Nothing But Net - Asia 2011 Internet Investment Guide _JP Morgan_

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					                                                                                                              Asia Pacific Equity Research
                                                                                                              06 January 2011




Nothing But Net - Asia
2011 Internet Investment Guide


                                                                                                              China Internet
                                                                                                                          AC
                                                                                                              Dick Wei
                                                                                                              (852) 2800-8535
                                                                                                              dick.x.wei@jpmorgan.com
                                                                                                              J.P. Morgan Securities (Asia Pacific) Limited

                                                                                                              Japan Internet
                                                                                                                                  AC
                                                                                                              Hiroshi Kamide
                                                                                                              (81-3) 6736 8602
                                                                                                              hiroshi.kamide@jpmorgan.com

                                                                                                              JPMorgan Securities Japan Co., Ltd.

                                                                                                              Korea Internet
                                                                                                                                           AC
                                                                                                              Sungmin Chang, CFA
                                                                                                              (82-2) 758-5719
                                                                                                              sungmin.chang@jpmorgan.com

                                                                                                              J.P. Morgan Securities (Far East) Ltd, Seoul
                                                                                                              Branch

                                                                                                              US Internet
                                                                                                              Imran Khan
                                                                                                              (1-212) 622-6693
                                                                                                              imran.t.khan@jpmorgan.com

                                                                                                              J.P. Morgan Securities LLC




This report is an excerpt of “Nothing But Net: 2011 Internet Investment
Guide", published on Jan 3, 2011



See page 178 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may
have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision.
    Dick Wei                  Asia Pacific Equity Research
    (852) 2800-8535           06 January 2011
    dick.x.wei@jpmorgan.com




                              Table of Contents
                              China: Top Predictions for 2011...................................................................... 5
                              China Internet Market Overview...................................................................... 6
                              Online Advertising ......................................................................................... 10
                              Display Advertising........................................................................................ 15
                              Online Search................................................................................................ 16
                              Online Video.................................................................................................. 25
                              Social Networking.......................................................................................... 30
                              Miniblog Platform........................................................................................... 33
                              eCommerce................................................................................................... 34
                              Online Gaming .............................................................................................. 44
                              Japan Internet Market Overview ................................................................... 57
                              Korea: Sector Summary................................................................................ 81
                              Companies
                              Alibaba.com Limited ...................................................................................... 85
                              Baidu.com ..................................................................................................... 89
                              China Finance Online.................................................................................... 95
                              Netease ......................................................................................................... 99
                              Shanda Games ........................................................................................... 103
                              Shanda Interactive Entertainment Ltd......................................................... 107
                              Sina Corp .................................................................................................... 111
                              Sohu.Com ................................................................................................... 115
                              Tencent ....................................................................................................... 119
                              The9 Limited................................................................................................ 123
                              DeNA (2432) ............................................................................................... 127
                              Gree (3632) ................................................................................................. 135
                              Mixi (2121)................................................................................................... 143
                              Rakuten (4755)............................................................................................ 149
                              Yahoo Japan (4689).................................................................................... 163
                              Daum........................................................................................................... 175


                              The authors acknowledge the contribution of Gon Suk Lee of J.P. Morgan
                              Securities (Far East) Ltd, Seoul Branch,Ritesh Gupta of J.P. Morgan India
                              Private Ltd, and Yusuke Maeda of J.P. Morgan Securities Japan Co., Ltd to
                              this report .




2   2
    Dick Wei                  Asia Pacific Equity Research
    (852) 2800-8535           06 January 2011
    dick.x.wei@jpmorgan.com




                                                             Sector Overview




                                                                               3
3
    Dick Wei                  Asia Pacific Equity Research
    (852) 2800-8535           06 January 2011
    dick.x.wei@jpmorgan.com




4   2
    Dick Wei                  Global Equity Research
    (852) 2800-8535           03 January 2011
    dick.x.wei@jpmorgan.com




                                                                                                                         China
                              China Top Predictions for 2011
                              (1) eCommerce to see wider adoption, driven by convenience, lower-price
                              alternatives to traditional retail, and improved trust & safety. Gross merchandise
                              volume (GMV) is expected to reach Rmb723B in 2011, or less than 4% of retail
                              sales.

                              (2) Social commerce. Expect social sites to be an emerging and important traffic
                              generator for eCommerce companies. Synergistic relationship between social
                              networks and commerce merchants will fuel growth for both segments.

                              (3) Game segment likely to see re-rating with good game titles launch. Highly
                              anticipated games in 2011 include Duke of Mountain Deer, World of Warcraft
                              Cataclysm, etc., which could generate greater player interest and, as such, sector re-
                              rating.

                              (4) Video advertising to prompt ad dollar shift from TV to internet. With the
                              recent IPO of Youku, a broader range of online video content, growing online video
                              user base, and a familiar ad format, TV advertisers are likely to accelerate the ad
                              budget shift from offline to online.

                              (5) Mobile internet to see increased competition. We expect internet leaders like
                              Baidu and Tencent to formally launch middle-ware products that could include third-
                              party application distribution platforms; compete with existing players  UCWeb
                                  other mobile game platforms.

                              (6) Search continues to see solid growth, with wider market adoption. Baidu still
                              maintains dominance, other players such as Soso and Sogou still unlikely to gain
                              meaningful market share.

                              (7) Solid consumer spending trend supports good advertising segment growth.
                              Expect continued good macro environment to support consumer spending. We
                              believe the sector growth story remains intact: internet usage growth, particularly in
                              lower-tier cities, to drive ad budgets online.

                              (8) Expect transition from time-base pricing to CPM-base pricing to accelerate
                              in 2011, but remain gradual, driven by user-segregation and better online ad-
                              serving/tracking technology. Yet, leading portals will still benefit from their own
                              brand influence.

                              (9) 2011 Rmb appreciation to improve sector profitability. Expect sector margins
                              to have very slight improvements from Rmb appreciation, as only a small portion of
                              costs are in US dollars (game licensing fee, overseas video/sports content fee, and
                              some servers, etc.). Benefits to come from translation gains from Rmb-denominated
                              EPS to US$-denominated EPS.

                              (10) More IPOs likely in 2011. We expect investors will likely continue to look for
                              growth investment opportunities in 2011. We think China’s internet segment offers
                              good secular growth, as well as a number of sizable private companies. We believe
                              more new listings are likely.



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




                              China Internet Market Overview
                              Internet penetration still low at 31%
                              China’s internet population grew at a rapid pace in 2010, increasing 24% Y/Y to
                              420M by June 2010, or at a penetration rate of 31.2%, according to China Internet
                              Network Information Center (CNNIC). Since late 2008, China has the world’s
                              largest internet user base. This strong growth in recent years has been driven by
                              factors such as robust GDP growth, lower-priced computers, more affordable
                              telecom connection fees, government support for internet usage, and low-cost
                              entertainment aspects.

                              China Internet Users and Penetration Rate

                               600                                                                                                                                                                                          534       40%
                                                                                                                                                                                                                  494
                                                                                                                                                                                                        454                           35%
                               500                                                                                                                                                             420
                                                                                                                                                                                      384                                             30%
                               400                                                                                                                                           338
                                                                                                                                                                    298                                                               25%
                               300                                                                                                                         253                                                                        20%
                                                                                                                                                  210
                               200                                                                                               137 162                                                                                              15%
                                                            103 111 123
                                                   80 87 94                                                                                                                                                                           10%
                               100     34 46 59 68
                                                                                                                                                                                                                                      5%
                                  0                                                                                                                                                                                                   0%




                                                                                                                                                                                                        Dec-10E


                                                                                                                                                                                                                            Dec-11E
                                      Dec-01


                                                        Dec-02


                                                                          Dec-03


                                                                                            Dec-04


                                                                                                              Dec-05


                                                                                                                                Dec-06


                                                                                                                                                  Dec-07


                                                                                                                                                                    Dec-08


                                                                                                                                                                                      Dec-09
                                               Jun-02


                                                                 Jun-03


                                                                                   Jun-04


                                                                                                     Jun-05


                                                                                                                       Jun-06


                                                                                                                                         Jun-07


                                                                                                                                                           Jun-08


                                                                                                                                                                             Jun-09


                                                                                                                                                                                               Jun-10


                                                                                                                                                                                                                  Jun-11E
                                                                          Number of China Internet Users (Left, millions)
                                                                          Penetration Rate as % of Total Population (Right)



                              Source: CNNIC J.P. Morgan estimates.


                              Further, rural internet populations continued to adopt the internet in 1H10 with a
                              7.8% growth rate.

                              Rural Internet Penetration Reached 16.0% from 11.7% in One and a Half Years

                                60%                                                                                                                                                                     48.6%
                                50%
                                                                                                                                 35.2%
                                40%
                                30%                         19.7%
                                                                                                                                                                                                                            16.0%
                                20%                                                                                                                  11.7%
                                10%                                                3.1%
                                 0%
                                                                     Dec-06                                                                Dec-08                                                                 Jun-10

                                                                 Penetration Rate (Urban Population)                                                       Penetration Rate (Rural Population)

                              Source: CNNIC.




6                                                                                                                                                                                                                                           143
    Dick Wei                                                Global Equity Research
    (852) 2800-8535                                         03 January 2011
    dick.x.wei@jpmorgan.com




                                                            How much more growth?
                                                            Despite this rapid growth, China's internet penetration rate of about 31% of the
                                                            population is still well below that of developed markets like the US, Japan, and
                                                            Korea (over 70%). We expect internet users to grow by around 17.7% Y/Y in 2011
                                                            to reach ~534MM, or the penetration rate to reach ~39% of the population by the end
                                                            of 2011.

                                                            We draw the parallel between internet penetration and mobile phone penetration in
                                                            China. We observe that in recent years internet penetration has lagged mobile phone
                                                            penetration by around four to five years. This gives us confidence that internet
                                                            penetration will likely continue to grow in the future, with lower-cost connection fees
                                                            and equipment costs.

                                                            China Internet and Mobile Phone Users
                                                                  900
                                                                  800
                                                                  700

                                                                  600
                                                                  500
                                                                  400
                                                                  300

                                                                  200
                                                                  100
                                                                    0
                                                                        Jun-99

                                                                                 Jun-00

                                                                                          Jun-01

                                                                                                    Jun-02

                                                                                                             Jun-03

                                                                                                                           Jun-04

                                                                                                                                       Jun-05

                                                                                                                                                Jun-06

                                                                                                                                                         Jun-07

                                                                                                                                                                   Jun-08

                                                                                                                                                                            Jun-09

                                                                                                                                                                                     Jun-10

                                                                                                                                                                                                Jun-11

                                                                                                                                                                                                         Jun-12

                                                                                                                                                                                                                  Jun-13

                                                                                                                                                                                                                             Jun-14

                                                                                                                                                                                                                                      Jun-15
                                                                            Mobile phone users (Mn)                                  Intenet users (Mn)                       Mobile users shifted 4.5 years

                                                            Source: CNNIC, Ministry of Industry and Information Technology (MIIT), J.P. Morgan estimates.


                                                            Broadband and Mobile continue rapid growth
                                                            According to CNNIC, the number of users with broadband internet access grew 28%
                                                            Y/Y to 346M (90% of total users) by the end of 2009, and to 364MM (87% of total
                                                            users) by June 2010.

    Broadband Internet Users in China                                                                        Broadband Internet Users as % of Total Internet Users
     400                                                                          346         364               100%                                                         85%              91%         94%              90%         87%
                                                                    319                                                                           75%             78%
                                                          270                                                    80%                66%
     300                                         214
                                        163                                                                      60%
     200                       122
             77       91                                                                                         40%
     100
                                                                                                                 20%
       0                                                                                                              0%
           Jun-06    Dec-06   Jun-07   Dec-07   Jun-08   Dec-08    Jun-09        Dec-09     Jun-10                                  Dec-06      Jun-07        Dec-07        Jun-08        Dec-08         Jun-09        Dec-09         Jun-10

                                          Broadband Users (Mn)                                                                                               Broadband users as % of total Internet users

    Source: CNNIC.                                                                                           Source: CNNIC.




7   144
    Dick Wei                  Global Equity Research
    (852) 2800-8535           03 January 2011
    dick.x.wei@jpmorgan.com




                              According to the latest MIIT data, the number of broadband subscriber lines reached
                              123.2 million by October 2010.

                              Broadband Subscriber Penetration by Number of Broadband Lines
                                                                                    2005          2006          2007           2008         2009   2010*
                              Broadband subscribers (MM)                             37.5          51.9          66.5           83.4       105.0    123.2
                              Population Penetration (%)                            2.9%          4.0%          5.1%           6.4%        7.9%     9.0%
                              Households Penetration (%)                            9.1%         12.5%         16.1%          20.0%       24.0%    28.2%
                              Source: CNNIC, Ministry of Industry and Information Technology (MIIT), J.P. Morgan estimates.
                              Note: Data as of October 2010.


                              Internet access device
                              The number of mobile internet users increased by 78% Y/Y to 277M by Jun-10, as
                              per CNNIC. The number of mobile internet users was 66% of all internet users and
                              33% of all mobile users. We expect mobile internet usage to increase significantly
                              once 3G penetration increases amongst consumers.

                              Methods of Accessing by Device
                                80%                     73.6%
                                                                                                                                        65.9%
                                70%
                                60%
                                50%
                                                                                                36.8%
                                40%
                                30%
                                20%
                                10%
                                 0%
                                                        Desktop                                 Laptop                             Mobile Phone

                              Source: CNNIC (Jun-10).


                              Home has become preferred place to access the internet
                              Given the increase in internet-accessible computers, broadband penetration, and per
                              capita wealth, the home has become the preferred place for most users to access the
                              internet, with more than four-fifths of all internet users accessing the internet from
                              home. The number of people accessing the internet from the office also increased to
                              33% at the end of 1H10 from 30% in late 2009.

                              Main Access Locations
                                100%                    88.40%

                                 80%

                                 60%
                                                                                                33.60%                                 33.20%
                                 40%

                                 20%

                                  0%
                                                          Home                               Internet Café                             Company

                              Source: CNNIC (Jun-10).


8                                                                                                                                                    145
    Dick Wei                  Global Equity Research
    (852) 2800-8535           03 January 2011
    dick.x.wei@jpmorgan.com




                              Average time spent online remains stable
                              CNNIC’s Jun-10 survey showed users spent an average of 19.8 hours per week
                              online. This was up from 18.7 hours per week six months earlier. While the overall
                              average online time per user remains stable, we note old users likely spend more time
                              online than new users. We also note that internet usage has more than doubled
                              compared to the 9.8 hours per week spent online in December 2002.

                              Average Time Spent Online
                              Hours/week

                               25
                                                                                              18.6          19.0             18.7 19.8
                               20                                            15.9 16.5 16.9          16.2          16.6 18.0
                                             13.0 13.4 12.3 13.2 14.0
                               15      9.8
                               10
                                 5
                                 0
                                      Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun- Dec- Jun-
                                       02     03        03   04   04    05    05   06    06    07     07    08     08    09    09    10

                                                                        Av erage Accessing Time Per Week

                              Source: CNNIC (Jun-10).


                              Media is the most popular internet use
                              According to the Jun-10 CNNIC survey, online music is the most popular use of the
                              internet, with 82.5% of internet users accessing online music. Online news is also
                              popular, with 78.5% usage, while search engine use was 76.3%. Online payment and
                              online shopping have seen fast growth with 36.2% and 31.4% user increases in six
                              months by June 2010, respectively.

                              Internet Usage by Category
                              Service type                                     % of surveyed use the service              Users in millions
                              Online Music/download                                                   82.5%                          346.5
                              News                                                                    78.5%                          329.7
                              Search engine                                                           76.3%                          320.5
                              Instant messaging ( chat room, QQ, ICQ)                                 72.4%                          304.1
                              Online Games                                                            70.5%                          296.1
                              Online movie (include download)/Video                                   63.2%                          265.4
                              Email                                                                   56.5%                          237.3
                              Blog                                                                    55.1%                          231.4
                              Social Networking                                                       50.1%                          210.4
                              Online literature                                                       44.8%                          188.2
                              Online shopping                                                         33.8%                          142.0
                              BBS/forum                                                               31.5%                          132.3
                              Online payment                                                          30.5%                          128.1
                              Online banking                                                          30.5%                          128.1
                              Online stock trading                                                    15.0%                            63.0
                              Online travel reservation                                                8.6%                            36.1
                              Source: CNNIC (Jun-10).


                              Chinese mobile users cite chat as the most used function while accessing the internet
                              with their phones. Mobile search is chosen by 48.4% of mobile users while
                              listening/downloading music was the third most popular activity with 45.3% users.




9   146
     Dick Wei                           Global Equity Research
     (852) 2800-8535                    03 January 2011
     dick.x.wei@jpmorgan.com




                                        Chat Is the Most Used Application on Mobile
                                         70%      61.5%
                                         60%                      48.4%      45.3%         43.3%
                                         50%
                                                                                                        35.5%
                                         40%
                                         30%                                                                         21.1%        20.4%
                                                                                                                                               16.0%
                                         20%                                                                                                                  6.1%
                                         10%
                                          0%
                                               Mobile Chat       Mobile   Online music     Mobile        Mobile  Online mobile Mobile Video Mobile email    Mobile
                                                                 Search    listening or   Literature   community     game                                  Payment
                                                                          downloading

                                        Source: CNNIC (Jun-10).


                                        Online Advertising
                                        Maintain positive view on 2011 and longer-term online ad market growth
                                        We expect the rising number of internet users and increasing times spent on the
                                        internet will continue to drive online ad allocation. Lower computer prices, declining
                                        connection fees, higher influence of online media, and government support should
                                        continue to drive internet growth in China. Time spent on internet per users should
                                        accelerate from the increased penetration of smartphones and tablets.

                                        Increasing Time Spent on Internet per User per Week
                                         21
                                                                                                                                                       19.8
                                         20
                                                                                                                                18.7
                                         19                                                               18
                                         18
                                                                                16.6
                                         17               16.2
                                         16
                                         15
                                                         Dec-07                Dec-08                   Jun-09                 Dec-09                  Jun-10

                                                                                          Time Spent Online (In Hr/Week)

                                        Source: CNNIC.


                                        The total online ad market still accounts for a relatively small portion of China’s
                                        overall advertising market (expected to be around 15.8% in 2011). We forecast the
                                        online ad market to witness 23% YoY growth in 2011, to reach Rmb30B (or
                                        US$4.4B) and 31% YoY growth in 2012 to reach Rmb39.3B (US$5.8B).

     China search ad is still ~50% of   Search ads continue to grow faster than brand ads
     the total online ad market. This   We expect search advertising to continue to see stronger growth than brand
     compares with around 67% in        advertising in 2011. From a top-down perspective, search ad is ~61% of the total
     the US
                                        online ad market in China in 2011E. This compares with ~70% in the US. As such,
                                        we still see room for growth.

                                        From a bottom-up perspective, we expect market drivers to be: 1) increasing user
                                        adoption of search, 2) higher SME advertisers’ adoption of pay-for-performance
                                        advertising, 3) search usage to increase with the growing eCommerce market, and 4)
                                        use of search ads as a brand advertising tool.




10                                                                                                                                                                   147
   Dick Wei                                                  Global Equity Research
   (852) 2800-8535                                           03 January 2011
   dick.x.wei@jpmorgan.com




   China Online Advertising Market Forecast from 2006 to 2012E
                                                              2006                2007        2008    2009E         2010E        2011E          2012E
   Brand Advertising (RMB M)                                 3,377               4,559       6,428     6,942         9,025       11,462         14,442
   Search Advertising (RMB M)                                1,442               2,851       5,309     7,213        12,015       18,427         24,751
   Other Online Format (RMB M)                                 109                 122         135       135           135          135            135
   Total Online ad market (RMB M):                           4,928               7,533      11,872    14,290        21,175       30,023         39,328
   Total Online ad market (US$M)                               621                 999       1,721     2,083         3,100        4,448          5,826
   Growth Rate (Rmb, %)                                     54.6%               60.8%       72.3%     21.1%         48.8%        43.5%          31.0%
   Total China ad market (Rmb M)                           105,712             116,422     139,707   142,501       165,301      190,096        216,709
   Growth Rate (Rmb, %)                                     16.5%               10.1%       20.0%      2.0%         16.0%        15.0%          14.0%
   Ad market as % of GDP                                    0.48%               0.44%       0.46%     0.42%         0.42%        0.44%          0.45%
   Online ad as % of Total ad market                         4.7%                6.5%        8.5%     10.0%         12.8%        15.8%          18.1%
   Source: iResearch, CNNIC, J.P. Morgan estimates. Note: Growth rates are in Rmb terms.


                                                             Online advertising: top-down perspective
                                                             Internet usage growth – same old story, but is that what is driving the online ad
                                                             spending growth expected in 2011?
                                                             We expect China's internet user base to grow around 20% CAGR (2009–11) to reach
                                                             a penetration rate of 39% by the end of 2011, up from the current penetration rate of
                                                             31%. Drivers for the sector include lower-priced computers, more affordable telecom
                                                             connection fees, government support of internet usage, and low-cost entertainment
                                                             alternative.

                                                             We believe if the number of internet users grows 20% Y/Y (or roughly equal to the
                                                             increase in media consumption), a minimum of 20% Y/Y growth in online brand ad
                                                             spending should be achievable, given: 1) higher number of hours spent online per
                                                             user, 2) the internet can reach a broader audience in smaller cities in China, 3) more
                                                             measurable and lower cost compared with traditional media like TV, 4) general
                                                             inflation in advertising rates, and 5) GDP growth should also drive overall ad
                                                             spending up.

                                                             U.S. advertising spending = 2% of GDP vs. China’s 0.5%
                                                             Ad spend as a percentage of GDP in China is still below the US level; as such, we
                                                             still believe advertising in China can grow at least in line with GDP. Online ads
                                                             should grow even faster.

                                                             Online advertising: bottom-up perspective
                                                             The few sectors that we believe are likely to see fast growth next year are: autos,
                                                             FMCG (Fast Moving Consumer Goods), and eCommerce. China Government’s drive
                                                             to push consumption in the country should continue to help drive retails sales. As a
                                                             result, the advertising industry should benefit from this trend.

                                                             Automobiles advertising outlook for 2011
                                                             Driver 1: Increased auto ad dollars
                                                             In 2011, we believe the auto sales environment will become more competitive with
                                                             less government subsidies and oversupply. Our China Autos Analyst Frank Li
                                                             suggests that auto sales for personal vehicles will decline to 15% YoY in 2011 vs.
                                                             29% in 2010E. However, excess capacity build-up over the last few years will also
                                                             lead to higher competition which, in turn, should help drive up marketing expenses
                                                             by auto makers.

                                                             Driver 2: Increased online allocation
                                                             We believe that with an affluent internet population growing, more measurable
                                                             results, and lower rates vs. TV, automobile companies will continue to increase

11 148
     Dick Wei                  Global Equity Research
     (852) 2800-8535           03 January 2011
     dick.x.wei@jpmorgan.com




                               budget allocations to online advertising. Currently ~7.3% of automobiles’ advertising
                               budget is allocated online in China, according to iResearch. iResearch expects auto
                               online advertising spending to increase to 10.9% by 2013.

                               In addition, we believe more advertising budget will be directed to drive product
                               sales (through advertising particular models, driving traffic for test drives) rather than
                               general branding exercise. In our opinion, a product-specific campaign would be
                               more effective over the internet as Chinese consumers tend to do a lot of their own
                               research before their first car purchase.

                               Driver 3: Geographic expansion in autos sales
                               As we believe lower-tier cities will see faster autos sales in the next few years, we
                               believe advertisers would also be well served by investing more on the internet for
                               nationwide customer reach (rather than magazine and newspapers, which have
                               limited geographic coverage).

                               Real estate advertising
                               Worst is over, 2011 to be a better year
                               In 2010, the private real estate market was quite weak due to a series of restrictive
                               measures to curb investment demand and housing price growth. Real estate
                               advertising saw a big downturn in 1H10 as a result. We expect the reverse trend that
                               begun in 2H10 to continue in 2011. Although we expect the government to maintain
                               its tightening stance in 2011, the policy theme should shift from curbing demand to
                               pushing out more housing supply while limiting price increases. We believe such a
                               situation will benefit advertising demand.

                               A geographic diversification story beyond Beijing, Shanghai
                               All the major leading portals including Sohu, CRIC, and Baidu have been increasing
                               their presence in Tier 2/Tier 3 cities, which should drive up the advertising allocation
                               to internet from these cities. Currently, online ad spending in lower-tier cities is
                               around 50% or less compared to Tier-1 cities.

                               Online eCommerce advertising
                               We believe the fast-growing eCommerce market will prompt eCommerce companies
                               to increase spending online. In addition, with rising competition and fight for market
                               share, eCommerce companies will be aggressive in online ad spending. In addition to
                               general brand building through banner advertising, we expect eCommerce companies
                               to increase spending on search as well.

                               For eCommerce merchants, other attractive ad formats would be ads in social
                               networking websites.

                               Financial services advertising
                               Investment funds increased their overall ad budgets in late 2007 and 2008; however,
                               we’ve seen a significant pullback in 2009. With a better macro environment, we
                               think these advertisers will likely come back in 2010 and 2011. These advertisers
                               likely advertise with leading portals such as Sina and Sohu for stronger brand
                               influence. We expect new drivers for the finance segment over the next few years
                               could be insurance companies, personal banking, brokerage and wealth management
                               advertisements.



12                                                                                                                     149
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




                             Fast-moving consumer goods
                             Historically, these advertisers allocated less spending online. We expect the trend to
                             continue to change with more allocation online, given a large internet population, a
                             wider online demographic, and more integrated marketing campaign required to
                             differentiate a brand.

                             Furthermore, we believe with an increasing trend in luxury retailing, the internet
                             would offer very cost-effective advertising. We note that brands like Cartier have
                             begun advertising online.

                             China - Number of Households with Assets Above US$1 Million

                              800                                                                                           697
                                                                                                                      609
                                                                                                         529
                              600                                                              453
                                                                            437       417
                              400                                 305
                                                        223
                                               179
                                       141
                              200

                                 0
                                       2003   2004      2005     2006      2007      2008      2009     2010E     2011E     2012E

                                                      China - Number of households w ith assets abov e US$1 million

                             Source: ACMR.


                             Telecom sector spending
                             We expect telcos will continue to invest in advertising in order to drive 3G adoption
                             (government-mandated strategy) and higher competition in the space with operators
                             trying to recoup their capex spending.

                             Good growth in CCTV auctions
                             Every year on November 18 (last year on November 8), CCTV (China Central
                             Television) holds an advertising auction for the next year’s prime time ad resources
                             on CCTV channels. This important event auctions off ~15% of the country’s total
                             TV ad spending and sets the tone for ad growth in the coming year.

                             In November 2010, CCTV reported prime time ad auction revenue of Rmb12.67B,
                             up 15.52% Y/Y: This is slightly above industry expectations of around 15%. We see
                             the following implications: (1) while advertisers are generally cautiously optimistic
                             about 2011’s outlook, the auction results suggest consensus (hundreds of advertisers
                             participated) is more optimistic than cautious; (2) with the CCTV auction setting a
                             positive tone, the online brand ad rate is likely to achieve >20% growth; (3)
                             published rates for leading portals and other media are likely to increase good next
                             year.

                             We continue to expect the online branded ad segment to benefit from decent 2011
                             overall ad market growth as well as increased online ad allocation.

                             Industry segments
                             The top bidders were from the food and beverage sectors, home appliances, as well
                             as finance and security. There was also an increased presence by the auto and
                             tourism industries.
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                               We look at absolute dollar amounts of ads sold at the auction. The table below shows
                               the auction results growth rate vs. online brand ad growth rate (in Rmb terms).



                               CCTV Auction Results vs. Online Brand Ad Growth
                               Year             CCTV Prime time              YoY Growth           Online Brand   Number of times (X): [Online
                                                Auction Revenue                                    Ad Growth      Brand Ad Growth / CCTV
                                                  (Rmb billion)                                                    Auction Growth Ratio]
                               2003                   3.31                        26%                  102%                  3.9
                               2004                   4.41                        33%                  72%                   2.2
                               2005                   5.25                        19%                  37%                   2.0
                               2006                   5.87                        12%                  45%                   3.8
                               2007                   6.80                        16%                  35%                   2.2
                               2008                   8.03                        18%                  41%                   2.3
                               2009                   9.26                        15%                   8%                   0.5
                               2010                   10.97                       19%                  30%                   1.6
                               2011E                  12.67                       16%                  27%                   1.7
                               Source: CCTV, Zenith Optimedia. Note: J. P. Morgan current estimates.




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                             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.

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                                                                 We believe the leading portals have strict internal compliance departments and
                                                                 automated content scans to ensure contents are in compliance with government
                                                                 standards. In addition, leading portals have gained trusts and have an existing
                                                                 relationship with the government. Leading portals are the most trusted by the
                                                                 government among internet companies and have the best compliance procedures;
                                                                 further, the financial impact would be less significant because still only a small
                                                                 portion of their revenues come from User Generated Contents, which could be
                                                                 subject to government regulation.

                                                                 Online Search
                                                                 Still in early high-growth stage
                                                                 The search advertising market in China is expected to grow 53% Y/Y in 2011, as per
                                                                 our estimates, to reach Rmb18.4B (US$2.7B). We believe search advertising is still
                                                                 in an early high-growth stage in China, driven by: 1) rising internet penetration, 2)
                                                                 significant growth in websites and pages, 3) higher search usage (due to greater mass
                                                                 of web content), and 4) large number of SMEs (with small ad budgets) turning to
                                                                 search advertising (due to the higher ROI).

     China Search Market Forecast
                                                                           2006      2007        2008        2009E       2010E        2011E       2012E
     Avg. Internet users (Mn)                                               123       162         253          338         420          494        577
     Number of search (Bn)                                                   81       116         181          254         334          429        521
     Coverage                                                               17%       21%         24%         25%         32%          34%         35%
     Click through rate                                                     22%       25%         25%         24%         22%          22%         22%
     Price per click (Rmb)                                                  0.34      0.42        0.45        0.45        0.50         0.56        0.60
     P4P Search Market (Rmb M)                                             1,062     2,472       4,945       6,849       11,644       18,048      24,364
     P4P Search Market (US$ M)                                              134       328         717          999       1,705        2,674       3,610
     Growth rate (Rmb, %)                                                  110%      133%        100%         39%         70%          55%         35%
     Total Search Market (Rmb M)                                           1,442     2,851       5,309       7,213       12,015       18,427      24,751
     Total Search Market (US$ M)                                            182       378         770        1,052       1,759        2,730       3,667
     Growth rate (Rmb, %)                                                   70%       98%         86%         36%         67%          53%         34%
     Search ad as % of total ad market                                     1.4%      2.4%        3.8%         5.1%        7.3%         9.7%       11.4%
     Source: CNNIC, J.P. Morgan estimates. Note: Excluding distributor discount.


                                                                 How big can China’s search market grow?
                                                                 Using various comparisons to the US and Korean search market, we estimate
                                                                 China’s search market could reach US$3B-US$4.6B by 2013
                                                                 This compares to our current 2013 forecast of US$3.4B and US search market 2009
                                                                 size of US$15B. Please also refer to the chart below for analysis of market size
                                                                 comparison with the US and Korean markets.

                                                                 Other factors that could lead to positive surprise to our forecast include faster-than-
                                                                 expected inflation and RMB appreciation.

                                                                 China search market size potential analysis
                                                                 If we use Korea and US as a proxy for online search market growth rate and growth
                                                                 potential, we see more upside possible upside to our base case forecast.

                                                                 We present five different scenarios for our forecast:

                                                                 Scenario 1: We compared search market size as a percentage of nominal GDP in
                                                                 China and the US. We shifted US search market size as a percentage of nominal
                                                                 GDP six years to estimate China search market size in 2010-2014. We think the
                                                                 market will reach US$3.0B and US$4.6B in 2011 and 2012, respectively.
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   dick.x.wei@jpmorgan.com




                                                           Scenario 2: We compared search market size as a percentage of nominal GDP in
                                                           China and Korea. We shifted Korea search market size as a percentage of nominal
                                                           GDP five years to estimate China’s search market size in 2010-2014. We think the
                                                           market will reach US$3.0B and US$4.5B in 2011 and 2012, respectively.

                                                           Scenario 3: We compared search market growth rate in China and US. We shifted
                                                           the US search market growth rate six years to estimate China’s search market size in
                                                           2010-2014, and think the market will reach US$3.0B and US$4.3B in 2011 and 2012,
                                                           respectively.

                                                           Scenario 4: We compared search market growth in China and the US and shifted
                                                           2003-2008 CAGR of US search market growth six years to estimate China’s search
                                                           market size in 2010-2014. We think the market will reach US$2.3B and US$3.4B in
                                                           2011 and 2012, respectively.

                                                           Scenario 5: We compared search market size as a percentage of personal
                                                           consumption in China and the US. We shifted US search market size as a percentage
                                                           of personal consumption five years to estimate China’s search market size in 2010-
                                                           2014. We think the market will reach US$2.1B and US$3.0B in 2011 and 2012,
                                                           respectively.

   Five Scenarios for China’s Search Market Size Estimate
   US$M

    9,000


    8,000

    7,000


    6,000

    5,000


    4,000

    3,000


    2,000

    1,000


         0
                       2008                     2009               2010E               2011E             2012E                2013E               2014E

                                          China Search Ad Market Size (US$ M) (Scenario 1)     China Search Ad Market Size (US$ M) (Scenario 2)
                                          China Search Ad Market Size (US$ M) (Scenario 3)     China Search Ad Market Size (US$ M) (Scenario 4)
                                          China Search Ad Market Size (US$ M) (Scenario 5)

   Source: iResearch, World Bank, J.P. Morgan estimates.




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     dick.x.wei@jpmorgan.com




                               Competitive landscape
                               Baidu continued to gain more market share from Google China. Baidu market share
                               reached 72.8% by revenue in 3Q10 vs.64.9% in 3Q09. Sogou and Soso both
                               expanded markets here slightly to 1.2% and 1.0%, respectively. Google’s market
                               share declined to 24.6% in 3Q10 vs. 31.2% in 3Q09.

                               Baidu has successfully expanded its search revenue market share by more than 10
                               percentage points since 1Q09. Google is still having trouble with its advertising
                               agencies. We expect Baidu to at least continue to maintain its current share.

                               Baidu Gaining Market Share Consistently (by Revenues)
                                                        1Q09            2Q09             3Q09            4Q09             1Q10    2Q10   3Q10
                               Baidu                   62.3%           63.6%            64.9%           64.0%            67.8%   70.8%   72.9%
                               Google                  33.0%           32.5%            31.2%           32.8%            29.5%   27.3%   24.6%
                               Sogou                    1.2%            0.9%             1.0%            1.2%             1.0%    0.8%    1.2%
                               SoSo                     1.5%            1.2%             1.0%            0.6%             0.8%    0.6%    1.0%
                               Others                   2.0%            1.8%             1.8%            1.3%             0.9%    0.5%    0.4%
                               Source: iResearch.


                               In addition to gaining search market share, the company significantly reduced the
                               gap between its volume and search market share. We expect this to further reduce
                               with time.

                               Baidu Search Market Share (by volume of search queries)
                                                         1Q09            2Q09            3Q09             4Q09            1Q10    2Q10   3Q10
                               Baidu                    74.1%           75.7%           77.0%            77.1%           75.3%   80.2%     NA
                               Google China             20.9%           19.8%           17.9%            17.5%           18.4%   14.1%     NA
                               Others                    5.0%            4.5%            5.1%             5.4%            6.3%    5.7%     NA
                               Difference in
                               marketshare*             15.1%           14.1%           13.1%            18.7%           11.3%   10.2%
                               Source: iResearch. * means difference in search volume and search revenue market share.


                               Soso and Sogou will take longer to become a challenge to Baidu
                               Tencent’s Soso and Sohu’s Sogou have been working on developing their own
                               search technologies. We believe they will not be a potential threat to Baidu for the
                               medium term, as we believe the technology of these two search engines is still
                               behind that of Baidu. Soso and Sogou’s total market share was 2.2% in 3Q10 as per
                               iResearch.

                               In mid-2010, Sogou and its related technology (pinyin, toolbar, etc) was spin off as a
                               separate business entity. Alibaba Group and related persons invested in Sogou.

                               Alibaba launches eCommerce search
                               Alibaba joined with Microsoft to launch a beta version of search site Etao. Etao aims
                               to drive traffic for Alibaba’s Taobao.com. The search results displayed in groups
                               include Taobao listings, links to related online forums, information websites, and
                               web search results provided by Microsoft’s Bing in the same order.

                               While Etao has the potential to become a eCommerce focus search engine, we do not
                               expect Etao to be successful as a general search engine.

                               We note that in 2007, Baidu announced that it would introduce its own e-commerce
                               platform called Youa to compete with Taobao. Taobao responded by blocking Baidu
                               from searching goods on its website.

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                                     Government-backed search team
                                     (1) During August 2010, Xinhua News Agency and China Mobile announced plans
                                     to set up a new search engine company.

                                     (2) People’s Daily Newspaper group launched new search engine, goso.cn. The
                                     search engine is led by former Olympics Ping Pong Champion Deng Ya Ping.

                                     We do not expect these government-backed search companies to gain meaningful
                                     traction in the market. However, the move could lead to the government’s closer
                                     monitoring of the search engine industry in China.

                                     Baidu
                                     Phoenix Nest latest update
                                     The full Phoenix Nest transition happened in December 2009. While the Phoenix
                                     Nest launch led to a significant revenue increase for Baidu in 1H10, we expect
                                     Phoenix Nest to continue to bring benefits to Baidu. One of Baidu’s key initiatives is
                                     to continue to improve Phoenix Nest performance in the long term.
                                     Baidu application platform: announced in September 2010
                                     To enhance user’s search experience, Baidu launched an applications library which
                                     allows third-party offerings in the library to launch directly on Baidu rather than
                                     moving to another website. These third-party applications appear in search results
                                     when a user is looking for certain specific queries such as those related to games,
                                     music, etc.

                                     Baidu estimates that 30% of search queries in China are for applications rather than
                                     information.

   Baidu estimates that 30% of       The company currently has more than 400 applications under this library. Baidu and
   search queries in China are for   third-party application providers will split revenues in a ratio of 30:70. Baidu’s
   applications rather than
   information
                                     application will be based around music, e-books, games, and videos. Open platform
                                     strategy allows apps developers or book writers to submit content through
                                     open.baidu.com. This initiative is part of the larger “box computing” initiatives by
                                     the company. We believe this step could drive up search volumes in the future.

                                     Developers or book writers can get revenue from: 1) direct content purchase, 2)
                                     embedded ads. Currently Baidu has 400+ partners which give Baidu content, info
                                     and apps. Baidu is not specific about revenue sharing with apps developers. We think
                                     this will be one potential strategy.

                                     Searches that led to downloadable apps or content:

                                     三重门 – This is the name of popular fiction. Users can buy e-books directly from
                                     results link. Publishers or writers can put their own books online. In the future, there
                                     is no need to go to Amazon or DangDang.

                                     坦克大战 – A basic online game. Users can download this game or other games on
                                     the list of recommendations.

                                     金山毒霸 – Kingsoft anti-virus software. Links to download right away.

                                     豆瓣电台 – Online radio station. Users can listen to radio directly on Baidu’s page.

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                               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.

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                             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

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                                   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.




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                             Number of SMEs by Different Segments




                             Source: SAIC, J.P. Morgan estimates.


                             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

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                               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




                               Source: J.P. Morgan.




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   Dick Wei                               Global Equity Research
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   dick.x.wei@jpmorgan.com




                                          Traffic Breakdown in Baidu.com Domain
                                                             Domain Name                      Traffic breakdown
                                           baidu.com                                                              44.5%
      Image search is the third-largest    tieba.baidu.com                                                        14.5%
      search channel after web page and    image.baidu.com                                                        13.5%
      Tiebar. MP3 search continues to      zhidao.baidu.com                                                        8.4%
      lose dominance                       hi.baidu.com                                                            3.5%
                                           mp3.baidu.com                                                           3.3%
                                           video.baidu.com                                                         2.8%
                                           baike.baidu.com                                                         1.6%
                                           zhangmen.baidu.com                                                      1.6%
                                           news.baidu.com                                                          1.2%
                                          Source: Alexa.com. As of Oct 21, 2010.


