2011 Internet Sector Outlook by J. P. Morgan

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2011 Internet Sector Outlook by J. P. Morgan (January 2011 report)

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2011 Internet Sector Outlook by J. P. Morgan

  1. 1. North America Equity Research January 2011Nothing But Net2011 Internet Sector OutlookInternet, Media & EntertainmentImran KhanACSenior Analyst(212) 622 6693 622-6693Imran.t.khan@jpmorgan.comJ.P. Morgan Securities LLCSee the end pages of this presentation for analyst certification and important disclosures.J.P. Morgan dJP M does and seeks t d b i d k to do business with companies covered in it research reports. A a result, i ith i d i its h t As lt investors should b aware th t the firm may t h ld be that th fihave a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making theirinvestment decision.
  2. 2. New Forces Threaten to Disrupt the Order of Traditional Industries Social Over the Top p Networks N t k Retail Travel Publishing TV Movies News Media Globalization Mobile The Bottom Line: Companies that don’t embrace these trends could find themselves in danger by the end of the decade. Source: J.P. Morgan. 1
  3. 3. A New World: What a Difference 10 Years Make!! 2000 2010 1,320 1,258 S&P 500 Index Dec 29, 2000 29 Dec 30 2010 Wireless Subscribers 97M 293M • Data Pl D t Plans (i R (in Revenue) ) $0.1B $0 1B $46.8B $46 8B Internet Users 124M 240M $28B $166B US eCommerce ~$18B ~$2B • Amazon $0.02B $0 02B $21.90B $21 90B Google (Search) (2 yrs old) (F’10 net rev) 500M+ Users Facebook (Social) Didn’t Exist Monetizing 100B views/yr Founders working for PayPal YouTube ~12M users streaming No Streaming Option NetFlix N tFli Source: J.P. Morgan. 2
  4. 4. What will 2015 or 2020 look like?Source: Viacom. 3
  5. 5. Dot.Khan sDot Khan’s Top Ten Things to Watch  Continued adoption of social media and its impact on existing businesses such as advertising, entertainment and eCommerce.  Increased smartphone penetration will further proliferate mobile web usage and app development and could disrupt the way we shop, consume content and communicate.  Consumers embracing “over the top” video consumption. We think content owners, distributors and advertisers must embrace the new order and either partner with Netflix or other services or launch their own.  Monetization of mobile search is a critical factor for Google’s growth.  US brick & mortar retailers’’ markett share losses could accelerate. Additionally, we expectt materiall markett bi k t t il k h l ld l t Additi ll t i k share shifts in countries such as China, where B&M brands are relatively weaker.  The online hotel business retains significant runway for international growth, and we expect an above- industry-average g y g growth rate in the segment. g  We expect more consolidation/M&A rather than share buybacks.  Despite its underperformance of the search market growth rate for most of the last ten years, we think display should match search revenue growth in 2011 2011.  We believe rapid internet and smartphone penetration growth will create many more exciting businesses outside the US – but we expect US companies to face major challenges in markets outside Western Europe.  We expect a major effort by internet companies all over the world to woo local advertisers. 4
  6. 6. Dot.Khan sDot Khan’s Top Ten Things to Watch  Continued adoption of social media and its impact on existing businesses such as advertising, entertainment and eCommerce.  Increased smartphone penetration will further proliferate mobile web usage and app development and could disrupt the way we shop, consume content and communicate.  Consumers embracing “over the top” video consumption. We think content owners and advertisers must embrace the new order and either partner with Netflix or other services or launch their own own.  Monetization of mobile search is a critical factor for Google’s growth.  US brick & mortar retailers’ market share losses could accelerate. Additionally, we expect material market share shifts i countries such as Chi h hift in ti h China, where B&M b d are relatively weaker. h brands l ti l k  The online hotel business retains significant runway for international growth, and we expect an above- industry-average growth rate in the segment.  We expect more consolidation/M&A rather than share buybacks.  Despite its underperformance of the search market growth rate for most of the last ten years, we think display should match search revenue growth in 2011.  We believe rapid internet and smartphone penetration growth will create many more exciting businesses outside the US – but we expect US companies to face major challenges in markets outside Western Europe.  We expect a major effort by internet companies all over the world to woo local advertisers advertisers. 5
  7. 7. Social Networking: A Next-Gen Web Platform/Traffic Gateway We See Social Sites as Network Platforms like Visa/MasterCard  Don’t Need to Monetize Directly from Customers  Can Enable Applications, Then Collect a Small Fee as Network Provider  Casual Games  Virtual Gifts  eCommerce Social Networks as a Platform eCommerce sites Analytics such as Zappos.com Google Content sites Comparison shopping such as NY Ti h Times such as shopping.com h h i Intuit MS Office Windows Adobe Photoshop Chase US Bank Payment MasterCard Visa Networks (e.g. Visa/MasterCard) Chase Ch Wells Fargo W ll F Visa Debit Card MasterCard Social Games Business/Nonprofit such as Farmville apps such as Causes pp Social Net orking Sites Networking Utility apps such Communication tools as Birthday Cards such as Windows Source: J.P. Morgan. & Horoscopes Live Messenger 6
