on Street consensus, Sohus game division (Changyou) trades at 8.8x 11 and 8x 12 PE. At our PT, we assume game segment to trade at 8.5x 11/12 P/E, or an implied value of US$1.6B (including Sohus claim on Changyou cash). We expect earnings upside could come from the launch of DMD (likely 1H11), while multiples expansion could come from re-rating of sustained solid growth for leading game companies. Sogou value at US$200 M Based on Alibabas investment amount, post money valuation for Sogou is US$150M. We have assumed a higher value, as we believe Alibabas cooperation will create value to Sogou. Baidu has ~80% market search share in China with ~US$40B market cap. For Sogou, it currently has ~1% market share. Making a direct comparison, this implies Sogou value of US$500M. Baidu is currently trading at 40.3x P/E 2011E. If we assume Sogou were also profitable with similar margins, then Sogou probably can only trade at 20x (given high growth end market, but not a dominant player). From this calculation, we estimate Sogous valuation to be US$200M. In other words, we take a more optimistic view that with Alibaba's investment, Sogou can have a higher value in the future. The US$50M value difference causes ~US$1 share price impact in our SOTP analysis. Sohu has net cash of US$510M or net cash of US$13.2 per diluted share (excluding Changyous claim cash). On a consolidated basis, Sohu has cash of US$609.3M as of 3Q10, or US$15.9 per diluted share.
116 344

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 websites, and volatility in wireless revenue due to policy change at mobile operators. For online games business, delays in upgrade and new game launches, and regulatory changes also add to downside risks.
Sohu Sum-of-the-Parts Valuation
2011E Net profit (US$M) 74.8 8.8 168.1 -10.6 Multiple (x) 16 8 7 nm Value (US$M) 1197.0 70.6 1176.6 106.0 317.3 192.1 3059.6 78.0 Multiple (x) 20 10 10 nm Value (US$M) 1496.3 88.3 1680.9 106.0 317.3 192.1 3880.8 99.0 88.5
Branded ads WVAS Games profit (after 66% of MI) Sogou (53% holdings) Sohu.com net cash and other Claim on Changyou cash (66.7% of Changyou cash) Total equity value Value per diluted share Mean value per share (US$)
Sohu DCF Model (base case scenario)

2010E 17.7% 31.5% 26.8% 3.2 (8.0) 3.0 15.0% 1.9
2011E 21.4% 31.1% 26.4% 3.2 (8.0) 3.0 15.0% 1.9
2012E 19.1% 30.3% 25.7% 3.2 (8.0) 3.0 15.0% 1.9
2013E 15.5% 29.5% 25.1% 3.2 (8.0) 3.0 15.0% 1.9
2014E 16.3% 28.7% 24.4% 3.2 (8.0) 3.0 15.0% 1.9
2015E 15.6% 27.9% 23.8% 3.2 (8.0) 3.0 15.0% 1.9
2016E 15.0% 27.7% 23.5% 3.2 (8.0) 3.0 15.0% 1.9
2017E 13.0% 27.7% 23.5% 3.2 (8.0) 3.0 15.0% 1.9
2018E 13.0% 27.7% 23.5% 3.2 (8.0) 3.0 15.0% 1.9
2019E 13.0% 27.7% 23.5% 3.2 (8.0) 3.0 15.0% 1.9
2020E 13.0% 27.7% 23.5% 3.2 (8.0) 3.0 15.0% 1.9

0% 107.6 93.0 81.1 71.3 63.2 56.4 50.6 1% 113.4 97.0 84.1 73.5 64.9 57.6 51.6 Terminal Growth (%) 2% 3% 4% 120.5 129.7 142.0 102.1 108.3 116.4 87.6 92.0 97.5 76.1 79.3 83.1 66.8 69.1 71.8 59.1 60.8 62.7 52.6 53.9 55.4 5% 159.2 127.1 104.5 87.9 75.1 65.1 57.1 6% 185.0 142.1 113.9 94.0 79.3 68.0 59.2 7% 228.0 164.7 127.0 102.2 84.7 71.7 61.7
10.00% 11.00% 12.00% 13.00% 14.00% 15.00% 16.00%
117
WACC
345
Sohu.com: Summary of financials

US$ in millions, year-end December Income statement FY08A Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.) Non-Operating Income (Exp.) Earnings before tax Tax Net Income (Reported) Net Income (Adjusted)* USD EPS (Reported) EPS (Adjusted)* BPS DPS Diluted Shares (Mn) Balance sheet Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY08A 314 37 0 28 379 0 76 67 522 FY09A 564 47 0 11 621 0 115 92 828 FY10E 651 51 0 42 744 0 125 228 1,097 FY11E 889 61 0 50 1,001 0 154 228 1,382 FY12E 1,164 71 0 58 1,293 0 189 228 1,710 429 106 323 43 115 164 189 4.3 0 0.0 -0.5 168 -9 159 169 4.04 4.30 10.13 0.00 39 FY09A 515 122 393 48 140 204 238 5.0 0 0.0 0.8 210 -34 148 162 3.57 3.99 15.68 0.00 39 FY10E 607 158 449 62 164 223 314 4.7 0 0.0 -1.3 226 -34 144 160 3.49 4.13 20.14 0.00 39 FY11E 737 198 539 67 203 269 327 11.0 0 0.0 0.0 280 -37 197 216 4.64 5.39 25.89 0.00 40 FY12E 877 233 644 89 233 323 387 14.8 0 0.0 0.0 337 -45 238 256 5.51 6.28 32.48 0.00 41 Ratio Analysis % Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth FY08A 75.3 44.0 38.2 37.0 10.0 26.9 127.1 400.9 354.1 345.6 FY09A 76.3 46.2 39.7 28.7 9.4 27.2 20.1 24.7 -6.8 -11.7 FY10E 74.0 51.7 36.8 23.8 10.2 27.0 17.7 9.1 -2.4 -2.3 FY11E 73.1 44.4 36.5 26.7 9.1 27.5 21.4 20.4 36.5 32.9 FY12E 73.4 44.2 36.8 27.1 10.1 26.5 19.1 20.2 20.6 18.6
-81.5 -81.5 82.2 2.6 56.0 54.8
-92.5 -92.5 62.2 1.4 38.9 38.1
-81.5 -81.5 55.3 1.2 31.2 30.7
-84.8 -84.8 53.3 1.1 29.7 28.8
-86.8 -86.8 51.3 1.0 27.4 26.4
Cash flow statement Net Income Depr. & Amortisation Change in working capital Other Cash flow from operations Capex Disposal/ (purchase) Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY08A 159 14 29 11 213 -24 0 -24 189 -2 0 5 0 3 192 123 314 FY09A 148 16 27 46 237 -80 0 -80 156 59 0 34 0 93 249 314 564 FY10E 144 63 -4 76 280 -209 0 -209 71 18 0 -1 0 17 87 564 651 FY11E 197 26 18 78 318 -55 0 -55 263 19 0 -45 0 -26 238 651 889 FY12E 238 30 17 90 375 -66 0 -66 309 21 0 -55 0 -34 275 889 1,164
0 4 126 131 0 5 136 386
0 5 146 150 0 68 218 610
0 7 176 182 0 115 297 799
0 8 211 218 0 115 334 1,048
0 9 245 254 0 115 369 1,341
* Adjustments: excluding stock based compensation expense
118 346

03 January 2011
Tencent
To Maintain Its Leadership Position in China Internet Space
We expect Tencent to continue maintaining its leadership position in Chinas internet space in 2011. New revenue from open platform applications, social eCommerce, mobile platform launch, and a new game pipeline could be some of the drivers for 2011. We remain Overweight with a Dec-11 PT of HK$205. Expect Tencent to Maintain its Leadership in China internet: Tencent has established itself as a leading internet platform in China with its leadership in social networking, online gaming, instant messaging, and online and wireless portal. We expect Tencent to further leverage and monetize its platform in 2011 through new ventures in eCommerce, mobile internet, third-party apps, and, to a certain extent, online search. As a well-executed leader in Chinas internet space, Tencent is likely to remain a key beneficiary of rising disposable incomes and increasing internet penetration in China. Open Platform to Be a Key Focus: The company has already created open platform interfaces for four key products: (1) social networks, (2) SoSo, (3) Paipai, and (4) Tenpay. The strategy is to increase user loyalty to Tencents community and eventually increase monetization. Tencent plans to upgrade Xiaoyou to PengYou with better open-platform support. Online games Should Continue to Be Strong: We expect game segment growth to continue to be driven by Cross Fire and Dungeon & Fighter upgrades and new unannounced titles launch (both in-house and licensed games). Mobile games and mobile social games will increase loyalty to Tencents platform and help Mobile VAS revenue. 2011 earnings drivers to come from: (1) potential upside in gaming revenue, driven by the launch of multiple games in 2011; (2) better-than-expected ad growth with macro pick-up and improving brand image; and (3) new growth potential in SNS (third party apps, eCommerce and others), and (4) early signs of the success of mobile internet products.
Reuters: 0700.HK, Bloomberg: 700 HK
Rmb MM, YE December Net sales Operating profit (EBIT) EBITDA Net Profit Adj. Net Profit Reported EPS (Rmb) P/E (x) Adj. EPS (Rmb) * Adj. P/E (x) EV/EBITDA P/BV (x) YE BPS (Rmb) FY09 FY10E FY11E FY12E 12,440 19,540 25,018 31,429 ROE (%) 6,020 9,803 12,094 15,246 ROIC (%) 6,801 10,840 13,489 16,839 Qtr GAAP EPS (Rmb) 5,156 8,130 10,589 13,479 EPS FY09 5,477 8,601 11,069 13,950 EPS FY10E 2.79 4.37 5.63 7.10 EPS FY11E 54.3 34.7 26.9 21.4 2.97 4.62 5.88 7.34 Abs. Perf.(%) 51.1 32.8 25.8 20.6 Rel. Perf.(%) 39.1 24.5 19.7 15.8 Cash 25.7 16.2 10.6 7.4 Equity 6.7 10.6 16.3 23.3
Overweight
0700.HK, 700 HK Price: HK$178.00 Price Target: HK$205.00
Internet Dick Wei

AC
(852) 2800-8535 dick.x.wei@jpmorgan.com
Ritesh Gupta
(91-22) 6157 3307 ritesh.z.gupta@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited
P r ic e P e r fo r m a n c e
180 HK$ 150 120
0700.HK share price (HK$) HSI (rebased)
YTD Abs Rel 2.8% -2.5%
1m 0.5% 1.4%
3m 2.5% -0.1%
12m 7.4% 0.6%
FY09 FY10E FY11E FY12E 54 51 43 37 52-week range 56 47 37 33 Shares outstg 1Q 2Q 3Q 4Q Avg daily value 0.57 0.65 0.77 0.81 Avg dly volume 0.96 1.03 1.16 1.22 Index (HSI) 1.27 1.36 1.46 1.54 Free float 1M 3M 12M Dividend yld (%) 0.5 2.5 7.7 Market cap 1.3 -0.1 0.8 Price target 11,354 19,066 30,270 44,212 Date of price 12,179 19,473 30,149 43,497
HK$120.4-193.0 1,851MM US$ 114MM 4.5MM 22,969 ~50% 0.3% US$41.2B HK$205 Dec 29, 2010
Source: Company data, Bloomberg, J.P. Morgan estimates. * Note: Excluding share-based compensation expenses.
Launch of Open Platforms to Be Next Growth Driver

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

We are maintaining our F11 revenue and adjusted EPS estimates of Rmb25.0B and Rmb5.88, respectively. Our F12 estimates call for revenue and adjusted EPS of Rmb31.4B and Rmb7.34, respectively.
Valuation, Rating Analysis and Risks

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

Rmb in millions, year-end December
Income statement
Revenues Cost of goods sold Gross profit R&D expenses SG&A expenses Others Operating profit (EBIT) EBITDA Interest income Investment income (exp.) Non-operating income (exp.) Earnings before tax Tax Net income (reported) Net income (adjusted) Rmb EPS (Reported) EPS (Adjusted) BPS DPS Diluted shares outstanding (MM)
FY08 7,155 2,170 4,984 518 1,332 0 3,134 3,654 112 0.0 -140.7 3,105 -289 2,785 2,945 1.51 1.60 3.88 0.14 1,841
FY09 12,440 3,889 8,550 581 2,026 0 5,943 6,801 78 0.0 -2.0 6,019 -819 5,156 5,477 2.79 2.97 6.73 0.35 1,845
FY10E 19,540 6,205 13,335 914 2,809 0 9,612 10,840 278 0.0 -1.1 9,889 -1,742 8,130 8,601 4.37 4.62 10.65 0.45 1,861
FY11E 25,018 7,892 17,126 1,001 4,031 0 12,094 13,489 468 0.0 0.0 12,562 -1,956 10,589 11,069 5.63 5.88 16.30 0.58 1,882
FY12E 31,429 9,860 21,568 1,257 5,065 0 15,246 16,839 714 0.0 0.0 15,961 -2,465 13,479 13,950 7.10 7.34 23.27 0.73 1,900
Ratio analysis
%, year-end December Gross Margin EBITDA margin Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC
FY08 69.7 51.1 43.8 38.9 7.2 18.6 87.2 100.1 77.8 77.1 -73.0 -73.0 72.6 1.9 45.6 45.6
FY09 68.7 54.7 47.8 41.4 4.7 16.3 73.9 89.6 85.2 84.8 -90.1 -91.6 71.1 1.9 53.7 55.8
FY10E 68.2 55.5 49.2 41.6 4.7 14.4 57.1 61.7 57.7 56.3 -65.3 -78.2 63.6 1.9 51.4 46.9
FY11E 68.5 53.9 48.3 42.3 4.0 16.1 28.0 25.8 30.3 28.8 -77.8 -87.7 58.0 1.5 42.7 37.2
FY12E 68.6 53.6 48.5 42.9 4.0 16.1 25.6 26.1 27.3 26.1 -85.3 -92.8 53.6 1.1 36.6 32.8
Balance sheet
Total cash Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity
FY08 5,129 983 5 378 6,496 389 2,041 930 9,856 0 245 1,847 2,092 0 743 2,835 7,021
FY09 11,354 1,229 0 574 13,157 972 2,623 753 17,506 202 697 3,664 4,563 0 764 5,327 12,179
FY10E 19,066 1,910 0 1,465 22,440 3,246 3,480 1,577 30,744 3,838 1,318 5,418 10,574 0 697 11,271 19,473
FY11E 30,270 2,401 0 1,817 34,488 3,246 3,837 1,577 43,148 3,838 1,652 6,813 12,303 0 697 13,000 30,149
FY12E 44,212 3,001 0 2,274 49,486 3,246 4,283 1,577 58,593 3,838 2,048 8,514 14,400 0 697 15,096 43,497
Cash flow statement

Net income Depr. & amortization Change in working capital Other Cash flow from operations Capex Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash F/X & term deposits change Beginning total cash Ending total cash
FY08 2,785 360 202 233 3,580 -1,705 -810 -2,515 1,875 -301 -292 -19 -258 -870 -76 119 1,190 3,820 5,129
FY09 5,156 537 1,833 365 7,891 -943 -584 -1,526 6,949 255 202 43 -639 -140 0 6,225 0 5,129 11,354
FY10E 8,130 756 804 490 10,180 -2,437 -2,274 -4,711 7,742 124 3,636 -704 -813 2,243 0 7,712 0 11,354 19,066
FY11E 10,589 915 885 497 12,885 -1,272 0 -1,272 11,614 666 0 -17 -1,059 -410 0 11,204 0 19,066 30,270
FY12E 13,479 1,121 1,041 488 16,129 -1,568 0 -1,568 14,561 746 0 -17 -1,348 -619 0 13,942 0 30,270 44,212
Source: Company data and J.P. Morgan estimates. *Note: Adjusted earnings exclude share-based compensation expense (non-cash) and one-time items.
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03 January 2011
The9 Limited
New Three-legged Strategy But Still Lacks a Strong Game
We expect weak operating performance for the company to continue in 2011. Our Dec-11 PT of US$6.1 is at a 20% discount to year-end 2011 estimated cash per share.
Company has restructured into three divisions: (1) Global strategy: Mainly based on R&D capability of Red 5 studio and other future investments. Red 5 studio is led by an ex-World of Warcraft developer from Blizzard. (2) Domestic strategy: Maintain in-house and licensing strategy. Currently, the company has an R&D staff of 300 for in-house development. (3) Alternative platform strategy: Mobile game/mobile game platform. The acquisition of minority stakes in Aurora Feint (an iPhone game platform with 28M registered users and 2,220 games) to help jump-start The9s mobile game business in China. Mobile gaming platform: The company has been trying to develop a mobile gaming platform along with three telco carriers in China. The company has tie-ups with Aurora Fient which runs the biggest game platform on iPhone in the US. The company also invested US$4 M in Openfeint previously for a 13% stake. Disclosed game pipeline includes: (1) 1Q11: Shen Xian Zhuan (in-house game from Hang Zhou studio), (2) Free Realms (a cartoon-style MMORPG licensed from Sony) to be launched in 2H11, and (3) Red 5, a subsidiary of The9 is also releasing a FPS game named Firefall in October 2011. The company terminated its online game FIFA Online from EA Sports recently. The game was generating losses for the company. Expect losses to continue and the stock to trade below cash: With a small revenue base, while maintaining company headcount of 800 to support potential future growth, we forecast losses to continue in the medium term. The company currently has net cash of US$9.0 per share. We do not expect strong results from Shen Xian Zhuan launch by the end of 2010. As such, we believe the company still lacks share price drivers. Potential drivers could come from successes in handset games and Red 5 game.
Reuters: NCTY; Bloomberg: NCTY US
(US$ MM, Y/E-Dec) Sales Operating profit EBITDA Pre-tax profit Reported Net Profit GAAP EPS (US$) P/E (x) Adj. EPS (US$) Adj. P/E (x) EV/EBITDA P/B (x) Y/E BPS (US$) FY08 249.1 19.6 60.7 24.7 14.1 0.51 13.5 0.78 8.7 -1.2 0.5 14.3 FY09 FY10E FY11E 111.5 15.5 19.7 ROE (%) -70.8 -42.7 -37.9 ROIC (%) -33.1 -27.4 -22.7 Qtr Diluted EPS (US$) -57.6 -41.0 -35.5 EPS FY09 -59.4 -38.8 -35.5 EPS FY10E -2.34 -1.53 -1.38 EPS FY11E nm nm nm -1.99 -1.33 -1.21 Abs. Perf.(%) nm nm nm Rel. Perf.(%) 2.3 2.7 3.3 0.6 0.7 0.7 Cash (US$ MM) 11.8 10.4 9.2 Equity (US$ MM) FY08 6.3 4.5 1Q -0.26 -0.44 -0.35 1M -1.7 -6.9 323.2 395.8 FY09 -13.9 -14.4 2Q -0.46 -0.38 -0.35 3M 35.5 23.3 245.5 294.8 FY10E -12.9 -13.0 3Q -0.43 -0.36 -0.34 12M -2.8 -20.3 215.4 261.5 FY11E -12.6 -11.9 4Q -1.20 -0.35 -0.34
Neutral
NCTY, NCTY US Price: $5.05 Price Target: $6.10
Internet Dick Wei

AC
Ritesh Gupta
Imran Khan
Price Performance
9 $ 6 3
NCTY share price ($) NASDAQ Composite (rebased)
YTD Abs Rel -9.8% -27.3%
1m 1.1% -5.7%
3m 24.0% 9.5%
12m -7.7% -25.1%
52-wk range (US$) Shares outstg (MM) Avg daily volume Avg daily value Index (NASD) Free float (%) Dividend yld (%) Market cap (US$) Price target (US$) Price Date
3.7-8.7 25Mn 0.1Mn US$0.4Mn 2,667 25% 0% 0.17B US$6.1 Dec 29, 2010
192.8 232.5
Source: Bloomberg, Company and J.P.Morgan estimates. Note: We have included share-based compensation adjustments starting 2006.

