North America Equity Research02 January 2008Nothing But Net2008 Internet Investment Guide2007 saw Internet companies outpe...
Imran Khan                  North America Equity Research(1-212) 622-6693            02 January 2008imran.t.khan@jpmorgan....
Imran Khan                                                    North America Equity Research(1-212) 622-6693               ...
Imran Khan                                                    North America Equity Research(1-212) 622-6693               ...
Imran Khan                  North America Equity Research(1-212) 622-6693            02 January 2008imran.t.khan@jpmorgan....
Imran Khan                  North America Equity Research(1-212) 622-6693            02 January 2008imran.t.khan@jpmorgan....
Imran Khan                                            North America Equity Research(1-212) 622-6693                       ...
Imran Khan                         North America Equity Research(1-212) 622-6693                   02 January 2008imran.t....
Imran Khan                  North America Equity Research(1-212) 622-6693            02 January 2008imran.t.khan@jpmorgan....
Imran Khan                  North America Equity Research(1-212) 622-6693            02 January 2008imran.t.khan@jpmorgan....
Imran Khan                                              North America Equity Research(1-212) 622-6693                     ...
Imran Khan                  North America Equity Research(1-212) 622-6693            02 January 2008imran.t.khan@jpmorgan....
Imran Khan                  North America Equity Research(1-212) 622-6693            02 January 2008imran.t.khan@jpmorgan....
Imran Khan                  North America Equity Research(1-212) 622-6693            02 January 2008imran.t.khan@jpmorgan....
U.S. Sector Outlooks
Imran Khan                        North America Equity Research(1-212) 622-6693                  02 January 2008imran.t.kh...
Imran Khan                                              North America Equity Research(1-212) 622-6693                     ...
Imran Khan                          North America Equity Research(1-212) 622-6693                    02 January 2008imran....
Imran Khan                          North America Equity Research(1-212) 622-6693                    02 January 2008imran....
Imran Khan                  North America Equity Research(1-212) 622-6693            02 January 2008imran.t.khan@jpmorgan....
Imran Khan                  North America Equity Research(1-212) 622-6693            02 January 2008imran.t.khan@jpmorgan....
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  1. 1. North America Equity Research02 January 2008Nothing But Net2008 Internet Investment Guide2007 saw Internet companies outperform the broader stock market, Internetas the HHH rose ~14%, vs. a ~5% rise in the S&P 500. We believe Imran Khan ACsome of the factors that drove F’07 outperformance will persist into (1-212) 622-6693F’08, and thus expect the sector to outperform the broader market. imran.t.khan@jpmorgan.com Bridget Weishaar• Expect 34% EPS Growth, vs. 8% for the S&P 500. We expect (1-212) 622-5032 revenue growth to decelerate to 21.2% in F’08, from 25.6% in bridget.a.weishaar@jpmchase.com F’07. We are projecting 34% earnings growth for our coverage Lev Polinsky, CFA universe, compared to 8% for the S&P 500. (1-212) 622-8343 lev.x.polinsky@jpmchase.com• Expect Blended CPM Pricing Growth Rate to Accelerate. We Joseph Boushelle, CFA think blended CPM pricing bottomed out in F’07. We expect (1-212) 622-8523 tighter offline inventory and better monetization techniques will joseph.d.boushelle@jpmchase.com lead to a re-acceleration of growth in F’08. China Internet• We Project Global Search Revenue to Hit $60B by 2011. We Dick WeiAC are raising our F’08 global search revenue estimate to $30.5B, (852) 2800 8535 from $26.2B, driven by strong volume trends, better-than-expected dick.wei@jpmorgan.com monetization, and continued robust growth in Continental Europe. We expect the global search market to reach $60B by 2011, growing at a 28% CAGR over the next four years.• Global Consumer Growth Should Benefit Internet Companies. Please see our notes changing World GDP growth has outpaced US growth in recent years, and a ratings for Priceline, and our note projected 3-year CAGR of 6.5% for emerging economies means changing estimates for the hundreds of millions of new consumers. We think large Internet remainder of our coverage companies’ global reach means they’ll benefit from this rising tide. released simultaneously.• M&A Market Likely to Remain Healthy. The five biggest companies in our universe generated $8.8B in FCF in F’07, a number we project will grow to $12.5B in F’08. While some of All data and valuation in this that cash should continue to fund share repurchases, we think a report priced as of 26 Dec 2007. significant portion of the incremental cash flow is likely to lead to continued M&A in the sector.• Top Picks. The above trends translate into our top Overweight ideas going into the new year: GOOG, YHOO, EXPE, OMTR, SFLY and MNST.www.morganmarkets.com J.P. Morgan Securities Inc.See page 309 for analyst certification and important disclosures, including investment banking relationships.JPMorgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firmmay have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor inmaking their investment decision. Customers of JPMorgan in the United States can receive independent, third-party research on the companyor companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research atwww.morganmarkets.com or can call 1-800-477-0406 toll free to request a copy of this research.
