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JAPAN INTERNET: SECTOR ANALYSIS

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JAPAN INTERNET: SECTOR ANALYSIS Powered By Docstoc
					Japan internet
Sector outlook
Stephen Leung
stephen.leung@clsa.com (813) 45805774

Pageviews and shopping carts
The internet is one of Japan’s few sectors experiencing double-digit topline growth. Yet despite 70% population penetration, there is room still for expansion thanks to a government push on ubiquitous access through “u-Japan” and more internet-enabled handsets. Online advertising drives revenue for dominant player Yahoo Japan, while Rakuten leads in the growing e-commerce segment. We have initiated coverage on Rakuten with a BUY rating and Yahoo Japan with an Underperform.

Key money-making area
27 June 2008

Japan
Media

The internet is one of the few sectors in Japan with revenue growing at double-digit rates, and there is room for further expansion. The main revenue models for internet sites are traffic-driven online advertising, transaction-driven e-commerce and paid-for content and games. We focus on online ads, where Yahoo Japan leads, and business-to-consumer (B2C) e-commerce, where Rakuten is the top player.

Microsoft’s bid for Yahoo! Inc
Yahoo Japan is independent of Yahoo! Inc, which holds a 33% stake, but pays it 3% of revenue in royalties. SoftBank Mobile is using Yahoo Japan as its portal (32% of total Arpu from data). Its broadband and internet culture segments also tie with Yahoo Japan and accounted for 18% and 47% of SoftBank’s FY3/08 revenue and operating profit. Yahoo Japan is unlikely to be a takeover target (similar to Yahoo! Inc) as SoftBank needs to leverage its 40% stake in Yahoo Japan to enhance its internet business.

Companies in focus Rakuten (4755 JP) BUY, TP ¥73,000, 27% upside Yahoo Japan (4689 JP) U-PF, TP ¥41,000, 1% downside

e-commerce development in Japan

By 2012, total e-commerce transaction volume is set to reach ¥10tn. Success for a shopping site means having the most shops and products for the widest range of users; for an auction site, it means having the most participants. Rakuten and Yahoo Japan make their money from merchant and system fees, which depend on transaction volume. The most appropriate way to value internet names is by the PE/growth ratio, instead of looking at the PE ratio in a particular fiscal year. This determines a stock's value while taking into account earnings growth. While Yahoo Japan deserves a premium for its dominant position, it is too dear at its current 1.7x FY3/08-11CL PE/growth ratio versus a US average of 0.8x. We thus rate it an Underperform. Rakuten trades at 24.2x FY12/09CL PE and project annual EPS growth of more than 20% for the next three years. BUY the e-commerce leader to our ¥73,000 target for 27% implied upside.

Fundamental and technical views align

Online adspend still strongest in PC applications, but mobile is growing fast 450 400 350 300 250 200 150 100 50 0 2005 www.clsa.com 2006 2007 2008CL 2009CL 2010CL 2011CL (¥bn) PC fixed Mobile fixed PC search-linked Mobile search-linked

Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg (CLSA <go>), Thomson First Call, Reuters Knowledge - and profit from our powerful CLSA evalu@tor® database at clsa.com

Japan internet

Contents
Executive summary ............................................................................ 3 Key money-making areas ................................................................... 4 Microsoft’s bid for Yahoo! Inc............................................................. 9 e-commerce development in Japan .................................................. 13 Fundamental and technical views align ............................................ 16 Company profiles Rakuten ..............................................................................................21 Yahoo Japan ........................................................................................35 Appendices 1. Online adspend money flow ...............................................................50 2. Internet infrastructure in Japan and Korea ...........................................52 3. Yahoo! Inc, Yahoo Japan, SoftBank stakeholders and holdings................54
All prices quoted herein are as at close of business 24 June 2008, unless otherwise stated

Go online in Asia with CLSA research

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Executive summary

Japan internet

Pageviews and shopping carts
About 70% of Japan’s population uses the internet

The internet is one of few sectors in Japan that has experienced double-digit top-line growth over the past few years. With 70% population penetration, there is room for further expansion thanks to a government push on u-Japan (ubiquitous Japan) and more internet-enabled handsets. Online advertising is the main revenue source for dominant player Yahoo Japan, while Rakuten leads in the growing e-commerce segment. We have initiated coverage of both firms; Yahoo Japan is an Underperform while Rakuten is a BUY. The main revenue models for internet sites are traffic-driven online advertising, transaction-driven e-commerce and paid-for content or games, with advertising being the major revenue stream. Currently, Yahoo Japan leads in online ads and auctions, while Rakuten has the most popular internet shopping site, Rakuten Ichiba. While Microsoft has withdrawn its bid for Yahoo! Inc, even if the deal went ahead it would have little effect on Yahoo Japan’s strategy, as it is independent. The chance of Yahoo Japan becoming a takeover target (similar to Yahoo! Inc) is low since SoftBank needs to leverage its 40% stake in Yahoo Japan to enhance its internet business and Yahoo! Inc holds 33% of Yahoo Japan. B2C e-commerce is taking off in Japan. By 2012 the total transaction volume is set to reach ¥10tn. For a shopping site, the key to generating higher transaction volume is to have the most shops and products for the widest range of users; for auctions, the key is to have as many participants as possible. There are four main revenue sources for e-commerce sites: merchant fees, system fees (margin), advertising and advisory fees. Rakuten and Yahoo Japan both charge merchant and system fees, which are positively linked to transaction volume. Yahoo Japan is an Underperform, with 1% implied downside to our DCFderived target price of ¥41,000, which represents a three-year PE/growth ratio of 1.7x. We are BUYers of Rakuten to our DCF-derived target price of ¥73,000, suggesting 27% upside.
B2C e-commerce transaction volume

Yahoo Japan is leader in online ads; Rakuten is leader in e-commerce

Microsoft’s bid for Yahoo! Inc has little effect on Yahoo Japan’s strategy

e-commerce taking off in Japan

Yahoo Japan to Underperform; BUY Rakuten

Mobile growing faster

8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

(¥bn)

Mobile

PC

2006

2007

2008CL

2009CL

2010CL

2011CL

2012CL

Source: CLSA Asia-Pacific Markets

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Section 1: Key money-making area

Japan internet

Key money-making area
The internet is one of few sectors in Japan that has experienced double-digit top-line growth over the past few years. Areas likely to experience high Cagrs over 2006-12 include blogs and social networking services (SNS) (37%), music (24%), games (20%), video-on-demand (19%), online transactions (18%), B2C e-commerce (17%) and online advertising (14%). We discussed blogs and SNS in our January 2008 Early bird report. This report focuses on online ads and e-commerce, and the two leading companies are Yahoo Japan and Rakuten. Growth drivers are:
For more on blogs and SNS in Japan

Increasing broadband penetration. Currently around 60% of Japanese households have broadband, versus around 90% in northern Europe. Increasing online adspend. Japan’s internet adspend as a proportion of total adspend over the past few years has grown at a similar rate to the US and is set to account for some 10% of the total by 2010. New entrants such as SNS players offer an opportunity for online advertisers to place more personal and customised target ads, resulting in greater recognition of online ads by the advertisers. Higher-spec, faster mobile handsets with bigger displays.

Figure 1

Internet service spending projections
(¥bn) Video-on-demand Online games Music Mobile content 2006 33.7 153.0 24.2 338.8 2007 52.6 185.0 40.6 353.0 08F 65.6 219.0 56.2 365.5 09F 75.8 270.0 71.4 373.9 10F 89.4 332.0 77.4 380.8 11F 94.0 396.0 83.0 386.4 12F 97.8 458.0 88.0 390.9 Six-year Beneficiaries Cagr (%) 19 Cable TV, copyright owners 20 Game developers 24 MSN Music, record labels 2 Japanese plays JSAT, Jupiter Telecom Koei, Square Enix Avex, Sony Music Growth has slowed down, but some traditional contents providers in Japan include GMode, faith, Dwango, Index Holdings etc NRI, Trend Micro, Digital Arts Webmoney; internet banks including Tokyo Star, Seven&I; credit card companies including Credit Saison DeNA, mixi

Security Online transactions Mobile PC Blogs and SNS SNS Blogs Adspend Mobile PC B2C e-commerce Mobile PC

284.3 146.4 19.6 126.8 26.8 15.6 11.2 363.0 39.0 324.0 4,040 521 2,830

316.9 180.0 26.5 153.5 44.3 27.3 17.0 473.7 65.1 408.6 4,939 715 3,519

349.7 214.5 34.0 180.5 73.0 47.5 25.5 575.2 87.7 487.5 5,881 933 4,223

382.6 250.2 42.1 208.1 108.9 72.3 36.6 634.5 111.2 523.3 6,887 1,177 4,949

415.7 287.1 51.0 236.1 142.5 94.5 48.0 698.2 134.6 563.6 7,964 1,450 5,711

448.9 337.6 62.9 274.7 164.2 107.0 57.2 748.0 158.7 589.3

482.2 392.4 76.1 316.3 175.8 112.6 63.2 784.4 181.4 603.0

9 IT service companies 18 25 16 37 39 33 14 29 11 17 26 17 e-commerce and mobile commerce providers Internet media companies Blog/SNS providers Transaction solution providers

Yahoo Japan, DeNA, mixi

9,113 10,323 1,753 6,514 2,084 7,360

Yahoo Japan, Rakuten

Source: CLSA Asia-Pacific Markets, NRI

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Section 1: Key money-making area

Japan internet

Three main ways to generate revenue on the internet
Only a limited number of revenue models for internet sites

There are only a few revenue models for internet sites. The three main models are: traffic-driven (portals with search engines, SNS functions, content and communications like MSN Messenger that lead to advertising); transaction-driven (revenue generated from e-commerce transactions); and paid-for content or online games (beyond the scope of this report). These elements constantly evolve and converge. In Japan, there are four major types of internet sites: portals, search engines, e-commerce and SNS. Each type has a representative player. Key features are as follows: Portal: Gives its users as much information as possible. May include email, search, shopping, auctions, etc. Portals make most of their revenue from advertising and sometimes from e-commerce transactions. Ads can include sponsored ads (search-keyword-sensitive) and banner ads. The fundamental goal is to gather a lot of information, sellers, or products to attract the most users. Yahoo Japan is an example. Search engine: Harder to enter but incumbents can be beaten with better technology, ease of use and search algorithms. Examples: Google Japan, Baidu in China. Note that Google sells ad-linked keywords or sponsored ads, not banner ads. e-commerce: Can be included in a portal, but more often a standalone site where users buy/sell goods. Rakuten Ichiba is an example. SNS: Easy to build and hard to dislodge once leadership is established, SNS sites make money through online ads (targeted and untargeted) and premium services. Mixi is an example.
Figure 2 Figure 3

Four major types of internet sites in Japan

Projected revenue from blogs and SNS
120 100 80 60 40 20 0
2006 2007 2008CL 2009CL 2010CL 2011CL 2012CL

Projected online adspend growth
450 400 350 300 250 200 150 100 50 0 (¥bn)
PC fixed Mobile fixed PC search-linked Mobile search-linked

(¥bn)

SNS

Blog

2005

2006

2007

2008CL 2009CL 2010CL 2011CL

Note: SNS revenue includes advertising fees, usage fees, commissions from e-commerce sites, etc. Blog revenue includes advertising fees, usage fees, etc. Adspend in blogs is included in the overall online adspend. Source: CLSA Asia-Pacific Markets, NRI, Dentsu
Figure 4

Overall adspend unlikely to increase, but internet adspend proportion likely to grow
(%) Newspapers Magazines Radio TV Sales promotion (direct mail, billboards, etc) Satellite media Internet Total 2000 20 7 3 34 34 0 1 100 2001 20 7 3 34 34 1 1 100 2001 19 7 3 34 35 1 1 100 2003 18 7 3 34 34 1 2 100 2004 18 7 3 35 33 1 3 100 2005 17 7 3 34 33 1 5 100 2006 17 6 3 34 33 1 6 100 2007 17 6 2 33 33 1 7 100 08F 16 6 2 33 33 1 9 100 09F 15 6 2 33 33 1 10 100 10F 14 6 2 33 33 1 11 100 11F 13 6 2 33 33 1 12 100

Source: CLSA Asia-Pacific Markets, Dentsu

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Section 1: Key money-making area

Japan internet

About 75% of internet users’ time is spent at portals

According to the Online Publishers Association’s March 2008 Internet Activity Index, internet users spend about 75% of their time at portals, suggesting that advertising is still the main revenue stream for internet companies. Internet users also spend 7.5% of their time at community sites, implying that SNS will likely be one of the important growth areas, possibly even threatening the position of portals.
Figure 5

Internet users start to spend time in SNS (community) sites

How internet users spend their time (%) 100 80 60 40 20 0 Nov 07 Sep 07 Dec 07 Mar 07 Feb 07 Jul 07 May 07 Jun 07 Aug 07 Apr 07 Oct 07 Jan 07 Jan 08 Commerce Community Communications Search Content

Source: CLSA Asia-Pacific Markets, online-publishers.org
Figure 6

Banner ad and sponsored ad

Banner ad

Searching for “car” here . . .

. . . brings up sponsored ads related to “car” here

Source: CLSA Asia-Pacific Markets, Yahoo Japan

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Section 1: Key money-making area

Japan internet

Limitations to internet company growth
Big companies are sometimes less agile

As internet companies become successful, they run into a conundrum: success makes them bigger, but that very size makes them less agile and more indecisive, preventing them from recognising and entering new online spaces before smaller, more nimble players get in first. One way for internet companies to remain at the leading edge of user preferences is through M&A - examples include Google acquiring Youtube and Microsoft acquiring a small stake in Facebook. This option is available only to internet companies with plenty of free cash. As News Corp CEO Rupert Murdoch has said, ‘The world is changing very fast. Big will not beat small any more. It will be the fast beating the slow.’ For now, Yahoo Japan leads in online ads and auctions. Rakuten has the most popular internet shopping site, Rakuten Ichiba. Mixi is the PC SNS leader, while DeNA’s Mobile Game Town is the mobile SNS leader. One could argue that smaller names such as Mixi and DeNA could be acquired. However, both Yahoo Japan and Rakuten have stated that they currently have no plans to acquire any SNS players, although they will keep their options open. As a company’s cash piles up, it increases the asset and equity amounts in its balance sheet. Most Japanese internet names have a lot of cash - Yahoo Japan has ¥113bn (it announced on May 23 it will buy back 2% of shares, or 1.21m, for ¥60bn and plans to cancel the shares), DeNA has ¥18bn and Mixi has ¥7.7bn (as of FY3/08).

Big companies use M&A to sustain growth

Most internet names in Japan flush with cash

Internet usage statistics
About 70% of Japanese use the internet

Currently, internet penetration in Japan is about 60% of households. One household represents 2.49 people and there are about 51 million households, so about 88m or 70% of Japan’s population of 128m uses the internet. By comparison, penetration in northern Europe is close to 90%, suggesting that further growth is likely, given the government’s u-Japan policy. In order to take advantage of the u-Japan 2010 Policy (see Figure 7) by the Ministry of Internal Affairs and Communications (MIC), many Japanese companies are working towards promoting a ubiquitous society – the end goal is to have 100% of the population with access to high-speed or ultra-high-speed internet.
Figure 7

Ubiquitous Japan, a society of four-Ws whenever, wherever, whatever, whoever communicable network by 2010

Advancing from e-Japan to u-Japan

Source: MIC

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Section 1: Key money-making area

Japan internet

Japan is mobile-centric

Since Japan is a mobile-centric country, it is also imperative to study mobile internet penetration. Not surprisingly, Japan mobile internet penetration (number of mobile internet-enabled handset users over number of mobile users) is around 70%, higher than most of the rest of the world. In Japan, mobile internet traffic surpassed PC internet traffic two years ago. This is because commuting times in Japan are usually long and mobile technology in terms of display, content and data speed - is exceptionally advanced. Thus we can conclude that for an internet company to be successful in Japan, it must provide popular mobile and PC portals. The most popular sites (defined by number of unique visitors) in the AsiaPacific region include Yahoo! Inc, Microsoft (MSN) and Google. Worldwide, the most popular site is Google, followed by MSN and Yahoo! Inc.