We are maintaining our F11 revenue and adjusted EPS estimates of $15.5M and $(1.33), respectively. Our F12 estimates call for revenue and adjusted EPS estimates of $19.7M and $1.21, respectively.
Rating and Valuation

Our Dec-11 price target is US$6.1 We recently rolled over our Dec-10 PT of US$6.1 to Dec-11. The company had total cash of US$226M at the end of 1H10 with zero debt. We expect 2011-end cash to fall to US$192.5M. At 2011-end, the company is expected to have US$7.7 per ADS in cash. We keep our 2011-end PT at a 20% discount to estimated 2011-end cash. We remain Neutral on The9 due to low revenue visibility and earnings decline from operating losses and R&D investments. However, we believe the share price will be supported by the current cash level of US$9.0 per ADS. The stock has been trading in the range of a 20%-30% discount to net cash over the past few quarters. We expect The9 to continue to trade within this range. The company could trade closer to a 20% discount to its net cash, given the potential success of some of its new game launches. Share price drivers We believe drivers will come from strong gamer response from newly launched games and alternative platform strategy.
Risks to Our Price Target and Rating
Downside risks to our price target and rating include: (1) larger-than-expected investments in game titles and studios, (2) new game launches that disappoint. We expect positive share price drivers/risks to be: (1) Better-than-expected performance of The9s new game launches, and (2) the company being an acquisition target (due to its high cash).
124 352
The9: Summary of financials

Income statement
Revenues Cost of Goods Sold Gross Profit R&D Expenses SG&A Expenses Operating Profit (EBIT) EBITDA Interest Income Interest Expense Investment Income (Exp.) Non-Operating Income (Exp.) Earnings before tax Tax Net Income (Reported) Adj. Net Income (ex-123R exp.) RMB: Diluted EPS (Reported) Adj. EPS (ex-123R exp.) BPS DPS Shares outstanding (MM) Rmb in millions, year-end December FY07 1,280 700 580 41 284 236 448 50.7 0.0 -5.7 -30.1 251 -9 241 289 8.71 10.44 97.56 0.00 27 FY08 1,711 998 714 74 423 135 365 56.7 0.0 -2.2 -19.0 170 -48 97 149 3.50 5.38 98.42 0.00 28 FY09 761 712 48 114 338 -483 -308 30.5 0.0 -2.6 61.8 -393 6 -405 -346 -15.95 -13.61 80.33 0.00 26 FY10E 106 108 -2 121 169 -291 -222 24.7 0.0 -8.2 -5.0 -280 0 -265 -230 -10.45 -9.08 71.01 0.00 25 FY11E 134 120 14 104 168 -258 -185 23.8 0.0 -3.6 -4.0 -242 0 -242 -212 -9.41 -8.22 62.95 0.00 25
Ratio analysis
Gross Margin EBITDA margin
%, year-end December FY07 45.3 35.0 18.4 18.8 3.2 22.2 29.8 -12.7 -22.9 -31.8 FY08 41.7 21.3 7.9 5.7 4.3 24.7 33.8 -43.0 -59.8 -60.2 FY09 6.3 -40.6 -63.5 -53.3 15.0 44.4 -55.6 -458.9 -518.4 -556.1 FY10E -1.6 -209.2 -274.5 -249.8 113.6 159.3 -86.1 39.7 34.6 32.1 FY11E 10.2 -138.1 -192.6 -180.6 77.5 125.4 26.5 11.3 8.6 11.0
Operating Margin Net Margin R&D/sales SG&A/Sales Sales growth Operating Profit Growth Net profit growth EPS (Reported) growth
Net debt to total capital Net debt to equity Asset Turnover Working Capital Turns (X) ROE ROIC ROIC (net of cash)
-72.4 -75.1 39.4 0.9 14.0 11.6 44.0
-73.4 -76.9 52.5 0.9 6.3 4.5 19.4
-79.6 -81.2 32.7 0.4 -13.9 -14.4 -69.9
-60.0 -68.4 4.4 0.1 -12.9 -13.0 -54.9
-58.1 -67.2 6.0 0.1 -12.6 -11.9 -41.0
Balance sheet
Rmb in millions, year-end December Cash and cash equivalents Accounts receivable Inventories Others Current assets LT investments Net fixed assets Others Total assets Liabilities ST loans Payables Others Total current liabilities Long term debt Other liabilities Total liabilities Shareholders' equity FY07 2,215 27 101 72 2,415 179 344 307 3,246 107 285 48 440 0 0 440 2,806 FY08 2,221 9 126 139 2,494 403 200 166 3,263 129 345 69 544 0 0 544 2,719 FY09 1,675 2 126 0 1,803 395 76 52 2,325 41 22 248 312 0 2 314 2,011 FY10E 1,469 2 182 0 1,653 408 60 269 2,390 0 30 307 337 249 20 607 1,784 FY11E 1,315 3 208 0 1,526 404 35 277 2,242 0 35 352 387 249 20 656 1,586
Cash flow statement
Rmb in millions, year-end December Net Income Depr. & Amortization Change in working capital Other Cash flow from operations Capex / investment Others Cash flow from investing Free cash flow Equity raised/ (repaid) Debt raised/ (repaid) Other Dividends paid Cash flow from financing Net change in cash Beginning cash Ending cash FY07 241 212 31 49 533 -362 -144 -506 171 1,229 70 -49 0 1,250 1,277 938 2,215 FY08 97 230 7 77 412 -46 -122 -168 365 -138 23 -123 0 -238 5 2,215 2,221 FY09 -405 174 1 160 -69 -71 60 -11 -140 -115 -88 -262 0 -466 -546 2,221 1,675 FY10E -265 69 11 20 -165 -271 -13 -284 -435 3 208 32 0 243 -206 1,675 1,469 FY11E -242 73 23 31 -116 -56 4 -53 -172 14 0 0 0 14 -154 1,469 1,315
Source: Company data and J.P.Morgan estimates.
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Japan Equity Research

03 January 2011
DeNA (2432)
Domestic Growth Peaking, Competitive Pressures Overseas
We are maintaining our Underweight rating on DeNA, with a target price of 2,200 to November 2011. We believe domestic growth prospects have peaked, and consequently we expect returns to fall due to greater competition and pressure to spend on marketing to keep market share. We have low expectations for DeNAs plans for overseas expansion and believe that these efforts will not offset the declining domestic growth profile. We maintain our Underweight rating. We view DeNA as being in the 'early glory' phase of the mobile social gaming market cycle, as it dominates the domestic market (we estimate a 40% share in CY10). We believe Y/Y growth rates have peaked, and although short-term earnings visibility is high the decelerating Y/Y growth profile looks unattractive. Overseas expansion via M&A does position the company strongly versus domestic peers, but we believe competitive threats are also high as the market overcrowds. Overall, we believe medium-term growth prospects are muted as domestic demand enters a declining profile, with measured advances to be gained overseas. With the business exiting a high-growth phase and entering a flattening growth profile in our view, we rate the shares Underweight. Domestic prospects diminishing, overseas competitive threats. Mobile social gaming is a new developing market, and the supply/demand balance is still in favor of early movers with hit content. Social gaming content has the advantage of being able to be changed and adjusted 'on the go' in order to meet user needs and can have a long shelf life compared with traditional package software. However, with more games on the market we think the business model will become more reliant on winning new users and keeping them activewe believe marketing costs will rise, resulting in lower returns. As we think the domestic market is unlikely to see a reacceleration of demand, positioning in the overseas markets becomes important for DeNA. However, competitive threats are significantly higher, and we envisage that replicating the success seen domestically will be very difficult to execute overseas. Despite acquiring US app maker ngmoco and having access to overseas resources and the virtual social gaming network 'Plus+', we believe it will become a niche service given the preference of overseas users to operate with real social graphs.
Underweight
2432.T, 2432 JT Price: 2,954 Price Target: 2,200
Japan
Internet Hiroshi Kamide

AC
(81-3) 6736 8602 hiroshi.kamide@jpmorgan.com
Yusuke Maeda
(81-3) 6736-8654 yusuke.x.maeda@jpmorgan.com JPMorgan Securities Japan Co., Ltd.
Price Performance
2,800 Y 2,200 1,600
2432.T share price (Y TOPIX (rebased)
Company Data
Price Price date Market capitalization Shares outstanding 52-week range TOPIX Dividend (F10E) Dividend yield (F10E) ROE (F10E) 2,954 Dec. 29, 2010 420.7B 142.4M 3,105 1,680 908.01 46.5 1.6% 63.9%
Source: Bloomberg, J.P. Morgan estimates.
Valuation and risks. The shares are trading at 11.0x our F11 EPS forecast,
which is not a demanding valuation in our opinion. On our medium-term forecasts with decelerating earnings growth that turns negative, we believe the shares offer little upside, and hence our Underweight rating. Risks to our price target include a reaccelerating growth profile in the domestic market and speedy and pronounced earnings generation from overseas expansion.
Consolidated Y/E Mar 2009 2010 2011E 2012E 2013E Sales (B) 37.6 48.1 113.3 140.1 141.3 Y/Y (%) 26.5 27.9 135.5 23.7 0.9 OP (B) 15.8 21.3 55.5 64.0 61.8 Y/Y (%) 25.1 34.2 160.8 15.3 -3.3 RP (B) 16.1 21.5 55.7 64.2 62.1 Y/Y (%) 25.6 33.7 158.9 15.2 -3.3 NP (B) 8.0 11.4 33.1 38.1 36.9 Y/Y (%) 17.4 42.9 191.0 15.2 -3.3 EPS () 55.1 79.8 232.4 267.7 258.9 P/E (x) 53.7 37.0 12.7 11.0 11.4 P/B (x) 17.5 12.2 6.1 4.0 3.0 EV/EBITDA (x) 22.5 17.1 6.7 5.8 6.0
Source: Company data and J.P. Morgan estimates. Note: The company had not disclosed its earnings forecasts as of Dec. 29, 2010.
Our Estimates and Outlook for F11

We are maintaining our F11 estimates for DeNA, with revenue of 140.1B and operating profit of 64.0B. Our key assumptions are as follows: Average registered monthly usersWe estimate the number of annual average registered users will grow 12.3% Y/Y to 24.3M in F11, a marked slowdown from the estimated 38.9% Y/Y growth for F'10. Monthly ARPU per registered user We believe annualized monthly ARPU will peak at 406.6 in F11. We expect operating margins to decline Y/Y, with marketing cost increases and margin dilution from the consolidation of overseas acquisitions.
Our Estimates and Outlook for F12

We are maintaining our F12 estimates for DeNA, with revenue of 141.3B and operating profit of 61.8B. Our key assumptions are as follows: Average registered monthly usersWe estimate the number of annual average registered users will grow 3.1% Y/Y to 25.0M in F12. Monthly ARPU per registered user We believe annualized monthly ARPU will decline 4.2% Y/Y to 389.4. We expect operating margins to continue declining Y/Y as the decline in earnings from the domestic social gaming business is not offset by overseas expansion.
We Are Maintaining Our Nov. 2011 Price Target of 2,200

DeNA is the dominant player in mobile SNS social gaming services in Japan (40% share in CY10 based on our estimates) and is conducting M&A for overseas market expansion. Despite the high earnings visibility in the short term, we believe the company faces the following challenges:
Growth in domestic market has peaked Cost increases via marketing lowering margins, in order to maintain sales volume
We believe growth rates for their domestic SNS operation has peaked, and unlikely to reaccelerate hereon in. Domestic ARPU levels are currently high, and we believe they are overreaching realistic levels of sustainability. With registered user growth slowing Y/Y, there is pressure on sales volume expansion and associated marketing costs (user acquisition costs) to maintain user activity on the site. Overseas expansion places the company in a relatively strong position compared to domestic peers. Competitive threats are rising in a rapidly overcrowding market, and we believe DeNA will not be able to replicate the level of overseas success seen in Japan. With a reaccelerating growth profile unlikely to occur in the medium term, and with a domestic business that looks to have peaked, we rate the shares Underweight.
Overseas expansion - limitations via intense competition
Valuation and Rating Analysis

Despite the volatility in growth rates at the company, free cash flow conversion is high and hence we have used DCF as our valuation method to derive a fair value for the stock.
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Our basic premise is that on a WACC of 10.5% and generating an average annual 33.9B of free cash flow into perpetuity (with a zero terminal growth rate), we derive a net present value of 273.3B. We then add back 46.5B net cash and equivalents, and the resultant fair value equity is 319.8B, producing a fair value of around 2,200 per share. For the number of shares outstanding, we have used 147.26M shares (includes the forthcoming third-party equity issuance for the acquisition of ngmocopending dilution from 1.0% warrants issued, and 1.0% dilution from the earn-out clause have been excluded).
Investment Risks
We view the risks to our investment thesis as follows: Upside risk Growth reaccelerating in the domestic market Overseas earnings growth more pronounced than expected into F11 Major M&A activity to raise market position and scale of operations Downside risk Growth decelerating faster than expected in the domestic market Overseas expansion failing to produce results in the expected timeframe Major equity financing for M&A activity resulting in dilution
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Key Assumptions
DeNAs mainstay business is social media, which accounts for the vast majority (8090%) of its earnings. In the social media business, social gaming is the primary earnings source and is exhibiting dominant strength. We believe the current market share in terms of revenues generated by item sales including social gaming and advertising are as follows: DeNA 40%, GREE 25%, and Mixi 5%. We believe that in the short term this situation will not change dramatically. DeNA has been active in overseas M&A, most recently acquiring ngmoco in October 2010, which signaled a major expansion into overseas markets. We believe financing requirements are low for DeNA as it has completed a major deal with ngmoco.
Business Lines
Business segment Social Media Game related Avatar Ad sales Other ngmoco Commerce Other Sales split 86.0% 68.8% 9.8% 6.3% 1.1% 0.0% 0.0% NA Description Comprises of the following service divisions Item sales, game ad sales, SAP ad sales, mixiAppli sales (ad and fee), affiliate ads Avatar item sales and affiliate ad sales Display, tie-up, search, content matched and affiliate ad program sales Overseas sales, 'Everystar' mobile portal, others 100% US subsidiary, specializing in smartphone apps Mobile and PC auction and shopping sites Travel and insurance agency operations
Source: J.P. Morgan based on company data
Recent HistoryImpact of Kaitou Royale

DeNA experienced its turning point in terms of raising its market positioning in the mobile social gaming market in October 2009 (3Q F09). The company up until then was in decelerating in growth, as its online avatar service was experiencing a slowdown. The company operated MobageTown, its mobile SNS gaming portal site and decided to follow GREE's success in social gaming content and developed its first breakthrough title called 'Kaitou Royale'. This title was initially exclusive to MobageTown, and had the following impact to user ARPU traffic, and earnings growth:
Impact of Social Gaming Content Introduced in 3Q F09 on ARPU, Pageviews and OP
F09 Monthly ARPU Q/Q Y/Y User pageviews Q/Q Y/Y OP Q/Q Y/Y OPM /user % % B % % B % % % 1Q 124.8 -27.5 -35.1 52.9 3.3% 14.6% 2Q 111.3 -10.8 -33.2 55.5 5.0% 14.1% 3.1 -1.7% -10.6% 36.0 3Q 166.3 49.4 1.8 94.6 70.5% 102.3% 5.2 69.4% 31.9% 44.8 4Q 292.3 75.8 69.9 158.6 67.6% 209.6% 9.8 87.9% 136.0% 51.5 F10 1Q 356.9 22.1 186.1 184.3 16.2% 248.5% 12.0 22.1% 282.2% 49.6 2Q 371.8 4.2 234.1 NA NA NA 13.6 13.6 341.8 50.3
3.1 -24.6% -26.5% 35.6
Kaitou Royale is a mafia/gang category game, with the objective to become a successful thiefa similar overseas equivalent title is 'Mafia Wars' from Zynga,
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which is very popular on Facebook. Since 3Q F09, the company has rolled out spinoff versions of the title, such as 'Sengoku Royale' (the same game in a samurai historical setting) in April 2010. DeNA also released Kaitou Royale on the Mixi mobile platform in December 2009, and another PC browser game version Kaitou Royale ZERO on Yahoo Japans Yahoo! Mobage service in from September 2010. Other in-house social gaming titles are: Setururin: A pet sim Nouen Hokorina: A gardening sim Aqua Square': A fish/aquarium sim, similar to Zyngas 'Fishville
Quarterly Earnings Estimates