                                          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
                                           300
                                                                                                                                 265
                                                                                                                          240
                                           250                                                        222
                                                                                      202
                                           200                                180
                                                           161

                                           150

                                           100
                                                         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

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     (852) 2800-8535                 03 January 2011
     dick.x.wei@jpmorgan.com




                                     mobile devices (phones, tablets), and internet-enabled TV. The wider choice of
                                     device allows users to enjoy content anytime in different platforms.

                                     Online Video Advertising Revenues in China
                                      200%                                                                                             13.1       14
                                                                                                                                                  12
                                      150%                                                                                   8.6                  10
                                                                                                                                                  8
                                      100%                                                                      5.4
                                                                                                                                                  6
                                                                                                   2.9
                                        50%                                                                                                       4
                                                                                        1.4
                                                     0.1          0.3        0.6                                                                  2
                                         0%                                                                                                       0
                                                   2006          2007       2008       2009       2010E        2011E       2012E      2013E

                                                           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.

     Similar to media market         Most of the video sites in China monetize by 1) in-video advertisements, 2)
     worldwide, both ad-supported    program/channel sponsorship by brand advertisers, or 3) affiliate advertising from
     and subscription-based models
     are used in China. The ad-
                                     text-based ads by search engines.
     supported model is more
     popular by far in China         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


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   dick.x.wei@jpmorgan.com




                                      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.

   Thirty percent of online video     Young demographics/more affluent population
   viewers have a college degree or   China’s online video market offers more attractive and targeted user demographics
   higher level of education,         vs. traditional television market in terms of users’ age, level of education and
   whereas only 14% of the            potential spending power. Online video viewers in China, on average, are younger
   television audience is similarly
                                      than traditional television viewers, but slightly older than the overall internet
   educated, according to CNNIC
   and CSM Media Research             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
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     Dick Wei                                           Global Equity Research
     (852) 2800-8535                                    03 January 2011
     dick.x.wei@jpmorgan.com




                                                        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                         3Q10 Market Share Based on Revenue
             Spent Watching Online Video in China
                                                                                                     Others, 16.9%
                           Pheonix , 1.0%          Others, 5.1%                                                                   Youku, 22.5%
                    Joy .cn, 1.0%
                     CNTV, 2.5%                                                                  Joy , 2.9%
               Sina Video, 2.9%                                                          Xunlei Kankan,
              56.com, 4.3%                                           Youku, 39.6%            3.2%
                  Ku6, 6.1%                                                            Sina Video, 3.5%

               Xunlei Kankan,                                                               PPLiv e, 5.3%
                                                                                                                                       Tudou, 18.5%
                     5.8%
                                                                                                   Ku6, 5.6%
               Sohu Video, 9.0%
                                                                                                      CNTV, 6.1%
                                                                                                         Sohu Video, 6.4%   PPStream, 8.9%

                                             Toudu, 22.8%

             Source: iResearch. Data as of 3Q10.                                     Source: Analysys. Data as of 3Q10.




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




   China Video Portal Data (Monthly Data for Oct 2010)

   Total Unique Visitors (000)                                                  Total Minutes (MM)
     YOUKU.COM                                                         77,439     YOUKU.COM                     1,620
     Tudou Sites                                                       65,817     Tudou Sites                   1,297
     KU6.COM                                                           62,719     KU6.COM                         747
     PPS.TV                                                            49,406     PPS.TV                        3,171
     56.COM                                                            35,702     56.COM                          306
     SINA Video                                                        30,760     SINA Video                      322
     IFENG.COM                                                         30,417     IFENG.COM                     1,712
     SOHU.COM TV                                                       24,487     SOHU.COM TV                     455
     JOY.CN                                                            16,646     JOY.CN                          436
     CNTV.CN                                                           13,298     CNTV.CN                         129
     QIYI.COM                                                          12,780     QIYI.COM                        113
     PPLIVE.COM                                                         2,934     PPLIVE.COM                        5
     SMGBB.CN                                                           2,594     SMGBB.CN                         13
     IMGO.TV                                                            1,216     IMGO.TV                           6

   Average Daily Visitors (000)                                                 Average Minutes per Usage Day
     YOUKU.COM                                                          9,538     YOUKU.COM                       5.5
     Tudou Sites                                                        7,762     Tudou Sites                     5.4
     KU6.COM                                                            6,482     KU6.COM                         3.7
     PPS.TV                                                            12,363     PPS.TV                          8.3
     56.COM                                                             2,857     56.COM                          3.5
     SINA Video                                                         2,875     SINA Video                      3.6
     IFENG.COM                                                          4,809     IFENG.COM                      11.5
     SOHU.COM TV                                                        2,444     SOHU.COM TV                     6.0
     JOY.CN                                                             1,570     JOY.CN                          8.9
     CNTV.CN                                                            1,055     CNTV.CN                         4.0
     QIYI.COM                                                             862     QIYI.COM                        4.2
     PPLIVE.COM                                                           202     PPLIVE.COM                      0.8
     SMGBB.CN                                                             162     SMGBB.CN                        2.6
     IMGO.TV                                                               80     IMGO.TV                         2.3
   Source: Comscore.




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     dick.x.wei@jpmorgan.com




                               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
                                3000                                                                       2,850
                                2500
                                2000                                                           1,632
                                1500
                                                                               780
                                1000
                                                            420
                                                   240
                                  500
                                     0
                                                   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.
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   dick.x.wei@jpmorgan.com




                             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
                                                      Not ev ery w eek
                                                            26%
                                                                                         Once a w eek or
                                                                                               less
                                                                                               40%




                                                   More than Once
                                                          16%                       Once per day
                                                                                        18%

                             Source: CNNIC.




                             Users by Access Method

                                                            Only using mobile
                                                                   8%


                                                                                          Only using
                                              Ov erlapping users                           computer
                                                      39%                                     53%




                             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..

                             .


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     dick.x.wei@jpmorgan.com




                               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.




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                                                  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.



   Sina’s Weibo Monetization Model

                   Brand Adv                                                       Platform Model


                        Brand Product Line                                                              Indirect Monetization
                                                                  Direct Monetization
                 • Interaction with Weibo                                                           • Weibo.com – Open API
                                                            • Internally developed apps
                 • Integrate online and offline                                                     • Rmb 200M fund to support
                                                            • SME marketing and services
                   events                                                                             third party developers

   Source: Company data, J.P. Morgan.




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     (852) 2800-8535                      03 January 2011
     dick.x.wei@jpmorgan.com




                                          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.
     China eCommerce transaction          The China eCommerce transaction value is estimated to account for 3.4% of total
     value is estimated to account for    retail sales in 2010 and is expected to grow to 6.5% of total retail sales in 2013.
     3.4% of total retail sales in 2010
     and is expected to grow to 6.5%
     of total retail sales in 2013        China eCommerce Market Size by GMV
                                          Rmb B

                                            1,400                                                                                                         1,269   7%
                                            1,200                                                                                                994              6%
                                            1,000                                                                                                                 5%
                                              800                                                                                       723                       4%
                                              600                                                                              476                                3%
                                              400                                                                  263                                            2%
                                                                                             56         128
                                              200          5          16         26                                                                               1%
                                                0                                                                                                                 0%
                                                        2004        2005        2006       2007        2008        2009      2010E     2011E    2012E     2013E

                                                                      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.
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   Dick Wei                  Global Equity Research
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   dick.x.wei@jpmorgan.com




                             Fast Growth of China Online Shopping Users
                               300                                                                                34.6%       36.2%      40.0%
                                                                                                   32.4%                          245
                               250                                                   30.2%                         213
                                           26.2%          26.8%             28.4%                  180                                   30.0%
                               200                                                    145
                               150                                           109                                                         20.0%
                                                            80
                               100          55
                                                                                                                                         10.0%
                                50
                                 0                                                                                                       0.0%
                                           2007            2008             2009     2010E         2011E          2012E       2013E

                                                         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

                               250                                                                                                       120%
                                                                            110%                                             201
                                                                                            103%                                         100%
                               200                                                                               90%
                                                                                                                                         80%
                               150                                                                         118                     71%
                                                                                                                                         60%
                               100                                                    62                                                 40%
                                                                       31
                                50               15                                                                                      20%
                                 0                                                                                                       0%
                                              2009                    2010E          2011E               2012E               2013E

                                                                 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.

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




                               (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.

                               China B2C Retailers Market Share by GMV in 3Q10
                                                           Coo8.com, 1.1%        Others, 26.9%
                                                              New 7, 1.3%
                                                       Mecox Lane, 2.2%
                                                        Redbaby , 2.3%
                                                      icson.com, 3.1%
                                                           New egg, 4.4%

                                                              Vancl, 5.3%
                                                                                                 360Buy , 35.6%

                                                       Joy o Amazon, 8.9%
                                                                       Dangdang, 8.9%
                               Source: iResearch (2010).



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




   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           1. The largest B2C retailer in China in    1. The third-largest B2C retailer in
                                           China in terms of transaction value.        terms of transaction value.                China in terms of transaction value.
                                           2. Around 15k merchants sell products       2. Well-known for its 3C (computer,        2. Supported by international B2C giant
                                           with 20k brands.                            communication, consumer electronics)       Amazon.
                                           3. Merchants need to pay gurantee           products.                                  3. Well-known for its media products
                                           money of Rmb 10,000 to open a store         3. Expand to sell various products,        sales such as books and music.
                                           in Taobao Mall. Besides that, Taobao        including books, cosmectics, household 4. Expand to sell software products,
                                           Mall charges annual service fee of Rmb      products and etc.                          electronic goods, toys, household
                                           6,000 and online transaction technical      4. Announce to offer group buying          products, cosmetics, jewelry, watches
                                           fee of 1% ~ 5% as of transaction value      products from Dec 20, 2010.                and baby products, etc.
                                           per transaction.
   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                         1. Cash-on-delivery and mobile POS
                                           debit card, time saving for online          2. Online Banking Payment                   payment
                                           payment                                     3. Credit card payment                      2. Online Banking Payment
                                           2. Credit card payment                      4. Third-party payment: Alipay, Tenpay      3. Credit card payment
                                           3. Online banking Payment                   and 99Bill                                  3. Third-party payment: Alipay and
                                           4. Alipay                                   5. Mobile payment                           PayEase
                                           5. Consumer card payment                    6. Installment payment                      7. Remittance
                                           6. Cash-on-delivery                         7. Remittance                               8. Banking Account Transferring
                                                                                       8. Banking Account Transferring             9. Amazon gift card payment
   Logistics                               Third-party logistics companies. Taobao     1. Five logistics centers are in Beijing,   1. Nine self-established logistics
                                           started to establish its own distribution   Shanghai, Guangzhou, Chengdu and            centers in Beijing, Suzhou, Guangzhou,
                                           center and invested in one logistics        Wuhan. Self-established logistics           Chengdu, Wuhan, Shenyang, Xi'an,
                                           company in 2010.                            networks reach 24 cities.                   Xiamen.
                                                                                       2. Cooperate with third-party logistics     2. Free of charge for delivery service.
                                                                                       companies.                                  3. Cooperate with third-party logistics
                                                                                                                                   companies.
   History                                 1. B2C marketplace started in2008.          Founded in 2004.                            1. Founded in 2000.
                                           2. Taobao Mall with independent                                                         2. Acquired by Amazon in 2004.
                                           domain name was launched in Nov
                                           2010.
   Source: Company reports, J.P. Morgan.




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




     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            1. A B2C retailer to offer fashion products through its website
                                             transaction value.                                                 and physical stores in China.
                                             2. Well-known for its its media products sales such as books       2. The products include apparel and accessories, home
                                             and music.                                                         products, beauty and healthcare products and other products,
                                             3. Expand to sell various products, including cosmetics,           under its own brands of Euromoda and Rampage as well as
                                             electronic goods, household products, baby products and etc.       selected 3rd party brands.
                                             4. Invite third-party merchants to sell general merchandize at     3. Invite third-party merchants to sell products at its "plug-and-
                                             Dangdang platform under its marketplace program.                   play" platform.

     Registered Members                      1. Active customers were 6.8M for the nine months ended Sep          1. Active online customers were 2.1M as of June 2010.
                                             30, 2010.                                                            2. Average daily unique visitors of the company’s website: 671k
                                             2. Average daily unique visitors were 1.6M in Sep 2010.              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                                            2. Online Banking Payment
                                             3. Credit card payment                                               3. Third-party payment: Alipay, Tenpay, and 99Bill
                                             4. Third-party payment: Alipay, Tenpay, 99Bill, PayEase and          4. Credit card payment
                                             UnionPay                                                             5. Remittance
                                             5. Remittance                                                        6. Banking Account Transferring
                                             6. Banking Account Transferring
                                             7: Dangdang gift coupon payment
     Logistics                               1. Ten self-established logistics centers: two central logistics     1. Centralized logistics center in Shanghai, other three in
                                             centers in Beijing, eight regional logistics centers in five major   Beijing, Chengdu and Guangzhou. Warehouse space totals
                                             cities outside Beijing. Warehouse space totals 180k square           around 58.7k square meters and can handle 50k orders per
                                             meters and can handle 165k+ orders per day.                          day.
                                             2. Cooperate with 104 third-party inter-city transportation          2. Cooperate with third-party logistics companies.
                                             companies and courier companies.
     History                                 1. Founded in 1999.                                                  1. Founded in 1996.
                                             2. Listed on NYSE in Dec 2010.                                       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.




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




   B2C Marketplace Transaction Service Fees
                                              Taobao Mall               Lekutian             Dangdang             QQ Mall
   Guarantee Money                            Rmb 10,000               Rmb 15,000      Rmb 3,000 - Rmb 10,000    Rmb 20,000
   Real-time Technical Service Fee Ratio
   Fashion & Accessories                          5%                     4.5%                   4%                   0
   Outdoors                                       5%                     4.5%                   4%                   0
   Home & Decor                                   5%                     4.5%                   4%                   0
     Water Heater                                 2%                     4.5%                   nm                   0
     Bathroom Warmer                              2%                     4.5%                   nm                   0
     Shaving Razor                                2%                     4.5%                   nm                   0
   Baby                                                                                         nm                   0
     Infant Formula                               2%                     1.5%                   nm                   0
     Children's Wear                              5%                     4.5%                   nm                   0
     Intelligence Toys & Baby Carrier &           5%                     4.5%                   nm                   0
   Child Cot & Schoolbag
     Diapering                                    2%                     1.5%                   nm                   0
   Cosmetics                                      4%                     3.5%                   nm                   0
   Jewelry                                        2%                     1.5%                   2%                   0
    Gold                                          1%                     0.6%                   nm                   0
    Natural Jade                                  5%                     4.5%                   nm                   0
    Natural Pearls                                5%                     4.5%                   nm                   0
    Natural Amber                                 5%                     4.5%                   nm                   0
   Electronics & Technology                       2%                     1.5%                  1-2%                  0
    Electronics Parts                             nm                      nm                    4%                   0
    Home Appliance                                nm                      nm                    2%                   0
   Motors                                         2%                     1.5%                   2%                   0
   Foods & Health Care Products                   2%                     1.5%                   nm                   0
    Tea Drink & Vegetable Drink                   1%                     0.6%                   nm                   0
    Cooking Oil & Food Grains                     1%                     0.6%                   nm                   0
   Books, Movies & Music                          2%                     1.5%                   nm                   0
   Serivces, such as Tickets, Internet            2%                     1.5%                   nm                   0
   Serivces and etc.
    Virtual Recharge                            nm                       0.6%                    nm                  0
   Annual Technical Service Fee               Rmb 6,000                    0        1) SKU<500, Rmb 300/month,       0
                                                                                    2) 500<SKU<1,000, Rmb
                                                                                       500/month
                                                                                    3) 1,000<SKU<2,000, Rmb
                                                                                       1,000/month
                                                                                    4) SKU>2,000, Rmb
                                                                                       2,000/month
   Source: Company reports, J.P. Morgan.




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




                                                                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

                                                                  4,000                                                                                 3,800

                                                                  3,000                                                            2,620

                                                                  2,000                                       1,650
                                                                                        980
                                                                  1,000

                                                                       0
                                                                                       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.


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




                                                           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                        Meituan                 Dingping Tuan                  QQ Tuan                 Juhuansuan
                                   http://www.lashou.com/       http://www.meituan.com/       http://t.dianping.com/       http://tuan.qq.com/      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   Meituan is the leading        Dingping Tuan is           QQ Tuan is launched by   Juhuansuan is launched
                                  largest group buying site    group buying site in China.   launched by                Tencent. QQ Tuan also    by Taobao, Alibaba's
                                  in China. It plans to                                      Dingping.com, a well-      offers group buying      subsidiary on
                                  expand to 200-300 cities                                   known living social site   products only for QQ     eCommerce. It is a
                                  by 2011.                                                   in China.                  members with lower       product based group
                                  2. Lashou is trying to add                                                            discount price.          buying site, covering
                                  more functions to its                                                                                          across whole China
                                  group buying site, such                                                                                        rather than location
                                  as "Check-in" and SNS                                                                                          based.
                                  games.
   Source: Company reports, J.P. Morgan.




41 178
     Dick Wei                  Global Equity Research
     (852) 2800-8535           03 January 2011
     dick.x.wei@jpmorgan.com




                               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

                                                                 Eachnet, 3.6%

                                                            Paipai, 11.6%




                                                                                                             Taobao , 84.8%




                               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).




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




                                                           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

                                                                                                    Others, 16.2%

                                                                                      Toocle, 1.0%
                                                                                 DHgate.com, 1.8%
                                                                              My steel.com, 2.6%
                                                                           GlobalMarket, 3.3%

                                                                            Made-in-China.com,                                             Alibaba, 57.0%
                                                                                       3.4%
                                                                                   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                 Global Sources is a leading B2B media            HC International offers both online and
                               marketplace in China.                                   company and a primary facilitator of trade       offline B2B services in China.
                               1. International marketplace, Chinese                   with Greater China. The company's principal      1. Online marketplace: Mai-Mai-Tong (买
                               marketplace, Japanese marketplace, and                  business is to provide services that allow       卖通)
                               global wholesale marketplace.                           global buyers to identify suppliers and          2. Offline marketing products: HC Trade
                               2. Ali loan: outstanding portfolio of Rmb 20B-          products, and enable suppliers to market their   Catalogues, HC Yellow Page Directory,
                               Rmb 30B.                                                products to a large number of buyers.            Industrial Market Research
                               3. Acquisition: acquired AliSoft, HiChina,
                               Vendio, Auctiva, and OneTouch as a part of
                               "Work at Alibaba" strategy.
   Registered Members          1. International marketplace: 15M                       Mainland China registered online users and       Online marketplace Mai-Mai-Tong
                                  - # of paying users of China Gold supplier           magazine readers: 2M+                            - Registered users (2009): 10M
                               members: 108.6k                                                                                          - Mai-Mai-Tong IM users: 7M
                                  - # of paying users of Int'l Gold Suppliers:
                               11k
                               2. Chinese marketplace: 42M
                                  - # of China Trust Pass members: 631.3k
   Revenue                     1. Generate revenue from (1) membership                 1. Generate revenue from (1) online and          1. Generate revenue from (1) subscription
                               payment (2) value-added services                        other media services (2) exhibitions             fee from online services (2) advertising
                                  - 2010E: Rmb 5,452M (US$801.8M)                         - 2009: US$174.5M                             income from industry portals, trade
                                  - 2009: Rmb 3,875M (US$569.9M)                       2. Revenue breakdown (FY09)                      catalogues, yellow page directories and
                               2. Revenue breakdown (FY09)                                - Online and other media services: 66.1%      printed periodicals (3) hosting of trade
                                  - International marketplace: 62.1%                        a) Online services: 48.9%                   exhibitions and business seminars (4)
                                  - Chinese marketplace: 36.5%                              b) Print services: 17.2%                    customer-specific market research reports
                                  - Others: 1.4%                                          - Exhibitions: 31.6%                             - 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%
   Margin (FY09)               - Gross Margin: 86.2%                                   - Gross Margin: 36.7%                            - Gross Margin: 52.5%
                               - Operating Margin: 26.6%                               - Operating Margin: 9.2%                         - Operating Margin: 0.56%
                               - Profit Margin: 26.1%                                  - Profit Margin: 9.2%                            - Profit Margin: 0.67%
   History                     Founded in 1999.                                        Founded in 1971.                                 Founded in 1992.
   Source: Company reports, Bloomberg, J.P. Morgan.




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




                               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 MMORPG Market Forecast
                                                                      2006      2007      2008      2009      2010E     2011E      2012E
                               MMORPG gamers (million)                  25.5      37.0      53.3      66.6       77.7      91.5      106.7
                               Game users penetration                 18.6%     17.6%     17.9%     18.1%      18.5%     18.5%      18.5%
                               Average ARPU per month (Rmb)             19.7      21.3      23.7      25.8       26.6      27.1       27.6
                               Market size (Rmb million)               6,043     9,463    15,125    20,608    24,767    29,738     35,380
                               MMORPG Market size (US$M)                 762     1,255     2,192     3,005      3,626     4,406      5,242
                               Growth Rate:                             27%       65%       75%       37%        21%       21%        19%
                               Source: J.P. Morgan estimates.


                               China Casual and Social Game Market Forecast
                                                                      2006      2007      2008      2009      2010E     2011E      2012E
                               Casual game players (million)            32.6      47.3      68.1      88.5     102.9      122.8      145.1
                               Casual players penetration             23.8%     22.5%     22.8%     24.0%     24.5%      24.8%      25.2%
                               APRU per month (Rmb)                       2.7       2.9       3.2       3.5       3.8        4.2        4.6
                               Market size (Rmb million)               1,044     1,634     2,589     3,669     4,694      6,158      8,005
                               Casual Market size (US$M)                 132       217       375       535       687        912      1,186
                               Growth Rate:                             52%       65%       73%       43%       28%        33%        30%
                               Source: J.P. Morgan estimates.


                               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).


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




                                                     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      Jul-10
                                                                                                              (acquired by Shanda
                                                                                                              Games in 2010)
   Duke of Mountain           鹿鼎记                    Martial arts     3D                  Sohu Changyou       Sohu Changyou         1. Expect to be
   Deer                                              adventure                                                                      launched in 1H11
                                                                                                                                    2. Started closed
                                                                                                                                    beta testing in Dec-
                                                                                                                                    10.
   ZT Online II               征途2                    Martial arts     2D                  Giant Interactive   Giant Interactive     1. Expect to be
                                                     adventure                                                                      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:         魔兽世界:大灾变               Fantasy          3D                  NetEase             Blizzard              The new version has
   The Catastrophe                                                                                                                  been launched in
                                                                                                                                    other countries
                                                                                                                                    except mainland
                                                                                                                                    China in Dec-10.
   Source: Company reports, J.P. Morgan estimates.




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




                                                           Comparison of Leading Games and Game Companies

                                                           Market Share of Leading Online Gaming Companies by Revenue
                                                                                            2007                   2008                2009           First Nine Months of 2010
                                                           Tencent                                  6%                     11%                20%                           29%
                                                           Shanda                                  17%                     16%                18%                           14%
                                                           NetEase                                 14%                     12%                12%                           15%
                                                           Sohu Changyou                            2%                      7%                 7%                             7%
                                                           Perfect World                            5%                      7%                 8%                             8%
                                                           Giant Interactive                       12%                      8%                 5%                             4%
                                                           Kingsoft                                 3%                      3%                 3%                             2%
                                                           NetDragon                                5%                      3%                 2%                             2%
                                                           The9                                    10%                      8%                 3%                           0.3%
                                                           Others                                  25%                     23%                21%                           18%
                                                           Source: Company reports, iResearch, J.P. Morgan estimates.


     Leaders in MMOG Quarterly Active Paying Accounts (Free-to-Play Model)
     (In '000s)                           1Q08         2Q08          3Q08            4Q08          1Q09          2Q09        3Q09       4Q09        1Q10      2Q10       3Q10
     Tencent                                 921          2,713         3,684          5,024         5,960         6,919       8,377     8,304        8,518     8,526      9,243
     Sequential growth                                 194.7%          35.8%          36.4%         18.6%         16.1%       21.1%      -0.9%        2.6%      0.1%       8.4%
     Shanda                                  4,110        4,239         5,189          5,889         7,189         8,580       9,060     9,420        9,620     9,640      9,190
     Sequential growth                                    3.1%         22.4%          13.5%         22.1%         19.3%        5.6%       4.0%        2.1%      0.2%      -4.7%
     Sohu Changyou                           1,514        1,807         2,006          1,981         2,270         2,390       2,400     2,400        2,400     2,790      2,610
     Sequential growth                                   19.4%         11.0%          -1.2%         14.6%          5.3%        0.4%       0.0%        0.0%     16.3%      -6.5%
     Perfect World                           1,701        1,530         1,610          1,546         1,464         1,877       1,643     2,188        1,670     1,433      1,274
     Sequential growth                                  -10.1%          5.2%          -4.0%         -5.3%         28.2%      -12.5%     33.2%       -23.7%    -14.2%     -11.1%
     Giant Interactive                       1,447        1,760           937          1,290         1,236         1,204       1,108     1,138        1,373     1,435      1,497
     Sequential growth                                   21.6%        -46.8%          37.7%         -4.2%         -2.6%       -8.0%       2.7%       20.7%      4.5%       4.3%
     Source: Company reports, J.P. Morgan estimates.


     Leaders in MMOG Quarterly ARPU per Active Paying Accounts (Free-to-play Model)
     (In Rmb)                             1Q08         2Q08          3Q08            4Q08          1Q09          2Q09        3Q09       4Q09        1Q10      2Q10       3Q10
     Tencent                                     68          33             33            78            81            83          88         90          98        99      101
     Sequential growth                                  -51.0%          -0.3%        136.3%          3.3%          2.6%        5.5%       2.3%        9.7%      0.1%      2.5%
     Shanda                                    156         164            149            149           132          126          130        135        106       105       106
     Sequential growth                                    5.4%          -9.3%          0.4%        -11.8%         -4.5%        3.6%       3.5%      -21.1%     -0.9%      0.4%
     Sohu Changyou                             192         176            177            194           179          186          190        196        201       184       214
     Sequential growth                                   -8.3%           0.8%          9.6%         -7.9%          3.9%        2.2%       3.2%        2.6%     -8.5%     16.3%
     Perfect World                             151          188           196            225           244          237          266        223        306       292       323
     Sequential growth                                   24.5%           4.3%         14.8%          8.4%         -2.9%       12.2%     -16.2%       37.2%     -4.6%     10.6%
     Giant Interactive                       325.1        285.9         282.1          272.7         299.7          300        259.4      240.5        220       223       225
     Sequential growth                                  -12.1%          -1.3%         -3.3%          9.9%          0.1%      -13.5%      -7.3%       -8.5%      1.4%      0.9%
     Source: Company reports, J.P. Morgan estimates.




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




                             US Game Software Leading Companies’ Revenue Growth vs. US GDP (Nominal) Growth
                               70%                                                                                                                       7%
                               60%                                                                                                                       6%
                               50%                                                                                                                       5%
                               40%                                                                                                                       4%
                               30%                                                                                                                       3%
                               20%                                                                                                                       2%
                               10%                                                                                                                       1%
                                0%                                                                                                                       0%
                                       1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
                                                             Game Company Rev enues                               US GDP grow th rate

                             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.




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




                               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.




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




                             China SNS Game Market Forecast
                              3,000                                                                   109.2%         2,850
                                                                                85.7%                                          1
                              2,500
                                                                75.0%                                                          0.8
                              2,000                                                              1,632
                                                                                                                     74.6%     0.6
                              1,500
                                                                                780                                            0.4
                              1,000
                                                                 420
                                                 240                                                                           0.2
                                 500
                                     0                                                                                         0
                                                 2009           2010E           2011E            2012E               2013E

                                                           SNS Game Market Size (Rmb M)           YoY Grow th (%)

                             Source: Analysys.


                             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).

                             Qzone Continues Stable Growth
                              500
                                                                                                                       459    481
                              400                                                                              428
                                                                                                     388
                              300
                                                                                           305
                              200                                                  228
                                                                         183
                              100                  131   138       150
                                         115
                                 0
                                         1Q08     2Q08   3Q08     4Q08   1Q09    2Q09     3Q09    4Q09     1Q10       2Q10   3Q10

                                                                           Qzone Activ e Users (M)

                             Source: Company reports.


                             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

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     dick.x.wei@jpmorgan.com




                                   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.




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




                             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


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     dick.x.wei@jpmorgan.com




                               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.


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   dick.x.wei@jpmorgan.com




                             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.




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




              Gender Breakout of Online Gamers in China                         Age Breakout of Online Gamers in China
                                                                                                         Abov e 50, 7.1%   Below 11, 0.7%
                                Female, 14.6%
                                                                                               41-50, 12.1%                          11-20, 24.8%




                                                                                          31-40, 14.2%




                                                       Male, 85.4%
                                                                                                                           21-30, 41.2%
              Source: IDC (2009).                                               Source: IDC (2010).




                                                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


54                                                                                                                                              191
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




                             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.




55 192
     Dick Wei                  Global Equity Research
     (852) 2800-8535           03 January 2011
     dick.x.wei@jpmorgan.com




                               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)
                                 60,000
                                 50,000
                                 40,000
                                 30,000
                                 20,000
                                 10,000
                                      0
                                                05

                                                         05




                                                                                     07
                                       04




                                                                   06

                                                                            06




                                                                                               07

                                                                                                        08

                                                                                                                  08

                                                                                                                           09


                                                                                                                                    09

                                                                                                                                              10

                                                                                                                                                       10
                                     3Q

                                              1Q

                                                       3Q


                                                                 1Q

                                                                          3Q

                                                                                   1Q


                                                                                             3Q

                                                                                                      1Q

                                                                                                                3Q

                                                                                                                         1Q


                                                                                                                                  3Q

                                                                                                                                            1Q

                                                                                                                                                     3Q




                                                                                          Lineage 1            Lineage 2

                               Source: Company reports.




56                                                                                                                                                           193
     Hiroshi Kamide                Global Equity Research
     (81-3) 6736 8602              03 January 2011
     hiroshi.kamide@jpmorgan.com




                                                                                                                                                                     Japan
                                   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 Penetration Rate
                                   million, %

                                    120                                                                                                                  100.0
                                                                                                                                                         90.0
                                    100                                                                                   73.0         75.3     78.0
                                                                                                    70.8        72.6                                     80.0
                                                           57.8           64.3          66.0                                                             70.0
                                      80
                                                46.3                                                                                                     60.0
                                      60                                                                                                                 50.0
                                                                                                                                                         40.0
                                      40                                                                                                                 30.0
                                      20                                                                                                                 20.0
                                                                                                                                                         10.0
                                       0                                                                                                                 0.0
                                             CY'01       CY'02       CY'03         CY'04          CY'05      CY'06     CY'07      CY'08        CY'09
                                                                   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

                                    80.0
                                    70.0                                                                                              9.2      7.9      8.1
                                                                                                                11.3      11.2
                                    60.0
                                    50.0                                                   12.4       12.4
                                                                                 10.2                                                          31.0     33.8
                                                                    8.2                                                   30.7        35.6
                                    40.0                                                                        28.5
                                                         4.8       14.1          17.8      22.4       23.1
                                    30.0        1.3
                                                         5.7
                                    20.0         2.2                                                                                           33.1
                                                                   26.2          25.9                           26.5      27.9        26.3              31.6
                                    10.0        18.8     21.2                              24.2       23.7
                                     0.0
                                             Apr-00    Apr-01     Apr-02     Apr-03 Apr-04 Apr-05 Apr-06 Apr-07                   Apr-08      Apr-09   Apr-10
                                                                               PC only PC & mobile Mobile only

                                   Source: J.P. Morgan based on Nielsen Online Internet Base Survey.




57                                                                                                                                                             195
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




                                 Internet User Population Trend, Access Via PC at Home
                                 million

                                  60.0
                                                                                                                                                        51.6
                                                                                                                                     48.3      48.6
                                  50.0                                                                                       44.7
                                                                                                                41.1
                                                                                                   36.9
                                  40.0                                                                                               21.2      21.9     23.7
                                                                                        30.8                                 19.7
                                                                            27.1                                18.1
                                  30.0                            24.3                             16.2
                                                                                        13.2
                                  20.0                 15.4       10.5      11.6
                                              8.5       6.1                                                                  25.0    27.0      26.7     27.8
                                  10.0                                                             20.7         23.0
                                              3.2                 13.9      15.4        17.6
                                              5.4       9.2
                                    0.0
                                           Apr-00     Apr-01    Apr-02     Apr-03       Apr-04 Apr-05 Apr-06              Apr-07    Apr-08    Apr-09   Apr-10
                                                                                             Male Female

                                 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, %

                                              14.8                                   60 ov er                                          18.4
                                                                     30%                              8%
                                                               5.1                   55-59                                5.2
                                                                         37%                              20%
                                                                4.4                  50-54                             4.4
                                                                     62%                                   36%
                                                                   3.9               45-49                         3.9
                                                                     69%                                    52%
                                                                  4.1                                               4.0
                                                                     70%             40-44
                                                                                                              64%
                                                                 4.4                 35-39                          4.3
                                                                      58%                                       68%
                                                               4.9                                                   4.8
                                                                     58%             30-34
                                                                                                                 71%
                                                                 4.2                 25-29                         4.1
                                                                       52%                                    63%
                                                                   3.8               20-24                       3.6
                                                                        49%                                  58%
                                                                      2.7                                     2.6
                                                                          46%        16-19
                                                                                                          46%
                                                                         1.9         13-15                  1.8
                                                                           55%                            57%
                                                         6.6                                                                  6.3
                                                                         27%         2-12
                                                                                                           25%

                                                       Male Population                                             Female Population
                                                       Penetration                                                 Penetration


                                 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).


58 196
     Hiroshi Kamide                Global Equity Research
     (81-3) 6736 8602              03 January 2011
     hiroshi.kamide@jpmorgan.com




                                   Internet Penetration by Age and Gender, Access via Mobile
                                   million, %

                                                14.8                                             60 ov er                                                      18.4
                                                                                     8%                             4%
                                                                 5.1                             55-59                                   5.2
                                                                                20%                                  16%
                                                                   4.4                           50-54                               4.4
                                                                                24%                                    27%
                                                                       3.9                       45-49                             3.9
                                                                              42%                                           34%
                                                                    4.1                                                      4.0
                                                                             55%                 40-44
                                                                                                                        44%
                                                                   4.4                           35-39                        4.3
                                                                           54%                                            52%
                                                                 4.9                                                           4.8
                                                                      58%                        30-34
                                                                                                                           60%
                                                                   4.2                           25-29                       4.1
                                                                       59%                                              70%
                                                                    3.8                          20-24                     3.6
                                                                     81%                                               72%
                                                                       2.7                                              2.6
                                                                        75%                      16-19
                                                                                                                    76%
                                                                          1.9                    13-15                1.8
                                                                             26%                                    48%
                                                           6.6                                                                              6.3
                                                                                        4%       2-12
                                                                                                                       4%

                                                          Male Population                                                          Female Population
                                                          Penetration                                                              Penetration


                                   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%.

                                   Smartphone Penetration
                                   %
                                                                                     11.5%
                                                                                                11.4%




                                    14%
                                                                                                                   10.2%




                                    12%
                                                                                             9.6%
                                                                                                            8.6%
                                                                              8.3%
                                                                    8.0%




                                    10%
                                                                                                                                               7.1%
                                                                                                        6.4%


                                                                                                                           6.4%
                                                                 6.3%




                                     8%
                                                                                                                                                                                5.9%
                                                                                                                                                                        5.3%
                                                         5.2%




                                                                                                                                                               5.0%
                                                                                                                                     4.7%
                                                        4.5%




                                                                                                                                                                      4.3%
                                                4.2%




                                                                                                                                                             4.1%




                                     6%
                                                                                                                                  2.5%
                                             2.4%




                                                                                                                                                      2.4%




                                     4%
                                     2%
                                     0%
                                                13-15   16-19     20-24        25-29 30-34               35-39      40-44          45-49 50-54               55-59      60     Total
                                                                                                                                                                       ov er
                                                                                                         Male       Female
                                   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.


59                                                                                                                                                                                 197
   Hiroshi Kamide                   Global Equity Research
   (81-3) 6736 8602                 03 January 2011
   hiroshi.kamide@jpmorgan.com




                                    Internet Advertising
   Japan online ad spend 11.9% of   We estimate that the online advertising market will resume a healthier growth profile
   total ad spend in CY’09          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.



                                    Internet Advertising Expenditure
                                    ¥ billion, %
                                                                             CY’06   CY’07     CY’08   CY’09   CY’10E   CY’11E   CY’12E
                                    Internet ad expenditure                  363.0   459.1     537.3   544.8    595.5    651.4    705.5
                                     PC                                      324.0   397.0     446.0   441.7    481.8    524.1    564.9
                                       Ad placements                         231.0   268.8     288.5   270.7    293.7    317.2    339.4
                                       Search ads                             93.0   128.2     157.5   171.0    188.1    206.9    225.5
                                     Mobile                                   39.0    62.1      91.3   103.1    113.7    127.3    140.6
                                       Ad placements                          39.0    53.6      74.3    80.7     88.0     97.6    107.4
                                       Search ads                              0.0     8.5      17.0    22.4     25.8     29.6     33.2

                                    Y/Y
                                    Internet ad expenditure                      -   26.5%     17.0%    1.4%     9.3%     9.4%     8.3%
                                     PC                                          -   22.5%     12.3%   -1.0%     9.1%     8.8%     7.8%
                                       Ad placements                             -   16.4%      7.3%   -6.2%     8.5%     8.0%     7.0%
                                       Search ads                                -   37.8%     22.9%    8.6%    10.0%    10.0%     9.0%
                                     Mobile                                      -   59.2%     47.0%   12.9%    10.3%    11.9%    10.5%
                                       Ad placements                             -   37.4%     38.6%    8.6%     9.0%    11.0%    10.0%
                                       Search ads                                -        -   100.0%   31.8%    15.0%    15.0%    12.0%

                                    Source: Dentsu, J.P. Morgan estimates.


                                    Domestic internet advertising spend is expected to continue gaining market share
                                    against traditional mass media, as seen with historic trends.




60 198
     Hiroshi Kamide                            Global Equity Research
     (81-3) 6736 8602                          03 January 2011
     hiroshi.kamide@jpmorgan.com




                                                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)                                          Domestic Advertising by Media (CY’09)
                                             News paper                                                                               News paper
                                                                                                                                                 Magazine
                                              15.2%       Magazine                                                                     11.4%
                                                                                                                                                  5.1%
                                                           7.1%
                         Sales promotion                                                                  Sales promotion                            Radio
                             38.9%                                                                            39.1%                                  2.3%
                                                            Radio
                                                            2.6%
                                                                                                                                                    TV
                             Internet                                                                                                             28.9%
                              5.5%
                                                            TV
                  Satellite media                         29.9%                                                  Internet
                      0.7%                                                                                                                   Satellite media
                                                                                                                  11.9%
                                                                                                                                                 1.2%



     Source: J.P. Morgan based on Dentsu.                                           Source: J.P. Morgan based on Dentsu.




                                               Comparison with US market
     US online ad spend 14.3% of               The US market size for online advertising was $22.7B in CY’09, according to the
     total ad expenditure in CY’09             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%.




61                                                                                                                                                               199
   Hiroshi Kamide                      Global Equity Research
   (81-3) 6736 8602                    03 January 2011
   hiroshi.kamide@jpmorgan.com




                                       U.S. Advertising Expenditure by Media Type
                                       $ billion, %
                                                                                     CY’04         CY’05        CY’06        CY’07    CY’08        CY’09
                                       TV                                              49.3          53.9         72.4         71.3     68.2         62.1
                                       Newspapers                                      46.2          47.9         51.2         48.6     34.4         24.6
                                       Internet                                         9.6          12.4         16.9         21.2     23.4         22.7
                                         Y/Y                                         32.1%         29.2%        36.3%        25.4%    10.4%        -3.0%
                                       Radio                                           20.7          21.7         20.8         19.8     17.2         14.0
                                       Consumer magazines                              12.4          12.9         24.6         13.8     12.7         10.0
                                       Others                                          63.5          70.6         62.5         18.6     31.0         25.6
                                       Composition (%)
                                       TV                                            24.4%         24.6%        29.1%        36.9%    36.5%        39.1%
                                       Newspapers                                    22.9%         21.8%        20.6%        25.1%    18.4%        15.5%
                                       Internet                                       4.8%          5.7%         6.8%        11.0%    12.5%        14.3%
                                       Radio                                         10.3%          9.9%         8.4%        10.2%     9.2%         8.8%
                                       Consumer magazines                             6.1%          5.9%         9.9%         7.1%     6.8%         6.3%
                                       Others                                        31.5%         32.2%        25.2%         9.6%    16.6%        16.1%

                                       Source: IAB Internet Ad Revenue Report; PricewaterhouseCoopers.



