Deutsche BankMarkets Research                               Industry                                            Date      ...
Deutsche BankMarkets ResearchAsia                            Industry                                              DateChi...
Deutsche Bank                           02 December 2011                     Software & Services      China Internet      ...
Deutsche Bank                 02 December 2011              Software & Services              China Internet               ...
Deutsche Bank                  02 December 2011                Software & Services            China Internet              ...
Deutsche Bank                                     02 December 2011                          Software & Services           ...
Deutsche Bank                                 02 December 2011                      Software & Services                 Ch...
Deutsche Bank                02 December 2011             Software & Services           China Internet                    ...
Deutsche Bank                  02 December 2011              Software & Services             China Internet               ...
Deutsche Bank                 02 December 2011              Software & Services              China Internet               ...
Deutsche Bank                                      02 December 2011                   Software & Services           China ...
Deutsche Bank                                     02 December 2011                        Software & Services           Ch...
Deutsche Bank                  02 December 2011               Software & Services              China Internet             ...
Deutsche Bank                  02 December 2011               Software & Services              China Internet             ...
Deutsche Bank                  02 December 2011               Software & Services            China Internet               ...
Deutsche Bank                02 December 2011            Software & Services            China Internet                    ...
Deutsche Bank                                     02 December 2011                   Software & Services                  ...
Deutsche Bank                 02 December 2011              Software & Services              China Internet               ...
Deutsche Bank                 02 December 2011              Software & Services              China Internet               ...
Deutsche Bank                                           02 December 2011             Software & Services            China ...
Deutsche Bank                                02 December 2011                             Software & Services             ...
Deutsche Bank                 02 December 2011               Software & Services              China Internet              ...
Deutsche Bank                02 December 2011              Software & Services             China Internet                 ...
Deutsche Bank                                     02 December 2011                                 Software & Services    ...
Deutsche Bank                02 December 2011              Software & Services             China Internet                 ...
Deutsche Bank                 02 December 2011              Software & Services             China Internet                ...
Deutsche Bank               02 December 2011            Software & Services           China Internet                      ...
Deutsche Bank                 02 December 2011              Software & Services              China Internet               ...
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  1. 1. Deutsche BankMarkets Research Industry Date 02 December 2011 China Internet Asia Insights China Technology Software & Services Alan Hellawell III Research Analyst (+852) 2203 6240 alan.hellawell@db.com Alex Yao Yoshio Ando, CMA Research Analyst Research Analyst (+86) 21 3896 2831 (+81) 3 5156-6681 alex.yao@db.com yoshio.ando@db.com Jeetil Patel Research Analyst (+1) 415 617-4223 jeetil.patel@db.comF.I.T.T. for investorsChina social games: New characters,new plots, new twistsChinas social gaming companies are climbing the same steep growth curves plotted by theircounterparts in the US and Japan. The market otherwise has very distinct elements to it, from thewide range of revenue shares that its competing SNS platforms offer to the delicate partner-competitor duality that gaming companies and platforms must negotiate. We expect Sina Weiboto disturb the current order as it builds share, while Tencent grapples with social gamingsdeflationary impact on its high-ARPU online gaming business.________________________________________________________________________________________________________________Deutsche Bank AG/Hong KongAll prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourcedfrom local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subjectcompanies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus,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. DISCLOSURES ANDANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 146/04/2011.
  2. 2. Deutsche BankMarkets ResearchAsia Industry DateChina 02 December 2011 China InternetTechnology FITT ResearchSoftware & Services Insights Alan Hellawell III Research AnalystChina social games: New characters, (+852) 2203 6240 alan.hellawell@db.comnew plots, new twists Alex Yao Yoshio Ando, CMASocial gaming business model morphs as underlying platforms do battle Research Analyst Research AnalystChinas social gaming companies are climbing the same steep growth curves (+86) 21 3896 2831 (+81) 3 5156-6681plotted by their counterparts in the US and Japan. The market otherwise has alex.yao@db.com yoshio.ando@db.comvery distinct elements to it, from the wide range of revenue shares that itscompeting SNS platforms offer to the delicate partner-competitor duality that Jeetil Patelgaming companies and platforms must negotiate. We expect Sina Weibo to Research Analystdisturb the current order as it builds share, while Tencent grapples with social (+1) 415 617-4223gamings deflationary impact on its high-ARPU online gaming business. jeetil.patel@db.comMore than just planting crops; Sina likely to reap the greatest benefitsChances are that many readers of this report have played social games on their Top Picksfavorite social networks (SNS). Social games are a critical component ofkeeping users on SNS sites. An estimated two-thirds of Facebook users play Sina Corp (SINA.OQ),USD66.08 Buygames at least once a week, and gaming represents 40-50% of time spent on Companies Featuredthe platform. China continues to deepen its embrace of these social games. Tencent (0700.HK),HKD145.20 BuyWe expect social games’ revenues to double in 2012 to RMB3.5bn compared 2010A 2011E 2012Eto 2011. We believe battles being waged across SNS portals Tencent, Renren P/E (x) 29.8 20.7 16.7and Sina Weibo to woo game developers reflect their much broader struggle to EV/EBITDA (x) 22.5 15.2 11.5become the outright leader in social networking. As a result of our analysis, we Price/book (x) 12.3 7.0 5.1are changing our outlook for social gaming and the impact it will have on the Renren Inc (RENN.N),USD3.70 Holdcompanies we follow. We upgrade Sina to Buy, as it vaults towards a more 2010A 2011E 2012Edominant role in social gaming, and as broader Weibo usage grows and P/E (x) – – –monetization kicks in. EV/EBITDA (x) – – –For social gaming heavyweights Tencent and Renren, next steps are pivotal Price/book (x) 0.0 0.8 1.2With low barriers to entry, we expect scale, breadth of platform involvement, Sina Corp (SINA.OQ),USD66.08 Buygeographical diversification and other elements to prove crucial for success in 2010A 2011E 2012Ethe inevitable consolidation. As regards platform partners, Tencent is China’s P/E (x) 26.2 70.8 49.6biggest. However, it may struggle to maintain its dominance, as its games EV/EBITDA (x) 12.6 – 40.7developers, many failing to make money from operating on Tencent, Price/book (x) 3.4 4.6 4.3investigate the more generous competing revenue shares from Sina andRenren. Moreover, with ARPUs of only RMB3-5/month, Tencent couldencounter cannibalization of its hardcore games. Renren, China’s first mover inthird-party social gaming, is seeing its share decline as it continues to diversifybeyond games revenues, while maneuvering for success as the group-buyingindustry undergoes painful consolidation.Revising target prices for Sina, Tencent and Renren; upgrading Sina to BuyWe raise our Sina target price to USD94.8 and upgrade our rating to Buy fromHold. We reduce our target price on Tencent from HKD230 to HKD195 and onRenren from USD8.17 to USD4.11. Across most of the Chinese internet sector,we apply a PEG multiple to a three-year earnings CAGR as our primaryvaluation methodology, due to its ability to balance valuation multiples againstgrowth prospects. Upside risks include acceleration in the monetization ofsocial advertising, better games performance and broader execution of openplatform strategy. Downside risks include potential regulatory action, SNSproduct issues and inability to efficiently monetize SNS products.________________________________________________________________________________________________________________Deutsche Bank AG/Hong KongAll prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourcedfrom local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subjectcompanies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus,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. DISCLOSURES ANDANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 146/04/2011.
