China Internet - Splash - BNP Paribas EQresearch

Transcription

EQUITIES RESEARCH
CHINA INTERNET
CONNECTING USERS TO ADVERTISING
■ This report focuses on the emerging business model in China of connecting more Internet users to
more advertising through Ad Exchange platforms – a.k.a. Real-Time Bidding (RTB).
■ Ad Exchange platforms enable millions of websites to make their ad spaces available to advertisers
through a real-time bidding process, optimizing pricing efficiency.
■ We believe large, established search platforms are in a good position to benefit as they already have
large bases of diverse online advertising customers.
■ We initiate coverage of China’s two biggest search engine platforms: Baidu (BUY; TP USD113.00),
and Qihoo 360 (HOLD; TP USD44.20).
Alen Lin
[email protected]
+852 2825 1801
BNP Paribas Securities (Asia) Ltd research is available on Thomson One, Bloomberg, TheMarkets.com, Factset and on http://eqresearch.bnpparibas.com/index. Please contact
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PREPARED BY BNP PARIBAS SECURITIES ASIA
THIS MATERIAL HAS BEEN APPROVED FOR U.S DISTRIBUTION. IMPORTANT DISCLOSURES CAN BE FOUND IN THE DISCLOSURES APPENDIX
27 JUNE 2013
27 JUNE 2013
SECTOR REPORT
CHINA INTERNET
POSITIVE
Connecting users to advertising
n
We initiate coverage with a positive outlook and BUY rating on Baidu, HOLD on Qihoo 360
This report focuses on the emerging business model in China of connecting more Internet users to
more advertising through Ad Exchange platforms. These platforms make the ad space on millions of
websites available to advertisers through a real-time bidding (RTB) process, optimising price
efficiency. We initiate coverage of China’s two biggest search engine platforms: Baidu (BUY; TP
USD113.00), and Qihoo 360 (HOLD; TP USD44.20).
n
New business model getting off the ground in China
Ad Exchange represented only 0.7% of total display ad spend in China in 2012, with IDC forecasting
a 2012-16 CAGR of 145%, contributing 11.1% (USD627m) of total display ad spend in 2016.
Platforms being established include Baidu Exchange Service, Tencent AdExchange, Sina, and
Alibaba’s Alimama. Key success factors for Ad Exchange platforms include a large base of online
advertisers and a network of Internet properties that covers a broad range of user segments.
n
Search engines in a good position to capitalise on the emerging opportunity
We believe large, established search platforms are in a good position, as they have substantial
existing bases of diverse online advertising customers. Baidu Union already includes hundreds of
thousands of members that make their websites available for ad placement. We view Ad Exchange as
a new product offering for search engine platforms that will incrementally drive their ad revenue
growth as they expand from traditional search ads to include display ads on member websites.
BNPP recommendations
Company
BBG code
Rating
Share price
Target price
Upside/downside
Baidu Inc - ADR
BIDU US
BUY
91.09
113.00
+24.1%
QIHOO 360 TECHNOLOGY
QIHU US
HOLD
44.14
44.20
+0.1%
Prices at 25 June 2013
Source: Bloomberg; BNP Paribas
Alen Lin
[email protected]
+852 2825 1801
2
Alen Lin
China Internet
Investment thesis
Baidu – Initiate coverage at BUY with a TP of USD113.00
Ad Exchange, aka Real-Time Bidding (RBT), is starting to
emerge as a new business model in China’s Internet
industry; the platforms are well established in the US and it
is a proven business model to connect advertisers with
relevant Internet properties. Various platforms have been
established including Baidu’s BES, Tencent’s AdExchange,
Sina’s SAX, Alibaba’s Alimama, and Taobao’s tanx. We
believe the business model favours platforms with strong
established networks of online advertisers and Internet
properties.
We believe Baidu is in the process of diversifying its
revenue beyond search advertising. While we expect search
advertising to remain strong, with our forecast industry
revenue CAGR of 31.9% between 2012 and 2015, we
believe the company has yet to tap into new products such
as Ad Exchange. We believe the exchange platform will
enable large search engine platforms like Baidu to expand
into new advertising segments to include the vast number of
Internet properties available and mobile apps. We expect
Baidu’s revenue growth to remain >30% y-y through 2015
and see margins stabilising in 2014, leading to a return to
strong profit growth. We also estimate Baidu’s ROAE will
remain above 30% through 2015.
We view the search engine industry as a high-performance
subsector of Ad Exchange that enables the serving of highly
targeted ads to Internet users. Large-scale search engines
have already built up significant online advertising customer
bases for monetisation purposes – an important component
for an Ad Exchange platform. In 2012, Google generated
28.5% of its advertising revenue from Google Network
Member websites, which we believe is closely related to its
DoubleClick Ad Exchange platform; we see significant
advertising potential in China’s Internet industry, as the
segment only contributed 0.7% of industry display
advertising revenue in 2012.
Qihoo 360 – Initiate coverage at HOLD; TP USD44.20
While Qihoo 360 has posed a challenge to rival search
engine platforms in China, we believe organic market share
gains will become more difficult. In our view, the company
needs to maintain high levels of marketing and R&D spend,
which could pose a downside risk to consensus
expectations. In the near term, we expect key revenue
contributors to remain navigation ads and online gaming.
Given the high valuation (2013/14E PEs of 126x/43x), we
believe potential upside to the share price is limited at
current levels.
Ad Exchange platform
CONTENTS
Executive summary
4
6
Internet search engine – a high-performance subset of Ad
Exchange
14
Competitive landscape in the China search engine industry 22
Regulatory control; a significant force in the search engine
27
industry
Ad Exchange favours participants with large user bases and
30
advertisers
Company reports
31
Contribution to Ad Exchange display ad sales
United States
Western Europe
Japan
China
Others
2013
2014
2015
2016
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2010
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2012
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China Internet
Alen Lin
Executive summary
Our report focuses on the emerging business model in China of connecting more
Internet users to more advertising through Ad Exchange platforms – aka Real-Time
Bidding (RTB). While various platforms have been established, including Baidu’s
BES, Tencent’s AdExchange, Sina’s SAX, Alibaba’s Alimama, and Taobao’s tanx, the
business model favours platforms with strong established networks of online
advertisers and Internet properties. Regardless of the perceived utilities for Internet
users for various Internet services, they are ultimately all in the business of
connecting users to advertising. We believe multiple platforms can exist in China,
targeting various industry verticals that differentiate through different segments of
online advertisers and Internet properties.