  8. 8. Social Networking: Facebook Leading the Race Facebook Reach Now Comparable to Yahoo!, Google  Facebook’s user reach is now north of 70% of all US internet users Facebook s  In 2H’10, users are for the first time spending more minutes on Facebook than on Yahoo! sites Facebook’s Expanding User Reach FB Minutes Surpass Yahoo!’s 100% Users as % of US I nternet 14% % of All US I nternet Minutes 12% 80% 10% 60% 8% 40% 79% 84% 79% 81% 6% 12% 70% 9% 10% 48% 4% 20% 4% 5% 2% 4% 0% 0% Yahoo Google Facebook Yahoo Google Facebook Aug-Oct 09 Aug-Oct 10 Aug-Oct 09 Aug-Oct 10 Source: comScore, J P Morgan estimates. S S J.P. M i Source: comScore, J P Morgan estimates. S S J.P. M i  The Tollbooth at the Center of the More than Half of Facebook Users Visit Site Daily Internet 40% 35%  Social Networking Sites (Primarily 30% 25% 38% 29% 20% Facebook) Are Becoming the Next- 15% 13% 13% 8% Generation Web Platform 10% 5%  Payments, Games, Payments Games eCommerce all 0% At least once a Almost ev ery day 1-2x a w eek 1-2x a month Nev er potentially game-changing opportunities day Source: J.P. Morgan consumer survey. 7
  9. 9. Social Networking: Becoming an Important Traffic Source A Potential Threat to Google’s Dominance?  Google currently generates ~36% of all online ad revenue by being at the center of the 36% ecosystem  Thus far, Google largely retaining its share, but Facebook gaining rapidly  The ability to drive traffic is highly connected to the ability to drive revenue  We think Facebook Connect is helping drive this trend (see next slide) Traffic to nytimes.com Traffic to Amazon Sites Traffic to eBay Sites 25% 25% 15% 20% 20% 15% 10% 15% 10% 20.8% 20.4% 2.9% 10% 20.0% 19.6% 11.8% 11.4% 5% 5% 2.6% 4.8% 5% 1.8% 7.7% 4.7% % 0% 0% 0% Google, -2% Y/Y Facebook, +66% Google, -2% Y/Y Facebook, +328% Google, -3% Facebook, +81% Oct-09 Oct-10 Oct-09 Oct-10 Oct-09 Oct-10 Source: comScore. 8
  10. 10. Social Networking: Becoming an Important Traffic Source  Facebook Connect: Used by over 250M users / month  Lets users use Facebook login on other sites and link activity back to their profile  The next step in the evolution of discovery: Traditional Early Web y 2000s Web Social Web Portal site Search site Social site User’s Curator: Editor Editor User Connections Fragmentation: Limited Limited Growing Multiplying Mismatch of editors’ User has to know User has to know Lack of intent- Limitation: interests vs. where to look what to search for based search readers’ Source: J.P. Morgan. 9
  11. 11. Understanding Social Games Global digital gaming market was almost $16B in 2009 and is expected to reach $20B in 2010, according to Electronic Arts; we believe social games, which are a subset of digital, are growing significantly faster than the segment as a whole Digital gaming grew at ~36% CAGR since 2004 and now represents 41% of the worldwide games market, up from 14% six year ago Key social gaming companies: Zynga, Playfish, CrowdStar, Playdom et al More Frequent Facebook Visitors Also Play Games More Often Use FB: At least 1x /day 54% play games Almost ev ery day 38% 1-2x a w eek 20% 1-2x a month 6% 0% 10% 20% 30% 40% 50% 60% % of users playing social games, by frequency of FB visits Source: J.P. Morgan December 2010 consumer survey. 10
  12. 12. Dot.Khan sDot Khan’s Top Ten Things to Watch  Continued adoption of social media and its impact on existing businesses such as advertising, entertainment and eCommerce.  Increased smartphone penetration will further proliferate mobile web usage and app development, and could disrupt the way we shop, consume content and communicate.  Consumers embracing “over the top” video consumption. We think content owners and advertisers must embrace the new order and either partner with Netflix or other services or launch their own own.  Monetization of mobile search is a critical factor for Google’s growth.  US brick & mortar retailers’ market share losses could accelerate. Additionally, we expect material market share shifts i countries such as Chi h hift in ti h China, where B&M b d are relatively weaker. h brands l ti l k  The online hotel business retains significant runway for international growth, and we expect an above- industry-average growth rate in the segment.  We expect more consolidation/M&A rather than share buybacks.  Despite its underperformance of the search market growth rate for most of the last ten years, we think display should match search revenue growth in 2011.  We believe rapid internet and smartphone penetration growth will create many more exciting businesses outside the US – but we expect US companies to face major challenges in markets outside Western Europe.  We expect a major effort by internet companies all over the world to woo local advertisers advertisers. 11
