Global Equity Research 03 January 2011 Nothing But Net 2011 Internet Investment Guide Internet Imran Khan AC (1-212) 622-6693 [email protected]J.P. Morgan Securities LLC Bridget Weishaar AC (1-212) 622-5032 [email protected]J.P. Morgan Securities LLC Lev Polinsky, CFA (1-212) 622-8343 [email protected]J.P. Morgan Securities LLC Shelby Taffer (212) 622-6518 [email protected]J.P. Morgan Securities LLC Vasily Karasyov (1-212) 622-5401 [email protected]J.P. Morgan Securities LLC China Internet Dick Wei AC (852) 2800-8535 [email protected]J.P. Morgan Securities (Asia Pacific) Limited Japan Internet Hiroshi Kamide AC (81-3) 6736 8602 [email protected]JPMorgan Securities Japan Co., Ltd. Korea Internet Sungmin Chang, CFA AC (82-2) 758-5719 [email protected]J.P. Morgan Securities (Far East) Ltd, Seoul Branch Russian Internet Alexei Gogolev AC (7-495) 967-1029 [email protected]J.P. Morgan Bank International LLC See page 412 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
See page 412 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
J.P.Morgan Securities LLC • Equity Research • 383 Madison Avenue Å New York, NY 10179
January 3, 2011
Dear Investors and Internet Enthusiasts,
The past year was an exciting one for the internet business. 2010 saw many of our key investment themes play out, with a significant recovery in display advertising, eCommerce outperforming the retail market, online travel agencies gaining market share and a very healthy M&A market. Internet stocks performed strongly as the broader market rebounded, with several of our 2010 top picks outperforming the S&P.
We expect 2011 to be a significant inflection point in the development of the internet market, as a number of major trends are taking shape that could potentially disrupt many existing businesses. In fact, in our view there is more innovation in the sector today, and more uncertainty, than at any time since the industry was commercialized in the mid-1990s.
In particular, we see five trends as disruptive forces to the over $1 trillion market cap industry. First, social media consumption has fundamentally changed consumer behavior, personal information/privacy boundaries, communication patterns and time allocation. Second, new mobile and internet-enabled technology devices — phones, readers, tablets and TVs — have allowed consumers to demand ubiquity of information, communication and entertainment in all places, across all devices, at all times. (We are especially excited to see what surprises the CES has in store for us this week!) Third, monetization of “over the top” video consumption has taken off. After years of speculation about its potential, Google finally released data showing that YouTube is monetizing 2 billion views per week; and with Netflix among others making impressive subscriber gains, we think fragmentation of media consumption, potential cord cutting (small scale) and content viewership will continue to drive over-the-top video consumption. Fourth, localization has become a key theme, driven by trends toward personalization and new devices. Again, growth here is coming following years of speculation. Finally, international growth remains a significant story, with a growing middle class and continued internet penetration driving new business opportunities.
We hope that this report will help you sort through the complexities of the internet in 2011. While we don’t have a crystal ball, we have spoken with various entrepreneurs around the globe, surveyed over 1,000 internet users to get insight into consumer behavior and eCommerce trends and broadened our global internet expertise with analyst contributions from China, Russia, Japan and Korea.
We aim to provide useful research and ideas in your investment decision-making process and hope that our work helped you in 2010. May 2011 bring all of you continued good fortune and exciting opportunities!
Table of Contents Key Investment Themes ................................................................................. 7 Dot.Khan’s Top Ten Things to Watch ........................................................... 19 U.S. Sector Outlooks .............................................................. 21 State of Advertising Overview ....................................................................... 23 Online Advertising Primers ............................................................................ 28 Search Advertising ........................................................................................ 33 Display Advertising ........................................................................................ 37 Mobile Advertising ......................................................................................... 44 Local Advertising ........................................................................................... 64 Social Networking .......................................................................................... 68 eCommerce Outlook ..................................................................................... 80 Online Alternative Payments ......................................................................... 95 "Over the Top" Survey Results ................................................................... 106 Online Travel Agencies ............................................................................... 111 Cloud Computing ......................................................................................... 123 eReaders ..................................................................................................... 131 International Sector Outlooks ............................................. 139 China: Top Predictions for 2011 .................................................................. 141 China Internet Market Overview .................................................................. 143 Online Advertising ....................................................................................... 147 Display Advertising ...................................................................................... 152 Online Search .............................................................................................. 153 Online Video ................................................................................................ 162 Social Networking ........................................................................................ 167 Miniblog Platform ......................................................................................... 170 eCommerce ................................................................................................. 171 Group Buying: A Hot Trend in China, Too .................................................. 177 SNS and Microblogs: Help Drive Social eCommerce ................................. 179 Leading C2C Players in China .................................................................... 179 Leading B2B Players in China .................................................................... 180 Online Gaming ............................................................................................ 181 The Rise of Social Gaming ......................................................................... 185 Summary of Gaming Regulations in China ................................................. 188 Online Gaming Primer ................................................................................. 189 Japan Internet Market Overview ................................................................. 195 Korea: Sector Summary .............................................................................. 219 Russia Internet Industry .............................................................................. 221
U.S. Company Outlooks ....................................................... 237 Amazon.com ............................................................................................... 239 AOL Inc. ...................................................................................................... 243 Blue Nile ...................................................................................................... 247 Dice Holdings, Inc. ...................................................................................... 251 eBay, Inc ..................................................................................................... 255 Expedia, Inc. ................................................................................................ 259 Google ......................................................................................................... 263 IAC/InterActive Corp.................................................................................... 267 Liberty Interactive ........................................................................................ 271 MediaMind ................................................................................................... 275 MercadoLibre, Inc. ....................................................................................... 279 Netflix Inc ..................................................................................................... 283 Orbitz Worldwide, Inc. ................................................................................. 287 Priceline.com ............................................................................................... 291 QuinStreet, Inc. ........................................................................................... 295 ReachLocal ................................................................................................. 299 Shutterfly, Inc. ............................................................................................. 303 Yahoo Inc .................................................................................................... 307 International Company Outlooks ........................................ 311 Alibaba.com Limited .................................................................................... 313 Baidu.com ................................................................................................... 317 China Finance Online .................................................................................. 323 Netease ....................................................................................................... 327 Shanda Games ........................................................................................... 331 Shanda Interactive Entertainment Ltd ......................................................... 335 Sina Corp .................................................................................................... 339 Sohu.Com ................................................................................................... 343 Tencent ....................................................................................................... 347 The9 Limited ................................................................................................ 351 DeNA (2432) ............................................................................................... 355 Gree (3632) ................................................................................................. 363 Mixi (2121) ................................................................................................... 371 Rakuten (4755) ............................................................................................ 377 Yahoo Japan (4689) .................................................................................... 391 Daum ........................................................................................................... 403 Mail.ru Group ............................................................................................... 407 Please see our separate rating change notes on Blue Nile (NILE/December 31st close, $57.06/Neutral) and MercadoLibre (MELI/December 31st close, $66.65/Overweight), also published on January 3, 2011. The authors acknowledge the contribution to this report of Jigar Vakharia and Ritesh Gupta of J.P. Morgan Services India Private Ltd.
* Yhoo's Enterprise Value assumes Yahoo!'s Asian assets are worth $8/shareNote: EBITDA= Operat ing income+D&A+/- Extraordinary chargesAll EPS est imates are GAAP, except EXPE, PCLN, and M ELI^ indicates First Call consensus est imates are used for revenue and EPS
Source: Company reports and J.P. Morgan estimates.
Key Investment Themes The Internet Is Becoming Increasingly Social, Which Could Be Disruptive to Many Businesses If They Can’t Adapt to It Over the last five years, there has been a fundamental change in consumer behavior on the web, as consumers are now more expressive and willing to share personal information online. As a result, social, which was ignored as a diversion by many observers (e.g., the ’05 and ’06 editions of this report barely mentioned social networking), has emerged as a major medium of the web, and we believe it is a potentially significant disruptive factor to many existing businesses over the next five years. While Facebook is the ten-thousand-pound gorilla in the space, we expect social to be a key theme in the internet space, and the category as a whole to become a significant portion of consumers’ online life. We think many companies will have to adopt a social component into their businesses in the coming years. Facebook now represents over 10% of all US internet usage time and over half of all global time spent on social networking sites, as reported by comScore.
We view the social sites (especially Facebook) as network platforms, like Visa/MasterCard. As such, they don’t necessarily need to monetize directly from their customers: they can enable applications such as casual games (or payments, or eCommerce, or virtual gifts) and collect a small fee as the providers of the network. We believe linking the social graph with a platform for payments, advertising and commerce, and improved micropayments capacity, represent a landscape-shifting opportunity.
Additionally, casual games, integrated into the social network landscape, experienced another very strong year of growth in 2010. We think such applications are one of several paths toward the successful monetization of social networks.
The disruptive nature of social networking sites becomes even more apparent when examining the traffic sources of some major websites. The last year has seen a dramatic shift in the volume of traffic driven to key sites by social networks, especially Facebook. As seen in the graphs below, Google remains the largest driver of traffic to sites such as nytimes.com and Amazon. At the same time, the portion of traffic coming from Facebook has increased rapidly.
Advertising Continues to Go through a Structural Change; Online Ad Growth Fundamentally Remains Strong We think the online advertising market is at an interesting inflection point. On the one hand, time spent online continues to grow, DVR usage is on the rise and newspaper advertising revenues are consistently declining.
Ad Spend vs. Time Spent in 2003 and 2009
7%
27%
52%
14%23%
8%
24%
3%
0%10%20%30%40%50%60%
Print Radio TV Online
Time Spent Ad Spend
12%16%
31% 28%26%
9%
39%
13%
0%
10%
20%
30%
40%
50%
Print Radio TV Online
Time Spent Ad Spend
Source: SRI Knowledge Networks, Universal McCann 6/03, IAB 3/04 and Yahoo! 2010 Analyst Day presentation.
Newspaper Ad Spend Continues to Decline $ in billions
The cost of content creation and distribution is decreasing, which brings in new content to consumers. Furthermore, consumers have more ways than ever to consume content, and we think consumers are seeking ubiquity and the unbundling and ability to share this content. Currently, many traditional media sources are not equipped to fulfill consumers’ changing demand, and therefore, we think time spent online will continue to grow.
As a result, we believe online publishers will experience strong growth in advertising and are modeling global paid search revenues to grow at a 17% CAGR over the next four years and global graphical advertising to grow at a four-year CAGR of 11%. Overall, we forecast global online advertising to reach ~$105B by 2014.
We Expect Global Online Advertising to Reach $105B by 2014 $ in millions
70,78460,27951,368
105,37493,761
82,072
48,61139,067
020,00040,00060,00080,000
100,000120,000
2007 2008 2009 2010E 2011E 2012E 2013E 2014E
US International
Source: J.P. Morgan estimates.
Growth in US Display Advertising to Match Search For a long time, search advertising growth significantly outpaced display ad growth as advertisers flocked to the proven performance model. For example, search revenue grew at a ~32% CAGR from 2004 to 2009, which is roughly 2x the growth of display revenue over the same period. However, we are starting to see signs of this trend reversing due to the following two factors:
Brand advertising. First, we think brand advertisers are latecomers to online advertising and that display advertising will make more sense for them to get their messages across.
Social networking. Second, we note that social networking has had a large impact on viewership trends and that advertisers are likely to follow the eyeballs.
Thus, we see 2011 as a strong year for display advertising and are modeling 13% Y/Y growth, in line with our search advertising growth estimate.
Source: J.P. Morgan estimates, company reports, comScore, Nielsen//NetRatings, IDC, IWS and IAB.
Mobile Phone/Devices on Par with Television = Huge Ad Opportunity With approximately 233 million mobile phone users in the US, we can claim that the mobile phone market is on its way to maturity. If we assume that there are 2.5 people to a household, this would imply that almost 93 million US households have a mobile phone vs. 115 million US households possessing at least 1 TV. While this reach offers interesting possibilities to the advertising market, the implications for carriers are somewhat less attractive. Carrier growth is now dependent on winning customers from competitors and coming up with new data services packages. Thus, handsets and content experience are becoming as key to carrier growth as they are to handset manufacturers and content providers.
Mobile Phone Market Is on Its Way to Maturity Subscribers in millions
May -08226
May -09233
Jan-10234
200205210
215220225230
235240
+ 3%
Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation and March 2010 press release.
Additionally, we expect significant growth of tablet devices this year (J.P. Morgan’s hardware analyst, Mark Moskowitz, estimates that 46M tablets will be sold in 2011). We think such growth is driving a significant increase in web usage and changing consumer behavior. Further, consumers now have more freedom to access and spend time on the web, and as a result the web is becoming integrated into people’s daily lives. Therefore, we believe a failure to establish mobile leadership and understand the mobile audience could be dangerous for content aggregators, publishers and advertisers.
Time Spent across Platforms Is Becoming More Fragmented -- Mobile Usage Only Accelerates this Trend
12%16%
31%28%
0%5%
10%15%20%25%30%35%
Print Radio TV Online
Source: Yahoo! 2010 Investor Day presentation.
eCommerce Continues to Gain Significant Market Share We expect the global eCommerce market to grow 18.9% in F’10 and at a 19.4% CAGR over the next three years. The key growth drivers are as follows.
Economic rebound + Secular market shift = Robust growth We believe that eCommerce is benefiting from several positive trends, including the continued rollout of broadband, increasing user comfort shopping online and the decline of certain brick-and-mortar retailers. At the same time, as the economic environment appears to be getting at least marginally better, we see an additional tailwind for eCommerce growth. We expect F’11 US and global eCommerce growth of 13.2% and 18.9%, respectively.
We’ve come a long way . . . . and have a long way to go Even after several years of very robust growth in eCommerce, the sector represents less than 5% of all retail sales in the US and is even less developed in many other countries. Thus, we think there are still tremendous opportunities for rapid growth. We think the experience of Diapers.com is instructive: the site launched in 2005 and was bought by Amazon for $540M five years later after achieving predominance in its vertical.
eCommerce Penetration Lags Online Advertising
1.4% 1.8% 2.1% 2.5% 3.4%
4.8% 5.1% 5.4% 6.0% 6.4%8.2%
10.5%
3.6% 3.9%
2.9%
13.7%
0%
5%
10%
15%
2002 2003 2004 2005 2006 2007 2008 2009
eCommerce as % of all US retail Online as % of all US Adv ertising
Source: US Census Bureau, Magna Global, J.P. Morgan estimates.
Mobile eCommerce could further hurt brick-and-mortar retailers We think that the proliferation of mobile devices and mobile apps could have a profoundly negative impact on the business model of traditional retailers. Historically, getting a customer in the store was half the battle for a retailer. Mobile apps turn this dynamic on its head by giving consumers more price and product comparisons, and thus more power to the shopper, even in-store. We continue to believe that pressure on traditional retail can accelerate eCommerce growth.
Amazon continues to gain market share; size is an entry barrier We think the secret of Amazon’s success is highly unglamorous: an obsessive focus on execution, pricing, innovation and reducing friction that creates a best-in-class user experience. We think many of the elements of the company’s success are creating virtuous circles that will enable above-market growth to continue; Prime and Fulfillment by Amazon (FBA) are two such key elements.
Over the Top: Changing TV Consumption; Netflix Matches the Total # of DIRECTV Customers in the US Another major trend is that consumers are willing to consume more video content on the internet. Additionally, significant increases in device penetration that allow users to stream online content to the TV, as well as massive growth in tablet devices, are changing consumer behavior. In recent months, the internet TV space has been long on speculation and short on data. So we probed online video trends as one of the areas of focus in our proprietary survey of 1,002 US internet users. Following are our key findings:
More than a quarter would consider Over the Top. Although most pay TV subscribers (72%) would not even consider getting rid of their cable/satellite package in favor of getting video over the internet, 28% of our respondents said they would consider it. Of these, 63% would do it even if it meant losing access to live sporting events. Additionally, 12% of our sample said they do not have a cable/satellite TV subscription.
Unbundling could help consumers. A slight majority (52%) of pay TV subscribers said they would want to pay less for their cable subscription in exchange for getting fewer channels. Of these, 45% said they would want to get 25% fewer channels and pay 25% less. Those wanting the biggest cut in their packages were also the most likely to consider dropping pay TV.
Netflix subscribers are more likely to consider dropping their cable packages. Those who are more regular users of Netflix streaming are even more likely: among those who use streaming 1-2 times a month or more, 39% said they would consider dropping their package (and another 8% already don’t have cable).
Higher-income households less likely to go without pay TV; also less happy with it. Within our sample, only 6% of those with incomes over $100K said they didn’t have a cable/satellite TV subscription, compared to 18% of those with incomes below $50K. However, 54% of pay TV subscribers with incomes over $100K would prefer to pay less for a smaller package of channels, compared to only 45% of those who make less than $50K.
Online Travel Agencies Gain Share as Consumers Remain Focused on Bargain Hunting In 2010, online travel agency companies in the US performed relatively well compared to offline agencies and suppliers. Moreover, we continued to see the shift between online travel agencies (OTAs) to online supplier sites stabilize. Although supplier websites outperformed the market overall, they are projected by PhoCusWright to grow at only half the rate of OTAs in 2010. Among the reasons for this outperformance are that supplier websites were particularly affected by the pullback among older, frequent leisure travelers who tend to favor supplier sites. Much of the growth in supplier websites in 2010 came from the unmanaged and managed business travelers who returned to the road.
In 2011, we expect to see a restrained recovery continue as corporate travel increases and consumers continue to spend more but unemployment levels remain high. We expect online travel agencies to be the biggest beneficiary of these trends as consumers will likely remain focused on bargain hunting and employ the social networking, review sites, and personalized offers that are OTA strengths.
Hotels: the most promising growth opportunity We think hotels will continue to be the most attractive opportunity for online travel agents for a number of reasons. First, margins are much higher in this segment than in air, especially in heavily fragmented markets. Second, online penetration in hotels is much lower than in air. PhoCusWright estimates that only 30% of hotel sales were booked through hotel websites and OTAs in 2009. Third, segment-specific drivers are making airlines even less attractive going forward.
Priceline dominates domestic market share gains Priceline posted domestic gross bookings growth of 16% Y/Y in the first 3 quarters of 2010 vs. 17% growth at Expedia and 16% growth at Orbitz during the same period despite both Expedia and Orbitz removing and discounting booking fees. We think Priceline’s strength can be attributed both to its opaque business model and lowest-price/discount-brand positioning. In 2011, we think Priceline will continue to gain market share, especially now that booking fee removals/discounts are comped.
Source: PhoCusWright US Online Travel Overview, Tenth Edition.
US Market Share, 1H10
Ex pedia, 44%Priceline,
11%
Trav elocity 19%
Orbitz, 26%
Source: PhoCusWright US Online Travel Overview, Tenth Edition.
International markets benefit from online penetration We expect online underpenetration to remain a tailwind to OTAs in 2011. However, despite the overall low online penetration of the European travel market as a whole, we do note that there is much variance on a country-by-country basis. The UK remains the largest online travel market in Europe. In 2009, the UK generated 28% of European online bookings. However, over time Germany, France and Spain are expected to be the main share gainers. Scandinavia has the highest online leisure and unmanaged business penetration, at 45% in 2009, with the UK just behind at 44%. France and Germany have similar online penetration rates, at 31% and 29%, respectively. Spain and Italy are the major markets with the lowest online booking penetration at 22% and 18%. We think OTAs with a higher exposure to underpenetrated markets (OTAS such as Priceline) will continue to outperform the competition in 2011.
We Expect Healthy M&A Activity As expected, in 2010 we saw a strong pickup in M&A activity as management teams began to feel more comfortable with the economic outlook. In 2011, as market fundamentals continue to improve, we expect M&A activity to remain healthy. To the extent acquirers are willing to part with cash, we expect them to have the resources: large internet and media companies continue to generate significant cash flows. Additionally, the loosening of the credit markets should make financing more accessible to companies seeking to borrow funds.
Selected M&A Activity in the Internet Space, 2010 Symbol Deal Type Date Target Acquirer Seller Annc’d Tot Payment Status NWSA DIV 01/04/10 Rotten Tomatoes Flixster Inc News Corp N/A Stock Complete YHOO DIV 01/12/10 Zimbra Inc VMware Inc Yahoo! Inc N/A Undisclosed Complete AOL ACQ 01/25/10 StudioNow Inc AOL Inc 36.50 Cash and Stock Complete
GOOG DIV 01/25/10 DART business Google Inc TCI MCM Solution Inc
N/A Cash Complete
YHOO DIV 02/03/10 HotJobs.com Ltd Monster Worldwide Inc
We continue to see three key factors as motivating drivers for M&A activity in the internet space:
Traffic. Developing high-traffic sites is difficult, and larger companies are often willing to pay for sites that have proven an ability to generate traffic.
Technology. Companies that develop a technology that is difficult or uneconomical to replicate are often targets for acquisitions; such companies may also generate traffic, but the technology is often a motivator for the buyer.
Transactional. Companies with proven track records of revenue and sales generation can make attractive targets as well.
Key attributes of acquisition targets We believe the attributes that potential acquirers will seek in a target include:
Brand strength. Acquirers will likely seek a company that garners recognition and respect from both its customers and partners.
Product leadership. We think acquirers will seek out companies that have the products viewed as best by customers, partners and competitors.
Ease of integration. With an increasing focus on profitability in this time of economic uncertainty, we think companies will attach more importance to the level of challenge in integrating the company and the time required to recognize synergies.
Barriers to entry. This will likely be a key determining factor in the build-vs.-buy decision-making process.
Within our universe, we believe the two independent companies that best embody these attributes are MercadoLibre and Netflix.
Our Top Picks In our coverage universe, we think the internet companies that are best positioned and offer the best risk/reward return for investors are: Amazon (price target $199) and Priceline (price target $484) of our large cap stocks; MercadoLibre (price target $82) for our mid cap stocks; and ReachLocal (price target $23) among our small cap names. Additionally, J.P. Morgan’s China internet analyst Dick Wei’s top picks are Tencent and NetEase. Please see the company sections for detailed analyses of our thesis for each.
Dot.Khan’s Top Ten Things to Watch 1. Continued consumer adoption of social media and its impact on other
existing businesses, such as advertising, entertainment and eCommerce.
2. Increased penetration of smartphones and tablet devices will further proliferate mobile web usage and app development, which could potentially be disruptive to the way we shop, consume content and communicate.
3. Consumers are embracing “over the top” video consumption. In our view, content owners and advertisers must also accept this new order and will have to either partner with Netflix and other services or launch their own online services.
4. Monetization of mobile searches is a critical factor for Google’s growth; we estimate Google generates ~15% of its query volume from mobile devices, yet mobile searches contribute just ~3% of revenue.
5. Brick-and-mortar market share losses could accelerate in the US; additionally, we expect material share shifts in countries such as China, where brick-and-mortar brands are relatively weaker compared to the US.
6. The online hotel business still retains significant runway for international growth, and we expect an above-industry-average growth rate in this segment.
7. We expect more consolidation/M&A rather than share buybacks.
8. Despite its underperformance of the search market growth rate for most of the last ten years, we think display advertising growth should match search revenue growth in 2011.
9. We believe rapid internet and smartphone penetration growth will create many more exciting internet businesses outside the US. Primarily, we expect US companies to continue to face major challenges in markets such as Russia, China, Korea, India and Eastern European countries.
10. We expect a major effort by internet companies around the world to woo the local advertising dollar.
State of Advertising Overview We think the online advertising market is at an interesting inflection point. On the one hand, time spent online continues to grow, DVR usage is on the rise and newspaper advertising revenues are consistently declining. Consumers have more choices than ever when it comes to consuming content. The cost of content creation and distribution is decreasing, which brings new content to consumers. We think this new world of content consumption offers significant challenges for advertisers. Advertisers and content providers still seem to be struggling with targeting, successful brand advertising campaigns, copyright issues and the massive amounts of inventory. Below we will look at drivers of the total advertising market and then, in the following sections, we will study the issues relating specifically to search, display, video and mobile advertising.
Consumers Are Seeking Ubiquity Consumers want access to information, entertainment, retail and communications at all times, in all places and across all devices. This has revolutionized how people think about communicating, seeking information, accessing media and shopping. These activities were once distinct, but we believe they are now thoroughly enmeshed.
In our opinion, new devices have been the driver of this revolution. We see two devices as responsible for changing how people think about communicating, reading and buying/viewing entertainment. In 2007, the iPhone launched, giving consumers worldwide portable information access similar to that provided by BlackBerry to businesses. As of 3Q’10, Apple had sold ~74M iPhones and spurred the development of many other competitive products. That same year, Amazon introduced the Kindle, changing the way people access written information and entertainment. We estimate that by the end of 2010, 12M eReaders will have been sold in the US market. 2010 saw the launch of many more innovative devices, including Apple’s iPad, Google TV and a new Apple TV, all of which combine TV, music, reading and internet content onto a single device. In the two quarters after its release, Apple sold over 7.5M iPads.
Unbundling of Content Creates an Interesting Opportunity The cost of content creation and distribution is decreasing. In the traditional media model, there were multiple steps from author to consumer and production costs were high. All of the bottlenecks were upstream in the process. However, in the new model, there are fewer steps to distribution and lower productions costs, making the bottleneck consumers’ time. This additional content means more fragmented audiences. In 1980, the average US household received 10.2 channels, but by 2007 this number had increased to 107.4 channels. In addition to increasing options on TV, US consumers have also embraced the internet. YouTube is monetizing over 2B views per week, with over 24 hours of video uploaded every minute and over 2B views per day. Social networking has gained so much traction that an average 124M US consumers (59% of the internet population) spent almost an hour per week (58 min) on Facebook over the last 12 months. We believe that there is currently a large disconnect between ad spend vs. time spent on each medium and that the rectification of this will help drive internet ad spend in 2011. Additionally, performance-based
advertising will continue to get traction as advertisers are looking for more ROI-driven ads.
Ad Spend vs. Time Spent in 2003 and 2009
7%
27%
52%
14%23%
8%
24%
3%
0%10%20%30%40%50%60%
Print Radio TV Online
Time Spent Ad Spend
12%16%
31% 28%26%
9%
39%
13%
0%
10%
20%
30%
40%
50%
Print Radio TV Online
Time Spent 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 We believe that newspaper advertising declines will continue to accelerate going forward. We estimate that newspaper ad spend declined 29% in 2009, an acceleration in declines from 2008’s 18% Y/Y drop and 2007’s 9% drop. Newspaper circulation is also falling, with average daily circulation down 5.0% Y/Y in September 2010. In our opinion, people are becoming increasingly dependent on the internet for breaking news. Furthermore, blogs are becoming more accepted as a trusted news source and opinion provider. Given the decline in both circulation and ad spend, we think the existing cost structure will make this business model unsustainable in the future.
Newspaper Ad Spend Continues to Decline $ in billions
Source: Audit Bureau of Circulation, J.P. Morgan estimates.
While Content Consumption Is Growing, It Is Increasingly Difficult to Reach TV Viewers Overall TV viewership continues to rise, with total TV use growing 1% Y/Y through 3Q’10 according to Nielsen. The rise in total viewership is despite roughly flat viewership among the big 4 broadcast networks, which are more than offset by rising cable audiences. However, it is increasingly difficult to reach engaged TV viewers as the growing number of alternatives increases fragmentation. Additionally, the alternatives offer interesting challenges for advertisers to justify significant cost-per-thousand (CPM) price increases every year.
"TiVo May Be `Disaster' for TV Industry" - Bloomberg
"Bye-bye TV? YouTube debuts live streaming" - Fortune
"Hulu Is An H-Bomb Ready To Destroy The TV Industry"
- Business Insider
Source: Nielsen Media Research and J.P. Morgan.
Thus, Cable and Internet Advertising Are Gaining Share In 2010, we expect internet advertising to grow the fastest, at 13.6% Y/Y. We also see TV expenditures continuing at a healthy clip, with total TV expenditures up 6% Y/Y, driven by spot advertising (up 8% Y/Y) and cable (up 6% Y/Y). We expect radio and newspapers to be the weakest platforms. Network ad dollars are still below 2007 levels, while national cable is still below 2008 levels. We think syndication could face significant challenges from Netflix services.
Trends in Ad Dollar Expenditure by Platform $ in millions
We expect the trend for national cable will continue, but our bullishness on internet ad dollars is unabated, and we expect internet ad dollars to reach 20% of overall ad spend in less than 5 years.
Online Advertising Primers Graphical Advertising 101 Graphical advertising, also known as display advertising, includes all forms of advertising excluding search. Thus a range of advertisements from traditional banner ads to video and lead generation are included in this category. Because of the range included in this category, it is more difficult to make generalizations about graphical ad characteristics. However, the following factors should be evaluated when looking at the graphical advertisement space.
We expect more innovation in the display advertising market We think display advertising companies will aggressively tackle challenges including 1) unlimited inventory, 2) lack of marketer confidence with ROI, and 3) declining RPMs. Some key developments that we expect to see:
Sponsorship advertising. We think content providers are misusing page views by creating excessive content and ads. As a result, we think sponsored ads, which allow the advertiser to control the entire user experience, will become more widespread, particularly with brand advertisers.
Time-based advertising. We think advertisers will begin to use time spent on a page as a measure of user engagement. This could then give guidance as to what ads are shown and how much of an impact they had on a user.
New ad formats. We think many users are beginning to tune out the standard banner ads on a page view. As a result, we think new ad formats beyond those of the IAB need to be introduced to engage user attention.
More optimization. We think that display ads need to be better targeted through use of behavioral targeting and interest-based ads.
Content quality Probably one of the most important factors in ad placement is the content near where the ad will be placed. In general, graphical ads are less targeted than search ads since search ads are dictated by the interest of the user whereas graphical ads are generally determined by the content of the host website. Typically, web pages are grouped into two categories: premium inventory and non-premium inventory. Premium inventory is more focused on a specific vertical of content or demographic. An example of premium inventory would be the Yahoo! Finance page. Non-premium inventory includes very general untargeted pages. Examples of non-premium inventory include social networking sites and email.
Revenue model Revenue for graphical advertising can be cost per thousand (CPM), cost per click (CPC) or cost per action (CPA). CPM-based advertising is the traditional TV model employed in graphical advertising. In this model, advertisers negotiate a rate that will be paid for every thousand times the ad is displayed. Because the likelihood of a target market user seeing the ad is much higher on premium inventory than on non-premium inventory (for which advertisers likely pay for many non-target users to see the ad), the range of CPMs is wide. Premium inventory can carry CPMs north of $30, while non-premium CPMs can be below $1.00.
CPC and CPA models fall into the category of performance-based advertising since an action by the user is required before the advertiser is charged for the advertisement. In CPC advertisements, the advertiser is charged per click on the ad. In CPA models, the advertiser is charged when a predefined action is taken by the user (such as providing contact information on a form).
Ad characteristics A final consideration in graphical advertising is the specifics of the advertisement. Banner ads can be found in a variety of sizes and shapes, can be in video form, and can be incorporated into pop-ups. Positioning on the web page is also a key concern. These factors are all important in the consideration of setting a price for the advertisement.
Why use graphical advertising? Since no action is required on the part of the user, this form of advertising is very attractive to brand advertisers who are hoping to cultivate name recognition and brand identification rather than to drive immediate sales. However, there has been some evidence that graphical advertisements can directly increase sales, when mixed with a search advertising campaign. In a study conducted by Atlas Solutions, participants were split into three groups: those who clicked only on search advertisements, those who clicked only on display advertisements and those who clicked on a search advertisement and also viewed or clicked a display advertisement. Using the display-click-only group’s conversion rate as a baseline, Atlas found that search-click-only users convert at a rate over 3 times higher. Users exposed to both search and display convert at an even higher rate – 22% better than search alone and 400% better than display only.
Placing and measuring a graphical advertisement The graphical ad placement process is a little more intensive than the search ad placement process. First, the banner ad or video needs to be created according to the specifications of the host website. As different websites might have different requirements, the format may have to be altered to meet various content website demands. A price and budget is then negotiated with the content website. Larger websites typically have their own sales force, with which advertisers deal directly. However, smaller websites often outsource the process of finding advertisers and hosting ads to ad networks that standardize the process across multiple host websites. The ad is then provided to each website or to the ad network for placement and performance tracking.
New technologies have made the measurement of display advertisements more difficult. For example, AJAX technology now allows users to preview the contents of a page without actually clicking over to the page itself. These technologies have begun to render page views as a less important metric of performance (time spent at a site is becoming more important), and performance measurement and content monetization are currently hotly debated topics.
How graphical ad revenue is determined The total revenue of a publishing site is determined by 3 factors:
Page views (the total number of pages viewed in a given period);
Coverage (the proportion of pages which had an ad);
Average CPM (the average price advertisers paid per 1,000 ad views).
The role of TAC rates in graphical advertising Because of the relatively high costs associated with developing and maintaining the graphical advertising platform and with attracting and servicing advertisers, some content providers have chosen to outsource the placement of display ads with larger content providers or ad networks. An example of this is the Newspaper Consortium developed by Yahoo!. In these cases, the revenue is split between the parties. The traffic acquisition cost (TAC) rate is established in negotiations and is in force for the length of the partnership. The TAC rate is the percentage of revenue which is paid to the content owner for obtaining the traffic. Typically, this rate is lower than the TAC rate for search as the graphical advertising process is more complex and less automated. For the content providers which provide the outsourced display advertisements (such as Yahoo!), the company usually reports gross revenue and net revenue, the latter excluding TAC payments.
Search Advertising 101 Search advertising has become the leading form of online advertising due to multiple characteristics.
Advertisements are very targeted since the searcher enters a key word or phrase describing the information he would like to receive.
The searcher is very receptive to looking at advertisements since information gathering is the focus of his activity (this in contrast with television or radio ads, for which the main focus of the viewer is being entertained).
Search advertisements have significant reach given the large volume of searches conducted.
Given the automated nature of search advertising, advertisers of all sizes and all ad budgets can easily take advantage of this marketing method.
Finally, advertisers do not pay to have the ad appear, but only pay when a searcher clicks on their advertisement and is transferred to the website. Because an action is required on the part of the searcher (clicking on the ad) and advertisers do not pay unless this action occurs, search advertising is considered a form of performance-based advertising.
Efforts are being made to innovate in search After years of the same format for search results, we have seen most of the key players start to innovate in the space. Some key developments that we expect to see:
Multimedia search results. We think search companies will embrace the diversity of data media and incorporate more video, image and audio results into searches.
Increased personalization. We think a greater focus will be made to target results based on geographic location and other factors.
Dynamic results. With data constantly being added to the web through blogs, Twitter, and social networks, we think real-time results will become more the standard.
The auction process Advertisers or search engine marketers (SEMs are advertising agencies which manage the search ad campaigns of larger companies) first create a text ad, which is a very short (~70 characters in length), text-only, advertisement or description of the website. Advertisers then select the key search words or phrases which they would like their ads to appear alongside. Advertisers also select their monthly budget and their maximum cost per click, which is the amount an advertiser is willing to spend to have one searcher click on the ad and be transferred to the advertising website.
When a searcher uses the key word in a search, a search algorithm compares all of the maximum bids for the key word and the quality of the advertising site. Both factors are usually used in the formula for selecting an advertisement and determining the order in which advertisements appear since search engines are concerned with providing the most relevant ads to users to maximize the user experience. Thus, there are occasions when ads with lower maximum-CPC bids appear above ads with higher bids. The ads then appear in the order determined by the algorithm. If the searcher clicks on an ad, that advertiser is charged a CPC based on other bids in the auction and the quality determination of the advertiser.
How search revenue is determined The total revenue of an owned and operated search engine is determined by 4 factors:
Query volume (the total number of searches in a given period);
Coverage (the proportion of searches which had an ad);
Click-through rate (CTR) (the number of ads which were clicked as a proportion of total ads);
Average CPC (the average price advertisers paid for each click received).
The role of TAC rates in search advertising Because of the relatively high costs associated with developing and maintaining the search advertising platform and with attracting and servicing advertisers, some search and content providers have chosen to outsource the placement of text ads with larger search engines. Examples of this include both AOL and Ask, which outsource search advertisements to Google. In these cases, the revenue is split between the parties. The traffic acquisition cost rate is established in negotiations and is in force for the length of the partnership. The TAC rate is the percentage of revenue which is paid to the content owner for obtaining the traffic. Typically, this rate is north of 75%. For the search engine which provides the outsourced search advertisements (such as Google), the company usually reports gross revenue and net revenue, which excludes TAC payments.
Search Advertising The search advertising market had a solid year in 2010. We think this industry, in addition to having more favorable ad budgets as a whole, benefited from an increased share of advertising dollars and a recovery in costs per click (CPCs). Looking forward, within the US we expect the market to start to enter the maturation phase. By this, we mean that we think internet population and query growth will slow and market share shifts will stabilize. However, we think international markets will continue to benefit from increased search usage and broadband subscriber growth. Following are our more detailed thoughts on the space.
Advertisers Likely to Explore New Search Avenues We think advertisers will show a new interest in social media search, mobile search and local search going into 2011. In a recent survey by Covario, 36% of US advertisers listed their top SEO priority to be social media program integration. According to the research, social media advertising on Facebook was top of the list of priorities for almost half (46%) of respondents, followed by local search advertising programs (18%), and mobile search advertising (11%). Although Facebook would likely be one of the biggest beneficiaries of social media spend, Google will likely do well with shifts to local and mobile spend. At a Mobile Marketing and Advertising event in Las Vegas, Diana Pouliot (director of mobile advertising at Google) stated that one-third of all Google searches via the mobile web pertain to some aspect of the searcher’s local environment. Furthermore, StatCounter data reveal that Google has a 97.3% market share of mobile searches in the US.
US Market Share Shifts 2009 saw the introduction of Microsoft’s new search engine, Bing, which started to change market share dynamics. Further changes came in 2010, with the beginning of Microsoft/Yahoo! search integration and changes in search methodology, including contextual shortcuts (hovers), slideshows and Google Instant Results. However, now that Bing is starting to anniversary its launch and comScore data has adjusted for methodology changes, we have started to see some trends emerge. First, we think Google’s market share has begun to stabilize as it now commands ~72% of the search market (including AOL and Ask searches). Secondly, Yahoo! appears to be
Worldwide Market Share Trends On a worldwide basis, we have begun to see our thesis regarding social media play out. While Google’s search market share has fallen to 62.6% from 65.8% at the beginning of the year, Facebook has grown its share to 2.3% from 1.3% in the same period. Country-specific search engines also appear to be doing well, with Baidu, Tencent and Alibaba either maintaining or growing market share during the year.
Worldwide qSearch Market Share % of total worldwide searches
Global Search Expected to Grow 20% in F’11 We forecast that global paid search revenues will grow by 20% in 2011 on the back of 18% Y/Y growth in F’10. From a metrics standpoint, we believe that query volumes will grow 18% in F’11, while RPS will grow 2%. We anticipate a climb in search usage as consumers are still price-conscious and engage in comparison shopping; however, we think monetization will improve this year as ad budgets will likely result in more bidding for key words. We continue to see personalized search and vertical search as hot topics.
US Search Expected to Grow 13% in F’11 We are now modeling 13% Y/Y growth in F’11, flat with 2010 performance. Broken down by metric, we are modeling US query volume growth of 12% Y/Y in 2011 (a deceleration from the 14% we observed in 2010), driven by an increase in the number of searches conducted per user and a slight increase, 1%, in the domestic internet population. We expect mobile search usage to be the main driver of query volume growth. Although these searches admittedly have lower revenue per search (RPS), we think usage of search on mobile phones is healthy and on the rise. As smartphone uptake continues, we expect it to continue to be a large driver of growth.
On the monetization front, we expect the domestic RPS to reach $70.73 per 1,000 searches in 2011, up slightly from $70.14 in 2010 (a 1% increase). We expect higher levels of RPS in 2011 to be driven by stabilization in advertisers’ budgets, which should lead to higher keyword bids.
J.P. Morgan’s US Search Advertising Revenue Forecast Units as indicated
United States 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 09-’14E CAGR
Internet Population (M) 203 211 217 222 227 231 235 239 243 1.8% Queries / Month / User 47 57 68 78 87 95 104 112 120 8.9% Number of Queries (M) 114,896 144,080 177,938 208,188 236,293 264,648 293,759 323,135 348,986 10.9%
Source: J.P. Morgan estimates, company reports, comScore, Nielsen//NetRatings, IDC, and IWS.
International Search Growth Accelerates We continue to believe the opportunities for paid search in the international marketplace are even more significant than in the US. In our estimate, while the UK is at par with or ahead of the US market, the overall international paid search market is still 2+ years behind the US in terms of development.
The international market is now larger than the domestic market, reaching $21B in F’10E. Thus, we believe that international markets will be a key growth driver in the upcoming year. We think the largest driver will be query growth. While we expect the US to experience query growth of 12% Y/Y in 2011, we believe international
markets will see a 19% Y/Y lift in the number of queries. Accenting these gains are likely increases in foreign currency exchange rates. We see international RPS growing 5% in USD.
We are now modeling F’11 paid search revenue growth of 25% Y/Y to $25.7B.
J.P. Morgan’s International Search Advertising Revenue Forecast
Source: J.P. Morgan estimates, company reports, comScore, Nielsen//NetRatings, IDC, IWS.
Global Equity Research 03 January 2011
36
Display Advertising We believe that there was a resurgence in interest in display advertising in 2010, particularly in the premium space. We think this trend will remain very strong as online video continues to proliferate, social network platforms continue to develop and mobile devices gain traction. We expect this to be supported in 2011 as brand advertisers shift spend online from newspapers and TV to match audience viewing patterns. However, despite this positive driver, we see plenty of challenges continuing in the space.
We Think Global Graphical Advertising Will Grow 14% Y/Y in 2011 We think that 2010 showed signs of recovery for graphical advertising publishers, as we expected, and that this rebound will continue into 2011. On the back of estimated 15% Y/Y growth in 2010, we believe global graphical advertising revenues will grow 14% in F’11. From a metrics standpoint, we believe page views will grow 12% Y/Y (driven by social networking and mobile devices) while revenue per thousand impressions (RPMs) increase 2% Y/Y. We expect the global internet population growth to remain strong at 7% Y/Y, reaching 1.5B in 2011.
J.P. Morgan’s Global Graphical Advertising Revenue Forecast Units as indicated
Global 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 09-'14E CAGR Internet Population (M) 1,020 1,113 1,205 1,295 1,385 1,482 1,561 1,645 1,719 5.8%
Source: J.P. Morgan estimates, company reports, comScore, Nielsen//NetRatings, IDC, IWS and IAB.
Growth in US Display Advertising to Match Search For a long time, search advertising growth significantly outpaced display ad growth as advertisers flocked to the proven performance model. However, we are starting to see signs of this trend reversing due to a couple of factors. First, we think that brand advertisers are latecomers to online advertising and that display advertising will make more sense for them to get their messages across. Second, we note that social networking has had a large impact on viewership trends and that advertisers will follow the eyeballs. Thus, we see 2011 as a strong year for graphical advertising and are modeling 13% Y/Y growth, in-line with our search advertising growth estimate.
As discussed later, we think the display advertising industry needs to do a better job of educating clients and presenting clear metrics for the industry. This is essential to tapping into this growth opportunity. Specifically, we think the following improvements would greatly aid the industry:
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;
Creative ad formats with real-time updating for better targeting.
We expect the US graphical advertising market to grow 13% in 2011 vs. 2010E growth of 15%. We believe that page views will grow 9% in 2011 (down only slightly from 10% in 2010) as social networking sites and blogs drive usage. In our estimate, page view growth will be driven by an increase of 2% in internet users and an increase of 7% in usage per internet user. We are modeling RPMs to increase 4% in 2011, driven by flat growth in impressions per page offset by a 4% increase in cost per thousand (CPM).
J.P. Morgan’s US Graphical Advertising Revenue Forecast Units as indicated
United States 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 09-'14E CAGRInternet 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% Total Pages Viewed (B) 3,341 3,608 3,933 4,307 4,737 5,164 5,577 5,967 6,385 8.2%
Source: J.P. Morgan estimates, company reports, comScore, Nielsen//NetRatings, IDC, IWS and IAB.
2009 Global Display Market Share
Other71%
Microsoft5%
AOL6%
Google10%
Yahoo!8%
Source: Company reports and J.P. Morgan estimates.
2010 Global Display Market Share
Other71%
Microsoft5%
AOL4%
Google11%
Yahoo!9%
Source: Company reports and J.P. Morgan estimates.
International Growth More of a Driver in 2011 International markets will likely benefit not only from higher ad spend due to the macro economy but also from higher foreign currency exchange rates. We think this will accent increased broadband penetration and increased ad spend moving online. We think page view growth will hold up and reach 13% Y/Y in 2011, up from 11% in 2010E. However, we are modeling RPM increases of 1% Y/Y.
Source: J.P. Morgan estimates, Company reports, comScore, Nielsen//NetRatings, IDC, IWS and IAB.
Drivers of Display Advertising Growth Since the downturn, we think many publishers have focused on innovation to drive ad growth. Additionally, social networking sites, such as Facebook, are more focused and have improved the self-service ad model.
Online video advertising We think the online video advertising space is taking off, with Google reporting that it is seeing ~2B monetized views/week. Therefore, we are changing our outlook on the space and are bullish on online video ad growth in 2011. We believe both performance-based marketers and brand advertisers are looking at three variables in determining their investment: reach, content quality and performance measurability. Although reach has been growing over the last few years, our concerns about content quality caused us to be cautious on the space. However, we think 2010 was marked by a shift of quality video content online and thus believe ad dollars will grow in 2011.
Viewing videos online has become the norm According to comScore, as of October 2010 almost 85% of the US web population had viewed a video online. On a per viewer basis, the 175M unique viewers watched an average of 15.1 hours per viewer. Perhaps even more surprising than its high penetration rates is the fact that online video usage is still growing at a fast clip. In October, unique viewers grew 7% Y/Y while videos viewed grew an impressive 31%. With such great reach and engagement, it is easy to see how this platform would attract the attention of advertisers.
Content quality is improving We believe online video can be classified into 3 groups:
1. Premium content, professionally produced by traditional media and entertainment companies;
2. Web video, independently produced and made by professional and semiprofessional crews and production teams;
3. User-generated content, which includes videos uploaded on social networking or video sharing sites.
We think the amount of premium and web video content is growing. We note that video ads reached 45% of the total US population an average of 34x during the month, according to comScore. Video ads accounted for 13% of all videos viewed and 1% of all minutes spent viewing video online.
Videos Streamed Share of Top 10 Video Sites
Top TenSites, 55.5%
Non-Top-Ten Video Sites, 44.5%
Google Sites, 69.9%
Microsoft Sites, 4.4%
Hulu, 7.1%
VEVO, 2.3%ADAP.TV, 2.3%
BrightRoll, 2.4%
Fox , 2.3%
Viacom Digital, 3.1%Yahoo! Sites, 3.5%
Tremor Media, 2.7%
Source: comScore data, September 2010.
Ad formats are diverse; performance measures are limited Many online video sites have experimented with video pre-rolls, post-rolls, advertising breaks in the video and advertisements running concurrent with the video at the bottom of the screen. So far, no advertising format seems widely accepted by users, publishers and advertisers. Additionally, we think most of the ads are shown on a CPM basis.
Performance-based marketer interest We think performance-based marketers are solely focused on a measurable return on investment. We do think that some videos are well suited to the cost-per-action (CPA) model. Videos that feature content as information and education, such as how-to videos, exercise segments or niche-specific informational videos (travel, professional talks, etc.) would be excellent candidates for clickable overlays, in video ads, or for companion ads to allow the viewer to buy related merchandise. We think this is a valuable opportunity to deliver highly relevant advertising at a great point in the purchase cycle.
Video presents many challenges for brand advertisers We believe publishers have a difficult, if not impossible, time guaranteeing viewership for any specific video the way television does in the up-front model. Often, it is very hard to tell, or guess, which video will be popular. This makes it
difficult for publishers to determine pricing and for brand advertisers to strategically invest in videos to meet their content quality requirements, demographic profiles and reach targets.
2011 will likely be a year of innovation We think the display advertising industry will continue to do a better job of educating clients and presenting clear metrics for the industry. Specifically, we think the following improvements would greatly aid the industry:
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;
Time-based ads which leverage user engagement;
Creative ad formats with real-time updating for better targeting.
Some Challenges Internet users have faced a large influx of inventory While portals were once dominant, Yahoo!, AOL and Microsoft accounted for ~19% of minutes spent online in August 2010, down from 42% in August 2002. Meanwhile social networking websites have experienced 44% Y/Y growth in 2010 to date (October) in minutes spent online and now account for 13% of time spent online. This fragmented audience not only makes it more difficult for advertisers to reach their target audience through only a few publishers but also makes it difficult for publishers to attract advertisers given their limited scale. While increasing user reach is half the battle, we recognize that many page views are meaningless to advertisers unless user information can be gathered and ads targeted. In order to most effectively target the ads, publishers need to have access to user behavior on multiple sites to collect data and to repeatedly show ads to the user.
DSPs are becoming increasingly popular As a result of the fragmentation of inventory, demand-side platforms (DSPs) have become increasingly popular as a way to manage campaigns. A DSP is a system that allows digital advertisers to manage multiple ad exchange and data exchange accounts through one interface. Real-time bidding for display online ads takes place within the ad exchanges, and by utilizing a DSP, marketers can manage their bids for the banners and the pricing for the data that they are layering on to target their audiences. Ultimately, demand-side platforms are designed to give advertisers greater control over pricing, targeting and managing their online media campaigns. We see this as an encouraging development as some of the control, automation and measurement/analytic capabilities associated with search advertising are now being transferred to the display space. We believe more advertisers will embrace display advertising with better measurement and ROI potential.
Performance focus remains a headwind; need more measurement We see advertisers placing higher value on clear ROIs. This is clearly demonstrated in the ongoing shift toward performance in internet ad revenues. According to IAB/PwC data, performance-based revenue grew to 61% of total internet ad revenues in 1H10 from 58% in 1H09. Conversely, impression-based revenue fell to 35% from 38% in the same period. Thus, we believe publishers need to do a better job of improving measurement so they can attract more TV dollars.
Source: IAB Internet Advertising Revenue Report 2010 First Half-Year Results.
1H10 Internet Ad Revenues by Pricing
Impression-
based, 35%
Hy brid, 4%
Performance-
based, 61%
Source: IAB Internet Advertising Revenue Report 2010 First Half-Year Results.
Historical Pricing Model Trends % of total revenue
0%10%20%30%40%50%60%70%
2005 2006 2007 2008 2009 1H10
CPM Performance Hy brid
Source: IAB Internet Advertising Revenue Report 2010 First Half-Year Results.
Monetizing non-premium inventory The concept of behavioral targeting is not a new one, and it has been held out as a solution to declining CPMs for some years now. Marketers appear to value targeted advertising as demonstrated by Google’s well-targeted search ads generating revenue per query (RPQ) more than double Yahoo!’s. We expect that this same principle will apply to graphical advertising and note that Revenue Science estimates a 15x CPM premium for behaviorally targeted ads. However, the industry has encountered some problems using behavioral targeting in getting the scale necessary for this to be effective for advertisers and to effectively fight off privacy issues. Google is the latest to offer behavioral targeting capabilities in its interest-based advertising product launched in March 2009. But, according to estimates by TechCrunch and Jim Brock, founder of PrivacyChoice, chairman of Attributor, and a former senior VP at Yahoo!, only about 25% of AdSense sites are serving targeted ads.
Mobile Advertising Mobile Phone Scale on Par with Television = Huge Ad Opportunity With approximately 233M mobile phone users in the US, we can claim that the mobile phone market is on its way to maturity. If we assume that there are 2.5 people to a household, this would imply that almost 93M US households have a mobile home vs. 115M US households possessing at least 1 TV. While this reach offers interesting possibilities to the advertising market, the implications for carriers are somewhat less inspiring. Carrier growth is now dependent on winning customers from competitors or driving share gains through data service packages. Thus handsets and content experience are becoming as key to carrier growth as they are to handset manufacturers and content providers.
Mobile Subscriber Growth Is Slowing Subscribers in millions
May -08226
May -09233
Jan-10234
200205210
215220225230
235240
+ 3%
Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation and March 2010 press release.
Worldwide Mobile Phone vs. Broadband Penetration Billions
0
2
4
6
2005 2006 2007 2008 2009 2010
Mobile Subscriptions Internet Users
Fix ed Broadband Subscriptions Mobile Broadband Subscriptions
There Is Much Room for Broadband Subscription Growth However, unlike mobile phone subscribers, smartphone users are still growing at a healthy clip. Only about 18% of mobile subscribers use smartphones according to Nielsen, but this number is up from 13% in 2008. As these users are 3x as likely to browse the mobile web, 3x as likely to use a mobile app, and 2x as likely to send photos or videos (per comScore), we think smartphone penetration is key to mobile advertising growth.
Smart vs. Nonsmart Phone Penetration
Non-smartphone Users, 82%
Smartphone Users, 18%
Source: Nielsen 2010 Media Industry Fact Sheet.
Smartphone Penetration by Country
0%10%20%30%40%50%60%
2010 2012 2014
N. America W. Europe Asia-Pacific
Central and Eastern Europe Middle East and Africa Latin America
Source: adenyo presentation, 2010.
Use of the Mobile Web Is Becoming Mainstream According to Nielsen data the number of mobile web users has risen to 61M in 2009 (up 33% from 2008). We think improved hardware, better data speeds, and more versatile data plans are driving this uptake. The top 5 activities on cell phones still relate to SMS, camera, and messaging services; however, mobile games now rank in the top 10 activities, and game applications are showing the second-highest annual growth rate at 111% (comScore).
1 Sent text message to another phone 138.6 59.5% 21.0% 2 Took photos 105.1 45.1% 15.8% 3 Used network services for photos/videos 73.9 31.7% 30.9% 4 Sent photo directly to another phone 67.9 29.1% 29.8% 5 Received an SMS ad 58.9 25.3% 33.1% 6 Changed to native ringtone 57 24.5% 7.8% 7 Played games 55.4 23.8% 13.4% 8 Set graphics with camera 55.2 23.7% 14.1% 9 Changed to native graphics 52 22.3% 18.3% 10 News or info via browser 47.7 20.5% 42.3% 11 Transferred photo to PC 46.3 19.9% 29.0% 12 Used email 42.3 18.2% 41.5% 13 Captured video 40.9 17.6% 32.3% 14 News or info via SMS 32.9 14.1% 84.5% 15 IM 31.6 13.6% 63.0% 16 Made own ringtone 30.3 13.0% 27.5% 17 Listened to music on mobile phone 28.3 12.1% 51.4% 18 News or info via app 24.5 10.5% 111.3% 19 Uploaded video to computer 22.1 9.5% 51.3% 20 Listened to music transferred from PC 21.2 9.1% 48.4%
Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation.
By Creating More Media Fragmentation, Mobile Is Posing New Challenges/Opportunities for Advertisers and Content Publishers With better devices, improved data speeds, and more attractive data plans, content and service providers have been able to recognize distinct growth in usage. Mobile users spend ~24 minutes per day on Facebook and average 3.3 visits per day, an amount of time that equals if it does not exceed that of PC users, who spend 27.5minutes per day and average 2.3 visits. On the more traditional content side, browsers were used by ~29% of US mobile subscribers according to comScore January 2010 data. Furthermore, branding remains key, with strong web brands dominating mobile devices.
Top 5 Mobile Websites and Video Channels Websites Video Channels
1 Google Search YouTube 2 Yahoo! Mail Fox Interactive Media 3 Gmail The Weather Channel 4 The Weather Channel Comedy Central 5 Facebook CBS
Source: Nielsen 2010 Media Industry Fact Sheet.
Mobile users access their smartphones across all times and days, with slight peaks during the daytime and evening hours that are consistent with sleeping patterns. We think this offers advertisers an attractive pattern as ad rates and consumer reach should not be dependent on certain prime-time hours and days.
Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation, March 2009.
Surprisingly, early data indicate that mobile usage is actually providing a site visitation lift rather than cannibalizing the existing internet site visitor base. In a cross-media panel conducted in February 2009, comScore found that the business directories category actually saw a 3% site visitation lift due to mobile visitation.
Cross-Platform Website Reach Directories % Mobile users
accessing content via PC
% PC users accessing content via mobile
device
Site visitation lift (Increase in internet site
visitor base due to mobile visitation)
Google 64% 2% 1% Yahoo! 28% 1% 4% Yellowpages.com 43% 4% 6% Business Directories Category
64% 5% 3%
Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation, Feb 2009.
Bottom line We think mobile web browsing is creating even more fragmentation in media consumption. In our opinion, content publishers (both new and traditional media) need to be aggressive in reaching out to the mobile audience as it will assist them in bolstering their main platform. Historically, we learned that not having a web
presence early in the internet life cycle hurt many traditional media companies. In the same way, we think failure to establish early mobile leadership could hurt content aggregators and publishers. At the same time, failure to understand the mobile audience could lead to market share loss for producers and advertisers.
Time Spent across Platforms Is Becoming More Fragmented -- Mobile Usage Only Accelerates this Trend
12%16%
31%28%
0%5%
10%15%20%25%30%35%
Print Radio TV Online
Source: Yahoo! 2010 Investor Day presentation.
Still Very Early Stage of Mobile Ad Adoption Cycle It is not a large leap of logic to conclude that advertisers will be attracted to mobile media as cell-phone adoption has reached critical mass; well over 50% of cell-phone users take advantage of non-voice features, and smartphone launches and consumer purchases are increasing exponentially. However, we also think 2011 will still be an experimental year in mobile advertising as advertisers are forced to deal with the variety in devices and capabilities and the fragmented usage of SMS, browsing and applications. We note that, while there is still a large gap between ad spend and time spent on a medium, ad spend is shifting to better reflect user behavior.
As the mobile time spent grows, we think the space will be able to attract ad dollars similar to the way the internet did.
Ad Spend vs. Time Spent, 2003
7%
27%
52%
14%23%
8%
24%
3%
0%10%20%30%40%50%60%
Print Radio TV Online
Time Spent Ad Spend
Source: SRI Knowledge Networks, Universal McCann 6/03 and IAB 3/04.
Ad Spend vs. Time Spent, 2009
12%16%
31% 28%26%
9%
39%
13%
0%
10%
20%
30%
40%
50%
Print Radio TV Online
Time Spent Ad Spend
Source: Yahoo! 2010 Analyst Day presentation.
When looking at the relationship between internet ad spend as a percentage of total ad spend in the US and broadband penetration growth, we notice that there is a clear correlation. Furthermore, we notice that there was an inflection point in ad spend when broadband penetration traveled north of 20%. We think that this may be indicative of the pattern mobile ad spend will follow as smartphone adoption increases.
There Is a Clear Correlation between Internet Ad Spend and Broadband Penetration
0%
5%
10%
15%
20%
25%
2005 2006 2007 2008 2009
Broadband Penetration of Total US Population Internet Ad Spend as % of Total
Source: “Advertising Expenditure Forecast,” ZenithOptimedia; J.P. Morgan US Internet Advertising forecast, International Telecommunications Union (http://www.itu.int/ITU-D/ict/statistics); http://www.cia.gov/cia/publications/factbook/index.html, and J.P. Morgan estimates.
Right now, comScore estimates that subscribers are pretty evenly divided between accessing content through browsing, applications and SMS. As we expect users to continue to test these various platforms, we think both content publishers and advertisers will utilize all three platforms. As in the offline space, of the top search and portal sites Google and Yahoo! maintain the largest reach on mobile devices.
Lead Online Search and Content Provider Reach reach % within category
Browsing Applications SMS Total AOL 24.4% 27.6% 24.5% 29.2% Google 50.4% 28.6% 30.2% 47.2% Microsoft 22.5% 21.5% 13.1% 24.7% Yahoo! 47.8% 39.6% 41.7% 48.4% Other 87.6% 54.2% 35.5% 82.7% Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation, Feb 2009.
In terms of the types of advertisers, it is not surprising that mobile-related industries are dominating mobile banner advertising. However, nonmobile sectors are also adopting mobile banner ads.
Top Nonmobile Advertising Industries, May 2009 % share of 191,380 ad instances
Source: comScore Wired – Connecting to the Mobile Marketing Revolution presentation, Feb 2009.
With approximately 60M Americans now actively using mobile internet service, we think that the market has reached enough scale to begin to be attractive to advertisers. We have subdivided mobile internet advertising into 4 categories: Message Advertising, Mobile Display, Mobile Search and Video.
SMS advertising We think that mobile message advertising is currently the largest medium for mobile advertising as text messaging usage does not require high data speeds or advanced phone capabilities. Campaigns can include placement in text messages, direct spending on a message campaign and spending on promotional coverage of end-user messaging costs.
Mobile display advertising Mobile display advertising includes spending on display banners, links, or icons placed on WAP or mobile HTML sites or embedded in mobile applications such as maps or games and videos. We think mobile display advertising will be a high-growth area over the next few years as improvements to data-loading speeds and better phones fuel mobile internet usage. However, we see growth in mobile internet users and increased advertiser spend slightly offset by declines in CPM due to available inventory increases.
In addition to high growth, we think that the mobile display market will also undergo a competitive shift favoring traditional internet display companies. Early mobile display advertising was dominated by mobile-specific ad networks such as Third Screen Media and AdMob, which specialize in delivering ads for phone browsers. However, the latest browsers, such as MobileSafari on the iPhone, are designed to bypass mobile websites and display full-size, hi-fi websites and ads. Thus, the iPhone browser loads an ad the same way a computer does, eliminating the need for a special mobile ad network with different technology. We think that the trend toward these advanced phones will favor existing internet players which already have many advertiser partnerships.
Mobile search advertising Mobile search advertising includes spending on sponsored display ads and text links that appear alongside mobile search results as well as spending on audio ads played to mobile phone callers making a directory inquiry (e.g., to GOOG-411 and 1-800-FREE411. We think mobile search advertising will be a high-growth area given its high volume and starting-point status. Unlike mobile CPM, we actually think CPC will grow as adoption increases.
Some Opportunities and Challenges Impact on the Content Ecosystem
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 put ads people download branded apps companies with lower brand recognition will be
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 more attractive to consumers
less coverage
reach larger audience with more available time apps allow consumers to create own personal aggregation
Video high demand for video content while traveling smaller screen 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 estimates.
Small screen Over time internet publishers and search engines have learned to balance the number and placement of ads on a page to maximize revenue with the creation of a user experience which would encourage repeat visits. For search, this has meant about 1-3 ads at the top of a results page with the remainder down the right side of the page.
For quality publishing sites, we now see about 1 large ad and 1-2 smaller ads discreetly placed around the content. However, on mobile phones, neither of these standards will work as one traditional search ad would occupy almost one third of the screen and one traditional display ad would take up the whole screen. This problem has resulted in significantly lower coverage on both content and search results pages. We note that, on the iPhone, Google and Yahoo! are putting only ~1-2 ads at the top of a mobile search results page with ~2-3 more at the bottom (much scrolling is required to see these). Many content publishers have resorted to putting a small display ad in a long narrow bar format (taking up about the same amount of space as a search text ad). On average, we saw only one ad on the screen at a time. We think some of this weakness will be offset by better pricing, with AdMob estimating that mobile CPCs averaged about 11-12 cents and mobile CPMs around $12-$14 in 2009 (Business Insider, June 2009). However, we note that the greater load times on mobile devices makes users less likely to click on ads and thus the greater pricing is more than offset by lower coverage and click-through rates. A recent key development which has been able to offset these small screen size concerns is the introduction of the iPad and the expectation of more tablet devices. At about 9.7 inches (diagonally), this device is still small enough to be considered mobile but large enough to show ads more similar to those seen on a computer. We think these devices will help spur mobile advertising.
Lack of a standard mobile platform The Mobile Marketing Association has published mobile advertising guidelines, but it is difficult to keep such guidelines current in such a fast-developing area. There are hundreds of handsets in the market, and they differ by screen size and supported technologies (e.g., MMS, WAP 2.0). For color images, typically PNG, JPG, GIF and BMP, with WBMP being the most basic (and the most common). Thus, the MMA notes that the biggest difference between buying mobile web display ads and internet display ads is that mobile web ads are not sold by unit size. To create the best experience for both consumers and advertisers, the size of mobile web banners are optimized to best fit the handset on which the ad is being viewed to maximize the user experience, ad readability, creative flexibility and effectiveness. In cases where the ad-serving system can’t identify the device’s capabilities, the current default standard is applied. As a result publishers and ad networks will likely request advertisers to provide multiple versions of the banner with mobile web campaigns.
Handsets Display and Corresponding Ad Images Handset Approx Handset Screen Size (pixels) Example Handsets Ad Size (pixels)
X-Large 320 x 320 Palm Treo 700p; Nokia E70 305 x 64 Large 240 x 320 Samsung MM-A900; LG VX-8500
Chocolate 215 x 34
Medium 176 x 208 Motorola RAZRs; LG VX-8000; Motorola ROKR E1
167 x 30
Small 128 x 160 Motorola V195 112 x 20 Source: Mobile Marketing Association Mobile Advertising Guidelines (North America), Dec 2007.
Multiple-player value chain For advertisers, another significant difference between advertising on the internet and advertising on mobile devices is the number of players in the value chain. This is particularly true in the case of mobile operators, which possess a large degree of control of content distribution, a role that is pretty much absent online, where anyone can publish content without negotiating with an ISP.
We like Strategy Analytics’ model, which breaks the value chain into 5 components: content ownership, design/development, publishing/aggregation, provisioning/hosting, and marketing/delivery. Much of the user content in the mobile world (everything from ringtones to complex multiplayer games and location-based information) originates with a commercial entity. Design and development exists as a separate step in the value chain because existing content often has to be modified for mobile platforms. Games originally intended for console or PC play may have to be redesigned or recoded for devices with smaller screens and less graphics-processing power. Often this step is made more complicated by the multitude of devices, and the desirability of having content available on many devices has to be weighed against the costs of making different versions for different handsets. Publishers and aggregators are specialists who take content from multiple sources, test and validate that it operates on different devices and networks, price and promote the content to operators and other distributors, and create content bundles when appropriate. Provisioning and hosting includes providing hosting services that physically store and deliver content ordered from network operators. Finally, marketing and delivery includes operators, OEMs (handset makers) and independent retailers.
Although the revenue split among players in the value chain varies with brand equity, value-add attributes and proximity to the customer, in general Strategy Analytics estimates that for every $1 of revenue, content owners receive 33%, design/development 12%, publishing/aggregation 5%, provisioning/hosting 25%, and marketing/delivery 25%.
Typical Revenue Splits in Mobile Data
Content Ow nership, 33%
Marketing/Deliv ery , 25%
Publishing/Aggregation, 5%
Prov isioning/Hosting, 25%
Design/Dev elopment, 12%
Source: Strategy Analytics, Wireless Media Strategies.
We believe it is fair to say that the mobile advertising market is still in the very early stages of development and that models for payment systems are still being worked out. Consequently, there are very few standard practices. When designers/developers create the ads themselves, this is typically done on a work-for-hire basis. Distribution of revenue for advertising within content is likely to be managed by the mobile operator or ad networks, such as Yahoo!, Doubleclick, Third Screen Media, AdMob (Strategy Analytics, 2008).
User expectations According to a Nielsen/NetRatings survey of 2,000 US internet users in 2007, 92% said that they would be irritated by advertising on their mobile phones. 74% stated that they preferred to search for local products and services rather than having ads sent directly to them. However, two thirds favored more targeted ads. 56% of
respondents said they only get ads relevant to them when using the internet and 53% said the same of television. We think that people will use their phones to actively search for products and services, especially on a local level. However, these results demonstrate the importance of carefully targeted advertising. In addition to the annoyance of receiving ads they don’t want, users must deal with the fact that load times are much slower on phones and thus the time spent loading ads or clicking through to pages will be much higher on a mobile device than on the internet.