We place particular focus on the search engine industry as its core business has
always been about connecting advertisers to the most relevant audience. We view
search engines as a high-performance subset of the Ad Exchange structure. Search
queries initiated by Internet users enable search platforms to serve highly targeted
advertisements to users. By nature of the business model, large-scale search
platforms such as Baidu have built up significant online advertising customer bases;
we view this as a key component of an Ad Exchange. While this has enabled these
platforms to monetise their respective search services, we believe they also lay the
foundation for rapid expansion into the Ad Exchange platform. Google in 2012
generated 28.5% of its advertising revenue from Google Network Member websites,
which we believe is largely attributable to its DoubleClick Ad Exchange platform.
Ad Exchange as a new business
model in China – Internet players
already positioning for the opportunity
Internet search engines in a unique
position as online advertisements
play to their core strengths
On this theme, we initiate coverage on Baidu (BIDU US) with a BUY
recommendation and TP of USD113.00. We also initiate coverage on Qihoo 360
(QIHU US) with a HOLD recommendation and TP of USD44.20.
Baidu – Initiate coverage at BUY with a TP of USD113.00
We believe Baidu is in the process of expanding beyond its core PC search business
to tap into new growth drivers. In our view, successful execution of its Baidu
Exchange Service (BES) would enable the company to drastically increase its
inventory of Internet properties for advertising, which could also include mobile
applications. We assume the following in our investment case:
§
Baidu’s Internet search market share to remain dominant, given the positive
feedback loop of the industry where a higher number of users drives a higher
number of online advertising customers, leading to rising revenue/customer. This
enables Baidu to maintain its ability to monetise its core search services. We
estimate Baidu’s revenue growth for 2013-15 to be 37.4%/32.4%/32.7%.
§
Margin decline in 2013 (NM from 46.9% in 2012 to 33.6% in 2013), primarily
because of product mix change including acquisitions of online video services
and greater emphasis on BES. While BES is likely to have lower margins
compared with the search service, the service is a new product offering that
leverages Baidu’s existing customer base and creates a new revenue stream.
§
Baidu’s breadth of Internet services should help to maintain its strong user base.
While the non-search services may not be profitable as standalone businesses,
they are important in retaining Internet users on Baidu properties and serve as
important traffic sources for Baidu’s advertising business.
§
We estimate net profit growth will return to 30%+ in 2014 as revenue growth
remains robust on stable blended margins. This implies ROAE for 2013-2015E of
32.9%/31.4%/30.7%. Our target price implies 2013-15E P/E multiples of
23.8x/18.1x/13.5x.
Initiate coverage of Baidu at BUY
Qihoo 360 – Initiate coverage at HOLD with a TP of USD44.2
We believe the company will continue to depend on its navigation website and online
gaming for revenue growth. While Qihoo 360 has made significant market share
gains in Internet search in recent quarters (14.1% in May 2013), we believe organic
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Initiate coverage of Qihoo 360 at
HOLD
27 JUNE 2013
China Internet
Alen Lin
growth in search market share will be challenging. In our view, other methods for
market share gain would have a negative impact on margins or balance sheet.
§
Qihoo 360’s navigation site remains the key contributor for its online advertising
revenue. As its search service mostly depends on its navigation site for traffic,
organic growth of search traffic could be limited as its navigation site is a
relatively mature platform with a stable user base. Nevertheless, we believe
search revenue growth could be realised by focusing on an expanding number of
search advertising customers. We estimate its online advertising revenue growth
for 2013-15 to be +65%/+47.6%/20.8%.
§
Online games has seen strong growth (+72% y-y to 150 games) as Qihoo 360
added new games that drove up the number of paying users by 102% y-y in
1Q13 to 281k; we estimate the number will rise to 405k by the end of 2013, +70%
y-y. We expect this to remain a key growth driver for the company.
§
We estimate net profit growth for 2013-15 of -10.3%/+191.2%/+77.7% on the
effects of operating leverage; this implies ROAE of 7.9%/18.5%/24.6%. Our
target price implies P/E multiples of 126x/43.2x/24.3x.
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China Internet
The various services available online have different business models and offer
different functions for users; however, they typically have a common theme –
connecting users to advertising. Whether the perceived function is to search for
information on the Internet, to consume media content, to socialise, or to shop for
merchandise, advertising is a common revenue model across sites.
Internet services are mostly about
connecting users to advertising;
advertising Ad
Exchange platforms are a mature
segment in the US, with multiple
platforms in existence
This observation leads us to shift our focus to understanding the business model of
online advertising. Taking the search engine industry for example, it is commonly
understood that search engines generate advertising revenues by responding with
paid-advertisements to relevant search queries; therefore, the more online
advertisers and search traffic there is, the greater the revenue potential for search
engines. There is, however, another role a search engine platform can play that is
less intuitive to an Internet user, commonly known as Ad Exchange or Real-Time
Bidding (RTB).
Ad Exchange platforms effectively connect online advertisers to a much broader set
of Internet users through networks of Internet properties. Such Ad Exchange
platforms are already in large scale commercial service in mature Internet markets
such as the US, including Yahoo’s Right Media, Google’s DoubleClick, Facebook’s
FBX, and independent platforms OpenX Market and AppNexus; these are all
established exchanges for buying and selling website advertising space.