  13. 13. Future of Mobile Advertising Worldwide Mobile Phone vs. Broadband Penetration Mobile phone scale on par with television = 6 Billions huge ad opportunity 4 2 There is much room for broadband 0 subscription growth 2005 2006 2007 2008 2009 2010 Mobile Subscriptions Internet Users Fix ed Broadband Subscriptions Mobile Broadband Subscriptions Use of the mobile web is becoming Source: adenyo presentation. presentation mainstream: eMarketer estimates ~7.5% of all media time spent by US adults is happening on Time spent across platforms is becoming more mobile fragmented – Mobile usage only accelerates this trend 35% 31% 28% 30% Mobile is creating more media 25% 20% 16% fragmentation; posing new challenges / 12% 15% opportunities for advertisers and content 10% publishers 5% 0% Print Radio TV Online Early leaders in the field: Phone OEMs & Source: Yahoo! 2010 Investor Day presentation. OSs 12
  14. 14. Still Very Early Stage of Mobile Ad Adoption Cycle US Mobile Ad Spend Forecast $ in millions $3,000.0 $2,036.8 $2,549.5 $2,500.0 (36%) (25%) $1,501.3 $2,000.0 $1,102.4 (36%) $1,500.0 $743.1 (48%) $416.0 (79%) $1,000.0 $1 000 0 (30%) $500.0 $- 2009 2010 2011 2012 2013 2014 US Mobile Ad Spend Source: emarketer, Sep 2010. US Mobile Ad Spend Share by Format 2014 2013 2012 2011 2010 2009 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Messaging Display Search Video Source: emarketer, Sep 2010. 13
  15. 15. Mobile Devices – More than Just a Phone  We estimate that there are approximately 233M mobile phone users in the US, and smartphones are becoming an increasingly large proportion of the mix Smart vs. Nonsmart Phone Penetration Smartphone Users, 18% Non-smartphone Users, 82% Source: Nielsen 2010 Media Industry Fact Sheet.  Smartphone users are 3x more likely to browse the mobile web and to use a mobile app and 2x as likely to send photos or videos (comScore) 14
  16. 16. Mobile Devices Present Some Challenges in Addition to Opportunities Opportunity Challenge Search more searches less coverage more targeted less transactional (eCommerce) more product/place oriented application demand News Sites reinstates the importance of a strong brand less space to p ads p g p put people download branded apps companies with lower brand recognition less likely to sell apps Games more time spent multiple platform/device compatibility issues less barriers to entry smaller screen/fewer buttons hard to differentiate in crowded app market Aggregators slow loading speed will make aggregators less coverage more attractive to consumers reach larger audience with more available apps allow consumers to create own personal time aggregation Video high demand for video content while smaller screen traveling still run into internet issue of how to monetize Coupons larger audience than print may be harder to track source for in-store use can access for immediate demand Source: J P Morgan J.P. Morgan. 15
  17. 17. eReaders: A Different Kind of Mobile Device Although a Majority Don’t Read Much, Device proliferation is driving ubiquity ~16% Read 26 Books per Year 16% R d 26+ B k Y Prices falling as devices get better 60% 49% A niche market can still be a big market 50% 40% We think the money’s in content % 30% 20% 20% 10% Content means more than just books 10% 9% 7% 6% 0% eBook success could threaten traditional 0-10 books/y r 11-15 16-20 21-25 26-30 31+ retail Source: J.P. Morgan Internet Team December 2010 Survey. eBooks Penetration of Trade Print Is Growing Exponentially 10% 9% 8% 6% 3% 4% 1% 2% 0.5% 0.6% 0% 2006 2007 2008 2009 2010 eBooks as % of Trade Print Source: Association of American Publishers; J.P. Morgan estimates. Note: 2010 estimate based on Jan-Oct data. 16
  18. 18. eReaders: Marketing and Price Drive Penetration  Amazon has marketed 100% Kindle aggressively, and 80% its brand awareness is up 60% to 76% 40% 76% 84% 20% 45% 0% Kindle Nook iPad Brand Aw areness (Know the name & w hat it is) Source: J.P. Morgan Internet Team December 2010 surveys.  Compared to our mid-2009 30% 25% survey, significantly more 20% users said they either 15% 28% owned a Kindle or planned 10% 5% 7% to buy one in the next 12 0% months Jul 2009 Dec 2010 % say ing they either ow n a Kindle or plan to buy one in the nex t 12 months Source: J.P. Morgan Internet Team July 2009 and December 2010 surveys. 17
  19. 19. Is the iPad a Kindle Killer? No No.  When the iPad came out, many investors feared it would be the end of the Kindle  These fears appear to have been misplaced: Kindle has sold well in recent quarters  We think the price difference is one key factor: $139 for the lowest-priced Kindle vs. $499 for the lowest-priced iPad  Our survey suggests people are happy with both: ~40% of iPad owners also reported owning a Kindle  Another 23% of iPad owners plan to buy a Kindle in the next 12 months Not mutually exclusive: Many of the iPad owners in our survey also reported owning Kindle Also ow n Kindle 40% Plan to buy Kindle nex t 12 months 23% No plan to buy Kindle 23% Dont know / Not sure w hat Kindle is 14% Percentage among iPad Ow ners in our Surv ey 0% 20% 40% Source: J.P. Morgan Internet Team December 2010 survey conducted by a third-party vendor; 1,002 total survey respondents. 18