                                       U.S. Internet Ad Revenues by Industry
                                       %
                                                                                                 CY’08 (1)           CY’09 (2)         (2) - (1)
                                        Retail                                                       22.0%               20.0%          -2.0ppt
                                        Telecom                                                      15.0%               16.0%          1.0ppt
                                        Financial services                                           13.0%               12.0%          -1.0ppt
                                        Automotive                                                   12.0%               11.0%          -1.0ppt
                                        Computing                                                    10.0%               10.0%          0.0ppt
                                        Consumer packaged goods                                          6.0%             6.0%          0.0ppt
                                        Leisure travel                                                   6.0%             6.0%          0.0ppt
                                        Entertainment                                                    4.0%             4.0%          0.0ppt
                                        Pharma & healthcare                                              4.0%             4.0%          0.0ppt
                                        Media                                                            3.0%             4.0%          1.0ppt
                                        Others                                                           5.0%             7.0%          2.0ppt
                                        Total                                                      100.0%                100.0%                -
                                       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
   China online ad spending made       In CY’09 the China online ad market was US$2.1B, growing about 21% Y/Y and
   up 10% of total ad expenditure in   making up 10% of total advertising spend. Compared to the US and Japanese
   CY’09
                                       markets the size remains relatively small.




62 200
     Hiroshi Kamide                                              Global Equity Research
     (81-3) 6736 8602                                            03 January 2011
     hiroshi.kamide@jpmorgan.com




                                                                 Internet Advertising Expenditure CY’09 - U.S., Japan and China
                                                                 $ billion

                                                                   25.0                                                                                                                    30.0%

                                                                   20.0                                                                                                 20.4%
                                                                                                                                                                                           20.0%
                                                                   15.0
                                                                                                                                                                                           10.0%
                                                                   10.0
                                                                                                                                                                                           0.0%
                                                                    5.0                                                          1.2%
                                                                                       -3.0%
                                                                    0.0                                                                                                                    -10.0%
                                                                                          U.S.                                Japan                                China
                                                                                                           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        Sales per visitors
                                                                                                                                                                 (month)                  (month)
                                             Registered         Unique users                PC          Mobile           PC (¥ M)        Mobile (¥ M)                  (¥)                       (¥)
                                              users (M)                  (M)                (B)            (B)
     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
                             2440                     7.1                    20.0           0.8                -           5,902.0                     -               2.34                     98.37
     Navigator
     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.




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                                 Trend of Domestic BtoC ECommerce Market
                                 ¥ billion                                                                                                            %

                                  5,000          145.2%                                                                                               160%
                                  4,500                                                                                                               140%
                                  4,000
                                                                                                                                                      120%
                                  3,500
                                  3,000                   80.1%      80.9%                   85.4%                                                    100%

                                  2,500                                                                                                               80%
                                  2,000                                                                                                               60%
                                                                           64.8%
                                  1,500
                                                                                                                                                      40%
                                  1,000                                                                        25.4%
                                                                                                                           22.1% 17.0%
                                                                                                                                            13.1% 20%
                                    500                                                              19.4%
                                       0                                                                                                              0%
                                             CY'00     CY'01      CY'02      CY'03     CY'04      CY'05      CY'06     CY'07      CY'08    CY'09

                                                                          BtoC (retail & service, LHS)           Y/Y(RHS)

                                 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.




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                                   Survey – Most Recent Online Shopping Site Used via PC

                                                          Manufacturer direct
                                                                  sales
                                                                                        Unknow n      Rakuten Books
                                                                   7%
                                                                                              4%             9%
                                                            Niche e-tailer
                                                                  8%

                                                Real w orld retailer
                                                      net store                                                        Rakuten Mall

                                                          8%                                                               30%

                                           Other online mall
                                                operators
                                                               Catalogue sales
                                                   4%
                                                                  companies                                Yahoo! Shopping
                                                                       9%      Amazon Japan
                                                                                                                  8%
                                                                                      13%



                                   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                        None                                           Lawson
                                   at convenience store
                                   Gift card availability                         None                                           Available
                                   Credit card services                   Rakuten Point Club card                                  No

                                   Source: J.P. Morgan based on company website.

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   hiroshi.kamide@jpmorgan.com




                                 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.




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     (81-3) 6736 8602                                        03 January 2011
     hiroshi.kamide@jpmorgan.com




     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.




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   hiroshi.kamide@jpmorgan.com




                                     SNS in Japan
                                     Background
   Japanese SNS sites first          Western social networking services such as Friendster and MySpace began in 2003,
   appeared in 2003, the same time   making an impact as the concept of expansive online communities took hold. It was
   as US/European counterparts       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 and Gree both began in        Mixi—Initially an online PC service with an invitation-only user registration
   February 2004                       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.
   Mobile SNS and gaming content     Japan’s user-generated content sites were predominantly in the form of blogs (online
   spurred user adoption             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.




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     User Demographics                                                          Traffic Per Platform

                                                          Under 20                                            PC SNS
                                                           18.0%                                               usage
                                                                                                                5.0%
                     Over 30
                      41.0%


                                                                                                                               Mobile SNS
                                                                                                                                 usage
                                                         20 to 30                                                                95.0%
                                                          41.0%


     Source: Company data, J.P. Morgan estimates.                               Source: Company data, J.P. Morgan estimates.


     Sales Split

                        20.0%


                                                             80.0%

                        80.0%


                                                             20.0%

                Mobile SNS sales split                 PC SNS sales split
                       Vitual 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
     Gree pioneered social gaming in
     2007
                                                       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.


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   hiroshi.kamide@jpmorgan.com




   Current market leader DeNA    The latecomer to social gaming was DeNA’s ‘Mobage’ mobile site, which originally
   commenced social gaming in    started as a standard publishing mobile gaming portal in February 2006. The site
   2009
                                 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 generally found on a PC portal services
                                 content
                                 - 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.




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     (81-3) 6736 8602                 03 January 2011
     hiroshi.kamide@jpmorgan.com




     Domestic SNS a de facto mobile   Apart from the wealth of content on offer, the key difference between Japanese and
     service                          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.
     Fast, affordable data             The fall in pricing for packet download fees via carrier competition, and the
                                        introduction of fixed pricing plans made heavy mobile usage more affordable.
     Convenient carrier billing        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   70% paid to
                                       ¥ x currency                        game items                                   recognized        SAP



                                                                                           In-house game application
                                                           10%~15%                                                      All revenue
                                                     Carrier commissions                                                recognized



                                      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.
71                                                                                                                                                 209
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                                  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                                     ¥1,000 - ¥5,000
                                 User) range
                                 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.




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     (81-3) 6736 8602                  03 January 2011
     hiroshi.kamide@jpmorgan.com




                                       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 is a user acquisition   Marketing costs in the early-to-mid cycle stages of a game title release can be viewed
     cost – must balance with ARPU     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

                                        1,200
                                                                                                                             956
                                        1,000
                                           800                                                                 679
                                                                                                 550                                                           549
                                           600                                                                                                       469
                                                                                                           357          372                 367
                                           400                                               292
                                                         209                                                                          176         187       192
                                           200      66            63 13         58 89
                                              0
                                                    Jan-Mar       Apr-Jun      Jul-Sep       Jan-Mar       Apr-Jun       Jul-Sep      Jan-Mar     Apr-Jun   Jul-Sep

                                                                    mixi                                 DeNA                                     GREE
                                                                                                       ARPU UAC

                                       Source: J.P. Morgan based on company data.
                                       Note: Number of users is calculated by taking the average of the current and the last quarter end.




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   Hiroshi Kamide                      Global Equity Research
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   hiroshi.kamide@jpmorgan.com




                                       ARPU and User Acquisition Cost—Y/Y Growth (CY’10)
                                       ¥/person
                                                                                    ARPU       Y/Y          UAC             Y/Y
                                       Mixi                 Jan-Mar                  65.5     9.1%         209.3        2909.1%
                                                            Apr-Jun                  63.1    10.7%          13.3         100.9%
                                                            Jul-Sept                 58.0     0.6%          89.4        3555.5%
                                       DeNA                 Jan-Mar                 292.3    69.9%         550.3          25.9%
                                                            Apr-Jun                 356.9   186.1%         678.8         196.1%
                                                            Jul-Sept                371.8   234.1%         956.1         211.6%
                                       Gree                 Jan-Mar                 175.8    20.6%         367.2         246.7%
                                                            Apr-Jun                 186.9    22.4%         468.7         182.7%
                                                            Jul-Sept                192.2    16.9%         549.4         284.6%
                                       Source: J.P. Morgan based on company data.




                                       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 are not virtual   Foreign SNS sites tend to focus on real social graphs, and we believe this has been
   communities, unlike Japanese        the overriding factor in their lack of popularity in Japan where users prefer greater
   SNS sites
                                       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.



74 212
     Hiroshi Kamide                Global Equity Research
     (81-3) 6736 8602              03 January 2011
     hiroshi.kamide@jpmorgan.com




                                   Internet Usage Rates (September 2010)
                                                                    Monthly                 Reach               Monthly                 Average            Average usage
                                                                    visitors                  (%)             Pageviews               pageviews                  duration
                                                                         (M)                                         (M)                    (PV)                (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
75                                                                                                                                                                   213
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




                                      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.




76 214
     Hiroshi Kamide                Global Equity Research
     (81-3) 6736 8602              03 January 2011
     hiroshi.kamide@jpmorgan.com




                                   Monthly ARPU Comparison (July-September 2010E)
                                   ¥/person

                                    400                                                           372
                                    350
                                    300
                                    250
                                    200                                                                                157
                                    150
                                    100                                  58
                                      50
                                       0
                                                                                       mixi     DeNA         GREE
                                   Source: J.P. Morgan based on company data.



                                   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.




77                                                                                                                                        215
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




                                 Competition in the Smartphone Game Application Market



                                                      PC browser /
                                                 SNS game developers
                                                         - Zy nga                                            Domestic social
                                                        - Play dom                                         application profiders
                                                        - Play fish                                            - Cy ber Agent
                                                        - RockYou                                                 - Cav e
                                                       - Crow dStar



                                                                              iPhone Apple iOS / Android




                                                                                                                    Domestic feature
                                                                                                                       phone SNS
                                                SNS platforms
                                                                                Traditional videogame                       - DeNA
                                                   - Facebook
                                                                                     companies                              - GREE
                                                   - My Space
                                                                                      - Capcom                              - mix i
                                                                                      - KONAMI
                                                                                     - Square Enix
                                                                                     - Tecmo Koei
                                                                                    - Namco Bandai




                                 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.




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     Hiroshi Kamide                                            Global Equity Research
     (81-3) 6736 8602                                          03 January 2011
     hiroshi.kamide@jpmorgan.com




     Major Smartphone Platform Distribution Channels
                                     Android            App Store         Windows Marketplace                 Ovi Store                  BlackBerry App       Palm App Catalog
                                      Market                                   for Mobile                                                     World
     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          Credit charge           Credit charge         Credit charge, SMS charge             Credit charge          Credit charge
                                      charge                                                       carrier charge, adding charge
     Revenue % (operator)              30%                30%                    30%                            30%                           20%                  30%
     Revenue % (developer)             70%                70%                    70%                            70%                           80%                  70%
     App name                       Android app        iPhone app          Windows Mobile app         Symbian app, Java app                 Java app             WebOS app
                                                                                                      WRT widget, Flash app
     App development                    Java           Objective-、                 .Net               C/C++, Java, JavaScript                 Java            JavaScript/CSS/HT
     language                                            C/C++                                     FlashLite 1.0, 1.1, 2.0, 2.1, 3.0                                 ML
     Site name for                     Android         iPhone Dev            Windows Mobile                 Forum Nokia                BlackBerry Developer    Palm Developer
     developers                        Market            Center              developer Center                                                 Zone                 Network
     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.




79                                                                                                                                                                           217
   Hiroshi Kamide                                           Global Equity Research
   (81-3) 6736 8602                                         03 January 2011
   hiroshi.kamide@jpmorgan.com




   Valuation Table
  Company                                         Yahoo                                                                       CYBER         Kakaku.        Gourmet        Weighted
                                                                Rakuten            Mixi          DeNA            Gree
                                                  Japan                                                                       AGENT            com        Navigator           avg.
  Code                                             4689            4755            2121           2432           3632           4751           2371           2440

  Currency                                            JPY            JPY            JPY             JPY             JPY           JPY             JPY            JPY               -
  Market cap          (¥B)                       1,853.3          893.4           68.3           420.7           243.1         115.1           137.3           30.9                -
  Share price         (¥)                         31,950         68,200        441,500           2,954           1,069       177,900         474,000        118,900                -
  Liquidity (daily)   ($M/day)                      33.1           27.4             9.5          113.4            56.8          44.3            10.9             1.6               -
  P/E                    (X)     F’10E              19.9           24.8           37.1            12.7            14.4          17.9            29.9           17.7             20.5
                         (X)     F’11E              18.2           21.6           28.6            11.0            12.7          14.5            23.7           13.6             18.1
                         (X)     F’12E              16.9           19.4           21.9            11.4            11.5          13.1            20.1           13.8             16.6
  Div. yield             (%)     F’10E               1.0             0.1            0.0             1.6             0.5          1.5             0.6             1.7             0.8
                         (%)     F’11E               1.4             0.1            0.0             1.8             0.5          1.8             0.7             1.7             1.0
                         (%)     F’12E               1.5             0.1            0.0             1.8             0.5          2.0             0.8             1.7             1.1
  EV/EBITDA              (X)     F’10E               9.3           13.7           11.1              6.7             7.5          7.2            15.2             5.1            10.1
                         (X)     F’11E               8.6           12.3             9.5             5.8             6.6          6.0            12.1             4.6             9.1
                         (X)     F’12E               8.0           11.2             7.7             6.0             6.0          5.3            10.0             4.6             8.4
  EV/sales               (X)     F’10E               5.4             3.1            3.3             3.4             4.0          0.9             7.6             1.0             4.4
                         (X)     F’11E               5.1             2.8            2.7             2.8             3.4          0.8             6.3             0.9             4.0
                         (X)     F’12E               4.8             2.7            2.2             2.7             3.0          0.7             5.4             0.9             3.8
  P/B                    (X)     F’09A               6.0             4.4            4.7           12.2            11.8           4.5            13.7             2.7             6.9
  Price movt.            (%)     1 month             6.2             7.1            4.1           21.1              6.9         12.7            13.1            -1.7               -
                         (%)     3 month             9.0             7.6           -0.5             9.3          -22.1          18.5             3.5             7.6               -
                         (%)     6 month           -11.8             9.8            2.1           14.7           -25.2          38.8            26.8             9.1               -
                         (%)     1 year             14.1            -3.7         -40.7            56.2             -7.1          6.2            32.6          -40.2                -

  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.




80 218
     Sungmin Chang, CFA                                                                          Global Equity Research
     (82-2) 758-5719                                                                             03 January 2011
     sungmin.chang@jpmorgan.com




                                                                                                                                                                                                           Korea
                                                                                                 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.

          Search Ad Revenue Growth                                                                                                                                     Display Ad Revenue Growth
                   %                                                                                                                                                    120      %
           110
                                                                                                                                                                        100
            90
                                                                                                                                                                         80
            70                                                                                                                                                                                     Daum
                                                                                                                                                          Daum
                                                                                                                                                                         60
            50                                                                                                                                                           40
            30                                                                                                                                                           20                        NHN
            10                                                                                                                                                 NHN         0
            (10)                                                                                                                                                         (20)
                       1Q 06
                               2Q 06
                                       3Q 06
                                               4Q 06
                                                       1Q 07
                                                               2Q 07
                                                                       3Q 07
                                                                               4Q 07
                                                                                       1Q 08
                                                                                               2Q 08
                                                                                               3Q 08
                                                                                                       4Q 08
                                                                                                               1Q 09
                                                                                                                       2Q 09
                                                                                                                               3Q 09
                                                                                                                                       4Q 09
                                                                                                                                               1Q 10
                                                                                                                                                       2Q 10
                                                                                                                                                               3Q 10




                                                                                                                                                                                1Q06
                                                                                                                                                                                2Q06
                                                                                                                                                                                3Q06
                                                                                                                                                                                4Q06
                                                                                                                                                                                1Q07
                                                                                                                                                                                2Q07
                                                                                                                                                                                3Q07
                                                                                                                                                                                4Q07
                                                                                                                                                                                1Q08
                                                                                                                                                                                2Q08
                                                                                                                                                                                3Q08
                                                                                                                                                                                4Q08
                                                                                                                                                                                1Q09
                                                                                                                                                                                2Q09
                                                                                                                                                                                3Q09
                                                                                                                                                                                4Q09
                                                                                                                                                                                1Q10
                                                                                                                                                                                2Q10
                                                                                                                                                                                3Q10

          Source: Company data.                                                                                                                                        Source: Company data.




                                                                                                 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.



81                                                                                                                                                                                                   219
   Sungmin Chang, CFA           Global Equity Research
   (82-2) 758-5719              03 January 2011
   sungmin.chang@jpmorgan.com




                                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.

   .




82 220
     Dick Wei                  Asia Pacific Equity Research
     (852) 2800-8535           05 January 2011
     dick.x.wei@jpmorgan.com




                                                              Companies




83
   Dick Wei                  Asia Pacific Equity Research
   (852) 2800-8535           05 January 2011
   dick.x.wei@jpmorgan.com




84 2
                                                                                                                               Global Equity Research
                                                                                                                               03 January 2011




                                                                                                                               Neutral
Alibaba.com Limited                                                                                                            1688.HK, 1688 HK




                                                                                                                                                                                         China
                                                                                                                               Price: HK$15.00
Slowdown in Customer Growth Limits Near-term Stock
                                                                                                                               Price Target: HK$16.00
Upside

We remain Neutral on Alibaba with a Dec-11 PT of HK$16. We expect                                                              Internet
China’s marketplace to grow at a faster rate than the international marketplace                                                                AC
                                                                                                                               Dick Wei
in 2011. Value-added services should also continue to gain more revenue                                                        (852) 2800-8535
share in 2011.                                                                                                                 dick.x.wei@jpmorgan.com

 International marketplace net-adds to continue to be slow: With                                                              Ritesh Gupta
  higher fee Rmb30K annual fee package launch next year, and Alibaba’s                                                         (91-22) 6157 3307
                                                                                                                               ritesh.z.gupta@jpmorgan.com
  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                                                       J.P. Morgan Securities (Asia Pacific) Limited

  2011. China marketplace revenues accounted for ~34% of total revenues in
                                                                                                                               Price Performance
  2010. We expect China marketplace’s share to increase with the increase in
  the domestic eCommerce market. We currently expect China’s marketplace                                                             20

  to grow 36% YoY vs. the international marketplace expected growth rate of                                                    HK$ 16
  20% YoY in 2011.
                                                                                                                                     12
 Future monetization potential on Alibaba platform: AliExpress                                                                       Dec-09        Mar-10   Jun-10   Sep-10   Dec-10
  (international transaction base platform) saw GMV (gross merchandise                                                                           1688.HK share price (HK$
  volume) up 3 times QoQ in 3Q10. AliLoan program cumulative loan                                                                                MSCI-Cnx (rebased)

  amounts reached Rmb20 M. Both could lead to longer-term monetization                                                                           YTD           1m         3m       12m
  potential. AliLoan could start monetization as soon as 1H10. International                                                   Abs             -24.8%        2.9%     -13.4%    -24.6%
  expansion is still in the early stages. India and Turkey are the key potential                                               Rel             -26.0%        5.3%     -12.8%    -27.7%
  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
                            FY09   FY10E FY11E FY12E                                              FY09      FY10E     FY11E    FY12E
Net sales                    3,875 5,452 6,761 8,302 ROE (%)                                        20.3      23.2      22.8     21.4 52-week range                   HK$12.3-19.6
Operating profit             1,073 1,561 2,124 2,674 ROIC (%)                                       18.0      20.9      20.5     19.1 Shares outstg                       5,039Mn
EBITDA                       1,280 2,002 2,602 3,269 GAAP dil. EPS (RMB)                              1Q        2Q        3Q      4Q  Avg daily volume                       9.6Mn
Pre-tax profit               1,176 1,732 2,365 2,989 EPS FY09                                       0.05      0.05      0.05     0.06 Avg daily value                  US$21.4Mn
Net profit                   1,013 1,423 1,933 2,444 EPS FY10E                                      0.06      0.07      0.07     0.07 Index (HSI)                           22,969
Diluted EPS (Rmb)             0.20   0.28  0.37  0.46 EPS FY11E                                     0.08      0.09      0.10     0.10 Free float                               19%
P/E (x)                       60.3   43.3  32.9  26.4                                                 1M        3M      12M           Dividend yld                              0%
Adjusted EPS (Rmb)            0.24   0.34  0.43  0.53 Absolute perf. (%)                              0.0    -12.0     -23.4          Market cap                        US$8.9Bn
Adjusted P/E (x)              50.4   35.6  28.0  22.6 Relative perf. (%)                              0.8    -14.7     -30.2          Price target                          HK$16
EV/EBITDA                     43.5   27.8  21.4  17.0 Cash (Rmb M)                                 7,216    10,770    14,376   23,501 Date of price                   Dec 29, 2010
P/B (x)                       12.2    8.6   6.5   5.0 Equity (Rmb M)                               5,018     7,253     9,696   16,535
Y/E BPS (Rmb)                 0.98   1.41  1.86  2.42
Source: Company reports, Bloomberg and J.P. Morgan estimates. * Note: Adj. EPS excludes share-based compensation expense.
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




                             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.




86 314
     Dick Wei                                        Global Equity Research
     (852) 2800-8535                                 03 January 2011
     dick.x.wei@jpmorgan.com




     Alibaba—DCF Model (base-case scenario)
                                          FY10E       FY11E       FY12E        FY13E         FY14E       FY15E      FY16E      FY17E       FY18E      FY19E         FY20E
     Sales growth                          40.7%       24.0%       22.8%        23.1%         22.0%       21.4%      18.0%      18.1%       15.2%      13.2%         11.2%
     EBIT margin                           28.6%       31.4%       32.2%        33.4%         33.5%       33.6%      33.6%      33.6%       32.6%      31.6%         30.6%
     NOPAT margin                          22.6%       24.7%       25.3%        26.2%         26.3%       26.3%      26.9%      26.9%       26.1%      25.3%         24.5%
     Year end net fixed assets turns         6.77        6.98        7.19         7.47          7.74        8.04       7.50       7.50        7.50       7.50          7.50
     Year end net working capital turns      (1.4)       (1.3)       (1.3)        (1.3)         (1.3)       (1.3)      (1.3)      (1.3)       (1.3)      (1.3)         (1.3)
     Year end net other assets turns        14.95       18.54       22.77        28.04         34.20       41.51      40.00      40.00       40.00      40.00         40.00
     Cash operating taxes as % of EBIT     20.9%       21.5%       21.5%        21.5%         21.6%       21.7%      20.0%      20.0%       20.0%      20.0%         20.0%
     Year end Invested Capital turns       (1.95)      (1.74)      (1.75)       (1.70)        (1.68)      (1.65)     (1.64)     (1.64)      (1.64)     (1.64)        (1.64)
     Source: J.P. Morgan estimates.


                                                     DCF Sensitivity Analysis
                                                                                                                Terminal Growth (%)
                                                                                       0%          1%           2%        3%         4%            5%             6%            7%
                                                                      9.0%            22.7        22.9         23.1      23.4       23.9          24.6           25.7          27.9
                                                                     10.0%            20.0        20.0         20.1      20.2       20.4          20.6           20.8          21.3
                                                                     11.0%            17.8        17.8         17.8      17.8       17.8          17.8           17.8          17.8
                                                     WACC




                                                                     12.0%            16.0        16.0         15.9      15.9       15.8          15.7           15.6          15.5
                                                                     13.0%            14.5        14.5         14.4      14.3       14.3          14.2           14.0          13.8
                                                                     14.0%            13.3        13.2         13.2      13.1       13.0          12.9           12.7          12.6
                                                                     15.0%            12.2        12.2         12.1      12.0       12.0          11.8           11.7          11.5
                                                     Source: J.P. Morgan estimates.




87                                                                                                                                                                             315
   Dick Wei                                                Global Equity Research
   (852) 2800-8535                                         03 January 2011
   dick.x.wei@jpmorgan.com




   Alibaba.com: Summary of financials
   Rmb in millions, year-end December
   Income statement                                                                                    Ratio analysis
                                          FY08A      FY09A      FY10E       FY11E      FY12E           %, year-end December         FY08A    FY09A    FY10E    FY11E    FY12E

   Revenues                                3,002      3,875       5,452      6,761      8,302          Gross Margin                  87.0     86.2      83.4     83.1     83.2
    Cost of goods sold                       391        534         907      1,145      1,392          EBITDA margin                 41.9     32.0      35.4     37.5     38.6
   Gross profit                            2,612      3,340       4,546      5,616      6,910          Operating Margin              39.3     27.7      28.6     31.4     32.2
    R&D expenses                             194        384         544        582        706          Net Margin                    39.7     26.1      26.1     28.6     29.4
    SG&A expenses                          1,416      2,034       2,532      3,045      3,696          R&D/sales                      6.5      9.9      10.0      8.6      8.5
    Others                                  -178       -151         -92       -135       -166          SG&A/Sales                    47.2     52.5      46.4     45.0     44.5
   Operating profit (EBIT)                 1,180      1,073       1,561      2,124      2,674
   EBITDA                                  1,258      1,241       1,929      2,536      3,203          Sales growth                  38.8      29.1     40.7     24.0     22.8
    Interest income                          239        141         177        241        315          Operating Profit Growth       46.8      -9.1     45.5     36.1     25.9
    Interest expense                           0          0           0          0          0          Net profit growth             23.3     -15.1     40.5     35.8     26.5
    Investment income (exp.)                 -16        -37          -6          0          0          EPS (Reported) growth         17.9     -15.3     39.2     31.8     24.4
    Non-operating income (exp.)                0          0           0          0          0
   Earnings before tax                     1,404      1,176       1,732      2,365      2,989
    Tax                                      210        163         309        433        545          Net debt to total capital    -133.1   -143.8   -148.5   -148.3   -144.2
   Net income (reported)                   1,193      1,013       1,423      1,933      2,444          Net debt to equity           -133.1   -143.8   -148.5   -148.3   -144.2
   Net income (adjusted)                   1,373      1,213       1,733      2,271      2,859
   Rmb                                                                                                 Asset Turnover                 38.0     41.0     42.3     39.9     38.9
   EPS (Reported)                           0.24       0.20        0.28       0.37       0.46          Working Capital Turns (X)       0.8      0.9      1.0      0.9      0.8
   EPS (Adjusted)                           0.27       0.24        0.34       0.43       0.53          ROE                            27.8     20.3     23.2     22.8     21.8
   BPS                                      0.98       0.98        1.41       1.86       2.42          ROIC                           23.3     18.0     20.9     20.5     19.6
   DPS                                      0.00       0.18        0.00       0.00       0.00          ROIC (net of cash)            -64.1    -53.0    -52.1    -47.7    -46.6
   Diluted shares outstanding (MM)         5,055      5,068       5,116      5,272      5,360

   Balance sheet                                                                                       Cash flow statement
                                          FY08A      FY09A      FY10E       FY11E      FY12E                                        FY08A    FY09A    FY10E    FY11E    FY12E

   Total cash                              6,612      7,216     10,770      14,376     18,349          Net income                   1,193    1,013     1,423    1,933    2,444
   Accounts receivable                         0          0          0           0          0          Depr. & amortization          76.6      119       151      209      280
   Inventories                                 0          0          0           0          0          Change in working capital      431      926     1,064    1,326    1,126
   Others                                    508        926        944       1,240      1,491          Other                         -132      175       309      337      414
   Current assets                          7,121      8,143     11,714      15,616     19,840          Cash flow from operations    1,569    2,234     2,947    3,805    4,264

   LT investments                             32          4         -2          -2         -2          Capex                          -267    -411      -209     -406     -498
   Net fixed assets                          376        783        806         969      1,154          Others                       -2,835    -261       204       33       33
   Others                                    365        527        365         365        365          Cash flow from investing     -3,102    -671        -5     -373     -465
   Total assets                            7,893      9,457     12,883      16,947     21,357          Free cash flow                1,302   1,823     2,738    3,399    3,766
                                                                                                       Equity raised/ (repaid)         -79     -70       171      171      171
   Liabilities                                                                                         Debt raised/ (repaid)             0       0         0        0        0
   ST loans                                    0          0           0          0          0          Other                            12       0       440        1        1
   Payables                                   16         24          30         38         46          Dividends paid                    0    -888         0        0        0
   Others                                  2,803      4,073       5,149      6,762      8,133          Cash flow from financing        -67    -958       611      172      172
   Total current liabilities               2,818      4,097       5,179      6,801      8,178
   Long term debt                              0          0           0          0          0          Net change in cash           -1,600     604     3,553    3,604    3,972
   Other liabilities                         106        342         451        451        451          F/X & term deposits change    2,939       0         0        0        0
   Total liabilities                       2,925      4,439       5,630      7,251      8,629          Beginning total cash          5,274   6,612     7,216   10,770   14,376
   Shareholders' equity                    4,968      5,018       7,253      9,696     12,728          Ending total cash             6,612   7,216    10,769   14,375   18,348

   Source: Company data and J.P. Morgan estimates. *Note: Adjusted earnings exclude share-based compensation expense.




88 316
                                                                                                                                  Global Equity Research
                                                                                                                                  03 January 2011




                                                                                                                                  Overweight
Baidu.com                                                                                                                         BIDU, BIDU US
                                                                                                                                  Price: $100.01
2011 To Be Another Year of Solid Growth
                                                                                                                                  Price Target: $120.00



 2011 to be another year of solid growth: We expect Baidu’s revenues to                                                          Internet
  see 57% Y/Y growth to reach $1.83B in FY’11. We believe medium-term                                                                            AC
                                                                                                                                  Dick Wei
  revenue drivers are: (1) continued gradual improvement in monetization                                                          (852) 2800-8535
  from Phoenix Nest, (2) secular trend in growth of search usage and search                                                       dick.x.wei@jpmorgan.com
  advertising in China, (3) growth in eCommerce–related advertising, (4)                                                          J.P. Morgan Securities (Asia Pacific) Limited
  increasing mobile search usage, and (5) upside from contextual advertising.
                                                                                                                                  Ritesh Gupta
  As a result, we believe ARPU growth will be faster than advertiser number
                                                                                                                                  (91-22) 6157 3307
  growth.                                                                                                                         ritesh.z.gupta@jpmorgan.com

 FY’10 margin expansion to remain intact in FY’11: Baidu’s operating                                                             J.P. Morgan India Private Limited
  margins expanded in 2010 to 50.3% vs. 38.0% in FY09 driven by lower                                                             Imran Khan
  TAC, and leverage over bandwidth and operating expenses. We expect the                                                          (1-212) 622-6693
  company to be able to maintain this margin level in 2011. However, further                                                      imran.t.khan@jpmorgan.com
  expansion will be limited with the potential increase in contextual search                                                      J.P. Morgan Securities LLC
  advertising. Our 2011 operating margin forecast is 50.3%.
                                                                                                                                  Price Performance
 Rising eCommerce trend may add upside: Baidu should also benefit from
                                                                                                                                     110
  the growing B2C eCommerce market in China. Increasing competition
  among B2C eCommerce companies and strong growth in eCommerce sales                                                               $ 70

  volume should help drive search ad demand on Baidu’s platform. Baidu has                                                            30
  already seen fast growth in eCommerce–related search demand – during                                                                  Dec-09      Mar-10   Jun-10   Sep-10    Dec-10
  3Q10, Baidu reported the number of online retail advertisers doubled Y/Y.                                                                      BIDU share price ($)
                                                                                                                                                 NASDAQ Composite (rebased)
 Maintain OW with Dec-11 PT of US$120: Our price target implies 53.3x
                                                                                                                                                     YTD        1m         3m       12m
  FY11E, and 39.7x FY12E diluted adjusted EPS, on the back of 53% and
                                                                                                                                  Abs            141.7%       -7.7%    -4.4% 136.2%
  35% EPS growth for FY11E and FY12E, respectively, or 1.3x PEG (based
                                                                                                                                  Rel            126.2%      -13.3%   -16.6% 119.7%
  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
     US$MM, YE-Dec          FY09 FY10E FY11E                    FY12E                                 FY09 FY10E FY11E FY12E
Net Sales                    651.4 1,168.0 1,828.7              2,514.2   ROE (%)                         40    53     48    40 52-Week range                             US$38.5-115.2
Operating Profit (EBIT)      235.1   573.9   887.3              1,212.6   ROIC (%)                        39    53     47    39 Shares Outstg                                    348Mn
EBITDA                       296.0   654.0   993.4              1,350.7   Qtr GAAP EPS (US$)              1Q    2Q     3Q    4Q Avg daily value                               US$996M
Pre Tax Profit               246.5   585.0   910.1              1,250.8   EPS FY09                      0.08  0.16   0.21  0.18 Avg dly volume                                  10.7Mn
Reported Net profit          217.5   507.4   790.1              1,073.7   EPS FY10E                     0.20  0.35   0.45  0.45 Index (NASD)                                      2,667
Reported EPS (US$)            0.62    1.45    2.21                 2.98   EPS FY11E                     0.42  0.53   0.62  0.64 Free float                                         75%
P/E (x)                      158.6    68.5    44.7                 33.2                                  1M     3M   12M        Dividend Yld (%)                                    0%
Adj. EPS *                    0.66    1.49    2.25                 3.02   Abs. Perf.(%)                 -9.7   -3.3 132.6       Market Cap                                   US$34.5B
Adj. P/E (x)                 149.9    66.7    44.0                 32.8   Rel. Perf.(%)                -14.9 -15.5  115.2       Price Target                                   US$120
EV/EBITDA                    115.3    52.2    34.4                 25.3   Cash                           671 1,172  2,101 3,315 Price Date                                 Dec 29, 2010
P/B (x)                       49.5    27.7    16.3                 10.5   Equity                         696 1,243  2,117 3,278
Y/E BPS (US$)                  2.0     3.6     6.1                  9.4
Source: Company data, J. P. Morgan estimates, Bloomberg. * Note: Excluding share-based compensation expense. Pricing data as of 29 December 2010.
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




                             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
90 318
     Dick Wei                                                                       Global Equity Research
     (852) 2800-8535                                                                03 January 2011
     dick.x.wei@jpmorgan.com




                                                                                    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
     Active Online Mktg.
     Customers                              161,000               181,000           194,000         197,000       185,000       203,000     216,000      223,000        221,000    254,000      272,000        282,880
     QoQ Chg. (%)                             3.9%                 12.4%              7.2%            1.5%          -6.1%         9.7%        6.4%         3.2%           -0.9%     14.9%         7.1%           4.0%
     YoY Chg. (%)                            43.8%                 41.4%             35.7%           27.1%         14.9%         12.2%       11.3%        13.2%          19.5%      25.1%        25.9%          26.9%
     Avg Qtly Spending /
     Customer (Rmb)                               3,557             4,432              4,733           4,576            4,379     5,402        5,918        5,652         5,852      7,533           8,292       8,541
     QoQ Chg. (%)                                -3.2%             24.6%               6.8%           -3.3%            -4.3%     23.4%         9.5%        -4.5%          3.6%      28.7%           10.1%        3.0%
     YoY Chg. (%)                                45.1%             41.6%              36.4%           24.5%            23.1%     21.9%        25.0%        23.5%         33.6%      39.5%           40.1%       51.1%
     Source: Company reports, J.P. Morgan estimates.




     Quarterly TAC Trend                                                                                                        Long-term TAC as % of Total Revenue
                                                          16.0%



                                                                           16.0%




      250,000                                                                                                     18%             14,000                                                                         18%
                                                  15.3%



                                                                   15.3%




                                                                                                                                                                                  15.7%
                                                                                                          9.1%
                                         14.5%




                                                                                                                  16%
                 13.3%




                                                                                                   8.9%




                                                                                                                                                                                                                 16%
                                                                                    13.2%

                                                                                            9.7%
                         12.7%




                                                                                                                                  12,000
      200,000                                                                                                                                                             13.1%
                                 11.8%




                                                                                                                  14%
                                                                                                                                                                                                                 14%
                                                                                                                                  10,000                       11.5%
                                                                                                                  12%
      150,000                                                                                                                                                                                10.2%               12%
                                                                                                                                                                                                       9.7%
                                                                                                                  10%                                  9.0%
                                                                                                                                   8,000                                                                         10%
                                                                                                                  8%
      100,000                                                                                                                                6.3%                                                                8%
                                                                                                                  6%               6,000
                                                                                                                                                                                                                 6%
        50,000                                                                                                    4%               4,000
                                                                                                                  2%                                                                                             4%
                                                                                                                                   2,000
             0                                                                                                    0%                                                                                             2%
                 1Q08

                         2Q08

                                 3Q08

                                         4Q08

                                                  1Q09

                                                          2Q09

                                                                   3Q09

                                                                           4Q09

                                                                                    1Q10

                                                                                            2Q10

                                                                                                   3Q10

                                                                                                          4Q10E




                                                                                                                                        0                                                                        0%
                                                                                                                                             2005      2006      2007      2008    2009      2010E     2011E
                    TAC (LHS, Rmb '000s)                                           TAC as % of rev enue (RHS, %)
                                                                                                                                                               Total Rev enue (Left, RMB millions)
                                                                                                                                                               TAC as % of total rev enue (Right)

     Source: Company reports, J.P. Morgan estimates.                                                                            Source: Company reports, J.P. Morgan estimates.




91                                                                                                                                                                                                                319
   Dick Wei                                       Global Equity Research
   (852) 2800-8535                                03 January 2011
   dick.x.wei@jpmorgan.com




                                                  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%



   Baidu—DCF Model
                                        FY10E      FY11E       FY12E        FY13E          FY14E      FY15E     FY16E     FY17E        FY18E     FY19E     FY20E
   Sales growth                          77.2%      55.2%       37.5%        33.4%          31.0%      25.9%     22.0%     21.0%        20.0%     20.0%     20.0%
   EBIT margin                           49.1%      48.5%       48.2%        46.2%          45.9%      45.4%     45.2%     45.2%        45.2%     45.2%     45.2%
   NOPAT margin                          42.4%      41.9%       41.1%        39.3%          39.1%      38.7%     38.5%     38.5%        38.5%     38.5%     38.5%
   Year-end net fixed assets turns          5.0        6.3         6.9          7.0            7.0        7.0       7.0       7.0          7.0       7.0       7.0
   Year-end net working capital turns      -7.2       -7.5        -7.6         -7.0           -7.0       -7.0      -7.0      -7.0         -7.0      -7.0      -7.0
   Year-end net other assets turns         22.5       35.6        49.0         30.0           30.0       30.0      30.0      30.0         30.0      30.0      30.0
   Cash operating taxes as % of EBIT     13.7%      13.6%       14.8%        14.8%          14.8%      14.8%     14.8%     14.8%        14.8%     14.8%     14.8%
   Year-end Invested capital turns          9.5       18.2        30.7         30.0           30.0       30.0      30.0      30.0         30.0      30.0      30.0
   Source: J.P. Morgan estimates.


                                                  DCF Sensitivity Analysis
                                                                                                            Terminal growth (%)
                                                                                     0%         1%          2%        3%         4%           5%         6%            7%
                                                                  10.0%            167.6      175.6       185.7     198.6     215.8         239.9      276.1         336.3
                                                                  11.0%            140.9      146.5       153.2     161.6     172.4         186.9      207.1         237.4
                                                  WACC




                                                                  12.0%            119.9      123.8       128.4     134.0     141.1         150.2      162.3         179.2
                                                                  13.0%            103.1      105.8       109.0     112.9     117.7         123.6      131.2         141.4
                                                                  14.0%             89.4       91.4        93.7      96.4       99.7        103.6      108.6         115.0
                                                                  15.0%             78.2       79.6        81.3      83.2       85.5         88.2       91.6          95.8
                                                  Source: J.P. Morgan estimates.