Early Leaders in the Field Phone OEMs According to comScore, Samsung ranked as the top OEM, with ~24% of US mobile subscribers in the 3-month average ending September 2010. Rounding out the top 5 were LG with a 21% share, Motorola with an 18% share, Research in Motion with a 9% share and Nokia with a 7% share.
Top Mobile OEMs 3-mo avg ending Sept 2010 vs. 3-mo avg ending June 2010
Jun-10 Sep-10 Point Change Motorola 22.8% 23.5% 0.7 LG 21.2% 21.1% -0.1 Samsung 20.5% 18.4% -2.1 Nokia 8.8% 9.3% 0.5 RIM 8.1% 7.4% -0.7 Source: comScore MobiLens.
When looking only at the smartphone market, BlackBerry and iPhone dominate. According to Nielsen data, the BlackBerry 8300 Curve has the largest market share at 17%, followed by the Apple iPhone 3G at 15%, Apple iPhone 3G S at 12%, BlackBerry 9530 Storm at 6% and BlackBerry 8100 Pearl at 5%.
Top Smartphone OEMs
Other45%
Apple iPhone 3G15%
Blackberry 9530 Storm
6%
Apple iPhone 3G S12%
Blackberry 8300 Curv e17%
Blackberry 8100 Pearl5%
Source: Nielsen 2010 Media Industry Fact Sheet.
Phone Operating Systems (OS) Of the smartphone platforms (now totaling ~59M out of the total 234M mobile subscribers), RIM still leads the market with a 37% share, followed by Apple (24% share), Google (21% share), Microsoft (10% share) and Palm (4% share).
Top Smartphone Platforms 3 mo ave ending Sep 2010 vs. 3 mo ave ending Jun 2010
Jun-10 Sep-10 Point Change RIM 40.1% 37.3% -2.8 Apple 24.3% 24.3% 0.0 Microsoft 14.9% 21.4% 6.5 Google 12.8% 10.0% -2.8 Palm 4.7% 4.2% -0.5 Source: comScore MobiLens.
Android OS According to the most recent AdMob Mobile Metrics Report (March 2010), the Android ecosystem is gathering ever-increasing penetration and diversity. In September 2009, two Android devices (the HTC Dream and HTC Magic) represented 96% of Android traffic. However, only seven months later, 11 devices represented 96% of Android traffic in the AdMob network. The top three devices in the US were the Motorola Droid, HTC Dream and Motorola CLIQ.
6% 1.5 Samsung 320 x 480 No 800 MHz 512 MB (16 GB)
256 MB
Samsung Behold 2
2% 1.5 Samsung 320 x 480 No 800 MHz 512 MB (16 GB)
320 MB
Google Nexus One
2% 2.1 HTC 800 x 480 No 1 GHz 512 MB (32 GB)
512 MB
Other 6% NA NA NA NA NA NA NA Source: AdMob Mobile Metrics report, March 2010.
iPhone OS According to AdMob data, as of March 2010 (prior to the launch of the iPad), there were six devices running the iPhone OS. iPhone OS traffic is composed of two device types: the iPhone (60%) and the iPod touch (40%). The most popular iPhone OS device in the AdMob network is the iPhone 3GS, followed by the second-generation iPod touch. iPhone 3GS traffic share increased from 30% in September 2009 to 39% in March 2010. The first-generation iPhone only generated 2% of iPhone OS requests in March 2010. The second-generation iPod touch generated over 2x more traffic than the third-generation iPod touch, released in September 2009.
iPhone OS Handset Distribution, Worldwide, March 2010
iPhone 3GS, 39%iPod touch 1st Gen,
2%
iPod touch 2nd Gen, 25%
iPod touch 3rd Gen, 12%
iPhone 1st Gen, 2%
iPhone 3G, 20%
Source: AdMob Mobile Metrics report, March 2010.
Mobile Applications: A New Form of Content Consumption Within the first 8 months of the Apple App Store, over 25,000 applications were introduced and over 800M applications were downloaded by users. Now more tech companies want to get in on the action, and we have seen or soon expect to see Android Marketplace (Google), SkyMarket (Microsoft Windows Mobile), BlackBerry App World (RIM), Ovi Store (Nokia) and others. When looking at the user profile of the iTunes App Store, we find that the average app store user comes from a higher income level than traditional online users. According to comScore research, 35% had a household income of more than $100K per year, 32% above that level for the average online user. More than half of app users come from households making at least $75K per year. We think apps have proven to be an interesting way for advertisers to reach an attractive consumer base through self-selection.
Mobile app analytics company Distimo has compiled its findings on the six largest mobile app stores, those offered by Apple, Palm, RIM, Google, Nokia and Microsoft. For quantity of apps, Apple’s App Store has a significant advantage, with over 150,000 apps; Google comes in a distant second, with just under 20,000. Windows Mobile, Palm, Nokia and BlackBerry trail have 690, 1,450, 6,120 and 4,760, respectively.
However, Android’s growth rate is faster (off a lower base), posting roughly 3,000 new apps per month (15% growth) vs. Apple’s 14,000 new apps per month (9% growth).
App Store Growth new applications per month (Dec 2009-Jan 2010)
Source: Distimo presentation, Mobile World Congress 2010.
In terms of pricing, RIM’s apps were the most expensive, at an average of $8.26, followed by Windows Mobile’s, at an average of $7.00. Apps sold by Nokia, Apple, Google and Palm all came out in roughly the same average price range of $2.50-$3.60.
Paid App Price Comparison average price for all paid apps
$3.62
$8.26
$3.27 $3.47$2.53
$6.99
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
Apple Blackberry Android Nokia Palm Window s
Source: Distimo presentation, Mobile World Congress 2010.
Source: Distimo presentation, Mobile World Congress 2010.
Monetizing apps We think that the majority of the best-known app stores have fallen roughly in line with the 30/70 revenue split introduced by Apple. Unsurprisingly, 80% of developers in North America think they should receive more than 70% of the revenue generated by their apps, according to the Spring North American Development Survey of over 400 developers in April 2010. App stores are the preferred distribution model for only 15% of North American developers, with over half preferring direct sales to end users or enterprises. Finally, over 70% thought that app stores should not impose any restrictions on price, and while a third thought content restrictions were acceptable, almost half thought there should be none at all (Cellular-News.com).
Mobile Ad Networks Google’s acquisition of AdMob, Apple’s acquisition of Quattro Wireless and the announcement of the iAd advertising platform have ignited investor interest in the mobile ad space. Mobile ad networks play an important role in connecting mobile marketers with mobile publishers. Because the mobile ad network space is still in its infancy, the market is very fragmented and there is no real way to estimate market share as there are no published revenue data. MobiThinking has divided networks into three categories based on business model. At one extreme there are blind networks that work mostly on a cost-per-click basis; at the other extreme are networks focused on premium publishers, which work mostly on a cost per thousand impressions basis.
According to MobiThinking, blind networks are usually the largest in terms of publishers, advertisers and impressions. They serve a high volume of advertising to an extensive base of mostly independent mobile publishers (mobile sites and applications), supplemented by premium publishers’ unfilled inventory. They offer plenty of options for targeting – e.g., by country and by content channels (news, sports, etc.) – but do not usually allow advertisers to choose specific websites.
Premium networks focus on a limited number of high-quality publishers – mobile operators and big-name destinations – for which they act like an extension of their direct-sales team. In the case of Nokia and AOL, much of the mobile inventory they sell is on Nokia or AOL sites. Premium networks attract big-brand advertisers who are prepared to pay premium prices to secure the prime locations on top-tier mobile destinations. This means CPMs can vary greatly, from $5 to $75. Advertisers should
expect more direct sales and support and a multitude of targeting options. Publishers should expect to receive a majority share of advertising revenue, roughly 50%-70%. Deals are usually negotiated on a case-by-case basis.
Following is a summary of a selective list of mobile ad networks based on MobiThinking’s Mobile Ad Network Guide.
Summary of Mobile Ad Networks Year Established HQ # Publishers on
Network # of Advertisers on
Network Page Impressions Geographic
Coverage Pricing Model Cost Range for
Advertiser Premium Networks Advertising.com/AOL 2005 New York, NY, US Over 75 publishers,
representing over 100 sites and applications
Over 100/year Over 1B page impressions/month
Primarily focused on the US, with growing presence in Canada, UK and other countries
CPM, CPC and CPA CPM ranges from US$5-US$25; CPC ranges from US$0.05-US$0.50; depending on campaign objectives and parameters
Hands 1999 São Paulo, Brazil 52 premium publishers
International advertisers include Unilever, GM, DHL and Mitsubishi; local advertisers include Loterias da Caixa and INPG
N/A All of Brazil 100% CPM. Each ad deal is negotiated; there is no self-service marketplace common with blind and premium blind networks
This varies according to how many impressions the advertiser buys. However CPM is on average US$20
Microsoft Mobile Advertising
2007 Redmond, WA, US; European HQ: Paris, France
Key partners include Verizon Wireless, Bouygues Telecom and independent publishers such as MSNBC, CNBC and Fox Sports. Microsoft mobile sites include: MSN, Windows Live Messenger, Windows Live Hotmail and the Bing search engine
N/A Nearly 2B page impressions/month
US, Canada, UK, France, Spain, Italy, Germany, Sweden, Denmark, Belgium, Netherlands and Norway
Either CPM or CPC. Microsoft also selectively offers advertisers the option to purchase mobile media on a CPA basis
N/A
Nokia Interactive Advertising
2004 Boston, MA, US NIA focuses on advertising on Nokia services, such as Nokia.mobi and Nokia Internet Radio, and works with strategic partners, top-tier publishers and operators, such as RTL in Germany, Airtel in India and Sprint in the US
In 2008 NIA ran almost 4,000 campaigns for over 350 brands
Over 5,000 different ads/month
Americas, Europe, India, Southeast Asia, Middle East, Africa
CPM, predominantly, being a premium network
From US$15 to US$75 CPM, depending upon region, class of publisher and targeting selected
USA 90%; 10% other Offers both self-service, auction-based campaigns and premium managed campaigns. Advertisers can purchase CPM, CPC, CPA or a combination thereof
This varies widely. Performance and run of network can be as low as US$0.05 CPC, and premium can be as high as US$20 CPM
Madhouse 2006 Shanghai, China 1,000 publishers, with some exclusive partners
Over 50 leading brands and 20 advertising agencies
approaching 1B targeted ad impression/month
100% Mainland China.
Fixed ad position / time, CPM, CPC and CPA.
Costs range from US$10,000 to US$500,000 per campaign, depending on campaign requirements, scale, complexity and level of targeting
Millennial Media 2006 Baltimore, MD, USA The network includes thousands of sites, but 80% of impressions come from Nielsen’s top 100 sites
Around 300 advertisers/month on the network (70% brand, 30% performance)
7.3B impressions/month globally, of which 6.4B impressions come from US consumers
USA (85%) and Europe.
CPM for brand advertising (about 70% of business); CPC for performance ads (30%)
CPM cost varies from US$2 to US$15 depending on a number of factors
Quattro Wireless 2006 Waltham, MA, USA Thousands of sites and applications
Hundreds of campaigns running every week
4B mobile ads/month Quattro serves ads in nearly every country on the planet, but most are served in the US
Blind Networks AdMob 2006 San Mateo, CA, US 9,000 Mobile Web
sites and 3,000 applications
Advertisers include Adidas, Diet Coke, P&G, Toshiba, MTV, Disney, Gap, Best Buy, American Express, RIM, Toyota and Jaguar
More than 10B impressions/month, which represent 32,000 different ads/month and 9,400 ads/day
US (49%), India (5.9%), UK (4.1%), Indonesia (3.9%), Canada (2.4%), others (34.7%) defined by ad requests (Oct 2009)
CPM for brand ads. CPC for performance ads, calculated through an auction-based pricing system
The auction system calculates a CPC bid price that could start at US$0.01; the maximum bid price is determined by the advertiser’s bid. CPM prices fluctuate according with geography and availability of inventory
Admoda/Adultmoda 2006 London Over 2,000. Admoda/Adultmoda turn down 70% of sites that apply to join the network
Advertisers on Admoda include: Gameloft, Buongiorno, Dada, Zed, Fox, MTV, Adidas. Advertisers on Adultmoda include Private, Brazzers, Reality Kings, iPorn, mConnect
2.1B mobile ads/month
Top 10 countries for Admoda: South Africa, Italy, US, UK, India, Germany, Australia, Indonesia, Kenya, France. Top 10 countries for Adultmoda: US, South Africa, UK, Germany, Italy, France, Spain, Australia, Netherlands, Norway
95% CPC This varies widely depending on the targeting options chosen
BuzzCity Network 2006; company 1999
Singapore 2,000 publishers; predominantly independent and mobile-focused, from mobile social networking to ad-supported download sites. Branded media sites use BuzzCity to fill unsold inventory
More than 200 regular advertisers; 70% are mobile companies
Delivers 3B ads/month
200 countries in total: South Africa (34%), Indonesia (32%), India (8 percent), UK (5%), US (5%), Other (16%)
CPC predominantly; determined by bids in the auction-based self-service market place
For untargeted campaigns: average CPC across network is US$0.03; average CPC in South Africa – US$0.20; Australia – US$0.11; United Kingdom – US$0.09
InMobi 2007 Bangalore, India Over 750 Over 150 4B ads served in Aug '09
Asia 55% of business; Africa 18%; Europe 14%; Americas 9%; Australia 4%.
CPC and CPM are both available, but the vast majority is CPC.
This varies between countries.
Mobclix 2008 Palo Alto, CA, US 20+ ad networks Advertisers include Bank of America, Crest, Virgin and Coca Cola
~10K unique visitors according to Compete in April 2010 (as cited by TechCrunch)
Local Advertising Local Online Advertising Is a Small % of Overall Market In the US, local advertising is an ~$82B industry, with only ~15% of the total estimated to be spent online in 2010, according to Veronis Suhler Stevenson. Over time, we expect ad expenditure to more closely parallel consumers’ time spent with media; as a result, given that nearly half of media consumption occurs online, we believe the internet is poised to gain further share within advertising.
US Local Advertising Spend by Medium in 2010E
Magazines, 2%
Yellow Pages, 14%
Radio, 14%
Pure-play Internet, 7%
New spapers, 33%
TV, 24%Out-of-home, 6%
Source: Veronis Suhler Stevenson; J.P. Morgan estimates.
Local advertising spend in the US through traditional media sources, including yellow pages, newspapers, TV, radio, magazines, and out-of-home media, as well as their associated online platforms, is projected to decline from $101.5B in 2007 to $73.6B in 2011. Over the same period, local online ad spend in the US is projected to grow from $8.7B to $15.9B, according to Borrell Associates.
SMBs: Spenders of Local Advertising Small and medium-size businesses, or SMBS (including such businesses as lawyers, physicians, florists, contractors, small retailers, plumbers and auto dealers, to name a few), comprise a significant portion of global business revenue. According to Borrell Associates, there were more than 15 million businesses with less than 50 employees in the US in 2008. Of these, more than three million spent an average of $1,200 per month on advertising. Furthermore, these 15B SMBs represented approximately 62% of US business revenue, with the remainder from the ~100,000 businesses in the US employing 50 employees or more.
The picture is broadly similar in several other countries. For example, according to the Office for National Statistics, in the UK, there were 2.4 million businesses with less than 20 employees in 2009; in Australia, there were ~1.9 million businesses with less than 50 employees, according to Dun & Bradstreet. Historically, SMBs have not been very well served by the major online advertisers and agencies. Looking forward, we think internet companies will increase their efforts to unlock the local dollars revenue stream.
Major Players in the Local Ad Market Traditional media sources Traditional media sources represent the largest players in the local advertising market, with newspapers, television and radio comprising 33%, 24% and 14% of local ad spend, respectively. Additionally, roughly $11.5B of local ad spend is estimated to be spent with Yellow Pages in 2010, representing ~14% of the total.
Share of Local Ad Spend
46% 45% 42% 39%36% 33%
24%22%21%20%19%18%
14%14%14%15%15%15%
0%
10%
20%
30%
40%
50%
2005 2006 2007 2008 2009E 2010E
New spapers Telev ision Radio
Source: Veronis Suhler Stevenson.
We note that while many of the traditional offline media companies have digital offerings, they are beholden to legacy businesses, which are generally declining and difficult to transition online.
Pure-play internet players Internet publishers and search engines. These websites offer services for local targeted ads, such as Google AdWords. However, many of these services have a self-service model which is not well-suited for local businesses.
Group buying, social media and review sites. Social networking sites such as Facebook allow local businesses to create fan pages and are a useful way for SMBs to maintain contact with their customers. Group buying companies, such as Groupon, and online review sites (e.g., Yelp) help customers find, connect with and review local businesses.
SMB marketing platform providers. These companies provide local advertising services to SMBs, including search and display advertising, and search engine-optimization. Examples of these include ReachLocal, Yodle, OrangeSoda and Web Visible.
ReachLocal Provides a suite of online marketing and reporting solutions to help SMBs acquire, maintain and retain customers via the internet
Yodle Provider of local online advertising services to SMBs, including search marketing and optimization, site setup and call tracking
OrangeSoda Local internet marketing company aimed at SMBs; offers marketing services including search engine optimization, pay-per-click advertising and search engine maps optimization; also offers a white-label solution via partnerships
Web Visible Offers a software-as-a-service (SaaS) technology aimed at SMBs’ marketing needs Source: Company reports and J.P. Morgan.
Rapid Changes in the Advertising Landscape Create Customer Acquisition Challenges The growth of local advertising spend has lagged the growth in online media consumption. According to Forrester Research, roughly 50% of weekly media consumption among US adults is done online. However, SMBs spend just 11% of their ad budgets online, according to Borrell Associates (vs. an estimated 15% of local advertising spent online). We believe the following factors have contributed to the lag in online local ad spend from SMBs:
Lack of time. Most SMBs are owner-operated, and the owner is the primary source of revenue for the business. Any results from time spent on an online marketing campaign are offset by the opportunity cost of lost revenue that could have been generated by using that time serving clients.
Complexity of online advertising. Online ad campaigns involve several steps, including account creation, keyword selection, budget allocation, etc. Additionally, an online ad campaign generally requires constant tweaking to maintain effective performance. We think most SMBs are unfamiliar with the process and lack the dedicated resources to allocate their spending given the fragmented nature of the internet.
Lack of media knowledge. Successfully advertising online demands familiarity with multiple forms of advertising and media: search, display, social media, directory sites, etc. Many SMBs often do not have the tools or know-how necessary to balance the spend between these varied media. In addition, they have difficulty getting access to publishers or the right advertising inventory.
Lack of transparency. Much of online marketing is aimed at tracking “clicks,” which is not an intuitive measure for SMBs to understand their advertising ROI.
Fragmentation a growing challenge Over the past several years, local SMB advertisers have faced the additional challenge of media fragmentation as consumer habits change. Whereas many consumers used to search for a local business in the yellow pages, they are now increasingly using the internet (e.g., sites such as Yelp, Citysearch, etc.) and searching on Google. Likewise, consumers who used to read the newspaper are turning to online news sites, social networking sites or blogs.
According to a TMP Directional Marketing and comScore Local Search Usage Study, consumers used online sources for 64% of local business searches, and of these consumers, 46% contacted the business owner over the phone and 37% visited the business following their online search.
In addition to overall media fragmentation, the internet itself is highly fragmented, forcing advertisers to choose between thousands of websites and ad formats.
Our Outlook for the Local Ad Market We believe 2011 will see continued increases in online local advertising spend. Given the challenges discussed above, we think ReachLocal is well positioned for a local market that continues to develop.
Disrupting existing business models. Social, which was ignored as a diversion by many observers (e.g., the ’05 and ’06 editions of this report barely mentioned social networking), has emerged as a major medium of the web, and we believe it is a potentially significant disruptive factor to many existing businesses over the next five years. Outside Mail.ru and Tencent, there are not many major public companies that are primarily social. However, given our view on the disruptive potential of the space, we are taking a longer look at this emerging field.
User adoption continues to grow; becoming a large traffic source. While Facebook is the ten-thousand-pound gorilla in the space, we expect social to be a key theme in the internet space, and the category as a whole to become a significant portion of consumers’ online life. Facebook now represents 10% of all US internet usage time, and over half of all global time spent on social networking sites, as reported by comScore. We think Facebook is beating MySpace and other similar platforms because of its 1) trusted network effect, 2) robust app economy, and 3) scalable technology platform that makes it easier for users to connect and share.
Social networks are platforms. As we highlighted in last year’s guide, we view the social sites (especially Facebook) as network platforms, like Visa/MasterCard. As such, they don’t necessarily need to monetize directly from their customers: they can enable applications such as casual games (or payments, or eCommerce, or virtual gifts) and collect a small fee as the providers of the network.
Expect significant revenue/user growth over the next few years. We believe linking the social graph with a platform for payments, advertising and commerce, plus improved micropayments capacity, represent a landscape-shifting opportunity. Additionally, casual games, integrated into the social network landscape, experienced another very strong year of growth in 2010. We think such applications are one of several paths toward the successful monetization of social networks.
Facebook Reach Now Comparable to Yahoo!, Google In many ways, Facebook is becoming the ten-thousand-pound gorilla of the internet. A year ago, the site was still reaching only half of US internet users. In the second half of 2010, users are for the first time spending more minutes on Facebook than they are on Yahoo! sites. Additionally, Facebook’s user reach is now north of 70% of all US internet users.
However, our view is that social is bigger than just Facebook, large though the site’s user base is. Specifically, while Facebook appears to be dominating more casual uses, there are strong players targeting specific verticals or geographies (e.g., VKontakte).
During the past decade, we saw a fundamental shift in how people do business on the internet. Paid search drove the first shift in the early 2000s, rapidly transforming the web and creating/enabling previously unworkable business models. In the coming decade, we think social, as a category, is poised to do the same thing. Thus, we think social can become a tollbooth for the internet, just as paid search did.
Traffic Growth Accelerating, Facebook Not the Only Winner The growth of social networks in 2010 remained very strong, with comScore estimating that minutes of usage across all worldwide social networking sites were up 48% Y/Y through the first ten months of 2010, accelerating from the growth last year.
However, the majority of the growth occurred at market share leader Facebook, which represented 63% of minutes spent worldwide at social networking sites in October 2010, according to comScore. As noted in the table below, worldwide minutes spent decreased at most of the other key players in the social networking space, though several added users. An additional outperformer was the Russia-focused VKontakte.ru (“in contact”), which posted 79% user growth and 106% growth in time spent through the first ten months of the year. Note that the high US growth rates for VKontakte are coming off a very low base.
Source: comScore. Note: sites ranked in order of Oct. 2010 worldwide minutes spent.
The Tollbooth at the Center of the Internet The unquestioned champion of online monetization up to now has been Google, which collects ~36% of all online ad revenue. Google has achieved this by efficiently bringing users to the sites they want to see. We believe social networks are in a position to join – or even displace – Google, as they play a variety of roles.
Either Always or Never: More than Half of Facebook Users Visit the Site Daily
38%
8% 13% 13%29%
0%
10%
20%
30%
40%
At least once aday
Almost ev ery day 1-2x a w eek 1-2x a month Nev er
Facebook
Source: J.P. Morgan Internet Survey 2010.
One key aspect to Facebook achieving a role as a user’s entry point to the internet is daily usage. As can be seen in the figure above, among those US internet users in our survey who reported using Facebook, a majority could be described as nearly constant users, visiting the site at least once a day. Data from comScore bear out this point: the daily user base of Facebook represents a percentage of its monthly traffic similar to those for Google or Yahoo!. By comparison, Amazon sees only ~9% of its monthly user base on a given day.
Google, Yahoo! and Facebook Get Visited by ~40% of their User Base Each Day Average # of Daily Visitors/Average # of Monthly Visitors
42% 40% 41%
80% of US internet users go online each day
0%
20%
40%
60%
80%
100%
Google Yahoo Facebook
Source: comScore, J.P. Morgan estimates. Data from Jul-Nov 2010.
As with Google, successful monetization is driven not only by the value of a social site’s own product but also by its ability to integrate communication, entertainment and commerce resources in a valuable way.
Social Networking Sites (Primarily Facebook) Are Becoming the Next-Generation Web Platform We think social networking sites are increasingly becoming web platforms, which opens a variety of monetization opportunities. Specifically, we think a useful analogy is to look at payment networks such as Visa or MasterCard, which benefit from network effects without a need to charge consumers directly.
We believe social networking sites have the capacity to work in a similar fashion. The sites aggregate their users’ social connections and provide a platform. On that platform, and using those connections, others can create tools (such as games or other applications). These tools can be used to earn revenue, of which the underlying platform site takes a cut.
One benefit of such a platform strategy is that it encourages the social sites to allow the development of an ecosystem of applications without the need to pick specific winners. As a result, sites can be more open to the growth of the tools that are most effective. We think this strategy maximizes the user experience, which drives repeat usage.
At the same time, monetization of social sites remains in a very early stage. On a revenue/user basis, eCommerce sites appear to perform the best (though margins are less favorable), whereas – as of now – Facebook is bringing up the rear. We expect monetization to continue to improve as the model matures.
Globally, Google Generates 6x More Revenue per User than Facebook
$189
$39 $24 $10 $8 $4 $4 $4$0
$50
$100
$150
$200
Amazon Ebay Google Mail.ru Yahoo Tencent Baidu Facebook
Rev enue per Unique User
Source: comScore, Bloomberg, J.P. Morgan estimates. Note: For public companies, F’10E revenue. Amazon, eBay, Google, Mail.ru, Yahoo! and Facebook unique users from comScore. For Facebook, revenue estimate of $2.0B is based on press reports, as cited by Bloomberg 12/16/10. Tencent and Baidu usage numbers are J.P. Morgan estimates.
Traffic source – A potential threat to Google? The last year has seen a dramatic shift in the volume of traffic driven to key sites by social networks, especially Facebook. As seen in the figures below, Google remains
the largest driver of traffic to sites such as nytimes.com and Amazon. At the same time, the portion of traffic coming from Facebook has increased rapidly.
Sources of Traffic to nytimes.com
20.8% 20.4%
4.8%2.9%
0%
5%
10%
15%
20%
25%
Google, -2% Y/Y Facebook, +66%
Oct-09 Oct-10
Source: comScore.
Source of Traffic to Amazon sites
20.0% 19.6%
7.7%1.8%
0%
5%
10%
15%
20%
25%
Google, -2% Y/Y Facebook, +328%
Oct-09 Oct-10
Source: comScore.
Source of Traffic to eBay sites
11.8% 11.4%
4.7%2.6%
0%2%4%6%8%
10%12%14%
Google, -3% Facebook, +81%
Oct-09 Oct-10
Source: comScore.
Facebook Connect We believe a key driver of the increasing importance of Facebook as a traffic source is the company’s Facebook Connect initiative. This enables users to use their Facebook login on other sites and to link their activity on such sites back to their profile. The company has reported that over 250M users are using Connect monthly.
For example, many large blogs use the Disqus service for comments. Rather than forcing users to create a separate Disqus sign-in, Facebook Connect enables Disqus to let users maintain their identity across multiple sites. The result is better engagement at the other site and a relatively seamless user experience.
Alternatively, an eCommerce site can use Facebook Connect to enable users to comment on or review an item and then allow their friends to see it. Incorporating such a social component can make reviews more compelling than when similar recommendations are made by strangers.
Fragmentation heightens the value of discovery One of our core theses is that the web continues to become more and more fragmented. We believe that, on a fragmented web, social sites will become more crucial in enabling consumers to find and discover content. In our view, this creates another growing point of potential competition between Google and Facebook.
The Recent Evolution of Discovery Medium Traditional Early Web 2000s Web Social Web Example Newspaper Portal site Search site Social site Curator Editor Editor User User’s connections Fragmentation Minimal Limited Growing Multiplying Limitation Interests of editors
may not match readers’
User has to know where to look
User has to know what to search for
Lack of intent-based search
Source: J.P. Morgan.
In our view, social networking both builds on and causes greater fragmentation. As seen in the above table, in a traditional media environment, there were limited news
sources (a few newspapers, magazines, TV networks), and editors and producers, rather than readers, were in the driver’s seat.
As content began to shift onto the web, it created more opportunities for niche sites and catering to personalized interests. However, without an effective discovery mechanism, the ability of a user to find relevant content was constrained.
Search engines helped to resolve this problem, triggering significant growth in fragmentation as thousands of sites catering to niche interests could count on search engines to help users discover them. However, the search paradigm is still dependent on a user knowing what to look for.
We think social discovery can address this last point: users’ interests are likely to be similar to their friends. As such, we think social sites can enable the success of an even more fragmented web, with users who share interests helping each other discover content.
Google’s ad platform vs. Facebook’s The difference between social discovery and discovery through search is manifested in the different ways that Google’s and Facebook’s ad platforms are built. Specifically, as per the figure below, a Facebook advertiser creates a campaign to target a specific type of user. On Google, advertising targets actions, so even if an advertiser seeks a specific demographic, the campaign must still be driven on the basis of specific keywords.
Case Study: Starting an Ad Campaign on Facebook vs. Google
Create ad copy, link; choose keywords; set bid parameters
Finalize and pay.
Facebook ad creation flow: Google ad creation flow:
Source: Company websites, J.P. Morgan.
Potential to become a major payment network We view payments as one of the most significant growth opportunities for social network sites. Including only eCommerce and travel, online payments volume in the US alone exceeded $260B last year; the addition of peer-to-peer transfers and other adjacent categories could drive the size of the pie even higher. We believe the integration of a successful micropayments solution with a social site can be a
uniquely powerful solution, as it would enable all sorts of online businesses to more seamlessly get paid by users.
Paying for content. While consumers have been conditioned to view online content as free, part of the problem is that there is no economical way to pay, e.g., 5c for an article – and a user is unlikely to create a login, enter credit card, etc., in order to pay such a small amount. However, if a user is already logged into a social site, and only needs to press a single button to make a payment, such a model becomes more likely.
Paying for games. The growth of social game companies such as Zynga has been explosive, and we believe an improved ability to collect small payments for in-game items can be a catalyst for incremental growth. Currently, only 1-5% of users pay for premium in-game features, a number we believe could rise if payments are integrated into the social sites that the games are being played on.
Paying for virtual goods. As social sites become a more central part of users’ identities, users become more willing to purchase virtual goods (such as “flowers” to send to someone as a birthday present). A simpler payments system speeds this process.
Peer-to-peer payments. A healthy payment platform combined with a site’s social graph could create additional opportunities. E.g., an integration of a payments platform with a wish list could open the opportunity for all of a user’s friends to chip in a small amount for a birthday present.
Social games In the US alone, NPD estimates games to be a ~$15B market. As usage of social sites grows, we expect an ever-larger portion of this spend to occur on social platforms. Additionally, the low cost of the platform allows games to be aimed at audiences that may be reluctant to spend several hundred dollars on a console but may be quite willing to spend small amounts monthly for a fuller experience in an online game.
Unsurprisingly, frequent Facebook visitors are much more likely to report playing social games than those who visit the site only occasionally.
More than Half of Users Who Visit Facebook Daily Say They Play Social Games
6%
20%
38%
54% play games
0% 10% 20% 30% 40% 50% 60%
1-2x a month
1-2x a w eek
Almost ev ery day
Use FB: At least 1x /day
% of users playing social games, by frequency of FB visits
Whereas console video games tend to be largely played by men (when a console has a primary user, that user is a male 83% of the time, according to NPD), our survey suggests social games are somewhat more popular with women: 40% of female Facebook users in our survey reported playing social games, compared to 34% of male Facebook users.
Social commerce As eCommerce continues to increase its market share within total retail, we believe social extensions of the eCommerce market ($166B in the US in F’10E) can be a catalyst for incremental growth and for market share shifts.
Reviews and recommendations are two of the most powerful features of good eCommerce sites, and we believe both benefit significantly from integration with a social platform – where the reviews and recommendations can come from people a user already knows. In a way, we believe reviews represented the original implementation of social for eCommerce. Right now, however, personalization and links between eCommerce and social sites are driving the development of social eCommerce 2.0.
For example, in Russia, Ozon.ru has partnered with the social network VKontakte to incorporate social components into Ozon’s growing eCommerce platform. The combination of the social graph with a high-volume review platform could create a promising ecosystem for companies like Amazon.com. As noted above, we believe reviews from friends and other contacts are a much more compelling source of product information than reviews from strangers.
Further, the combination of social with eCommerce can manifest itself in social buying sites such as Groupon and LivingSocial, both of which have seen explosive growth in recent quarters. E.g, LivingSocial was founded in 2007 and has said it expects to generate in excess of $500M in revenue in 2011.
Our survey of US internet users suggests that social shopping sites are still in a very early stage of their development. Although 88% of the users we surveyed noted that they have bought something online, less than 17% said they had bought something through a social shopping site. Even among only those users who have bought something online, 39% reported they were not familiar with such sites.
Even Among Online Shoppers, Users of Social Shopping Sites Still a Minority
Age and income are strong determinants of users’ familiarity with social shopping sites. Younger users are much more likely to have used or heard of such sites, and the same is true of those on the higher end of the income distribution.
Younger and Higher-Income Users Much More Likely to Use Social Shopping Sites
Bought from a social shopping site Familiar w ith such sites, but nev er bought
Source: J.P. Morgan US Internet User Survey.
Communications A letter to a friend is inherently different from a letter to the editor, and we view different social networks as offering a variety of options for personal communication. For example, a site such as Facebook enables users to narrowcast their daily experiences to their circle of friends. By comparison, a professional networking site lets users communicate with colleagues and business partners in a less personal way. And a site such as Twitter focuses much more on real-time updates – making it much more of a broadcast medium than the others.
The difference in focus drives a difference in business models. A site that can attract a more professional audience can generate higher cost per thousands (CPMs). By contrast, Twitter, with its focus on real-time updates, can monetize the service, in part, by selling its data: through a service called Gnip, it is possible to buy a “half-hose” consisting of 50% of all Twitter updates for $360K/year, or 5% for $60K/year. (Twitter has also struck deals with large players, such as Google, for the “fire hose” of all updates.) The ability to monitor trends and problems in real time can be of value to managers of large brands. Additionally, as we move toward a more real-time web, services like Twitter could become more valuable for business.
Understanding Social Games Globally, digital gaming represented an almost $16B market in 2009, according to Electronic Arts, with the pie projected to grow to nearly $20B in 2010. Digital gaming has grown at a ~36% CAGR since 2004 and now represents 41% of the worldwide games market, up from 14% six years ago.
Worldwide Games Market Seeing Rapid Growth, Boosted by Digital Games
18.328.2
19.9
3.2
0
10
20
30
40
50
2004 2010E
Packaged Games Digital Games
Source: iResearch, Electronic Arts.
The majority of the revenue within digital games has historically come from massive multiplayer online (MMO) games, such as World of Warcraft. However, we believe the key opportunity going forward is in the more casual games that predominate on social network platforms.
Key companies Three companies stand out as providing some of the most popular applications for social network-based casual games.
Playdom After several financing rounds in past years that enabled it to develop and acquire games, Playdom was itself acquired by the Walt Disney Company in a deal announced July 2010. Playdom’s key products include games for both Facebook and MySpace, including Mobsters and Social City. Since the acquisition, the company has also developed games utilizing Disney brands, such as ESPNU College Town.
Playfish In November 2009, London-based Playfish was acquired by Electronic Arts for ~$300M (with another $100M in possible earnouts), with press reports suggesting annual revenue of ~$75M as of the time of the deal. Key games include Pet Society, Restaurant City and Country Story (all on Facebook).
Zynga San Francisco-based Zynga has reported significant growth in recent months, with Business Insider reports citing industry sources as estimating the company’s annual revenue run rate at $600M. An early product was a Texas Hold’Em Poker game for Facebook; more recent hits include Mafia Wars, YoVille (which was acquired in mid-2008) and Farmville, which has surpassed 60M users within a half year of its June 2009 introduction.
Revenue generation for casual games Although the market is fragmented and largely driven by private companies (and thus reliable figures are hard to come by), we believe casual online games generated in excess of $1B in F’10. We see three key revenue streams for these applications.
Advertising How: Show ads to users as they play game; add product placements to game.
Discussion: This was the revenue model for the original hit game on Facebook, Scrabulous (a Scrabble clone that was shut down as part of a rights dispute with Hasbro, then reincarnated, but with less success, as Lexulous). Currently, many games sell advertising. We think some of the challenges for the ad-supported models are (a) the inventory is very low quality; (b) users are not hugely receptive to advertising while playing games; and (c) unless there is a very large advertiser base, CPMs go down as users are saturated with multiple impressions of the same ad. However, we think there may be some revenue opportunity if game designers can build more creative integrations (e.g., cars in a Mafia game are of a particular brand), or advertisers promote their products with branded giveaways – but such integrations can be hard to scale.
Lead generation How: Users can activate advanced features in a game by providing information for promotional offers.
Discussion: Lead generation has brought (mostly negative) attention to the industry, as press reports (including the technology blog TechCrunch) have suggested some of the revenue was being driven by deceptive marketing practices. As a result, many of the game companies have raised their standards to cut down on egregious abuses of this process.
Virtual goods and premium services How: Users can generally play a limited, entry-level version of a game for free, but additional in-game features and resources can be activated at extra cost.
Discussion: Sales of virtual items are believed to be the largest revenue stream for game companies, with Zynga saying in a statement that it gets ~90% of its revenue from such sales. Playfish recently reported that it sells 90 million virtual items daily (though most are likely to be quite inexpensive if not outright free). According to the company, roughly 0.5% of its active monthly users pay for virtual items. We think the monetization story is likely to play out in this area for game companies. Although the majority of users will remain truly casual, we think a sufficient proportion can become more immersed in the games and would thus be willing to pay for incremental services. Additionally, we think the social aspect of such games can be a motivator: if others in your network are paying for extra features, it is easier to justify opening your wallet.
One challenge is that the current online payment infrastructure is not ideally configured for such sales, which tend to be fairly small in size, resulting in a disproportionately high payment processing cost if using a method such as credit cards. We expect innovation in the area of micropayments as well as growing user comfort with making such purchases to drive growth in virtual goods sales. We think PayPal’s PayPal X initiative, which opened its platform to developers, can be a catalyst for innovation. Please see the Online Payments section for further details.
eCommerce Outlook Key Themes Economic rebound + Secular market shift = Robust growth We believe that eCommerce is benefiting from several positive trends, including the continued rollout of broadband, increasing user comfort shopping online and the decline of certain brick-and-mortar retailers. At the same time, as the economic environment appears to be getting at least marginally better, we see an additional tailwind for eCommerce growth. We expect F’11 US and global eCommerce growth of 13.2% and 18.9%, respectively.
We’ve come a long way . . . . and have a long way to go Even after several years of very robust growth in eCommerce, the sector represents less than 5% of all retail sales in the US and is even less developed in many other countries. Therefore, we think there are still tremendous opportunities for rapid growth. We think the experience of Diapers.com is instructive: the site launched in 2005 and was bought by Amazon for $540M five years later, after achieving predominance in its vertical.
Amazon continues to gain market share; size is an entry barrier We think the secret of Amazon’s success is highly unglamorous: an obsessive focus on execution, pricing, innovation and reducing friction creates a best-in-class user experience. We think many of the elements of the company’s success are creating virtuous circles that will enable above-market growth to continue; Prime and Fulfillment by Amazon (FBA) are two such key elements.
Mobile eCommerce could further hurt brick-and-mortar retailers We think that the proliferation of mobile devices and mobile apps could have a profoundly negative impact on the business model of traditional retailers. Historically, getting a customer in the store was half the battle for a retailer. Mobile apps turn this dynamic on its head by giving more power to the shopper, even in-store. We continue to believe that pressure on traditional retail can accelerate eCommerce growth.
Retail Moving Online Less Quickly than Advertising Online retail has lagged online advertising in terms of market share gains, suggesting significant runway still exists for incremental growth. For example, online commerce in the US gained a full percentage point of market share between 2006 and 2009, going from 2.9% of all retail to 3.9%. However, during the same period of time, the market share of online advertising more than doubled, going from 6.4% to 13.7%. We think that, while adoption of online shopping has moved at a slower pace, the penetration could accelerate as consumer habits change.
eCommerce as % of all US retail Online as % of all US Adv ertising
Source: US Census Bureau, Magna Global, J.P. Morgan estimates.
Barriers to Entry Are Rising Ultimately, we believe eCommerce is very much a volume business, and high-volume online retailers benefit from several sets of barriers and scale economies that make for a very challenging competitive environment. This is manifesting itself in a larger share of the pie going to large eCommerce sites.
Top eCommerce Sites Gaining Market Share in US, 3Q’09 vs. 3Q’10
64.4%35.6%
3Q'09: Top 25 sites All others
69.9%30.1%
3Q'10: Top 25 sites All others
Source: comScore.
We see several significant benefits to scale that combine to create challenges for new entrants:
Purchasing. Because price is often a key factor in attracting customers, the ability to purchase inventory on attractive terms is a huge competitive advantage. Additionally, scale can give an advantage in auxiliary items such as cost to process credit cards; e.g., PayPal charges its smallest sellers 100 bps more than larger ones. (And the largest sellers of all likely pay even less than the published rate card.)
Shipping infrastructure. An enterprise eCommerce site requires a massive accompanying logistics operation; e.g., Amazon operates ~50 fulfillment centers globally. A network of fulfillment centers enables a site to optimize shipping distance (and thus lower shipping cost) by delivering items from a location that is closer to the end consumer. A new entrant can thus find it difficult to offer competitive pricing on shipping.
Data. eCommerce, like most internet businesses, is highly data-intensive. Small differences in site optimization can drive large revenue improvements at very low incremental cost. We believe the success of companies such as Amazon is driven in part by their successful use of data: both to optimize user flow through the site and to increase user value through tools such as a recommendation engine. Additionally, scale can enable a site to buy keywords more efficiently than competitors.
At the same time, small sites certainly can and do compete successfully, even in an environment in which large sites have the advantage. Two such sites were Zappos and Diapers.com, both of which managed to outflank Amazon in key verticals and eventually ended up being acquired by the giant.
In both cases, we think success was driven by a high degree of vertical focus (shoes for Zappos and baby for Diapers), which we believe enabled these companies to achieve better terms with their suppliers. E.g., we believe Diapers.com was getting more favorable supplier pricing on certain items than Amazon at the time of the acquisition. Additionally, both sites created a unique buyer experience and thus were able to differentiate themselves in the minds of consumers.
We Expect a Continued Focus on User Frequency We think companies that are best able to use their existing customer data to optimize their operations are more likely to become the winners in the eCommerce space. Specifically:
Higher customer lifetime value. Bringing existing customers back to your site is a lot cheaper than the initial cost of acquiring a customer. Therefore, being able to amortize that initial cost over multiple purchases improves profitability and boosts the value of each customer.
Optimization drives a virtuous circle. Better site optimization and streamlining of the shopping cart process can drive improved conversion and thus reduce e-retailers’ sales and marketing costs. We think this can create a virtuous circle: better conversion lowers marketing costs; lower marketing costs can enable lower selling prices; lower selling prices increase volume and improve the capacity for additional optimization.
Offline Pain Continues to Drive Online Gain We see three trends that affect offline retail in a way we think should be a positive for online retailers:
Inventory management We believe eCommerce companies benefit from their less complicated supply chain: instead of needing to maintain appropriate stock levels at several hundred stores, web retailers only need to worry about inventory levels at one warehouse (or, at most, a handful of warehouses).
Mobile commerce We believe the increased penetration of smartphones could have a significant impact on traditional retailers by giving shoppers the capacity to comparison shop even as they’re in a retail store. This suggests that high-touch business models for items with
minimal differentiation – such as media or electronics – are likely to be challenged going forward. Specifically, it is very difficult for a retailer to cover its higher overhead if it has to price items in line with an online-only retailer such as Amazon.
Brick-and-mortar bankruptcies A variety of brick-and-mortar retailers have gone through bankruptcy since the start of the economic downturn. We think offline bankruptcies can have the following effects on eCommerce:
Near-term pricing pressure. As stores enter bankruptcy and close, the push to liquidate inventory could result in margin pressure on the survivors, both online and offline.
Upheaval changes consumer behavior. We believe some consumers establish shopping habits and relationships with retailers that can be difficult to break. A bankruptcy can drive these customers, who would have otherwise been difficult to acquire, to examine alternative options and form new shopping habits. For some of them, changes in the offline world could result in lower convenience (e.g., the store nearby closes and now the closest store is too far away), which could drive greater adoption of eCommerce.
In the medium-to-long term, we think thinning the brick-and-mortar herd could prove to be a positive for online retailers, which could find it easier to win and maintain wallet share in a marketplace with fewer competitors.
We think one significant winner is likely to continue to be Amazon, which stands to gain from the decline of players in both its core media arena (given the difficulties for Borders) and in its growing electronics business (Circuit City et al.). Similarly, we think Blue Nile could see its market share increase as traditional jewelers struggle.
Catalysts for International Growth We believe the rising tide of increased internet use across the world is likely to help lift eCommerce globally. However, we see three key challenges to overcome for eCommerce to fulfill its potential:
Improvement of shipping infrastructure. Postal and parcel service in many parts of the world can be unreliable, and a reliable distribution channel is an essential prerequisite for the growth of eCommerce.
Improved payment systems. This is not a worldwide challenge but rather a slew of country-specific challenges related to the idiosyncrasies of different countries’ banking systems and conventions. Even in more developed countries, significant differences emerge: e.g., Germany and Austria have historically seen lower rates of PayPal use than other eBay geographies due to the prevalence of bank transfers as a mode of payment there; likewise, Korea has an idiosyncratic payment culture that prevents high PayPal penetration.
Better fraud protection. The promise of eCommerce has been one of lower prices and/or better selection, with the trade-off that many purchases must be made sight unseen. The threat of fraud remains present, and structures that insure buyers against fraud should help smooth operations in an eCommerce environment that is not yet fully mature. (An example is eBay’s PayPal, which has, over the course of the past year, augmented the level of fraud protection it provides in the US from $2K per transaction to as much as the full purchase price of the transaction. PayPal uses such protection to create buyer confidence, with transaction loss rates for the PayPal unit of 24-33 bps, as denominated by total payment volume).
We note that the above is not intended to be an exhaustive list of catalysts for international growth – many specific markets can present unique challenges – such as governmental ones – for the operation of eCommerce companies.
Additionally, we think a rebound in economic growth in the global economy can boost disposable incomes, especially in the developing world – thus creating a broader middle class and extending the audience of possible online shoppers.
Reducing Friction Is a Key Driver of Success We think part of the success of Amazon in gaining market share in recent years has been driven by a focus on reducing friction in eCommerce so as to provide customers with a seamless user experience. We see several drivers that sites can use to reduce friction:
Free shipping. The growing prevalence of free shipping offers (usually with a spending threshold) is an indication that sellers see this as a key tool in their arsenal. Additionally, orders with free shipping tend to carry a higher average order value. Finally, we see the success of Zappos, with a very customer-friendly shipping and returns policy, as an indication of the way a site can benefit from reduced shipping-related friction.
Easier payment. Tools such as PayPal, and especially PayPal Express Checkout (which allows a customer to pay with only his or her email address and password, without needing to re-enter data such as shipping/billing address and a credit card number), speed up the checkout process and thus reduce friction.
Giving the customers what they want. Another tool available to retailers is better merchandising through personalized recommendations. We think recommendation engines – as well as other optimization and testing tools – will continue to be a driver of incremental sales.
A Multichannel Environment We think eCommerce, from a seller’s perspective, is becoming more complicated: inventory goes through large sites, such as eBay and Amazon (and likely more tomorrow), and through your own site, aided by search engine marketing and comparison shopping sites. On top of this, a seller needs inventory management, email marketing and analytics. As a result, better seller tools that can tie these needs and platforms together become a near necessity.
From the perspective of the big sites, we think price and selection continue to be critical. The ability to lock in customers remains low (with Amazon Prime and eBay Bucks as possible exceptions). Thus, competitive pricing and broad selection (we think broader selection improves traffic conversion, which is ever-important in a more fragmented web) are key to success, and it’s not surprising we’re seeing more sites attempting to set up third-party marketplaces.
Third-Party Platforms Proliferating eBay was the original model for a successful third-party platform, with the company taking on no inventory but providing a meeting place for sellers and buyers. Over time, Amazon has gained on eBay, and now over 30% of the units sold on Amazon’s sites are sold by third-party sellers. In 2009, we saw Wal-Mart begin making an effort to expand its third-party capacity. More recently, in May 2010, Japan-based Rakuten acquired buy.com, with the stated intention of developing an additional successful third-party marketplace in the US. We think these developments are emblematic of a secular shift toward a multichannel world.
Multichannel Whereas in the past, eBay was the primary avenue for an online business to move merchandise, we now operate in a world where sellers put their inventory on eBay – but then also on Amazon and buy.com (and perhaps Wal-Mart as its stable of sellers grows) as well as their own sites, making greater use of comparison shopping engines and search engines to drive traffic.
Getting third-party rights is hard In our opinion, a significant portion of Amazon’s success in growing its third-party business has been driven by a focus on the customer experience. While maintaining a positive experience is challenging for all online sellers, we think a third-party business – where a smaller seller is often piggybacking on the reputation of a larger one – is especially fraught with complications.
The scope of differences between platforms was highlighted by a November New York Times report about an online seller that used obnoxious customer service to create negative attention, which generated better search results. In a telling side note, the article noted that the seller offered good customer service on sales through the Amazon platform, because “Amazon doesn’t mess around . . . . [it] just kicks you off its site if you infuriate customers.”
Key differentiator: FBA One factor differentiating Amazon’s third-party offering is Fulfillment by Amazon, a program that lets sellers on Amazon have their items stored and shipped by the company, thereby making them eligible for Amazon Prime and for Super-saver shipping. Additionally, the shipping rates for third-party sellers (not using FBA) on Amazon’s site are largely standardized, depending on the type of product.
Private Sales: A Growing Subsector Private sale sites are members-only sites that invite their members to short-term sales. Many of these sites are concentrated in the apparel vertical, though other types of products that have become increasingly popular include travel, home, food and local deals.
These sites follow a fairly straightforward business model, buying mostly overstocked or excess inventory from brand-name designers at a discount. The sites can then turn around and sell the merchandise to customers at a sharp discount to retail prices. Items are often launched on the sites at a specific time each day and frequently sell out quickly, creating a rush similar to a sample sale (with no danger of physical violence). Additionally, some sites (including Gilt Groupe) give shoppers a limited amount of time to complete a purchase after placing items in their carts.
We think these “shopping clubs” are likely to continue to attract high-end designers as the perceived exclusivity of the sites does not diminish their luxury-brand image. Conversely, discount retailers (e.g., T.J. Maxx or Marshalls) do not have an exclusivity or luxury connotation and thus are less able to attract luxury-brand designers.
VillageVines New York, NY Food Members pay $10 to make a reservation and secure exclusive pricing (typically 30% off your party’s bill)
Source: Company sites, press reports.
Category expansion While many private sale sites are concentrated in the apparel vertical, there has been a growing trend to expand into other product and lifestyle categories including travel, beauty and local deals. Examples of private sale companies that have expanded into new verticals include:
Gilt Groupe. The company began selling apparel and accessories on Gilt.com. In the fall of 2009, Gilt Groupe launched Jetsetter, a private sale site offering luxury travel and vacation packages. Further, in April 2010, the company introduced Gilt City, a local deals service site that offers weekly deals (at least 5 at a time) for various cities in the US. Such deals include spa and beauty packages, discounts to high-end restaurants and tickets to exclusive events.
HauteLook. The company began selling luxury clothing for women, men and children, as well as home furnishings and beauty products. As a result of new funding, the company is introducing new categories including gourmet food and wine, gym packages and spa services and travel getaways.
Increased investment activity The area has received significant attention from investors. Gilt Groupe reportedly raised a total of ~$83M in venture funding from General Atlantic LLC and Matrix
Partners. In addition, the company is said to have recently received ~$15M in debt financing from TriplePointCapital. In June, HauteLook announced a $31M Series C round of financing led by Insight Venture Partners, bringing the total investments to $41M.
December 2009 saw One Kings Lane, a home décor private sale site, receive funding from Kleiner Perkins Caufield & Byers, First Round Capital and angel investor Reid Hoffman. Additionally, in October 2009, GSI Commerce acquired Retail Convergence, the parent company of Rue La La (a private sale site) and SmartBargains.com (an off-price eCommerce marketplace) for a package of $180M and an additional $170M in earnouts.
Usage and traffic growth Private sale sites continue to see strong member growth as current members continue to invite friends to join. Both Gilt Groupe and Rue La La have over 2 million members. On a Y/Y basis, unique users to the two sites have grown 94% and 33%, respectively, since last November.
Social Shopping Sites The growth of social shopping sites such as Groupon and LivingSocial in recent months has received significant attention; please see Over the Top, on social networking, elsewhere in this report, for a more in-depth discussion of these sites, which tend to be primarily promotional vehicles for offline businesses rather than direct competitors to eCommerce sites.
2011 eCommerce Forecast We think US growth in eCommerce will experience another year of strong growth, though without the benefit of the easy comps that enabled midteens growth through most of 2010. We think a continued economic recovery can help eCommerce growth. Additionally, we expect a greater proportion of retail sales to continue to shift online, driven by (1) increases in product selection, (2) continued Y/Y improvements online for brick-and-mortar retailers, (3) volatility and uncertainty in the offline retail space, and (4) further improved efficiencies from site optimization.
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.
After a year during which the growth of eCommerce volumes slowed down significantly in much of the developed world, F’10 saw a rebound in growth. The rebound occurred despite a headwind from a stronger dollar, especially in areas such
as the UK, where eCommerce is already at a relatively higher penetration. Going forward, we think this FX impact is likely to be more muted.
Both in the US and worldwide, we expect the growth of eCommerce to benefit from several drivers, some region-specific and some general. Of primary importance among these is the growing adoption of broadband, which is much more conducive to eCommerce growth than slower forms of internet access. Additionally, as noted above, we think the struggles of brick-and-mortar retailers during the slowdown will be a catalyst for eCommerce growth as established consumer habits are dislocated. Other factors include: (1) continued rises in online shopping penetration in Western Europe, (2) continued investments by online retailers in broadening selection, (3) improvements in shipping infrastructure, (4) improved payment systems, (5) better fraud protection, and (6) the continued expansion of the global middle class.
Global eCommerce Forecast (Excluding Travel) $ in millions Global eCommerce Forecast 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E ’10-’13
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.
Internet Sales Tax: Mostly Headline Risk In 2008, the state of New York began requiring online retailers to collect sales taxes even if they had no physical presence in the state, so long as members of their affiliate networks (who get paid a commission for driving sales traffic to the site) are present in the state.
Several companies, notably Amazon, have started collecting the NY sales tax while appealing the ruling. Overstock.com, on the other hand, has chosen to drop its NY-based affiliates and not charge the tax.
In 2009, several other states, including North Carolina and Rhode Island, took similar steps. As a result, Amazon ended its affiliate relationships in those states. Other states, including most significantly California, ended up choosing not to enact similar sales tax changes.
In all, we believe the impact of such laws is limited, especially on a site like Amazon, which focuses on offering consumer value rather than the lowest available price. We think the lower transparency of sales taxes, which are not visible until the checkout screen, limits the impact on sales revenue in those states where a sales tax is charged.
Additionally, Amazon has seen very rapid growth in its international business, even though the company collects sales tax or VAT in all of its major international operations.
As eCommerce Matures, Private Labels Could Help Margins Private label items accounted for ~22% of sales at US mass, food and drug retailers in the year ending July 2010. The share represented a significant increase over the prior year, according to Nielsen data.
Chris Horvers, J.P. Morgan’s hardlines retail analyst, estimates that private label products account for approximately 25% of sales at retail office superstores (e.g., Staples or Office Depot) and 10%-15% at large consumer electronics or home improvement retailers (e.g., Best Buy, Home Depot or Lowe’s).
In the past, few online-only retailers have had the scale to bring private label products to market. However, as the industry matures and as more and more eRetailers start to attain significant sales volumes, we expect them to look at private label as an additional margin lever. Already, Amazon is offering private label goods in certain home categories as well as connector cables and recordable media.
Drivers of private label growth Several factors can drive growth of private label offerings for traditional retailers; as shown below, some of these have a higher relevance to online sellers than others.
Drivers of Private Label Development Key Driver Description eCommerce Relevance
High Trade Concentration The more concentrated the market share at retail, the higher the private label opportunity
Medium
Channel Blurring With increased competition from nontraditional sources, retailers create private label product in other categories to differentiate their assortments (e.g., grocery channel offering seasonal products in response to mass marketers expanding into food)
Low
Mature, Slow-Growth Categories & Markets Slow turning, nondifferentiated brands can be replaced by higher-margin and better-value private label brands
High
Consumer Acceptance of Private Label Private label has reached 100% of households in North America. Category acceptance of private label will vary, but consumer acceptance continues to grow. One in four packages purchased is a private label product
Medium
Supply Chain Efficiencies and Global Direct Sourcing
Direct sourcing and supply chain efficiencies have enabled retailers to replace undifferentiated national brands
Medium
Mix of Consumables The higher the mix of consumables in an assortment, the higher the potential penetration of private label
Medium
Relative Power: Retailer vs. Manufacturer Retailers have become brands in their own right, at times decreasing the relative importance of consumer product labels and taking mind share from manufacturers
High
Source: J.P. Morgan, “Taking Stock of the Private Label Opportunity” (C. Horvers, Aug. ’06).
Private label risks Although branching into private labels can be an opportunity to improve sales and margins, doing so carries certain risks.
Core vs. Noncore Skillsets Traditional skillsets of retailers do not include product development, quality control, import logistics, life cycle management, etc.
Medium
Extending the Supply Chain By direct sourcing, retailers run in-stock risk due to a longer supply chain Medium Relationship with the Brand Manufacturer The consumer products company often manufactures or sources the private label
product offered by retailers, which could strain the relationship between the two High
Eponymous Brands Own-brand merchandise that is named after the retailer creates overall brand risk if the product underperforms
High
Source: J.P. Morgan, “Taking Stock of the Private Label Opportunity” (C. Horvers, Aug. ’06).
Margin expansion opportunity For traditional retailers, private label goods can generally drive 1,000+ bps gross margin improvement compared to equivalent items, and ~100-800 bps of benefit to operating margins, depending on the industry vertical and the specifics of the product.
J.P. Morgan Internet User Survey In late 2010, we surveyed 1,002 US internet users through a third party. We asked them many questions on eCommerce, including several questions that we had previously asked in a similar survey in 2007. The key points follow.
Penetration and frequency growing As expected, the number of those shopping online has grown over time: in 2007, only 80% of internet users reported they had bought something online in the previous year, a number that has grown to 88% in three years. The portion of those who reported shopping very frequently has also grown.
Online Shopping Gaining Penetration Question: How many times do you purchase items online per month?
Source: J.P. Morgan Internet User surveys, 2007 and 2010.
Unsurprisingly, wealthier users are more likely to be online shoppers and much more likely to be heavy users of eCommerce: 33% of those with incomes over $100K reported ordering 3 or more items online per month, compared to only 13% among those whose incomes were below $49K.
Higher-Income Users Shop Online More Frequently Question: How many times do you purchase items online, per month?
19%
41%
27%
10%3% 1%
9%
35% 36%
16%
2% 2%6%
27%34%
23%
6% 5%
0%10%20%30%40%50%
Don't Shoponline
Buy less thanonce/month
1-2x /month 3-6x /month 7-9x /month 10x +/month
$0-$49K $50K-$99K $100K+
Source: J.P. Morgan Internet User survey, 2010.
Apparel and media Media, including books, music and video, have long been the staple of online shopping; the earliest successful online retail models, such as Amazon and CDnow, were built around media. Therefore, it’s interesting to note that the portion of internet users who reported purchasing media items in 2010 was not far different from that reported by our users in 2007: 53%, up from 52%.
While media held a comfortable lead in penetration in 2007, the category in which the greatest number of users reported buying this year was apparel & accessories, with 53%, up from 45% in the survey three years ago. Consumer electronics, computers & videogames, and health & beauty also saw strong increases vs. the 2007 results. On the other hand, in a result reflective of eBay’s recent struggles, collectibles represented the only category that saw a decline from our previous survey.
Categories Shifting Over Time Question: Which items have you purchased online in the past year?
15%
11%
10%
12%
16%
23%
23%
26%
32%
45%
52%
11%
12%
14%
14%
20%
25%
29%
33%
38%
53%
53%
0% 10% 20% 30% 40% 50% 60%
Collectibles
Tools and auto supplies
Groceries, bev erages & other food
Sports and outdoor equipment
Home and gardening
Toy s
Electronics (incl. TV & stereo equipmt)
Health and beauty
Comp. & v ideogame soft & hardw are
Apparel and accessories
Books, music, v ideos
2007 2010
Source: J.P. Morgan Internet User Surveys, 2007 and 2010.
Price remains key As in the past, price was chosen as by far the #1 factor for online shoppers in choosing a store. In fact, compared to the responses three years ago, online shoppers appear to have become even more price-conscious: 96% ranked price as one of the top five factors in choosing a store, compared to only 87% who did so when we asked a similar question three years ago.
Price Remains Top Factor as Consumers Have Become Even More Price-Conscious Question: What are the 5 major factors when choosing an online store, list in order of importance? (Ranked)
2010 results: #1 Factor #2 Factor In top 5 Top 5 in 2007 Survey Price 63.7% 14.4% 96.3% 87.1% Selection 14.3% 41.8% 85.8% 74.3% Promotions/Advertisements 3.1% 9.5% 49.9% 48.0% Customer Service 1.9% 7.3% 46.3% 43.4% Familiarity/experience with store 5.7% 5.6% 44.3% 42.0% Payment options 1.6% 5.4% 43.1% 40.9% Access to customer reviews/product info 2.5% 4.9% 38.4% 40.0% Name Recognition 3.9% 6.0% 37.2% 37.8% Ability to purchase multiple items 1.9% 2.5% 36.4% 33.7% Recommendations from friends/relatives 1.0% 2.3% 18.1% 23.1% Source: J.P. Morgan Internet User Surveys, 2007 and 2010.
Online Alternative Payments Key Themes From top down to bottom up Historically, the payments ecosystem was designed by banks and reflected their needs. Consumers trusted the banks with their money, and banks acted as a gatekeeper for those funds. The internet has rapidly created demand for alternative solutions, often built to satisfy specific consumer needs, and such solutions are now on the payments map, both helping the incumbents increase volume and beginning to compete with them for market share.
A nearly trillion dollar business is no place for a revolution Newer payment networks benefit from having attractive relationships with consumers. However, existing players have access to consumer funds and maintain merchant relationships that have taken decades to develop into a business that generated $914B in 2009. Therefore, we believe new entrants into the space will largely be built on top of the existing payments infrastructure, since the greatest value add seems to come from adding value to the utility rather than replicating it.
Not a lot of room on the pedestal Visa and MasterCard control ~80% of US card volume. They also enable much of the activity for the sole online-only player, PayPal, to gain meaningful traction as a payment solution, despite attempts by deep-pocketed players, including Amazon and Google, to enter the space .The bottom line is that providing payment services at scale is hard for new players, since they lack critical mass (chicken-and-egg problem), must build trust, and deal with complex regulatory requirements, and we think the number of winners will be determined by those who can effectively meet consumer needs and at the same time cooperate with established payment networks. We think social networking platforms such as Facebook have the potential to create payment platforms of their own.
Mobile opportunity is vast; key growth area for 2011 Many of the entities that have a window into the space – banks, existing payment networks, carriers, device makers, online communication networks – are already running pilot programs to ensure a foothold in what is widely expected to be an area of rapid growth. Contactless/near field communications (NFC) payment solutions, mobile eCommerce, mobile banking, and mobile person-to-person (P2P) money transfers are all in early stages of adoption in the US.
Where the Money Is McKinsey estimates global payments revenue reached $914B in 2009. Thus, it’s hardly surprising many new entrants have tried to crack into this space, which was traditionally (and logically) dominated by entities consumers trust to hold onto their money, notably banks. Banks granted access to such funds to a limited number of legacy networks including ACH (used to settle checks, direct debits, etc.), ATMs, and debit/credit cards (via Visa, MasterCard, Amex, Discover).
We thank J.P. Morgan’s computer services & IT consulting analyst, Tien-tsin Huang, for his contribution to this section.
Traditionally, Banks Have Served as the Gatekeepers of the Payment System
BanksConsumers
Merchants
ACH et al
ATM networks
Card networks
Source: J.P. Morgan.
However, thanks to the web, social networks and smartphones, consumption is becoming more digital on large network platforms that consumers frequent more often than their traditional bank. As a result, consumers are increasingly demanding more dynamic ways to initiate payments and unwittingly are creating new billing relationships with new age payment networks.
As System Evolves, Consumers Are in the Driver’s Seat
BanksConsumers
Merchants
ACH et al
ATM networks
Card networks
Contentsites
SocialNetworksMobile
OnlineGames
eCommerce
Source: J.P. Morgan.
We think this new environment enables business models that are more focused on the consumer. PayPal is one illustration of this trend, but we believe it illustrates a key difference between previous-generation vs. newer payment platforms: traditional platforms, such as Visa or MasterCard, had banks as their primary customers, and thus catered mostly to their needs. Newer platforms are built on top of direct consumer relationships, and we believe social networking sites are uniquely
positioned, as they are personal relationship management platforms for millions of people.
We think that the new platforms’ access to the user is a key catalyst for their continued growth and for their ability to start cutting into the nearly trillion dollar payments pie currently under the incumbents’ control. For 2011, we believe there are two key emerging payment battlegrounds to watch:
Mobile payments and
Web platforms.
In both cases, large consumer billing relationships already exist or are developing.
Incremental, Not Revolutionary We believe the winning models will initially, if not permanently, leverage existing payment networks (e.g., ACH, Visa/MasterCard, ATM networks) to gain scale, since existing payment networks have access to both consumer funds and merchants.
While new age networks have access to lots of content and consumers, they lack the same level of relationship with merchants (necessary to conduct a transaction) and still need to build up trust with consumers to manage their money (and avoid the associated fraud, security risks, etc.).
In our view, consumers are not very open to change when it comes to matters of their money. This should buy time for banks and legacy networks to develop business models in partnership with new age networks, allowing the old and new networks to coexist in the medium term.
However, we think incumbents must invest in innovation or risk displacement in the longer term. A risk to watch for the new age networks will be if the banks make it more difficult for nonbank entities to access consumer checking accounts.
The Web Spawned PayPal . . . . PayPal was the big winner in landing on the payments map during the formative years of eCommerce by developing an elegant, convenient consumer/merchant solution when incumbents were slow to innovate.
In our view, part of its success came from leveraging existing payment networks, giving consumers the flexibility to pay the way they want (e.g., via credit/debit card, direct ACH debit from checking account), but branded as a PayPal transaction. In our view, this could be a template for how mobile payments will evolve.
. . . What Will Mobile Spawn? In line with what we are seeing on the internet landscape, we view consumers’ growing desire for ubiquity as driving innovation in payments. On the mobile payments side, competition is already quite heavy, with all key players in the food chain developing pilots in an attempt to gain early-mover advantage. Some of the key mobile payment strategies in place today in the U.S. are as follows; in many cases these build on trends already more advanced in other markets, especially in Asia:
Contactless, or NFC This is a technology solution, bringing to mobile phones the “wave” or “bump” near field communications (NFC) technology resident on certain credit/debit cards. To conduct the transaction, a physical swipe is replaced by NFC authentication, but the merchant must be equipped with an NFC reader (only about 150K merchants are contactless ready versus nearly 8 million that take traditional Visa/MC cards).
There are various forms of mobile NFC being tested today:
NFC sticker that can be attached to a phone and substitutes for a card. Citi and Discover have full-fledged contactless stickers available to any customer who requests one. BofA announced it would make them available next year. First Data also has a product, called Go Tag, that it is shopping to various issuers.