  20. 20. Dot.Khan sDot Khan’s Top Ten Things to Watch  Continued adoption of social media and its impact on existing businesses such as advertising, entertainment and eCommerce.  Increased smartphone penetration will further proliferate mobile web usage and app development and could disrupt the way we shop, consume content and communicate.  Consumers embracing “over the top” video consumption. We think content owners and advertisers must embrace the new order and either partner with Netflix or other services or launch their own own.  Monetization of mobile search is a critical factor for Google’s growth.  US brick & mortar retailers’ market share losses could accelerate. Additionally, we expect material market share shifts i countries such as Chi h hift in ti h China, where B&M b d are relatively weaker. h brands l ti l k  The online hotel business retains significant runway for international growth, and we expect an above- industry-average growth rate in the segment.  We expect more consolidation/M&A rather than share buybacks.  Despite its underperformance of the search market growth rate for most of the last ten years, we think display should match search revenue growth in 2011.  We believe rapid internet and smartphone penetration growth will create many more exciting businesses outside the US – but we expect US companies to face major challenges in markets outside Western Europe.  We expect a major effort by internet companies all over the world to woo local advertisers advertisers. 19
  21. 21. Over the Top Video – A Consumer-Driven Tsunami  Approximately 12M Netflix subscribers are taking advantage of streaming services  With millions of devices out there (and another 46M tablets projected by JPM’s computer and hardware JPM s analyst to be sold in 2011), we think consumers’ appetite to view content in a broader range of ways is growing rapidly  We think members of the younger generation are more willing and more open to consuming content from alternative sources and on alternative devices  Our survey suggests as many as a quarter of pay TV subscribers would consider cutting the cord, and most of them would do so even at the loss of live sports. Those who are already using Netflix Watch Instantly (streaming) are even more open to cutting the pay TV cord  The success of Netflix is attracting additional entrants into the space 20
  22. 22. “Over the Top” Survey Results Over Top More than 25% would consider Over the Top – Including 16% of those who are currently satisfied with pay TV lineup & pricing Would you consider switching from Cable to Broadband Video? Among users who subscribe to a cable/satellite TV package 75% 50% 72% 25% Source: J.P. Morgan consumer survey. 28% 0% Yes No Source: J.P. Morgan consumer survey.  63% of these would consider it even if it meant losing access to live sporting events 21
  23. 23. “Over the Top” Survey Results Over Top Netflix Watch Instantly subscribers are more likely to consider dropping their cable packages Those who use Watch Instantly are more likely to consider switching away from Cable 75% 50% 67% 25% 58% 53% 42% 47% 33% Source: J.P. Morgan consumer survey. 0% Not a NFLX subscriber Nev er used streaming/tried once Stream at least 1-2x /month Would consider dropping pay TV / dont hav e pay TV Would not consider Source: J.P. Morgan consumer survey. g y  Netflix subscribers are more likely to also be premium pay TV subscribers  (And premium pay TV subscribers are more likely to be Netflix subscribers) 22
  24. 24. Online Video Advertising Market to Grow in 2011,Mainly Due to Shift of Quality Video Content Online Viewing online videos has become the norm Online Video Viewer Trends thousands 40,000,000 40 000 000 185,000 185 000 180,000 30,000,000 175,000 20,000,000 170,000 165,000 10,000,000 10 000 000 160,000 0 155,000 Oct- Nov - Dec- Jan- Feb- Mar- Apr- May - Jun- Jul- Aug- Sep- Oct- 2009 2009 2009 2010 2010 2010 2010 2010 2010 2010 2010 2010 2010 Source: comScore d S S data Total Unique Vi ers (000) T t lU i View Videos (000) Vid Source: comScore data. Content quality is improving Ad formats are diverse; performance measures are limited but improving Brand advertisers are increasingly adopting the model 23
  25. 25. Dot.Khan sDot Khan’s Top Ten Things to Watch  Continued adoption of social media and its impact on existing businesses such as advertising, entertainment and eCommerce.  Increased smartphone penetration will further proliferate mobile web usage and app development and could disrupt the way we shop, consume content and communicate.  Consumers embracing “over the top” video consumption. We think content owners and advertisers must embrace the new order and either partner with Netflix or other services or launch their own own.  Monetization of mobile search is a critical factor for Google’s growth.  US brick & mortar retailers’ market share losses could accelerate. Additionally, we expect material market share shifts i countries such as Chi h hift in ti h China, where B&M b d are relatively weaker. h brands l ti l k  The online hotel business retains significant runway for international growth, and we expect an above- industry-average growth rate in the segment.  We expect more consolidation/M&A rather than share buybacks.  Despite its underperformance of the search market growth rate for most of the last ten years, we think display should match search revenue growth in 2011.  We believe rapid internet and smartphone penetration growth will create many more exciting businesses outside the US – but we expect US companies to face major challenges in markets outside Western Europe.  We expect a major effort by internet companies all over the world to woo local advertisers advertisers. 24