                                                  (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%).

92 320
     Dick Wei                  Global Equity Research
     (852) 2800-8535           03 January 2011
     dick.x.wei@jpmorgan.com




                               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.




93                                                                                                                   321
   Dick Wei                                                Global Equity Research
   (852) 2800-8535                                         03 January 2011
   dick.x.wei@jpmorgan.com




   Baidu: Summary of financials
   Income statement                                                                                      Ratio analysis
   US$ in millions, year-end December                                                                    %, year-end December
                                           FY08       FY09      FY10E       FY11E       FY12E                                                 FY08    FY09    FY10E    FY11E    FY12E
   Revenues                                465.5      651.4     1,168.0    1,828.7     2,514.2           Gross Margin                          64.0   63.8     72.6      72.4     71.6
    Cost of Goods Sold                     167.5      235.8      320.4       504.4       713.9           EBITDA margin                         45.4   45.4     56.0      54.3     53.7
   Gross Profit                            298.0      415.6      847.6     1,324.3     1,800.3           Operating Margin                      34.3   36.1     49.1      48.5     48.2
    R&D Expenses                            36.2       55.9       97.5       157.2       216.3           Net Margin                            32.8   33.4     43.4      43.2     42.7
    SG&A Expenses                           90.0      112.1      162.9       266.9       357.2           R&D/sales                              7.8    8.6      8.3       8.6      8.6
    Share-based Expense                     12.2       12.6       13.3        12.8        14.1           SG&A/Sales                            19.3   17.2     13.9      14.6     14.2
   Operating Profit (EBIT)                 159.6      235.1      573.9       887.3     1,212.6
   EBITDA                                  211.4      296.0      654.0       993.4     1,350.7           Sales growth                         100.9   39.9     79.3      56.6     37.5
    Interest Income, net                     6.9        4.8        9.1        22.3        37.6           Operating Profit Growth              119.7   47.3    144.1      54.6     36.7
    Investment Income (Exp.)                 0.0        0.0        0.0         1.0         1.0           Net profit growth                     82.6   42.6    133.3      55.7     35.9
    Other Income (Exp.)                      2.9        6.7        2.1         0.6         0.6           Diluted EPS growth                    82.5   42.4    131.7      53.0     34.7
   Earnings before tax                     169.4      246.5      585.0       910.1     1,250.8
    Tax                                     16.9       29.0       77.7       120.0       177.1
   Net Income (Reported)                   152.5      217.5      507.4       790.1     1,073.7           Net debt to total capital            -86.2   -96.4    -94.3    -99.3   -101.1
   Net Income (Adjusted) *                 164.8      230.2      520.7       803.0     1,087.9           Net debt to equity                   -86.2   -96.4    -94.3    -99.3   -101.1
   US$
   Diluted EPS (GAAP)                       0.44       0.62        1.45        2.21       2.98           Asset Turnover                        81.2   72.2     75.3      72.3     65.7
   Adj. Diluted EPS *                       0.47       0.66        1.49        2.25       3.02           Working Capital Turns (X)              2.1    1.6      1.6       1.4      1.1
   BPS                                       1.3        2.0         3.6         6.1        9.4           ROE                                   44.3   40.1     53.5      47.7     40.3
   DPS                                       0.0        0.0         0.0         1.0        1.0           ROIC                                  42.8   39.4     52.7      46.6     39.2
   Shares Outstanding (Mn)                  348        348         350         357        360

   Balance sheet                                                                                         Cash flow statement
   US$ in millions, year-end December                                                                    US$ in millions, year-end December
                                           FY08       FY09      FY10E       FY11E       FY12E                                                 FY08    FY09    FY10E    FY11E    FY12E
   Cash and cash equivalents                388        671       1,172       2,058       3,248           Net Income                            153     218      507       790    1,074
   Accounts receivable                       14         24          39          57          76           Depr. & Amortisation                   40      48       67        91      121
   Inventories                                0          0           0           0           0           Change in working capital              24      70       51       110      121
   Others                                    14         15          48          69          93           Other                                  38      13       13        13       14
   Current assets                           415        709       1,259       2,184       3,416           Cash flow from operations             254     348      638     1,005    1,330

   LT investments                              2          2          8           7           7           Capex / Investments                   -59     -82     -159      -147     -191
   Net fixed assets                          129        146        233         286         355           Others                                -34       0       -5         0        0
   Other LT assets                            28         44         52          50          50           Cash flow from investing              -93     -82     -164      -147     -191
   Total assets                              573        902      1,551       2,528       3,829           Free cash flow                        195     267      480       858    1,139
   Liabilities                                                                                           Equity raised/ (repaid)                -9      17       18        59       72
   ST loans                                    0          0          0           0           0           Debt raised/ (repaid)                   0       0        0         0        0
   Payables                                   62        110        128         194         270           Other                                   4      -3        1         0        0
   Others                                     62         95        179         260         347           Dividends paid                          0       0        0         0        0
   Total current liabilities                 124        205        307         454         617           Cash flow from financing               -5      14       19        59       72
   Long term debt                              0          0          0           0           0
   Other liabilities                           0          1          1           1           1           Net change in cash                    176     283      501       886    1,189
   Total liabilities                         124        206        308         455         618           Beginning cash                        211     388      671     1,172    2,058
   Shareholders' equity                      450        696      1,243       2,074       3,211           Ending cash                           388     671    1,172     2,058    3,248
   Source: Company data and J.P. Morgan estimates. *Note: Excluding share-based compensation expenses.




94 322
                                                                                                                                    Global Equity Research
                                                                                                                                    03 January 2011




                                                                                                                                    Neutral
 China Finance Online                                                                                                               JRJC, JRJC US
                                                                                                                                    Price: $6.64
 Remain Neutral on Lack of Near-term Price Drivers
                                                                                                                                    Price Target: $8.30



 While the company has established good checks on its operating                                                                    Internet
  expenses to reduce losses, we believe the company still lacks a product                                                           Dick Wei
                                                                                                                                                   AC

  that could strengthen its revenue quality in the medium term.                                                                     (852) 2800-8535
                                                                                                                                    dick.x.wei@jpmorgan.com
 Business Still Lacks New Drivers: We believe China Finance Online is                                                              J.P. Morgan Securities (Asia Pacific) Limited
  still lacking a product that could drive their revenues. While the
                                                                                                                                    Ritesh Gupta
  company has been working on a few new products, these new products                                                                (91-22) 6157 3307
  are yet to be introduced to the market place. In addition, existing                                                               ritesh.z.gupta@jpmorgan.com
  products are also negatively impacted due to rising competition and the                                                           J.P. Morgan India Private Limited
  IPO of its competitor in the A-share market (Grand Wisdom).
                                                                                                                                    Imran Khan
                                                                                                                                    (1-212) 622-6693
 Weaker 2011 Outlook: JRJC still lacks new revenue drivers in the near                                                             imran.t.khan@jpmorgan.com
  term. A decline in cash revenues for 3Q10 and a muted outlook for next
                                                                                                                                    J.P. Morgan Securities Inc.
  quarter would mean weaker revenue recognition until 2Q11 due to
  amortization of subscription revenues. We recently revised down our                                                               Price Performance
  2011 revenue estimate by 19% and adjusted our EPS estimate (ex share-
                                                                                                                                       9.0
  based expenses) by 40%. We are now also forecasting increased sales
                                                                                                                                    $ 7.5
  and marketing and research and development expenses.
                                                                                                                                       6.0
 Dec-11 PT of US$8.3: Our DCF-based Dec-11 price target implies                                                                          Dec-09    Mar-10   Jun-10     Sep-10     Dec-10

  67.3x/31.7x 2011E/2012E adjusted diluted P/E. Excluding net cash of                                                                              JRJC share price ($)
  US$4.53 per diluted share, our PT implies 67.3x/31.7x 2011E/2012E                                                                                NASDAQ Composite (rebased)

  adjusted diluted P/E. Downside risks to our PT include: (1) deterioration                                                                          YTD         1m          3m        12m
  in domestic stock market activity, reducing demand for JRJC products,                                                             Abs            -11.5%    -16.4%      -6.7%      -11.5%
                                                                                                                                    Rel            -27.0%    -22.0%     -18.9%      -28.0%
  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.
Reuters: JRJC; Bloomberg: JRJC US
US$MM, Y/E Dec             FY09 FY10E FY11E FY12E                                             FY09     FY10E      FY11E      FY12E
 Net Revenue                53.6  59.2  54.7  59.2 ROE (%)                                      0.4       6.4        2.6        5.1       52-Week range               US$6.8-9.1
 Adj. Op. Profit *          -1.8   3.6   1.1   4.7 ROIC (%)                                    -0.8       5.0        1.3        3.7       Shares Outstg                    22Mn
 GAAP Net Profit            -6.2   2.1   1.0   4.4 Qtr GAAP EPS(US$)                            1Q        2Q         3Q         4Q        Avg daily volume               0.05Mn
 Adj. net profit *           0.4   6.6   3.0   6.4 EPS FY09                                   -0.01     -0.11      -0.05      -0.13       Avg daily value                 0.4Mn
 Reported EPS (US$)        -0.30  0.09  0.04  0.18 EPS FY10 E                                  0.01      0.02       0.06       0.01       Index (NASD)                     2,667
 P/E (x)                     nm   71.8 161.2  36.8 EPS FY11 E                                  0.01      0.01       0.01       0.01       Free float                        52%
Adj. EPS (US$)             0.02       0.28      0.12     0.26                                              1M         3M        12M       Dividend Yld (%)                 0%
Adj. P/E (x) *            371.5       23.3      53.8     25.4    Abs. Perf.(%)                           -17.2       -6.7      -14.2      Market Cap                US$146M
EV/EBITDA (x)              33.2        6.2      13.6      6.3    Rel. Perf.(%)                           -22.3      -18.9      -31.6      Price Target                US$ 8.3
P/B (x)                     1.4        1.3       1.2      1.1    Cash (US$m)                  107.5      105.9      112.4      130.8      Price Date              Dec 29, 2010
Y/E BPS (US$)               4.6        5.0       5.6      6.2    Equity (US$m)                 97.4      107.8      119.3      134.3
Source: Company reports, Bloomberg, J.P. Morgan estimates. * Note: Adjusted figures exclude share-based comps & one-off expenses.
   Dick Wei                                       Global Equity Research
   (852) 2800-8535                                03 January 2011
   dick.x.wei@jpmorgan.com




                                                  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.



                                                  DCF Sensitivity Analysis
                                                                                                            Terminal Growth (%)
                                                                                    0%          1%          2%        3%         4%           5%            6%           7%
                                                                  10.0%            10.3        10.4        10.4      10.5       10.7         10.9          11.1         11.6
                                                                  11.0%             9.5         9.5         9.5       9.6        9.6          9.7           9.8          9.9
                                                  WACC




                                                                  12.0%             8.8         8.8         8.8       8.8        8.8          8.8           8.8          8.8
                                                                  13.0%             8.3         8.3         8.3       8.2        8.2          8.2           8.1          8.1
                                                                  14.0%             7.8         7.8         7.8       7.8        7.7          7.7           7.6          7.6
                                                                  15.0%             7.5         7.4         7.4       7.4        7.3          7.3           7.2          7.2
                                                                  16.0%             7.1         7.1         7.1       7.1        7.0          7.0           6.9          6.9
                                                  Source: J.P. Morgan estimates.




96 324
     Dick Wei                                                 Global Equity Research
     (852) 2800-8535                                          03 January 2011
     dick.x.wei@jpmorgan.com




     China Finance Online: Summary of financials
     Income statement                                                                                    Ratio analysis
     USD in millions, year-end December                                                                  %, year-end December
                                              FY08       FY09      FY10E      FY11E      FY12E                                                FY08    FY09     FY10E    FY11E    FY12E
     Revenues                                  56.2       53.6       59.2        54.7       59.2         Gross Margin                         83.3     84.8      86.0     84.4     84.9
      Cost of Goods Sold                        9.4        8.1        8.3         8.5        9.0         EBITDA margin                        40.1       2.5     12.0      5.9     11.7
     Gross Profit                              46.9       45.5       50.9        46.2       50.3         Operating Margin                     22.8     -15.6     -1.4     -1.7      4.5
      R&D Expenses                              5.6       10.7       12.7        12.9       13.0         Net Margin                           33.8     -11.6      3.6      1.8      7.5
      SG&A Expenses                            28.5       43.1       39.0        34.3       34.6         R&D/sales                             9.9      20.0     21.5     23.5     22.0
     Operating Profit (EBIT)                   12.8       -8.4       -0.8        -0.9        2.7         SG&A/Sales                           50.6      80.5     65.9     62.6     58.4
     EBITDA                                    22.5        1.3        7.1         3.2        6.9
      Interest Income                           1.6        1.4        1.5         1.6        1.8         Sales growth                        117.1      -4.7     10.4     -7.6      8.3
      Interest Expense                          0.0        0.0        0.0         0.0        0.0         Operating Profit Growth             185.0    -165.3     89.9     -9.8    387.2
      Investment Income (Exp.)                  0.0        0.0        0.0         0.0        0.0         Net profit growth                   560.9    -132.7    134.3    -53.2    342.1
      Non-Operating Income (Exp.)               1.8        0.4        1.6         0.4        0.4         EPS (Reported) growth              -491.0    -135.1   -131.2    -55.4    338.1
     Earnings before tax                       16.2       -6.7        2.2         1.1        4.9
      Tax                                       2.6        0.4       -0.3        -0.3       -0.7
     Net Income (Reported)                     19.0       -6.2        2.1         1.0        4.4         Net debt to total capital          -101.1    -110.3    -98.3    -94.2    -97.4
     Net Income (Adjusted)                     26.6        0.4        6.6         3.0        6.4         Net debt to equity                 -101.1    -110.3    -98.3    -94.2    -97.4
     USD:
     EPS (Reported)                            0.84      -0.30       0.09        0.04       0.18         Asset Turnover                       39.8     32.4      34.7     31.6     30.5
     EPS (Adjusted) *                          1.18       0.02       0.28        0.12       0.26         Working Capital Turns (X)             0.9      0.7       0.7      0.6      0.6
     BPS                                        4.9        4.6        5.0         5.6        6.2         ROE                                  32.5      0.4       6.4      2.6      5.1
     DPS                                        0.0        0.0        0.0         0.0        0.0         ROIC                                 30.5     -0.8       5.0      1.3      3.7
     ADS Outstanding (Diluted, Mn)             19.8       21.0       21.5        21.4       21.5

     Balance sheet                                                                                       Cash flow statement
     USD in millions, year-end December                                                                  USD in millions, year-end December
                                             FY08        FY09      FY10E      FY11E      FY12E                                                FY08    FY09     FY10E    FY11E    FY12E
     Cash and cash equivalents                97.5       107.5      105.9      112.4      130.8          Net Income                            19.0    -6.2       2.1      1.0      4.4
     Accounts receivable                       2.9         5.4       16.1       15.7       17.6          Depreciation & Amortization            2.1     3.1       3.5      2.2      2.3
     Inventories                               0.0         0.0        0.0        0.0        0.0          Change in working capital             -1.1     6.4      -9.6     -3.2      4.4
     Others                                   12.7        20.8       20.6       18.0       20.1          Other                                  7.3     6.6       4.2      1.8      1.8
     Current assets                          113.1       133.7      142.6      146.1      168.5          Cash flow from operations             27.3     9.9       0.2      1.7     12.9

     LT investments                            1.5         1.5        1.5        1.5         1.5         Capex/investments                    -11.2     -6.9      0.3     -1.1     -1.2
     Net fixed assets                          8.6        10.3        8.0        7.4         6.8         Others                                 0.0      0.0      0.0      0.0      0.0
     Others                                   18.0        20.2       18.6       18.2        17.7         Cash flow from investing             -11.2     -6.9      0.3     -1.1     -1.2
     Total assets                            141.2       165.6      170.8      173.2       194.5         Free cash flow                        16.1      3.0      0.5      0.6     11.6
     Liabilities                                                                                         Equity raised/ (repaid)                2.5      0.6      3.8      8.5      8.5
     ST loans                                   0.0        0.0        0.0        0.0         0.0         Debt raised/ (repaid)                  0.0      0.0      0.0      0.0      0.0
     Payables                                   7.0       21.7       24.8       19.3        20.8         Other                                  4.2      6.4     -5.9     -2.7     -1.8
     Others                                    28.3       30.7       28.5       27.8        34.7         Dividends paid                         0.0      0.0      0.0      0.0      0.0
     Total current liabilities                 35.4       52.4       53.3       47.1        55.5         Cash flow from financing               6.7      6.9     -2.0      5.9      6.7
     Long term debt                             0.0        0.0        0.0        0.0         0.0
     Other liabilities                          9.4       15.8        9.7        6.8         4.7         Net change in cash                   22.8      9.9      -1.5      6.5     18.3
     Total liabilities                         44.8       68.2       63.0       53.9        60.2         Beginning cash                       74.7     97.5     107.5    105.9    112.4
     Shareholders' equity                      96.5       97.4      107.8      119.3       134.3         Ending cash                          97.5    107.5     105.9    112.4    130.8
     Source: Company data and J.P. Morgan estimates. * Note: We have included 123R share-based compensation adjustments starting in 2006.




97                                                                                                                                                                       325
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




98 326
                                                                                                                                  Global Equity Research
                                                                                                                                  03 January 2011




                                                                                                                                  Overweight
Netease                                                                                                                           NTES, NTES US
                                                                                                                                  Price: $36.07
Leading Game Developer in China. Starcraft 2, WoW
                                                                                                                                  Price Target: $45.00
Upgrade to Provide Growth in F'11

We see Netease as the top online game developer and operator in China, and                                                        Internet
expect the company to see ~20% gaming revenue growth in 2011. Success of                                                                         AC
Starcraft 2, WoW Cataclysm, and other in-house games could drive the stock                                                        Dick Wei
                                                                                                                                  (852) 2800-8535
higher.
                                                                                                                                  dick.x.wei@jpmorgan.com
 WoW and Fantasy WWJ to remain strong: Online games saw healthy                                                                  J.P. Morgan Securities (Asia Pacific) Limited
  growth over the last two quarters for Netease. New "Perfect Beauty" and having                                                  Ritesh Gupta
  Jay Chou as spokesperson helped Fantasy WWJ drive good growth in 2Q11 and                                                       (91-22) 6157 3307
  3Q11. WoW also saw good sequential growth with the launch of new expansion                                                      ritesh.z.gupta@jpmorgan.com
  pack “Wrath of Lich King” in 2011. We believe these games should continue to                                                    J.P. Morgan India Private Limited
  maintain their franchise with the launch of promotion events and new expansion
                                                                                                                                  Imran Khan
  packs.                                                                                                                          (1-212) 622-6693
 Starcraft 2 may be launched in 2011: Netease has already submitted                                                              imran.t.khan@jpmorgan.com

  information and materials related to the game to relevant government                                                            J.P. Morgan Securities LLC
  authorities and the game is undergoing the review process. We expect that
                                                                                                                                  Price Performance
  Starcraft 2 may be launched in 2011.
                                                                                                                                       40
 Online advertising to benefit from new advertising placement system: We                                                          $
  expect Netease to see healthy portal revenue growth of 26% next year. We                                                             34

  believe the company should benefit from improved awareness amongst                                                                   28

  advertisers from: (1) sponsorship of Asian Games in Guangzhou, and (2) launch                                                         Dec-09   Mar-10   Jun-10      Sep-10    Dec-10

  of a new ad placement system which provides analytics for effectiveness of                                                                     NTES share price ($)
                                                                                                                                                 NASDAQ Composite (rebased)
  advertisements placed on Netease portal. Portal traffic on Netease is up 40%
  YTD as of the end of 3Q10.                                                                                                                       YTD        1m           3m        12m
                                                                                                                                  Abs            -12.5%    -5.6%        -8.2%      -2.9%
 2011 outlook: We expect 2011 revenues to see 19.7% growth YoY to reach                                                          Rel            -28.0%   -11.2%      -20.4%      -19.4%
  US$947M. We expect gross margins to remain intact with slight improvement
  in operating margins on lower marketing expenses. Online Games should see
  19.2% growth YoY in 2011 from continued performance of WoW and Fantasy
  WWJ. Launch of Starcraft 2 should be a key revenue driver for 2011, in our
  view. Netease has one of the strongest R&D teams and we expect the company
  to maintain its strength as a gaming franchise.
Reuters: NTES; Bloomberg: NTES US
(US$MM, Y/E Dec)          FY09     FY10E      FY11E FY12E                                      FY09 FY10E FY11E FY12E
Net Sales                 550.2     789.7      946.6 1,055.7 ROE (%)                            28.9  26.0  25.0  21.6 52-Week range (US$)                            26.2-43.7
Operating Profit          296.3     359.3      441.8 496.5 ROIC (%)                             27.3  24.7  23.5  20.1 Shares Outstg (MM)                                 130M
EBITDA                    322.0     409.2      506.0 570.5 GAAP Qtr EPS (US$)                     1Q    2Q    3Q    4Q Avg daily volume                                    0.9M
Pre Tax Profit            314.9     368.2      472.4 536.2 EPS FY09                             0.47  0.53  0.44  0.64 Avg daily value                               US$31.4M
Net Profit                269.0     311.8      393.3 441.0 EPS FY10E                            0.51  0.55  0.66  0.68 Index (NASD)                                       2,667
Reported EPS (US$)         2.07      2.39       2.94    3.22 EPS FY11E                          0.68  0.72  0.76  0.78 Free float (%)                                     ~50%
Reported P/E (x)           17.6      15.3       12.4    11.3                                      1M    3M  12M        Dividend yld (%)                                      0%
Adj. EPS (US$)             2.11      2.51       3.10    3.40 Abs. Perf.(%)                       -6.7  -8.7  -2.8      Market Cap                                      US$4.7B
Adj. P/E (x)               17.3      14.5       11.8    10.7 Rel. Perf.(%)                     -11.9 -20.9 -20.3       Price target (US$)                               US$45
EV/EBITDA                  12.6       9.9        8.0     7.1                                                           Price Date                                  Dec 29, 2010
P/B (x)                     4.1       3.2        2.5     2.0 Cash (US$MM)                      1,046 1,519 2,004 2,544
Y/E BPS (US$)               8.8      11.4       14.7    18.3 Equity (US$MM)                    1,087 1,429 1,891 2,404
Source: Company reports, Bloomberg, J.P. Morgan estimates. Note: We have included 123R share-based expense adjustments starting in 2006.
   Dick Wei                                       Global Equity Research
   (852) 2800-8535                                03 January 2011
   dick.x.wei@jpmorgan.com




                                                  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).



   NTES—DCF model (base case scenario)
                                        FY10E       FY11E       FY12E       FY13E         FY14E      FY15E     FY16E     FY17E        FY18E        FY19E        FY20E
   Sales growth                         42.8%       19.7%       11.5%       10.1%         10.8%      10.0%     10.0%     10.0%        10.0%        10.0%        10.0%
   EBIT margin                          45.5%       46.7%       47.0%       46.0%         45.4%      42.0%     40.0%     38.0%        36.0%        36.0%        36.0%
   NOPAT margin                         38.2%       38.0%       37.6%       36.8%         36.3%      33.6%     32.0%     30.4%        28.8%        28.8%        28.8%
   Year-end net fixed assets turns          7.8         9.3        10.4        12.0          12.0       12.0      12.0      12.0         12.0         12.0         12.0
   Year-end net working capital turns     (4.4)       (4.8)       (4.9)       (4.9)         (4.9)      (4.9)     (4.9)     (4.9)        (4.9)        (4.9)        (4.9)
   Year-end net other assets turns         24.3        29.1        32.5        22.0          22.0       22.0      22.0      22.0         22.0         22.0         22.0
   Cash operating taxes as % of EBIT    16.0%       18.6%       20.0%       20.0%         20.0%      20.0%     20.0%     20.0%        20.0%        20.0%        20.0%
   Year-end Invested capital turns       (17.1)      (15.1)      (12.7)      (13.0)        (13.0)     (13.0)    (13.0)    (13.0)       (13.0)       (13.0)       (13.0)
   Source: J.P. Morgan estimates.


                                                  DCF sensitivity analysis
                                                                                                           Terminal growth (%)
                                                                                    0%         1%          2%        3%         4%           5%               6%           7%
                                                                   9.9%            57.3       59.3        61.8      64.9       69.2         75.2             84.3         99.6
                                                                  10.9%            52.3       53.8        55.5      57.7       60.5         64.3             69.6         77.6
                                                                  11.9%            48.2       49.3        50.5      52.1       54.0         56.5             59.9         64.6
                                                  WACC




                                                                  12.9%            44.8       45.6        46.5      47.6       49.0         50.7             52.9         55.9
                                                                  13.9%            41.9       42.5        43.2      44.0       45.0         46.2             47.7         49.7
                                                                  14.9%            39.4       39.8        40.4      41.0       41.7         42.6             43.7         45.0
                                                                  15.9%            37.2       37.6        38.0      38.5       39.0         39.7             40.4         41.4
                                                  Source: J.P. Morgan estimates.



100 328
      Dick Wei                                            Global Equity Research
      (852) 2800-8535                                     03 January 2011
      dick.x.wei@jpmorgan.com




      Netease: Summary of financials
      Income statement                                                                               Ratio analysis
      Rmb in millions, year-end December                                                             %, year-end December
                                            FY08     FY09      FY10E      FY11E       FY12E                                               FY08    FY09    FY10E    FY11E    FY12E
      Revenues                              2,938    3,757      5,364      6,420       7,159         Gross Margin                          81.4    74.9     68.2     68.2     68.4
       Cost of Goods Sold                     546      943      1,707      2,044       2,261         EBITDA margin                         63.3    57.7     50.0     51.1     51.8
      Gross Profit                          2,392    2,814      3,657      4,375       4,899         Operating Margin                      60.2    53.9     45.5     46.7     47.0
       R&D Expenses                           185      220        280        356         394         Net Margin                            50.6    48.9     39.5     41.5     41.8
       SG&A Expenses                          439      570        936      1,023       1,138         R&D/sales                              6.3     5.9      5.2      5.5      5.5
      Operating Profit (EBIT)               1,768    2,023      2,441      2,996       3,367         SG&A/Sales                            14.9    15.2     17.5     15.9     15.9
      EBITDA                                1859     2167       2682       3282        3706
       Interest Income                      144.8    128.2      139.5      207.5       269.4         Sales growth                          32.7    27.9     42.8     19.7     11.5
       Interest Expense                         0         0         0          0           0         Operating Profit Growth               46.6    14.5     20.6     22.7     12.4
       Investment Income (Exp.)               1.5       0.4       0.2        0.0         0.0         Net profit growth                     17.6    24.5     15.1     25.2     12.1
       Non-Operating Income (Exp.)         -163.5      -1.3     -79.0        0.0         0.0         EPS (Reported) growth                 20.2    22.9     14.5     22.9      9.8
      Earnings before tax                   1,751    2,151      2,501      3,203       3,636
       Tax                                   -264     -314       -383       -536        -646
      Net Income (Reported)                 1,487    1,837      2,118      2,667       2,991         Net debt to total capital        -101.8      -96.2   -106.3   -106.0   -105.8
      Net Income (Adjusted) *               1,555    1,869      2,230      2,816       3,153         Net debt to equity               -101.8      -96.2   -106.3   -106.0   -105.8
      RMB
      EPS (Reported)                       11.53     14.17       16.22      19.92      21.87         Asset Turnover                        46.3    42.7     45.2     42.1     37.7
      EPS (Adjusted) *                     12.05     14.41       17.07      21.03      23.06         Working Capital Turns (X)              0.7     0.6      0.7      0.6      0.5
      BPS                                  45.90     60.36       77.14      99.81     124.21         ROE                                   34.9    28.9     26.0     25.0     21.6
      DPS                                   0.00      0.00        0.00       0.00       0.00         ROIC                                  30.1    27.3     24.7     23.5     20.1
      Shares outstanding (MM)               125       129         129        127        130


      Balance sheet                                                                                  Cash flow statement
      Rmb in millions, year-end December                                                             Rmb in millions, year-end December
                                           FY08       FY09     FY10E      FY11E       FY12E                                               FY08    FY09    FY10E    FY11E    FY12E

      Cash and cash equivalents            5,613     7,141     10,316     13,615      17,278         Net Income                           1,487   1,837    2,118    2,667    2,991
      Accounts receivable                    231       187        408        465         514         Depr. & Amortization                    91     144      242      286      339
      Inventories                              0         0          0          0           0         Change in working capital              111      77      947      167      170
      Others                                 129       645        224        264         292         Other                                   68      18      100      149      163
      Current assets                       5,974     7,973     10,949     14,344      18,085         Cash flow from operations            1,757   2,076    3,407    3,269    3,662

      LT investments                           0         0          0          0           0         Capex / investments                   -214    -602     -322     -289     -332
      Net fixed assets                       259       558        691        693         686         Others                                   0       0        0        0        0
      Others                                 113       273        220        220         220         Cash flow from investing              -214    -602     -322     -289     -332
      Total assets                         6,346     8,803     11,860     15,258      18,991         Free cash flow                       1,543   1,473    3,085    2,980    3,330
      Liabilities                                                                                    Equity raised/ (repaid)                453      40       54      318      334
      ST loans                                 0         0           0         0           0         Debt raised/ (repaid)                 -642       0        0        0        0
      Payables                               320       582       1,132     1,257       1,385         Other                                  100       0       25        0        0
      Others                                 510       796         993     1,132       1,251         Dividends paid                           0       0        0        0        0
      Total current liabilities              829     1378        2125      2389        2636          Cash flow from financing               -88      40       79      318      334
      Long term debt                           0         0           0         0           0
      Other liabilities                        0         0          25        25          25         Net change in cash                   1,455   1,513    3,164    3,298    3,664
      Total liabilities                      829     1,378       2,151     2,415       2,661         Beginning cash                       4,159   5,613    7,141   10,316   13,615
      Shareholders' equity                 5,516     7,425       9,709    12,843      16,330         Ending cash                          5,613   7,141   10,316   13,615   17,278
  Source: Company data, J.P. Morgan estimates. * Adjusted EPS excludes share-based compensation expense.




101                                                                                                                                                                 329
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




102 330
                                                                                                                             Global Equity Research
                                                                                                                             03 January 2011




                                                                                                                             Overweight
Shanda Games                                                                                                                 GAME, GAME US
                                                                                                                             Price: $6.33
2011 Could Mark a Turnaround
                                                                                                                             Price Target: $8.00



 2011 outlook: Shanda Games currently guides 4Q10 revenues to be 3% to 5%                                                   Internet
  higher sequentially in 4Q10. We expect Shanda Games could return to growth                                                                AC
                                                                                                                             Dick Wei
  in 2011, particularly if Dragon Nest can continue to gain traction in 2011. F’11                                           (852) 2800-8535
  could well mark the turnaround for Shanda Games: We expect the company                                                     dick.x.wei@jpmorgan.com
  to see double-digit growth on the top line. Dragon Nest has gotten a good                                                  J.P. Morgan Securities (Asia Pacific) Limited
  response from gamers. Another promising game in the F’11 pipeline is Final
  Fantasy XIV.                                                                                                               Price Performance

 Dragon Nest could be the second-largest game next year: Dragon Nest PCUs                                                       11
  have already touched 700K levels. We believe by next year the game could                                                   $
                                                                                                                                  8
  reach 10% of total revenues for Shanda Games, or become the second-largest
                                                                                                                                  5
  game after Mir2, and to surpass Woool. We believe the revenues from new                                                          Dec-09   Mar-10   Jun-10   Sep-10      Dec-10
  games could ease the pressure from the potential decline in legacy games.
                                                                                                                                            GAME share price ($)
                                                                                                                                            NASDAQ Composite (rebased)
 Acquisition of Eyedentity: The company acquired Eyedentity games for
                                                                                                                                              YTD        1m        3m          12m
  US$95M, which will save the company from paying royalties on Dragon Nest.
                                                                                                                             Abs            -40.6%   11.2%     19.4%       -38.4%
  Additionally, this will also contribute some international revenues to Shanda
                                                                                                                             Rel            -56.1%     5.6%      7.2%      -54.9%
  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
     US$MM, YE-Dec           FY09 FY10E              FY11E      FY12E                                 FY09 FY10E FY11E FY12E
Net Sales                    703.3 655.8              727.8      825.4   ROE (%)                          81   38     28    26 52-Week range                           US$5.0-11.0
Operating Profit (EBIT)      253.8 193.7              217.1      253.6   ROIC (%)                         82   37     28    25 Shares Outstg                                288Mn
EBITDA                       298.1 234.8              261.9      305.5   Qtr GAAP EPS (US$)               1Q   2Q     3Q    4Q Avg daily value                            US$ 6Mn
Pre Tax Profit               282.4 229.5              251.2      294.6   EPS FY09                       1.13 1.33   1.58  1.54 Avg dly volume                                1.0Mn
Reported Net profit          212.6 180.6              187.2      220.0   EPS FY10E                      1.19 1.22   1.10  1.11 Index (NASD)                                   2,667
Reported EPS (US$)            0.75  0.62               0.62       0.72   EPS FY11E                      1.08 1.11   1.14  1.20 Free float                                     ~29%
P/E (x)                        8.4  10.2               10.2        8.8                                   1M   3M    12M        Dividend Yld (%)                                 0%
Adj. EPS *                    0.82  0.68               0.66       0.77   Abs. Perf.(%)                  11.1 13.7  -38.2       Market Cap                                US$1.82B
Adj. P/E (x)                   7.7   9.4                9.6        8.3   Rel. Perf.(%)                   6.0  1.5  -55.7       Price Target                                   US$8
EV/EBITDA                      5.7   7.3                6.5        5.6   Cash                            374  545    732   940 Price Date                              Dec 29, 2010
P/B (x)                        4.4   3.0                2.3        1.8   Equity                          413  616    803 1,023
Y/E BPS (US$)                  1.4   2.1                2.8        3.6
Source: Company reports, Bloomberg, J. P. Morgan estimates, Bloomberg. * Note: Excluding share-based compensation expense.
   Dick Wei                                       Global Equity Research
   (852) 2800-8535                                03 January 2011
   dick.x.wei@jpmorgan.com




                                                  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.



   DCF model (base case scenario)
                                        FY10E      FY11E     FY12E     FY13E     FY14E     FY15E     FY16E     FY17E     FY18E     FY19E     FY20E
   Sales growth                          -6.8%     11.0%     13.4%     12.0%     12.3%     11.7%     10.0%     10.0%      10.0%     10.0%     10.0%
   EBIT margin                          29.5%      29.8%     28.7%     28.4%     29.3%     29.4%     29.4%     28.9%      28.9%     28.9%     28.9%
   NOPAT margin                         22.6%      21.8%     22.5%     22.4%     22.4%     22.4%     21.7%     21.3%      21.3%     21.3%     21.3%
   Year-end net fixed assets turns         21.9       16.9      13.0      10.2       8.8       8.1      7.80      7.80      7.80      7.80      7.80
   Year-end net working capital turns    (79.9)     (68.0)    (78.2)    (76.9)    (82.0)    (86.5)    (82.5)    (82.5)   (82.50)   (82.50)   (82.50)
   Year-end net other assets turns          6.0        6.7       7.6       8.5       9.5      10.6      10.6      10.6     10.64     10.64     10.64
   Cash operating taxes as % of EBIT    23.4%      26.8%     26.7%     26.5%     26.2%     26.2%     26.2%     26.2%      26.2%     26.2%     26.2%
   Year-end Invested capital turns          5.0        5.2       5.1       4.9       4.9       4.8       4.8       4.8       4.8       4.8       4.8
   Source: J.P. Morgan estimates.




104 332
      Dick Wei                  Global Equity Research
      (852) 2800-8535           03 January 2011
      dick.x.wei@jpmorgan.com




                                DCF sensitivity analysis
                                                                                Terminal growth (%)
                                                                  0%     1%     2%        3%         4%     5%     6%     7%
                                               9.11%             12.3   12.8   13.5      14.4       15.7   17.6   20.7   26.8
                                              10.11%             11.0   11.3   11.8      12.4       13.2   14.3   16.0   18.7
                                              11.11%              9.9   10.1   10.5      10.9       11.4   12.1   13.1   14.5


                                WACC
                                              12.11%              9.0    9.2    9.4       9.7       10.1   10.5   11.1   12.0
                                              13.11%              8.2    8.4    8.6       8.8        9.0    9.3    9.7   10.3
                                              14.11%              7.6    7.7    7.9       8.0        8.2    8.4    8.7    9.0
                                              15.11%              7.1    7.2    7.3       7.4        7.5    7.7    7.9    8.1
                                Source: J.P. Morgan estimates.




105                                                                                                                      333
   Dick Wei                                                Global Equity Research
   (852) 2800-8535                                         03 January 2011
   dick.x.wei@jpmorgan.com




   Shanda Games: Summary of financials
   Income statement                                                                                      Ratio analysis
   US$ in millions, year-end December                                                                    %, year-end December
                                           FY08       FY09      FY10E      FY11E       FY12E                                                  FY08    FY09    FY10E    FY11E    FY12E
   Revenues                                  491        703        656         728        825            Gross Margin                          55.9    59.8     58.9    59.9     60.6
    Cost of Goods Sold                       216        283        270         291        325            EBITDA margin                         39.6    42.4     35.8    36.0     37.0
   Gross Profit                              274        420        386         436        500            Operating Margin                      34.3    36.1     29.5    29.8     30.7
    R&D Expenses                              35         50         66          79         90            Net Margin                            27.7    30.2     27.5    25.7     26.7
    SG&A Expenses                             71        117        126         140        157            R&D/sales                              7.1     7.1     10.1    10.9     10.9
    Share-based Expense                        3         18         15          14         14            SG&A/Sales                            14.6    16.6     19.2    19.2     19.0
   Operating Profit (EBIT)                   168        254        194         217        254
   EBITDA                                    194        298        235         262        305            Sales growth                          59.1    43.4     -6.8    11.0     13.4
    Interest Income, net                       5          4          8          12         16            Operating Profit Growth              102.6    51.0    -23.7    12.1     16.9
    Investment Income (Exp.)                   0          0          0           0          0            Net profit growth                     72.9    56.4    -15.0     3.6     17.5
    Other Income (Exp.)                        1         25         28          22         25            Diluted EPS growth                    72.9    54.9    -17.4    -0.8     16.9
   Earnings before tax                       174        282        230         251        295
    Tax                                       36         63         45          58         68
   Net Income (Reported)                     136        213        181         187        220            Net debt to total capital            -78.7   -89.7    -88.5    -91.2    -91.9
   Net Income (Adjusted) *                   139        231        196         201        234            Net debt to equity                   -78.7   -90.2    -88.5    -91.2    -91.9
   US$
   Diluted EPS (GAAP)                       0.49       0.75       0.62        0.62        0.72           Asset Turnover                       138.2   109.8     79.4    69.4     63.8
   Adj. Diluted EPS *                       0.50       0.82       0.67        0.66        0.77           Working Capital Turns (X)             10.0     3.9      1.6     1.2      1.0
   BPS                                       0.6        1.4        2.1         2.8         3.6           ROE                                   91.3    80.5     38.1    28.3     25.6
   DPS                                       0.0        0.0        0.0         0.0         0.0           ROIC                                  85.9    81.6     37.4    27.7     24.9
   Shares Outstanding (Mn)                  279        282        290         303         304

   Balance sheet                                                                                         Cash flow statement
   US$ in millions, year-end December                                                                    US$ in millions, year-end December
                                           FY08       FY09      FY10E      FY11E       FY12E                                                  FY08    FY09    FY10E    FY11E    FY12E
   Cash and cash equivalents                125        374        545        732          940            Net Income                            136     213      181      187      220
   Accounts receivable                       64         62         91        105          116            Depr. & Amortisation                   23      26        26      31       38
   Inventories                                0          0          0          0            0            Change in working capital              15       7       -33       6        5
   Others                                    40         46         48         56           62            Other                                  -7      25        19      19       20
   Current assets                           230        482        684        893        1,118            Cash flow from operations             166     271      192      244      283

   LT investments                              3          1          3           3          3            Capex / Investments                    -18    -61       -8      -44      -59
   Net fixed assets                           14         28         30          43         63            Others                                  -3      2       -2        0        0
   Other LT assets                           108        129        109         109        109            Cash flow from investing               -21    -59      -10      -44      -59
   Total assets                              355        641        826       1,048      1,294            Free cash flow                         148    210      184      199      225
   Liabilities                                                                                           Equity raised/ (repaid)                -52    168        9      -14      -14
   ST loans                                    0          2          0           0          0            Debt raised/ (repaid)                    0      2       -2        0        0
   Payables                                   14         14         14          16         18            Other                                  -63    -65      -10        1       -3
   Others                                    157        168        165         191        213            Dividends paid                           0    -78        0        0        0
   Total current liabilities                 171        185        180         208        230            Cash flow from financing              -115     28       -4      -12      -17
   Long term debt                              0          0          0           0          0
   Other liabilities                           4          6          4           4          4            Net change in cash                     39     249      171      187      208
   Total liabilities                         176        190        184         212        234            Beginning cash                         87     125      374      545      732
   Shareholders' equity                      159        413        616         803      1,023            Ending cash                           125     374      545      732      940
   Minority interests                         20         30         26          33         37
   Total Liabilities and Equity              355        633        826       1,048      1,294
   Source: Company data and J.P. Morgan estimates. *Note: Excluding share-based compensation expenses.