  2. 2. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com Table of Contents Key Investment Themes ..........................................................5 Dot.Khan’s Top Ten for 2008 .................................................13 U.S. Sector Outlooks..............................................................15 China Outlook .........................................................................99 Amazon.com, Neutral ($92.85) ............................................121 Blue Nile, Neutral ($74.16) ...................................................129 CNET Networks, Neutral ($8.90) ..........................................136 eBay, Overweight ($34.49) ...................................................144 Expedia, Overweight ($32.56)..............................................154 Google, Overweight ($710.84) .............................................161 HouseValues, Underweight ($2.94) .....................................169 InfoSpace, Neutral ($18.96)..................................................177 InnerWorkings, Neutral ($18.40)..........................................183 Liberty Interactive, Neutral ($19.79) ....................................190 Mercadolibre, Overweight ($72.85) .....................................199 Monster Worldwide, Overweight ($33.91)...........................208 Move, Inc., Neutral ($2.70) ...................................................215 Omniture, Overweight ($34.95)............................................222 Priceline, Overweight ($118.23)...........................................229 Shutterfly, Overweight ($27.38) ...........................................239 ValueClick, Overweight ($23.39)..........................................247 Yahoo!, Overweight ($23.96) ...............................................255 Baidu, Overweight ($399.67)................................................267 China Finance Online, Overweight ($23.75) .......................272 NetEase, Neutral ($19.33).....................................................276 Ninetowns, Underweight ($3.45) .........................................281 Shanda, Overweight ($34.39)...............................................285 Sina, Neutral ($45.50) ...........................................................290 Sohu, Overweight ($56.58)...................................................294 The9, Overweight ($23.50) ...................................................299 The authors acknowledge the contribution of Deval Delivala and Rachna Srivastava of J.P. Morgan Services India Private Ltd., Mumbai, and John Ventimiglia of J.P. Morgan Securities Inc. to this report.2
  3. 3. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.comFigure 1: JPMorgan Internet Technology Universe$ in millions, except per share data JP Morgan Internet Technology Universe Ticker Rating Price Mkt Cap Ent .Val. EPS Cal PE LT EPS PEG EBITDA ($M) Ent. Val/EBITDA Rev ($M) 12/26 12/26 12/26 2007E 2008E 2009E 2007E 2008E 2009E Grth (%) 2007E 2008E 2009E 2007E 2008E 2009E 2007E 2008E 2009E 2007E 2008E 2009E Search/Advertising CNET CNET N 8.90 1,350 1,364 NM 0.14 0.22 NM NM 40.4 15 NM NM 2.7 82 100 118 16.7 13.7 11.6 411 451 494 Google GOOG OW 710.84 225,035 211,948 15.42 20.92 26.33 46.1 34.0 27.0 35 1.3 1.0 0.8 6,958 9,917 12,647 30.5 21.4 16.8 11,719 16,957 22,332 Infospace INSP N 18.96 629 54 (1.49) (0.88) 0.11 NM NM 167.0 5 NM NM 33.4 (9) 17 18 (5.8) 3.2 3.0 240 139 141 ValueClick VCLK OW 23.39 2,343 2,092 0.71 0.84 1.01 33.0 27.7 23.1 20 1.6 1.4 1.2 164 190 220 12.8 11.0 9.5 639 735 859 Yahoo* YHOO OW 23.96 33,426 25,615 0.43 0.49 0.58 55.9 49.4 41.0 25 2.2 2.0 1.6 1,906 2,248 2,533 13.4 11.4 10.1 5,095 5,895 6,433 Group Average 45.0 37.0 59.7 1.7 1.4 7.9 18.3 12.1 10.2 Leading e-Commerce brands Amazon AMZN N 92.85 39,461 39,294 1.10 1.51 1.87 84.5 61.6 49.7 20 4.2 3.1 2.5 1,093 1,474 2,178 35.9 26.7 18.0 14,488 17,938 21,269 Blue Nile NILE N 74.16 1,254 1,180 1.03 1.23 1.50 71.9 60.4 49.5 20 3.6 3.0 2.5 30 36 44 38.8 32.6 26.9 322 388 454 Dice DHX R 8.14 505 587 eBay EBAY OW 34.49 46,727 42,283 1.48 1.70 1.98 23.3 20.3 17.4 25 0.9 0.8 0.7 2,863 3,337 3,754 14.8 12.7 11.3 7,685 9,007 10,506 Expedia EXPE OW 32.56 10,183 10,326 1.23 1.39 1.58 26.5 23.4 20.6 10 2.6 2.3 2.1 725 808 887 14.3 12.8 11.6 2,643 3,006 3,318 InnerWorkings INWK N 18.34 921 852 0.32 0.52 0.73 57.3 35.1 25.1 20 2.9 1.8 1.3 27 46 65 31.8 18.6 13.1 288 472 641 InterActive Corp IACI N 27.56 8,410 7,421 1.55 1.81 NA 17.8 15.2 NA 10 1.8 1.5 NA 867 958 NA 8.6 7.7 NA 6,352 6,897 NA Liberty Interactive LINTA N 19.79 12,428 16,810 0.73 0.80 0.89 27.1 24.8 22.2 10 2.7 2.5 2.2 1,707 1,766 1,871 9.8 9.5 9.0 7,721 8,094 8,583 Mercadolibre MELI OW 72.85 3,227 3,164 0.21 0.58 0.86 354.1 126.2 84.6 30 11.8 4.2 2.8 24 43 68 132.2 73.7 46.3 84 134 195 Monster.com MNST OW 33.91 4,434 3,807 1.42 1.90 2.27 23.9 17.8 14.9 20 1.2 0.9 0.7 301 441 514 12.7 8.6 7.4 1,350 1,519 1,727 Orbitz Worldwide OWW R 9.43 784 1,320 Priceline.com PCLN OW 118.23 5,430 4,930 3.96 4.87 6.08 29.8 24.3 19.4 15 2.0 1.6 1.3 161 296 408 30.5 16.6 12.1 1,402 1,710 2,026 Shutterfly SFLY OW 27.38 671 576 0.38 0.53 0.75 71.6 51.3 36.3 20 3.6 2.6 1.8 32 45 61 18.1 12.9 9.4 183 251 328 Group Average 63.6 38.1 30.7 3.1 2.1 1.7 28.2 19.1 14.8 Online Services Move.com MOVE N 2.70 419 233 (0.05) 0.03 0.05 NM 88.6 56.1 25 NM 3.5 2.2 29 42 49 8.1 5.6 4.8 294 320 349 HouseValues SOLD UW 2.94 72 7 (0.09) 0.02 0.07 NM 191.8 40.3 10 NM NM NM 3 7 8 2.2 1.0 0.9 60 49 54 Group Average NM 140.2 48.2 NM 3.5 2.2 5.1 3.3 2.8 Enabling Platforms Akamai^ AKAM NR 36.80 6,590 5,859 1.29 1.66 2.01 28.6 22.2 18.3 25 1.1 0.9 0.7 275 368 469 21.3 15.9 12.5 628 805 994 Omniture OMTR OW 34.95 2,248 2,270 0.20 0.39 0.70 NA NM 49.8 35 NA NM 1.4 22 37 71 101.1 60.8 32.0 141 213 309 Salesforce.com^ CRM NR 63.87 7,682 7,176 0.13 0.32 0.65 NA 199.4 98.9 40 NM 5.0 2.5 38 77 NA 189.4 92.7 NA 741 1,030 1,372 Visual Sciences VSCN NR 19.31 369 394 0.59 0.75 0.74 32.9 25.6 26.1 20 1.6 1.3 1.3 15 21 NA 26.2 19.1 NA 82 90 NA Websense^ WBSN NR 17.16 777 496 0.90 1.13 1.35 19.1 15.1 12.8 15 1.3 1.0 0.9 53 47 85 9.4 10.5 NA 226 309 338 Group Average 26.9 65.6 41.2 1.4 2.0 1.4 69.5 39.8 22.2 Average 59.0 55.7 42.8 2.7 2.1 3.2 33.6 21.7 14.0Source: Company reports and JPMorgan estimates for JPMorgan rated companies. First Call consensus for non-covered companies. Note: Yahoo! EV assumes Yahoo! Japan is worth $26.9B. EBITDA – Operating Income + D&A +/- extraordinary chargesData in this table and this report is priced as of December 26, 2007 closeJPMorgan is currently subject to a research blackout period for Dice Holdings, Inc and Orbitz Worldwide, Inc. Company write-ups are omitted here in compliance with NYSE and NASD provisions relating to lock-up agreements. 3