EXHIBIT 1: Major US Ad Exchange platforms
Source: Company websites
Ad Exchange – efficiently connecting advertisers to Internet properties
The first step in connecting users to advertising is to efficiently connect advertisers to
relevant Internet properties, ie websites. An Ad Exchange platform fulfils such a
purpose by making a large number of Internet properties available to advertisers;
effectively an online market place where Internet properties can auction off their
advertising spaces to the highest bidders. Within the Google framework, the bidding
is done via its AdSense interface. The value of the service increases when the Ad
Exchange platform enables advertisers to better target the audience by finely
segmenting the various Internet properties based on their respective user attributes,
enabling the serving of advertising to the most relevant audience.
Exhibit 2 is an illustration by Google to describe the structure of the Ad Exchange.
The buyers are advertisers that are seeking ad space. The sellers are Internet
property owners that have ad space available for sale. The buyers become AdWords
advertisers and interface with the Ad Exchange through Google’s AdWords interface;
this is also knows as a Demand Side Platform (DSP). Advertisers have the ability to
select a target audience through the AdWords interface. The sellers interface with the
Ad Exchange through Google’s AdSense interface; this is also known as the Supply
Side Platform (SSP). AdSense partners make their Internet properties available to
the Ad Exchange platform that best fits the attributes of their user profile.
Ad Exchange platforms efficiently
connect advertisers to available ad
space through real-time bidding
In our view, while the various sub-segments within the Internet industry have unique
business models, a common theme that encompasses much of the industry is the
science of connecting users to advertising. More importantly, Ad Exchange can be
utilised for various user platforms including PC and mobile Internet, as the Internet
properties can include PC websites, mobile apps, video content, etc. This vastly
expands the potential for online advertising, along with the number and variety of
Internet properties available.
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China Internet
In China, Ad Exchange platforms have started to take shape in recent quarters with
Baidu’s Baidu Exchange Service (BES), Tencent’s AdX, Sina’s Sina Ad Exchange
(SAX), Alibaba’s Alimama, and Taobao’s Taobao Ad Network & Exchange (tanx). We
believe Ad Exchange presents a new business opportunity for the Chinese Internet
industry and has the potential to become a new growth driver. A key criterion for a
viable Ad Exchange platform is having large bases of advertisers and Internet
properties that target a wide range of demographics and interests. A critical hurdle is
to educate both the advertisers and Internet property owners on the value of the Ad
Exchange platform. We believe the Ad Exchange platform is an over-arching
business model that encompasses the various sub-sectors of the Internet industry
and will continue to displace traditional media as the preferred advertising
mechanism.
A number of Ad Exchange platforms
emerging in China, backed by Baidu,
Tencent, Sina, Alibaba, and others
EXHIBIT 2: Ad Exchange platform
Source: Google
EXHIBIT 3: Major Ad Exchanges in China
Source: Company websites
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EXHIBIT 4: China RTB advertising technology landscape
Source: RTB China, http://www.rtbchina.com/wp-content/uploads/2013/03/China-RTB-Ad-Tech-Landscape_V-March-20131.jpg
Monetisation of online advertising
Internet property owners participate in the Ad Exchange platform by becoming
members in the particular exchange. In the case of Google, they become Google
Network Members and use AdSense to put their advertising space on the exchange
for sale. Baidu has also started to build up Baidu Union, where union members make
their advertising space available. The Internet properties can be websites, mobile
websites/apps, and other platforms where Internet content is consumed by users.
According to Google, it has over 2m Google Network Members participating in its
AdSense programme; in terms of revenue contribution, Google generated 28.5% of
its advertising revenue from Google Network Members’ websites (Exhibit 5).
Internet properties become members
of Ad Exchange networks, such as
Google Network and Baidu Union,
and make their ad space available
through the exchange platforms
Baidu has also stated that Baidu Union members number in the hundreds of
thousands; in our view, the low base provides significant upside potential for the Ad
Exchange business model as there are 13.4m domain names registered in China
(end of 2012); in terms of available websites, we expect it to be multiples of the
domain names registered. We believe this could be a strategic growth area for the
company and is effectively a new product offering for its advertising customers.
According to China Internet Watch, total spending on online advertising in 2012 was
RMB79.1b vs RMB29.3b for search advertising (Exhibit 6); Ad Exchange platforms
can become participants in the RMB50b display advertisement market.
Through the Ad Exchange platforms, advertisers bid for advertising spots on various
Internet properties. Advertisers can choose placements of their advertisements
based on various criteria, such as demographics, location and other specific
attributes, enabling advertisers to target very specific Internet users and context,
improving the effectiveness of ad placements. Ad Exchange platforms maximise
efficiency of advertising pricing through numerous pricing strategies. The following
are basic types of pricing structures:
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Advertisers bid for advertising spots
in real time based on various
attributes of the websites and Internet
users
27 JUNE 2013
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Alen Lin
§
Cost-per-thousand-impressions (CPM) – bidding price is based on the frequency
the advertisement is displayed.
§
Cost-per-click (CPC) – bidding price is based on the frequency Internet search
users click on an advertisement.
§
Cost-per-acquisition (CPA) – bidding price is based on the frequency an
advertisement leads to an actual transaction, or number of conversions.
Advertising prices are ultimately determined by how effective the advertisement is,
as measured by the click-through-rate (CTR). The serving of advertisements to the
most relevant Internet users would maximise the CTR, potentially leading to a higher
conversion rate.
EXHIBIT 5: Google’s advertising revenue breakdown
(RMB b)
Google websites
EXHIBIT 6: China’s online advertising spending
Google Network Members' websites
50,000
(RMB b)
90
45,000
80
40,000
70
35,000
60
30,000
Search Ads
50
25,000
40
20,000
30
15,000
20
10,000
10
5,000
0
0
2010
Source: Google
Online Ads
2011
2008
2012
2009
2010
2011
2012
Source: China Internet Watch
Focus on click-through rate – a measure of effectiveness and value of online
advertising
A key measure of online advertising’s effectiveness is the frequency with which users
interact with a particular advertisement, the click-through-rate (CTR). While the range
of CTR can be wide depending on where the advertisement is displayed, this is a
practical measure. The CTR is a key determinant for the cost of advertising, as a
high CTR would translate into higher advertising revenue for the Internet property
owners, and higher probability of converting the impression (display of
advertisement) into a transaction for the advertiser. CTR ultimately reflects the
quality of the advertisement, and the relevance of the advertisement to the user; as
such, advertising platforms’ knowledge of the users can greatly increase the
relevance of advertisement to the users. Such characteristics favour platforms that
have extensive data on their users. Through the Ad Exchange mechanism, the
supply and demand of advertising space would determine the price of advertising
placements in various contexts.
