Asia Pacific Equity Research
                                                                                             ...
Dick Wei                  Asia Pacific Equity Research
    (852) 2800-8535           06 January 2011
    dick.x.wei@jpmorg...
Dick Wei                  Asia Pacific Equity Research
    (852) 2800-8535           06 January 2011
    dick.x.wei@jpmorg...
Dick Wei                  Asia Pacific Equity Research
    (852) 2800-8535           06 January 2011
    dick.x.wei@jpmorg...
Dick Wei                  Global Equity Research
    (852) 2800-8535           03 January 2011
    dick.x.wei@jpmorgan.com...
Dick Wei                  Global Equity Research
    (852) 2800-8535           03 January 2011
    dick.x.wei@jpmorgan.com...
Dick Wei                                                Global Equity Research
    (852) 2800-8535                        ...
Dick Wei                  Global Equity Research
    (852) 2800-8535           03 January 2011
    dick.x.wei@jpmorgan.com...
Dick Wei                  Global Equity Research
    (852) 2800-8535           03 January 2011
    dick.x.wei@jpmorgan.com...
Dick Wei                           Global Equity Research
     (852) 2800-8535                    03 January 2011
     dic...
Dick Wei                                                  Global Equity Research
   (852) 2800-8535                       ...
Dick Wei                  Global Equity Research
     (852) 2800-8535           03 January 2011
     dick.x.wei@jpmorgan.c...
Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com

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

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

...
Dick Wei                  Global Equity Research
     (852) 2800-8535           03 January 2011
     dick.x.wei@jpmorgan.c...
Asia Pacific Equity Research 06 January 2011 Nothing But Net - Asia 2011 Internet Investment Guide
Asia Pacific Equity Research 06 January 2011 Nothing But Net - Asia 2011 Internet Investment Guide
Asia Pacific Equity Research 06 January 2011 Nothing But Net - Asia 2011 Internet Investment Guide
Asia Pacific Equity Research 06 January 2011 Nothing But Net - Asia 2011 Internet Investment Guide
Asia Pacific Equity Research 06 January 2011 Nothing But Net - Asia 2011 Internet Investment Guide
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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 OLNHUCWeb
DQGother 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 t

Asia Pacific Equity Research 06 January 2011 Nothing But Net - Asia 2011 Internet Investment Guide

  1. 1. Asia Pacific Equity Research 06 January 2011 Nothing But Net - Asia 2011 Internet Investment Guide China Internet AC Dick Wei (852) 2800-8535 dick.x.wei@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited Japan Internet AC Hiroshi Kamide (81-3) 6736 8602 hiroshi.kamide@jpmorgan.com JPMorgan Securities Japan Co., Ltd. Korea Internet AC Sungmin Chang, CFA (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.
  2. 2. Dick Wei Asia Pacific Equity Research (852) 2800-8535 06 January 2011 dick.x.wei@jpmorgan.com 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 . 2 2
  3. 3. Dick Wei Asia Pacific Equity Research (852) 2800-8535 06 January 2011 dick.x.wei@jpmorgan.com Sector Overview 3 3
  4. 4. Dick Wei Asia Pacific Equity Research (852) 2800-8535 06 January 2011 dick.x.wei@jpmorgan.com 4 2
  5. 5. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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 re- rating. (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 third- party 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 ad- serving/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 China’s internet segment offers good secular growth, as well as a number of sizable private companies. We believe more new listings are likely. 5 141
  6. 6. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com China Internet Market Overview Internet penetration still low at 31% China’s 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 world’s 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 600 534 40% 494 454 35% 500 420 384 30% 400 338 298 25% 300 253 20% 210 200 137 162 15% 103 111 123 80 87 94 10% 100 34 46 59 68 5% 0 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 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% 48.6% 50% 35.2% 40% 30% 19.7% 16.0% 20% 11.7% 10% 3.1% 0% Dec-06 Dec-08 Jun-10 Penetration Rate (Urban Population) Penetration Rate (Rural Population) Source: CNNIC. 6 143