  4. 4. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.comTable 1: JPMorgan Estimates vs. Consensus Estimates$ in millions, except per share data EPS RevenueCompany Ticker FC 08 JPM 08 FC 09 JPM 09 FC 08 JPM 08 FC 09 JPM 09Amazon.Com Inc AMZN 1.62 1.51 2.41 1.87 18,256 17,938 22,373 21,269CNET Networks Inc CNET 0.14 0.14 0.20 0.22 450 451 487 494eBay Inc EBAY 1.66 1.70 1.94 1.98 9,031 9,007 10,603 10,506Expedia Inc EXPE 1.46 1.39 1.74 1.58 3,008 3,006 3,371 3,318Google Inc GOOG 20.65 20.92 25.89 26.33 16,547 16,957 21,306 22,332IAC/Interactivecorp IACI 1.81 1.81 2.06 6,862 6,897 7,206Infospace Inc INSP -0.29 -0.88 -0.42 0.11 137 139 144 141Innerworkings Inc INWK 0.52 0.52 0.72 0.73 468 472 625 641Liberty Media Interactive LINTA 0.79 0.80 1.02 0.89 8,156 8,094 8,727 8,583Mercadolibre Inc MELI 0.53 0.58 0.83 0.86 131 134 186 195Monster Worldwide Inc MNST 1.83 1.90 2.22 2.27 1,561 1,519 1,815 1,727Move Inc MOVE 0.04 0.03 0.17 0.05 318 320 374 349Blue Nile Inc NILE 1.32 1.23 1.67 1.50 394 388 470 454Omniture Inc OMTR 0.41 0.39 0.69 0.70 220 213 327 309Priceline.Com Inc PCLN 4.78 4.87 5.79 6.08 1,690 1,710 1,870 2,026Shutterfly Inc SFLY 0.57 0.53 0.90 0.75 252 251 326 328HouseValues Inc SOLD -0.07 0.02 N/A 0.07 46 49 #N/A 54Valueclick Inc VCLK 0.82 0.84 1.06 1.01 741 735 869 859Yahoo Inc YHOO 0.55 0.49 0.72 0.58 5,954 5,895 6,833 6,433Source: Company filings, First Call, and JPMorgan estimates4
  5. 5. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com Key Investment Themes We Expect CPMs to Rise in 2008 While we think CPM growth was relatively muted in 2007, we expect 2008 will see it accelerate, driven by several factors, including easier comps, better inventory sell- through, behavioral and geographic targeting, and ad exchanges. Tighter Offline Inventory Broadcast network total day ratings were ~8% lower in 2007, and we expect inventory is likely to continue shrinking further in 2008. Additionally, the reduced supply will face higher demand, as we believe as much as 6% of spot TV ads in 2008 may be taken up by political ads. We expect the inventory tightness will have a spillover effect online, as advertisers continue to shift a greater percentage of their spend away from traditional media. The Rise of Ad Networks More than 80% of online inventory currently sells for less than a $1 CPM. As such, we think ad networks present a significant opportunity for publishers to increase yield, and, given the low base, the CPM enhancement from using ad networks will not have to be very large, in absolute terms, to move the needle. Inventory Aggregation Many companies are aggregating traffic through partnerships and acquisitions. We think aggregation is likely to lead to a certain degree of pricing power for the aggregators. More importantly, we expect advertisers to be more willing to buy from aggregators that offer them sufficient scale. Easier Comps 2007 saw pressure on graphical ad CPMs, driven primarily by increases in non- premium inventory, from sites such as MySpace and Facebook. We think the 2007 softness in the market is likely to set a lower base for 2008. Free Cash Flow Likely to Drive M&A Activity Large Internet companies are generating a significant amount of cash flow: looking at the five largest Internet-only companies in our coverage universe, we estimate they generated nearly $8.8B in FCF in F’07, and are poised to produce $12.5B FCF in F’08. Table 2: Free Cash Flow Generation at 5 Large Internet Companies $ in millions 2007 2008 GOOG $ 3,490 $ 5,675 YHOO $ 1,307 $ 1,643 AMZN $ 1,351 $ 1,705 EBAY $ 2,067 $ 2,612 EXPE $ 566 $ 860 Top 5 Total $ 8,781 $ 12,494 Source: Company reports, JPMorgan estimates 5
  6. 6. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com While we believe some of these companies will use part of their income stream on share repurchases, we expect that a significant part will continue to spur increased M&A activity in the sector. Table 3: Uses of Free Cash Flow at 5 Large Internet Companies, TTM $ in million, 4Q’06 – 3Q’07 TTM FCF ($M) Cash Acquisitions/FCF Buyback/FCF GOOG 2,902 33.4% 0.0% YHOO 1,300 33.6% 104.9% AMZN 801 6.1% 31.0% EBAY 2,052 15.5% 105.8% EXPE 777 8.0% 179.8% Top 5 Total 7,831 23.4% 66.1% Source: Company reports, JPMorgan Estimates Note: Table does not include acquisitions made with stock, such as Google’s YouTube acquisition In particular, we believe large companies will continue to seek out investments in social media, where sites often grow virally and the large-caps appear satisfied, for the most part, to let the public pick the winners out of a crowded field before making acquisitions. In the ad network and ad exchange space, we expect the need for scale to lead to continued consolidation and M&A activity, although perhaps not at the scale we have witnessed in F’07, most sizably with the DoubleClick and aQuantive transactions. We expect continued M&A to be motivated by one or more of these key factors: • Traffic. Developing high-traffic sites is difficult, and larger companies are often willing to pay for sites that have proven an ability to generate traffic. • Technology. Companies that develop a technology that is difficult or uneconomical to replicate are often targets for acquisitions; such companies may also generate traffic, but the technology is a motivator for the buyer. • Transactional. Companies with a proven track record of revenue and sales generation make attractive targets, as well; a recent example of a transactional- focused acquisition is the 2007 purchase of Mezimedia by ValueClick. Additionally, we continue to believe that there are synergies to be captured by a strategic partnership among large-cap Internet companies, due to (1) increased scale, (2) strengthened global footprint, (3) broadened user insights and (4) improved operational efficiencies. We believe continuing share gains and product introductions by Google may compel other large-cap Internet companies to explore strategic alliances.6