Worldwide, Google is most popular site, followed by MSN and Yahoo! Inc
Figure 8

Global internet usage and growth rates
Region 2007 population 941,249,130 3,733,783,474 127,733,000 49,044,790 801,821,187 192,755,045 334,659,631 % of world Number using population internet in 2000 14.25 4,514,400 56.51 114,304,000 1.93 47,080,000 0.74 19,040,000 12.14 105,101,631 2.92 3,284,699 5.07 108,098,699 8.61 0.51 100 18,247,341 7,618,338 361,169,107 Number using internet in 2007 44,234,240 461,703,143 87,540,000 34,910,000 343,787,434 33,510,500 237,168,545 122,384,914 19,243,921 1,262,032,697 % of population using internet 5 12 69 71 43 17 71 22 57 19 % of world usage 4 37 7 3 27 3 19 10 2 100 Growth from 2000-07 (%) 880 304 86 83 227 920 119 571 153 249

Africa Asia Japan Korea Europe Middle East North America Latin America 569,133,474 Oceania 33,568,225 Total 6,606,970,166

Source: CLSA Asia-Pacific Markets, Internetworldstats
Figure 9 Figure 10

Japan population trend
130 125 120 115 110 105 100 07 08F 09F 10F 11F 12F 13F 14F 15F 16F 17F (m)

Data-enabled handset penetration
Middle East and Africa Japan Asia-Pacific India China Europe Latin America North America

(%) 0 20 40 60 80 100

Source: CLSA Asia-Pacific Markets, National Institute of Population and Social Security Research
Figure 11

Most-popular websites by country/region
Country World Asia-Pacific Australia China HK India Japan Malaysia New Zealand Singapore Korea Taiwan 1st Google Yahoo Microsoft Microsoft Yahoo Yahoo Yahoo Yahoo Microsoft Yahoo NHN Yahoo 2nd Microsoft Microsoft Google Baidu Microsoft Google Microsoft Google Google Microsoft Lycos Microsoft 3rd Yahoo Google Yahoo Tencent Google Microsoft Google Microsoft Fairfax Media Google Microsoft Google

Source: CLSA Asia-Pacific Markets, ComScore World Matrix

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Section 2: Microsoft’s bid for Yahoo! Inc

Japan internet

Microsoft’s bid for Yahoo! Inc
Microsoft tried to acquire Yahoo! Inc in Jan

In January 2008, Microsoft made a hostile bid to acquire Yahoo! Inc for US$46bn. After failing to find an alternative buyer, Yahoo! Inc’s board rejected the bid and Microsoft walked away in early May. In mid-June the talks between Microsoft and Yahoo! Inc ended after Microsoft decided that it is not interested in pursuing an acquisition of all of Yahoo! Inc (it was only interested in the search business). Yahoo! Inc also announced that to it has reached a 10-year agreement with Google that will enhance its ability to compete in the converging search and display marketplace, even instant messaging services. The agreement comprises a four-year agreement and two three-year agreements, to be renewed under Yahoo! Inc’s prerogative. Yahoo! Inc’s tie-up with Google allows the latter to extend its dominance of the online ad market. The biggest winner will be Google as it can increase its reach into Yahoo! Inc’s customers (ie, online advertisers).

Impact of a Microsoft-Yahoo! Inc merger on Yahoo Japan
Yahoo Japan is paying royalties to use brand

Yahoo Japan was established in 2007 as a joint-venture between Yahoo! Inc and SoftBank. Yahoo! Inc owns 33% of Yahoo Japan, while SoftBank has 40%. Under the joint-venture agreement, Yahoo Japan pays Yahoo! Inc a royalty of about 3% of its group revenue for the right to use the brand. Based on our conversation with Yahoo Japan, the impact of Yahoo! Inc’s strategy on Yahoo Japan is quite limited, as they are two independent companies. The chance of Yahoo Japan becoming a takeover target (similar to Yahoo! Inc) is low because SoftBank needs to leverage its 40% stake in Yahoo Japan to enhance its internet business. SoftBank Mobile is using Yahoo Japan as its portal (~32% of total Arpu from data); SoftBank’s broadband and internet culture segments also closely tie with Yahoo Japan and accounted for 18% and 47% of SoftBank’s FY3/08 revenue and operating profit respectively.

Impact on Yahoo Japan limited

Yahoo Japan unlikely to become an M&A target

Figure 12

Major events in Microsoft’s bid for Yahoo! Inc
31 Jan 2008 4 Feb 2008 11 Feb 2008 4 Feb 2008 5 Apr 2008 7 Apr 2008 10 Apr 2008 2 May 2008 18 May 2008 7 Jun 2008 13 Jun 2008 Microsoft offers US$44.6bn (shares and cash, 62% premium) to acquire Yahoo! Inc Yahoo! Inc works with Google to counter the bid Yahoo! Inc states that the bid is below Yahoo! Inc’s valuation News of potential AOL alliance with Yahoo! Inc Microsoft states that if Yahoo! Inc does not accept the bid, it may reduce its offer Yahoo! Inc states that it is OK with the merger but wants a better price News Corp works with Microsoft to acquire Yahoo! Inc while Yahoo! Inc is works on an alliance with AOL Microsoft walks away Microsoft and Yahoo! Inc start talks on a deal again, but this time Microsoft will take only part of Yahoo! Inc’s business Carl Icahn suggests that Yahoo! Inc be sold to Microsoft at US$34.375/share, but Yahoo! Inc disagrees. Its general shareholders meeting is scheduled for 1 August 2008 Yahoo! Inc announces Microsoft talks have concluded and Microsoft will not proceed with the bid. Yahoo! Inc will also be able to use Google's search and contextual advertising technology through its AdSense for Search and AdSense for Content advertising programs. At current monetisation rates, this is an approximately US$800m annual revenue opportunity. In the first 12 months following implementation, Yahoo! Inc expects the agreement to generate US$250450m in incremental operating cashflow.

Source: CLSA Asia-Pacific Markets

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Section 2: Microsoft’s bid for Yahoo! Inc

Japan internet

We don’t believe Yahoo! Inc has found its direction

We don’t believe Yahoo! Inc has found its direction as a company. It has focused on being the starting point for a user’s internet experience, but altering a browser’s home page takes only a few clicks. To be successful, an internet player does not always need to be at the forefront; it just needs to provide the best available tool or information to the majority of internet users, who are not always at the leading-edge of trends. In the end, for Yahoo! Inc to survive and maintain its position it must focus on either its search engine or its portal. Google dominates the search-engine market. It started to become popular in 2000, with its simple interface and innovative PageRank, which ranks each web page based on the number and PageRank of other websites and pages that link to it. At that time, Yahoo! Inc provided search services based on Inktomi's search engine. Yahoo! Inc acquired Inktomi in 2002 and sponsoredad expert Overture in 2003, then switched to using Google's search engine until 2004, when it launched its own search engine based on the combined technologies of its acquisitions. Although a number of country-specific searchengine companies have gained exposure - for example, Baidu is the most popular search engine in China - Google is still the most popular Web search engine worldwide. Yahoo! Inc’s portal strategy was once good and Yahoo Japan’s portal strategy is still good, but the main business model for a portal is selling online ads. Without online ad revenue, it is hard to maintain the portal. The only thing that Yahoo! Inc does better than Google is its little tools - Yahoo Mail, News, Finance, etc - which earn no revenue.

Google started to become popular in 2000

The only thing that Yahoo! Inc does better than Google is little tools

Figure 13

Yahoo! Inc operational data (US$m) Revenue Yahoo! Inc (US$m) US International Total US International Total US International Total Total (%) FY12/04 2,653 921 3,575 891 141 1,032 216 92 308 9 FY12/05 3,668 1,590 5,258 1,220 338 1,557 102 89 191 4 FY12/06 4,366 2,060 6,426 1,452 454 1,906 633 308 941 15 FY12/07 4,727 2,242 6,969 1,434 493 1,867 381 315 695 10

Operating income before depreciation, amortisation and stock-based compensation expense Operating profit

Operating profit margin
Source: CLSA Asia-Pacific Markets

Figure 14

Google rules the world

Worldwide search market share (December 2007) Company Google Yahoo Baidu Microsoft NHN eBay Time Warner (includes AOL) Ask.com and related Yandex Alibaba.com Total
Source: CLSA Asia-Pacific Markets

Millions of searches 28,454 10,505 8,428 7,880 2,882 2,428 1,062 728 566 531 61,221

Relative market share (%) 46.47 17.16 13.76 12.87 4.71 3.90 1.60 1.10 0.90 0.80 100.00

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Section 2: Microsoft’s bid for Yahoo! Inc

Japan internet

Microsoft is good at desktop applications

Microsoft’s strength is in desktop applications. Even if it were to merge with Yahoo! Inc, their combined strength would not be a big threat to Google in search advertising. Instead of acquiring Yahoo! Inc, Microsoft ought to focus on internet-based desktop applications and its operating system, rather than on products like MSN Search, XBox (27.4m wii sold versus 19.1m XBox sold in the year to June according to vgchartz.com) and Zune (150m iPod vs 2m of Zune according to company data).
Figure 15

History of different search engines

Google’s search engine launched in 1998, Yahoo! Inc’s in 2004 Year 1993 1994 Engine Aliweb WebCrawler Infoseek Lycos AltaVista Excite Dogpile Inktomi HotBot Ask Jeeves Northern Light Google AlltheWeb Naver Teoma Vivisimo Baidu Info.com Yahoo Search A9.com MSN Search Ask.com GoodSearch Wikiseek Quaero Ask.com Live Search ChaCha Guruji.com Wikiseek AskWiki Event Launch Launch Launch Launch Launch (part of DEC) Launch Launch Founded Founded Founded Launch Launch Launch Launch Founded Founded Founded Launch Final launch Launch Final launch Launch Launch Founded Founded Launch Launch Beta launch Beta launch Launched Launched

1995 1996

1997 1998 1999

2000 2003 2004 2005

2006

2007

Note: "Launch" refers only to web availability of original crawl-based web search-engine results. Source: CLSA Asia-Pacific Markets, Wikipedia

The internet has no borders and the barriers to entry are low

The internet has no borders and the barriers to entry are low. Being an internet conglomerate does not make things easier as management becomes distracted and faster, smaller and more innovative players can leap ahead. Yahoo! Inc has missed big opportunities before: Failure to acquire Facebook. Yahoo! Inc once developed a relationship with Facebook’s CEO Mark Zuckerberg and planned to acquire the SNS player for US$1bn, but through either indecisiveness or too many decision layers, the deal did not go through. Last year Microsoft acquired 1.6% of Facebook for US$240m, valuing it at US$15bn. Too slow to acquire YouTube and Jotspot (one of the earliest sites for sharing information in enterprises).

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Section 2: Microsoft’s bid for Yahoo! Inc

Japan internet

Since it would have an even bigger management structure after a merger with Microsoft, we doubt whether Yahoo! Inc could start a new advertising model as Google did with YouTube’s AdSense for video.
Yahoo Japan was also late in launching its SNS site

Let’s go back to Japan and examine some big opportunities missed by Yahoo Japan. Yahoo Japan was also late in starting its SNS site Yahoo 360, which launched in 2006, giving smaller players like Mixi (started in 2004) and DeNA’s Mobile Game Town (started in 2006) time to gain market share. It was also late in launching price-comparison sites like kakaku.com or videosharing site Nico Nico Douga (nicovideo.jp). In May, Yahoo Japan announced a tie-up with the Nico Nico Douga. Services include: Nico Nico Douga Ichiba (e-commerce site for anime and manga items) products will be the Yahoo! Shopping database; Nico Nico Douga (will be included in Yahoo Japan video site); and Yahoo toolbar to support Nico Nico Douga search. We see pros and cons to this deal. It will help Yahoo Japan maintain its dominant position as a search tool, but it will also probably increase traffic for Nico Nico Douga and Nico Nico Ichiba, allowing them to take greater market share in online advertising. Most Nico Nico Douga users are males with a strong interest in animation and manga (comics), meaning site owner Niwango (which in turn is owned by Dwango) will have a hard time attracting different advertisers.
Figure 16

Otaku-friendly

Screenshot of Nico Nico Douga

Source: Niwango

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Section 3: e-commerce development in Japan

Japan internet

e-commerce development in Japan
More virtual shopping through mobile

e-commerce is taking off in Japan. By 2012, total B2C transaction volume is set to reach ¥10tn (up from ¥5tn in 2007). Up to now, most of the growth has been from users shopping via their computers, but thanks to the introduction of plans that let mobile users surf shopping sites for a flat rate, and improved mobile handset displays that let them view high-definition pictures of products, mobile e-commerce is set for rapid growth. The most popular products include music, books, travel and accessories. To get the most out of a shopping platform, the key is to have the most shops. e-commerce shopping sites not only let stores take responsibility for inventory and handling charges, they also take advantage of one of the favourite Web 2.0 buzzwords: the “long tail”, also known as the 80-20 rule. According to the 80-20 rule, 80% of sales come from 20% of the products. In a department store, the store manager may choose to only put the most popular, newest, hottest, best-priced and least bulky items on the shelf, implying a potential loss of sales on less-popular, outdated, old-fashioned, expensive, or bulky products. In e-commerce, the best sites are those that have the greatest variety of shops, with products for the widest range of users. Of course, customer service (response time to user requests and a secure environment) and a reliable search engine on the shopping site are also of the utmost importance.
Figure 17

The key is to have the most shops

No inventory constraints on the internet

Growth in mobile e-commerce is faster

Projected B2C e-commerce growth

8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

(¥bn)

Mobile

PC

2006

2007

2008CL

2009CL

2010CL

2011CL

2012CL

Source: CLSA Asia-Pacific Markets, NRI
Figure 18

Rakuten Ichiba has the most stores

Representative e-commerce sites (as of December 2007) No. of stores Rakuten Ichiba Yahoo! Shopping 22,396 15,881 No. of buyers (m) 5.81 -

Note: Yahoo! Shopping does not disclose buyer numbers. Source: Companies

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Section 3: e-commerce development in Japan

Japan internet

Figure 19

Figure 20

e-commerce transaction volume
12,000 10,000 8,000 6,000 4,000 2,000 0 05 06 07 08CL 09CL 10CL 11CL 12CL (¥bn) PC Mobile

Market share by transaction volume
14 12 10 8 6 4 2 0 05 06 07 08CL 09CL 10CL 11CL 12CL (%) Rakuten Ichiba Yahoo! Shopping

Note: 2005 is Mar 2006 for Yahoo Japan, Dec 2005 for Rakuten. Source: CLSA Asia-Pacific Markets

There are four main business models for e-commerce sites: Merchant fees: A monthly fee merchants pay to be listed on the e-commerce site. System fees/margin: Usually 2-5% of the merchant’s revenue generated through the e-commerce site. Advertising: Banner-ad fees paid by online advertisers. Advisory fee: Fees for helping new merchants to set up their pages and professional advice on product placement, marketing, etc.
Rakuten and Yahoo Japan have merchant fees of around ¥50,000/month

Rakuten Ichiba uses the merchant fee and system fee models. Its standard plan costs ¥50,000/month with a one-year contract. A maximum of 5,000 items can be listed. The system fee is 2-4%, paid every six months. Yahoo! Shopping also uses both merchant fees and system fees. Its Royal plan costs ¥49,800/month (for revenue over ¥10m/month) with a one-year contract, no limitation on the number of items and a 1.9-3.7% system fee.

What do users buy and how much do they spend?
The most popular e-commerce products are books and magazines

According to a recent survey by Internet Association Japan, the most popular e-commerce products are books and magazines, CDs, DVDs, accessories and clothes. More than 40% of the surveyed e-commerce users had purchased these products. Most spent less than ¥50,000 per year.
Figure 21 Figure 22

e-commerce purchases
Books & magazines CDs, video, DVDs Clothes, accessories, fashion Travel & hotels PC hardware & software

Amount spent yearly
<¥5,000 ¥5,000-10,000 ¥10,000-50,000 ¥50,000-100,000 ¥100,000-300,000 ¥300,000-500,000 ¥500,000-1m >¥1m

(%) 0 10 20 30 40 50 60 70

Don’t know

(%) 0 5 10 15 20 25 30

Source: CLSA Asia-Pacific Markets, Internet Association Japan

Making money through bidding and selling at auction sites
Trading volume is one parameter used to measure the success of an auction site

Auction sites have also boomed. Again, the more participants an auction site has, the greater its chance of success. Women are also more receptive to mobile auctions. Currently, Yahoo! Auction is the most successful auction site in Japan, with a majority of transactions.

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Section 3: e-commerce development in Japan

Japan internet

Yahoo Japan and eBay announced that they will start an alliance

In December 2007, Yahoo Japan and eBay announced that they would start an alliance, allowing their users to bid on items listed on both Yahoo! Auction and eBay. Yahoo! Auction users were supposed to be able to bid for eBay items through Yahoo! Auction from March 2008, but the project has been delayed. The current three phases are: Phase 1: Yahoo! Auction users can bid for eBay-listed items through Netprice subsidiary Seikaimon, Yahoo! Auction’s partner (started December 2007). Phase 2: Yahoo! Auction users can directly see eBay products listed through Seikaimon on the Yahoo! Auction page (date not set). Phase 3 eBay users can bid on products in Yahoo! Auction through the eBay page (date not set).