  7. 7. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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 Jun-15 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 Broadband Internet Users as % of Total Internet Users 400 346 364 100% 85% 91% 94% 90% 87% 319 75% 78% 270 80% 66% 300 214 163 60% 200 122 77 91 40% 100 20% 0 0% Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Broadband Users (Mn) Broadband users as % of total Internet users Source: CNNIC. Source: CNNIC. 7 144
  8. 8. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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 2005 2006 2007 2008 2009 2010* Broadband subscribers (MM) 37.5 51.9 66.5 83.4 105.0 123.2 Population Penetration (%) 2.9% 4.0% 5.1% 6.4% 7.9% 9.0% Households Penetration (%) 9.1% 12.5% 16.1% 20.0% 24.0% 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% 73.6% 65.9% 70% 60% 50% 36.8% 40% 30% 20% 10% 0% Desktop Laptop Mobile Phone Source: CNNIC (Jun-10). 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% 88.40% 80% 60% 33.60% 33.20% 40% 20% 0% Home Internet Café Company Source: CNNIC (Jun-10). 8 145
  9. 9. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com Average time spent online remains stable CNNIC’s 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 18.6 19.0 18.7 19.8 20 15.9 16.5 16.9 16.2 16.6 18.0 13.0 13.4 12.3 13.2 14.0 15 9.8 10 5 0 Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- 02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 Av erage Accessing Time Per Week Source: CNNIC (Jun-10). 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 % of surveyed use the service Users in millions Online Music/download 82.5% 346.5 News 78.5% 329.7 Search engine 76.3% 320.5 Instant messaging ( chat room, QQ, ICQ) 72.4% 304.1 Online Games 70.5% 296.1 Online movie (include download)/Video 63.2% 265.4 Email 56.5% 237.3 Blog 55.1% 231.4 Social Networking 50.1% 210.4 Online literature 44.8% 188.2 Online shopping 33.8% 142.0 BBS/forum 31.5% 132.3 Online payment 30.5% 128.1 Online banking 30.5% 128.1 Online stock trading 15.0% 63.0 Online travel reservation 8.6% 36.1 Source: CNNIC (Jun-10). 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. 9 146
  10. 10. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com Chat Is the Most Used Application on Mobile 70% 61.5% 60% 48.4% 45.3% 43.3% 50% 35.5% 40% 30% 21.1% 20.4% 16.0% 20% 6.1% 10% 0% Mobile Chat Mobile Online music Mobile Mobile Online mobile Mobile Video Mobile email Mobile Search listening or Literature community game Payment downloading Source: CNNIC (Jun-10). 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 19.8 20 18.7 19 18 18 16.6 17 16.2 16 15 Dec-07 Dec-08 Jun-09 Dec-09 Jun-10 Time Spent Online (In Hr/Week) Source: CNNIC. The total online ad market still accounts for a relatively small portion of China’s 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$5.8B). China search ad is still ~50% of Search ads continue to grow faster than brand ads the total online ad market. This We expect search advertising to continue to see stronger growth than brand compares with around 67% in advertising in 2011. From a top-down perspective, search ad is ~61% of the total the US online ad market in China in 2011E. This compares with ~70% in the US. As such, we still see room for growth. From a bottom-up perspective, we expect market drivers to be: 1) increasing user adoption of search, 2) higher SME advertisers’ adoption of pay-for-performance advertising, 3) search usage to increase with the growing eCommerce market, and 4) use of search ads as a brand advertising tool. 10 147
  11. 11. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com China Online Advertising Market Forecast from 2006 to 2012E 2006 2007 2008 2009E 2010E 2011E 2012E Brand Advertising (RMB M) 3,377 4,559 6,428 6,942 9,025 11,462 14,442 Search Advertising (RMB M) 1,442 2,851 5,309 7,213 12,015 18,427 24,751 Other Online Format (RMB M) 109 122 135 135 135 135 135 Total Online ad market (RMB M): 4,928 7,533 11,872 14,290 21,175 30,023 39,328 Total Online ad market (US$M) 621 999 1,721 2,083 3,100 4,448 5,826 Growth Rate (Rmb, %) 54.6% 60.8% 72.3% 21.1% 48.8% 43.5% 31.0% Total China ad market (Rmb M) 105,712 116,422 139,707 142,501 165,301 190,096 216,709 Growth Rate (Rmb, %) 16.5% 10.1% 20.0% 2.0% 16.0% 15.0% 14.0% Ad market as % of GDP 0.48% 0.44% 0.46% 0.42% 0.42% 0.44% 0.45% Online ad as % of Total ad market 4.7% 6.5% 8.5% 10.0% 12.8% 15.8% 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 (2009–11) 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. China’s 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 Government’s 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 11 148