  7. 7. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.comTable 4: Selected M&A Activity in the Internet Space, 2007 (Please see Appendix of this section for full list) Ticker Date Target Acquirer Seller Annc’d Tot Payment StatusAMZN 5/14/2007 www.Dpreview.Com Amazon.com Inc NA Undisclosed CompleteAMZN 5/23/2007 Brilliance Audio Inc Amazon.com Inc NA Cash CompleteCNET 10/25/2007 Webshots American Greetings Corp Cnet Networks Inc 45 Cash CompleteCNET 11/5/2007 Findarticles.Com CNET Neworks Looksmart 20.5 Cash PendingEBAY 1/10/2007 Stubhub eBay 310 Cash CompleteEBAY 2/27/2007 Beijing Union Mobile Pay Ltd eBay 105 Cash PendingEBAY 5/3/2007 Gittigidiyor.Com eBay NA Cash CompleteEBAY 5/30/2007 Stumbleupon Inc eBay 75 Cash CompleteEBAY 10/4/2007 Via-Online Gmbh eBay NA Cash CompleteEBAY 12/20/2007 Tom Online Inc eBay NA Undisclosed PendingEXPE 2/28/2007 Smarter Travel Media Llc Expedia Inc NA Undisclosed CompleteEXPE 5/23/2007 Independent Traveler Inc Expedia Inc NA Undisclosed CompleteGOOG 10/31/2006 Jotspot Inc Google NA Undisclosed CompleteGOOG 1/4/2007 Shenzen Xunlei Netwk Tech Google NA Undisclosed CompleteGOOG 3/16/2007 Adscape Media Inc Google NA Undisclosed CompleteGOOG 4/13/2007 Doubleclick Google Multiple Sellers 3100 Cash PendingGOOG 4/17/2007 Tonic Systems Google NA Undisclosed CompleteGOOG 4/20/2007 Video Conf. Software Google Marratech Ab NA Cash CompleteGOOG 5/29/2007 Greenborder Tech Ltd Google NA Undisclosed CompleteGOOG 5/31/2007 Panoramio.Com Google 7 Cash PendingGOOG 6/1/2007 Feedburner Inc Google NA Undisclosed CompleteGOOG 6/6/2007 Peakstream Inc Google NA Undisclosed CompleteGOOG 6/20/2007 Zenter Google NA Undisclosed CompleteGOOG 7/2/2007 Grandcentral Communicat. Google NA Undisclosed CompleteGOOG 7/9/2007 Postini Google 625 Cash PendingGOOG 7/19/2007 Beijing Feixiangren Informat Google NA Undisclosed CompleteGOOG 9/28/2007 Zingku Google NA Undisclosed CompleteGOOG 10/9/2007 Jaiku Ltd Google NA Undisclosed CompleteGOOG 12/18/2007 Endoxon Google NA Undisclosed CompleteIACI 12/20/2006 Ilike.Com IAC/ Interactive corp NA CompleteIACI 2/27/2007 Edodo.Com IAC/ Interactive corp NA CompleteIACI 2/27/2007 Netclub IAC/ Interactive corp NA CompleteIACI 3/1/2007 Insider Pages IAC/ Interactive corp NA PendingIACI 3/19/2007 Echomusic IAC/ Interactive corp NA CompleteIACI 4/19/2007 Rqi Holdings Ltd IAC/ Interactive corp Gaylord Entertainment Co 109.12 CompleteIACI 5/17/2007 Front Line Mgmt IAC/ Interactive corp NA CompleteIACI 5/24/2007 Emma Enterntainment Hold IAC/ Interactive corp NA CompleteIACI 7/2/2007 Paciolon IAC/ Interactive corp NA PendingINSP 9/17/2007 Switchboard.Com Idearc Inc Infospace Inc 225 Cash PendingLINTA 5/11/2007 Backcountry.Com Liberty Media Interactive NA Cash PendingMELI 10/1/2001 Ibazar Com Br Ltd MercadoLibre Inc Ebay Inc NA Stock CompleteMELI 11/13/2005 Deremate.Com MercadoLibre Inc NA Undisclosed CompleteMNST 1/17/2007 Arbeidskamerater As Monster Worldwide NA Undisclosed CompleteMSFT 5/18/2007 Aquantive Microsoft 5460.65 Cash CompleteMSFT 8/30/2007 Screentonic Microsoft NA Undisclosed CompleteMSFT 10/3/2007 Jellyfish.Com Microsoft NA Undisclosed CompleteMSFT 10/7/2007 Newsvine Inc MULTIPLE ACQUIRERS NA Undisclosed CompleteMSFT 10/24/2007 Facebook Inc Microsoft 240 Cash PendingOMTR 1/18/2007 Instadia Omniture Inc 14.41 Cash CompleteOMTR 2/14/2007 Touch Clarity Omniture Inc 48.5 Cash PendingOMTR 9/7/2007 Offermatica Omniture Inc 65 Cash & Stock PendingOMTR 10/25/2007 Visual Sciences Inc Omniture Inc 390.27 Cash & Stock PendingPCLN 11/8/2007 Agoda Co Priceline.com Inc NA Cash CompleteSFLY 6/27/2007 Make It About Me! Shutterfly NA Undisclosed CompleteTFSM 5/17/2007 24/7 Real Media Inc WPP Group PLC 580.67 Cash CompleteVCLK 12/4/2006 Shopping.Net ValueClick Inc 26.28 Cash CompleteVCLK 7/16/2007 Mezimedia Inc ValueClick Inc 100 Cash PendingYHOO 1/9/2007 Mybloglog Yahoo! Inc CompleteYHOO 4/30/2007 Right Media Inc Yahoo! Inc 340 Cash & Stock CompleteYHOO 6/21/2007 Rivals.Com Yahoo! Inc NA Undisclosed PendingYHOO 9/4/2007 Bluelithium Inc Yahoo! Inc 300 Cash CompleteYHOO 9/14/2007 Buzztracker.Com Yahoo! Inc Participate Media NA Cash CompleteYHOO 9/17/2007 Zimra Inc Yahoo! Inc 350 Undisclosed PendingSource: Bloomberg, company reports, news reports 7
  8. 8. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com Worldwide Growth and Economic Prosperity Creating an Ever-Larger Consumer Base JPMorgan estimates that GDP growth has been stronger outside the US than domestically in all but one year since 2000. At the same time, worldwide Internet penetration has been growing rapidly, as well. As such, we believe that, for larger Internet companies, the importance of the US, while remaining high, will continue to fade in relative terms in coming years. Table 5: JPMorgan’s Global GDP growth projections 2001 2002 2003 2004 2005 2006 2007E 2008E 2009E World 1.6% 1.9% 2.5% 3.8% 3.2% 3.6% 3.4% 3.0% 3.4% Developed mkts 1.2% 1.3% 1.8% 2.9% 2.4% 2.8% 2.4% 2.1% 2.7% G-7 1.0% 1.2% 1.8% 2.8% 2.3% 2.7% 2.2% 2.1% 2.7% Emerging Econ. 3.0% 4.1% 5.0% 7.0% 6.3% 6.9% 6.9% 6.3% 6.2% Latin America 0.5% 0.1% 1.8% 6.2% 4.3% 5.3% 5.1% 4.5% 4.4% Emerging Asia 5.1% 6.6% 7.2% 7.9% 7.8% 8.4% 8.5% 7.7% 7.6% ex China 2.7% 4.8% 5.1% 6.3% 6.0% 6.5% 6.3% 5.8% 5.9% China 8.3% 9.1% 10.0% 10.1% 10.4% 11.1% 11.4% 10.5% 10.0% Emerging Eur. 1.6% 4.5% 5.7% 6.8% 5.8% 6.4% 6.3% 5.8% 5.7% ex Russia -0.6% 4.4% 4.7% 6.6% 5.5% 6.2% 5.5% 5.1% 5.2% Russia 5.1% 4.7% 7.3% 7.2% 6.4% 6.7% 7.5% 6.8% 6.3% Developed Eur. 1.9% 1.1% 1.1% 2.2% 1.8% 3.0% 2.8% 1.9% 2.4% World ex-US 1.9% 2.0% 2.5% 3.8% 3.2% 4.0% 3.9% 3.2% 3.5% United States 0.7% 1.6% 2.5% 3.6% 3.1% 2.9% 2.2% 2.5% 3.1% Source: JPMorgan Economic and Policy Research We believe the continued global GDP growth is creating an ever-expanding consumer class. Twinned with the trend of rising Internet penetration, we believe an ever-growing market opportunity exists outside the US for Internet companies, especially those with the scale to invest meaningfully in their international operations.Internet companies are more Table 6: Revenue Mix Is Shifting Away from US at Large Ad-driven, eCommerce and Travel Sitesinternationally diversified: we % of revenue derived from USestimate that ~64% of therevenue of S&P 500 companies 2006 2007E 2008E 2009Eis derived from US/North Amazon (see note) 54.8% 55.0% 54.7% 54.0%American sales, compared to eBay 52.1% 49.3% 47.5% 47.0% Expedia (see note) 74.2% 70.0% 67.1% 64.6%less than 60% for large Internet Google 57.0% 52.4% 50.6% 49.4%firms. Priceline 59.4% 44.9% 35.8% 29.8% Yahoo! 75.0% 74.9% 73.5% 68.9% Total (revenue wtd) 59.0% 55.8% 54.0% 52.4% Source: Company reports, JPMorgan estimates Note: For Amazon and Expedia, the percentage given is North America revenue share, rather than US. In this respect, we believe Internet companies are somewhat ahead of the broader market: based on FactSet data we estimate that ~64% of the revenue of S&P 500 companies is derived from US/North American sales. We see no reason for the shift away from the US to abate in the near future, and as such we believe that the large-cap companies in our coverage universe are likely to retain at least a somewhat firm footing even if the US economy and US consumer experience a slowdown. At the same time, given the significant exposure of these companies to the US, we believe it would be a mistake to think of them as “recession-proof”.8
