China Internet/Media: e-Commerce Harversting in Digital China

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Morgan Stanley April 2011 report on e-commerce in China

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China Internet/Media: e-Commerce Harversting in Digital China

  1. 1. MORGAN STANLEY RESEARCH ASIA/PACIFIC Morgan Stanley Asia Limited+ Richard W Ji Richard.Ji@morganstanley.com Jenny Wu, CFA Philip Wan, CFA Carol Wang Timothy Chan, CFAApril 15, 2011 Gillian ChungChina Internet/Media Morgan Stanley & Co. Incorporated Scott Devitt Morgan Stanley MUFG Securities Hironori Tanakae-Commerce: Harvesting in Co., Ltd.+ Industry ViewsDigital China Industry Industry View China Internet Attractive China Media Attractivee-Commerce – blossoming in a fruitful land: Weexpect China’s business to consumer (B2C) Companies Featurede-commerce market to surge 70-75% annually for the Share Pricenext three years, ranking it among the fastest-growing Company Ticker Rating (4/13/2011)consumer sectors in China. AirMedia AMCN.O Overweight US$5.0 Alibaba.com 1688.HK Equal-Weight HK$14.8 B-ray Media 600880.SS Overweight Rmb16.5China online retailers stand out: 1) China online Baidu BIDU.O Equal-Weight US$145.7retailers are rapidly capturing market share from ChangYou CYOU.O Overweight US$34.9fragmented offline rivals (we estimate China’s top 20 China Digital TV STV.N Overweight US$7.1retailers own below 10% of total retail sales vs. 40-50% Ctrip CTRP.O Overweight US$44.9for US). 2) China’s e-commerce leaders offer cheaper Dangdang DANG.N Equal-Weight US$19.7goods (often 30-40% discounts to offline products), Focus Media FMCN.O Overweight US$32.1 Gehua 600037.SS Equal-Weight Rmb12.8convenience, like fast yet free delivery, and broader Giant GA.N Overweight US$7.9selections – 10-100x more items than offline leaders. Hunan TV 000917.SZ Underweight Rmb24.43) Group buying services are performance-centric, with NetEase NTES.O Overweight US$52.9heavy local focus, viral marketing from referrals among Oriental Pearl Group 600832.SS Underweight Rmb8.7online friends and capital efficiency, thanks to customer Perfect World PWRD.O Overweight US$24.1 Shanda SNDA.O Equal-Weight US$43.1prepayment. Yet such services require robust local Shanda Game GAME.O Overweight US$6.7execution with mounting marketing costs and competition Sina SINA.O Overweight US$120.0(China hosts an estimated 1,800+ group buying players). Sohu SOHU.O Overweight US$96.3 Tencent 0700.HK Overweight HK$199.4In search of China’s e-commerce winners: We VisionChina VISN.O Overweight US$4.0 51Job JOBS.O Overweight US$61.5consider the following merits key to future Chinese Source: FactSet, Morgan Stanley Researche-commerce leaders: 1) Scale – Last year, Taobaobooked Rmb400bn transaction value, or 2-3% of What’s ChangedChina’s total retail sales, and originated nearly half of Sina 2011/12e EPS Down 4.9%/ 4.6%total package delivery in China. 2) Operating efficiency –“Retail is all about detail”. Dangdang stands out insourcing, inventory management, and logistics for onlinebook sales. 3) Capital efficiency – Thanks to theirbargaining power, retail leaders often demand suppliersto fund their working capital. 4) Cost leadership – As Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. Asleading retailers like Amazon, Suning and Wal-mart a result, investors should be aware that the firm mayhave net margins of only 3-5%, every penny saved is a have a conflict of interest that could affect thepenny earned. objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only aAd leaders: side beneficiaries of e-commerce boom single factor in making their investment decision.We observe that e-commerce has become the fastest- For analyst certification and other importantgrowing advertising category in China. Such robust disclosures, refer to the Disclosure Section, located at the end of this report.demand will favor ad leaders such as Baidu, Sina, Sohu,AirMedia, and Focus Media, in our view. += Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.
  2. 2. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/Mediae-Commerce – Harvesting in Digital ChinaBooming e-commerce in China Exhibit 2e-Commerce, albeit still at an early stage, has emerged as one e-Commerce: Capturing Retail Sales Market Shareof the fastest-growing sectors in China, aided by rising 2,000 (Rmb bn) 7%domestic consumption, higher Internet penetration, and the 6% Chinas online shopping marketincreasing adoption of online shopping: As % of Chinas total retail sales 6% 5% 1,500• According to iResearch, the combined transaction value 4% 1,308 5% for business to consumer (B2C) and consumer to 4% consumer (C2C) services in China climbed over six times 3% 983 1,000 from 2007 to 2010, making it one of the country’s 3% 697 fastest-growing industries. As shown in Exhibit 1, we 2% estimate that China’s market for online commerce, 455 2% 500 1% including both B2C and C2C, will expand 40-50% annually 1% 263 1% from 2011-2013. This would exceed the rates for most 128 other online services, including online travel (high-20%s), 56 0 0% online advertising and online recruiting (mid-20%s) as well 2007 2008 2009 2010E 2011E 2012E 2013E as online games (high-teens). E = Morgan Stanley Research estimates Source: iResearch, Morgan Stanley ResearchExhibit 1China e-Commerce: A Fast-growing Online Industry We estimate that B2C accounts for 6-7% of the e-commerce transactions in China, versus ~15% in the US. According to 50% iResearch, total B2C transactions have more than doubled low-40% each year since 2007. Yet B2C penetration still remains low at 40% only 0.2% of the overall retail sales in China, versus 3-7% in CAGR for 2010-2013E Japan, the US, and the UK (Exhibit 2). 30% high-20% mid-20% mid-20% Exhibit 3 high-teen% China: Low B2C Online Shopping Penetration 20% 8% 10% 6.6% B2C as % of total retail sales 6% 0% e-commerce Online travel Online Online Online booking advertising recruiting gamesE = Morgan Stanley Research estimates 4% 3.5%Source: Morgan Stanley Research 2.9% 2%• We expect online shopping sales to nearly triple from 2010 to 2013e to ~Rmb1.3tn (or ~US$200bn), accounting for 0.2% 6% of China’s total retail sales, up from a modest 1% three 0% years ago. China Japan US UK Source: iResearch (2009), Morgan Stanley Research (B2C – business to consumer) • On our estimates, China’s B2C market will surge 70-80% per annum over the next three years to over Rmb150bn by the end of 2013, representing ~12% of e-commerce 2