According to discussions on Google’s AdWords community, the CTR for a typical
Internet search generated advertisement could be in the range of 1-5% (Exhibit 8).
The same advertisement placed through “display advertisement” on typical websites
could be <1% (Exhibit 7 – display ad in top right corner of a web page); however, the
number of impressions is generally much greater. The difference in CTR is because
advertisements generated through Internet search are effective in targeting users
that have interests in the specific topic as the search is user initiated. The same
comparison can be made in other sub-sectors such as e-commerce; an
advertisement generated through a user’s merchandise search is likely to have
significantly higher CTR than a display advertisement that is served through a
generic shopping portal.
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Effectiveness of advertising
measured by frequency with which
users click on specific ads (clickthrough-rate); a key measure for
pricing online ads
Internet search ads have higher CTR
than display ads; however, display
ads deliver a greater number of
impressions
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China Internet
EXHIBIT 7: Sample of common display advertisement
Source: hao123.com
EXHIBIT 8: Sample of common search advertisement
Source: Baidu
Visualising the Ad Exchange auction process
We use an auction example of Ad Exchange to illustrate the mechanics of online
advertising placement. Referencing Exhibit 9, when an Internet user visits a website
that belongs to a Supply Side Platform (SSP), ie, Baidu Union or Google Network
Member, information of the user is sent to the Data-Management Platform (DMP) of
the Ad Exchange. This may include the user profile and any relevant information
about the user that may be extracted from the cookies stored on the user’s web
browser. Based on the website visited by the user, user profile, cookies, and other
contextual information, the DMP determines the advertisements that are most
suitable for the user in the current context.
Information taken into account by the
advertiser during a bidding process
includes attributes of the website,
Internet user profile, tracking cookies,
and other contextual information
On the other side of the Ad Exchange platform, the Demand Side Platform (DSP), ie,
the platform on which advertisers bid for advertising space, has bidding information
for the specific advertising space. The Ad Exchange takes into account the bidding
price and sometimes Quality Score for the particular advertisement based on
historical CTR, to determine the winner of the particular auction; Quality Score is a
quantitative measure by the Ad Exchange to gauge the effectiveness of an ad. In this
auction example, Advertiser-1 wins the auction at USD8, assuming the three
advertisers have similar Quality Scores; the advertisement is displayed on the
Internet property for the user to see instantly.
If the auction was done based on CPM pricing, the advertiser would pay the price per
impression for the advertisement. For CPC pricing, the advertiser would only pay if
the user clicks on the advertisement, and similarly for the CPA pricing model.
Regardless of the pricing model, the underlying determinant of the price is the
probability of converting an advertisement into a transaction for the advertiser.
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Alen Lin
EXHIBIT 9: Ad Exchange auction process
Demand Side Platform
(DSP)
Supply Side Platform
(SSP)
Internet user
Winner gets the placement – advertisement-1
is placed on the web page
Heads to a
page on a
publisher’s
website
Advertiser-1
Bids $8
Winner of this auction
Web Page
Sends user profile
and associated set
of attributes
(cookies)
Ad Exchange
Platform
Advertiser-2
Bids $3
Targets advertisers based on
user profile and attributes
Sends out bid
requests
Advertiser-3
Bids $5
Source: BNP Paribas
A self-optimising multi-platform advertising mechanism
The structure of the Ad Exchange platform is conducive for adapting advertisements
for wide-ranging types of device platforms and user segments; the exchange enables
different types of advertisements and different types of Internet properties to come
together. As the price of the advertising service will reflect the effectiveness of the ad
placements on various platforms in an efficient exchange, we believe the ecosystem
will self-optimise to maximise value creation. In our view, such self-optimising occurs
when the supply and demand for advertising reaches critical mass, enabling full
efficiency of the platform.
Ad Exchange platforms enable
various types of advertisements and
Internet properties to come together
efficiently; potentially cutting across
multiple user access devices
This could be an important mechanism for mobile advertising to become a more
meaningful contributor to the overall online advertising Industry. Given a more
fragmented mobile application environment, where apps dominate user access to
mobile Internet as opposed to the typical browser access on a PC, we believe the Ad
Exchange advertising structure will play a very important role in the serving of
advertisements to users through various mobile apps. Such a mechanism enables
app developers to tap into the vast amount of advertising demand available.
Ad Exchange just getting off the ground in China
Globally, the Ad Exchange segment has been growing rapidly; total Ad Exchange
display ad spend for 2012 reached USD2.97b, +119% y-y (Exhibit 10). IDC forecasts
a four-year CAGR through 2016 of 47%, reaching USD13.9b. As US companies
have been the pioneers of platforms, the US represented 73.4% of global Ad
Exchange revenue in 2012; this is expected by IDC to decline to 64% by 2016 as
other markets begin to adopt the business model. Based on IDC estimates, by 2016,
Western Europe will represent 18.1% of global revenue and China 4.5%.