  9. 9. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com Rising Broadband Penetration Remains Growth Catalyst We believe faster Internet connections are necessary for a variety of online functions – obvious ones such as media and gaming, but even eCommerce – to achieve mainstream use. As such, we think rising broadband penetration across the world remains a key catalyst for the growth of the companies in our coverage universe. We note that, in the US, eCommerce spend as tracked by the Department of Commerce has increased at a similar pace as Broadband penetration. We believe this is not coincidental: speed is a key component of user experience, and a positive user experience is likely to drive greater use of eCommerce sites. Figure 2: US eCommerce has grown hand-in-hand with Broadband penetration $ in millions; eCommerce quarterly average spend 30% 30000 25% 20% 20000 15% 10% 10000 5% 0 0% 1H02 2H02 1H03 2H03 1H04 2H04 1H05 2H05 1H06 2H06 1H07 eCommerce, $M Broadband Penetration, % Source: Department of Commerce, OECD, JPMorgan estimates OECD data suggests many countries in Continental Europe remain 1-2 years behind the US and UK in terms of broadband penetration. As such, we think higher broadband usage is likely to be a growth catalyst in those countries as well as in the US in coming years. While eCommerce has grown in parallel with Broadband penetration, online ad spend, as measured by the IAB, has grown at a more rapid pace in recent years than Broadband adoption: Figure 3: US Online ad spend rising faster than Broadband penetration $ in millions; IAB quarterly average ad spend 30% 5000 25% 20% 15% 2500 10% 5% 0 0% 1H02 2H02 1H03 2H03 1H04 2H04 1H05 2H05 1H06 2H06 1H07 Ad spend, $M Broadband Penetration, % Source: OECD, IAB, JPMorgan estimates 9
  10. 10. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com We believe the faster rate of growth can be attributed in part to network effects: as more users have access to a faster, more complete Internet experience, a greater number of advertisers find it economical to direct part of their spend online. An additional factor is the ability of richer media ads – which take advantage of higher bandwidth – to command higher CPMs. Newspaper Ad Spend Declining Advertising spend at US newspapers is continuing to decline: 2007 saw an acceleration of newspaper ad spend declines, and we think this trend is likely to continue as time spent on newspapers declines in favor of time spent online. We expect a continuation of the shift away from newspapers to be a tailwind for Internet advertising in the coming year. Figure 4: Newspaper Ad Spend Continues to Decline $ in billions 3.9% 4.0% 1.9% 1.5% 2.0% 55.0 0.0% -1.7% -2.0% 45.0 -8.6% -4.0% 47.4 -6.0% 44.9 46.7 46.6 42.6 -8.0% 35.0 -10.0% 2003 2004 2005 2006 2007 Source: NAA.org, JPMorgan estimates Involvement of Regulatory Authorities Likely to Grow As the industry grows and becomes entwined in more and more aspects of people’s lives, we think regulators are going to take more and more notice of Internet companies. Going forward, regulatory risk will likely grow, although we believe it will remain relatively small, compared to other industries. M&A in question 2007 saw several large mergers take place within the Internet space, most notably Google’s purchase of DoubleClick and Microsoft’s acquisition of aQuantive. While the latter was able to achieve regulatory clearance, European authorities are still (as of mid-December) examining whether the Google – DoubleClick merger will create a player in the online ad industry that is too dominant. We think such regulatory flare-ups are likely to reoccur. Further, as online advertising continues to take share away from traditional avenues, we expect the incumbent players to pursue a variety of approaches, including lobbying for regulatory/legislative intervention, to attempt to defend their position. Privacy concerns abound As search companies become larger and ad networks begin to capture more and more data about users, privacy concerns have become more common.10
  11. 11. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com In response, several companies have made voluntary steps to lower the quantity of personalized data collection they do. For example, Google has said it will anonymize searcher data after 18 months, while Ask has given users the option of erasing their search history immediately. Social networking sites, which often collect more personal information than do search engines, have also faced attention in regards to their data practices. As we note in the Social Networks Primer, below, we think history indicates that users are willing to sacrifice incremental erosions of their privacy in exchange for features they find useful, especially if sites do not over-reach. Thus far, the desire of users to express themselves has been stronger than the desire to hide, and we think that is likely to continue. Internet Taxation: Likely Not on the Horizon in US Two key Internet tax issues exist in the US: an Internet access tax and a sales tax. A bill renewing the ban on an Internet access tax for seven years passed the US Congress in October 2007. As regards sales taxes on online retail sales, JPMorgan’s Senior Vice President for Government Relations, Tom Block, believes that a recently proposed bill, intended to allow states to implement an Internet sales tax under certain conditions, does not have a significant chance of passing in the foreseeable future. While offline retailers and state governors have lobbied for rules such as this, voting for this bill could be construed as a tax increase, and Tom Block thinks that makes passage of the bill a non-starter, especially in an election year. Internet IPO Market Remains Healthy 2007 saw solid IPO activity in the Internet and online space, with deals in the double digits (please see chart below). We believe the trend is likely to continue in F’08, as an ever-evolving marketplace gives rise to new opportunities.Table 7: Selected Internet IPOs, F’07$ in millions except per-share amountsPricing Date Issuer Name Symbol Amt ($mm) Mkt cap ($mm) % mcap Offering Price Price, 12/7 Performance06/26/07 Comscore Inc SCOR 101 457 22% 16.50 36.13 