  3. 3. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchTable Of ContentsExecutive summary ....................................................................... 5Our main thesis ............................................................................. 8Social games introduction........................................................... 10China’s social games growth prospects...................................... 12The basic business model ........................................................... 18The Chinese social gamer ........................................................... 21Battle of the platforms ................................................................ 26Competition in China social gaming............................................ 29Emerging opportunities: Mobile social gaming ........................... 32Key risks ...................................................................................... 35Conclusions................................................................................. 36Other social games company profiles ......................................... 37Appendix A ................................................................................. 55Appendix B.................................................................................. 58Appendix C ................................................................................. 62Renren Inc ................................................................................... 63Sina Corp .................................................................................... 63Tencent ....................................................................................... 63About the cover page:1. Top left : "Landlord Lady" from KingNets Happy Tower game2. Top right: "Youko" from Rekoos Sunshine Ranch game3. Center: "Daisy" from Renrens Renren Party game.4. Bottom left: "Cao Pi" from Vanchus Back to the Three Kingdoms game5. Bottom right: "Xiao Die" from Vanchus Back to the Three Kingdoms game.Page 4 Deutsche Bank AG/Hong Kong
  4. 4. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchExecutive summaryChina social games: exciting growth prospects as platforms,business models in fluxFame and fortune abroad, exciting challenge and change domesticallyChina’s social games developers tend to carry dual passports: while several of theleading players have come to derive appreciable revenues from major overseasplatforms such as Facebook and its counterparts in Japan, Korea and elsewhere, all ofthem are in various states of trying, or having tried, to crack the more challengingbusiness models of the domestic platforms. Although key to keeping China’s competingSNS platforms vibrant and attractive, the independent social games studios, broadlyspeaking, face less generous revenue share terms from some of China’s SNS platforms,and, moreover, are competing against games internally developed by their socialnetworking hosts. We expect the all-important revenue share to shift gradually in favorof the social games developers, as China’s SNS platforms battle for developerallegiances.Will Weibo woo? Expecting shift in share; upgrading Sina; cutting Tencent, Renrentarget pricesSNS ‘juggernauts’ Tencent and Renren dominate domestically in the provisioning ofsocial games. With its hit Weibo service, Sina, in its never-ending diversification awayfrom its strict micro-blog roots to a much broader SNS and social media platform, isactively challenging the dominance of China’s SNS incumbents, having targeted amongother areas, their basic business models (e.g. social games revenue share). Our upgradeof Sina is in anticipation of a long-awaited monetization of its Weibo platform, and alsoin the belief that it will continuously refine its social games strategy to compete moreeffectively with Tencent and Renren. We also lower our target prices on both Tencentand Renren.Will Chinas social games sector go the way of traditional on-line games?Social games present a growing threat to traditional on-line games, as time spent shiftsfrom one to the other. Paradoxically, despite the allure of widening social gaming take-up both domestically and abroad, China’s social games studios run a real risk ofencountering the same painful challenges of their on-line games predecessors. Most ofChina’s publically listed gaming players suffer from weak valuations, indicative ofdecelerating growth, given low barriers to entry. Adding to these potential challengesfor China’s social gaming companies is the aforementioned concentration of power andleverage among China’s SNS platforms. In the absence of a “super-game studio”, suchas Zynga, the beneficiaries of China’s inevitable social games consolidation are likely torequire unrivaled delivery capabilities, revenue diversification, both geographically andplatform-based, and other factors to prevail.Our bold three-year prediction: Alibaba to become a playerWhen we consider some of the crucial elements required to succeed in socialnetworking and social games, we regard a deep knowledge of the user as a startingpoint. Strength in areas such as CRM and billing are also important. Robust brandequity, dominance in respective lines of business and longevity of the platform inserving users should also prove supportive of success in SNS. Of all of the majorinternet companies with the optionality of entering SNS, social gaming, etc., weconsider the Alibaba Group. A web site, Taojianghu, with Facebook-style applicationsand Twitter-style feeds, was grafted into Taobao.com in April 2009. With more of asocial commerce orientation, Taojianghu ultimately saw an underwhelming take-up.Deutsche Bank AG/Hong Kong Page 5
  5. 5. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchHowever, we still believe that Alibaba is in the rare position of launching a much higherprofile and successful SNS offering should it so desire. Hiring veteran managers fromthe admittedly young SNS space would mark the first major step in that direction, in ourview.ValuationOur universe of Chinese internet companies currently trades at 0.8-1.1x PEG and 15-45x2011E PE. We regard China internet sector valuations as generally attractive at currentlevels, compared to their historical trading range.We upgrade Sina to Buy and raise our target price to USD94.8. In valuing Sina, weassign a 22x ex-cash 2012E PE to its online ads non-GAAP 2012E net profit ofUSD182.2m; and an 8x 2012E ex-cash PE to 2012 non-ad business non-GAAP net profitof USD8.0m. We value Sina Weibo at USD1.8bn, or USD1.5bn to Sina after optionsdilution. Our valuation of Weibo is based on our 2014 Weibo net profit forecast ofUSD55m and a 2014E PE of 40x. A valuation of USD1.5bn is equal to USD22 per share.We maintain our Buy rating on Tencent and cut our target price to HKD195 fromHKD230. Our target price is based on a 2012E non-GAAP EPS of HKD8.61, 2012-14EEPS CAGR of 23%, and a PEG of 1.0x. We cut our PEG from 1.1x to 1.0x, largely onrecent evidence that the company is no longer consistently outperforming our forecasts.We maintain Hold on Renren and cut our target price to USD4.11 from USD8.17 on: a softening earnings growth outlook in the next 24 months due to increasing investment and weakening outlook for the group-buy business slower-than-expected adoption of Renren’s self-service ad system mentioned later in this report, indicating the inability to capture significant long tail ad budget in the next 24 months competitive pressure from Sina Weibo, not just in social gaming, but across other frontsWe adopt a sum-of-the-parts valuation methodology to value 1) Renren ex-Nuomi, 2)Nuomi and 3) 56.com separately, given that they are in different development stages,participate in segments with very different market share structures, and, broadlyspeaking, exhibit major differences in visibility and competitive landscape. We assignUSD466m to Renren ex-Nuomi, USD44m to Nuomi and USD54m to 56.com.Our top picks across the China internet space are Baidu and Sina. We believe bothcompanies offer strong growth potential and trade at attractive valuations. Baidu tradesat 28x 2012E non-GAAP PE against our 2012-14 earnings CAGR of 29%, translating to aPEG of 0.7x. Sina’s current stock price is 9% below fair value of Sina ex-Weibo (ourestimate: USD72 per share). We expect Sina’s PE to drop quickly after 2012 as Weibobegins to contribute earnings and the company retreats from aggressive marketingefforts.Page 6 Deutsche Bank AG/Hong Kong