  3. 3. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/Media transaction value and ~0.7% of retail sales in China Exhibit 5 (Exhibit 4). Online Shopping Under-penetrated in ChinaExhibit 4 80%China’s B2C: Fueled by Rising Online Activity ~70% Online shopping penetration 250 15% 60% China As % of total e-commerce transation 12% Chinas B2C market (Rmb bn) 200 10% 40% 35% 155 10% 28% 8% 25% 150 22% 7% 20% 5% 6% 101 100 5% 58 0% 50 2007 2008 2009 2010 US 30 15 7 *Penetration of Internet population Source: CNNIC, Morgan Stanley Research 0 0% 2008 2009 2010E 2011E 2012E 2013E We believe the global financial crisis in 2008-2009 boostedE = Morgan Stanley Research estimatesSource: iResearch, Morgan Stanley Research e-commerce in China, as consumers became more price sensitive. Unlike traditional retailing, e-commerce saves onlineIn our view, several tailwinds are fueling the robust expansion retailers store operating costs, lowers their marketingof e-commerce in China: expenses, and improves their inventory turnover, allowing them to offer competitive prices. Chinese consumers often• According to the Computer Network Information Center of enjoy 30-40% discounts when shopping online, relative to China (CNNIC), Chinese Internet users reached ~457mn shopping at the traditional retail stores. at the end of 2010, more than the size of the US population. Yet, the Internet population in China is far from saturated, • Customers may also find online shopping more convenient, as it represents only ~34% of the total Chinese population, as most online retailers offer free door-to-door delivery far behind the 70-80% levels for advanced nations such as within days. 1) China hosts four tier-1 cities, 280+ tier-2 the US, Japan, and South Korea (Exhibit 5). We estimate and -3 cities as well as 370+ tier-4 and -5 cities. 2) China that Chinese Internet penetration will climb to 50% by the has 124 cities with over 1mn population vs. only 10 in the end of 2014. US. 3) These cities tend to have different road conditions and local dialects, creating demand for efficient local• Relative to advanced countries, online shopping is courier services. under-penetrated in China. To date, approximately 35% of the Chinese Internet population has shopped online, up • Thanks to unlimited shelf space, customers have more from 22% in 2007 but still significantly below the ~70% product options when shopping online. 1) Chinese online level in the United States. In other words, e-commerce has commerce leaders typically offer 10x more items than their penetrated only ~10% of the entire Chinese population, offline rivals. 2) In the case of Taobao, the gap often pointing to significant upside. widens to 50-100x. • The evolution of online payment, especially the escrow-based system offered by Alipay, has mitigated settlement risks for online transactions, which used to be a “bottleneck” for online commerce activity. According to CNNIC, over 30% of Chinese Internet users have employed online payment services, up from about 15% in 2007. 3
  4. 4. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/Media• Unlike in the US, the traditional retail market in China is Exhibit 7 highly fragmented. According to Euromonitor, the top 20 e-Commerce: Favorable for Book Distribution offline retailers combined own less than 10% of the retail market in China, far below the 40-50% in the US and the Apparel 35% UK (Exhibit 5). We believe such market fragmentation offers a window of opportunity for e-commerce leaders, Music & books 15% such as Taobao, Dangdang, Amazon/Joyo and Vancl, to garner market share from the offline retailers. Online prepaid 11% cardsExhibit 6China: Fragmented Market Favors Online Shopping Beauty care 8% 50% Home 40-50% 5% accessories Top 20 retailers market share 40% 0% 10% 20% 30% 40% Contribution to online shopping transaction in China 30% Source: iResearch (2009), Morgan Stanley Research 20% 10% <10% 0% China US and UKSource: Euromonitor International (2009); Morgan Stanley ResearchWithin China’s e-commerce market, apparel is the mostpopular online shopping category, followed by books andmedia (iResearch). 1) Nearly 46% of Chinese Internet usershave purchased books and media content online, second onlyto apparel (~57%). 2) As shown in Exhibit 7, the top 5e-commerce categories in transaction value were apparel(~35%), music & books (~15%), online prepaid cards (11%),beauty care (~8%), and home accessories (5%). 3) Somee-commerce players, such as VANCL, Dangdang and Zbird,are becoming the category leaders in China’s online commercemarket, on our observation. 4
  5. 5. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/MediaChina’s Book Market – Benefiting from e-commerce Boom In Search of e-Commerce Winners in China We consider the following merits key to future ChineseWe estimate that book consumption per capita in China e-commerce leaders:approximates only ~4% of the US level, implying significantupside. We believe online book sales contribute 9-10% of • Scale - Scale could offer e-commerce leaders: 1) much-China’s book market sales, up from ~3% in 2007. needed bargaining power over suppliers and logistics partners to get better terms and more timely service; 2)• Similar to the retail industry, China’s book market is also economies of scale, as operating costs per transaction highly fragmented (Exhibit 8). According to China often shrink with larger transaction volume; 3) operating Publishing Today, the largest book retailer (i.e., Xinhua leverage, as e-commerce revenues often outpace cost bookstore) contributes only ~2% of the country’s book growth, improving margins; and 4) network effect, as sales. In comparison, Barnes & Noble, the leading market leaders typically attract more customers, who in bookstore in the US, represents nearly 30% of the market turn draw more suppliers and vice versa, thus raising the (IBISWorld). entry barriers for rivals. Chinese e-commerce leaders enjoying such scale benefits include Taobao, whichExhibit 8 booked Rmb400bn in transaction value last year, making itBook Market: Highly Fragmented in China the largest e-commerce platform in China. Notably, 1) the 40% company contributed 2-3% of China’s total retail sales after less than seven years of operation. 