billion F10 Q1 24.2 20.4 3.4 0.4 12.0 11.6 1.1 -0.0 -0.7 % % % % % % % % % % 49.6 56.7 33.4 -7.6 174.6 289.9 33.4 -7.6 Q2 27.1 23.2 3.4 0.5 13.6 13.0 1.1 0.0 -0.4 50.3 55.9 31.8 0.4 216.2 369.9 31.8 0.4 Q3 E 29.7 25.5 3.7 0.5 14.4 13.8 1.2 0.0 -0.6 48.6 54.0 33.0 5.0 154.6 230.4 33.0 5.0 Q4 E 32.3 27.9 3.6 0.8 15.4 15.0 1.1 0.1 -0.8 47.8 53.9 31.8 6.3 69.4 87.5 31.8 6.3 F11 Q1 E 33.6 28.7 1.1 3.4 0.4 15.5 15.2 -0.3 1.2 0.0 -0.6 46.1 53.0 -29.2 34.0 10.0 38.7 40.6 Q2 E 34.0 28.8 1.3 3.4 0.5 15.7 15.3 -0.1 1.2 0.0 -0.7 46.1 53.0 -7.7 34.0 10.0 25.6 24.2 Q3 E 35.4 29.6 1.6 3.7 0.5 16.3 15.5 0.2 1.3 0.0 -0.8 46.0 52.5 13.9 34.0 10.0 19.3 16.1 Q4 E 37.1 31.3 1.8 3.3 0.7 16.5 16.1 0.4 0.9 0.1 -0.9 44.6 51.6 20.9 25.7 10.0 14.7 12.1 -7.8 -13.6 F12 Q1 E 35.7 29.9 2.0 3.4 0.4 16.0 15.5 0.1 1.2 0.0 -0.8 44.9 52.0 3.6 34.0 10.0 6.3 4.3 79.7 Q2 E 33.8 27.8 2.2 3.4 0.5 14.7 14.2 0.3 1.2 0.0 -0.9 43.6 51.0 12.4 34.0 10.0 -0.6 -3.6 64.7 Q3 E 35.5 28.9 2.4 3.7 0.5 15.3 14.6 0.5 1.3 0.0 -1.1 43.1 50.5 20.3 34.0 10.0 0.1 -2.4 44.9 Q4 E 36.4 30.3 2.5 3.0 0.6 15.8 15.3 0.6 1.0 0.1 -1.2 43.4 50.5 25.3 34.0 10.0 -1.8 -3.3 42.0 -8.3 -14.9 F10E 113.3 97.0 14.1 2.2 55.5 53.3 4.6 0.0 -2.5 57.2 55.0 32.5 2.0 135.5 196.0 5.0 15.0 F11E 140.1 118.3 5.8 13.9 2.1 64.0 62.1 0.2 4.4 0.2 -3.0 45.7 52.5 3.1 32.0 10.0 23.7 22.1 -2.0 -5.0 F12E 141.3 116.8 9.0 13.6 2.0 61.8 59.6 1.5 4.6 0.2 -4.0 43.8 51.0 16.2 34.0 10.0 0.9 -1.3 55.0 -2.0 -5.0
Sales Social media ngmoco eCommerce Other - travel and insurance agencies Operating profit Social media ngmoco eCommerce Other - travel and insurance agencies Eliminations OPM Social media ngmoco eCommerce Other - travel and insurance agencies Sales growth Y/Y Social media ngmoco eCommerce Other - travel and insurance agencies Social media Users (quarterly avg.) Q/Q Y/Y Monthly ARPU Q/Q Y/Y
M % % /user % %
19.0 12.0 36.1 356.9 22.1 186.1
20.8 9.5 40.6 371.8 4.2 234.1
22.4 7.7 44.9 379.2 2.0 128.0
23.5 4.9 38.5 395.8 4.4 35.4
23.7 0.9 24.7 403.0 1.8 12.9
24.0 1.3 15.4 400.3 -0.7 7.7
24.5 2.1 9.4 402.6 0.6 6.2
24.8 1.2 5.5 420.4 4.4 6.2
25.0 0.8 5.5 398.5 -5.2 -1.1
25.0 4.2 370.4 -7.1 -7.5
25.0 2.0 385.2 4.0 -4.3
25.0 0.8 403.4 4.7 -4.1
21.6 38.9 373.1 118.2
24.3 12.3 406.6 9.0
25.0 3.1 389.4 -4.2
Source: Company data, J.P. Morgan estimates
Our earnings forecasts are based on the following key variable factors for the Social Media business:
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Average registered monthly userswe expect a gradual slowdown trend to continue into F12, with the ceiling of around 25M users Monthly ARPU per registered users we believe that ARPU is nearing its ceiling limit as well, despite the tendency for the over 30s demographic to be high spenders.
Corporate History and Basic Information

DeNA Corporate History
Year 1999 2004 2005 2006 2007 2009 2010 Summary Established in Tokyo, as an online PC auction site Bidders Open's "Mobaoku" mobile auction site Tie-up with KDDI as their official auction service Lists on TSE Mothers Open's "Mobage Town" mobile game portal and social network service with avatar content Lists on TSE 1st section Launches social gaming on "Mobage Town" Launches "Mobile Game" open platform Launches "Game Community" globally to iPhone and iPod touch Acquires US iPhone app company ngmoco Launches "Yahoo! Mobage" with Yahoo Japan
Source: J.P. Morgan based on company report.
DeNA Shareholder Structure

Tomoko Namba 15% Others 48% Sonet Entertainment 14% Trustee Accounts 23%
Source: J.P. Morgan based on company data Note: Data as March 2010
DeNAs shareholder structure shows management (CEO Namba) and So-net Entertainment as core shareholders. The free float is estimated to be 6.4% as of March 2010.
Acquisition of ngmoco
DeNA announced the 100% acquisition of US based smartphone game application developer ngmoco on October 12, 2010. The key details are as follows:
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ngmocoBasic Financial Outline and Transaction Details

Purchase price ($M) Final price Equity finance Options Cash Earn-out phase Equity finance Options Cash Closing phase Earn-out phase 303.0 146.0 27.0 128.0 100.0 31.0 12.0 56.0 Nov-10 Dec-11 From F11 San Francisco Neil Young* June 25 2008 0.5 3.2 -2.5 -10.9 3.3 28.3 274.7 100.0 23.3 8.5 3.4 1.0 1.0
Completion dates Consolidation date Company location CEO Incorporated Financials Sales ($M) OP ($M) Total assets ($M) Estimate goodwill ($M) Estimate goodwill (B) DeNA equity dilution (%)
F08* F09 F08* F09 F08 F09 Closing phase Earn-out phase Closing phase Earn-out phase Closing phase Stock options exercised from closing phase Earn-out phase
Source: J.P. Morgan based on company data Note: ngmocos F08 was a seven month reporting period. * The founder and CEO of ngmoco, not the Canadian singer/songwriter. Forex rate is $1=85.
CEO Namba commented at the 2Q F10 analyst meeting that ngmoco is growing so that its profits will offset any annual goodwill amortization charge arising in F11. We have asked the company about the amortization schedule and was told it was over around a 10-year period.
Company Disclosure
DeNA has ceased to release monthly data regarding user registration numbers and pageview traffic for its MobageTown service, as well as data from its mobile ecommerce operations (shopping transaction volume and subscription customers) from August 2010. The reason given by the company was that, given the major shift in business model, the company felt that disclosure was no longer required as these monthly data was not related to actual recent trading. Although we agree that mobile ecommerce operations have little bearing on earnings visibility now, the data supplied for MobageTown' are useful indicators of user activity. The company now releases registered user numbers at quarter end at quarterly financial reporting, but nothing on pageview statistics.
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Financial Statement DeNA (2432)

billion Income Statement - Annual Revenues Social media ngmoco eCommerce Others Operating profit Social media ngmoco eCommerce Others Eliminations Non operating income Non operating expense Recurring profit Extraordinary income Extraordinary expense Pre-tax profit Tax Minority interests Net profit EPS BPS DPS Payout ratio Ratio Analysis <Y/Y growth> Sales Operating profit Recurring profit Net profit <Margins> GPM OPM RPM Effective tax rate <Valuations> P/E P/B Dividend yield EV/EBITDA EV/EBIT EV/Sales <Profitability> ROCE ROE ROA % % % 68.1 35.1 21.3 68.5 38.7 20.6 102.5 63.9 29.0 71.0 43.6 23.8 49.6 30.2 19.1 % % % % % % % % x x % x x x F08A 37.6 24.1 0.0 11.9 1.6 15.8 0.0 0.0 3.1 -0.8 13.6 0.3 0.0 16.1 0.0 -1.0 15.1 -6.7 -0.5 8.0 55.1 169.2 6.0 10.9 F08A 26.5 25.1 25.6 17.4 76.6 42.1 42.8 44.1 53.7 17.5 0.2 22.5 24.5 10.3 F09A 48.1 32.8 0.0 13.5 1.9 21.3 18.5 0.0 4.4 -0.3 -1.4 0.3 0.0 21.5 0.2 -1.0 20.7 -8.7 -0.6 11.4 79.8 243.0 12.0 15.0 F09A 27.9 34.2 33.7 42.9 77.8 44.2 44.7 42.1 37.0 12.2 0.4 17.1 18.3 8.1 F10E 113.3 97.0 0.0 14.1 2.2 55.5 53.3 0.0 4.6 0.0 -2.5 0.3 0.0 55.7 0.0 0.0 55.7 -22.7 0.1 33.1 232.4 484.0 46.5 20.0 F10E 135.5 160.8 158.9 191.0 80.0 57.2 49.2 40.7 12.7 6.1 1.6 6.7 7.0 3.4 F11E 140.1 118.3 5.8 13.9 2.1 64.0 62.1 0.2 4.4 0.2 -3.0 0.3 0.0 64.2 0.0 0.0 64.2 -26.1 0.1 38.1 267.7 743.0 53.5 20.0 F11E 23.7 15.3 15.2 15.2 80.0 45.7 45.8 40.7 11.0 4.0 1.8 5.8 6.1 2.8 F12E 141.3 116.8 9.0 13.6 2.0 61.8 62.1 0.2 4.4 0.2 -5.1 0.3 0.0 62.1 0.0 0.0 62.1 -25.3 0.1 36.9 258.9 971.3 51.8 20.0 F12E 0.9 -3.3 -3.3 -3.3 80.0 43.8 43.9 40.7 11.4 3.0 1.8 6.0 6.3 2.7 Segment Statement - Quarterly Revenues Social media eCommerce Others Operating profit Social media eCommerce Others Eliminations OPM Social media eCommerce Others Revenue growth Y/Y Social media eCommerce Others % % % % % % % % 4Q F'09A 19.1 14.9 3.5 0.7 9.8 9.1 1.1 0.1 -0.4 51.5 60.9 31.8 7.5 81.5 123.7 5.3 67.0 1Q F10A 24.2 20.4 3.4 0.4 12.0 11.6 1.1 0.0 -0.7 49.6 56.7 33.4 -7.6 174.6 289.9 4.1 27.2 2Q F10A 27.1 23.2 3.4 0.5 13.6 13.0 1.1 0.0 -0.5 50.3 55.9 31.8 0.4 216.2 369.9 6.8 8.6 3Q F10E 29.7 25.5 3.7 0.5 14.4 13.8 1.2 0.0 -0.6 48.6 54.0 33.0 5.0 154.6 230.4 6.0 10.0 4Q F'10E 32.3 27.9 3.6 0.8 15.4 15.0 1.1 0.1 -0.8 47.8 53.9 31.8 6.3 69.4 87.5 3.2 14.9
Balance Sheet and Cash Flow <Balance sheet> Current assets Cash and cash equivalents Accounts receivable Other current assets Tangible fixed assets Intangible fixed assets Investments and other assets Total assets Current liabilities Long term liabilities Total liabilities Shareholders' equity Minority interest Total net assets Total liabilities and net assets <Cash Flow> Cash flow from operating activities Cash flow from investing activities Cash flow from financial activities Gross change in cash/cash equivalents Cash and cash equivalents at the beginning of the year Effect of change in consolidated companies Cash/ cash equivalents at FY end Free cash flow Free cash flow conversion Free cash flow yield % %
F08A 32.4 24.5 5.3 2.7 0.9 1.4 2.7 37.3 11.5 0.2 11.7 24.1 1.6 25.7 37.3 9.5 -3.8 -4.0 1.7 21.8 0.0 23.4 7.2 45.5 1.7
F09A 49.1 33.5 10.2 5.5 1.1 1.7 3.4 55.3 18.6 0.0 18.6 34.6 2.0 36.7 55.3 13.5 -2.5 -1.0 10.0 23.4 0.0 33.4 10.1 47.4 2.4
F10E 84.7 55.6 18.1 11.0 1.2 24.6 3.4 114.0 42.1 0.0 42.2 68.9 2.8 71.7 114.0 23.1 -4.0 5.8 24.9 33.4 0.0 58.3 43.4 78.2 10.3
F11E 127.5 95.9 22.4 9.2 1.2 28.3 3.4 160.5 51.8 0.0 51.9 105.8 2.8 108.6 160.5 22.1 -4.0 -7.6 10.5 58.3 0.0 68.8 45.9 71.7 10.9
F12E 156.1 124.3 22.6 9.2 1.3 32.6 3.4 193.4 52.3 0.0 52.3 138.3 2.8 141.1 193.4 14.9 -4.0 -7.4 3.5 68.8 0.0 72.4 37.8 61.1 9.0
Source: Company data, earning results and J.P. Morgan estimates. Note: Fiscal year ends March. Stock price as of Dec. 29, 2010.
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03 January 2011
Gree (3632)
ARPU Growth Slowing, User Acquisition Costs Rising
We are maintaining our Neutral rating on GREE, with a target price of 1,000 through November 2011. We believe the shares have corrected to reflect the competitive pressures and structural issues regarding peaked demand in the domestic market. However, we think that GREE will struggle to surprise on the upside with limited resources. We maintain our Neutral rating. The company pioneered mobile social gaming in Japan with Tsuri-Sta!, a casual fishing game in May 2007. The situation today is in stark contrast, as DeNA has become the market leader and GREE is struggling to compete in terms of content offering, marketing spend, and user monetization. We believe much of these negatives have been priced into the stock, but with sluggish earnings growth and no positive catalysts in sight we rate the shares Neutral. Marketing cost increases heighten our concern. We think recent performance metrics have given rise to concern. Average monthly ARPU growth has visibly slowed, with 1Q10 showing 2.5% growth Q/Q (ARPU 192 per month) despite the launch of the platform business in June 2010 and the release of two new in-house game titles (Columbus and Monster Planet). At the same time, marketing spend has increased 22.3% Q/Q (monthly 549 spend per user). We conclude that users activity is waning as the games on offer are entering the latter stages of their product cycle and replacements have yet to construct a recovery. With more social gaming content available compared to three years ago, we believe GREE is finding it difficult to construct winning titles as the SNS platform becomes more competitive and hit driven.
Neutral

AC
Yusuke Maeda
Price Performance
1,400 Y 1,100 800
Company Data
Price Price date Market capitalization Shares outstanding 52-week range TOPIX Dividend (F10E) Dividend yield (F10E) ROE (F10E) 1,069 Dec. 29, 2010 243.1B 227.4M 1,580 875 908.01 5.0 0.5% 55.9%
Valuation and risks. As of December 29, the shares have fallen 32% from their
52-week high in June 2010, and we believe the structural negatives (increasing competition, rising costs) have been priced in. Short-term earnings visibility is fair but not one denoting a reacceleration of growth. The shares are currently trading on a P/E of 12.7x our F11 EPS forecast, which we do not think is demanding considering our 45% Y/Y OP growth forecast, but as this is in line with expectations we believe the shares are fairly valued. Upside risk factors include ARPU growth via strong title releases. Downside risk factors include declining profitability through increasing marketing expenditure.
Parent Y/E June 2010 2011E 2011Co.E 2012E 2013E
Revenue (B) 35.2 56.0 54.0 ~ 60.0 65.2 73.0
Y/Y (%) 152.6 58.8 53.3 ~ 70.3 16.5 12.0
OP (B) 19.6 28.4 27.0 ~ 30.0 32.3 35.8
Y/Y (%) 134.1 44.9 37.9 ~ 53.2 13.7 10.9
RP (B) 19.6 28.4 27.0 ~ 30.0 32.3 35.8
Y/Y (%) 135.3 44.9 37.8 ~ 53.1 13.7 10.9
NP (B) 11.5 16.8 15.9 ~ 17.7 19.1 21.2
Y/Y (%) 157.6 46.3 38.2 ~ 53.8 13.7 10.9
EPS () 50.7 74.0 70.0 ~ 77.9 84.2 93.3
P/E (x) 21.1 14.4 12.7 11.5
P/B (x) 11.8 6.1 4.0 3.0
EV/EBITDA (x) 11.3 7.5 6.6 6.0
Source: Company data and J.P. Morgan estimates.
Our Estimates and Outlook for 2011

We are maintaining our F11 estimates for GREE, with revenue of 65.2B and operating profit of 32.3B. Our key assumptions are as follows: Average registered monthly usersWe expect a gradual slowdown in user growth into F11, reaching 27M users in 4Q11. This is slightly higher than DeNA (25M) given the more casual nature of the platform. Monthly ARPU per registered user We believe ARPU will remain in the 190-210 zone. Y/Y we expect monthly ARPU to grow by 5% on an annualized basis to 206.1. We expect operating margins to decline slightly Y/Y, with marketing costs growing faster than topline growth.

We are maintaining our F12 estimates for GREE, with revenue of 73.0 and operating profit of 35.8B. Our key assumptions are as follows: Average registered monthly usersWe expect registered user numbers to reach 29M. Monthly ARPU per registered user Y/Y we expect monthly ARPU to grow by 4% on an annualized basis to 213.3. We believe that operating margins will stabilize, but with no major improvement as the business needs to invest in order to maintain its growth profile.

The challenges faced by DeNA are not dissimilar to GREEslowing domestic growth prospects and execution risks over expansion into the heavily contested overseas market. We believe these issues are more pronounced at GREE, as it has a more mature growth profile compared to DeNA in social gaming. GREEs most successful fishing game was released in May 2007DeNA's core game Kaitou Royale was released in October 2009. The key points to make are: We believe growth rates for their domestic SNS operations has peaked and unlikely to reaccelerate hereon in. GREE has a more mature growth profile compared to its peer group. We think operating costs are likely to increase in order for the company to remain competitivenew game developments, proactive marketing and staff increases. We believe much of these negative factors have been priced into the stock. Although we think a reaccelerating growth profile is unlikely in the medium term, we believe the company will perform in line with our expectations. We rate the shares Neutral.