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BNP PARIBAS
Global Ad Exchange CAGR through
2016 forecast at 47%; US currently
the key market, representing 73.4%
of global revenue in 2012
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EXHIBIT 10: Worldwide Ad Exchange display ad sales
Worldwide total RTB-based display ad
sales (LHS)
(USD b)
Growth (RHS)
16,000
EXHIBIT 11: Contribution to Ad Exchange display ad sales
United States
(y-y)
100%
250%
90%
200%
12,000
10,000
150%
8,000
100%
6,000
China
Others
2014
2015
2016
70%
60%
50%
40%
30%
4,000
50%
2,000
20%
10%
0
0%
2010
2011
2012
2013
2014
2015
2016
0%
2010
2011
2012
2013
Source: IDC
Source: IDC
The US is by far the largest market for Ad Exchange, with 2012 total industry ad
spend of USD2.18b, +105% y-y (Exhibit 13). Major Ad Exchanges include Google’s
DoubleClick, Yahoo’s Right Media, AppNexus (affiliated with Microsoft), and OpenX
Market (unaffiliated with major Internet entities). In 2012, Facebook launched its
Facebook Exchange (FBX) to monetise its extensive user base. Of all display
advertising spend, the share of Ad Exchange spend is forecast by IDC to rise from
15.7% in 2012 to 32.6%% by 2016, indicating the increasing importance of Ad
Exchange platforms.
EXHIBIT 12: US total display ad sales
(USD m)
(y-y)
30%
US total RTB-based display ad sales (LHS)
(USD m)
y-y growth (RHS)
10,000
25,000
25%
20,000
20%
15,000
15%
10,000
10%
5,000
5%
0
0%
2010
2011
2012
2013
2014
US Ad Exchange spend contributed
15.7% of total display ad spend in
2012, forecast by IDC to rise to
32.6% by 2016
EXHIBIT 13: US Ad Exchange display ad sales
US total display ad sales (LHS)
Growth (RHS)
30,000
2015
250%
Share of total display ad sales (RHS)
8,000
200%
6,000
150%
4,000
100%
2,000
50%
0
0%
2010
2016
2011
2012
2013
2014
2015
2016
Source: IDC
The Ad Exchange market in China is just starting to get off the ground, with 2012
revenue of USD21m, 0.7% of the total market display ad spend of USD2.85b (Exhibit
14). IDC forecasts a four-year Ad Exchange ad spend CAGR of 145% through 2016,
reaching USD627m by 2016. Despite the strong growth forecast for the next few
years, IDC expects Ad Exchange display ad revenue to still only represent 11.1% of
total display ad revenue for the market; we believe there could be further upside from
IDC’s forecast. We see great potential for the online advertising category as Ad
Exchanges become more efficient and advertisers and Internet property owners
become more educated about their effectiveness.
12
Japan
80%
14,000
Source: IDC
Western Europe
BNP PARIBAS
China Ad Exchange spend
contributed 0.7% of total display ad
spend in 2012, forecast by IDC to
increase to 11.1% by 2016, CAGR of
145%
27 JUNE 2013
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Alen Lin
EXHIBIT 14: China total display ad sales
EXHIBIT 15: China Ad Exchange display ad sales
(RMB m)
China total display ad sales (LHS)
(y-y)
6,000
Growth (RHS)
35%
4,000
700
25%
600
300%
500
250%
400
200%
300
150%
200
100%
5%
100
50%
0%
0
20%
15%
2,000
10%
1,000
0
Source: IDC
13
2012
2013
2014
2015
Share of total display ad sales (RHS)
30%
3,000
2011
y-y growth (RHS)
(RMB m)
5,000
2010
China total RTB-based display ad sales (LHS)
2016
350%
0%
2012
2013
2014
2015
2016
Source: IDC
BNP PARIBAS
27 JUNE 2013
China Internet
Alen Lin
Internet search engine – a high-performance subset of Ad Exchange
We view the Internet search engine industry as a subset of the Ad Exchange
mechanism, as search engines are capable of serving highly targeted
advertisements to Internet users with particular interest in a subject. As discussed in
earlier sections, advertisements served through Internet search platforms have
significantly higher CTR than display advertisements. This makes large Internet
search platforms highly valuable Internet properties for advertising purposes.
Internet search engines enable the
targeting of Internet users with
relevant ads, leading to high CTR
with potential to extend into new
products
In markets outside of China, Google is the recognised leader in Internet search. In
the US, it represented 66.5% of search market share in April 2013, far ahead of the
second largest search platform, Microsoft’s Bing with 17.3% market share (according
to comScore). Google’s success, however, has not been replicated in China, where
Baidu remains the dominant search platform with 70% market share (by usage) in
1Q13; we attribute Baidu’s dominance to its strength in Chinese language search
and government policies that potentially put Google in a weaker market position in
China. We believe Baidu will continue to be a dominant search platform for the China
market, given the strong positive feedback loop effect of the search industry (Exhibit
19).
Beyond the core Internet search activities of the existing search platforms in China,
we also expect them to begin to develop the Ad Exchange business model and
increasingly become broader online advertising platforms. This should create new
revenue opportunities for Chinese search platforms as they already have existing
online advertising customers and have the potential to rapidly tap into new
inventories of Internet properties through Ad Exchanges. In 2012, Google Network
Members generated 28.5% of Google’s total advertising revenue; Baidu still depends
on its core search business for over 90% of revenue.
China Internet search engine – industry still on a strong upward trend
China’s Internet penetration has risen from 16% at the end of 2007 to 42.1% in 2012;
over the same period, Internet search industry revenue has increased from RMB2.9b
to RMB29.3b. The five-year CAGR for China’s Internet user growth through 2012
was 21.8%, while the search engine industry revenue CAGR was 58.8% (Exhibit 16).
This implies that while the number of Internet users in China rose rapidly, revenue
generated per user also rose from RMB13.8 to RMB52. This indicates that the
industry has already hit an inflection point; in the early phase of the search engine
industry, the number of Internet users was the primary driver of search industry
revenue; however, the main growth driver has now shifted to search revenue per
Internet user, driven by the increasing number of online advertisers.
While Internet penetration growth in China has been impressive in recent years, we
see no signs of this tapering off, as penetration of 42.1% at the end of 2012 remains
low compared with that in mature markets such as Japan and Korea; both are at
c80% penetration, and Taiwan, Singapore, and Hong Kong are at c75% penetration
(Exhibit 17). The US has the lowest penetration of the mature markets at 78%. We
believe China’s aggressive upgrades of its fixed-line broadband network in recent
years will continue to drive up Internet penetration; in addition, the rise in smartphone
adoption presents incremental opportunities for the Internet search industry. In our
view, these trends set the foundation for the continuing growth of China’s search
engine industry.