This is the first time eBay has returned to Japan since it retreated in 2002

This is eBay’s first foray into Japan since it left in 2002 due to its small scale compared to Yahoo Japan and Rakuten. Yahoo! Auction has been one of Yahoo Japan’s most successful services, generating about 15% of group revenue. Allowing users to bid for eBay items should generate more transaction volume for the group. In FY3/09, we expect about 17% of the group’s revenue (2% from advertising and the rest from merchant fees and commissions) to derive from auctions.
Figure 23

Some more information on mobile auctions

Notable auction sites in Japan
Auction sites Yahoo! Auction Details Operated by Yahoo Japan. Can be accessed from all three MNO handsets; can be easily navigated from Yahoo Keitai, thanks to a single sign-on function. Biggest auction site in Japan with transaction volume at around ¥730bn in FY08. Operated by Rakuten. Can be accessed from all three MNO handsets, but on 20 Nov 2006, Rakuten started an exclusive mobile auction site with NTT DoCoMo called oku tomo, through which users exchange auction information with their friends, dress themselves using avatars, and blog. To protect user privacy, private information on bidders and sellers is handled through a Rakuten anshin torihiki system (literally "Rakuten ease of mind transaction”). According to the Rakuten Auction business group leader in a Bloomberg interview, Rakuten is aiming at revenue of ¥400bn and 15m members by the end of 2010. Operated by DeNA Majority of users are from younger generations between 10-30’s Source: CLSA Asia-Pacific Markets, companies
Figure 24

Fees Monthly fee of ¥294; ¥10.5 per item to sell; 5% of the bid amount as commission Free registration and monthly maintenance fee; 3.15% of bid amount as commission

Rakuten Auction

Moba-oku

Monthly fee of ¥315

Volume many times greater than that of its rivals

Yahoo! Auction transaction volume

1,000 800 600 400 200 0

(¥bn)

FY06
Yahoo! auction

FY07

FY08CL

FY09CL

FY10CL

FY11CL

FY12CL

FY13CL

Bidders (includes bidders, pocket bidders, moba oku, au auction, etc)

Source: CLSA Asia-Pacific Markets

27 June 2008

stephen.leung@clsa.com

15

Section 4: Fundamental and technical views align

Japan internet

Fundamental and technical views align
Focus on PE/growth rather than PE in a particular year

The most appropriate way to value internet names is by the PE/growth ratio, instead of looking at the PE ratio in a particular fiscal year. The PE/growth ratio is used to determine a stock's value while taking into account earnings growth. We conducted discounted cashflow (DCF) analysis to derive our target prices. First we use DCF to come up with a forecast share price, then we multiply it forward by the cost of equity twice to derive fair value of the company in a year's time. This is equivalent to saying that our one-year target price is based on a forecast price for two years ahead.

Yahoo Japan deserves a premium, but not this much
Yahoo Japan should enjoy a premium

Yahoo Japan is the most popular portal in Japan, with a dominant share of online adspend and as such should enjoy a premium compared to its domestic peers. Our target price of ¥41,000 represents a three-year PE/growth ratio of 1.7x, which is still higher than its peers. Our target implies 1% downside for this Underperformer.

Rakuten more compelling
Rakuten’s PE to contract even faster if we take TBS’s earnings contribution into account

In the case of Rakuten, we see several possible scenarios. In Figure 27, we examine Rakuten’s valuation as a standalone company, excluding the extraordinary items in FY12/07, and including Tokyo Broadcasting System’s (TBS) earnings contribution from FY12/09CL. Currently, Rakuten trades at 24x FY12/09CL PE. If we include TBS’ earnings contribution to Rakuten’s EPS, its PE ratio would contract even faster. Our ¥73,000 target implies 27% upside and we are BUYers of the stock. Please refer to our note on Rakuten for more information about TBS. Yahoo Japan provides monthly figures for pageviews, active user IDs, auction stores, number of products, etc. We have listed the data in our accompanying initiation note on Yahoo Japan. We believe the most useful indictor is monthly PC and mobile pageviews, as this measures the site’s momentum and popularity. Rakuten does not disclose monthly figures, but its investor relations section is quite accessible. Neither company provides year-end guidance due to the fluctuations in the internet space, but Yahoo Japan provides guidance for the next quarter, while Rakuten provides no guidance. In Figures 25 and 26 we present a summary for the past few financial years.
Figure 25

Both companies are IR friendly

Neither company provides year-end guidance

Yahoo Japan actual versus IBES and guidance (provided at end of 3Q)
Revenue 2002 2003 2004 2005 2006 2007 2008
Figure 26

Net profit Beat IBES y n n y n y n Beat guidance

Beat IBES y y n n n y n

Beat guidance

y n y n

y n y n

Rakuten actual versus IBES
Beat IBES 2001 2002 2003 2004 2005 2006 2007 Source: CLSA Asia-Pacific Markets Revenue n y y y y y y Net profit n n n n y y n

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27 June 2008 stephen.leung@clsa.com 17

Figure 27

Internet names comparison
Bloomberg Ticker Internet China Baidu.com Sina Corp Sohu.com Ctrip.com Int'l Tencent Holdings Shanda Interactive Ent The9 Limited Netease Alibaba.com Weighted Average Korea NHN NCsoft CDNetworks Megastudy Weighted average Japan Rakuten 4755 JP BUY ¥ 57,400.00 73,000.00 27.18 8,605.50 8,605.50 8,605.50 4689 JP 9984 JP 2432 JP 2121 JP SELL NR BUY SELL ¥ ¥ ¥ ¥ 41,250.00 1,824.00 662,000 753,000 41,000.00 830,000 700,000 (0.61) 25.38 (7.04) 27,740.18 22,802.02 2,982 1,056 28.4 28.4 27.0 30.0 22.6 38.1 54.6 27.8 24.2 24.2 22.0 27.4 15.3 30.5 41.8 23.0 21.3 21.3 19.4 25.3 15.1 23.8 31.5 20.9 (1.7) 22.2 26.1 16.3 8.0 25.6 22.4 (14.0) 1.1 0.8 1.7 1.9 1.2 1.9 1.6 (8.5) 26.8 33.0 20.6 11.6 24.3 17.6 (2.8) 0.9 0.7 1.3 1.3 1.3 2.4 1.2 15.6 15.1 7.4 17.5 25.2 10.0 13.2 13.4 6.9 13.5 19.3 8.8 12.0 6.5 10.3 14.6 7.8 11.1 035420 KQ 036570 KS 073710 KS 072870 KQ U-PF SELL O-PF SELL won won won won 178,500 48,400 12,400 304,500 190,000 40,000 20,000 300,000 6.44 (17.36) 61.29 (1.48) 8,282 955 170.94 1,861.31 22.9 25.3 9.2 34.5 24.8 19.2 18.1 7.5 27.7 20.3 17.4 9.5 1.9 26.0 12.3 50.6 25.9 0.7 1.5 0.1 1.1 0.8 14.7 10.1 4.0 24.2 15.8 12.1 6.9 2.6 18.6 12.6 5.8 BIDU US SINA US SOHU US CTRP UQ 700 HK SNDA US NCTY US NTES US 1688 HK BUY BUY BUY U-PF BUY BUY BUY U-PF U-PF US$ US$ US$ US$ US$ US$ US$ US$ HK$ 318.86 44.39 75.83 46.43 62.75 28.30 23.26 21.32 11.58 420.00 64.00 77.00 56.00 77.00 45.00 35.00 19.00 13.50 31.72 44.18 1.54 20.61 22.71 59.01 50.47 (10.88) 16.58 10,884 2,427 2,862 3,085 14,431 2,026 669 2,719 7,493 80.8 31.3 34.6 41.8 40.4 12.2 12.1 13.0 45.1 46.6 53.5 25.1 29.6 32.3 31.0 10.2 9.4 11.0 30.8 33.5 37.9 19.8 23.4 25.4 24.0 9.1 8.6 10.6 22.9 25.3 46.7 29.2 48.2 28.4 37.6 3.5 26.4 12.1 31.7 1.1 0.9 0.6 1.1 0.8 2.9 0.4 0.9 1.0 1.0 49.6 30.4 60.7 29.2 42.3 (0.5) 35.7 16.2 30.4 1.1 0.8 0.5 1.1 0.7 (22.1) 0.3 0.7 1.0 (0.1) 62.7 22.0 24.8 31.0 27.5 17.0 2.0 256.3 31.8 48.7 40.3 16.8 20.1 22.7 20.9 13.8 1.2 227.7 20.0 36.6 28.1 12.2 12.8 16.8 15.7 11.7 0.4 222.5 13.5 29.7 CLSA Rec. Price Curr. 24 Jun 08 Target price Upside/ downside (%) Mkt cap (US$m) PE (x) 09CL 10CL 11CL EPS 3yr PE/G (x) EPS 2yr PE/G (x) Cagr 08-11CL Cagr 08-10CL 08-11CL 08-10CL EV/Ebitda (x) 09CL 10CL 11CL

Section 4: Fundamental and technical views align

Excluding extraordinary items in 08A (Dec 07) Including TBS contribution Yahoo Japan SoftBank DeNA2 mixi Inc2 Weighted average US Google Yahoo eBay Amazon.COM Weighted average GOOG US YHOO US EBAY US AMZN US NR NR NR NR US$ US$ US$ US$ 545.21 21.45 27.73 80.68 -

171,247 29,512 36,492 33,698

27.2 30.7 16.0 43.8 28.1

22.2 27.5 14.2 32.8 23.0

18.4 22.7 12.7 23.6 18.7

27.8 26.2 14.3 41.7 27.5

0.8 1.0 1.0 0.8 0.8

31.6 28.9 15.6 41.9

0.7 1.0 0.9 0.8 0.8

17.0 14.6 9.9 23.5 16.6

13.5 12.4 8.9 18.5 13.4

11.1 11.1 7.8 13.6 11.0

Japan internet

¹ Revenue, Ebitda, Net profit, EPS are adjusted for non-cash connection revenue. ² For Japanese names except Rakuten, 09CL is Mar 09, For Rakuten and other names, 09CL is Dec 08. ³ Based on IBES numbers. Note: Foreign shareholding: Rakuten 20.8%, Yahoo Japan 44.4%, SoftBank 21.6%, DeNA 28.7%, Mixi 6.8%. Revenue, Ebitda, net profit, EPS are adjusted for non-cash connection revenue. For Japanese names except Rakuten, 09CL is Mar 09, For Rakuten and other names, 09CL is Dec 08. Based on IBES numbers. Source: CLSA Asia-Pacific Markets, Toyo Keizai

Japan internet

Notes

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Japan internet

Company profiles
Rakuten............................................................................................ 21

Yahoo Japan ..................................................................................... 35

All prices quoted herein are as at close of business 24 June 2008, unless otherwise stated

26 June 2008

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19

Japan internet

Notes

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Rakuten
¥57,400 - BUY
Stephen Leung
stephen.leung@clsa.com (813) 45805774

Plugged in
Rakuten enjoys dominant positions in a diverse range of online businesses, from shopping and travel to securities trading. Its stake in Tokyo Broadcasting System (TBS) and credit-regulatory issues have been a drag on the share price since 2005, but things are improving. With the stock trading at 24x FY12/09CL PE, with more than 20% EPS growth over FY12/07-11CL, we have initiated coverage with a BUY rating.

Dominant in e-commerce
Four of Rakuten’s seven main businesses - e-commerce, travel, credit and payment, and securities - are set to drive more than 85% of revenue and 95% of operating profit in FY12/08CL. Its shopping website, Rakuten Ichiba, accounts for 10% of Japan’s e-commerce transactions, which are likely to reach ¥10tn by end-2012, representing a 17% FY12/06-12 Cagr. Other players like Amazon will find it hard to displace Rakuten Ichiba due to its diverse business model that includes travel and securities trading.
4755.Q 4755 JQ

27 June 2008

Japan
Media
Reuters Bloomberg

TV-broadcasting aspirations
Rakuten acquired a 19.84% stake in Tokyo Broadcasting System (TBS) for ¥3,100/share. A merger or alliance would see Rakuten become a leading media-internet firm. TBS’s transformation into a holding company under the revised broadcasting law, which came into effect in April, could drive a rerating. Our forecasts currently do not include any contribution from TBS.

Priced on 24 June 2008 Topix @ 1,349.2
12M hi/lo 12M price target ±% potential Target set on Shares in issue Free float (est.) Market cap

¥67,600/33,300 ¥73,000 +27% 27 June 2008 13.0m 47.5% US$6,948m

Finance-related divisions back on track
The firm’s switch to a conservative method for estimating the allowance for interest-repayment losses resulted in a one-time provision in the credit and payment division in 4QFY12/07. This is sufficient for 6.9 years, allowing Rakuten to focus on expanding the division with greater loan balances and card transactions. The regulator has capped the effective interest rate at 20%, meaning further intervention is unlikely. We see more downside protection versus its peers due to cross-selling among its more than 40 million members.

3M average daily volume

¥5,255.6m

(US$50.6m)

We see value ahead
Stripping out FY12/07CL extraordinary losses, Rakuten is trading at 24x FY12/09CL PE on a FY12/07-10 EPS Cagr of 22%. Its 1.1x FY12/07-10CL PE/growth ratio beats Yahoo Japan’s 1.7x. At our ¥73,000 DCF-derived target price, it would trade at 1.4x three-year PE/growth. The US peers are trading at a weighted average of 23x, with 27% three-year EPS growth. Our estimate is conservative as we have not factored in potential earnings from Rakuten Ichiba’s Taiwan operation with President Chain Store and the near-10% EPS boost from TBS should a merger/alliance go ahead. Financials
Year to 31 Dec Revenue (¥m) Operating profit (¥m) Recurring profit (¥m) Recurring profit (% YoY) Net profit (¥m) EPS (¥) CL/consensus(10)(EPS%) PE (x) P/CF (x) PB (x) ROE (%)
Source: CLSA Asia-Pacific Markets

Major shareholders

Crimson Group 17.3% Hiroshi Mikitani 16.7%
Foreign s'holding

20.8%

Stock performance (%)
Absolute Relative Abs (US$)
80,000 70,000 60,000 50,000 40,000 30,000 Jun 06 Feb 07 Oct 07 (¥) Rakuten (LHS) Rel to Topix

1M 0.9 2.9 (2.8)

3M 6.1 (3.7) (1.9)
(%)

12M 35.1 78.0 54.9
120 110 100 90 80 70 60 50 40 Jun 08

Source: Bloomberg

06A 203,271 29,148 30,405 (15.13) 2,701 207.6 276.93 77.5 4.5 1.9

07A 213,936 120 2,378 (92.18) 36,900 2,836.5 20.27 16.5 3.6 18.6

08CL 237,847 43,193 44,819 1,784.74 26,337 2,024.5 113.00 28.40 18.3 3.2 12.8

09CL 265,548 49,920 51,142 14.11 30,870 2,373.0 105.00 24.23 16.0 2.9 13.3

10CL 290,160 56,430 58,028 13.46 35,027 2,692.5 107.00 21.35 13.8 2.5 13.4

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Rakuten – BUY

Japan internet

Rakuten - ¥57,400 - BUY
The business Competition & market franchise

Rakuten was founded in 1997. It has been constantly expanding and currently has seven business divisions: e-commerce (Ichiba), portal & media, online travel, online securities, a professional baseball team, credit & payment, and communications (internet service provider). It has been one of the most representative internet conglomerates in Japan over the past few years. One of its most controversial moves was a bid for Tokyo Broadcasting System, as it believes in order to grow an internet company, it is essential to merge internet content seamlessly with broadcast TV content.

Rakuten dominates the e-commerce segment with its online shopping website Rakuten Ichiba, which accounts for around 10% of Japan’s e-commerce transaction volume. Other players in this space include Yahoo Shopping and Amazon Japan. In online travel services, Rakuten Travel competes with travel agency websites (HIS, JTB, etc) and online travel operator Ikkyu. In the online-brokerage business, Rakuten is the third-largest player in terms of number of accounts after E*TRADE and Monex. It also has a baseball team, which is a great promotional tool for the group.

Valuation history
PE bands
745,000 240,000 82,000 28,000 9,700 3,300

EV/Ebitda band
log scale - (¥)
262.8x 118.1x 66.0x 41.0x 15.9x 1,274,999 339,999 100,000 29,000 8,600 2,500 0.1x

Comment

log scale - (¥)
32.8x 17.9x 9.0x 4.6x

The stock once traded at its low PE band. This could be due to two previous issues: consumer-finance regulatory intervention and issues with Tokyo Broadcasting System.

Jan 01

Jun 03

Nov 05

Apr 08

Jan 01

Jun 03

Nov 05

Apr 08

Bands (from the top): max, +1sd, avg, -1std, min.

Rakuten SWOT analysis
Strengths Weaknesses

CEO Mikitani is one of the most energetic and aggressive business leaders in Japan’s internet space, with a strategic mindset and an MBA from Harvard. Diverse businesses enable the group to hedge some of its operating risks.

Management’s allocation of time to various business divisions. The TBS issue is likely to be a continuous drag on the share price as the market may feel that Rakuten is stuck with its investment in the TV station.