119%10/02/07 Constant Contact CTCT 123 433 28% 16.00 21.69 36%07/17/07 Dice Holdings Inc DHX 221 805 27% 13.00 10.01 -23%03/21/07 Glu Mobile Inc GLUU 86 327 26% 11.50 5.33 -54%11/16/07 Internet Brands Inc INET 48 334 14% 8.00 7.99 0%06/07/07 Limelight Networks Inc LLNW 276 1,192 23% 15.00 8.01 -47%08/09/07 MercadoLibre Inc MELI 333 752 44% 18.00 43.77 143%07/19/07 Orbitz Worldwide Inc OWW 510 1,244 41% 15.00 9.87 -34%07/25/07 Perfect World Co Ltd PWRD 217 894 24% 16.00 31.53 97%02/15/07 Salary.com Inc SLRY 69 158 44% 10.50 13.27 26%05/16/07 TechTarget Inc TTGT 115 508 23% 13.00 13.66 5%02/08/07 U.S. Auto Parts Network Inc PRTS 115 298 39% 10.00 8.59 -14%03/08/07 Xinhua Finance Media Ltd XFML 300 883 34% 13.00 6.80 -48%Source: Company reports, FactSet, JPMorgan estimates We see the Internet landscape continuing to undergo changes in F’08. We expect several types of companies to start achieving a level of scale and operational visibility where a public offering makes sense. Particularly, we think the growing maturity of sectors of the Internet previously thought to be not yet mature, such as social networks, will spur deal activity. 11
  12. 12. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com We Think 2008 Could Bring Greater Profitability In 2006, 12 of the Internet companies in our coverage universe saw EBITDA margins decline, and nine had increases. In F’07, the numbers were reversed, with 12 risers and nine decliners. We think, as some of the companies in our universe reach greater maturity, profitability becomes a higher priority than growth, and more achievable, and are forecasting rising EBITDA margins at 16 of these companies in F’08. At the same time, we do not believe that, given the scale of these firms, the leverage that can be achieved in the short term is significant: of the 16 companies whose margins we expect to improve, we are modeling greater than 100 bps EBITDA margin improvement at only eight. Finally, we would note that, should an economic downturn in F’08 be more severe than currently expected, it is possible that our projected margin levels could see pressure. Table 8: Change in EBITDA margins for the JPMorgan Internet Coverage Universe 2006 2007E 2008E EBITDA mgn Y/Y change EBITDA mgn Y/Y change EBITDA mgn Y/Y change AMZN 6.6% -1.0% 7.5% 1.0% 8.2% 0.7% CNET 20.8% 1.5% 19.9% -0.8% 22.1% 2.2% DHX 35.0% -0.4% 41.4% 6.4% 41.5% 0.2% EBAY 34.4% -6.3% 33.1% -1.3% 33.3% 0.1% EXPE 27.3% -3.2% 27.4% 0.2% 26.9% -0.6% GOOG 63.2% -2.0% 59.4% -3.8% 58.5% -0.9% IACI 15.2% 0.7% 13.6% -1.6% 13.9% 0.2% INSP -7.5% -28.3% -3.9% 3.6% -11.2% -7.3% INWK 9.0% 2.4% 9.3% 0.3% 9.7% 0.4% LINTA 36.3% 3.0% 35.2% -1.1% 34.8% -0.4% MELI 14.2% 5.8% 28.3% 14.1% 32.1% 3.8% MNST 25.1% 2.1% 22.3% -2.8% 29.0% 6.7% MOVE 8.4% 6.3% 9.8% 1.4% 13.0% 3.2% NILE 8.9% -0.8% 9.5% 0.5% 9.3% -0.1% OMTR 10.1% 24.1% 16.0% 5.9% 17.5% 1.6% OWW -8.3% -8.3% 11.6% 19.9% 16.8% 5.2% PCLN 9.5% 2.3% 11.5% 2.0% 17.3% 5.8% SFLY 16.8% -0.8% 17.4% 0.6% 17.8% 0.5% SOLD 8.3% -19.5% 5.7% -2.6% 15.1% 9.4% VCLK 26.6% -1.8% 25.6% -0.9% 25.8% 0.2% YHOO 41.8% -0.3% 37.4% -4.4% 38.1% 0.7% Source: Company reports, JPMorgan estimates12
  13. 13. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com Dot.Khan’s Top Ten for 2008 1. CPM growth rate will accelerate 2. M&A market will remain robust 3. Audience Fragmentation: Will the Ad Network strategy work? 4. Domestic eCommerce growth will slow: Can Amazon continue to deliver above- market growth? 5. Can Jerry Yang turn Yahoo! around? 6. Mobile ads will be like video ads: A whole lot of talk, not a whole lot of $ 7. Booking fees are not going away: consider that USAirways just introduced fees 8. Economic slowdown may impact profitability somewhat, but we expect margins to stabilize 9. Internet will continue to cannibalize Newspaper ad spend, which declined ~8% in F’07 10. Battle of Facebook vs. MySpace: both will thrive, but we think Facebook will do better 13
  14. 14. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com14
  15. 15. U.S. Sector Outlooks
  16. 16. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com 2008 Search Advertising Outlook Given a very strong 2007 performance, we are increasing our outlook for the global paid search market heading into 2008. We now believe global paid search revenues will reach $30.5B in 2008, up from our prior estimate of $26.2B. We believe that 2008 paid search growth will be driven by: • International growth due to continued adoption of paid search as a marketing vehicle • Keyword price inflation due to increased volume in advertisements • Volume growth driven by increases in web usage • CTR improvement driven by improvements in relevancy Within search, we continue to believe that Google will take volume market share from competitors as we have greater faith in the company’s ability to execute relevancy enhancements and technological improvements and in its superior brand. However, we believe that on a dollar market share basis, Yahoo! will grow its share over Google due to the improved monetization from the global rollout of Project Panama.Yahoo! will grow its share over We estimate that Google has a 73% dollar market share currently (including revenuesGoogle due to the improved from AOL, Ask, and other affiliates). We believe that this may decline to 71% bymonetization from the globalrollout of Project Panama. the end of 2008 as AOL and Ask have renegotiated their TAC rates and Yahoo! has improved its monetization. While Internet and broadband usage appears to be flattening out in developed countries, we believe that advertiser adoption of this well- targeted marketing vehicle is in its infancy and that there is still much room for monetization and click-through rate improvements. Lessons Learned from 2007 In our “Nothing but Net" preview and outlook for 2007, we stated that we preferred paid search to other Internet sub-sectors such as e-commerce, travel, and graphical advertising. Looking back on the year, paid search actually exceeded our expectations. Entering 2007, we expected the paid search market to grow 39% over 2006 (29% in the US and 52% internationally). However, due to better monetization by Google, Yahoo!, and MSN, as well as volume gains, we now expect global paid search revenues to grow 48% in 2007 (37% in the US and 64% internationally). We were surprised by how robust search volume growth was during F07. At the beginning of the year we thought that much of F’07’s US search market growth would come from increases in coverage and were modeling a 190 bp improvement in coverage vs. 18% Y/Y growth in search volume. We now think that F’07 US coverage will only improve 70 bps vs 25% growth in volume. We are encouraged by this trend as it demonstrates that the market is less mature than we thought and that search companies have not had to resort to increasing the number of ads on a page. Global Search Overview: Global Search Expected to Grow 39% in F’08 We believe 2008 will be another strong year for global paid search. On the back of 48.3% growth in 2007, we forecast that global paid search revenues will grow 38.7% 17