2) Last year, it Book sales market share ~30% 30% originated nearly half of total package delivery in China. 3) Within two years after inception, Taobao took market 20% leadership from eBay/Eachnet, which used to have 80-90% of China’s B2C/C2C e-commerce market share. 10% We believe Taobao achieved such quick turnaround ~2% largely because of its free listing services, better local 0% execution, and later network effect (please see our report, Xinhua bookstores (China) Barnes & Noble (US) China Internet – Creating Consumer Value in Digital China,Source: China Publishing Today, IBISWorld, Morgan Stanley Research (2008) dated September 12, 2005). 4) Investors may see Yahoo! and Softbank as ways to benefit from Taobao’s rapid• In our view, e-commerce is favorable for book distribution, expansion. These two companies own ~40% and ~30%, thanks to the standardization of book products, which respectively, of Alibaba Group, which owns 100% of makes inventory management and distribution simpler. Taobao. Online bookstores typically enjoy greater scalability and higher operating efficiency than traditional ones. • Operating efficiency - “Retail is all about detail”. We Traditional book retailers are often constrained by consider this principle applicable to both online and offline operating hours and geographic presence, whereas retailing. To lead the online commerce market, companies customers can buy books online anytime and anywhere. In have to stand out in operational details. For instance, in addition, physical bookstores generally suffer from higher China’s online books sales market, Dangdang sets itself operating and inventory costs, while online bookstores apart from peers in: 1) supplies – It has established often offer wider book selections, as they are not limited by strategic partnerships with ~100 book suppliers, which shelf space (Exhibit 9). offer favorable procurement terms. We estimate these strategic suppliers contribute ~50% of the company’sExhibit 9 revenues. Dangdang has obtained exclusive onlineAdvantages for Online Book Distribution distribution rights for ~25,000 titles (or 3-4% of its titles) Traditional Online bookstores bookstores from its strategic partners. In contrast, its closest rival, Amazon/Joyo, has no such strategic suppliers; 2)Operating & inventory cost High Low Inventory management - Dangdang turns over itsGeographic coverage Regional Nationwide inventory three times a year vs. 1-2 times for most leadingBook selection Limited Unlimited traditional bookstores in China. As the company can returnScalability Low High most of its unsold inventory to suppliers at no extra cost, itSource: Company data, Morgan Stanley Research has written off only ~US$2mn of inventories to date in its 5
  6. 6. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/Media entire operating history; 3) fulflilment – Dangdang has one generates a gross margin ~5ppts above that of its closest of the largest logistics capacities among B2C peers in rival, Amazon/Joyo. 2) From 2007 to 2009, while China. The company has 10 logistics centers strategically Dangdang’s active customer base tripled from 2007 to located in six cities. It boasts a nationwide distribution 2009, its customer acquisition cost shrank 30-40% network for 800 cities by partnering with over 100 annually, partly thanks to its industry-high repeat customer third-party local couriers. According to the company, ratio (~80%). 3) Helped by its scale and bargaining power nearly 90% of the orders are dispatched within 24 hours over logistics partners, Dangdang’s fulfillment costs as a and about 70% of them are delivered the next day; and 4) percentage of sales declined nearly 6ppts from ~19% in customer service - To improve customers’ shopping 2007 to ~13% in 2010. experience, Dangdang offers dedicated 24x7 customer service via various channels, including hotline, email, and In our view, like the “pick-and-shovel” suppliers in the Gold online messaging. Notably, while Dangdang is one of the Rush, e-commerce infrastructure players, such as the leading few Chinese e-commerce companies to offer cash refunds logistics companies and online payment service providers, will on delivery, its overall return rate has been low at ~3% be key beneficiaries of the rapid proliferation of online historically. commerce in China. To date, China Post, the state-owned post office and mail services provider, and AliPay, the leading online• Capital efficiency - Due to their bargaining power, online payment system in China, wholly owned by the Alibaba Group, retail leaders often demand that their suppliers fund are the dominant players in this area. working capital, thus enjoying positive cash flow. For instance, nearly 80% of Dangdang’s sales are collected To benefit from Taobao and Alipay’s rapid expansion, investors via cash on delivery (COD), which the company receives may look to Yahoo! and Softbank. These two companies own from its local logistics partners within 2-3 days. On the ~40% and ~30% of Alibaba Group, respectively, which in turn other hand, it usually pays its suppliers in 5-6 months. owns 100% of Taobao and Alipay. Thanks to such negative working capital requirements, the company had raised only ~US$40mn of capital before • According to our US Internet analyst Scott Devitt, Yahoo! going public. shares could be challenged in C2011 as core business weakness offsets Asian asset strength. He thinks• Cost leadership –- As the leading retailers like Amazon, competition from social media could drive traffic declines Suning, and Wal-mart have net margins of only 3-5%, and challenge monetization. His team will focus on market every penny saved is a penny earned. In our opinion, cost share trends in display/search advertising as we are leaders enjoy several important benefits, as: 1) they can cautious on Yahoo!’s ability to maintain share as always offer cheaper goods to consumers. On our competition increases, despite management’s optimism observation, most online retailers are selling “commodity” regarding a positive turn in the business. Given the limited products, where pricing becomes a key differentiation upside from current share price, he rates the shares factor to swing customers’ purchase decision. 