  6. 6. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchFigure 1: China internet comp table Ticker Rating Price Mkt Cap EV CY11E CY12E CY13E CY11E CY12E CY13E (m) (m) PE PE PE PS PS PSChina internet portalsBaidu BIDU.OQ Buy USD 124.92 43,488 40,408 43.0 x 27.5 x 19.6 x 19.7 x 12.5 x 8.9 xSina SINA.OQ Buy USD 62.67 3,871 3,136 67.4 x 47.1 x 20.6 x 8.5 x 6.6 x 4.7 xSohu SOHU.OQ Buy USD 48.05 1,829 1,291 9.8 x 8.8 x 8.0 x 2.2 x 1.6 x 1.4 xTencent 0700.HK Buy HKD 145.20 266,912 243,402 21.4 x 17.2 x 13.3 x 8.0 x 6.2 x 5.0 xAlibaba 1688.HK Hold HKD 7.79 38,900 26,738 15.7 x 13.4 x 11.3 x 5.0 x 4.3 x 3.8 xCRIC CRIC.OQ NR USD 4.61 661 371 15.2 x 11.0 x 9.5 x 2.7 x 2.3 x 2.0 xSouFun SFUN.N Buy USD 12.18 926 957 9.0 x 7.1 x 6.0 x 2.7 x 2.2 x 1.9 xQihoo QIHU.OQ NR USD 16.10 1,888 1,571 45.0 x 21.2 x 11.5 x 11.8 x 6.8 x 4.1 xBitauto BITA.OQ NR USD 4.67 193 446 24.1 x 18.4 x 23.4 x 1.9 x 1.4 x 1.1 xRenren RENN.N Hold USD 3.77 1,987 1,594 -125.7 x -125.7 x 37.7 x 12.8 x 8.6 x 5.5 xPhoenix New Media FENG.N Buy USD 5.21 394 318 19.2 x 12.9 x 8.3 x 2.9 x 1.9 x 1.2 xTaomee TAOM.N Buy USD 4.78 173 52 9.2 x 8.8 x 5.2 x 3.7 x 2.9 x 2.1 xMean 27.8 x 19.1 x 13.7 x 6.8 x 4.8 x 3.5 xChina online gamesGiant Interactive GA.N NR USD 3.78 892 592 5.9 x 5.0 x 4.7 x 3.2 x 2.7 x 2.4 xNetdragon 0777.HK NR HKD 4.74 2,439 847 12.8 x 9.3 x 6.4 x 3.4 x 2.7 x 2.2 xPerfect World PWRD.OQ NR USD 9.93 499 1,766 3.3 x 3.1 x 2.7 x 1.1 x 1.0 x 0.9 xKingsoft 3888.HK NR HKD 3.01 3,515 1,915 7.3 x 6.0 x 5.4 x 3.3 x 2.9 x 2.5 xChangyou CYOU.OQ NR USD 21.63 1,126 700 5.4 x 4.7 x 4.2 x 2.5 x 2.1 x 1.9 xShanda Interactive SNDA.OQ Hold USD 39.88 2,254 238 21.3 x 13.8 x 11.7 x 2.1 x 1.9 x 1.8 xShanda Games GAME.OQ Buy USD 4.35 1,253 862 5.3 x 4.7 x 4.3 x 1.6 x 1.4 x 1.3 xNetEase NTES.OQ Buy USD 42.95 5,588 564 11.2 x 9.8 x 8.5 x 5.0 x 4.2 x 3.8 xThe9 NCTY.OQ NR USD 5.50 138 -467 -3.1 x -7.1 x N/A 6.2 x 1.2 x N/AMean 9.1 x 7.0 x 6.0 x 2.8 x 2.4 x 2.1 xChina traveleLong LONG.OQ NR USD 14.23 479 1,265 38.5 x 29.6 x 24.5 x 5.3 x 4.2 x 3.6 xCtrip CTRP.OQ Hold USD 26.16 3,756 477 18.9 x 15.8 x 12.9 x 7.0 x 5.5 x 4.5 xMean 28.7 x 22.7 x 12.9 x 6.2 x 4.8 x 4.1 xChina e-commerceDangdang DANG.OQ NR USD 4.45 352 121 -12.5 x -6.9 x -6.9 x 0.6 x 0.4 x 0.3 xMecox Lane MCOX.OQ NR USD 1.54 88 6 -3.3 x -3.9 x -4.5 x 0.4 x 0.4 x 0.4 xMean -7.9 x -5.4 x -4.5 x 0.5 x 0.4 x 0.3 xChina VideoYouku YOKU.OQ NR USD 17.56 2,000 2,551 -106.4 x -175.6 x 84.0 x 14.3 x 7.8 x 4.7 xKu6 Media HRAY.OQ NR USD 1.17 59 19 N/A N/A N/A N/A N/A N/ALeTV 300104.SZ NR CNY 30.93 6,805 6,974 54.7 x 35.8 x 25.4 x 14.2 x 9.2 x 6.4 xTudou TUDO.OQ Buy USD 11.82 335 174 -3.7 x -17.1 x 16.0 x 4.7 x 2.3 x 1.4 xMean -25.8 x -69.9 x 25.4 x 14.2 x 9.2 x 6.4 xSource: Deutsche Bank, Bloomberg Finance LP, closing date 29 November 2011RisksWe believe investors need to be aware of the following key risks when investing inChinese online social names: Regulation risk Change of revenue share term between operator and developer Cannibalization on operators core business from social games Monetization of social apps, in particular non-gaming appsDeutsche Bank AG/Hong Kong Page 7
  7. 7. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchOur main thesisOf high growth and major transformationWhile China’s social gaming industry significantly resembles that of any other market –with third-party games developers porting their games into the large social networkingplatforms – there also exist some very profound differences. The two prime componentsof successful social gaming – the social networking platforms and the games developersegment – have far less industry concentration than the widely profiled symbiosisbetween giants Facebook and Zynga in other markets. China’s social gaming businessmodel is similarly variegated. While the country’s dominant SNS platform, Tencent,takes the lion’s share of gaming revenue and the game author a minority slice, thedominant player in real-name SNS (by which the user discloses his/her real identity inusing the platform), Renren, offers a more favorable share, while challenger Sina,through its Weibo platform, passes through nearly all of its revenues to its gamingpartner. We believe both the business model and competitive landscape are set tochange throughout 2012. The dramatic shift of time away from traditional SNS tomicro-blog is likely to give rise to new power brokers in the industry, particularly asSina’s Weibo platform continues to refine its games strategy. Assuming revenue shareis a tactical weapon in this battle of the platforms, industry wealth may well be pouredback into the coffers of China’s social games developers. Listed companies withsignificant exposure to these trends are: Platforms Tencent, Renren, Sina Traditional gaming companies such as Shanda Game, Netease, etc.In Figure 2, we show a summary, highlighting some of the conclusions of this report.Figure 2: Exposure to China social gamesCompany Ticker 2013E social 2013E social 2013E social 2013E social Net impact from Notes games rev games rev as % of games operating games OP as % of social games (USDm) total rev profit (USDm) total OP thesisRenren RENN 13.8 5% 7.6 41% Usage share declining ●Sina SINA 23.1 3% 12.7 8% Major gainerTencent 0700.HK 369.2 5% 203.1 7% ◐ Risk to existing gamesNetEase NTES NM <5% NM <5% ◐ Exposed to social games cannibalizationShanda Games GAME NM <5% NM <5% ◐ Exposed to social games cannibalizationSohu (Changyou) SOHU NM <5% NM <5% ◐ Exposed to social games cannibalizationSource: Deutsche Bank estimatesNote: Empty circle : positive, Black circle ●: negativeSource: Deutsche BankPage 8 Deutsche Bank AG/Hong Kong
  8. 8. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchKey focus questionsOur broad aim in this report is to offer a thorough overview of China’s social gamesmarket. However, more specifically, we hope to add value in attempting to answer whatwe believe to be the three most important questions relating to the future of socialgaming through the highlighted “Focus” sections throughout the report. Thesequestions are: How will the basic social games business model evolve, and who is likely to benefit? (Discussion begins on page 12.) Will new platform players emerge to challenge the current order? (Discussion from page 18.) Can China social gaming remain attractive long term? (Section begins on page 21.)Deutsche Bank AG/Hong Kong Page 9
  9. 9. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchSocial games introductionWhat is a social game?A social game is, in short, a browser-based game that is intimately tied to one’s socialnetworking presence, allowing a gamer to play with friends, update them on theiraccomplishments, and build a community in ways that discreet online games do not.Social games tend to have the attribute of being easy to pick up and leave, if need be,while allowing the player to resume again after logging back into the underlying socialnetworking site. Social games are, in this regard, considered “light core” or “middlecore” games. Massively multi-player on-line role playing games (MMORPGs) andadvanced casual games (ACGs), in contrast, tend to range from middle core to hardcore. These terms are used to characterize the intensity and complexity of the game-play, the system requirements for computers used to play the game, and often thesheer size of the “client” that a player must download (sometimes multiple gigabits insize.)Gaming website gamesbrief.com recently compiled a list of the characteristics of thesocial gaming genre from industry experts. We have extracted several useful attemptsat defining the category below: "My definition of a social game is a game that has a very gentle learning curve, easy-to-understand user interface ("UI"), and lives on a social network, taking advantage of your friendships in meaningful ways within the game...these games are predominantly free-to-play and employ microtransactions as a business model..." - John Romero, game designer "A social game is a game played on and using the infrastructure of a social networking website...a social game is a game played with, against or alongside social-network friends, often asynchronously...games are open-ended and lack win-states or fail-states: the only way to win or lose is not to play." - James Wallis, game designer "Social games take advantage of the social graph to include your real life friends into the game experience. They are easy to get into, challenging over a long period of time and they create a highly competitive atmosphere among our real live friends." - Jens Begemann, CEO, wooga "...the most important mechanisms of reward and pleasure come attached to explicitly social aims. And these aims will tend to involve sharing, competing and cooperating with other players, as well as harnessing existing social bonds and networks as part of the game’s fundamental mechanisms of progress and achievement." Tom Chatfield, authorThe global social games marketTotal social games market including Facebook to hit USD8.6bn in revenue by 2014The social games market has seen strong growth in many parts of the world, driven byboth the rapid expansion of adoption of its underlying SNS host platforms (such asFacebook, Renren, Tencent) and on its own unique merits. We profile the rise of socialnetworking as a growth driver in Appendix A of this report. Gaming has become one ofthe most popular activities on the internet across most markets. Having once accountedfor nearly 25% of all time spent on the Chinese internet as of 2006, pure-play gamingremains some 10-15%, according to iResearch. Indeed, on-line gaming could stillrepresent nearly 20% of the average Chinese netizen’s time on-line if we include itslatest incarnation, namely, as a part of the social networking experiencePage 10 Deutsche Bank AG/Hong Kong