Despite the volatility in growth rates at the company, free cash flow conversion is high and hence we have used DCF as our valuation method to derive a fair value.
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Our basic premise is that on a WACC of 10.5% and generating an average annual 18.8B in free cash flow into perpetuity (with a zero terminal growth rate), we derive a net present value of 209.6B. We then add back 21.4B in net cash and equivalents, and the resultant fair value equity is 231.0B, producing a fair value of around 1,000 per share.
Investment Risks
We view the risks to our investment thesis as follows: Upside risks New game releases that reignite user activity, resulting in ARPU increases Major influx of advertising demand on the SNS site Inactive users are recaptured Downside risks Faster-than-expected decline in user activity, leading to drops in ARPU Major hikes in marketing spend to compete with peers Increasing development costs of new games, as more resources are required to create competitive titles
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Key Assumptions
GREEs mainstay business is item sales through the sales of social games and avatars and accounts for 80-90% of total revenues. With an estimated market share of 25% in CY10, GREE holds the No. 2 spot in sales among domestic SNS companies, behind DeNA. We believe that in the short term this situation will not change dramatically. GREE is taking a longer-term view on overseas expansion, completing a small transaction to acquire a minority stake in countries such as South Africa and Indonesia. We believe GREE is not prioritizing M&A strategy, and hence its financing requirements are low.
Business Lines
Business segment Item sales Sales split 82% Description Premium service subscriptions (300 per month) Monthly user defined virtual currency purchases (300 to 5,000 per purchase) Discretionary user spend on virtual currency (300 to 5,000 per purchase) Discretionary user spend on avatar items (1,000 to 10,000 per purchase) Banner and listings ads, primarily for mobile content providers, internet services, finance
Advertising
18%
Quarterly Earnings Estimates

billion F10 Q1 Revenue Item sales Advertising Operating profit OPM Sales growth Y/Y Item sales Advertising Sales assumptions Average registered monthly users Q/Q Y/Y Monthly total ARPU per user Q/Q Y/Y % % % % 12.4 10.1 2.3 6.2 50.1 81.5 91.5 47.3 Q2 E 13.8 11.0 2.8 6.9 50.0 69.0 71.5 60.0 Q3 E 14.6 11.9 2.7 7.4 51.0 57.5 59.3 50.0 Q4 E 15.1 12.2 3.0 7.8 51.5 38.2 35.6 50.0 F11 Q1 E 15.5 11.9 3.6 7.7 50.0 24.9 17.1 60.0 Q2 E 16.0 11.6 4.5 8.0 50.0 16.0 4.9 60.0 Q3 E 16.5 12.4 4.1 8.3 50.0 13.2 4.7 50.0 Q4 E 17.1 12.7 4.4 8.2 48.1 13.1 4.1 50.0 F12 Q1 E 17.4 11.7 5.8 8.7 50.0 8.7 0.8 29.2 Q2 E 17.8 10.6 7.2 8.9 50.0 7.7 -14.7 76.0 Q3 E 18.8 12.7 6.1 9.4 50.0 10.2 0.5 37.6 Q4 E 18.9 12.3 6.7 8.7 46.1 8.6 5.5 15.1 F10E 56.0 45.2 10.7 28.4 50.7 58.8 60.6 51.9 F11E 65.2 48.5 16.6 32.3 49.5 16.5 7.4 54.7 F12E 73.0 47.3 25.7 35.8 49.0 12.0 -2.6 54.9
M % % /user % %
21.5 10.3 55.3 192.2 2.8 16.9
23.6 9.8 48.4 195.0 1.5 13.9
24.6 4.0 40.6 198.0 1.5 12.6
25.1 2.0 28.7 201.0 1.5 7.5
25.6 2.0 19.1 202.0 0.5 5.1
26.1 2.0 10.4 205.0 2.0 5.1
26.6 2.0 8.2 207.0 2.0 4.5
27.1 2.0 8.2 210.0 2.0 4.5
27.7 2.0 2.0 210.0 0.0 4.0
28.2 2.0 8.2 210.0 0.0 2.4
28.8 2.0 8.2 218.0 3.8 5.3
29.4 2.0 8.2 215.0 -1.4 2.4
23.8
26.4
28.5
196.0 13.8
206.1 5.1
213.3 3.5
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GREE Corporate History
Year 2004 2006 2007 2008 2010 2010 2010 Summary Establishes GREE PC social networking site Business and capital tie-up with KDDI, leading to mobile "EZ GREE" site Launches social games on GREE SNS Lists on Mothers Lists on TSE 1st Section Starts GREE Platform third party application developers selected to bolt on gaming content Announces capital tie-up with Project Goth Inc., operator of SNS platform Mig33
We make no earnings assumptions for overseas expansion plans, given that the tie-up with Project Goth Inc. involves little capital (less than 0.5B) and planned to be a long-term relationship aimed at emerging market opportunities.
GREE Shareholder Structure
Others 25%
Trustee Accounts 18% KDDI 7%
Yoshikazu Tanaka 50%
Source: J.P. Morgan based on company report. Note: Data as of June 2010.
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Key Game Titles

GREEs in-house social gaming titles are as follows:
In-house Social Gaming Titles
Title Tsuri-Sta! Clinoppe Dorirando Hakoniwa Monster Planet Columbus Service start May-07 Jul-07 Aug-09 Sep-08 Jun-10 Aug-10 Category Fishing game Pet sim Excavation game Gardening sim Monster sim/battle game Pirate game
Source: J.P. Morgan based on company report
GREEs core title Tsuri Sta! has been active since May 2007. While this is a testament to the longevity of social gaming applications, recent title releases have performed poorly. We believe that increasing competition from DeNA and other social application providers are giving GREE a run for their money, and that GREEs client base may be shifting between titles thereby not creating incremental growth via item sales.
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Financial Statement GREE (3632)

billion Income Statement Annual Revenues Item sales Advertising Operating profit Non operating income Non operating expense Recurring profit Extraordinary income Extraordinary expense Pre-tax profit Tax charge Minority interests Net profit EPS BPS DPS Payout ratio Ratio Analysis <Y/Y growth> Sales Operating profit Recurring profit Net profit <Margins> GPM OPM RPM Effective tax rate <Valuations> P/E P/B Dividend yield EV/EBITDA EV/EBIT EV/Sales <Profitability> ROCE ROE ROA % % % 166.0 88.7 28.6 132.0 77.5 35.8 94.2 55.9 31.7 64.1 38.0 24.9 50.2 29.8 21.5 F08A 13.9 10.5 3.5 8.4 0.0 0.0 8.3 0.0 0.0 8.3 -3.9 0.0 4.5 20.0 40.8 5.0 25.1 F08A % % % % % % % % 374.7 696.4 692.3 667.1 92.2 60.0 59.7 -46.4 F09A 35.2 28.2 7.1 19.6 0.0 0.0 19.6 0.0 -0.2 19.4 -7.9 0.0 11.5 50.7 90.5 5.0 9.9 F09A 152.6 134.1 135.3 157.6 92.1 55.6 55.6 -40.7 F10E 56.0 45.2 10.7 28.4 0.0 0.0 28.4 0.0 0.0 28.4 -11.6 0.0 16.8 74.0 174.6 5.0 6.8 F10E 58.8 44.9 44.9 46.3 92.0 50.7 50.7 -40.7 F11E 65.2 48.5 16.6 32.3 0.0 0.0 32.3 0.0 0.0 32.3 -13.1 0.0 19.1 84.2 267.9 5.0 5.9 F11E 16.5 13.7 13.7 13.7 91.9 49.5 49.5 -40.7 F12E 73.0 47.3 25.7 35.8 0.0 0.0 35.8 0.0 0.0 35.8 -14.6 0.0 21.2 93.3 359.2 5.0 5.4 F12E 12.0 10.9 10.9 10.9 91.5 49.0 49.0 -40.7 Segment Statement - Quarterly Revenues Item sales Advertising Operating profit OPM Revenue growth Y/Y Item sales Advertising % % % % 4Q F09A 10.9 9.0 2.0 5.3 48.4 112.7 126.2 67.3 1Q F10A 12.4 10.1 2.3 6.2 50.1 81.5 91.5 47.3 2Q F10E 13.8 11.0 2.8 6.9 50.0 69.0 71.5 60.0 3Q F10E 14.6 11.9 2.7 7.4 51.0 57.5 59.3 50.0 4Q F10E 15.1 12.2 3.0 7.8 51.5 38.2 35.6 50.0
x x % x x x
53.6 26.2 0.5 26.4 26.5 15.9
21.1 11.8 0.5 11.3 11.3 6.3
14.4 6.1 0.5 7.5 7.8 4.0
12.7 4.0 0.5 6.6 6.9 3.4
11.5 3.0 0.5 6.0 6.2 3.0
Balance Sheet and Cash Flow <Balance sheet> Current assets Cash and cash equivalents Accounts receivable Other current assets Tangible fixed assets Intangible fixed assets Investments and other assets Total assets Current liabilities Long term liabilities Total liabilities Shareholders' equity Minority interest Total net assets Total liabilities and net assets <Cash Flow> Cash flow from operating activities Cash flow from investing activities Cash flow from financial activities Gross change in cash/cash equivalents Cash and cash equivalents at the beginning of the year Effect of change in consolidated companies Cash and cash equivalents at FY end Free cash flow Free cash flow conversion Free cash flow yield
F08A 15.3 10.6 3.8 0.9 0.1 0.0 0.2 15.6 6.5 0.0 6.5 9.1 0.0 9.1 15.6 5.7 -0.1 3.7 9.3 1.3 0.0 10.6 4.5 0.5 1.9
F09A 30.9 21.4 7.7 1.9 0.2 0.2 1.0 32.2 11.6 0.0 11.6 20.6 0.0 20.6 32.2 11.6 -10.8 -0.1 0.8 10.6 0.0 11.4 9.6 0.5 3.9
F10E 51.6 37.4 11.8 2.5 0.2 0.3 1.0 53.1 13.4 0.0 13.4 39.7 0.0 39.7 53.1 5.3 -2.2 -1.1 2.0 11.4 0.0 13.3 14.7 0.5 6.0
F11E 75.1 54.9 17.6 2.5 0.2 0.4 1.1 76.8 15.8 0.0 15.8 60.9 0.0 60.9 76.8 5.4 -2.2 -1.1 2.0 13.3 0.0 15.4 16.3 0.5 6.7
F12E 96.9 74.4 19.7 2.7 0.3 0.5 1.1 98.7 17.1 0.0 17.1 81.7 0.0 81.7 98.7 8.7 -2.2 -1.1 5.3 15.4 0.0 20.6 21.0 0.6 8.6
% %
Source: Company data, earning results and J.P. Morgan estimates Note: Fiscal year ends June. Stock price as of Dec. 29, 2010.
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142 370

03 January 2011
Mixi (2121)
Obstacles Remain on the Road to Monetization
We are maintaining our Neutral rating on Mixi, with a target price of 425,000 to November 2011. We believe management is taking a long-term view of the business, focusing on developing new services and improving user experience. The focus on advertising as the key revenue driver should see improving prospects with smartphone penetration, but this will still take over a year to materialize in our opinion. While valuations are not inexpensive, we believe Mixi has interesting prospects longer term. We maintain our Neutral rating. Mixi continues to roll out new services and functions to improve the site, and a current TV advertising campaign is under way aimed at raising brand awareness. Online advertising demand continues to grow albeit at a relatively modest pace, as we think feature phone mobile media remains high maintenance and unwieldy for most advertisers. Item sales from the various applications available on Mixis platform are beginning to gain traction, but management's emphasis on providing useful utility-type services cannot compete in terms of generating user ARPU available from social gaming in our opinion. Keeping users satisfied, thinking long term. The release of functions such as Mixi Check (a sharing function similar to Twitter and Facebook share/like icons) and Mixi Voice (an updated version of their microblogging service) continue to keep the user community involved. We believe this is the core strength of Mixis management, with their focus on providing well thought out services and a deep user experience. Monetizing user traffic is a core activity, but as we understand management takes user satisfaction as its key objective.
Neutral

AC
Yusuke Maeda
Price Performance
900,000 Y 600,000 300,000
Company Data
Price Price date Market capitalization Shares outstanding 52-week range TOPIX Dividend (F10E) Dividend yield (F10E) ROE (F10E) 441,500 Dec. 29, 2010 68.3B 0.155M 777,000 383,000 908.01 0.0 0.0% 11.9%
Valuation and risks. The shares are currently trading at 28.6x our F11 EPS
forecast, which is a high valuation multiple. However, the shares have consistently traded at high levels, and hence we do not see this as being a major mispricing. We think advertising demand should benefit from smartphone penetration. More applications are available on the platform now (around 1,000 for mobile SNS, 1,300 for PC), which will likely grow as users adapt to new services. Upside risks include major application hit services resulting in major item sales. Downside risks include unplanned investment into new services and further marketing activities to boost user activity.
Consolidated Y/E Mar 2010 2011E 2011Co.E 2012E 2013E
Sales (B) 13.6 16.8 17.4 20.7 25.0
Y/Y (%) 12.8 23.4 27.6 23.6 20.5
OP (B) 2.8 3.6 2.8 4.4 5.8
Y/Y (%) -27.0 29.5 0.6 24.6 30.2
RP (B) 2.7 3.6 2.8 4.4 5.8
Y/Y (%) -29.4 32.8 3.2 24.7 30.3
NP (B) 1.3 1.8 1.4 2.4 3.1
Y/Y (%) -33.0 40.6 6.2 29.8 30.3
EPS () 8,476 11,911 8,985 15,457 20,143
P/E (x) 52.1 37.1 49.1 28.6 21.9
P/B (x) 4.7 4.2 3.6 3.1
EV/EBITDA (x) 17.7 11.1 9.5 7.7
Source: Company data and J.P. Morgan estimates.

We are maintaining our F'11 revenue forecast of 20.7B and operating profit forecast of 4.4B, representing Y/Y growth of 24% and 25%, respectively. We estimate that top-line growth will remain stable and high as the company improves its media power and makes more inroads into winning new customer accounts. However, opportunities for margin improvement are likely to be limited as the company invests in new service development as well as marketing costs.

We are maintaining our F'11 revenue forecast of 25.0B and operating profit forecast of 5.8B, representing Y/Y growth of 21% and 30%, respectively. In F'12 we believe that demand for mobile advertising will benefit from smartphone penetration, greater adoption by major advertisers, a greater range of advertising products, and Mixi's ability to raise pricing.

Mixi is the leading SNS operating with a real user community, as opposed to a virtual one. The company has no direct domestic competitor and is hence strongly positioned as an internet media company with potential for longevity and a loyal user base. However, we believe it faces the following challenges:
Mobile advertising demand still hampered by technology
The dominance of mobile advertising revenue (63% of total ad revenue in 1Q F11) limits short-term growth potential, as the media itself remains high maintenance and cumbersome for the majority of advertisers. The focus on social utility applications being made available on the Mixi platform delivers some potential for user monetization by item sales, but compared to social gaming applications its impact is limited. We believe the site is yet to clearly show its monetization potential, but in the medium term we expect steady progress as opposed to a major ramp up in earnings growth.
User monetization with social applications limited

Despite the volatility in growth rates at the company, free cash flow conversion is high and hence we have used DCF as our valuation method to derive a fair value for the stock. Our basic premise is that on a WACC of 10.5% and generating an average annual 4.6B free cash flow into perpetuity (with a zero terminal growth rate), we derive a net present value of 53.1B. We then add back 12.6B in net cash and equivalents, and the resultant fair value equity is 65.7B, producing a fair value of around 425,000 per share.
Investment Risks
We view the risks to our investment thesis as follows:
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Upside risk Major hit services on the Mixi platform, resulting in strong reacceleration of item sales Major adoption of smartphones, leading to more mobile advertising clients and greater demand for advertising Downside risk Ineffective but expensive marketing campaigns that deteriorate margins Major upfront investment costs for new developments, e.g. contractor fees
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373
Key Assumptions
Mixis mainstay business is internet media, and advertising revenue accounts for 8090% of its earnings. We believe current market share in terms of revenues generated by item sales including social gaming and advertising are as follows: DeNA 40%, Gree 25%, and Mixi 5%. We think that this situation will not change dramatically in the short term, although driven by mobile advertising demand increasing with smartphone adoption, we think Mixi will increase its market share over the medium term. Mixi has operations in China, but we believe management is prioritizing organic growth. We do not think Mixi is prioritizing M&A strategy, hence financing requirements are low.
Business Lines
Business segment Internet media Advertising Item sales Recruitment Other Sales split 80% 16% 4% Description Sales of banners, tie-ups, listings and search ads on PC and mobile sites Sale of virtual currency to use application services, provided by third parties Job listings site for IT specialists Includes China star-up operations
Mixi - Quarterly Earnings Estimates

billion Sales Internet media Recruitment listings Other Operating profit Internet media Recruitment listings Other Eliminations OPM Internet media Recruitment listings Other Sales growth Y/Y Internet media Recruitment listings Other Sales assumptions Average registered monthly users Q/Q Y/Y Monthly total ARPU per user Q/Q Y/Y F10 Q1 4.0 3.8 0.2 1.1 1.4 0.1 0.0 -0.4 26.8 35.6 80.6 31.2 31.3 30.8 Q2 3.9 3.7 0.2 0.6 0.9 0.2 0.0 -0.4 15.8 24.6 84.6 22.0 21.5 34.8 Q3 E 4.2 4.0 0.2 0.9 1.2 0.1 0.0 -0.5 20.7 30.0 85.0 21.6 21.1 35.0 Q4 E 4.7 4.5 0.2 1.0 1.3 0.2 0.0 -0.4 21.6 29.6 75.0 20.0 19.5 31.7 F11 Q1 E 5.1 5.0 0.2 1.1 1.5 0.1 0.0 -0.5 21.3 30.0 80.0 28.3 29.1 10.0 Q2 E 4.9 4.7 0.2 1.0 1.5 0.2 -0.1 -0.6 20.7 31.0 80.0 25.7 26.5 10.0 Q3 E 5.1 5.0 0.2 1.0 1.5 0.1 -0.1 -0.6 20.1 31.0 80.0 23.7 24.3 10.0 Q4 E 5.6 5.3 0.2 1.3 1.7 0.2 0.0 -0.6 23.3 31.9 80.0 17.7 18.0 10.0 F12 Q1 E 6.3 6.1 0.2 1.4 1.8 0.2 0.0 -0.6 21.5 30.0 80.0 23.0 23.4 10.0 Q2 E 5.9 5.7 0.2 1.3 1.8 0.2 -0.1 -0.7 22.0 32.0 80.0 21.4 21.9 10.0 Q3 E 6.2 6.0 0.2 1.4 2.0 0.2 -0.1 -0.7 23.2 33.0 80.0 19.9 20.2 10.0 Q4 E 6.6 6.3 0.3 1.7 2.3 0.2 0.0 -0.8 25.7 36.8 80.0 18.2 18.5 10.0 F10E 16.8 16.0 0.7 3.6 4.8 0.6 -0.1 -1.7 21.2 30.0 81.0 23.4 23.0 33.0 F11E 20.7 19.9 0.8 4.4 6.2 0.6 -0.2 -2.2 21.4 31.0 80.0 23.6 24.2 10.0 F12E 25.0 24.1 0.9 5.8 8.0 0.7 -0.2 -2.7 23.1 33.0 80.0 20.5 21.0 10.0 -
% % % % % % % %
M % % /user % %
20.3 5.6 18.6 63.1 -3.7 10.7
21.3 4.9 20.5 58.0 -8.1 0.7
22.5 5.8 23.5 61.4 5.9 2.2
23.7 5.0 23.1 66.5 8.2 1.5
24.3 2.5 19.5 70.7 6.4 12.1
24.9 2.5 16.7 65.6 -7.3 13.1
25.5 2.5 13.1 67.2 2.5 9.4
26.1 2.5 10.4 70.9 5.5 6.6
26.6 2.0 2.0 79.2 11.7 11.9
26.9 1.0 8.2 73.6 -7.1 12.2
27.2 1.0 6.7 75.6 2.7 12.4
27.4 1.0 5.1 79.7 5.5 12.4
22.0 21.4 63.5 1.7
25.2 14.3 68.6 8.1
27.0 7.4 77.0 12.2
Our earnings forecasts are based on the following assumptions:

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Average registered monthly usersWe believe a steady increase of 2.5% Q/Q for the medium term is realistic for Mixi, as it continues to attract users with real identities that want to use it as a communication tool. Hence, the market Mixi caters to is broader than that of social gaming sites. Monthly ARPUWe believe monthly ARPU trends will see a slow but steady climb, primarily driven by item sales demand. However, it will remain considerably low compared to social gaming peers.