  26. 26. Google sGoogle’s Challenge: Monetizing Mobile Search  Although Google has seen its desktop strength extend to the mobile device, the question is: Can Google narrow this gap? Searches coming from Mobile 15% Dev ices Rev enue Coming from Mobile 3% Dev ices 0% 2% 4% 6% 8% 10% 12% 14% 16% Source: J.P. Morgan estimates. g Note: 3% gross revenue includes AdMob and mobile display revenue. 25
  27. 27. Dot.Khan sDot Khan’s Top Ten Things to Watch  Continued adoption of social media and its impact on existing businesses such as advertising, entertainment and eCommerce.  Increased smartphone penetration will further proliferate mobile web usage and app development and could disrupt the way we shop, consume content and communicate.  Consumers embracing “over the top” video consumption. We think content owners and advertisers must embrace the new order and either partner with Netflix or other services or launch their own own.  Monetization of mobile search is a critical factor for Google’s growth.  US brick & mortar retailers’ market share losses could accelerate. Additionally, we expect material market share shifts i countries such as Chi h hift in ti h China, where B&M b d are relatively weaker. h brands l ti l k  The online hotel business retains significant runway for international growth, and we expect an above- industry-average growth rate in the segment.  We expect more consolidation/M&A rather than share buybacks.  Despite its underperformance of the search market growth rate for most of the last ten years, we think display should match search revenue growth in 2011.  We believe rapid internet and smartphone penetration growth will create many more exciting businesses outside the US – but we expect US companies to face major challenges in markets outside Western Europe.  We expect a major effort by internet companies all over the world to woo local advertisers advertisers. 26
  28. 28. eCommerce: Economic Rebound + Secular Market Shift =Robust Growth Retail moving online less quickly than eCommerce penetration lags online advertising advertising 15% 13.7% 10.5% Amazon continues to gain market share; 10% 8.2% 6.0% 6.4% size is an entry barrier 4.8% 5.1% 5.4% 3.9% 3.6% 5% Mobile eCommerce could further hurt brick- 1.4% 1.8% 2.1% 2.5% 2.9% 3.4% and-mortar retailers 0% 2002 2003 2004 2005 2006 2007 2008 2009  Inventory management eCommerce as % of all US retail Online as % of all US Adv ertising  Mobile commerce Source: US Census Bureau, Magna Global, J.P. Morgan estimates.  Brick-and-mortar bankruptcies Catalysts for international growth  I Improvement of shipping i f f hi i infrastructure  Improved payment systems  Better fraud protection Internet sales tax; in our view, probably the headline risk As eCommerce matures, private labels could help margins 27
  29. 29. eCommerce Forecast (excluding Travel); US and GlobalRevenue to grow by 13.2% and 18.9%, respectively, in 2011 13 2% 18 9% respectively J.P. Morgans US eCommerce Revenue Forecast: $235B in 2013 Units as indicated US eCommerce Forecast 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 10 - 13 CAGR Internet population (M) 186 195 203 211 217 222 227 231 235 239 1.8% Online Shoppers 104 117 130 143 153 160 170 176 184 189 3.6% Shopping sessions / shopper / month 1.90 1.75 1.88 1.91 1.87 1.99 2.13 2.25 2.38 2.45 4.8% Total shopping sessions / year (M) 2,069 2,464 2,925 3,281 3,427 3,821 4,342 4,745 5,243 5,560 8.6% Average price / session $ 39.50 $ 41.25 $ 43.00 $ 45.50 $ 45.00 $ 41.00 $ 41.50 $ 43.00 $ 44.00 $ 46.00 3.5% Total eCommerce revenue (US $M)) 81,731 101,621 125,764 149,287 154,228 156,657 180,207 204,014 230,710 255,749 12.4% Product return rate 10.0% 9.0% 9.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 0.0% Net Revenue 73,558 92,475 114,445 137,344 141,890 144,124 165,791 187,693 212,253 235,289 12.4% Y/Y Growth 25.7% 23.8% 20.0% 3.3% 1.6% 15.0% 13.2% 13.1% 10.9% Source: Department of Commerce, Internet World Stats, company reports, J.P. Morgan estimates.  We expect the US eCommerce market to grow at a 12.4% CAGR from 2010 to 2013 J.P. Morgans Global eCommerce Revenue Forecast: $963B in 2013 $ in Millions Global eCommerce Forecast 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 10 - 13 CAGR US 73,558 92,475 114,445 137,344 141,890 144,124 165,791 187,693 212,253 235,289 12.4% Europe 52,430 72,690 98,193 134,387 175,305 188,446 195,174 210,876 246,651 283,014 13.2% Asia 24,274 32,450 41,911 54,569 76,783 107,078 155,718 208,953 266,560 323,065 27.5% ROW 9,440 13,216 18,502 25,903 34,970 41,963 55,811 73,113 95,047 121,660 29.7% Total 159,702 210,831 273,052 352,204 428,948 481,612 572,494 680,635 820,511 963,028 19.4% Y/Y Growth 32.0% 29.5% 29.0% 21.8% 12.3% 18.9% 18.9% 20.6% 17.4% Source: Department of Commerce, Internet WorldStats, UK eStats, Forrester Research, IDC, Iresearch, Korea National Statistics Office, Japanese Statistics Bureau, eMarketer, PhuCusWright, TIA.org, Jupiter, company reports, J.P. Morgan estimates.  We expect the Global eCommerce market to grow at a 19.4% CAGR from 2010 to 2013 28