Opportunities

Threats (risks)

Potential entry to the TV-content and broadcasting business allows the group to diversify its top line. Entry to the Taiwanese e-commerce market through its alliance with President Chain Store (the largest retailer in Taiwan).

As the group grows bigger, it may lack the ability and boldness to start new internet services (socialnetworking sites, etc). Though unlikely, there may be more challenges in the consumer-finance market when Japan’s macro conditions worsen again, with more bad loans and consequent regulatory moves.

The

Asia Box

Rakuten successfully started its Ichiba e-commerce website in Taiwan on 5 May (in an alliance with President Chain Store, Taiwan's biggest convenience-store operator). It gathered 300 merchants, 20,000 items and 90,000 members in the first 10 days. The company also plans to explore e-commerce markets in Europe, US and BRIC (Brazil, Russia, India and China).

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Rakuten – BUY

Japan internet

Dominant in e-commerce
Rakuten Ichiba has always had a distinct advantage e-commerce is an easy and cheap way to shop

Rakuten’s online shopping website, Rakuten Ichiba, has always had a distinct advantage in terms of the number of member stores, market share, etc, in the business-to-consumer (B2C) e-commerce segment. e-commerce is a cheap and convenient way to shop. With a rising consumer price index (CPI) (102.7 in January 2004 to 105.2 in January 2008) and a lower unemployment rate (4.9% in January 2004 to 3.8% in January 2008), the average spending at Rakuten Ichiba has increased. This could also be partly due to a better macro conditions.
Inflation expectation by consumers (12m ahead)

Rising inflation expectations

3.5 3.0 2.5 2.0 1.5 1.0 0.5

(%)

Apr 04

Oct 04

Apr 05

Oct 05

Apr 06

Oct 06

Apr 07

Oct 07

Apr 08

Note: Consumers expected inflation in 12 months time to be around 3.2% YoY, up from 0.9% in April 2007.Based on consumer confidence survey results. Source: Economic and Social Research Institute, Cabinet Office.

Our global equity strategist Chris Wood is bullish on Japanese financials and brokers, with the chart above illustrating a shift of inflation expectations to 3.1%, which should boost consumption.
Rakuten users growth
50 40 30 20 10 0 2Q 3Q 4Q 2Q 3Q 4Q 2Q 3Q 4Q 2Q 3Q 1QFY04 1QFY05 1QFY06 1QFY07 4Q (m) Rakuten group members Rakuten members

Average spending per user
30,000 28,000 26,000 24,000 22,000 20,000 Dec 08CL Dec 09CL Dec 10CL Dec 11CL Dec 12CL Dec 04 Dec 05 Dec 06 Dec 07 (¥)

Note: “Rakuten members” includes members of Rakuten Ichiba, Rakuten Travel, Infoseek, etc. “Rakuten group members” includes all Rakuten members plus Rakuten Securities, Rakuten KC and Rakuten Credit. Source: CLSA Asia-Pacific Markets

Rakuten to keep leading both e-commerce and online-travel segments

If a telco does not have a dominant position in the mobile market, the portal it uses is unlikely to be a success in that segment. SoftBank Mobile, which leverages Yahoo Japan (and thus Yahoo Shopping and Auction) as its official mobile portal, has only 18% of Japan’s mobile market. We believe Rakuten derives particular benefit from a sustained leading position in both e-commerce and online travel services.

27 June 2008

stephen.leung@clsa.com

23

Rakuten – BUY

Japan internet

Rakuten’s e-commerce revenue and OP
16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 (¥m) Revenue OP

Rakuten’s e-commerce operational data
180 160 140 120 100 80 60 40 20 0 (¥bn) Total transaction No. of orders (RHS) (m) 25 20 15 10 5 0 2Q 3Q 4Q 2Q 3Q 4Q 2Q 3Q 4Q 1QFY05 1QFY06 1QFY07 4Q 10,000 9,500 9,000 8,500 8,000 7,500 7,000 2Q 3Q 4Q 2Q 3Q 4Q 2Q 1QFY05 1QFY06 1QFY07 3Q

2Q

3Q

4Q

2Q

3Q

4Q

2Q

3Q

1QFY05

1QFY06

Source: CLSA Asia-Pacific Markets

Rakuten Ichiba is different from Amazon Japan

We believe Rakuten Ichiba is a bit different from Amazon Japan. First, Ichiba focuses on long-lasting relationships with merchant members, which benefits both parties. Rakuten has Japan’s largest online-customer database and the widest variety of online products. It also helps new merchants cultivate their online stores, providing knowhow and training. Again, customer stickiness is key. Rakuten retains Rakuten ichiba users through collaborative and innovative services, such as the Rakuten Super Point programme and a single identity for different services - travel, securities, banking, etc. Rakuten Super Point allows users to accumulate points upon purchases in Rakuten Ichiba or Rakuten Travel, which can then be used when making the next purchase.

Rakuten plans to expand operations outside Japan

Starting this year, Rakuten also plans to expand its presence in Taiwan, Europe and elsewhere, with the aim of extending operations to 27 countries by 2013. While the objective is too far off for an internet company, we believe it is a good sign as it shows Rakuten’s commitment to further boost top-line growth, which is the most important aspect for an internet firm. Rakuten has joined forces with President Chain Store (Taiwan’s largest retailer) to offer e-commerce services in Taiwan, similar to its Ichiba business model in Japan. Operations started in early May, and the company aims to turn black in FY12/09, expanding to 3,000 merchants in three years. We have yet to include the Taiwan operations in our forecasts, as Rakuten is likely to offer more guidance and visibility later this year.

Travel segment provides stable revenue and OP

Rakuten’s travel revenue and OP
4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 (¥m) Revenue OP

1QFY07

4Q

Rakuten’s travel operational data
8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 ('000) No. of stays (¥) Transaction/stay (RHS)

2Q

3Q

4Q

2Q

3Q

4Q

2Q

3Q

1QFY05

1QFY06

Source: CLSA Asia-Pacific Markets

TV-broadcasting aspirations
TBS has so far spurned Rakuten

A merger with TV broadcaster TBS would open up a number of opportunities for Rakuten, including TV e-commerce, high-definition-content delivery, video on demand, more interesting advertising methods (because it is easier to gather user demographics in the Internet), etc. TBS has objected to a merger with Rakuten, arguing that broadcasting is a protected industry - the Japanese financial authorities limit foreign ownership in Japanese broadcasting firms to below 20%. Both TBS and Raktuten have stated that discussions are ongoing, but there has not been much actual progress.

24

stephen.leung@clsa.com

1QFY07

4Q

27 June 2008

Rakuten – BUY

Japan internet

Now Rakuten group has 19% of TBS

In October 2005, Rakuten bought a 15.5% stake in TBS, raising its ownership to over 19% (as of May 2008). It had planned to eventually merge with TBS. However, after numerous rounds of discussions in the past three years, Rakuten finally withdrew its bid in November 2006, proposing instead to form an alliance with TBS. This could be one reason why Rakuten’s share price does not reflect its fair value. Under the Ministry of Internal Affairs and Communications’ (MIC) new broadcasting law, effective from April 2008, broadcasters are allowed to bring satellite-TV companies, radio stations, film companies and various media and content-related businesses under a holding-company structure, though any single shareholder is prohibited from owning more than 33% of the holding company’s voting rights. For example, Fuji TV plans to change its name to Fuji Media and to transfer its terrestrial-TV broadcasting business to a new unit. Other broadcasters are also looking at this option because, by doing so, they could run their businesses in a manner similar to US media conglomerates like Time Warner. In May, the Japan Economic Times (Nikkei Newspaper) reported that TBS will reorganise its TV business under a holding-company structure. TBS mentioned that it is considering different possibilities, and has yet to confirm its plans. If true, we could see a rerating of its share price. Since Fuji TV announced its plan to become a holding company in March, its share price has surged nearly 25%, partly due to market expectations of diversification and a top-line boost. On average, Rakuten’s TBS stake cost ¥3,100/share - representing a roughly 30% loss. TBS’ share price may be rerated once it becomes a holding company, meaning Rakuten could get out without making to much of a loss. TBS’s Notice of Convocation of the 81st Ordinary General Meeting of Shareholders, to be held in late June, refers to the issue with Rakuten as ‘one of the assignments for TBS company to deal with’. The issue has been dragging on since 2005 and most of the negative sentiments/impact should be reflected in Rakuten’s share price. Currently, our forecasts do not include any numbers from TBS. However, we have conducted a scenario analysis below. If Rakuten can form an equity-method affiliate alliance with TBS or increase its stake to more than 20%, it could enjoy a near-10% rise in EPS from FY12/09CL, since TBS would be an equity-method affiliate.

New broadcasting law from April 2008

Could see a rerating in TBS’ share price

Looking at potential TBS’s earnings impact on Rakuten’s EPS

EPS analysis after taking TBS’ net profit into account
Source TBS net profit (¥m) Rakuten EPS (¥) Rakuten EPS (with 20% of TBS NP) Increase (%) Bloomberg CLSA FY end Mar Dec FY12/08 or FY3/09 17,063 2,025 2,155 6 FY12/09 or FY3/10 17,334 2,373 2,638 11

Source: Bloomberg, CLSA Asia-Pacific Markets

Fuji TV and TBS share price from Mar-08
3,000 2,800 2,600 2,400 2,200 2,000 1,800 2 Apr 08 10 Mar 08 14 Mar 08 21 Mar 08 27 Mar 08 8 Apr 08 14 Apr 08 18 Apr 08 24 Apr 08 1 May 08 (¥) Tokyo Broadcasting System Fuji Television Network (RHS) (¥) 180,000 170,000 160,000 150,000 140,000 130,000

Rakuten EPS incl 20% of TBS profit
3,000 2,500 2,000 1,500 1,000 500 0 FY12/08 FY12/09 (¥) Impact of 20% of TBS NP on Rakuten EPS Rakuten EPS

Source: CLSA Asia-Pacific Markets

27 June 2008

stephen.leung@clsa.com

25

Rakuten – BUY

Japan internet

Finance-related divisions back on track
One of the largest online-brokerage houses in Japan

Rakuten Securities is one of the largest online-brokerage houses in Japan (third in terms of number of accounts, after E*TRADE at 1.6m and Monex at 812,000). The online securities-broking business, however, depends greatly on market sentiment. March core CPI increased 0.4% MoM and 1.2% YoY. Our chief economist in Japan, Susumu Kato, expects inflation to continue to rise, which could result in rate hikes later this year. Our Japan research team also predicts an inflation-driven rally, with bullish implications for the Japanese financial institutions. Brokerage analyst Yuin Lim recently upgraded his ratings on Nomura (from Underperform to BUY) and Daiwa (from Underperform to BUY).
Commissions for major online brokers
(bp) 4QFY3/07 4QFY3/08 E*TRADE 3.3 2.8 Monex 10.9 10.6 Matsui 9.1 11.6 Rakuten 4.5 4.5 kabu.com 7.9 8.0

Comparing the commissions of major online brokers

E*TRADE and Rakuten Securities experienced the least decline in asset under custody during the stock market collapse

Assets under custody
(¥bn) Asset under custody (4QFY3/07) Asset under custody (4QFY3/08) YoY (%)
Source: CLSA Asia-Pacific Markets

E*TRADE 4,126.3 3,754.9 (9)

Monex 2,127.6 1,752.0 (18)

Matsui 1,738.4 1,276.3 (27)

Rakuten 1,349.4 1,159.5 (14)

kabu.com 1,245.1 1,021.1 (18)

Rakuten Securities gaining market share and number of accounts

Rakuten Securities, being one of the larger online-brokerage houses, is likely to be a beneficiary of the inflation hike. The company has been able to gain market share in trading volume and number of accounts. With market leader E*TRADE likely to experience flat commissions, we do not anticipate a commission war among online brokers. One interesting note is that E*TRADE and Rakuten, with a combined market share of 52% of accounts, experienced the smallest decline in assets under custody during the past year.
E*TRADE commission flattening
5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 2QFY06 4QFY06 2QFY07 4QFY07 2QFY08 4QFY08 (bp)

Further decline in commission is unlikely

Market share by trading volume
50 40 30 20 10 0 Mar 05 Sep 05 Apr 06 Oct 06 May 07 Dec 07 (%) E*TRADE Matsui kabu.com Monex Rakuten

Note: Individual trade volume. Source: CLSA Asia-Pacific Markets, companies

Growing number of accounts

No. of online brokerage accounts
2.0 1.5 1.0 0.5 0.0 Mar 05 Sep 05 Apr 06 Oct 06 May 07 Dec 07 (m) E*TRADE Matsui kabu.com Monex Rakuten

Market share by no. of trading accounts
50 40 30 20 10 Mar 05 Sep 05 Apr 06 Oct 06 May 07 Dec 07 (%) E*TRADE Matsui kabu.com Monex Rakuten

Source: CLSA Asia-Pacific Markets, companies

26

stephen.leung@clsa.com

27 June 2008

Rakuten – BUY

Japan internet

Policy change in interestreturn-allowance reserve in FY12/07

In its credit and payment division, Rakuten changed its policy on interestreturn-allowance reserves in FY12/07 because of a lack of data to calculate interest-repayment claims prior to this. Previously, it looked at latest claim records and estimated the provision using 2.5 years as the quotation period. In FY12/07, it gathered enough statistical data to quantify the risk in interestrepayment claims and calculated a one-time provision needed for future potential cases. Using the old methodology, Rakuten would have had ¥11.2bn/month in expenses for interest-repayment claims. But because of its one-time provision, this cost is gone and the division should turn around. Bigger consumer-loan companies like Acom and Takefuji are guiding for lower revenue and operating profit for FY12/09 due to tougher, unpredictable business conditions. We partly attribute this to internal compliance issues, as well as the tighter money-lending law (maximum annual interest rates at 1520%, depending on the size of loans). For Rakuten’s credit and payment division, a better comparison would be credit card companies including Aeon Credit (guiding for slight increase of 2.6% revenue and flat operating profit YoY), Saison Card (guiding for 5% increase in revenue and 12% increase in operating profit YoY), and OMC (guiding for 5% decrease in revenue and 16% increase in operating profit YoY), so things are not all bad. On the bright side, unemployment is declining and we see the CPI rising with fewer personal bankruptcies. This may signal inflation and increasing consumer consumption.
Personal bankruptcy applications
24,000 22,000 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 (No.)

Tighter moneylending law

Decreasing personal bankruptcy applications

Unemployment rate and CPI
6 5 4 3 2 1 0 101 99 97 Jan 05 Jan 06 Jan 07 Jan 08 (%) Unemployment rate CPI (RHS) 107 105 103

Jan 04

Jan 05

Jan 06

Jan 07

Jan 08

Jan 04

Source: CLSA Asia-Pacific Markets, Supreme court, MIC, Ministry of Economy Trade and Industry

We see value ahead
DCF valuation methodology

We have listed our DCF assumptions in the following table. We also conducted a sensitivity analysis using different risk-free rate and beta assumptions. We conducted discounted cashflow (DCF) analysis to derive the target price. First we use DCF to come up with a forecast share price, then we multiply it forward by the cost of equity twice to derive fair value for the company in a year's time. This is equivalent to saying that our one-year target price is based on a forecast price for two years ahead. Stripping out FY12/07 extraordinary losses, Rakuten’s 1.1x FY12/07-11CL PE/growth beats Yahoo Japan’s 1.7x. At our ¥73,000 DCF-derived target price, Rakuten would be trading at 1.4x three-year PE/growth. Our estimate is conservative as we have not factored in potential earnings from Rakuten Ichiba’s Taiwan operation with President Chain Store and the near-10% EPS boost from TBS should the merger/alliance go ahead.