2) They can Equal-weight. (Please see his report on Yahoo!, CQ4: be more competitive in price wars. Retailers with better Decent Results, Weak Guidance, Lowering Ests, dated cost structure can often price out their weaker rivals, which January 26, 2011.) can wage price wars yet can not last long due to their substandard cost structure. 3) In advanced markets, • According to our Japan telecom analyst Hironori Tanaka: almost without exception, the most successful retailers, Softbank’s earnings are brisk, and he likes the stock as a such as Wal-mart in the US, Uniqlo in Japan, Zara, H&M, telecom industry growth story, forecasting an operating and Ikea families in Europe, and Gome, a leading profit CAGR 10.9% for the next five years. The drivers of electronics retailer in China are all discount retailers. In earnings growth are the Internet culture business (25% of other words, their profits were largely created through cost our F2011 OP estimate), with Yahoo Japan at its core, and leadership. On our observation, Chinese online commerce the mobile business (63% of OP). Within this, we expect leaders are increasingly enjoying such cost leadership. the large increase in high-end subscribers thanks to For instance, 1) Dangdang generates one of the highest iPhone effects to produce impressive mobile business gross margins in China’s book industry, as it benefits from segment profit growth of 45% in F2011 and 11% in F2012. higher volume rebates and hence lower procurement With earnings strength largely in the price he has an costs. We estimate that, on average, the company pays Equal-weight rating, but notes potential interest in the near 20-30% less for books than do most of its peers and term, given: 1) the market’s expectations for a lower 6
  7. 7. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/Media interest rate burden and consolidation of the firm’s three • To expedite customer acquisition, most Chinese group telecom subsidiaries facilitated by WBS (whole business buying leaders plan to aggressively lift marketing spending. securitization) loan refinancing, which Softbank is For instance, according to 21st Century Business Herald, considering from November 2011; and 2) the potential for proposed sales and marketing budgets for this year will be re-rating of overseas investment assets, especially those Rmb300-400mn for Dianping Net, Rmb200mn for Nuomi, in China. Investments in companies with attractive growth Rmb130mn for Meituan, and over Rmb100mn for Ftuan. We potential in China are of particular interest. These include: observe that 1) while Gaopeng could tap into Tencent’s the 33% stake in the Alibaba Group (which owns 100% of massive installed customer base, standalone group buying Taobao, the largest C2C business, and Alipay, the largest players may have difficulty acquiring customers. 2) It often online payment service); the 39.7% stake in one of the costs group buying players over Rmb100 to acquire one leading SNS platforms; and the 35% stake in Synacast new customer. 3) In our view, maintaining a high repeat (PPLive), China’s largest IPTV operator. customer ratio is key to building a group buying franchise, as the cost of acquiring a new customer is often 5 to 10Group Buying – A Battlefield or a Promised Land? times above that for retaining an old one.The proliferating group buying (or social commerce) market inChina is fraught with opportunities and risks. In our view, such • Competition is intensifying in China’s social commerceservices enjoy several advantages relative to other online market. According to CNNIC, China now hosts 1,800+ groupservices: buying players, due partly to low entry barriers but steady cash flow of such business. Given the local focus and market• Group buying services promote discounted deals or services fragmentation, winners may not take all in this sector; rather (such as dining and spa) online, setting a minimal threshold several leaders may coexist over the long term. According to of participants for these deals, thus motivating potential iResearch, the most popular group buying websites in China buyers to help propagate such deals. Unlike other advertising by monthly users include Ju Huasuan of Taobao, Lashou, channels, group buying services are typically Meituan, and QQ Tuan (Exhibit 10). performance-centric, as merchants do not need to pay any Exhibit 10 promotion fees to the providers, which typically charge China’s Top 10 Most Popular Group Buying Websites commissions only on completed transactions. Rank Name Monthly Users (mn)• Group buying services fill in the void of local search to promote products or services from small local companies, 1 Ju Huasuan of Taobao 75.6 which cannot afford large advertising budgets and focus 2 Lashou 45.1 primarily on local customers. 3 Meituan 30.4• Group buying services often enjoy a viral marketing effect from referrals among trusted online friends. 4 QQ Tuan 25.1 5 Groupon.cn 18.8• Group buying services enjoy capital efficiency, as the customers prepay for the discounted deals before group 6 24quan 17.7 buying services providers pay the merchants. 7 Manzuo 17.5Yet there are some risks in group buying. 8 t.58 17.3• To solicit local merchants and local customers, group buying 9 Nuomi 15.1 services players need intense local execution. Unlike other online services (such as travel), which can centralize all 10 Didatuan 12.0 customer transactions on one platform, group buying Source: iResearch (2011.3), Morgan Stanley Research operators need to establish many “satellite offices” in local markets, thus affecting long-term scalability. Notably, • Customer complaints in China’s social commerce market Lashou, a leading group buying pure-play in China, has a have been rising. In March, CCTV exposed malpractice in the sales presence in over 130 cities to date. group buying market, including overstated or sometimes fake discounts and substandard services/products from the 7