NFC built directly into the phone itself: Isis, a mobile carrier joint venture aiming to develop its own mobile commerce platform, is pursuing this strategy initially.
NFC embedded through phone add-ons, such as a microSD card; Visa with DeviceFidelity is pushing this approach.
As noted, Visa is partnering with DeviceFidelity on an add-on solution. We believe Visa’s US mobile strategy is focused on supporting issuers – allowing consumers to use existing bank accounts – and building upon smartphone mobile banking solutions. Separately, Google has acquired a company called Zetawire, which has patents for technology related to this space.
Mobile eCommerce In addition to expanding traditional eCommerce platforms beyond the web and onto mobile browsers and apps, there is room for innovation in payments through mobile solutions.
Essentially, these apps can allow a phone to function as a tool to transact business via credit card. For example, a customer may use his or her cell phone to generate an authentication, which is then displayed on the phone like a bar code. A merchant can scan that code to complete the transaction.
Extension of mobile banking Many banks are looking to own the mobile wallet, and extending their mobile banking platforms could be a means to achieve this. At this point, services are still in the early stages, but this is an area to watch. As noted above, banks have an inherent advantage in that they have already established consumer trust, and they host the money.
Person-to-person payments P2P has historically been a fairly tough nut to crack. Even though PayPal appears to benefit from a network effect in terms of having the largest installed base, P2P has been very much a secondary business for the company. Note that the ability to transfer money in this way varies widely country by country, with the US in many ways lagging other developed economies.
Challenges for person-to-person payments include regulatory concerns as well as network compatibility – if both participants are not on the same network, the level of difficulty in fraud prevention and monetization both increase.
Companies pursuing this space include PayPal as well as ZashPay (owned by Fiserv) and Western Union.
ZashPay Officially launched at the end of July, ZashPay is a P2P payments service. It enables users to electronically send and receive money from and to existing bank accounts using solely the recipient’s name and e-mail address or mobile phone number. Initially, transactions cost ~$0.75 per transaction and are capped at $100, a limit that can increase with time and use.
Fiserv has sized the personal payments opportunity at 1.4B check transactions and 10B cash transactions, with almost no electronification at present. ZashPay leverages its parent’s network advantages, requiring no separate account and, as a result, taking significantly less time (~1 day vs. 3-6 days) to transfer payments.
The service can be accessed via the ZashPay website or through the bill payment systems of participating financial institutions. ZashPay currently has signed up over 200 financial institutions and 250K registered users. Future initiatives for ZashPay include enabling money requests, group collections and small business payments and collections.
Western Union WU.com, Western Union’s online money transfer service, enables consumers to electronically send money to receivers’ bank accounts, mobile phones, prepaid cards, or to a physical location for cash pickup. Online money transfer is an area of focus for the company and is growing transactions at around 20% globally (50% growth at international locations, though off a much lower base). Account-to-account transfer services are offered in the US/Brazil/Mexico only.
Getting Micropayments Right: Watch . . . Apple? One of the challenges in monetizing content websites, social networks, casual games, and a variety of similar sites, is that the price users may be willing to pay tends to be quite small. However, the credit card ecosystem is not, at present, designed to manage small payments, and merchants pay significantly more for payment processing if all the payments they process are in the sub-$5 range.
We see several factors that lead us to expect progress in micropayments:
PayPal X. PayPal has opened its system to developers, broadening the number of people working to improve the online payment landscape. Improved micropayment platforms were among the targeted areas of development.
Ad-supported sites continue to struggle. Simply put, content sites are not generating hoped-for levels of revenue through advertising, and publishers are increasingly exploring alternatives (such as micropayments) to better monetize content.
Demand from casual games. Casual games have become immensely popular, and these applications are often monetized via the sale of virtual goods. The need to process such transactions efficiently increases the demand for a solution.
Further, micropayments may bring in a competitor few associate with the payments space: Apple. The company has developed a bustling business in its iTunes store and its app stores, selling nearly $1B quarterly, much of it in 99c songs. Thus, Apple has had to grow its expertise in processing small payments efficiently. Apple has filed several payment patents that would enable it to adopt NFC technology into future iPhones, though no announcements to that effect have been made by the company.
However, more interesting than the phone opportunity is the prospect of Apple commercializing its iTunes payment capability, since it already has a unique (and frequent) billing relationship with iTunes users, complete with email and password authentication and bank card information.
Can Apple build upon its account base and make it possible for consumers to buy any online good with their Apple accounts – e.g., will you be able to buy an airline ticket using your Apple account? Is Apple willing to take receivables risk? Apple could be more successful in managing risk than others: consumers don’t want to risk losing their Apple account, since they wouldn’t be able to buy things on iTunes – so they wouldn’t want to be blackballed.
Along with Apple, another big player that we believe could pursue an avenue into the ecosystem through micropayments is Google, via apps for the Android platform as well as the existing need to process payments for the Android marketplace.
Payments on social networks Please see this report’s section on Social Networking for a more detailed discussion of this opportunity. Key positives for the opportunity include the size of the user base and the possibility of leveraging the social graph to improve fraud prevention. Challenges will include creating avenues for consumers to put money into (and especially out of) the system as well as whether these sites can create platforms for their payment systems that stretch beyond the core networking sites.
Payment Business Basics When a buyer hands cash to a seller, the transaction is self-contained. If a credit (or debit) card is involved, however, several other parties become involved in the transaction, which we describe below.
Issuer (cardholder’s bank). Card transactions start with a card issued by an issuing bank (e.g., Bank of America, Chase, etc.) to a consumer. In terms of economics, the bank that issued the consumer’s credit card takes the purchase price, collects its interchange fee (in the US, ~170-225 bps, depending on the type of card) and passes the remainder to the . . .
Acquirer (commonly the merchant’s bank). The acquirer provides merchant services to the merchant, handling all the card and/or electronic payment acceptance needs of the merchant. The merchant’s acquiring bank accepts the payment, collects a merchant discount (generally in the 30- to
For a primer on the payments industry, please see Payment Processing: Payments Market Share Handbook, published on June 5, 2009, by J.P. Morgan’s computer services & IT consulting analyst, Tien-tsin Huang.
50-bp range in the US) and forwards the balance to the seller/merchant. Both the issuer and the acquirer pay a small (~7-9 bps each) fee to the payment network (see below). Merchant acquirer functions include:
Signing up merchants to enable them to accept card payments;
Enabling merchants to authorize card payments via the network;
Paying all network and associated fees for a merchant’s transactions;
Facilitating clearing and settlement of card payments; and
Providing incremental services, e.g., sending out statements, etc.
Payment network (e.g., Visa, MasterCard). As the backbone of the payments industry, networks connect various banks that need to process credit card payments with merchants and provide authorization, clearing and settlement services. Networks also set rules and interchange rates (earned by the issuing bank).
Payment gateway. In the offline world, the payment gateway is the equivalent of a point-of-sale terminal that accepts the payment type (e.g., credit, debit card) and translates it into a format that can be accepted by the merchant acquirer. In the online world, the gateway generally connects an eCommerce site with the merchant acquirer. PayPal already functions as a payment gateway, largely as a result of its acquisition of VeriSign’s payment business, which had 144,000 customers when acquired in 4Q’05.
Note: The sample transaction flow above assumes the acquiring and processing functions are performed by separate entities, however, in some instances these functions are performed by the same entity in which case there wouldn’t be an explicit “processing fee.” Figures are rounded and can vary depending on payment and merchant type.
Source: J.P. Morgan.
Understanding the Role of Online Payment Services Essentially, online payment services such as PayPal or Amazon Payments arbitrage the spread charged by merchant acquirers, while at the same time allowing merchants to increase consumers’ level of trust for the transactions. PayPal, the largest service, wears multiple hats within the business, functioning in some ways like a Merchant and a Merchant Acquirer and an independent sales organization (ISO).
On the cost side, for a large retailer (e.g., Wal-Mart), its merchant acquirer will charge only a handful of basis points over the standard interchange fees. On the other hand, for a small merchant with minimal bargaining power, the best deal available may be at ~100 bps over interchange (when factoring in all fees), if not more. An online payment service can use its scale to bridge this gap – though at times its service may be less flexible or offer less hands-on service than a merchant acquirer.
Additionally, using an online payment service can help boost a consumer’s willingness to consummate a transaction, as financial data are handled by a trusted intermediary as opposed to a merchant with which the consumer may have no previous experience.
The Challenge for Incumbent Players We think part of the challenge for Visa and MasterCard, the two largest incumbent players in the space, is that they have historically been involved in the marketplace on a B2B level, and thus it is more difficult for them to actively market to consumers. On the other hand, online payments is a much more consumer-driven business, with the trust and safety concerns of consumers driving them to choose some solutions over others. Consequently, we think it could be more difficult for these large incumbents to squeeze out online-only providers than their market share might suggest.
Additionally, we believe that as much as half of PayPal’s total payment volume (TPV) represents volume that is coming from extremely small vendors – vendors that likely would not have had the capacity to accept credit cards without using PayPal. Therefore, we think PayPal broadens the playing field in online payments.
PayPal Remains the Largest Online Player; Still a Drop in the Bucket Compared to Credit Cards PayPal is quickly establishing itself as a global payment processor with scale, facilitating over $86B in total payment volume in the 12 months ending 3Q’10. It remains the largest player focused solely on online payments; however, when compared to the total volume of large global players, such as Visa and MasterCard, PayPal’s volume remains fairly small: its F’09 $72B TPV was just over 1% of the total volume of payments processed during that year by Visa and MasterCard combined.
PayPal’s Volume Dwarfed by Incumbents’ $ in billions, 12 months ending 3Q’10
1,910
1,2351,497
48486
0
500
1,000
1,500
2,000
2,500
Visa (Credit) Visa (Debit) MasterCard(Credit)
MasterCard (Debit) Pay Pal
Source: Company reports, J.P. Morgan estimates. Note: Parts of PayPal volume may be processed using Visa’s or MasterCard’s network; Visa volume excludes Visa Europe.
PayPal is an established payment network and brand – A rare commodity PayPal is in rare company, successfully making itself a formidable payment network and brand alongside dominant payment brands Visa, MasterCard, American Express and Discover. Payment networks sit at the top of the value chain in payments, collecting high-margin fees for facilitating payments from participants seeking access to a network of trusted merchants and consumers. PayPal overcame the classic chicken-and-egg dilemma and now has a critical mass of users in its network, differentiated as a trusted brand for facilitating online payments with the potential to extend its presence into offline opportunities longer term.
One driver of PayPal’s growth is that, unlike traditional payment methods that developed in an offline world and have been overlaid onto eCommerce, PayPal’s platform was built with eCommerce in mind. Thus, PayPal has developed tools and risk management measures to address the unique complexities of handling card-not-present payments over the web – one of the fastest growth categories in payments. Moreover, in our view, PayPal is elegantly structured to simplify the web of connections required in a traditional payment system, making it well positioned to penetrate the small business payments market.
PayPal Simplifies the Payment Process
Source: J.P. Morgan.
We think the online marketplace, and sellers in particular, benefit from this simplification in several ways:
Ease of use. PayPal gives virtually anyone the capacity to accept payments, enabling a merchant to operate even at an initial scale that would otherwise be uneconomical (i.e., there are no minimum requirements for payment volume in order to use PayPal).
Higher level of trust. The payments system is not very transparent, and not all aspects were intended for mass use. A trusted central clearinghouse like PayPal can encourage use of online payments by lowering users’ safety concerns and raising their willingness to send money online.
PayPal is differentiated beyond just online commerce PayPal is different from other payment brands (e.g., MasterCard, Visa) in that it is a vertically integrated payment provider. In other words, PayPal is a single source provider of payment services. By contracting directly with PayPal Merchant Services, small merchants can get all of their payment needs and do not necessarily need a separate merchant bank account or payment gateway services provider.
PayPal is gradually expanding its presence off eBay by promoting itself as an integrated payment offering alongside other payment brands (e.g., MasterCard, Visa), supported by PayPal’s own merchant services offering and alliances with payment vendors such as CyberSource (payment gateway) and Chase Paymentech (largest merchant acquirer in the US).
PayPal’s product offerings for online sellers PayPal offers several different products for payment acceptance, based on the size and needs of the merchant:
Email Product. This is the offering used largely by smaller eBay merchants, who receive payments entirely via email, with no site of their own on which they need to integrate PayPal.
Website Payments Standard. This product allows merchants to place a PayPal button on their sites, and when a user is ready to check out, the user hits the button and is taken to the PayPal site where the actual checkout occurs.
Website Payments Pro. With an incremental $30 monthly fee, the Pro product is better integrated into a seller’s site. The product is intended for small to medium-size sellers and requires the seller to be using a compatible shopping cart vendor (most are compatible).
Express Checkout. Intended for larger merchants (those already accepting include Dell and Barnes & Noble). Express Checkout is incremental to the payment acceptance service used by a vendor – it gives users an additional checkout option. When a shopper uses Express Checkout, s/he logs into PayPal, and PayPal then forwards address and other info to the merchant. This allows an existing PayPal user to bypass entering personal and shipping information again, even if it is the user’s first time using the specific merchant.
Fee Structures of Current US Online Payment Providers At this point, all three major providers in the US – PayPal, Amazon Payments and Google Checkout – use similar fee structures, as shown in the table below. Note that PayPal allows users to sign up for a separate micropayments pay schedule, in which case all payments are charged at the 5% + 5c rate.
Fees for PayPal, Google, Amazon Remain Similar Transaction Type/Volume
PayPal Google Checkout Checkout by Amazon
Micropayments 5% of transaction + 5 cents for each transaction
Same as below See below
Transactions under $10 Same as below Same as below 5.0% of transaction + 5 cents
Up to $3,000 / month 2.9% of transaction + 30 cents
2.9% of transaction + 30 cents
2.9% of transaction + 30 cents
$3K-$10K 2.5% of transaction + 30 cents
2.5% of transaction + 30 cents
2.5% of transaction + 30 cents
$10K-$100K 2.2% of transaction + 30 cents
2.2% of transaction + 30 cents
2.2% of transaction + 30 cents
$100K and above 1.9% of transaction + 30 cents
1.9% of transaction + 30 cents
1.9% of transaction + 30 cents
Cross-border Varies by currency but ~1% extra; payments with currency conversion add 2.5% charge
1% of transaction US only (seller and buyer must have US-based account)
“Over the Top” Survey Results In recent months, the internet TV space has been long on speculation and short on data. Therefore, we probed online video trends as one of the areas of focus in our proprietary survey of 1,002 US internet users.
Main Takeaways from Our Survey More than a quarter would consider Over the Top (OTT). Although
most pay TV subscribers (72%) would not even consider getting rid of their cable/satellite package in favor of getting video over the internet, 28% of our respondents said they would consider it. Of these, 63% would do it even if it meant losing access to live sporting events. Additionally, 12% of our sample said they do not have a cable/satellite TV subscription.
Unbundling could help consumers. A slight majority (52%) of pay TV subscribers said they would want to pay less for their cable subscription in exchange for getting fewer channels. Of these, 45% said they would want to get 25% fewer channels and pay 25% less. Those wanting the biggest cut in their packages were also the most likely to consider dropping pay TV.
Netflix subscribers are more likely to consider dropping their cable packages. Those who are more regular users of Netflix streaming are even more likely: among those who use streaming 1-2 times a month or more, 39% said they would consider dropping their package (and another 8% already don’t have cable).
Higher-income households less likely to go without pay TV; also less happy with it. Within our sample, only 6% of those with incomes over $100K said they didn’t have a cable/satellite TV subscription, compared to 18% of those with incomes below $50K. However, 54% of pay TV subscribers with incomes over $100K would prefer to pay less for a smaller package of channels, compared to only 45% of those who make less than $50K.
Price and Choice Seem to Drive Consumers’ Willingness to Consider New Services Our survey showed that 28% of respondents who currently have a pay TV subscription would consider dropping it in favor of video delivered via the internet. Please note that the question wasn’t whether or not respondents are planning to change the way they currently consume video entertainment in the immediate future but if they would merely consider it. In this light, we think it’s interesting to see that 72% of the survey participants answered “No.”
Would You Consider Dropping Your Cable TV Subscription and Using Broadband Internet (Such as Netflix Streaming, Hulu, etc.) for Video Content? Among users who subscribe to a cable/satellite TV package
28%
72%
0%
25%
50%
75%
Yes No
Source: J.P. Morgan consumer survey.
Further analysis shows that 37% of those who said they would consider dropping pay TV in favor of internet-only video options would not be willing to do so if they lose access to live sports programming while 63% would not be deterred.
Would You Consider Dropping Your Cable TV Subscription If Doing So Meant You Would Not Be Able to Watch Live Sporting Events on Your TV? Among those responding “yes” to the question above
Yes, 63%
No, 37%
Source: J.P. Morgan consumer survey.
Not surprisingly, those who are dissatisfied with their current cable/satellite lineup and pricing were more likely to consider switching to internet video: 39% of those who would prefer to pay less for a smaller cable package would consider dropping their pay TV subscription vs. only 16% of those who were satisfied with their package. This suggests that (a) pay TV providers retain some power: even unsatisfied customers do not, for the most part, see a viable alternative; and (b) some who are dissatisfied could be convinced to remain subscribers with lower pricing.
Pay TV Subscribers Less Likely to Consider Dropping If They’re Satisfied with Their Channel Lineup and Price
16%
39%84%
61%
0%
30%
60%
90%
Satisfied w ith current lineup/price Would prefer to pay less for a package w ithfew er channels
Would consider dropping pay TV Would not consider
Source: J.P. Morgan consumer survey.
Those with Access to Netflix Watch Instantly Are More Open to Substituting OTT for Pay TV We also looked at how those respondents who have access to the Netflix streaming service responded to this question. We believe Netflix Watch Instantly to be the most widely available streaming-to-TV service and think this question offers an important insight into the preferences of consumers who are in a position to compare traditional pay TV packages with the OTT experience.
As illustrated in the figure below, people who use Watch Instantly are more likely to say they would consider dropping their current pay TV package. We note that, in general, Netflix subscribers are more open to OTT options than those who don’t use Netflix.
Those Who Use Watch Instantly Are More Likely to Consider Switching from Cable
33% 42% 47%67% 58% 53%
0%
25%
50%
75%
Not a NFLX subscriber Nev er used streaming/tried once Stream at least 1-2x /month
Would consider dropping pay TV / don't hav e pay TV Would not consider
Source: J.P. Morgan consumer survey.
On the other hand, Netflix subscribers were 1.4x as likely to subscribe to a premium channel (such as HBO) as those who are not Netflix subscribers.
Roughly Half of Respondents Are Happy with Their Current Package while the Other Half Could Give Up Channels to Pay Less Our survey shows that current pay TV subscribers are almost evenly split between those who are happy with the TV package they have and those who would like to pay less for fewer channels.
Would You Want to Pay Less for Your Cable Subscription to Get a Smaller Number of Channels Offered?
No, I am happy with the current
package, 48%Yes, I would like to pay less for a smaller package,
52%
Source: J.P. Morgan consumer survey.
Interestingly, it appears that the highest percentage of those respondents who would like a cheaper and smaller pay TV package would prefer 25% fewer channels for a 25% lower price. Both of the more extreme options – a 10% lower price and 10% fewer channels and a 75% lower price and 75% fewer channels – were chosen by a minority of respondents, as shown in the figure below.
In Which of the Following Changes Would You Be Most Interested? %
17%
45%
30%
9%
0%
10%
20%
30%
40%
50%
10% lower price and 10% fewerchannels
25% lower price and 25% fewerchannels
50% lower price and 50% fewerchannels
75% lower price and 75% fewerchannels
Source: J.P. Morgan consumer survey.
Our survey found that higher-income households were significantly less likely than lower-income households to go without a pay TV subscription: 18% of those with incomes below $50K do not subscribe compared to only 6% of those with incomes over $100K.
On the other hand, pay TV subscribers in the higher-income category were more likely to say they were not satisfied with either their channel lineup or the price of their pay TV package (see figure on right below).
Higher-Income Households More Likely to Subscribe to Pay TV . . . % of all households
18%
6%0%
5%
10%
15%
20%
$0-49K $100K+
Don't subscribe to Pay T V
Source: J.P. Morgan consumer survey.
. . . But Less Likely to Be Satisfied with Package Lineup/Pricing % of all pay TV subscribers
55%46%
0%
20%
40%
60%
$0-49K $100K+
Satisfied w ith current lineup/price
Source: J.P. Morgan consumer survey.
Global Equity Research 03 January 2011
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Online Travel Agencies In 2009, online travel agency companies in the US performed relatively well compared to offline agencies and suppliers, primarily due to some countercyclical effects of the weak macroeconomic environment. We think that, as suppliers were faced with excess inventory, they effectively used both online travel agencies (OTAs) and promotional activity to clear some of their levels. Thus, we think 2009 was one of the first years when shifts between online travel agencies to online supplier sites stabilized.
Surprisingly, economic recovery in 2010 has not changed this story. Although supplier websites outperformed the market overall, they are projected by PhoCusWright to grow at only half the rate of OTAs in 2010. Among the reasons for this outperformance are that supplier websites were particularly affected by the pullback among older, frequent leisure travelers who tend to favor supplier sites. Much of the growth in supplier websites in 2010 came from the unmanaged and managed business travelers who returned to the road.
In 2011, we expect to see a restrained recovery continue as corporate travel increases and consumers continue to spend more but unemployment levels remain high. We expect online travel agencies to be the biggest beneficiary of these trends as consumers will likely remain focused on bargain hunting and employ social networking, review sites and personalized offers, which are a strength of OTAs.
Corporate Travel Becomes a Bit of a Headwind We think the hardest-hit area of the recession was business travel. According to PhoCusWright estimates, managed corporate travel declined ~23% Y/Y in 2009 vs. only a ~7% decline in online leisure and unmanaged business travel and a ~18% decline in offline leisure channels. We think OTAs were the biggest beneficiary of this decline as suppliers moved the excess inventory that had previously gone to corporate sales to leisure sales on OTA sites.
Online vs. Total Travel Market Y/Y Growth Rates
-20%-15%-10%-5%0%5%
10%15%
2008 2009 2010
Online Leisure/Unmanaged Biz Total Trav el Market
Source: PhoCusWright US Online Travel Overview, Tenth Edition.
However, we expect this trend to reverse itself in 2011 as corporate travel recovers. For the first time in a while, we expect traditional travel agents to grow their share vs. online travel bookings. It is important to note that this would not be due to a shift from offline to online booking but simply to a recovery of corporate travel, which is booked primarily through offline channels. PhoCusWright estimates that the online travel market increased approximately 8% Y/Y in 2010, while the total travel market grew 10%. Looked at another way, online leisure/unmanaged business share jumped to 38% in 2009 from 35% in 2008 as corporate travel demand fell dramatically. In 2010, PhoCusWright estimates that online leisure/unmanaged business penetration of the total travel market will be flat at 38% as corporate travel recovers. We think this is a one-time anomaly, due to business travel trends, and expect online travel to outpace the total travel market again after corporate travel recovers to more normal levels.
OTAs Gain Market Share from Suppliers Supplier websites’ share of the online travel market was as high as 62% in 2008 but had fallen to 59% in 2010 as a result of OTAs’ countercyclical performance, according to PhoCusWright data. OTAs and supplier websites tend to attract different types of consumers, with OTAs targeting budget-conscious travelers willing to shop around for deals and suppliers attracting more frequent travelers with greater budgets and business travelers. We think the fact that the recovery from the recession has been slow and fraught with job/housing concerns will continue to benefit OTAs going forward. As a result, we see them continuing to gain a larger piece of the pie.
Channel Market Share of Online Revenue by Segment 2008 2009 2010
Air Supplier Website Share of Online Revenue 69% 67% 66% OTA Share of Online Revenue 31% 33% 34% Hotel Supplier Website Share of Online Revenue 59% 56% 54% OTA Share of Online Revenue 41% 44% 46% Cruise Supplier Website Share of Online Revenue 41% 44% 44% OTA Share of Online Revenue 59% 56% 56% Car Supplier Website Share of Online Revenue 66% 66% 66% OTA Share of Online Revenue 34% 34% 34% Packaging Supplier Website Share of Online Revenue 12% 12% 12% OTA Share of Online Revenue 88% 88% 88% Total Supplier Website Share of Online Revenue 62% 60% 59% OTA Share of Online Revenue 38% 40% 41% Source: PhoCusWright US Online Travel Overview, Tenth Edition.
Hotels Will Likely Be the Most Promising Growth Opportunity For a number of reasons, we think hotels will continue to be the most attractive opportunity for online travel agents. First, margins are much higher in this segment than in air, especially in heavily fragmented markets. Second, online penetration in hotels is much lower than in air. PhoCusWright estimates that only 30% of hotel sales were booked through hotel websites and OTAs in 2009. Third, segment-specific drivers are making airlines even less attractive going forward. In 2010,
Google announced its intention to acquire ITA. Although Google has stated that it has no intention of becoming a transactional engine, its huge sway over traffic and the potential to favor its own travel content pages have some OTAs concerned about advertising costs. Additionally, tensions have increased between OTAs and airlines, with airline executives voicing the opinion that sellers should be paying them to access their content, rather than the airlines paying distributors. American Airlines took this attitude to the next level declaring that it would deny Orbitz the ability to sell its inventory as of December 1st. Airlines are also keeping capacity suppressed to keep fares up. We think these occurrences will push OTAs to focus on the hotel market.
Online and Total Travel Market by Segment $ in millions 2008 2009 2010 Airline Online 52,791 48,893 52,890 Growth 0% -7% 8% Airline Total 117,587 97,867 110,100 Growth 4% -17% 12% Online as a Percentage of All Air Revenue 45% 50% 48% Car Online 6,281 6,038 6,208 Growth 2% -4% 3% Car Total 15,873 14,155 14,736 Growth -4% -11% 4% Online as a Percentage of All Car Revenue 40% 43% 42% Cruise Online 1,153 1,106 1,189 Growth 20% -4% 7% Cruise Total 13,828 12,012 12,793 Growth 3% -13% 7% Online as a Percentage of All Cruise Revenue 8% 9% 9% Hotel and Lodging Online 27,988 27,248 29,447 Growth 6% -3% 8% Hotel and Lodging Total 108,017 92,340 99,048 Growth 1% -15% 7% Online as a Percentage of All Hotel and Lodging Revenue 26% 30% 30% Rail Online 825 783 884 Growth 32% -5% 13% Rail Total 1,698 1,564 1,693 Growth 14% -8% 8% Online as a Percentage of All Rail Revenue 49% 50% 52% Packaging Online 741 674 749 Growth 7% -9% 11% Packaging Total 12,289 9,954 11,248 Growth -5% -19% 13% Online as a Percentage of All Packaging Revenue 4% 4% 4% OTA-Int'l Suppliers/Other 4,902 4,766 5,569 Growth -6% -3% 17% Total Online (Leisure/Unmanaged Business) 94,682 89,511 96,934 Growth 8% -5% 8% Total Travel Market 274,194 232,658 255,186 Growth 2% -15% 10% Online as Percentage of all Travel Revenue 35% 38% 38% Source: PhoCusWright US Online Travel Overview, Tenth Edition.
Priceline Dominates Domestic Market Share Gains In 2009 Priceline blew the competition away, with domestic gross bookings growth of 18.3% vs. 1.5% growth at Expedia and a 6.9% decline at Orbitz during the same period. Strength continued for Priceline in 2010. Priceline posted domestic gross bookings growth of 16% Y/Y in the first 3 quarters of 2010 vs. 17% growth at Expedia and 16% growth at Orbitz during the same period despite both Expedia and
113
both to its opaque business model and lowest-price/discount-brand positioning. In 2011, we think Priceline will continue to gain market share, especially now that booking fee removals/discounts are comped.
US Market Share, 1H08
Ex pedia, 43%
Priceline, 9%
Orbitz, 26%
Trav elocity 22%
Source: PhoCusWright US Online Travel Overview, Tenth Edition.
US Market Share, 1H10
Ex pedia, 44%Priceline,
11%
Trav elocity 19%
Orbitz, 26%
Source: PhoCusWright US Online Travel Overview, Tenth Edition.
International Markets Benefit from Online Penetration Economic recovery in Europe has been slow. PhoCusWright estimates that European travel growth is just 2.2% for 2010 due to macroeconomic factors and complications from the volcanic ash cloud. However, in some ways we think this has been beneficial to OTAs as it has forced a sometimes change-averse society to try new things. Travelers hesitant to book online are beginning to turn to the internet to find more affordable options. According to PhoCusWright, this trend has contributed to drive the total market share of online leisure and unmanaged business bookings to 31% in 2009 from 27% in 2008.
European Travel Market Share by Channel (Euros in billions)
65.3 66.4 73.4
175.5 148.9 146.7
050
100150200250300
2008 2009 2010
Online Leisure/Unmanaged Business Offline/Business
Source: PhoCusWright European Online Travel Overview, Sixth Edition.
However, despite the overall low online penetration of the European travel market, we do note that there is much variance on a country-by-country basis. The UK remains the largest online travel market in Europe. In 2009, the UK generated 28% of European online bookings. However, over time Germany, France and Spain are expected to be the main share gainers. Scandinavia has the highest online leisure and unmanaged business penetration, at 45% in 2009, with the UK just behind at 44%. France and Germany have similar online penetration rates, at 31% and 29%,
respectively. Spain and Italy are the major markets with the lowest online booking penetration, at 22% and 18%. Lower levels of internet access, ongoing economic challenges and a powerful traditional travel distribution network contribute to this weakness (PhoCusWright).
European Online Leisure/Unmanaged Business Gross Bookings, 2009 Euros in billions
45.9 42.3 39.6
20.516.7
11.813.418.6
12.14.4 3.1 5.2
0
10
20
30
40
50
Germany UK France Spain Italy Scandinav ia
Total Market Online Leisure/Unmanaged Bus iness
Source: PhoCusWright European Online Travel Overview, Sixth Edition.
Priceline Passes Expedia in European Market Share Despite Priceline’s niche hotel focus in European markets, the company has experienced such dramatic growth that it has passed market leader Expedia’s market share among the top 5 pan-European online travel agencies. Most of Priceline’s gains appear to come from Travelocity Europe, whose market share has fallen to 15% in 2009 from 19% in 2008. In contrast, Priceline grew its share to 33% from 27%. However, we note that the European market is most characterized by its fragmented nature and that the top 5 OTAs account for 49% of the total European online travel agency market. As a result, we see most market share gains coming from offline and smaller OTAs rather than directly from other OTAs.
Source: PhoCusWright European Online Travel Overview, Sixth Edition.
Top 5 Pan-European OTA Market Share, 2009
Ex pedia Europe,
32%
Trav elocity
Europe, 15%
Opodo, 12%
Orbitz WW
Europe, 9%
Priceline Europe,
33%
Source: PhoCusWright European Online Travel Overview, Sixth Edition.
The APAC Travel Market Is Not Far Behind the US in Size PhoCusWright estimates that the Asia Pacific (APAC) travel market totaled ~$202B in F’09, demonstrating that the region is not far behind the US at $232B and Europe at $317B. Although it can be said that all countries experienced a slowdown in travel starting in 4Q’08, differences emerged in the magnitude of the impact on a country-by-country basis. The effects of the slowdown were more pronounced in countries highly dependent on the US economy, such as China and Japan. However, countries with large and well-established domestic markets, such as India, Australia and New Zealand, were somewhat shielded from the impact of the recessionary global economy. Finally, predominantly inbound travel markets, including Thailand, Singapore, Hong Kong and Malaysia, were pressured by declining international passenger revenues and a lack of domestic demand.
Total Travel Market Growth by Country US$ in billions
2008 2009 % growth China 61.1 58.3 -4.6% India 12.9 15.4 19.4% Japan 65.7 62.7 -4.6% Australia/New Zealand 23.7 22.7 -4.2% Singapore 5.6 5.0 -10.7% Source: PhoCusWright Asia Pacific Online Travel Overview, Third Edition, and J.P. Morgan estimates.
Medium Low Source: PhoCusWright Asia Pacific Online Travel Overview, Third Edition, and J.P. Morgan estimates.
We think three of the most attractive markets are Japan, Australia/New Zealand and Singapore due to their high levels of internet penetration and credit card adoption, relatively supportive regulatory systems and decent lodging supply. In fact, based on PhoCusWright estimates, we think Japan, Australia/New Zealand and Singapore will post 2%, 8% and 4% Y/Y growth respectively in 2010.
Total Travel Market Forward Growth Estimates by Country US$ in billions
Source: PhoCusWright Asia Pacific Online Travel Overview, Third Edition.
APAC Significantly Trails US and European Markets in Online Travel Penetration Although the APAC region offers a significant addressable market, recent upside has been limited by very low online travel booking penetration rates. As a whole, the APAC region has roughly an 18% online travel booking penetration level, as estimated by PhoCusWright, vs the US at 37% and Europe at 32%. We think this offers great future upside.
The APAC online travel industry includes five markets, which control ~93% of the industry. Based on PhoCusWright’s 2008 data points, Japan had a 38% market share, Australia/New Zealand accounted for 20%, China held a 23% share and Singapore and India came in at 3% and 10%, respectively. Breaking it down by segment, air accounted for 53% of total online bookings followed by lodging at 34%.
The variance in penetration levels can be chalked up to both regulatory and cultural differences. Surprisingly, Japan (the most technologically advanced market) and China (the market with the highest domestic potential) have some of the lowest online travel penetration rates, at 17% and 11%, respectively. In Japan, a number of GDS/CRS) systems exist but are incapable of communicating with each other. This discourages integrated inventory for airlines in Japan. China has a GDS monopoly with travelsky, limiting the entry of new players. However, countries such as Singapore and India are largely deregulated, enabling a variety of competitive low-cost carriers (LCCs) to thrive.
The Online Travel Market Opportunity, 2008
0.83.1
6.9 6.2
11.5
62%
6%19%
83%74%
0%
20%
40%
60%
80%
100%
Singapore India China ANZ Japan02468101214
Online Market Size (USD billions) Internet Penetration
Source: PhoCusWright Asia Pacific Online Travel Overview, Third Edition.
Online Travel Booking Penetration Rates, 2008 Population Internet
Penetration Total Travel
Market Total Online
Leisure/Unmanaged Business Travel Market
Online Travel Penetration
China 1.3B 18% $61.1B $6.9B 11% India 1.1B 8% $12.9B $3.1B 24% Japan 127M 74% $65.7B $11.5B 17% Australia/New Zealand
25M 87% $23.7B $6.2B 26%
Singapore 4M 65% $5.6B $0.8B 14% Source: PhoCusWright Asia Pacific Online Travel Overview, Third Edition.
Inbound Travel Demand to China Is an Opportunity According to the World Tourism Organization, China generates the fifth-highest international tourism receipts, at $41B in 2008, following only the US, Spain, France and Italy. Although travel was somewhat dampened in 2009 due to the impact of the recession on the US and Europe and concerns about the flu epidemic, the international market remains important to China. Furthermore, China significantly increased its hotel inventory availability in conjunction with hosting the Olympics. The Asia Pacific region as a whole received 21% of international tourist arrivals in 2009. We think Priceline would be attractive to the Chinese hotels given its international consumer reach and brand recognition.
Source: UNWTO World Tourism Barometer, January 2010.
Fragmented Markets Make this Region Attractive to OTAs The LCC market and the fragmented hotel segment represent opportunities for OTAs to develop. However, with the airline commission model eliminated in Japan, other markets reconsidering the model and the GDS monopoly in China, we see lodging as the more exciting APAC segment for OTAs.
Source: PhoCusWright Asia Pacific Online Travel Overview, Third Edition.
Top 5 APAC OTA Market Share, 2008
Recruit, 24%
Rakuten Trav el,
27%
Ctrip, 34%
Asia Rooms,
5%
Wotif, 10%
Source: PhoCusWright Asia Pacific Online Travel Overview, Third Edition.
The largest OTAs are based in Japan, China and Australia. The top five local OTAs in APAC are Rakuten Travel, Ctrip, Recruit, Wotif and AsiaRooms. Combined, these five OTAs reported about $8.6B in gross bookings in 2008, with about 50-75% of revenues coming from hotel bookings. Commission rates vary regionally, with OTAs asking for an 8% commission for booking hotels in Japan (Ikyu), 10% in Australia (Wotif) and about 15% for India and China (PhoCusWright). Primarily inbound markets – including Macau, Hong Kong, Singapore and Thailand – are generally handled by foreign OTAs such as Expedia and Orbitz.
Major APAC OTA Growth Rates and Market Share Country OTA Y/Y Growth 2008 Market Share
China eLong 15.8% 3.7% Ctrip 34.5% 24.5% Others 58.1% 5.1%
Source: PhoCusWright Asia Pacific Online Travel Overview, Third Edition.
The Hotel Segment Seems Most Attractive for OTAs The hotel category should see strength across markets. The 2008 Olympics in Beijing fueled an enormous increase in the supply of hotel rooms. Similarly, the Japanese hotel market saw a real estate bubble burst in 2008, leading to excessive room supply and deteriorating demand. Both China and Japan have more than 2 million rooms, with Australia, Thailand, Malaysia, Singapore and Hong Kong coming in next with a moderate inventory. India and Vietnam are still at relatively low room inventory levels. We believe this growing hotel inventory is a key condition for suppliers and consumers valuing the use of OTAs and for OTAs to thrive. In 2008, OTAs had a combined 43% share of gross bookings in the total market (including air, car, etc.), compared to 57% for supplier websites (PhoCusWright data). However, in the online
120
lodging sales segment (hotel only), OTAs accounted for 72% of all online lodging sales.
APAC Online Gross Bookings by Channel and Segment, 2008 US$ in millions
Market Forecast In the US, we expect accelerating online travel spend growth in 2011. We expect this growth to be led by a recovery in average daily rates (ADRs) and travel volume. We are modeling total US gross bookings to grow 5% to $269B and online leisure/unmanaged business gross bookings to grow 11% to $108B. We expect online gross bookings to account for roughly 40% of total travel spend in 2011.
In both Europe and the Asia Pacific, we expect this recovery to proceed more slowly. We are modeling 2011 total travel gross bookings to be up 5% Y/Y in Europe and up 3% Y/Y in APAC. We think shifts toward online booking will continue, and we are modeling European online leisure/unmanaged business gross bookings to grow 10% Y/Y in 2011 and APAC online leisure/unmanaged business gross bookings to grow 18% Y/Y. We think these increases in online penetration will be a major growth driver for OTAs in the upcoming year.
Cloud Computing Key Themes Clouds accelerate start-up activity and foster innovation . . . . In this section, we detail the large revenue potential of cloud services. However, we also view clouds as a driver of robust start-up activity. Cloud solutions can enable startups to go from idea to product much more rapidly, reaching near-enterprise scale without making enterprise-scale investments in hardware; one prominent example is Twitter, a service that has seen exponential growth and was built largely on top of Amazon Web Services.
. . . but growth is also coming from enterprise adoption In May, Netflix announced that it was expanding its use of Amazon Web Services to include a variety of mission-critical applications, and migrating some of these functions from internal technology solutions onto the cloud. Certain aspects of Netflix’s streaming service are operating off Amazon’s infrastructure. We believe many large enterprises are currently doing due diligence, and we expect more rapid adoption beyond small and medium-size businesses and startups in the future.
Clouds enable ubiquity We view ubiquity – the ability to access content across multiple devices and locations – as a key emerging trend for the internet space. Some cloud software offerings are already becoming mainstream, such as email services that bridge PCs and smartphones. We expect a growing demand for ubiquity (of data, content, and services) to be a catalyst for increased uptake of cloud services, and the proliferation of devices such as the iPad should encourage this trend.
Why “Cloud”? The name serves as a metaphor for the internet, with processing and computing functions occurring in the internet “cloud” rather than on a specific server. Although the term technically has a more narrow definition, the more common use, which we will adopt here, is for “cloud computing” to refer, essentially, to a computer that isn’t on your own desk or in your own data center but at a centralized facility.
Significant revenue growth opportunity. Cloud computing is now a relatively uncontroversial part of the IT marketplace, although the scope of the eventual opportunity remains somewhat unclear: will it take over the computing world or merely be one more option within it? In either case, with only 5% of global IT spend currently going to cloud solutions (a number IDC expects to more than double by 2013), the near term should bring significant growth in the use of cloud solutions.
IDC Expects Cloud Spending to Grow at a 28% CAGR to 2013 Worldwide IT spend in $ billions
359416
45 (10%)17 (5%)
0
100
200
300
400
500
2009 2013EOn-premise Cloud Serv ices
Source: IDC.
Cloud applications aim to replace software. The abilities to collaborate more easily with other users and to access documents from a browser window anywhere are two key benefits. Revenue growth at providers of on-demand solutions is projected to remain very strong in 2010; e.g., Salesforce.com revenue is expected to accelerate growth to 23% Y/Y after rising 21% in 2009 (Bloomberg consensus). However, viewed as an overall part of the $144B application software market, cloud solutions remain in a very early stage of growth.
Cloud storage, processing aim to replace hardware. Companies such as Amazon, Google and Microsoft have massive economies of scale, and it’s a lot cheaper for them to buy and operate servers and hard drives than it is for almost anyone else. Amazon, Google, Microsoft and IBM have all entered this business to some extent.
Not selling excess capacity. A common misconception is that cloud providers such as Amazon are merely taking advantage of excess capacity. However, in our view, selling cloud services is a full-fledged service and not simply a case of taking already existing capacity and monetizing the unused, excess portion. In the case of Amazon, the bandwidth used by its Web Services division began to exceed the bandwidth used by Amazon’s own websites in mid-2007.
Web Services Bandwidth Far Exceeds that of “Core” Amazon
Source: Company presentation.
Fostering innovation. We think an underappreciated aspect of the growth of cloud computing is the way this growth is fostering innovation. An entrepreneur with a promising idea faces much lower costs when trying to start a business. Fast growers such as Twitter and Playfish use Amazon Web Services. As a result, we think cloud solutions can enable innovation to continue at a faster pace than would be possible otherwise.
One Name, Many Concepts As with many internet trends, cloud computing has broadened in meaning as diverse companies and tools have jumped on the “cloud”; appropriate to the word, people can see many different things in the term. At its core, though, the idea is actually quite simple: the benefits of using applications, storage and processing capacity online can often outweigh the costs, especially as internet connections speed up and offer near-instantaneous response.
Cloud computing, as defined by companies, has now expanded to include two key concepts. We will touch upon each of these in more detail below:
Cloud applications and software as a service. Google Docs is a frequently cited example; essentially, these are apps that replace software you might have otherwise used on your own computer, such as a word processor or spreadsheet. At a somewhat higher level of complexity, companies such as Salesforce.com, which offers on-demand SaaS (software as a service) solutions, now describes its platforms as operating in the cloud.
Cloud services. Amazon has been the notable leader here, though others, including Google and Microsoft, also have offerings; services include storage and processing time and allow smaller companies to lower costs by
taking advantage of the big guns’ superior processing power and purchasing power.
Additionally, there is a growing market for “private” cloud implementations, which involve large enterprises developing their own, internal cloud-computing solutions. “Private clouds” are essentially hyperefficient data centers — as are the platforms used to provide cloud services in the public domain. Private solutions can enable a large company to benefit from the flexibility of cloud implementation while getting around certain issues, such as data security, that may otherwise prevent them from using public cloud solutions.
Cloud Applications For simple, consumer-facing applications, cloud applications already have a foothold in replacing the more traditional software-on-your-computer model. The most successful is perhaps not what some would first think of as a cloud application: email.
Nevertheless, comScore estimates that out of nearly 1.3B worldwide internet users. almost 65% access email sites. And both Yahoo! and Google’s email services work using Ajax, which makes them behave with a user interface and responsiveness similar to what one would expect from a desktop application.
Additionally, the ability to move processing off a user’s computer and onto a server could permit a larger number of devices to run more sophisticated communications tools, which may need more processor capacity than is available on, e.g., a mobile phone.
Beyond email, companies ranging in size from startups to Google have made available a variety of applications that are more typically associated with the desktop, including word processing, spreadsheets, presentations and photo editing. Although the reach of these applications is significantly smaller than that of webmail, their growth over the past two years has been quite rapid.
Unique Visitors to Google Docs Grew More than 10x from Oct. 2007 to Oct. 2010 Unique Visitors in Millions and Y/Y Growth Rates
3.86.4
7.79.7
11.2 10.813.1 13.4
181% 247% 198% 227% 193% 69% 70% 38%
0
5
10
15
4Q'08 1Q'09 2Q'09 3Q'09 4Q'09 1Q'10 2Q'10 3Q'10
Av g. Monthly Unique Vis itors (millions) and Y/ Y Grow th (%)
Source: compete.com.
We think continued growth for cloud applications on the consumer and small business side is quite likely for several reasons:
Ubiquity. The file can be available wherever the user can open a browser window. Additionally, as the application is designed to work in a browser, the user is not confined to computers with the right software installed.
Collaboration. Multiple people can work on the same document and see each others’ changes in real time. We think collaboration will become an even more core component of software innovation over the next decade.
Convenience. The web application model frees the user from needing to ensure that software is up to date.
Price point. Many of Google’s tools, e.g., are available for free or for an annual fee of $50/user account for businesses. While we don’t expect these tools to make much headway at most large corporations, a smaller business may find the price compelling, compared to a Microsoft Office price point of over $100 retail.
For the software company, easier to avoid piracy. The provider can ration access to the application, and there is less of a danger that multiple copies could be made from a single source.
At the same time, the model brings with it a variety of drawbacks, some more significant than others:
Data security. Some clients, especially enterprise clients, may not want to put valuable information online in a way that enables the whole world to possibly access it.
Lack of features. While online applications continue to make strides, they generally remain far short of the capabilities offered by a full-featured application such as Microsoft Excel. We believe that, for many users, a tool that offers only a fraction of Excel’s capabilities is likely to be sufficient, and the lack of the full suite of features may not be a significant drawback.
Reliance on internet connection. Lose your link to the network, and you lose your documents – a trade-off some may not be willing to risk. Some providers let users edit documents offline – but doing so temporarily removes some of the advantages described above.
Google Apps Features Feature Details Price $50 / user account / year
Messaging application features Gmail and Google Calendar Included Gmail storage 25 GB / account Gmail: ads Can be disabled Email Security Provided by Postini Resource Scheduling in Google Calendar Included Gmail, Google Calendar, Google Talk 99.9% Uptime Service Level Agreement Interoperability with MSFT Outlook email/calendar Included Sync with Blackberry Enterprise Server Included Collaboration Application features Google Docs, Google Sites Included Google Sites storage 10 GB, plus 500 MB / user for shared storage Google Video Private video sharing Google Docs, Google Sites Uptime 99.9% Uptime Service Level Agreement
Support Email support Included Phone support For critical issues
Integration Single sign-on API Included User and group provisioning API Included Email migration tools and API Included Email routing and email gateway support Included Source: http://www.google.com/apps/intl/en/business/details.html.
Software as a service Software as a service, or SaaS, is frequently delivered over the web in a way that can be said to rely on the cloud; Salesforce.com has described its CRM product as taking advantage of cloud computing. Such offerings are also occasionally called on-demand applications.
These tools tend to be more sophisticated (and expensive) than the small business- and consumer-targeted offerings described above. Nevertheless, they can take advantage of many of the features noted above, including data portability and, for the vendor, easier updating.
On-Demand Software Companies Units as indicated, pricing as of 12/29/10
Name Symbol Mkt Cap ($M) 2010 Price chg Rev ’11E ($M) Concur Technologies Inc. CNQR 2.792 +25% 365.26 Constant Contact Inc. CTCT 904 +94% 217.5 Demandtec Inc. DMAN 317 +19% 92.1 Kenexa Corp. KNXA 495 +67% 242.3 Logmein Inc. LOGM 1,092 +131% 118.0 Netsuite Inc. N 1,602 +56% 224.3 Rightnow Technologies Inc. RNOW 760 +35% 214.7 Salesforce.Com Inc. CRM 17,469 +80% 2,014.6 Successfactors Inc. SFSF 2,325 +85% 255.0 Taleo Corp-Class A TLEO 1,119 +18% 296.1 Ultimate Software Group Inc. ULTI 1,234 +66% 270.9 Vocus Inc. VOCS 573 +53% 112.1 Source: Bloomberg consensus estimates. Note: CNQR revenue estimate is CY'11E; CRM and DMAN revenue estimates are F’11E due to non-Dec. fiscal years.
Cloud Services The web services space has seen Amazon take a leading role, with key products that offer storage (Amazon Simple Storage Service, or S3) and processing (Amazon Elastic Compute Cloud, or EC2), both introduced in 2006. More recently, other large players have joined the fray; Google rolled out its App Engine in April 2008, while Microsoft announced the availability of its Azure suite of web services in October 2008. Additionally, IBM has expanded the suite of cloud products it offers over the past year.
Although the details and implementation can vary, these web services tend to operate around a similar general concept; the service offers its users an ability to add scale, in terms of either storage or processing, that would be difficult to ramp independently. We note that these services are not a case of large companies selling their excess computing capacity. For example, Amazon has reported that its Web Services accounted for 2x as much bandwidth use as Amazon.com’s core website by the early part of 2008.
Sample Companies Using Amazon Web Services Customer Description of AWS use
Autodesk SAAS application hosting Urbanspoon Backbone for iPhone App Linden Lab Content Delivery for Virtual World Harvard Medical School Research Models and Simulations Washington Post Special projects Indianapolis 500 Media hosting and streaming Playfish Social games co. “operates entirely on AWS” NASA Jet Propulsion Lab Processing high resolution satellite images Source: amazon.com.
The intended users are, for the most part, smaller companies such as startups that may not have the capital or know-how to build up server capacity immediately, as well as small and medium-size companies, which may experience occasional spikes in usage and find it more economical to rent the processing capacity to deal with such spikes, rather than purchase equipment ahead of time that can handle peak loads but that would also sit idle for the majority of the time.
At the same time, large enterprise clients such as Netflix are using Amazon Web Services, as well, with the companies announcing in May 2010, that Netflix was shifting certain functions related to processing and streaming its Watch Instantly video content away from in-house infrastructure and onto AWS.
For storage, the pricing generally includes a per-GB cost for transferring data in or out, as well as storage costs per GB per month; by way of example, Amazon charges US users on a sliding scale, starting at $0.15 per GB per month (see below).
Costs of Amazon S3 for US Users Storage Data Transfer: In Data Transfer: Out
Volume/mo Price Volume/mo Price Volume/mo Price First 1 TB $0.14/GB All $0.10/GB First 1 GB Free Next 49 TB $0.125/GB Up to 10 TB $0.15/GB Next 450 TB $0.11/GB Next 40 TB $0.11/GB Next 500 TB $0.095/GB Next 100 TB $0.09/GB Next 4000 TB $0.08/GB Over 150 TB $0.08/GB Over 5000 TB $0.055/GB Source: http://aws.amazon.com/s3/#pricing. Note: Prices for storage somewhat higher in Northern California.
Similarly, services that offer processing time are priced on a sliding scale depending on usage. (Google’s App Engine is the exception, for now – the service is free, up to certain usage limits.)
Advantages of cloud services model: Scalability. Rather than trying to project the growth of expected computing
needs, an enterprise can pay for exactly the level of computing resources it requires. Additionally, if a company’s needs spike unexpectedly, the cloud services model can absorb the spike vs. needing to wait for resources to be bought and installed.
Pricing. The large companies that offer these services tend to benefit from immense economies of scale, allowing them to price the services at levels that can be lower than a smaller company would be able to achieve if buying its own hardware.
Focus. Few companies, especially smaller ones, have a core competency in managing hardware and servers. By outsourcing these functions to a service provider, a company can focus on its core business.
Disadvantages: Less configurable. The processing and storage resources that are bought in
a cloud model may not offer the option of being configured in precisely the way a user would prefer.
Data security. As with cloud applications, some businesses may not be comfortable having key data stored on someone else’s computer.
Transition costs and complications. For companies that begin with an on-premise solution, switching to the cloud can involve a somewhat complicated transition.
eReaders Since Amazon introduced the Kindle in 4Q’07, the eReader market has undergone rapid growth. The past 15 months have seen the introduction of the B&N Nook as well as Apple’s iPad, and we believe we remain in a very early stage for digital reading, with the landscape likely to continue to shift.
Key Takeaways Device proliferation is driving ubiquity. Three trends have helped drive
adoption: increased availability of devices from multiple vendors, lower device prices and platforms that extend the reach of eBooks onto other devices, such as mobile phones, tablets and PCs.
Prices falling as devices get better. Compared to a year ago, eReader devices are being sold with better screens and more storage – and prices that are ~25% lower Y/Y. We think this trend should continue, broadening the appeal of the devices, and we expect prices on low-end devices to dip below $100 this year, further driving adoption.
A niche market can still be a big market. The majority of the population doesn’t read many books (if any). But even if only 15% of US adults read 25+ books a year, that would represent nearly 35M people, more than enough to allow for multiple winners in the eReader market – even setting aside any global opportunities.
We think the money’s in content. We continue to believe selling the devices is likely to be a less important business than selling eBooks – and other content – for the devices.
Content means more than just books. Newspapers and magazines are, if anything, a more natural use for an eReader: the current paper format is largely disposable. Amazon’s introduction of Singles – essays that are shorter than a book – hints at the scope for continued innovation.
More than one business model can succeed. We think a variety of possibilities exist for the eReader market: e.g., cell-phone-type plans with unlimited content for a set monthly fee, or “book club” deals where an eReader is free but the consumer must buy a certain number of titles. In the near future, we think an advertising-supported approach is less plausible for books, where the user experience suffers with interruption. eNewspapers, on the other hand, could eventually be supported partly with advertising, just as print newspapers are.
eReader Marketplace Getting Crowded Below is a quick primer on eReader devices currently (or soon) available. As a note, throughout this report we refer to the devices as eReaders and to the content as eBooks. First, here is a look at key features shared by many of the devices.
Key features The majority of recent eReader devices have many or all of the following features:
E Ink display. Perhaps the key differentiator of eReaders from other handheld devices, an E Ink display is not backlit, and allows the reader to look at a surface that is like paper, which reduces eye strain for many users. One downside of available displays is a slower image refresh than traditional screens. Additionally, most E Ink screens are currently black & white (or multiple shades of gray), but we expect color to become more broadly available in future years. Finally, as of now the display backgrounds tend to be gray, rather than white, which means contrast is not quite as sharp as ink on paper.
Variable font size. A sometimes overlooked advantage, but extremely useful for older readers who are no longer at the mercy of publishers’ choices about which content to release in large-print editions.
Wireless connection. Some sort of connection is now more or less standard, with some cheaper devices equipped with only a wi-fi connection, whereas higher-priced models generally use the cellular network in some way.
Touch screen. Increasingly the interface of choice; both the B&N Nook (below the reading surface) and the latest Sony models (on the whole display) have one. As of now, the Kindle does not, using a miniature keyboard instead.
Macro screen. Several devices (Kindle DX, Reader Daily Edition) have a larger screen that allows for better display of certain types of content and images; some also feature an accelerometer that allows the device to show content in either portrait or landscape when the user turns the device.
Key Devices Sony Reader The first Sony Reader was released in September 2006, and currently the company sells three versions. All three of the models have experienced a price decline since last year, as noted in the table below. Note that for the Pocket Edition and Touch Edition, the price is lower even though the company has introduced new versions with updated displays, more memory and a slightly smaller size.
Summary of Sony Reader Models Pocket Edition Touch Edition Daily Edition
Price $179 $229 $299 1-yr Px Change Down 10% from $199 Down 23% from $299 Down 25% from $399 Available September 2010 September 2010 Late 2009 Display 5-inch E Ink, gray (16 shades) 6-inch E Ink, gray (16 sh.) 7-inch E Ink, gray (16 sh.) Interface Buttons Touch Screen Touch Screen Usable Capacity ~2GB ~2GB ~ 2GB Wireless? No No Yes Bookstore For all three models: Sony eBook Store, Google Books for public domain books Size 5.7"x4.1"x0.3" 6.6"x4.7"x0.4” 7.9”x5.0”x0.4” Weight 5.5 oz 7.6 oz 9.6 oz Source: Sonystyle.com, press reports.
Sony sells books for its Readers via its own eBook store and has a deal with Google for public domain books to be available as well. Although the availability of public domain books expands the nominal size of the catalog, most titles available through the Google deal are likely to be of extremely limited interest to most users.
Amazon Kindle Amazon released the first version of the Kindle in November 2007, selling for $399. Over the last three years, the company has rolled out several updated versions, with the pace of rollouts accelerating somewhat after the first year:
May 2008: Cut price to $359
February 2009: Kindle 2, $359
March 2009: Kindle iPhone App
May 2009: Kindle DX (9.7” screen, $489)
July 2009: Cut Kindle 2 price to $299
October 2009: Int’l edition; Kindle for PC; Cut Kindle 2 price to $259
January 2010: Kindle DX Int’l version
February 2010: Kindle for Blackberry App
March 2010: Kindle for Mac
April 2010: Kindle for iPad App
May 2010: Kindle for Android App
June 2010: Cut Kindle 2 price to $189
July 2010: New version of Kindle DX, $379
August 2010: Kindle 3: wi-fi only for $139, 3G for $189
December 2010: Kindle for Web released
In three years, the price of the core Kindle reader has dropped by more than half from $399 to $189. This is despite improvements in the display, battery life and storage capacity.
Barnes & Noble Nook B&N began selling its eReader, called Nook, in November 2009. The company now sells three versions of the device: a wi-fi only Nook with an advertised price of $149, a version that includes a 3G connection for $199, and a full-color Nook for $249. As with both the Sony Reader and the Kindle, Nook has seen its price decline significantly: the original version of the device (most similar to the $199 version) sold for $259 when it debuted a year ago. All devices are enabled for free wi-fi
access at B&N stores as well as AT&T wi-fi hotspots, and all use Barnes & Noble’s eBook store, which has over 1M titles available. Additionally, Barnes & Noble allows users to read full eBooks when at a B&N store and enables Nook users to “lend” eBooks to one another.
Apple iPad In April 2010, Apple introduced the iPad, which is not a dedicated reading device but a tablet with reading one of its many functions; J.P. Morgan estimates that nearly 12 million units will be sold globally in the first year.
Still in the early innings We think it is instructive to compare the first-edition iPod (10 GB, no Windows compatibility, B&W screen, mechanical scroll wheel, 10 hours battery life) with current models. We expect eReaders to undergo a similar evolution and think the devices available five years from now are likely to have features and capabilities significantly beyond what is currently available.
Textbook market begging for innovation Most of the eReaders currently being sold are designed primarily with readers of mass-market books in mind, with some devices aimed more at business-focused readers. However, we believe the textbook market, which represents a tremendous opportunity, will require further innovation on the device side in order to flourish. We expect new devices catering to this segment to hit the market in coming years.
Marketing Matters: Consumer Awareness Rising In July 2009, we surveyed 765 US internet users, and found that 63% of them had either not heard of the Kindle or had heard of it but didn’t know what it was. When we conducted a similar survey in December 2010, that number was down to 24%. It appears Amazon’s somewhat aggressive marketing push for the Kindle is bearing fruit. By comparison, the Barnes & Noble Nook has lower awareness:
Marketing Efforts Paying off in Higher Awareness for Apple, Amazon
76%45%
84%
0%
20%
40%
60%
80%
100%
Kindle Nook iPad
Brand Aw areness (Know the name & w hat it is )
Source: J.P. Morgan Internet Team December 2010 survey.
Is the Market Big Enough? The majority of the population does not read very much, which cuts into the possible size of the market, and we continue to believe eReaders are unlikely to reach the penetration levels of MP3 players.
However, in our recent survey of US internet users, we found that 16% are heavy readers, reading at least two books per month.
Although the Majority Doesn’t Read Much, ~16% Read 26+ Books per Year
49%
20%
9% 7% 6%10%
0%
10%
20%
30%
40%
50%
60%
0-10 books/y r 11-15 16-20 21-25 26-30 31+
Source: J.P. Morgan Internet Team December 2010 survey.
We think the majority of the target market for eReaders is in this group (although some of those who read fewer books may consume a significant quantity of other written content, such as newspapers and magazines). Across the entire population of US adults, 16% represents in excess of 35M people.
Additionally, with prices declining, we believe interest in eReaders is rising significantly. When we asked in July 2009 about purchase interest, ~7% of our sample reported either owning a Kindle or planning to purchase one within 12 months. A year and a half later, that number has quadrupled.
With Prices Down and Awareness Up, Kindles Approaching Mainstream
7%
28%
0%5%
10%15%20%25%30%
Jul 2009 Dec 2010
% say ing they either ow n a Kind le or plan to buy one in the nex t 12 months
Source: J.P. Morgan Internet Team July 2009 and December 2010 surveys.
28% of adult US Internet users would represent nearly 48M people. While we believe such rapid uptake is unlikely, we think the scale of the opportunity is quite large.
Globally, we think the opportunity for device sales is even larger. EU and UK statistics on heavy readers suggest numbers broadly in line with the US (with significant variation across countries). We estimate that, between the US and Europe, there are ~100M adults who are heavy readers, and who would thus be part of the target market for eReaders and eBooks.
Finally, the focus on adults excludes another potential market: textbooks. The American Association of Publishers estimated net sales for K-12 and higher education books in 2009 to constitute a $9.5B market, or nearly 40% of the US total.
There is a significant cost component of textbooks related to the manufacture of the physical books, and we think it is likely that a slightly differentiated set of eReader devices will develop to service the textbook market.
Focus on Content, Not Devices We think the opportunity from device sales pales in comparison to the scale of the opportunity from content sales, for several reasons.
The majority of eReader owners appear to be buying at least 2 books/month for their device. At $10/book, this represents $240/year in annual revenue – well ahead of most device prices. Even if we assume eBook prices eventually fall to $5, two books a month comes to $120 annually, in line with where the lowest-priced devices are selling today. Since we expect an eReader to be a fairly durable item, it’s nearly assured most users will spend more on content than on devices.
Most eReader Owners Buy at Least Two Books a Month
27%33%
22%18%
0%5%
10%15%20%25%30%35%
0-1 Books/month 2 3 4 or more
Source: J.P. Morgan Internet Team December 2010 survey.
Comp #1: the cell phone market First, by way of comparison, we note that cellular carrier service revenue (~$150B in the US last year) was approximately 7-8x as large as handset sales revenue (or 4-5x as large when adjusting for handset subsidies). Further, we think eReaders are likely to have longer useful lives than cellular phones, which tend to get replaced as often as every 1.5-2 years.
Comp #2: digital music We note that digital sales represented ~40% of all US music sales in 2009 (as per IFPI), a number that is likely to continue to grow. If eBooks could achieve even 10% penetration (or less than 1/3 the level in music) of the roughly ~$24B books market, the $2.4B in annual sales would be equivalent to roughly 16M device sales, assuming current pricing.
Market fragmentation less likely in eBooks than eReaders Additionally, whereas we expect continued fragmentation in the eReader market, we think content sales are likely to become the province of three or four main players. It appears that, as of now, only Amazon, Barnes & Noble, Google and Sony are seriously pursuing eBook sales. We do not foresee the market shrinking to less than a duopoly: we expect publishers to be very resistant to allowing one merchant to reach the market power that Apple has achieved in digital music.
Altogether, we see both a greater revenue potential for eBooks and greater room for market concentration.
eBooks Penetration of Trade Print Is Growing Exponentially
0.5% 0.6% 1%
3%
9%
0%
2%
4%
6%
8%
10%
2006 2007 2008 2009 2010
eBooks as % of Trade Print
Source: Association of American Publishers; J.P. Morgan estimates. Note: 2010 estimated based on Jan-Oct data.
Content Means More than Books We think one of the underappreciated aspects of the development of eReaders is the capacity to deliver medium- and long-form content other than books. Specifically, we believe the devices are in many ways ideally suited for reading newspapers and magazines.
Both newspapers (especially) and magazines (for the most part) are intended for immediate consumption with little thought of long-term value. Additionally, two of the key consumer disadvantages of eReaders – the difficulty of sharing a book, and uncertainty about maintaining longer-term ownership of digitally acquired books – are virtual nonissues for periodicals, which are largely disposable.
Further, given the history of publishing that has developed around the economics of the book, we think new formats are likely to emerge. Amazon has made an early entry into this space with Amazon Singles: essay-length content that would be too short for a book but too long for a magazine article.
Business Models Should Evolve We think mass adoption of eReaders could drive changes in the standard business model of selling one book at a time. Below, we sketch out several possibilities for alternative business models. Some of these may succeed; some may never get off the ground:
The cellular model. After acquiring an eReader (possibly subsidized, like a cell phone), you sign up for a monthly plan that lets you download a certain
quantity of reading material each month. Different plans could include or exclude different types of content (e.g., new releases, or specialized business titles, or newspapers). Publishers could license content for a flat rate, or perhaps use revenue sharing with an imputed value for each download (a la Netflix).
The “Columbia House” model. The user gets a (discounted/free) eReader after agreeing to purchase a specified number of titles over a specified period.
Serialized content. In a world where publishing is not tied to physical paper, writers and publishers may choose to release books chapter by chapter, rather than all at once. This runs parallel to –
Lower-priced content. An eReader combined with a micro-payments platform could allow for sales of content in ways that were not previously practical: e.g., $0.25 for a short story, or perhaps newspapers/magazines that sell individual articles for a few cents apiece.
Enhanced content. Once writers become more comfortable with the format, a digital book could offer the possibility of a richer user experience, esp. in nonfiction. Some of the possibilities: much deeper sourcing or footnotes, more interlinked information, etc.
A variety of academic and specialty uses. For publications such as scientific journals, faster distribution can be combined with greater depth of content. Publications that are of high value, but only to a low circulation, can benefit significantly from lower distribution costs.
Textbooks. As noted above, textbooks involve significant manufacturing expenses. A format that allows students to use eReaders instead of textbooks could achieve economies through lower manufacturing cost. Lighter backpacks would be another plus.
Ad-supported content. We are skeptical of ad-supported books. Reading is too immersive to be well-suited to the interruption of an ad, even if it is targeted well. On the other hand, periodicals, with shorter articles, could well develop an advertising model (their readers would be used to it). We would worry about issues of privacy (since the device seller knows exactly who the device owner is) as well as finding an ad format that’s desirable to advertisers but that does not significantly diminish the user experience.
Search. As the devices and their wireless connections improve, we think there could be some capacity for search distribution deals, similar to existing toolbar deals between PC manufacturers and search engines.
China Top Predictions for 2011 (1) eCommerce to see wider adoption, driven by convenience, lower-price alternatives to traditional retail, and improved trust & safety. Gross merchandise volume (GMV) is expected to reach Rmb723B in 2011, or less than 4% of retail sales.
(2) Social commerce. Expect social sites to be an emerging and important traffic generator for eCommerce companies. Synergistic relationship between social networks and commerce merchants will fuel growth for both segments.
(3) Game segment likely to see re-rating with good game titles launch. Highly anticipated games in 2011 include Duke of Mountain Deer, World of Warcraft Cataclysm, etc., which could generate greater player interest and, as such, sector re-rating.
(4) Video advertising to prompt ad dollar shift from TV to internet. With the recent IPO of Youku, a broader range of online video content, growing online video user base, and a familiar ad format, TV advertisers are likely to accelerate the ad budget shift from offline to online.
(5) Mobile internet to see increased competition. We expect internet leaders like Baidu and Tencent to formally launch middle-ware products that could include third-party application distribution platforms; compete with existing players like UCWeb and other mobile game platforms.
(6) Search continues to see solid growth, with wider market adoption. Baidu still maintains dominance, other players such as Soso and Sogou still unlikely to gain meaningful market share.
(7) Solid consumer spending trend supports good advertising segment growth. Expect continued good macro environment to support consumer spending. We believe the sector growth story remains intact: internet usage growth, particularly in lower-tier cities, to drive ad budgets online.
(8) Expect transition from time-base pricing to CPM-base pricing to accelerate in 2011, but remain gradual, driven by user-segregation and better online ad-serving/tracking technology. Yet, leading portals will still benefit from their own brand influence.