106 334
                                                                                                                                   Global Equity Research
                                                                                                                                   03 January 2011



 Shanda Interactive
                                                                                                                                   Overweight
 Entertainment Ltd                                                                                                                 SNDA, SNDA US
                                                                                                                                   Price: $39.60
 New Businesses Shaping Up Well But Stock Price Still
                                                                                                                                   Price Target: $47.00
 Hinges On Online Games

  We expect Shanda Interactive to continue investing in its Shanda Online and                                                     Internet
   Shanda Literature businesses in 2011. Still, we think the stock price will largely                                                             AC
                                                                                                                                   Dick Wei
   depend on the performance of its gaming business, Shanda Games.                                                                 (852) 2800-8535
                                                                                                                                   dick.x.wei@jpmorgan.com
  Good Shanda Online outlook: Shanda Online is an integrated service platform
                                                                                                                                   J.P. Morgan Securities (Asia Pacific) Limited
   providing total solutions to all kinds of accounts and application developers.
   The three core service modules are content delivery, promotion & payment, and                                                   Ritesh Gupta
   customer relationship management. Shanda Online is also working to include                                                      (91-22) 6157 3307
                                                                                                                                   ritesh.z.gupta@jpmorgan.com
   the systematic integration of users’ personal information, preferences,
   messages, relationships. There are a total of 72 third-party providers working                                                  J.P. Morgan India Private Limited

   with Shanda Online. We expect the segment to see good traction in 2011, as                                                      Imran Khan
   Shanda continues to improve its presence in this area.                                                                          (1-212) 622-6693
                                                                                                                                   imran.t.khan@jpmorgan.com
  Shanda Literature continues to see good traction: The Literature business                                                       J.P. Morgan Securities Inc.
   achieved solid sequential growth in 3Q10 by implementing its core strategy of
   establishing a complete copyright operation platform. In addition, Shanda                                                       Price Performance
   Literature (SDL) recently unveiled its Cloudary initiative, combining Shanda                                                        65

   Literature's rich IP library with the content from external parties. The Cloudary
                                                                                                                                   $ 50
   offers a massive online collection of literary works. It brings together over 70
   billion Chinese characters of literary content, 3 million copyrighted books and                                                     35

   more than 1000 electronic magazines and periodical publications. SDL                                                                  Dec-09   Mar-10   Jun-10   Sep-10    Dec-10

   currently works with more than 100 publishers for its Cloudary initiatives.                                                                    SNDA share price ($)
                                                                                                                                                  NASDAQ Composite (rebased)
   Bambook has also been a decent success for SDL.
                                                                                                                                                    YTD        1m        3m        12m
  2011 outlook: We maintain our Overweight rating on Shanda, given its low-                                                       Abs            -30.6%    -1.0%      2.5%    -23.4%
   valuation and high cash level. We maintain our view that: (1) Shanda Games’                                                     Rel            -46.1%    -6.6%     -9.7%    -39.9%
   potential success is in its new games, (2) potentials exist in Shanda Online, Ku6
   and other new ventures, and (3) the company continues to make synergetic
   investments to become a leading interactive entertainment provider in China,
   generating additional sources of revenues.
 Reuters: SNDA, Bloomberg: SNDA US
(US$MM, Y/E - Dec)        FY09     FY10E     FY11E FY12E                                       FY09     FY10E      FY11E      FY11E
 Net Sales                767.2     807.9     937.8 1,074.8 ROE (%)                             25.1        8.6        8.2       8.7 52-week range            US$36.3-59.9
 Operating profit         298.5     141.6     155.4 180.6 ROIC (%)                              22.5        7.7        7.6       8.1 Shares outstg.                   69M
 EBITDA                   367.1     226.2     246.0 287.0 Qtr GAAP Dil EPS (US$)                  1Q        2Q         3Q        4Q  Avg daily vol.                 0.23M
 Net Profit               233.1      91.5      92.8 109.2 EPS FY09                              1.02      1.18       1.27       1.40 Avg daily value             US$9.2M
 Reprtd. EPS (US$)         3.38      1.36      1.31    1.53 EPS FY10E                           0.90      0.56       0.51       0.53 Index (NASD)                    2,667
 P/E (x)                   11.7      29.2      30.2    25.9 EPS FY11E                           0.60      0.60       0.63       0.64 Free float                       49%
 Adj. EPS (US$) *          3.74      1.83      1.68    1.90                                       1M        3M       12M             Div yield (%)                     0%
 Adj. P/E (x)              10.6      21.6      23.5    20.9 Absolute perf. (%)                    0.4       3.6     -23.4            Market Cap                   US$2.7B
 EV/EBITDA                  6.5      10.6       9.7     8.4 Relative perf. (%)                   -4.8      -8.7     -40.8            Price target                  US$47
 P/B (x)                    1.6       1.5       1.5     1.4 Cash & Equiv. (US$ M)              1,912     2,030      2,227      2,446 Price date:              Dec 29, 2010
 Y/E BPS (US$)             24.5      26.6      27.1    28.8 Equity (US$ M)                     1,690     1,790      1,918      2,061
 Source: Company data, Bloomberg, J.P. Morgan estimates. * Note: We have included share-based compensation adjustments starting in 2006.
   Dick Wei                                       Global Equity Research
   (852) 2800-8535                                03 January 2011
   dick.x.wei@jpmorgan.com




                                                  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.


108 336
      Dick Wei                                                 Global Equity Research
      (852) 2800-8535                                          03 January 2011
      dick.x.wei@jpmorgan.com




                                                               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.

      DCF Model (Base Case Scenario)
                                                     FY10E       FY11E       FY12E       FY13E         FY14E      FY15E     FY16E     FY17E        FY18E        FY19E     FY20E
      Sales growth                                    5.3%       16.1%       14.6%       13.2%         12.7%      11.9%     12.0%     12.0%        12.0%        12.0%     12.0%
      EBIT margin                                    21.6%       19.4%       19.3%       18.9%         18.8%      18.9%     18.9%     18.9%        18.9%        18.9%     18.9%
      NOPAT margin                                   11.7%       14.7%       14.6%       14.3%         14.3%      14.3%     14.3%     14.3%        14.3%        14.3%     14.3%
      Year-end net fixed assets turns                  10.0        10.0        10.0        10.0          10.0       10.0      10.0      10.0         10.0         10.0      10.0
      Year-end net working capital turns               (4.0)       (4.0)       (4.0)       (4.0)         (4.0)      (4.0)     (4.0)     (4.0)        (4.0)        (4.0)     (4.0)
      Year-end net other assets turns                    2.5         2.5         2.5         2.5           2.5        2.5       2.5       2.5          2.5          2.5       2.5
      Cash operating taxes as % of EBIT              24.0%       24.0%       24.0%       24.0%         24.0%      24.0%     24.0%     24.0%        24.0%        24.0%     24.0%
      Year-end Invested capital turns                    4.0         4.0         4.0         4.0           4.0        4.0       4.0       4.0          4.0          4.0       4.0
      Source: Company data, J.P. Morgan estimates.



                                                               DCF Sensitivity Analysis
                                                                                                                        Terminal growth (%)
                                                                                                 0%         1%          2%        3%         4%           5%            6%            7%
                                                                               9.92%            67.3       70.1        73.6      78.1       84.1         92.5         105.2         126.7
                                                                              10.92%            61.4       63.4        65.9      69.0       73.0         78.4          86.0          97.4
                                                               WACC




                                                                              11.92%            56.6       58.1        59.9      62.1       64.9         68.5          73.3          80.1
                                                                              12.92%            52.6       53.7        55.1      56.7       58.7         61.2          64.5          68.8
                                                                              13.92%            49.3       50.2        51.2      52.4       53.9         55.7          57.9          60.8
                                                                              14.92%            46.5       47.1        47.9      48.9       50.0         51.3          52.9          54.9
                                                                              15.92%            44.1       44.6        45.2      45.9       46.8         47.8          48.9          50.4
                                                               Source: J.P. Morgan estimates.




109                                                                                                                                                                                  337
   Dick Wei                                                Global Equity Research
   (852) 2800-8535                                         03 January 2011
   dick.x.wei@jpmorgan.com




   Shanda: Summary of financials
   Income statement                                                                                      Ratio analysis
   US$ in millions, year-end December                                                                    %, year-end December
                                           FY08       FY09      FY10E      FY11E       FY12E                                                  FY08    FY09     FY10E    FY11E    FY12E
   Revenues                                  519        767        808         938      1,075            Gross Margin                         71.9     71.7      61.9    61.6     61.8
    Cost of Goods Sold                      146        217        308         360         411            EBITDA margin                        48.3     47.9      28.0    26.2     26.7
   Gross Profit                             374        550        500         577         664            Operating Margin                     40.4     38.9      17.5    16.6     16.8
    R&D Expenses                              40         61         91        103         118            Net Margin                           34.5     30.4      11.3     9.9     10.2
    SG&A Expenses                           124        191        267         319         365            R&D/sales                             7.7      8.0      11.2    11.0     11.0
   Operating Profit (EBIT)                  210        299        142         155         181            SG&A/Sales                           23.8     24.8      33.1    34.0     34.0
   EBITDA                                   251        367        226         246         287
    Interest Income                         10.5        2.0        3.5         0.0         0.0           Sales growth                          44.7    46.8       5.3    16.1     14.6
    Interest Expense                        -4.1       -8.2        0.0         0.0         0.0           Operating Profit Growth               43.4    41.4     -52.6     9.7     16.3
    Investment Income (Exp.)                 1.2        6.2        0.0         0.0         0.0           Net profit growth                    -11.7    29.2     -60.8     1.4     17.7
    Non-Operating Income (Exp.)              3.9       29.8       18.5        14.1        16.1           EPS (Reported) growth                 -2.1    36.4     -59.8    -3.3     16.5
   Earnings before tax                      221        328        164         169         197
    Tax                                      -40        -71        -47         -43         -49
   Net Income (Reported)                    179        233          91          93        109            Net debt to total capital            -67.3    -95.4    -96.8   -100.4   -103.8
   Net Income (Adjusted)                    187        258        124         119         136            Net debt to equity                   -84.8   -104.1   -105.0   -108.3   -111.4
   US$
   EPS (Reported)                           2.48       3.38       1.36        1.31        1.53           Asset Turnover                       55.2     32.4      32.4    34.4     36.2
   EPS (Adjusted)                           2.59       3.74       1.83        1.68        1.90           Working Capital Turns (X)             1.3      0.7       0.5     0.5      0.5
   BPS                                       7.7       24.5       26.6        27.1        28.8           ROE                                  34.9     25.1       8.6     8.2      8.7
   DPS                                       0.0        0.0        0.0         0.0         0.0           ROIC                                 29.9     22.5       7.7     7.6      8.1
   Shares Outstanding (Mn)                    72         67         65          69          69

   Balance sheet                                                                                         Cash flow statement
   US$ in millions, year-end December                                                                    US$ in millions, year-end December
                                           FY08       FY09      FY10E      FY11E       FY12E                                                  FY08    FY09     FY10E    FY11E    FY12E
   Cash and cash equivalents                619       1,912      2,030      2,227       2,446            Net Income                            179     233        91       93      109
   Accounts receivable                        5          17         19         22          24            Depr. & Amortisation                   33      44        52       64       80
   Inventories                                0           7          9         11          12            Change in working capital              39      59         -2      32       26
   Others                                    49          58         68         80          91            Other                                  10      49        58       60       65
   Current assets                           673       1,993      2,126      2,339       2,574            Cash flow from operations             261     384       199      250      280

   LT investments                             14         12         12          12         12            Capex/investments                     -33     -148      -46      -82      -94
   Net fixed assets                           45         70         64          81         95            Others                                -11        2        0        0        0
   Others                                    209        289        290         290        290            Cash flow from investing              -44     -146      -46      -82      -94
   Total assets                              941      2,366      2,492       2,722      2,971            Free cash flow                        228      236      153      168      186
   Liabilities                                                                                           Equity raised/ (repaid)                27      923      -24        8        8
   ST loans and payables                       0          2          0           0          0            Debt raised/ (repaid)                 146        7       -2        0        0
   Payables                                    8         15         24          28         30            Other                                -175      122       -9       21       25
   Others                                    182        261        265         310        348            Dividends paid                          0        0        0        0        0
   Total current liabilities                 190        279        288         338        379            Cash flow from financing               -2    1,051      -35       29       33
   Long term debt                            146        151        151         151        151
   Other liabilities                           6         11         35          35         35            Net change in cash                    215    1,290       118     197      219
   Total liabilities                         342        441        474         523        564            Beginning cash                        404      622     1,912   2,030    2,227
   Shanda Shareholders' equity               557      1,690      1,790       1,918      2,061            Ending cash                           619    1,912     2,030   2,227    2,446
   MI                                         42        234        227         282        346
   Total liabilities and Equity              941      2,366      2,492       2,722      2,971
   Source: Company data and J.P. Morgan estimates. *Note: Excluding share-based compensation expenses.




110 338
                                                                                                                                  Global Equity Research
                                                                                                                                  03 January 2011




                                                                                                                                  Neutral
Sina Corp                                                                                                                         SINA, SINA US
                                                                                                                                  Price: $70.31
Miniblog and Video Portal to Expand Portal
                                                                                                                                  Price Target: $68.00
Leadership. Remain Neutral on Valuation

 Sina to remain as the leading portal in China: We maintain our view that                                                        Internet
  Sina should continue to be the leading portal in China. Secular online                                                                            AC
                                                                                                                                  Dick Wei
  advertising growth and Sina’s leadership position should be positive drivers in                                                 (852) 2800-8535
  the long run. However, we also note media segregation leading to market share                                                   dick.x.wei@jpmorgan.com
  loss to other verticals, online videos, and social network sites.                                                               J.P. Morgan Securities (Asia Pacific) Limited

 Platform strategy playing out well: We believe video and microblogs should                                                      Ritesh Gupta
  continue to help maintain traffic share at Sina's portal. In terms of monetization,                                             (91-22) 6157 3307
                                                                                                                                  ritesh.z.gupta@jpmorgan.com
  we do not see much direct contribution from microblogs till end of next year.
                                                                                                                                  J.P. Morgan India Private Limited
 Sina to maintain leadership in microblogging: Sina continued to maintain its                                                    Imran Khan
  leadership in microblogging with the number of miniblog users surpassing 50M                                                    (1-212) 622-6693
  in 3Q10 vs. 20M last quarter. The company has been adding more than 10M                                                         imran.t.khan@jpmorgan.com
  users during the last two months. We expect Sina Miniblog to further solidify                                                   J.P. Morgan Securities LLC
  Sina’s media influences, and to help maintain long-term advertising revenue
  growth across both PC and mobile platforms.                                                                                     Price Performance


 Sina expects to monetize Miniblog through: (1) brand advertising and SME                                                             70
                                                                                                                                   $
  advertising, targeted by 2H11, and (2) revenue share from applications built                                                         50

  around microblog platform, targeted by 2012. Sina has set up an Rmb200M                                                              30
  Miniblog fund with venture capital from Sequoia, IDG, and DFJ to support                                                              Dec-09      Mar-10    Jun-10   Sep-10     Dec-10
  third-party developers to develop applications on SINA’s Miniblog platform.                                                                    SINA share price ($)
                                                                                                                                                 NASDAQ Composite (rebased)
 Video strategy: Sina won live broadcasting rights to NBA matches for the next                                                                       YTD         1m        3m         12m
  three years. NBA games are a popular sports event amongst Chinese youth and                                                     Abs               53.7%       7.9%    35.9%       57.2%
  should enhance the portal traffic from young users. The company also plans to                                                   Rel               38.2%       2.3%    23.7%       40.7%
  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
                             FY09 FY10E               FY11E       FY12E                                  FY09      FY10E      FY11E         FY12E
 Sales                     353.9   382.5              467.9       585.6     ROE (%)                     47.8        8.0        8.4          10.2         52-Week range          US$32.0-76.4
 Operating Profit (EBIT)    27.8    77.7              102.3       129.9     ROIC (%)                    42.6        6.9        7.5           9.2         Shares Outstg.                67Mn
 EBITDA                     81.9   114.3              140.7       173.9     Qtr GAAP EPS ($)             1Q         2Q         3Q            4Q          Avg. daily vol.              1.5Mn
 Pre Tax Profit            415.7    99.7              123.5       169.2     EPS FY09                    0.17       0.23       0.29          5.95         Avg. daily value          US$105M
 Reported Net profit       407.4    89.0              104.0       143.0     EPS FY10E                   0.30       0.31       0.40          0.34         Index (NASD)                  2,667
 Reported EPS (US$)         6.64    1.35               1.55        2.11     EPS FY11E                   0.23       0.36       0.44          0.51         Free float                     73%
 P/E (x)                    10.6    52.1               45.5        33.3                                  1M         3M        12M                        Dividend Yld (%)                0%
 Adjusted EPS               7.26    1.71               2.00        2.56     Abs. Perf.(%)               13.8       35.5       57.6                       Market Cap                 US$4.2B
 Adj. P/E (x)                9.7    41.1               35.1        27.4     Rel. Perf.(%)                8.7       23.3       40.1                       Price Target                US$68
 EV/EBITDA                  45.9    32.9               26.7        21.6                                                                                  Price date             Dec 29, 2010
 P/B (x)                     3.5     3.2                2.9         2.6     Cash                        746         615         693           784
 Y/E BPS (US$)              20.3    22.2               24.1        26.7     Equity                    1,222       1,361       1,491         1,663
Source: Company data, Bloomberg, J.P. Morgan estimates. Note: We have excluded quarterly revenue of US$4.7M related to CRIC IPO starting 4Q09.
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




                             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.



112 340
      Dick Wei                                       Global Equity Research
      (852) 2800-8535                                03 January 2011
      dick.x.wei@jpmorgan.com




                                                     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.


                                                     DCF sensitivity analysis
                                                                                                                  Terminal Growth (%)
                                                                                       0%           1%            2%        3%        4%                   5%          6%           7%
                                                                         9%           60.3        63.0        66.6          71.3         78.0         87.9      104.5          137.6
                                                                        10%           53.2         55.1         57.5         60.5         64.5         70.2           78.6         92.7
                                                     WACC




                                                                        11%           47.7         49.0         50.6         52.6         55.1         58.5           63.3         70.5
                                                                        12%           43.2         44.1         45.2         46.6         48.3         50.4           53.3         57.3
                                                                        13%           39.6         40.2         41.0         41.9         43.0         44.4           46.2         48.7
                                                                        14%           36.5         37.0         37.5         38.2         38.9         39.9           41.1         42.6
                                                                        15%           34.0         34.3         34.7         35.2         35.7         36.3           37.1         38.1
                                                     Source: J.P. Morgan estimates.




113                                                                                                                                                                                341
    Dick Wei                                                 Global Equity Research
    (852) 2800-8535                                          03 January 2011
    dick.x.wei@jpmorgan.com




    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
    Revenues                                   370        354         383        468         586         Gross Margin                      60.2      56.8      57.3      57.4      57.2
     Cost of Goods Sold                       147        153         163         199        250          EBITDA margin                     24.9      15.1      26.3      26.7      26.6
    Gross Profit                              223        201         219         268        335          Operating Margin                  20.2       9.2      20.3      21.9      22.2
     R&D Expenses                               28        30           31          36         47         Net Margin                        21.8     115.1      23.3      22.2      24.4
     SG&A Expenses                            118        135         107         129        157          R&D/sales                          7.7       8.4       8.2       7.7       8.0
    Operating Profit (EBIT)                     75        33           78        102        130          SG&A/Sales                        32.0      38.1      28.0      27.6      26.9
    EBITDA                                      92        53         101         125        156
     Interest Income                          17.7        8.1         8.3         7.0        9.6         Sales growth                      50.2      -4.2       8.1      22.3      25.2
     Interest Expense                            0          0           0           0          0         Operating Profit Growth           46.2     -56.4     139.0      31.6      27.0
     Investment Income (Exp.)                  0.0        0.0        13.7        14.2       29.8         Net profit growth                 39.7     405.2     -78.2      16.8      37.6
     Non-Operating Income (Exp.)               2.4      375.1         0.0         0.0        0.0         EPS (Reported) growth             37.9     397.8     -79.7      14.5      36.5
    Earnings before tax                         95       416         100         123        169
     Tax                                       -14         -8         -11         -20        -26                                         #DIV/0!   #DIV/0!   #DIV/0!   #DIV/0!   #DIV/0!
    Net Income (Reported)                       81       407           89        104        143          Net debt to total capital         -39.5     -49.0     -35.3     -37.4     -38.9
    Net Income (Adjusted) *                     94       445         113         134        174          Net debt to equity                -45.8     -53.0     -37.9     -39.9     -41.2
    US$
    EPS (Reported)                            1.33       6.64        1.35       1.55        2.11         Asset Turnover                    44.9      21.9      22.6      25.6      29.2
    EPS (Adjusted) *                          1.56       7.26        1.71       2.00        2.56         Working Capital Turns (X)          0.7       0.5       0.5       0.5       0.6
    BPS                                      11.10      20.29       22.16      24.12       26.72         ROE                               17.0      47.8       8.0       8.4      10.2
    DPS                                       0.00       0.00        0.00       0.00        0.00         ROIC                              12.3      42.6       6.9       7.5       9.2
    Shares Outstanding (Mn)                     56         54          61         62          62         ROIC (net of cash)                24.2      79.9      11.1      11.3      14.5

    Balance sheet                                                                                        Cash flow statement
    US$ in millions, year-end Dec          FY08A       FY09A      FY10E       FY11E      FY12E           US$ in millions, year-end Dec   FY08A     FY09A     FY10E     FY11E     FY12E
    Cash and cash equivalents                383         746        615          693        784          Net Income                         81       407         89      104       143
    Accounts receivable                       79          75         80          103        126          Depr. & Amortisation               17        21         23       22        26
    Short-term investments                   221          75        236          236        236          Change in working capital           5        22        -51        -7        -6
    Others                                     9          22         28           36         44          Other                              14        33         14       16        18
    Current assets                           692         919        958        1,068      1,189          Cash flow from operations         117       483         75      136       181

    LT investments                               0        581         633        661         721         Capex/investments                  -29        -5       -12       -20       -23
    Net fixed assets                            34         23          14         12          10         Others                             -14      -435      -213       -28       -60
    Others                                      96         91          89         88          87         Cash flow from investing           -43      -440      -225       -48       -82
    Total assets                               822      1,614       1,694      1,830       2,007         Free cash flow                      88       478        63       116       158

    Liabilities                                                                                          Equity raised/ (repaid)             10       -33        -3        10        11
    ST loans                                     0          0          0           0          0          Debt raised/ (repaid)                0         0         0         0         0
    Payables                                     1          2          6           8         10          Other                               27       353        21       -19       -19
    Others                                      94        123         78         101        124          Dividends paid                       0         0         0         0         0
    Total current liabilities                   95        125         85         110        134          Cash flow from financing            37       320        18        -9        -8
    Long term debt                              99         99         99          99         99
    Other liabilities                            8        168        149         130        112          Net change in cash                 112       363      -132        79        90
    Total liabilities                          202        392        333         339        345          Beginning cash                     272       383       746       615       693
    Shareholders' equity                       621       1222       1361        1491       1663          Ending cash                        383       746       615       693       784
  Source: Company data, J.P. Morgan estimates. * Note: We have included share-based compensation adjustments starting 2006.




114 342
                                                                                                                                  Global Equity Research
                                                                                                                                  03 January 2011




                                                                                                                                  Overweight
Sohu.Com                                                                                                                          SOHU, SOHU US
                                                                                                                                  Price: $65.76
Potential Upside from Ad Margin and Games to Drive
                                                                                                                                  Price Target: $89.00
Share Price

We maintain our Overweight rating on Sohu with a Dec-11 PT of US$89. We                                                           Internet
expect advertising margin expansion and upside from DMD to be share price                                                                         AC
                                                                                                                                  Dick Wei
drivers for the stock in 2011.                                                                                                    (852) 2800-8535
                                                                                                                                  dick.x.wei@jpmorgan.com
 Expect Sohu to maintain brand advertising market share: We expect Sohu                                                          J.P. Morgan Securities (Asia Pacific) Limited
  2011 brand revenue to grow by 19%. Increased video monetization should help
  overall brand advertising revenues for Sohu, in over view. We expect autos,                                                     Ritesh Gupta
                                                                                                                                  (91-22) 6157 3307
  fast-moving consumer goods, and eCommerce to be key segments to watch.                                                          ritesh.z.gupta@jpmorgan.com
  While real estate revenues should continue to be affected by new government
                                                                                                                                  J.P. Morgan India Private Limited
  policies and regulations, penetration into second-tier cities is likely to drive
  growth.                                                                                                                         Imran Khan
                                                                                                                                  (1-212) 622-6693
 2011 to experience margin expansion in online advertising: With a positive                                                      imran.t.khan@jpmorgan.com

  macro environment, we believe Sohu should see margin expansion on the back                                                      J.P. Morgan Securities LLC
  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                                                       Price Performance

  in 2011, as the company plans to reduce spending on video and begin to get                                                         80
  more traction from video advertising.                                                                                            $ 60


 Upside to come from online game business: Based on Street consensus,                                                               40

  Sohu’s game division (Changyou) currently trades at 8.3x ‘11 and 7.3x ’12 P/E.                                                        Dec-09    Mar-10   Jun-10    Sep-10    Dec-10

  We expect earnings upside could come from the launch of DMD (likely 1H’11),                                                                     SOHU share price ($)
                                                                                                                                                  NASDAQ Composite (rebased)
  while multiple expansion could come from re-rating of leading game companies
  given sustained long-term growth. At our PT, we assume the game segment                                                                           YTD        1m         3m        12m
  trades at 8.5x ‘11/’12 P/E.                                                                                                     Abs             13.5%    -10.9%       8.4%     14.9%
                                                                                                                                  Rel             -4.0%    -17.7%      -6.1%      -2.5%
 2011 stock price drivers: Earning upgrades potential may come from: (1)
  stronger trend in online video monetization; (2) launch of Duke of Mountain
  deer generates strong interest amongst online gamers. Re-rating could happen
  from the multiple expansion of the online gaming sector through sustained solid
  growth by online gaming companies in 2011.
Reuters: SOHU, Bloomberg: SOHU US
 US$MM, YE-Dec                  FY09     FY10E      FY11E     FY12E                                 FY09 FY10E FY11E FY12E
 Net Sales                      515.2     606.6      736.5     877.1   ROE (%)                       38.9  31.2    29.7    27.4 52-Week range                       US$40.1-80.9
 Operating Profit (EBIT)        204.4     223.0      268.6     322.7   ROIC (%)                      38.1  30.7    28.8    26.4 Shares Outstg                               38M
 EBITDA                         238.0     313.6      327.1     387.4   Qtr GAAP EPS (US$)             1Q    2Q      3Q      4Q Avg daily value                          US$55M
 Pre Tax Profit                 210.2     226.4      279.6     337.5   EPS FY09                      1.15  0.79    0.88    0.75 Avg dly volume                              1.2M
 Reported Net profit            147.8     144.3      197.0     237.5   EPS FY10E                     0.73  0.82    1.01    0.94 Index (NASD)                               2,667
 Reported EPS (US$)              3.57      3.49       4.64      5.51   EPS FY11E                     0.97  1.15    1.23    1.30 Free float                                  45%
 P/E (x)                         17.8      18.2       13.7      11.6                                  1M    3M     12M          Dividend Yld (%)                              0%
 Adj. EPS *                      3.99      4.13       5.39      6.28   Abs. Perf.(%)                -12.8   7.9    12.2         Market Cap                            US$2.41B
 Adj. P/E (x)                    16.0      15.4       11.8      10.1   Rel. Perf.(%)                -18.0  -4.4    -5.3         Price Target                             US$89
 EV/EBITDA                        9.0       6.8        6.5       5.5   Cash                         563.8 651.3 889.0 1,163.7 Price Date                            Dec 29, 2010
 P/B (x)                          4.1       3.2        2.5       2.0   Equity                       609.8 799.5 1,048.5 1,341.2
Source: Company data, Bloomberg, J.P. Morgan estimates. * Note: We have included share-based compensation expense adjustments starting in 2006.
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




                             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.
116 344
      Dick Wei                                                 Global Equity Research
      (852) 2800-8535                                          03 January 2011
      dick.x.wei@jpmorgan.com




                                                               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     Multiple (x)         Value           Multiple (x)       Value
                                                                                                            (US$M)                               (US$M)                             (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.


                                                               DCF Sensitivity Analysis
                                                                                                                         Terminal Growth (%)
                                                                                                  0%         1%          2%        3%         4%                 5%           6%             7%
                                                                              10.00%            107.6      113.4       120.5     129.7     142.0               159.2        185.0          228.0
                                                                              11.00%             93.0       97.0       102.1     108.3     116.4               127.1        142.1          164.7
                                                                              12.00%             81.1       84.1        87.6      92.0       97.5              104.5        113.9          127.0
                                                               WACC




                                                                              13.00%             71.3       73.5        76.1      79.3       83.1               87.9         94.0          102.2
                                                                              14.00%             63.2       64.9        66.8      69.1       71.8               75.1         79.3           84.7
                                                                              15.00%             56.4       57.6        59.1      60.8       62.7               65.1         68.0           71.7
                                                                              16.00%             50.6       51.6        52.6      53.9       55.4               57.1         59.2           61.7
                                                               Source: J.P. Morgan estimates.




117                                                                                                                                                                                         345
   Dick Wei                                                  Global Equity Research
   (852) 2800-8535                                           03 January 2011
   dick.x.wei@jpmorgan.com




   Sohu.com: Summary of financials
   US$ in millions, year-end December
   Income statement                                                                                      Ratio Analysis
                                          FY08A        FY09A      FY10E       FY11E      FY12E           %                           FY08A    FY09A    FY10E    FY11E    FY12E
   Revenues                                  429          515         607        737        877          Gross Margin                 75.3     76.3      74.0    73.1     73.4
    Cost of Goods Sold                       106          122        158        198         233          EBITDA margin                44.0     46.2      51.7    44.4     44.2
   Gross Profit                              323          393        449        539         644          Operating Margin             38.2     39.7      36.8    36.5     36.8
    R&D Expenses                              43           48          62         67          89         Net Margin                   37.0     28.7      23.8    26.7     27.1
    SG&A Expenses                            115          140        164        203         233          R&D/sales                    10.0      9.4      10.2     9.1     10.1
   Operating Profit (EBIT)                   164          204        223        269         323          SG&A/Sales                   26.9     27.2      27.0    27.5     26.5
   EBITDA                                    189          238        314        327         387
    Interest Income                           4.3         5.0         4.7       11.0        14.8         Sales growth                127.1      20.1     17.7    21.4     19.1
    Interest Expense                            0           0           0          0           0         Operating Profit Growth     400.9      24.7      9.1    20.4     20.2
    Investment Income (Exp.)                  0.0         0.0         0.0        0.0         0.0         Net profit growth           354.1      -6.8     -2.4    36.5     20.6
    Non-Operating Income (Exp.)              -0.5         0.8        -1.3        0.0         0.0         EPS (Reported) growth       345.6     -11.7     -2.3    32.9     18.6
   Earnings before tax                       168          210        226        280         337
    Tax                                        -9         -34         -34        -37         -45
   Net Income (Reported)                     159          148        144        197         238          Net debt to total capital    -81.5    -92.5    -81.5    -84.8    -86.8
   Net Income (Adjusted)*                    169          162        160        216         256          Net debt to equity           -81.5    -92.5    -81.5    -84.8    -86.8
   USD
   EPS (Reported)                           4.04         3.57        3.49       4.64       5.51          Asset Turnover               82.2     62.2      55.3    53.3     51.3
   EPS (Adjusted)*                          4.30         3.99        4.13       5.39       6.28          Working Capital Turns (X)     2.6      1.4       1.2     1.1      1.0
   BPS                                     10.13        15.68       20.14      25.89      32.48          ROE                          56.0     38.9      31.2    29.7     27.4
   DPS                                      0.00         0.00        0.00       0.00       0.00          ROIC                         54.8     38.1      30.7    28.8     26.4
   Diluted Shares (Mn)                        39           39          39         40         41

   Balance sheet                                                                                         Cash flow statement
                                          FY08A        FY09A      FY10E       FY11E      FY12E                                       FY08A    FY09A    FY10E    FY11E    FY12E
   Cash and cash equivalents                314          564        651          889      1,164          Net Income                    159      148      144      197      238
   Accounts receivable                       37           47         51           61         71          Depr. & Amortisation           14       16       63       26       30
   Inventories                                0            0          0            0          0          Change in working capital      29       27        -4      18       17
   Others                                    28           11         42           50         58          Other                          11       46       76       78       90
   Current assets                           379          621        744        1,001      1,293          Cash flow from operations     213      237      280      318      375

   LT investments                              0            0           0          0          0          Capex                         -24      -80      -209     -55      -66
   Net fixed assets                           76          115         125        154        189          Disposal/ (purchase)            0        0         0       0        0
   Others                                     67           92         228        228        228          Cash flow from investing      -24      -80      -209     -55      -66
   Total assets                              522          828       1,097      1,382      1,710          Free cash flow                189      156        71     263      309

   Liabilities                                                                                           Equity raised/ (repaid)         -2      59       18       19       21
   ST loans                                    0            0           0          0          0          Debt raised/ (repaid)            0       0        0        0        0
   Payables                                    4            5           7          8          9          Other                            5      34       -1      -45      -55
   Others                                    126          146         176        211        245          Dividends paid                   0       0        0        0        0
   Total current liabilities                 131          150         182        218        254          Cash flow from financing         3      93       17      -26      -34
   Long term debt                              0            0           0          0          0
   Other liabilities                           5           68         115        115        115          Net change in cash            192      249       87      238      275
   Total liabilities                         136          218         297        334        369          Beginning cash                123      314      564      651      889
   Shareholders' equity                      386          610         799      1,048      1,341          Ending cash                   314      564      651      889    1,164
   Source: Company data, J.P. Morgan estimates.     * Adjustments: excluding stock based compensation expense




118 346
                                                                                                                         Global Equity Research
                                                                                                                         03 January 2011




                                                                                                                         Overweight
Tencent                                                                                                                  0700.HK, 700 HK
                                                                                                                         Price: HK$178.00
To Maintain Its Leadership Position in China Internet
                                                                                                                         Price Target: HK$205.00
Space

We expect Tencent to continue maintaining its leadership position in China’s                                             Internet
internet space in 2011. New revenue from open platform applications, social                                                              AC
                                                                                                                         Dick Wei
eCommerce, mobile platform launch, and a new game pipeline could be some of
                                                                                                                         (852) 2800-8535
the drivers for 2011. We remain Overweight with a Dec-11 PT of HK$205.                                                   dick.x.wei@jpmorgan.com

                                                                                                                         Ritesh Gupta
• Expect Tencent to Maintain its Leadership in China internet: Tencent has                                               (91-22) 6157 3307
  established itself as a leading internet platform in China with its leadership in                                      ritesh.z.gupta@jpmorgan.com
  social networking, online gaming, instant messaging, and online and wireless                                           J.P. Morgan Securities (Asia Pacific) Limited
  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                                        P r ic e P e r fo r m a n c e
  certain extent, online search. As a well-executed leader in China’s internet
                                                                                                                                180
  space, Tencent is likely to remain a key beneficiary of rising disposable
                                                                                                                          HK$ 150
  incomes and increasing internet penetration in China.
                                                                                                                                120
• Open Platform to Be a Key Focus: The company has already created open                                                            Dec-09     Mar-10     Jun-10   Sep-10   Dec-10
  platform interfaces for four key products: (1) social networks, (2) SoSo, (3)
                                                                                                                                             0700.HK share price (HK$)
  Paipai, and (4) Tenpay. The strategy is to increase user loyalty to Tencent’s                                                              HSI (rebased)
  community and eventually increase monetization. Tencent plans to upgrade                                                                   YTD          1m         3m        12m
  “Xiaoyou” to “PengYou” with better open-platform support.                                                              Abs                2.8%         0.5%      2.5%       7.4%
                                                                                                                         Rel                -2.5%        1.4%     -0.1%       0.6%
• 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.
Reuters: 0700.HK, Bloomberg: 700 HK
Rmb MM, YE December             FY09 FY10E FY11E FY12E                                               FY09 FY10E FY11E FY12E
Net sales                       12,440 19,540 25,018 31,429 ROE (%)                                      54     51     43     37 52-week range                     HK$120.4-193.0
Operating profit (EBIT)          6,020  9,803 12,094 15,246 ROIC (%)                                     56     47     37     33 Shares outstg                          1,851MM
EBITDA                           6,801 10,840 13,489 16,839 Qtr GAAP EPS (Rmb)                           1Q     2Q     3Q     4Q Avg daily value                      US$ 114MM
Net Profit                       5,156  8,130 10,589 13,479 EPS FY09                                   0.57   0.65   0.77   0.81 Avg dly volume                            4.5MM
Adj. Net Profit                  5,477  8,601 11,069 13,950 EPS FY10E                                  0.96   1.03   1.16   1.22 Index (HSI)                               22,969
Reported EPS (Rmb)                2.79   4.37   5.63   7.10 EPS FY11E                                  1.27   1.36   1.46   1.54 Free float                                 ~50%
P/E (x)                           54.3   34.7   26.9   21.4                                             1M      3M   12M         Dividend yld (%)                            0.3%
Adj. EPS (Rmb) *                  2.97   4.62   5.88   7.34 Abs. Perf.(%)                               0.5     2.5   7.7        Market cap                            US$41.2B
Adj. P/E (x)                      51.1   32.8   25.8   20.6 Rel. Perf.(%)                               1.3    -0.1   0.8        Price target                            HK$205
EV/EBITDA                         39.1   24.5   19.7   15.8 Cash                                     11,354 19,066 30,270 44,212 Date of price                       Dec 29, 2010
P/BV (x)                          25.7   16.2   10.6    7.4 Equity                                   12,179 19,473 30,149 43,497
YE BPS (Rmb)                       6.7   10.6   16.3   23.3
Source: Company data, Bloomberg, J.P. Morgan estimates. * Note: Excluding share-based compensation expenses.
   Dick Wei                     Global Equity Research
   (852) 2800-8535              03 January 2011
   dick.x.wei@jpmorgan.com




                                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.

   By leveraging its strong     The company is increasingly open to the idea of investing in small third-party
   Qzone/QQ user base, the      developers focusing on developing applications for Qzone platform. In addition,
   company creates a strong
   ecosystem with third-party
                                Tencent has been expanding its technology infrastructure to host more social
   content.                     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.