  8. 8. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/Media merchants offering group buying opportunities. That said, Exhibit 11 some group buying leaders, such as Nuomi, have started to Chinese e-Commerce Leaders: Stepping up Ad Spending offer full refunds for unsatisfactory services or unused credits. 2011 adv budget Name Type Source Rmb mnGiven that China’s group buying market debuted only a year VANCL B2C 1000 Itxinwen.comago, it is challenging to pinpoint which players will be theultimate winners among thousands of competitors. We will thus Groupon.cn Group buy 550 21cbhclosely monitor certain key metrics, such as customeracquisition costs, average customer spending, repeat Dianping Group buy 300 21cbhcustomer ratio, customer complaint trends, sales growth andmargin profiles per city, commission trends, and take rate per Nuomi Group buy 200 21cbhdeal. In our view, a sharp customer focus, brand building andfirst-class local execution are the keys to thrive in the social Meituan Group buy 130 21cbhcommerce market. Ftuan Group buy 100 21cbhAd Leaders - Side Beneficiaries of e-Commerce Boom Source: Company data, Morgan Stanley Research. Note: 21cbh stands for 21st Century Business HeraldIn our opinion, e-commerce is the fastest-growing advertisingcategory in China. Such robust demand should favor the Among these advertising leaders, we note that:advertising leaders, including Baidu, Sina, Sohu, AirMedia, andFocus Media. • Sina’s microblog Weibo has widened its market leadership, with registered users surging 25 times last year to over• Internet and e-commerce services are among the top two 100mn. 1) The company has added over 50mn new users advertising categories for NetEase and Tencent, two of the since the end of 3Q10. 2) The average number of daily leading online portals in China. microblog posts amount to 25mn, with over 10mn videos played each day. 3) Weibo has attracted ~60,000• Sina’s advertising sales from Internet services (e.g., “celebrity” bloggers, ~5,000 corporate users and ~2,700 e-commerce) more than doubled YoY to become its media users. 4) Sina’s management intentionally slowed fifth-largest contributor to advertising sales. Likewise, its initiatives to monetize Weibo to improve product Sohu has enjoyed greater demand from e-commerce development, user experience, brand recognition and companies. market dominance of such services. According to Charles Chao, Sina’s CEO, “2011 will be a year of investment for• Despite its relatively small base, e-commerce emerges as Weibo”. That said, to capitalize on Weibo’s vigorous the most rapidly growing advertising sector for Focus growth, it is conceivable that Sina may provide interactive Media. product promotions for big corporations and targeted advertisements for SMEs (small- and medium-sized• AirMedia, the dominant leader in airport advertising in enterprises). It could also share revenues with third parties China, counts travel services, luxury brands, and for their applications developed for Weibo users. To date, e-commerce as its fastest-growing sectors. over 800 applications have been launched on Sina’s Weibo, on our count. 5) Weibo users now approximate one• Many e-commerce and group buying leaders in China plan third of Tencent’s user base. Hypothetically, if Weibo is to significantly step up their advertising budgets this year, worth 10% of Tencents value, it implies a long-term particularly given that most of them have deeper pockets “option value” of ~US$5bn embedded in Sina’s stock, on after private financing (Exhibit 11). our estimates. (Please also see our report on Sina, Microblog Weibo – A Vital Catalyst, but not without Cost, dated March 2, 2011.) • For Focus Media, the stock trades at 20-25x our 2011e earnings vs. ~30% of non-GAAP earnings growth p.a. for the next three years, on our estimates. In our view, Focus Media should benefit from China’s robust advertising 8
  9. 9. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/Media uptrend. 1) The company raised the real advertising selling AirMedia, On Track for Profit Upswing, dated March 8, price by 10% for its entire network. Sales growth from price 2011.) hikes tends to boost earnings without incurring extra costs. 2) Focus aims to double its LCD displays in tier-3 and • Sohu trades at ~20x our conservative 2011e earnings. In tier-4 cities while expanding its in-store advertising 4Q10, its latest reported quarter, Sohu’s advertising sales network from the current ~160 cities to over 300 cities. 3) climbed 37% YoY to a record high, with brand advertising Via its investment in VisionChina, Focus may capture sales rising 31% and search revenues up 1.3x to ~10% of more advertising budgets from the mass market and make total ad sales. The company’s online game sales its advertising network more interactive. (Please see our advanced 30% YoY, thanks to the popularity of TLBB. report on Focus Media, Sales Escalation on All Fronts…, Sohu has started a marketing campaign for its new game, dated March 9, 2011.) DMD, which boasted one of the longest development cycles in Chinese online game history. We believe DMD• AirMedia trades at 9-10x our 2011e earnings, with net has a high chance of being a new blockbuster. Sohu cash accounting for over one third of its market value. We ranked No. 3 in China by viewers’ time spent on watching believe AirMedia is on track to enjoy a profit upswing in online videos, with its market share up 10ppt YoY to 13.4% 2011. 