Mixi Corporate History
Year 1997 2004 2006 2007 2009 2010 Summary Commences "Find Job!" job listings site Launches "Mixi" SNS Lists on TSE Mothers Releases the mobile service Launches "Mixi Appli" the open platform service based on Googles OpenSocial API standard Membership policy changes from invitation only to an open registration Announce business alliance with China's Renren and Korea's Cyworld SNS sites Facebook offers export tool to Mixi users
Mixi Shareholder Structure
Others 28%
ngi group 1% Trustee Accounts 13%
Kenji Kasahara 58%
Source: J.P. Morgan based on company report. Note: Data as March 2010.
CEO Kasahara is the largest shareholder, with legacy investor ngi group as a minority shareholder with about 1%. The free float is estimated to be 14.8%.
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Financial Statement Mixi (2121)

billion Income Statement Annual Revenues Internet media Recruitment listings Others Operating profit Internet media Recruitment listings Others Non operating income Non operating expense Recurring profit Extraordinary income Extraordinary expense Pre-tax profit Tax charge Minority interests Net profit EPS BPS DPS Payout ratio <Y/Y growth> Sales Operating profit Recurring profit Net profit <Margins> GPM OPM RPM Effective tax rate <Valuations> P/E P/B Dividend yield EV/EBITDA EV/EBIT EV/Sales <Profitability> ROCE ROE ROA % % % 31.2 16.1 12.9 19.6 9.5 7.5 23.2 11.9 9.3 25.4 13.6 10.4 28.6 15.3 11.6 F08A 12.1 11.2 0.9 0.0 3.8 4.3 0.5 -0.2 0.0 0.0 3.8 0.0 0.0 3.8 -1.8 0.0 2.0 12,741 85,626 F08A 19.9 0.6 1.0 -2.1 79.9 31.3 31.4 -48.2 34.7 5.2 0.0 13.2 14.9 4.7 F09A F10E F11E F12E Segment Statement - Quarterly Revenues Internet media Recruitment listings Others Operating profit Internet media Recruitment listings Others OPM Internet media Recruitment listings Others Revenue growth Y/Y Internet media Recruitment listings Others 4Q F'09A 3.9 3.8 0.2 0.0 0.3 0.4 0.1 0.0 6.9 10.1 81.8 0.0 25.4 26.5 3.2 0.0 1Q F10A 4.0 3.8 0.2 0.0 1.1 1.4 0.1 0.0 26.8 35.6 80.6 0.0 31.2 31.3 30.8 0.0 2Q F10A 3.9 3.7 0.2 0.0 0.6 0.9 0.2 0.0 15.8 24.6 84.6 0.0 22.0 21.5 34.8 0.0 3Q F10E 4.2 4.0 0.2 0.0 0.9 1.2 0.1 0.0 20.7 30.0 85.0 0.0 21.6 21.1 35.0 0.0 4Q F'10E 4.7 4.5 0.2 0.0 1.0 1.3 0.2 0.0 21.6 29.6 75.0 0.0 20.0 19.5 31.7 0.0
13.6 16.8 20.7 25.0 13.0 16.0 19.9 24.1 0.5 0.7 0.8 0.9 0.0 0.0 0.0 0.0 2.8 3.6 4.4 5.8 3.5 4.8 6.2 8.0 0.4 0.6 0.6 0.7 -0.2 -0.1 -0.2 -0.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2.7 3.6 4.4 5.8 0.0 0.0 0.0 0.0 -0.1 -0.1 0.0 0.0 2.6 3.4 4.4 5.8 -1.3 -1.6 -2.0 -2.7 0.0 0.0 0.0 0.0 1.3 1.8 2.4 3.1 8,476 11,911 15,457 20,143 93,871 105,861 121,318 141,461 F09A F10E F11E F12E 12.8 -27.0 -29.4 -33.0 74.5 20.2 19.7 -49.3 52.1 4.7 0.0 17.7 20.9 4.1 23.4 29.5 32.8 40.6 74.5 21.2 21.2 -46.0 37.1 4.2 0.0 11.1 15.8 3.3 23.6 24.6 24.7 29.8 74.5 21.4 21.4 -46.0 28.6 3.6 0.0 9.5 12.7 2.7 20.5 30.2 30.3 30.3 74.5 23.1 23.1 -46.0 21.9 3.1 0.0 7.7 9.7 2.2
% % % % % % % %
% % % % % % % % x x % x x x
Balance Sheet and Cash Flow <Balance sheet> Current assets Cash and cash equivalents Accounts receivable Other current assets Tangible fixed assets Intangible fixed assets Investments and other assets Total assets Current liabilities Long term liabilities Total liabilities Shareholders' equity Minority interest Total net assets Total liabilities and net assets <Cash Flow> Cash flow from operating activities Cash flow from investing activities Cash flow from financial activities Effect of exchange rate change on cash/cash equivalents Gross change in cash/cash equivalents Cash and cash equivalents at the beginning of the year Effect of change in consolidated companies Cash and cash equivalents at FY end Free cash flow Free cash flow conversion Free cash flow yield % %
F08A 13.2 11.4 1.6 0.2 1.0 0.2 0.7 15.1 2.0 0.0 2.0 13.1 0.0 13.1 15.1 2.2 0.4 0.0 0.0 2.6 7.8 0.0 10.4 1.5 40.0 2.2
F09A 15.1 12.2 2.7 0.2 1.0 0.2 1.1 17.4 2.9 0.0 2.9 14.5 0.0 14.5 17.4 1.8 -2.7 0.1 0.0 -0.7 10.4 0.0 9.7 1.9 70.4 2.8
F10E 17.3 14.2 2.9 0.3 1.0 0.2 1.4 19.8 3.4 0.0 3.4 16.4 0.0 16.4 19.8 2.8 -0.6 -0.1 0.0 2.2 9.7 0.0 11.8 3.3 93.8 4.9
F11E 20.2 16.4 3.5 0.3 1.0 0.2 1.6 23.0 4.2 0.0 4.2 18.8 0.0 18.8 23.0 3.0 -0.6 0.0 0.0 2.4 11.8 0.0 14.2 3.4 77.1 5.0
F12E 23.8 19.2 4.2 0.3 1.0 0.2 1.9 27.0 5.1 0.0 5.1 21.9 0.0 21.9 27.0 3.8 -0.6 0.0 0.0 3.2 14.2 0.0 17.4 4.2 71.8 6.1
Source: Company data, earning results and J.P. Morgan estimates. Note: Fiscal year ends March. Stock price as of Dec. 29, 2010.
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03 January 2011
Rakuten (4755)
Steady Domestic Prospects
We are maintaining our Neutral rating on Rakuten. We view the business as a stable domestic eCommerce growth story but believe this has already been priced in. Although online shopping is defensive in a downturn, we believe the business is not economy-sensitive enough to benefit from an economic upturn. We are maintaining our 63,000 price target to November 2011. We maintain our Neutral rating. We believe the companys growth prospects are acknowledged and unlikely to yield major positive surprises, and we think overseas expansion plans for eCommerce operations are unlikely to yield material results in the medium term. We believe the shares are fairly valued on a F11 P/E of 21.6x. Dominant market position in a growth market: Well-known themes. Rakutens business model is idiosyncratic, with business activities ranging from eCommerce to financial services. Its core activities remain online shopping and travel, having major domestic market shares with strong track records. The domestic eCommerce market remains firm and is expected to maintain a steady yet unspectacular medium-term growth profile. Whilst these are positive traits, we believe they are well-acknowledged themes and in themselves provide little catalyst for the shares. Overseas expansion: Managing expectations. Consolidating its operations after the consumer finance crash of F07, Rakuten has recently begun to expand into niche eCommerce operations overseas via M&A and partnerships. The consensus view is that this is a positive development. We take a more balanced view, as we estimate that overseas operations made up around 2-3% of 3Q F10 total sales, highlighting the progress required to meaningfully impact earnings. The joint venture with Baidu.com in China commenced in October 2010, and we estimate that generating material earnings here will take time due to strong local competition. Valuation and risks. We believe the shares are fairly valued. However, upside risks to our price target include positive news flow regarding speedy and solid execution of overseas expansion. An upturn in activity at the financial operations (brokerage and credit) would also boost earnings visibility. Downside risks include higher operating costs due to overseas expansion, a drop in growth in online consumer activity, and ad-hoc business diversification.
Consolidated Y/E Dec 2008 2009 2010E 2011E 2012E Sales (B) 249.9 298.3 345.9 385.4 402.8 Y/Y (%) 16.8 19.4 16.0 11.4 4.5 OP (B) 47.2 56.6 62.8 71.9 79.7 Y/Y (%) 20.1 10.8 14.5 10.8 RP (B) 44.5 54.9 60.1 69.1 76.9 Y/Y (%) 23.3 9.5 15.0 11.2 NP (B) -55.0 53.6 36.1 41.4 46.0 Y/Y (%) -32.7 14.8 11.1
Neutral
4755.OS, 4755 JQ Price: 68,200 Price Target: 63,000

AC
Yusuke Maeda
Price Performance
75,000 Y 65,000 55,000
4755.OS share price (Y TOPIX (rebased)
Company Data
Price Price date Market capitalization Shares outstanding 52-week range TOPIX Dividend (F10E) Dividend yield (F10E) RoE (FY10E) 68,200 Dec. 29, 2010 893.4bn 13.1mn 74,30056,200 908.01 100 0.1% 16.2%
EPS () -4,203.9 4,092.3 2,752.8 3,160.7 3,512.1
P/E (x) 16.7 24.8 21.6 19.4
P/B (x) 6.0 4.4 3.7 3.2 2.7
EV/EBITDA (x) 16.9 13.9 13.7 12.3 11.2
Source: Company data, earnings results, and J.P. Morgan estimates

We are maintaining our F11 estimates for Rakuten, with revenue of 385.4B and operating profit of 71.9B. We believe that the core eCommerce operation will see a decline in growth Y/Y post acquisitions (up 20% Y/Y versus 25% Y/Y in F10) and experience margin dilution as a result. The travel business should see stable growth Y/Y as leisure travel demand increases on the site, and it is sensitive to an economic upturn. However, we estimate it will contribute only 16% of total F'11 operating profit. We estimate the financial operations will remain stable yet generate little in terms of earnings for the group.

We are maintaining our F12 estimates for Rakuten, with revenue of 402.8B and operating profit of 79.7B. We estimate that the eCommerce operation will see a marked slowdown in growth (up 7% Y/Y) as hurdles become higher and domestic operations begin to experience growth limitations. Margins are unlikely to improve significantly, as overseas operations are likely to remain dilutive to the sales mix. We estimate the financial operations will remain stable but continue to generate little in terms of earnings for the group. The credit card operation should have grown significantly over the period, but earnings are highly dependent on marketing costs, which are unlikely to decline significantly over time.

Rakuten is a major online shopping mall operator and travel service in Japan. These core businesses have been the central hub around which the company has diversified its activities into financial services, telecommunications and other net media. Recent plans for overseas expansion of its eCommerce operations have been met with a relatively muted response by the market, which we believe is symptomatic of the companys firm but unspectacular long-term domestic growth prospects. We rate the shares Neutral for the following reasons:
Rakutens market dominance and growth prospects priced in
Rakutens dominant domestic market position in eCommerce and its growth prospects are understood. This well-known theme provides little upside risk for the shares. As things currently stand, we do not believe that plans for overseas expansion will yield material results in the medium term. Rakuten is targeting small niche markets in Asia, and we believe the joint venture with Baidu.com in China will be a lengthy process before material earnings are generated.
Overseas expansion unlikely to be material in the medium term

Historically Rakuten has had an inconsistent record of generating free cash flow. Using DCF may not be best suited to ascertaining fair value for the company, but with a stabilized financial operation we believe there are sufficient grounds to estimate that free cash flow will be a more regular occurrence going forward.
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We use a synthetic free cash flow, as the normal cash flow statement does not give us a relevant figure to work withEBITDA less adjusted taxes, net capex and working capital adjustments. We omit changes in financial-related working capital, as we believe Rakutens core activity remains eCommerce. Changes in credit, bank and brokerage assets and liabilities distort what we deem to be a more useful picture of Rakutens free cash flow.
WACC 7.3%, terminal growth rate 0.5%
Our basic premise is that on a WACC of 7.3% and generating an average around 60.0B annual free cash flow into perpetuity (with 0.5% terminal growth), we derive an enterprise value of 908.3B. We then subtract net debt of 141.1B, being the indebtedness of the Rakuten parent company and ignoring financial services liabilities, and add 59.3B in investments. The resultant market value of equity is 826.5B, and this produces a fair value of 63,000 per share.
Investment Risks
We view the risks to our investment thesis as follows: Upside risk Positive news flow regarding speedy and solid execution of overseas expansion Improving market conditions for financial services, chiefly increased activity in the online brokerage and a rising loan book at consumer credit services Downside risk Bigger-than-anticipated increase in operating costs as a result of overseas expansion An unexpected slowdown in online user activity Ad-hoc business diversification that might impair fundamentals, such as further indebtedness or margin dilution
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Key Assumptions
Earnings Forecasts by Business Segment
Sales growth Y/Y eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Total sales growth OPM estimates eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Total OPM
Source: J.P. Morgan estimates
F'10E 25.0% 9.0% 27.0% 19.5% -12.0% 10.5% 16.0% 28.5% 3.5% 9.5% 45.0% 20.0% -10.0% 5.0% 4.0% -15.2% 18.1%
F'11E 20.0% 5.0% 10.0% 15.0% 5.0% 5.0% 11.4% 28.0% 3.0% 10.0% 43.0% 20.0% -9.0% 3.5% 10.0% -10.0% 18.7%
F'12E 7.0% 10.0% 7.0% 2.0% 5.0% 4.5% 29.0% 3.0% 10.0% 43.0% 20.0% -9.0% 2.0% 15.0% -10.0% 19.8%
CAGR F'10E-12E 13.3% 2.5% 10.0% 10.9% 3.5% 5.0% 7.9% -
Key assumptions for our earnings forecasts are as follows: Sales growth Shopping After high Y/Y growth in F10 partly fueled by acquisitions, we estimate the pace of growth will slow as hurdles become higher Y/Y. We estimate high single-digit growth in F'12, when sales should reach 184.6B. Credit We expect little change in sales volume, as the growth in credit card receivables is offset by the continued decline in the grey zone loan book. Portal/media Scale of operations remain small, enabling CAGR F10E-12E of 10%Y/Y. Broker Dependent on market conditions and consequent trading volume. We have flat growth forecasts. Sports and Telco We see no major growth prospects. Bank and eMoney A gradual profile, but no major growth factors are expected. OPM estimates Shopping Acquisitions and the Chinese joint venture operating at a loss should mean that opportunities for operational leverage will be limited going forward. Credit No major changes in annual OPM, although quaterly fluctuations are expected given securitization revenues. Portal/media No major changes expected. Broker No major changes expected.
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Sports and Telco We see no major growth prospects. Bank and eMoney We estimate better cost control should lead to gradual improvements in profitability.
Company Overview
Dominant B2B2C domestic business
Assessing overseas growth potential A household name in Japan, Rakuten has a dominant position as an online shopping mall without a major warehousing function, relying on a B2B2C business model connecting 'brick and mortar' retailers to consumers online. The attractions of Rakuten's model to potential tenants of virtual shop fronts are: Access to an active user base of 41.38M members within the Rakuten group. A business that caters to long tail demand the site is aimed at selling any conceivable item. There are currently 65M items listed for sale on the site (although this includes same items from multiple shops). Access to Rakutens reward points scheme, which can be effective in encouraging user loyalty and activity (although pricing remains the biggest draw for online consumerism). These points can be converted to other point programs, such as ANA mileage and T-Points program from CCC. Although the business priority remains in domestic operations, CEO Hiroshi Mikitani has made it plain that overseas expansion is required in order to generate growth, including his stated goal of doing business in 27 countries. International shipping has been available to overseas customers since 2008, albeit a limited service. Progress to date has been relatively slow compared to US counterparts but has recently speeded up:
Overseas Expansion Milestones to Date
Date Sep-05 Feb-08 Sep-09 Jan-10 May-10 Jul-10 Event Acquires 100% LinkShare US, an affiliate marketing company Signs joint venture agreement with President Store Chain in Taiwan, to set up Rakuten Ichiba Taiwan Acquires 67% stake in TARAD Dot Com in Thailand Reaches agreement to set up joint venture with Baidu.com to jointly operate online shopping mall in China (Rakuten stake 51%) Signs joint venture agreement with PT Global Mediacom in Indonesia, to set up Rakuten Ichiba Indonesia (Rakuten stake 51%) Acquires 100% Buy.com Inc - price $256M Acquires 100% PriceMinister - price euro 180M
41M active users 65M items listed for sale
Reward points scheme in place
To date overseas shopping sales less than 1% of total group sales
Initial forays overseas appeared focused on niche geographies such as Taiwan and Thailand, and we estimate they contributed less than 1% of gross merchandising volume in 2Q F10. Since the beginning of 2010 with the agreement with Baidu.com in China, Rakuten has made tentative moves into the US with Buy.com and Europe with PriceMinister. The immediate impact on gross merchandising volume will be around 2.5B during 3Q F10 from overseas markets, making up around 1% of the total. For group sales we estimate overseas operations will make up 2% to 3% of total sales in 3Q F10. We assess these opportunities in turn.
On consolidation of PriceMinister and Buy.com, overseas sales grow to 2% to 3% of total group sales
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Baidu.com Baidu.com is the premier search engine in China and therefore a formidable local partner to operate online shopping. Despite Baidu.coms success in its core field of search and pay for placement advertising, individually it has had little success in online shopping with its 'Youa' site.
Baidu.com
Baidu.com factsheet Established Location Prior contact with Japan IPO Sales in F09 Geographic reach Business model Number of members Number of products for sale Holding in joint venture 2000 Beijing HQ, China Commenced online search service in 2008 2005 N/A Shopping in China Commenced online shopping site 'Youa' in 2008 N/A N/A 51%
Market Share of C2C Market (CY08) in China (by Transaction Volume)
Tencent Paipai 7% eBay 7%
Others (including Baidu) 0%
Taobao 86%
Source: J.P. Morgan based on Analysys International
Pros and Cons of JV with Baidu.com