  17. 17. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com in 2008. From a metrics standpoint, we believe query volumes will grow 29.9% in F’08, while RPS will grow 6.8%. We believe substantial monetization opportunities exist and we anticipate a climb in search usage. In 2008, we expect local search, personalized search and vertical search to be hot topics. Beyond 2008, we expect the global paid search market to grow at a 28.4% CAGR through 2011.Table 9: JPMorgans Global Search Advertising Revenue ForecastUnits as indicated Global 2002 2003 2004 2005 2006E 2007E 2008E 2009E 2010E 2011E 07-11 CAGR Internet Population (M) 593 710 820 924 1,020 1,113 1,205 1,295 1,380 1,471 7.2% Queries / Month / User 12 17 22 29 36 44 53 61 68 74 14.2% Number of Queries (M) 83,030 142,017 220,128 323,827 441,796 585,395 760,474 943,475 1,123,558 1,313,311 22.4% RPS (per 1,000 searches) $14.57 $19.04 $23.42 $28.17 $33.58 $37.58 $40.12 $41.98 $44.75 $45.59 4.9% % Coverage 31.7% 35.3% 38.7% 41.7% 43.9% 44.5% 44.5% 45.2% 45.6% 47.1% 1.4% % Clickthrough Rate 15.1% 16.3% 17.3% 18.8% 20.6% 21.5% 22.2% 22.7% 23.5% 23.3% 2.0% $ Revenue / Click $0.30 $0.33 $0.35 $0.36 $0.37 $0.39 $0.41 $0.41 $0.42 $0.42 1.4%Global Search Forecast ($M) 1,210 2,704 5,156 9,121 14,835 21,999 30,511 39,606 50,275 59,868 28.4% Y/Y Growth 197.0% 123.4% 90.7% 76.9% 62.6% 48.3% 38.7% 29.8% 26.9% 19.1%Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS Increasing F’08 US Search Growth Estimate: Now We Expect to Grow 32% Based on out-performance in 2007, we are increasing our 2008 growth estimate for the domestic paid search market. We are now modeling 31.9% growth in 2008, up from our prior estimate of 19.9%. Broken down by metrics, we are modeling US query volume growth of 23.5% in 2008 (a very minor deceleration from the 25.4% we observed in 2007), driven by an increase in the number of searches conducted per user and a slight increase (3.0%) in the domestic Internet population.We expect the domestic RPS to On the monetization front, we expect the domestic RPS to reach $87.21 in 2008, upreach $87.21 in 2008, up from from $81.65 in 2007 (6.8% Y/Y growth). We expect increases in RPS to be driven$81.65 in 2007 (6.8% Y/Y growth) by advertiser demand for keywords as well as continued increases in sponsored-link relevancy. Table 10: JPMorgans US Search Advertising Revenue Forecast Units as indicated United States 2006 2007E 2008E 2009E 2010E 2011E 07-11 CAGR Internet Population (M) 203 211 217 222 227 231 2.4% Queries / Month / User 47 57 68 81 92 102 15.6% Number of Queries (M) 114,896 144,080 177,938 215,305 249,754 282,222 18.3% RPS (per 1,000 searches) $74.86 $81.65 $87.21 $88.73 $94.62 $94.91 3.8% % Coverage 62.8% 63.5% 64.2% 64.3% 64.3% 64.5% 0.4% % Clickthrough Rate 26.2% 27.3% 28.3% 28.6% 30.0% 30.0% 2.4% $ Revenue / Click $0.46 $0.47 $0.48 $0.48 $0.49 $0.49 1.0% US Search Forecast ($M) 8,602 11,764 15,518 19,104 23,631 26,786 22.8% Y/Y Growth 47.2% 36.8% 31.9% 23.1% 23.7% 13.4% Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS Our Proprietary Research Shows... Market Share Shifts Are Likely to Continue In November, the JPMorgan Internet Team surveyed over 1,200 US residents to determine Internet usage behavior. Our market research found that Google is the dominant search engine with 54.6% of participants listing it as their most frequently used search engine. Yahoo! ranked second among participants with 21.8% of18
  18. 18. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com participants using it most frequently. MSN and AOL trailed with 8.6% and 7.2% of participants using them most frequently, respectively. Figure 5: Most Frequently Used Search Engine % of participants Dont use/Dont Other know AOL 3% 2% 7% Ask Yahoo! 3% 22% MSN 9% Google 54% Source: JPMorgan research However, we note that while Google was the overwhelming favorite among participants, 38.5% of respondents use search engines other than their favorite at least 30% of the time. Thus, it appears that respondents are willing to try different search engines for better results.44% of participants older than 42 Surprisingly, older participants were more likely to try different brand search enginesused a search engine other than than younger participants. 44% of participants older than 42 used a search enginetheir favorite more than 30% ofthe time vs. only 32% of other than their favorite more than 30% of the time vs. only 32% of participants inparticipants in the 18-41 age the 18-41 age category. This difference was statistically significant (t=-4.37, p<.05).category. 62% of Respondents Would Be Willing to Consider Switching Search Engines When asked what improvements by other search engines would cause you to switch from your preferred brand, only 38% of respondents stated that nothing would cause them to switch as they were satisfied with their current search engine. The most frequently selected improvement was results that better matched the search term, with 43% of respondents stating that this would cause them to switch search engines. Other factors that would cause respondents to consider switching search engines were the user-friendliness of the site (28% of participants) and search engine speed (28% of participants). Table 11: Factors that Would Cause Search Engine Switching % of Respondents Results that better match search term 42.9% Results that include video, music, and other forms of information 14.2% A more uncluttered easy to navigate site 27.8% Ability to preview web content 22.5% Faster response speed to searches 27.5% Other 1.7% Nothing, happy with current search engine 37.6% Source: JPMorgan research 19