(9) 2011 Rmb appreciation to improve sector profitability. Expect sector margins to have very slight improvements from Rmb appreciation, as only a small portion of costs are in US dollars (game licensing fee, overseas video/sports content fee, and some servers, etc.). Benefits to come from translation gains from Rmb-denominated EPS to US$-denominated EPS.
(10) More IPOs likely in 2011. We expect investors will likely continue to look for growth investment opportunities in 2011. We think China’s internet segment offers good secular growth, as well as a number of sizable private companies. We believe more new listings are likely.
China Internet Market Overview Internet penetration still low at 31% China’s internet population grew at a rapid pace in 2010, increasing 24% Y/Y to 420M by June 2010, or at a penetration rate of 31.2%, according to China Internet Network Information Center (CNNIC). Since late 2008, China has the world’s largest internet user base. This strong growth in recent years has been driven by factors such as robust GDP growth, lower-priced computers, more affordable telecom connection fees, government support for internet usage, and low-cost entertainment aspects.
China Internet Users and Penetration Rate
34 46 59 68 80 87 94 103 111 123162
210253
298338
384420
454494
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Number of China Internet Users (Left, millions)
Penetration Rate as % of Total Population (Right)
Source: CNNIC J.P. Morgan estimates.
Further, rural internet populations continued to adopt the internet in 1H10 with a 7.8% growth rate.
Rural Internet Penetration Reached 16.0% from 11.7% in One and a Half Years
How much more growth? Despite this rapid growth, China's internet penetration rate of about 31% of the population is still well below that of developed markets like the US, Japan, and Korea (over 70%). We expect internet users to grow by around 17.7% Y/Y in 2011 to reach ~534MM, or the penetration rate to reach ~39% of the population by the end of 2011.
We draw the parallel between internet penetration and mobile phone penetration in China. We observe that in recent years internet penetration has lagged mobile phone penetration by around four to five years. This gives us confidence that internet penetration will likely continue to grow in the future, with lower-cost connection fees and equipment costs.
China Internet and Mobile Phone Users
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Mobile phone users (Mn) Intenet users (Mn) Mobile users shifted 4.5 years Source: CNNIC, Ministry of Industry and Information Technology (MIIT), J.P. Morgan estimates.
Broadband and Mobile continue rapid growth According to CNNIC, the number of users with broadband internet access grew 28% Y/Y to 346M (90% of total users) by the end of 2009, and to 364MM (87% of total users) by June 2010.
According to the latest MIIT data, the number of broadband subscriber lines reached 123.2 million by October 2010.
Broadband Subscriber Penetration by Number of Broadband Lines 2005 2006 2007 2008 2009 2010*
Broadband subscribers (MM) 37.5 51.9 66.5 83.4 105.0 123.2 Population Penetration (%) 2.9% 4.0% 5.1% 6.4% 7.9% 9.0% Households Penetration (%) 9.1% 12.5% 16.1% 20.0% 24.0% 28.2% Source: CNNIC, Ministry of Industry and Information Technology (MIIT), J.P. Morgan estimates. Note: Data as of October 2010.
Internet access device The number of mobile internet users increased by 78% Y/Y to 277M by Jun-10, as per CNNIC. The number of mobile internet users was 66% of all internet users and 33% of all mobile users. We expect mobile internet usage to increase significantly once 3G penetration increases amongst consumers.
Methods of Accessing by Device
73.6%
36.8%
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Desktop Laptop Mobile Phone
Source: CNNIC (Jun-10).
Home has become preferred place to access the internet Given the increase in internet-accessible computers, broadband penetration, and per capita wealth, the home has become the preferred place for most users to access the internet, with more than four-fifths of all internet users accessing the internet from home. The number of people accessing the internet from the office also increased to 33% at the end of 1H10 from 30% in late 2009.
Average time spent online remains stable CNNIC’s Jun-10 survey showed users spent an average of 19.8 hours per week online. This was up from 18.7 hours per week six months earlier. While the overall average online time per user remains stable, we note old users likely spend more time online than new users. We also note that internet usage has more than doubled compared to the 9.8 hours per week spent online in December 2002.
Average Time Spent Online Hours/week
9.813.0 13.4 12.3 13.2 14.0 15.9 16.5 16.9 18.6
16.219.0
16.6 18.0 18.7 19.8
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10152025
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Av erage Accessing Time Per Week
Source: CNNIC (Jun-10).
Media is the most popular internet use According to the Jun-10 CNNIC survey, online music is the most popular use of the internet, with 82.5% of internet users accessing online music. Online news is also popular, with 78.5% usage, while search engine use was 76.3%. Online payment and online shopping have seen fast growth with 36.2% and 31.4% user increases in six months by June 2010, respectively.
Internet Usage by Category Service type % of surveyed use the service Users in millions Online Music/download 82.5% 346.5 News 78.5% 329.7 Search engine 76.3% 320.5 Instant messaging ( chat room, QQ, ICQ) 72.4% 304.1 Online Games 70.5% 296.1 Online movie (include download)/Video 63.2% 265.4 Email 56.5% 237.3 Blog 55.1% 231.4 Social Networking 50.1% 210.4 Online literature 44.8% 188.2 Online shopping 33.8% 142.0 BBS/forum 31.5% 132.3 Online payment 30.5% 128.1 Online banking 30.5% 128.1 Online stock trading 15.0% 63.0 Online travel reservation 8.6% 36.1 Source: CNNIC (Jun-10).
Chinese mobile users cite chat as the most used function while accessing the internet with their phones. Mobile search is chosen by 48.4% of mobile users while listening/downloading music was the third most popular activity with 45.3% users.
Online Advertising Maintain positive view on 2011 and longer-term online ad market growth We expect the rising number of internet users and increasing times spent on the internet will continue to drive online ad allocation. Lower computer prices, declining connection fees, higher influence of online media, and government support should continue to drive internet growth in China. Time spent on internet per users should accelerate from the increased penetration of smartphones and tablets.
Increasing Time Spent on Internet per User per Week
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Time Spent Online (In Hr/Week)
Source: CNNIC.
The total online ad market still accounts for a relatively small portion of China’s overall advertising market (expected to be around 15.8% in 2011). We forecast the online ad market to witness 23% YoY growth in 2011, to reach Rmb30B (or US$4.4B) and 31% YoY growth in 2012 to reach Rmb39.3B (US$5.8B).
Search ads continue to grow faster than brand ads We expect search advertising to continue to see stronger growth than brand advertising in 2011. From a top-down perspective, search ad is ~61% of the total online ad market in China in 2011E. This compares with ~70% in the US. As such, we still see room for growth.
From a bottom-up perspective, we expect market drivers to be: 1) increasing user adoption of search, 2) higher SME advertisers’ adoption of pay-for-performance advertising, 3) search usage to increase with the growing eCommerce market, and 4) use of search ads as a brand advertising tool.
China search ad is still ~50% of the total online ad market. This compares with around 67% in the US
China Online Advertising Market Forecast from 2006 to 2012E 2006 2007 2008 2009E 2010E 2011E 2012E Brand Advertising (RMB M) 3,377 4,559 6,428 6,942 9,025 11,462 14,442 Search Advertising (RMB M) 1,442 2,851 5,309 7,213 12,015 18,427 24,751 Other Online Format (RMB M) 109 122 135 135 135 135 135 Total Online ad market (RMB M): 4,928 7,533 11,872 14,290 21,175 30,023 39,328 Total Online ad market (US$M) 621 999 1,721 2,083 3,100 4,448 5,826 Growth Rate (Rmb, %) 54.6% 60.8% 72.3% 21.1% 48.8% 43.5% 31.0% Total China ad market (Rmb M) 105,712 116,422 139,707 142,501 165,301 190,096 216,709 Growth Rate (Rmb, %) 16.5% 10.1% 20.0% 2.0% 16.0% 15.0% 14.0% Ad market as % of GDP 0.48% 0.44% 0.46% 0.42% 0.42% 0.44% 0.45% Online ad as % of Total ad market 4.7% 6.5% 8.5% 10.0% 12.8% 15.8% 18.1%
Source: iResearch, CNNIC, J.P. Morgan estimates. Note: Growth rates are in Rmb terms.
Online advertising: top-down perspective Internet usage growth – same old story, but is that what is driving the online ad spending growth expected in 2011? We expect China's internet user base to grow around 20% CAGR (2009–11) to reach a penetration rate of 39% by the end of 2011, up from the current penetration rate of 31%. Drivers for the sector include lower-priced computers, more affordable telecom connection fees, government support of internet usage, and low-cost entertainment alternative.
We believe if the number of internet users grows 20% Y/Y (or roughly equal to the increase in media consumption), a minimum of 20% Y/Y growth in online brand ad spending should be achievable, given: 1) higher number of hours spent online per user, 2) the internet can reach a broader audience in smaller cities in China, 3) more measurable and lower cost compared with traditional media like TV, 4) general inflation in advertising rates, and 5) GDP growth should also drive overall ad spending up.
U.S. advertising spending = 2% of GDP vs. China’s 0.5% Ad spend as a percentage of GDP in China is still below the US level; as such, we still believe advertising in China can grow at least in line with GDP. Online ads should grow even faster.
Online advertising: bottom-up perspective The few sectors that we believe are likely to see fast growth next year are: autos, FMCG (Fast Moving Consumer Goods), and eCommerce. China Government’s drive to push consumption in the country should continue to help drive retails sales. As a result, the advertising industry should benefit from this trend.
Automobiles advertising outlook for 2011 Driver 1: Increased auto ad dollars In 2011, we believe the auto sales environment will become more competitive with less government subsidies and oversupply. Our China Autos Analyst Frank Li suggests that auto sales for personal vehicles will decline to 15% YoY in 2011 vs. 29% in 2010E. However, excess capacity build-up over the last few years will also lead to higher competition which, in turn, should help drive up marketing expenses by auto makers.
Driver 2: Increased online allocation We believe that with an affluent internet population growing, more measurable results, and lower rates vs. TV, automobile companies will continue to increase
budget allocations to online advertising. Currently ~7.3% of automobiles’ advertising budget is allocated online in China, according to iResearch. iResearch expects auto online advertising spending to increase to 10.9% by 2013.
In addition, we believe more advertising budget will be directed to drive product sales (through advertising particular models, driving traffic for test drives) rather than general branding exercise. In our opinion, a product-specific campaign would be more effective over the internet as Chinese consumers tend to do a lot of their own research before their first car purchase.
Driver 3: Geographic expansion in autos sales As we believe lower-tier cities will see faster autos sales in the next few years, we believe advertisers would also be well served by investing more on the internet for nationwide customer reach (rather than magazine and newspapers, which have limited geographic coverage).
Real estate advertising Worst is over, 2011 to be a better year In 2010, the private real estate market was quite weak due to a series of restrictive measures to curb investment demand and housing price growth. Real estate advertising saw a big downturn in 1H10 as a result. We expect the reverse trend that begun in 2H10 to continue in 2011. Although we expect the government to maintain its tightening stance in 2011, the policy theme should shift from curbing demand to pushing out more housing supply while limiting price increases. We believe such a situation will benefit advertising demand.
A geographic diversification story beyond Beijing, Shanghai All the major leading portals including Sohu, CRIC, and Baidu have been increasing their presence in Tier 2/Tier 3 cities, which should drive up the advertising allocation to internet from these cities. Currently, online ad spending in lower-tier cities is around 50% or less compared to Tier-1 cities.
Online eCommerce advertising We believe the fast-growing eCommerce market will prompt eCommerce companies to increase spending online. In addition, with rising competition and fight for market share, eCommerce companies will be aggressive in online ad spending. In addition to general brand building through banner advertising, we expect eCommerce companies to increase spending on search as well.
For eCommerce merchants, other attractive ad formats would be ads in social networking websites.
Financial services advertising Investment funds increased their overall ad budgets in late 2007 and 2008; however, we’ve seen a significant pullback in 2009. With a better macro environment, we think these advertisers will likely come back in 2010 and 2011. These advertisers likely advertise with leading portals such as Sina and Sohu for stronger brand influence. We expect new drivers for the finance segment over the next few years could be insurance companies, personal banking, brokerage and wealth management advertisements.
Fast-moving consumer goods Historically, these advertisers allocated less spending online. We expect the trend to continue to change with more allocation online, given a large internet population, a wider online demographic, and more integrated marketing campaign required to differentiate a brand.
Furthermore, we believe with an increasing trend in luxury retailing, the internet would offer very cost-effective advertising. We note that brands like Cartier have begun advertising online.
China - Number of Households with Assets Above US$1 Million
China - Number of households w ith assets abov e US$1 million
Source: ACMR.
Telecom sector spending We expect telcos will continue to invest in advertising in order to drive 3G adoption (government-mandated strategy) and higher competition in the space with operators trying to recoup their capex spending.
Good growth in CCTV auctions Every year on November 18 (last year on November 8), CCTV (China Central Television) holds an advertising auction for the next year’s prime time ad resources on CCTV channels. This important event auctions off ~15% of the country’s total TV ad spending and sets the tone for ad growth in the coming year.
In November 2010, CCTV reported prime time ad auction revenue of Rmb12.67B, up 15.52% Y/Y: This is slightly above industry expectations of around 15%. We see the following implications: (1) while advertisers are generally cautiously optimistic about 2011’s outlook, the auction results suggest consensus (hundreds of advertisers participated) is more optimistic than cautious; (2) with the CCTV auction setting a positive tone, the online brand ad rate is likely to achieve >20% growth; (3) published rates for leading portals and other media are likely to increase good next year.
We continue to expect the online branded ad segment to benefit from decent 2011 overall ad market growth as well as increased online ad allocation.
Industry segments The top bidders were from the food and beverage sectors, home appliances, as well as finance and security. There was also an increased presence by the auto and tourism industries.
We look at absolute dollar amounts of ads sold at the auction. The table below shows the auction results growth rate vs. online brand ad growth rate (in Rmb terms).
CCTV Auction Results vs. Online Brand Ad Growth Year CCTV Prime time
Auction Revenue (Rmb billion)
YoY Growth Online Brand Ad Growth
Number of times (X): [Online Brand Ad Growth / CCTV
Display Advertising We forecast overall ad spending to see ~27% growth in 2011 For 2009, brand advertising growth was only around 8%, the lowest rate in the past few years. In 2010, the branded ad segment grew around 30%. For 2011, we expect the growth rate to be slightly lower than last year.
Factors driving 2011 display ad spend include: On the positive side: 1) accelerated shift from offline to online given higher awareness in video sites and social network sites, 2) higher CCTV and satellite TV rates makes online ad a lower rate alternatives, and 3) improving ad serving technology in China.
On the negative side: 1) lack of major events in 2011, 2) higher revenue base in 2010, and 3) higher competition among leading players.
Longer term, we remain positive on the online display ad outlook, given the continuing increase in internet usage, higher cost effectiveness, and more measurable results for advertisers. Further, our China economics team expects consumer spending growth to accelerate in the next few years, which should also support the growth of branded advertising.
China Branded Ad Segment Forecast 2006 to 2012E 2006 2007 2008 2009E 2010E 2011E 2012E
Branded Advertising (RMB M) 3,377 4,559 6,428 6,942 9,025 11,462 14442 Branded Advertising (US$ M) 426 605 932 1,012 1,321 1698 2140 Growth rate (Rmb, %) 45% 35% 41% 8% 30% 27% 26% Branded ad as % of ad market 3.2% 3.9% 4.6% 4.9% 5.5% 6.0% 6.7% Source: J.P. Morgan estimates.
Expect vertical sites to gain more market share Video and SNS portals such as Youku, and Tudou have gained significant traffic over the last few years. Additionally, industry-focused websites such as Soufun and CRIC are also gaining good traffic.
While these sites have driven eyeballs and ad dollars away from traditional portals, we still expect leading portals to hold dominant user market share and to gain revenue market share, given: 1) Sina and Sohu are the leading news sites in China with strong brand awareness –other news sites do not have a similar level of media influence; 2) portals are also aggressively expanding horizontally to offer SNS, blogs and video services.
Online Brand Ad Market Share Trend for Leading Portals Year 2006 2007 2008 2009E 2010E 2011E 2012E
Market share of key portal players* (%) 62% 62% 63% 58% 59% 60% 60% Source: Company reports, Bloomberg estimates, J.P. Morgan estimates. * Includes: Sina, Sohu, NetEase, Tencent (Bloomberg estimates for Tencent).
Regulatory risk remains lower than other online sectors We believe the regulatory risk remains lower for the portal online ad business compared to other segments in China, such as online games, mobile blogs and Wireless Value Added Services. Online advertising is the most established online business in China (since the late 1990s), and regulations and boundaries are well understood by industry players.
We believe the leading portals have strict internal compliance departments and automated content scans to ensure contents are in compliance with government standards. In addition, leading portals have gained trusts and have an existing relationship with the government. Leading portals are the most trusted by the government among internet companies and have the best compliance procedures; further, the financial impact would be less significant because still only a small portion of their revenues come from User Generated Contents, which could be subject to government regulation.
Online Search Still in early high-growth stage The search advertising market in China is expected to grow 53% Y/Y in 2011, as per our estimates, to reach Rmb18.4B (US$2.7B). We believe search advertising is still in an early high-growth stage in China, driven by: 1) rising internet penetration, 2) significant growth in websites and pages, 3) higher search usage (due to greater mass of web content), and 4) large number of SMEs (with small ad budgets) turning to search advertising (due to the higher ROI).
Avg. Internet users (Mn) 123 162 253 338 420 494 577 Number of search (Bn) 81 116 181 254 334 429 521 Coverage 17% 21% 24% 25% 32% 34% 35% Click through rate 22% 25% 25% 24% 22% 22% 22% Price per click (Rmb) 0.34 0.42 0.45 0.45 0.50 0.56 0.60 P4P Search Market (Rmb M) 1,062 2,472 4,945 6,849 11,644 18,048 24,364 P4P Search Market (US$ M) 134 328 717 999 1,705 2,674 3,610 Growth rate (Rmb, %) 110% 133% 100% 39% 70% 55% 35% Total Search Market (Rmb M) 1,442 2,851 5,309 7,213 12,015 18,427 24,751 Total Search Market (US$ M) 182 378 770 1,052 1,759 2,730 3,667 Growth rate (Rmb, %) 70% 98% 86% 36% 67% 53% 34% Search ad as % of total ad market 1.4% 2.4% 3.8% 5.1% 7.3% 9.7% 11.4%
Source: CNNIC, J.P. Morgan estimates. Note: Excluding distributor discount.
How big can China’s search market grow? Using various comparisons to the US and Korean search market, we estimate China’s search market could reach US$3B-US$4.6B by 2013 This compares to our current 2013 forecast of US$3.4B and US search market 2009 size of US$15B. Please also refer to the chart below for analysis of market size comparison with the US and Korean markets.
Other factors that could lead to positive surprise to our forecast include faster-than-expected inflation and RMB appreciation.
China search market size potential analysis If we use Korea and US as a proxy for online search market growth rate and growth potential, we see more upside possible upside to our base case forecast.
We present five different scenarios for our forecast:
Scenario 1: We compared search market size as a percentage of nominal GDP in China and the US. We shifted US search market size as a percentage of nominal GDP six years to estimate China search market size in 2010-2014. We think the market will reach US$3.0B and US$4.6B in 2011 and 2012, respectively.
Scenario 2: We compared search market size as a percentage of nominal GDP in China and Korea. We shifted Korea search market size as a percentage of nominal GDP five years to estimate China’s search market size in 2010-2014. We think the market will reach US$3.0B and US$4.5B in 2011 and 2012, respectively.
Scenario 3: We compared search market growth rate in China and US. We shifted the US search market growth rate six years to estimate China’s search market size in 2010-2014, and think the market will reach US$3.0B and US$4.3B in 2011 and 2012, respectively.
Scenario 4: We compared search market growth in China and the US and shifted 2003-2008 CAGR of US search market growth six years to estimate China’s search market size in 2010-2014. We think the market will reach US$2.3B and US$3.4B in 2011 and 2012, respectively.
Scenario 5: We compared search market size as a percentage of personal consumption in China and the US. We shifted US search market size as a percentage of personal consumption five years to estimate China’s search market size in 2010-2014. We think the market will reach US$2.1B and US$3.0B in 2011 and 2012, respectively.
Five Scenarios for China’s Search Market Size Estimate US$M
0
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China Search Ad Market Size (US$ M) (Scenario 1) China Search Ad Market Size (US$ M) (Scenario 2)
China Search Ad Market Size (US$ M) (Scenario 3) China Search Ad Market Size (US$ M) (Scenario 4)
China Search Ad Market Size (US$ M) (Scenario 5)
Source: iResearch, World Bank, J.P. Morgan estimates.
Competitive landscape Baidu continued to gain more market share from Google China. Baidu market share reached 72.8% by revenue in 3Q10 vs.64.9% in 3Q09. Sogou and Soso both expanded markets here slightly to 1.2% and 1.0%, respectively. Google’s market share declined to 24.6% in 3Q10 vs. 31.2% in 3Q09.
Baidu has successfully expanded its search revenue market share by more than 10 percentage points since 1Q09. Google is still having trouble with its advertising agencies. We expect Baidu to at least continue to maintain its current share.
In addition to gaining search market share, the company significantly reduced the gap between its volume and search market share. We expect this to further reduce with time.
Baidu 74.1% 75.7% 77.0% 77.1% 75.3% 80.2% NA Google China 20.9% 19.8% 17.9% 17.5% 18.4% 14.1% NA Others 5.0% 4.5% 5.1% 5.4% 6.3% 5.7% NA Difference in marketshare* 15.1% 14.1% 13.1% 18.7% 11.3% 10.2% Source: iResearch. * means difference in search volume and search revenue market share.
Soso and Sogou will take longer to become a challenge to Baidu Tencent’s Soso and Sohu’s Sogou have been working on developing their own search technologies. We believe they will not be a potential threat to Baidu for the medium term, as we believe the technology of these two search engines is still behind that of Baidu. Soso and Sogou’s total market share was 2.2% in 3Q10 as per iResearch.
In mid-2010, Sogou and its related technology (pinyin, toolbar, etc) was spin off as a separate business entity. Alibaba Group and related persons invested in Sogou.
Alibaba launches eCommerce search Alibaba joined with Microsoft to launch a beta version of search site Etao. Etao aims to drive traffic for Alibaba’s Taobao.com. The search results displayed in groups include Taobao listings, links to related online forums, information websites, and web search results provided by Microsoft’s Bing in the same order.
While Etao has the potential to become a eCommerce focus search engine, we do not expect Etao to be successful as a general search engine.
We note that in 2007, Baidu announced that it would introduce its own e-commerce platform called Youa to compete with Taobao. Taobao responded by blocking Baidu from searching goods on its website.
Government-backed search team (1) During August 2010, Xinhua News Agency and China Mobile announced plans to set up a new search engine company.
(2) People’s Daily Newspaper group launched new search engine, goso.cn. The search engine is led by former Olympics Ping Pong Champion Deng Ya Ping.
We do not expect these government-backed search companies to gain meaningful traction in the market. However, the move could lead to the government’s closer monitoring of the search engine industry in China.
Baidu Phoenix Nest latest update The full Phoenix Nest transition happened in December 2009. While the Phoenix Nest launch led to a significant revenue increase for Baidu in 1H10, we expect Phoenix Nest to continue to bring benefits to Baidu. One of Baidu’s key initiatives is to continue to improve Phoenix Nest performance in the long term.
Baidu application platform: announced in September 2010 To enhance user’s search experience, Baidu launched an applications library which allows third-party offerings in the library to launch directly on Baidu rather than moving to another website. These third-party applications appear in search results when a user is looking for certain specific queries such as those related to games, music, etc.
Baidu estimates that 30% of search queries in China are for applications rather than information.
The company currently has more than 400 applications under this library. Baidu and third-party application providers will split revenues in a ratio of 30:70. Baidu’s application will be based around music, e-books, games, and videos. Open platform strategy allows apps developers or book writers to submit content through open.baidu.com. This initiative is part of the larger “box computing” initiatives by the company. We believe this step could drive up search volumes in the future.
Developers or book writers can get revenue from: 1) direct content purchase, 2) embedded ads. Currently Baidu has 400+ partners which give Baidu content, info and apps. Baidu is not specific about revenue sharing with apps developers. We think this will be one potential strategy.
Searches that led to downloadable apps or content:
三重门 – This is the name of popular fiction. Users can buy e-books directly from results link. Publishers or writers can put their own books online. In the future, there is no need to go to Amazon or DangDang.
坦克大战 – A basic online game. Users can download this game or other games on the list of recommendations.
金山毒霸 – Kingsoft anti-virus software. Links to download right away.
豆瓣电台 – Online radio station. Users can listen to radio directly on Baidu’s page.
Baidu estimates that 30% of search queries in China are for applications rather than information
新三国 – A popular soap opera. Video links have been verified by Baidu for high-quality content.
开心网/126 邮箱 – NetEase mail box or SNS site. Users can directly login on Baidu page. Currently Tencent is not a partner with Baidu Open Platform. As such, users can't log in QQ mailbox “QQ 邮箱" directly from Baidu page.
Aladdin: to search the hidden web As announced on the last conference call, there has been an ongoing R&D effort aimed at uncovering useful parts of the hidden web in order to enrich search results for Baidu users. This is an ongoing effort by the company’s R&D team. The service was launched in mid-April. The site is: http://aladin.baidu.com/.
As a part of Project Aladdin, Baidu launched the beta version of an open data sharing platform on April 15, 2010. The new platform allows webmasters and developers to submit data to Baidu in order to generate direct search results for dynamic information.
Mobile search: Baidu still leads in market share Mobile search is still in an early growth phase. Google partners with China Mobile to be their default search engine on WAP website.
We believe Baidu’s traffic from mobile devices is around 10% of its total traffic. However, revenue only accounts for 1-2%.
We are encouraged to see Baidu demand leading market share in mobile search as well, according to Analysys. Baidu is also building more mobile search applications (e.g., Baidu Palm) to expand its usage.
During 2010 Baidu World, Baidu showcased 3-D maps and various mobile features: voice search, map search new version of Baidu Palm and input method. While there were no discussions on Baidu mobile phone OS, Baidu discusses various potential applications to help search users obtain content easier on a large number of mobile phone platforms. Baidu also plans to work with web masters to help them make webpages more easily displayed on mobile phones.
Mobile Search Market Share by PV Company Market share (%) Baidu 33.7% Google China 19.5% 3GYY 14.1% YiCha.cn 14% Others 18.7% Source: Analysys International.
Baidu’s brand zone Baidu provides additional marketing services to some of its key customers. Key customers can engage in integrated search marketing services across Baidu platform.
Baidu charges extra fixed fee for an integrated campaign with Brand Zone. The company has reported strong growth from Brand Zone in 2010.
For example, “Meng Niu” Milk product advertises across different properties on Baidu.
We compared the search results between “Meng Niu” Milk that uses brand zone services and “Wan Da Shan” milk that is not using the services.
When we search "Meng Niu” Milk using Baidu Knows and Baidu Web Search, "Meng Niu” brand zone comes first with detailed company information, such as the company’s brand logo, weblink, recent events, etc.
When we search “Wan Da Shan” Milk, the company related information is less. “Meng Niu” Milk also has banner advertise in Baidu News.
Search usage vs. advertiser readiness vs. monetization To better understand the growth potential of China’s Internet search market, we think it would be useful to look at the search space from three different perspectives: 1) search users, 2) advertisers, and 3) search monetization/market size. We view search usages and advertiser readiness as the two main drivers for the monetization of the online search market.
Search Monetization Driven by Both Search Usage and Advertising Readiness
Source: J.P. Morgan.
Search market outlook: usage Like the US, online search in China provides users with personalized information. As users become more experienced, they look for information on the internet beyond the major portals. Entertainment-related content, such as pictures and music, have always been popular in China. Going forward, we believe the non-entertainment related searches such as eCommerce and e-Government will continue to gain popularity.
Growing usage in China The latest statistics from CNNIC show that the number of users in China has reached 420M as of June 2010. We expect usage in China to continue to grow, driven by such factors as:
• Entertainment tool. Digital entertainment, such as MP3, movies, etc., can be downloaded from the web virtually free of cost or at a very low cost. Online games—LAN-based (local area network), MMORPG (massively multiplayer online role playing games), or casual board and chess games—are also low-cost alternatives to offline entertainment. Internet in general is a low-cost form of entertainment—internet café access costs about Rmb2-3 per hour vs. Rmb40 for a movie.
• Communication tool. Migrant workers (about 10% of total population, or 140 million people in China, are floating population) as well as relocated white-collar workers visit internet cafés after work to use instant messenger and e-mail, or to
play games or watch movies. Despite the government constantly monitoring these services, blogs and bulletin board services have also increased in popularity in China—they serve as channels for the Chinese to express their personal views and communicate with others.
• Information source. Most traditional media is still tightly controlled by the government. The Internet offers an alternative information source that users seem to find more friendly and entertaining to use. Major portals have also been increasing their content over the past few years to make more information available to users. Other government initiatives such as electronic tax filing, customer clearing, and government agency websites also boost internet usage. Apart from growth in the number of users, the time spent online per week as well as the number of days online per week is on the rise.
Users turning to search in China With information on the internet ever expanding, it is natural that users turn to search engines to organize the high volume of information. As a result, the number of searches in China is expected to more than double from 2009 to 2012. According to the 2010 CNNIC report, more than 76% of internet users use search engines.
Search market outlook: advertisers’ readiness As in the US, we believe the paid search ad is particularly well suited for small and medium enterprises (SME) in generating sales leads. Yet, as with the low internet adoption rate in China, paid search is still a new advertising concept for these advertisers. Hence, continuous education and marketing are required to drive market growth.
1. Large available SME market for search advertising, but low internet usage According to the National Development and Reform Commission, Department of Small and Medium-Sized Enterprises figures, there were 43 million SMEs in China. These SMEs are mainly 39 million individual businesses (small businesses registered with some government departments). Statistics from the State Administration for Industry & Commerce (SAIC) suggest that the number of SMEs in China is roughly 24 million. Despite the discrepancies, we believe the overall number of SMEs is large.
According to the SAIC, there were 4.3 million larger-size SMEs (registered directly with the SAIC). The total number of websites in China is 2.8M (as of Jun 2010). We estimate 60% of the websites are corporate (excluding personal sites, bulletin boards, and inactive sites). Therefore, the number of corporate websites in China is roughly 1.7M.
We do not think the market is saturated Based on Baidu’s 3Q10 active marketing customers of 272,000, the company’s penetration among larger SMEs is 6%. Hence, we believe the market is far from reaching a saturation point.
2. eCommerce should be another growth driver While C2C eCommerce has seen good adoption over the past few years, driven by factors such as: 1) better acceptance for mail order (China’s catalogue sales are non-existent, and most transactions are done face to face) through increased online and offline marketing, and larger product selection; 2) improved trust and safety features by eCommerce sites; and 3) more regulated online payment infrastructure. In the US, eCommerce companies are leading users for paid search advertising. We believe a similar trend will emerge in China too, as paid search is an effective method for targeting prospective buyers who already have items in mind. We expect paid search to benefit from eCommerce growth in the future.
3. Local search: another promising area Similar to the US, we believe there is a large commercial potential for local search in China. Particularly, there are a large number of households/individual businesses eager to promote their local businesses. In addition, IP address assignment is quite well organized in China. We expect IP-based marketing to be more popular going forward as online advertisers become more sophisticated.
4. IT outsourcing companies are the main educators for search usage The two types of companies that help drive paid search usage of SMEs are ad agencies and IT outsourcing companies. While ad agencies mainly focus on companies that already have websites, IT outsourcing companies target SMEs that are less sophisticated in IT infrastructure.
IT outsourcing companies such as Sino-I (250.HK, or CE.Net) and Hichina (net.cn, acquired by Alibaba.com) provide one-stop services for SMEs—domain name registration, web hosting, website design, and promotions (mainly through search engine optimization, paid search, directory listing). We believe the IT outsourcing companies will be key players in the future to drive Internet adoption growth and search usage for SMEs.
5. Ad agencies would have to drive search market growth Paid search marketing campaigns are usually more involved than display ads. Advertisers need to decide on what keywords to use, the number of keywords, bidding strategy and bidding period. In addition, more sophisticated advertisers also
pay attention to competitors’ strategy, lead quality and ROI. A well-run search campaign is arguably more difficult than banner ads where advertisers simply design the banners and place them on as many relevant websites as possible.
Furthermore, budgets for search campaigns are more difficult to manage as spending is based on the number of clicks, which non-experienced advertisers do not have control over. The ad spending amount essentially has no limit. Hence, advertisers are generally quite cautious about the initial spending and only allocate a small daily budget for trial, or even worse, may simply give up on paid search campaigns. We believe education by agents and distributors can eventually help advertisers overcome these barriers, and advertisers will thus increase their budgets on search campaigns.
Search market outlook: monetization We expect monetization of the paid search market to grow quickly, driven by both higher search usage by users and better adoption by advertisers. The coverage ratio is low compared with that of the US, and we expect it to increase and drive monetization of the market.
Self-fueling cycle to expand monetization We view the market as a self-fueling cycle driven by users and advertisers growth. Higher search usage leads to a higher number of sales leads for advertisers. With more high-quality leads coming from paid search, advertisers would place more keywords in more search engines. As users find more relevant product information by advertisers, they will conduct more searches, thus leading to higher usage. This cycle should continue, and lead to market size expansion.
Monetization Increase Driven by Self-Fueling Cycle
Online Video Online video has seen strong growth in China with the number of users growing to ~300M monthly users by end of September 2010, representing ~83% of total internet subscribers, according to CNNIC.
Growing Online Video Users in China (users in millions
161180
202222
240265
100
150
200
250
300
Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10
Source: CNNIC.
Driving factors for growth of China Online video services include:
(1) Existing media companies are not commercially driven. Existing TV broadcaster or cable operators are tightly controlled by the government. Contents broadcast schedule many times are not commercially driven. As such, contents may not be tailor to viewers’ interests. As such, alternative online video would be well adopted by viewers.
(2) Availability of large amounts of content were not broadcasted. There are large numbers of television stations and movie production companies across the country. Many of the content produced were not properly shown due to an under developed media distribution system in China. For example, out of approximately 12,000 television episodes produced each year, fewer than half are ultimately broadcast. Similarly, fewer than one-third of the approximately 450 movies produced in 2009 were released in theaters.
(3) Multiple delivery platform enhances user experience. While Video Online Demand service has advantages over viewing scheduled TV programs, leading online video companies also make content available on different devices such as
Image search is the third-largest search channel after web page and Tiebar. MP3 search continues to lose dominance
Online Video Adv ertising Rev enues (Rmb Bn, RHS) Grow th Rate (in %, LHS)
Source: iResearch.
Industry outlook for 2011 Profitability still many quarters away In terms of content, most video portals in China operate on a mix of “Youtube" (user generated content) and “Netflix” (professional content) in China. While US video portals which mostly have user generated content or news clips as their top content, Chinese video portals have more viewership of licensed content such as movies, drama, etc. As a result, Chinese companies often pay a high content licensing fee in order to procure premium content to retain users.
Similar to the media market worldwide, both ad-supported and subscription-based models are used in China. The ad-supported model is by far more popular in China.
Most of the video sites in China monetize by 1) in-video advertisements, 2) program/channel sponsorship by brand advertisers, or 3) affiliate advertising from text-based ads by search engines.
Some players such as Tudou have also launched premium content service for which users will have to pay a fixed subscription fee.
Content costs on the rise From Youku’s prospectus, the average license fee for television serial drama increased in 2009 by more than 200% vs. 2008, and such fees have increased in 9M10 by more than 100% as compared to 2009. The average license fee for movies has also increased in 9M10 by more than 90% vs. 2009.
In-house produced contents also slightly help control content costs and build brand Youku and Tudou also have their own content development department creating popular movies and dramas. In addition, this content helps to further solidify branding of leading video sites.
Industry still focused on “land grabbing,” profitability still quarters away As most of the online video players are focused on gaining market share rather than profitability, we believe content inflation will continue. However, this should be
Similar to media market worldwide, both ad-supported and subscription-based models are used in China. The ad-supported model is more popular by far in China
slightly eased by reduced demand for exclusivity of content from online video players.
While advertisers are still gradually adopting online video advertising, with high content and bandwidth costs, we expect profitability in the sector could still be many quarters away.
Online video should drive ad dollar shift from TV Television accounted for 39.1% of overall advertising expenditures in China, according to ZenithOptimedia. We expect that online video should accelerate TV ad spend to move toward brand advertising due to its similarity of format with television. In addition, online video offers attractive user profiles (from a higher income and young adults demographics perspective) and targeted advertising than TV.
As per CR-Nielsen, in September 2009, Chinese online video users spent 23.4 hours per week on average watching online videos, which is approximately six hours more than they spent viewing television. Additionally, a CNNIC 2009 China Internet user video behavior study found that online video is the only media viewing choice for 16.4% of the total online population in China.
Young demographics/more affluent population China’s online video market offers more attractive and targeted user demographics vs. traditional television market in terms of users’ age, level of education and potential spending power. Online video viewers in China, on average, are younger than traditional television viewers, but slightly older than the overall internet population. According to iResearch, close to 80% of the online video viewers are between 18 and 40 years of age and only 8% of online video viewers are below the age of 18. Moreover, 30% of online video viewers have a college degree or higher level of education, whereas only 14% of the television audience is similarly educated, according to CNNIC and CSM Media Research.
Cost-effective advertising SARFT (The State Administration of Radio, Film and Television) in 2009 published a new “Act No. 61” which considerably limited the advertising inventory on TV especially on prime-time. This has also led to significant price rise by TV operators over last 2 years. The advertising rates for 2011 have gone up further by 20%-60% for CCTV and other satellite channels. In contrast, video advertising site has lower CPM, and offers more dispersed and targeted advertising options to brand advertisers in a similar format.
Competitive landscape Video portals in China face stiff competition from both standalone video portals as well as integrated portals such as Baidu, Sina and Sohu. We profile some of the key players here.
Youku Youku is the leading online video player in China. As per iResearch, it commands 40% (largest) share of time spent on watching videos online in 2Q10. As of September 30, 2010, their video content library contained more than 2,200 movie titles, 1,250 television serial drama titles, and over 231,000 hours of other professionally produced content, including 194 variety shows. The company had
Thirty percent of online video viewers have a college degree or higher level of education, whereas only 14% of the television audience is similarly educated, according to CNNIC and CSM Media Research
total revenues of Rmb153.6M in 2009, and Rmb234.6M in 9M10. Net losses were Rmb182.3M and Rmb167.0M in 2009 and 9M10, respectively. The company listed on Nasdaq in December 2010.
Tudou Tudou is the second-largest online video portal in China. As of 3Q10 end, the company had a content library of more than 36.3M video clips. The company also started providing mobile video services channel on China Mobile. Tudou has been shrinking the losses. It had had total revenues of Rmb113.2M and Rmb224.8M in 2009 and 9M10, respectively. The company had total losses of Rmb144.8M and Rmb83.7M in 2009 and 9M10, respectively.
Sohu video Sohu has a separate video channel on its website. This channel provides users free access to extensive and varied video content, including popular domestic and overseas movies and TV dramas, in-house produced online talk shows, exclusive celebrity interviews, live webcasts, on-demand sports games, and user-generated video clips. Sohu is the third largest player in terms of online video views in China, as per iResearch.
3Q10 Market Share Based on Total Effective Time Spent Watching Online Video in China
Social Networking Social networking has a long and successful presence in China, notably by the success of Tencent. The social networking trend in China is quite similar to that of the US. Companies earn their revenues through a mix of social games, selling virtual items as well as from brand advertising.
Key trends for 2011: social commerce We expect social networking companies tobe a key beneficiary of the rising eCommerce trend in China. With increasing time spent on social networks connecting with friends, these sites would be increasingly important traffic generators for eCommerce companies.
In addition to basic brand advertising and friends referrals, social network companies help promote products through integrated product marketing such as themed games to promote products or onsite avatars to build brand awareness.
Revenue generation for SNS websites can be broken down into three types:
(1) Banner advertising: Nearly half of the advertising revenues are generated from putting up banner advertisements on various locations on the site: e.g., profile pages of the users.
(2) Integrated marketing: Many companies promote themselves by putting virtual items associated with their brands in game applications.
(3) Fan pages: Another way of advertising on social networks is through fan pages. We estimate this accounts for nearly a quarter of social network advertising in China.
SNS Game Market Size
240 420780
1,632
2,850
0500
10001500200025003000
2009 2010 2011E 2012E 2013E
SNS Games Market Size (Rmb Mn)
Source: Analysys.
SNS users already cross 200M mark As per CNNIC, the number of SNS users reached the 210 million mark (up 19.6% YoY) in Jun-2010. Currently 51% of China internet users are using social networks up from 46% users, a year ago. In 1H10, revenue for China’s SNS market was RMB 489 million, with growth of 19.4% YoY.
Favorable demographic distribution As per CNNIC, more than half of Chinese users spend around 1 hour on SNSs, 22.6% spend up to 2 hours per day, and 12.8% are logged on for more than 2 hours.
59.1% of Chinese SNS users have a college degree and above, 34% higher than other Chinese internet users.
Frequency of Logging Onto Social Networking Websites
Once a w eek or less40%
More than Once 16%
Not ev ery w eek 26%
Once per day 18%
Source: CNNIC.
Users by Access Method
Only using computer
53%
Ov erlapping users39%
Only using mobile8%
Source: CNNIC.
Competitive landscape The four major social networks in China are:
Qzone: Qzone of Tencent is the largest social networking portal in China. Tencent's leadership in instant messaging and casual gaming helps Qzone capture a dominant share in the social networking market. The company reported 481M user accounts at the end of 3Q10. Qzone is perceived to be more popular among teenagers than college students and office-goers. However, we believe Qzone covers a wide range of users that resemble general internet users in China.
The company earns most its revenues from fees charged to users for upgrading to premium features such as social games, avatars, etc. The company also launched a portal named Xiaoyou, which focuses on college students..
51.com: 51.com has more users from lower-tier cities. By the end of 2009, the company had 178M registered users and 40M+ monthly unique users. In April 2010, 51.com achieved breakeven. Most of its revenues generate from revenue shares from 20+ SNS games. The second tranche of revenues are from users’ payments. The third tranche of revenues are from advertising. Giant Interactive has a 25% stake in 51.com.
2011 outlook Expect healthy growth from Advertising and Social Gaming We expect social networking websites to gain a greater more share of online brand advertising revenues. Social networking provides: (1) more innovative ways of brand promotions such as virtual items, fan pages, etc. (2) more targeted user base, which is young and has higher disposable incomes. Additionally, we expect SNS to be a key beneficiary of rising eCommerce spending.
Social gaming should benefit as leading websites such as Qzone open. This should lead to a higher number of social applications on there portals, which would ultimately drive higher revenues. The number of users should also see healthy double-digit growth. Analysys Data forecasts the social gaming market to grow more than 86% YoY in 2011.
We expect Tencent to be a key beneficiary of the rising social networking trend in China. With the traffic Tencent commands thanks to its QQ platform, we believe it can attract the best of the applications with even less revenue sharing.
Miniblog Platform Mini blog platform has added another dimension to social networking in China. Sina has seen a lot of success through its mini-blog. Miniblog registered users on Sina’s platform were close to 50M at the end of 3Q10 compared with Twitter monthly unique users of 190 million in mid-2010, according to Twitter COO Dick Costolo. Sina has been witnessing an addition of 10M users every month. Netease also had close to 9M users at the end of 3Q10. Tencent, Sohu and other sites are catching up with their own mini-blogs.
Easy access from mobile phones Miniblog platform should also see more popularity from users accessing the internet from mobile devices. Currently 45% of active mini-blogs on Sina platform are accessed through mobile devices. With strong growth in mobile internet usage, mini-blog usage is likely to further increase.
A celebrity broadcasting platform Microblog traffic in China is centered around VIP accounts. Sina currently has around 20,000 VIP accounts which are verified by Sina. Most of the traffic revolves around following favorite movie stars, business leaders, etc.
Monetization model becomes visible Sina recently discussed various monetization methodologies during different phases of Weibo development. Direct monetization (CPM base model) from brand advertisers is expected to begin on a larger scale in late 2011.
Indirect monetization or platform strategy to kick off in late 2011. Platform strategy refers to local SMEs open storefront on Weibo and revenue sharing with third-party apps developers.
eCommerce eCommerce is in fast growth stage in China eCommerce usage has seen rapid growth, but it still only penetrated 30.2% of total internet users in China with around 109M users in 2010, according to iResearch. We believe there is a high potential for further growth in eCommerce.
The internet has become an emerging sales and marketing channel for retail sellers. The China eCommerce transaction value is estimated to account for 3.4% of total retail sales in 2010 and is expected to grow to 6.5% of total retail sales in 2013.
B2C+C2C, ex cluding B2B (Rmb B) As a % of Total Retail Sales (%)
Note: Transaction for virtual goods and online utility payment are not included. Source: iResearch (2010).
Factors driving growth of online shopping in china Large number of internet users: China now has the largest internet population in the world with a penetration rate of more than 30%. China already has the largest number of Internet users in the world. Additionally, increasing penetration of internet-enabled mobile phones is also driving up time spent on the internet.
Rising trust in online transactions: (1) Credible eCommerce companies have helped to improve China’s online shopping ecosystem and to decrease fraud and bad transactions in online shopping. (2) Well-known retail brands are starting to sell products online, with many users having good online purchasing experiences. (3) Well-developed payment alternatives. Chinese online shoppers have adopted online banking payment as well as third-party payments (such as Alipay and Tenpay) based on their good experiences.
Rising disposable incomes: As per NBSC (National Bureau of Statistics of China), China’s GDP per capita has grown at a CAGR of 15.4% from 2005 to 2009, reaching US$3,714.2 in 2009. We believe the rise in disposable income should continue in coming years. Additionally, with rapid urbanization and more people transitioning to an affluent class, online eCommerce should see faster growth.
Government thrust on pushing consumption-led growth: Chin’s consumption is 34.5% of GDP vs. 70.1% of GDP in United States. With the Chinese government pushing the growth model to shift from investment and exports-led growth to consumption-driven growth, we expect it to take many structural steps to boost consumption.
China eCommerce transaction value is estimated to account for 3.4% of total retail sales in 2010 and is expected to grow to 6.5% of total retail sales in 2013
Online Shopping Users (M) As a % of Totla Internet Users (%)
Source: iResearch (2010).
B2C eCommerce enjoys significant growth in 2010 Players converging to marketplace model B2C eCommerce in China can be categorized into B2C retailers and B2C marketplace operators by business model. In 2010, we have seen:
(1) Leading C2C eCommerce operators expand and develop the B2C eCommerce marketplace (such as Taobao expanding to Taobao Mall),
(2) B2C retailers began to introduce third-party merchants to their platform,
(3) B2C sites emerge as a new sales and promotion channel for retail brands.
China B2C eCommerce Market Size by GMV Rmb B
15 3162
118
201110% 103%90%
71%
0
50
100
150
200
250
2009 2010E 2011E 2012E 2013E
0%20%40%60%80%100%120%
B2C eCommerce GMV (Rmb B) YoY Grow th (%)
Note: B2C marketplace is not included. Source: iResearch (2010).
China internet giants focus on developing B2C eCommerce marketplace (1) Taobao started B2C eCommerce in 2008. The company announced the independent domain name for Taobao Mall in Nov 2010, following with a series of promotion events. Since its launching, Taobao Mall has earned a high reputation and recorded the highest transaction value of Rmb1B on Nov 11 2010.
(2) Tencent upgraded its “QQ members store” to “QQ Mall” in Mar 2010 to leverage its C2C Paipai experience to B2C eCommerce.
(3) Baidu launched “Lekutian," an online B2C marketplace, jointly with Japanese eCommerce leader Rakuten in June 2010.
China portals entered B2C eCommerce market, still at an early stage (1) Sina started B2C eCommerce around 10 years ago, but Sina Mall is still struggling to attract customers under tough competition.
(2) NetEase also started B2C eCommerce 10 years ago. NetEase started to focus more on its eCommerce sector this year and launched B2C marketplace in December 2010.
B2C retailers start to mix B2C marketplace model with their online retailing model The leading B2C retailers such as Dangdang and Vancl have introduced third-party merchants to their B2C platform. 360Buy is also preparing to open its platform to third-party sellers. These companies have seen the demands from third-party merchants to use well-established B2C platforms as a sales and marketing channel.
Self-established logistics B2C eCommerce companies have endeavored to build their own logistical systems, including warehouses and logistics centers. We believe well-built logistics is one of the key factors for further growth of B2C eCommerce. (1) B2C eCommerce operators can lower delivery cost, shorten delivery time and expand to tier-2 and tier-3 cities. (2) B2C companies can shorten processing time on returned goods to improve user experiences. In addition, incumbent delivery companies and logistics services are not sophisticated.
Popular online selling products are apparel, media products such as books and music, cosmetics and IT products. These are the products that B2C retailers are focusing on. We have seen: (1) Dangdang and Joyo-Amazon that are well-known for online books selling, (2) 360Buy that emphasizes online IT and electronics products selling, and (3)Vancl that is a well-recognized online apparel seller.
Leading B2C players in China 360Buy, Dangdang, Joyo Amazon are the three leading B2C retailers, while Taobao Mall is the leading B2C marketplace operator in China. We have summarized some facts about these companies below.
Leading B2C Players in China (Taobao Mall, 360Buy and Joyo Amazon) B2C Marketplace B2C Retailers
Taobao Mall 360Buy Joyo Amazon Business Description 1. The largest B2C marketplace in
China in terms of transaction value. 2. Around 15k merchants sell products with 20k brands. 3. Merchants need to pay gurantee money of Rmb 10,000 to open a store in Taobao Mall. Besides that, Taobao Mall charges annual service fee of Rmb 6,000 and online transaction technical fee of 1% ~ 5% as of transaction value per transaction.
1. The largest B2C retailer in China in terms of transaction value. 2. Well-known for its 3C (computer, communication, consumer electronics) products. 3. Expand to sell various products, including books, cosmectics, household products and etc. 4. Announce to offer group buying products from Dec 20, 2010.
1. The third-largest B2C retailer in China in terms of transaction value. 2. Supported by international B2C giant Amazon. 3. Well-known for its media products sales such as books and music. 4. Expand to sell software products, electronic goods, toys, household products, cosmetics, jewelry, watches and baby products, etc.
Registered Members 170M in 2009 (Including Taobao C2C) 14M+ in 2010 n/a Revenue/GMV (2009 estimated) Rmb 208.3B (GMV) Rmb 10.2B (GMV) n/a Payment 1. Alipay Katong payment: link with
1. Cash-on-delivery and mobile POS payment 2. Online Banking Payment 3. Credit card payment 3. Third-party payment: Alipay and PayEase 7. Remittance 8. Banking Account Transferring 9. Amazon gift card payment
Logistics Third-party logistics companies. Taobao started to establish its own distribution center and invested in one logistics company in 2010.
1. Five logistics centers are in Beijing, Shanghai, Guangzhou, Chengdu and Wuhan. Self-established logistics networks reach 24 cities. 2. Cooperate with third-party logistics companies.
1. Nine self-established logistics centers in Beijing, Suzhou, Guangzhou, Chengdu, Wuhan, Shenyang, Xi'an, Xiamen. 2. Free of charge for delivery service. 3. Cooperate with third-party logistics companies.
History 1. B2C marketplace started in2008. 2. Taobao Mall with independent domain name was launched in Nov 2010.
Founded in 2004. 1. Founded in 2000. 2. Acquired by Amazon in 2004.
Listed Leading B2C Players in China (Dangdang and Mecox Lane) B2C Retailers
Dangdang Mecox Lane Business Description 1. The second-largest B2C retailer in China in terms of
transaction value. 2. Well-known for its its media products sales such as books and music. 3. Expand to sell various products, including cosmetics, electronic goods, household products, baby products and etc. 4. Invite third-party merchants to sell general merchandize at Dangdang platform under its marketplace program.
1. A B2C retailer to offer fashion products through its website and physical stores in China. 2. The products include apparel and accessories, home products, beauty and healthcare products and other products, under its own brands of Euromoda and Rampage as well as selected 3rd party brands. 3. Invite third-party merchants to sell products at its "plug-and-play" platform.
Registered Members 1. Active customers were 6.8M for the nine months ended Sep 30, 2010. 2. Average daily unique visitors were 1.6M in Sep 2010.
1. Active online customers were 2.1M as of June 2010. 2. Average daily unique visitors of the company’s website: 671k in June 2010.
Revenue (FY09) Rmb 1.5B Rmb 1.2B Payment 1. Cash-on-delivery: cover 750+ cities and towns in China
1. Cash-on-delivery: cover 100+ cities in China 2. Online Banking Payment 3. Third-party payment: Alipay, Tenpay, and 99Bill 4. Credit card payment 5. Remittance 6. Banking Account Transferring
Logistics 1. Ten self-established logistics centers: two central logistics centers in Beijing, eight regional logistics centers in five major cities outside Beijing. Warehouse space totals 180k square meters and can handle 165k+ orders per day. 2. Cooperate with 104 third-party inter-city transportation companies and courier companies.
1. Centralized logistics center in Shanghai, other three in Beijing, Chengdu and Guangzhou. Warehouse space totals around 58.7k square meters and can handle 50k orders per day. 2. Cooperate with third-party logistics companies.
History 1. Founded in 1999. 2. Listed on NYSE in Dec 2010.
1. Founded in 1996. 2. Listed on NASDAQ in Nov 2010.
Source: Company reports, J.P. Morgan.
B2C marketplace transaction service fees Third-party merchants at B2C marketplace need to pay: (1) “guarantee money”, (2) a percentage of sales per transaction as real-time technical service fee, and (3) annual technical service fee to B2C marketplace operators. We present the transaction service fees that the key B2C marketplace operators charge.
Group Buying: A Hot Trend in China Too Group buying market size grows from zero to Rmb980M in one year The group buying eCommerce model originated from the U.S.'s GroupOn and became popularized in China in 2010. We have seen the emergence of hundreds of independent group buying sites, as well as sites launched by China's key internet players such as Tencent, Baidu, Sina, and Sohu. According to Analysys, a leading internet industry research firm in China, the group buying market size is around Rmb980M in 2010 and is expected to reach Rmb3,800M in 2013.
Classification of group buying categories: Location-based Group Buying Sites and Products-based Nationwide Group Buying Sites。
Main customers: Young, white-collar workers and college students aged 20-35, who would like to try fresh things.
Major products: Entertainment products such as movie tickets and karaoke coupons, restaurant coupons, beauty & hair salon coupons, travel & hotel coupons, etc.
Major cities: Tier-1 cities, such as Beijing, Shanghai, Guangzhou, Shenzhen, Changsha, Xi’an, Hangzhou, Chengdu, Wuhan and Tianjin.
China Group Buying Market Size by Transaction Value Rmb M
9801,650
2,620
3,800
0
1,000
2,000
3,000
4,000
2010E 2011E 2012E 2013E
Group Buy ing Transaction Value (Rmb M)
Source: Analysys (2010).
Number of Group Buying Sites in China Beijing Shanghai Guangzhou Shenzhen Changsha Xi'an Hangzhou Chengdu Wuhan Tianjin Others Total
# of Sites 473 183 77 75 65 56 53 52 49 44 537 1,664 Note: The statistics is as of Nov. 2010. Source: 2010 Group Buying Industry Credit Research Report, Internet Society of China.
Factors driving growth of group buying market in china 1. Cheap price. Many small- to medium-sized merchants use group buying sites as a promotion channel and offer high discount price to attract customers. The 60%-90% discount price is very attractive.
2. Attractive products. Group buying sites offer products that are attractive to young people with low prices, such as cake-making class coupons, laser gun game coupon, etc.
3. Customer’s adoption of online payment method. Online banking payments and third-party online payments are the major payment methods for group buying sites. Chinese customers, especially the ones in tier-1 cities, have increased their trust in online payment with their online shopping experiences.
4. A new promotion channel for small- to medium-size merchants. With increasing internet usage, group buying sites can help small- to medium-size merchants to attract new customers from internet users. The promotion cost of using group buying sites is relatively smaller than that of print media.
2011 Outlook for group buying market 1. Consolidation. We believe we will see consolidation in the group buying sector. Because of low entry barriers, hundreds of group buying sites emerged in a short period of time. We observe that the group buying market is in disorder and the user experiences are poor. We think that the group buying sites serving low-quality products will be acquired by bigger sites or go bankrupt.
2. Combination with Portals, eCommerce Sites, Living Social Sites and SNS Sites. Group buying sites and other internet sites could complement each other’s advantage. Portals and SNS sites have large user basees. eCommerce sites can provide products for group buying. Living social sites have the networks of local merchants. Vise versa, group buying services can improve user experiences for the above sites.
Select Group Buying Sites in China Lashou
http://www.lashou.com/ Meituan
http://www.meituan.com/ Dingping Tuan
http://t.dianping.com/ QQ Tuan
http://tuan.qq.com/ Juhuansuan
http://ju.taobao.com/ Launching Date Sep, 2009 Mar, 2010 June, 2010 July, 2010 Mar, 2010 Networks 100+ Cities 12 Cities 7 Cities 11 Cities Products based
nationwide site Business Description 1. Lashou is the first and
largest group buying site in China. It plans to expand to 200-300 cities by 2011. 2. Lashou is trying to add more functions to its group buying site, such as "Check-in" and SNS games.
Meituan is the leading group buying site in China.
Dingping Tuan is launched by Dingping.com, a well-known living social site in China.
QQ Tuan is launched by Tencent. QQ Tuan also offers group buying products only for QQ members with lower discount price.
Juhuansuan is launched by Taobao, Alibaba's subsidiary on eCommerce. It is a product based group buying site, covering across whole China rather than location based.
SNS and Microblogs: Help Drive Social eCommerce We observe that social networking sites (SNS) and microblogs are the new channels to promote online shopping products and social living information.
Click “sharing” to share the information of online shopping products Sharing links with SNS and microblogs’ labels are located under or above the product picture at online shopping malls and group buying sites. SNS and micro-blogs include the most popular ones,Tencent micro-blog and Sina microblog. Netizens can also click to copy the URL and paste it to MSN or QQ or their emails.
Click “forward” to share social living information Same as the link at online shopping sites, the links to SNS and mirco-blogs are also located under or above the picture of social living information at social living site.
It is generally straightforward for a user to forward a Cafe’s information at Dingping.com to a Sina Microblog. First step: the user selects the Cafe and clicks Sina Microblog label under the picture of the Cafe. Second step, at the pop-out webpage the user can log into Sina Microblog and click “forward.” Third step, the user can check that the Cafe information has been published on Sina’s Microblog.
Leading C2C Players in China Taobao, the eCommerce subsidiary of Alibaba, is the leading online marketplace operator in China. Taobao reached registered members of 170M by 2009 and is one of the world’s Top 20 most visited websites. Paipai is Tencent’s C2C marketplace and ranks second, leveraging Tencent’s large IM user base.
China C2C eCommerce Market Share by GMV in 3Q10
Taobao , 84.8%
Paipai, 11.6%
Eachnet, 3.6%
Note: 1. Taobao includes GMV from both Taobao C2C shopping mall and Taobao Mall. 2. Paipai includes GMV from both C2C Paipai and QQ Mall. Source: iResearch (2010).
Leading B2B Players in China The B2B eCommerce sector has seen stable growth in 2010. Alibaba is still the leading player, with market share of 57% in 3Q10.
China B2B eCommerce Market Share by Revenue in 3Q10
Alibaba, 57.0%
DHgate.com, 1.8%
Others, 16.2%
My steel.com, 2.6%
Made-in-China.com,3.4%
GlobalMarket, 3.3%
Toocle, 1.0%
HC360, 4.1%Global Resources,
10.7%
Source: iResearch (2010).
China’s Leading B2B Players Alibaba Global Resources HC International
Business Description Alibaba operates the leading online B2B marketplace in China. 1. International marketplace, Chinese marketplace, Japanese marketplace, and global wholesale marketplace. 2. Ali loan: outstanding portfolio of Rmb 20B-Rmb 30B. 3. Acquisition: acquired AliSoft, HiChina, Vendio, Auctiva, and OneTouch as a part of "Work at Alibaba" strategy.
Global Sources is a leading B2B media company and a primary facilitator of trade with Greater China. The company's principal business is to provide services that allow global buyers to identify suppliers and products, and enable suppliers to market their products to a large number of buyers.
HC International offers both online and offline B2B services in China. 1. Online marketplace: Mai-Mai-Tong (买卖通） 2. Offline marketing products: HC Trade Catalogues, HC Yellow Page Directory, Industrial Market Research
Registered Members 1. International marketplace: 15M - # of paying users of China Gold supplier members: 108.6k - # of paying users of Int'l Gold Suppliers: 11k 2. Chinese marketplace: 42M - # of China Trust Pass members: 631.3k
Mainland China registered online users and magazine readers: 2M+
1. Generate revenue from (1) online and other media services (2) exhibitions - 2009: US$174.5M 2. Revenue breakdown (FY09) - Online and other media services: 66.1% a) Online services: 48.9% b) Print services: 17.2% - Exhibitions: 31.6%
1. Generate revenue from (1) subscription fee from online services (2) advertising income from industry portals, trade catalogues, yellow page directories and printed periodicals (3) hosting of trade exhibitions and business seminars (4) customer-specific market research reports - 2009: Rmb 317.7M (US$46.7M) 2. Revenue breakdown (FY09) - Online services: 40% - Trade catalogues and yellow page directories: 36% - Market research and analysis: 16% - Seminars and other services: 8.1%
Online Gaming Growth outlook remains robust The online gaming sector continued to see good growth in 2011, with ~23% Y/Y growth to reach Rmb35.9B (~US$5.3B), as per our estimates. The MMORPG segment (~84% of total gaming market) expected to growth ~21% Y/Y in 2011 to reach ~US$4.4B, as per our estimates, with the launch of few key games next year with different genre, such Final Fahe. The casual and social game segments are likely to benefit from SNS sites opening up their platforms for new social games.
Overall for 2011, we expect companies with strong operating and marketing capabilities and healthy game pipelines to continue to benefit from the market’s growth.
China Total Game Market Forecast 2006 2007 2008 2009 2010E 2011E 2012E
Total Game Market size (Rmb million) 7,086 11,097 17,714 24,277 29,460 35,896 43,386 Total Game Market size (US$M) 893 1,472 2,568 3,539 4,313 5,318 6,428 Growth Rate: 30% 65% 74% 38% 22% 23% 21%
Source: J.P. Morgan estimates.
Key industry drivers We expect continued robust growth of online gaming in China to be driven by:
1) Continued strong internet user growth in China (2009-12E CAGR of 17%).
2) Upside in gamer penetration, which is still less than one-third of Korea’s penetration (also below HK and Taiwan), with additional gamers coming particularly from lower-tier cities.
3) Increasing broadband penetration, with 364MM broadband internet users as of Jun-10, or 87% of total internet users; CAGR of ~47% over the last five years.
4) Efforts of game companies – new genre, better quality, more innovative games and more effective promotions to continue to attract players; also, success of the free-to-play (item-based sales) model (contributing ~79.4% of industry revenues in 2009, up from ~76.2% in 2008, as per IDC estimates).
5) Limited leisure alternatives – teenagers in first-tier China cities spending more on entertainment like internet/games, with the trend being replicated in smaller cities.
2011 -- Look for companies with product specific drivers With market growth slowing down from the high double-digit level a few years ago, we expect more intense competition among leading game companies. We look for companies with game-specific drivers going into 2011.
Key MMORPG Games in 2011 We expect new games launching in 2011 to lead industry growth.
In 2010, we think only “Dragon Nest,” launched by Shanda Games in late July, performed well with PCU of 700k+.
In 2011, a few key games we will watch for are Changyou and Giant Interactive to release “Duke of Mountain Deer” and “ZT Online II” in 1H11, respectively. Netease may launch Blizzard’s “WoW: The Catastrophe” as well as “Starcraft II”, but it still depends on the approval procedures of China-related bureaus. Final Fantasy XIV will also be a game to watch which will be launched by Shanda Games.
Key MMORPG New Games in 2010 and 2011 Game Chinese Title Genre Visual Dimensions Game Operator Game Developer Launch Date
Dragon Nest 龙之谷 Action 3D Shanda Games Eyedentity Games (acquired by Shanda Games in 2010)
Jul-10
Duke of Mountain Deer
鹿鼎记 Martial arts adventure
3D Sohu Changyou Sohu Changyou 1. Expect to be launched in 1H11 2. Started closed beta testing in Dec-10.
ZT Online II 征途2 Martial arts adventure
2D Giant Interactive Giant Interactive 1. Expect to be launched in 1H11 2. Started unlimited closed beta testing in Nov-10.
Final Fantasy XIV 最终幻想14 Fantasy 3D Shanda Games Square-Enix Shanda Games announced the acquisition of an exclusive license for the game in Sep-10.
World of Warcraft: The Catastrophe
魔兽世界：大灾变 Fantasy 3D NetEase Blizzard The new version has been launched in other countries except mainland China in Dec-10.
Game software industry typically not correlated with macroeconomic growth; thus, should be less vulnerable in an economic slowdown Historically, the game software industry has not been significantly correlated with macroeconomic growth. For instance, in developed markets such as the US, the videogame software industry has historically exhibited cyclicality driven by game hardware launches (consoles, handheld devices). These, in turn, result from technological advances by the hardware manufacturers – in terms of faster processing devices with superior graphics and game play capabilities – typically every four to five years, which creates the need for newer software and also drives consumer demand. As a result, the game software industry is relatively less vulnerable in an economic slowdown, compared to other industries and software segments.
Source: DataStream. Note: Correlation coefficient: -0.19 (weak correlation). 1) Leading US game software companies’ revenue growth based on total revenue of Electronic Arts, Activision, THQ and Take Two. 2) Prior game platform cycles were 1995-2000 and 2000-05; current console cycle started in 2005 (Xbox 360 launch).
In addition to the above, in recent times, other aspects contributing to potentially greater resilience of the gaming sector have been: 1) the increasing acceptance of gaming among a wider demographic (e.g., games being seen as a family entertainment avenue, including women and children); 2) increasing penetration of the internet and more broadband connections driving online gaming; 3) emergence of innovative business models such as free-to-play online games and in-game advertising making gaming more affordable for consumers; and 4) greater variety of games (e.g., casual games such as music and dancing games) to appeal to diverse tastes.
The Rise of Social Gaming What is social gaming? Social gaming is a new form of gaming which is closer to casual games in complexity level accompanied by community features and frequent updates.
Sticky platform What really makes social games sticky is the amount of user-engagement that these games have. Users start engaging in a virtual life with the game. For example: Many users playing Farmville actually start feeling like farmers, they are involved with choosing crops, sowing seeds, providing nutrients, and then harvesting at the right time. Many users often set alarms to wake up at the right time for harvesting. Game companies keep adding new items making users' farming better, which keeps the user interested in the game continuously.
Social games are quite different from traditional MMORPG games in the sense that they are not heavy on strategy, do not have heavy graphics, and have no high hardware requirements. They differ from casual games in the sense that they have more community-based features and are more frequently updated.
Increasingly, social games find their popularity amongst advanced gamers, casual gamers, and people who have traditionally been non-gamers.
How social gaming is different from casual gaming? 1) Social gaming has community features: a) people can track the progress of their friends trough SNS platform, b) can be played with both online and offline friends.
2) The development team is continuously involved, making updates frequently. As social games do not have a lot of graphic interface, their updates are more frequent than MMORPGs.
3) The SNS platform assists in doing viral marketing for the game. Members are aware of actions of other friends in the game, which again gives birth to a sense of competitiveness and makes the platform stickier.