  10. 10. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchApp platform Viximo and market research firm SuperData Research recently conducteda study together on the worldwide social games market. The report predicts that theglobal social games market, including both Facebook and its peers globally, willgenerate USD8.6bn revenue by the end of 2014 (not including ad revenue). Asia is thelargest social games market, with revenues of about USD2bn in 2011. South America,Western and Eastern Europe are growing at very fast rates. In terms of social gameusers, Russia has 35m, while Brazil has reached 32.6m. China is estimated to have202m social gamers (42% of China’s internet population). Among all Europeancountries, Germany is generating the most social games revenues, with expectedrevenue of more than USD173m in 2011. Meanwhile, the country is expected togenerate more than USD250m by 2014. iResearch expects China to generate socialgames revenues of RMB1.8bn in 2011. Please note that the estimated revenue statisticsfor China and Asia are from two different sources, one from Viximo and the other onefrom iResearch.While Facebook is the world’s largest social network, other large regional social gamenetworks include Renren and Tencent in China, Hyves in the Netherlands, Tuenti inSpain, SudiVZ in Germany, and Badoo in the United Kingdom. Google+ is also emergingas both an SNS of scale and a growing social games platform in North America, and isnow considered to be the most serious competitor to Facebook since the demise ofMySpace.Non-Facebook social games to hit USD5.6bn in revenue by 2014The report by Viximo and SuperData Research also highlighted that revenues fromsocial games played outside of the Facebook social platform will grow to USD5.6bn by2014 (or 65% of the aforementioned total of USD8.6bn), from a current level ofUSD3.2bn. This estimate is grounded by hard data, which include the surveying ofsome 774,158 unique transactions by 152,159 individuals playing social games for thesix months ending June 2011. As such, Facebook is clearly not the only platform wheresocial games are booming. Despite Facebook being the largest social games platform inthe US and globally, it represents only one-third of total traffic. The study expects thatnon-Facebook platforms in western markets will account for nearly one quarter of theworldwide social games market within the next three years.Viximo expects key social game markets such as China, Brazil, Germany, Russia andTurkey to see strong growth in non-Facebook traffic. As Asia is currently the largestsocial games market, we indeed expect the Chinese market to be one of the majorgrowth catalysts due to its large population and the rapidly rising popularity of socialnetworks.Recent insight into growth: the Information Solutions Group studyLeading casual games company PopCap in mid-November released the results of anexhaustive study that it commissioned led by the Information Solutions Group. Thestudy notes that, as of September, significantly more Internet users in both the US andthe UK were playing social games than in January, 2010. Some 41% of Internet users inthe US and UK had played a social game in the past three months, and moreover playmore than 15 minutes per week compared to only 24% in January 2010. The number ofwhat the study terms “Avid social game players” (those who play at least six hours aweek) had more than doubled over the same period. We refer readers to the underlying76-page study at the following link:http://www.infosolutionsgroup.com/pdfs/2011_PopCap_Social_Gaming_Research_Results.pdfDeutsche Bank AG/Hong Kong Page 11
  11. 11. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchChina’s social games growthprospectsOutlookChinese “netizens” are well-known for their fondness for online gaming relative to theircounterparts in almost any other country. Below, we present the past and forecastgrowth of the broader on-line games market.Figure 3: 2007–2013E China online games market 80 62.8% 67.4% 70 33.8% 25.2% 18.1% 14.2% 8.2% 60 51.2 50 47.3 RMB billion 41.4 40 35.1 28.0 30 20.9 20 12.5 10 0 2007A 2008A 2009A 2010A 2011E 2012E 2013E transaction value (RMBb) % YoY growthSource: Deutsche Bank with input from iResearchNot only has China gamers’ appetite for traditional massively multi-player on-line roleplaying games (MMORPGs) and casual games created a large sub-segment of theinternet economy, but their adoption of social games, available to those who socializeon SNS platforms, is also growing rapidly. Revenue in social gaming is almostexclusively derived from the purchase of in-game virtual items, from fertilizer for a farmgame, to weapons for a war strategy game.Market research firm iResearch estimates that the transaction value of the China socialgames market totaled RMB491m in 2010, up 338% YoY. iResearch meanwhile forecaststhat the China social games market will continue this strong growth in the next twoyears, reaching a transaction value of RMB5bn by 2013, representing a CAGR of 117%from 2010-2013. iResearch also forecasts that the share of social games as apercentage of total online games revenue will continue to increase from 1.4% in 2010 to9.8% in 2013. We present iResearch’s predictions of the rise of social games revenuesbelow.Page 12 Deutsche Bank AG/Hong Kong
  12. 12. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchFigure 4: 2007–2013E China online games market breakdown 100% 1.1% 3.1% 1.4% 6.2% 4.3% 7.4% 7.9% 6.1% 9.5% 9.8% 90% 5.9% 11.6% 6.0% 11.7% 11.8% 80% 6.6% 7.7% 8.6% 70% 60% 50% 91.0% 90.8% 87.5% 40% 83.1% 77.4% 73.2% 69.9% 30% 20% 10% 0% 2007A 2008A 2009A 2010A 2011E 2012E 2013E MMORPG Platform games Web games Social gamesSource: Deutsche Bank with input from iResearchIn growing to nearly 10% of total China on-line gaming revenues by 2013, social gamesgrowth will likely nearly double in 2012 alone, as illustrated below.Figure 5: 2009–2013E China social games market 6,000 338% 263% 5,015 5,000 96% 43% 4,000 3,500 RMB million 3,000 2,000 1,781 1,000 491 112 0 2009A 2010A 2011E 2012E 2013E Transaction value (RMBm) 112 491 1,781 3,500 5,015 % YoY growth 338% 263% 96% 43%Source: Deutsche Bank with input from iResearchStage I of growth for China social gaming companies largely overseasMany Chinese social games developers have benefited greatly from opportunities in theinternational markets, as these markets often have relatively higher ARPU than theirChinese counterparts, and revenue share can be more generous. We believe Chinasocial games companies going overseas are regarded as a value-add to the domesticmarket, as they can earn a higher revenue from the international market and gain moreexperience in terms of content development, marketing, customer services, etc., whichwill ultimately give them more resources and experience to expand the domestic marketat an appropriate time. For instance, Beijing-based social game company Rekoo isfamous for its social games in Japan. The company has 90% of its 400 staff in China,but it is one of the leading social games developers in Japan’s leading social network,Deutsche Bank AG/Hong Kong Page 13
  13. 13. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchMixi. Company CEO Liu Yong announced in February 2011 that, while he expectedsteady growth in the Japanese market, the more substantial growth would be in China.Liu expected revenues in China to grow from the current RMB1m per month to USD1-2m per month by the end of 2011. The company now has more resources to expand thedomestic market and recently just signed a deal with Tencent.Social games follow social networks’ growth; forecasting 340m social game users by2013EChina’s leading social networks have, over the years, increasingly integrated onlinegames as a prominent offering for their users. Social games have thus rapidly gainedpopularity alongside the evolution of social networks, as they provide entertainmentservices and serve to increase communication among users. Social games includesocial network identity, and they exist as a plug-in that allows convenient access withina social network. While a majority of these games can be played on a “free” basis, theintroduction of virtual items (e.g. special fertilizers to grow one’s crop more quickly in afarming game) has become the major form of monetization for this game genre. Atpresent, we believe the number of social gamers in China is about 202m (or some 75%of total 2011E China SNS users of 269m), with active paying users of about 1.8m.Meanwhile, we expect the number of social gamers to reach 340m by 2013(representing 80% of 2013E China SNS users of 425m), with active paying users ofabout 3.7m.Leading indicators for growth: Renren, Facebook already deriving significant revenuesfrom gamesIn looking at two leading SNS platforms, it is clear that on-line gaming has become aprominent source of revenues for both Renren and Facebook. We expect games-relatedrevenues to represent roughly 38% of Renren’s 2011E revenues of USD115m(moreover, this number captures only two-thirds of the company’s third-party socialgames revenues – the balance is shared with the games developer). eMarketermeanwhile forecasts that Facebook will realize roughly USD4.3bn in revenues in 2011.It also forecasts that the dominant SNS platform will derive $3.8bn from advertising thisyear (+104% YoY, from USD1.86bn in 2010), and USD470m from Facebook Credits, avirtual currency program that lets users buy items in games (accounting for more than3x the USD140m it made in 2010). Bearing witness to the sheer amount of social gamestraffic on more advanced platforms such as Facebook, it seems quite clear that China’sSNSA platforms should see strong secular growth in this space for years to come. Weestimate there to be more than 50 games and other apps on Facebook with multi-million daily active users (DAU.) We believe there will be only a handful of such apps onTencent. We believe online games will remain an important revenue source for thesocial networking industry in the short term. We profile an even more basic driver forthe social games industry, the social networking industry itself, in our Appendix Asection.Major driversProliferation of open platforms in ChinaWe regard the proliferation of open platforms in China, and growth in SNS useraccounts, to represent the most basic driver of social games growth. While we discussin detail the three main SNS presences in China, namely Tencent, Renren and SinaWeibo, other platforms to which games are being ported include Baidu box computing,Qihoo, Shanda, and others. As such, social game users will continue to ride on thegrowth of the open platform in China.Page 14 Deutsche Bank AG/Hong Kong