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Alen Lin
EXHIBIT 16: Number of Internet users and search industry
revenue
EXHIBIT 17: Internet penetration comparison (2011)
(Percentage of individuals using the Internet)
Number of Internet users (LHS)
100
China
10
5
0
0
2007
2008
2009
2010
Sources: CEIC; China Internet Watch; BNP Paribas
2011
2012
Korea
15
200
Germany
20
300
France
25
400
Japan
30
U.S.
500
Hong Kong
35
Taiwan
600
90
80
70
60
50
40
30
20
10
0
Singapore
Search industry revenue (RHS)
(%)
(RMB b)
Spain
(m)
Source: ITU
Industry growth should continue to outpace Internet user growth
In our view, the increasing maturity and efficiency of the Internet search industry
provide the fundamental support for search industry revenue growth to outpace
Internet user growth in China. We illustrate the value creation process of the industry
in Exhibit 18. The products being sold by search engines are their inventories of
user-specific search queries. Based on the user profiles and activities, search
engines create value by funnelling users with specific profiles to paying advertisers
that seek a specific audience. The ultimate customers of the search engine industry
are the advertisers that promote their products and services to targeted sets of
Internet users.
Search engines’ positive feedback
loop, with increasing search users
and increasing advertisers, should
continue to drive industry value
Internet search industry dynamics closely follow the academic definition of an
information economy, where at the macro level the value of the industry increases
exponentially as the number of industry participants increases. As illustrated in
Exhibit 19, the rising number of Internet users drives growth of online advertisers.
This leads to rising quality of search results, which in turn drives the growth of
Internet users; as the numbers of products (Internet users and Internet properties)
and customers (advertisers) rise, the probability of matching the right product to the
right customer also rises, leading to higher revenue per product offered.
Specific search engines also play an important role in raising the quality of search
through enhanced profiling of Internet users. This can be achieved by collecting indepth data about the particular user and analysing the data to better understand and
predict a user’s interests, habits, and behaviour. Such data collections and analytics
can further enhance the matching of Internet users to paying advertisers, leading to
higher conversion rates, or click-thru-rates (CTR). This provides more potential for
raising the value of the industry as advertisers are willing to pay more to gain
exposure to the relevant audience.
Search engines create incremental
value by applying user data and
analytics in search algorithms to
maximise CTR
In our view, the combination of a rising number of Internet users and improving
search quality through data analytics provides a solid foundation for continuing
industry revenue growth, as evident in Exhibit 16.
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27 JUNE 2013
China Internet
Alen Lin
EXHIBIT 18: Internet search engine value chain
Inventory: search queries and user profiles
Value Creation
Search Engines
Advertising Distributors
Advertisers
Source: BNP Paribas
EXHIBIT 19: Positive feedback loop for Internet search value chain
Rising number of Internet users drives higher
number of advertisers
Number Internet
users
Number advertisers
Rising number of advertisers drives higher
number of Internet users
Source: BNP Paribas
Industry outlook – no sign of a slowdown
To analyse the relationship between search industry revenue and general Internet
usage, and to quantify industry potential, we have developed a regression model. As
the model is based on historical data, the potential contributions from Ad Exchange
and mobile Internet are not fully factored in as they are still new business models in
China; they could offer upside potential as they gain momentum.
We develop a regression model to
project search industry revenue
growth – we forecast a 2012-15
CAGR of 31.9%
Our regression model forecasts an industry revenue CAGR of 31.9% between 2012
and 2015, vs 58.8% for the five years between 2007 and 2012, as the comparison
base has grown significantly in recent years (Exhibit 20). A major component of this
is search revenue per Internet user, for which we forecast a CAGR of 25.8% over the
period vs CAGR of 30.3% over the past five years. This is consistent with our earlier
discussion that the rising numbers of Internet users and online advertisers will drive
growth in advertising revenue per user. This is also consistent with Baidu’s disclosure
that revenue per online advertising customer rose to RMB37,300 in 2012, from
RMB5,800 in 2006, a CAGR of 45.1%.
Our regression analysis indicates that industry revenue is most sensitive to Internet
search user penetration and the number of Internet search users, while the hours of
Internet use per week, seasonality, and number of Internet users are also strong
predictors. The number of mobile Internet users yields the lowest t-ratio in our model,
suggesting that the growth of mobile Internet users has so far not contributed
significantly to industry revenue. This could be a new growth driver as the industry
finds mechanisms for monetising mobile Internet usage; we believe the Ad Exchange
platform could be a powerful tool with which to more effectively monetise mobile
Internet.
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BNP PARIBAS
Regression analysis indicates high
sensitivity to search user penetration
and number of search users; Internet
usage time, seasonality, and number
of Internet users also important
27 JUNE 2013
China Internet
Alen Lin
EXHIBIT 20: Search industry revenue forecasts
(RMB b)
Search industry revenue (LHS)
40
Search revenue/Internet user (RHS)
(m)
60
35
50
30
40
25
20
30
15
20
10
10
5
2H15E
1H15E
2H14E
1H14E
2H13E
1H13E
2H12
1H12
2H11
1H11
2H10
1H10
2H09
1H09
2H08
0
1H08
0
Sources: BNP Paribas estimates, CEIC and China Internet Watch
Industry value drivers – combination of search users, advertisers, and analytics
A search engine is effectively a factory that packages its inventory, the Internet
search users, and sells this inventory to its customers, the advertisers. The search
engine’s role ends when it connects the inventory to the customer. Any interactions
or transactions that occur beyond this point are made outside the initial connection
created by the search engine. There are a number of factors that affect the
probability of an interaction taking place after the initial search connection, including
the size of the inventory, the number of customers, and the analysis performed by
the search algorithm that matched a particular search query/user to a particular
advertiser (Exhibit 21). The value of the inventory depends on the quantity and
quality of search users (subjective measure used by advertisers, based on user
profile and attributes); higher quality search users increase the probability of a
transaction between the user and advertiser.