What’s unique about social gaming in China? Social games in China are quite similar to the popular ones on Facebook. For most of the popular games in China such as farm and aquarium games, the concept has been adapted from Facebook and other English-based social networking websites. However, Chinese social games are supposed to be more competitive and have some added features like stealing items.
We believe the social gaming trend will continue to pick up in China because 1) community features add to the stickiness of social games, 2) social games attract new sets of users who were traditionally non-gamers or did not have time to do heavier games (such as housewives), 3) better stickiness and monetization vs. casual games.
Social gaming proves to be a goldmine for Tencent With the rising popularity of social games on Facebook and other Chinese websites, Tencent introduced many new social gaming applications with more interactive functionalities such as farming, aquarium, etc. to increase user stickiness. The company has adopted a mixed content sourcing strategy where it is sourcing the popular games like social farm from third-party vendors while also working in-house to keep the game launch pipeline green. As social games are simple, they are expected to have smaller life cycles and continuous churn of new games becomes necessary.
The success of social games on Qzone led to a rise in the number of users from 150M in 4Q08 to 481M in 3Q10. The revenues have also gone up to 35.1% YoY in 3Q10 to reach Rmb580M. We estimate daily active users on Chinese SNS websites playing social games to be comparable to the number of active users on Facebook (500M+ active users).
Social gaming – a big opportunity for China game publishers China internet companies focus on an open platform strategy, which should help developers publish their social games.
• Tencent announced its open platform strategy after “QQ vs. 360 war.” Tencent’s SNS open platform is still in open beta testing, but it already becomes a popular
channel for third-party application developers to publish their SNS games at Qzone. “Skyscraper,” a popular third-party game at Qzone developed by Kingnet, recorded 70M game users, according to Kingnet’s CEO.
• The9 invested in Openfeint, a mobile game platform developer and operator, in July 2010. In December 2010, The9 signed a five-year license to use OpenFeint's mobile social gaming network software in China. The OpenFeint software is one of the most successful mobile social gaming network software for iOS and Android devices in the US. More than 13,000 mobile game developers are registered to integrate OpenFeint's SDK into their games and there are over 50 million registered users and approximately 4,000 games in the Apple App Store and Google Market running on OpenFeint's platform.
We believe Chinese social game developers will grow fast with the popularity of SNS and social games in China as in other countries. In the US, key social game developers such as Zynga and Playfish have been attracting large numbers of players to their games. Zynga has more than 320M registered users, according to an article by GamesBeat.
Playfish was acquired by Electronic Arts for approximately US$275M in cash and approximately $US25 M in equity retention arrangements. In addition, Playfish will receive additional variable cash consideration, up to a maximum of US$100M, contingent upon the achievement of certain performance milestones through December 31, 2011.
Summary of Gaming Regulations in China Summary of historical gaming regulations The General Administration of Press and Publication (GAPP) has been the key regulatory body since online games were introduced 10 years ago. This is because online games were assumed to be publications by online game companies, and, as such, they turn to GAPP for approvals.
On July 11, 2008, the State Council issued “Three Regulations” outlining responsibilities of various government bodies (including Ministry of Culture [MoC] and GAPP) in the regulation of animation, online gaming, and the cultural market in general. Even after this regulation, GAPP and the MoC both conduct their own approval process independently.
On September 7, 2009, China's State Commission Office for Public Sector Reform issued a notice clarifying responsibilities of various government bodies in the regulation of animation, online gaming, and the cultural market in general.
According to this notice, MoC is the key regulatory body, responsible for market planning, management of the industry, project development, conferences, and market oversight for the animation and online gaming industries. By the end of 2009, all the transition in responsibility should be complete.
MoC gets involved - released “Interim Measures for Online Games” in 2010 In late September 2009, MoC held a meeting with leading games companies stating that MoC will be the key regulatory body.
MoC released “Interim Measures for Online Games” on June 3, 2010, after about two years of preparation. The implementation of “Interim Measures” began on August 1, 2010. News about the rules was reported on Sina.com on June 22, 2010. The key points are:
- Detailed the requirements (registered capitals of no less than Rmb10M, etc.) for online game companies to obtain “Online Culture Operating Permit.” MoC is responsible for reviewing online game content. However, games have already been approved by other departments (GAPP), no separate review is required by MoC.
- Application process: If there is a change in operator for imported games in China, the game needs to be re-approved. For domestic developed games, the game needs to be filed with MoC within 30 days of operation. If game content is substantially changed, the game needs to be re-filed with MoC.
- No illegal game content which are considered as negative to Chinese culture, society, etc. Games should include details for suitable age groups. No gambling items in game allowed.
- Real name registration for players. Online game companies are required to implement “anti-addiction system” (time limits) for minors.
- Virtual game currencies: (1) cannot be used for payment, other physical product purchases, or other non-game product purchases, (2) game operators to keep record
of game currencies trading for at least 180 days, (3) data for game currencies types/prices/total amount issued to be filed with MoC.
- If a game ceased to operate for 30 days, operators will return money to gamers. There are fines for non-compliance, and potential criminal charges.
Regulations on virtual currency and virtual items trading platform Separation of online game operators that issue virtual currencies and online game items trading platform MoC and the Ministry of Commerce (MOFCOM) jointly issued a notice regarding strengthening the administration of online game virtual currency on June 4, 2009. The notice prohibits businesses that issue online game virtual currency from providing services that would enable the trading of such virtual currency.
“Interim Measures” regulates virtual game currency and virtual currency trading platform - Virtual game currencies cannot be used for other payments instead of online game products and services. Virtual game currency issuers cannot issue virtual currencies for the purpose of occupying the prepaid capital. The record of purchasing virtual game currencies should be kept for at least 180 days. Data for virtual game currency types/price/total amount issued should be filed with MoC-related bureaus.
- Virtual online game currency trading platform cannot provide trading service for: 1) minors, and 2) online games that are not approved or filed with MoC. The trading platform should require real name registration for buying/selling parties and the registration information should match bank account information. The trading and account information should be kept for at least 180 days.
Online Gaming Primer What are online games? Broadly speaking, we can separate online games into two segments: 1) casual games, and 2) serious games/MMORPG. Causal games are easy to play and only require brief tutorials. Some examples are puzzles, board games, and some old arcade games. Demographics for casual games are diverse: they cut across age groups (from young children to senior citizens) and are equally split across genders. Very often, these games are free.
What is a MMORPG online game? These are more complex games with a large number of scenes, multiple players and characters. Serious game players are also more committed to the games than casual players. They usually comprise young adults or teens who spend more than 10 hours per week on online games.
The most popular games that account for most of China’s online game revenues (~84% of total online gaming market, as per our estimates) are Massively Multiplayer Online Role Playing Games (MMORPG). These games are not simply about shooting and killing or finding treasures and saving the princess, as in some other games. MMORPG are community-based and players can interact with other players, form coalitions with acquaintances to fight battles, make villages more livable, and even have virtual marriages.
MMORPG games are very dynamic; game developers and operators always extend the map, create new weapons and run special virtual events. Typically, operators have a new release every month and a major upgrade once a year—and users can download them free of cost.
What is a casual game? Casual games are online games that are typically less evolving compared with MMORPG games. Players typically only spend less than 30 minutes per game session. The content and depth is much simpler, and requires fewer skills or less training to play the games.
Casual games can be broadly classified into 1) board and chess games, and 2) advanced casual games. Board and chess games, as the name suggests, are board games, chess, different types of card games, and other traditional games put online. These are viewed more as commodity products, and difficult to differentiate from competitors. As such, monetization is typically lower.
Advanced casual games are online games that have more depth and content compared with board and chess games. However, they are not as involved as MMORPG. Gamers spend less than an hour per game session. Successful advanced casual games are typically more innovative, and bring in new ideas to the market space. The popular advanced casual games include: Cross Fire, QQ Speed, QQ Dancer, Audition, Crazy Racing, CSOnline, AVA, etc. Successful casual games generate more revenue compared to board and chess games.
The revenue model for casual games is in-game item sales. Typical game items are: avatars (virtual clothing, accessories, and decorative products), tools (i.e., virtual golf clubs to play golf), weapons, special features (i.e., ability to see competitors’ cards in card games), and membership (priority access to game servers, and “members only” games).
Casual and MMORPG are complementary rather than competing products We believe casual games and MMOPRG satisfy needs of players at different times. For example, if a player has 15 minutes to kill, they likely would turn to casual games, but if a player has a few hours everyday, playing a simple casual game is likely to become too boring. Therefore, this same player could play both types of games at different times, depending on his or her availability and needs.
We believe new innovative advanced casual games attract non-game players to online games and further expand the gamer base. We observe this from the demographic differences between casual games and MMORPG games. These additional players could perhaps become MMORPG gamers down the road, if they find online gaming interesting.
Do gamers have time to play both advanced casual and MMORPG? In China, the market trend is to develop advanced casual games that are more complex and involved, and, as such, these casual games consume more time compared with before. Investors are concerned that this would reduce spending on MMORPG games. We believe this may be true, but the effects on MMORPG should be minimal, in our opinion. First, it is not uncommon for users to play multiple games, so users can play both MMORPG and casual games during the same day. Second, an expanded casual game user base should also bring new users to MMORPG.
Online games—a sticky business In online games, players build a strong community with other game players. They communicate through instant messengers in the game. Once players have been playing for a certain period, they start building their seniority and respect within the gaming community, as well as their stock of accumulated weapons. As such, fair play becomes very important. Hacking not only demoralizes players but also seems to cause “community unrest” and to threaten the “social order” in the game space. Game operators hire game masters or ‘GMs’ who patrol the game space to check for unfair practices, and remove those users who violate the rules. Leaving the game means severing ties with the community, as well as giving up weapons and armors accumulated over time. As such, players have proved to be quite loyal to the games.
A well-run game is therefore very sticky, and the operators’ goal is to make their game stickier. To further increase user loyalty, game operators organize special events in the virtual space, as well as organize offline promotions and parties. One good example is Lineage in Korea, which was launched in Korea about six years ago and remains one of the top games in the country.
Any piracy issues in online games? Online games are designed to get around the piracy issue. There are two sets of software – server software and client software. Server software is installed inside game companies’ servers. The game server is designed to protect against hackers trying to copy or alter the server software. Client software is distributed free of charge and can be downloaded from a game operator's site at any time. Since client
software is free, unlike game consoles where game software is charged a fee, there is no reason to make pirated copies. As such, piracy problems are very limited.
What are pirated servers? This refers to the situation where the main server software is stolen from game companies or the server software is being reverse-engineered. In this situation, “criminals” put stolen/pirated server codes on home-run servers and charge users a lower fee than authentic servers to play the game on their servers. These are referred to as “pirated” servers.
Games that are operated widely across the globe are more prone to being pirated. This is because game developers need to distribute a source code to outside game local operators, and as such, there is a higher chance of the source code being leaked out. For example, Mir2, Aion, and Lineage are well known for having pirated servers in China.
NetEase, which develops its games in-house, has not seen any pirated server issues. Also, new games have more security features to protect the server software from being pirated. For example, we have not noted any pirated servers for World of Warcraft.
What are hacking tools software? Hacking in online games typically refers to special (purchased or self-written) programs that run on players’ PCs. With these special hacking tools, game players can, for example, get infinite lives, nuke all the adjacent players, or take tools from others. Hacking demoralizes other players and results in their leaving the game.
To tackle the issue, online game operators can: 1) amend the actual game software, 2) hire more game masters to patrol the virtual community, and 3) bar hacking players from playing the game. The first option is the most effective way to deal with the problem. However, as many online game operators only purchase games from other developers and do not have access to the source code, there could be a time delay in addressing a particular hacking issue. In fact, this is a fairly frequent issue raised by operators in China, and has led to the decline of some early online games.
Economy of games We believe the required number of concurrent users is low for a MMORPG game to break even. Excluding development costs or licensing fees, a game can achieve an operational breakeven at 4,000-5,000 average concurrent users.
With relatively low breakeven user numbers, we believe the number of MMORPG game titles will continue to grow. However, many of these will likely be small-scale games that we expect will target niche audiences, much like different types of movies: action-adventure, science-fiction, martial arts, war, mystery, medieval, etc.
Estimated Gross Income of a MMORPG Under Various Concurrent Users Case 1 Case 2 Case 3
Average concurrent users 1,000 4,000 10,000 Active paying users 11,000 44,000 110,000 ARPU per users (RMB): 9 9 9 Revenue after distributor’s discount 79,200 316,800 792,000 Number of servers 3 4 9 Monthly server amortization & bandwidth cost 16,375 21,833 49,125 Game masters and other labor cost 48,000 64,000 144,000 Marketing and promotion 55,440 110,880 158,400 Other operating expenses 47,520 95,040 158,400 Gross Net Income (88,135) 25,047 282,075 Source: J.P. Morgan estimates. Note: Excluding development cost, amortization of licensing fee or revenue sharing with game developer.
How fast would a game decline from its peak? As a rule of thumb, typical popular MMOPRG games reach their peak in around three years. The rate of decline from the peak varies depending on different factors. Some games decline at a faster rate compared with others. For example, we noted Mu, operated by 9Webzen, experienced a step function (around 50% drop each step) type of sharp fall, mainly due to hacking and cheating tools, while Mir 2 declined 30% Q/Q in 3Q05, mainly due to pirated servers.
We believe the rate of decline from the peak varies, depending mainly on these factors: 1) hacking or pirated server issues, 2) ongoing promotion and user activities, and 3) availability of upgrade packs.
Some of the Korean games have still maintained a high level of usage for over 10 years.
Revenues for Long-Running Korean Online Games (In KRW M)
Japan Internet Market Overview Broadband the Norm – Mobile Surfing Taking Over Japan has enjoyed relatively high bandwidth availability since CY’02, and with it high internet usage from both fixed line and mobile.
Internet subscribers (LHS) Broadband service (LHS)Mobile subscribers (LHS) Penetration rate (RHS)
Source: J.P. Morgan based on MIC's Survey of "Telecommunications Usage Trend Survey 2009" and "Number of Broadband Service Contracts, Etc." Note: Broadband service is a sum of FTTH, DSL, CATV, and FWA.
Since CY’00 we can see that users have become more accustomed to surfing the net via both PC and mobile. In April 2010 according to Nielsen Online, 46% of users accessed the net in this manner; back in April 2000 access via only PC stood at 84%. We believe that with greater smartphone penetration going forward, this trend whereby mobile substitutes for PC usage will continue.
Internet User Population Trend via PC and Mobile million
Source: J.P. Morgan based on Nielsen Online NetView.
With regard to the gender split of internet users, we have also seen a gradual increase in the female user population for PC traffic.
Internet Penetration by Age and Gender, Access via PC at Home million, %
6.3
1.8
2.6
3.6
4.1
4.8
4.3
4.0
3.9
4.4
5.28%
20%
36%
52%
64%
68%
71%
63%
58%
46%
57%
25%
18.4
Female PopulationPenetration
6.6
1.9
2.7
3.8
4.2
4.9
4.4
4.1
3.9
4.4
5.130%
37%
62%
69%
70%
58%
58%
52%
49%
46%
55%
27%
14.8
2-12
13-15
16-19
20-24
25-29
30-34
35-39
40-44
45-49
50-54
55-59
60 ov er
Male PopulationPenetration
Source: J.P. Morgan based on Nielsen Online NetView (Apr 2010).
The most active internet users are in the 30-to-44 age group, which is in line with the most active users on eCommerce sites. Advertising on major portals would be greatly influenced by this key demographic group. However, internet penetration is currently fastest in the elderly population (aged 60 and over).
Internet Penetration by Age and Gender, Access via Mobile million, %
6.3
1.8
2.6
3.6
4.1
4.8
4.3
4.0
3.9
4.4
5.2
4%
48%
76%
72%
70%
60%
52%
44%
34%
27%
16%
4%18.4
Female PopulationPenetration
6.6
1.9
2.7
3.8
4.2
4.9
4.4
4.1
3.9
4.4
5.1
4%
26%
75%
81%
59%
58%
54%
55%
42%
24%
20%
8%14.8
2-12
13-15
16-19
20-24
25-29
30-34
35-39
40-44
45-49
50-54
55-59
60 ov er
Male PopulationPenetration
Source: J.P. Morgan based on Nielsen Online NetView (Apr 2010).
When comparing user demographics for mobile internet users, unsurprisingly the core age category is younger than PC internet users, with the 16-to-24 age group being the main users, where penetration is almost 80%.
Source: J.P. Morgan based on Nielsen Online Internet Base Survey (June 2010).
Although smartphone penetration is still low (5.9% according to Nielsen Online), usage rates are relatively high among men in their 30s, and females in their late 20s and early 30s.
Internet Advertising We estimate that the online advertising market will resume a healthier growth profile Y/Y for CY’10 and CY’11, as online media gains more share from traditional mass media and pricing rises. Although this is nothing new, this does bode positively for Yahoo Japan as the leading net property for advertising spend.
Domestic Advertising Expenditure by Media Type ¥ billion, % CY’05 CY’06 CY’07 CY’08 CY’09 Value Total ad expenditure 6,824 6,940 7,019 6,693 5,922 Newspapers 1,038 999 946 828 674 Magazines 484 478 459 408 303 Radio 178 174 167 155 137 TV 2,041 2,016 1,998 1,909 1,714 Satellite media 49 54 60 68 71 Internet 378 483 600 698 707 Sales promotion 2,656 2,736 2,789 2,627 2,316 Composition Newspapers 15.2% 14.4% 13.5% 12.4% 11.4% Magazines 7.1% 6.9% 6.5% 6.1% 5.1% Radio 2.6% 2.5% 2.4% 2.3% 2.3% TV 29.9% 29.1% 28.5% 28.5% 28.9% Satellite media 0.7% 0.8% 0.9% 1.0% 1.2% Internet 5.5% 7.0% 8.6% 10.4% 11.9% Sales promotion 38.9% 39.4% 39.7% 39.3% 39.1% Y/Y Total ad expenditure - 1.7% 1.1% -4.7% -11.5% Newspapers - -3.8% -5.2% -12.5% -18.6% Magazines - -1.3% -4.0% -11.1% -25.6% Radio - -1.9% -4.2% -7.3% -11.6% TV - -1.2% -0.9% -4.4% -10.2% Satellite media - 11.7% 10.8% 12.1% 4.9% Internet - 27.8% 24.4% 16.3% 1.2% Sales promotion - 3.0% 1.9% -5.8% -11.8% Source: J.P. Morgan based on Dentsu. Note: Internet advertising includes product expenditure.
Domestic Advertising by Media (CY’05)
Sales promotion38.9%
Internet5.5%
TV29.9% Satellite media
0.7%
Radio2.6%
Magazine7.1%
News paper15.2%
Source: J.P. Morgan based on Dentsu.
Domestic Advertising by Media (CY’09)
Sales promotion39.1%
Internet11.9%
TV28.9%
Satellite media1.2%
Radio2.3%
Magazine5.1%
News paper11.4%
Source: J.P. Morgan based on Dentsu.
Comparison with US market The US market size for online advertising was $22.7B in CY’09, according to the Interactive Advertising Bureau (IAB). The US online market is three times the size of the Japanese market spend, online advertising made up 14.3% of total advertising spend, larger than Japan at 11.9%.
US online ad spend 14.3% of total ad expenditure in CY’09
Source: IAB Internet Ad Revenue Report; PricewaterhouseCoopers.
Sector-wise spending is focused on retail, telecom and financial services – different from Yahoo Japan’s core exposure to financial services, auto, cosmetics/toiletries and real estate.
The IAB Internet Advertising Revenue Report shows that revenues were recovering +11.3% Y/Y in 1H CY’10 in the U.S.
Comparison with China market In CY’09 the China online ad market was US$2.1B, growing about 21% Y/Y and making up 10% of total advertising spend. Compared to the US and Japanese markets the size remains relatively small.
China online ad spending made up 10% of total ad expenditure in CY’09
Internet Advertising Expenditure CY’09 - U.S., Japan and China $ billion
20.4%
1.2%-3.0%
0.0
5.0
10.0
15.0
20.0
25.0
U.S. Japan China-10.0%
0.0%
10.0%
20.0%
30.0%
Internet Ads Spend (LHS) Y/Y (RHS)
Source: J.P. Morgan Asia Research, Dentsu, and IAB “Internet Advertising Revenue Report”. Note: Currency based on end-December, 2009.
Comparison of Traffic and Sales for Key Domestic Internet Names Company Code Monthly visitors Monthly page views Sales (Apr-Jun 2010) Sales per PV
(month) Sales per visitors
(month) Registered
users (M) Unique users
(M) PC (B)
Mobile (B)
PC (¥ M) Mobile (¥ M) (¥) (¥)
Mixi 2121 20.7 14.1 5.2 24.3 4,013.0 - 0.05 94.87 Cookpad 2193 0.4 9.4 - - 2,207.0 - - 77.93 Kakaku.com 2371 - 27.6 0.6 0.1 3,561.6 - 1.60 43.05 DeNA 2432 19.9 - - 71.6 - 24,193.0 0.11 404.63 Gourmet Navigator 2440 7.1 20.0 0.8 - 5,902.0 - 2.34 98.37 Gree 3632 20.6 - 0.4 35.4 - 10,940.0 0.10 177.11 Dwango 3715 17.4 - 2.3 - 6,931.0 - 1.02 132.47 Yahoo Japan 4689 24.0 224.2 40.9 7.9 70,506.0 - 0.48 104.81 Cyber Agent 4751 9.9 - 7.5 7.1 1,940.0 - 0.04 65.45 Rakuten 4755 41.4 - - - 41,300.0 - - 332.69 Source: J.P. Morgan based on companies’ data. Note: Unique users refer to the # of accessing users in a month. Rakuten visitors refers to both PC and mobile ads combined; sales refer to total net services (EC, travel, and portal media). Cyber Agent refers to Ameba business. DeNA refers to Mobage mobile portal. Dwango refers to Nico Nico Douga video site. Data as of end-June 2010.
eCommerce The size of the Japanese B2C eCommerce market is estimated to be ¥4.5T, which is approximately 3.3% of the entire domestic retail market, worth ¥135.0T. However, in the core internet user demographic (i.e., 30-to-40 age group), eCommerce makes up a greater proportion of individual retail activity. Internet shopping also now dominates the non-store retail channel (such as phone, television and catalog mail order), with around 60% market share.
Source: J.P. Morgan based on METI Surveys on eCommerce Market Size. Note: CY’00 to CY’04 are based on J.P. Morgan assumption.
Online shopping is dominated by Rakuten, Amazon Japan and Yahoo Japan. The number of items for sale shows that the leaders have taken a long tail approach.
Number of Items for Sale Rakuten Amazon Japan Yahoo Shopping Yahoo Auction 65,706,254 items 28,566,407 items 36,295,435 items 22,490,000 items
Source: J.P. Morgan based on company data. Note: Rakuten and Amazon Japan data as of Oct. 15, 2010, Yahoo Shopping Oct. 28, and Yahoo Auction end-Sep. 2010.
The marketplace model (virtual shop tenants operating on a platform) has been very successful in Japan, as seen by the number of merchants active on Rakuten and Yahoo Japan.
Number of Merchants Rakuten Yahoo Shopping Yahoo Auction 35,681 stores 17,834 stores 17,393 stores
Source: J.P. Morgan based on company data. Note: Rakuten data as of Oct. 15, 2010; Yahoo Shopping and Yahoo Auction end-Sep. 2010.
Survey – Most Recent Online Shopping Site Used via PC
Rakuten Books9%
Rakuten Mall30%
Yahoo! Shopping8%
Unknow n4%
Manufacturer direct sales
7%
Niche e-tailer8%
Real w orld retailer net store
8%
Other online mall operators
4% Catalogue sales companies
9% Amazon Japan13%
Source: J.P. Morgan based on Fujitsu Research.
Service comparisons between leader Rakuten and Amazon Japan We believe the key differences in the services offered by Rakuten and Amazon Japan are:
Amazon Japan has greater flexibility to offer customer experience improvements for shopping online (such as same-day delivery, private brands), given its key role as a retailer with the necessary infrastructure in place.
Rakuten’s strength lies in product selection and the ability to offer different online services within the group, such as travel and financial services, in addition to auction.
Comparisons of Rakuten and Amazon Japan Rakuten Amazon Japan
Characteristic Shopping model All marketplace (online mall tenants) Primary retailer, with growing third party sellers Third party sellers Mainly retailers and individuals Include manufacturers Own brands None Javari Amazon Basic Free delivery On select items and books On all items Same-day delivery None Yes - on select items 24 hour delivery Yes - on select 'Rakuten 24' service Yes - pending stock availability eBook sales None Via Kindle eBook reader Fulfillment services Yes - on select 'Rakuten 24' service For in-house and third party sellers using
Fulfillment services Point program Rakuten Points Amazon Points - but not applicable to all items Auction items Available None Group buying Available None Settlement and delivery at convenience store
None Lawson
Gift card availability None Available Credit card services Rakuten Point Club card No Source: J.P. Morgan based on company website.
There has been a growing emphasis by Amazon Japan on its third-party seller base, as it aims to diversify its products on offer. A comparison of marketplace fees highlights the following:
Rakuten has an initial fee and fixed monthly charge, which provides an incentive that attracts many mall operators.
Amazon Japan has a smaller monthly fee for large sellers, but its cost structure is more complex. The seller has the option for fulfillment to be carried out by Amazon Japan.
We think Rakuten’s brand and cost structure is likely to prove attractive to individuals and small businesses—especially for first timers.
Participation Costs for Marketplace Sellers Rakuten Ichiba Standard plan Ganbare! Plan Light plan Mega-shop plan Monthly fixed fee ¥ 52,500 20,475 41,790 105,000 Number of items registered for sale Item 20,000 5,000 5,000 No limit Variable commission % 2.0~4.0% 3.5~6.5% 3.5~5.0% 2.0~4.0% Contract period 1 yr 1 yr 3 mos 1 yr Payment method Once in 6 mos Yearly Once in 3 mos Once in 6 mos Initial joining fee ¥ 33,600 33,600 33,600 33,600
Yahoo! Shopping Store Regular plan Master plan Royal plan Monthly fixed fee ¥ 20,790 31,290 52,290 Number of items registered for sale Item 200,000 200,000 200,000 Variable commission % 3.0~4.5% 2.1~3.9% 1.9~3.7% Contract period 6 mos 1 yr 1 yr Payment method Payable at 1 mos. - - Initial joining fee ¥ 21,000 21,000 21,000
Amazon Market Place (Japan) Large plan Small plan Monthly fixed fee ¥ 4,900 - Basic contract ¥ - ¥100 per transaction System charge % - - Number of items registered for sale Item No limit, All 21 categories Category limits in place, max ¥ 1 mn price tag Variable commission % 21 categories: 8~20% 15 categories: 8~15% Others are un-registerable Per transaction sales fee (domestic sales) ¥ 4 categories: ¥30~140 Other categories: free 15 categories: ¥30~140 Others are un-registerable Initial joining fee ¥ - - eBay Auction-style format listings -- Insertion fees Starting or reserve price Insertion fee $0.01 - $0.99 Free (up to 100 listings) $1.00 - $9.99 $0.25 $10.00 - $24.99 $0.50 $25.00 - $49.99 $0.75 $50.00 - $199.99 $1.00 $200.00 or more $2.00 -- Final value fees Final sale price Final value fee Item not sold No fee $0.01 - $50.00 9.0% of sale price (maximum charge $50.00) $50.01 - $1,000.00 9.0% of sale price (maximum charge $50.00) $1,000.01 or more 9.0% of sale price (maximum charge $50.00) Fixed price format listings -- Insertion fees Buy It Now price Insertion fee $0.99 or higher $0.50 -- Final value fees Final sale price Final value fee Item not sold No fee $0.99 - $50.00 8~15% of the final sale price $50.01 - $1,000.00 8~15% of the initial $50.00, plus 5~9% of the remaining final sale price balance $1,000.01 or more 8~15% of the initial $50.00, plus 5~9% of the next $50.01-$1,000.00, plus 2%
of the remaining final sale price balance Source: J.P. Morgan based on company websites. Note: Tax included. Data as of end-Sept. 2010.
SNS in Japan Background Western social networking services such as Friendster and MySpace began in 2003, making an impact as the concept of expansive online communities took hold. It was around the same time that numerous small special-interest SNS sites were emerging in Japan, but the two generalist sites that began to build major user bases were:
Mixi—Initially an online PC service with an invitation-only user registration format. Began in February 2004, with a mobile service starting in September 2004.
Gree—Commenced as a PC service with open registration to users in February 2004, launching a mobile service in December 2004 which became the mainstay service.
Japan’s user-generated content sites were predominantly in the form of blogs (online diaries) and forums (such as 2Channel). User adoption of SNS however was relatively swift, in part due to the convenience factor offered by mobile access, and with the more recent introduction of social gaming content.
Key characteristics The defining characteristics of Japanese SNS sites are as follows:
Key Characteristics of Japanese SNS Potential user audience Estimate 40M (50% of 15 to 64 age group), 30% of national
population Current user penetration Estimated 50% - 60% of potential user audience User growth 35% Y/Y (at Sept 2010) Gender split Dependent on site, overall evenly split between male and female User age group distribution - Under 20 years old - 18%
- 20 years to 30 years old - 41% - 30 years and above - 41%
Age group with highest ARPU 30 years old and over PC SNS usage Less than 5% of total user traffic Mobile SNS usage Over 95% of total user traffic – driven by gaming content Popular settlement method for virtual currency Mobile carrier settlement Mobile SNS sales split Virtual goods and gaming content - 80%
Advertising - 20% PC SNS sales split Virtual goods and gaming content - 20%
Advertising - 80% Social graph Predominantly virtual; real identification rarely used Source: Companies' data, J.P. Morgan estimates.
Japanese SNS sites first appeared in 2003, the same time as US/European counterparts
Mixi and Gree both began in February 2004
Mobile SNS and gaming content spurred user adoption
Mobile SNS sales split PC SNS sales splitVitual goods and gaming content Advertising
Source: Company data, J.P. Morgan estimates.
From the above, we believe there are two key issues that face the SNS industry:
The focus on the mobile platform means that the advertising market remains small, although it remains a growth area. The leaning toward virtual social graphs and user behavior focused on gaming also limits its appeal as advertising media.
The key earnings driver is virtual goods and gaming content. We believe that the SNS market (both advertising and social gaming) is worth around ¥200B in CY’10 growing at 185% Y/Y, with DeNA (40%), Gree (25%) and Mixi (5%) making up around 70% of total market share. We believe growth will slow drastically to 15% Y/Y in CY’11, a marked slowdown as both user numbers and ARPU growth domestically begin to flatten with market saturation.
Social gaming Social games are simple-to-play titles that were inherently free to play, encouraged user interaction, and introduced pay-to-play virtual items for sale to enhance game play experience – a common ‘freemium’ model whereby a basic web service is offered for free, while charging for premium offerings. Gree was the first SNS to successfully pioneer the concept of mobile social gaming in 2007.
The latecomer to social gaming was DeNA’s ‘Mobage’ mobile site, which originally started as a standard publishing mobile gaming portal in February 2006. The site changed into a SNS service later that year with the introduction of avatars, with the company launching its social gaming service in October 2009.
Structure of SNS Services The basic structure of an SNS consists of the following:
User profile – either real (e.g. real name) or virtual (e.g. pet name) personal data
Posting diary entries/blog posts
Compile and share a list of contacts – allowing users to search and connect to each other
Joining specialist interest communities
The key aim is to be able to stay in touch with your contacts and to allow for ease of communication as well as the ability to behave as a group in a virtual setting.
Service overview Domestic mobile SNS sites have evolved to become a generalist destination site like a portal, as they have expanded the services on offer:
SNS Service Overview Service Comments Social networking functionalities - User profiles Mostly pet names and pseudonyms on domestic SNS sites - Blogs Online diary entries - Friends/contacts List of users on your personal network - Groups/communities Joining special interest forums - Mail function Used as email/messaging service - Avatars Virtual characters, which can be 'dressed up' usually for a fee Games In-house developed as well as third party. Use of Flash and Java programming. - Casual games Staple basic puzzle games, generally a free service - Social games Key earnings driver for DeNA and Gree - - Core gaming content More akin to traditional videogame titles, subscription fee service Virtual currency Prepaid currency to purchase virtual items, primarily for gaming content User generated content All uploaded by individual users for general consumption - Photos Uploading pictures - Novels - Music Artist profiles and fan clubs Entertainment and information content
Content generally found on a PC portal services
- News - Weather - Transport/access search - Search - Reference data Equivalent to ‘Wiki’ pages - Horoscopes - Celebrities content Premium services Additional services for PC site access, such as additional data storage
capabilities Source: J.P. Morgan based on company data.
Current market leader DeNA commenced social gaming in 2009
Apart from the wealth of content on offer, the key difference between Japanese and overseas SNS services is the focus on the mobile platform versus the PC. We believe this occurred due to the following factors:
Early adapters of mobile services were the younger under 30 demographic, whose net usage behavior was skewed to handset usage rather than PC, thereby meeting their needs.
The fall in pricing for packet download fees via carrier competition, and the introduction of fixed pricing plans made heavy mobile usage more affordable.
Ease of purchase of virtual currency via carrier settlement made it more convenient to transact.
Social Gaming Primer Revenue structure Key points related to the revenue model for social gaming are as follows:
The ‘pay-to-play’ revenue model is a valid approach to online gaming, as users tend to reward for quality content after first being able to assess its worth via the free-to-play environment.
Games on offer can be in-house developed by the SNS operator, or by third-party developers. An open platform allows for greater product diversity.
Virtual currency is required to purchase game items—a common method to acquire currency is via carrier settlement, credit card, or prepaid money available at convenience stores.
Social Game Monetization Model SAP games
User acquires Purchase 30% Commissions¥ x currency game items recognized
In-house game application10%~15% All revenue
Carrier commissions recognized
70% paid to SAP
Source: J.P. Morgan assumption. Note: SAP stands for Social Application Provider, a developer of a social game application.
Why social gaming can be highly profitable The success of social gaming comes from two key angles:
The relatively low barrier to entry into the market via low development costs.
Low priced download titles and free-to-play item sale titles are meeting the needs of gamers, and replacing demand for mid-tier quality software from the traditional videogame industry.
The launch of a social gaming title is the start of on ongoing development cycle, where the game can be fine-tuned and improved ‘on the go' with direct customer feedback.
We set out the basic cost structure for developing and operating a social gaming title.
Social Gaming—Initial Cost Estimates Initial development costs ¥10M - ¥30M Server costs Around 25% of revenue generated (15% for hardware, 10% for tuning) Marketing costs Usually low, apart from flagship titles that can use TV advertising Source: J.P. Morgan estimates.
Traditional Videogame Platforms—Illustrative Development Cost Estimates Game Platform Cost Nintendo DS ¥10.0M - ¥50.0M Sony PSP ¥10.0M - ¥75.0M Wii Upwards of ¥0.4B PlayStation 3/Xbox 360 Upwards of ¥1.0B Source: J.P. Morgan estimates.
We are making a generalization of development costs for traditional video gaming software, which can range significantly in scale and budget. However, social gaming titles involve a relatively small outlay of cost to start up and operate. The key attractions here are that:
Marketing costs are relatively low, as internet content there is greater emphasis on viral marketing and user feedback
The ability to exceed breakeven point is relatively easy, resulting in a potentially high margin earnings stream.
The key variables in the revenue structure of a typical social game are as follows:
Social Gaming Titles—Typical Factors Affecting Revenues Revenue Variables Range Participation rate of total registered user base 2% - 6% Typical monthly ARPU range for registered users ¥50 - ¥300 Monthly ARPPU (Average Revenue Per Paying User) range
¥1,000 - ¥5,000
Game shelf life/lifetime value period 3 month to 12 months typically; average 6 months For reference – typical pricing range of handheld software Nintendo DS software ¥2,800 - ¥4,800 PSP software ¥5,040 - ¥6,090 Source: Company data, J.P. Morgan estimates.
From this, we can surmise that a simplified game title revenue model is:
Gross revenue = Number of registered users × Participation rate × ARPU × Shelf life
Less the following costs to derive profit:
Server fees and game tuning = gross revenue × around 25%
Marketing costs
Initial development fee
Carrier and platform provider commissions
Therefore, it is possible to exceed the breakeven point in a comparatively short period of time and generate earnings over the longer term through this model. Also, titles can be cancelled if proven to be unsuccessful, with no negative residual issues such as reducing pricing or scrapping inventory.
Cost drivers The initial cost driver for social gaming is staffing cost related to engineers and creators developing a game title. After release the key cost drivers are marketing spend to promote the title, and server costs as user traffic increases.
Marketing costs in the early-to-mid cycle stages of a game title release can be viewed as a user acquisition cost—the cost and investment required to win new users, as well as keeping old ones active. Despite growth in user traffic generated by gaming content, traffic growth is limited and marketing costs are a necessary tool to encourage user activity.
Monthly ARPU and Avg. Monthly User Acquisition Costs (UAC) Trends (CY’10) ¥/person
Social application providers The SNS sites act as a platform for social network game developers (called Social Application Providers, or SAP) to plug in game applications on the sites, with the view of generating revenues either by virtual items sales or generating advertising income for traffic generated. Major overseas players include Zynga, Electronic Art's subsidiary Playfish, Disney’s Playdom, RockYou!, and other key players on the Facebook PC platform such as CrowdStar , 6 Waves (based in Hong Kong), and Digital Chocolate Inc.
We view major PC browser-based game companies as a cluster of new entrants into the social gaming market—key players here are Germany's Bigpoint and Gameforge, France’s Gameloft, UK’s Mind Candy and Jagex.
Key SAP companies in Japan are as follows:
CyberAgent (4751): A leading online advertising agency and blog site, has established three dedicated subsidiaries to social gaming
KLab: IT services firm with social gaming content
Cave (3760): A PC online game operator branching out into smartphone social gaming
Foreign SNS Presence in Japan Foreign SNS sites tend to focus on real social graphs, and we believe this has been the overriding factor in their lack of popularity in Japan where users prefer greater privacy. The exception has been the social networking and microblogging service Twitter.
Facebook—The largest global SNS platform provided by Facebook Inc. Nielsen Netview estimates that there are two million Facebook PC users in Japan as of September 2010.
Twitter—Twitter is a mini-blog service provided by Twitter Inc. Nielsen Netview estimates that there are 11.1M Twitter PC users in Japan as of September 2010. We believe that there is more user activity on the mobile platform, especially with the adoption of smartphones.
Foreign SNS sites are not virtual communities, unlike Japanese SNS sites
(minutes) Mixi 9.6 15.8 3,369 353 206 Twitter 11.1 18.4 841 76 41 Facebook 2.1 3.4 119 57 36 Source: Nielsen Netview , J.P. Morgan. Note: Reach is calculated as the number of monthly visitors divided by the potential domestic internet user audience.
Overseas Expansion—An Assessment of Growth Prospects Assessing competitive forces The SNS market is a developing growth business and is therefore a target of both start-ups and mature businesses aiming to take advantage of its user traffic growth.
With reference to Michael Porter’s Five Forces model to assess the competitive landscape of SNS and social gaming, we conclude that despite the potential growth prospects, it is rapidly becoming an overcrowded and highly competitive space.
Competitive Forces Analysis Competitive Forces Rating Commentary Barriers to entry LOW Initial investment (time and cost) low for application development
No technology barriers to develop social games/SNS Threat of new entrants HIGH - Individuals can easily develop content and self-publish
- PC browser-game developers targeting smartphone market - Traditional video gaming companies adopting to social gaming
Bargaining power of buyers HIGH Users can choose to ignore or embrace new games Switching costs are virtually zero Bargaining power of suppliers MEDIUM Application developers choose the most successful SNS platform to
provide content The lack of quality content results in quickly falling user traffic
Competitive rivalry HIGH SNS sites spend user acquisition costs to attract new users Existing users need to be continually engaged to remain customers
Conclusion A highly competitive environment Source: J.P. Morgan estimates.
Barriers to entry: Physically and technologically low barriers to build a SNS/social gaming applications; know-how over game development and tuning can be gained over time.
Threat of new entrants: Substitution risk is high for social gaming developers as new entrants appear from PC browser-game market and the traditional video-gaming players.
Bargaining power of buyers: End users can choose and decide whether a game is worth playing or not, impacting future monetization.
Bargaining power of suppliers: Social gaming developers can choose to place their content on SNS platforms of choice. Less popular SNS sites are not seen as desirable given less user traffic generated.
Competitive rivalry: It is much easier to make and release a game with available authoring tools, and with self-publishing distribution channels such as the Apple App Store and Android Markets. This has thrown the door wide open to new
entrants, and localized players are all beginning to look at the global picture for growth opportunities in the SNS market.
With overseas markets expected to be a new growth opportunity, we believe that this view overlooks the intensifying competitive forces involved.
Overseas M&A activity Domestic SNS players and leading social application developers are eager to explore and build overseas growth opportunities. DeNA acquired US company ngmoco in October 2010, but there have been other transactions taking place.
Recent M&A Activity in Social Gaming Space Company Acquirer/investor Price Date Daily Average
Users Playdom Disney $563M + $200M earn-out Jul-10 4.6M Playfish Electronic Arts $300M + $100M earn-out Jul-09 7.7M Chillingo Electronic Arts Less than $20M Oct-10 NA
ngmoco DeNA $303M + $100M earn-out Oct-10 NA Astro Ape DeNA NA Sept-10 NA Gameview Studios DeNA NA Sept-10 NA IceBreaker US Inc DeNA NA Oct-09 NA Slide.com Google $182M Aug-10 NA Unoh Zynga Japan NA Aug-10 NA Source: Company reports and J.P. Morgan estimates.
The key difference between DeNA and other deals undertaken is that the company is acquiring firms with a focus on the smartphone platform e.g. content on iPhone and/or Android, as opposed to the PC. Although this approach may buy time for DeNA versus competitors also diversifying into smartphones, we believe this will not be a major competitive advantage over the medium term.
Differences in ARPU DeNA has highlighted a major difference between social gaming markets in Japan and the West: (1) Compared to Facebook, DeNA estimates that its ARPU is 30 times higher and (2) compared to Zynga, DeNA estimates that its ARPU is 15 times higher.
ARPU difference is significantly affected by the type of community (virtual or social). DeNA operates on a mobile platform, with a virtual community social graph; Facebook and Zynga are PC-based with a real social graph. Japanese mobile user behavior is adapted to mobile gaming, and virtual user interaction fosters gaming activity. Conversely, we believe that operating a SNS with a real social graph will not be a conductive environment to really drive gaming behavior to the levels seen in Japan.
Domestically, Mixi’s ARPU is lower than its peers due to:
Revenue driver remains advertising.
Users on the Mixi SNS mostly go to the site for communication purposes, as opposed to social gaming, which is the main draw for DeNA and Gree.
Smartphone Adoption—New Distribution Channels International Data Corporation (IDC) estimates that global smartphone shipments will grow 55.4% Y/Y in CY’10, from 173.5M units in CY’09 to 269.6M units. Growth is expected to continue at 24.5% Y/Y in CY’11. This is a factor that would drive SNS and social gaming companies to see smartphones as new distribution systems for their services, rather akin to video gaming software makers that took the 'multiplatform' approach for their game titles.
IDC expects that Symbian will be the leading operating system by 2014, followed by Android.
Worldwide Converged Mobile Device Operating System Market Shares and 2010-2014 Growth Operating System 2010E Market Share 2014E Market Share 2014E/2010E Change Symbian 40.10% 32.90% -18.00% BlackBerry OS 17.90% 17.30% -3.50% Android 16.30% 24.60% 51.20% IOS 14.70% 10.90% -25.80% Windows Mobile 6.80% 9.80% 43.30% Others 4.20% 4.50% 8.30% Source: IDC Worldwide Quarterly Mobile Phone Tracker, September 7, 2010
While there is a positive outlook from a market growth perspective for smartphones, we are drawn to the competitive threats involved despite the Apple iOS and Android platforms being perceived as a ‘green-field’ site.
Competition in the Smartphone Game Application Market
iPhone Apple iOS / Android
Traditional videogamecompanies - Capcom - KONAMI
- Square Enix - Tecmo Koei
- Namco Bandai
Domestic featurephone SNS
- DeNA - GREE - mix i
Domestic socialapplication profiders
- Cy ber Agent - Cav e
SNS platforms - Facebook - My Space
PC browser /SNS game developers
- Zy nga- Play dom - Play fish - RockYou
- Crow dStar
Source: J.P. Morgan based on company data.
We feel that in order for smartphone penetration overseas to result in (1) a major hike in user activity on SNS sites and (2) widespread adoption of social gaming content, the following environment is necessary:
Social gaming content has high penetration rates in Japan, as the social graphs are virtual—overseas SNS sites which have real social graphs will have to replicate this level of activity, or
With compelling content on offer, virtual SNS sites need to be built with virtual communities, offering a new service compared to real social graph SNS. A current proxy would be Microsoft's Xbox Live online gaming service on the console.
We do however believe that social gaming will be appealing to a niche audience overseas, which in terms of scale may still present an attractive new market for Japanese companies to target.
Major Smartphone Platform Distribution Channels Android
Market App Store Windows Marketplace
for Mobile Ovi Store BlackBerry App
World Palm App Catalog
Operator Google Apple Microsoft Nokia Research In Motion Palm Start date Oct-08 Jul-08 Sep-09 May-09 Apr-09 Jul-09 OS/Runtime Android OS iPhone OS Windows OS Symbian OS BlackBerry OS WebOS Apps offered 55,000 85,000 1,000 10,000 6,000 1,000 Users (M) 20 100 NA Over 100 41 5 Charge methods Credit
Source: J.P. Morgan, based on "Internet White Paper 2010" (Impress Japan).
Overseas Social Gaming Networks Description Platform
OpenFeint Social gaming platform, with DeNA as a passive investor iOS, Android Plus+ ngmoco's social game platform iOS, soon Android Gameloft Live Gameloft's mobile gaming network with 1.5 million users iOS, Android Score∞p Funded by European VCs Target Partners and Earlybird iOS, Android AGON Online Operated by Aptocore founded in 2008 iOS Crystal Platform devised by Chillingo, now acquired by Electronic Arts iOS Social Gaming Network A game developer on iOS for multiplayer games iOS, soon Android Source: J.P. Morgan based on company data.
Efficiency of capital ROE (%) F’10E 26.2 16.2 11.9 63.9 55.9 17.9 37.7 13.8 29.8 ROA (%) F’10E 18.8 2.0 9.3 29.0 31.7 - 26.6 - - ROCE (%) F’10E 43.4 11.4 23.2 102.5 94.2 23.6 45.0 25.9 44.6 Source: Company data, Bloomberg and J.P. Morgan estimates. Note: Yahoo Japan, Rakuten, Mixi, DeNA and Gree are based on J.P. Morgan estimates. CyberAgent, Kakaku.com and Gourmet Navigator are based on Bloomberg consensus estimates. Share prices as of December 29, 2010.
Korea Sector Summary We recommend investors switch from NHN to Daum for internet exposure based on Daum’s superior growth outlook and valuation merit. We believe Daum is currently oversold due to overblown concerns on the Overture impact as well as its small market cap. As a result, Daum is currently trading at a deep discount to market leader NHN, despite the fact that it has a better growth outlook and its revenue consists of only search and display ad compared to NHN which generates about 30% of revenue from the lower multiple business of internet gaming.
As Overture concerns fade and Daum continues to generate superior earnings over the next few quarters, we believe the valuation discount will disappear and this will drive continued outperformance for Daum.
Divergent Growth Momentum Daum has been gaining market share in both search and display from 2008 based on improved service quality and renewed focus on core businesses. Given basic traffic volume that amounts to over 70% of NHN’s, we believe Daum’s growth momentum has more legs. Daum currently targets to increase its search market share to 30% by 2012 from the current 22%, while it has been raising pricing for both search and display ad more aggressively than NHN on the back of a big pricing gap.
Overture Impact As NHN defects Overture, which is a middleman between portals and advertisers, to internalize the intermediary platform business, Daum faces potential losses in advertiser pool. Such defection is seen as a threat, as it will likely lower clearing prices at Overture. While Daum was guiding for a maximum 20% decline in pricing over the next two years, its view has changed to a more positive one recently based on interaction with resellers. This means overall pricing pressure may turn out to be substantially smaller than previous guidance suggested, in which case there is room for positive earnings revisions from the Street over the next few months.
Positive Mobile vs. Negative SNS Impact in 2011 The internet sector is a very dynamic space where consumer preferences can change on a whiff. As such, the recent surge in popularity of SNS services such as Facebook and Twitter are negative developments for NHN and Daum in that they could lure away traffic in the longer term. For now, however, we think the impact is limited due to a relatively small user base for these new services but the longer-term impact will depend on how NHN and Daum can protect their traffic base by offering their own SNS services to satisfy consumer needs.
Mobile service, on the other hand, provides new growth momentum, as smartphone penetration is headed for over 30% in 2011E. As consumers increasingly access web on the move, this should create additional demand for Internet portals down the road. In this space, Daum is also leading NHN for now on the back of earlier investments in mobile content.
Russia Internet Industry Summary With over 53.3M internet users at the end of 2009, Russia is the second-largest internet market in Europe. While the internet penetration in Russia has already reached relatively high levels – 37.8% at the end of 2009 – we still believe that growth prospects for Russian internet companies remain high, as when we consider the potential addressable market share, we should take into account not only the Russian population but also Russian speakers in the former Soviet Union and Russian communities in other countries across the globe. The overall target audience of Russian-speaking potential internet users exceeds 250M. We expect that internet penetration in Russia is likely to increase to c47% in 2012 (66.5M) on the back of expected increases in PC, broadband reach and lack of entertainment, especially in the lower-income regions of Russia. Social networking is by far the main driver of online engagement in Russia, as the average Russian spends 6.6 out of 15 hours per visitor per month in social networks. We project that the Russian online advertising industry will expand at c29% CAGR during 2010-13 to reach $1.75B, driven by Russian GDP growth, expansion of private consumption and internet advertising budgets. The Russian IVAS market is expected to grow at an even faster pace – 33% CAGR during 2010-13E to reach $1.65B, on the back of increasing purchasing power of the Russian population and mainly driven by social games and other paid services segments.
Russian Online Market Overview Russia – 2nd-largest European market by user . . . We estimate that at the end of 2009 Russia had the second-largest internet audience in Europe, with 53.3M users – 7th largest globally after China (420M), the US (240M), Japan (99M), India (81M), Brazil (76M) and Germany (64.4M). We estimate that, by 2013, the Russian internet audience may surpass the German market, reaching a total of over 68M users.
Russia Is the Second-Largest Market in Europe by Users, 1Q’10 M internet users
64.453.3 51.5
36.931.1 28.6
20.910.7
0
20
40
60
80
Germany Russia UK France Italy Spain Poland Ukraine Source: Internetworldstats, ITU, J.P. Morgan estimates.
Number of Internet Users in Russia vs. Penetration lhs: M users; rhs: % penetration
0
25
50
75
100
2006 2007 2008 2009 2010E 2011E 2012E 2013E
0%
20%
40%
60%
80%
100%Number of internet users, mn Internet penetration as % of population
Source: J’Son & Partners (September 2010), ITU, J.P. Morgan estimates.
Internet Penetration as Percentage of Population (1Q’10) 83% 81% 79% 78% 78% 77%
69%58%
45% 43% 38% 37% 32%
7%
0%
20%
40%60%
80%
100%
UK SouthKorea
Germany Japan Canada US France Poland Turkey Iran Brazil Russia China India
Source: Internetworldstats, ITU, J.P. Morgan estimates.
. . . but still underpenetrated. Despite the relatively large size of the Russian internet market, we believe it remains underpenetrated when compared to other markets, both in Europe and in Asia: we estimate internet penetration at roughly 37% in Russia vs. 79% in Germany, 58% in Poland, 45% in Turkey and 38% in Brazil.
Internet penetration varies widely across Russian regions. Internet penetration of some parts of Russia (such as the city of Moscow or the North-West region) is significantly higher than the country average. This is explained by higher-than-average disposable incomes in those parts of the country, which stimulate faster infrastructure development.
Internet Penetration in the Federal Russian Districts (2H09) %
We may see a considerable variation by internet connection price in different regions. Moscow has the cheapest average cost per connection, roughly $3.5, while in the Far-East Federal District of Russia this rises to $49. This partially explains the growing popularity of mobile internet in the Russian regions as it becomes often cheaper than fixed line connection.
Price per Connection and Number of Web Domain Comparisons, by Region average price for connection
1000mbit/s (RuR) average price for connection
1000mbit/s ($) number of web domains per 1000 users Moscow 106 3.5 193 Central (without Moscow) 489 16.3 43 North-West 584 19.5 23 South 896 29.9 22 Volga 320 10.7 20 Urals 321 10.7 33 Siberian 546 18.2 25 Far East 1465 48.8 17 Source: GroupM, FOM.
Age groups younger than 24 years of age already have the highest internet penetration in Russia (roughly 73% in 2009). However, we note that the fastest-growing segment of internet users has so far been the 35-44 segment and that this segment is likely to drive growth of penetration in the near future, we believe.
Internet Penetration by Age Group 2007 2009 growth
Russians are 50% more engaged in social networking than Germans. Russia has the most engaged social networking audience in the world, with visitors spending an average of 6.6 hours and viewing 1,307 pages per month in May 2009. User engagement of the social networking audience in Russia has increased since then, with visitors spending an average of 10.8 hours in July 2010 on social networking websites.
Social Network Engagement Comparison by Country Country Average Hours per Visitor per month Average Pages per Visitor per month Worldwide 3.7 525 Russia 6.6 1,307 Brazil 6.3 1,220 Canada 5.6 649 Puerto Rico 5.3 587 Spain 5.3 968 Finland 4.7 919 United Kingdom 4.6 487 Germany 4.5 793 United States 4.2 477 Colombia 4.1 473 Source: comScore (July 2009).
Engagement is growing. Internet users in Russia are increasingly more active online, mainly driven by social networking phenomenon, which is driving engagement (amounted to 25% in 1Q’10 on the daily basis vs. 10% in 1Q’07). We also highlight that the gap between daily and monthly reach is diminishing.
Engagement %
10%14%
18%
25%22%
26%31%
37%
0%
10%
20%
30%
40%
1Q10 1Q08 1Q09 1Q10
Daily users, % Monthly users, %
Source: MASMI, FOM.
Time spent on social network hours per month
10.8
4.7 4.6
0
4
8
12
Russia US Global Av erage
Source: comScore, July 2010.
We highlight that growth of usage in Russia has been driven not only by a rising number of total internet users in Russia (53.3M users in 2009 vs. 44.8M users in 2008) but also by the rising time spent by Russian users online.
Internet Usage in Russia Jun-09 Jun-10 Y/Y
Average hours per Internet user per month 15 23 50.0% Average page views per Internet user per month 2,128 3,154 48.2% Ratio of daily internet users to monthly users, % 40 50 25.1% Source: comScore (June 2010).
Frequency of internet use. Most internet users go online for more than three hours a day and send up to three emails during that time.
Daily Time Spent on the internet (2009) %, measured among daily internet users
0%
10%
20%
30%
40%
less then 1hour
1-2 hours 3-4 hours 4-6 hours more than 6hours
no answ er
Source: MASMI, FOM.
Daily Number of Emails %, on average
0%
10%
20%
30%
40%
50%
less then 1e-mail
1-3 e-mails 4-10 e-mails 11-20 e-mails
21-50 e-mails
more then 50e-mails
no answ er
Source: MASMI, FOM.
Reasons for further engagement growth. We believe that further growth of internet engagement in Russia will be driven by a number of cultural factors, including a high level of education (28% of employed Russians have a higher education degree), willingness to embrace technology as indicated by the level of PC penetration (39% of households in 2009), lack of entertainment and harsh climate conditions (stimulating indoor entertainment).
Russian Internet Revenue Breakdown Summary of online segment dynamics. When looking at Russian internet market revenues, we consider two key segments: online advertising and internet value-added services (IVAS) revenues. In 2010, we expect each of those segments to contribute $670-700 M. We estimate that, of the two subsegments of online advertising, display and contextual (search), 39% of revenues come from display and the rest from contextual. On our estimates, both of those subsegments will be growing at roughly a similar pace – CAGR 29-30% during 2010E-13E. The two key subsegments of the IVAS market are MMO games and Community IVAS (social games and other paid services, such as virtual gifts, etc.). On our estimates MMO games will expand at CAGR of 21% during 2010E-13E, while Community IVAS will grow at 42% CAGR for the same period.
Nominal GDP ($ B) 1,666 1,232 1,472 1,662 1,855 2,089 12.4% Population (M) 142 140 142 142 142 142 GDP per capita ($) 11,739 8,697 10,408 11,782 13,178 14,878 GDP deflator, average 18.0% 2.3% 8.0% 6.5% 6.6% 6.0% Real GDP growth 5.6% -7.9% 5.0% 5.0% 5.0% 5.0% RUB/$, average 24.9 31.7 30.4 31.0 31.0 31.0 Gross Total advertising market, (RUB B) 277.4 204.0 237.8 274.6 315.8 361.6 15.0% growth Y/Y 18% -26% 17% 16% 15% 15% Net total advertising, RUB B* 199.0 135.9 156.9 181.3 208.4 238.7 15.0% Net total advertising, $ M 8,000 4,285 5,171 5,847 6,724 7,699 14.2% Advertising spending (net)/GDP (%) 0.48% 0.35% 0.35% 0.35% 0.36% 0.37% Net Ad spend per capita, $ 56.4 30.6 36.5 41.3 47.5 54.3 Net Internet share* 7% 12% 13% 15% 17% 19% Net Internet, $ M 567.6 498.6 686.3 888.3 1149.6 1454.7 growth Y/Y 42% -12% 38% 29% 29% 27% Gross Internet, $ M 708 600 827 1,070 1,385 1,753 Net Internet, RUB M 14,122 15,809 20,828 27,537 35,636 45,095 29.4% growth Y/Y 38% 12% 32% 32% 29% 27% Share of Display in total 42% 41% 39% 38% 37% 37% Share of Contextual in total 58% 59% 61% 62% 63% 63% Russian IVAS market, $ M 153 364 712 1,034 1,347 1,652 32.4% MMO Games market, $ M 134.3 223 358 464 562 637 21.1% Community IVAS market, $ M 18.5 140 354 570 786 1015 42.1% Source: RACA, GroupM, J.P. Morgan estimates. * Not accounting for VAT and client discounts.
Share of net internet revenues to reach 19% by 2013E. Russian internet advertising was the only segment that showed positive growth in 2009, while all other segments of the advertising industry declined by 18-43%. We believe that internet advertising in Russia will be the fastest-growing segment of the advertising industry, expanding at a 2010E-13E CAGR of 29.4% in LC and increasing as a share of total net advertising from 13.3% in 2010E to 18.9% in 2013E.
Search/display breakdown to remain stable. We expect internet market breakdown between contextual (search) and display to remain unchanged for the next three years at a c40/60 split respectively, as we do not expect a major shift by advertisers toward performance-based advertising forms.
IVAS segment to grow ahead of the internet industry. While online commerce remains undeveloped in Russia and still only a fraction of internet revenues, partially due to a lack of reliable online payment systems but also due to lack of software, we expect those segments to grow ahead of the industry: the Russian internet value-added services market is projected to grow at 32% CAGR for the 2010E-13E period. Although payment infrastructure is underdeveloped, we note that there are solutions for online payments, such as Qiwi, that show traction on revenue growth.
Key Industry Players Having analyzed the traffic data, we would highlight six top internet companies in the Russian internet space: Mail.ru Group, Yandex, VK, Rambler, Google and RBC.
Top Five Russian Internet Companies (by monthly unique Russian visitors) M visitors
October 2009 October 2010 Yandex 21.9 26.7 Mail.ru Group* 20.5 25.9 VK 16.9 21.5 Rambler 12.6 15.1 RBC 16.2 18.5 Source: TNS (October 2010); *Mail.ru Group combines 30 projects, including Mail.Ru sites, OK, ICQ and Headhunter. Mail.ru Group data are net of duplications.
User Dynamics of Three Largest Russian Social Networks userM
12,000
14,000
16,000
18,000
20,000
22,000
Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10
Vkontakte My World Odnoklassniki
Source: TNS.
User Dynamics of Two Largest Russian Portals userM
17,000
19,000
21,000
23,000
Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10
Yandex main Mail main
Source: TNS
Yandex. While Yandex’s website, “yandex.ru,” was first launched in 1997 and the company was incorporated only in 2000, the technology development was launched in 1989. Today, Yandex is Russia’s leader in internet search and contextual advertising. According to comScore, Yandex at the end of 2009 was the 7th-largest search property worldwide, with 1.9B searches. With 64.4% search engine traffic generated in Russia (LiveInternet.ru as of Aug 2010), Yandex is the leader in the Russian language search market, with more than 80% of Yandex revenues coming from contextual advertising. Yandex also provides a broad spectrum of other web services, including email, news, maps, photo hosting, online payments, price comparison, and social networking. Major shareholders include Baring Vostok Capital Partners, Tiger Global Management as well as the founders and management.
Mail.ru Group is the largest site in the Russian internet space, engaging almost 70% of total Russian monthly unique users. Since the advent of the Russian internet, the company has evolved from a simple web mailbox to an integrated communication and entertainment platform, offering instant messaging, social networking services, multiplayer/casual games and other paid services. In addition, the group has attractive portfolio investments in Russia (owns a 32.5% stake in Russia’s largest social network and a 25% stake in payments business) and abroad (2.38% in Facebook, 1.47% in Zynga and 5.13% in Groupon) that could provide balance sheet upside going forward.
VKontakte. Founded in 2005, the social network has become the #1 Russian language website and #1 social networking site (SNS), with over 70M registered users and 10.5M daily unique visitors. The website is the 6th most popular globally in terms of monthly page views (72.5B) and monthly minutes spent (25.5B). Mail.ru Group acquired a 24.99% stake in the company back in 2007 (recently increased the stake to 32.5%). We believe strategically it would make sense for Mail.ru Group to either increase its stake to a controlling one or to fully consolidate the asset. VK attracts a younger audience than Mail.ru’s Odnasklasniki (OK) and My World websites; 42% of VK’s user base as of July 2010 was in the under-25 age group, compared to 27% and 32% for OK and My World, respectively. VK was the first online social networking site in Russia to develop a contextual advertising system that allows users and advertisers to target advertisements to other users selectively based on information in user profiles, including gender, interests, geographies and education. VK was also the first online social networking site in Russia to open an application programming interface (API) to third-party developers.
RBC Group is a Russian media company (established in 1993) operating in the internet, TV, printed media and information-services segments. The company competes both in the online advertising market and in instant messaging (QIP – 3rd largest instant messaging service in Russia. Back in June 2010, Russia’s Onexim Group, owned by businessman Mikhail Prokhorov, bought a 51% stake in RBC for $80M, while another 11.5% is owned by Polyus Gold, in which Onexim is a blocking shareholder.
Rambler is an internet search engine that was developed in 1996. The company generates revenues from advertising (banner ads, context ads, sponsored key word searches), eCommerce referral and product placement. Based on TNS Gallup data, the company had c13.8 M monthly unique visitors in Russia on average in 2Q’10. The company also holds a 51% stake in contextual advertising business Begun. It was delisted from the London Stock Exchange (AIM) in 2009 and is currently 100% owned by Prof-Media Group.
QIWI. The company is the largest consumer payment processor in Russia, providing services to over 180K point-of-sale (POS) terminals (only owns a small number of terminals for replacement of terminals at agents). Being an almost-pure software company, Qiwi enjoys strong revenue growth without significant investments. Mail.ru Group acquired a 25.09% stake in the company in July 2007. Strategically, the blocking ownership stake makes sense as those systems will be the key channel for people inserting money into the system. The popularity of POS cash collection points (used to pay bills, etc.) is explained by consumers lacking credit/debt cards in Russia (payment card penetration is still only 0.8 cards per inhabitant).
Ozon.ru. Founded in 1998 as one of the first eCommerce projects in the business-to-consumer (B2C) segment, Ozon is Russia’s most popular internet shop operating in the Russian market (network covers 80% of Russian population) with over 600K of assorted goods (revenue breakdown: 30% books/CDs; 30% small electronics – one of the largest retailers in Russia). Ozon has 3.5M registered visitors and 400K active customers. In 2009 Ozon had roughly $100M of turnover, of which c52% came from Moscow and 15.6% from St. Petersburg. The company expects 40-50% revenue growth in 2010. The company has its own warehouse – 12,000 sq. m. – and will have enough capacity for the next 3 years. One key advantage enjoyed by Ozon is that it has its own courier company – distribution is very important in Russia; the post is
unreliable (only 10% of Ozon purchases are shipped via Russian post – to places that are difficult to reach otherwise).
Avito.ru. Founded in 2007, Avito.ru is currently Russia’s largest and fastest-growing online classified (consumer-to-consumer) trading business, with c11M unique visitors (vs. 3M users at the end of 2009) and over 2M new listings per month. Craigslist in the US, Leboncoin in France and Blocket in Sweden are its closest global peers with similar business models. Following Avito.ru’s successful operations in Moscow and St. Petersburg, the company in the fall of 2010 began expanding to other Russian regions (targeting operations in 10+ large cities). The listings are free of charge as the company is building up the brand in Russia, but the monetization process (premium services, AdSense, display, etc.) has begun in 2010 and is expected to ramp up significantly during 2011.
Russian Advertising Market Investments into Russian advertising dried up in 2009 due to falling consumer spending; however, advertising in online advertising continued to expand, led by paid search. Consistent with J.P. Morgan’s Russian nominal GDP forecasts of 14% CAGR for the period 2009-13E, we project that the Russian net advertising market will grow 15% in RUB terms for the same period, driven by a growing share of ad spend as a percentage of GDP (net ad spend in Russia amounted to 0.35% of GDP in 2009 and is projected to grow to 0.37% by 2013). We highlight that, instead of gross advertising, we focus on revenues net of discounts (which have risen as high as 35% in favorable economic conditions).
Russian Net Advertising Market lhs: RUB B; rhs: % growth
The Russian net advertising market saw a drop of 32% in 2009 in LC, but we expect growth to resume in 2010 (up 15.5%) and the net ad market to reach RUB226B by year-end 2013E, as the Russian economy recovers.
Russian Online Advertising Industry Share of online advertising relatively low. Despite its relatively low cost, internet advertising does not yet serve as a substitute for television advertising due to the relatively small audience size. Compared to other countries, the share of gross online advertising (does not account for discounts) in the total ad market is still relatively low in Russia: only 9% vs. 16% in China and 14% in the U.S. This is partially explained by a relatively low level of broadband penetration (30% in Russia vs. 69% in the U.S.). Prospects for broadband development in Russia are relatively attractive, given the economics of FTTB/DOCSIS roll out (cheap compared to Western Europe), so VIP/MTS, the top 2 mobile operators, are both involved in FTTB rollout. This is positive for usage/time spent on line. Even today we see that Russians can be considered heavy Internet users, despite relatively low penetration. We thus believe that, with a growing number of users and improvements in infrastructure, it looks like Russia is shaping up as an attractive internet market.
Share of Online Advertising in Total Gross Ad Revenues 2009, in % terms
We expect the share of internet advertising to grow. Over the next three years we believe the share of TV ad market will remain broadly flat, while the share of gross internet revenues will expand to c14% (vs. 9% in 2009), growing mainly at the expense of press and radio segments of the industry. Notably, most TV advertising revenues in Russia are still derived from consumer staple sectors such as food and household products, with consumer discretionary sectors such as finance, insurance and retail strongly under-represented. TV advertising remains brand/image advertising by nature. As the economy matures and disposable incomes rise, consumer discretionary sectors should increase their advertising budgets and explore new marketing channels, including the internet, in our view.
Gross Ad Market Breakdown by Types %
2009 2010E 2011E 2012E 2013E TV 55.7% 55.3% 55.3% 55.3% 55.3% Other 35.0% 34.1% 32.6% 31.1% 29.7% Internet 9.3% 10.6% 12.1% 13.6% 15.0% Source: J.P. Morgan estimates.