Positives Footprint in a major growth market Partnering with a local player Access to major online traffic
Source: J.P. Morgan assumptions.
Negatives Dominant local competition in place Partner's track record patchy User traffic not all with shopping intent
Rakuten and Baidu.com have announced plans to invest 4.3B ($50M) in capital in the first three years. We compare this amount to efforts made by eBay and its Chinese acquisition EachNet to develop its business in 2002-2003: Acquisition costs totaling $180M for 100% stake An additional $100M budget We assume that there are 120M users on competitor TaoBao's site. If we assume Rakuten were aiming to take away 25% of this user base:
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$50M capital commitment is on the low side Great opportunity in China, next two years the crucial period
Aim to gain 30M users over three years This would equate to user acquisition costs of $0.55 per user over the period, which does not strike us as being very high We believe there is an opportunity in the China eCommerce market, where users are looking for a greater sense of security about purchasing online. The next two years are likely to see major market growth especially in B2C sites (as opposed to auctions or B2B) and will also be a crucial period that decides which companies succeed and which do not. With such a strong market tailwind, Rakuten has a chance of performing if executing well on its services regarding settlements, logistics and customer servicesareas where it has expertise in Japan. The costs budgeted by Rakuten and Baidu.com do not seem very large when considering the challenges being faced. We therefore believe medium-term prospects for this joint venture have potential, but meaningful earnings remain difficult to ascertain. According to J.P. Morgan analyst Dick Wei, Head of Internet and Media for Asia Research, We don't expect this venture to have much impact on Baidu.coms earnings in the near future. However, we feel that the swift execution of this project is promising for the future. [Regional Internet Newsflow: Oct. 25, 2010] Buy.com Buy.com is a survivor of the dotcom era, having listed in 1999 and being taken private in 2001.
Buy.com
Buy.com factsheet Established Location Prior contact with Japan IPO Sales in F98 Sales in F09 OP in F09 Geographic reach Business model Number of members Number of products for sale Deal value Book value Total goodwill arising estimate 1997 California, USA Softbank invested in 1998 and 1999 pre-IPO October 1999 on NASDAQ; taken private November 2001 $125M $62M (5.7B) $4.4M (0.4B) - OPM 7.0% Canada, France, Germany, Italy, Spain Marketplace; major seller on eBay 14M 11.5M (March 2010) $256M (20.7B) 2.8B 17.9B
Joint venture not expected to make a major impact at Baidu.com in the near future
Source: J.P. Morgan based on company data. Note: Forex rate: $1 = 92. Total goodwill arising is J.P. Morgan estimate.
Pros and Cons of Buy.com Acquisition

Positives Footprint in the developed US eCommerce market Learn new online shopping model
Negatives Crowded market with two dominant players (Amazon, eBay) Patchy track record
Business model is marketplace similar to Rakuten
Buy.com operates a mall-type operation similar to Rakuten, connecting shoppers with distributors and retailers. It is similar to Rakuten's business model as it holds no inventory, and outsources distribution and fulfillment.
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Business strategy has centered on cost leadership
The company has a loyal following, although historically its strength has been in sales of technology and consumer electronicsvery unlike sales at Rakuten where sales rankings are dominated by cosmetics and toiletries, foodstuffs and fashion items. The challenge for Rakuten will be to operate a profitable business whilst aiming for market share gains in a very competitive market. Buy.com's operations in the past have focused on cost leadership and undercutting competitors to win businessthis has not been Rakutens focus to date. PriceMinister The key selling points of PriceMinisters online shopping model are: Empowering the individualthe site is designed for individual sellers and buyers, at a fixed price/slight negotiation but not auction-based.
Key selling point is security but this is an industry norm
There is emphasis on security. However, most auction and shopping sites operate with payment on delivery and have reimbursement policies. Rakuten guarantees reimbursement for undelivered goods up to 500,000.
PriceMinister
PriceMinister factsheet Established Location Prior contact with Japan IPO Sales in F09 OP in F09 Geographic reach Business model Number of members Number of products for sale Deal value Book value Total goodwill arising estimate 2000 Paris, France N/A N/A Euro 40.0M (3.6B) Euro 6.6M (0.7B) OPM 19.4% France, UK, Spain C2C, online travel, online real estate 11M 150M Euro 180M (20.5B) 3.6B 16.9B
Source: J.P. Morgan based on company data. Note: Forex rate: Euro1 = 112. Total goodwill arising is J.P. Morgan estimate.
Pros and Cons of PriceMinister Acquisition

Positives Footprint in Europe
Negatives Small niche player
A small footprint in Europe is unlikely to materially affect Rakuten's earnings visibility in our view.
Late movers can make an impact in eCommerce
Conclusion We believe first-mover advantage in the internet economy is exaggerated, as switching costs for online consumers as well as barriers to entry for new entrants are both low. This implies that late movers such as Rakuten have an opportunity to catch up with established global peers such as Amazon and eBay, and to take on strong local players in China such as the Alibaba groups Taobao.
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but dominant players have consolidated their market position
On the other hand, instances whereby new entrants have cracked markets with established dominant players in place have been rare. We believe this is due to wellexecuted online businesses being able to scale at a rapid pace, enabling them to cement their market position. Instances whereby latecomers beat established competitionfor example Taobao besting eBay in China on transaction volume involved competition over pricing and as well as the ability to deliver well designed localized services. In online shopping and auction, the key competitive strength is the size of the network of buyers and sellers, and the number of products offered. As market leaders consolidate their market position, Rakuten will have to be aggressive and persevering in order to make its mark overseas.
Key competitive strength is size and scale of service on offer
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Quarterly Earnings Forecast

F09 Q1 Sales (B) eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Operating profit (B) eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Intercompany OPM (%) eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Sales growth Y/Y (%) eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money 66.4 25.2 14.0 3.4 4.1 5.3 0.7 6.9 6.7 9.8 7.7 0.9 0.3 1.8 0.4 -1.2 0.2 -0.5 0.0 0.1 14.8% 30.6% 6.4% 8.6% 43.7% 8.5% -166.9% 3.3% -7.5% 11.5% 21.1% -15.2% 46.5% 15.5% -16.3% -25.9% -23.5% Q2 73.4 26.9 14.3 4.3 4.3 6.3 2.9 6.5 8.0 13.6 8.5 0.6 0.0 1.7 1.6 0.4 0.0 0.7 0.0 0.1 18.5% 31.7% 4.2% 1.0% 40.9% 25.2% 15.1% -0.6% 8.5% 17.4% 19.7% -12.0% 110.9% 16.5% -0.2% 1.2% -27.4% Q3 77.3 28.6 14.3 4.7 5.9 6.2 3.2 6.5 7.8 15.2 8.3 0.8 0.3 2.9 1.3 0.7 0.0 0.9 0.0 -0.1 19.7% 29.0% 5.8% 6.9% 48.5% 21.6% 22.2% 0.5% 10.9% 24.3% 31.6% -12.4% 139.3% 27.1% 0.1% 9.5% -21.7% Q4 81.2 34.3 15.1 5.2 5.0 5.7 1.6 6.5 7.8 18.0 11.7 1.0 0.5 2.4 1.1 -0.6 0.1 1.4 0.0 0.4 22.2% 34.1% 6.5% 9.6% 47.6% 18.9% 2.2% 17.8% 23.6% 31.7% -10.3% 55.6% 16.3% -3.7% 26.5% -18.5% F10 Q1 79.2 31.5 14.9 5.5 5.0 6.0 0.9 6.0 8.3 1.2 13.0 8.8 0.1 0.8 2.1 1.2 -1.2 0.5 0.5 -0.2 0.3 16.4% 28.1% 0.6% 13.9% 41.4% 20.2% 8.8% 6.5% -16.5% 19.3% 24.8% 6.7% 60.3% 20.7% 12.8% 24.4% -12.6% 23.5% Q2 84.9 33.4 15.6 5.5 5.2 6.9 2.9 5.7 8.5 1.2 15.3 9.7 0.2 0.3 2.0 1.8 0.3 0.1 0.7 -0.2 0.2 18.0% 29.0% 1.1% 6.4% 39.3% 26.4% 10.4% 1.0% 8.7% -12.9% 15.6% 24.5% 9.5% 26.4% 21.7% 8.5% 1.0% -12.2% 6.1% Q3 88.5 35.9 15.8 5.8 7.0 5.6 3.1 5.6 8.4 1.3 16.0 9.0 1.0 0.5 3.4 1.0 0.6 0.2 -0.1 -0.2 0.5 18.0% 25.2% 6.4% 8.6% 49.4% 18.1% 18.5% 4.2% -1.2% -19.0% 14.5% 25.4% 10.1% 24.2% 18.0% -9.7% -2.2% -14.4% 7.5% Q4 E 93.4 43.0 16.5 5.6 5.9 5.1 1.5 5.9 8.3 1.5 18.6 13.4 0.9 0.5 2.8 0.7 -0.5 0.3 0.2 -0.2 0.4 19.9% 31.1% 5.6% 9.2% 47.9% 13.2% 5.7% 1.9% -13.0% 15.0% 25.2% 9.6% 8.1% 18.4% -10.6% -8.4% -8.7% 6.8% F11 Q1 E 88.1 39.3 14.9 6.0 5.5 6.0 0.9 6.0 8.3 1.2 14.3 10.4 0.2 0.3 2.4 1.6 -1.5 0.1 0.8 -0.1 0.0 16.2% 26.5% 1.5% 5.0% 43.0% 27.0% 2.0% 10.0% -10.0% 11.3% 25.0% 10.0% 10.0% Q2 E 94.3 41.8 15.6 6.0 5.7 6.9 2.9 5.7 8.5 1.2 17.1 11.1 0.2 0.3 2.5 1.9 0.3 0.1 0.8 -0.1 0.0 18.1% 26.5% 1.5% 5.0% 43.0% 27.0% 10.0% 2.0% 10.0% -10.0% 11.1% 25.0% 10.0% 10.0% Q3 E 96.9 43.1 15.8 6.4 7.7 5.6 3.1 5.6 8.4 1.3 18.2 11.6 0.4 0.3 3.3 1.5 0.2 0.1 0.8 -0.1 0.0 18.7% 27.0% 2.5% 5.0% 43.0% 27.0% 15.0% 2.0% 10.0% -10.0% 9.6% 20.0% 10.0% 10.0% Q4 E 106.1 48.3 19.7 6.2 7.7 5.1 1.5 5.9 10.0 1.8 22.4 15.2 1.1 1.5 3.3 -0.3 0.2 0.5 1.0 -0.2 0.0 21.1% 31.4% 5.7% 24.9% 43.0% -5.1% -21.7% 7.9% 10.0% -10.0% 13.6% 12.4% 19.0% 10.0% 29.5% 20.1% 17.3% F10 E 345.9 143.8 62.9 22.4 23.1 23.5 8.4 23.2 33.5 5.2 62.8 41.0 2.2 2.1 10.4 4.7 -0.8 1.2 1.3 -0.8 1.5 18.1% 28.5% 3.5% 9.5% 45.0% 20.0% -10.0% 5.0% 4.0% -15.2% 16.0% 25.0% 9.0% 27.0% 19.5% -12.0% 10.5% F11 E 385.4 172.5 66.0 24.6 26.6 23.5 8.4 23.2 35.2 5.4 71.9 48.3 2.0 2.5 11.4 4.7 -0.8 0.8 3.5 -0.5 0.0 18.7% 28.0% 3.0% 10.0% 43.0% 20.0% -9.0% 3.5% 10.0% -10.0% 11.4% 20.0% 5.0% 10.0% 15.0% 5.0% 5.0% F12 E 402.8 184.6 66.0 27.1 28.4 23.5 8.4 23.2 35.9 5.7 79.7 53.5 2.0 2.7 12.2 4.7 -0.8 0.5 5.4 -0.6 0.0 19.8% 29.0% 3.0% 10.0% 43.0% 20.0% -9.0% 2.0% 15.0% -10.0% 4.5% 7.0% 10.0% 7.0% 2.0% 5.0%
-35.9% -135.8%
-35.4% -135.0%
Source: Company data, J.P. Morgan estimates
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Business Segment Outline (as of 3Q F10)

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

billion F07 75.5 70.2 7.5 12.9 30.6 7.6 9.7 213.9 -39.5 174.5 19.5 -25.2 -0.4 6.0 5.7 -0.8 -0.4 0.1 0.5 1.1 0.9 -1.3 2.4 57.4 -9.1 50.7 -15.0 1.2 36.9 2,826 100 3.5 5.2 -99.6 -92.2 -5.1 81.5 0.1 1.1 -29.5 Actual F08 91.1 65.9 9.7 16.2 24.8 8.0 34.2 249.9 -55.3 194.5 26.1 10.7 -0.2 7.5 3.9 -0.8 0.4 47.2 0.9 -2.1 0.6 -1.9 44.5 1.4 -80.9 -35.0 -20.6 0.6 -55.0 -4,204 100 -2.4 16.8 -22.7 77.9 18.9 17.8 58.9 F09 115.0 57.7 17.6 19.3 23.5 8.4 26.4 30.3 298.2 -70.0 228.2 36.2 3.3 1.2 8.8 4.5 -0.6 0.4 2.4 56.6 0.2 -2.0 0.6 -1.0 54.9 5.4 -7.8 52.5 0.6 0.4 53.6 4,092 100 2.4 19.4 20.1 23.3 35.9 76.5 19.0 18.4 1.2 J.P. Morgan Estimates F10E F11E 143.8 62.9 22.4 23.1 23.5 8.4 23.2 33.5 5.2 345.9 -79.6 266.4 41.0 2.2 2.1 10.4 4.7 -0.8 1.2 1.3 -0.8 62.8 0.2 -2.3 0.1 -1.0 60.1 60.1 -24.5 0.4 36.1 2,753 100 3.6 16.0 10.8 9.5 -32.7 17.7 77.0 18.1 17.4 -40.7 172.5 66.0 24.6 26.6 23.5 8.4 23.2 35.2 5.4 385.4 -88.7 296.8 48.3 2.0 2.5 11.4 4.7 -0.8 0.8 3.5 -0.5 71.9 0.2 -2.4 0.1 -1.0 69.1 69.1 -28.1 0.4 41.4 3,161 100 3.2 11.4 14.5 15.0 14.8 17.2 77.0 18.7 17.9 -40.7 F12E 184.6 66.0 27.1 28.4 23.5 8.4 23.2 35.9 5.7 402.8 -92.6 310.2 53.5 2.0 2.7 12.2 4.7 -0.8 0.5 5.4 -0.6 79.7 0.2 -2.4 0.1 -1.0 76.9 76.9 -31.3 0.4 46.0 3,512 100 2.8 4.5 10.8 11.2 11.1 16.3 77.0 19.8 19.1 -40.7
<Sales> eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Total sales COGS Gross profit <Operating profit> eCommerce Credit Portal/media Travel Broker Sports Telco Bank e-money Total operating profit Dividend income Net interest income Gains on securities Other gains Other losses Recurring profit Extraordinary gains Extraordinary losses Pre-tax profit Tax Minorities Net profit Per share EPS () DPS () Effective payout ratio (%) Y/Y % Sales (%) Operating profit (%) Recurring profit (%) Net profit (%) NAV (%) Operating performance GPM (%) OPM (%) RPM (%) Effective tax rate (%)
Source: Company data, earnings results and J.P. Morgan estimates.
160 388
Consolidated Balance Sheet

billion <Assets> Cash and cash equivalents Accounts receivables Marketable securities Inventories Deferred tax Non-bank related assets Securities related assets Bank related assets Other Current assets Tangible fixed assets Intangible fixed assets Goodwill Other Investments and other assets Total assets <Liabilities> Accounts payable Short term debt Cash deposits in escrow Margin trading liabilities Guarantees receivables Credit guarantees (KC) eBank deposits Other Current liabilities Long term debt Other Long term liabilities Reserves under special laws Total liabilities <Net assets> Shareholder's equity Valuation and translation adjustments Minority interest Total net assets Total liabilities and net assets Net debt Capital employed Net debt/equity (%) Debtor days Inventory days Creditor days ROCE (%) ROE (%) ROA (%)
F07 57.4 27.9 26.4 15.6 344.3 428.1 3.4 903.2 24.0 93.4 64.5 28.9 138.3 1,158.9 16.7 236.5 148.3 101.7 104.9 4.5 137.9 750.4 181.1 29.7 210.7 3.9 965.1 206.8 13.0 193.8 1,158.9 333.8 611.6 185.8 38 106 0.5 18.6 3.2
F08 88.6 32.2 2.6 12.8 387.4 307.5 19.1 850.3 21.1 93.3 65.1 28.2 122.2 1,086.9 20.2 289.3 142.6 53.5 88.7 3.6 104.9 702.9 194.1 28.1 222.1 3.2 928.2 150.7 0.7 8.8 158.7 1,086.9 392.2 642.1 263.3 44 122 7.7 -32.0 -5.1
F09 96.2 37.8 18.0 13.7 312.7 235.8 617.3 182.6 1,514.1 19.5 120.5 87.0 33.5 105.1 1,759.2 28.2 172.6 142.6 59.0 89.1 2.8 698.4 174.3 1,367.0 157.3 13.5 170.8 2.7 1,540.6 203.1 0.9 14.7 218.6 1,759.2 215.7 548.5 114.6 43 126 9.7 30.3 3.0
F10E 99.8 45.0 18.0 14.0 295.7 243.0 648.1 199.0 1,562.5 19.7 120.5 87.0 33.5 105.1 1,807.8 31.8 159.1 142.6 62.0 89.1 2.4 712.3 183.0 1,382.4 154.2 13.5 167.7 2.7 1,552.8 244.5 -4.5 15.0 255.0 1,807.8 195.5 568.3 89.0 44 138 11.4 16.2 2.0
F11E 118.7 50.1 18.0 14.0 288.5 252.3 661.1 203.7 1,606.4 19.9 121.7 82.7 39.0 105.1 1,853.1 35.5 141.8 142.6 65.1 89.1 2.0 726.6 186.7 1,389.4 151.1 13.5 164.6 2.7 1,556.7 290.5 -9.1 15.0 296.4 1,853.1 156.2 589.4 61.9 45 139 12.6 15.9 2.2
F12E 157.4 52.4 18.0 14.0 282.2 262.0 674.3 207.7 1,667.9 20.1 123.0 78.6 44.4 105.1 1,916.0 37.1 139.0 142.6 68.3 89.1 1.7 741.1 190.4 1,409.3 148.1 13.5 161.6 2.7 1,573.6 342.0 -14.5 15.0 342.4 1,916.0 111.7 629.5 39.6 46 143 13.2 15.1 2.4
161
389
Consolidated Cash Flow Statement

billion F07 Pre-tax profit Tax paid Depreciation and amortization Changes in working capital Changes in financial working capital Other Revaluation/sale of asset, equity income, net interest and provisioning Cash flow from operating activities Capital expenditure Net sale/purchase of securities Other Cash flow from investing activities Change in debt Dividends paid Net buybacks Equity issued Other Cash flow from financial activities Effect of exchange rate change on cash and cash equivalents Gross change in cash and cash equivalents Cash and cash equivalents at the beginning of the year Effect of Change in Consolidated Companies Cash and cash equivalents at FY end FCF per share () FCF yield (%) FCF conversion (%)
Source: Company data, earnings results and J.P. Morgan estimates. Note: Share price as of December 29, 2010
F08 -35.0 -22.4 16.2 -0.8 -31.4 -2.5 62.4 -13.5 -14.9 -21.6 -4.5 -41.0 64.5 -1.6 0.8 -1.3 62.4 -0.9 7.1 73.9 0.3 81.3 1,831.3 2.7 50.8
F09 52.5 -15.4 19.9 3.7 -118.1 10.2 -8.0 -55.2 -12.7 191.8 38.0 217.2 -163.3 -1.3 -4.1 -5.4 -174.2 -0.0 -12.3 81.3 34.6 103.6 4,659.8 6.8 107.7
F10E 60.1 -24.5 14.9 -3.5 -60.0 -2.1 -15.1 -11.7 -20.0 9.0 -22.7 91.2 -1.3 -2.3 87.6 -1.0 48.8 103.6 0.7 153.1 2,736.8 4.0 57.1
F11E 69.1 -28.1 15.0 -1.5 -60.0 -2.4 -7.9 -11.7 -11.7 -15.0 -1.3 -2.4 -18.7 -38.3 153.1 114.8 3,306.6 4.8 60.2
F12E 76.9 -31.3 15.1 -0.7 -50.0 -2.4 7.6 -11.7 -11.7 -15.0 -1.3 -2.4 -18.7 -22.8 114.8 92.0 3,729.1 5.5 61.3
50.7 -0.6 12.3 0.2 -1.2 3.8 -22.2 43.0 -14.8 65.3 4.5 55.1 -114.7 -1.0 0.6 1.4 -113.6 0.2 -15.4 89.2 73.9 -7.5 -0.0 -82.4
162 390