Search engines create value when
inventory – search users – are sold to
customers – the advertisers
EXHIBIT 21: Internet search industry value drivers
Sourcing/inventory of Internet search users
Direct search queries
www.baidu.com
www.so.com
www.sogou.com
www.soso.com
www.google.com
Navigation sites
Web/news portals
www.sina.com.cn
news.sogou.com
news.soso.com
hao.360.cn
www.hao123.com
Social Networking
Internet utilities
Email applications
E-Commerce sites
Video/entertainment sites
Web browsers
Etc.
Search Engine
Distribution of
advertising service
Advertising distributors
Advertisers
Advertisers
Advertisers
Buyers of advertising service
Source: BNP Paribas
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27 JUNE 2013
Alen Lin
China Internet
The battle to dominate Internet search traffic
A starting point for a search engine service is to maintain a stream of search queries,
ie, having a large pool of inventory; this maximises the traffic for which advertisers
pay. This can be done through capturing direct search queries through search engine
websites such as google.com, baidu.com, so.com, and others, or through other
Internet services (Exhibit 22). While direct search queries at a search engine website
are the most direct mechanism for search engines to acquire users, traffic tends to
flow to the dominant search engine brands and be less effective for the secondary
search engine brands. Secondary search engines must utilise other mechanisms to
acquire search traffic.
Aside from direct search queries, search engines tap into other sources of search
traffic such as Internet navigation sites including Baidu’s hao123.com and Qihoo
360’s hao.360.cn (Exhibits 22-23). These navigation sites are collections of Internet
resources that users frequently utilise to navigate the Internet and often serve as the
starting point for users. According to statistics compiled by China Internet Watch,
hao.360.cn contributed 11% of search engine traffic in November 2012, while
hao123.com contributed 8.2% (Exhibit 26).
Search users reach search engines
through direct access or traffic
referrals; Internet navigation sites
contribute a significant amount of
search traffic
Popular navigation websites are powerful as users frequently utilise the default
search engines within these websites. In 3Q12, Qihoo 360 changed the default
search engine of its popular navigation website from Baidu to its own (Exhibit 24),
and pushed Baidu to a lower position on the list of search engine selections; this had
an immediate impact on Qihoo 360’s search engine market share (Exhibit 25). These
navigation sites, while serving as a source for search engine traffic, may also be
revenue generating as a standalone service. Qihoo 360’s hao.360.cn contributes the
majority of its online advertising revenue currently, according to the company.
EXHIBIT 22: Qihoo 360 navigation site
EXHIBIT 23: Baidu navigation site
Source: hao.360.cn
Source: www.hao123.com
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Alen Lin
China Internet
EXHIBIT 24: Qihoo 360 navigation site default search engine
EXHIBIT 25: China Internet search market share by page
views
100%
Baidu
Qihoo
Soso
Google
Sogou
80%
60%
40%
Chart or other exhibit
20%
Source: hao.360.cn
2Q13
1Q13
4Q12
3Q12
2Q12
1Q12
4Q11
3Q11
2Q11
1Q11
4Q10
3Q10
0%
Source: cnzz.com
Other sources of search traffic come from online video/entertainment, social
networking, news portals, and others. Exhibit 27 lists the popular Internet services in
China that can serve as sources of search traffic. In our view, the popularity of online
video services is a major reason for Baidu owning video service providers iQiyi and
PPS; while these services may not be profitable as standalone entities currently, they
could be important search traffic sources when integrated into Baidu’s product
portfolio. In addition, premium content could generate additional revenues as the
online entertainment industry matures.
Internet services such as
entertainment, social networking and
news portals also contribute to
search traffic
In addition to having a strong position in navigation websites, Qihoo 360 also has a
solid market share in China’s web browsers; in recent quarters, Qihoo 360’s Secure
Browser maintained a market share of c25%, according to cnzz.com. These
browsers, when installed, default the home page to Qihoo’s hao.360.cn unless the
user changes the home page, but it also prompts users periodically to set Qihoo
360’s navigation as the home page. In conjunction with Qihoo’s popular antivirus
software, Qihoo has a dominant position on Internet users’ desktops. Despite the
initial success in gaining market share in 3Q-4Q12, the company’s ability to continue
converting navigation site users to its own search engine users is yet to be seen.
EXHIBIT 26: Navigation websites’ contribution to search engine traffic
Contribution to search engines (Nov 2012)
(%)
hao.360.cn
11
hao123.com
8.20
web.sogou.com
6.50
123.duba.net
4.20
2345.com
1.40
hao.uc.cn
0.90
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27 JUNE 2013
China Internet
Alen Lin
EXHIBIT 27: Top Internet services in China
Top Internet services in China (Jan 2013, million users)
Search service
454.0
Online video
452.0
Community friends
439.0
News information
413.0
E-commerce
404.4
Entertainment
403.8
IT digital products
395.0
Media domain
362.1
Financial service
361.5
Email
356.0
Expanding online advertising footprint
Another key value-driver for the search engine industry is its advertising footprint.
While search engines are designed to operate without geographical boundaries, a
search engine service provider’s ability to monetise its service depends on its ability
to distribute its advertising service. The search engine service provider has the ability
to reach advertising customers through direct channels or via advertising agencies
that act as distributors of the service.
Expansion of advertising footprint
critical to monetising search services;
search engines leverage direct sales
force and ad agencies to expand
footprint
China’s online advertising market continued to expand in recent quarters, with 1Q13
growing 39% y-y as advertisers increasingly shifted marketing budgets toward online
media, according to China Internet Watch data. Within the overall online advertising
market, search engine remains the largest category of spending, representing 34%
of total industry revenue in 1Q13; the category grew 36% y-y (Exhibit 28). The
second largest category of online advertising is vertical search, which represented
23% of total industry revenue in 1Q13, +84.3% y-y. While growth of the online
industry has been strong, we see no slowdown as the number of Internet users
continues to rise and advertisers increasingly find online advertising to be more
effective in targeting customers. Despite the benefits of online advertising, we
believe the number of advertisers can only grow as fast as the major online platforms
can expand and reach them.