In value terms, the internet market is expected to grow at CAGR of 29.4% during 2010E-13E, reaching RUB54.3B ($1.75B vs. c$600M in 2009). We expect support for online advertising mainly to come from growing broadband penetration and the redistribution of advertising budgets in favor of the cheaper internet.
Gross Ad Market by Types (RUB M) RUB M, unless stated otherwise RUB M 2009 2010E 2011E 2012E 2013E CAGR 10E-13E TV 113,655 131,492 151,873 174,654 199,979 15.0% Growth, % -18% 16% 16% 15% 15% Other 71,368 81,193 89,584 98,241 107,315 9.7% Growth, % -41% 14% 10% 10% 9% Internet 19,026 25,094 33,178 42,935 54,332 29.4% Growth, % 8% 32% 32% 29% 27% Source: Video International; AKAR: Zenith Optimedia; J.P. Morgan estimates.
Online Display Advertising Attractive CPT. Television is still the cheapest advertising medium in Russia on the basis of cost per thousand (CPT) – a commonly used measure to calculate the relative cost of an advertising campaign – as it offers the largest audience and greatest reach. However, we believe internet will soon begin offering low CPT, comparable to TV’s, which together with the growing online population that already exceeds that of some TV channels and flexible targeting and measurement capabilities, should lead to the rapid development of the display ad industry.
Cost per Thousand in Russia in 2009: Relative Costs of Different Media USD
0
2
4
6
TV Radio Internet New spapers Magazines Source: CTC Media.
We expect the display ad segment to expand at a CAGR of 39% during 2010E-13E.
Gross Display advertising ($ M) 244 321 405 516 653 38.8% growth Y/Y -18% 32% 26% 28% 27% Net Display advertising (RUB M) 6,414 8,095 10,408 13,278 16,806 37.9% growth Y/Y 6% 26% 29% 28% 27% Net Display advertising ($ M) 202 267 336 428 542 38.9% growth Y/Y -17% 32% 26% 28% 27% Share of Display in total online advertising revenues 41% 39% 38% 37% 37% Source: GroupM, J.P. Morgan estimates.
Three leading categories (auto, telecom and FMCG) account for 64% of total display spend. In 2009, Mobile TeleSystems was the biggest online spender, investing $9.7M compared to $7.2M for Megafon and $6.1M for Vimpelcom (source: consulting agency GroupM). Most of the car advertisers doubled or even tripled their online display budgets during 2009, while finance showed the highest decrease Y/Y due to the economic downturn in Russia. Mail.ru doesn’t have a single advertiser responsible for more than 5% of its display revenues.
Top 10 Advertisers in Display Ad Market ($ ’000, net)
2008 2009 Share in total Media budget of
the brand in 2009 (%) Y/Y growth % MTS 5950 9755 11,1% 64% Renault-Nissan 4795 7275 20,8% 52% Megafon 5790 7210 9,6% 25% Beeline 4960 6120 7,3% 23% PSA Peugeot Citroen 2315 5620 21,8% 143% Volkswagen Audi Group 1355 5355 13,1% 295% Toyota Motor Co. 2085 4995 17,1% 140% Samsung 3805 4630 12,1% 22% Procter & Gamble 1985 4530 2,8% 128% Ford Motor Co. (Ford only) 3470 3970 10,9% 14% Source: MindShare Interaction.
Contextual Advertising Engine of growth. Contextual advertising covers consumers’ immediate demands and provides higher measurability and cost-efficient transparent status. Over the past decade, contextual advertising has shown rapid growth levels and has been considered the financial engine of internet advertising. The share of contextual advertising in the Russian online market grew from 36% in 2004 to 59% in 2009, overtaking the share of display advertising. However, according to Group M estimates, this share will likely stabilize. During the crisis, contextual advertising continued to expand (up 17% in 2009), and we expect net contextual ad segment revenues to expand at a CAGR of 32.5% during 2009-13E on the back of: 1) online penetration growth resulting in an increasing number of search visitors and queries; 2) the growing number of small businesses that use mostly contextual rather than display advertising; 3) continued reallocation of budgets away from traditional (more expensive) advertising.
Going forward, we expect continued transformation of search advertising toward more content-focused ads. We note, however, that the primary focus of Mail.ru Group is display advertising and that it does not plan to invest in contextual advertising agencies, preferring to focus on growing its own search engine.
Net Contextual advertising $ M 296 411 553 721 913 32.5% growth Y/Y -8% 39% 35% 31% 27% Gross Contextual advertising $ M 356 495 666 869 1,099 32.6% Net Contextual advertising RUB M 9,395 12,733 17,130 22,359 28,290 31.7% growth Y/Y 17% 36% 35% 31% 27% Gross Contextual advertising RUB M 11,288 15,341 20,638 26,938 34,084 31.8% Share of Contextual in total 59% 61% 62% 63% 63% Source: AKAR; CNews; Rambler; RBC; ZenithOptimedia; J.P. Morgan estimates.
Search Market In the past, local search engines globally have been able to defend their market share due to language and cultural barriers. However, modern machine-learning techniques reduce language barriers quite dramatically, and Google, with its continued innovations, dominates search in all major internet markets. The only exceptions are Russia (dominated by local player Yandex), China (led by home-grown player Baidu), Japan and South Korea. We think Yandex’s competitive strength lies in the area of technology and superiority in understanding of local culture and local user needs.
Over the past 18 months, the Yandex search engine has maintained its leading position in the Russian internet (Runet), having increased its search share from 56.4% in January 2009 to 64.6% in June 2010 (source: Liveinternet.ru). In June 2010, the number of portal page views reached 10.7B pages, demonstrating growth of over 80% compared to June 2009. The monthly number of search result pages increased 50% Y/Y and was 220M pages as of June 2010. We highlight that during the period all major Yandex competitors, including Google, lost market share.
From the beginning of 2010, Mail.ru Group has offered search services using internally developed search engine technology. However, the company generates revenue from its internally developed search engine services through context advertising furnished through Google’s AdWords technology. This technology displays relevant ads using an auction-based program from Google in which advertisers bid to have their sponsored advertisements appear when specified search queries are entered. When a customer clicks on a sponsored advertisement, Google receives a fee from the advertiser and shares a portion of that revenue with Mail.ru Group. This contract is expected to be reviewed in January 2011, when Mail.ru Group may continue with Google or switch to Yandex.
Search Engine Traffic Generation in Russia, Jan 2009 % of Russian users coming to Russian sites via search
Yandex 56.4%
Google 23.1%
Mail.ru 9.2%
Rambler 6.1%
Other 5.3%
Source: Livejurnal.ru.
Search Engine Traffic Generation in Russia, Sept 2010 % of Russian users coming to Russian sites via search
While Google has made a significant push to move more aggressively and has created its own Russian language ad agency, it was not able to retain its search engine traffic generation share.
Growth Rate in the Number of Queries of Key Russian Players Number of transitions to web-sites based on counters
Russian Online Games Industry The average number of internet users reached almost 49M in 2009, of which 4.2% were playing MMO games, 1.7% were engaged in casual games and 17.7% involved in social network games. The highest share of MMO gamers are men in the 18-24 age group; both men and women in the highest age group (25-34) are equally engaged in the social network games, while the highest share of casual gamers are women in the 35-44 age group.
Sociodemographic Categories of Online Game Users (2009) Game type Age categories, % Gender structure, %
12-17 18-24 25-34 35-44 >45 Women Men ММО games 20.0% 35.0% 29.0% 10.0% 6.0% 38.0% 62.0% Casual 10.0% 15.0% 26.0% 30.0% 19.0% 70.0% 30.0% Social Network games 5.0% 32.8% 40.5% 14.1% 7.6% 52.0% 48.0% Source: J’son & Partners.
MMO Games Market The popularity of MMO games in Russia is growing quite rapidly (up to 3.4M users in 2009 vs. 2.5M in 2008); however, the market is relatively young in Russia, and the user base is dominated mostly by the so-called “hard-core” gamers (experienced and committed users), which explains the high level of ARPU in Russia (c$38/month, more than double the levels seen in China). MMO games are broken down by Client games installed on the users’ PCs, or Browser games accessible via any internet browser. MMO games typically have a free-to-play revenue model, in which basic game play is free of charge, but users can purchase in-game enhancements, typically by short messaging service (SMS) or via online payment systems.
1Q09 2Q09 1H09 3Q09 4Q09 2H09 2009 1Q10 2Q10 1H10 Legend 18,686 17,020 17,853 17,225 18,223 17,729 17,791 16,585 19,819 18,202 share of total active UU 23.8% 20.6% 22.2% 19.1% 18.2% 18.6% 20.2% 17.2% 19.4% 18.3% Allods Online 19,623 16,091 21,560 18,826 share of total active UU 31.3% 21.2% 31.7% 26.1% Perfect World 32,514 42,038 37,276 47,353 57,753 52,553 44,915 68,197 63,121 65,659 share of total active UU 23.4% 25.0% 24.3% 24.1% 26.7% 25.5% 25.0% 27.8% 22.4% 24.9% Source: Company data.
MMO games usually have a long life cycle but are relatively more expensive to develop than, for example, community games (may cost up to $15M) and take longer to develop (up to 3 years). The development of a new MMO title can cost as much as $10 million or more for a highly rated game that can compete globally.
MMO Games Market in Russia 2008 2009 2010E
Client games users, M 1.5 2 2.5 Browser games users, M 1 1.4 1.6 Share of paying players among MMO game players 19.5% 28.7% 31.7% Monthly ARPU 38.2 31.4 31.4 Client games revenue, $ M 81 134 210 Browser game revenue, $ M 54 89 140 Total MMO market, $ M 135 223 350 Source: J’Son & Partners (Sept 2010).
Highly competitive market. Having acquired Astrum Online, Russia’s largest online gaming business, in 2009, Mail.ru Group managed to secure leading positions in the Russian MMO games market. Of the international players, so far only Blizzard had a significant presence in Russia, with c10%. We note the market, however, remains highly fragmented, with c50% of the market taken up by a large number of small domestic players.
Community IVAS Community internet value-added services (IVAS) include social games as well as other paid services such as virtual gifts and avatars. Social games are linked within a social network environment and are usually less sophisticated games than MMO games that users may casually play without a strong commitment. Social games target a broad audience and are easily accessible and engaging but are less likely to capture a user’s attention over longer periods of time. Social games are typically less expensive and faster to develop ($100-500K) than MMO games but also have a much lower ARPU (c$3). The paid services market encompasses user payments for additional content and features on a social network. Some of the most popular paid services enable users to limit the information shared about their profile, send virtual gifts to their friends and enhance their profile with additional graphical images.
Community IVAS Market in Russia 2008 2009 2010E
Number of social network users, M 22.5 31 37.5 Share of paying social game players, % n/a 6% 7.60% Share of paid services users, % n/a 8.50% 12% Monthly social games ARPU, $ n/a 2.9 3.1 Monthly paid service ARPU, $ 0.5 2.8 4.3 Paid service revenues, $ M 6 77 212 Social games revenues, $ M n/a 28 97
eCommerce Over the past year two years we have seen an increase of cards used for retail purchases of goods and services in Russia; however, the share remains negligible compared to Europe’s and the US’s – only 3.8% of purchases made via cards in 2009. This was the main reason for a slow development and lukewarm monetization of the IVAS industry in Russia, with the lack of availability of payment methods affecting users’ willingness to pay for goods and services online. In Russia, as in many CIS countries, the lack of card infrastructure is substituted by various electronic money solutions, including SMS-based billing systems. In Russia, the majority of payments on social networks are still conducted through SMS. Another money solution is a network of payment terminals installed in convenient locations. The terminals may also be used for topping up mobile phones and making utility payments and money transfers. The top three operators of payment terminals in Russia combined had over 600,000 terminals and a turnover (total volume of payments processed) of approximately $15B in 2009.
Instant Messaging (IM) Mail.ru Group with its two assets (Mail.ru Agent and ICQ) is the leader in the Russian IM market – in December 2009 the company had c.16.5M unique users (UU), while one of its closest competitors, QIP, had 5.4M UU. We expect instant messaging to become more integrated in the social environment, enriching the consumer web experience through video applications and mobile devices.
Mobile Internet to Boost Usage The usage of cellphones to go online has not been widely used in Russia. This was partially due to the limited availability of 3G (has been introduced in many Russian cities throughout 2009 but was only launched in Moscow – the largest smartphone market – at the end of 2009). However, the main reason for limited use of mobile internet is a small share of smartphones (only about 6-7% by our estimates). The reason for such a small number of smartphones in Russia is the lack of subsidies from mobile operators on the handset market (the cheapest iPhone 4 is worth more than $1,000 per handset). However, we believe that this is likely to change once we see an inflow of affordable Korean and Chinese smartphones into the Russian market (expected in 2011).
Amazon.com (AMZN;AMZN US) 2009A 2010E 2011E 2012EEPS Reported ($) Q1 (Mar) 0.41 0.66A 0.78 1.11 Q2 (Jun) 0.32 0.45A 0.74 1.03 Q3 (Sep) 0.45 0.51A 0.77 1.01 Q4 (Dec) 0.85 0.93A 1.38 1.99 FY 2.03 2.55A 3.67 5.14Source: Company data, Bloomberg, and J.P. Morgan estimates. Note: The estimates above are GAAP estimates which include the impact of FAS123R.
Company Data Price ($) 183.37Date Of Price 29 Dec 1052-week Range ($) 185.65 - 105.80Mkt Cap ($ mn) 83,433.35Fiscal Year End DecShares O/S (mn) 455Price Target ($) 199.00Price Target End Date 31 Dec 11
We are maintaining our Overweight rating on Amazon as we believe the company will see continued market share gains in the eCommerce market. We also maintain our December 2011 price target of $199.
Amazon continues to gain market share. Through the first 9M’10, US retail sales grew 7%, US eCommerce grew 14% and Amazon North America retail revenue was up 46% Y/Y. We think Amazon has benefited from the development of its third-party platform as well as from a broader secular shift toward multichannel selling. Amazon currently holds ~14% of US eCommerce market share (on a gross revenue basis), and we see more opportunity for the company to gain share from competitors, including eBay (~11% of US market share), Target, Staples and others.
Structural margins should grow to the low double digits. As Amazon builds out categories within EGM that go beyond electronics, such as apparel and home furnishings, we think margins can rise. Electronics tend to carry very low gross margins (low teens) compared to Apparel (roughly 45%) and Home Furnishings (roughly 28%). Additionally, we expect margin expansion to result from continued leverage in fulfillment and tech & content. For example, as a percentage of revenue, we estimate fulfillment is ~8% of revenue in 2010 compared to 12% in 2001. Likewise, we expect tech and content to comprise ~4% of revenue in 2010, down from 8% in 2001.
International eCommerce remains in a very early stage. We estimate Amazon will derive ~46% of F’10 revenue from its int’l business. Though ecommerce represents an extremely small percentage of international retail, we expect penetration to increase as broadband penetration improves and consumers grow more comfortable shopping online. Therefore, we believe Amazon retains significant runway for revenue growth in the international markets.
Low capex drives strong FCF generation. We expect capex at less than 3% of net revenue in F’10, compared to 9% and 14% for Google and Yahoo!, respectively. We think the low need for investment, coupled with long-term prospects for margin expansion, should allow Amazon stock to trade at attractive multiples through the medium-to-long term. Additionally, we believe Amazon’s strong free cash flow generation creates a large buyback opportunity.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, EBITDA and EPS estimates of $44.90B, $3.20B and $3.67, respectively.
Our F’12 estimates call for revenue, EBITDA and EPS of $56.40B, $4.23B, and $5.14, respectively.
J.P. Morgan Estimates $ in millions except EPS
4Q’10E F’10E F’11E F’12E Revenue 13,036 34,293 44,904 56,397 EBITDA 823 2,458 3,202 4,232 EPS 0.93 2.55 3.67 5.14 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $199 We are maintaining our year-end 2011 price target of $199. Our price target is derived using a DCF analysis, with the parameters below.
Key DCF Assumptions Equity beta 1.04 Risk free rate (10yr yield) 2.5% Risk premium 8.5% Cost of Equity 11.4% Cost of debt 6.9% Final debt ratio 5.0% Equity as a % Cap 95.0% Source: Company reports, Bloomberg, J.P. Morgan estimates.
Valuation and Rating Analysis AMZN trades at a premium to its peers. Our F’11 assumptions yield a 2011E EV/EBITDA multiple of 24.7x our F’11 EBITDA estimate of $3.20B versus the eCommerce group at 14.3x. However, we expect Amazon to grow EBITDA by 30% Y/Y in F’11 vs. its peer group at 22%. Given the company’s rapid long-term revenue growth rate and superior industry position, we believe the stock has capacity to see further multiple expansion. In addition, our DCF analysis provides upside to the current price, hence our Overweight rating.
Investment Risks AMZN could underperform if it encounters difficulties in its international expansion, including regulatory hurdles that make the business climate less hospitable or less profitable than those of the markets in which it currently operates. Amazon may have difficulty growing revenues while maintaining its current operating margins. Amazon could suffer if consumer spending continues weakening or remains depressed longer than we expect. Amazon faces competition from a variety of online and offline retailers, and improved offerings from these competitors could hamper Amazon’s growth.
Company Data Price ($) 24.09Date Of Price 29 Dec 1052-week Range ($) 29.45 - 19.61Mkt Cap ($ mn) 2,584.86Fiscal Year End DecShares O/S (mn) 107Price Target ($) 26.00Price Target End Date 31 Dec 11
We expect AOL to start seeing recovery in graphical revenue in ’11 but think that continued loss, albeit at a slower pace, of subscription and search revenue, combined with investment in patch, will drive another year of adjusted EBITDA decline; we are modeling it to decline 32.6% Y/Y to $445M.
We expect search revenue to continue declining in ’11, albeit at a slower pace than in ’10. We forecast $360M in search revenue, a 14.2% decline next year compared to the 30.6% decline we are likely to see in ’10. We estimate that in organic terms search revenue will be down ~20% in ’10; our 14.2% decline estimate for next year assumes a Y/Y benefit from a better user experience, a renegotiated GOOG deal and easier comps.
Display is likely to stabilize and return to growth next year; we are modeling full ’11 revenue growth of 5.5%. We believe that improved Y/Y pipeline as well as pricing should help recovery next year. AOL entered every quarter of ’10 with the advertising sales pipeline down vs. the previous year, due to a large sales force restructuring the company undertook. We believe that starting in Q1 ’11 this trend should reverse and the pipeline will turn positive. In addition, we think that pricing will improve by 6% domestically. Our resulting ’11 graphical revenue forecast is $539M.
Subscription revenue trajectory should continue to reflect subscriber base contraction. We are currently modeling $780M in F’11 subscription revenue, down from our $1.01B estimate for full ’10. We believe that AOL will lose 1.3 million subscribers during ’10 and will lose 700K more next year, implying rates of decline of 26.0% and 18.9%, respectively. We expect ARPU to decline 4% in ’11 to $17.43.
Cost of revenue likely to remain flattish due to reinvestment in Patch. Despite AOL’s significant cost cutting late in ’09 and early in ’10, we model cost of revenue to decline only $10M to $1.40B in ’11 as incremental investment in Patch almost entirely offsets the benefit of restructuring; our gross margin assumption for next year is 35.0%, down from the 41.1% we expect for ’10.
Our Estimates and Outlook for 2011 and 2012 Our F’11 revenue, EBITDA and adjusted EPS estimates are $2.15B, $445.5M and $0.86, respectively.
Our F’12 estimates call for revenue, EBITDA and pro forma EPS of $2.07B, $401.6M and $0.68, respectively.
J.P. Morgan Estimates $ in millions
4Q’10E F’10E F’11E F’12E Revenue 585.6 2,388 2,150 2,072 EBITDA 146.1 662.9 445.4 401.6 Adjusted EPS 0.40 2.96 0.86 0.68 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $26 We use an EV/’10E EBITDA multiple of 5x to arrive at our end-2011 target price of $26.00. We derived the multiple from the average trading multiples of UNTD, ELNK and VCLK, which we believe to be AOL’s closest comps. Our price target is based on the cash balance as of Q3 and doesn’t include potential proceeds from deals announced but not completed.
Valuation and Rating Analysis We are encouraged by the arrival of Mr. Armstrong and his team to AOL and believe that they are focused on the right challenges and opportunities. However, we think that the turnaround is likely to take time since the company has to catch up on a decade of insufficient innovation which we see as a headwind for the stock price in the midterm. On the other hand, we think the valuation (AOL shares closed at $24.09 on December 29, 2010, in line with our price target) and earnings expectations are also low and limit any potential downside. Therefore, we rate AOL stock Neutral.
Investment Risks Risks to the upside: (1) AOL subscriber base may erode at a slower pace than we estimate. This would result in incremental operating profitability vs. our current model. (2) We may be underestimating headroom left for cost cutting at AOL. (3) Display advertising pricing may improve sooner than we expect and could drive upside to our revenue and EBITDA forecast. (4) The terms of the new search deal may be better than we anticipate.
Risks to the downside: (1) Display revenue growth potential may prove to be more limited than we estimate. (2) Restructuring initiatives may take longer and require more resources to implement than we think. (3) The terms of the new search deal may be worse than we anticipate.
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AOL Inc.: Summary of Financials Income Statement - Annual FY09A FY10E FY11E FY12E Income Statement - Quarterly 1Q10A 2Q10A 3Q10A 4Q10E Revenues 3,248 2,388 2,150 - Revenues 655 584 564 586 Operating Income 449 (1,106) 150 - Operating Income 76 (1,336) 81 74 D&A 406 345 295 - D&A 116 87 70 72 EBITDA 876 698 445 - EBITDA 216 178 158 146 Net interest income / (expense) 0 (0) (5) - Net interest income / (expense) 0 0 0 (1) Other income / (expense) (3) 4 4 - Other income / (expense) (3) (4) 14 (3) Pretax income 446 (1,102) 159 - Pretax income 73 (1,341) 94 71 Income taxes 207 (211) 64 - Income taxes 35 (269) (5) 28 Net income 240 (806) 95 - Net income 35 (1,055) 172 43 Weighted average diluted shares 106 107 110 - Weighted average diluted shares 107 107 107 107 Diluted EPS 3.42 2.96 0.86 0.68 Diluted EPS 0.44 0.67 1.46 0.40 Balance Sheet and Cash Flow Data FY09A FY10E FY11E FY12E Ratio Analysis FY09A FY10E FY11E FY12E Cash and cash equivalents 147 667 1,024 - Sales growth (22.0%) (26.5%) (10.0%) - Accounts receivable 462 316 285 - EBITDA growth (43.4%) (20.3%) (36.2%) - Other current assets 78 235 235 - EPS growth 162.7% (13.4%) (70.8%) - Current assets 687 1,219 1,544 - PP&E 705 503 411 - EBITDA margin 27.0% 29.2% 20.7% - Total assets 3,963 3,075 3,308 - Net margin 7.4% (33.8%) 4.4% - Total debt 42 83 48 - Debt / EBITDA 0.0 0.1 0.1 - Total liabilities 900 817 954 - Shareholders' equity 3,063 2,258 2,353 - Return on assets (ROA) 6.0% (26.2%) 2.9% - Return on equity (ROE) - - - - Net Income (including charges) 248 (891) 95 - D&A 406 345 295 - Enterprise value / EBITDA - - - - Change in working capital 189 52 (43) - Enterprise value / Free cash flow 0.0 0.0 0.0 - Other - - - - P/E 7.0 8.1 27.9 35.6 Cash flow from operations 908 572 496 - Capex (136) (100) (103) - Free cash flow 772 472 393 - Cash flow from investing activities (152) (5) (103) - Cash flow from financing activities (750) (41) (37) - Dividends - - - - Dividend yield - - - - Source: Company reports and J.P. Morgan estimates. Note: $ in millions (except per-share data). Fiscal year ends Dec
Company Data Price ($) 58.05Date Of Price 29 Dec 1052-week Range ($) 65.48 - 40.70Mkt Cap ($ mn) 865.18Fiscal Year End DecShares O/S (mn) 15Price Target ($) 49.00Price Target End Date 31 Dec 11
We are upgrading Blue Nile to Neutral as we expect the company to benefit from an increase in consumer spending and consolidation in the industry. We are also raising estimates, and our December 2011 price target goes to $49 from $39.
4Q trends appear to have picked up. While Blue Nile’s 3Q was below expectations, on the earnings call the company noted acceleration in both traffic and sales growth thus far in 4Q. Additionally, management commented that Blue Nile had a record Thanksgiving and Black Friday, in terms of both sales and traffic. Therefore, we are slightly raising our 4Q revenue growth estimate to 9% from our prior estimate of 8%.
International markets should see some improvement. In 3Q, Blue Nile’s international revenue grew 6% Y/Y and represented ~14% of total revenues. The company saw international weakness over the past two quarters, specifically in the UK and Europe. Looking ahead, we believe the stabilization of diamond prices as well as an increase in purchasing power will help drive improvement in the international markets.
Slight EBITDA margin lift. As its revenue grows, we expect Blue Nile to benefit from SG&A leverage, driving a slight lift to EBITDA margins. We are modeling an EBITDA margin of 10.1% in F’11 compared to our F’10 estimate of 9.6%.
Raising estimates. We now expect 4Q revenue, EBITDA and GAAP EPS of $112.2M, $12.3M and $0.42, compared to our prior estimates of $111.1M, $12.1M and $0.41, respectively. However, despite our increase in estimates, we think the stock is still expensive, hence our Neutral rating.
2011 drivers. In our view, the following factors will drive NILE shares in 2011: (1) improved consumer discretionary spending; (2) diamond price trends, especially in the international markets; (3) SG&A leverage.
Raising Estimates and Outlook for 2010, 2011 and 2012 We are now modeling F’10 revenue, EBITDA and EPS estimates of $330.3M, $32.0M and $0.94 compared to our previous estimates of $329.3M, $31.7M and $0.93, respectively.
We are now modeling F’11 revenue, EBITDA and EPS estimates of $380.2M, $38.3M and $1.15 compared to our previous estimates of $371.9M, $37.7M and $1.12, respectively.
Our F’12E calls for revenue, EBITDA and EPS of $435.7M, $43.7M and $1.39 compared to our previous estimates of $413.9M, $42.1M and $1.33, respectively.
J.P. Morgan Estimates $ in millions, except per-share data
Raising Our End-2011 Price Target to $49 from $39 As a result of our newly increased estimates, we are raising our December 2011 price target to $49 from $39 previously. Our price target is derived using a DCF model with the following parameters:
Key DCF Assumptions Equity beta 1.43 Risk free rate (10yr yield) 3.3% Risk premium 7.6% Cost of Equity 14.1% Final debt ratio 0.0% Equity as a % Cap 100.0%
Source: Company reports and J.P. Morgan estimates.
Valuation and Rating Analysis On an EV/EBITDA basis, NILE trades at 21x our F’11 EBITDA estimate of $38.3M vs. its peer group at 14x. Although we expect the company to benefit from an increase in consumer spending and consolidation in the jewelry industry, we do not think further multiple expansion is likely and thus rate the stock Neutral.
Investment Risks Blue Nile is highly dependent on its diamond and jewelry suppliers, and it would be difficult for the company’s business model to tolerate large fluctuations in the prices paid to acquire diamonds and jewelry. Blue Nile faces competition from both offline and online competitors, which operate in different spaces in the jewelry market. Online competitors include: diamond.com, amazon.com, walmart.com, mondera.com, and Ashford. If the company successfully executes its international business strategy or gains market share in the US from traditional retailers, our estimates could prove to be too conservative. Further, if the economy and consumer spending turn around more quickly than we expect, the stock could outperform.
Dice Holdings, Inc. (DHX;DHX US) 2009A 2010E 2011E 2012EEPS Reported ($) Q1 (Mar) 0.06 0.05A 0.09 0.11 Q2 (Jun) 0.04 0.05A 0.09 0.13 Q3 (Sep) 0.05 0.09A 0.10 0.13 Q4 (Dec) 0.06 0.10A 0.12 0.15 FY 0.20 0.29A 0.41 0.52Source: Company data, Bloomberg, J.P. Morgan estimates. For historical performance, assumes preferred stock converted to common stock. Full-year figures may not add due to rounding.
Company Data Price ($) 14.08Date Of Price 29 Dec 1052-week Range ($) 14.27 - 5.55Mkt Cap ($ mn) 951.26Fiscal Year End DecShares O/S (mn) 68Price Target ($) 11.00Price Target End Date 31 Dec 11
We are maintaining our Neutral rating on Dice. Though we have seen signs of improvement in the business and think management continues to execute well, we believe the overall recruitment market remains tough and do not foresee a full recovery in the near future. We are maintaining our December 2011 price target of $11.
Tech & clearance should remain an attractive vertical. We believe Dice operates in an attractive recruitment vertical, as the unemployment rate for tech professionals (~4.3%) is below the overall national average of 9.8%. Furthermore, we think the tech & clearance segment will continue to benefit from an increase in new business as well as service-level upgrades, yielding higher revenue per customer. Therefore, we expect tech & clearance to grow 23% Y/Y in F’11.
Finance segment to benefit from increased penetration. We expect finance revenues to grow 23% Y/Y in F’11, with growth in all regions led by strong demand in Asia. However, we believe continental Europe and the Middle East may see a slower pace of improvement. In the US, we think eFinancialCareers will focus on leveraging its core markets as well as expanding into new regions.
Building out energy vertical. With the acquisitions of WorldWideWorker and Rigzone in May and August of 2010, we expect Dice to increase its presence in the energy sector. We are modeling energy revenues to exceed $13M in 2011.
We expect EBITDA margins of 40+% in 2011. We are modeling an F’11 EBITDA margin of 41.2%, above our F’10E 40.3%. We believe margin expansion will be driven by continued cost efficiencies as well as a slight benefit from the higher-margin Rigzone business. However, we expect management to invest in the energy businesses, specifically with increased spend in marketing and product development.
2011 drivers. In our view, the following factors will drive DHX shares in 2011: (1) the employment outlook in the US and internationally, (2) market share gains from Monster (rated Overweight by JPM internet software and services analyst Alexia Quadrani) and (3) the company’s ability to maintain EBITDA margins above 40%.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11E revenue, EBITDA and EPS of $167.6M, $69.1M and $0.41, respectively.
Our F’12 estimates call for revenue, EBITDA and EPS of $198.3M, $82.1M and $0.52, respectively.
J.P. Morgan Estimates $ in millions, except per-share data
We Maintain Our End-2011 Price Target of $11 We are maintaining our year-end 2011 price target of $11. Our price target is derived using a DCF analysis, with the parameters below.
Key DCF Assumptions Equity beta 1.25 Risk free rate (10yr yield) 2.6% Risk premium 10.6% Cost of Equity 15.8% Cost of debt 3.9% Final debt ratio 25.0% Equity as a % Cap 75.0%
Source: Company reports, Bloomberg, J.P. Morgan estimates.
Valuation and Rating Analysis DHX trades at 14.0x our F’11E EBITDA, vs. the 14.3x peer group average. Despite the company’s strong free cash flow and international growth prospects, we believe a full recovery in the recruitment market will lag the broader economy, making multiple expansion unlikely in the near term. Thus, we reiterate our Neutral rating.
Investment Risks Upside risks: Our price target and Neutral thesis are predicated on prolonged economic challenges. Should our expectations prove too pessimistic for the macroeconomy or for one of Dice’s specific verticals, the company could outperform our estimates. Additionally, if the company is better able to retain clients than we expect in this environment, results could exceed our expectations.
Downside risks: Should the economic challenges persist longer than we expect, the stock could see further weakness. Additionally, Dice operates in a highly competitive landscape, with over 1,000 websites offering job postings, including some with significantly more financial resources than Dice. Plus, social networking sites have been generating significant traffic growth and are looking at job listings as a way to monetize traffic. Success of any of Dice’s competitors could negatively impact our growth expectations.
eBay, Inc. (EBAY;EBAY US) 2009A 2010E 2011E 2012EEPS Reported ($) Q1 (Mar) 0.28 0.31A 0.35 0.38 Q2 (Jun) 0.25 0.31A 0.35 0.39 Q3 (Sep) 0.27 0.33A 0.36 0.40 Q4 (Dec) 1.05 0.37A 0.41 0.46 FY 1.85 1.32A 1.47 1.62Bloomberg EPS FY ($) 1.54 1.69A 1.86 2.06Source: Company data, Bloomberg, J.P. Morgan estimates. Note: F'10, F'11, and F'12 estimates include adjustments for FAS123R. Excluding FAS123R, our F'10, F'11, and F'12 EPS estimates are $1.67, $1.82, and $2.01. 'Bloomberg' above denotes Bloomberg consensus non-GAAP EPS estimates.
Company Data Price ($) 28.36Date Of Price 29 Dec 1052-week Range ($) 31.64 - 19.06Mkt Cap ($ mn) 37,120.06Fiscal Year End DecShares O/S (mn) 1,309Price Target ($) 25.00Price Target End Date 31 Dec 11
We are maintaining our Neutral rating on eBay. We continue to expect the company to underperform the broader eCommerce market in the near term and think the stock is unlikely to work well until eBay’s market share losses stabilize. We are maintaining our December 2011 price target of $25.
eBay continues to lose domestic market share. In the first nine months of 2010, eBay’s US non-vehicles GMV grew 4%, compared to 14% growth for the broader US eCommerce market. We think the growth lag is partly due to higher friction compared to other leading platforms as well as a weaker technology platform. Furthermore, we believe there is much progress to be made before the eBay marketplace can grow in line with the industry, much less gain market share.
Future in the international marketplaces looks shaky. International non-vehicles GMV growth ex FX grew 8% in 3Q’10, below 9% growth seen in the first half of the year (excludes Gmarket). We think the slowdown of international growth is cause for concern.
PayPal is the biggest bright spot of the business. We continue to think PayPal is in an advantageous position in online payments and poised to grow rapidly. Out of PayPal’s two revenue streams, we think off-eBay TPV will experience robust growth, while the on-eBay portion (~40% of rev) will be more of a drag. Consequently, we think the slower on-eBay TPV growth could offset PayPal’s total growth going forward.
2011 drivers. In our view, the following factors will drive EBAY shares in 2011: (1) the turnaround of the marketplaces business, (2) PayPal’s on-eBay TPV growth, (3) take rate stabilization, (4) regulation in the payments space and (5) potential new competition in the payments business.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, EBITDA and pro forma EPS estimates of $10.28B, $3.62B and $1.82, respectively.
Our F’12 estimates call for revenue, EBITDA and pro forma EPS of $11.20B, $3.81B and $2.01, respectively.
J.P. Morgan Estimates $ in millions except EPS
4Q’10E 2010E 2011E 2012E GMV 16,827 61,687 66,606 70,900 Revenue 2,536 9,197 10,275 11,197 EBITDA 901 3,223 3,624 3,813 Pro forma EPS 0.45 1.67 1.82 2.01 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $25 We are maintaining our year-end 2011 price target of $25. Our price target is derived using a DCF analysis, with the parameters below.
Key DCF Assumptions Equity beta 1.05 Risk free rate (10yr yield) 2.5% Risk premium 8.6% Cost of Equity 11.5% Cost of debt 6.0% Final debt ratio 3.0% Equity as a % Cap 97.0%
WACC 11.3%
Source: Company reports, Bloomberg, J.P. Morgan estimates.
Valuation and Rating Analysis On a GAAP P/E basis, eBay trades 19.2x our F’11 estimate of $1.47. Due to the challenges faced by the company’s businesses, we believe the stock is unlikely to significantly outperform its peer group in the coming months, and thus we rate it Neutral.
Investment Risks Downside risks: Barriers to international expansion, risks related to the repositioning of eBay’s pricing structure, competition from sponsored search vendors, the company’s dependence on eBay Motors, competition from hardline retailers, risks associated with patent litigation, and valuation risks.
International expansion is a concrete part of eBay’s growth strategy. As the company continues to grow outside the US, it may face regulatory challenges and/or markets that make its business less profitable than it is in the US or other countries where it is already established. Thus far, we believe eBay’s international expansion has been carried out in a strategic and timely manner.
eBay also faces risks from hardline retailers. Although the bulk of eBay’s revenues come from the beginning and end of the retail life cycle, with each passing quarter,
the percentage of revenue it earns from the in-season retail and fixed price sales continues to increase. This puts the company in competition with traditional retailers and other eRetailers, including Amazon.com, Wal-Mart, BestBuy and Home Depot. Failure to meet these challenges could lead to relative stock price underperformance.
Upside risks: Should the company be able to improve its search technology more rapidly than we expect, this could result in an acceleration of trade on the platform. Additionally, if the company takes steps that help the market value the separate parts of the enterprise more fully, the stock could outperform.
Company Data Price ($) 25.58Date Of Price 29 Dec 1052-week Range ($) 29.85 - 18.30Mkt Cap ($ mn) 7,323.14Fiscal Year End DecShares O/S (mn) 286Price Target ($) 31.50Price Target End Date 31 Dec 11
We are maintaining our Neutral rating on Expedia. While we think the company will see healthy international growth as well as continued strength from TripAdvisor, we believe cyclical challenges and new pricing pressure in the industry could create headwinds. We are maintaining our December 2011 price target of $31.50.
International growth should remain healthy. We expect Expedia’s international business to see healthy growth in 2011 driven by: 1) increased penetration in the APAC region, 2) continued expansion of TripAdvisor, 3) rising average daily rates (ADRs) and 4) an easier comp from lapping the volcano impact in 2Q’10. We are modeling F’11 international gross bookings to grow 18% Y/Y.
US growth moderating. Expedia has benefited from healthy domestic room night growth, reflective of increased inventory and promotional activity during a period of macroeconomic uncertainty. However, as the economy continues to improve in 2011, we are concerned that hotel inventory levels may fall as suppliers lower the portion of inventory sold to online travel agencies. We are modeling domestic growth bookings growth of 5% Y/Y in F’11 vs. our F’10 estimate of 16% growth.
We expect selling and marketing spend to pick up in 2011. In the first half of 2010, Expedia cut back on its selling and marketing expense due to the weak macro environment in Europe. However, looking ahead, we expect spending to pick up in order to support growth. Furthermore, we think Expedia will continue to increase its spending on the newer European and Asia Pacific markets as well as continue its investments to expand TripAdvisor. We expect G&A leverage and further operational efficiencies to offset the increased investments, and are thus modeling an F’11 OIBA margin of 25.8%, up only slightly from 25.4% in F’10E.
2011 drivers. In our view, the following factors will drive EXPE shares in 2011: (1) revenue margin trends, (2) sales and marketing trends and (3) ADR and air capacity trends.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, EBITDA and pro forma EPS estimates of $3.71B, $1.09B and $2.06, respectively.
Our F’12 estimates call for revenue, EBITDA and pro forma EPS of $3.97B, $1.16B and $2.26, respectively.
J.P. Morgan Estimates $ in millions, except per-share data
4Q’10E 2010E 2011E 2012E Revenues 796.7 3,336.5 3,710.1 3,967.2 EBITDA 221.4 962.8 1,093.6 1,158.3 Pro Forma EPS 0.37 1.73 2.06 2.26 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $31.50 We are maintaining our year-end 2011 price target of $31.50. Our price target is derived using a DCF analysis, with the parameters below.
Parameters for Our DCF Price Target Derivation Base FCF 1,032.9 Terminal Growth Rate 4.0% Terminal WACC 13.62% Terminal Multiple 10 Terminal Value 11,165 PV of terminal value 5,896 Firm value NPV year 2011-2015 3,222 PV of terminal value 5,896 Enterprise value $9,118 Plus Net Cash (75) Equity value $9,043 Shares outstanding 286.3 Equity Value Per Share $31.50 Source: Company reports, Bloomberg, J.P. Morgan estimates.
Valuation and Rating Analysis On EV/EBITDA, Expedia trades at 7x our F’11 EBITDA estimate versus its peers at 14x. We think this valuation accurately reflects the cyclical challenges the company faces in addition to new pricing pressure in the industry. As we see better upside opportunities in other stocks in our coverage universe, we rate Expedia Neutral.
Investment Risks Upside risks: The company (1) achieves significant market share gains to offset pricing decreases, (2) eliminates pricing promotions and/or (3) makes significant market share gains in the international markets.
Downside risks: The company is unable to (1) withstand the competitive threat that the travel suppliers and travel search engines pose, (2) achieve a high ROI on selling and marketing investments, (3) achieve strong gross bookings growth in a weak economy and/or (4) achieve further expansion into international markets.
Google (GOOG;GOOG US) 2009A 2010E 2011E 2012EEPS Reported ($) Q1 (Mar) 4.49 6.06A 6.88 8.00 Q2 (Jun) 4.66 5.71A 6.81 7.98 Q3 (Sep) 5.13 6.72A 6.92 8.08 Q4 (Dec) 6.13 6.91A 7.72 8.77 FY 20.41 25.40A 28.32 32.82Source: Company data, Bloomberg, J.P. Morgan estimates. Note: Excluding the impact of FAS 123R, our pro forma EPS estimates for F'10, F'11, and F'12 are $28.77, $32.65, and $37.32.
Company Data Price ($) 601.00Date Of Price 29 Dec 1052-week Range ($) 630.85 - 433.63Mkt Cap ($ mn) 193,748.58Fiscal Year End DecShares O/S (mn) 322Price Target ($) 625.00Price Target End Date 31 Dec 11
We are maintaining our Overweight rating on Google as we believe the company will benefit from strong search revenue growth as well as likely incremental revenue from display and mobile. However, we think the margins will come under pressure as the newer revenue stream has incrementally lower margins. Therefore, we are maintaining our December 2011 price target of $625.
Search is still the biggest EPS driver. We believe search and AdSense for content are the most profitable business segments for the company. Moreover, our estimates suggest that 1% net revenue growth in Google’s search revenue generates $0.35 EPS for the company. We are modeling Google search gross revenue to grow ~12% in 2011.
Display offers a strong opportunity. We think Google has done an impressive job in growing its display business, as the company now earns a ~$2.5B run rate in gross revenue on non-text display products including YouTube and DoubleClick. We think the overall display business will contribute an incremental ~$1.2B, or 4 points of the growth. However, we note the display business margins are significantly lower than the company’s overall margins.
Mobile will drive search usage. Over the past two years, search queries from mobile have grown 5x, an accelerated pace. On Google’s 3Q earnings call, management indicated that mobile advertising is contributing $1B (~3% of gross revenue) in annualized run-rate revenue. As worldwide smartphone penetration continues to grow, we think mobile search will be incremental to Google’s business.
Risk to market share and increased government scrutiny. We think Google is facing an increasing amount of competition, with social networking sites emerging as a big threat to Google’s traffic and mobile applications letting users bypass search. Additionally, despite increasing competition, because of its leadership position in search volume share, we believe Google will continue to face more scrutiny from the government with regard to future acquisitions and business practices.
2011 drivers. In our view, the following factors will drive GOOG shares in 2011: (1) improved international online and ad spend penetration; (2) growth of non-search ad products, including YouTube, display, and mobile; (3) increasing competition from Facebook, Apple, etc.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 net revenue, EBITDA and pro forma EPS estimates of $26.10B, $15.48B and $32.65, respectively.
Our F’12 estimates call for net revenue, EBITDA and pro forma EPS of $29.21B, $17.79B and $37.32, respectively.
J.P. Morgan Estimates $ in millions, except per-share data
4Q’10E F’10E F’11E F’12E Net Revenue 6,234 21,866 26,100 29,208 EBITDA 3,721 13,116 15,485 17,787 ProForma EPS 7.92 28.77 32.65 37.32 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $625 We are maintaining our year-end 2011 price target of $625. Our price target is derived using a DCF analysis, with the parameters below.
Key DCF Assumptions $ in millions, except per-share data
Base FCF 15,512.7 Terminal Growth Rate 3.5% Terminal WACC 11.16% Terminal Multiple 13 Terminal Value 209,626 PV of terminal value 123,514 Firm value NPV year 2012-2016 48,021 PV of terminal value 123,514 Enterprise value $171,536 Plus Net Cash 30,059 Equity value $201,594
Shares outstanding 322.5
Equity Value Per Share $625.00
Source: J.P. Morgan estimates.
Valuation and Rating Analysis We believe GOOG shares are fundamentally attractive due to secular industry growth trends and expansion of new product categories such as contextual ads and local search. Google remains an Overweight pick. Google trades at 21x its F’11E EPS vs. its large-cap internet peers at 28x. Given Google’s growth rate, we think this discount is unjustified. Hence our Overweight rating.
Investment Risks Google has experienced fast revenue growth over the past few years. Our price target and Overweight rating are based on the assumption that Google will continue to be the market leader in the paid search space and will continue to enjoy strong revenue growth. If content publishers such as Yahoo! and Microsoft are able to gain market share through user defection from Google’s user base, our price target and rating could be too optimistic.
Our price target and Overweight rating are also predicated on the company’s success in the international market. If it cannot successfully build out a larger international advertising base, the company will not be able to increase its monetization rate abroad. Additionally, as Google continues to expand its business internationally, it may face regulatory hurdles that make the business climate less hospitable and potentially less profitable than those of the markets in which it currently operates.
IAC/InterActive Corp. (IACI;IACI US) 2009A 2010E 2011E 2012EEPS Reported ($) Q1 (Mar) (0.02) 0.00A 0.21 0.24 Q2 (Jun) 0.02 0.24A 0.32 0.34 Q3 (Sep) 0.34 0.32A 0.36 0.39 Q4 (Dec) 0.20 0.31A 0.36 0.36 FY 0.54 0.87A 1.25 1.32Bloomberg EPS FY ($) 0.41 0.89A 1.44 1.71Source: Company data, Bloomberg, J.P. Morgan estimates. Estimates in this table are pro forma. Note: FY EPS estimates may differ from quarterly summed estimates due to rounding 'Bloomberg' above denotes Bloomberg consensus estimates.
Company Data Price ($) 30.02Date Of Price 29 Dec 1052-week Range ($) 30.96 - 20.01Mkt Cap ($ mn) 3,188.96Fiscal Year End DecShares O/S (mn) 106Price Target ($) 35.00Price Target End Date 31 Dec 11
We are maintaining our Neutral rating on IAC. We are encouraged by the growth of Match.com and believe the company will continue to expand its subscriber base. However, we think the Ask.com business will remain challenged and will become less of a focus for management. We are maintaining our December 2011 price target of $35.
Match.com will likely be the major property. Now comprising 25% of revenue and 71% of OIBA, we think the Match business will be the largest driver of the stock. We expect growth to be primarily driven by continued healthy subscriber growth as well as the new Yahoo! arrangement. We are modeling F’11 revenue and OIBA of $428.7M and $122.9M, respectively.
We think Ask.com will be less of a priority to management. We think investments in the search business will be de-emphasized as the company focuses on better-performing properties such as Zwinky. Additionally, we believe the market will remain competitive for Ask.com, as large search players continue to make innovations to the space. We expect search revenue growth to decelerate and are modeling ~8% Y/Y search rev growth in F’11, compared to 18% growth in F’10E.
Although a smaller component of the company, ServiceMagic should continue to shine. For the first nine months of 2010, ServiceMagic revenue grew 19% Y/Y, driven by an increase in service requests. We expect the business to benefit from improving macroeconomic conditions in 2011. Additionally, we think margins will begin to stabilize as investment levels become steadier next year. We are modeling F’11 revenue and OIBA of $195.9M and $16.7M, respectively.
2011 drivers. In our view, the following factors could drive IACI shares in 2011: (1) growth of Match.com, (2) trend in the search space and (3) possible share buybacks.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, OIBA and pro forma EPS estimates of $1.77B, $208.9M and $1.25, respectively.
Our F’12 estimates call for revenue, OIBA and pro forma EPS of $1.85B, $216.0M and $1.32, respectively.
J.P. Morgan Estimates $ in millions, except per-share data
4Q’10E F’10E F’11E F’12E Revenue 432.8 1643.3 1770.7 1854.7 OIBA 54.5 189.1 208.9 216.0 Pro forma EPS 0.31 0.87 1.25 1.32 Source: J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $35 We are maintaining our year-end 2011 price target of $35. Our price target is derived using a DCF analysis, with the parameters below.
EV/EBITDA Multiple Analysis $ in millions except multiple, share count and price target
Source: Company reports and J.P. Morgan estimates.
Valuation and Rating Analysis On an EV/EBITDA basis, IACI trades at 6.3x our $281M FY’11 EBITDA estimate, vs. its peer group which trades at 14.3x. We maintain our Neutral rating.
Investment Risks Upside risks: The company is able to sustain growth in its media & advertising business and in the personals business despite a competitive search market and international pressures and/or introduces a large share-buyback program.
Downside risks: The company is unable to achieve higher query volumes from Ask.com, macroeconomic pressures impact ServiceMagic more than expected, and/or international weakness weighs on Personals. Strategic acquisitions could also weigh on the company’s performance.
Company Data Price ($) 15.59Date Of Price 29 Dec 1052-week Range ($) 16.80 - 10.07Mkt Cap ($ mn) 9,416.36Fiscal Year End DecShares O/S (mn) 604Price Target ($) 19.00Price Target End Date 31 Dec 11
We are maintaining our Overweight rating on LINTA as we believe the company will see a strong domestic QVC performance and robust international growth. We are maintaining our December 2011 price target of $19.
Domestic QVC growth likely to be driven by internet usage. We think that internet sales will be a significant driver for growth as existing customers embrace use of the vehicle to order or reorder items not currently aired on TV and as non-QVC customers discover the website though product searches on search engines. In the first nine months of 2010, internet penetration grew to 32% of purchases from 28% in the year-ago period. We are modeling this penetration rate to reach 35% in F’11 and 37% in F’12.
We think international revenue growth will outpace that of the US. International markets will likely be aided by the following factors: 1) improved subscriber penetration, 2) improved product mix, 3) contributions from QVC Italy. We are estimating international QVC rev of $2.9B in F’11, which includes $120M from QVC Italy.
Many headwinds will be comped. F’10 OIBDA was negatively impacted by the following factors: 1) the loss of the eCommerce commission-related businesses which contributed ~$32M to F’09 revenue; 2) the refinancing of the GE bank credit agreement; which would have negatively impacted OIBDA by ~$20-25M in F’09; 3) investment in QVC Italy, which we think will negatively impact OIBDA by ~$30-40M. If our estimates are adjusted for these events, we think F’10 OIBDA growth would be closer to ~11% Y/Y vs. our currently modeled 6% growth. Thus, we feel comfortable with our F’11 OIBDA growth estimate of 8% Y/Y.
LINTA should benefit from being a stand-alone company. We think LINTA’s tracking stock discount should disappear, new investors could be attracted to this asset-backed stock, there is additional clarity to the story, and the company has greater options in capital raising and acquisitions.
2011 drivers. In our view, the following factors will drive LINTA shares in 2011: (1) new customer growth at QVC, (2) performance of QVC Italy and (3) OIBDA expansion.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, OCF and pro forma EPS estimates of $9.65B, $1.89B and $0.73, respectively.
Our F’12 estimates call for revenue, OCF and pro forma EPS of $10.35B, $2.01B and $0.83, respectively.
J.P. Morgan Estimates $ in millions, except per-share data
4Q’10E F’10E F’11E F’12E Revenue 2,852.7 8,898.7 9,650.6 10,353.6 OCF 568.1 1,750.1 1,894.1 2,008.6 Pro forma EPS $0.23 $1.02 $0.73 $0.83 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $19 We are maintaining our year-end 2011 price target of $19. Our price target is derived using a DCF analysis, with the parameters below.
Key DCF Assumptions Equity beta 1.04 Risk free rate (10yr yield) 2.5% Risk premium 8.5% Cost of Equity 11.4% Cost of debt 6.9% Final debt ratio 5.0% Equity as a % Cap 95.0% Source: Company reports, Bloomberg, J.P. Morgan estimates.
Valuation and Rating Analysis LINTA is trading at 6.2x our F’11E EBITDA vs. the peer group average of 7.9x. We do not think that this discount is justified given QVC growth prospects in existing and new markets. We rate the stock Overweight.
Investment Risks Downside risks: QVC could underperform our expectations if QVC.com does not continue to outperform the domestic TV shopping business. Underperformance could also occur if the other eCommerce holdings do not outperform brick-and-mortar retail. Margins could be weaker than expected if production and broadcasting costs increase. Finally, given QVC’s exposure to international markets, we are assuming that there are no changes in the regulations governing its business in foreign countries.
Company Data Price ($) 13.71Date Of Price 29 Dec 1052-week Range ($) 16.11 - 10.50Mkt Cap ($ mn) 297.51Fiscal Year End DecShares O/S (mn) 22Price Target ($) 18.00Price Target End Date 31 Dec 11
We are maintaining our Overweight rating on MediaMind as we believe the company provides a critical solution for digital ad campaign management across a broad global reach. We are maintaining our December 2011 price target of $18.
Critical solution for digital ad campaign management. Global internet advertising is expected to be a ~$67B market in 2010, representing ~14% of total ad spend. Given that the consumption of online media continues to grow, IDC estimates that online ad spend will be ~$100B in 2013. However, the process of executing a digital ad campaign is becoming increasingly complex as the internet fragments further. Additionally, consumer banner blindness and the difficulty of interpreting performance data create challenges for advertisers. Because MediaMind addresses these challenges and provides a comprehensive solution for advertisers and ad agencies, we think the company will experience strong revenue growth.
Publisher-neutral platform is appealing to customers. Despite the fact that MediaMind’s largest competitors are parts of large advertising players such as Google and Microsoft, MediaMind grew its revenue 29% in the first nine months of 2010. We think many agencies are looking for an independent, publisher-neutral platform as they believe it will more likely serve ads without any bias toward channels, formats or specific websites.
Highly scalable business model. MediaMind’s business uses low capex (~4% of revenue in F’10E) and thus offers a strong margin-expansion opportunity. MediaMind has been profitable since 2002. As the revenue grows, we believe the company will see leverage from sales and marketing and R&D, and we expect operating margins to be 21.4% and 22.5% in F’11 and F’12, respectively, up from 16.9% in F’10E.
Platform customers to comprise over half of F’11E revenues. We believe MediaMind will generate more revenue per customer as it transitions clients to use more of the platform’s capabilities. By the end of 2011, we expect more than half of its total revenue to come from platform customers that adopt MediaMind as an end-to-end solution for all their ad campaigns.
2011 drivers. In our view, the following factors will drive MDMD shares in 2011: (1) further recovery of the advertising market, (2) new capabilities of the MediaMind platform and (3) sales and marketing leverage.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, EBITDA and EPS estimates of $95.3M, $26.4M and $0.68, respectively.
Our F’12 estimates call for revenue, EBITDA and EPS of $111.9M, $31.2M and $0.83, respectively.
J.P. Morgan Estimates $ in millions, except per-share data
4Q’10E 2010E 2011E 2012E Revenues 25.5 80.4 95.3 111.9 EBITDA 9.0 19.9 26.4 31.2 Diluted EPS 0.25 0.54 0.68 0.83 Pro forma EPS 0.28 0.61 0.81 0.96 Source: Company reports and J.P. Morgan estimates. Note: Diluted EPS are calculated assuming no accretion of preferred stock dividend. Pro forma EPS adds back stock-based comp. and uses full post-offering share count in all time periods.
We Are Maintaining Our End-2011 Price Target of $18 We are maintaining our year-end 2011 price target of $18. Our price target is derived using a DCF analysis, with the parameters below.
Key DCF Assumptions Equity beta 1.00 Risk free rate 2.6% Risk premium 8.4% Cost of equity 11.0% Cost of debt 8.0% Final debt ratio 0.0% Equity as a % cap 100.0%
WACC 11.0%
Source: J.P. Morgan estimates, Bloomberg.
Valuation and Rating Analysis MediaMind trades at 7.7x our F’11 EBITDA estimate of $26M vs. its peer group at 13.6x. We believe the company’s growth prospects do not merit this discount and thus rate MDMD Overweight.
Investment Risks The company is unable to compete successfully with Google and Microsoft; it loses a major customer - such as Microsoft, which is also a competitor – or faces a reduction in its customers’ advertising budgets; consolidation of internet advertising networks impairs MediaMind’s ability to serve advertisements and collect campaign data; the company either does not continue to innovate and provide high-quality solutions and services or does not do so as quickly as its competitors; the internet advertising market deteriorates or develops more slowly than expected; there is an extended downturn in the US, European or worldwide economy, driving weakness in ad spend; and/or fluctuations in currency exchange rates have a negative impact on the company’s operating results.
Company Data Price ($) 69.82Date Of Price 29 Dec 1052-week Range ($) 76.81 - 35.50Mkt Cap ($ mn) 3,081.14Fiscal Year End DecShares O/S (mn) 44Price Target ($) 82.00Price Target End Date 31 Dec 11
We are upgrading MELI to Overweight from Neutral. We believe the company is well-positioned to take advantage of eCommerce growth in Latin America, and we see upside to GMV growth. We are raising our end-2011 price target to $82 from $65.
Pago 3.0 rollout should help drive TPV growth. We believe the rollout of MercadoPago 3.0 should rapidly grow use of the payments solution and boost TPV. TPV was 21.4% of GMV in 3Q, crossing the 20% mark for the first time. We think significant additional penetration gains are possible and model TPV to reach 25% of GMV by the end of F’11. We also think broader integration of Pago should reduce friction and help drive GMV growth.
ASPs should begin to improve in 1Q’11. 3Q saw average selling prices (ASPs) decline due to the appreciation of the Brazilian real last year and the follow-up lag in seller price adjustments. As this impact dissipates, we expect ASPs to rise beginning in 1Q’11, with growth accelerating in 2H’11.
Very bullish on long-term outlook. We think MELI is well-positioned to capitalize on economic growth, higher broadband expansion and the growth of eCommerce in Latin America. GMV grew 23% in 9M’10 in dollar terms, driven by a 34% rise in successful items. We expect GMV growth to remain healthy as eCommerce penetration in Latin America is below 2%.
Managing business for growth. We expect MELI to manage take rates to maintain growth and minimize margin erosion. In the near term, we think the take rate could be pressured by the expansion of free listings on the site. However, longer term we believe there is plenty of upside to the take rate as the Latin America eCommerce market is still in the early stages of development.
Raising estimates. We are raising our F’11 revenue, EBITDA and EPS estimates to $296M, $119M and $1.63, from $282M, $110M, and $1.50, respectively. For F’12, we expect revenue, EBITDA and EPS of $392M, $158M and $2.20 vs. our prior respective estimates of $357.7M, $142.1M and $1.96.
2011 drivers. In our view, the following factors will drive MELI shares in 2011: (1) GMV growth, (2) MercadoPago penetration, (3) TPV growth and (4) take rate trends.
Raising Estimates and Outlook for 2010, 2011 and 2012 We are now modeling F’11 revenue, EBITDA and EPS of $295.9M, $118.9M and $1.63, up from our prior estimates of $281.6M, $109.9M and $1.50, respectively.
Our new F’12 estimates call for revenue, EBITDA and EPS of $392.0M, $157.9M and $2.20, above our prior estimates of $357.7M, $142.1M and $1.96, respectively.
We Are Raising Our End-2011 Price Target to $82 from $65 After flowing through our newly increased estimates, we are raising our year-end 2011 price target to $82, from $65 previously. Our price target is derived using a DCF analysis, with the parameters below.
DCF Valuation Equity beta 1.26 Risk free rate (10yr yield) 3.3% Risk premium 7.6% Cost of Equity 12.9% Equity as a % Cap 100.0%
WACC 12.9% Source: J.P. Morgan estimates, Bloomberg.
Valuation and Rating Analysis On a P/E basis, MELI trades at 43x our F’11 estimate of $1.63 vs. its peer group at 37x. We believe the company’s strong fundamentals and free cash flow generation justify a premium valuation and thus rate the stock Overweight.
Investment Risks Downside risks: (1) Several of MELI’s core markets have a history of economic turmoil and financial crises. Regional or global economic weakness, or an economic upheaval, could negatively impact our estimates for eCommerce growth in the region and therefore growth for MercadoLibre. (2) MELI operates in many countries with a history of political instability. Political instability could affect customers’ confidence and therefore their willingness to purchase goods online. In addition, governments may limit internet or eCommerce activities. (3) MELI has grown through a number of acquisitions since its inception in 1999. As the company looks to grow into new product offerings and markets, it may look to acquire other companies or be forced to spend substantial cash to develop its own products. Either event could stress its financial resources. (4) Creating an online marketplace requires little capital, since the owner does not need to stock merchandise and fulfill orders. Also, Latin American eCommerce growth might attract the interest of larger players, such as eBay, Google, Yahoo! or Amazon, which have deeper pockets than MELI’s.
Company Data Price ($) 180.27Date Of Price 29 Dec 1052-week Range ($) 209.24 - 48.52Mkt Cap ($ mn) 9,722.14Fiscal Year End DecShares O/S (mn) 54Price Target ($) 186.00Price Target End Date 31 Dec 11
We are maintaining our Overweight rating on Netflix as we believe the company is poised for additional subscriber growth while being able to manage its rising content costs. We are maintaining our December 2011 price target of $186.
Expect strong subscriber growth in F’11. Netflix grew its subscriber base 43% Y/Y in the first nine months of 2010, and we are projecting the company to exceed 26M subscribers by the end of 2011. We expect further subscriber growth to be driven by: 1) continued retail store closures, which we estimate put ~$1B in rental revenue up for grabs in 2010; and 2) international expansion, which we view as a potential low-risk investment.
Content costs are manageable. We are modeling a gross margin of 36.6% in F’11. While we expect Netflix to increase its content costs, we think rising costs are manageable, partially driven by lower utilization of DVD by mail, which carries a much higher cost of delivery (due to postage) than the streaming product. Therefore, we think content delivery costs will grow at a significantly slower pace than revenue growth.
Churn should see further declines. We are modeling an average monthly churn of 3.6% at the end of 4Q’11, down from 3.8% toward the end of 2010 and 3.9% at the end of 4Q’09. We think overall churn will decline as streaming subscribers increase and as the overall business matures.
International market offers a strong opportunity. We believe international expansion would be a key growth opportunity for Netflix as it would contribute to robust subscriber growth. Moreover, we think there is a lot of local long-tail content internationally that Netflix could successfully monetize. The company has indicated that international expansion could happen as early as 2H’11.
2011 drivers. In our view, the following factors will drive NFLX shares in 2011: (1) subscriber growth, (2) gross margins, (3) operating margins, (4) content deals and (5) free cash flow.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, EBITDA and pro forma EPS estimates of $3.00B, $712.3M and $4.64, respectively.
Our F’12 estimates call for revenue, EBITDA and pro forma EPS of $3.76B, $853.5M and $6.12, respectively.
J.P. Morgan Estimates units as indicated
4Q’10E F’10E F’11E F’12E Qtr-End Subs (M) 19.5 19.5 26.6 32.4 Revenue ($M) 594 2161 3004 3758 Pro Forma Operating Margin 12.7% 13.9% 14.3% 14.7% EBITDA ($M) 149 587 712 854 Pro forma EPS $0.79 $3.10 $4.64 $6.12 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $186 We are maintaining our year-end 2011 price target of $186. Our price target is derived using a DCF analysis, with the parameters below.
Key DCF Assumptions Equity beta 0.85 Risk free rate (10yr yield) 2.5% Risk premium 8.6% Cost of Equity 7.7% Cost of debt 8.5% Final debt ratio 10.0% Equity as a % Cap 90.0%
WACC 7.8%
Source: Company reports, Bloomberg, J.P. Morgan estimates.
Valuation and Rating Analysis Given the result of the DCF analysis above and our belief that Netflix is well positioned to benefit from trends in the movie rental industry, we rate the company Overweight. On an EV/EBITDA basis, Netflix trades at 13.3x our F’11E EBITDA vs. the peer group average of 7.8x. Given that NFLX is growing EBITDA at 21% Y/Y compared to a 7% average for the peer group, we believe it deserves a premium.
Investment Risks Downside risks: The company is not able to manage future postal price increases effectively. The company is not able to strike deals with content owners to continue to expand its streaming catalog. Competitors such as Redbox, Amazon or Apple, or sites such as YouTube, are able to offer more attractive customer offerings and thus take market share.
Company Data Price ($) 5.53Date Of Price 29 Dec 1052-week Range ($) 7.86 - 3.56Mkt Cap ($ mn) 582.53Fiscal Year End DecShares O/S (mn) 105Price Target ($) 8.00Price Target End Date 31 Dec 11
We are maintaining our Neutral rating on Orbitz. While we are encouraged by the company’s focus on growing its hotel business, we believe it will face challenges reaching the brand identity and inventory scale of Expedia and Priceline. We are maintaining our December 2011 price target of $8.
International growth will be supported by ebookers. International gross bookings grew 29% Y/Y in the first nine months of 2010, partly driven by a strong performance from ebookers. We believe the ebookers business will continue to post healthy transaction and room night growth in 2011, aiding Orbitz’s international performance. We are modeling international gross bookings growth of 15.0% in F’11, and a revenue margin of 9.6%.
Hotel room night sales will remain an area of focus in 2011. We expect management to continue its focus on building the company’s hotel business. We are pleased with the progress Orbitz has made from its global technology platform for its US businesses and are encouraged by the upcoming migration of HotelClub to the global platform. However, we remain cautious about the challenges to be overcome before reaching the brand identity and inventory scale of Expedia and Priceline.
Margins may be pressured by a continued investment phase. We expect Orbitz to continue its investment mode to achieve its goal of increasing hotel sales. We think margins may be pressured next year from increased marketing spend due to a likely rise in cost per click (CPC) as well as efforts to strengthen the Orbitz brand. We expect marketing as a percentage of revenue to be 29.3% in 2011, slightly above our 29.2% estimate in 2010.
2011 drivers. In our view, the following factors will drive OWW shares in 2011: (1) cash balance and leverage ratios, (2) growth of its hotel business and (3) increased investments.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, EBITDA and EPS estimates of $802M, $165M and $0.15, respectively.
Our F’12E revenue, EBITDA and EPS are $850M, $179M and $0.16, respectively.
J.P. Morgan Estimates $ in millions, except per-share data
4Q’10E 2010E 2011E 2012E Revenues 177 752 802 850 EBITDA 25 151 165 179 EPS (0.09) 0.09 0.15 0.16 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $8 We are maintaining our year-end 2011 price target of $8. Our price target is derived using a DCF analysis, with the parameters below.
DCF Analysis Base FCF 125.8 Terminal Growth Rate 0.0% Terminal WACC 10.07% Terminal Multiple 10 Terminal Value 1,249 PV of terminal value 773 Firm value NPV year 2012-2016 458 PV of terminal value 773 Enterprise value $1,231 Plus Net Cash (345) Equity value $ 887 Shares outstanding 105.3 Equity Value Per Share $8.00
Source: J.P. Morgan estimates.
Valuation and Rating Analysis Orbitz trades at 6x our pro forma F’11E EBITDA, below the peer group average of 14x. Given the difficult comps of the air product and company-specific headwinds, we think further multiple expansion unlikely and reiterate our Neutral rating.
Investment Risks Upside risks: 1) Hotel product sales and international sales exceed our expectations, 2) further acquisitions are made in the international space, 3) the company gains market share against its existing online travel agent competitors, and/or 4) the online travel market achieves penetration levels beyond our current expectations.
Downside risks: The company is unable to 1) withstand the competitive threat that the travel suppliers and travel search engines pose, 2) maintain its domestic leadership position, 3) grow the top line due to economic conditions, 4) successfully expand into the international market or increase hotel sales, and/or 5) meet debt covenants that could also hinder operational strategies.