1) Aided by strong demand, the company raised its in December 2010. Its online video advertising sales advertising price by 15-20% in January. 2) AirMedia has tripled in 2010, accounting for ~12% of its total advertising secured ~US$100mn of advertising orders to date, sales and emerging as its new growth catalyst. The approximating one-third of our full-year forecast revenues. company offered a solid 1Q outlook, with total sales 3) Its customer base expanded 55% YoY to over 1,100 in jumping 27-31% YoY and brand advertising sales 4Q10. We believe its partnership with CCTV will further expanding 39-44%. (Please see our report on Sohu, increase acceptance by advertisers. 4) AirMedia enjoys Online Video Advertising to Fuel Sales Growth, dated operating leverage – ~50% of its incremental sales turned January 31, 2011.) into operating profit last quarter. (Please see our report onPlease refer to these reports for our views about China’s Internet and media industry:• China Internet/Media – A Year for New Catalysts, January 13, 2011• China Internet/Media – Time to Add the Undervalued Market Followers, October 19, 2010• China Internet/Media – Lessons from Chinese CEOs, July 20, 2010• China Internet/Media – Advertising Rebound? Yes; Ex-growth? Surely Not…, April 14, 2010• China Internet – Google (China) Moves its Services to HK, What’s Next?, March 23, 2010• China Internet/Media – 2010: A Banner Year for Advertising…, January 20, 2010• China Internet/Media – Content Is King, Brand Is Queen…, October 19, 2009• China Internet/Media – Seven Things that Mr. Market May Have Missed, July 21, 2009• China Internet/Media – First-class Growth in a Bear Market, April 23, 2009• China Internet/Media – Eight Good Things about a Bear Market, January 22, 2009• 3G: A New Wireless Chapter for Chinese Internet Players, January 12, 2009• China Internet/Media – Winter is at the Door, October 15, 2008• China Internet/Media – Five and a Half Pair Trading Ideas, July 17, 2008• Media Content – Blossoming in Digital China, June 27, 2008• China Internet/Media – Bargain Hunting in Digital China, April 17, 2008 9
  10. 10. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/MediaExhibit 11Valuation Comparison for Internet/Media Companies Company name Ticker MS Price Market EV P/E P/E, Ex-cash PEG EV/EBITDA EV/Sales 52 Week Price Rating (US$mn) (US$mn) 2011E 2012E 2011E 2012E 2011E2012E 2011E 2012E 2011E 2012E High LowChina InternetAlibaba.com Limited 1688.HK E HKD 14.8 9,997 8,477 34.3 25.9 31.9 22.9 1.2 1.1 23.7 16.5 7.7 5.7 17.7 12.5Baidu.com, Inc. BIDU.O E USD 145.7 50,907 49,656 63.2 45.4 61.1 42.5 1.5 1.4 47.3 32.4 27.7 19.0 143.5 59.7Changyou CYOU.O O USD 34.9 1,857 1,633 9.3 8.0 7.3 5.4 0.6 0.6 5.9 4.3 3.5 2.5 39.7 24.9Ctrip.com CTRP.O O USD 44.9 6,860 6,583 35.8 29.0 32.0 24.6 1.5 1.3 27.4 20.7 10.6 8.0 53.2 31.4Dangdang DANG.N E USD 19.7 1,445 1,468 152.3 70.2 118.0 53.4 0.9 0.8 84.8 37.8 2.2 1.5 36.4 18.8Giant Interactive GA.N O USD 7.9 1,835 848 12.5 12.8 7.2 6.4 0.7 1.3 4.8 3.8 2.7 2.0 8.3 6.051job, Inc JOBS.O O USD 61.5 1,806 1,583 35.9 29.0 31.2 24.1 1.0 1.0 24.6 17.8 7.3 5.6 68.6 16.6Netease.com NTES.O O USD 52.9 6,909 5,392 16.2 14.0 13.7 10.7 0.8 0.9 9.4 7.1 4.6 3.4 52.7 26.2Perfect World PWRD.O O USD 24.1 1,279 953 9.3 8.3 6.2 4.7 0.8 0.7 5.2 3.8 2.0 1.4 39.2 19.7Shanda Games GAME.O O USD 6.7 1,893 1,330 9.2 8.5 6.7 5.2 0.9 1.3 4.2 2.9 1.4 0.9 7.6 5.0Shanda Interactive SNDA.O E USD 43.1 2,629 1,454 28.2 23.4 14.4 10.6 1.6 1.0 9.4 6.4 1.2 0.9 48.9 36.3Sina Corporation SINA.O O USD 120.0 7,906 6,796 63.4 55.3 57.1 47.5 2.4 1.5 56.5 39.9 13.4 10.2 116.7 32.0Sohu.com Inc SOHU.O O USD 96.3 3,724 3,229 21.2 16.8 17.6 13.6 1.1 0.8 11.3 8.0 4.3 3.5 98.5 40.1Tencent Holdings Ltd. 0700.HK O HKD 199.4 47,765 45,905 29.4 23.8 26.8 20.6 1.1 1.1 20.5 15.6 10.8 8.2 228.8 120.4China MediaAirMedia AMCN.O O USD 5.0 341 247 9.0 6.2 6.3 3.8 - 0.1 3.4 2.1 0.8 0.6 8.2 2.8Beijing Gehua CATV Network 600037.SS E CNY 12.8 2,074 1,826 27.5 22.5 25.8 21.2 - - 10.8 8.7 5.5 4.5 18.2 11.6Chengdu B-ray Media Co. Ltd 600880.SS O CNY 16.5 1,577 1,453 23.3 20.8 21.5 18.6 - - 15.9 13.3 6.6 5.8 22.5 15.0China Digital TV STV.N O USD 7.1 419 186 10.4 10.3 8.5 6.9 1.3 1.5 5.2 4.0 2.6 1.9 9.5 5.2Clear Media 0100.HK O HKD 4.8 329 246 13.9 12.1 10.6 8.5 1.2 1.1 7.4 6.0 1.4 1.1 5.3 3.9Focus Media FMCN.O O USD 32.1 4,546 3,821 28.6 19.3 24.3 15.3 0.6 0.6 14.9 10.6 5.5 4.2 31.2 14.4Shanghai Oriental Pearl (Group) 600832.SS U CNY 8.7 4,234 3,739 24.4 26.5 19.9 21.6 - - 18.4 17.4 6.3 6.3 14.8 7.6SinoMedia 0623.HK O HKD 2.8 204 87 7.0 6.4 3.0 2.2 0.5 0.6 1.8 1.3 0.3 0.2 3.1 1.7Television Broadcasts Limited 0511.HK E HKD 47.1 2,654 2,453 12.3 11.7 10.0 9.1 - - 6.6 6.1 3.4 3.1 49.0 31.9VisionChina Media VISN.O O USD 4.0 289 198 25.2 10.7 7.4 3.4 - 0.1 14.2 6.8 1.6 1.3 5.1 2.5Adv AgencyJCDecaux JCDX.PA E EUR 22.9 7,355 8,035 25.6 21.1 24.1 18.9 - - 9.7 8.4 2.2 2.0 25.1 17.7Lamar Advertising Co. LAMR.O E USD 32.8 3,041 5,458 NA 127.2 NA 131.6 - - 10.8 9.6 4.5 4.1 41.9 23.8China TelecommunicationsChina Mobile Limited 0941.HK E HKD 73.5 193,737 144,944 10.9 11.6 8.7 9.1 - - 3.8 3.7 1.8 1.7 84.8 68.5China Telecom 0728.HK U HKD 5.0 51,540 55,172 19.5 20.4 17.6 17.7 - - 4.7 4.6 1.5 1.4 5.0 3.3China Unicom 0762.HK O HKD 14.8 45,526 51,932 69.8 31.9 71.2 31.9 1.2 0.5 5.5 4.8 1.8 1.7 13.9 8.7Asia InternetDaum Communications Corp. 035720.KQ O KRW 98,800 1,184 1,056 13.0 11.2 12.2 9.5 0.9 1.3 6.9 5.3 2.3 1.8 101,300 64,300NHN Corp 035420.KS E KRW 196,000 8,646 7,636 17.3 15.8 16.3 14.0 1.7 1.9 10.6 8.9 4.4 3.7 229,500 169,500NCsoft 036570.KS O KRW 277,000 5,686 5,078 31.0 18.9 34.3 18.5 1.0 0.5 20.3 11.6 8.4 6.2 275,000 139,000Softbank 9984.T E JPY 3,400 45,974 64,039 17.4 14.6 14.5 13.2 - - 4.5 4.2 1.3 1.3 3,515 1,997Yahoo Japan 4689.T O JPY 28,250 19,635 16,215 16.6 14.3 13.2 10.4 - - 6.3 5.0 3.8 3.1 38,500 25,250US InternetAmazon.com AMZN.O O USD 182.3 83,728 75,075 60.9 38.4 58.3 35.5 1.5 0.9 31.3 22.1 1.7 1.3 191.6 105.8Google GOOG.O O USD 576.3 186,531 156,896 18.2 16.0 16.9 13.2 1.1 1.5 10.0 7.8 5.4 4.2 643.0 433.6Yahoo! YHOO.O E USD 16.6 21,848 14,388 23.4 20.6 21.9 18.7 - - 10.3 9.3 3.0 2.7 19.1 12.9E= Morgan Stanley Research estimates, except where noted.Source: Company data, FactSet, Morgan Stanley Research (Prices as of Apr 13, 2011) 10