  30. 30. “Online Shopping” Survey Takeaways Online Shopping Online Shopping Gaining Penetration Question: How many times do you purchase items online per month? 40% 30% 20% 34% 36% 28% 32% 10% 20% 12% 13% 15% 2% 3% 1% 2% 0% Don t Dont Shop Buy less than 1-2x /month 3-6x /month 7-9x /month 10x +/month online once/month 2007 2010 Source: J.P. Morgan Internet User surveys, 2007 and 2010. Higher-income Users Shop Online More Frequently Question: How many times do you purchase items online, per month? 50% 41% 35% 36% 34% 40% 27% 27% 30% 23% 19% 16% 20% 10% 9% 6% 3% 2% 6% 5% 10% 1% 2% 0% Dont Shop Buy less than 1-2x /month 3-6x /month 7-9x /month 10x +/month online once/month $0-$49K $50K-$99K $100K+ Source: J.P. Morgan Internet User survey, 2010. 29
  31. 31. Dot.Khan sDot Khan’s Top Ten Things to Watch  Continued adoption of social media and its impact on existing businesses such as advertising, entertainment and eCommerce.  Increased smartphone penetration will further proliferate mobile web usage and app development and could disrupt the way we shop, consume content and communicate.  Consumers embracing “over the top” video consumption. We think content owners and advertisers must embrace the new order and either partner with Netflix or other services or launch their own own.  Monetization of mobile search is a critical factor for Google’s growth.  US brick & mortar retailers’ market share losses could accelerate. Additionally, we expect material market share shifts i countries such as Chi h hift in ti h China, where B&M b d are relatively weaker. h brands l ti l k  The online hotel business retains significant runway for international growth, and we expect an above- industry-average growth rate in the segment.  We expect more consolidation/M&A rather than share buybacks.  Despite its underperformance of the search market growth rate for most of the last ten years, we think display should match search revenue growth in 2011.  We believe rapid internet and smartphone penetration growth will create many more exciting businesses outside the US – but we expect US companies to face major challenges in markets outside Western Europe.  We expect a major effort by internet companies all over the world to woo local advertisers advertisers. 30
  32. 32. US Online Travel Spend to Grow by 10 5% in 2011E 10.5% Corporate travel becomes a bit of a US Market Share, 1H08 and 1H10 Share headwind Trav eloc OTAs gain market share from suppliers Trav eloc ity , 22% ity , 19% Hotels will likely be the most p y promising g Ex pedia, 43% Priceline, Ex pedia, 44% growth opportunity Priceline, 11% 9% Priceline dominates domestic market share gains Orbitz, Orbitz, 26% 26% Source: PhoCusWright US Online Travel Overview, Tenth Edition. US Travel Market Forecast $ in Millions 2005 2006 2007 2008 2009 2010E 2011E 2012E Total Travel Spend 233,000.0 256,000.0 269,000.0 274,000.0 233,000.0 256,300.0 269,115.0 282,570.8 % online 28.3% 31.3% 32.7% 34.7% 38.6% 38.0% 40.0% 42.0% Online Leisure/Unmanaged Biz Travel Spend 66,000.0 80,000.0 88,000.0 95,000.0 90,000.0 97,394.0 107,646.0 118,679.7 Total Travel Spend Growth 9.9% 5.1% 1.9% -15.0% 10.0% 5.0% 5.0% Online Travel Spend Growth 21.2% 10.0% 8.0% -5.3% 8.2% 10.5% 10.3% Source: J.P. Morgan estimates, PhoCusWright, eMarketer, TIA.org, Jupiter and IPK International. 31
  33. 33. European Online Travel Spend to Grow by 10 4% in 2011E 10.4% International markets benefit from online penetration Priceline passes Expedia in European market share European Travel Market Share by Channel European Online Leisure/Unmanaged Business Euros in Billions Gross Bookings 2009 Euros in Billions 300 50 45.9 42.3 250 39.6 40 200 175.5 30 150 148.9 146.7 18.6 20.5 16.7 16 7 100 20 13.4 12.1 11.8 50 10 4.4 3.1 5.2 65.3 66.4 73.4 0 0 2008 2009 2010 Germany UK France Spain Italy Scandinav ia Online Leisure/Unmanaged Business Offline/Business Total Market Online Leisure/Unmanaged Business Source: PhoCusWright European Online Travel Overview, Sixth Edition. Source: PhoCusWright European Online Travel Overview, Sixth Edition Europe Travel Market Forecast Euros in Millions 2006 2007 2008 2009 2010E 2011E 2012E Total Travel Spend 228,800.0 240,800.0 240,800.0 215,300.0 220,682.5 231,716.6 243,302.5 % online 21.2% 24.8% 27.1% 30.8% 33.3% 35.0% 36.0% Online Leisure/Unmanaged Biz Travel Spend 48,500.0 59,800.0 65,300.0 66,400.0 73,487.3 81,100.8 87,588.9 Total Travel Spend Growth 5.2% 0.0% -10.6% 2.5% 5.0% 5.0% Online Travel S d G th O li T l Spend Growth 23.3% 23 3% 9.2% 9 2% 1.7% 1 7% 10.7% 10 7% 10.4% 10 4% 8.0% 8 0% Source: J.P. Morgan estimates, PhoCusWright, eMarketer, TIA.org, Jupiter and IPK International. 32
  34. 34. Asia-Pacific Online Travel Spend to Grow by 17 7% in 2011E 17.7% The APAC travel market is not far APAC Travel Market Forward Growth Estimates behind the US in size US$ in Billions APAC significantly trails US and China 2008 61.1 2009 58.3 2010E 61.5 2011E 65.3 Y/Y Growth -4.6% 5.5% 6.2% European markets in online travel India 12.9 15.4 17 19.4 penetration Y/Y Growth 19.4% 19 4% 10.4% 10 4% 14.1% 14 1% Japan 65.7 62.7 64.1 66.5 Y/Y Growth -4.6% 2.2% 3.7% Inbound travel demand to China is an Australia/New Zealand Y/Y Growth 23.7 22.7 -4.2% 24.4 7.5% 26.6 9.0% opportunity Singapore 5.6 5 5.2 5.5 Y/Y Growth -10.7% 4.0% 5.8% F Fragmented markets make thi region t d k t k this i Source: : PhoCusWrights Asia Pacific Online Travel Overview 3rd Ed attractive to OTAs The hotel segment seems to be most attractive for OTAs APAC Travel Market Forecast $ in Millions 2006 2007 2008 2009 2010E 2011E 2012E Total Travel Spend 226,666.7 232,727.3 215,100.0 202,200.0 196,134.0 202,018.0 210,098.7 % online 9.0% 11.0% 14.4% 18.0% 21.0% 24.0% 27.0% Online Leisure/Unmanaged Biz Travel Spend 20,400.0 25,600.0 31,000.0 36,000.0 41,188.1 48,484.3 56,726.7 Total Travel Spend Growth 2.7% -7.6% -6.0% -3.0% 3.0% 4.0% Online Travel Spend Growth 25.5% 21.1% 16.1% 14.4% 17.7% 17.0% Source: J.P. Morgan estimates, PhoCusWright, eMarketer, TIA.org, Jupiter and IPK International. 33