120 348
      Dick Wei                                                 Global Equity Research
      (852) 2800-8535                                          03 January 2011
      dick.x.wei@jpmorgan.com




      Tencent: Summary of financials
      Rmb in millions, year-end December
      Income statement                                                                                     Ratio analysis
                                               FY08       FY09      FY10E      FY11E      FY12E            %, year-end December                     FY08     FY09    FY10E    FY11E    FY12E

      Revenues                                 7,155    12,440      19,540     25,018     31,429           Gross Margin                              69.7     68.7     68.2     68.5     68.6
       Cost of goods sold                      2,170     3,889       6,205      7,892      9,860           EBITDA margin                             51.1     54.7     55.5     53.9     53.6
      Gross profit                             4,984     8,550      13,335     17,126     21,568           Operating Margin                          43.8     47.8     49.2     48.3     48.5
       R&D expenses                              518       581         914      1,001      1,257           Net Margin                                38.9     41.4     41.6     42.3     42.9
       SG&A expenses                           1,332     2,026       2,809      4,031      5,065           R&D/sales                                  7.2      4.7      4.7      4.0      4.0
       Others                                      0          0           0         0          0           SG&A/Sales                                18.6     16.3     14.4     16.1     16.1
      Operating profit (EBIT)                  3,134     5,943       9,612     12,094     15,246
      EBITDA                                   3,654     6,801      10,840     13,489     16,839           Sales growth                              87.2     73.9     57.1     28.0     25.6
       Interest income                           112        78         278        468        714           Operating Profit Growth                  100.1     89.6     61.7     25.8     26.1
       Investment income (exp.)                  0.0        0.0         0.0       0.0        0.0           Net profit growth                         77.8     85.2     57.7     30.3     27.3
       Non-operating income (exp.)            -140.7       -2.0        -1.1       0.0        0.0           EPS (Reported) growth                     77.1     84.8     56.3     28.8     26.1
      Earnings before tax                      3,105     6,019       9,889     12,562     15,961
       Tax                                      -289      -819      -1,742     -1,956     -2,465
      Net income (reported)                    2,785     5,156       8,130     10,589     13,479           Net debt to total capital                -73.0    -90.1    -65.3    -77.8    -85.3
      Net income (adjusted)                    2,945     5,477       8,601     11,069     13,950           Net debt to equity                       -73.0    -91.6    -78.2    -87.7    -92.8
      Rmb
      EPS (Reported)                           1.51        2.79       4.37       5.63        7.10          Asset Turnover                            72.6     71.1     63.6     58.0     53.6
      EPS (Adjusted)                           1.60        2.97       4.62       5.88        7.34          Working Capital Turns (X)                  1.9      1.9      1.9      1.5      1.1
      BPS                                      3.88        6.73      10.65      16.30       23.27          ROE                                       45.6     53.7     51.4     42.7     36.6
      DPS                                      0.14        0.35       0.45       0.58        0.73          ROIC                                      45.6     55.8     46.9     37.2     32.8
      Diluted shares outstanding (MM)         1,841       1,845      1,861      1,882       1,900


      Balance sheet                                                                                        Cash flow statement
                                               FY08       FY09      FY10E      FY11E      FY12E                                                     FY08     FY09    FY10E    FY11E    FY12E

      Total cash                              5,129     11,354      19,066     30,270     44,212           Net income                               2,785    5,156    8,130   10,589   13,479
      Accounts receivable                       983      1,229       1,910      2,401      3,001           Depr. & amortization                       360      537      756      915    1,121
      Inventories                                 5          0           0          0          0           Change in working capital                  202    1,833      804      885    1,041
      Others                                    378        574       1,465      1,817      2,274           Other                                      233      365      490      497      488
      Current assets                          6,496     13,157      22,440     34,488     49,486           Cash flow from operations                3,580    7,891   10,180   12,885   16,129

      LT investments                            389        972       3,246      3,246      3,246           Capex                                   -1,705     -943   -2,437   -1,272   -1,568
      Net fixed assets                        2,041      2,623       3,480      3,837      4,283           Others                                    -810     -584   -2,274        0        0
      Others                                    930        753       1,577      1,577      1,577           Cash flow from investing                -2,515   -1,526   -4,711   -1,272   -1,568
      Total assets                            9,856     17,506      30,744     43,148     58,593           Free cash flow                           1,875    6,949    7,742   11,614   14,561
                                                                                                           Equity raised/ (repaid)                   -301      255      124      666      746
      Liabilities                                 0         202      3,838      3,838      3,838           Debt raised/ (repaid)                     -292      202    3,636        0        0
      ST loans                                  245         697      1,318      1,652      2,048           Other                                      -19       43     -704      -17      -17
      Payables                                1,847       3,664      5,418      6,813      8,514           Dividends paid                            -258     -639     -813   -1,059   -1,348
      Others                                  2,092       4,563     10,574     12,303     14,400           Cash flow from financing                  -870     -140    2,243     -410     -619
      Total current liabilities                                                                                                                       -76        0        0        0        0
      Long term debt                              0          0           0          0          0           Net change in cash                         119    6,225    7,712   11,204   13,942
      Other liabilities                         743        764         697        697        697           F/X & term deposits change               1,190        0        0        0        0
      Total liabilities                       2,835      5,327      11,271     13,000     15,096           Beginning total cash                     3,820    5,129   11,354   19,066   30,270
      Shareholders' equity                    7,021     12,179      19,473     30,149     43,497           Ending total cash                        5,129   11,354   19,066   30,270   44,212

      Source: Company data and J.P. Morgan estimates. *Note: Adjusted earnings exclude share-based compensation expense (non-cash) and one-time items.




121                                                                                                                                                                           349
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




122 350
                                                                                                                                    Global Equity Research
                                                                                                                                    03 January 2011




                                                                                                                                    Neutral
 The9 Limited                                                                                                                       NCTY, NCTY US
                                                                                                                                    Price: $5.05
 New Three-legged Strategy But Still Lacks a Strong
                                                                                                                                    Price Target: $6.10
 Game

 We expect weak operating performance for the company to continue in                                                                Internet
 2011. Our Dec-11 PT of US$6.1 is at a 20% discount to year-end 2011                                                                Dick Wei
                                                                                                                                               AC
 estimated cash per share.                                                                                                          (852) 2800-8535
                                                                                                                                    dick.x.wei@jpmorgan.com
  Company has restructured into three divisions: (1) Global strategy:                                                              J.P. Morgan Securities (Asia Pacific) Limited
   Mainly based on R&D capability of Red 5 studio and other future
                                                                                                                                    Ritesh Gupta
   investments. Red 5 studio is led by an ex-World of Warcraft developer from                                                       (91-22) 6157 3307
   Blizzard. (2) Domestic strategy: Maintain in-house and licensing strategy.                                                       ritesh.z.gupta@jpmorgan.com
   Currently, the company has an R&D staff of 300 for in-house development.                                                         J.P. Morgan India Private Limited
   (3) Alternative platform strategy: Mobile game/mobile game platform.
                                                                                                                                    Imran Khan
   The acquisition of minority stakes in Aurora Feint (an iPhone game
                                                                                                                                    (1-212) 622-6693
   platform with 28M registered users and 2,220 games) to help jump-start                                                           imran.t.khan@jpmorgan.com
   The9’s mobile game business in China.
                                                                                                                                    J.P. Morgan Securities Inc.
  Mobile gaming platform: The company has been trying to develop a
                                                                                                                                    Price Performance
   mobile gaming platform along with three telco carriers in China. The
                                                                                                                                      9
   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                                                                $ 6
   Openfeint previously for a 13% stake.
                                                                                                                                      3
  Disclosed game pipeline includes: (1) 1Q11: Shen Xian Zhuan (in-house                                                              Dec-09   Mar-10   Jun-10     Sep-10    Dec-10

   game from Hang Zhou studio), (2) Free Realms (a cartoon-style MMORPG                                                                        NCTY share price ($)
   licensed from Sony) to be launched in 2H11, and (3) Red 5, a subsidiary of                                                                  NASDAQ Composite (rebased)

   The9 is also releasing a FPS game named Firefall in October 2011. The                                                                          YTD        1m         3m        12m
   company terminated its online game FIFA Online from EA Sports recently.                                                          Abs         -9.8%      1.1%     24.0%       -7.7%
   The game was generating losses for the company.                                                                                  Rel        -27.3%      -5.7%      9.5%    -25.1%

  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$9.0 per share. We do not expect
   strong results from Shen Xian Zhuan launch by the end of 2010. As such, we
   believe the company still lacks share price drivers. Potential drivers could
   come from successes in handset games and Red 5 game.
 Reuters: NCTY; Bloomberg: NCTY US
(US$ MM, Y/E-Dec)        FY08      FY09 FY10E FY11E                                         FY08       FY09     FY10E     FY11E
 Sales                   249.1     111.5  15.5  19.7 ROE (%)                                  6.3      -13.9     -12.9     -12.6      52-wk range (US$)           3.7-8.7
 Operating profit         19.6     -70.8 -42.7 -37.9 ROIC (%)                                 4.5      -14.4     -13.0     -11.9      Shares outstg (MM)            25Mn
 EBITDA                   60.7     -33.1 -27.4 -22.7 Qtr Diluted EPS (US$)                    1Q         2Q        3Q        4Q       Avg daily volume             0.1Mn
 Pre-tax profit           24.7     -57.6 -41.0 -35.5 EPS FY09                               -0.26      -0.46     -0.43     -1.20      Avg daily value          US$0.4Mn
 Reported Net Profit      14.1     -59.4 -38.8 -35.5 EPS FY10E                              -0.44      -0.38     -0.36     -0.35      Index (NASD)                  2,667
 GAAP EPS (US$)           0.51     -2.34 -1.53 -1.38 EPS FY11E                              -0.35      -0.35     -0.34     -0.34      Free float (%)                 25%
 P/E (x)                  13.5       nm    nm    nm                                           1M         3M       12M                 Dividend yld (%)                 0%
 Adj. EPS (US$)           0.78     -1.99 -1.33 -1.21 Abs. Perf.(%)                           -1.7       35.5      -2.8                Market cap (US$)              0.17B
 Adj. P/E (x)              8.7       nm    nm    nm Rel. Perf.(%)                            -6.9       23.3     -20.3                Price target (US$)          US$6.1
 EV/EBITDA                -1.2       2.3   2.7   3.3                                                                                  Price Date             Dec 29, 2010
 P/B (x)                   0.5       0.6   0.7   0.7 Cash (US$ MM)                          323.2     245.5      215.4      192.8
 Y/E BPS (US$)            14.3      11.8  10.4   9.2 Equity (US$ MM)                        395.8     294.8      261.5      232.5
 Source: Bloomberg, Company and J.P.Morgan estimates. Note: We have included share-based compensation adjustments starting 2006.
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




                             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).




124 352
      Dick Wei                                             Global Equity Research
      (852) 2800-8535                                      03 January 2011
      dick.x.wei@jpmorgan.com




      The9: Summary of financials
      Income statement                                                                       Ratio analysis
      Rmb in millions, year-end December                                                     %, year-end December
                                              FY07     FY08     FY09    FY10E     FY11E                                           FY07    FY08    FY09     FY10E    FY11E
      Revenues                                                                               Gross Margin
                                             1,280     1,711     761      106        134                                           45.3    41.7      6.3     -1.6     10.2
        Cost of Goods Sold                                                                   EBITDA margin
                                                700      998     712       108        120                                          35.0    21.3    -40.6   -209.2   -138.1
      Gross Profit                              580      714      48         -2        14    Operating Margin                      18.4     7.9    -63.5   -274.5   -192.6
       R&D Expenses                              41       74     114       121        104    Net Margin                            18.8     5.7    -53.3   -249.8   -180.6
       SG&A Expenses                            284      423     338       169        168    R&D/sales                              3.2     4.3     15.0    113.6     77.5
      Operating Profit (EBIT)                   236      135    -483      -291       -258    SG&A/Sales                            22.2    24.7     44.4    159.3    125.4
      EBITDA                                    448      365    -308      -222       -185
       Interest Income                         50.7     56.7    30.5      24.7       23.8    Sales growth                          29.8    33.8    -55.6    -86.1     26.5
       Interest Expense                         0.0      0.0      0.0       0.0        0.0   Operating Profit Growth              -12.7   -43.0   -458.9     39.7     11.3
       Investment Income (Exp.)                -5.7     -2.2     -2.6      -8.2       -3.6   Net profit growth                    -22.9   -59.8   -518.4     34.6      8.6
       Non-Operating Income (Exp.)            -30.1    -19.0    61.8       -5.0       -4.0   EPS (Reported) growth                -31.8   -60.2   -556.1     32.1     11.0
      Earnings before tax                       251      170    -393      -280       -242
       Tax                                       -9      -48        6         0          0
      Net Income (Reported)                     241       97    -405      -265       -242    Net debt to total capital            -72.4   -73.4    -79.6    -60.0    -58.1
      Adj. Net Income (ex-123R exp.)            289      149    -346      -230       -212    Net debt to equity                   -75.1   -76.9    -81.2    -68.4    -67.2
      RMB:
      Diluted EPS (Reported)                  8.71      3.50   -15.95   -10.45      -9.41    Asset Turnover                        39.4    52.5     32.7      4.4      6.0
      Adj. EPS (ex-123R exp.)                10.44      5.38   -13.61    -9.08      -8.22    Working Capital Turns (X)              0.9     0.9      0.4      0.1      0.1
      BPS                                    97.56     98.42    80.33    71.01      62.95    ROE                                   14.0     6.3    -13.9    -12.9    -12.6
      DPS                                     0.00      0.00     0.00     0.00       0.00    ROIC                                  11.6     4.5    -14.4    -13.0    -11.9
      Shares outstanding (MM)                   27        28       26       25         25    ROIC (net of cash)                    44.0    19.4    -69.9    -54.9    -41.0

      Balance sheet                                                                          Cash flow statement
      Rmb in millions, year-end December                                                     Rmb in millions, year-end December
                                             FY07      FY08    FY09     FY10E     FY11E                                           FY07    FY08    FY09     FY10E    FY11E
      Cash and cash equivalents              2,215     2,221   1,675     1,469     1,315     Net Income                            241      97     -405      -265     -242
      Accounts receivable                       27         9       2         2         3     Depr. & Amortization                  212     230      174        69       73
      Inventories                              101       126     126       182       208     Change in working capital              31       7        1        11       23
      Others                                    72       139       0         0         0     Other                                  49      77      160        20       31
      Current assets                         2,415     2,494   1,803     1,653     1,526     Cash flow from operations             533     412      -69      -165     -116

      LT investments                           179       403     395       408        404    Capex / investment                    -362     -46     -71      -271      -56
      Net fixed assets                         344       200      76        60         35    Others                                -144    -122      60       -13        4
      Others                                   307       166      52       269        277    Cash flow from investing              -506    -168     -11      -284      -53
      Total assets                           3,246     3,263   2,325     2,390      2,242    Free cash flow                         171     365    -140      -435     -172
      Liabilities                                                                            Equity raised/ (repaid)              1,229    -138    -115         3       14
      ST loans                                 107       129      41         0          0    Debt raised/ (repaid)                   70      23     -88       208        0
      Payables                                 285       345      22        30         35    Other                                  -49    -123    -262        32        0
      Others                                    48        69     248       307        352    Dividends paid                           0       0       0         0        0
      Total current liabilities                440       544     312       337        387    Cash flow from financing             1,250    -238    -466       243       14
      Long term debt                             0         0       0       249        249
      Other liabilities                          0         0       2        20         20    Net change in cash                   1,277       5    -546      -206     -154
      Total liabilities                        440       544     314       607        656    Beginning cash                         938   2,215   2,221     1,675    1,469
      Shareholders' equity                   2,806     2,719   2,011     1,784      1,586    Ending cash                          2,215   2,221   1,675     1,469    1,315
      Source: Company data and J.P.Morgan estimates.




125                                                                                                                                                         353
   Dick Wei                  Global Equity Research
   (852) 2800-8535           03 January 2011
   dick.x.wei@jpmorgan.com




126 354
                                                                                                                                  Japan Equity Research
                                                                                                                                  03 January 2011




                                                                                                                                  Underweight
DeNA (2432)                                                                                                                       2432.T, 2432 JT




                                                                                                                                                                                            Japan
                                                                                                                                  Price: ¥2,954
Domestic Growth Peaking, Competitive Pressures
                                                                                                                                  Price Target: ¥2,200
Overseas

We are maintaining our Underweight rating on DeNA, with a target price of                                                         Internet
¥2,200 to November 2011. We believe domestic growth prospects have peaked,                                                                                  AC
and consequently we expect returns to fall due to greater competition and pressure                                                Hiroshi Kamide
                                                                                                                                  (81-3) 6736 8602
to spend on marketing to keep market share. We have low expectations for                                                          hiroshi.kamide@jpmorgan.com
DeNA’s plans for overseas expansion and believe that these efforts will not offset
the declining domestic growth profile.                                                                                            Yusuke Maeda
                                                                                                                                  (81-3) 6736-8654
 We maintain our Underweight rating. We view DeNA as being in the 'early                                                         yusuke.x.maeda@jpmorgan.com

  glory' phase of the mobile social gaming market cycle, as it dominates the                                                      JPMorgan Securities Japan Co., Ltd.
  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                                                      Price Performance

  decelerating Y/Y growth profile looks unattractive. Overseas expansion via
                                                                                                                                      2,800
  M&A does position the company strongly versus domestic peers, but we                                                            Y
  believe competitive threats are also high as the market overcrowds. Overall, we                                                     2,200

  believe medium-term growth prospects are muted as domestic demand enters a                                                          1,600

  declining profile, with measured advances to be gained overseas. With the                                                               Dec-09   Mar-10    Jun-10      Sep-10   Dec-10

  business exiting a high-growth phase and entering a flattening growth profile in                                                                   2432.T share price (Y
  our view, we rate the shares Underweight.                                                                                                          TOPIX (rebased)

                                                                                                                                  Company Data
 Domestic prospects diminishing, overseas competitive threats. Mobile social
                                                                                                                                  Price                                        ¥2,954
  gaming is a new developing market, and the supply/demand balance is still in                                                    Price date                            Dec. 29, 2010
  favor of early movers with hit content. Social gaming content has the advantage                                                 Market capitalization                      ¥420.7B
  of being able to be changed and adjusted 'on the go' in order to meet user needs                                                Shares outstanding                          142.4M
                                                                                                                                  52-week range                         ¥3,105– 1,680
  and can have a long shelf life compared with traditional package software.                                                      TOPIX                                        908.01
  However, with more games on the market we think the business model will                                                         Dividend (F’10E)                              ¥46.5
  become more reliant on winning new users and keeping them active—we                                                             Dividend yield (F’10E)                         1.6%
  believe marketing costs will rise, resulting in lower returns. As we think the                                                  ROE (F’10E)                                   63.9%
  domestic market is unlikely to see a reacceleration of demand, positioning in the                                               Source: Bloomberg, J.P. Morgan estimates.
  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           17.1
2011E                       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.
   Hiroshi Kamide                     Global Equity Research
   (81-3) 6736 8602                   03 January 2011
   hiroshi.kamide@jpmorgan.com




                                      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:

   Growth in domestic market has      • We believe growth rates for their domestic SNS operation has peaked, and
   peaked                                unlikely to reaccelerate hereon in.
   Cost increases via marketing       • Domestic ARPU levels are currently high, and we believe they are overreaching
   lowering margins, in order to         realistic levels of sustainability. With registered user growth slowing Y/Y, there
   maintain sales volume
                                         is pressure on sales volume expansion and associated marketing costs (user
                                         acquisition costs) to maintain user activity on the site.
   Overseas expansion - limitations   • Overseas expansion places the company in a relatively strong position compared
   via intense competition               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.
128 356
      Hiroshi Kamide                Global Equity Research
      (81-3) 6736 8602              03 January 2011
      hiroshi.kamide@jpmorgan.com




                                    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




129                                                                                                                    357
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




                                 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             Sales     Description
                                 segment               split
                                 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
                                                                         1Q            2Q             3Q              4Q             1Q             2Q
                                 Monthly ARPU         ¥/user           124.8         111.3          166.3           292.3          356.9          371.8
                                  Q/Q                   %              -27.5         -10.8           49.4            75.8           22.1            4.2
                                  Y/Y                   %              -35.1         -33.2            1.8            69.9          186.1          234.1
                                 User pageviews         B               52.9          55.5           94.6           158.6          184.3            NA
                                  Q/Q                   %              3.3%          5.0%          70.5%           67.6%          16.2%             NA
                                  Y/Y                   %             14.6%         14.1%         102.3%          209.6%         248.5%             NA

                                 OP                     ¥B               3.1           3.1             5.2            9.8           12.0           13.6
                                  Q/Q                   %            -24.6%         -1.7%           69.4%          87.9%          22.1%            13.6
                                  Y/Y                   %            -26.5%        -10.6%           31.9%         136.0%         282.2%           341.8
                                 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,

130 358
      Hiroshi Kamide                                          Global Equity Research
      (81-3) 6736 8602                                        03 January 2011
      hiroshi.kamide@jpmorgan.com




                                                              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
                                                     0.4     0.5     0.5     0.8     0.4     0.5     0.5     0.7     0.4     0.5     0.5     0.6     2.2     2.1       2.0
  insurance agencies

  Operating profit                                  12.0    13.6    14.4    15.4    15.5    15.7    16.3    16.5    16.0    14.7    15.3    15.8    55.5    64.0      61.8
  Social media                                      11.6    13.0    13.8    15.0    15.2    15.3    15.5    16.1    15.5    14.2    14.6    15.3    53.3    62.1      59.6
  ngmoco                                               -       -       -       -    -0.3    -0.1     0.2     0.4     0.1     0.3     0.5     0.6       -     0.2       1.5
  eCommerce                                          1.1     1.1     1.2     1.1     1.2     1.2     1.3     0.9     1.2     1.2     1.3     1.0     4.6     4.4       4.6
  Other - travel and
                                                    -0.0     0.0     0.0     0.1     0.0     0.0     0.0     0.1     0.0     0.0     0.0     0.1     0.0     0.2       0.2
  insurance agencies
  Eliminations                                      -0.7    -0.4    -0.6    -0.8    -0.6    -0.7    -0.8    -0.9    -0.8    -0.9    -1.1    -1.2    -2.5    -3.0      -4.0

  OPM                                 %             49.6    50.3    48.6    47.8    46.1    46.1    46.0    44.6    44.9    43.6    43.1    43.4    57.2    45.7      43.8
  Social media                        %             56.7    55.9    54.0    53.9    53.0    53.0    52.5    51.6    52.0    51.0    50.5    50.5    55.0    52.5      51.0
  ngmoco                              %                -       -       -       -   -29.2    -7.7    13.9    20.9     3.6    12.4    20.3    25.3       -     3.1      16.2
  eCommerce                           %             33.4    31.8    33.0    31.8    34.0    34.0    34.0    25.7    34.0    34.0    34.0    34.0    32.5    32.0      34.0
  Other - travel and
                                      %             -7.6     0.4     5.0     6.3    10.0    10.0    10.0    10.0    10.0    10.0    10.0    10.0     2.0    10.0      10.0
  insurance agencies

  Sales growth Y/Y                    %        174.6       216.2   154.6    69.4    38.7    25.6    19.3    14.7     6.3    -0.6     0.1    -1.8   135.5    23.7       0.9
  Social media                        %        289.9       369.9   230.4    87.5    40.6    24.2    16.1    12.1     4.3    -3.6    -2.4    -3.3   196.0    22.1      -1.3
  ngmoco                              %            -           -       -       -       -       -       -       -    79.7    64.7    44.9    42.0       -       -      55.0
  eCommerce                           %         33.4        31.8    33.0    31.8       -       -       -    -7.8       -       -       -    -8.3     5.0    -2.0      -2.0
  Other - travel and
                                      %             -7.6     0.4     5.0     6.3       -       -       -   -13.6       -       -       -   -14.9    15.0    -5.0      -5.0
  insurance agencies

  Social media
  Users (quarterly avg.)              M         19.0        20.8    22.4    23.5    23.7    24.0    24.5    24.8    25.0    25.0    25.0    25.0    21.6    24.3      25.0
   Q/Q                                %         12.0         9.5     7.7     4.9     0.9     1.3     2.1     1.2     0.8       -       -       -
   Y/Y                                %         36.1        40.6    44.9    38.5    24.7    15.4     9.4     5.5     5.5     4.2     2.0     0.8    38.9    12.3       3.1
  Monthly ARPU                      ¥/user     356.9       371.8   379.2   395.8   403.0   400.3   402.6   420.4   398.5   370.4   385.2   403.4   373.1   406.6     389.4
   Q/Q                                %         22.1         4.2     2.0     4.4     1.8    -0.7     0.6     4.4    -5.2    -7.1     4.0     4.7
   Y/Y                                %        186.1       234.1   128.0    35.4    12.9     7.7     6.2     6.2    -1.1    -7.5    -4.3    -4.1   118.2     9.0      -4.2
      Source: Company data, J.P. Morgan estimates




                                                              Our earnings forecasts are based on the following key variable factors for the Social
                                                              Media business:

131                                                                                                                                                            359
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




                                 • 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
                                                 Others                                      Entertainment
                                                  48%                                            14%


                                                                                         Trustee
                                                                                        Accounts
                                                                                          23%



                                 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:




132 360
      Hiroshi Kamide                Global Equity Research
      (81-3) 6736 8602              03 January 2011
      hiroshi.kamide@jpmorgan.com




                                    ngmoco—Basic Financial Outline and Transaction Details
                                    Purchase price ($M)                Final price                                                303.0
                                                                         Equity finance                                           146.0
                                                                         Options                                                  27.0
                                                                         Cash                                                     128.0
                                                                       Earn-out phase                                             100.0
                                                                         Equity finance                                           31.0
                                                                         Options                                                  12.0
                                                                         Cash                                                     56.0

                                    Completion dates                   Closing phase                                              Nov-10
                                                                       Earn-out phase                                             Dec-11
                                    Consolidation date                                                                            From F’11
                                    Company location                                                                              San Francisco
                                    CEO                                                                                           Neil Young*
                                    Incorporated                                                                                  June 25 2008

                                    Financials
                                    Sales ($M)                         F’08*                                                      0.5
                                                                       F’09                                                       3.2
                                    OP ($M)                            F’08*                                                      -2.5
                                                                       F’09                                                       -10.9
                                    Total assets ($M)                  F’08                                                       3.3
                                                                       F’09                                                       28.3
                                    Estimate goodwill ($M)             Closing phase                                              274.7
                                                                       Earn-out phase                                             100.0
                                    Estimate goodwill (¥B)             Closing phase                                              23.3
                                                                       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.




133                                                                                                                                                                361
   Hiroshi Kamide                                                Global Equity Research
   (81-3) 6736 8602                                              03 January 2011
   hiroshi.kamide@jpmorgan.com




   Financial Statement – DeNA (2432)
   ¥ billion
   Income Statement - Annual                F’08A      F’09A        F’10E    F’11E    F’12E    Segment Statement - Quarterly              4Q       1Q       2Q       3Q       4Q
                                                                                                                                         F'09A    F’10A    F’10A    F’10E    F'10E
   Revenues                                   37.6       48.1       113.3    140.1    141.3    Revenues                                    19.1     24.2     27.1     29.7     32.3
    Social media                              24.1       32.8        97.0    118.3    116.8     Social media                               14.9     20.4     23.2     25.5     27.9
    ngmoco                                     0.0        0.0         0.0      5.8      9.0     eCommerce                                   3.5      3.4      3.4      3.7      3.6
    eCommerce                                 11.9       13.5        14.1     13.9     13.6     Others                                      0.7      0.4      0.5      0.5      0.8
    Others                                     1.6        1.9         2.2      2.1      2.0    Operating profit                             9.8     12.0     13.6     14.4     15.4
   Operating profit                           15.8       21.3        55.5     64.0     61.8     Social media                                9.1     11.6     13.0     13.8     15.0
    Social media                               0.0       18.5        53.3     62.1     62.1     eCommerce                                   1.1      1.1      1.1      1.2      1.1
    ngmoco                                     0.0        0.0         0.0      0.2      0.2     Others                                      0.1      0.0      0.0      0.0      0.1
    eCommerce                                  3.1        4.4         4.6      4.4      4.4     Eliminations                               -0.4     -0.7     -0.5     -0.6     -0.8
    Others                                    -0.8       -0.3         0.0      0.2      0.2
    Eliminations                              13.6       -1.4        -2.5     -3.0     -5.1    OPM                                   %     51.5     49.6     50.3     48.6     47.8
   Non operating income                        0.3        0.3         0.3      0.3      0.3     Social media                         %     60.9     56.7     55.9     54.0     53.9
   Non operating expense                       0.0        0.0         0.0      0.0      0.0     eCommerce                            %     31.8     33.4     31.8     33.0     31.8
   Recurring profit                           16.1       21.5        55.7     64.2     62.1     Others                               %      7.5     -7.6      0.4      5.0      6.3
   Extraordinary income                        0.0        0.2         0.0      0.0      0.0    Revenue growth Y/Y                    %     81.5    174.6    216.2    154.6     69.4
   Extraordinary expense                      -1.0       -1.0         0.0      0.0      0.0     Social media                         %    123.7    289.9    369.9    230.4     87.5
   Pre-tax profit                             15.1       20.7        55.7     64.2     62.1     eCommerce                            %      5.3      4.1      6.8      6.0      3.2
   Tax                                        -6.7       -8.7       -22.7    -26.1    -25.3     Others                               %     67.0     27.2      8.6     10.0     14.9
   Minority interests                         -0.5       -0.6         0.1      0.1      0.1
   Net profit                                  8.0       11.4        33.1     38.1     36.9
   EPS                                 ¥      55.1       79.8       232.4    267.7    258.9
   BPS                                 ¥     169.2      243.0       484.0    743.0    971.3
   DPS                                 ¥        6.0      12.0        46.5     53.5     51.8
   Payout ratio                        %       10.9       15.0        20.0     20.0     20.0

   Ratio Analysis                           F’08A      F’09A        F’10E    F’11E    F’12E    Balance Sheet and Cash Flow               F’08A    F’09A    F’10E    F’11E    F’12E
                                                                                               <Balance sheet>
   <Y/Y growth>                                                                                 Current assets                            32.4     49.1     84.7    127.5    156.1
   Sales                               %      26.5       27.9       135.5     23.7      0.9       Cash and cash equivalents               24.5     33.5     55.6     95.9    124.3
   Operating profit                    %      25.1       34.2       160.8     15.3     -3.3       Accounts receivable                      5.3     10.2     18.1     22.4     22.6
   Recurring profit                    %      25.6       33.7       158.9     15.2     -3.3       Other current assets                     2.7      5.5     11.0      9.2      9.2
   Net profit                          %      17.4       42.9       191.0     15.2     -3.3     Tangible fixed assets                      0.9      1.1      1.2      1.2      1.3
                                                                                                Intangible fixed assets                    1.4      1.7     24.6     28.3     32.6
   <Margins>                                                                                    Investments and other assets               2.7      3.4      3.4      3.4      3.4
   GPM                                 %       76.6       77.8        80.0     80.0     80.0   Total assets                               37.3     55.3    114.0    160.5    193.4
   OPM                                 %       42.1       44.2        57.2     45.7     43.8    Current liabilities                       11.5     18.6     42.1     51.8     52.3
   RPM                                 %       42.8       44.7        49.2     45.8     43.9    Long term liabilities                      0.2      0.0      0.0      0.0      0.0
   Effective tax rate                  %       44.1       42.1        40.7     40.7     40.7   Total liabilities                          11.7     18.6     42.2     51.9     52.3
                                                                                                Shareholders' equity                      24.1     34.6     68.9    105.8    138.3
   <Valuations>                                                                                 Minority interest                          1.6      2.0      2.8      2.8      2.8
   P/E                                 x      53.7       37.0        12.7     11.0     11.4    Total net assets                           25.7     36.7     71.7    108.6    141.1
   P/B                                 x      17.5       12.2         6.1      4.0      3.0    Total liabilities and net assets           37.3     55.3    114.0    160.5    193.4
   Dividend yield                      %       0.2        0.4         1.6      1.8      1.8
   EV/EBITDA                           x      22.5       17.1         6.7      5.8      6.0    <Cash Flow>
   EV/EBIT                             x      24.5       18.3         7.0      6.1      6.3    Cash flow from operating activities          9.5    13.5     23.1     22.1     14.9
   EV/Sales                            x      10.3        8.1         3.4      2.8      2.7    Cash flow from investing activities         -3.8    -2.5     -4.0     -4.0     -4.0
                                                                                               Cash flow from financial activities         -4.0    -1.0      5.8     -7.6     -7.4
                                                                                               Gross change in cash/cash
   <Profitability>                                                                                                                         1.7     10.0     24.9     10.5      3.5
                                                                                               equivalents
                                                                                               Cash and cash equivalents at the
   ROCE                                %       68.1       68.5      102.5      71.0     49.6                                              21.8     23.4     33.4     58.3     68.8
                                                                                               beginning of the year
                                                                                               Effect of change in consolidated
   ROE                                 %       35.1       38.7        63.9     43.6     30.2                                               0.0      0.0      0.0      0.0      0.0
                                                                                               companies
   ROA                                 %       21.3       20.6        29.0     23.8     19.1   Cash/ cash equivalents at FY end           23.4     33.4     58.3     68.8     72.4

                                                                                               Free cash flow                              7.2     10.1     43.4     45.9     37.8
                                                                                               Free cash flow conversion             %    45.5     47.4     78.2     71.7     61.1
                                                                                               Free cash flow yield                  %     1.7      2.4     10.3     10.9      9.0

   Source: Company data, earning results and J.P. Morgan estimates.
   Note: Fiscal year ends March. Stock price as of Dec. 29, 2010.



134 362
                                                                                                        Global Equity Research
                                                                                                        03 January 2011




                                                                                                        Neutral
Gree (3632)                                                                                             3632.T, 3632 JT
                                                                                                        Price: ¥1,069
ARPU Growth Slowing, User Acquisition Costs Rising
                                                                                                        Price Target: ¥1,000



We are maintaining our Neutral rating on GREE, with a target price of ¥1,000                            Internet
through November 2011. We believe the shares have corrected to reflect the                                                        AC
                                                                                                        Hiroshi Kamide
competitive pressures and structural issues regarding peaked demand in the                              (81-3) 6736 8602
domestic market. However, we think that GREE will struggle to surprise on the                           hiroshi.kamide@jpmorgan.com
upside with limited resources.
                                                                                                        Yusuke Maeda
                                                                                                        (81-3) 6736-8654
 We maintain our Neutral rating. The company pioneered mobile social
                                                                                                        yusuke.x.maeda@jpmorgan.com
  gaming in Japan with “Tsuri-Sta!”, a casual fishing game in May 2007. The
                                                                                                        JPMorgan Securities Japan Co., Ltd.
  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,
                                                                                                        Price Performance
  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                            1,400
  sight we rate the shares Neutral.                                                                     Y
                                                                                                            1,100

 Marketing cost increases heighten our concern. We think recent performance                                 800
                                                                                                                Dec-09   Mar-10    Jun-10      Sep-10   Dec-10
  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)                                                         3632.T share price (Y
                                                                                                                           TOPIX (rebased)
  despite the launch of the platform business in June 2010 and the release of two
                                                                                                        Company Data
  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                             Price                                         ¥1,069
                                                                                                        Price date                             Dec. 29, 2010
  conclude that users activity is waning as the games on offer are entering the                         Market capitalization                       ¥243.1B
  latter stages of their product cycle and replacements have yet to construct a                         Shares outstanding                           227.4M
  recovery. With more social gaming content available compared to three years                           52-week range                           ¥1,580– 875
                                                                                                        TOPIX                                         908.01
  ago, we believe GREE is finding it difficult to construct winning titles as the                       Dividend (F’10E)                                 ¥5.0
  SNS platform becomes more competitive and hit driven.                                                 Dividend yield (F’10E)                          0.5%
                                                                                                        ROE (F’10E)                                    55.9%
 Valuation and risks. As of December 29, the shares have fallen 32% from their                         Source: Bloomberg, J.P. Morgan estimates.
   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.



Parent                 Revenue           Y/Y         OP      Y/Y       RP      Y/Y       NP      Y/Y      EPS             P/E               P/B     EV/EBITDA
Y/E June                   (¥B)          (%)       (¥B)      (%)     (¥B)      (%)     (¥B)      (%)        (¥)            (x)               (x)            (x)
2010                        35.2        152.6       19.6    134.1     19.6    135.3     11.5    157.6      50.7           21.1              11.8           11.3
2011E                       56.0         58.8       28.4     44.9     28.4     44.9     16.8     46.3      74.0           14.4               6.1            7.5
2011Co.E                  54.0 ~       53.3 ~     27.0 ~   37.9 ~   27.0 ~   37.8 ~   15.9 ~   38.2 ~    70.0 ~               -                 -              -
                            60.0         70.3       30.0     53.2     30.0     53.1     17.7     53.8      77.9
2012E                       65.2         16.5       32.3     13.7     32.3     13.7     19.1     13.7      84.2           12.7               4.0                 6.6
2013E                       73.0         12.0       35.8     10.9     35.8     10.9     21.2     10.9      93.3           11.5               3.0                 6.0
Source: Company data and J.P. Morgan estimates.
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




                                 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.



136 364
      Hiroshi Kamide                Global Equity Research
      (81-3) 6736 8602              03 January 2011
      hiroshi.kamide@jpmorgan.com




                                    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




137                                                                                                                   365
   Hiroshi Kamide                                         Global Equity Research
   (81-3) 6736 8602                                       03 January 2011
   hiroshi.kamide@jpmorgan.com




                                                          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             Sales     Description
                                                          segment              split
                                                          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
                                                          Source: J.P. Morgan based on company data


   Quarterly Earnings Estimates
   ¥ billion
                                         F’10                                  F’11                                   F’12                                    F’10E      F’11E   F’12E
                                          Q1      Q2 E     Q3 E        Q4 E    Q1 E      Q2 E         Q3 E   Q4 E     Q1 E      Q2 E      Q3 E      Q4 E

   Revenue                               12.4      13.8     14.6        15.1    15.5     16.0         16.5    17.1     17.4      17.8      18.8      18.9      56.0       65.2    73.0
   Item sales                            10.1      11.0     11.9        12.2    11.9     11.6         12.4    12.7     11.7      10.6      12.7      12.3      45.2       48.5    47.3
   Advertising                            2.3       2.8      2.7         3.0     3.6      4.5          4.1     4.4      5.8       7.2       6.1       6.7      10.7       16.6    25.7

   Operating profit                        6.2      6.9      7.4         7.8     7.7       8.0         8.3     8.2      8.7       8.9       9.4       8.7      28.4       32.3    35.8

   OPM                         %         50.1      50.0     51.0        51.5    50.0     50.0         50.0    48.1     50.0      50.0      50.0      46.1      50.7       49.5    49.0

   Sales growth Y/Y            %         81.5      69.0     57.5        38.2    24.9     16.0         13.2    13.1      8.7       7.7      10.2       8.6      58.8       16.5    12.0
   Item sales                  %         91.5      71.5     59.3        35.6    17.1      4.9          4.7     4.1      0.8     -14.7       0.5       5.5      60.6        7.4    -2.6
   Advertising                 %         47.3      60.0     50.0        50.0    60.0     60.0         50.0    50.0     29.2      76.0      37.6      15.1      51.9       54.7    54.9

   Sales assumptions
   Average registered
                               M         21.5      23.6     24.6        25.1    25.6     26.1         26.6    27.1     27.7      28.2      28.8      29.4      23.8       26.4    28.5
   monthly users
    Q/Q                        %         10.3       9.8      4.0         2.0     2.0      2.0          2.0     2.0      2.0       2.0       2.0       2.0
    Y/Y                        %         55.3      48.4     40.6        28.7    19.1     10.4          8.2     8.2      2.0       8.2       8.2       8.2
   Monthly total
                            ¥/user      192.2     195.0   198.0     201.0      202.0    205.0     207.0      210.0   210.0     210.0     218.0     215.0      196.0      206.1   213.3
   ARPU per user
    Q/Q                        %          2.8       1.5      1.5         1.5     0.5       2.0         2.0     2.0      0.0       0.0       3.8      -1.4
    Y/Y                        %         16.9      13.9     12.6         7.5     5.1       5.1         4.5     4.5      4.0       2.4       5.3       2.4      13.8        5.1     3.5

   Source: Company data, J.P. Morgan estimates.




138 366
      Hiroshi Kamide                Global Equity Research
      (81-3) 6736 8602              03 January 2011
      hiroshi.kamide@jpmorgan.com




                                    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


                                                          Others
                                                           25%




                                                Trustee                                       Yoshikazu
                                               Accounts                                        Tanaka
                                                 18%                                            50%
                                                           KDDI
                                                            7%



                                    Source: J.P. Morgan based on company report.
                                    Note: Data as of June 2010.