  12. 12. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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, we’ve 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. 12 149
  13. 13. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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 800 697 609 529 600 453 437 417 400 305 223 179 141 200 0 2003 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 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 year’s prime time ad resources on CCTV channels. This important event auctions off ~15% of the country’s total TV ad spending and sets the tone for ad growth in the coming year. 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 2011’s 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. 13 150
  14. 14. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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 CCTV Prime time YoY Growth Online Brand Number of times (X): [Online Auction Revenue Ad Growth Brand Ad Growth / CCTV (Rmb billion) Auction Growth Ratio] 2003 3.31 26% 102% 3.9 2004 4.41 33% 72% 2.2 2005 5.25 19% 37% 2.0 2006 5.87 12% 45% 3.8 2007 6.80 16% 35% 2.2 2008 8.03 18% 41% 2.3 2009 9.26 15% 8% 0.5 2010 10.97 19% 30% 1.6 2011E 12.67 16% 27% 1.7 Source: CCTV, Zenith Optimedia. Note: J. P. Morgan current estimates. 14 151
  15. 15. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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 2006 2007 2008 2009E 2010E 2011E 2012E Branded Advertising (RMB M) 3,377 4,559 6,428 6,942 9,025 11,462 14442 Branded Advertising (US$ M) 426 605 932 1,012 1,321 1698 2140 Growth rate (Rmb, %) 45% 35% 41% 8% 30% 27% 26% Branded ad as % of ad market 3.2% 3.9% 4.6% 4.9% 5.5% 6.0% 6.7% Source: J.P. Morgan estimates. 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 2006 2007 2008 2009E 2010E 2011E 2012E Market share of key portal players* (%) 62% 62% 63% 58% 59% 60% 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. 15 152
  16. 16. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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$2.7B). We believe search advertising is still in an early high-growth stage in China, driven by: 1) rising internet penetration, 2) significant growth in websites and pages, 3) higher search usage (due to greater mass of web content), and 4) large number of SMEs (with small ad budgets) turning to search advertising (due to the higher ROI). China Search Market Forecast 2006 2007 2008 2009E 2010E 2011E 2012E Avg. Internet users (Mn) 123 162 253 338 420 494 577 Number of search (Bn) 81 116 181 254 334 429 521 Coverage 17% 21% 24% 25% 32% 34% 35% Click through rate 22% 25% 25% 24% 22% 22% 22% Price per click (Rmb) 0.34 0.42 0.45 0.45 0.50 0.56 0.60 P4P Search Market (Rmb M) 1,062 2,472 4,945 6,849 11,644 18,048 24,364 P4P Search Market (US$ M) 134 328 717 999 1,705 2,674 3,610 Growth rate (Rmb, %) 110% 133% 100% 39% 70% 55% 35% Total Search Market (Rmb M) 1,442 2,851 5,309 7,213 12,015 18,427 24,751 Total Search Market (US$ M) 182 378 770 1,052 1,759 2,730 3,667 Growth rate (Rmb, %) 70% 98% 86% 36% 67% 53% 34% Search ad as % of total ad market 1.4% 2.4% 3.8% 5.1% 7.3% 9.7% 11.4% Source: CNNIC, J.P. Morgan estimates. Note: Excluding distributor discount. How big can China’s search market grow? Using various comparisons to the US and Korean search market, we estimate China’s 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-than- expected 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. 16 153
  17. 17. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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 China’s 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 China’s 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 China’s 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 China’s search market size in 2010- 2014. We think the market will reach US$2.1B and US$3.0B in 2011 and 2012, respectively. Five Scenarios for China’s Search Market Size Estimate US$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 2) China Search Ad Market Size (US$ M) (Scenario 3) China Search Ad Market Size (US$ M) (Scenario 4) China Search Ad Market Size (US$ M) (Scenario 5) Source: iResearch, World Bank, J.P. Morgan estimates. 17 154