03 January 2011
Yahoo Japan (4689)

Cash Cow Geared for Recovery in Advertising
We are maintaining our Overweight rating on Yahoo Japan, with a price target of 35,000 to November 2011. We believe the company is geared for a recovery in online advertising, with effective cost control resulting in pronounced margin expansion. We view improving fundamentals as a precursor to changes in corporate governance, as high cash generation is put to good use. We expect fundamentals to continue improving in 2011. We believe Yahoo Japan will continue to benefit from a recovery in ad demand as the premier player in Japans net media space. We expect medium-term margin expansion through effective cost management and scaling of recent business initiatives, such as social gaming and eCommerce partnerships with leading players. The advertising recovery is gaining pace. Concerns remain over visibility for online advertising expenditure in 2H F10. However, we believe a recovery profile is gaining pace at Yahoo Japan, with display ad sales showing Y/Y growth since 4Q F09 and listings showing reaccelerating growth from 2Q F09. With around 60% of total sales derived from advertising, we believe this is a key swing factor regarding the company's prospects going forward. Cost reductions and digital content are incremental positives. The company sharply reduced operating costs in F09 and is continuing to cut costs. We think the divesture of the online market research business and the license renegotiations carried out in 2Q F10 were practical measures to maximize margin growth. Developing a digital content platform heralds a new approach to improve the sales mix. We believe these are incremental positives that raise earnings visibility at the company. Valuation and risks. The shares are trading at 18.2x our F11 EPS forecast, which we believe is undervalued for a geared recovery story. The company has consistently improved free cash flow generation and has more cash cow characteristics than a high-growth company. We think this will result in improved corporate governance via dividend hikes over the medium term. Risks to our price target include a slower-than-anticipated recovery in ad demand and a potentially disruptive cutover to Googles search engine in January 2011.
Consolidated Y/E Mar 2009 2010 2011E 2012E 2013E Sales (B) 265.8 279.8 289.0 307.9 328.5 Y/Y (%) 1.4 5.3 3.3 6.5 6.7 OP (B) 134.6 143.8 157.4 171.7 185.3 Y/Y (%) 7.9 6.8 9.5 9.1 7.9 RP (B) 132.9 143.4 157.5 171.8 185.3 Y/Y (%) 9.4 7.8 9.9 9.1 7.9 NP (B) 74.7 83.5 93.4 101.9 110.0 Y/Y (%) 19.4 11.8 11.8 9.1 7.9
Overweight

AC
Yusuke Maeda
Price Performance
38,000 Y 32,000 26,000
Company Data
Price Price date Market capitalization Shares outstanding 52-week range TOPIX Dividend (F10E) Dividend yield (F10E) RoE (FY10E) 31,950 Dec. 29, 2010 1,853bn 58.0mn 38,50027,230 908.01 322 1.0% 26.2%
EPS () 1,255.9 1,439.7 1,609.5 1,756.2 1,895.6
P/E (x) 25.4 22.2 19.9 18.2 16.9
P/B (x) 7.9 6.0 4.6 3.7 3.0
EV/EBITDA (x) 10.8 10.2 9.3 8.6 8.0
Source: Company data, earnings results, and J.P. Morgan estimates

We are maintaining our F11 estimates for Yahoo Japan, with revenue of 307.9B and operating profit of 171.7B, driven primarily by the rebound in advertising demand, although we expect the consumer business (eCommerce - shopping and auction) to post a growth profile. Our model calls for a stable operating profit margin improvement Y/Y to 55.8% from 54.5%, as sales volume expansion drives operational gearing.

We are maintaining our F12 estimates for Yahoo Japan, with revenue of 328.5B and operating profit of 185.3B. The scenario we are modeling is similar to F'11, with advertising demand at stable growth rates Y/Y resulting in margin expansion. We believe some new business initiatives that commenced in F'10, such as social gaming, eCommerce collaborations and smartphone content, will be feeding material earnings for the business.

Yahoo Japan is the domestic market leader in internet media, its key earnings driver being advertising demand. We believe that in a sustained economic recovery scenario, Yahoo Japan will benefit from operational gearing based on the following factors:
Ad demand recovery drive operational gearing
We estimate advertising makes up approximately 60% of total sales. Demand has begun to stabilize Y/Y, with both listings and banner display advertising showing continued growth since 2Q F09. Continued recovery in ad demand would result in margin expansion with increasing sales volume. The company conducted cost reductions in F09, resulting in marked increases in profitability during 1H F10. We believe continued cost management and business expansion into digital content will lead to a further increase in profitability. With the companys cash cow status, we believe corporate governance will improve via dividend hikes in the medium term. We believe that Yahoo Japan is a geared play on a sustained recovery in online advertising demand, as it maintains its market leader status as an online go to destination for domestic internet users.
Cost reduction efforts also allow for increase in profitability
We expect a dividend hike from this cash cow

Yahoo Japan has been free cash flow generative since F01, when it was experiencing a high growth profile. We calculate that annual free cash flow generation has consistently grown every year since then, but its growth has flattened somewhat since F08 (F09 being an exception due to a low tax payment). As free cash flow remains steady, and free cash flow conversion remain high, we have used DCF as our valuation method to derive fair value for the stock.
WACC 7.6%, 0.5% terminal rate
Our basic premise is that on a WACC of 7.6% and generating an average annual 116B free cash flow into perpetuity (with a 0.5% terminal growth rate), we derive a net present value of 1,755.2B. We then add back 136.3B in net cash, and 167.5B in investments and land (including 120B in preferred shares in Softbank). The
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resultant Market Value of Equity is 2,059B, and this produces a fair value of 35,000 per share.
Investment Risks
We view the risks to our investment thesis as follows: Upside risks Banner display advertising demand picks up faster than expected in 2H F10. Digital content sales from online gaming operations experiences significant growth. Management undertakes price hikes for advertising and eCommerce services. Downside risks Ad demand recovery slower than anticipated. Cutover to new Google search technology is disruptive and results in advertising client loss. New business developments lead to higher than expected costs.
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393
AdvertisingThe Swing Factor

Yahoo Japan's core earnings driver is advertising, with the company's unrivalled media power in the online market. Advertising takes broadly two forms: Display advertising panels of advertising space on a webpage, primarily for brand advertising Listings text-based advertising, which can be driven by search queries, standard listings or by targeting The company says profitability is similar for both products, although this is dependent on utilization rates (the amount of ad space inventory being sold) for banners, and pricing.
Advertising Sales Breakdown by Product 2Q F10
30% Display 70% Listing
9% Targeting
21% Brand panel, prime display
65% Search, tex t-based ads
5% Interest match
Source: J.P. Morgan based on company interview.
Display ads demand fell significantly in 1H F09, as demand from financial, real estate and recruitment sectors dropped. However, spending bottomed in 3Q F09, and has been recovering Y/Y since 4Q F09. Listings ads have maintained a resilient Y/Y growth profile throughout the economic downturn. Demand reaccelerated in 2Q F10, and demand from the weak sectors such as finance has begun to bottom.
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Yahoo Japans Display Advertising Revenue by Industry

Industry Finance/Insurance/Securities Autos (Transport Equipment) Cosmetics/Toiletries Real Estate/Construction Transportation/Leisure Foodstuffs Beverages/Cigarettes internet Information Site/Email service Fashion/Accessories Medicament/Pharmaceuticals Mobile Communications Service Entertainment Related Software Others Total
2Q F08 (1) 18.9% 10.7% 10.2% 11.5% 7.9% 3.4% 3.9% 3.4% 3.3% 3.1% 23.7% 100.0%
2Q F10 (2) 16.8% 13.3% 9.3% 9.3% 7.2% 4.5% 4.1% 3.7% 3.6% 3.3% 3.1% 2.9% 18.9% 100.0%
(2) - (1) -2.1ppt 2.6ppt -0.9ppt -2.2ppt -0.7ppt 1.1ppt 0.2ppt 0.2ppt -0.2ppt -0.2ppt -
Yahoo Japan has managed to increase operating margins over the last year and a half, through a combination of cost reductions and the ongoing recovery in advertising spending: Cost cutting measures in F09 focused on reducing contractor costs, administrative expenses and IT costs. During 2Q F10, the divesture of Yahoo Value Insight (online market research), the termination of search services with Yahoo! Inc. and renegotiating a contract with an advertising partner reduced COGS.
Quarterly Sales and OPM Trend
million
76,000 72,000 68,000 64,000 1Q 2Q FY'08 3Q 4Q
Bottoming of listings demand
Continued margin expansion
56% 54% 52%
Bottoming of display ad demand
50% 48% 46%
1Q
2Q FY'09
3Q
4Q
1Q FY'10
2Q
Sales (LHS)
OPM (RHS)
167
395
Quarterly Advertising Sales Trends

% Display ads sales growth Y/Y F09 1Q 2Q 3Q 4Q F10 1Q 2Q -10% -10% -3% 15% 7%-8% less than 10% Listings ads (including search and Interest Match) sales growth Y/Y 2%-3% Flat positive 2%-3% 7%-8% 7%-8% Plus 10% Total sales growth Y/Y 3.2% 2.8% 5.6% 8.9% 4.2% 4.6% Total OPM 50.4% 50.8% 51.5% 52.9% 53.3% 54.2% Notes
M&A growth impact Y/Y: Softbank IDC and Gyao Corp. Bottom of listings decline. 1Q-2Q Major cost cutting exercise contractor and administration costs Bottoming of banner ad demand Major display ad recovery Y/Y Pullback Q/Q for display ads, listings ads demand steady OPM continue to improve via cost reductions: - Sale of Yahoo Value Insight - Renegotiate license contract w/ ad partners - Renegotiate search license fee with Yahoo! Inc..
Key Assumptions
J.P. Morgan Assumptions for Domestic Sales and OPM
F10E Sales growth Y/Y Media Business services Consumer Total sales growth OPM estimates Media Business services Consumer Total OPM
F11E 8.7% 7.3% 3.9% 6.5%
F12E 9.0% 8.8% 2.7% 6.7%
CAGR 10E-12E 8.8% 8.0% 3.3% 6.6%
4.7% 7.5% -0.7% 3.3%
53.0% 49.7% 66.6% 54.5%
54.4% 50.3% 67.9% 55.8%
55.2% 50.8% 68.6% 56.4%
The three business segments refer to the following: Media all display advertising sales, listings advertising sales via advertising agency Business services listings advertisings sold direct (search and targeted), listings advertising sold in Yahoo! Real Estate, Yahoo! Rikunavi (recruitment) and Yahoo! Motor. Also sales of data center operations Consumer income from auction site (fixed tenancy fees and variable commission/system fees), income from shopping site (fixed tenancy fee and variable commission), premium user id monthly fee, digital content sales, and legacy ISP fees
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Key assumptions for our earnings forecasts are as follows: Sales growth Media online ad likely demand to maintain a steady growth trajectory, from both display and listings. Business services dependent on listings, ad demand from finance, real estate and recruitment to recover, but starting from a low base. Consumer a bottoming in online auction activity, with growth stemming from the company's efforts to drive shopping volume at the marketplace operation. Small impact from digital content sales. OPM estimates Media - steady margin expansion Y/Y through sales volume hikes and controlled costs. Business services - no major hikes in margins, although with ad demand returning, some scope for margin expansion through sales volume growth. Consumer - stability in the auction business and an improving sales mix from digital content sales with very high margins.
169
397
Quarterly Earnings Forecasts

( billion) Sales Media Business services Consumer Adjustments Operating profit Media Business services Consumer Adjustments OPM Media Business services Consumer Adjustments Sales growth Y/Y Media Business services Consumer Adjustments F09 Q1 67.6 23.6 17.5 26.4 0.2 34.3 11.0 7.4 18.1 -2.2 50.7% 46.7% 42.7% 68.4% 3.2% 3.2% 3.2% 3.2% 3.2% Q2 68.0 24.6 17.5 25.7 0.2 34.4 11.4 7.7 17.2 -1.9 50.6% 46.4% 43.7% 67.0% 3.1% 7.2% 3.1% -0.3% -5.9% Q3 70.9 25.9 17.7 27.2 0.2 36.4 12.4 8.0 17.9 -1.9 51.4% 48.1% 45.2% 65.9% 5.9% 10.8% 2.4% 4.0% -6.8% Q4 73.2 28.2 18.7 26.1 0.2 38.7 14.7 9.2 16.9 -2.1 52.9% 52.2% 49.2% 64.7% 9.1% 20.8% 8.0% -0.6% 1.2% F10 Q1 70.5 25.6 18.4 26.3 0.2 37.6 13.1 8.9 17.6 -2.1 53.3% 51.3% 48.5% 66.9% 4.2% 8.7% 5.7% -0.5% -19.8% Q2 70.9 26.4 19.0 25.4 0.1 38.4 13.9 9.4 16.8 -1.7 54.2% 52.7% 49.5% 66.1% 4.2% 7.2% 8.3% -1.1% -47.4% Q3 E 72.7 27.1 19.5 26.0 0.1 39.9 14.5 9.8 17.3 -1.7 54.9% 53.5% 50.2% 66.5% 2.6% 5.0% 10.1% -4.3% -47.6% Q4 E 74.9 28.0 19.9 26.9 0.1 41.5 15.2 10.0 18.1 -1.7 55.5% 54.2% 50.5% 67.0% 2.2% -1.0% 6.1% 3.4% -51.9% F11 Q1 E 75.5 28.2 20.1 27.1 0.1 41.9 15.2 10.0 18.3 -1.7 55.5% 54.0% 50.0% 67.5% 7.1% 10.3% 8.8% 3.2% -39.8% Q2 E 76.2 28.7 20.3 27.1 0.1 42.4 15.5 10.1 18.5 -1.7 55.6% 54.0% 50.0% 68.0% 7.4% 8.5% 6.7% 6.8% 0.0% Q3 E 77.2 29.2 20.8 27.1 0.1 43.2 15.9 10.5 18.5 -1.7 55.9% 54.5% 50.5% 68.0% 6.2% 7.7% 6.7% 4.2% 0.0% Q4 E 79.0 30.3 21.3 27.3 0.1 44.3 16.6 10.8 18.6 -1.7 56.1% 55.0% 50.5% 68.0% 5.5% 8.2% 7.2% 1.4% 0.0% F09 279.8 102.3 71.4 105.4 0.8 143.8 49.6 32.3 70.1 -8.1 51.4% 48.5% 45.3% 66.5% 5.3% 10.5% 4.2% 1.5% -2.1% F10 E 289.0 107.1 76.8 104.7 0.5 157.4 56.7 38.2 69.8 -7.2 54.5% 53.0% 49.7% 66.6% 3.3% 4.7% 7.5% -0.7% -41.5% F11 E 307.9 116.4 82.4 108.7 0.4 171.7 63.3 41.4 73.8 -6.8 55.8% 54.4% 50.3% 67.9% 6.5% 8.7% 7.3% 3.9% -14.2%
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Consolidated Profit and Loss Statement

billion F07 91.3 67.6 102.4 0.8 262.0 -28.3 233.8 38.3 27.0 68.6 -9.1 124.8 -3.1 0.0 -0.3 0.5 -0.5 121.5 0.0 -7.5 114.0 -50.7 -0.7 62.6 1,035.3 104.0 10.0 23.3 17.5 18.2 8.0 29.0 89.2 47.6 46.4 -44.5 Actual F08 92.5 68.6 103.8 0.8 265.8 -27.8 237.9 43.5 29.5 71.2 -9.6 134.6 -1.1 0.1 -0.2 1.3 -1.8 132.9 1.6 -8.1 126.4 -51.1 -0.6 74.7 1,255.9 130.0 10.4 1.4 7.9 9.4 19.4 -1.7 89.5 50.7 50.0 -40.4 F09 102.3 71.4 105.4 0.8 279.8 -32.6 247.2 49.6 32.3 70.1 -8.1 143.8 -0.2 0.1 -0.1 0.0 -0.4 143.4 0.4 -3.1 140.7 -56.8 -0.4 83.5 1,439.7 288.0 20.0 5.3 6.8 7.8 11.8 32.5 88.4 51.4 51.2 -40.4 J.P. Morgan Estimates F10E F11E 107.1 76.8 104.7 0.5 289.0 -30.3 258.7 56.7 38.2 69.8 -7.2 157.4 0.1 -0.1 0.0 -0.4 157.5 157.5 -63.6 -0.5 93.4 1,609.5 321.9 20.0 3.3 9.5 9.9 11.8 29.5 89.5 54.5 54.5 -40.4 116.4 82.4 108.7 0.4 307.9 -30.8 277.1 63.3 41.4 73.8 -6.8 171.7 0.1 -0.1 0.0 -0.4 171.8 171.8 -69.4 -0.5 101.9 1,756.2 439.1 25.0 6.5 9.1 9.1 9.1 25.4 90.0 55.8 55.8 -40.4 F12E 126.9 89.6 111.6 0.4 328.5 -31.2 297.3 70.0 45.5 76.6 -6.8 185.3 0.1 -0.1 0.0 -0.4 185.3 185.3 -74.9 -0.5 110.0 1,895.6 473.9 25.0 6.7 7.9 7.9 7.9 21.8 90.5 56.4 56.4 -40.4
<Sales> Media Business services Consumer Adjustments Total sales COGS Gross profit <Operating profit> Media Business services Consumer Adjustments Total operating profit Affiliate income Dividend income Net interest income Gains on securities Other gains Other losses Recurring profit Extraordinary gains Extraordinary losses Pre-tax profit Tax Minorities Net profit Per share EPS () DPS () Effective payout ratio (%) Y/Y % Sales (%) Operating profit (%) Recurring profit (%) Net profit (%) NAV (%) Operating performance GPM (%) OPM (%) RPM (%) Effective tax rate (%)
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Consolidated Balance Sheet