  11. 11. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/MediaChina Internet/Media Company Earnings Preview 1Q11AirMedia (Overweight) Exhibit 12 AirMedia: Quarterly Income StatementWe believe AirMedia is on track to enjoy a profit upswing in (US$m m ) 1Q10 2Q10 3Q10 4Q10 1Q11E QoQ YoY2011, thanks to surging advertising demand and operating Digital screens in airports 6.5 6.6 7.3 8.6 6.3 -26% -2% Digital screens on airplanes 6.9 5.9 5.2 9.6 6.3 -34% -7%leverage: Digital frame/light box 22.4 27.0 31.1 32.7 28.6 -12% 28% Traditional media 9.9 12.2 12.1 14.2 12.6 -12% 27%• AirMedia guided its 1Q sales to range from US$58-60mn, Other revenues in air travel 0.5 0.9 1.1 1.6 1.1 -30% 122% up 19-23% YoY but down 15-18% QoQ. The first quarter is Gas station media netw ork 0.2 0.8 1.1 1.6 1.8 18% 945% Other media 2.5 3.0 2.6 2.6 2.6 0% typically a weak season for advertising in China due to the Total revenues 48.8 56.3 60.6 70.8 59.4 -16% 22% Chinese New Year holidays and often contributes less % change QoQ 8% 16% 8% 17% -16% than 20% of full-year advertising revenues. That said, Net revenues 47.8 55.1 59.0 68.7 57.6 -16% 21% management’s guidance does not include potential % change QoQ 8% 15% 7% 16% -16% advertising revenues from newly signed billboards and Concession fees (31.9) (33.3) (33.3) (35.8) (36.2) 1% 13% gate bridges contracts at the Beijing Airport. Cost of services (45.5) (48.6) (49.4) (54.3) (51.7) -5% 14%• We are positive about AirMedia’s outlook for 2011. Thanks Gross profits Gross margin (%) 2.2 5% 6.5 12% 9.5 16% 14.3 21% 5.9 10% -59% to strong advertising demand, the company raised its % change QoQ 179% 189% 47% 50% -59% advertising prices in January for most of its services, General and administrative (6.6) (7.7) (5.2) (5.2) (5.2) including its digital frame network, TV screens on airlines, Sales and marketing (4.1) (4.5) (4.6) (4.9) (4.9) and the mega LED screen in Guangzhou by 10-30%. In Operating profits (8.5) (5.8) (0.2) 4.3 (4.3) Operating margin (%) -18% -10% 0% 6% -7% addition, AirMedia plans to raise advertising rates % change QoQ 65% 32% 97% 2373% -199% temporarily during peak seasons, such as Labor Day and the National Holidays, by up to 30%. On our estimates, its Net profits (6.5) (4.7) 1.2 5.1 (3.1) Net profit margin (%) -14% -9% 2% 7% -5% full-year 2011 revenues may expand ~30%. According to % change QoQ 66% 27% 126% 322% -160% the company, it has secured over US$100mn advertising Net earnings per ADS, basic ($) (0.10) (0.07) 0.02 0.08 (0.05) Net earnings per ADS, dilute ($) (0.10) (0.07) 0.02 0.07 (0.04) dollars as of March, approximately one-third of our E = Morgan Stanley Research estimates full-year revenue forecast. Source: Company data, Morgan Stanley Research• The company expects total concession fees to be ~US$38 in 1Q, up ~7% QoQ. The increase is due mainly to the For 1Q11, we forecast that: incremental concession fees related to the newly signed billboards and gate bridge contracts. Excluding the new • AirMedia’s total revenues will drop 16% QoQ but expand contracts, total concession fees in 1Q would be largely flat 22% YoY to US$59.4mn. Sales from digital TV screens in with the 4Q level. The new contracts, which were signed airports (11% of total revenues) will dip 2% YoY to as per customers’ request, are on margin-neutral terms US$6.3mn. Revenues from digital TV screens on and should have limited impact pm AirMedia’s bottom line. airplanes (11% of total) will decline 7% YoY to US$6.3mn. In other words, if the company does not generate sales Sales from digital frames will grow 28% YoY to from these media, it can likely defer its concession costs US$28.6mn (48% of total revenue). Sales from traditional based on its agreement with the Beijing airport. media will expand 27% YoY to US$12.6mn (21% of total revenues).• AirMedia recently announced a share repurchase program of up to US$20mn worth of its outstanding shares within • The company will record an operating loss of US$4.3mn two years from March 21, 2011. On our calculations, vs. a US$4.3mn gain in 4Q10 and an US$8.5mn loss in based on the closing price of US$4.7, the size of its share 1Q10. Net loss will be US$3.1mn vs. a US$5.1mn gain in buyback program approximates 6-7% of its total shares 4Q10 and a US$6.5mn loss in 1Q10. Fully diluted loss per outstanding. At the end of 2010, AirMedia reported net ADS will be US$0.04 vs. earnings per ADS of US$0.07 in cash of ~US$127mn (over 30% of its market value) with no 4Q10 and a loss per ADS of US$0.10 in 1Q10. debt. Notably, share repurchase often signals that management considers the stock undervalued. 11
  12. 12. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/MediaPlease refer to the following reports for more on our views:• 4Q10: On Track for Profit Upswing, March 8, 2011• 3Q10: Turned Profitable; Earnings Acceleration Next…, October 27, 2010• 2Q10: Brighter Outlook; Profitability in Sight…, August 12, 2010• 1Q10: Advertising Rebounded; Execution Would be Key…, May 4, 2010Exhibit 13AirMedia: Income Statement, 2006-13E(US$ m m ) 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013EDigital screens in airports 0.9 10.5 26.9 47.6 37.3 28.9 37.1 45.1 52.5Digital screens on airplanes 0.4 4.9 11.1 19.2 17.1 27.6 33.1 38.6 43.5Digital frame/light box 1.3 45.0 66.3 113.2 150.6 188.0 228.5Traditional media 6.5 27.2 48.4 62.1 74.6 86.8Other revenues in air travel 0.1 3.5 4.3 7.2 4.6 4.1 4.9 5.6 6.3Gas station media netw ork 0.1 3.7 9.2 15.0 23.0Others 10.7 12.6 14.8 17.3Total revenues 1.4 18.9 43.6 125.5 152.5 236.5 309.6 381.7 457.9 % change YoY 1300% 131% 188% 21% 55% 31% 23% 20%Business tax and other sales tax (0.0) (1.0) (2.0) (6.1) (3.1) (6.0) (9.2) (13.3) (18.2)Net revenues 1.3 17.9 41.6 119.4 149.4 230.5 300.4 368.4 439.7 % change YoY 1230% 132% 187% 25% 54% 30% 23% 19%Concession fees (2.2) (6.8) (12.0) (45.7) (110.1) (134.3) (145.7) (163.2) (179.5)Cost of services (3.2) (10.0) (21.4) (71.0) (147.5) (197.9) (218.6) (250.4) (283.2)Gross