  18. 18. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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. Google’s 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) 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 Baidu 62.3% 63.6% 64.9% 64.0% 67.8% 70.8% 72.9% Google 33.0% 32.5% 31.2% 32.8% 29.5% 27.3% 24.6% Sogou 1.2% 0.9% 1.0% 1.2% 1.0% 0.8% 1.2% SoSo 1.5% 1.2% 1.0% 0.6% 0.8% 0.6% 1.0% Others 2.0% 1.8% 1.8% 1.3% 0.9% 0.5% 0.4% Source: iResearch. 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) 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 Baidu 74.1% 75.7% 77.0% 77.1% 75.3% 80.2% NA Google China 20.9% 19.8% 17.9% 17.5% 18.4% 14.1% NA Others 5.0% 4.5% 5.1% 5.4% 6.3% 5.7% NA Difference in marketshare* 15.1% 14.1% 13.1% 18.7% 11.3% 10.2% Source: iResearch. * means difference in search volume and search revenue market share. Soso and Sogou will take longer to become a challenge to Baidu Tencent’s Soso and Sohu’s Sogou have been working on developing their own search technologies. 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 Sogou’s 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 Alibaba’s Taobao.com. The search results displayed in groups include Taobao listings, links to related online forums, information websites, and web search results provided by Microsoft’s 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. 18 155
  19. 19. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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) People’s 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 government’s 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 Baidu’s key initiatives is to continue to improve Phoenix Nest performance in the long term. Baidu application platform: announced in September 2010 To enhance user’s 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 The company currently has more than 400 applications under this library. Baidu and search queries in China are for third-party application providers will split revenues in a ratio of 30:70. Baidu’s applications rather than information 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: 三重门 – 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. 坦克大战 – A basic online game. Users can download this game or other games on the list of recommendations. 金山毒霸 – Kingsoft anti-virus software. Links to download right away. 豆瓣电台 – Online radio station. Users can listen to radio directly on Baidu’s page. 19 156
  20. 20. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 新三国 – A popular soap opera. Video links have been verified by Baidu for high- quality content. 开心网/126 邮箱 – 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 邮箱" 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 company’s 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 Baidu’s 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 Market share (%) Baidu 33.7% Google China 19.5% 3GYY 14.1% YiCha.cn 14% Others 18.7% Source: Analysys International. Baidu’s 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. 20 157
  21. 21. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com 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 company’s 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 China’s 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 games—LAN-based (local area network), MMORPG (massively multiplayer online role playing games), or casual board and chess games—are also low-cost alternatives to offline entertainment. Internet in general is a low-cost form of entertainment—internet café 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 cafés after work to use instant messenger and e-mail, or to 21 158
  22. 22. Dick Wei Global Equity Research (852) 2800-8535 03 January 2011 dick.x.wei@jpmorgan.com play games or watch movies. Despite the government constantly monitoring these services, blogs and bulletin board services have also increased in popularity in China—they serve as channels for the Chinese to express their personal views and communicate with others. • 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 Baidu’s 3Q10 active marketing customers of 272,000, the company’s penetration among larger SMEs is 6%. Hence, we believe the market is far from reaching a saturation point. 22 159

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