139                                                                                                                                             367
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




                                 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.




140 368
      Hiroshi Kamide                                                  Global Equity Research
      (81-3) 6736 8602                                                03 January 2011
      hiroshi.kamide@jpmorgan.com




      Financial Statement – GREE (3632)
      ¥ billion
      Income Statement -                                                                                                                    4Q        1Q        2Q       3Q       4Q
                                             F’08A       F’09A         F’10E   F’11E    F’12E    Segment Statement - Quarterly
      Annual                                                                                                                               F’09A     F’10A     F’10E    F’10E    F’10E
      Revenues                               13.9        35.2          56.0     65.2     73.0    Revenues                                    10.9      12.4      13.8     14.6     15.1
       Item sales                            10.5        28.2          45.2     48.5     47.3     Item sales                                  9.0      10.1      11.0     11.9     12.2
       Advertising                            3.5         7.1          10.7     16.6     25.7     Advertising                                 2.0       2.3       2.8      2.7      3.0
      Operating profit                        8.4        19.6          28.4     32.3     35.8    Operating profit                             5.3       6.2       6.9      7.4      7.8
       Non operating income                   0.0         0.0           0.0      0.0      0.0
       Non operating expense                  0.0         0.0           0.0      0.0      0.0    OPM                                   %      48.4      50.1     50.0     51.0      51.5
      Recurring profit                        8.3        19.6          28.4     32.3     35.8
       Extraordinary income                   0.0         0.0           0.0      0.0      0.0    Revenue growth Y/Y                    %    112.7       81.5     69.0     57.5      38.2
       Extraordinary expense                  0.0        -0.2           0.0      0.0      0.0     Item sales                           %    126.2       91.5     71.5     59.3      35.6
      Pre-tax profit                          8.3        19.4          28.4     32.3     35.8     Advertising                          %     67.3       47.3     60.0     50.0      50.0
       Tax charge                            -3.9        -7.9         -11.6    -13.1    -14.6
       Minority interests                     0.0         0.0           0.0      0.0      0.0
      Net profit                              4.5        11.5          16.8     19.1     21.2
      EPS                             ¥       20.0        50.7         74.0     84.2     93.3
      BPS                             ¥       40.8        90.5        174.6    267.9    359.2
      DPS                             ¥        5.0         5.0          5.0      5.0      5.0
      Payout ratio                    %       25.1         9.9          6.8      5.9      5.4

      Ratio Analysis                         F’08A       F’09A         F’10E   F’11E    F’12E    Balance Sheet and Cash Flow                F’08A     F’09A     F’10E    F’11E     F’12E
      <Y/Y growth>                                                                               <Balance sheet>
      Sales                           %     374.7       152.6          58.8     16.5    12.0      Current assets                            15.3      30.9      51.6     75.1      96.9
      Operating profit                %     696.4       134.1          44.9     13.7    10.9        Cash and cash equivalents               10.6      21.4      37.4     54.9      74.4
      Recurring profit                %     692.3       135.3          44.9     13.7    10.9        Accounts receivable                      3.8       7.7      11.8     17.6      19.7
      Net profit                      %     667.1       157.6          46.3     13.7    10.9        Other current assets                     0.9       1.9       2.5      2.5       2.7
                                                                                                  Tangible fixed assets                      0.1       0.2       0.2      0.2       0.3
      <Margins>                                                                                   Intangible fixed assets                    0.0       0.2       0.3      0.4       0.5
      GPM                             %        92.2        92.1         92.0     91.9     91.5    Investments and other assets               0.2       1.0       1.0      1.1       1.1
      OPM                             %        60.0        55.6         50.7     49.5     49.0   Total assets                               15.6      32.2      53.1     76.8      98.7
      RPM                             %        59.7        55.6         50.7     49.5     49.0    Current liabilities                        6.5      11.6      13.4     15.8      17.1
      Effective tax rate              %       -46.4       -40.7        -40.7    -40.7    -40.7    Long term liabilities                      0.0       0.0       0.0      0.0       0.0
                                                                                                 Total liabilities                           6.5      11.6      13.4     15.8      17.1
      <Valuations>                                                                                Shareholders' equity                       9.1      20.6      39.7     60.9      81.7
      P/E                             x      53.6        21.1          14.4     12.7    11.5      Minority interest                          0.0       0.0       0.0      0.0       0.0
      P/B                             x      26.2        11.8           6.1      4.0     3.0     Total net assets                            9.1      20.6      39.7     60.9      81.7
      Dividend yield                  %       0.5         0.5           0.5      0.5     0.5     Total liabilities and net assets           15.6      32.2      53.1     76.8      98.7
      EV/EBITDA                       x      26.4        11.3           7.5      6.6     6.0
      EV/EBIT                         x      26.5        11.3           7.8      6.9     6.2     <Cash Flow>
      EV/Sales                        x      15.9         6.3           4.0      3.4     3.0     Cash flow from operating activities          5.7      11.6       5.3      5.4      8.7
                                                                                                 Cash flow from investing activities         -0.1     -10.8      -2.2     -2.2     -2.2
      <Profitability>                                                                            Cash flow from financial activities         3.7       -0.1      -1.1     -1.1     -1.1
                                                                                                 Gross change in cash/cash
      ROCE                            %      166.0       132.0          94.2     64.1    50.2                                                9.3       0.8       2.0      2.0       5.3
                                                                                                 equivalents
                                                                                                 Cash and cash equivalents at the
      ROE                             %        88.7        77.5         55.9     38.0    29.8                                                1.3      10.6      11.4     13.3      15.4
                                                                                                 beginning of the year
                                                                                                 Effect of change in consolidated
      ROA                             %        28.6        35.8         31.7     24.9    21.5                                                0.0       0.0       0.0      0.0       0.0
                                                                                                 companies
                                                                                                 Cash and cash equivalents at FY
                                                                                                                                            10.6      11.4      13.3     15.4      20.6
                                                                                                 end

                                                                                                 Free cash flow                              4.5       9.6      14.7     16.3      21.0
                                                                                                 Free cash flow conversion             %     0.5       0.5       0.5      0.5       0.6
                                                                                                 Free cash flow yield                  %     1.9       3.9       6.0      6.7       8.6
      Source: Company data, earning results and J.P. Morgan estimates
      Note: Fiscal year ends June. Stock price as of Dec. 29, 2010.




141                                                                                                                                                                          369
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




142 370
                                                                                                  Global Equity Research
                                                                                                  03 January 2011




                                                                                                  Neutral
Mixi (2121)                                                                                       2121.T, 2121 JT
                                                                                                  Price: ¥441,500
Obstacles Remain on the Road to Monetization
                                                                                                  Price Target: ¥425,000



We are maintaining our Neutral rating on Mixi, with a target price of ¥425,000 to                 Internet
November 2011. We believe management is taking a long-term view of the                                                       AC
                                                                                                  Hiroshi Kamide
business, focusing on developing new services and improving user experience.                      (81-3) 6736 8602
The focus on advertising as the key revenue driver should see improving prospects                 hiroshi.kamide@jpmorgan.com
with smartphone penetration, but this will still take over a year to materialize in
                                                                                                  Yusuke Maeda
our opinion. While valuations are not inexpensive, we believe Mixi has interesting                (81-3) 6736-8654
prospects longer term.                                                                            yusuke.x.maeda@jpmorgan.com
                                                                                                  JPMorgan Securities Japan Co., Ltd.
 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
                                                                                                  Price Performance
  way aimed at raising brand awareness. Online advertising demand continues to                      900,000
  grow albeit at a relatively modest pace, as we think ‘feature phone’ mobile
  media remains high maintenance and unwieldy for most advertisers. Item sales                    Y 600,000

  from the various applications available on Mixi’s platform are beginning to gain
                                                                                                    300,000
  traction, but management's emphasis on providing useful utility-type services                            Dec-09   Mar-10        Jun-10   Sep-10   Dec-10
  cannot compete in terms of generating user ARPU available from social gaming
                                                                                                                    2121.T share price (Y
  in our opinion.                                                                                                   TOPIX (rebased)

                                                                                                  Company Data
 Keeping users satisfied, thinking long term. The release of functions such as
  ‘Mixi Check’ (a sharing function similar to Twitter and Facebook share/like                     Price                                     ¥441,500
                                                                                                  Price date                            Dec. 29, 2010
  icons) and ‘Mixi Voice’ (an updated version of their microblogging service)                     Market capitalization                       ¥68.3B
  continue to keep the user community involved. We believe this is the core                       Shares outstanding                          0.155M
  strength of Mixi’s management, with their focus on providing well thought out                   52-week range                    ¥777,000– 383,000
                                                                                                  TOPIX                                        908.01
  services and a deep user experience. Monetizing user traffic is a core activity,                Dividend (F’10E)                                ¥0.0
  but as we understand management takes user satisfaction as its key objective.                   Dividend yield (F’10E)                         0.0%
                                                                                                  ROE (F’10E)                                   11.9%
 Valuation and risks. The shares are currently trading at 28.6x our F’11 EPS                     Source: Bloomberg, J.P. Morgan estimates.
   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.



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)
2010                         13.6       12.8        2.8   -27.0     2.7   -29.4     1.3   -33.0    8,476            52.1               4.7            17.7
2011E                        16.8       23.4        3.6    29.5     3.6    32.8     1.8    40.6   11,911            37.1               4.2            11.1
2011Co.E                     17.4       27.6        2.8     0.6     2.8     3.2     1.4     6.2    8,985            49.1                  -               -
2012E                        20.7       23.6        4.4    24.6     4.4    24.7     2.4    29.8   15,457            28.6               3.6             9.5
2013E                        25.0       20.5        5.8    30.2     5.8    30.3     3.1    30.3   20,143            21.9               3.1             7.7
Source: Company data and J.P. Morgan estimates.
   Hiroshi Kamide                    Global Equity Research
   (81-3) 6736 8602                  03 January 2011
   hiroshi.kamide@jpmorgan.com




                                     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:

   Mobile advertising demand still   •    The dominance of mobile advertising revenue (63% of total ad revenue in 1Q
   hampered by technology                 F’11) limits short-term growth potential, as the media itself remains high
                                          maintenance and cumbersome for the majority of advertisers.
   User monetization with social     •    The focus on social utility applications being made available on the Mixi
   applications limited                   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:



144 372
      Hiroshi Kamide                Global Equity Research
      (81-3) 6736 8602              03 January 2011
      hiroshi.kamide@jpmorgan.com




                                    Upside risk
                                    • Major hit services on the Mixi platform, resulting in strong reacceleration of item
                                      sales
                                    • Major adoption of smartphones, leading to more mobile advertising clients and
                                      greater demand for advertising
                                    Downside risk
                                    • Ineffective but expensive marketing campaigns that deteriorate margins
                                    • Major upfront investment costs for new developments, e.g. contractor fees




145                                                                                                                   373
   Hiroshi Kamide                                       Global Equity Research
   (81-3) 6736 8602                                     03 January 2011
   hiroshi.kamide@jpmorgan.com




                                                        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                Sales     Description
                                                        segment                 split
                                                        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.


   Mixi - 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                                      4.0     3.9     4.2         4.7      5.1       4.9       5.1       5.6       6.3       5.9      6.2       6.6       16.8      20.7    25.0
   Internet media                             3.8     3.7     4.0         4.5      5.0       4.7       5.0       5.3       6.1       5.7      6.0       6.3       16.0      19.9    24.1
   Recruitment listings                       0.2     0.2     0.2         0.2      0.2       0.2       0.2       0.2       0.2       0.2      0.2       0.3        0.7       0.8     0.9
   Other                                         -      -       -           -         -        -         -         -          -        -        -         -          -         -       -
   Operating profit                           1.1     0.6     0.9         1.0      1.1       1.0       1.0       1.3       1.4       1.3      1.4       1.7        3.6       4.4     5.8
   Internet media                             1.4     0.9     1.2         1.3      1.5       1.5       1.5       1.7       1.8       1.8      2.0       2.3        4.8       6.2     8.0
   Recruitment listings                       0.1     0.2     0.1         0.2      0.1       0.2       0.1       0.2       0.2       0.2      0.2       0.2        0.6       0.6     0.7
   Other                                      0.0     0.0     0.0         0.0      0.0      -0.1      -0.1       0.0       0.0      -0.1     -0.1       0.0       -0.1      -0.2    -0.2
   Eliminations                              -0.4    -0.4    -0.5        -0.4     -0.5      -0.6      -0.6      -0.6      -0.6      -0.7     -0.7      -0.8       -1.7      -2.2    -2.7
   OPM                             %         26.8    15.8    20.7        21.6     21.3      20.7      20.1      23.3      21.5      22.0     23.2      25.7       21.2      21.4    23.1
   Internet media                  %         35.6    24.6    30.0        29.6     30.0      31.0      31.0      31.9      30.0      32.0     33.0      36.8       30.0      31.0    33.0
   Recruitment listings            %         80.6    84.6    85.0        75.0     80.0      80.0      80.0      80.0      80.0      80.0     80.0      80.0       81.0      80.0    80.0
   Other                           %             -      -       -           -         -        -         -         -          -        -        -         -          -         -       -

   Sales growth Y/Y                %         31.2    22.0    21.6        20.0     28.3      25.7      23.7      17.7      23.0      21.4     19.9      18.2       23.4      23.6    20.5
   Internet media                  %         31.3    21.5    21.1        19.5     29.1      26.5      24.3      18.0      23.4      21.9     20.2      18.5       23.0      24.2    21.0
   Recruitment listings            %         30.8    34.8    35.0        31.7     10.0      10.0      10.0      10.0      10.0      10.0     10.0      10.0       33.0      10.0    10.0
   Other                           %            -       -       -           -        -         -         -         -         -         -        -         -          -         -       -

   Sales assumptions
   Average registered
                                   M         20.3    21.3    22.5        23.7     24.3      24.9      25.5      26.1      26.6      26.9     27.2      27.4       22.0      25.2    27.0
   monthly users
    Q/Q                            %          5.6     4.9     5.8         5.0      2.5       2.5       2.5       2.5       2.0       1.0       1.0      1.0          -         -       -
    Y/Y                            %         18.6    20.5    23.5        23.1     19.5      16.7      13.1      10.4       2.0       8.2       6.7      5.1       21.4      14.3     7.4
   Monthly total ARPU
                                 ¥/user      63.1    58.0    61.4        66.5     70.7      65.6      67.2      70.9      79.2      73.6     75.6      79.7       63.5      68.6    77.0
   per user
    Q/Q                            %         -3.7    -8.1     5.9         8.2      6.4      -7.3        2.5      5.5      11.7      -7.1      2.7       5.5          -         -       -
    Y/Y                            %         10.7     0.7     2.2         1.5     12.1      13.1        9.4      6.6      11.9      12.2     12.4      12.4        1.7       8.1    12.2

   Source: Company data, J.P. Morgan estimates.


                                                        Our earnings forecasts are based on the following assumptions:

146 374
      Hiroshi Kamide                Global Equity Research
      (81-3) 6736 8602              03 January 2011
      hiroshi.kamide@jpmorgan.com




                                    • 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



                                                          Others
                                                           28%



                                              ngi group
                                                 1%                                            Kenji Kasahara
                                                                                                     58%
                                                        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%.




147                                                                                                                                           375
   Hiroshi Kamide                                              Global Equity Research
   (81-3) 6736 8602                                            03 January 2011
   hiroshi.kamide@jpmorgan.com




   Financial Statement – Mixi (2121)
   ¥ billion
   Income Statement -                   F’08A       F’09A      F’10E        F’11E    F’12E    Segment Statement - Quarterly              4Q      1Q      2Q      3Q      4Q
   Annual                                                                                                                               F'09A   F’10A   F’10A   F’10E   F'10E

   Revenues                               12.1        13.6      16.8     20.7     25.0        Revenues                                    3.9     4.0     3.9     4.2     4.7
    Internet media                        11.2        13.0      16.0     19.9     24.1         Internet media                             3.8     3.8     3.7     4.0     4.5
    Recruitment listings                    0.9         0.5      0.7      0.8      0.9         Recruitment listings                       0.2     0.2     0.2     0.2     0.2
    Others                                  0.0         0.0      0.0      0.0      0.0         Others                                     0.0     0.0     0.0     0.0     0.0
   Operating profit                         3.8         2.8      3.6      4.4      5.8        Operating profit                            0.3     1.1     0.6     0.9     1.0
    Internet media                          4.3         3.5      4.8      6.2      8.0         Internet media                             0.4     1.4     0.9     1.2     1.3
    Recruitment listings                    0.5         0.4      0.6      0.6      0.7         Recruitment listings                       0.1     0.1     0.2     0.1     0.2
    Others                                 -0.2        -0.2     -0.1     -0.2     -0.2         Others                                     0.0     0.0     0.0     0.0     0.0
   Non operating income                     0.0         0.0      0.0      0.0      0.0        OPM                                   %     6.9    26.8    15.8    20.7    21.6
   Non operating expense                    0.0         0.0      0.0      0.0      0.0         Internet media                       %    10.1    35.6    24.6    30.0    29.6
   Recurring profit                         3.8         2.7      3.6      4.4      5.8         Recruitment listings                 %    81.8    80.6    84.6    85.0    75.0
   Extraordinary income                     0.0         0.0      0.0      0.0      0.0         Others                               %     0.0     0.0     0.0     0.0     0.0
   Extraordinary expense                    0.0        -0.1     -0.1      0.0      0.0        Revenue growth Y/Y                    %    25.4    31.2    22.0    21.6    20.0
   Pre-tax profit                           3.8         2.6      3.4      4.4      5.8         Internet media                       %    26.5    31.3    21.5    21.1    19.5
   Tax charge                              -1.8        -1.3     -1.6     -2.0     -2.7         Recruitment listings                 %     3.2    30.8    34.8    35.0    31.7
   Minority interests                       0.0         0.0      0.0      0.0      0.0         Others                               %     0.0     0.0     0.0     0.0     0.0
   Net profit                               2.0         1.3      1.8      2.4      3.1
   EPS                             ¥    12,741        8,476 11,911 15,457 20,143
   BPS                             ¥    85,626      93,871 105,861 121,318 141,461
   DPS                             ¥            -           -        -        -        -
   Payout ratio                                 -           -        -        -        -
                                        F’08A       F’09A     F’10E    F’11E    F’12E         Balance Sheet and Cash Flow               F’08A   F’09A   F’10E   F’11E   F’12E
                                                                                              <Balance sheet>
   <Y/Y growth>                                                                                Current assets                            13.2    15.1    17.3    20.2    23.8
   Sales                           %      19.9        12.8          23.4     23.6     20.5       Cash and cash equivalents               11.4    12.2    14.2    16.4    19.2
   Operating profit                %       0.6       -27.0          29.5     24.6     30.2       Accounts receivable                      1.6     2.7     2.9     3.5     4.2
   Recurring profit                %       1.0       -29.4          32.8     24.7     30.3       Other current assets                     0.2     0.2     0.3     0.3     0.3
   Net profit                      %      -2.1       -33.0          40.6     29.8     30.3     Tangible fixed assets                      1.0     1.0     1.0     1.0     1.0
                                                                                               Intangible fixed assets                    0.2     0.2     0.2     0.2     0.2
   <Margins>                                                                                   Investments and other assets               0.7     1.1     1.4     1.6     1.9
   GPM                             %       79.9        74.5          74.5     74.5     74.5   Total assets                               15.1    17.4    19.8    23.0    27.0
   OPM                             %       31.3        20.2          21.2     21.4     23.1    Current liabilities                        2.0     2.9     3.4     4.2     5.1
   RPM                             %       31.4        19.7          21.2     21.4     23.1    Long term liabilities                      0.0     0.0     0.0     0.0     0.0
   Effective tax rate              %      -48.2       -49.3         -46.0    -46.0    -46.0   Total liabilities                           2.0     2.9     3.4     4.2     5.1
                                                                                               Shareholders' equity                      13.1    14.5    16.4    18.8    21.9
   <Valuations>                                                                                Minority interest                          0.0     0.0     0.0     0.0     0.0
   P/E                             x      34.7        52.1          37.1     28.6     21.9    Total net assets                           13.1    14.5    16.4    18.8    21.9
   P/B                             x       5.2         4.7           4.2      3.6      3.1    Total liabilities and net assets           15.1    17.4    19.8    23.0    27.0
   Dividend yield                  %       0.0         0.0           0.0      0.0      0.0
   EV/EBITDA                       x      13.2        17.7          11.1      9.5      7.7    <Cash Flow>
   EV/EBIT                         x      14.9        20.9          15.8     12.7      9.7    Cash flow from operating activities         2.2     1.8     2.8     3.0     3.8
   EV/Sales                        x       4.7         4.1           3.3      2.7      2.2    Cash flow from investing activities         0.4    -2.7    -0.6    -0.6    -0.6
                                                                                              Cash flow from financial activities         0.0     0.1    -0.1     0.0     0.0
                                                                                              Effect of exchange rate change
   <Profitability>                                                                                                                        0.0     0.0     0.0     0.0     0.0
                                                                                              on cash/cash equivalents
                                                                                              Gross change in cash/cash
   ROCE                            %       31.2        19.6         23.2      25.4     28.6                                               2.6    -0.7     2.2     2.4     3.2
                                                                                              equivalents
                                                                                              Cash and cash equivalents at the
   ROE                             %       16.1         9.5         11.9      13.6     15.3                                               7.8    10.4     9.7    11.8    14.2
                                                                                              beginning of the year
                                                                                              Effect of change in consolidated
   ROA                             %       12.9         7.5          9.3      10.4     11.6                                               0.0     0.0     0.0     0.0     0.0
                                                                                              companies
                                                                                              Cash and cash equivalents at FY
                                                                                                                                         10.4     9.7    11.8    14.2    17.4
                                                                                              end

                                                                                              Free cash flow                              1.5     1.9     3.3     3.4     4.2
                                                                                              Free cash flow conversion             %    40.0    70.4    93.8    77.1    71.8
                                                                                              Free cash flow yield                  %     2.2     2.8     4.9     5.0     6.1
   Source: Company data, earning results and J.P. Morgan estimates.
   Note: Fiscal year ends March. Stock price as of Dec. 29, 2010.




148 376
                                                                                                            Global Equity Research
                                                                                                            03 January 2011




                                                                                                            Neutral
Rakuten (4755)                                                                                              4755.OS, 4755 JQ
                                                                                                            Price: ¥68,200
Steady Domestic Prospects
                                                                                                            Price Target: ¥63,000



We are maintaining our Neutral rating on Rakuten. We view the business as a                                 Internet
stable domestic eCommerce growth story but believe this has already been priced                                                        AC
                                                                                                            Hiroshi Kamide
in. Although online shopping is defensive in a downturn, we believe the business                            (81-3) 6736 8602
is not economy-sensitive enough to benefit from an economic upturn. We are                                  hiroshi.kamide@jpmorgan.com
maintaining our ¥63,000 price target to November 2011.
                                                                                                            Yusuke Maeda
                                                                                                            (81-3) 6736-8654
 We maintain our Neutral rating. We believe the company’s growth prospects
                                                                                                            yusuke.x.maeda@jpmorgan.com
  are acknowledged and unlikely to yield major positive surprises, and we think
                                                                                                            JPMorgan Securities Japan Co., Ltd.
  overseas expansion plans for eCommerce operations are unlikely to yield
  material results in the medium term. We believe the shares are fairly valued on
                                                                                                            Price Performance
  a F’11 P/E of 21.6x.
                                                                                                                75,000
 Dominant market position in a growth market: Well-known themes.                                           Y
                                                                                                                65,000
  Rakuten’s business model is idiosyncratic, with business activities ranging from
                                                                                                                55,000
  eCommerce to financial services. Its core activities remain online shopping and
                                                                                                                     Dec-09   Mar-10    Jun-10      Sep-10   Dec-10
  travel, having major domestic market shares with strong track records. The
  domestic eCommerce market remains firm and is expected to maintain a steady                                                 4755.OS share price (Y
                                                                                                                              TOPIX (rebased)
  yet unspectacular medium-term growth profile. Whilst these are positive traits,
  we believe they are well-acknowledged themes and in themselves provide little                             Company Data
  catalyst for the shares.                                                                                  Price                                           ¥68,200
                                                                                                            Price date                                Dec. 29, 2010
 Overseas expansion: Managing expectations. Consolidating its operations                                   Market capitalization                        ¥ 893.4bn
  after the consumer finance ‘crash’ of F’07, Rakuten has recently begun to                                 Shares outstanding                              13.1mn
                                                                                                            52-week range                           ¥74,300–56,200
  expand into niche eCommerce operations overseas via M&A and partnerships.                                 TOPIX                                            908.01
  The consensus view is that this is a positive development. We take a more                                 Dividend (F’10E)                                   ¥100
  balanced view, as we estimate that overseas operations made up around 2-3% of                             Dividend yield (F’10E)                             0.1%
                                                                                                            RoE (FY’10E)                                     16.2%
  3Q F’10 total sales, highlighting the progress required to meaningfully impact
  earnings. The joint venture with Baidu.com in China commenced in October                                  Source: Bloomberg, J.P. Morgan estimates.

  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.
Consolidated              Sales            Y/Y            OP         Y/Y     RP     Y/Y      NP      Y/Y        EPS            P/E               P/B     EV/EBITDA
Y/E Dec                    (¥B)            (%)           (¥B)        (%)    (¥B)    (%)     (¥B)     (%)         (¥)            (x)               (x)            (x)
2008                      249.9           16.8           47.2           -   44.5       -   -55.0        -   -4,203.9               -              6.0           16.9
2009                      298.3           19.4           56.6       20.1    54.9   23.3     53.6       -     4,092.3           16.7               4.4           13.9
2010E                     345.9           16.0           62.8       10.8    60.1     9.5    36.1   -32.7     2,752.8           24.8               3.7           13.7
2011E                     385.4           11.4           71.9       14.5    69.1   15.0     41.4    14.8     3,160.7           21.6               3.2           12.3
2012E                     402.8            4.5           79.7       10.8    76.9   11.2     46.0    11.1     3,512.1           19.4               2.7           11.2
Source: Company data, earnings results, and J.P. Morgan estimates
   Hiroshi Kamide                   Global Equity Research
   (81-3) 6736 8602                 03 January 2011
   hiroshi.kamide@jpmorgan.com




                                    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 market dominance       • Rakuten’s dominant domestic market position in eCommerce and its growth
   and growth prospects priced in     prospects are understood. This well-known theme provides little upside risk for
                                      the shares.
   Overseas expansion unlikely to   • As things currently stand, we do not believe that plans for overseas expansion
   be material in the medium term     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.




150 378
      Hiroshi Kamide                Global Equity Research
      (81-3) 6736 8602              03 January 2011
      hiroshi.kamide@jpmorgan.com




                                    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.

      WACC 7.3%, terminal growth    Our basic premise is that on a WACC of 7.3% and generating an average around
      rate 0.5%                     ¥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




151                                                                                                                   379
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




                                 Key Assumptions
                                 Earnings Forecasts by Business Segment
                                                                  F'10E         F'11E            F'12E   CAGR F'10E-12E
                                 Sales growth Y/Y
                                 eCommerce                        25.0%        20.0%             7.0%               13.3%
                                 Credit                            9.0%         5.0%                 -               2.5%
                                 Portal/media                     27.0%        10.0%            10.0%               10.0%
                                 Travel                           19.5%        15.0%             7.0%               10.9%
                                 Broker                                -            -                -                   -
                                 Sports                                -            -                -                   -
                                 Telco                           -12.0%             -                -                   -
                                 Bank                             10.5%         5.0%             2.0%                3.5%
                                 e-money                               -        5.0%             5.0%                5.0%
                                 Total sales growth               16.0%        11.4%             4.5%                7.9%

                                 OPM estimates
                                 eCommerce                        28.5%         28.0%            29.0%                   -
                                 Credit                            3.5%          3.0%             3.0%                   -
                                 Portal/media                      9.5%         10.0%            10.0%                   -
                                 Travel                           45.0%         43.0%            43.0%                   -
                                 Broker                           20.0%         20.0%            20.0%                   -
                                 Sports                          -10.0%         -9.0%            -9.0%                   -
                                 Telco                             5.0%          3.5%             2.0%                   -
                                 Bank                              4.0%         10.0%            15.0%                   -
                                 e-money                         -15.2%        -10.0%           -10.0%                   -
                                 Total OPM                        18.1%         18.7%            19.8%                   -
                                 Source: J.P. Morgan estimates




                                 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.
                                 • Portal/media – No major changes expected.
                                 • Broker – No major changes expected.


152 380
      Hiroshi Kamide                      Global Equity Research
      (81-3) 6736 8602                    03 January 2011
      hiroshi.kamide@jpmorgan.com




                                           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
      Dominant B2B2C domestic             A household name in Japan, Rakuten has a dominant position as an online shopping
      business                            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:

      41M active users                     Access to an active user base of 41.38M members within the Rakuten group.
      65M items listed for sale            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).
      Reward points scheme in place        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
                                                        Indonesia (Rakuten stake 51%)
                                            Jul-10      Acquires 100% Buy.com Inc - price $256M
                                                        Acquires 100% PriceMinister - price euro 180M
                                          Source: J.P. Morgan based on company data.


      To date overseas shopping sales     Initial forays overseas appeared focused on niche geographies such as Taiwan and
      less than 1% of total group sales   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.

      On consolidation of                 For group sales we estimate overseas operations will make up 2% to 3% of total sales
      PriceMinister and Buy.com,          in 3Q F’10.
      overseas sales grow to 2% to 3%
      of total group sales
                                          We assess these opportunities in turn.


153                                                                                                                                                       381
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




                                 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)


                                                            Tencent Paipai                                Others
                                                                 7%                                 (including Baidu)
                                                                                                           0%
                                                         eBay
                                                          7%




                                                                                             Taobao
                                                                                              86%




                                 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:


154 382
      Hiroshi Kamide                     Global Equity Research
      (81-3) 6736 8602                   03 January 2011
      hiroshi.kamide@jpmorgan.com




                                         • Aim to gain 30M users over three years
      $50M capital commitment is on
      the low side                       • This would equate to user acquisition costs of $0.55 per user over the period,
                                           which does not strike us as being very high
      Great opportunity in China, next   We believe there is an opportunity in the China eCommerce market, where users are
      two years the crucial period       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.

      Joint venture not expected to      The costs budgeted by Rakuten and Baidu.com do not seem very large when
      make a major impact at             considering the challenges being faced. We therefore believe medium-term prospects
      Baidu.com in the near future
                                         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.




      Business model is marketplace –    Buy.com operates a mall-type operation similar to Rakuten, connecting shoppers
      similar to Rakuten                 with distributors and retailers. It is similar to Rakuten's business model as it holds no
                                         inventory, and outsources distribution and fulfillment.


155                                                                                                                                                           383
   Hiroshi Kamide                    Global Equity Research
   (81-3) 6736 8602                  03 January 2011
   hiroshi.kamide@jpmorgan.com




   Business strategy has centered    The company has a loyal following, although historically its strength has been in
   on cost leadership                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.
   Key selling point is security –   • There is emphasis on security. However, most auction and shopping sites operate
   but this is an industry norm        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
   Late movers can make an impact    We believe first-mover advantage in the internet economy is exaggerated, as
   in eCommerce…                     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.




156 384
      Hiroshi Kamide                     Global Equity Research
      (81-3) 6736 8602                   03 January 2011
      hiroshi.kamide@jpmorgan.com




      …but dominant players have         On the other hand, instances whereby new entrants have cracked markets with
      consolidated their market          established dominant players in place have been rare. We believe this is due to well-
      position
                                         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.

      Key competitive strength is size   In online shopping and auction, the key competitive strength is the size of the
      and scale of service on offer      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.




157                                                                                                                         385
   Hiroshi Kamide                                           Global Equity Research
   (81-3) 6736 8602                                         03 January 2011
   hiroshi.kamide@jpmorgan.com




   Quarterly Earnings Forecast
                                 F’09                                      F’10                                 F’11                                F’10     F’11     F’12
                                   Q1            Q2       Q3       Q4       Q1        Q2       Q3      Q4 E     Q1 E     Q2 E     Q3 E     Q4 E        E        E        E
   Sales (¥B)                     66.4       73.4        77.3     81.2     79.2      84.9     88.5     93.4     88.1     94.3     96.9    106.1    345.9    385.4    402.8
   eCommerce                      25.2       26.9        28.6     34.3     31.5      33.4     35.9     43.0     39.3     41.8     43.1     48.3    143.8    172.5    184.6
   Credit                         14.0       14.3        14.3     15.1     14.9      15.6     15.8     16.5     14.9     15.6     15.8     19.7     62.9     66.0     66.0
   Portal/media                    3.4           4.3      4.7      5.2      5.5       5.5      5.8      5.6      6.0      6.0      6.4      6.2     22.4     24.6     27.1
   Travel                          4.1           4.3      5.9      5.0      5.0       5.2      7.0      5.9      5.5      5.7      7.7      7.7     23.1     26.6     28.4
   Broker                          5.3           6.3      6.2      5.7      6.0       6.9      5.6      5.1      6.0      6.9      5.6      5.1     23.5     23.5     23.5
   Sports                          0.7           2.9      3.2      1.6      0.9       2.9      3.1      1.5      0.9      2.9      3.1      1.5      8.4      8.4      8.4
   Telco                           6.9           6.5      6.5      6.5      6.0       5.7      5.6      5.9      6.0      5.7      5.6      5.9     23.2     23.2     23.2
   Bank                            6.7           8.0      7.8      7.8      8.3       8.5      8.4      8.3      8.3      8.5      8.4     10.0     33.5     35.2     35.9
   e-money                           -             -        -        -      1.2       1.2      1.3      1.5      1.2      1.2      1.3      1.8      5.2      5.4      5.7


   Operating profit (¥B)           9.8       13.6        15.2     18.0     13.0      15.3     16.0     18.6     14.3     17.1     18.2     22.4     62.8     71.9     79.7
   eCommerce                       7.7           8.5      8.3     11.7      8.8       9.7      9.0     13.4     10.4     11.1     11.6     15.2     41.0     48.3     53.5
   Credit                          0.9           0.6      0.8      1.0      0.1       0.2      1.0      0.9      0.2      0.2      0.4      1.1      2.2      2.0      2.0
   Portal/media                    0.3           0.0      0.3      0.5      0.8       0.3      0.5      0.5      0.3      0.3      0.3      1.5      2.1      2.5      2.7
   Travel                          1.8           1.7      2.9      2.4      2.1       2.0      3.4      2.8      2.4      2.5      3.3      3.3     10.4     11.4     12.2
   Broker                          0.4           1.6      1.3      1.1      1.2       1.8      1.0      0.7      1.6      1.9      1.5     -0.3      4.7      4.7      4.7
   Sports                         -1.2           0.4      0.7     -0.6     -1.2       0.3      0.6     -0.5     -1.5      0.3      0.2      0.2     -0.8     -0.8     -0.8
   Telco                           0.2           0.0      0.0      0.1      0.5       0.1      0.2      0.3      0.1      0.1      0.1      0.5      1.2      0.8      0.5
   Bank                           -0.5           0.7      0.9      1.4      0.5       0.7     -0.1      0.2      0.8      0.8      0.8      1.0      1.3      3.5      5.4
   e-money                         0.0           0.0      0.0      0.0     -0.2      -0.2     -0.2     -0.2     -0.1     -0.1     -0.1     -0.2     -0.8     -0.5     -0.6
   Intercompany                    0.1           0.1     -0.1      0.4      0.3       0.2      0.5      0.4      0.0      0.0      0.0      0.0      1.5      0.0      0.0


   OPM (%)                     14.8%      18.5%        19.7%    22.2%    16.4%    18.0%      18.0%   19.9%    16.2%    18.1%    18.7%    21.1%    18.1%    18.7%    19.8%
   eCommerce                   30.6%      31.7%        29.0%    34.1%    28.1%    29.0%     25.2%    31.1%    26.5%    26.5%    27.0%    31.4%    28.5%    28.0%    29.0%
   Credit                        6.4%       4.2%        5.8%     6.5%     0.6%       1.1%    6.4%     5.6%     1.5%     1.5%     2.5%     5.7%     3.5%     3.0%     3.0%
   Portal/media                  8.6%       1.0%        6.9%     9.6%    13.9%       6.4%    8.6%     9.2%     5.0%     5.0%     5.0%    24.9%     9.5%    10.0%    10.0%
   Travel                      43.7%      40.9%        48.5%    47.6%    41.4%    39.3%     49.4%    47.9%    43.0%    43.0%    43.0%    43.0%    45.0%    43.0%    43.0%
   Broker                        8.5%     25.2%        21.6%    18.9%    20.2%    26.4%     18.1%    13.2%    27.0%    27.0%    27.0%     -5.1%   20.0%    20.0%    20.0%
   Sports                    -166.9%      15.1%        22.2%    -35.9% -135.8%    10.4%     18.5%    -35.4% -135.0%    10.0%    15.0%    -21.7%   -10.0%    -9.0%    -9.0%
   Telco                         3.3%      -0.6%        0.5%     2.2%     8.8%       1.0%    4.2%     5.7%     2.0%     2.0%     2.0%     7.9%     5.0%     3.5%     2.0%
   Bank                         -7.5%       8.5%       10.9%    17.8%     6.5%       8.7%    -1.2%    1.9%    10.0%    10.0%    10.0%    10.0%     4.0%    10.0%    15.0%
   e-money                           -             -        -        -   -16.5%   -12.9%    -19.0%   -13.0%   -10.0%   -10.0%   -10.0%   -10.0%   -15.2%   -10.0%   -10.0%


   Sales growth Y/Y (%)        11.5%      17.4%        24.3%    23.6%    19.3%    15.6%      14.5%   15.0%    11.3%    11.1%     9.6%    13.6%    16.0%    11.4%     4.5%
   eCommerce                   21.1%      19.7%        31.6%    31.7%    24.8%    24.5%     25.4%    25.2%    25.0%    25.0%    20.0%    12.4%    25.0%    20.0%     7.0%
   Credit                      -15.2%     -12.0%       -12.4%   -10.3%    6.7%       9.5%   10.1%     9.6%         -        -        -   19.0%     9.0%     5.0%         -
   Portal/media                46.5%     110.9%        139.3%   55.6%    60.3%    26.4%     24.2%     8.1%    10.0%    10.0%    10.0%    10.0%    27.0%    10.0%    10.0%
   Travel                      15.5%      16.5%        27.1%    16.3%    20.7%    21.7%     18.0%    18.4%    10.0%    10.0%    10.0%    29.5%    19.5%    15.0%     7.0%
   Broker                      -16.3%      -0.2%        0.1%     -3.7%   12.8%       8.5%    -9.7%   -10.6%        -        -        -        -        -        -        -
   Sports                      -25.9%       1.2%        9.5%    26.5%    24.4%       1.0%    -2.2%    -8.4%        -        -        -        -        -        -        -
   Telco                       -23.5%     -27.4%       -21.7%   -18.5%   -12.6%   -12.2%    -14.4%    -8.7%        -        -        -        -   -12.0%        -        -
   Bank                              -             -        -        -   23.5%       6.1%    7.5%     6.8%         -        -        -   20.1%    10.5%     5.0%     2.0%
   e-money                           -             -        -        -        -         -        -        -        -        -        -   17.3%         -    5.0%     5.0%


   Source: Company data, J.P. Morgan estimates




158 386
      Hiroshi Kamide                                          Global Equity Research
      (81-3) 6736 8602                                        03 January 2011
      hiroshi.kamide@jpmorgan.com




      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.




