Internet & media. abc. Telecoms, media &technology team

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1 Telecoms, media &technology team Tucker Grinnan* Head of Asia Telecoms & Media Research The Hongkong and Shanghai Banking Corporation Limited Chi Tsang* Analyst The Hongkong and Shanghai Banking Corporation Limited Howon Rim* Analyst The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations 1

2 2 Sector structure Verticals Ctrip E-Commerce * China & Korea Internet Industry Online Gaming Portals Search Engines Baidu Online Video Youku Social Networking Asia-Pacific Equity Research elong 360Buy.com Netease Google China Tudou Xueda Shanda Sogou (Sohu) Dangdang PerfectWorld Qihoo Soso (Tencent) iqiyi (Baidu) Renren Vancl Changyou NHN Jiayuan Suning.com Kingsoft Daum Amazon China Ncsoft Neowiz *Removed for Compliance reasons Note: The list of companies in this chart is not exhaustive, but we believe it offers the best representation of the sector Source: HSBC

3 Performance of Internet blue chips 5,000 4,000 3,000 2,000 EM flows starts Tencent re-rating Baidu launches Phoenix Nest Asia-Pacific Equity Research 1,000 0 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Bidu Netease Sina Tencent NCSoft NHN Source: Thomson Reuters Datastream, HSBC 3

4 Sector description China s Internet user base has increased 10x over the past decade, and with over 500m Internet users, the penetration rate has reached nearly 40%. Over the past 5 years, China s E-economy has grown at an average rate of 60%, comprised of 40% growth for online advertising, 27% for online gaming, 115% for e- commerce and 36% for mobile. The market is dominated by domestic private companies in each of the key segments search, portals, gaming, e-commerce and online video. Importantly, asset managers and hedge funds can actively invest in a broad selection of companies in various segments with market caps ranging from less than USD1bn to more than USD50bn on the Nasdaq and the Hong Kong Stock Exchange. Tucker Grinnan* Head of Asia Telecoms & Media Research The Hongkong and Shanghai Banking Corporation Limited tuckergrinnan@hsbc.com.hk *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Tencent, which has 750m registered accounts, is the leading portal, dominates online gaming and is a key player in social networking. Baidu has an 80% market share in the personal computer (PC) search word advertising market. NetEase and Shanda established the massive multi-player online role playing game market in China. Sina is the dominant Internet portal, with more than 300m people using its leading social networking platform. Dangdang, the leader in online book sales, is an important e-commerce company with national reach. Finally, Youku is the No 1 online video company in China, with 300m unique monthly visitors. Korea s Internet user base rose a remarkable 159% between 1999 and 2001 and then increased at a more gradual rate. We estimate Internet penetration had reached 74% as of This has mainly benefited the Internet portals (online ads) and online game companies (monthly subscription, in-game item sales), which have been able to monetise the increased traffic. Korea s Internet ad market expanded at 30%+ annually until 2007 when the growth rate started to decline. At 20%, online ad penetration rate is one of the highest in the world and the market is still growing 10%+ a year. Korea, a leader in online games, has seen this market record annual growth of 20%+ over the past five years, underpinned by the launch of new major new titles. The domestic market is becoming more saturated as competition increases, so Korean companies are increasingly focusing on overseas markets. NHN is the largest Internet portal in Korea followed by Daum. NCsoft is the leading massive multiplayer online role playing game (MMORPG) developer, while Neowiz Games is one of Korea s largest online game publishers. Key themes Going mobile The China Internet space is evolving rapidly and the competitive landscape is shifting from the PC to mobile. Smartphone prices are declining and smartphone penetration in China is set to double in 2012 from 4% in This is driving a significant shift in user behaviour 20% of Baidu s search volume is already on mobile and 60% of Sina s Weibo users log in from smartphones. All of the players are scrambling to develop strategies and business models to monetise mobile traffic, whether in advertising, gaming, social networking or other applications. This shift in traffic from PC to mobile will have profound effects on all the China Internet players and those with the most transferrable strengths will benefit the most. Korea Internet companies started to focus on the online ad mobile platform in This has been driven by the increasing smartphone penetration rate, which we estimate has reached 47% by end This is also affecting online games, as mobiles are attracting traffic from casual online games. 4

5 Fragmentation of video Increasing broadband adoption is driving much higher viewership of online video. The Chinese telcos have invested heavily in a national fibre optic upgrade. One of the key drivers is the desire to expand into Internet protocol television services (IPTV), which are currently subject to severe regulatory restrictions. Since 2008, the average time spent playing online games has declined from 25% of usage to less than 10%. Online video consumption is cannibalising gaming, with usage increasing from 5% in 2008 to 30%. China has a number of independent online video companies, such as Youku, but Baidu, Sohu (a portal company) and Tencent, all have fast growing online video businesses. The rise of e-commerce E-commerce has experienced a significant influx of capital in recent years, spawning hundreds if not thousands of group-buying companies, business to consumer (B2C), consumer to consumer (C2C) and business to business to consumer (B2B2C) businesses. Competition is intense, from both online players such as 360buy, as well as bricks-and-mortar players such as Suning pushing sales online. Most recently, Tencent acquired 51Buy and announced a USD1bn initiative for its own e-commerce unit. More focus on overseas As the market becomes more saturated there is an increasing need for Korea Internet and online gaming companies to focus on overseas markets. Korea s online ad market growth has slowed due to a high online ad penetration rate (online ads as a percentage of total ad market) which we estimate reached 20% in The leading Internet portal, NHN, is investing in Japan and international markets are a priority for Korean online game developers. Valuation Our preferred way of valuing the sector is on a PE-to-growth basis, using a three-year forward rolling average earnings growth rate for each company. We believe this appropriately captures the near-term earnings momentum of the companies. 5