27 June 2008

stephen.leung@clsa.com

27

Rakuten – BUY

Japan internet

DCF assumptions
Risk-free rate (%) Equity premium (%) Beta (x) Cost of equity Ke (%) Cost of debt Kd (%) WACC (%) Forecast share price (¥) Forecast share price¹ (1+Ke) (¥) Forecast share price¹ (1+Ke)² (¥) Target price (¥) 1.75 5.0 1.00 6.8 3.5 6.3 63,775 68,080 72,675 73,000

Two-year rolling beta
2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 Apr 02 Oct 03 Apr 05 Oct 06 Apr 08 Rakuten Average TOPIX

We stress-tested our DCF assumptions with different risk-free rates

Sensitivity analysis of risk-free-rate assumptions
Risk-free rate Forecast share price (¥) Forecast share price¹ (1+Ke) (¥) Forecast share price¹ (1+Ke)² (¥) 1.25% 73,467 78,059 82,937 1.75% 63,775 68,080 72,675 2.25% 55,827 59,875 64,216 4.00% 36,873 40,192 43,809

Sensitivity analysis of beta assumptions
Beta (x) Forecast share price (¥) Forecast share price¹ (1+Ke) (¥) Forecast share price¹ (1+Ke)² (¥) 0.8 85,472 90,387 95,584 1.0 63,775 68,080 72,675 1.2 49,223 53,037 57,148

¹ One year target, ² Two year target. Source: CLSA Asia-Pacific Markets

We have also compared the EV/IC and ROIC /WACC for the company based on the cumulative analysis of its upcoming profit streams. Like Yahoo Japan, Rakuten experienced a massive spike in valuation in FY12/04-05, but has been undervalued since FY12/06.
Figure 1

Experienced spike in valuation in FY12/04-05

EV/IC and ROIC/WACC

35 30 25 20 15 10 5 0 01

(x) ROIC/WACC EV/IC

02

03

04

05

06

07

08E

09E

10E

Figure 2

Figure 3

We also looked at the EVA spread in FY12/01-10CL

EVA spread
25 20 15 10 5 0 (5) (10) 01 (%) EVA™ WACC ROIC

EV/IC vs ROIC/WACC
35 30 25 20 15 10 5 0 0 EV/IC (x)
y = 4.2389x - 1.1118 R2 = 0.4956

ROIC/WACC (x) 1 2 3 4 5 6 7

02

03

04

05

06

07

08E 09E 10E

Source: CLSA Asia-Pacific Markets

28

stephen.leung@clsa.com

27 June 2008

Rakuten – BUY

Japan internet

Representative internet company in Japan

Corporate governance and management Rakuten is a representative Japanese internet company, with most investors mentioning Yahoo Japan and Rakuten together. Rakuten has implemented corporate governance measures. For example, it has an executive officer system that clearly defines management roles, making directors responsible for management decision-making and supervision, while executive officers are responsible for the execution of business activities. One of the best recent examples of corporate social responsibility initiatives is that Rakuten, together with other big internet firms DeNA, Microsoft and Yahoo Japan, announced in Spring 2008 the launch of a collaborative effort to make the internet safer for children. There have been some cases of misuse of internet SNS sites, resulting in certain immoral activities back in late 2007. The CEO Hiroshi Mikitani, with a Harvard MBA, is the founder and has been the CEO since 1997. Prior to founding Rakuten, Mikitani established a consulting business Crimson Group and has worked in a bank before that. Segment breakdown discussion Rakuten has many business segments. The major revenue contributors are ecommerce (Rakuten ichiba), Rakuten Securities and credit and payment, accounting for about 78% of revenue in FY12/09CL. We have listed details in the following tables. The major operating profit contributors are the ecommerce segment (Rakuten ichiba), Rakuten Securities and the travel business, accounting for about 85% of the group total. Rakuten has not disclosed detailed metrics such as the number of pageviews for the past few quarters. The company mentioned that the majority of group revenue is from merchant fees and transaction commissions, so it does not consider itself too heavily dependent on online advertising. The professional baseball team is a good tool for marketing and to promote the Rakuten brand in Japanese consumers’ minds.

e-commerce is a major contributor

Business divisions
Division e-commerce Description This division consists mainly of Rakuten Ichiba (Japan's largest online-shopping site), Rakuten Auction and Rakuten Books. Transactions on Rakuten Ichiba (including books) account for 10% of Japan’s total e-commerce transactions. This division consists mainly of Infoseek, Rakuten Research and College Students’ Portal Community. It focuses on the operation of internet-portal sites and community-networking sites, as well as internet market research and distribution of broadband content. Infoseek is the second-largest portal in Japan after Yahoo Japan. This division consists of Rakuten Travel and its subsidiaries and affiliates. It focuses on operating travel-related websites and services, such as hotel bookings. Its mobile site allows businessmen to make domestic hotel and travel bookings via their mobile phones. This division consists of Rakuten Securities and its subsidiaries. It provides online securities brokerage and other services. Rakuten Securities is the third-largest online broker in Japan in terms of the number of accounts, with more than 750,000 as at December 2007 (17% market share among the top-five online brokers). Operating costs will decline due to better operating efficiencies at data centres - ¥1.2bn/year savings likely from FY12/08. This division consists of Rakuten Baseball and Rakuten Sports Properties. It manages the Tohoku Rakuten Golden Eagles (“Rakuten Eagles”) professional baseball team and plans and sells related goods. This division consists mainly of Rakuten Credit, Rakuten KC and consolidated subsidiaries and affiliates. It is primarily engaged in the consumer credit-card, shopping-credit and consumer-loan businesses. The division provides internet services (10Mbps at ¥2,000/month) and VoIP phone services through its subsidiary Fusion Communications.

Portal & media

Travel

Rakuten Securities

Professional sports Credit & payment Communications

Source: CLSA Asia-Pacific Markets, company

27 June 2008

stephen.leung@clsa.com

29

Rakuten – BUY

Japan internet

Important segments e-commerce, securities and credit & payment

Division breakdown
(¥m) Dec 06 Revenue e-commerce 57,686 Portal & media 8,510 Travel 10,464 Rakuten Securities 40,524 Professional sports 6,547 Credit & payment 79,537 Communications 0 Elimination Total 203,271 Advertising revenue e-commerce division 13,543 Portal & other division 5,379 Total advertising revenue 18,922 % of total group revenue Ad revenue/e-commerce division revenue (%) 23.5 Ad revenue/portal & other division revenue (%) 63.2 Ad revenue/total (%) 9.3 OP e-commerce 17,657 Portal & media 393 Travel 4,659 Rakuten Securities 15,358 Professional sports (1,396) Credit & payment (6,149) Communications 0 Elimination (1,374) Total 29,148 OP margin e-commerce 30.6 Portal & media 4.6 Travel 44.5 Rakuten Securities 37.9 Professional sports (21.3) Credit & payment (7.7) Communications Elimination Total 14.3 Revenue breakdown (%) e-commerce Portal & media Travel Rakuten Securities Professional sports Credit & payment Communications Elimination Total Operating profit breakdown (%) e-commerce Portal & media Travel Rakuten Securities Professional sports Credit & payment Communications Elimination Total
Source: CLSA Asia-Pacific Markets

Dec 07 75,512 7,510 12,909 30,556 7,553 70,196 9,700

Dec 08 86,649 13,856 13,788 49,718 8,714 54,987 10,135

Dec 09

Dec 10

99,661 111,593 15,867 17,588 15,902 17,409 55,391 60,846 10,052 11,597 58,209 60,207 10,466 10,919

213,936 237,847 265,548 290,160 18,363 6,000 24,363 24.3 79.9 11.4 19,541 (362) 6,004 5,746 (836) (25,175) (394) (4,404) 120 25.9 10.0 46.5 18.8 (11.07) (35.9) (4.1) 0.1 20,435 8,758 29,193 23.6 63.2 12.3 21,557 1,386 6,332 10,549 (482) 3,581 271 0 43,193 24.9 10.0 45.9 18.8 (5.53) 6.5 2.7 18.2 23,402 10,029 33,431 23.5 63.2 12.6 25,292 1,587 7,462 11,753 (278) 3,825 279 0 49,920 25.4 10.0 46.9 18.8 (2.77) 6.6 2.7 18.8 25,940 11,117 37,058 23.2 63.2 12.8 28,878 1,759 8,343 12,911 232 4,016 291 0 56,430 25.9 10.0 47.9 18.8 2.00 6.7 2.7 19.4

Rakuten also makes some of its group revenue from online advertising

Revenue and operating profit breakdown

28.4 4.2 5.1 19.9 3.2 39.1 0.0 100.0

35.3 3.5 6.0 14.3 3.5 32.8 4.5 0.0 100.0

36.4 5.8 5.8 20.9 3.7 23.1 4.3 0.0 100.0 49.9 3.2 14.7 24.4 (1.1) 8.3 0.6 0.0 100.0

37.5 6.0 6.0 20.9 3.8 21.9 3.9 0.0 100.0 50.7 3.2 14.9 23.5 (0.6) 7.7 0.6 0.0 100.0

38.5 6.1 6.0 21.0 4.0 20.7 3.8 0.0 100.0 51.2 3.1 14.8 22.9 0.4 7.1 0.5 0.0 100.0

60.6 16,284.2 1.3 (301.7) 16.0 5,003.3 52.7 4,788.3 (4.8) (696.7) (21.1) (20,979.2) (328.3) (4.7) (3,670.0) 100.0 100.0

30

stephen.leung@clsa.com

27 June 2008

Rakuten – BUY

Japan internet

What the charts say
Since bottoming out at ¥33,000 last Summer, Rakuten has been working within a large three wave recovery. The second rally from January remains incomplete and the recent move above ¥54,000 sets up further upside towards ¥74,000, which also coincides with a 62% retracement of the 2005-2007 decline. Having already failed once at ¥68,000 resistance, however, we will keep the stop-loss tight at ¥53,000. A break below this support level suggests the rally is already complete to set up a retracement back to ¥42-45,000 Rakuten weekly with 40-week WMA

Price Action

These views are based on technical analysis and may or may not be in agreement with the ‘fundamental’ view.

For further information please contact Mark Stevenson, Head of Technical Research Tel: (8610) 59652146 e-mail: mark.stevenson@clsa.com

27 June 2008

stephen.leung@clsa.com

31

Rakuten – BUY

Japan internet

Risks & drivers
Sales (¥m)
350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 2005A 2007A 2009CL

Investment by numbers
Rakuten has seven business segments. We expect Rakuten Ichiba and Rakuten Travel to deliver constant revenue and operating profit streams for the group. While Rakuten does not disclose pageviews in its ad revenue, growth should be in line with the overall online adspend market, given the network effect in the Rakuten ecosystem. We have not included any earnings contribution from TBS in our Rakuten model. If the company does form an alliance with TBS or increase its stake to more than 20%, it could enjoy around a 10% increase in its EPS from FY12/09CL. For Rakuten KC, due to regulatory changes, we have a 20% effective interest rate assumption for credit cards and 18% effective interest rate assumption for money cards. We expect an inflation-driven rally, with bullish implications for the Japanese financial institutions, and Rakuten Securities would benefit from a rebound in trading volume to 2006 levels or higher.

Op profit (¥m)
60,000 50,000 40,000 30,000 20,000 10,000 0 2005A 200,000 100,000 0 (100,000) (200,000) (300,000) (400,000) (500,000) (600,000) (700,000) 2005A 2007A 2009CL 2007A 2009CL

Net cashflow (¥m)

Since there is no capex disclosure, we assume a fairly constant capex-to-sales ratio. We use a DCF valuation model with a three-stage growth assumption for Rakuten at 10% over 2013-20, 5% over 2021-25 and 1% from 2025 onwards.

Risks to our view
There are three key risks: an economic downturn, regulatory risks and IT security risks. The overall macroeconomic risk may discourage consumer spending in the internet, which would not only hurt the eCommerce business, but would also negatively affect the travel, securities, and portal and media segments. Though unlikely, there could be sudden changes in the regulatory environment. As we saw in the case of DeNA, whose mobile SNS portal Mobile Game Town was used by individuals involved in a homicide, sudden regulatory changes are a potential risk for Rakuten Ichiba. The Rakuten group cannot check the validity or safety of all the products listed in its eCommerce site. Besides, one of the risks for the consumer finance business is the government intervention in maximum interest rates, which may have a negative impact on Rakuten Credit. The Rakuten Group has a lot of personal and confidential user information. Leakage of user information would damage the group’s reputation.

Debt coverage (years)
20 0 (20) (40) (60) (80) (100) 2005A 2007A 2009CL

800 700 600 500 400 300 200 100 0

Net debt(cash)/equity (%)

Key earnings drivers
Year to 31 December
2005A 2007A 2009CL

2006A

2007A

2008CL

2009CL

2010CL

Earnings yield (%)
6 5 4 3 2 1 0 (1) (2) 2005A 2007A 2009CL

Internet adspend (¥bn) Unique buyers (m) Gross merch sales/buyer (¥) Merchants in Rakuten Ichiba Members in the credit biz Loan balance (¥bn) Internet subscriptions (m) B2C transcation volume (¥bn) Internet hh penetration (%)

454 17.78 23,812 18,637 81,312 84.2 25.3 4,040.3 49.6

543 20.86 25,740 22,396 103,843 103.6 26.7 4,938.7 52.3

622 24.40 25,500 24,396 114,227 114.0 27.9 5,881.4 54.7

690 27.1908 26,350 25,896 125,650 125 29 6,887 57

756 29.5856 27200 26,896 138,215 137.9 30.1 7,964.0 59.1

32

stephen.leung@clsa.com

27 June 2008

Rakuten – BUY

Japan internet

Summary financials
Summary P&L forecast (¥m)
Year to 31 December 2006A Revenue 203,271 Cogs (27,301) SG&A (139,871) Operating profit 29,148 Non-operating balance 1,257 Recurring profit 30,405 Extraordinary balance (27,196) Pretax profit 3,209 Tax and other adjustments 508 Net profit 2,701 Summary cashflow forecast (¥m) Operating Ebit 29,148 Depreciation/amortisation 6,951 Working capital - Trade (4,907) Other operating items (9,655) Operating cashflow 21,537 Net interest/taxes/other (27,926) Capital expenditure (45,550) Acquisition/inv/disposal (6,363) Free cashflow (51,939) Dividends paid (584) Other items 239,537 Decrease in net debt 180,651 Summary balance sheet forecast (¥m) Cash & equivalents 111,182 Debtors - Trade 16,714 Inventories - Trade 0 Other current assets 837,002 Fixed assets 48,940 Intangible assets 83,088 Other term assets 199,136 Total assets 1,296,062 Short-term debt 278,837 Creditors-trade 6,258 Other current liabilities 521,724 Long-term debt/CBs 286,047 Other long-term liabilities 0 Minority int/other equity 36,169 Shareholder funds 167,027 Total liabilities & equity 1,296,062 Ratio analysis (¥m) Revenue growth (%) 56.6 Operating profit growth (%) (16.4) Recurring profit growth (%) (15.1) Net profit growth (%) (86.1) Operating profit margin (%) 14.3 Net profit margin (%) 1.3 Dividend payout (%) 24.1 Tax rate (%) 139 Free cashflow (51,939) ROE (%) 1.9 ROA (%) 0.2 ROIC (%) 0.3 Enterprise value (EV) 1,017,598 EV/IC (x) 1.59 Equity ratio (%) 12.9 Net debt/equity (%) 223.3 2007A 213,936 (39,479) (165,819) 120 2,258 2,378 48,296 50,674 13,774 36,900 120 8,518 (781) 35,187 43,044 (78) (16,629) 71,698 26,337 (648) (22,412) 74,975 57,437 27,904 0 817,859 24,027 93,410 138,286 1,158,923 225,197 16,667 508,577 214,658 0 (12,980) 206,804 1,158,923 5.2 (99.6) (92.2) 1266.1 0.1 17.2 2.6 30 26,337 18.6 3.0 4.8 960,418 1.45 17.8 197.3 2008CL 237,847 (43,891) (135,795) 43,193 1,627 44,819 (1,187) 43,632 17,295 26,337 43,193 14,968 (1,256) 595 57,500 (18,481) (30,920) (20,000) 8,099 (1,301) 0 (13,202) 23,785 31,023 0 817,859 39,979 93,410 158,286 1,164,342 213,862 18,530 508,577 205,543 0 (14,011) 231,840 1,164,342 11.2 35893.8 1784.7 (28.6) 18.2 11.1 4.9 42 8,099 12.8 2.3 4.2 936,636 1.78 19.9 181.6 2009CL 265,548 (49,003) (148,243) 49,920 1,074 50,994 0 50,994 20,213 30,781 49,920 18,382 (1,455) 1,782 68,629 (22,125) (34,521) (20,000) 11,983 (1,626) 0 (9,643) 26,555 34,636 0 817,859 56,118 93,410 178,286 1,206,864 220,743 20,688 508,577 211,076 0 (15,215) 260,996 1,206,864 11.6 15.6 13.8 16.9 18.8 11.6 5.3 42 11,983 13.3 2.6 4.8 908,936 1.78 21.6 164.9 2010CL 290,160 (53,545) (158,090) 56,430 1,152 57,583 0 57,583 22,825 34,758 56,430 22,095 (1,293) 1,782 79,014 (24,814) (37,721) (20,000) 16,479 (1,951) 0 (5,472) 29,016 37,846 0 817,859 71,744 93,410 198,286 1,248,161 225,140 22,605 508,577 214,612 0 (16,575) 293,802 1,248,161 9.3 13.0 12.9 12.9 19.4 12.0 5.6 42 16,479 13.3 2.8 5.1 877,422 1.68 23.5 148.2

OP decrease in FY12/07 was mainly due to the lump-sum provision to allowance for interest repayment losses in the credit & payment division.

Non-operating gain (¥1,105m) from selling some of its investment in 1QFY12/07.

Extraordinary losses in FY12/08 due to securities segment datacentre consolidation and data-centre leasecontract discontinuation.

Much of the capex in the securities business was spent in FY12/06, so capex decreases in FY12/07.

Equity issuance in FY12/06 for Rakuten KC allowance reserve.