159                                                                                                                 387
   Hiroshi Kamide                                            Global Equity Research
   (81-3) 6736 8602                                          03 January 2011
   hiroshi.kamide@jpmorgan.com




   Consolidated Profit and Loss Statement
   ¥ billion
                                                                        Actual                      J.P. Morgan Estimates
                                                           F’07                   F’08    F’09   F’10E            F’11E     F’12E
   <Sales>
     eCommerce                                             75.5                   91.1   115.0   143.8           172.5      184.6
     Credit                                                70.2                   65.9    57.7    62.9            66.0       66.0
     Portal/media                                           7.5                    9.7    17.6    22.4            24.6       27.1
     Travel                                                12.9                   16.2    19.3    23.1            26.6       28.4
     Broker                                                30.6                   24.8    23.5    23.5            23.5       23.5
     Sports                                                 7.6                    8.0     8.4     8.4             8.4        8.4
     Telco                                                  9.7                   34.2    26.4    23.2            23.2       23.2
     Bank                                                     -                      -    30.3    33.5            35.2       35.9
     e-money                                                  -                      -       -     5.2             5.4        5.7
     Total sales                                          213.9                  249.9   298.2   345.9           385.4      402.8

   COGS                                                   -39.5                  -55.3   -70.0   -79.6            -88.7     -92.6

   Gross profit                                           174.5                  194.5   228.2   266.4           296.8      310.2

   <Operating profit>
     eCommerce                                             19.5                   26.1    36.2    41.0             48.3      53.5
     Credit                                               -25.2                   10.7     3.3     2.2              2.0       2.0
     Portal/media                                          -0.4                   -0.2     1.2     2.1              2.5       2.7
     Travel                                                 6.0                    7.5     8.8    10.4             11.4      12.2
     Broker                                                 5.7                    3.9     4.5     4.7              4.7       4.7
     Sports                                                -0.8                   -0.8    -0.6    -0.8             -0.8      -0.8
     Telco                                                 -0.4                    0.4     0.4     1.2              0.8       0.5
     Bank                                                     -                      -     2.4     1.3              3.5       5.4
     e-money                                                  -                      -       -    -0.8             -0.5      -0.6
     Total operating profit                                 0.1                   47.2    56.6    62.8             71.9      79.7

   Dividend income                                             -                   0.9     0.2     0.2              0.2       0.2
   Net interest income                                       0.5                  -2.1    -2.0    -2.3             -2.4      -2.4
   Gains on securities                                       1.1                     -       -       -                -         -
   Other gains                                               0.9                   0.6     0.6     0.1              0.1       0.1
   Other losses                                             -1.3                  -1.9    -1.0    -1.0             -1.0      -1.0

   Recurring profit                                         2.4                   44.5    54.9    60.1             69.1      76.9

   Extraordinary gains                                     57.4                    1.4     5.4       -                -         -
   Extraordinary losses                                    -9.1                  -80.9    -7.8       -                -         -

   Pre-tax profit                                          50.7                  -35.0    52.5    60.1             69.1      76.9
   Tax                                                    -15.0                  -20.6     0.6   -24.5            -28.1     -31.3
   Minorities                                               1.2                    0.6     0.4     0.4              0.4       0.4

   Net profit                                              36.9                  -55.0    53.6    36.1             41.4      46.0

   Per share
     EPS (¥)                                              2,826              -4,204      4,092   2,753           3,161      3,512
     DPS (¥)                                                100                 100        100     100             100        100
     Effective payout ratio (%)                             3.5                 -2.4       2.4     3.6             3.2        2.8
   Y/Y %
     Sales (%)                                              5.2                   16.8    19.4    16.0             11.4       4.5
     Operating profit (%)                                 -99.6                      -    20.1    10.8             14.5      10.8
     Recurring profit (%)                                 -92.2                      -    23.3     9.5             15.0      11.2
     Net profit (%)                                           -                      -       -   -32.7             14.8      11.1
     NAV (%)                                               -5.1                  -22.7    35.9    17.7             17.2      16.3
   Operating performance
     GPM (%)                                               81.5                   77.9    76.5    77.0             77.0      77.0
     OPM (%)                                                0.1                   18.9    19.0    18.1             18.7      19.8
     RPM (%)                                                1.1                   17.8    18.4    17.4             17.9      19.1
     Effective tax rate (%)                               -29.5                   58.9     1.2   -40.7            -40.7     -40.7
    Source: Company data, earnings results and J.P. Morgan estimates.



160 388
      Hiroshi Kamide                                            Global Equity Research
      (81-3) 6736 8602                                          03 January 2011
      hiroshi.kamide@jpmorgan.com




      Consolidated Balance Sheet
      ¥ billion
                                                                              F’07         F’08      F’09     F’10E     F’11E     F’12E
      <Assets>
       Cash and cash equivalents                                               57.4         88.6      96.2      99.8     118.7     157.4
       Accounts receivables                                                    27.9         32.2      37.8      45.0      50.1      52.4
       Marketable securities                                                   26.4          2.6      18.0      18.0      18.0      18.0
       Inventories                                                                -            -         -         -         -         -
       Deferred tax                                                            15.6         12.8      13.7      14.0      14.0      14.0
       Non-bank related assets                                                344.3        387.4     312.7     295.7     288.5     282.2
       Securities related assets                                              428.1        307.5     235.8     243.0     252.3     262.0
       Bank related assets                                                        -            -     617.3     648.1     661.1     674.3
       Other                                                                    3.4         19.1     182.6     199.0     203.7     207.7
      Current assets                                                          903.2        850.3   1,514.1   1,562.5   1,606.4   1,667.9
      Tangible fixed assets                                                    24.0         21.1      19.5      19.7      19.9      20.1
      Intangible fixed assets                                                  93.4         93.3     120.5     120.5     121.7     123.0
         Goodwill                                                              64.5         65.1      87.0      87.0      82.7      78.6
         Other                                                                 28.9         28.2      33.5      33.5      39.0      44.4
      Investments and other assets                                            138.3        122.2     105.1     105.1     105.1     105.1
      Total assets                                                          1,158.9      1,086.9   1,759.2   1,807.8   1,853.1   1,916.0

      <Liabilities>
       Accounts payable                                                       16.7         20.2       28.2      31.8      35.5      37.1
       Short term debt                                                       236.5        289.3      172.6     159.1     141.8     139.0
       Cash deposits in escrow                                               148.3        142.6      142.6     142.6     142.6     142.6
       Margin trading liabilities                                            101.7         53.5       59.0      62.0      65.1      68.3
       Guarantees receivables                                                104.9         88.7       89.1      89.1      89.1      89.1
       Credit guarantees (KC)                                                  4.5          3.6        2.8       2.4       2.0       1.7
       eBank deposits                                                            -            -      698.4     712.3     726.6     741.1
       Other                                                                 137.9        104.9      174.3     183.0     186.7     190.4
      Current liabilities                                                    750.4        702.9    1,367.0   1,382.4   1,389.4   1,409.3
       Long term debt                                                        181.1        194.1      157.3     154.2     151.1     148.1
       Other                                                                  29.7         28.1       13.5      13.5      13.5      13.5
      Long term liabilities                                                  210.7        222.1      170.8     167.7     164.6     161.6
      Reserves under special laws                                              3.9          3.2        2.7       2.7       2.7       2.7
      Total liabilities                                                      965.1        928.2    1,540.6   1,552.8   1,556.7   1,573.6

      <Net assets>
      Shareholder's equity                                                    206.8        150.7     203.1     244.5     290.5     342.0
      Valuation and translation adjustments                                    13.0          0.7       0.9      -4.5      -9.1     -14.5
      Minority interest                                                           -          8.8      14.7      15.0      15.0      15.0
      Total net assets                                                        193.8        158.7     218.6     255.0     296.4     342.4
      Total liabilities and net assets                                      1,158.9      1,086.9   1,759.2   1,807.8   1,853.1   1,916.0

      Net debt                                                               333.8        392.2     215.7     195.5     156.2     111.7
      Capital employed                                                       611.6        642.1     548.5     568.3     589.4     629.5
      Net debt/equity (%)                                                    185.8        263.3     114.6      89.0      61.9      39.6
      Debtor days                                                              38            44       43        44        45        46
      Inventory days                                                             -            -         -         -         -         -
      Creditor days                                                           106           122      126       138       139       143
      ROCE (%)                                                                 0.5          7.7       9.7      11.4      12.6      13.2
      ROE (%)                                                                 18.6        -32.0      30.3      16.2      15.9      15.1
      ROA (%)                                                                  3.2         -5.1       3.0       2.0       2.2       2.4
      Source: Company data, earnings results and J.P. Morgan estimates.




161                                                                                                                                 389
   Hiroshi Kamide                                            Global Equity Research
   (81-3) 6736 8602                                          03 January 2011
   hiroshi.kamide@jpmorgan.com




   Consolidated Cash Flow Statement
   ¥ billion
                                                                                       F’07      F’08      F’09     F’10E     F’11E     F’12E

    Pre-tax profit                                                                      50.7     -35.0      52.5      60.1      69.1      76.9
    Tax paid                                                                            -0.6     -22.4     -15.4     -24.5     -28.1     -31.3
    Depreciation and amortization                                                       12.3      16.2      19.9      14.9      15.0      15.1
    Changes in working capital                                                           0.2      -0.8       3.7      -3.5      -1.5      -0.7
    Changes in financial working capital                                                -1.2     -31.4    -118.1     -60.0     -60.0     -50.0
    Other                                                                                3.8      -2.5      10.2      -2.1      -2.4      -2.4
    Revaluation/sale of asset, equity income, net interest and provisioning            -22.2      62.4      -8.0         -         -         -
   Cash flow from operating activities                                                  43.0     -13.5     -55.2     -15.1      -7.9       7.6

    Capital expenditure                                                                -14.8     -14.9    -12.7      -11.7     -11.7     -11.7
    Net sale/purchase of securities                                                     65.3     -21.6    191.8      -20.0         -         -
    Other                                                                                4.5      -4.5     38.0        9.0         -         -
   Cash flow from investing activities                                                  55.1     -41.0    217.2      -22.7     -11.7     -11.7

    Change in debt                                                                    -114.7     64.5     -163.3     91.2      -15.0     -15.0
    Dividends paid                                                                      -1.0     -1.6       -1.3     -1.3       -1.3      -1.3
    Net buybacks                                                                           -        -       -4.1        -          -         -
    Equity issued                                                                        0.6      0.8          -        -          -         -
    Other                                                                                1.4     -1.3       -5.4     -2.3       -2.4      -2.4
   Cash flow from financial activities                                                -113.6     62.4     -174.2     87.6      -18.7     -18.7

   Effect of exchange rate change on cash and cash equivalents                           0.2     -0.9      -0.0      -1.0         -         -
   Gross change in cash and cash equivalents                                           -15.4      7.1     -12.3      48.8     -38.3     -22.8
   Cash and cash equivalents at the beginning of the year                               89.2     73.9      81.3     103.6     153.1     114.8
   Effect of Change in Consolidated Companies                                              -      0.3      34.6       0.7         -         -
   Cash and cash equivalents at FY end                                                  73.9     81.3     103.6     153.1     114.8      92.0

   FCF per share (¥)                                                                    -7.5   1,831.3   4,659.8   2,736.8   3,306.6   3,729.1
   FCF yield (%)                                                                        -0.0       2.7       6.8       4.0       4.8       5.5
   FCF conversion (%)                                                                  -82.4      50.8     107.7      57.1      60.2      61.3

   Source: Company data, earnings results and J.P. Morgan estimates.
   Note: Share price as of December 29, 2010




162 390
                                                                                                          Global Equity Research
                                                                                                          03 January 2011




                                                                                                          Overweight
Yahoo Japan (4689)                                                                                        4689.T, 4689 JT
                                                                                                          Price: ¥31,950
Cash Cow Geared for Recovery in Advertising
                                                                                                          Price Target: ¥35,000



We are maintaining our Overweight rating on Yahoo Japan, with a price target of                           Internet
¥35,000 to November 2011. We believe the company is geared for a recovery in                                                        AC
                                                                                                          Hiroshi Kamide
online advertising, with effective cost control resulting in pronounced margin                            (81-3) 6736 8602
expansion. We view improving fundamentals as a precursor to changes in                                    hiroshi.kamide@jpmorgan.com
corporate governance, as high cash generation is put to good use.
                                                                                                          Yusuke Maeda
                                                                                                          (81-3) 6736-8654
 We expect fundamentals to continue improving in 2011. We believe Yahoo
                                                                                                          yusuke.x.maeda@jpmorgan.com
  Japan will continue to benefit from a recovery in ad demand as the premier
                                                                                                          JPMorgan Securities Japan Co., Ltd.
  player in Japan’s net media space. We expect medium-term margin expansion
  through effective cost management and scaling of recent business initiatives,
                                                                                                          Price Performance
  such as social gaming and eCommerce partnerships with leading players.
                                                                                                            38,000
 The advertising recovery is gaining pace. Concerns remain over visibility for                           Y 32,000
  online advertising expenditure in 2H F’10. However, we believe a recovery
                                                                                                            26,000
  profile is gaining pace at Yahoo Japan, with display ad sales showing Y/Y
                                                                                                                  Dec-09   Mar-10    Jun-10      Sep-10   Dec-10
  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                                             4689.T share price (Y
                                                                                                                            TOPIX (rebased)
  key swing factor regarding the company's prospects going forward.
                                                                                                          Company Data
 Cost reductions and digital content are incremental positives. The company
                                                                                                          Price                                          ¥31,950
  sharply reduced operating costs in F’09 and is continuing to cut costs. We think                        Price date                               Dec. 29, 2010
  the divesture of the online market research business and the license                                    Market capitalization                       ¥ 1,853bn
  renegotiations carried out in 2Q F’10 were practical measures to maximize                               Shares outstanding                             58.0mn
                                                                                                          52-week range                          ¥38,500–27,230
  margin growth. Developing a digital content platform heralds a new approach to                          TOPIX                                           908.01
  improve the sales mix. We believe these are incremental positives that raise                            Dividend (F’10E)                                  ¥322
  earnings visibility at the company.                                                                     Dividend yield (F’10E)                            1.0%
                                                                                                          RoE (FY’10E)                                    26.2%
 Valuation and risks. The shares are trading at 18.2x our F’11 EPS forecast,                             Source: Bloomberg, J.P. Morgan estimates.
  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.
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                      265.8             1.4         134.6        7.9   132.9    9.4     74.7   19.4    1,255.9          25.4               7.9           10.8
2010                      279.8             5.3         143.8        6.8   143.4    7.8     83.5   11.8    1,439.7          22.2               6.0           10.2
2011E                     289.0             3.3         157.4        9.5   157.5    9.9     93.4   11.8    1,609.5          19.9               4.6            9.3
2012E                     307.9             6.5         171.7        9.1   171.8    9.1   101.9     9.1    1,756.2          18.2               3.7            8.6
2013E                     328.5             6.7         185.3        7.9   185.3    7.9   110.0     7.9    1,895.6          16.9               3.0            8.0
Source: Company data, earnings results, and J.P. Morgan estimates
   Hiroshi Kamide                      Global Equity Research
   (81-3) 6736 8602                    03 January 2011
   hiroshi.kamide@jpmorgan.com




                                       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:

   Ad demand recovery drive             • We estimate advertising makes up approximately 60% of total sales. Demand has
   operational gearing                     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.
   Cost reduction efforts also allow    • The company conducted cost reductions in F’09, resulting in marked increases in
   for increase in profitability           profitability during 1H F’10. We believe continued cost management and
                                           business expansion into digital content will lead to a further increase in
                                           profitability.
   We expect a dividend hike from       • With the company’s ‘cash cow’ status, we believe corporate governance will
   this cash cow                           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.

   WACC 7.6%, 0.5% terminal rate       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

164 392
      Hiroshi Kamide                Global Equity Research
      (81-3) 6736 8602              03 January 2011
      hiroshi.kamide@jpmorgan.com




                                    resultant Market Value of Equity is ¥2,059B, and this produces a fair value of
                                    ¥35,000 per share.

                                    Investment Risks
                                    We view the risks to our investment thesis as follows:

                                    Upside risks
                                     • Banner display advertising demand picks up faster than expected in 2H F’10.
                                     • Digital content sales from online gaming operations experiences significant
                                        growth.
                                     • Management undertakes price hikes for advertising and eCommerce services.
                                    Downside risks
                                     • Ad demand recovery slower than anticipated.
                                     • Cutover to new Google search technology is disruptive and results in advertising
                                        client loss.
                                     • New business developments lead to higher than expected costs.




165                                                                                                                  393
   Hiroshi Kamide                                          Global Equity Research
   (81-3) 6736 8602                                        03 January 2011
   hiroshi.kamide@jpmorgan.com




                                                           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%                      21%                                                   65%                                 5%
                     Targeting     Brand panel, prime display                                Search, tex t-based ads            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.




166 394
      Hiroshi Kamide                Global Equity Research
      (81-3) 6736 8602              03 January 2011
      hiroshi.kamide@jpmorgan.com




                                    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.
                                    Quarterly Sales and OPM Trend
                                    ¥ million

                                                                                      Bottoming of                   Continued margin expansion      56%
                                                                                      listings demand
                                     76,000
                                                                                                                                                     54%

                                     72,000                                                                                                          52%

                                                                                                                                                     50%
                                                                                                                        Bottoming of display
                                     68,000
                                                                                                                        ad demand                    48%

                                     64,000                                                                                                          46%
                                                  1Q          2Q           3Q    4Q      1Q        2Q           3Q       4Q        1Q           2Q

                                                                   FY'08                                FY'09                           FY'10
                                                                                  Sales (LHS)           OPM (RHS)


                                    Source: J.P. Morgan based on company data.




167                                                                                                                                                   395
   Hiroshi Kamide                                        Global Equity Research
   (81-3) 6736 8602                                      03 January 2011
   hiroshi.kamide@jpmorgan.com




   Quarterly Advertising Sales Trends
   %
                       Display ads sales               Listings ads               Total sales         Total   Notes
                             growth Y/Y           (including search               growth Y/Y          OPM
                                                and Interest Match)
                                                   sales growth Y/Y
          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
                                                                                             F’10E   F’11E             F’12E      CAGR 10E-12E
                                                         Sales growth Y/Y
                                                         Media                                4.7%   8.7%              9.0%                   8.8%
                                                         Business services                    7.5%   7.3%              8.8%                   8.0%
                                                         Consumer                            -0.7%   3.9%              2.7%                   3.3%
                                                         Total sales growth                   3.3%   6.5%              6.7%                   6.6%

                                                         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




168 396
      Hiroshi Kamide                Global Equity Research
      (81-3) 6736 8602              03 January 2011
      hiroshi.kamide@jpmorgan.com




                                    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.




169                                                                                                                     397
   Hiroshi Kamide                                        Global Equity Research
   (81-3) 6736 8602                                      03 January 2011
   hiroshi.kamide@jpmorgan.com




   Quarterly Earnings Forecasts
                                  F’09                                  F’10                                 F’11                                F’09     F’10     F’11
   (¥ billion)                     Q1         Q2      Q3       Q4        Q1        Q2      Q3 E     Q4 E     Q1 E    Q2 E     Q3 E     Q4 E                  E        E
   Sales                          67.6       68.0    70.9     73.2      70.5      70.9     72.7     74.9     75.5    76.2     77.2     79.0    279.8     289.0    307.9
   Media                          23.6       24.6    25.9     28.2      25.6      26.4     27.1     28.0     28.2    28.7     29.2     30.3    102.3     107.1    116.4
   Business services              17.5       17.5    17.7     18.7      18.4      19.0     19.5     19.9     20.1    20.3     20.8     21.3     71.4      76.8     82.4
   Consumer                       26.4       25.7    27.2     26.1      26.3      25.4     26.0     26.9     27.1    27.1     27.1     27.3    105.4     104.7    108.7
   Adjustments                     0.2        0.2     0.2      0.2       0.2       0.1      0.1      0.1      0.1     0.1      0.1      0.1      0.8       0.5      0.4


   Operating profit               34.3       34.4    36.4     38.7      37.6      38.4     39.9     41.5     41.9    42.4     43.2     44.3    143.8     157.4    171.7
   Media                          11.0       11.4    12.4     14.7      13.1      13.9     14.5     15.2     15.2    15.5     15.9     16.6     49.6      56.7     63.3
   Business services               7.4        7.7     8.0      9.2       8.9       9.4      9.8     10.0     10.0    10.1     10.5     10.8     32.3      38.2     41.4
   Consumer                       18.1       17.2    17.9     16.9      17.6      16.8     17.3     18.1     18.3    18.5     18.5     18.6     70.1      69.8     73.8
   Adjustments                    -2.2       -1.9    -1.9     -2.1      -2.1      -1.7     -1.7     -1.7     -1.7    -1.7     -1.7     -1.7     -8.1      -7.2     -6.8


   OPM                          50.7%      50.6%    51.4%    52.9%    53.3%    54.2%     54.9%    55.5%    55.5%    55.6%    55.9%    56.1%    51.4%    54.5%    55.8%
   Media                        46.7%      46.4%    48.1%    52.2%    51.3%    52.7%     53.5%    54.2%    54.0%    54.0%    54.5%    55.0%    48.5%    53.0%    54.4%
   Business services            42.7%      43.7%    45.2%    49.2%    48.5%    49.5%     50.2%    50.5%    50.0%    50.0%    50.5%    50.5%    45.3%    49.7%    50.3%
   Consumer                     68.4%      67.0%    65.9%    64.7%    66.9%    66.1%     66.5%    67.0%    67.5%    68.0%    68.0%    68.0%    66.5%    66.6%    67.9%
   Adjustments                       -          -        -        -        -        -         -        -        -        -        -        -        -        -        -


   Sales growth Y/Y              3.2%       3.1%     5.9%     9.1%      4.2%     4.2%      2.6%     2.2%     7.1%    7.4%     6.2%     5.5%     5.3%      3.3%     6.5%
   Media                         3.2%       7.2%    10.8%    20.8%      8.7%     7.2%      5.0%    -1.0%    10.3%    8.5%     7.7%     8.2%    10.5%      4.7%     8.7%
   Business services             3.2%       3.1%     2.4%     8.0%      5.7%     8.3%     10.1%     6.1%     8.8%    6.7%     6.7%     7.2%     4.2%      7.5%     7.3%
   Consumer                      3.2%      -0.3%     4.0%    -0.6%     -0.5%    -1.1%     -4.3%     3.4%     3.2%    6.8%     4.2%     1.4%     1.5%     -0.7%     3.9%
   Adjustments                   3.2%      -5.9%    -6.8%     1.2%    -19.8%   -47.4%    -47.6%   -51.9%   -39.8%    0.0%     0.0%     0.0%    -2.1%    -41.5%   -14.2%

   Source: Company data, J.P. Morgan estimates.




170 398
      Hiroshi Kamide                                           Global Equity Research
      (81-3) 6736 8602                                         03 January 2011
      hiroshi.kamide@jpmorgan.com




      Consolidated Profit and Loss Statement
      ¥ billion
                                                                          Actual                        J.P. Morgan Estimates
                                                             F’07                   F’08     F’09     F’10E         F’11E        F’12E
      <Sales>
      Media                                                  91.3                   92.5    102.3     107.1         116.4        126.9
      Business services                                      67.6                   68.6     71.4      76.8          82.4         89.6
      Consumer                                              102.4                  103.8    105.4     104.7         108.7        111.6
      Adjustments                                             0.8                    0.8      0.8       0.5           0.4          0.4
        Total sales                                         262.0                  265.8    279.8     289.0         307.9        328.5

      COGS                                                  -28.3                  -27.8     -32.6     -30.3        -30.8         -31.2

      Gross profit                                          233.8                  237.9    247.2     258.7         277.1        297.3

      <Operating profit>
      Media                                                  38.3                   43.5     49.6      56.7          63.3         70.0
      Business services                                      27.0                   29.5     32.3      38.2          41.4         45.5
      Consumer                                               68.6                   71.2     70.1      69.8          73.8         76.6
      Adjustments                                            -9.1                   -9.6     -8.1      -7.2          -6.8         -6.8
        Total operating profit                              124.8                  134.6    143.8     157.4         171.7        185.3

      Affiliate income                                        -3.1                  -1.1      -0.2         -            -             -
      Dividend income                                          0.0                   0.1       0.1       0.1          0.1           0.1
      Net interest income                                     -0.3                  -0.2      -0.1      -0.1         -0.1          -0.1
      Gains on securities                                        -                     -         -         -            -             -
      Other gains                                              0.5                   1.3       0.0       0.0          0.0           0.0
      Other losses                                            -0.5                  -1.8      -0.4      -0.4         -0.4          -0.4

      Recurring profit                                      121.5                  132.9    143.4     157.5         171.8        185.3

      Extraordinary gains                                      0.0                   1.6       0.4         -            -             -
      Extraordinary losses                                    -7.5                  -8.1      -3.1         -            -             -

      Pre-tax profit                                        114.0                  126.4    140.7     157.5         171.8        185.3
      Tax                                                   -50.7                  -51.1    -56.8     -63.6         -69.4        -74.9
      Minorities                                             -0.7                   -0.6     -0.4      -0.5          -0.5         -0.5

      Net profit                                             62.6                   74.7     83.5      93.4         101.9        110.0

      Per share
        EPS (¥)                                           1,035.3             1,255.9      1,439.7   1,609.5      1,756.2       1,895.6
        DPS (¥)                                             104.0               130.0        288.0     321.9        439.1         473.9
        Effective payout ratio (%)                           10.0                10.4         20.0      20.0         25.0          25.0
      Y/Y %
        Sales (%)                                            23.3                    1.4      5.3       3.3           6.5          6.7
        Operating profit (%)                                 17.5                    7.9      6.8       9.5           9.1          7.9
        Recurring profit (%)                                 18.2                    9.4      7.8       9.9           9.1          7.9
        Net profit (%)                                        8.0                   19.4     11.8      11.8           9.1          7.9
        NAV (%)                                              29.0                   -1.7     32.5      29.5          25.4         21.8
      Operating performance
        GPM (%)                                              89.2                   89.5      88.4      89.5         90.0          90.5
        OPM (%)                                              47.6                   50.7      51.4      54.5         55.8          56.4
        RPM (%)                                              46.4                   50.0      51.2      54.5         55.8          56.4
        Effective tax rate (%)                              -44.5                  -40.4     -40.4     -40.4        -40.4         -40.4
      Source: Company data, earnings results and J.P. Morgan estimates.




171                                                                                                                                       399
   Hiroshi Kamide                                 Global Equity Research
   (81-3) 6736 8602                               03 January 2011
   hiroshi.kamide@jpmorgan.com




   Consolidated Balance Sheet
   ¥ billion
                                                                F’07       F’08     F’09    F’10E    F’11E    F’12E
   <Assets>
    Cash and cash equivalents                                  113.0        37.0   139.2    209.4    306.3    409.5
    Accounts receivables                                        34.7        33.4    35.9     38.8     41.4     44.2
    Marketable securities                                          -           -     0.0      0.0      0.0      0.0
    Inventories                                                  0.2         0.3     0.2      0.3      0.3      0.3
    Deferred tax                                                 4.3         3.6     6.7      6.7      6.7      6.7
    Other                                                       12.0        17.2    21.3     23.1     24.6     26.3
   Current assets                                              164.3        91.4   203.3    278.3    379.4    487.0
   Tangible fixed assets                                        16.6        29.2    27.1     27.4     27.7     27.9
   Intangible fixed assets                                      13.8        18.7    15.0     15.1     15.3     15.4
   Goodwill                                                      2.5         6.4     4.9      4.9      4.9      4.8
   Other                                                        11.3        12.3    10.1     10.2     10.4     10.6
   Investments and other assets                                174.9       172.3   172.8    174.6    176.3    179.8
   Total assets                                                369.7       311.5   418.3    495.4    598.6    710.1

   <Liabilities>
     Accounts payable                                            6.6         5.3     7.5      7.6      7.7      8.1
     Short term debt                                            20.0        20.0    10.0      0.0      0.0      0.0
     Other                                                      62.4        39.4    88.1     83.5     84.7     85.8
   Current liabilities                                          89.0        64.7   105.6     91.0     92.4     93.9
     Long-term debt                                             30.0        10.0     0.0      0.0      0.0      0.0
     Other                                                       0.0         0.4     0.4      0.4      0.4      0.4
   Long-term liabilities                                        30.0        10.4     0.4      0.4      0.4      0.4
   Total liabilities                                           119.0        75.1   106.0     91.5     92.8     94.4

   <Net assets>
   Shareholders’ equity                                        246.5       234.2   308.0    401.4    503.3    613.2
   Valuation and translation adjustments                         1.7         0.2     2.0      0.0      0.0      0.0
   Minority interest                                             2.4         2.1     2.3      2.5      2.5      2.5
   Total net assets                                            250.7       236.5   312.3    403.9    505.8    615.7
   Total liabilities and net assets                            369.7       311.5   418.3    495.4    598.6    710.1

   Net debt                                                    -63.0        -7.0   -129.2   -209.4   -306.3   -409.5
   Capital employed                                            300.7       266.5    322.3    403.9    505.8    615.7
   Net debt/equity(%)                                          -25.4        -3.0    -41.7    -52.2    -60.9    -66.8
   Debtor days                                                     6          47       45       47       48       48
   Inventory days                                                 -3          -3       -3       -3       -4       -4
   Creditor days                                                 -49         -78      -72      -91      -91      -92
   ROCE (%)                                                     43.4        47.2     48.8     43.4     37.8     33.1
   ROE (%)                                                      28.4        31.0     30.7     26.2     22.5     19.7
   ROA (%)                                                      16.9        24.0     20.0     18.8     17.0     15.5
   Source: Company data, J.P. Morgan estimates.
   Note: Net debt/equity: net cash position.




172 400
      Hiroshi Kamide                                   Global Equity Research
      (81-3) 6736 8602                                 03 January 2011
      hiroshi.kamide@jpmorgan.com




      Consolidated Cash Flow Statement
      ¥ billion
                                                                        F’07      F’08      F’09     F’10E     F’11E     F’12E

        Pre-tax profit                                                  114.0    126.4     140.7     157.5     171.8     185.3
        Tax paid                                                        -51.1    -55.4     -15.8     -63.6     -69.4     -74.9
        Depreciation                                                     13.6     12.7      11.1      10.9      11.0      11.1
        Changes in working capital                                        1.6      4.1       0.6      -3.1      -2.6      -2.5
        Other                                                            -1.0     -4.2       0.4      -6.6      -0.4      -0.6
      Gain/loss on asset sale/valuation                                   4.5      4.3       3.1         -         -         -
      Cash flow from operating activities                                81.5     87.8     140.1      95.1     110.4     118.4

        Capital expenditure                                             -11.2     -11.1      -6.7      -3.6      -3.6      -3.6
        Net sale/purchase of securities                                  -6.6     -43.6      -1.6      -2.0      -2.0      -2.0
        Other                                                             0.9       0.8       0.9         -         -         -
      Cash flow from investing activities                               -17.0     -53.9      -7.4      -5.6      -5.6      -5.6

      Change in debt                                                    -20.1     -20.0     -20.4     -20.0         -         -
      Dividends paid                                                     -5.8      -6.3      -7.5     -18.7     -25.5     -27.5
      Net buybacks                                                          -     -82.0      -3.1         -         -         -
      Equity issued                                                       0.4       0.2       0.2         -         -         -
      Other                                                              -0.6      -1.8      -0.5         -         -         -
      Cash flow from financial activities                               -26.2    -109.9     -31.4     -38.7     -25.5     -27.5

      Gross change in cash and cash equivalents                          38.3    -76.1     101.4      50.8      79.3      85.3
      Cash and cash equivalents at the beginning of the year             75.2    113.0      37.0     138.3     187.3     266.6
      Effect of Change in Consolidated Companies                         -0.5      0.0      -0.1      -1.8         -         -
      Cash and cash equivalents at FY end                               113.0     37.0     138.3     187.3     266.6     352.0

      FCF per share (¥)                                               1,209.4   1,337.1   2,274.3   1,577.0   1,840.8   1,979.5
      FCF yield (%)                                                       3.8       4.2       7.1       4.9       5.8       6.2
      FCF conversion (%)                                                 58.6      59.1      91.7      58.1      62.2      62.0
      Source: Company data, J.P. Morgan estimates.
      Note: Share prices as of December 29, 2010.




173                                                                                                                        1
   Hiroshi Kamide                Global Equity Research
   (81-3) 6736 8602              03 January 2011
   hiroshi.kamide@jpmorgan.com




174 402
                                                                                                         Global Equity Research
                                                                                                         03 January 2011




                                                                                                         Overweight
Daum                                                                                                     035720.KQ, 035720 KQ




                                                                                                                                                        Korea
                                                                                                         Price: W76,300
The Little Engine That Could
                                                                                                         Price Target: W100,000



We maintain our Overweight rating on Daum, the second-largest search portal in                           Internet
Korea. Our Jun-11 price target is W100,000, based on a 2011E P/E of 15.5x. On a                                                      AC
cash-adjusted basis, our target translates to only 9.0x 2011E P/E.                                       Sungmin Chang, CFA
                                                                                                         (82-2) 758-5719
                                                                                                         sungmin.chang@jpmorgan.com
    Daum is the second-largest search portal in Korea. It was founded in 1995 as
                                                                                                         J.P. Morgan Securities (Far East) Ltd, Seoul
     a provider of various types of web service including free web-based e-mail,                         Branch
     messaging service, communities and news. Currently, Daum controls the
                                                                                                         Gon Suk Lee
     search query market in Korea with a share of 23% and the display ad market                          (82-2) 758 5710
     with a share of 25%.                                                                                gon.s.lee@jpmorgan.com

                                                                                                         J.P. Morgan Securities (Far East) Ltd, Seoul
 Daum provides pure exposure to internet portal, as the company focuses on                              Branch
  search and display ads only compared to NHN, which generates one-third of
                                                                                                         James R. Sullivan, CFA
  revenue from internet games.
                                                                                                         (65) 6882-2374
                                                                                                         james.r.sullivan@jpmorgan.com
 While Daum is a pure portal that is accorded higher multiples than game
                                                                                                         J.P. Morgan Securities Singapore Private
  companies, it is currently trading at some 42% discount to NHN on 2011E P/E.                           Limited
  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                                 Please see our Note on
  to 15% for NHN in 3Q10.                                                                                     Daum dated 04 January
                                                                                                              2011 for our revised
 We believe the overall growth momentum for Daum will continue to be better
                                                                                                              2011/12 earnings
  than the industry and NHN over the next couple of years.
                                                                                                              estimates and PT.
 2011 drivers: We believe Daum will continue to gain market share in both
                                                                                                              Daum: Another display ad
  search and display ads based on improved search quality, innovative marketing
                                                                                                              price hike
  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.




Daum (Reuters: 035720.KQ, Bloomberg: 035720 KQ)
W in mn, year-end Dec                                        FY10E FY11E FY12E Shares O/S (mn)                                                    13
Revenue (W bn)                                                 345       394     445 Market cap (W mn)                                     1,017,537
Net Profit (W bn)                                             113.5     84.6    110.6 Market cap ($ mn)                                          886
EPS (W)                                                    8,643.70 6,442.22 8,427.12 Price (W)                                               76,300
DPS (W)                                                           0         0       0 Date Of Price                                        29 Dec 10
Revenue growth (%)                                           41.0% 14.4% 12.9% Free float (%)
EPS growth (%)                                              263.0% -25.5% 30.8% 3mth Avg daily volume                                     122,795.00
ROCE                                                         33.9% 29.7% 30.6% 3M - Average daily Value (W mn)                              9,619.02
ROE                                                          42.3% 22.9% 24.1% Average 3m Daily Turnover ($ mn)                                 8.38
P/E (x)                                                         8.8     11.8      9.1 KOSPI                                                    2,043
P/BV (x)                                                        3.1       2.4     2.0 Exchange Rate                                         1,147.90
EV/EBITDA (x)                                                  -1.5     -1.7     -1.8 Fiscal Year End                                            Dec
Dividend Yie ld                                               0.0%     0.0%     0.0%
Source: Company data, Bloomber g, J.P. Morgan estimates.
   Sungmin Chang, CFA           Global Equity Research
   (82-2) 758-5719              03 January 2011
   sungmin.chang@jpmorgan.com




                                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.




176 404
      Sungmin Chang, CFA                                 Global Equity Research
      (82-2) 758-5719                                    03 January 2011
      sungmin.chang@jpmorgan.com




      Daum: Summary of financials
      Won in billions, year-end December
      Profit & loss statement                                                     Cash flow statement
                                       FY09         FY10E     FY11E    FY12E                                             FY09    FY10E    FY11E    FY12E
      Revenues                           245           345       394      445     Net Income                                31     113        85     111
      Search ad                          125           190       217      243     Depreciation & amortization               23       25       30       29
      Display ad                         105           138       158      180     Other non-cash items                       4      -17      -13      -25
      Operating cost                     200           251       285      305     Change in working capital                 -2       30        2      -15
      Labor                               41            51        64       71     Cash flow from operations                 56     151      101      115
      Commission                          53            61        62       64     Purchase of PP&E                          15      -14      -25      -25
      Operating profit                     45           94       110      140     Other assets disposal/ (purchase)        -17      -12      -18      -15
      EBITDA                               67          119       139      169     Cash flow from investing                 -14      -26      -43      -40
      Pre-tax Profit                       38          120       113      141     Equity raised/(repaid)                     0        0        0        0
      Net Income - Reported                31          113        85      111     Debt raised/(repaid)                     -16      -20        0        0
      Net income - Adjusted                31          113        85      111     Other charges                             12        6        2      -15
      EPS - Reported                  2,381          8,644     6,442    8,427     Cash dividends                             0        0        0        0
      EPS - Adjusted                  2,381          8,644     6,442    8,427     Cash flow from Financing                 -12      -13        2      -15
      Growth                                                                      Net Effect of FX rate changes              0        0        0        0
      Revenues                            5%         41%        14%      13%      Net Changes in Cash                       30     112        60       60
      Operating profit                   -3%        112%        16%      28%      Beginning cash                            40       69     181      241
      Pre-tax Profit                   -45%         219%        -6%      25%      Ending cash                               69     181      241      301
      EPS - Adjusted                    50%         263%       -25%      31%      DPS (Won)                                  0        0        0        0


      Balance sheet                                                               Ratio Analysis
                                            FY09    FY10E     FY11E    FY12E                                             FY09    FY10E    FY11E    FY12E
      Cash and Cash Equivalents                69      181       241      301     EBIT Margin (%)                         18%      27%      28%      32%
      Accounts receivable                      46       64        69       79     EBITDA margin (%)                       27%      35%      35%      38%
      Inventories                               0        0         0        0     Net profit margin (%)                   13%      33%      21%      25%
      Others current assets                    45       19        18       24     Operating cost/sales (%)                17%      15%      16%      16%
      Current assets                          160      264       328      403
      LT investments                           56       61        62       62     Sales per share growth (%)               4%     40%       14%      13%
      Net fixed assets                         61       62        72       78     Sales growth (%)                         5%     41%       14%      13%
      Other long term assets                   26       33        50       65     EBIT growth (%)                         -3%    112%       16%      28%
      Total Assets                            297      419       512      608     Net profit growth (%)                  -32%    265%      -25%      31%
      ST Debt and CPLTD                        20        0         0        0     EPS growth (%)                          50%    263%      -25%      31%
      Account Payables                         16       24        24       24
      Other current liabilities                42       56        62       62     Interest Coverage (x)                   24.7   243.2      n.m     35.1
      Total current liabilities                78       80        86       86     Inventory Turnover (x)                    na      na       na       na
      Long term debt                            0        0         0        0     Net Debt (cash) to total Capital (%)   -22%    -55%     -59%     -59%
      Other Long term liabilities              10       13        14       15     Net debt (cash) to equity (%)          -24%    -55%     -59%     -59%
      Total liabilities                        88       93       100      101     Sales/Assets (%)                        82%     82%      77%      73%
      Shareholder's equity                    210      327       411      507     Assets/Equity (%)                      142%    128%     124%     120%
      Total Liab. & Equity                    297      419       512      608     ROE (%)                                 16%     42%      23%      24%
      BVPS (Won)                           16,050   24,894    31,336   38,605     ROA (%)                                 10%     27%      17%      18%
      Source: Company, J.P. Morgan estimates.




177                                                                                                                                                  405
   Dick Wei                                     Asia Pacific Equity Research
   (852) 2800-8535                              06 January 2011
   dick.x.wei@jpmorgan.com


   Companies Recommended in This Report (all prices in this report as of market close on 05 January 2011)
   NHN (035420.KS/W222,500/Neutral)
   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

       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: 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)




178 4
      Dick Wei                                         Asia Pacific Equity Research
      (852) 2800-8535                                  06 January 2011
      dick.x.wei@jpmorgan.com


      J.P. Morgan Equity Research Ratings Distribution, as of December 31, 2010
                                                          Overweight      Neutral     Underweight
                                                          (buy)           (hold)      (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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179                                                                                                                                                              5
   Dick Wei                                       Asia Pacific Equity Research
   (852) 2800-8535                                06 January 2011
   dick.x.wei@jpmorgan.com


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