  19. 19. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com What would make participants try a different search engine? Friend and family recommendations held the most weight, with 33.8% of respondents stating this as a driver to try a new search engine. 21.7% of respondents stated that the recommendation of a tech expert would influence them to try a new engine. Trailing in the rankings of persuasiveness were TV ads (11.3% of respondents), billboards (4.1% of respondents), newspapers and magazines (7.7% of respondents), and radio (3.5% of respondents). Over Half of Respondents Use Their Toolbar for Less than 40% of Searches Approximately 75% of respondents to our survey use a search toolbar. Google was the predominant choice of toolbars, with 40.7% of respondents having downloaded it. Yahoo! came in second with 24.1% of respondents having downloaded it. MSN, Ask, and AOL all had under 10% usage by respondents. Surprisingly, while almost three-fourths of our respondents had toolbars, their usage of them was infrequent. 42.4% of respondents who had toolbars used them less than 20% of the time. Figure 6: Toolbar Usage Frequency % of respondents 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Less than 20% 21-40% 41-60% 61-80% 81-100% Source: JPMorgan research International Market to Top the US by F’09 We continue to believe the opportunities for paid search in the international marketplace are even more significant than in the US. In our estimate, while the U.K. is at par or ahead of the US market, the overall international paid search market is still 2+ years behind the US in terms of development.We expect the international However, we now believe that the international market will be larger than themarket to reach $20.5B in F’09 domestic market in F’09 with a market size of $20.5B vs. the US estimated marketvs. the US market size of $19.1B. size of $19.1B. As such, we believe that the international markets will be a key growth driver in the upcoming year. We believe a key driver in the international markets will be query growth. While we expect the US to experience query growth of 23.5% Y/Y, we believe international markets will see a 32% Y/Y lift in the number of queries.20
  20. 20. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com Figure 7: US vs. International Query Volume millions 200,000 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 3Q06 4Q06 1Q07 2Q07 3Q07 U.S. International Source: comScore data and JPMorgan estimates We are modeling paid search revenues to grow 46.5% in F’08, up from our prior estimate of 34.9% driven primarily by higher growth in queries and, to a lesser extent, monetization gains. Broken down by metrics, we are modeling international query volume growth of 32.0% in 2008 (a very minor deceleration from the 35.0% we observed in 2007), driven by an increase in the number of searches conducted per user and an increase (9.5%) in the domestic Internet population. On the monetization front, we expect the international RPS to reach $25.74 in 2008, up from $23.19 in 2007 (11.0% Y/Y growth). We expect increases in RPS to be sustainable as the international market RPS is significantly below US levels ($81.65 in F’07). Gains will likely be driven by advertiser demand for keywords as well as continued increases in sponsored-link relevancy. Table 12: JPMorgans International Search Advertising Revenue Forecast Units as indicated International 2006E 2007E 2008E 2009E 2010E 2011E 07-11 CAGR Internet Population (M) 817 903 988 1,072 1,153 1,239 8.2% Queries / Month / User 33 41 49 57 63 69 14.2% Number of Queries (M) 326,900 441,315 582,536 728,170 873,804 1,031,0 23.6% 89 RPS (per 1,000 searches) $19.07 $23.19 $25.74 $28.16 $30.49 $32.08 8.5% % Coverage 37.2% 38.3% 38.5% 39.5% 40.2% 42.3% 2.5% % Clickthrough Rate 17.2% 18.4% 19.1% 19.8% 20.5% 20.5% 2.8% $ Revenue / Click 0.30 0.33 0.35 0.36 0.37 0.37 2.9% Intl Search Forecast ($M) 6,233 10,235 14,993 20,502 26,644 33,082 34.1% Y/Y Growth 90.1% 64.2% 46.5% 36.7% 30.0% 24.2% Source: JPMorgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS 21
  21. 21. Imran Khan North America Equity Research(1-212) 622-6693 02 January 2008imran.t.khan@jpmorgan.com 2008 Graphical Advertising Outlook After a difficult 2007 where CPMs were pressured from a non-premium inventory glut, we believe that 2008 will see stronger graphical advertising growth. Specifically, we think that 2008 growth will be driven by: • Easier comps as growth will be computed off of this year’s depressed CPMs • Improving CPMs as companies employ targeting techniques and use ad exchanges • Improving RPMs due to higher sell-through and increased ads per page • Increased advertiser interest due to the increased TV ad demand due to political campaigns • Increased page views from rising broadband usage and social networking As a result, we are slightly increasing our F’08 graphical advertising global growth estimate to 22.1% from 20.6% to reflect better monetization (CPMs) through the use of targeting and exchanges and expected growth from social networking sites and blogs. We favor web publishers who are organically growing their page views at a rapid pace and who have targeting capabilities. Lessons Learned from 2007 In our “Nothing but Net” preview and outlook for 2007, we expressed our view that the US graphical advertising market was poised to grow 20% in 2007. Now that the year is almost complete, we have revised our F’07 US growth estimate to 23.4%. We believe that we correctly recognized the audience fragmentation trend due to the rise of social networking and blog usage. We also forecasted the resulting depressed CPMs from the glut of non-premium inventory. However, we did overestimate the impact of video advertising. We thought that the increase in video inventory, coupled with lower CPMs, would cause many graphical advertisers to shift their advertising budgets toward video and away from more traditional graphical advertising. We now recognize that reaching revenue sharing agreements and developing unobtrusive video ads accepted by viewers will be a longer process than we first thought. Global Graphical Advertising Overview: Expect to Grow 22.1% in F’08 We believe that 2008 will be a strong year for graphical advertising publishers, particularly those with targeting capabilities. On the back of expected 23.4% growth in 2007, we believe global graphical advertising revenues will grow 22.1% in F’08. From a metrics standpoint, we believe page views and RPMs will grow 11.1% and 9.9% in 2008, respectively. We expect the global Internet population to expand 8.3% to 1.2B in 2008 and web usage to expand by 2.7% per Internet user. We believe RPM growth will be driven by (1) improving CPMs as companies employ targeting techniques and use ad exchanges, (2) increased sell-through rates, and (3) increased ads per page. We expect the global graphical advertising market to grow at a 17.6% CAGR from 2007 through 2011.22

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