Minority interest reduction in FY12/07 due to the sale of an investment trust in Rakuten Securities. Operating margin at more than 18%.

Group’s equity ratio to improve.

27 June 2008

stephen.leung@clsa.com

33

Rakuten – BUY

Japan internet

Notes

34

stephen.leung@clsa.com

27 June 2008

Yahoo Japan
¥41,250 - UNDERPERFORM
Stephen Leung
stephen.leung@clsa.com (813) 45805774

Good, but not like before
Though Yahoo Japan remains the leader in online advertising, other players like Google Japan and SNS players like Mixi have taken some of its market share. While the stock deserves to trade at a premium for its dominant position, even at our ¥41,000 target it is trading at more than 27x FY3/10CL and a three-year PE/growth ratio of 1.7x, above Rakuten’s at 24x PE and 1.1x PE/G. We have initiated coverage with an Underperform rating given 1% implied downside to our target.

Advertisers now have more choices
27 June 2008

Japan
Media
Reuters Bloomberg 4689.T 4689 JP

Yahoo Japan enjoyed above-average growth in online advertising over 200406. However, since then other internet media companies such as Mixi, DeNA and Google Japan have emerged to take market share. Yahoo Japan’s advertising revenue growth has slowed and is now in line with the expansion in total online advertising expenditure.

SoftBank limits Yahoo Japan’s growth
SoftBank Mobile has leveraged its 40% holding in Yahoo Japan to introduce the mobile portal Yahoo! Keitai on its handsets. Currently SoftBank Mobile has 19m subscribers, versus DoCoMo with 53.5m and KDDI with 30.3m Both DoCoMo and KDDI have announced partnerships with Google Japan. Yahoo! Mobile’s pageviews are stagnant compared to other mobile portals such as Mixi and DeNA’s Mobile Game Town and, with Google Mobile’s increasing popularity as a search engine, Yahoo Japan is unlikely to maintain its leadership in the mobile market. Our scenario analysis suggests that while the 3G iPhone launch by SoftBank is likely to result in more mobile internet traffic, the impact on Yahoo Japan will be negligible.

Priced on 24 June 2008 Topix @ 1,349.2
12M hi/lo

¥59,000/35,200

12M price target ¥41,000 -1% ±% potential 27 June 2008 Target set on Shares in issue Free float (est.) Market cap

60.5m 22.2% US$23,096m

Baidu Japan: Long-term threat?
The official version of Baidu Japan’s portal site started in January 2008. Baidu started from nothing to become the top search engine in China within seven years, beating Google China and Yahoo China. According to its CEO Robin Li, Baidu Japan plans to remain in Japan for a long time, suggesting further disruption and competition for Yahoo Japan.

3M average daily volume

¥8,074.5m

(US$77.7m)

Major shareholders

Too expensive
We would rate Yahoo Japan an Underperform until it reaches our DCF-derived target price of ¥41,000. With the most popular portal in Japan and a dominant share of online adspend, the stock should enjoy a premium compared with its domestic peers. However, at more than 27x FY3/10CL PE with only 16% EPS growth for the next three years (Google at 22x with 27% growth for the next three years), it is too expensive. Financials
Year to 31 Mar Revenue (¥m) Operating profit (¥m) Recurring profit (¥m) Recurring profit (% YoY) Net profit (¥m) EPS (¥) CL/consensus(17)(EPS%) PE (x) P/CF (x) PB (x) ROE (%)
Source: CLSA Asia-Pacific Markets

SoftBank (9984) 40.2% Yahoo! Inc 33.4%
Foreign s'holding

44.4%

Stock performance (%)
Absolute Relative Abs (US$)
65,000 60,000 55,000 50,000 45,000 40,000 35,000 30,000 Jun 06 Yahoo Japan Rel to Topix (RHS) Feb 07 Oct 07 (¥)

1M (5.9) (4.0) (9.3)

3M (18.3) (25.9) (24.5)
(%)

12M (4.3) 26.1 9.8
120 110 100 90 80 70 60 50 40

Jun 08

Source: Bloomberg

07A 212,552 106,234 102,825 28.75 57,964 958.4 43.05 37.5 13.1 34.5

08A 262,027 124,806 121,510 18.17 62,616 1,034.9 39.85 34.3 10.1 28.3

09CL 295,260 141,296 142,147 16.98 81,596 1,376.2 101.00 30.58 27.1 7.6 28.4

10CL 322,569 154,223 155,595 9.46 89,315 1,506.4 95.00 27.94 25.0 6.1 24.4

11CL 348,270 166,374 168,322 8.18 96,621 1,629.6 90.00 25.82 23.3 5.0 21.5

www.clsa.com

Find CLSA research on Bloomberg (CLSA <go>), Thomson First Call, Reuters Knowledge - and profit from our powerful CLSA evalu@tor® database at clsa.com

Yahoo Japan – U-PF

Japan internet

Yahoo Japan - ¥41,250 - Underperform
The business Competition and market franchise

Yahoo Japan is the most-visited portal in Japan, providing various services and information to end users. The online advertising segment makes up about 50% of the group’s revenue and operating profit. Other services include nonad-related commissions such as merchant fees, transaction commissions in Yahoo! Auction and Yahoo! Shopping and paid services for Yahoo! Premium members. It pays a royalty fee to Yahoo! Inc to use its brand. SoftBank owns about 40% of Yahoo Japan, while Yahoo! Inc has 33%.

While the Yahoo! brand is known almost all over the world, Japan is one of the few regions where it is still dominant. Yahoo Japan once experienced better-than-sector growth in online advertising revenue, but this has fallen inline with the sector since social networking service (SNS) players and Google Japan emerged. Competition in display (banner) ads includes portals such as MSN Japan, Mixi, Infoseek and Excite. In sponsored ads (search-keywordsensitive), Google Japan’s Adword is the main competitor to Yahoo Japan’s subsidiary Overture.

Valuation history
PE bands
280,000 110,000 50,000 22,000 10,000 4,500

EV/ebitda bands
log scale - (¥)
204.8x 124.1x 88.2x 52.3x 36.2x 5,469,996 1,269,998 310,000 77,000 19,000 4,700 1.3x 0.2x 84.6x 38.1x 19.7x

Comment Yahoo Japan trades fairly inline with the online adspend market, as it makes around 50% of its revenue and operating profit through its ad segment. It has been expensive and slowly rerating to normal PE levels.

log scale - (¥)

Apr 02

Apr 04

Apr 06

Apr 08

Apr 02

Apr 04

Apr 06

Apr 08

Bands (from the top): max, +1sd, avg, -1std, min.

Yahoo Japan SWOT analysis
Strengths Weaknesses

Yahoo Japan has the most traffic in Japan and will likely remain one of the dominant players in online advertising. Yahoo! Auction is one of the largest auction sites in Japan and continues to contribute revenue and operating profit. As a huge information aggregator, it attracts all kinds of information seekers.
Opportunities

Its large scale hinders its decisiveness; it failed to become first mover in such Web 2.0 services as SNS and video sharing. Over 50% of its revenue and operating profit comes from online advertisements, making Yahoo Japan highly dependent on momentum/sentiment in the online adspend market
Threats (Risks)

An alliance with eBay may allow Yahoo Japan to increase its leading position in the auction business. Working with Niwango in video sharing site nicovideo.jp should boost internet traffic for Yahoo Japan.

It lacks agility and boldness in starting new businesses. Other smaller players move much faster. SoftBank’s 40% stake in Yahoo Japan may hinder Yahoo Japan’s growth in the mobile market, given that DoCoMo and KDDI have an alliance with Google Japan. Baidu Japan may create long-term disruption to Yahoo Japan.

The

Asia Box

Yahoo Japan pays about 3% of its group revenue to Yahoo! Inc as royalties to use the brand. Yahoo! Inc’s investment in Yahoo Japan is accounted for using the equity method. Yahoo Japan does not disclose the overseas revenue contribution as it is less than 10% of the group’s revenue.

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Yahoo Japan – U-PF

Japan internet

Advertisers now have more choices
Online ads contributed about 50% of Yahoo Japan’s total revenue and OP for FY3/08

Online advertising made up about 50% of Yahoo Japan’s total revenue and operating profit for FY3/08. By contrast, it accounted for 99% of Google’s total revenue for FY12/07. Google did not disclose Google Japan’s contribution, but it has stated that overseas revenue was approximately 39% of total revenue in 2005, 43% in 2006 and 48% in 2007, with the majority of customers outside the US located in Europe and Japan. This suggests the two regions’ contributions to Google’s total revenue have risen. Google Japan’s growth over the past few years implies that its contribution to Google’s overall revenue is increasing, suggesting it is a threat to Yahoo Japan. Note that Yahoo! Inc made approximately 85% of its FY12/07 revenue of US$6.9bn from “marketing services” - ie, advertising.
Overseas contribution to Google’s revenue is increasing

6,000 5,000 4,000 3,000 2,000 1,000 0

(US$m) Total revenue Revenue from overseas (RHS)

(%)

50 48 46 44 42 40 38 36 34 32 30

1QFY12/05

2QFY12/05

3QFY12/05

4QFY12/05

1QFY12/06

2QFY12/06

3QFY12/06

4QFY12/06

1QFY12/07

2QFY12/07

3QFY12/07
(¥)

Source: Google

Over 50% of revenue and OP comes from online ad

Yahoo Japan does not give figures for revenue from mobile advertising. However, it stated that the proportion is small, so we assume 3% for previous years and 5% for FY3/09.
Share price versus QoQ increase in ad segment revenue 30 25 20 15 10 5 0 (5) Dec 03 Dec 04 Dec 05 Dec 06 (%) QoQ increase in ad segment revenue Share price of Yahoo Japan (RHS) 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Dec 07

Source: CLSA Asia-Pacific Markets

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Yahoo Japan – U-PF

Japan internet

Display ads and sponsored ads are two major kinds of internet ad

Two kinds of advertisements are displayed on a portal site: display ads and sponsored ads. Display ads include banner ads, video ads, etc, whereas sponsored ads are usually search-keyword-sensitive. Display ads are more eye-catching and cost more; revenue from these ads is more sensitive to economic performance. As of 4QFY3/08, about 53% of Yahoo Japan’s advertising segment revenue came from sponsored ads (up from 45% in 4QFY3/07) and the rest came from display ads.
Yahoo Japan display ad advertisers by sector (%) 4QFY07 1QFY08 Financial, insurance, brokerage 18.5 17.8 Autos 10.7 10.2 Real estate 11.0 9.8 Transport, leisure 6.5 6.2 Computer 6.5 4.2 Cosmetics 6.0 7.7 Recruitment 7.4 5.1 Mobile services 3.2 6.1 Food 3.2 3.3 Entertainment software 2.7 2.6 Beverages 3.1 4.8 Fashion 2.5 3.1 IT, software 1.8 1.7 Others 16.9 17.4 Total 100.0 100.0
Source: CLSA Asia-Pacific Markets, Yahoo Japan

Financial sector has the largest proportion of advertisers

2QFY08 17.8 12.0 10.0 6.4 3.2 8.5 4.0 4.7 3.4 2.3 5.0 2.7 1.2 18.8 100.0

3QFY08 15.8 10.8 9.2 7.3 3.8 7.7 4.0 8.5 2.6 3.5 2.9 3.2 2.8 17.9 100.0

4QFY08 18.9 11.8 11.4 9.1 6.8 6.3 4.6 3.9 2.7 2.7 2.4 2.4 2.1 14.9 100.0

Quantifying cashflow with pageviews

The key metric for how well an internet media company is selling advertising is to calculate market share using the revenue from its advertising segment.
Online ad revenue growth in Japan versus Yahoo Japan’s ad segment growth 80 70 60 50 40 30 20 10 0 FY3/05 FY3/06 FY3/07 FY3/08 FY3/09 FY3/10 FY3/11 FY3/12 (% YoY) Online adspend Yahoo Japan ad segment Yahoo Japan ad segment ex-Overture contribution

Note: Overture became a Yahoo Japan subsidiary in mid-2007. Source: CLSA Asia-Pacific Markets

Yahoo Japan’s ad segment revenue growth is inline with total online adspend growth

Yahoo Japan’s ad segment enjoyed higher-than-sector growth over FY3/0406. However, after other internet companies like Mixi, DeNA and Google Japan emerged, this growth slowed and is now inline with growth in total online adspend. Although these other companies have leveraged their large traffic to demand higher revenue per pageview, they are still cheaper than Yahoo Japan, which is therefore unlikely to increase its own revenue per pageview.

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Yahoo Japan – U-PF

Japan internet

PC usage of top-five search engines
100 80 60 40 20 0 Yahoo! Japan Google goo infoseek MSN search (%) 2005 (n=1600) 2006 (n=1705)

Online adspend revenue market share
50 40 30 20 10 0 FY3/04 FY3/06 FY3/08 FY3/10 FY3/12 (%) Yahoo Japan PC (including Overture) Yahoo Japan PC (excluding Overture) infoseek (Rakuten) mixi PC

Source: CLSA Asia-Pacific Markets, companies

SoftBank limits Yahoo Japan’s growth
DoCoMo and KDDI have announced partnerships with Google Japan

SoftBank Mobile has leveraged its 40% holding in Yahoo Japan to introduce the mobile portal Yahoo! Keitai in its handsets, whereas DoCoMo and KDDI have announced partnerships with Google Japan. Currently SoftBank Mobile has 19m subscribers, versus DoCoMo’s 53.5m and KDDI’s 30.3m Both DoCoMo and KDDI have announced partnerships with Google Japan. We don’t think SoftBank will sell its stake in Yahoo Japan for three reasons. First, Yahoo Japan is one of its most successful subsidiaries. Second, SoftBank needs to leverage the Yahoo! mobile portal in its handsets to increase its Arpu figures. Third, it needs to maintain its more-than-40% stake in Yahoo Japan in order to treat it as a subsidiary. The number of mobile internet users in Japan (89m) has already surpassed PC internet users (87m). Unfortunately we have no mobile pageview data for Google, but comparing Yahoo Japan’s stagnant mobile pageviews against other mobile portals such as Mixi and DeNA’s Mobile Game Town, and considering Google’s increasing popularity as a mobile search engine, we are not confident Yahoo Japan can maintain its leading position in the mobile market.
Yahoo Japan (46% user penetration) vs Google Japan (22% user penetration)
Yahoo Japan Number of users (m) Number of PC pageviews (m) Increase in users Sep-05 to Jul-07 (%) Sep 05 33.7 21,894 Sep 06 38.5 23,620 Jul 07 41.1 22 Google Japan Sep 05 12.1 1,182 Sep 06 17.4 1,981 Jul 07 19.4 60

Mobile internet user numbers have surpassed PC internet user numbers

Comparison between Yahoo Japan and Google Japan

Note: Some 70% of Japan’s population are internet users. Source: CLSA Asia-Pacific Markets, Net Ratings

Top-three mobile portal pageviews
20 15 10 5 0 Feb 06 Aug 06 Feb 07 Aug 07 Feb 08 (bn) Mobile game town Mixi mobile Yahoo! mobile

Google increasing mobile search share
80 60 40 20 0 Yahoo! Mobile Google YiCHA livedoor F★ROUTE Mobile (%) 10/5/2006 (n=9,790) 9/20/2007 (n=4,336)

Source: CLSA Asia-Pacific Markets

Japan is a key battleground for mobile advertising and Google looks set to emerge the winner. Both DoCoMo’s Imode portal and KDDI’s Ezweb portal contain a search box with the phrase “enhanced by Google” that lets users search for sites among the official portals, for off-portal mobile sites and for PC sites that can be viewed on handsets. DoCoMo executive vice president
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Yahoo Japan – U-PF

Japan internet

Kiyoyuki Tsujimura told journalists one of the goals of the tie-up with Google was to boost DoCoMo's shared search-related advertising revenues to US$94m. There is a lot of potential for DoCoMo and KDDI users in Google services such as mobile Gmail and mobile Adsense. Google Japan also collects an enormous amount of data on consumer behaviour by monitoring the search habits of its vast pool of mobile internet users; the Japanese receptiveness to new technology makes the country a good testing ground for ad-embedded services. Given flat top lines, telecoms companies need to cut costs; Google’s low-cost Android mobile platform gives them a chance to reduce their high handset-development costs. Android’s emergence is likely to have a negative effect on Yahoo! Mobile’s pageviews and potential. Will 3G iPhone result in more ad revenue for Yahoo Japan? The 3G iPhone will be distributed in Japan by SoftBank from 11 July. In early June, CLSA Senior Technology Analyst Jenny Lai produced a Pan-Asia product accessing the implications on various Asian companies. Apple has sell-through forecasts of 10m iPhones in 2008. We have a house-view sell-in forecast (number used to access the impact on component makers) of 18m units in 2008.
3G iPhone from 11 July in the following countries

Apple has a sell-through forecasts of 10m of iPhone in 2008

Source: CLSA Asia-Pacific Markets , Apple

We assess potential impact of the iPhone

To assess the impact of the 3G iPhone launch on a service provider (telco or internet company), we need to consider the amount of 3G iPhone sellthrough. We expect four million will end up as inventory; two million have already been sold in 1H08, so our forecast for sell-through is 18-4-2=12m for the rest of 2008. Our number is higher than what Apple is guiding, but in 2H07 with 2G iPhone in nearly only one country (US - Europe launch was in late November), Apple sold around four million units at prices double that of the 3G iPhone. Among the countries where iPhone will go on sale on 11 July, only four are have mobile penetration of less than 100% (Canada at 60% with 21.5m subs, US at 85% at 254m subs, Mexico at 70% with 76m and Japan at 83% with 103m subs). We forecast SoftBank will have 20.7m subscribers by March 2009, gaining 2.1m new subscribers (2.68m churners and a gross addition of 4.78m) in FY3/08-09. We conducted a scenario analysis below, trying to assess the positive impact on Yahoo Japan thanks to the potential higher mobile internet user activity of those with a 3G iPhone, but even in our bullish case, the potential percentage of online ad segment revenue contribution is only about 0.01%, suggesting a negligible impact on our DCF target price.