Priceline.com (PCLN;PCLN US) 2009A 2010E 2011E 2012EEPS Reported ($) Q1 (Mar) 1.09 1.70A 2.14 2.78 Q2 (Jun) 2.02 3.09A 3.86 4.87 Q3 (Sep) 3.45 5.33A 7.21 8.56 Q4 (Dec) 1.99 3.00A 4.10 4.97 FY 8.52 13.12A 17.31 21.18Bloomberg EPS FY ($) 8.29 13.16A 17.56 21.30Source: Company data, Bloomberg, J.P. Morgan est. EPS est. in table are on a pro forma basis. 'Bloomberg' above denotes Bloomberg consensus estimates.
Company Data Price ($) 405.70Date Of Price 29 Dec 1052-week Range ($) 428.10 - 173.32Mkt Cap ($ mn) 20,511.79Fiscal Year End DecShares O/S (mn) 51Price Target ($) 484.00Price Target End Date 31 Dec 11
We are maintaining our Overweight rating on Priceline as we believe the company will continue to gain market share both domestically and internationally. Additionally, we are maintaining our December 2011 price target of $484.
International offers a secular growth opportunity. We are encouraged by the large portion of gross profit dollars coming from Priceline’s international business (80%) as we believe this growth is more sustainable than the company’s domestic growth. We expect Priceline to benefit from continued international growth driven by: 1) secular internet penetration growth (40% in the US vs. 35% in Europe and 24% in Asia, with the hotel market having even lower penetration rates, leaving more room for growth); 2) new market entrance for booking.com including the US, Brazil, Africa, etc.; 3) continued ADR recovery; 4) greater exposure to more fragmented markets that favor aggregators; 5) modest take rate increases as emerging markets develop. We model international gross bookings to grow 39% Y/Y in F’11.
booking.com in the US offers market share gains. We think Priceline's domestic hotel business will benefit from the continued development of booking.com in the US. While the primary focus remains on European travelers, we think there is a significant opportunity to expand coverage and build out inventory in the US. Furthermore, we expect Priceline to see further domestic market share gains in 2011. We are modeling domestic gross bookings to grow 7% Y/Y in F’11.
Margins should expand. Gross profit growth has outpaced advertising expense growth in the last two quarters, and we expect Priceline to continue to benefit from improved advertising efficiency. Additionally, we think higher ADRs and increased brand awareness (better organic traffic) will help moderate ad expense growth. We are modeling an F’11 pro forma operating margin of 31.0%, up from 28.1% in F’10E and 23.3% in F’09.
2011 drivers. In our view, the following factors will drive PCLN shares in 2011: (1) ADR trends, (2) volume growth and (3) Euro currency rates.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, EBITDA and pro forma EPS estimates of $3.73B, $1.20B and $17.31, respectively.
Our F’12 estimates call for revenue, EBITDA and pro forma EPS of $4.30B, $1.46B and $21.18, respectively.
J.P. Morgan Estimates 4Q’10E F’10E F’11E F’12E
Revenue 728.8 3,082.4 3,731.8 4,299.6 EBITDA 205.6 884.0 1,201.7 1,460.4 EPS (Pro forma) $3.00 $13.12 $17.31 $21.18 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $484 We are maintaining our year-end 2011 price target of $484. Our price target is derived using a DCF analysis, with the parameters below.
DCF Analysis Base FCF 1,868.0 Terminal Growth Rate 4.0% Terminal WACC 10.54% Terminal Multiple 15 Terminal Value 29,713 PV of terminal value 18,005 Firm value NPV year 2012-2016 5,456 PV of terminal value 18,005 Enterprise value $23,461 Plus Net Cash 1,005 Equity value $24,466
Shares outstanding 50.6
Equity Value Per Share $484.00
Source: J.P. Morgan estimates.
Valuation and Rating Analysis Priceline currently trades at 23.4x vs. the peer group average of 38.1x. As we are modeling 32% Y/Y EPS growth (in line with the peer group average at 32%), we think such a discount is unjustified. Thus we rate the stock Overweight.
Investment Risks Priceline shares could underperform those of other companies in our coverage universe if PCLN’s domestic growth is pressured by competition from other online travel agencies or suppliers, if it has difficulty obtaining merchant inventory, if macroeconomic weakness hinders top-line growth, if it experiences increased competition in the international market, if ADRs and exchange rates fall further than expected, and/or if sales and marketing and technology expenses increase significantly.
QuinStreet, Inc. (QNST;QNST US) 2010A 2011E 2012EEPS Reported ($) Q1 (Sep) 0.14A 0.17A 0.15 Q2 (Dec) 0.05A 0.11A 0.13 Q3 (Mar) 0.11A 0.15A 0.17 Q4 (Jun) 0.14A 0.14A 0.17 FY 0.44A 0.57A 0.63Source: Company data, Bloomberg, J.P. Morgan estimates. Note: F'10 EPS numbers are calculated based on post-offering share count; GAAP F'10 EPS as reported by the company was $0.50.
Company Data Price ($) 19.48Date Of Price 29 Dec 1052-week Range ($) 21.38 - 9.79Mkt Cap ($ mn) 917.74Fiscal Year End JunShares O/S (mn) 47Price Target ($) 24.00Price Target End Date 31 Dec 11
We are maintaining our Overweight rating on QuinStreet as we believe the company will continue to see healthy growth in its financial services vertical. Additionally, we think QuinStreet’s education revenue growth rate will accelerate as the company laps the reduction of spend from DeVry. We are maintaining our $24 December 2011 price target.
Financial services vertical a large market opportunity. QuinStreet’s financial services vertical represents a ~$15B market, roughly 5x the size of the education market (~$3B). Financial services revenue grew 68% in the first nine months of CY’10 and has been the largest client vertical for the past three quarters. We believe continued growth will be driven by: 1) expansion of its customer base, 2) continued shift of marketing spend to online and 3) additional acquisitions in the space. We are modeling FS revenue to grow 45% in FY’11.
Education revenue growth to accelerate due to easier comps. Education revenue was roughly flat in the first nine months of CY’10. We expect education revenue growth to accelerate in the back half of FY’11 once the company has anniversaried the reduction of spend from DeVry. Furthermore, we model education revenue to grow 6% Y/Y in FY’11 and 9% in FY’12. While regulatory changes in the education vertical will reduce spending on lead generation, we think QNST will benefit as education companies consolidate their spend with more reputable vendors that can provide higher-quality leads.
Other verticals a longer-term catalyst. QuinStreet’s other verticals grew 71% in the first nine months of CY’10 and represent a ~$20B market in North America. As the economy improves and the company focuses more on execution, we expect QuinStreet to build out depth within these other verticals (including home services, medical and B2B) through the organic development of sites as well as strategic acquisitions.
20% EBITDA margin is sustainable. Management has consistently targeted a 20% annual EBITDA margin. We expect future results to hew fairly close to this level as the company uses the target to benchmark its decisions of investing in growth vs. profitability. We are modeling F’11 and F’12 EBITDA margins of 21% and 20%, respectively.
2011 drivers. In our view, the following factors will drive QNST shares in 2011: (1) expansion of the FS vertical, (2) the education regulatory environment and (3) growth from other noncore verticals.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our FY’11 revenue, EBITDA and pro forma EPS estimates of $420.7M, $89.3M and $0.94, respectively.
Our CY’11 estimates call for revenue, EBITDA and pro forma EPS of $463.0M, $93.0M and $0.96.
We are maintaining our FY’12 revenue, EBITDA and pro forma EPS estimates of $505.0M, $100.3M and $1.01, respectively.
Our CY’12 estimates call for revenue, EBITDA and pro forma EPS of $537.2M, $111.2M and $1.11.
J.P. Morgan Estimates FY 2Q’11E F’11E F’12E
Revenue 97.9 420.7 505.0 EBITDA 19.3 89.3 100.3 EPS (pro forma) $0.19 $0.94 $1.01 Source: Company reports and J.P. Morgan estimates.
We Maintain Our $24 End-2011 Price Target We are maintaining our December 2011 price target of $24. Our price target is derived using a DCF model with the parameters below.
Key DCF Assumptions $ in millions except as indicated
Equity beta 1.00 Risk free rate 2.6% Risk premium 8.5% Cost of equity 11.0% Cost of debt 7.5% Final debt ratio 10.0% Equity as a % cap 90.0%
WACC 10.4%
Source: Bloomberg, J.P. Morgan estimates.
Valuation and Rating Analysis QuinStreet trades at 9.5x our CY’11 EBITDA estimate of $93M vs. its peer group at 12.6x. We believe the company’s growth prospects do not merit this discount and thus rate QNST Overweight.
Investment Risks Downside risks: Changes in regulations or government actions negatively impact QuinStreet clients’ marketing practices and budgets, thereby adversely affecting the company’s financial results; a rapid decline in revenue from a major client, given that a limited number of clients account for a large proportion of revenue, especially in education; the company is not able to identify and complete strategic acquisitions at attractive prices or is unable to successfully integrate the acquisitions it does make; the company’s reputation is harmed due to improper actions of third-party publishers which drive the majority of QuinStreet’s traffic but over whose operations QuinStreet has limited oversight and control.
Company Data Price ($) 19.42Date Of Price 29 Dec 1052-week Range ($) 21.14 - 11.80Mkt Cap ($ mn) 540.81Fiscal Year End DecShares O/S (mn) 28Price Target ($) 23.00Price Target End Date 31 Dec 11
We are maintaining our Overweight rating on ReachLocal as we believe the company will benefit from adding new markets and internet marketing consultants (IMCs), from expanding its product offering and from the maturation of its sales force. We are maintaining our $23 end-2011 price target.
Increased penetration into new markets. ReachLocal operates in 45 markets worldwide, with 7 markets added in the last two quarters alone. We believe the company retains significant runway to build its presence across new markets both in the US and internationally. Additionally, we expect ReachLocal to continue to expand its IMC sales force (currently at nearly 700), which we believe presents a key barrier to entry.
Product expansion drives cross-sell opportunities. We think ReachLocal can continue to innovate and expand its product portfolio, gradually building an even broader suite of digital marketing products for small to medium-size businesses (SMBs) that encompass search, display, online presence and social solutions. During 4Q, the company began rolling out ReachCast, its new digital presence, social media and reputation management platform. We believe the increasing fragmentation of the internet, along with the growth of social media, will drive demand for this product.
Sales force maturation should increase productivity. ReachLocal is in the very early stages of its growth curve, and even its longer-tenure IMCs are relatively new. As the average tenure improves, productivity per IMC should go up, driving revenue growth. We are modeling revenue to grow 40% in 2011 and 38% in 2012.
Margins should benefit from scale in underclassman expense. As the ratio of experienced IMCs to underclassmen increases, the cost of the company’s investment in training its underclassmen should grow less rapidly than revenue growth, e.g., we are modeling 40% revenue growth in F’11, compared to only 16% growth in underclassmen expense. Thus, we believe there is significant room for ReachLocal to expand margins in the medium-to-long term.
2011 drivers. In our view, the following factors will drive RLOC shares in 2011: (1) expansion into new markets, (2) continued product development and (3) the maturation of the sales force.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, EBITDA and pro forma EPS estimates of $407.8M, $12.6M and $0.06, respectively.
Our F’12 estimates call for revenue, EBITDA and pro forma EPS of $561.3M, $43.9M and $0.66, respectively.
J.P. Morgan Estimates 4Q’10E F’10E F’11E F’12E
Revenue 80.3 291.5 407.8 561.3 EBITDA -0.3 0.4 12.6 43.9 Pro forma EPS -0.07 -0.16 0.06 0.66 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $23 We are maintaining our year-end 2011 price target of $23. Our price target is derived using a DCF analysis, with the parameters below.
Key DCF Assumptions $ in millions, except as indicated
Equity beta 1.00 Risk free rate (10yr yield) 2.7% Risk premium 8.3% Cost of Equity 11.0% Cost of debt 6.9% Final debt ratio 0.0% Equity as a % Cap 100.0%
WACC 11.0%
Source: Bloomberg, J.P. Morgan estimates.
Valuation and Rating Analysis ReachLocal currently trades at ~10.5x our F’12 EBITDA estimate of $44M vs. its peer group at ~12.6x. We believe the company’s growth prospects do not merit this discount and thus rate RLOC Overweight.
Investment Risks Downside risks: The company fails to adequately recruit, train and retain its internet marketing consultants. Google and, to a lesser extent, Yahoo!, MSN et al, take actions that are adverse to the company’s interests. SMBs increasingly opt to perform advertising tasks on their own or go directly to internet search engines and publishers. The company fails to increase the number of its clients or to retain existing SMB clients. The company is unable to maintain relationships with its national brands, agencies or resellers. The cost of the advertising media that the company purchases on behalf of its clients rises faster than expected, putting pressure on profitability. The economic situation worsens, jeopardizing the ability of ReachLocal’s clients to increase or maintain advertising spend. Key executives leave the company (four of ReachLocal’s founders are still with the company – the departure of any could create risk).
Company Data Price ($) 34.89Date Of Price 29 Dec 1052-week Range ($) 36.69 - 15.46Mkt Cap ($ mn) 952.22Fiscal Year End DecShares O/S (mn) 27Price Target ($) 39.00Price Target End Date 31 Dec 11
We are maintaining our Overweight rating on Shutterfly as we believe the company will continue to benefit from strong growth in its personalized products and services (PP&S) business. Additionally, we think Shutterfly will achieve better printing facility utilization via the development of its commercial print business. We are raising our end-2011 price target to $39 from $32.
Continued growth of PP&S business. We expect Shutterfly’s non-print revenue to grow 30% in F’10, representing 71% of total revenues. We believe increased penetration of photobooks and continued product development will drive growth in Shutterfly’s personalized products & services business. We are now modeling 20% PP&S growth in F’11, comprising ~73% of total revenues.
Retail partnerships could help boost print revenue. In October 2010, Shutterfly announced a partnership with CVS/pharmacy and Walgreens, giving Shutterfly customers an in-store pickup option at any CVS/pharmacy or Walgreens US store location with a photo center. This adds to the company’s existing retail partnership with Target, announced in May 2007. We think Shutterfly’s expanded retail presence could drive not only print volume growth, as it reduces friction, but also increased awareness and demand for the company’s other products.
Commercial print business an attractive opportunity. Shutterfly’s commercial print business contributed $3.8M in revenues in 2009 and $2.9M in the first nine months of 2010. We believe the WMSG acquisition, announced in November 2010, will help Shutterfly expand its presence in the commercial print market. Furthermore, we think the expansion of its commercial print business will provide an important use for its non-seasonal manufacturing capacity. We are modeling commercial print revenue of ~$11M in F’12, which we believe is very conservative.
Growth of social media makes Shutterfly a more utilized tool. We expect Shutterfly to take advantage of the growth of social media sites. As consumers are taking pictures via multiple devices and sharing their photos on many sites, we think Shutterfly will become a more utilized tool.
2011 drivers. In our view, the following factors will drive SFLY shares in 2011: (1) continued mix shift trend from print to non-print products, (2) development of commercial print business and (3) margin expansion.
Raising Estimates and Outlook for 2010, 2011 and 2012 We are now modeling F’10 revenue, EBITDA and EPS estimates of $296.8M, $61.6M and $0.42 compared to our previous estimates of $294.1M, $60.9M and $0.40.
We are now modeling F’11 revenue, EBITDA and EPS estimates of $347.1M, $71.2M and $0.48 compared to our previous estimates of $337.4M, $69.9M and $0.45, respectively.
Our F’12 estimates call for revenue, EBITDA and EPS of $412.3M, $85.4M and $0.68 compared to our previous estimates of $391.4M, $83.7M and $0.65, respectively.
J.P. Morgan Estimates $ in millions, except per-share data
Raising Our End-2011 Price Target to $39 from $32 As a result of our newly increased estimates, we are raising our December 2011 price target to $39 from $32 previously. Our price target is derived using a DCF model with the following parameters:
Key DCF Assumptions Equity beta 1.17 Risk free rate (10yr yield) 3.3% Risk premium 7.6% Cost of Equity 12.1% Final debt ratio 0.0% Equity as a % Cap 100.0%
Source: Company reports and J.P. Morgan estimates.
Valuation and Rating Analysis SFLY trades at a discount to its peers. On an EV/EBITDA basis, SFLY trades at 11.1x our F’11 EBITDA estimate of $71.2M vs. its peer group at 14.3x. Given SFLY’s strong growth prospects, we believe there is opportunity for multiple expansion and thus rate the stock Overweight.
Investment Risks Downside risks: (1) Currently, Shutterfly’s business is very seasonal, with approximately 50% of revenues earned in the fourth quarter. If the company were unable to deliver customer orders during the holiday season, there would be downside risk. (2) Pricing on 4X6 prints has come down over the last few years, causing the company to look for growth in other product segments. Should other product segments experience similar pricing pressure, our estimates could be at risk. (3) If consumer spending slows more rapidly than we currently expect, the company may have difficulty meeting our revenue estimates, and there could be downside risk to the stock.
Yahoo Inc (YHOO;YHOO US) 2009A 2010E 2011E 2012EEPS Reported ($) Q1 (Mar) 0.08 0.22A 0.19 0.22 Q2 (Jun) 0.10 0.15A 0.19 0.23 Q3 (Sep) 0.13 0.29A 0.19 0.22 Q4 (Dec) 0.11 0.22A 0.22 0.25 FY 0.42 0.89A 0.79 0.92Source: Company data, Bloomberg, J.P. Morgan estimates. Note: Est's include FAS 123R adjustment. FY total may not add up due to rounding.
Company Data Price ($) 16.61Date Of Price 29 Dec 1052-week Range ($) 19.12 - 12.94Mkt Cap ($ mn) 22,308.79Fiscal Year End DecShares O/S (mn) 1,343Price Target ($) 20.00Price Target End Date 31 Dec 11
Despite its poor execution and some structural challenges, we are maintaining our Overweight rating on Yahoo! as we believe the company will benefit from continued margin expansion, part of which can be attributed to the Microsoft search deal. Additionally, we think the current share price does not fully reflect upside from Asian assets. We are maintaining our December 2011 price target of $20.
Display growing faster than market but may not be sustainable going forward. In the first half of 2010, Yahoo! grew its O&O graphical revenue 19% Y/Y, above the display market growth rate of ~16%. However, we think Yahoo!’s growth rate significantly underperformed that of Google and Facebook. Furthermore, despite getting into the business much later than Yahoo!, we believe Google and Facebook will have display market share similar to YHOO’s by 2011. Additionally, if AOL improves its market share going forward, we think such gains could come from the slowdown of Yahoo!’s growth.
However, current share price does not reflect the full asset value. We believe there is significant value in Yahoo!’s private assets as well as the company’s Asian assets, which we believe are undervalued by the Street. We see at least ~$7.4B ($5.51/share) in value from Yahoo! Japan and Alibaba, which does not include any contribution from the value of TaoBao, owned by Alibaba Group. Further, Yahoo! has $2.82B in cash, equivalents and marketable securities on its balance sheet, representing an additional $2.10/share in value.
Benefits from the completion of the Microsoft search deal. We think Yahoo! will see an uplift in RPS from the Microsoft search alliance. Additionally, search comps will be easier once Yahoo! laps the discontinuation of paid inclusion (in 1Q’11). We note that Yahoo!’s 3Q O&O search revenue would have been up 1% Y/Y excluding the removal of paid inclusion (compared to a 7% nominal decline).
2011 drivers. In our view, the following factors will drive YHOO shares in 2010: (1) display ad growth, (2) monetization/valuation revision of Asian assets, (3) margin trends and (4) search market share trends.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue, EBITDA and EPS estimates of $4.47B, $1.69B and $0.79, respectively.
Our F’12 estimates call for revenue, EBITDA and EPS of $4.67B, $1.89B and $0.92, respectively.
J.P. Morgan Estimates $ in millions, except per-share data
4Q’10E F’10E F’11E F’12E Net Revenue ($M) 1,174.1 4,557.1 4,470.4 4,670.2 EBITDA ($M) 430.7 1,599.0 1,692.5 1,893.1 GAAP EPS 0.22 0.89 0.79 0.92 Source: Company reports and J.P. Morgan estimates.
We Maintain Our End-2011 Price Target of $20 We are maintaining our year-end 2011 price target of $20. Our price target is derived using a DCF analysis, with the parameters below.
DCF Analysis Base FCF 1,627.6 Terminal Growth Rate 3.0% Terminal WACC 10.93% Terminal Multiple 13 Terminal Value 20,514 PV of terminal value 12,211 Firm value NPV year 2012-2016 4,373 PV of terminal value 12,211 Enterprise value $ 16,583 Plus Net Cash 3,455 Equity value $ 20,039 Shares outstanding 1,343.1 Adjusted equity value (+strike price) $ 20,039 Yahoo Japan $ 4,983 Other Investment $ 2,416 Nols $ - Total Value $ 27,437 Total shares o/s for stock price calc $ 1,343 Equity Value Per Share $ 20.00
Source: J.P. Morgan estimates.
Valuation and Rating Analysis Given our belief that the management is effectively implementing a turnaround and asset value limits downside, we rate the stock Overweight. On an EV/EBITDA basis, Yahoo! trades at 7.1x our F’11 EBITDA estimate vs. its large cap peers at an average 12.8x F’11 estimates.
Investment Risks Yahoo! is heavily dependent on the performance of the online advertising industry. Yahoo! generates the majority of its net revenues from its marketing services revenue unit. The advertising industry is susceptible to overarching economic conditions, making a large portion of Yahoo!’s revenues vulnerable to general economic risk.
We remain Neutral on Alibaba with a Dec-11 PT of HK$16. We expect China’s marketplace to grow at a faster rate than the international marketplace in 2011. Value-added services should also continue to gain more revenue share in 2011.
International marketplace net-adds to continue to be slow: With higher fee Rmb30K annual fee package launch next year, and Alibaba’s plan to slow down new customer net adds, 2011 membership net-adds are likely to see slow growth. We forecast around 4K quarterly net-adds in 2011. China marketplace revenues accounted for ~34% of total revenues in 2010. We expect China marketplace’s share to increase with the increase in the domestic eCommerce market. We currently expect China’s marketplace to grow 36% YoY vs. the international marketplace expected growth rate of 20% YoY in 2011.
Future monetization potential on Alibaba platform: AliExpress (international transaction base platform) saw GMV (gross merchandise volume) up 3 times QoQ in 3Q10. AliLoan program cumulative loan amounts reached Rmb20 M. Both could lead to longer-term monetization potential. AliLoan could start monetization as soon as 1H10. International expansion is still in the early stages. India and Turkey are the key potential target markets for the company.
Company to execute “Work at Alibaba” strategy in 2011. “Meet at Alibaba” has been the company strategy for many years. Alibaba offers SMEs access to Alibaba’s marketing services (annual fee to marketplace, VAS for keywords, etc.) in order to meet with potential buyers. The newly added “Work at Alibaba” strategy will help SMEs to reduce operating costs by offering them more value-added services.
2011 drivers: (1) Increasing monetization of value-added services, (2) Good growth in China marketplace from growth of local eCommerce market, (3) Improvement in operating margins from leverage over SG&A expenses.
Reuters: 1688.HK; Bloomberg: 1688 HK Rmb in millions, year-end December
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue and adjusted EPS estimates of Rmb6.8 B and Rmb0.43, respectively.
Our F’12 estimates call for revenue and adjusted EPS estimates of Rmb8.3 B and Rmb0.53, respectively.
Dec-11 Price Target of HK$16 Our price target is based on DCF valuation of HK$16 (WACC = 12%, with terminal growth of 0%).
Our PT of HK$16 implies 32.4x FY11E, and 26.2 FY12E diluted adjusted EPS, or 38.1x FY11E, and 30.6x FY12E diluted reported EPS.
Our PT implies 1.1x PEG (based on 2011E P/E and 2012E EPS growth). We note that on a forward P/E basis, Alibaba has historically traded at high multiples since its IPO. To date, the company has not traded below a forward P/E of 20x even during market lows.
We also use P/FCF ratio as a reference to set our Dec-11 price target. At HK$16, Alibaba trades at 19.1x 2012E P/FCF, in line with the current valuation of other China Internet market leaders, such as Baidu, Tencent.
We believe a higher multiple for Alibaba can be justified, given: (1) Alibaba’s leadership in the China B2B market (60% market share); (2) strong cash position to get through current downturn and use cash to gain market share; and (3) upside in earnings from new initiatives and currently free VAS.
Maintain Neutral While the company has a strong platform for future growth and monetization, we believe there could be near-term downside risks from: (1) slowdown in China’s exports, (2) new “Work at Alibaba” pricing strategy could be risky. We maintain our N, given the high valuation and high volatility of the stock.
Risks to Our Rating and PT Downside risks include (1) slowdown in Gold Supplier and China Trustpass customer growth, (2) VAS does not gain good traction as expected in both marketplaces, and (3) global macro fundamentals turn negative.
Upside risks include (1) better-than-expected Gold Supplier and China Trustpass customer growth due to the company’s strong execution and strong export market growth, (2) VAS penetration rate grew faster than expected, (3) new VAS such as Aliloan, (4) share buybacks, and (5) RMB appreciation.
2011 to be another year of solid growth: We expect Baidu’s revenues to see 57% Y/Y growth to reach $1.83B in FY’11. We believe medium-term revenue drivers are: (1) continued gradual improvement in monetization from Phoenix Nest, (2) secular trend in growth of search usage and search advertising in China, (3) growth in eCommerce–related advertising, (4) increasing mobile search usage, and (5) upside from contextual advertising. As a result, we believe ARPU growth will be faster than advertiser number growth.
FY’10 margin expansion to remain intact in FY’11: Baidu’s operating margins expanded in 2010 to 50.3% vs. 38.0% in FY09 driven by lower TAC, and leverage over bandwidth and operating expenses. We expect the company to be able to maintain this margin level in 2011. However, further expansion will be limited with the potential increase in contextual search advertising. Our 2011 operating margin forecast is 50.3%.
Rising eCommerce trend may add upside: Baidu should also benefit from the growing B2C eCommerce market in China. Increasing competition among B2C eCommerce companies and strong growth in eCommerce sales volume should help drive search ad demand on Baidu’s platform. Baidu has already seen fast growth in eCommerce–related search demand – during 3Q10, Baidu reported the number of online retail advertisers doubled Y/Y.
Maintain OW with Dec-11 PT of US$120: Our price target implies 53.3x FY11E, and 39.7x FY12E diluted adjusted EPS, on the back of 53% and 35% EPS growth for FY11E and FY12E, respectively, or 1.3x PEG (based on 2012E P/E and long-term growth of 30%). Risks to our PT include slower-than-expected revenue growth and a potential macro slowdown. Positive on market potential: Using various references to the US and Korea search markets, we estimate China’s search market size could reach US$3B-US$4.6B by 2013. This compares to our current 2013 forecast of US$3.4B and US search market 2009 size of US$15B.
Reuters: BIDU, Bloomberg: BIDU US US$ in millions, year-end December
Source: Company data, J. P. Morgan estimates, Bloomberg. * Note: Excluding share-based compensation expense. Pricing data as of 29 December 2010.
Key Drivers for 2011 On the monetization side We expect three major revenue drivers:
(1) Continued improvement in Phoenix Nest algorithm will likely increase Baidu’s search monetization potential. We believe both click through and coverage ratios will gradually increase, driven by better quality ads being served in more search results. In addition, large numbers of customers will also lead to keyword pricing increase. As such, we believe the company is likely to see higher revenue per search next year.
(2) Upside from eCommerce advertisers: eCommerce in China is expected to experience strong growth over the next few years, with online B2C retailers offering a wide selection of good-quality products at low prices. Logistics, as well as trust and safety, have improved significantly over the past year. We expect competition among eCommerce merchants likely to increase, and as a result an increase in advertising spending on search. Indeed, Baidu has already seen the number of eCommerce advertisers double Y/Y during 3Q10. We believe the eCommerce segment could account for a double-digit percentage of revenues for Baidu in 2011.
(3) Contextual advertisements are likely to be another growth driver in the medium term. The company has been investing its R&D capability to improve its contextual search technology. We note that a significant portion of Google China’s revenue comes from contextual search. Contextual advertisements will create a win-win situation for Baidu as well as content providers who have not been able to monetize their content properly.
On search queries side We believe the search market in China is still in the early stages of growth as (1) internet penetration still has good upside, (2) increasing amount of Chinese content is available online, (3) higher reliance on search in daily life. To further enhance users’ search experience, the company focuses on box computing initiatives.
(1) Open Data platform (Aladdin) providing users with more dynamic and comprehensive information.
(2) Open Application platform to provide users with their more common application–related needs such as web-based games, eBooks, software, etc. Thirty percent of general search queries on Baidu are applications related.
We believe improvements in search quality should further increase the number of search queries per user.
Cost side Baidu Union optimization: The company’s new revenue-sharing policy has been effective in enhancing Baidu Union's traffic quality and lowering traffic acquisition costs in 2010.
Contextual ads to increase TAC in 2011: However, a decrease in TAC from currently search box-related traffic would be balanced by a rise in payouts related to contextual advertising. Contextual advertising usually has higher payout ratios for third-party websites. If contextual becomes very successful, TAC could move up
back to the low teens level as a percentage of revenue. We currently forecast TAC at 10% of revenues in 2011.
New Businesses The Video and eCommerce businesses are still in the early stages of growth. We believe the company could maintain its strategy of taking a minority stake in new businesses by providing traffic.
We believe the company could make more acquisitions over the next two to three years, when the revenue growth rate slows.
Active Online Marketing Customers and Average Quarterly Spending Trend 1Q08 2Q08 3Q08 4Q08 2Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10E
Rating and Price Target We maintain our Overweight rating on Baidu as it remains one of the dominant market leaders in China’s online search market, which is still in an early high-growth stage. Google’s potential exit from China is likely to be beneficial to Baidu as well.
With China’s search market around five to six years behind the US in terms of monetization, we believe the risks are on the upside that the search ad market could develop at a faster pace, with lack of other well-established offline SME marketing platforms and the network of distributors and sales agencies.
We maintain our Dec 2011 price target of US$120. Our price target implies 53.3x FY11E, and 39.7x FY12E diluted adjusted EPS, on the back of 53% and 35% EPS growth for FY11E and FY12E respectively, or 1.3x PEG (based on 2012 P/E and long-term growth of 30%).
(1) DCF valuation We use a 15-year DCF valuation for Baidu, with an estimated 17% long-term growth rate from 2020E-25E. Our nominal case DCF valuation is based on a WACC of 12% and 0% terminal growth. Based on the assumptions, our DCF valuation is US$120.4.
We also performed some near-term revenue growth sensitivity analysis on a potential growth slowdown. Our current forecast implies 2012-2015E CAGR to be 30%. If we assume near-term growth to slow down to 25%, our DCF valuation is US$120, with a terminal growth rate at 3%
(2) PEG ratio analysis At our PT of US$120, Baidu trades at 1.3x PEG (based on 2012 P/E and long-term growth of 30%), or 1.5x PEG (based on 2011E P/E and 2012E EPS growth of 35%).
As a reference, the S&P 500 currently trades at 12x forward P/E with the next three-year CAGR of 7%, or a PEG of 1.7x.
(3) Market size potential Using various references to the US and Korea search markets, we estimate China’s search market size could reach US$3B-US$4.6B by 2013. This compares to our current 2013 forecast of US$3.4B and US search market 2009 size of US$15B. Please also refer to the chart below for analysis of market size comparison with US/Korea market.
Other factors that could lead to positive surprises to our forecast include faster-than-expected inflation and RMB appreciation.
Risks to Our Rating and Price Target Downside risks to our rating and price target include:
• Slower-than-expected online search growth: This would be due to Baidu’s execution, economic slowdown, government policy changes, fraudulent clicks causing a general decline in ROI, and availability of an alternative more effective advertising form.
• Potential margin decline: While we expect Baidu to see a slight increase in TAC, upside surprise to TAC could come from a ramp-up of contextual search on affiliate sites and partnerships with new affiliate members. In addition, higher bandwidth cost increases, higher marketing expenses, and higher R&D could lead to a margin decline.
• Large infrastructure-related expense: During the early phase of search advertising growth, Baidu could invest in servers and bandwidths more significantly than we forecast. While this would be a positive in the long term, the share price could be impacted in the near term due to lower earnings.
• Unsuccessful new initiatives: Baidu began investments in Japan in 2007 with US$15million in expenses. The company also invested in a video site (Qiyi.com) and eCommerce site (JV with Rakuten). If these ventures were unsuccessful or required additional financing, Baidu could take an investment loss.
While the company has established good checks on its operating expenses to reduce losses, we believe the company still lacks a product that could strengthen its revenue quality in the medium term.
Business Still Lacks New Drivers: We believe China Finance Online is still lacking a product that could drive their revenues. While the company has been working on a few new products, these new products are yet to be introduced to the market place. In addition, existing products are also negatively impacted due to rising competition and the IPO of its competitor in the A-share market (Grand Wisdom).
Weaker 2011 Outlook: JRJC still lacks new revenue drivers in the near term. A decline in cash revenues for 3Q10 and a muted outlook for next quarter would mean weaker revenue recognition until 2Q11 due to amortization of subscription revenues. We recently revised down our 2011 revenue estimate by 19% and adjusted our EPS estimate (ex share-based expenses) by 40%. We are now also forecasting increased sales and marketing and research and development expenses.
Dec-11 PT of US$8.3: Our DCF-based Dec-11 price target implies 67.3x/31.7x 2011E/2012E adjusted diluted P/E. Excluding net cash of US$4.53 per diluted share, our PT implies 67.3x/31.7x 2011E/2012E adjusted diluted P/E. Downside risks to our PT include: (1) deterioration in domestic stock market activity, reducing demand for JRJC products, and (2) higher-than-expected product development expenses. Upside risks include: (1) the government announcing new policies or innovative products that could lead to higher spot/futures market activity, and (2) the company diversifying into other brokerage–related businesses.
2011 and 2012 Outlook We expect 2011 revenues of US$54.7M (down 7.6% Y/Y) and adjusted EPS (excluding share-based expenses) of US$0.12 (down 56.7% Y/Y). Our 2012 revenue estimates are US$59.2M (up 8.3% Y/Y) and adjusted EPS of US$0.26 (up 112.2% Y/Y).
Price Target, Valuation and Rating Analysis Maintain Neutral with our Dec-11 PT of US$8.3. Our DCF-based PT (WACC of 13%, terminal growth of 0%) of US$8.3 implies 67.3x/31.7x 2011E/2012E adjusted diluted P/E. Excluding net cash of US$4.53 per diluted share, our PT implies 65.7x/20.0x 2011E/2012E adjusted diluted P/E.
Risks to Our Rating and Price Target Key downside risks include: (1) deterioration in domestic stock market activity (negatively affecting demand for JRJC’s products), (2) increase in competition in financial analysis software, and (3) larger-than-expected in-house investment in product development and database.
DCF Model (Base case scenario) 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E
Sales growth 10.4% -7.6% 8.3% 9.2% 11.7% 11.7% 11.7% 11.7% 11.7% 11.7% 11.7% EBIT margin -1.4% -1.7% 4.5% 10.8% 14.2% 14.6% 14.6% 14.6% 14.6% 14.6% 14.6% NOPAT margin -1.9% -2.3% 3.3% 8.0% 10.5% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% Year end net fixed assets turns 7.4 7.4 8.7 8.7 8.7 8.7 8.7 8.7 8.7 8.7 8.7 Year end net working capital turns (4.3) (5.1) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) Year end net other assets turns 3.2 3.0 3.3 4.5 4.5 4.5 4.5 4.5 4.5 4.5 4.5 Cash operating taxes as % of EBIT -33.5% -33.0% 25.7% 25.7% 25.7% 25.7% 25.7% 25.7% 25.7% 25.7% 25.7% Year end Invested Capital turns 4.5 3.7 6.1 11.5 11.5 11.5 11.5 11.5 11.5 11.5 11.5 Source: J.P. Morgan estimates.
We see Netease as the top online game developer and operator in China, and expect the company to see ~20% gaming revenue growth in 2011. Success of Starcraft 2, WoW Cataclysm, and other in-house games could drive the stock higher.
WoW and Fantasy WWJ to remain strong: Online games saw healthy growth over the last two quarters for Netease. New "Perfect Beauty" and having Jay Chou as spokesperson helped Fantasy WWJ drive good growth in 2Q11 and 3Q11. WoW also saw good sequential growth with the launch of new expansion pack “Wrath of Lich King” in 2011. We believe these games should continue to maintain their franchise with the launch of promotion events and new expansion packs.
Starcraft 2 may be launched in 2011: Netease has already submitted information and materials related to the game to relevant government authorities and the game is undergoing the review process. We expect that Starcraft 2 may be launched in 2011.
Online advertising to benefit from new advertising placement system: We expect Netease to see healthy portal revenue growth of 26% next year. We believe the company should benefit from improved awareness amongst advertisers from: (1) sponsorship of Asian Games in Guangzhou, and (2) launch of a new ad placement system which provides analytics for effectiveness of advertisements placed on Netease portal. Portal traffic on Netease is up 40% YTD as of the end of 3Q10.
2011 outlook: We expect 2011 revenues to see 19.7% growth YoY to reach US$947M. We expect gross margins to remain intact with slight improvement in operating margins on lower marketing expenses. Online Games should see 19.2% growth YoY in 2011 from continued performance of WoW and Fantasy WWJ. Launch of Starcraft 2 should be a key revenue driver for 2011, in our view. Netease has one of the strongest R&D teams and we expect the company to maintain its strength as a gaming franchise.
2011 and 2012 Outlook We expect 2011 revenues of US$946.6M (up 19% Y/Y) and adjusted EPS (excluding share based expenses) of US$3.10 (up 23.4% Y/Y). We expect 2012 revenues of US$1,055.7M and adjusted EPS of US$3.40.
Rating and Price Target OW with Dec-11 price target of US$45 We maintain our OW rating on Netease and recently rolled over our PT time frame to Dec-11 from Dec-10. Our PT is US$45 based on DCF valuation of US$45 (assuming WACC of 12.9% and 0% terminal growth).
Our price target of US$45 implies 17.9x ’10, 14.5x ’11E, and 13.2x ‘12E diluted adjusted EPS. If we exclude cash of US$9.9 per share, our price target of US$45 implies 14.0x ’10, 11.3x ’11E, and 10.3x ‘12E ex-cash P/E. The company has a strong cash position of US$1.29B (US$9.9 per diluted share).
Share Price Drivers We expect new game launches such as Starcraft 2 and WoW upgrade to Cataclys will be share price drivers for NetEase
Risks to Our Rating and Price Target Downside risks to our price target include: intense competition resulting in a negative industry environment, delays in game launches, hacking or pirated server issues limiting user growth, and risks of losing operating rights for licensed games (such as WoW).
2011 outlook: Shanda Games currently guides 4Q10 revenues to be 3% to 5% higher sequentially in 4Q10. We expect Shanda Games could return to growth in 2011, particularly if Dragon Nest can continue to gain traction in 2011. F’11 could well mark the turnaround for Shanda Games: We expect the company to see double-digit growth on the top line. Dragon Nest has gotten a good response from gamers. Another promising game in the F’11 pipeline is Final Fantasy XIV.
Dragon Nest could be the second-largest game next year: Dragon Nest PCUs have already touched 700K levels. We believe by next year the game could reach 10% of total revenues for Shanda Games, or become the second-largest game after Mir2, and to surpass Woool. We believe the revenues from new games could ease the pressure from the potential decline in legacy games.
Acquisition of Eyedentity: The company acquired Eyedentity games for US$95M, which will save the company from paying royalties on Dragon Nest. Additionally, this will also contribute some international revenues to Shanda Games.
2011 pipeline healthy: Shanda Games maintains a healthy pipeline of 5 MMORPG games and one casual game for next year. We believe Final Fantasy XIV could be a popular game for Shanda. The game is licensed from Square Enix and has seen good response from gamers internationally.
We believe the company could also benefit from Final Fantasy XIV and other in-house games.
Reuters: GAME, Bloomberg: GAME US US$ in millions, year-end December
Source: Company reports, Bloomberg, J. P. Morgan estimates, Bloomberg. * Note: Excluding share-based compensation expense.
2011 and 2012 Outlook We expect Shanda Games to register US$727.8M (up 11.0% Y/Y) in revenues in 2011 while adjusted EPS (excluding share-based expenses) to be US$0.66 (down 1.8% Y/Y). 2012 revenues are expected to be US$825.4M (up 13.4% Y/Y) while adjusted EPS are expected to be US$0.77 (up 15.8% Y/Y).
Rating, Price Target and Valuation Maintain OW with Dec-11 PT of US$8 Our PT is based on the historical 12-month midpoint of forward P/E of 10x. Our Dec-11 PT implies 12.1x 11E and 10.4x 12E diluted adjusted P/E. Excluding US$1.8 per share (or US$500M of cash), our PT implies 10.0x 11E and 8.7x 12E.
We believe the stock is undervalued given its leading position in China online game space. As such, we maintain our OW rating on Shanda Games. We expect share price drivers to be few months away, with (1) stabilization of Mir 2 revenue, (2) upside from Dragon Nest and other new games.
DCF valuation Our DCF valuation assumes 10-year revenue growth and 0% terminal growth. At a WACC of 12.1%, our DCF valuation is US$9. We believe DCF is a good reference to value the company. However, with risks in the game pipeline, we believe Shanda Games may not be able to trade at its DCF valuation.
Risks to Our Rating and Price Target Risk to our price target include: (1) slower-than-expected revenue growth due to an aging game portfolio and Shanda Games fails to launch successful new games or new upgrade packs, (2) increased competition in the game industry, (3) larger-than-expected spending in marketing, overseas expansion or game sourcing, (4) disruption in the distribution contract with Shanda Interactive, and (5) regulatory changes that could impact the operation of existing games or delay new game launches.
We expect Shanda Interactive to continue investing in its Shanda Online and Shanda Literature businesses in 2011. Still, we think the stock price will largely depend on the performance of its gaming business, Shanda Games.
Good Shanda Online outlook: Shanda Online is an integrated service platform providing total solutions to all kinds of accounts and application developers. The three core service modules are content delivery, promotion & payment, and customer relationship management. Shanda Online is also working to include the systematic integration of users’ personal information, preferences, messages, relationships. There are a total of 72 third-party providers working with Shanda Online. We expect the segment to see good traction in 2011, as Shanda continues to improve its presence in this area.
Shanda Literature continues to see good traction: The Literature business achieved solid sequential growth in 3Q10 by implementing its core strategy of establishing a complete copyright operation platform. In addition, Shanda Literature (SDL) recently unveiled its Cloudary initiative, combining Shanda Literature's rich IP library with the content from external parties. The Cloudary offers a massive online collection of literary works. It brings together over 70 billion Chinese characters of literary content, 3 million copyrighted books and more than 1000 electronic magazines and periodical publications. SDL currently works with more than 100 publishers for its Cloudary initiatives. Bambook has also been a decent success for SDL.
2011 outlook: We maintain our Overweight rating on Shanda, given its low-valuation and high cash level. We maintain our view that: (1) Shanda Games’ potential success is in its new games, (2) potentials exist in Shanda Online, Ku6 and other new ventures, and (3) the company continues to make synergetic investments to become a leading interactive entertainment provider in China, generating additional sources of revenues.
2011 and 2012 Outlook We expect Shanda Interactive to generate US$937.8M (up 16.1% Y/Y) in revenues for F’11 and adjusted EPS (exc. Share-based expenses) of US$1.68 for 2011. We expect F’12 revenues of US$1,074.8M (up 14.6% Y/Y) and adjusted EPS of US$1.90 (up 16.5% Y/Y).
Rating, Price Target and Valuation Remain Overweight on Shanda We maintain our Overweight rating on Shanda, given its low valuation and high cash levels.
We maintain our view that: (1) Shanda Games’s potential success is in its new games, (2) potentials exist in Shanda Online, Ku6 and other new ventures, and (3) the company continues to make synergetic investments to become a leading interactive entertainment provider in China, generating additional sources of revenues.
Dec-11 price target of US$47 Our Dec-11 PT of US$47 is based on SOTP valuation. Our price target of US$47 implies 35.8x 2011E and 30.8x 2012E diluted adjusted EPS. Shanda has net cash (excluding Shanda Games cash) of US$1.259B (or US$18.2 per share). Excluding cash, our PT implies 22.0x 2011E and 18.8x 2012E P/E.
Our PT of US$47 is based on SOTP valuation. We assume:
(1) Value of Shanda Game of US$1.29B (given the large 70% stake Shanda owns, we believe it is reasonable to assume a liquidity discount of 20% from US$1.61 B, which is based on our Shanda Games PT of US$8 ).
(2) Other non-game business (SDO, SDL, and others) of US$740M. We assume an 8x forward P/E multiple for the group of businesses.
(3) Net cash level of US$1.4B (excluding Game cash and net of debt). We do not apply any discount to the cash level. While the company will likely invest its cash in new non-game businesses and as such reduce its cash level, we believe these new initiatives would create value in the longer term.
DCF valuation of US$56.6 assumes a WACC of 11.9%, a 10-year revenue growth and 0% terminal growth. We believe DCF is a good tool to value the company. However, with risks in the game pipeline, we believe Shanda Games may not be able to trade at its DCF valuation.
Shanda: SOTP Valuation Table SOTP valuation (US$M) At current GAME share price of US$6.3 At current GAME TP of US$8 Market value of Shanda Games (70% of GAME) 1,270 1,613 M.V. after applying 20% holding company discount: 1,016 1,290 Value of non-game initiatives: 738 738 Cash & ST investment at SNDA(excluding GAME cash)* 1,412 1,412 Debt at SNDA (153) (153) Sum: 3,013 3,287 Value per diluted share (US$): 42.6 46.5 Source: J.P. Morgan.
Near-term share price drivers We expect the share price could still trade sideways, given lack of strong guidance from Shanda Games and new initiatives
We expect share price drivers to be a few quarters away, with (1) better performance of Shanda Games, (2) non game initiatives see stronger-than-expected growth, (3) further synergetic investments to lead to higher value of Shanda Group.
Risks to Our Rating and Price Target Downside risks include: (1) Existing games experiencing a significant decline from lack of new content or promotion; (2) new, big titles MMORPG seeing lower-than-expected gamer interest; (3) large investment do not provide near-term profitability, and (4) new investments fail to generate expected value.
Sina to remain as the leading portal in China: We maintain our view that Sina should continue to be the leading portal in China. Secular online advertising growth and Sina’s leadership position should be positive drivers in the long run. However, we also note media segregation leading to market share loss to other verticals, online videos, and social network sites.
Platform strategy playing out well: We believe video and microblogs should continue to help maintain traffic share at Sina's portal. In terms of monetization, we do not see much direct contribution from microblogs till end of next year.
Sina to maintain leadership in microblogging: Sina continued to maintain its leadership in microblogging with the number of miniblog users surpassing 50M in 3Q10 vs. 20M last quarter. The company has been adding more than 10M users during the last two months. We expect Sina Miniblog to further solidify Sina’s media influences, and to help maintain long-term advertising revenue growth across both PC and mobile platforms.
Sina expects to monetize Miniblog through: (1) brand advertising and SME advertising, targeted by 2H11, and (2) revenue share from applications built around microblog platform, targeted by 2012. Sina has set up an Rmb200M Miniblog fund with venture capital from Sequoia, IDG, and DFJ to support third-party developers to develop applications on SINA’s Miniblog platform.
Video strategy: Sina won live broadcasting rights to NBA matches for the next three years. NBA games are a popular sports event amongst Chinese youth and should enhance the portal traffic from young users. The company also plans to add more licensed content in Video for next year.
2011 outlook: We expect a healthy online advertising growth rate of 28% for 2011. Auto is expected to be strong, while the growth rate should moderate due to a higher base effect. The company expects healthy growth in advertising from growing eCommerce activities in China. In addition, FMCG and luxury goods-related advertising should also gain traction. Sina brand advertising should also benefit from increased traffic generation from video (includes NBA video) and some contribution from microblogs in 2H11.
Reuters: SINA, Bloomberg: SINA US US$ in millions, year-end December
Source: Company data, Bloomberg, J.P. Morgan estimates. Note: We have excluded quarterly revenue of US$4.7M related to CRIC IPO starting 4Q09.
2011 and 2012 Outlook We expect 2011 revenues to be US$467.9M (up 22.3% Y/Y) and adjusted EPS (excluding share based expenses) of US$2.00 (up 16.9% Y/Y). 2012 revenues are expected to be US$585.6M (up 25.2% Y/Y) and adjusted EPS of US$2.56 (up 28.2% Y/Y).
Rating and Price Target Remain Overweight with Dec-11 PT of US$68 We remain Overweight with Dec-11 PT of US$68. Our PT is based on SOTP valuation of Sina’s organic business (valued at US$39.8), Weibo (valued at US$10), 33% holding in CRIC (valued at US$6), and gross cash of US$13.
Value Weibo at US$664M We value Weibo based on 80M active Weibo users in 2012. In addition page view, we also include small revenue from revenue-sharing of third-party apps and other VAS to small to medium-sized enterprises. We estimate the business to generate net income of US$27M. We assign a 25x P/E, or a value of US$664M.
Excluding equity income from CRIC, we value Sina business based on SOTP valuation (see table below). The mid-range of SOTP valuation is US$62. Excluding equity earnings from CRIC and excluding interest income, 11E/12E adjusted diluted EPS are US$1.51 and US$2.07, respectively.
Excluding values of Weibo and CRIC, or at a share price of US$52, this implies Sina’s core business (excluding Weibo) is valued at 34.6x ’11E and 24.9x ’12E diluted adjusted P/E.
Excluding gross cash of US$13, values of Weibo and CRIC, share price of US$39 implies Sina’s organic business is valued at 25.9x ’11E and 18.6x ’12E diluted adjusted P/E.
We believe this is a fair P/E multiple, given a CAGR growth rate of roughly 25% over the next few years, or PEG ratio of around 1x.
We value Sina’s 33% holding in CRIC based on the share price of US$10. This represents US$405M or US$6.1 per Sina share (with a 15% holding discount). As such, we value this part of the business at US$6.1.
At our PT of US$68, this implies 34.0x/26.5x 11E/12E diluted adjusted P/E, or at ex-cash 30.0x/23.5x 11/12 P/E. The company has convertible debt of US$100M, but we believe looking at gross cash is more relevant, as dilution impacts from convertible debt has already been reflected in diluted share counts.
Maintain our Neutral rating We maintain our Neutral rating on Sina due to: (1) high expected 2011 ad growth, (2) newly listed vertical sites and video sites could compete with Sina (and may limit revenue upside), and (3) cautious in assigning a large value to Miniblog, which will likely not contribute meaningful earnings until 2012 — such assigned value is likely to change at high beta.
Sina to remain the leading portal in China We maintain our view that Sina should continue to be the leading portal in China. Secular online advertising growth and Sina’s leadership position should be positive drivers in the long run. However, we also note media segregation leading to market share loss to other verticals, online videos, and social network sites.
Risks to Our Rating and Price Target Upside risks to our price target include better-than-expected online advertising growth and better-than-expected performance for Weibo.
Downside risks to our price target include a decline in online ad gross margin, lower-than-expected growth in advertising spending in China, and competition with other Internet vertical sites. In addition, changes in regulations in wireless value-added space, as well as further declines in wireless-related revenue due to strong competition and regulatory changes are downside risks.
2011 Sum-of-the-parts valuation (2012E) Business lines Earnings (US$M)* Multiple (x) Value (US$M)
Low- End Hi -End Low- End Hi -End Advertising 108.9 20 25 2,178.9 2,723.6 WVAS 12.2 10 15 121.5 182.3 Others 1.5 10 15 14.7 22.0 Weibo 664.5 664.5 Gross cash and investments 857.0 857.0 Total value* 3,836.6 4,449.4 Price per dil. share (US$) 57.1 66.2 Average Price (US$) 61.7 Source: J.P. Morgan. Note: * Exclude earnings contribution from CRIC.
SINA—DCF model (base case scenario) 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E
Sales growth 8.1% 22.3% 25.2% 22.6% 20.6% 18.8% 17.5% 16.7% 15.8% 15.5% 15.5% EBIT margin 23.9% 24.9% 25.1% 25.2% 25.2% 25.2% 23.2% 22.7% 22.7% 22.7% 21.8% NOPAT margin 17.5% 21.5% 21.6% 21.7% 21.8% 21.8% 20.0% 19.6% 19.6% 19.6% 18.8% Year end net fixed assets turns 27.4 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 15.0 Year end net working capital turns 1.4 1.5 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 Year end net other assets turns 0.5 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 Cash operating taxes as % of EBIT 13.8% 13.8% 13.8% 13.8% 13.8% 13.8% 13.8% 13.8% 13.8% 13.8% 13.8% Year end Invested Capital turns 0.4 1.0 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 1.2 Source: J.P. Morgan estimates.
Sina Corp: Summary of financials Income statement Ratio Analysis US$ in millions, year-end Dec FY08A FY09A FY10E FY11E FY12E %, year-end Dec FY08A FY09A FY10E FY11E FY12E
We maintain our Overweight rating on Sohu with a Dec-11 PT of US$89. We expect advertising margin expansion and upside from DMD to be share price drivers for the stock in 2011.
Expect Sohu to maintain brand advertising market share: We expect Sohu 2011 brand revenue to grow by 19%. Increased video monetization should help overall brand advertising revenues for Sohu, in over view. We expect autos, fast-moving consumer goods, and eCommerce to be key segments to watch. While real estate revenues should continue to be affected by new government policies and regulations, penetration into second-tier cities is likely to drive growth.
2011 to experience margin expansion in online advertising: With a positive macro environment, we believe Sohu should see margin expansion on the back of fixed portal costs. We expect online advertising margins in 2011 to expand to 61.1% from 60.5% in 2010E. We believe Sohu could see more margin leverage in 2011, as the company plans to reduce spending on video and begin to get more traction from video advertising.
Upside to come from online game business: Based on Street consensus, Sohu’s game division (Changyou) currently trades at 8.3x ‘11 and 7.3x ’12 P/E. We expect earnings upside could come from the launch of DMD (likely 1H’11), while multiple expansion could come from re-rating of leading game companies given sustained long-term growth. At our PT, we assume the game segment trades at 8.5x ‘11/’12 P/E.
2011 stock price drivers: Earning upgrades potential may come from: (1) stronger trend in online video monetization; (2) launch of Duke of Mountain deer generates strong interest amongst online gamers. Re-rating could happen from the multiple expansion of the online gaming sector through sustained solid growth by online gaming companies in 2011.
Source: Company data, Bloomberg, J.P. Morgan estimates. * Note: We have included share-based compensation expense adjustments starting in 2006.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue and adjusted EPS estimates of $736.5M and $5.39, respectively.
Our F’12 estimates call for revenue and adjusted EPS estimates of $877.1M and $6.28, respectively.
Rating and Price Target We maintain our Dec-11 PT of US$89. Our PT implies 21.5x 2010E, 16.5x 2011E and 14.2x 2012E diluted adjusted P/E, or 25.5x 2010E, 19.2x 2011E, and 16.2x 2011E GAAP P/E.
Our price target is based on the midpoint of our sum-of-the-parts valuation of US$78-US$99.4. As a reference, our Dec-11 DCF value for Sohu is US$81, based on a 10-year DCF forecast, WACC of 12%, and terminal growth rate of 0%.
Sohu’s portal At the mid-point of our SOTP valuation, portal is valued at US$1.3B, which we think is relatively low, compared with Sina at US$2.5B and Soufun at US$1.4B. Given Sohu’s brand name and content investment, we believe Sohu’s portal could see a higher valuation. However, due to Sohu’s portal recent content investments, we believe Sohu's portal cannot demand a higher value in the near term.
Online games Based on Street consensus, Sohu’s game division (Changyou) trades at 8.8x ‘11 and 8x ’12 PE. At our PT, we assume game segment to trade at 8.5x 11/12 P/E, or an implied value of US$1.6B (including Sohu’s claim on Changyou cash). We expect earnings upside could come from the launch of DMD (likely 1H’11), while multiples expansion could come from re-rating of sustained solid growth for leading game companies.
Sogou value at US$200 M Based on Alibaba’s investment amount, post money valuation for Sogou is US$150M. We have assumed a higher value, as we believe Alibaba’s cooperation will create value to Sogou.
Baidu has ~80% market search share in China with ~US$40B market cap. For Sogou, it currently has ~1% market share. Making a direct comparison, this implies Sogou value of US$500M. Baidu is currently trading at 40.3x P/E 2011E. If we assume Sogou were also profitable with similar margins, then Sogou probably can only trade at 20x (given high growth end market, but not a dominant player). From this calculation, we estimate Sogou’s valuation to be US$200M. In other words, we take a more optimistic view that with Alibaba's investment, Sogou can have a higher value in the future.
The US$50M value difference causes ~US$1 share price impact in our SOTP analysis.
Sohu has net cash of US$510M or net cash of US$13.2 per diluted share (excluding Changyou’s claim cash). On a consolidated basis, Sohu has cash of US$609.3M as of 3Q10, or US$15.9 per diluted share.
Risks to Our Rating and Price Target Risks to our price target include a slowdown in the Chinese economy that could result in lower online advertising revenue growth, significant market share loss in online advertising to other websites, and volatility in wireless revenue due to policy change at mobile operators. For online games business, delays in upgrade and new game launches, and regulatory changes also add to downside risks.
Sohu Sum-of-the-Parts Valuation 2011E Net profit
(US$M) Multiple (x) Value
(US$M) Multiple (x) Value
(US$M) Branded ads 74.8 16 1197.0 20 1496.3 WVAS 8.8 8 70.6 10 88.3 Games profit (after 66% of MI) 168.1 7 1176.6 10 1680.9 Sogou (53% holdings) -10.6 nm 106.0 nm 106.0 Sohu.com net cash and other 317.3 317.3 Claim on Changyou cash (66.7% of Changyou cash) 192.1 192.1 Total equity value 3059.6 3880.8 Value per diluted share 78.0 99.0 Mean value per share (US$) 88.5 Source: Company data, J.P. Morgan estimates.
Sohu DCF Model (base case scenario) 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E
Sales growth 17.7% 21.4% 19.1% 15.5% 16.3% 15.6% 15.0% 13.0% 13.0% 13.0% 13.0% EBIT margin 31.5% 31.1% 30.3% 29.5% 28.7% 27.9% 27.7% 27.7% 27.7% 27.7% 27.7% NOPAT margin 26.8% 26.4% 25.7% 25.1% 24.4% 23.8% 23.5% 23.5% 23.5% 23.5% 23.5% Year end net fixed assets turns 3.2 3.2 3.2 3.2 3.2 3.2 3.2 3.2 3.2 3.2 3.2 Year end net working capital turns (8.0) (8.0) (8.0) (8.0) (8.0) (8.0) (8.0) (8.0) (8.0) (8.0) (8.0) Year end net other assets turns 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 Cash operating taxes as % of EBIT 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% Year end Invested Capital turns 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 Source: Company data, J.P. Morgan estimates.
We expect Tencent to continue maintaining its leadership position in China’s internet space in 2011. New revenue from open platform applications, social eCommerce, mobile platform launch, and a new game pipeline could be some of the drivers for 2011. We remain Overweight with a Dec-11 PT of HK$205.
• Expect Tencent to Maintain its Leadership in China internet: Tencent has established itself as a leading internet platform in China with its leadership in social networking, online gaming, instant messaging, and online and wireless portal. We expect Tencent to further leverage and monetize its platform in 2011 through new ventures in eCommerce, mobile internet, third-party apps, and, to a certain extent, online search. As a well-executed leader in China’s internet space, Tencent is likely to remain a key beneficiary of rising disposable incomes and increasing internet penetration in China.
• Open Platform to Be a Key Focus: The company has already created open platform interfaces for four key products: (1) social networks, (2) SoSo, (3) Paipai, and (4) Tenpay. The strategy is to increase user loyalty to Tencent’s community and eventually increase monetization. Tencent plans to upgrade “Xiaoyou” to “PengYou” with better open-platform support.
• Online games Should Continue to Be Strong: We expect game segment growth to continue to be driven by Cross Fire and Dungeon & Fighter upgrades and new unannounced titles launch (both in-house and licensed games). Mobile games and mobile social games will increase loyalty to Tencent’s platform and help Mobile VAS revenue.
• 2011 earnings drivers to come from: (1) potential upside in gaming revenue, driven by the launch of multiple games in 2011; (2) better-than-expected ad growth with macro pick-up and improving brand image; and (3) new growth potential in SNS (third party apps, eCommerce and others), and (4) early signs of the success of mobile internet products.
Source: Company data, Bloomberg, J.P. Morgan estimates. * Note: Excluding share-based compensation expenses.
Launch of Open Platforms to Be Next Growth Driver The company plans to expand Qzone and Tenpay into open platforms with the flexibility to host more third-party applications. By leveraging strong Qzone/QQ user base, the company creates a strong ecosystem with third-party content.
The company is increasingly open to the idea of investing in small third-party developers focusing on developing applications for Qzone platform. In addition, Tencent has been expanding its technology infrastructure to host more social applications to integrate Qzone with other content websites.
For Tenpay, the company has been allowing other applications with payment needs to be integrated with its platform. The company has already been working with close to 100 applications. Tencent has been also working on developing a strategy to attract more applications with strong user interest on Tenpay.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue and adjusted EPS estimates of Rmb25.0B and Rmb5.88, respectively.
Our F’12 estimates call for revenue and adjusted EPS of Rmb31.4B and Rmb7.34, respectively.
Valuation, Rating Analysis and Risks DCF valuation Our 10-year DCF-based valuation (assuming a WACC of 12% and a terminal growth rate of zero) yields a PT of HK$205. We expect Tencent to post a revenue CAGR of >20% from 2010 to 2015, and subsequently mid-teen growth from 2015 to 2021.
We maintain our long-term growth forecast and DCF assumptions. We maintain our DCF-based Dec-11 PT of HK$205.
Remain Overweight with a Dec-11 price target of HK$205 Our DCF-based Dec-11 price target of HK$205 implies 41.2x FY10E, 32.0x FY11E, and 25.3x FY12E reported EPS, or 38.9x FY10E, 30.6x FY11E, and 24.5x FY12E adjusted EPS, on the back of 41%/26% FY11E/12E EPS growth.
The company has around HK$10.7 cash per share, after DST investments.
We expect potential earnings upside to drive its share price further: (1) potential upside in gaming revenue, with new title and upgrade launches; (2) launch of new open-platform applications across QQ products, which also creates synergy in the QQ ecosystem, (3) better-than-expected ad growth with macro pick-up and improving brand image.
Share price risks, in our view, include: tightened content censorship in China, revenue volatility of short-life cycle SNS applications, faster-than-expected decline in game revenue, and regulatory risks.
By leveraging its strong Qzone/QQ user base, the company creates a strong ecosystem with third-party content.
We expect weak operating performance for the company to continue in 2011. Our Dec-11 PT of US$6.1 is at a 20% discount to year-end 2011 estimated cash per share.
Company has restructured into three divisions: (1) Global strategy: Mainly based on R&D capability of Red 5 studio and other future investments. Red 5 studio is led by an ex-World of Warcraft developer from Blizzard. (2) Domestic strategy: Maintain in-house and licensing strategy. Currently, the company has an R&D staff of 300 for in-house development. (3) Alternative platform strategy: Mobile game/mobile game platform. The acquisition of minority stakes in Aurora Feint (an iPhone game platform with 28M registered users and 2,220 games) to help jump-start The9’s mobile game business in China.
Mobile gaming platform: The company has been trying to develop a mobile gaming platform along with three telco carriers in China. The company has tie-ups with Aurora Fient which runs the biggest game platform on iPhone in the US. The company also invested US$4 M in Openfeint previously for a 13% stake.
Disclosed game pipeline includes: (1) 1Q11: Shen Xian Zhuan (in-house game from Hang Zhou studio), (2) Free Realms (a cartoon-style MMORPG licensed from Sony) to be launched in 2H11, and (3) Red 5, a subsidiary of The9 is also releasing a FPS game named Firefall in October 2011. The company terminated its online game FIFA Online from EA Sports recently. The game was generating losses for the company.
Expect losses to continue and the stock to trade below cash: With a small revenue base, while maintaining company headcount of 800 to support potential future growth, we forecast losses to continue in the medium term. The company currently has net cash of US$9.0 per share. We do not expect strong results from Shen Xian Zhuan launch by the end of 2010. As such, we believe the company still lacks share price drivers. Potential drivers could come from successes in handset games and Red 5 game.
Our Estimates and Outlook for 2011 and 2012 We are maintaining our F’11 revenue and adjusted EPS estimates of $15.5M and $(1.33), respectively.
Our F’12 estimates call for revenue and adjusted EPS estimates of $19.7M and $1.21, respectively.
Rating and Valuation Our Dec-11 price target is US$6.1 We recently rolled over our Dec-10 PT of US$6.1 to Dec-11. The company had total cash of US$226M at the end of 1H10 with zero debt. We expect 2011-end cash to fall to US$192.5M. At 2011-end, the company is expected to have US$7.7 per ADS in cash. We keep our 2011-end PT at a 20% discount to estimated 2011-end cash.
We remain Neutral on The9 due to low revenue visibility and earnings decline from operating losses and R&D investments. However, we believe the share price will be supported by the current cash level of US$9.0 per ADS.
The stock has been trading in the range of a 20%-30% discount to net cash over the past few quarters. We expect The9 to continue to trade within this range. The company could trade closer to a 20% discount to its net cash, given the potential success of some of its new game launches.
Share price drivers We believe drivers will come from strong gamer response from newly launched games and alternative platform strategy.
Risks to Our Price Target and Rating Downside risks to our price target and rating include: (1) larger-than-expected investments in game titles and studios, (2) new game launches that disappoint. We expect positive share price drivers/risks to be: (1) Better-than-expected performance of The9’s new game launches, and (2) the company being an acquisition target (due to its high cash).
Company Data Price ¥2,954 Price date Dec. 29, 2010 Market capitalization ¥420.7B Shares outstanding 142.4M 52-week range ¥3,105– 1,680 TOPIX 908.01 Dividend (F’10E) ¥46.5 Dividend yield (F’10E) 1.6%ROE (F’10E) 63.9%Source: Bloomberg, J.P. Morgan estimates.
We are maintaining our Underweight rating on DeNA, with a target price of ¥2,200 to November 2011. We believe domestic growth prospects have peaked, and consequently we expect returns to fall due to greater competition and pressure to spend on marketing to keep market share. We have low expectations for DeNA’s plans for overseas expansion and believe that these efforts will not offset the declining domestic growth profile.
We maintain our Underweight rating. We view DeNA as being in the 'early glory' phase of the mobile social gaming market cycle, as it dominates the domestic market (we estimate a 40% share in CY’10). We believe Y/Y growth rates have peaked, and although short-term earnings visibility is high the decelerating Y/Y growth profile looks unattractive. Overseas expansion via M&A does position the company strongly versus domestic peers, but we believe competitive threats are also high as the market overcrowds. Overall, we believe medium-term growth prospects are muted as domestic demand enters a declining profile, with measured advances to be gained overseas. With the business exiting a high-growth phase and entering a flattening growth profile in our view, we rate the shares Underweight.
Domestic prospects diminishing, overseas competitive threats. Mobile social gaming is a new developing market, and the supply/demand balance is still in favor of early movers with hit content. Social gaming content has the advantage of being able to be changed and adjusted 'on the go' in order to meet user needs and can have a long shelf life compared with traditional package software. However, with more games on the market we think the business model will become more reliant on winning new users and keeping them active—we believe marketing costs will rise, resulting in lower returns. As we think the domestic market is unlikely to see a reacceleration of demand, positioning in the overseas markets becomes important for DeNA. However, competitive threats are significantly higher, and we envisage that replicating the success seen domestically will be very difficult to execute overseas. Despite acquiring US app maker ngmoco and having access to overseas resources and the virtual social gaming network 'Plus+', we believe it will become a niche service given the preference of overseas users to operate with real social graphs.
Valuation and risks. The shares are trading at 11.0x our F’11 EPS forecast, which is not a demanding valuation in our opinion. On our medium-term forecasts with decelerating earnings growth that turns negative, we believe the shares offer little upside, and hence our Underweight rating. Risks to our price target include a reaccelerating growth profile in the domestic market and speedy and pronounced earnings generation from overseas expansion.