  14. 14. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchAbundant supply of domestic social game developersChina is regarded as one of the world’s most prolific social games development hubs. InAugust 2011, Tencent’s VP announced that the company’s open platform had almost80,000 registered developers. We estimate that the whole China gaming market mayhave close to 100,000 developers. Even though some Chinese social games companieschoose to go overseas, the abundant supply of Chinese social games developers stillsuffices for domestic market expansion. In addition, the large number of domesticdevelopers who have gained strong operational experience from overseas socialplatforms can help the development and expansion of the domestic market.Rapidly increasing internet penetration rates and SNS user growthChinese internet users reached 485m in June 2011, and the internet penetration ratereached 36.2%, increasing by 1.9% YoY compared with 2010. This number is still fallingbehind the 70% penetration rate in developed countries such as the United States andJapan. The strong growth of internet access and broadband connections in Chinaprovides a solid foundation for the continued growth of the online gaming industry inChina. Meanwhile, we estimate China internet users to reach 800m by 2015,representing a CAGR of 13% (2011–15E). China SNS growth will also be another majorgrowth driver for social games. iResearch forecasts that China will have 269m SNSusers by the end of 2011, and will reach 425m SNS users by 2013, representing a CAGRof 26% (2011-2013).We also note that the number of mobile internet users totaled 318m in June 2011,which means that around 65.5% of Chinese netizens are using mobile devices to accessthe internet. China’s expanding 3G mobile network allows users to surf the internetmore conveniently and at a faster rate, which should pave the way for mobile socialgaming growth in the next few years.China’s massive network convergence plan should benefit social gamingThe Chinese government has begun a massive nationwide network convergenceinitiative by which it seeks to be able to deliver multiple services to a user through oneconnection. Currently, fixed telephony, television, internet, mobile communications andother forms of media are delivered over disparate, costly and largely redundantpathways. The government is encouraging China’s cable operators and telecomsproviders to deliver most/all of these services over one connection, and to create tightconnections across them so that media can be shared across TV, the internet, on ahandheld, etc. This ambitious convergence initiative should open a window ofopportunity for cross-platform implementation of online games, including social games.Under this ambitious planned framework, it will be possible to play a game interactivelyacross TV, computers, mobile phones, and other devices. We believe that suchconvergence, while likely only to emerge over the next five years, should providegreater access to social games for interested users, while creating valuableopportunities for new participants, such as broadcasting and television companies, toexpand into the online gaming market. “Viral channels” – China’s platforms, Facebook going in opposite directions?One key to the rapid growth in popularity of games on the social networking platformsrelated to the broad, and nearly costless “viral channels” that the SNS platform allowedbetween the game and the platform’s large user base. A viral channel is best describedas any means that leads to the rapid spread of a piece of media, be it a funny videovirally spread on Youtube, to a joke virally spread to millions of Twitter users in a matterof minutes through re-tweets, or a social game attracting massive new registrations, asSNS users respond to their friends’ accomplishments in the game on their SNS walls bythemselves signing up for the game.Deutsche Bank AG/Hong Kong Page 15
  15. 15. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchGame developers, for instance, were permitted by Facebook to send invites to the SNS“friends” of a gamer’s Facebook contacts. Frequent status updates from a player’sachievements in a game were often pushed to a gamer’s wall. These updates, requestsfor assistance, or outright invitations to play the game, would show up in the“Notifications” or news flow of his/her friends, serving to pique the interest of otherusers, thus expanding the player base very rapidly, and with little cost or effort. Samplepostings might include: Alan Hellawell sent you a request in Happy City Alan has attained Level 8 in Happy City! Alan reached Level 8 in Happy City and received a new title of Senior City Planner. Join him and build your own city of happiness!Facebook, from late-2010 onwards, began closing off some of these pathways,consolidating frequent updates into groups of notifications, and limiting theopportunities for games to communicate so widely throughout the SNS platform.Facebook claimed that its users were, as Josh Williams, president of Kontagent puts it,“tiring of the high-volume, low-quality, spam that many apps were sending out. Thisfatigue was reflected in dramatically reduced viral message response rates in manyapps over just a year ago.” Mr. Williams claims that, since Facebook’s changes to usercommunication channels, viral response rates are now trending higher (probablyspecifically because fewer messages are being sent out to each user per week).China social games should clearly benefit should SNS platforms open viral channelsfurtherFrom discussions with both China’s social gaming companies and its leading SNSplatforms, it seems that China’s platforms are experimenting with more liberal viralchannels of communications between games played on the platforms and the largeSNS user bases. In the case of Tencent, social games players can send invites to SNSbuddies. Other promotional channels include free in-game items for buddies and statusupdates on SNS user walls.“Requests” and “Invitations” are indeed among the more common forms of viralmarketing on Tencent. A request, often sent to dozens of a player’s friends, might be “Alan Hellawell is trying to complete a task in the game Farmhand and needs your help. Can you send him a mini-saw?”An invitation, meanwhile, could appear in the following form: “Enjoy the exhilaration of racing the countryside and come play Country Road Race with me!”Opening up APIs to improve gamer experience further, and better empower gamescompaniesThese viral channels are significantly enabled by the APIs that platform owners such asTencent and Facebook extend to their social games partners. Generally speaking, themore APIs that are opened to the games developers, the more interactive and relevantthe game can become. We estimate that there are fewer than 10 APIs available to socialgames developers on Tencent, including: “Request invitation”, “Send present tofriends ” , “ Share information ” (must be confirmed by user) , “ Acquire userinformation”, “Get friend’s information,” “Inner game blog”, etc. Not surprisingly,Facebook offers a wider range of APIs, including “ Feed ” (automatically sharesinformation, does not need the user to approve and confirm); “Request invitation“(the third-party developer can track where the user comes from.) While these links canbe abused and result in spam to the users involved, if applied intelligently, they canPage 16 Deutsche Bank AG/Hong Kong
  16. 16. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets Researchserve to improve the gaming experience, while improving the social games vendor’saccess to valuable information in order to consistently improve game play,monetization, etc. We expect China’s major SNS platforms to continue testing therelease of more APIs to the social games developer community.Open API merely the first step: how the platform "surfaces" games news flow isimportantWhile the basic APIs enable the basic analysis, composition and sharing of playerinformation, the ultimate success in viral sharing relies upon how the underlying SNSplatform "surfaces" and shares this information with other users. Facebook has spentthree to four years attempting to distill and refine the massive flow of data intointelligible, actionable news flow. In September, 2011, Facebook decided to insertgames updates into a "top news" stream into the right-center column of a users page.We believe that Tencent remains far behind Facebook in learning how to curate orsurface these news flows for maximal effect, and we expect progress in this area tobenefit social games.Deutsche Bank AG/Hong Kong Page 17
  17. 17. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchThe basic business modelRevenue sharing with social networking platforms: Chinacompared and contrastedSocial games developers derive a majority of their revenues from virtual goodstransactions. Social networking platforms, in general, share part of their revenues withsocial games developers from virtual goods transactions (for instance, Facebook takes a30% share of all transactions that use Facebook Credits to purchase virtual goods, andZynga and other developers take the remaining 70%). In-game advertising is alsoanother, much smaller, revenue source for social games developers and SNS platforms.Getting to net revenue: channel fees and platform sharingChina’s leading SNS platforms offer a wide range of social games revenue sharing. Weestimate that Renren takes 36-52% of gaming revenue, while competitor Tencent takes70-80% of its social games partners’ revenue. This ratio tends to improve with thepopularity of a specific social game (with more revenue share being given todevelopers). Sina Weibo, however, passes through 100% of its games partner’s revenuein year 1. As we discuss later in this report, we believe that revenue share willincreasingly be used as a weapon among the dominant SNS platforms to win allegiancefrom the social games makers, and thus traffic from SNS users. Below, we profile thebroad social gaming revenue share arrangements of China’s major SNS platforms, andalso compare them with arrangements outside of China. An SNS platform such asTencent will charge its game partner a “channel fee” to cover costs, such as back-endbilling operations, elements of customer