We forecast SoftBank will have 20.7m subscribers by Mar-09

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Yahoo Japan – U-PF

Japan internet

3G iPhone will likely to have a positive impact on mobile internet user activity but the impact is small
iPhone sales in Japan (m) % of Daily iPhone Yahoo 2008 Japan sales in mobile terms of PVs (m) units Daily 50% Yahoo more Japan activity mobile for PV/user 3GiPhone (SoftBank user has ~19m users) Total number of mobile PVs Mobile internet activity increase (m, total number of PVs vs daily mobile PVs) Monthly increase in mobile ad revenue (¥m, about ¥0.1/PV) Yearly CLSA % of positive increase in FY3/09 contribution to mobile ad online ad online ad revenue segment segment (¥m, 8 forecasts revenue of months (¥m) Yahoo Japan from Aug because of 2008-Mar potential 2009) increasing iPhone user mobile internet activity 16.54 157,019 0.0105 Description

Bullish case

2.21

18.4

118

6.24

9.37

138.68

20.68

2.07

Assume Canada (21.5m subs), US (254m subs), Mexico (76m subs) and Japan (103m subs) account for 70% of iPhone sales in 2008. Japanese subs account for 23% of subs in the four countries Assume 20% of the new SoftBank subs (gross adds) get a 3G iPhone and have 50% more mobile internet activity than a normal SoftBank user on SoftBank's portal Yahoo! keitai Assume Canada (21.5m subs), US (254m subs), Mexico (76m subs) and Japan (103m subs) account for 20% of iPhone sales in 2008. Japanese subs account for 23% of subs in the four countries

CLSA forecasts

0.96

8.0

118

6.24

9.37

126.95

8.95

0.90

7.16

157,019

0.0046

Bearish case

0.55

4.6

118

6.24

9.37

123.17

5.17

0.52

4.14

157,019

0.0026

Source: CLSA Asia-Pacific Markets

Baidu Japan: Long-term threat?
Official version of Baidu Japan portal site was launched on Jan 2008

Baidu Japan launched its official portal site in January 2008. Baidu started its overseas operations in Japan because the nation has good internet infrastructure with increasing online adspend. In seven years, Baidu had come from nothing to be the top search engine in China, beating Google China and Yahoo China. According to its CEO Robin Li, Baidu Japan plans to stay on the Japanese battlefield for a long time. The company will start placing online advertisements in its search engine from 2010 and will develop a mobile search engine. Given Baidu Japan’s small size and agility, we expect it to develop a more market-driven product than Yahoo Japan offers.

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Yahoo Japan – U-PF

Japan internet

Baidu quickly dominated China’s search market
100 90 80 70 60 50 40 30 20 10 0 2003 2004 2005 2006 2007 (% of searches) Baidu Google Yahoo! Others

Baidu Japan website

Source: CLSA Asia-Pacific Markets, Baidu

The launch of Baidu Japan presents more downside risk

Although it is too early to say with certainty how much downside risk Baidu presents for Yahoo Japan, we can look at Baidu China for clues. The most important thing to note is that Baidu is strong in kanji (Chinese characters) search (Japan also uses kanji). Its search database covers 600m websites in China, one and a half times the number that Google China covers.

Too expensive
Use DCF analysis when conducting valuation

Yahoo Japan is one of the most popular portals in Japan, with a dominant share of online adspend and should trade at a premium compared to its domestic peers. Our target price of ¥41,000 represents a three-year PE/G ratio of 1.7x and a two-year PE/G ratio of 1.3x, which is still higher than the majority of its peers. We conducted discounted cashflow (DCF) analysis to derive the target price. First we use DCF to come up with a forecast share price, then we multiply it forward by the cost of equity twice to derive fair value for the company in a year's time. This is equivalent to saying that our one-year target price is based on a forecast price for two years ahead.
DCF assumptions
Risk-free rate (%) Equity premium (%) Beta Cost of equity Ke (%) Cost of debt Kd (%) WACC (%) Forecast share price (¥) Forecast share price¹ (1+Ke) (¥) Forecast share price¹ (1+Ke)² (¥) Target price 1.75 5.00 1.00 6.75 1.22 6.75 35,931 38,356 40,945 41,000

DCF assumptions and sensitivity analysis

Two-year rolling beta history
2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 Apr 02 Apr 03 Apr 04 Apr 05 Apr 06 Apr 07 Apr 08 Yahoo Japan Average Topix

¹ One year target, ² Two year target. Source: CLSA Asia-Pacific Markets

Sensitivity analysis of risk-free rate assumptions
Risk-free rate Forecast share price (¥) Forecast share price¹ (1+Ke) (¥) Forecast share price¹ (1+Ke)² (¥) 1.25% 41,002 43,674 46,404 1.75% 35,931 38,356 40,945 2.25% 31,672 33,968 36,431 4.00% 21,432 23,361 25,463

¹ One year target, ² Two year target. Source: CLSA Asia-Pacific Markets

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Yahoo Japan – U-PF

Japan internet

Sensitivity analysis of beta assumptions Beta Forecast share price (¥) Forecast share price¹ (1+Ke) (¥) Forecast share price¹ (1+Ke)² (¥) 0.8 47,492 50,223 53,111 1.0 35,931 38,356 40,945 1.2 28,119 30,299 32,647

¹ One year target, ² Two year target. Source: CLSA Asia-Pacific Markets

Also looked at EV/IC and ROIC/WACC

We have also compared the EV/IC and ROIC /WACC for the company based on the cumulative analysis of its upcoming profit streams. Yahoo Japan experienced a massive spike in valuation in FY3/04-05, but has since derated.
EV/IC and ROIC/WACC

Looked at EV/IC and ROIC/WACC history inFY03-11CL

180 160 140 120 100 80 60 40 20 0 03

(x)

ROIC/WACC

EV/IC

05

07

09E

11E

Source: CLSA Asia-Pacific Markets

EVA spread
90 80 70 60 50 40 30 20 10 0 03 (%) EVA™ WACC ROIC

EV/IC vs ROIC/WACC
180 160 140 120 100 80 60 40 20 0 EV/IC (x) y = 13.219x - 51.183 R2 = 0.7728

ROIC/WACC (x) 3 5 7 9 11 13

04

05

06

07

08

09E

10E

11E

Source: CLSA Asia-Pacific Markets

Source: CLSA Asia-Pacific Markets

Helping to reduce pirated products in online shopping and auction

Corporate governance and management Yahoo Japan has a clear corporate social responsibility and corporate governance policy, aiming to promote sound internet market development and enhance user security. The company set up Yahoo Japan Research in April 2007, which will work in collaboration with divisions of the company and the research institute of Yahoo! Inc, as well as with various academic, industry, and public-sector institutions both in Japan and overseas. The company is also proactive in preventing transaction fraud and sales of pirated products on Yahoo! Shopping and Yahoo! Auction. In terms of corporate governance, it clearly defines the roles and responsibilities of directors, corporate auditors, and employees. One of the best recent examples of corporate social responsibility is that in Spring 2008 Yahoo Japan, together with DeNA, NetSTAR, Microsoft and Rakuten, announced the launch of a collaborative effort to make the internet safer for

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Japan internet

children, following the MIC’s announcement that it was considering filtering some more harmful sites in the mobile internet. The group is collaborating with parents and educators to provide educational materials for parents, sending instructors to conduct study sessions for parents, and periodically releasing information regarding internet use by children, etc. The CEO Masahiro Inoue was a founder of Yahoo Japan and is well respected by the industry in Japan. He joined SoftBank in 1992 and established Yahoo Japan in 1996. He also holds the position of Director of SoftBank responsible for its Internet Culture business segment. Segment breakdown discussion Yahoo Japan is very dependent on online advertising, and its share price tends to trade in line with online adspend sentiment. Over 50% of total revenue and operating profit dervies from advertising. We do not expect this to change since it is the number 1 portal in Japan in terms of traffic, however traffic growth (in terms of pageviews) is slowing down. The business service segment mainly derives revenue from various services, including merchant listing fees and commissions. The segment ties with the ecommerce transaction volume. Yahoo Japan has one of the most successful auction sites called Yahoo! Auction, but online shopping is dominated by Rakuten Ichiba, which handles more than 10% of e-commerce transaction volume in Japan. In the internet world, an important key to success is claiming first-mover advantages in providing services and being able to maintain users. Rakuten Ichiba is obviously doing a better job at this than Yahoo! Shopping. The personal service segment basically earns fees on internet contents or auction commissions collected from individual users.
Segment description
Segment Advertising Description This segment consists of internet-based advertising-related services. The main sources of revenue include sales of banner and text ads on the Yahoo Japan website, the Sponsor Site paid search service and advertisement planning and production services. This segment consists of non-advertising-related services for companies. This segment derives revenue from fees and commissions for various information-listing services, online merchant fees and sales commissions from stores listed on the Yahoo! Auctions and Yahoo! Shopping sites, incentive fees for acquiring new subscribers to the Yahoo! BB broadband service and fees for other information services. This segment consists of services to individual internet users. The main revenue sources include Yahoo! Auctions systemuse fees, Yahoo! Premium membership fees, ISP fees from Yahoo! BB subscribers and sales of various kinds of content.

Trades in line with online adspend sentiment

Business services

Personal services

Source: CLSA Asia-Pacific Markets, Yahoo Japan

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Yahoo Japan – U-PF

Japan internet

Three main segments advertising, business services and personal services - each with several subsegments

Segment breakdown
(¥m) Sales Advertising Business services Personal services Others/elimination Total revenue Sales (%) Advertising Business services Personal services Others/elimination Total Advertising revenue Yahoo! BB Auctions Listings Shopping Media Business Corporate common Total YoY (%) Advertising revenue breakdown (%) Search (including Overture from mid FY3/08) Media Services Auctions Social networking Lifestyle Others Total Business service revenue Yahoo! BB Auctions Listings Shopping Media Business Corporate common Total Business service revenue Regional services New business offices Member services Auctions Shopping Others Total Business service breakdown (%) Regional services New business offices Member services Auctions Shopping Others Total Personal service revenue Member services Auctions New business offices Others Total Personal service breakdown (%) Member services Auctions New business offices Others Total Source: CLSA Asia-Pacific Markets FY3/07 89,201 48,213 75,281 (143) 212,552 42 23 35 0 100 3,628 3,529 44,612 3,469 20,725 243 12,991 89,201 30.4 46 16 12 5 5 0 17 100 5,633 6,074 18,473 5,031 807 6,110 252 42,380 15,398 11,261 7,093 6,126 5,370 2,752 48,000 32 23 15 13 11 6 100 FY3/08 131,042 58,067 73,051 (133) 262,027 50 22 28 0 100 5,329 5,184 65,538 5,096 30,446 356 19,084 131,042 24.9 59 13 10 3 4 1 11 100 3,839 6,682 21,243 5,534 848 7,027 265 45,437 18,247 14,334 5,632 9,281 7,527 2,879 57,900 32 25 10 16 13 5 100 FY3/09 157,019 60,499 77,941 (200) 295,260 53 20 26 0 100 6,386 6,212 78,530 6,106 36,482 427 22,867 157,019 19.8 59 13 10 3 4 1 11 100 5,351 7,016 23,368 5,811 890 7,729 278 50,443 19,436 15,125 5,351 9,698 7,865 3,025 60,499 32 25 9 16 13 5 100 FY3/10 179,818 62,470 80,481 (200) 322,569 56 19 25 0 100 7,313 7,113 89,933 6,993 41,779 489 26,188 179,818 14.5 59 13 10 3 4 1 11 100 5,111 7,367 24,536 6,102 935 8,116 292 52,457 20,484 15,618 5,111 10,014 8,121 3,124 62,470 33 25 8 16 13 5 100 FY3/11 199,323 65,178 83,969 (200) 348,270 57 19 24 0 100 8,106 7,885 99,687 7,751 46,311 542 29,028 199,323 10.8 59 13 10 3 4 1 11 100 4,871 7,735 25,763 6,407 981 8,521 306 54,585 21,833 16,295 4,871 10,448 8,473 3,259 65,178 33 25 7 16 13 5 100

Overture became Yahoo Japan subsidiary from FY3/08

Revenue breakdown by subsegments

34,193 31,908 5,072 3,927 75,100 45 42 7 5 100

29,689 33,186 6,206 3,819 72,900 41 46 9 5 100

33,889 34,676 7,015 2,362 77,941 43 44 9 3 100

33,744 35,806 7,243 3,688 80,481 43 44 9 3 100

34,181 37,358 7,557 4,874 83,969 43 44 9 3 100

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Japan internet

Quarterly data since March 2006
(m) Monthly pageviews Daily avg pageviews Monthly mobile pageviews Daily mobile pageviews Yahoo Japan users/IDs Yahoo Japan unique browsers Yahoo Japan active user IDs Yahoo Japan premium users e-commerce Yahoo! auction stores (unit) Yahoo! auction avg products Yahoo! auction unique browsers Yahoo! shopping stores (unit) Yahoo! shopping unique browsers Yahoo! shopping store unique browsers Average daily transaction volume by quarter (¥bn) Auctions Shopping Mobile commerce Quarterly transaction volume (¥bn) Auctions Shopping Mobile commerce Source: CLSA Asia-Pacific Markets 171.90 35.10 19.80 170.10 36.00 18.90 162.90 41.40 17.10 196.20 45.90 22.50 186.30 45.90 24.30 179.10 48.60 23.40 166.50 50.40 24.30 189.90 52.20 29.70 184.50 49.50 32.40 1.91 0.39 0.22 1.89 0.40 0.21 1.81 0.46 0.19 2.18 0.51 0.25 2.07 0.51 0.27 1.99 0.54 0.26 1.85 0.56 0.27 2.11 0.58 0.33 2.05 0.55 0.36 6,878 9.42 24.89 9,445 15.61 8,396 10.61 28.55 11,280 16.26 9,897 11.16 29.29 12,407 16.70 11,526 12.76 30.21 13,535 15.31 16.87 12,345 13.34 28.65 14,699 16.76 16.98 13,120 14.95 31.45 15,248 15.04 16.93 13,718 15.66 30.71 15,718 15.09 16.53 14,342 16.50 31.30 15,881 14.67 18.72 14,928 15.81 33.43 16,361 13.38 17.84 110.72 15.80 6.15 118.58 16.24 6.35 117.24 17.05 6.43 125.71 18.28 6.30 130.25 19.23 6.19 150.42 19.67 6.16 160.37 20.31 6.49 155.06 21.36 6.74 159.74 21.92 6.91 1,449 1,476 1,570 Mar 06 33,130 Jun 06 32,999 Sep 06 33,305 Dec 06 36,265 1,169 2,110 68 Mar 07 37,297 1,203 2,506 80 Jun 07 39,013 1,300 2,718 90 Sep 07 41,072 1,369 3,088 102 Dec 07 40,071 1,292 3,393 109 Mar 08 43,145 1,391 3,672 118

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Yahoo Japan – U-PF

Japan internet

What the charts say
Since making a low at ¥35,000 last August, Yahoo Japan has been working within a broad sideways triangle with two lower highs and three higher lows over the past year. Back in April we suggested selling the stock around ¥55,000 in anticipation of a move to the lower end of the range. Two months on the stock is now trading close to ¥35-37,000 support and we would be looking to buy again for a move back to ¥50,000. We would use a stop loss at ¥34,700 and would look to go short in anticipation of further weakness below ¥30,000 Yahoo Japan weekly with 40-week WMA

Price Action

These views are based on technical analysis and may or may not be in agreement with the ‘fundamental’ view.