Consolidated Sales Y/Y OP Y/Y RP Y/Y NP Y/Y EPS P/E P/B EV/EBITDA Y/E Mar (¥B) (%) (¥B) (%) (¥B) (%) (¥B) (%) (¥) (x) (x) (x) 2009 37.6 26.5 15.8 25.1 16.1 25.6 8.0 17.4 55.1 53.7 17.5 22.5 2010 48.1 27.9 21.3 34.2 21.5 33.7 11.4 42.9 79.8 37.0 12.2 17.12011E 113.3 135.5 55.5 160.8 55.7 158.9 33.1 191.0 232.4 12.7 6.1 6.7 2012E 140.1 23.7 64.0 15.3 64.2 15.2 38.1 15.2 267.7 11.0 4.0 5.8 2013E 141.3 0.9 61.8 -3.3 62.1 -3.3 36.9 -3.3 258.9 11.4 3.0 6.0 Source: Company data and J.P. Morgan estimates. Note: The company had not disclosed its earnings forecasts as of Dec. 29, 2010.
Japan
Our Estimates and Outlook for F’11 We are maintaining our F’11 estimates for DeNA, with revenue of ¥140.1B and operating profit of ¥64.0B. Our key assumptions are as follows:
• Average registered monthly users—We estimate the number of annual average registered users will grow 12.3% Y/Y to 24.3M in F’11, a marked slowdown from the estimated 38.9% Y/Y growth for F'10.
• Monthly ARPU per registered user —We believe annualized monthly ARPU will peak at ¥406.6 in F’11.
We expect operating margins to decline Y/Y, with marketing cost increases and margin dilution from the consolidation of overseas acquisitions.
Our Estimates and Outlook for F’12 We are maintaining our F’12 estimates for DeNA, with revenue of ¥141.3B and operating profit of ¥61.8B. Our key assumptions are as follows:
• Average registered monthly users—We estimate the number of annual average registered users will grow 3.1% Y/Y to 25.0M in F’12.
• Monthly ARPU per registered user —We believe annualized monthly ARPU will decline 4.2% Y/Y to ¥389.4.
We expect operating margins to continue declining Y/Y as the decline in earnings from the domestic social gaming business is not offset by overseas expansion.
We Are Maintaining Our Nov. 2011 Price Target of ¥2,200 DeNA is the dominant player in mobile SNS social gaming services in Japan (40% share in CY’10 based on our estimates) and is conducting M&A for overseas market expansion. Despite the high earnings visibility in the short term, we believe the company faces the following challenges:
• We believe growth rates for their domestic SNS operation has peaked, and unlikely to reaccelerate hereon in.
• Domestic ARPU levels are currently high, and we believe they are overreaching realistic levels of sustainability. With registered user growth slowing Y/Y, there is pressure on sales volume expansion and associated marketing costs (user acquisition costs) to maintain user activity on the site.
• Overseas expansion places the company in a relatively strong position compared to domestic peers. Competitive threats are rising in a rapidly overcrowding market, and we believe DeNA will not be able to replicate the level of overseas success seen in Japan.
With a reaccelerating growth profile unlikely to occur in the medium term, and with a domestic business that looks to have peaked, we rate the shares Underweight.
Valuation and Rating Analysis Despite the volatility in growth rates at the company, free cash flow conversion is high and hence we have used DCF as our valuation method to derive a fair value for the stock.
Growth in domestic market has peaked
Cost increases via marketing lowering margins, in order to maintain sales volume
Overseas expansion - limitations via intense competition
Our basic premise is that on a WACC of 10.5% and generating an average annual ¥33.9B of free cash flow into perpetuity (with a zero terminal growth rate), we derive a net present value of ¥273.3B. We then add back ¥46.5B net cash and equivalents, and the resultant fair value equity is ¥319.8B, producing a fair value of around ¥2,200 per share. For the number of shares outstanding, we have used 147.26M shares (includes the forthcoming third-party equity issuance for the acquisition of ngmoco—pending dilution from 1.0% warrants issued, and 1.0% dilution from the earn-out clause have been excluded).
Investment Risks We view the risks to our investment thesis as follows:
Upside risk • Growth reaccelerating in the domestic market
• Overseas earnings growth more pronounced than expected into F’11
• Major M&A activity to raise market position and scale of operations
Downside risk • Growth decelerating faster than expected in the domestic market
• Overseas expansion failing to produce results in the expected timeframe
• Major equity financing for M&A activity resulting in dilution
Key Assumptions DeNA’s mainstay business is social media, which accounts for the vast majority (80-90%) of its earnings. In the social media business, social gaming is the primary earnings source and is exhibiting dominant strength. We believe the current market share in terms of revenues generated by item sales including social gaming and advertising are as follows: DeNA 40%, GREE 25%, and Mixi 5%. We believe that in the short term this situation will not change dramatically.
DeNA has been active in overseas M&A, most recently acquiring ngmoco in October 2010, which signaled a major expansion into overseas markets. We believe financing requirements are low for DeNA as it has completed a major deal with ngmoco.
Business Lines Business segment
Sales split
Description
Social Media 86.0% Comprises of the following service divisions Game related 68.8% Item sales, game ad sales, SAP ad sales, mixiAppli sales (ad and fee), affiliate ads Avatar 9.8% Avatar item sales and affiliate ad sales Ad sales 6.3% Display, tie-up, search, content matched and affiliate ad program sales Other 1.1% Overseas sales, 'Everystar' mobile portal, others ngmoco 0.0% 100% US subsidiary, specializing in smartphone apps Commerce 0.0% Mobile and PC auction and shopping sites Other NA Travel and insurance agency operations Source: J.P. Morgan based on company data
Recent History—Impact of ‘Kaitou Royale’ DeNA experienced its turning point in terms of raising its market positioning in the mobile social gaming market in October 2009 (3Q F’09). The company up until then was in decelerating in growth, as its online avatar service was experiencing a slowdown. The company operated ‘MobageTown’, its mobile SNS gaming portal site and decided to follow GREE's success in social gaming content and developed its first breakthrough title called 'Kaitou Royale'. This title was initially exclusive to ‘MobageTown’, and had the following impact to user ARPU traffic, and earnings growth:
Impact of Social Gaming Content Introduced in 3Q F’09 on ARPU, Pageviews and OP F’09 F’10
OPM % 35.6 36.0 44.8 51.5 49.6 50.3 Source: J.P. Morgan based on company data
‘Kaitou Royale’ is a mafia/gang category game, with the objective to become a successful thief—a similar overseas equivalent title is 'Mafia Wars' from Zynga,
which is very popular on Facebook. Since 3Q F’09, the company has rolled out spin-off versions of the title, such as 'Sengoku Royale' (the same game in a samurai historical setting) in April 2010. DeNA also released ‘Kaitou Royale’ on the Mixi mobile platform in December 2009, and another PC browser game version ‘Kaitou Royale ZERO’ on Yahoo Japan’s ‘Yahoo! Mobage’ service in from September 2010.
Other in-house social gaming titles are:
• ‘Setururin’: A pet sim
• ‘Nouen Hokorina’: A gardening sim
• ‘Aqua Square': A fish/aquarium sim, similar to Zynga’s 'Fishville’
Quarterly Earnings Estimates ¥ billion F’10 F’11 F’12 F’10E F’11E F’12E Q1 Q2 Q3 E Q4 E Q1 E Q2 E Q3 E Q4 E Q1 E Q2 E Q3 E Q4 E Sales 24.2 27.1 29.7 32.3 33.6 34.0 35.4 37.1 35.7 33.8 35.5 36.4 113.3 140.1 141.3 Social media 20.4 23.2 25.5 27.9 28.7 28.8 29.6 31.3 29.9 27.8 28.9 30.3 97.0 118.3 116.8 ngmoco - - - - 1.1 1.3 1.6 1.8 2.0 2.2 2.4 2.5 - 5.8 9.0 eCommerce 3.4 3.4 3.7 3.6 3.4 3.4 3.7 3.3 3.4 3.4 3.7 3.0 14.1 13.9 13.6 Other - travel and insurance agencies
• Average registered monthly users—we expect a gradual slowdown trend to continue into F’12, with the ceiling of around 25M users
• Monthly ARPU per registered users —we believe that ARPU is nearing its ceiling limit as well, despite the tendency for the over 30s demographic to be high spenders.
Corporate History and Basic Information DeNA – Corporate History
Year Summary 1999 Established in Tokyo, as an online PC auction site “Bidders” 2004 Open's "Mobaoku" mobile auction site 2005 Tie-up with KDDI as their official auction service
Lists on TSE Mothers 2006 Open's "Mobage Town" mobile game portal and social network service with avatar content 2007 Lists on TSE 1st section 2009 Launches social gaming on "Mobage Town" 2010 Launches "Mobile Game" open platform
Launches "Game Community" globally to iPhone and iPod touch Acquires US iPhone app company ngmoco Launches "Yahoo! Mobage" with Yahoo Japan
Source: J.P. Morgan based on company report.
DeNA – Shareholder Structure
Tomoko Namba
15%
Sonet Entertainment
14%
Trustee Accounts
23%
Others48%
Source: J.P. Morgan based on company data Note: Data as March 2010 DeNA’s shareholder structure shows management (CEO Namba) and So-net Entertainment as core shareholders. The free float is estimated to be 6.4% as of March 2010.
Acquisition of ngmoco DeNA announced the 100% acquisition of US based smartphone game application developer ngmoco on October 12, 2010. The key details are as follows:
Earn-out phase 8.5 DeNA equity dilution (%) Closing phase 3.4
Stock options exercised from closing phase 1.0 Earn-out phase 1.0
Source: J.P. Morgan based on company data Note: ngmoco’s F’08 was a seven month reporting period. * The founder and CEO of ngmoco, not the Canadian singer/songwriter. Forex rate is $1=¥85.
CEO Namba commented at the 2Q F’10 analyst meeting that ngmoco is growing so that its profits will offset any annual goodwill amortization charge arising in F’11. We have asked the company about the amortization schedule and was told it was over around a 10-year period.
Company Disclosure DeNA has ceased to release monthly data regarding user registration numbers and pageview traffic for its ‘MobageTown’ service, as well as data from its mobile ecommerce operations (shopping transaction volume and subscription customers) from August 2010. The reason given by the company was that, given the major shift in business model, the company felt that disclosure was no longer required as these monthly data was not related to actual recent trading.
Although we agree that mobile ecommerce operations have little bearing on earnings visibility now, the data supplied for ‘MobageTown' are useful indicators of user activity. The company now releases registered user numbers at quarter end at quarterly financial reporting, but nothing on pageview statistics.
Company Data Price ¥1,069 Price date Dec. 29, 2010 Market capitalization ¥243.1B Shares outstanding 227.4M 52-week range ¥1,580– 875 TOPIX 908.01 Dividend (F’10E) ¥5.0 Dividend yield (F’10E) 0.5%ROE (F’10E) 55.9%Source: Bloomberg, J.P. Morgan estimates.
We are maintaining our Neutral rating on GREE, with a target price of ¥1,000 through November 2011. We believe the shares have corrected to reflect the competitive pressures and structural issues regarding peaked demand in the domestic market. However, we think that GREE will struggle to surprise on the upside with limited resources.
We maintain our Neutral rating. The company pioneered mobile social gaming in Japan with “Tsuri-Sta!”, a casual fishing game in May 2007. The situation today is in stark contrast, as DeNA has become the market leader and GREE is struggling to compete in terms of content offering, marketing spend, and user monetization. We believe much of these negatives have been priced into the stock, but with sluggish earnings growth and no positive catalysts in sight we rate the shares Neutral.
Marketing cost increases heighten our concern. We think recent performance metrics have given rise to concern. Average monthly ARPU growth has visibly slowed, with 1Q’10 showing 2.5% growth Q/Q (ARPU ¥192 per month) despite the launch of the platform business in June 2010 and the release of two new in-house game titles (“Columbus” and “Monster Planet”). At the same time, marketing spend has increased 22.3% Q/Q (monthly ¥549 spend per user). We conclude that users activity is waning as the games on offer are entering the latter stages of their product cycle and replacements have yet to construct a recovery. With more social gaming content available compared to three years ago, we believe GREE is finding it difficult to construct winning titles as the SNS platform becomes more competitive and hit driven.
Valuation and risks. As of December 29, the shares have fallen 32% from their 52-week high in June 2010, and we believe the structural negatives (increasing competition, rising costs) have been priced in. Short-term earnings visibility is fair but not one denoting a reacceleration of growth. The shares are currently trading on a P/E of 12.7x our F’11 EPS forecast, which we do not think is demanding considering our 45% Y/Y OP growth forecast, but as this is in line with expectations we believe the shares are fairly valued. Upside risk factors include ARPU growth via strong title releases. Downside risk factors include declining profitability through increasing marketing expenditure.
2012E 65.2 16.5 32.3 13.7 32.3 13.7 19.1 13.7 84.2 12.7 4.0 6.62013E 73.0 12.0 35.8 10.9 35.8 10.9 21.2 10.9 93.3 11.5 3.0 6.0Source: Company data and J.P. Morgan estimates.
Our Estimates and Outlook for 2011 We are maintaining our F’11 estimates for GREE, with revenue of ¥65.2B and operating profit of ¥32.3B. Our key assumptions are as follows:
• Average registered monthly users—We expect a gradual slowdown in user growth into F’11, reaching 27M users in 4Q’11. This is slightly higher than DeNA (25M) given the more casual nature of the platform.
• Monthly ARPU per registered user —We believe ARPU will remain in the ¥190-210 zone. Y/Y we expect monthly ARPU to grow by 5% on an annualized basis to ¥206.1.
We expect operating margins to decline slightly Y/Y, with marketing costs growing faster than topline growth.
Our Estimates and Outlook for 2012 We are maintaining our F’12 estimates for GREE, with revenue of ¥73.0 and operating profit of ¥35.8B. Our key assumptions are as follows:
• Average registered monthly users—We expect registered user numbers to reach 29M.
• Monthly ARPU per registered user —Y/Y we expect monthly ARPU to grow by 4% on an annualized basis to ¥213.3.
We believe that operating margins will stabilize, but with no major improvement as the business needs to invest in order to maintain its growth profile.
We Are Maintaining Our Nov. 2011 Price Target of ¥1,000 The challenges faced by DeNA are not dissimilar to GREE—slowing domestic growth prospects and execution risks over expansion into the heavily contested overseas market. We believe these issues are more pronounced at GREE, as it has a more mature growth profile compared to DeNA in social gaming. GREE’s most successful fishing game was released in May 2007—DeNA's core game “Kaitou Royale” was released in October 2009. The key points to make are:
• We believe growth rates for their domestic SNS operations has peaked and unlikely to reaccelerate hereon in. GREE has a more mature growth profile compared to its peer group.
• We think operating costs are likely to increase in order for the company to remain competitive—new game developments, proactive marketing and staff increases.
• We believe much of these negative factors have been priced into the stock. Although we think a reaccelerating growth profile is unlikely in the medium term, we believe the company will perform in line with our expectations. We rate the shares Neutral.
Valuation and Rating Analysis Despite the volatility in growth rates at the company, free cash flow conversion is high and hence we have used DCF as our valuation method to derive a fair value.
Our basic premise is that on a WACC of 10.5% and generating an average annual ¥18.8B in free cash flow into perpetuity (with a zero terminal growth rate), we derive a net present value of ¥209.6B. We then add back ¥21.4B in net cash and equivalents, and the resultant fair value equity is ¥231.0B, producing a fair value of around ¥1,000 per share.
Investment Risks We view the risks to our investment thesis as follows:
Upside risks • New game releases that reignite user activity, resulting in ARPU increases
• Major influx of advertising demand on the SNS site
• Inactive users are recaptured
Downside risks • Faster-than-expected decline in user activity, leading to drops in ARPU
• Major hikes in marketing spend to compete with peers
• Increasing development costs of new games, as more resources are required to create competitive titles
Key Assumptions GREE’s mainstay business is item sales through the sales of social games and avatars and accounts for 80-90% of total revenues. With an estimated market share of 25% in CY’10, GREE holds the No. 2 spot in sales among domestic SNS companies, behind DeNA. We believe that in the short term this situation will not change dramatically.
GREE is taking a longer-term view on overseas expansion, completing a small transaction to acquire a minority stake in countries such as South Africa and Indonesia. We believe GREE is not prioritizing M&A strategy, and hence its financing requirements are low.
Business Lines Business segment
Sales split
Description
Item sales 82% Premium service subscriptions (¥300 per month) Monthly user defined virtual currency purchases (¥300 to ¥5,000 per purchase) Discretionary user spend on virtual currency (¥300 to ¥5,000 per purchase) Discretionary user spend on avatar items (¥1,000 to ¥10,000 per purchase)
Advertising 18% Banner and listings ads, primarily for mobile content providers, internet services, finance
Corporate History and Basic Information GREE – Corporate History
Year Summary 2004 Establishes GREE PC social networking site 2006 Business and capital tie-up with KDDI, leading to mobile "EZ GREE" site 2007 Launches social games on GREE SNS 2008 Lists on Mothers 2010 Lists on TSE 1st Section 2010 Starts GREE Platform – third party application developers selected to bolt on gaming content 2010 Announces capital tie-up with Project Goth Inc., operator of SNS platform ‘Mig33”
Source: J.P. Morgan based on company report.
We make no earnings assumptions for overseas expansion plans, given that the tie-up with Project Goth Inc. involves little capital (less than ¥0.5B) and planned to be a long-term relationship aimed at emerging market opportunities.
GREE – Shareholder Structure
Others25%
Trustee Accounts
18%KDDI7%
Yoshikazu Tanaka
50%
Source: J.P. Morgan based on company report. Note: Data as of June 2010.
Key Game Titles GREE’s in-house social gaming titles are as follows:
In-house Social Gaming Titles Title Service start Category Tsuri-Sta! May-07 Fishing game Clinoppe Jul-07 Pet sim Dorirando Aug-09 Excavation game Hakoniwa Sep-08 Gardening sim Monster Planet Jun-10 Monster sim/battle game Columbus Aug-10 Pirate game Source: J.P. Morgan based on company report
GREE’s core title “Tsuri Sta!” has been active since May 2007. While this is a testament to the longevity of social gaming applications, recent title releases have performed poorly. We believe that increasing competition from DeNA and other social application providers are giving GREE a run for their money, and that GREE’s client base may be shifting between titles thereby not creating incremental growth via item sales.
Company Data Price ¥441,500 Price date Dec. 29, 2010 Market capitalization ¥68.3B Shares outstanding 0.155M 52-week range ¥777,000– 383,000 TOPIX 908.01 Dividend (F’10E) ¥0.0 Dividend yield (F’10E) 0.0%ROE (F’10E) 11.9%Source: Bloomberg, J.P. Morgan estimates.
We are maintaining our Neutral rating on Mixi, with a target price of ¥425,000 to November 2011. We believe management is taking a long-term view of the business, focusing on developing new services and improving user experience. The focus on advertising as the key revenue driver should see improving prospects with smartphone penetration, but this will still take over a year to materialize in our opinion. While valuations are not inexpensive, we believe Mixi has interesting prospects longer term.
We maintain our Neutral rating. Mixi continues to roll out new services and functions to improve the site, and a current TV advertising campaign is under way aimed at raising brand awareness. Online advertising demand continues to grow albeit at a relatively modest pace, as we think ‘feature phone’ mobile media remains high maintenance and unwieldy for most advertisers. Item sales from the various applications available on Mixi’s platform are beginning to gain traction, but management's emphasis on providing useful utility-type services cannot compete in terms of generating user ARPU available from social gaming in our opinion.
Keeping users satisfied, thinking long term. The release of functions such as ‘Mixi Check’ (a sharing function similar to Twitter and Facebook share/like icons) and ‘Mixi Voice’ (an updated version of their microblogging service) continue to keep the user community involved. We believe this is the core strength of Mixi’s management, with their focus on providing well thought out services and a deep user experience. Monetizing user traffic is a core activity, but as we understand management takes user satisfaction as its key objective.
Valuation and risks. The shares are currently trading at 28.6x our F’11 EPS forecast, which is a high valuation multiple. However, the shares have consistently traded at high levels, and hence we do not see this as being a major mispricing. We think advertising demand should benefit from smartphone penetration. More applications are available on the platform now (around 1,000 for mobile SNS, 1,300 for PC), which will likely grow as users adapt to new services. Upside risks include major application hit services resulting in major item sales. Downside risks include unplanned investment into new services and further marketing activities to boost user activity.
Our Estimates and Outlook for 2011 We are maintaining our F'11 revenue forecast of ¥20.7B and operating profit forecast of ¥4.4B, representing Y/Y growth of 24% and 25%, respectively.
We estimate that top-line growth will remain stable and high as the company improves its media power and makes more inroads into winning new customer accounts. However, opportunities for margin improvement are likely to be limited as the company invests in new service development as well as marketing costs.
Our Estimates and Outlook for 2012 We are maintaining our F'11 revenue forecast of ¥25.0B and operating profit forecast of ¥5.8B, representing Y/Y growth of 21% and 30%, respectively.
In F'12 we believe that demand for mobile advertising will benefit from smartphone penetration, greater adoption by major advertisers, a greater range of advertising products, and Mixi's ability to raise pricing.
We Are Maintaining Our Nov. 2011 Price Target of ¥425,000 Mixi is the leading SNS operating with a real user community, as opposed to a virtual one. The company has no direct domestic competitor and is hence strongly positioned as an internet media company with potential for longevity and a loyal user base. However, we believe it faces the following challenges:
• The dominance of mobile advertising revenue (63% of total ad revenue in 1Q F’11) limits short-term growth potential, as the media itself remains high maintenance and cumbersome for the majority of advertisers.
• The focus on social utility applications being made available on the Mixi platform delivers some potential for user monetization by item sales, but compared to social gaming applications its impact is limited.
• We believe the site is yet to clearly show its monetization potential, but in the medium term we expect steady progress as opposed to a major ramp up in earnings growth.
Valuation and Rating Analysis Despite the volatility in growth rates at the company, free cash flow conversion is high and hence we have used DCF as our valuation method to derive a fair value for the stock.
Our basic premise is that on a WACC of 10.5% and generating an average annual ¥4.6B free cash flow into perpetuity (with a zero terminal growth rate), we derive a net present value of ¥53.1B. We then add back ¥12.6B in net cash and equivalents, and the resultant fair value equity is ¥65.7B, producing a fair value of around ¥425,000 per share.
Investment Risks We view the risks to our investment thesis as follows:
Mobile advertising demand still hampered by technology
User monetization with social applications limited
Key Assumptions Mixi’s mainstay business is internet media, and advertising revenue accounts for 80-90% of its earnings. We believe current market share in terms of revenues generated by item sales including social gaming and advertising are as follows: DeNA 40%, Gree 25%, and Mixi 5%. We think that this situation will not change dramatically in the short term, although driven by mobile advertising demand increasing with smartphone adoption, we think Mixi will increase its market share over the medium term.
Mixi has operations in China, but we believe management is prioritizing organic growth. We do not think Mixi is prioritizing M&A strategy, hence financing requirements are low.
Business Lines Business segment
Sales split
Description
Internet media Advertising 80% Sales of banners, tie-ups, listings and search ads on PC and mobile sites Item sales 16% Sale of virtual currency to use application services, provided by third parties Recruitment 4% Job listings site for IT specialists Other - Includes China star-up operations Source: J.P. Morgan based on company data.
• Average registered monthly users—We believe a steady increase of 2.5% Q/Q for the medium term is realistic for Mixi, as it continues to attract users with real identities that want to use it as a communication tool. Hence, the market Mixi caters to is broader than that of social gaming sites.
• Monthly ARPU—We believe monthly ARPU trends will see a slow but steady climb, primarily driven by item sales demand. However, it will remain considerably low compared to social gaming peers.
Corporate History and Basic Information Mixi – Corporate History
Year Summary 1997 Commences "Find Job!" job listings site 2004 Launches "Mixi" SNS 2006 Lists on TSE Mothers 2007 Releases the mobile service 2009 Launches "Mixi Appli" – the open platform service based on Google’s OpenSocial API standard 2010 Membership policy changes from invitation only to an open registration
Announce business alliance with China's Renren and Korea's Cyworld SNS sites Facebook offers export tool to Mixi users
Source: J.P. Morgan based on company report.
Mixi – Shareholder Structure
Kenji Kasahara58%
Others28%
ngi group1%
Trustee Accounts
13%
Source: J.P. Morgan based on company report. Note: Data as March 2010.
CEO Kasahara is the largest shareholder, with legacy investor ngi group as a minority shareholder with about 1%. The free float is estimated to be 14.8%.
Company Data Price ¥68,200 Price date Dec. 29, 2010 Market capitalization ¥ 893.4bn Shares outstanding 13.1mn 52-week range ¥74,300–56,200 TOPIX 908.01 Dividend (F’10E) ¥100 Dividend yield (F’10E) 0.1% RoE (FY’10E) 16.2% Source: Bloomberg, J.P. Morgan estimates.
We are maintaining our Neutral rating on Rakuten. We view the business as a stable domestic eCommerce growth story but believe this has already been priced in. Although online shopping is defensive in a downturn, we believe the business is not economy-sensitive enough to benefit from an economic upturn. We are maintaining our ¥63,000 price target to November 2011.
We maintain our Neutral rating. We believe the company’s growth prospects are acknowledged and unlikely to yield major positive surprises, and we think overseas expansion plans for eCommerce operations are unlikely to yield material results in the medium term. We believe the shares are fairly valued on a F’11 P/E of 21.6x.
Dominant market position in a growth market: Well-known themes. Rakuten’s business model is idiosyncratic, with business activities ranging from eCommerce to financial services. Its core activities remain online shopping and travel, having major domestic market shares with strong track records. The domestic eCommerce market remains firm and is expected to maintain a steady yet unspectacular medium-term growth profile. Whilst these are positive traits, we believe they are well-acknowledged themes and in themselves provide little catalyst for the shares.
Overseas expansion: Managing expectations. Consolidating its operations after the consumer finance ‘crash’ of F’07, Rakuten has recently begun to expand into niche eCommerce operations overseas via M&A and partnerships. The consensus view is that this is a positive development. We take a more balanced view, as we estimate that overseas operations made up around 2-3% of 3Q F’10 total sales, highlighting the progress required to meaningfully impact earnings. The joint venture with Baidu.com in China commenced in October 2010, and we estimate that generating material earnings here will take time due to strong local competition.
Valuation and risks. We believe the shares are fairly valued. However, upside risks to our price target include positive news flow regarding speedy and solid execution of overseas expansion. An upturn in activity at the financial operations (brokerage and credit) would also boost earnings visibility. Downside risks include higher operating costs due to overseas expansion, a drop in growth in online consumer activity, and ad-hoc business diversification.
Our Estimates and Outlook for 2011 We are maintaining our F’11 estimates for Rakuten, with revenue of ¥385.4B and operating profit of ¥71.9B. We believe that the core eCommerce operation will see a decline in growth Y/Y post acquisitions (up 20% Y/Y versus 25% Y/Y in F’10) and experience margin dilution as a result. The travel business should see stable growth Y/Y as leisure travel demand increases on the site, and it is sensitive to an economic upturn. However, we estimate it will contribute only 16% of total F'11 operating profit.
We estimate the financial operations will remain stable yet generate little in terms of earnings for the group.
Our Estimates and Outlook for 2012 We are maintaining our F’12 estimates for Rakuten, with revenue of ¥402.8B and operating profit of ¥79.7B. We estimate that the eCommerce operation will see a marked slowdown in growth (up 7% Y/Y) as hurdles become higher and domestic operations begin to experience growth limitations. Margins are unlikely to improve significantly, as overseas operations are likely to remain dilutive to the sales mix.
We estimate the financial operations will remain stable but continue to generate little in terms of earnings for the group. The credit card operation should have grown significantly over the period, but earnings are highly dependent on marketing costs, which are unlikely to decline significantly over time.
We Are Maintaining Our Nov. 2011 Price Target of ¥63,000 Rakuten is a major online shopping mall operator and travel service in Japan. These core businesses have been the central hub around which the company has diversified its activities into financial services, telecommunications and other net media. Recent plans for overseas expansion of its eCommerce operations have been met with a relatively muted response by the market, which we believe is symptomatic of the company’s firm but unspectacular long-term domestic growth prospects.
We rate the shares Neutral for the following reasons:
• Rakuten’s dominant domestic market position in eCommerce and its growth prospects are understood. This well-known theme provides little upside risk for the shares.
• As things currently stand, we do not believe that plans for overseas expansion will yield material results in the medium term. Rakuten is targeting small niche markets in Asia, and we believe the joint venture with Baidu.com in China will be a lengthy process before material earnings are generated.
Valuation and Rating Analysis Historically Rakuten has had an inconsistent record of generating free cash flow. Using DCF may not be best suited to ascertaining fair value for the company, but with a stabilized financial operation we believe there are sufficient grounds to estimate that free cash flow will be a more regular occurrence going forward.
Rakuten’s market dominance and growth prospects priced in
Overseas expansion unlikely to be material in the medium term
We use a synthetic free cash flow, as the normal cash flow statement does not give us a relevant figure to work with—EBITDA less adjusted taxes, net capex and working capital adjustments. We omit changes in financial-related working capital, as we believe Rakuten’s core activity remains eCommerce. Changes in credit, bank and brokerage assets and liabilities distort what we deem to be a more useful picture of Rakuten’s free cash flow.
Our basic premise is that on a WACC of 7.3% and generating an average around ¥60.0B annual free cash flow into perpetuity (with 0.5% terminal growth), we derive an enterprise value of ¥908.3B. We then subtract net debt of ¥141.1B, being the indebtedness of the Rakuten parent company and ignoring financial services liabilities, and add ¥59.3B in investments. The resultant market value of equity is ¥826.5B, and this produces a fair value of ¥63,000 per share.
Investment Risks We view the risks to our investment thesis as follows:
Upside risk • Positive news flow regarding speedy and solid execution of overseas expansion
• Improving market conditions for financial services, chiefly increased activity in the online brokerage and a rising loan book at consumer credit services
Downside risk • Bigger-than-anticipated increase in operating costs as a result of overseas
expansion
• An unexpected slowdown in online user activity
• Ad-hoc business diversification that might impair fundamentals, such as further indebtedness or margin dilution
Key assumptions for our earnings forecasts are as follows:
Sales growth • Shopping – After high Y/Y growth in F’10 partly fueled by acquisitions, we
estimate the pace of growth will slow as hurdles become higher Y/Y. We estimate high single-digit growth in F'12, when sales should reach ¥184.6B.
• Credit – We expect little change in sales volume, as the growth in credit card receivables is offset by the continued decline in the ‘grey zone’ loan book.
• Portal/media – Scale of operations remain small, enabling CAGR F’10E-12E of 10%Y/Y.
• Broker – Dependent on market conditions and consequent trading volume. We have flat growth forecasts.
• Sports and Telco – We see no major growth prospects.
• Bank and eMoney – A gradual profile, but no major growth factors are expected.
OPM estimates • Shopping – Acquisitions and the Chinese joint venture operating at a loss should
mean that opportunities for operational leverage will be limited going forward.
• Credit – No major changes in annual OPM, although quaterly fluctuations are expected given securitization revenues.
Sports and Telco – We see no major growth prospects.
Bank and eMoney – We estimate better cost control should lead to gradual improvements in profitability.
Company Overview Assessing overseas growth potential A household name in Japan, Rakuten has a dominant position as an online shopping mall without a major warehousing function, relying on a B2B2C business model – connecting 'brick and mortar' retailers to consumers online. The attractions of Rakuten's model to potential tenants of virtual shop fronts are:
Access to an active user base of 41.38M members within the Rakuten group.
A business that caters to ‘long tail’ demand – the site is aimed at selling any conceivable item. There are currently 65M items listed for sale on the site (although this includes same items from multiple shops).
Access to Rakuten’s reward points scheme, which can be effective in encouraging user loyalty and activity (although pricing remains the biggest draw for online consumerism). These points can be converted to other point programs, such as ANA mileage and T-Points program from CCC.
Although the business priority remains in domestic operations, CEO Hiroshi Mikitani has made it plain that overseas expansion is required in order to generate growth, including his stated goal of doing business in 27 countries. International shipping has been available to overseas customers since 2008, albeit a limited service. Progress to date has been relatively slow compared to US counterparts but has recently speeded up:
Overseas Expansion Milestones to Date Date Event
Sep-05 Acquires 100% LinkShare US, an affiliate marketing company Feb-08 Signs joint venture agreement with President Store Chain in Taiwan, to set up Rakuten Ichiba Taiwan Sep-09 Acquires 67% stake in TARAD Dot Com in Thailand Jan-10 Reaches agreement to set up joint venture with Baidu.com to jointly operate online shopping mall in
China (Rakuten stake 51%) May-10 Signs joint venture agreement with PT Global Mediacom in Indonesia, to set up Rakuten Ichiba
Acquires 100% PriceMinister - price euro 180M Source: J.P. Morgan based on company data.
Initial forays overseas appeared focused on niche geographies such as Taiwan and Thailand, and we estimate they contributed less than 1% of gross merchandising volume in 2Q F’10. Since the beginning of 2010 with the agreement with Baidu.com in China, Rakuten has made tentative moves into the US with Buy.com and Europe with PriceMinister. The immediate impact on gross merchandising volume will be around ¥2.5B during 3Q F’10 from overseas markets, making up around 1% of the total.
For group sales we estimate overseas operations will make up 2% to 3% of total sales in 3Q F’10.
We assess these opportunities in turn.
Dominant B2B2C domestic business
41M active users
65M items listed for sale
Reward points scheme in place
To date overseas shopping sales less than 1% of total group sales
On consolidation of PriceMinister and Buy.com, overseas sales grow to 2% to 3% of total group sales
381
Baidu.com Baidu.com is the premier search engine in China and therefore a formidable local partner to operate online shopping. Despite Baidu.com’s success in its core field of search and pay for placement advertising, individually it has had little success in online shopping with its 'Youa' site.
Baidu.com Baidu.com factsheet Established 2000 Location Beijing HQ, China Prior contact with Japan Commenced online search service in 2008 IPO 2005 Sales in F’09 N/A Geographic reach Shopping in China Business model Commenced online shopping site 'Youa' in 2008 Number of members N/A Number of products for sale N/A Holding in joint venture 51%
Source: J.P. Morgan based on company data
Market Share of C2C Market (CY’08) in China (by Transaction Volume)
eBay7%
Tencent Paipai7%
Others(including Baidu)
0%
Taobao86%
Source: J.P. Morgan based on Analysys International
Pros and Cons of JV with Baidu.com Positives Negatives Footprint in a major growth market Dominant local competition in place Partnering with a local player Partner's track record patchy Access to major online traffic User traffic not all with shopping intent Source: J.P. Morgan assumptions.
Rakuten and Baidu.com have announced plans to invest ¥4.3B ($50M) in capital in the first three years. We compare this amount to efforts made by eBay and its Chinese acquisition EachNet to develop its business in 2002-2003:
• Acquisition costs totaling $180M for 100% stake
• An additional $100M budget
We assume that there are 120M users on competitor TaoBao's site. If we assume Rakuten were aiming to take away 25% of this user base:
• This would equate to user acquisition costs of $0.55 per user over the period, which does not strike us as being very high
We believe there is an opportunity in the China eCommerce market, where users are looking for a greater sense of security about purchasing online. The next two years are likely to see major market growth especially in B2C sites (as opposed to auctions or B2B) and will also be a crucial period that decides which companies succeed and which do not. With such a strong market tailwind, Rakuten has a chance of performing if executing well on its services regarding settlements, logistics and customer services—areas where it has expertise in Japan.
The costs budgeted by Rakuten and Baidu.com do not seem very large when considering the challenges being faced. We therefore believe medium-term prospects for this joint venture have potential, but meaningful earnings remain difficult to ascertain. According to J.P. Morgan analyst Dick Wei, Head of Internet and Media for Asia Research, “We don't expect this venture to have much impact on Baidu.com’s earnings in the near future. However, we feel that the swift execution of this project is promising for the future.” [Regional Internet Newsflow: Oct. 25, 2010]
Buy.com Buy.com is a survivor of the dotcom era, having listed in 1999 and being taken private in 2001.
Buy.com Buy.com factsheet Established 1997 Location California, USA Prior contact with Japan Softbank invested in 1998 and 1999 pre-IPO IPO October 1999 on NASDAQ; taken private November 2001 Sales in F’98 $125M Sales in F’09 $62M (¥5.7B) OP in F’09 $4.4M (¥0.4B) - OPM 7.0% Geographic reach Canada, France, Germany, Italy, Spain Business model Marketplace; major seller on eBay Number of members 14M Number of products for sale 11.5M (March 2010) Deal value $256M (¥20.7B) Book value ¥2.8B Total goodwill arising estimate ¥17.9B Source: J.P. Morgan based on company data. Note: Forex rate: $1 = ¥92. Total goodwill arising is J.P. Morgan estimate.
Pros and Cons of Buy.com Acquisition Positives Negatives Footprint in the developed US eCommerce market Crowded market with two dominant players (Amazon, eBay) Learn new online shopping model Patchy track record Source: J.P. Morgan assumptions.
Buy.com operates a mall-type operation similar to Rakuten, connecting shoppers with distributors and retailers. It is similar to Rakuten's business model as it holds no inventory, and outsources distribution and fulfillment.
$50M capital commitment is on the low side
Great opportunity in China, next two years the crucial period
Joint venture not expected to make a major impact at Baidu.com in the near future
Business model is marketplace – similar to Rakuten
The company has a loyal following, although historically its strength has been in sales of technology and consumer electronics—very unlike sales at Rakuten where sales rankings are dominated by cosmetics and toiletries, foodstuffs and fashion items.
The challenge for Rakuten will be to operate a profitable business whilst aiming for market share gains in a very competitive market. Buy.com's operations in the past have focused on cost leadership and undercutting competitors to win business—this has not been Rakuten’s focus to date.
PriceMinister The key selling points of PriceMinister’s online shopping model are:
• Empowering the individual—the site is designed for individual sellers and buyers, at a fixed price/slight negotiation but not auction-based.
• There is emphasis on security. However, most auction and shopping sites operate with payment on delivery and have reimbursement policies. Rakuten guarantees reimbursement for undelivered goods up to ¥500,000.
PriceMinister PriceMinister factsheet Established 2000 Location Paris, France Prior contact with Japan N/A IPO N/A Sales in F’09 Euro 40.0M (¥3.6B) OP in F’09 Euro 6.6M (¥0.7B) – OPM 19.4% Geographic reach France, UK, Spain Business model C2C, online travel, online real estate Number of members 11M Number of products for sale 150M Deal value Euro 180M (¥20.5B) Book value ¥3.6B Total goodwill arising estimate ¥16.9B Source: J.P. Morgan based on company data. Note: Forex rate: Euro1 = ¥112. Total goodwill arising is J.P. Morgan estimate.
Pros and Cons of PriceMinister Acquisition Positives Negatives Footprint in Europe Small niche player Source: J.P. Morgan assumptions.
A small footprint in Europe is unlikely to materially affect Rakuten's earnings visibility in our view.
Conclusion We believe first-mover advantage in the internet economy is exaggerated, as switching costs for online consumers as well as barriers to entry for new entrants are both low. This implies that late movers such as Rakuten have an opportunity to catch up with established global peers such as Amazon and eBay, and to take on strong local players in China such as the Alibaba group’s Taobao.
Business strategy has centered on cost leadership
Key selling point is security – but this is an industry norm
On the other hand, instances whereby new entrants have cracked markets with established dominant players in place have been rare. We believe this is due to well-executed online businesses being able to scale at a rapid pace, enabling them to cement their market position. Instances whereby latecomers beat established competition—for example Taobao besting eBay in China on transaction volume—involved competition over pricing and as well as the ability to deliver well designed localized services.
In online shopping and auction, the key competitive strength is the size of the network of buyers and sellers, and the number of products offered. As market leaders consolidate their market position, Rakuten will have to be aggressive and persevering in order to make its mark overseas.
…but dominant players have consolidated their market position
Key competitive strength is size and scale of service on offer
Business Segment Outline (as of 3Q F’10) Main services Group company 1. eCommerce Business Rakuten Ichiba (internet shopping mall) Rakuten Auction Rakuten Auction Consulting for eCommerce Rakuten Rakuten Books (book selling) Rakuten Foreign eCommerce site (Buy.com, PriceMinister, etc.) Rakuten Rakuten GORA (golf course reservation through internet) Rakuten Online DVE / CD rentals Rakuten Performance marketing LinkShare Corporation Logistics service Rakuten Rakuten business (business services) Rakuten 2. Credit Card Business Issues and services on credit cards (Rakuten Card) Rakuten KC 3. E-Money Business Planning and operating pre-paid money (Edy) BitWallet 4. Banking Business Internet banking services eBANK 5. Portal Media Business Portal sites (Infoseek) Rakuten Internet advertising Rakuten internet marketing Rakuten Research Marriage consultancy (O-net) O-net Delivering movie contents Showtime 6. Travel Business Booking rooms through internet, total traveling web-site (Rakuten Travel) Rakuten Travel 7. Securities Business Provide services for online securities dealing Rakuten Securities 8. Professional Sports Business Operating Tohoku Rakuten Golden Eagles and planning/merchandising of related- goods Rakuten Baseball Club 9. Telecommunication Business Provide IP telephony service, telephone exchanging services Fusion Communications Source: J.P. Morgan based on annual financial report.
Company Data Price ¥31,950 Price date Dec. 29, 2010 Market capitalization ¥ 1,853bn Shares outstanding 58.0mn 52-week range ¥38,500–27,230 TOPIX 908.01 Dividend (F’10E) ¥322 Dividend yield (F’10E) 1.0% RoE (FY’10E) 26.2% Source: Bloomberg, J.P. Morgan estimates.
We are maintaining our Overweight rating on Yahoo Japan, with a price target of ¥35,000 to November 2011. We believe the company is geared for a recovery in online advertising, with effective cost control resulting in pronounced margin expansion. We view improving fundamentals as a precursor to changes in corporate governance, as high cash generation is put to good use.
We expect fundamentals to continue improving in 2011. We believe Yahoo Japan will continue to benefit from a recovery in ad demand as the premier player in Japan’s net media space. We expect medium-term margin expansion through effective cost management and scaling of recent business initiatives, such as social gaming and eCommerce partnerships with leading players.
The advertising recovery is gaining pace. Concerns remain over visibility for online advertising expenditure in 2H F’10. However, we believe a recovery profile is gaining pace at Yahoo Japan, with display ad sales showing Y/Y growth since 4Q F’09 and listings showing reaccelerating growth from 2Q F’09. With around 60% of total sales derived from advertising, we believe this is a key swing factor regarding the company's prospects going forward.
Cost reductions and digital content are incremental positives. The company sharply reduced operating costs in F’09 and is continuing to cut costs. We think the divesture of the online market research business and the license renegotiations carried out in 2Q F’10 were practical measures to maximize margin growth. Developing a digital content platform heralds a new approach to improve the sales mix. We believe these are incremental positives that raise earnings visibility at the company.
Valuation and risks. The shares are trading at 18.2x our F’11 EPS forecast, which we believe is undervalued for a geared recovery story. The company has consistently improved free cash flow generation and has more ‘cash cow’ characteristics than a high-growth company. We think this will result in improved corporate governance via dividend hikes over the medium term. Risks to our price target include a slower-than-anticipated recovery in ad demand and a potentially disruptive cutover to Google’s search engine in January 2011.
Our Estimates and Outlook for 2011 We are maintaining our F’11 estimates for Yahoo Japan, with revenue of ¥307.9B and operating profit of ¥171.7B, driven primarily by the rebound in advertising demand, although we expect the consumer business (eCommerce - shopping and auction) to post a growth profile. Our model calls for a stable operating profit margin improvement Y/Y to 55.8% from 54.5%, as sales volume expansion drives operational gearing.
Our Estimates and Outlook for 2012 We are maintaining our F’12 estimates for Yahoo Japan, with revenue of ¥328.5B and operating profit of ¥185.3B. The scenario we are modeling is similar to F'11, with advertising demand at stable growth rates Y/Y resulting in margin expansion. We believe some new business initiatives that commenced in F'10, such as social gaming, eCommerce collaborations and smartphone content, will be feeding material earnings for the business.
We Are Maintaining Our Nov. 2011 Price Target of ¥35,000 Yahoo Japan is the domestic market leader in internet media, its key earnings driver being advertising demand. We believe that in a sustained economic recovery scenario, Yahoo Japan will benefit from operational gearing based on the following factors:
• We estimate advertising makes up approximately 60% of total sales. Demand has begun to stabilize Y/Y, with both listings and banner display advertising showing continued growth since 2Q F’09. Continued recovery in ad demand would result in margin expansion with increasing sales volume.
• The company conducted cost reductions in F’09, resulting in marked increases in profitability during 1H F’10. We believe continued cost management and business expansion into digital content will lead to a further increase in profitability.
• With the company’s ‘cash cow’ status, we believe corporate governance will improve via dividend hikes in the medium term.
We believe that Yahoo Japan is a geared play on a sustained recovery in online advertising demand, as it maintains its market leader status as an online ‘go to’ destination for domestic internet users.
Valuation and Rating Analysis Yahoo Japan has been free cash flow generative since F’01, when it was experiencing a high growth profile. We calculate that annual free cash flow generation has consistently grown every year since then, but its growth has flattened somewhat since F’08 (F’09 being an exception due to a low tax payment).
As free cash flow remains steady, and free cash flow conversion remain high, we have used DCF as our valuation method to derive fair value for the stock.
Our basic premise is that on a WACC of 7.6% and generating an average annual ¥116B free cash flow into perpetuity (with a 0.5% terminal growth rate), we derive a net present value of ¥1,755.2B. We then add back ¥136.3B in net cash, and ¥167.5B in investments and land (including ¥120B in preferred shares in Softbank). The
Ad demand recovery drive operational gearing
Cost reduction efforts also allow for increase in profitability
Advertising—The Swing Factor Yahoo Japan's core earnings driver is advertising, with the company's unrivalled media power in the online market. Advertising takes broadly two forms:
• Display advertising – panels of advertising space on a webpage, primarily for brand advertising
• Listings – text-based advertising, which can be driven by search queries, standard listings or by targeting
The company says profitability is similar for both products, although this is dependent on utilization rates (the amount of ad space inventory being sold) for banners, and pricing.
Advertising Sales Breakdown by Product – 2Q F’10
30% Display 70% Listing
9% Targeting
21% Brand panel, prime display
65%Search, tex t-based ads
5%Interest match
Source: J.P. Morgan based on company interview.
• Display ads demand fell significantly in 1H F’09, as demand from financial, real estate and recruitment sectors dropped. However, spending bottomed in 3Q F’09, and has been recovering Y/Y since 4Q F’09.
• Listings ads have maintained a resilient Y/Y growth profile throughout the economic downturn. Demand reaccelerated in 2Q F’10, and demand from the weak sectors such as finance has begun to bottom.
Yahoo Japan’s Display Advertising Revenue by Industry
Industry 2Q F’08 (1) 2Q F’10 (2) (2) - (1) Finance/Insurance/Securities 18.9% 16.8% -2.1ppt Autos (Transport Equipment) 10.7% 13.3% 2.6ppt Cosmetics/Toiletries 10.2% 9.3% -0.9ppt Real Estate/Construction 11.5% 9.3% -2.2ppt Transportation/Leisure 7.9% 7.2% -0.7ppt Foodstuffs 3.4% 4.5% 1.1ppt Beverages/Cigarettes 3.9% 4.1% 0.2ppt internet Information Site/Email service - 3.7% - Fashion/Accessories 3.4% 3.6% 0.2ppt Medicament/Pharmaceuticals - 3.3% - Mobile Communications Service 3.3% 3.1% -0.2ppt Entertainment Related Software 3.1% 2.9% -0.2ppt Others 23.7% 18.9% - Total 100.0% 100.0%
Source: J.P. Morgan based on company data.
Yahoo Japan has managed to increase operating margins over the last year and a half, through a combination of cost reductions and the ongoing recovery in advertising spending:
• Cost cutting measures in F’09 focused on reducing contractor costs, administrative expenses and IT costs.
• During 2Q F’10, the divesture of Yahoo Value Insight (online market research), the termination of search services with Yahoo! Inc. and renegotiating a contract with an advertising partner reduced COGS.
F’09 1Q -10% 2%-3% 3.2% 50.4% M&A growth impact Y/Y: Softbank IDC and Gyao Corp. 2Q -10% Flat → positive 2.8% 50.8% Bottom of listings decline. 1Q-2Q Major cost cutting
exercise – contractor and administration costs 3Q -3% 2%-3% 5.6% 51.5% Bottoming of banner ad demand 4Q 15% 7%-8% 8.9% 52.9% Major display ad recovery Y/Y
F’10 1Q 7%-8% 7%-8% 4.2% 53.3% Pullback Q/Q for display ads, listings ads demand steady 2Q less than 10% Plus 10% 4.6% 54.2% OPM continue to improve via cost reductions: - Sale of Yahoo Value Insight - Renegotiate license contract w/ ad partners - Renegotiate search license fee with Yahoo! Inc..
Source: J.P. Morgan based on company data.
Key Assumptions J.P. Morgan Assumptions for Domestic Sales and OPM
OPM estimates Media 53.0% 54.4% 55.2% - Business services 49.7% 50.3% 50.8% - Consumer 66.6% 67.9% 68.6% - Total OPM 54.5% 55.8% 56.4% -
Source: J.P. Morgan estimates.
The three business segments refer to the following:
• Media – all display advertising sales, listings advertising sales via advertising agency
• Business services – listings advertisings sold direct (search and targeted), listings advertising sold in ‘Yahoo! Real Estate’, ‘Yahoo! Rikunavi’ (recruitment) and ‘Yahoo! Motor’. Also sales of data center operations
• Consumer – income from auction site (fixed tenancy fees and variable commission/system fees), income from shopping site (fixed tenancy fee and variable commission), premium user id monthly fee, digital content sales, and legacy ISP fees
Key assumptions for our earnings forecasts are as follows:
Sales growth • Media – online ad likely demand to maintain a steady growth trajectory, from
both display and listings.
• Business services – dependent on listings, ad demand from finance, real estate and recruitment to recover, but starting from a low base.
• Consumer – a bottoming in online auction activity, with growth stemming from the company's efforts to drive shopping volume at the marketplace operation. Small impact from digital content sales.
OPM estimates • Media - steady margin expansion Y/Y through sales volume hikes and controlled
costs.
• Business services - no major hikes in margins, although with ad demand returning, some scope for margin expansion through sales volume growth.
• Consumer - stability in the auction business and an improving sales mix from digital content sales with very high margins.
Shares O/S (mn) 13 Market cap (W mn) 1,017,537 Market cap ($ mn) 886 Price (W) 76,300 Date Of Price 29 Dec 10 Free float (%) 3mth Avg daily volume 122,795.00 3M - Average daily Value (W mn) 9,619.02 Average 3m Daily Turnover ($ mn) 8.38 KOSPI 2,043 Exchange Rate 1,147.90 Fiscal Year End Dec
Source: Company data, Bloomberg, J .P. Morgan estimates.
We maintain our Overweight rating on Daum, the second-largest search portal in Korea. Our Jun-11 price target is W100,000, based on a 2011E P/E of 15.5x. On a cash-adjusted basis, our target translates to only 9.0x 2011E P/E. Daum is the second-largest search portal in Korea. It was founded in 1995 as
a provider of various types of web service including free web-based e-mail, messaging service, communities and news. Currently, Daum controls the search query market in Korea with a share of 23% and the display ad market with a share of 25%.
Daum provides pure exposure to internet portal, as the company focuses on search and display ads only compared to NHN, which generates one-third of revenue from internet games.
While Daum is a pure portal that is accorded higher multiples than game companies, it is currently trading at some 42% discount to NHN on 2011E P/E. Furthermore, Daum has been gaining market share in both the search and display market recently and this has led to 43% yoy revenue growth compared to 15% for NHN in 3Q10.
We believe the overall growth momentum for Daum will continue to be better than the industry and NHN over the next couple of years.
2011 drivers: We believe Daum will continue to gain market share in both search and display ads based on improved search quality, innovative marketing efforts, and differentiated customer profile from NHN.
Maintaining 4Q’10 estimates. We are maintaining our 4Q’10 revenue, EBITDA, and EPS estimates of W99B, W33B, and W1,485, respectively.
Korea
Our Estimates and Outlook for 2011 We forecast revenue of W394B in 2011, up 14% Y/Y, and EPS of W6,442, down 26%Y/Y. We believe revenue growth will slow down in 2011 on anticipated negative impact from NHN’s departure from Overture. However, we note that our estimates are based on very conservative price decline assumptions and, as suc,h there is a good possibility that search ad revenue will turn out better than our estimates. On the display ad side, we believe there is also room for positive earnings revisions, given the material price hike in October 2010 and growing corporate interest in display ads for their brand building efforts.
The EPS decline owes to a one-off gain from Lycos sales in 2010. So the number to focus on in 2011 is operating profit rather than EPS. We currently estimate operating profit will grow by 16% to W110B in 2011 based on 14% revenue growth to W394B. This implies an operating margin of 30.9% for 2011E, up from 27.5% in 2010E and net margin of 23.5% for 2011E.
Our Estimates and Outlook for 2012 We expect revenue to grow another 13% to W445B and EPS by 31% to W8,427 on ongoing growth in both the search and display businesses. We expect Daum to continue to gain market share in search, while display ads will continue to narrow the gap with NHN. We note Daum is spearheading the entry into the corporate sector through multiple innovative programs with large corporates lately and this should turn into a new and meaningful revenue source for Daum by 2012.
We Are Maintaining Our Price Target of W100,000 We are maintaining a Jun-2011 price target of W100,000. Our PT is based on a 2011E P/E of 15.5x, which is an 8% discount to our target multiple for NHN and a 0 to 6% discount to current multiples of global peers such as Google, Yahoo, and Yahoo Japan.
Valuation and Rating Analysis We believe the main discount factor for Daum is uncertainty on the Overture issue. Once this clarifies as having less impact than bears think, we believe the valuation discount on Daum will quickly disappear beginning in 1Q11.
Investment Risks The key risk is a larger-than-expected price decline due to Overture’s loss of pricing power in the search-ad market.
Company Data Price ($) 39.27Date Of Price 14 Dec 10Price Target ($) 51.72Price Target End Date 31 Dec 1152-week Range ($) 43.05 - 27.70Mkt Cap ($ bn) 8.4Shares O/S (mn) 214
Risk: Competition from Facebook
Catalyst: Raising VK stake to blocking or controlling
Russia’s Tencent? Mail.ru Group is the leading integrated content and communications platform in the Russian internet space, engaging about 70% of total Russian monthly unique users with instant messaging, social networking services, multiplayer/casual games and other paid services. Additionally, the group has attractive strategic investments in Russia (32.5% stake in Russia’s largest social network, VKontakte, and an option for 7.5% more, and a 25% stake in a leading payments business) and abroad (2.38% in Facebook, 1.47% in Zynga and 5.13% in Groupon) that could provide balance sheet upside. Supported by a joint shareholder in Naspers, Mail.ru aims at emulating in Russia the success experienced by Tencent in China.
A large and growing market. Russia is the 2nd-largest internet market in Europe, but its penetration is only 37% vs. 77% in the U.S. and 83% in the UK. The low base translates into strong growth, and penetration is adding 1pp per month. Mail.ru is strongly positioned to benefit from high internet user engagement in games and social networks, the rollout of a strong broadband infrastructure, an increasing share of online (9% of total gross advertising vs. 16% in China and 14% in the U.S.) in a growing advertising market (15-20% total ad growth expected in 2011).
We expect 33% core revenue CAGR from ’10 to ’13. This is equally driven by advertising revenue CAGR of 33% and internet value-added services (IVAS) revenue growth of 34% for the period. The company is integrating its diversified portfolio and could benefit from cost synergies as well as from high operating leverage (over 70% fixed costs): we project 53% EBITDA CAGR during 2010E-13E. The company is debt free, and we estimate FCF of $170M in 2012E.
Overweight rating, PT of $51.7/GDR. Our end-2011 price target of $51.7/GDR is based on SOTP and discounted terminal value calculation, including fair value of international assets (Facebook, etc.) based on “second market” estimates. Mail trades at 27.5x 2012E P/E, a 10% premium to peers; however, we think this could be justified by Mail’s growth prospects, market position, profitability and the scarcity of quality growth stories in Russia. Given the fast-moving nature of the internet, risks are significant and center on disruptive competition, but we believe Mail.ru Group is well positioned to face potential threats.
Russia
Our Estimates and Outlook for 2011 We expect F’11 revenue of $415M, up 36.5% Y/Y. We believe the pace of paying customer additions is likely to accelerate somewhat in 2011 (up 59% Y/Y to 360K in massively multiplayer online [MMO] games, up 25% Y/Y in Mail.ru community). We also believe that Mail will benefit from faster recovery in the Russian advertising segment. For profitability we project a substantial EBITDA margin improvement to 46% (vs. 34.3% in 2010, though 2010 EBITDA was impacted by $20M IPO-related costs). Our model calls for $191M of EBITDA and $0.71 EPS.
Our Estimates and Outlook for 2012 We expect F’12 revenue of $552M, up an estimated 33% Y/Y. The pace of paying customer additions is likely to accelerate further in 2012 (up 51% Y/Y to 545K in MMO, and up 30% Y/Y in Mail.ru community base reaching 1.8M subs). Mail should continue benefiting from growth of Internet advertising market (29% Y/Y growth in 2012). We are projecting a 340 bps EBITDA margin improvement to 49.4% (vs. 46% in 2011). Our model calls for $273M of EBITDA and $1.05 EPS.
We Maintain Our End-2011 Price Target of $51.7/GDR Our end-2011 PT of $51.7/GDR is based on a sum of the parts and discounted terminal value calculation, which at our PT implies 2012E EV/EBITDA and P/E of 29.3x and 43.9x, respectively. We note the multiple we are using for the terminal value at year-end 2015E, 21x, is significantly lower than the current year-out multiple of Tencent of 27x, although our projected EPS growth rate at 2015 is actually higher than what JPM projects for Tencent. When setting our PT we are using a forward P/E multiple of 21x at the end of 2015E (please see our full model, available upon request). We believe a 21x P/E multiple is reasonable in light of longer-term growth prospects for Mail and current internet sector valuation.
Valuation and Rating Analysis Our sum-of-parts valuation is derived by combining the discounted terminal value with independently derived equity values of Mail.ru Group’s international investments in global internet players (Facebook, Zynga and Groupon). The international investment valuation is based on the “second market” valuation (used for employees of private companies to sell their shares) and recent press reports (Bloomberg on December 1, 2010, reported that Google offered to buy a stake in Groupon, valuing it at $6B [not confirmed by either party]). Currently Mail trades at 27.5x 2012E P/E, a 10% premium to peers that we think is justified by growth prospects (33% revenue CAGR ’10E-’13E), market positioning, profitability (63% EPS CAGR ’10E-’13E) and the scarcity of quality growth stories in Russia.
Investment Risks Downside risks: (1) Mail.ru Group management is not able to maintain its leading position (mitigated by the likely significant stickiness of the mail/instant messaging/social network service platforms). (2) Facebook strengthens its position in Russia. (3) Given Mail’s acquisitive business model, expensive acquisitions are a risk – acquisition of a blocking stake in VK (natural acquisition target for the group). (4) High reliance on MMO games (1/3 of revenues); within MMO, three popular games accounted for 2/3 of MMO revenues in 2009.
Mail.ru Group: Summary of Financials Profit and Loss Statement Cash flow statement $ in millions, year end Dec FY09 FY10E FY11E FY12E FY13E $ in millions, year end Dec FY09 FY10E FY11E FY12E FY13E Revenues 199 304 415 552 723 Cash EBITDA - - - - -
Other companies recommended in this report (and priced as of December 29, 2010) Apple Inc. (AAPL/$325.29/Overweight) MasterCard (MA/$225.46/Overweight) Microsoft (MSFT/$27.97/Neutral) Monster Worldwide (MWW/$23.63/Overweight) Visa (V/$70.60/Overweight)
Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.
Important Disclosures for Korea and Japan
Beneficial Ownership (1% or more): J.P. Morgan beneficially owns 1% or more of a class of common equity securities of DeNA (2432).
Client of the Firm: NHN is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services. Rakuten (4755) is or was in the past 12 months a client of JPM.
Investment Banking (past 12 months): J.P. Morgan received, in the past 12 months, compensation for investment banking services from NHN.
Investment Banking (next 3 months): J.P. Morgan expects to receive, or intends to seek, compensation for investment banking services in the next three months from NHN.
Important Disclosures for Equity Research Compendium Reports: Important disclosures, including price charts for all companies under coverage for at least one year, are available through the search function on J.P. Morgan’s website https://mm.jpmorgan.com/disclosures/company or by calling this U.S. toll-free number (1-800-477-0406)
Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] J.P. Morgan Cazenove’s UK Small/Mid-Cap dedicated research analysts use the same rating categories; however, each stock’s expected total return is compared to the expected total return of the FTSE All Share Index, not to those analysts’ coverage universe. A list of these analysts is available on request. The analyst or analyst’s team’s coverage universe is the sector and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.
Coverage Universe: Imran Khan: AOL Inc. (AOL), Amazon.com (AMZN), Blue Nile (NILE), Dice Holdings, Inc. (DHX), Discovery Communications, Inc. (DISCA), Expedia, Inc. (EXPE), Google (GOOG), IAC/InterActive Corp. (IACI), MediaMind (MDMD), MercadoLibre, Inc. (MELI), Netflix Inc (NFLX), News Corporation, Inc. (NWSA), Orbitz Worldwide, Inc. (OWW), Priceline.com (PCLN), QuinStreet, Inc. (QNST), ReachLocal (RLOC), Shutterfly, Inc. (SFLY), The Walt Disney Co. (DIS), Time Warner (TWX), Viacom Inc (VIAb), Yahoo Inc (YHOO), eBay, Inc (EBAY)
Bridget Weishaar: Liberty Capital (A) (LCAPA), Liberty Interactive (LINTA), RHI Entertainment, Inc. (RHIEQ), Tivo (TIVO)
Dick Wei: AirMedia (AMCN), Alibaba.com Limited (1688.HK), Ambow Education (AMBO), Baidu.com (BIDU), China Finance Online (JRJC), Focus Media (FMCN), Netease (NTES), Shanda Games (GAME), Shanda Interactive Entertainment Ltd (SNDA), Sina Corp (SINA), Sohu.Com (SOHU), Tencent (0700.HK), The9 Limited (NCTY), VanceInfo Technologies Inc. (VIT), VisionChina (VISN)
Hiroshi Kamide: DeNA (2432) (2432.T), Gree (3632) (3632.T), Mixi (2121) (2121.T), Nintendo (7974) (7974.OS), Rakuten (4755) (4755.OS), Yahoo Japan (4689) (4689.T)
Sungmin Chang, CFA: Daum (035720.KQ), KT Corp. (030200.KS), LG Uplus Corp (032640.KS), NHN (035420.KS), Neowiz Games Corp. (095660.KS), SK Telecom (017670.KS)
Alexei Gogolev: AFK Sistema (SSAq.L), Center telecom (ESMO.RTS), Comstar UTS (CMSTq.L), Dalsvyaz (ESPK.RTS), Mail.ru Group (MAILRq.L), NorthWest Telecom (SPTL.RTS), Rostelecom (RTKM.RTS), Rostelecom (Preferred) (RTKM_p.RTS), Sibir Telecom (ENCO.RTS), Southern Telecom (KUBN.RTS), Uralsvyazinform (URSI.RTS), Volga Telecom (NNSI.RTS)
J.P. Morgan Equity Research Ratings Distribution, as of December 31, 2010
Overweight (buy)
Neutral (hold)
Underweight (sell)
J.P. Morgan Global Equity Research Coverage 46% 42% 12% IB clients* 53% 50% 38% JPMS Equity Research Coverage 43% 49% 8% IB clients* 71% 63% 59%
*Percentage of investment banking clients in each rating category. For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category.
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Imran Khan and the J.P. Morgan Internet, Media and Entertainment Team Imran Khan Imran Khan is J.P. Morgan’s head of global internet research and U.S. media & entertainment analyst. Mr. Khan has been with the firm since 2004 and was elected managing director in 2007 at the age of 29. Mr. Khan has been ranked one of the top 3 internet analysts by major third-party surveys such as the Institutional Investors All-America Research Poll and Greenwich Research Survey every year since 2005. Mr. Khan is the author of some of the most widely read research reports in the industry, including: Nothing But Net, The Rise of Ad Networks, and Large Cap Courtship and Consolidation. Mr. Khan is a frequent speaker at leading industry conferences and different corporate board/leadership meetings. Mr. Khan resides in New York City and serves on the board of the Make-A-Wish foundation’s metro New York chapter. Bridget Weishaar Bridget Weishaar joined the J.P. Morgan internet, media and entertainment team in 2006. Prior to J.P. Morgan, Ms. Weishaar was an associate analyst on the retail team at Bear Stearns, ranked #1 in the Institutional Investor All-America Research Poll. Ms. Weishaar obtained her MBA at the Wharton School, University of Pennsylvania, and holds a B.S. degree from the University of Notre Dame.
Lev Polinsky Lev Polinsky joined the J.P. Morgan internet, media and entertainment team in 2006. Prior to J.P. Morgan, Mr. Polinsky was a trader at Susquehanna Investment Group, covering a variety of industries. Mr. Polinsky is a CFA charterholder and received an A.B. in Economics from Harvard University.
Shelby Taffer Shelby Taffer joined the J.P. Morgan internet, media and entertainment team in 2008. Prior to joining J.P. Morgan, Ms. Taffer was at National Cable Communications, where she oversaw the company’s human resources initiatives. Ms. Taffer holds a B.A. from the University of Wisconsin – Madison.
Vasily Karasyov Vasily Karasyov joined the J.P. Morgan internet, media and entertainment team in 2006, focusing on media and entertainment companies. Prior to J.P. Morgan, he was an executive director, corporate development, at Sony Pictures, where he worked on M&A and financing transactions as well as strategic planning in film, television, home entertainment and new media. Mr. Karasyov holds an MBA from INSEAD.
Dick Wei Dick Wei’s primary research focus is on China internet. In addition, he is responsible for global technology research. Prior to joining J.P. Morgan in 2002, Mr. Wei worked with Merrill Lynch in the Hong Kong and New York offices. He was also a design engineer at Quantum Corporation (acquired by Maxtor). Mr. Wei graduated with an MBA from the Wharton School and obtained his M.Sc. degree in mechanical engineering from Stanford University.
Alexei Gogolev Alexei Gogolev joined J.P. Morgan equity research in Moscow in 2007. Prior to this, Mr. Gogolev worked in equity research at MDM Bank (Moscow) and at UBS for two years. A Russian national, he is a graduate of Edinburgh University.
Hiroshi Kamide Hiroshi Kamide graduated with a B.Sc. in human psychology from Aston University in 1994 and joined KPMG in London as an accountant. Hiroshi joined Cazenove Japan in 2002 and moved to KBC Securities Japan in 2003. He joined J.P. Morgan in September 2010 as an internet and game sector analyst. He is an associate member of the Institute of Chartered Accountants of England and Wales. In the Starmine Thomson Reuters rankings for stock-picking performance, Hiroshi was ranked fifth in 2010 and third in 2009 among all Japanese analysts.
Sungmin Chang Sungmin Chang covers the Korea internet and telecommunications sectors for J.P. Morgan. Mr. Chang’s coverage includes Daum, KT Corp., LG Uplus Corp, NHN, SK Telecom and Neowitz Games Corp. Mr. Chang is a CFA charterholder.