  35. 35. Hotel Volume Growing Faster than Air at OTAs  Hotel growth more robust at all three Priceline Air and Hotel Volume Growth major OTAs over the past year and a half, with Priceline especially strong. 30% 14% 44% 56% 16% 60% 57% 48% 54% 3% 4% -3% Expedia Air and Hotel Volume Growth 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 Air (Tickets) Hotel (Nights) Source: Company reports. 32% 26% 27% 27% 23% 22% 6% 18% 13% 12% 14% 10% Orbitz Air and Hotel Revenue Growth 2Q 09 2Q09 3Q 09 3Q09 4Q 09 4Q09 1Q 10 1Q10 2Q 10 2Q10 3Q 10 3Q10 3% 13% 9% 5% 10% 8% Air (Tickets) Hotel (Nights) Source: Company reports. -26% -33% -10% -12% -24% -31% 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 Air (Rev ) Hotel (Rev ) Source: Company reports. 34
  36. 36. Dot.Khan sDot Khan’s Top Ten Things to Watch  Continued adoption of social media and its impact on existing businesses such as advertising, entertainment and eCommerce.  Increased smartphone penetration will further proliferate mobile web usage and app development and could disrupt the way we shop, consume content and communicate.  Consumers embracing “over the top” video consumption. We think content owners and advertisers must embrace the new order and either partner with Netflix or other services or launch their own own.  Monetization of mobile search is a critical factor for Google’s growth.  US brick & mortar retailers’ market share losses could accelerate. Additionally, we expect material market share shifts i countries such as Chi h hift in ti h China, where B&M b d are relatively weaker. h brands l ti l k  The online hotel business retains significant runway for international growth, and we expect an above- industry-average growth rate in the segment.  We expect more consolidation/M&A rather than share buybacks.  Despite its underperformance of the search market growth rate for most of the last ten years, we think display should match search revenue growth in 2011.  We believe rapid internet and smartphone penetration growth will create many more exciting businesses outside the US – but we expect US companies to face major challenges in markets outside Western Europe.  We expect a major effort by internet companies all over the world to woo local advertisers advertisers. 35
  37. 37. We Expect Healthy M&A Activity As expected, 2010 saw a strong pickup in M&A activity, and we expect trends to remain healthy in 2011 as market conditions continue to improve Cash generation remains solid:  The companies in our coverage universe,, along with Microsoft and Apple,, have p g g pp nearly $150B gross cash on the balance sheet Additionally, we believe the internet companies we cover retain significant room for leverage Acquisitions driven by:  Technology: buy rather than build  Traffic: buy rather than develop virally  Transactional: buying companies with proven sales/revenue track record In our coverage universe, we believe the most attractive companies on these metrics are MercadoLibre and Netflix 36
  38. 38. Dot.Khan sDot Khan’s Top Ten Things to Watch  Continued adoption of social media and its impact on existing businesses such as advertising, entertainment and eCommerce.  Increased smartphone penetration will further proliferate mobile web usage and app development and could disrupt the way we shop, consume content and communicate.  Consumers embracing “over the top” video consumption. We think content owners and advertisers must embrace the new order and either partner with Netflix or other services or launch their own own.  Monetization of mobile search is a critical factor for Google’s growth.  US brick & mortar retailers’ market share losses could accelerate. Additionally, we expect material market share shifts i countries such as Chi h hift in ti h China, where B&M b d are relatively weaker. h brands l ti l k  The online hotel business retains significant runway for international growth, and we expect an above- industry-average growth rate in the segment.  We expect more consolidation/M&A rather than share buybacks.  Despite its underperformance of the search market growth rate for most of the last ten years, we think display should match search revenue growth in 2011.  We believe rapid internet and smartphone penetration growth will create many more exciting businesses outside the US – but we expect US companies to face major challenges in markets outside Western Europe.  We expect a major effort by internet companies all over the world to woo local advertisers advertisers. 37
  39. 39. State of Advertising Overview Consumers are seeking ubiquity Unbundling of content creates opportunity; threatens incumbent models Ad Spend vs. Time Spent in 2003 and 2009 60% 52% 50% 39% 50% 40% 31% 40% 26% 28% 27% 30% 30% 23% 24% 16% 14% 20% 12% 13% 20% 9% 7% 8% 10% 3% 10% 0% 0% P r in t R a d io TV O n lin e P r in t R a d io TV O n lin e T im e S p e n t Ad S pend T im e S p e n t Ad Spend Source: SRI Knowledge Networks, Universal McCann 6/03, IAB 3/04 and Yahoo! 2010 Analyst Day presentation. Our thesis on newspaper market share declines plays out Newspaper Ad Spend Continues to Decline 10.0% 44.9 46.7 47.4 46.6 42.2 50.0 1.9% 3.9% 1.5% 0.0% 34.7 40.0 -1.7% -10.0% -9.4% 24.8 -7.8%30.0 22.9 -20.0% -17.7% 20.0 -30.0% -28.6% 10.0 -40.0% 0.0 2003 2004 2005 2006 2007 2008 2009 2010 New spaper ad spend % change Source: NAA.org, J.P. Morgan estimates. 38