For further information please contact Mark Stevenson, Head of Technical Research Tel: (8610) 59652146 e-mail: mark.stevenson@clsa.com

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Yahoo Japan – U-PF

Japan internet

Risks & drivers
Sales (¥m)
350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 05A 06A 07A 08CL 09CL 10CL

Investment by numbers
We expect Yahoo Japan to remain a dominant player in the online adspend market with its popular portal. We forecast the company’s ad segment top-line growth to track sector growth. However, we have noticed slowing shopping transaction volume at Yahoo! Shopping. We expect the top line and operating profit to realise a three-year Cagr of 10% over 2008-11. We project a three-year net profit Cagr of 16%. The majority of Yahoo Japan's revenue and operating profit will derive from the online ad segment. Since Yahoo Japan does not disclose capex, we assume a fairly constant capex-tosales ratio. We use a DCF valuation model with a three-stage growth assumption of 10% over 2013-20, 5% over 2021-25 and 1% from 2025 onwards.

Op profit (¥m)
180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 05A 06A 07A 08CL 09CL 10CL

Net cashflow (¥m)
100,000 80,000 60,000 40,000 20,000 0 (20,000) (40,000) 05A 06A 07A 08CL 09CL 10CL

Risks to our view
We have a negative rating on Yahoo Japan. The key risk to this view is that the company may undertake some aggressive M&A to maintain strong growth at both the top and bottom line. Other than that, the company could increase its payout ratio to shareholders. However, based on our conversations with the company, it is unlikely to lift the payout ratio, in FY3/09 at least. Yahoo Japan pays Yahoo! Inc around 3% of its revenue to use the Yahoo! brand. If Yahoo! Inc is acquired by Microsoft, the agreement may be reviewed and Yahoo Japan could actually enjoy savings on royalty payments, which would boost its operating profit margins.

Net debt(cash)/equity (%)
0 (10) (20) (30) (40) (50) (60) (70) (80) 05A 06A 07A 08CL 09CL 10CL

Key earnings drivers
Earnings yield (%)
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 05A 06A 07A 08CL 09CL 10CL

Year to 31 March

2006A

2007A

2008CL

2009CL

2010CL

Internet adspend (¥bn) Internet subscriptions (m) e-commerce transaction volume (¥bn) Internet household penetration (%) Yahoo broadband lines (m) Registered users on Yahoo Japan ('000) Premium members ('000) Auction transaction volume (¥bn)

454 25.3 4,040 49.6 5,164 19,230 6,190 715.5

543 26.7 4,939 52.3 4,809 21,920 6,910 720.0

622 27.9 5,881 54.7 4,609 22,904 6,871 821.9

690 28.8 6,887 56.6 4,409 23,650 7,095 818.3

756 30.1 7,964 59.1 4,209 24,675 7,403 828.9

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Japan internet

Summary financials
Summary P&L forecast (¥m)
Year to 31 March Revenue Cogs SG&A Operating profit Non-operating balance Recurring profit Extraordinary balance Pretax profit Tax and other adjustments Net profit Operating Ebit Depreciation/amortisation Working capital - Trade Other operating items Operating cashflow Net interest/taxes/other Capital expenditure Acquisition/inv/disposal Free cashflow Dividends paid Other items Decrease in net debt Cash & equivalents Debtors - Trade Inventories - Trade Other current assets Fixed assets Intangible assets Other term assets Total assets Short-term debt Creditors-trade Other current liabilities Long-term debt/CBs Other long-term liabilities Minority int/other equity Shareholder funds Total liabilities & equity 2007A 212,552 (8,487) (89,255) 106,234 (3,409) 102,825 (1,056) 101,769 43,805 57,964 106,234 8,576 (4,906) 6,481 116,385 (43,675) (15,256) (145,147) 57,454 (4,715) 69,582 (22,826) 75,212 30,244 173 9,691 16,551 14,684 171,873 318,428 0 1,022 75,010 50,011 0 1,662 190,723 318,428 22.4 29.3 28.7 23.1 50.0 27.3 10.0 42.7 57,454 34.5 22.8 39.8 2,299,266 16.96 59.9 (13.1) 2008A 262,027 (28,261) (98,781) 124,806 (3,296) 121,510 (7,522) 113,988 51,372 62,616 124,806 10,179 (1,056) (1,687) 132,242 (50,749) (11,229) (5,752) 70,264 (5,805) (20,892) 37,815 113,027 36,831 240 14,212 16,623 13,803 174,924 369,660 0 6,620 82,356 30,011 0 2,450 248,223 369,660 23.3 17.5 18.2 8.0 47.6 23.9 10.0 44.5 70,264 28.3 18.2 25.8 2,240,218 9.96 67.1 (33.1) 2009CL 295,260 (29,526) (113,932) 141,296 851 142,147 0 142,147 60,551 81,596 141,296 10,505 (3,842) 0 147,959 (58,851) (11,851) 0 77,257 (8,160) 0 69,098 182,125 41,502 251 14,212 17,969 13,803 174,924 444,786 0 7,460 82,356 30,012 0 3,298 321,660 444,786 12.7 13.2 17.0 30.3 47.9 27.6 10.2 42.0 77,257 28.4 20.0 29.1 2,122,058 8.27 72.3 (46.8) 2010CL 322,569 (32,257) (125,536) 154,223 1,372 155,595 0 155,595 66,279 89,315 154,223 10,553 (3,172) 0 161,604 (63,978) (12,238) 0 85,388 (8,932) 0 76,457 258,582 45,341 274 14,212 19,653 13,803 174,924 526,789 0 8,150 82,356 30,012 0 4,228 402,044 526,789 9.2 9.1 9.5 9.5 47.8 27.7 10.2 42.0 85,388 24.4 18.4 25.2 2,046,531 6.26 76.3 (56.3) 2011CL 348,270 (34,827) (136,454) 166,375 1,948 168,322 0 168,322 71,701 96,621 166,375 10,614 (2,985) 0 174,004 (68,748) (12,769) 0 92,487 (9,662) 0 82,825 341,407 48,953 296 14,212 21,808 13,803 174,924 615,403 0 8,799 82,356 30,012 0 5,233 489,003 615,403 8.0 7.9 8.2 8.2 47.8 27.7 10.2 42.0 92,487 21.5 16.9 22.1 1,964,712 4.90 79.5 (63.0)

Online advertising will contribute the majority of the top line.

Cogs increasing after making Overture a subsidiary in FY08.

Summary cashflow forecast (¥m)

Summary balance sheet forecast (¥m)

Building up a cash position.

No short-term debt.

Ratio analysis
Revenue growth (%) Operating profit growth (%) Recurring profit growth (%) Net profit growth (%) Operating profit margin (%) Net profit margin (%) Dividend payout (%) Tax rate (%) Free cashflow ROE (%) ROA (%) ROIC (%) Enterprise value (EV) EV/IC (x) Equity ratio (%) Net debt/equity (%)

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Appendices

Japan internet

Appendix 1: Online adspend money flow
Internet media companies get about 70% of the online spending budget

We studied the flow of money from the advertisers to internet media companies. The money chart below is from our May 2007 internet sector review, Key takeaways from nine company visits. Advertisers first contact the advertising agency with an advertising budget. The advertising request is then sourced to the media representative, which acts as a distributor selling advertising space on behalf of the internet media companies.
Money flows from advertisers to internet companies

If online adspend goes up, internet media companies are key beneficiaries

1
Advertisers Advertisers

Advertising Advertising agencies agencies Opt (2389) Opt (2389) aun consulting (2459) aun consulting (2459) Septeni (4293) Septeni (4293) Dentsu (4324) Dentsu (4324) Hakuhodo (2433) Hakuhodo (2433)

Media Media representatives representatives cyber communications cyber communications (4788) (4788) DAC (4281) DAC (4281)

Internet media Internet media companies companies Yahoo Japan (4689) Yahoo Japan (4689) Rakuten (4755) Rakuten (4755) DeNA (2432) DeNA (2432) mixi (2121) mixi (2121)

2

Affiliate marketing Affiliate marketing ValueCommerce ValueCommerce (2491) (2491) F@N Communications F@N Communications (2461) (2461)

Source: CLSA Asia-Pacific Markets

Internet media companies receive about 70% of the budget

A media representative not only sells internet media advertising space but also provides all kinds of advertising and monitoring services. Advertising agencies and media representatives each get about 15% of the advertising budget, while internet media companies get about 70%. The role of internet media companies is to define the advertising standards and place the advertisements while ensuring their sites have plenty of visitors. This relates back to the first catalyst, as the ability to grasp the user demographics and behaviour are imperative because the information can be used for more effectively targeted advertisements. High-traffic internet media companies like Mixi are therefore the main beneficiaries of increased online adspend.
How does a sponsored ad work?

Source: Overture

Advertisers can bid for keywords in Adword or Overture

In the case of sponsored ads (search-keyword-sensitive), the advertisers can bid for keywords in Adword or Overture. For instance, if I were a car dealer in Minato-ku and I want my sponsored ad to be at the top when users conduct a search using Google Japan or Yahoo Japan, I may want to place a higher bid for keywords such as “car dealer”, “Minato-ku”, “customer satisfaction”, etc in
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Appendices

Japan internet

Adword or Overture. In addition I have to make sure the message displayed in my ad is clear so that it can generate a click: this is because both Adword and Overture have quality rankings as well. The other way I can do this is to let the media representatives handle the bidding process and write my script. About 80% of sponsored ad applications come directly from advertisers (the other 20% are handled by media representatives). But in terms of revenue, about 70% of the sponsored ad revenue comes from media representatives and the rest comes from online applications, suggesting media representatives provide extra and different service levels for advertisers.
Eight main types of online ad Different kinds of online advertisements Type Descriptions

Banner Click guarantee Affiliate

Displayed on a website, it sends the user to the product page when clicked. Displayed on the website until it is clicked a guaranteed number of times. Displayed in blogs. When a blog viewer clicks on the ad and makes a purchase, the blog owner receives a commission. Since advertisers do not pay until a purchase is made, the risk is low. Relevant ad displayed by analysing the theme/keywords in blogs and on websites. Relevant ad displayed by analysing the keywords entered in a search engine. Emails/newsletters with an ad. Used by SNS sites a lot. For example, Nike circles introduce different sports products. So in a blog which talks about sports, sports makers ads will be displayed A form of marketing where consumers do not realise they are being marketed to. Advertising products through other media as well as the internet.

Content-linked Search-keywordsensitive Email Viral marketing

Stealth marketing Cross-media marketing

Source: CLSA Asia-Pacific Markets, Diamond, Wikipedia

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Appendices

Japan internet

Appendix 2: Benchmarking Japan, Korea
This following analyses the internet space in the two most technologicallyadvanced Asian countries: Japan and Korea.
Japan has a great deal of competitive infrastructure

Japan has a great deal of competitive broadband infrastructure, comprising mainly DSL, cable and fibre-to-the-premises (FTTP). It is one of the few countries in the world where FTTP has begun to replace DSL, due to government intervention helping to drive deployment. Operators provide consumers with a good choice of affordable offerings and other bundled services including IPTV phones. Bandwidth availability is among the highest in the world and 100Mbps is available to a growing proportion of the population.
No. of broadband lines in Japan
35 30 25 20 15 10 5 0 04 05 06 07 08CL 09CL 10CL 11CL 12CL (m lines) ADSL CATV FTTH

Broadband penetration is very high in Japan and high in Korea

No. of broadband lines in Korea
16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 2005 2006 2007 (lines) FTTP Cable DSL

Source: CLSA Asia-Pacific Markets, MIC

Like Japan, Korea has a strongly competitive infrastructure, resulting in high broadband penetration and high geographic coverage from cable and FTTP. Korea Telecom is one of the most important internet service providers (ISPs) in Korea, similar to NTT in Japan.
Japan ISP market share 3Q07
Others 20% KDDI 2% USEN 3% Jupiter Communications 4% ACCA Networks 4% eAccess 7% NTT East/West 42%

Korea ISP market share 3Q07
Others 19% Korea Telecom 45%

LG Powercomm 11%

Yahoo! BB (SoftBank) 18%

HTI (Hanaro) 25%

Source: CLSA Asia-Pacific Markets

Bandwidth, packages and pricing
J:COM has started offering 160Mbps in some areas

Both Japan and Korea offer bandwidth up to 100Mbps (and J:COM has started offering 160Mbps in some areas in Japan). Japan and Korea are in the top five most competitive markets, suggesting there is a correlation between competitiveness and bandwidth.

Max and min bandwidth
Bandwidth offered (Mbps) Max downstream Min downstream NTT East/West 100 1 Yahoo BB (SoftBank) 100 8 eAccess 100 1 Jupiter Comms 30 0.256 USEN 100 100 KDDI 100 5 Korea Telecom 100 0.256 HTI (Hanaro) 100 10 LG Powercomm 100 10

Note: ACCA Networks: Multiple retail brands in Japan. Source: CLSA Asia-Pacific Markets, companies, ovum

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Japan internet

Monthly fees
Consumer pricing (US$) Highest monthly fee Lowest monthly fee Standard modem fee Standard activation fee Standard installation fee NTT East/West 46.33 14.68 0.00 6.99 26.65 Yahoo BB (SoftBank) 49.08 20.91 0.00 27.98+ 44.04+ Jupiter Comms 50.46 25.23 0.00 0.00 174.76 USEN 44.04 30.41 0.00 27.52 55.05+ KDDI 57.80 18.25 4.59 0.00 20.18+ Korea Telecom 42.78 22.46 8.56 0.00 32.08 HTI (Hanaro) 55.61 29.95 0.00 0.00 32.08 LG Powercomm 35.64 31.86 7.56 0.00 32.40

Note: Dec 2007 numbers. ACCA Networks and eAccess: Multiple retail brands. Source: CLSA Asia-Pacific Markets, companies, ovum

KDDI will start WiMAX service in mid 2009

KDDI will start WiMAX service in mid-2009 and we have tabulated the price/data speed comparison below. Japan and Korea offer the cheapest price/data speed.
Price/data speed comparison
France Italy Sweden Taiwan Holland Korea Japan (internet at home) KDDI WiMAX monthly fee 0
0.08 0.06 0.07 0.18 0.14 0.24 0.31 0.37

Japan internet household penetration
70 60 50 40 30
(US$/kbps)

(%)

20 10
02 03 04 05 06 07 08CL 09CL 10CL 11CL 12CL

0.1

0.2

0.3

0.4

Note: Countries more expensive than France include the US, Germany, HK, Canada, Brazil, Belgium and China. Japan’s population is 127m, with 2.49 people per household. Source: CLSA Asia-Pacific Markets, ITU

Competitive market is conducive to low-cost broadband availability

A competitive market is conducive to low-cost broadband availability. As highbandwidth services become more common, they become a facilitator for more advanced services such as high-definition video and IPTV phones.

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Appendices

Japan internet

Appendix 3: Stakeholders and holdings
Yahoo! Inc shareholders and holdings
Shareholder Capital World Investors Capital Research Global Investments David Filo Legg Mason Capital Management Jerry Yang % 10 7 6 5 4 Holdings Yahoo Japan (US$8bn) Google (US$807m) Gmarket Inc (US$109m) Engin (US$8m) % 33 0.62 10 58

Source: CLSA Asia-Pacific Markets, Bloomberg (Jun 24)

Yahoo Japan shareholders and holdings
Shareholder SoftBank Yahoo! Inc Japan Trustee Services Bank JP Morgan Chase Bank Master Trust Bank of Japan % 40.16 33.41 1.68 1.35 1.20 Holdings All About Inc (US$27m) GMO Internet Inc (US$23m) Telewave Inc (US$23m) Yume No Machi Iinkai Co Ltd (US$22m) ValueCommerce (US$20m) % 35 5 20 40 44

Source: CLSA Asia-Pacific Markets, Bloomberg (Jun 24)

SoftBank shareholders and holdings
Shareholder Son Masayoshi Capital Guardian Trust Company Japan Trustee Services Bank JP Morgan Chase Bank Master Trust Bank of Japan % 29 6 3 3 3 Holdings Yahoo Japan (US$9bn) GSI Commerce Inc (US$130m) UTStarcom Inc (US$81m) Shanda Interactive (US$73m) SoftBank Technology Corp (US$40m) % 40 17 12 4 50

Source: CLSA Asia-Pacific Markets, Bloomberg (Jun 24)

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Japan internet

Notes

The CLSA Group, CLSA's analysts and/or their associates do and from time to time seek to establish business or financial relationships with companies covered in their research reports. As a result, investors should be aware that CLSA and/or such individuals may have one or more conflicts of interests that could affect the objectivity of this report. The Hong Kong Securities and Futures Commission requires disclosure of certain relationships and interests with respect to companies covered in CLSA's research reports and the securities of which are listed on The Stock Exchange of Hong Kong Limited and such details are available at www.clsa.com/member/research_disclosures/. Disclosures therein include the position of the CLSA Group only and do not reflect those of Calyon and/or its affiliates. If investors have any difficulty accessing this website, please contact webadmin@clsa.com on (852) 2600 8111. If you require disclosure information on previous dates, please contact compliance_hk@clsa.com

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