profits (1.8) 7.9 20.3 48.4 1.9 32.6 81.7 118.0 156.5 Gross margin (%) -137% 44% 49% 41% 1% 14% 27% 32% 36% % change YoY 529% 157% 139% -96% 1627% 151% 44% 33%General and administrative (0.4) (1.3) (22.0) (14.4) (34.9) (24.6) (22.0) (25.8) (30.6)Sales and marketing (0.5) (2.8) (4.8) (10.2) (13.4) (18.1) (21.3) (27.4) (34.5)Operating profits (2.7) 3.9 (6.5) 23.9 (46.5) (10.2) 38.4 64.7 91.4 Operating margin (%) -199% 21% -16% 20% -31% -4% 13% 18% 21% % change YoY 244% -270% 466% -295% 78% 478% 68% 41%Interest income / (expense) 0.0 0.0 1.7 5.4 2.0 0.7 1.1 1.4 1.8Other income, net 1.1 1.2 0.9Pretax profits (2.7) 3.9 (4.8) 30.4 (43.2) (8.6) 39.6 66.1 93.1Income tax benefit / (expenses) 0.3 0.2 0.2 0.5 6.0 0.7 (4.0) (11.2) (21.4)Minority interest 0.0 0.0 (0.4) (0.2) 2.7 2.0 0.0 0.0Gain / (loss) on investment (0.5) (0.3) 0.2 0.3Net profits (2.4) 4.1 (5.1) 30.2 (37.2) (4.9) 37.6 54.8 71.7 Net profit margin (%) -178% 23% -12% 25% -25% -2% 13% 15% 16% % change YoY 269% -226% 691% -223% 87% 865% 46% 31%Net incom e / (loss) attributable to ordinary shareholders (2.7) 2.6 (8.5) 30.2 (37.2) (4.9) 37.6 54.8 71.7Net earnings per share, basic ($) (0.04) 0.03 (0.12) 0.23 (0.28) (0.04) 0.29 0.42 0.54Net earnings per share, dilute ($) (0.08) 0.22 (0.28) (0.04) 0.27 0.40 0.52Net earnings per ADS, basic ($) (0.23) 0.45 (0.57) (0.07) 0.57 0.83 1.09Net earnings per ADS, dilute ($) (0.15) 0.44 (0.57) (0.07) 0.55 0.80 1.04E = Morgan Stanley Research estimates. Source: Company data, Morgan Stanley Research 12
  13. 13. MORGAN STANLEY RESEARCH April 15, 2011 China Internet/MediaAlibaba.com (Equal-weight) Rmb24bn, more than double than year-ago level. As well, AliExpress, its online transaction platform for itsWe maintain our Equal-weight rating on Alibaba, due to the low international marketplace, has become the largest B2Bvisibility into the ongoing transition after management changes: transaction platform in traffic and transaction value. Finally,• We expect Alibaba’s customer net adds to slow in 1Q due transaction value on 1688.com, the company’s domestic to weak seasonality, as the Chinese New Year (CNY) online wholesale platform, quadrupled in the previous holidays often take two to three weeks off the working quarter. calendar. In addition, Alibaba ceased offering the Gold Exhibit 15 Supplier Starter Pack and replaced it with a high-priced Alibaba: Quarterly Income Statement Gold Supplier membership effective January 1, 2011; (Rm b m n) 1Q10 2Q10 3Q10 4Q10 1Q11E QoQ YoY hence more new customers signed up in 4Q before the International Marketplace 719 791 847 881 919 4% 28% China Gold Supplier 699 768 824 857 893 4% 28% price hike. Global Gold Supplier 20 23 23 24 26 6% 31% China Marketplace - China TrustPass 406 471 492 525 537 2% 32%Exhibit 14 China TrustPass 390 444 472 506 515 2% 32%Alibaba: Paying Members’ Projection for 1Q11 Others 16 26 20 19 22 16% 40% Others 96 104 110 116 118Paying members (000) 1Q10 4Q10 1Q11E QoQ YoY Total revenues 1,221 1,366 1,449 1,521 1,574 3% 29%China Gold Supplier 101 121 123 2% 22% Cost of services (194) (227) (242) (267) (277) 3% 42%Global Gold Supplier 16 10 10 -5% -39% Gross profits 1,026 1,139 1,207 1,254 1,297 3% 26% Gross margin (%) 84% 83% 83% 82% 82%China TrustPass 542 678 708 4% 31% Sales and Marketing (466) (498) (526) (560) (571) 2% 23%International marketplace 117 132 133 1% 14% Product development (117) (132) (160) (170) (173) 2% 48% General and administrative (122) (123) (145) (178) (173) -3% 41%China marketplace 542 678 708 4% 31% Other operating income (loss) 49 8 21 31 32 3% -35% Operating profits 369 394 396 377 412 9% 11%Total paying members 659 809 841 4% 28% Operating margin (%) 30% 29% 27% 25% 26%E = Morgan Stanley Research estimates Finance income, net 33 43 48 52 55Source: Company data, Morgan Stanley Research Income tax credit / (expense) (69) (74) (77) (17) (75) Others (0) 0 (9) (4) - Net profits 330 363 357 407 391 -4% 19%In our view, Alibaba is in transition after the management Net profit margin (%) 27% 27% 25% 27% 25%changes, as the company is focusing on cleaning upaccounting issues and tightening its customer acquisition Net earnings per share, basic (Rm b) 0.07 0.07 0.07 0.08 0.07 -16% 0% Net earnings per share, dilute (Rm b) 0.06 0.07 0.07 0.08 0.06 -17% 0%policy. That said, we believe these changes will benefit the Net earnings per share, basic (HK$) 0.07 0.08 0.08 0.09 0.07 -18% 0%company in the long run despite near-term uncertainties. Mr. Net earnings per share, dilute (HK$) 0.07 0.08 0.08 0.09 0.07 -18% 0%Jonathan Lu, now the CEO of both Alibaba.com and Taobao, E = Morgan Stanley Research estimates Source: Company data, Morgan Stanley Researchmay further align business strategies and boost synergies. For 1Q11, we forecast:• In our opinion, value added services (VAS), accounting for 20-25% of Alibaba’s total revenues, remain a key catalyst • Alibaba’s total revenues will grow 3% QoQ and 29% YoY for sales expansion in the near term. Notably, VAS to Rmb1.57bn. Sales from the international marketplace typically enjoy a 5-10ppt higher margin than membership (58% of total revenue) will increase 4% QoQ and 28% YoY sales due to lower sales commission costs. Moreover, to Rmb919mn, while sales from the China marketplace Alibaba is introducing more “operational” VAS, such as (34% of total) will rise 2% QoQ and 32% YoY to logistics, e-commerce training, and staffing services, Rmb537mn. which may enrich the overall customer experience and • Operating profit will grow 9% QoQ and 11% YoY to lower customer churn via higher switching costs. Rmb412mn, with an operating margin of 26% vs. 25% in• Alibaba has made progress in its new VAS initiatives, 4Q10 and 30% in 1Q10. Net profit will dip 4% QoQ but including online transactions and Ali-Loan, which may grow 19% YoY to Rmb391mn. Fully diluted earnings per offer further monetization opportunities. By the end of share will come in at HK$0.07 vs. HK$0.09 in 4Q10 and 2010, loans issued via the Ali-Loan program exceeded HK$0.07 in 1Q10. 13

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