billion <Assets> Cash and cash equivalents Accounts receivables Marketable securities Inventories Deferred tax Other Current assets Tangible fixed assets Intangible fixed assets Goodwill Other Investments and other assets Total assets <Liabilities> Accounts payable Short term debt Other Current liabilities Long-term debt Other Long-term liabilities Total liabilities <Net assets> Shareholders equity Valuation and translation adjustments Minority interest Total net assets Total liabilities and net assets Net debt Capital employed Net debt/equity(%) Debtor days Inventory days Creditor days ROCE (%) ROE (%) ROA (%)
Source: Company data, J.P. Morgan estimates. Note: Net debt/equity: net cash position.
F07 113.0 34.7 0.2 4.3 12.0 164.3 16.6 13.8 2.5 11.3 174.9 369.7 6.6 20.0 62.4 89.0 30.0 0.0 30.0 119.0 246.5 1.7 2.4 250.7 369.7 -63.0 300.7 -25.4 6 -3 -49 43.4 28.4 16.9
F08 37.0 33.4 0.3 3.6 17.2 91.4 29.2 18.7 6.4 12.3 172.3 311.5 5.3 20.0 39.4 64.7 10.0 0.4 10.4 75.1 234.2 0.2 2.1 236.5 311.5 -7.0 266.5 -3.0 47 -3 -78 47.2 31.0 24.0
F09 139.2 35.9 0.0 0.2 6.7 21.3 203.3 27.1 15.0 4.9 10.1 172.8 418.3 7.5 10.0 88.1 105.6 0.0 0.4 0.4 106.0 308.0 2.0 2.3 312.3 418.3 -129.2 322.3 -41.7 45 -3 -72 48.8 30.7 20.0
F10E 209.4 38.8 0.0 0.3 6.7 23.1 278.3 27.4 15.1 4.9 10.2 174.6 495.4 7.6 0.0 83.5 91.0 0.0 0.4 0.4 91.5 401.4 0.0 2.5 403.9 495.4 -209.4 403.9 -52.2 47 -3 -91 43.4 26.2 18.8
F11E 306.3 41.4 0.0 0.3 6.7 24.6 379.4 27.7 15.3 4.9 10.4 176.3 598.6 7.7 0.0 84.7 92.4 0.0 0.4 0.4 92.8 503.3 0.0 2.5 505.8 598.6 -306.3 505.8 -60.9 48 -4 -91 37.8 22.5 17.0
F12E 409.5 44.2 0.0 0.3 6.7 26.3 487.0 27.9 15.4 4.8 10.6 179.8 710.1 8.1 0.0 85.8 93.9 0.0 0.4 0.4 94.4 613.2 0.0 2.5 615.7 710.1 -409.5 615.7 -66.8 48 -4 -92 33.1 19.7 15.5
172 400
Consolidated Cash Flow Statement

billion F07 Pre-tax profit Tax paid Depreciation Changes in working capital Other Gain/loss on asset sale/valuation Cash flow from operating activities Capital expenditure Net sale/purchase of securities Other Cash flow from investing activities Change in debt Dividends paid Net buybacks Equity issued Other Cash flow from financial activities Gross change in cash and cash equivalents Cash and cash equivalents at the beginning of the year Effect of Change in Consolidated Companies Cash and cash equivalents at FY end FCF per share () FCF yield (%) FCF conversion (%)
Source: Company data, J.P. Morgan estimates. Note: Share prices as of December 29, 2010.
F08 126.4 -55.4 12.7 4.1 -4.2 4.3 87.8 -11.1 -43.6 0.8 -53.9 -20.0 -6.3 -82.0 0.2 -1.8 -109.9 -76.1 113.0 0.0 37.0 1,337.1 4.2 59.1
F09 140.7 -15.8 11.1 0.6 0.4 3.1 140.1 -6.7 -1.6 0.9 -7.4 -20.4 -7.5 -3.1 0.2 -0.5 -31.4 101.4 37.0 -0.1 138.3 2,274.3 7.1 91.7
F10E 157.5 -63.6 10.9 -3.1 -6.6 95.1 -3.6 -2.0 -5.6 -20.0 -18.7 -38.7 50.8 138.3 -1.8 187.3 1,577.0 4.9 58.1
F11E 171.8 -69.4 11.0 -2.6 -0.4 110.4 -3.6 -2.0 -5.6 -25.5 -25.5 79.3 187.3 266.6 1,840.8 5.8 62.2
F12E 185.3 -74.9 11.1 -2.5 -0.6 118.4 -3.6 -2.0 -5.6 -27.5 -27.5 85.3 266.6 352.0 1,979.5 6.2 62.0
114.0 -51.1 13.6 1.6 -1.0 4.5 81.5 -11.2 -6.6 0.9 -17.0 -20.1 -5.8 0.4 -0.6 -26.2 38.3 75.2 -0.5 113.0 1,209.4 3.8 58.6
173
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03 January 2011
Daum
The Little Engine That Could
We maintain our Overweight rating on Daum, the second-largest search portal in Korea. Our Jun-11 price target is W100,000, based on a 2011E P/E of 15.5x. On a cash-adjusted basis, our target translates to only 9.0x 2011E P/E. Daum is the second-largest search portal in Korea. It was founded in 1995 as a provider of various types of web service including free web-based e-mail, messaging service, communities and news. Currently, Daum controls the search query market in Korea with a share of 23% and the display ad market with a share of 25%.
Overweight
035720.KQ, 035720 KQ Price: W76,300 Price Target: W100,000
Korea
Internet Sungmin Chang, CFA

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

(82-2) 758 5710 gon.s.lee@jpmorgan.com J.P. Morgan Securities (Far East) Ltd, Seoul Branch
Daum provides pure exposure to internet portal, as the company focuses on search and display ads only compared to NHN, which generates one-third of revenue from internet games. While Daum is a pure portal that is accorded higher multiples than game companies, it is currently trading at some 42% discount to NHN on 2011E P/E. Furthermore, Daum has been gaining market share in both the search and display market recently and this has led to 43% yoy revenue growth compared to 15% for NHN in 3Q10. We believe the overall growth momentum for Daum will continue to be better than the industry and NHN over the next couple of years. 2011 drivers: We believe Daum will continue to gain market share in both search and display ads based on improved search quality, innovative marketing efforts, and differentiated customer profile from NHN. Maintaining 4Q10 estimates. We are maintaining our 4Q10 revenue, EBITDA, and EPS estimates of W99B, W33B, and W1,485, respectively.
James R. Sullivan, CFA

(65) 6882-2374 james.r.sullivan@jpmorgan.com J.P. Morgan Securities Singapore Private Limited
Please see our Note on Daum dated 04 January 2011 for our revised 2011/12 earnings estimates and PT. Daum: Another display ad price hike
Daum (Reuters: 035720.KQ, Bloomberg: 035720 KQ)

W in mn, year-end Dec Revenue (W bn) Net Profit (W bn) EPS (W) DPS (W) Revenue growth (%) EPS growth (%) ROCE ROE P/E (x) P/BV (x) EV/EBITDA (x) Dividend Yie ld
Source: Company data, Bloomber g, J.P. Morgan estimates.
FY10E FY11E FY12E Shares O/S (mn) 345 394 445 Market cap (W mn) 113.5 84.6 110.6 Market cap ($ mn) 8,643.70 6,442.22 8,427.12 Price (W) 0 0 0 Date Of Price 41.0% 14.4% 12.9% Free float (%) 263.0% -25.5% 30.8% 3mth Avg daily volume 33.9% 29.7% 30.6% 3M - Average daily Value (W mn) 42.3% 22.9% 24.1% Average 3m Daily Turnover ($ mn) 8.8 11.8 9.1 KOSPI 3.1 2.4 2.0 Exchange Rate -1.5 -1.7 -1.8 Fiscal Year End 0.0% 0.0% 0.0%
13 1,017,537 886 76,300 29 Dec 10 122,795.00 9,619.02 8.38 2,043 1,147.90 Dec

We forecast revenue of W394B in 2011, up 14% Y/Y, and EPS of W6,442, down 26%Y/Y. We believe revenue growth will slow down in 2011 on anticipated negative impact from NHNs departure from Overture. However, we note that our estimates are based on very conservative price decline assumptions and, as suc,h there is a good possibility that search ad revenue will turn out better than our estimates. On the display ad side, we believe there is also room for positive earnings revisions, given the material price hike in October 2010 and growing corporate interest in display ads for their brand building efforts. The EPS decline owes to a one-off gain from Lycos sales in 2010. So the number to focus on in 2011 is operating profit rather than EPS. We currently estimate operating profit will grow by 16% to W110B in 2011 based on 14% revenue growth to W394B. This implies an operating margin of 30.9% for 2011E, up from 27.5% in 2010E and net margin of 23.5% for 2011E.

We expect revenue to grow another 13% to W445B and EPS by 31% to W8,427 on ongoing growth in both the search and display businesses. We expect Daum to continue to gain market share in search, while display ads will continue to narrow the gap with NHN. We note Daum is spearheading the entry into the corporate sector through multiple innovative programs with large corporates lately and this should turn into a new and meaningful revenue source for Daum by 2012.
We Are Maintaining Our Price Target of W100,000

We are maintaining a Jun-2011 price target of W100,000. Our PT is based on a 2011E P/E of 15.5x, which is an 8% discount to our target multiple for NHN and a 0 to 6% discount to current multiples of global peers such as Google, Yahoo, and Yahoo Japan.

We believe the main discount factor for Daum is uncertainty on the Overture issue. Once this clarifies as having less impact than bears think, we believe the valuation discount on Daum will quickly disappear beginning in 1Q11.
Investment Risks
The key risk is a larger-than-expected price decline due to Overtures loss of pricing power in the search-ad market.
176 404
Daum: Summary of financials

Won in billions, year-end December Profit & loss statement FY09 Revenues 245 Search ad 125 Display ad 105 Operating cost 200 Labor 41 Commission 53 Operating profit 45 EBITDA 67 Pre-tax Profit 38 Net Income - Reported 31 Net income - Adjusted 31 EPS - Reported 2,381 EPS - Adjusted 2,381 Growth Revenues 5% Operating profit -3% Pre-tax Profit -45% EPS - Adjusted 50% Balance sheet Cash and Cash Equivalents Accounts receivable Inventories Others current assets Current assets LT investments Net fixed assets Other long term assets Total Assets ST Debt and CPLTD Account Payables Other current liabilities Total current liabilities Long term debt Other Long term liabilities Total liabilities Shareholder's equity Total Liab. & Equity BVPS (Won) FY10E 345 190 138 251 51 61 94 119 120 113 113 8,644 8,644 41% 112% 219% 263% FY11E 394 217 158 285 64 62 110 139 113 85 85 6,442 6,442 14% 16% -6% -25% FY12E 445 243 180 305 71 64 140 169 141 111 111 8,427 8,427 13% 28% 25% 31% Cash flow statement Net Income Depreciation & amortization Other non-cash items Change in working capital Cash flow from operations Purchase of PP&E Other assets disposal/ (purchase) Cash flow from investing Equity raised/(repaid) Debt raised/(repaid) Other charges Cash dividends Cash flow from Financing Net Effect of FX rate changes Net Changes in Cash Beginning cash Ending cash DPS (Won) Ratio Analysis EBIT Margin (%) EBITDA margin (%) Net profit margin (%) Operating cost/sales (%) Sales per share growth (%) Sales growth (%) EBIT growth (%) Net profit growth (%) EPS growth (%) Interest Coverage (x) Inventory Turnover (x) Net Debt (cash) to total Capital (%) Net debt (cash) to equity (%) Sales/Assets (%) Assets/Equity (%) ROE (%) ROA (%) FY09 31 23 4 -2 56 15 -17 -14 0 -16 12 0 -12 0 30 40 69 0 FY10E 113 25 -17 30 151 -14 -12 -26 0 -20 6 0 -13 0 112 69 181 0 FY11E 85 30 -13 2 101 -25 -18 -43 0 0 2 0 2 0 60 181 241 0 FY12E 111 29 -25 -15 115 -25 -15 -40 0 0 -15 0 -15 0 60 241 301 0
FY09 69 46 0 45 160 56 61 26 297 20 16 42 78 0 10 88 210 297 16,050
FY10E 181 64 0 19 264 61 62 33 419 0 24 56 80 0 13 93 327 419 24,894
FY11E 241 69 0 18 328 62 72 50 512 0 24 62 86 0 14 100 411 512 31,336
FY12E 301 79 0 24 403 62 78 65 608 0 24 62 86 0 15 101 507 608 38,605
FY09 18% 27% 13% 17% 4% 5% -3% -32% 50% 24.7 na -22% -24% 82% 142% 16% 10%
FY10E 27% 35% 33% 15% 40% 41% 112% 265% 263% 243.2 na -55% -55% 82% 128% 42% 27%
FY11E 28% 35% 21% 16% 14% 14% 16% -25% -25% n.m na -59% -59% 77% 124% 23% 17%
FY12E 32% 38% 25% 16% 13% 13% 28% 31% 31% 35.1 na -59% -59% 73% 120% 24% 18%
Source: Company, J.P. Morgan estimates.
177
405
Companies Recommended in This Report (all prices in this report as of market close on 05 January 2011) NHN (035420.KS/W222,500/Neutral)
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
Beneficial Ownership (1% or more): J.P. Morgan beneficially owns 1% or more of a class of common equity securities of DeNA (2432). Client of the Firm: NHN is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services. Rakuten (4755) is or was in the past 12 months a client of JPM. Investment Banking (past 12 months): J.P. Morgan received, in the past 12 months, compensation for investment banking services from NHN. Investment Banking (next 3 months): J.P. Morgan expects to receive, or intends to seek, compensation for investment banking services in the next three months from NHN.
Important Disclosures for 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 J.P. 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: J.P. Morgan 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.] J.P. Morgan Cazenoves UK Small/Mid-Cap dedicated research analysts use the same rating categories; however, each stocks expected total return is compared to the expected total return of the FTSE All Share Index, not to those analysts coverage universe. A list of these analysts is available on request. 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: Dick Wei: AirMedia (AMCN), Alibaba.com Limited (1688.HK), Ambow Education (AMBO), Baidu.com (BIDU), China Finance Online (JRJC), Focus Media (FMCN), Netease (NTES), Shanda Games (GAME), Shanda Interactive Entertainment Ltd (SNDA), Sina Corp (SINA), Sohu.Com (SOHU), Tencent (0700.HK), The9 Limited (NCTY), VanceInfo Technologies Inc. (VIT), VisionChina (VISN) Hiroshi Kamide: DeNA (2432) (2432.T), Gree (3632) (3632.T), Mixi (2121) (2121.T), Nintendo (7974) (7974.OS), Rakuten (4755) (4755.OS), Yahoo Japan (4689) (4689.T) Sungmin Chang, CFA: Daum (035720.KQ), KT Corp. (030200.KS), LG Uplus Corp (032640.KS), NHN (035420.KS), Neowiz Games Corp. (095660.KS), SK Telecom (017670.KS)
178 4
J.P. Morgan Equity Research Ratings Distribution, as of December 31, 2010 Overweight (buy) 46% 53% 43% 71% Neutral (hold) 42% 50% 49% 63% Underweight (sell) 12% 38% 8% 59%
J.P. Morgan Global Equity Research Coverage IB clients* JPMS Equity Research Coverage IB clients*
*Percentage of investment banking clients in each rating category. For purposes only of FINRA/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.
Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks on any securities recommended herein. Research is available at http://www.morganmarkets.com , or you can contact the analyst named on the front of this note or your J.P. Morgan representative. Analysts Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking. Registration of non-US Analysts: Unless otherwise noted, the non-US analysts listed on the front of this report are employees of non-US affiliates of JPMS, are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of JPMS, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account.
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Asia Pacific Equity Research

Nothing But Net - Asia

China Internet Dick Wei

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

Japan Internet Hiroshi Kamide

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

Korea Internet Sungmin Chang, CFA

US Internet Imran Khan

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

Asia Pacific Equity Research 06 January 2011

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

Asia Pacific Equity Research 06 January 2011

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

Asia Pacific Equity Research 06 January 2011

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

Global Equity Research 03 January 2011

China Top Predictions for 2011

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

Global Equity Research 03 January 2011

China Internet Market Overview

Source: CNNIC J.P. Morgan estimates.

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

Penetration Rate (Urban Population)

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

Global Equity Research 03 January 2011

Mobile phone users (Mn)

Intenet users (Mn)

Mobile users shifted 4.5 years

Broadband Internet Users as % of Total Internet Users

Broadband Users (Mn)

Broadband users as % of total Internet users

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

Global Equity Research 03 January 2011

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

Global Equity Research 03 January 2011

25 20 15 10 5 0 9.8 13.0 13.4 12.3 13.2 14.0 15.9 16.5 16.9

18.7 19.8 16.6 18.0

Av erage Accessing Time Per Week

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Global Equity Research 03 January 2011

Chat Is the Most Used Application on Mobile

Online music listening or downloading

Mobile Online mobile Mobile Video Mobile email community game

Source: CNNIC (Jun-10).

Time Spent Online (In Hr/Week)

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Global Equity Research 03 January 2011

China Online Advertising Market Forecast from 2006 to 2012E

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Global Equity Research 03 January 2011

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

Global Equity Research 03 January 2011

China - Number of households w ith assets abov e US$1 million

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Global Equity Research 03 January 2011

CCTV Auction Results vs. Online Brand Ad Growth

Source: CCTV, Zenith Optimedia. Note: J. P. Morgan current estimates.

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Global Equity Research 03 January 2011

2006 3,377 426 45% 3.2%

2007 4,559 605 35% 3.9%

2008 6,428 932 41% 4.6%