relationship management (CRM), etc.Figure 6: Social gaming revenue share arrangements of major SNS platformsPlatform Channel fee Post-channel fee revenue Effective split for platform claimTencent 40% 50-67% 70-80%Renren 20% 20-40% 36-52%Sina Weibo 0% 0% 0%Facebook, USA Combined channel+ rev share 30% 30%Mixi, Japan 20% for desktop, 30% for mobile 2030%Source: Company data, Deutsche Bank estimatesNote: Revenue share at three levels: more popular games enjoy better cut for games developers. Tencent offersrevenue sharing on a progressive basis and uses it as an incentive scheme for outperforming apps developers. Thevalues above are approximate. In the case of Tencent, for instance, channel fees can vary depending on theservices that the company provides to apps developers (e.g. cloud-based services).Among the Japanese platforms, we estimate that Mixi takes a 20-30% revenue cut, asthe table above shows; while both Gree and DeNa take 39%.Additional costs – advertising, bandwidth, otherFigure 6 fails to capture other potentially significant costs beyond revenue share, suchas advertising spend. A social games partner on Facebook, for instance, can spendmore than 100% of the gross revenues of a new game on advertising in the first severalweeks after it launches. Tencent, meanwhile, while staking by far the highest revenueclaim on games revenues, does offer a range of marketing and promotional assistance,although those supporting services seem somewhat opaque as to exactly when (e.g. atwhat scale) a social game qualifies for enhanced marketing support.Page 18 Deutsche Bank AG/Hong Kong
  18. 18. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchHigh profit margins on net revenuesFrom our discussions with industry professionals, the profit margin on net revenue forsocial games (after deducting revenue share and channel fees), can be relatively high(with a gross margin of about 90%), particularly overseas, as there are few significantcosts associated with the sale of virtual items. If we then include major costs, such asserver and bandwidth costs, we believe the average net profit margin in social gamingcan be as high as 50-60%.Focus question: How will the social games business modelevolve?"No one makes any money on Tencent"The past several months of research into this report involved numerous claims fromvarious parts of the social games eco-system that, between the revenue share structurethat Tencent maintains, and other costs associated with operating a game on theplatform, very few social games companies make any money operating on Tencent.We indeed expect the very basic elements of revenue share to evolve in China.Generally speaking, we expect social games developers to enjoy a gradual improvementin revenue realization, if only due to the mounting attempts from the ambitious SinaWeibo platform to gain market share in gaming platform revenues by passing theentirety of its gaming partner’s revenue back to the partner in year 1, and continuing toshare a majority of this revenue in subsequent years. While revenue share per se shoulddecline, other costs are likely to rise, such as advertising costs, as gaming companiesseek to draw attention to their games by placing targeted ads on their host SNSplatforms.More generous revenue share beneficial for social gaming companies; Sina likely to winamong platformsBroadly speaking, better revenue share is likely to mean good things for China’s socialgaming segment. The impact on China’s three aspiring SNS platforms is less clear.Social gaming revenues per se are likely to remain a small minority of each of the threelisted companies’ revenues. However, we believe the broader structural changes thataccompany this one element (including improvements in monetization, time spent, etc.)will eventually benefit Sina over Tencent and Renren.New monetization opportunities: In-game advertising for socialgames, the US precedentAccording to a study from PricewaterhouseCoopers, around USD1bn will be spent in2011 on in-game ads in the United States. PricewaterhouseCoopers expects thisnumber to increase at a 33% CAGR from 2011 to 2015. A majority of this spend will betargeted towards casual and social games, such as simple farming or fishing gamesthat can be played in a short period of time on a smartphone or on the Web. The studyhas found that advertisers feel there is a benefit in advertising through casual games, asthey are easy to play and are generally enjoyed by a wide audience. An analyst fromeMarketer commented that gaming is evolving from a young gamer pursuit to muchmore of a mainstream activity.eMarketer estimates that there are now about 90m casual gamers in the United States,more than double the number of gamers who regularly play on consoles. We expect thegrowing popularity of smartphones and tablets to continue to drive the growth ofcasual/social games. Interestingly, other than the typical web-style banner ad formats,some advertisers are innovatively trying to incorporate characteristics about theircompanies’ attributes into games in order to raise the brand awareness among users;for instance, inserting branded food items into restaurant menus appearing in a game.This type of advertising is known as Product Placement advertising.Deutsche Bank AG/Hong Kong Page 19
  19. 19. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchAccording to technologyreview.com, Google’s AdSense for Games allows companies toplace a message before, during, or after a casual game. Apple also distributes in-gameads through mobile devices. As reported in technologyreview.com, Apple givesdevelopers 60% of the ad revenue. We regard in-game ads for social gaming as beingstill in a nascent stage, with many companies doing beta testing.While mobile ads show promise, virtual goods likely to remain revenue sourceIn China, we have seen social games developers increasingly adopt in-gameadvertising, often in order to promote other games in their own portfolios, those of theirpartners, and various FMCG and other products and services. We would however notethat a report from eMarketer reveals that virtual goods ARPU for mobile games wasUSD7.80 as of September, 2011 (up from USD0.30 as of September, 2009), whileadvertising ARPU was only USD1.20 (actually down from USD1.50.)Page 20 Deutsche Bank AG/Hong Kong
  20. 20. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchThe Chinese social gamerProportion of social networking users playing social gamesAccording to the statistics of AppLeap and Great Wall Club, about 34% of Chinese SNSusers log into social networking sites every day; while 40-50% of Chinese SNS users loginto social networking sites due to social games. In addition, Chinese online users areeager to play online social games. About 34.69% of SNS users have played more than10 social games on SNS platforms, and this category represents the largest number ofonline users over the number of social games played. Only about 15.65% of SNS usershave never played social games before. Recent research from insidesocialgames.comhas shown that male gamers between the ages of 18 and 34 tend to monetize infreemium games at higher rates than most other demographics.According to IDC, Tencent’s Qzone SNS destination was the most frequently visitedsocial networking platform by social gamers in 2010 (90.8%), followed byKaixin001.com and Renren.com. We believe that the data shown in the figure belowmay understate Renren’s market share, given the sheer number of games on theplatform, and the basic traffic numbers as shown by Alexa.com and other third-partytraffic tracking services. The survey, released in April of this year, also fails to capturethe recent rise of Sina Weibo’s games center.Figure 7: Selection of social networking platforms by China social gamers as at year-end2010 Qzone 90.8 Kaixin001.com 4.3 renren.com 3.2 51.com 0.8 bai.sohu.com 0.3 dream.163.com 0.3 Others 0.1 0.0 20.0 40.0 60.0 80.0 100.0 % of respondentsSource: IDC and GPCNote: “Qzone” is a Tencent social networking propertyIn addition, more than two-thirds of social game users regard the “fun to play” aspectsand convenience of use to be their main determinants in choosing the type of socialgame to play. Referral from friends is also another important element in the selectionprocess.Deutsche Bank AG/Hong Kong Page 21
  21. 21. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchA similar study from iResearch revealed that about 25.3% of Chinese SNS users playsocial games every day, while 33.2% of users reported that they play social games“sometimes.” Another 22.9% of users mentioned that they have played social gamesbefore. We attribute the relatively high rate of occasional players of social games to theshorter gaming cycle of social games, and the lack of depth that the average MMORPGoffers, which tends to lower user stickiness and retention ratios.Figure 8: Proportion of social networking users playing social games in 2011 Played sometimes 33.2% Played daily 25.3% Have once played 22.9% Never played before 17.2% Dont know what social game is 1.4% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% % of respondentsSource: iResearchTypes of social games played by users by year-end 2010Among the major types of social games, character education games were the mostpopular as at year-end 2010.Figure 9: Types of social games played by users as at year-end 2010 Character TCG (e.g., Fashion Life) 90.1 Simulation Game (e.g., Glory Hospital, Renren Dining 4.7 room, Crazy Football, etc.) Farm TCG (e.g., The Farm, The Ranch, The Sea Island, 2.6 Fish Raising, etc.) Interactive social games (e.g., Friends for Sale, 2.2 Parking Dispute, etc.) Chess Game (e.g., Texas Holdem Poker) 0.3 Puzzle Game (e.g., Papaya Diamond, LLK) 0.1 Others 0.0 0 10 20 30 40 50 60 70 80 90 100 % of respondentsSource: IDC and GPCReasons people stop playing social gamesRegarding the reasons why people choose not to continue playing a social game, 48%of people mentioned lack of fun, while 41% of users mentioned that they had not had agood gaming experience. About 31% of users attributed the reason to instability of thegaming environment. As such, we believe companies that have consistently high-quality content generation ability and strong operational ability will become morecompetitive in China’s social games market.Page 22 Deutsche Bank AG/Hong Kong