  40. 40. State of Advertising Overview While content consumption is growing, it is increasingly difficult to reach TV viewers TV Viewership Alternatives Grow Analog to digital 8:38 Netflix launches transition online streaming "Can Netflix kill premium cable TV?" - Journal Enterprise 8:09 YouTube launched 7:40 DVD format "Bye-bye TV? YouTube debuts launched live streaming" - Fortune VOD launched 7:12 Hulu Blu-Ray Disc launched launched 6:43 Launch of HBO VHS Channel launched Hour:Min HD television launched "Hulu Is An H-Bomb 6:14 Pay-per-view Ready To Destroy launched The TV Industry" First TiVo DVR s o - Business Insider launched 5:45 Launch of DTH service "TiVo May Be `Disaster for Netflix 5:16 TV Industry" - Bloomberg launched 4:48 4 48 4:19 1949 - 1950 1954 - 1955 1959 - 1960 1964 - 1965 1969 - 1970 1974 - 1975 1979 - 1980 1984 - 1985 1989 - 1990 1994 - 1995 1999 - 2000 2004 - 2005 2009 - 2010 Source: Nielsen Media Research and J.P. Morgan. TV Season Thus, Cable and Internet advertising are gaining share 39
  41. 41. Display Advertising in 2011 2011 will likely be a year of innovation  Interactive brand sponsorships, which yield better content integration  Folding in purchase data for better targeting of branded ads  Better integration of real-time consumer intent data real time  Time-based ads which leverage user engagement  Creative ad formats with real-time updating for better targeting Challenges  Internet users have faced a large influx of inventory  Performance focus remains a headwind; need more measurement  Monetizing non-premium inventory Current resurgence of interest in premium display advertising to continue in 2011E as brand advertisers shift spend online 40
  42. 42. US Graphical Advertising to Grow at 13% Y/Y in 2011E  We are modeling RPMs to increase 4% in F’11, driven by flat growth in impressions per page offset b a 4% i ff by increase i CPM in CPMs  We expect the US graphical ad market to grow at a 10.7% CAGR from 2009 to 2014 J.P. Morgans US Graphical Advertising Revenue Forecast Units as indicated United States 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 09-14 CAGR Internet Population (M) 203 211 217 222 227 231 235 239 243 1.8% Pages Viewed / User / Day 45 47 50 53 57 61 65 68 72 6.3% 6 3% Total Pages Viewed (B) 3,341 3,608 3,933 4,307 4,737 5,164 5,577 5,967 6,385 8.2% Impressions / Page 0.50 0.60 0.62 0.60 0.61 0.61 0.62 0.63 0.64 1.3% Total Impressions (B) 1,671 2,165 2,438 2,584 2,890 3,150 3,458 3,759 4,086 9.6% CPM (per 1,000 impressions) $3.50 $3.31 $3.15 $3.05 $3.13 $3.25 $3.25 $3.25 $3.20 1.0% RPM (per 1,000 pages) $1.75 $1.99 $1.95 $1.83 $1.91 $1.98 $2.02 $2.05 $2.05 2.3% US Graphical Forecast ($M) p ($ ) 5,847 , 7,166 , 7,681 , 7,881 , 9,045 , 10,237 , 11,237 , 12,218 , 13,076 , 10.7% % Y/Y Growth 23% 23% 7% 3% 15% 13% 10% 9% 7% Source: J.P. Morgan estimates, company reports, comScore, Nielsen//NetRatings, IDC, IWS and IAB. 41
  43. 43. International Growth More of a Driver in 2011E J.P. Morgan’s International Graphical Advertising Revenue Forecast Units as indicated International 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 09-14 CAGR Internet Population (M) 817 903 988 1,072 1,158 1,251 1,326 1,406 1,476 6.6% Pages Viewed / User / Day 37 38 39 40 41 43 45 46 48 3.8% Total Pages Viewed (B) 10,934 12,378 13,925 15,470 17,172 19,439 21,577 23,735 25,634 10.6% RPM (per 1,000 pages) $0.73 $0.80 $0.82 $0.79 $0.82 $0.83 $0.83 $0.84 $0.85 1.5% Intl Graphical Forecast ($M) 7,982 9,902 11,418 12,222 14,081 16,134 17,909 19,937 21,789 12.3% Y/Y Growth 28% 24% 15% 7% 15% 15% 11% 11% 9% Source: J.P. Morgan estimates, company reports, comScore, Nielsen//NetRatings, IDC, IWS and IAB. We expect the international graphical ad market to grow at a 12.3% CAGR from 2009 to 2014 p g p g 42
  44. 44. We Estimate Global Graphical Advertising Marketto Reach $26 4B in 2011 Up 14% Y/Y $26.4B 2011, J.P. Morgan’s Global Graphical Advertising Revenue Forecast Units as indicated Global 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 09-14 CAGR Internet Population (M) 1,020 1,113 1,205 1,295 1,385 1,482 1,561 1,645 1,719 5.8% Pages Viewed / User / Day 38 39 41 42 43 45 48 49 51 4.0% Total Pages Viewed (B) 14,275 15,986 17,858 19,777 21,909 24,602 27,154 29,702 32,018 10.1% RPM (per 1,000 pages) $0.97 $1.07 $1.07 $1.02 $1.06 $1.07 $1.07 $1.08 $1.09 1.4% Global Graphical Forecast ($M) 13,829 17,068 19,099 20,103 23,126 26,371 29,146 32,155 34,865 11.6% Y/Y Growth 26% 23% 12% 5% 15% 14% 11% 10% 8% Source: J.P. Morgan estimates, company reports, comScore, Nielsen//NetRatings, IDC, IWS and IAB. 2009 Global Display Market Share 2010E Global Display Market Share Y! 8% Y! 9% Microsoft Microsoft Google & Yahoo 5% 5% gain 1% each in 2010E, while AOL AOL AOL loses out 6% 4% Google Other Google Other 11% 71% 10% 71% Source: Company reports and J.P. Morgan estimates. Source: Company reports and J.P. Morgan estimates. 43

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