  22. 22. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchSocial games versus traditional on-line gamesShorter development time, life cycle for social gamesThe development period for social games is usually shorter than MMORPG games.From our discussions with several social games developers, the development time for asocial game is around three to four months. Some can go beyond 6 months, dependingon the complexity of the game. There is usually an additional one to two monthsneeded to fine-tune a game before it is launched on the market. In contrast, thedevelopment period for MMORPG games is one to three years, again largely dependingon the complexity of the game. Although social games have relatively shortdevelopment periods, the games tend to have shorter life spans than MMORPGs.In general, gamers tend to refer to stronger psychological satisfaction in playingMMORPGs than in social games, as the former offer more sophisticated gaminginterfaces, story lines and content.Low ARPU for social gamesIn China, monetization remains a challenge for social game developers, despite the highpopularity of social games. From our discussions with several social game industryplayers, the ARPU for domestic social games is around RMB3 to RMB5 per month,while that of MMORPG is around RMB66.7 per month (RMB200 per quarter).Discussions with several industry professionals also revealed that ARPU for US socialgames is around USD0.9 per month (RMB6 per month), which is slightly higher thanthat of China.Many Chinese developers are looking for opportunities in the international markets, asthey have relatively higher ARPUs than their Chinese counterparts. According to anestimate by the CEO of Rock you, ARPU in Japan is up to 12x greater than in China.Upside opportunity for active user payment rateSocial games, in general, have a shorter gaming cycle. We believe the willingness ofusers to pay much for virtual items, etc., remains relatively low compared withMMORPG games. Discussions with industry professionals suggest that the active userpayment rate of social games in China is believed to be in the range of 0.5% to 1.5%,depending on the various aspects of each game. In comparison, Facebook’s active userpayment rate of social games is believed to be about 1%. Broadly speaking, the activeuser payment rate of social games in China is thus similar to that in the US. We believeChinese game users, in general, are used to pay for virtual items online.Distribution of work differs dramatically between traditional on-line games and socialgamesWhile the development timeline of a social game can be as little as two to three months(and that of an MMORPG two to three years), management at one social games housesuggested that 70% of the work around a social game occurs after a platform launch,with developers working around the clock to add refinements and other updates asfrequently as weekly. “Expansion packs”, as they are referred to in the MMORPG world,may happen only once or twice a year, or even less frequently.Social games are more likely to convert non-gamers into gamersSocial games are usually free to play and are easy to learn; as a result, it is more likelyto convert non-gamers into gamers. We believe social games appeal to a wideraudience range when compared with MMORPGs’ target audience. Social networksleverage their large user base in promoting their games. We believe having an activesocial network is vital for the growth and development of social games. Many non-gamers on SNSs have picked up playing social games, following friends introducing thegames to them. Gamers enjoy chatting with friends, posting updates to their walls, etc.,thus contributing to a totally different gaming experience.Deutsche Bank AG/Hong Kong Page 23
  23. 23. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchDegree of cannibalization of traditional gamesSocial games are easy to learn, and are enjoyed by a wider audience range, whencompared with the MMORPGs’ target audience. Industry statistics from marketresearch firm IDC have shown that gamers are able to chat in a social game, whileactively playing the game, due to the relative ease of control compared with MMORPGgames. In addition, according to the 2011 China web-based game survey report, 53.1%of web-based game users received information regarding social games throughrecommendations from friends or other people. The content on gaming websites is alsoan effective way to promote social games. About 48.3% of users have shown interest ina particular game by reading the description of games on gaming websites. We believethe usage shift to social games from MMORPGs is likely to be detrimental to overallonline gaming growth, due to the low paying ratio and ARPU of social games.Furthermore, social games tend to have less monetization ability than MMORPGs. Inour view, China’s MMORPG market has been largely over-monetized in the past severalyears.Social games are taking up possible MMORPG airtimeIn a recent China TMT Daily dated Oct 17 with title “East meets west: student SNSusers”, Online PHD, a resource provider for potential, current and former PHD students,recently conducted a study about students’ activities on Facebook. The study showsthat students, both graduates and undergraduates, spend roughly 100 minutes onFacebook, with six visits, on average, each day. In terms of activities, “less engaged”students (per number of friends and posts) mostly spend their time on Facebook forplaying social games, while more engaged students normally comment on posts andbrowse photos.Renren recently analyzed college students’ usage of SNS in China. According to itssurvey, based on 800 college students’ visits on Renren, around 96% visited theplatform, averaging 1.8 visits and 1.1 hours on the platform per day. Those visitors, onaverage, generated 0.7 posts, shared 3.7 pieces of user-generated content (UGC),browsed 8.4 posts and played social games on a daily basis. The study also suggeststhat Renren, Tencent’s Pengyou and Douban are the three most visited social networkplatforms among students. More than 80% of the 90s generation use IM and SNS tokeep in touch with classmates and friends, as well as relatives, and accounted fornearly 47% of students’ regular contacts. Similar to the US, Chinese universities havestarted to use SNS to market to, and interact with, students.Based on the above statistics, social network sites, such as Facebook, Renren andTencent’s Pengyou, have become part of must-visit web sites every day and these userstend to play social games on a daily basis. We believe this has taken up possibleMMORPG airtime. Online users now have the option of spending their time on SNSsrather than on their MMORPG portal. Below is a chart showing the rapid decline in timespent on online games and the increase in time spent on social platforms from aniResearch study.Ultimate characterization of the Chinese social gamer hard to predictThe Chinese social gamer is, in many ways, a new creature. Not only are the gamedynamics quite different from traditional Chinese on-line gaming, but much of theChinese social gamer demographic has never played on-line games before. It is thus notclear how much time and money these players will spend playing social games, orwhen, if ever, they will tire of them, etc.Page 24 Deutsche Bank AG/Hong Kong
  24. 24. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchFigure 10: User time spent on Internet applications 40% 35% IM 30% 25% Online gaming 20% Online video 15% SNS 10% Search News 5% E-commerce 0% 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11Source: iResearchDeutsche Bank AG/Hong Kong Page 25
  25. 25. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchBattle of the platformsAnalysis of extremes: Tencent vs. SinaTencent takes a more aggressive cut of social games revenuesAs we have mentioned in previous sections of this report, social game developers derivea majority of their revenues from virtual goods transactions. Social networkingplatforms in general share part of the revenue with the social game developers from thesale of virtual goods transactions. Current social game dominant player Tencent takes amore aggressive cut of social games revenues (an estimated 70% to 80% of itspartners’ revenue). We believe that the effective revenue share can go beyond 80% dueto the additional services Tencent provides its game partners, including advertisingservices. Leading real-name player Renren takes an apparently more modest 36-52% ofgross revenue, a level which similarly rises should a social gaming partner seek, forinstance, to advertise on the Renren site.Drivers behind Tencent’s revenue share arrangementsTencent management indicated that in 3Q11, the number of gaming apps on bothplatforms exceeded 10,000. Some of the gaming apps are also accessible on TencentMicroblog and Q+ platforms. Tencent currently has more than 500 social games on itsQzone platform alone. However, from the discussions with several industryprofessionals, the number of Tencent’s in house developed social games available onthe Qzone platform does not exceed more than ten games, which represents only amere 2% of the total number of Qzone social games. However, significant revenues(“significant double digits” of total Tencent social game revenues) are believed to begenerated from these in-house developed games. We believe Tencent is likely to havegiven priority to its in-house developed social games, including more advertising spacefor the games on the Qzone platform, more aggressive advertisements, shorter gamereview periods, other free resources, etc. In-house developed games obviouslycontribute 100% of their revenue to the Tencent platform.Sina 100% revenue share likely to drive market gainsSina Weibo is, in our mind, the major emerging platform in the SNS market, andpossibly stands to gain the greatest incremental traction in social gaming. Scale,however, could be a challenge. Sina Weibo currently has less than 50 social gamesavailable on its platform, far below the 500 social games available in Tencent’s Qzone.In order to gain market share, Sina is now offering 100% revenue sharing with its socialgames partners in the first year. The number of active users on Qzone alone was 539min 3Q11. While Sina does not disclose the number of active users on its Sina Weiboplatform, we estimate the number of monthly active users is around 20% of its totalregistered users (about 250m), reaching 50m. In order to determine which company willoffer a higher revenue to social game partners, our rationale is to use this formula:(number of active users * rate of paying active users * ARPU * revenue share portion).As neither company discloses the ARPU for social games and Sina does not disclose itsrate of paying active users, it is hard to estimate which company will offer a higherrevenue to social game partners.Page 26 Deutsche Bank AG/Hong Kong
  26. 26. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchFocus question: Will the SNS platform order change?Our upgrade of, and preference for, Sina to some extent driven by social games gainsGiven these very disparate revenue share terms, we have begun to see nearly all of thegame developers interviewed for this report begin to develop games for the Sina Weiboplatform, creating a good opportunity for Sina to build market share. In the next one ortwo years, we view Sina as gradually taking market share away from Renren andTencent owing largely to the 100% revenue share Weibo is offering. We do not expectSina to scrap its 100% first-year revenue share strategy in the short term until it hasgained a significant market share in the social game industry.Much of the social games community seems to welcome the disruptive presence of theSina Weibo platform. Developers like that the Sina Weibo user tends to be of awealthier, white collar pedigree, compared to the prevailing profile of the Tencent useras being younger and less wealthy. Indeed, some of the more successful games on SinaWeibo, such as Boyaa Texas Hold’em, boast amongst the highest ARPUs in the sector.Challenges in Sina Weibo’s attempts at social gamingHowever, Sina Weibo faces a wide range of challenges. First and most immediatelyapparent is the still-inadequate offerings and forms of support that it offers to gamesdevelopers relative to the likes of more seasoned operators such as Renren andTencent. Tencent for instance has:1. A well-established online payment system (users can pay by Q coin or Tenpay to purchase items of the apps). Much of the platform’s massive user base has a long- term billing relationship with Tencent, and online payment behaviors are well established.2. Extensive marketing and promotional resources including cross-selling across other Tencent platforms, the bundling of apps privileges into monthly subscriptions, and self-help advertising delivery.3. Relatively strong technical support (e.g. cloud-based services), and data analysis (user demographic, online behavior, traffic, etc.)Sina seems to lack these strengths, although we believe it is racing to come up to parwith Tencent on these and other fronts.The Weibo user: although wealthier than the Tencent QQ user, interest in games not asclearWe would also note that the same qualities of the Weibo user (being largely whitecollar, coastal urbanites) may well preclude much traction for the platform on the socialgaming front. Such a profile of user may not have the same level of time or interest toplay games on-line. From another perspective, the Sina Weibo platform at its heart ismore media-oriented (users trawling tweets for newsflow, celebrity updates, etc.). SinaWeibo since its launch has been accepted above all as an effective information centerand powerful media channel by users. It is unclear whether the average user will findcause to expand his/her Weibo usage beyond following movie stars and newsflow, tobegin playing games.On the other hand, most of Tencent’s properties are at their core more oriented towardrecreating, socializing and communicating. Gaming is in this light a natural extension ofthese areas. And with Tencent deriving some 55% of current revenues from traditionalon-line gaming, it would make natural sense that China’s largest SNS platform wouldalso dominate in social gaming.Deutsche Bank AG/Hong Kong Page 27
  27. 27. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchDespite disparate demographic, forecasting 20%+ of SNS gaming usage market sharefor Sina by 2013Extrapolating from the amount of development China’s leading social gaming houseshave diverted to the Sina Weibo platform, assuming that both overall SNS time spentwill continue to shift to Sina Weibo and a more generous revenue share regimecontinues, we would expect Sina Weibo to capture at least 20% of China’s SNS gamingusage by 2013. We view the number of daily active users (DAU) as a useful proxy formarket share. We estimate that Sina Weibo’s games portal already boasts 10%-15% ofthe DAU AND MAU of Tencent. This level may have already exceeded Renren, which bysome accounts is about 10% of the DAU/MAU of Tencent.Domestic social games active user payment rate is similar to that in the USFrom discussions with industry professionals, we believe the domestic social games’active user payment rate to be 0.5-1.5%, depending on the various aspects of eachgame. We meanwhile estimate the active user payment rate on Facebook to be about1%. Broadly speaking, the active user payment rate of social games in China is thussimilar to that in the US. We expect this rate to gradually increase as the marketdevelops further and monetization mechanisms improve.Page 28 Deutsche Bank AG/Hong Kong
  28. 28. Deutsche Bank 02 December 2011 Software & Services China Internet InsightsMarkets ResearchCompetition in China socialgamingPeeling away the layers of competitionAre China’s traditional online gaming companies viable competition?We do not regard the leading lights of traditional Chinese on-line gaming, such asNetease, Shanda and others, as constituting significant competition to China’s pure-play social gaming segment going forward. The former category of companies, withyears of refining business models built around delivering massive MMORPG projectsover as much as a few years supported by multi-million dollar budgets, seem to find themore compact development timelines, lighter focus on content and story line, andfrequent, real-time database-driven updates somewhat anathema to their core valueproposition. The sticker shock of such low ARPU’s may also have dissuaded thesecompanies from developing much social gaming competence. We also believe that theneed to interact relatively deeply with the underlying SNS platforms, and specificallycompetitor Tencent, does not appeal to these largely client-based development housesand distributors.How will the partner-competitor relationship with Tencent, Renren evolve?Outside of fellow third-party social games developers, the companies we profile towardthe end of this report actually find their most direct competition embedded in the SNSplatforms in China from which they operate. For instance, on numerous occasions,Tencent Chairman Pony Ma has emphasized the company’s growing commitment toboth its open API initiative, and the third-party games and other applications it isdesigned to encourage, we believe, that Tencent continues to derive a vast majority ofits games revenues on platforms such as Qzone from its own web games and socialgames. Judging from statements from leadership from both companies, we predict thatTencent and Renren will gradually shift emphasis from internally developed gamestoward a greater collaboration with, and dependence upon, third-party social games.Profile of a successful Chinese social game: Hoolai Three KingdomsOne of China’s more successful social games companies is Hoolai. With a heavyemphasis on the local market, the company recently reported peak DAU of more than10m and peak MAU of more than 40m on the Tencent platform. Tencent’s top third-party social game is Hoolai Three Kingdoms. As we profile later in this report, ThreeKingdoms was launched in December 2010, and is a flash-based game. The game isbased on the Chinese Three Kingdoms tale from ancient Chinese history. It is acombination of strategy and city-building simulation. Management estimates averageDAU of 5-6m, and MAU of 30-40m. Local media sources suggest that monthly revenuestands at RMB35-45m.Hoolai Three Kingdoms DAU and MAU not too far off Facebook leader CityVilleAccording to AppData, Zynga’s game CityVille currently tops the Facebook charts with10.6m DAU, and MAU of 50.3m. Hoolai Three Kingdom’s user numbers are thus not toofar off those of the world’s most popular social game. While it is impossible to define anaverage social game, we would compare the numbers above to more commonplaceDAU levels on the Chinese SNS platforms of 100,000-200,000, MAU of 300,000-500,000, and monthly revenue of RMB300,000.Deutsche Bank AG/Hong Kong Page 29

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