At the end of 1Q13, Baidu had 410,000 online advertising customers, +28% y-y;
Qihoo 360 currently has less than 10,000 as it had just begun to monetise its Internet
search business. While Qihoo 360 aims to rapidly increase its search advertising
customers, its scale could be limited by its search users. On the other hand, given
Qihoo 360’s smaller search market share, its lower advertising price could serve a
niche market of smaller advertisers.
Both Baidu and Qihoo 360 leverage direct internal sales forces in major markets and
external advertising agencies in other markets to reach additional advertising
customers. In the case of Baidu, we estimate the top three markets, Beijing,
Shanghai, and Guandong, represent over 50% of advertising revenue and are mostly
covered by its direct sales force. While Qihoo is still building up its customer base, it
is also primarily targeting tier-1 markets with its internal sales force.
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Alen Lin
EXHIBIT 28: China online advertising market in 1Q13
Search Engine
(RMB b)
25
Video
Vertical Search
Rich Media
EXHIBIT 29: Baidu’s online advertising statistics
No of online marketing customers (LHS)
Brand Graphic
(nos)
Other
20
Average revenue per customer (RHS)
40,000
600,000
35,000
30,000
500,000
15
(RMB)
700,000
25,000
400,000
20,000
300,000
10
15,000
200,000
5
10,000
100,000
5,000
0
0
0
2006 2007 2008 2009 2010 2011 2012
1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13
Source: Baidu
Improving advertising performance through Internet user profiles
In an effort to improve the effectiveness of search results and search advertising,
search engines could leverage contextual data about the user in the search
algorithm. Such data could include a user’s location, historical Internet activities or
other personal data. When utilised in online advertising, this leads to more targeted
ads. The popular Internet services Baidu operates could serve the purpose of
collecting user data and profiling users; these services include Baidu Knows, Baidu
Post Bar, Qunar travel service, and the numerous video services such as iQiyi and
the recently acquired PPS.
Fine-tuning search performance
through extensive user data
collection and analytics; breadth of
popular Internet services provides an
advantage
Partnerships with Internet services that have access to detailed user information can
also be powerful. Theoretically, search engines such as Baidu could partner with
Internet social networking services to exchange user profiles and improve their
advertising effectiveness. This could ultimately lead to higher prices for advertising
on the particular search platform.
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Competitive landscape in the China search engine industry
EXHIBIT 30: Porter's five-forces for Internet search engine
Threat of new entrants: Low
The challenges for new entrants to reach critical
mass in a networked industry inhibits expansion of
new entrants as scale in terms of market share is
necessary to gain new Internet users and advertising
customers. Such dynamics is prohibitive for new
entrants to compete against incumbents.
Supplier bargaining power:
Medium
Internet services that feed
search users to search engines
are the key suppliers; as they
are key sources of user traffic,
they could be in the position to
charge the search engines
Through referral fee structure.
Others are infrastructure
suppliers such as computer
servers and network operators
which have relatively lower
bargaining power.
Internal rivalry: Medium
Internet search industry conforms closely with the
positive feedback characteristics of a networked
industry; as the number of users who use its
service increases, the value of its service
increases. Such dynamic tends to limit smaller
rivals to serving niche market segments.
Buyer bargaining power:
Medium
The price of service provided
by search engines is generally
determined by bidding
process where advertising
customers bid for search
words. The price depends on
the search engines’ user market
share and its ability to match
users to the advertisers.
Threat of substitutes: Medium
Traditional media are substitutes for online
advertising services; however, they have been losing
ground to online advertising channels in recent
years. Other online channels also compete for
advertising budget; they include Internet portals,
social networking services, etc. In addition, in
mobile Internet environment, browser based search
is being displaced by mobile applications.
Source: BNP Paribas
Top-3 search engines account for over 90% of search traffic
The China search engine industry is dominated by the top three search engines,
Baidu, Qihoo 360, and Sogou, with a combined search market share of over 90% in
the past year, as measured by search usage by cnzz.com. Baidu remains the most
dominant player, with over 70% market share in 1Q13; this is a decline from nearly
80% a year earlier. Since August 2012, Qihoo 360 has gained market share to reach
nearly 15% as the company leveraged its strong presence on PCs to direct search
traffic to its own search engine, instead of to Baidu as it did previously. This was
effective for Qihoo 360 as its browser and navigation site have an established user
base, and they serve as effective sources of search traffic. The number three search
engine, as measured by search usage, Sohu’s Sogou, leverages the many Internet
services provided by Sohu, such as sohu.com, as sources of search traffic to
achieve a search market share of 7-8%.
We expect traffic share among the top three to shift as the two smaller players look
for ways to gain traffic share both organically and through partnerships with other
Internet services. In May 2013, Qihoo 360 and Alibaba announced a partnership to
launch 360.etao.com to position the search service for online shopping; this is
intended to both increase vertical search traffic for Qihoo 360 and to raise brand
awareness of Qihoo 360 search by leveraging Taobao’s dominance in e-tailing.
Higher brand awareness could lead to higher direct search queries via Qihoo 360’s
so.com. Qihoo 360 has publicly stated its target of 20% traffic share by the end of
2013.
Highly concentrated industry with top
three in China representing over 90%
of search usage
Smaller search engines likely to seek
partnerships or acquisitions to
increase market share; they could
target niche verticals to differentiate
themselves from the dominant player
It has also been widely reported that Sohu could be seeking to sell its Sogou search
engine; in our view, an acquisition could be more complementary to entities other
than the existing large search platforms. While the top search engine platforms
continue to compete for traffic share, we believe Baidu will maintain its revenue
share as its scale has enabled it to gain substantially more online advertising
customers than rivals have; Baidu’s 2012 revenue market share was 79% according
to China Internet Watch (Exhibit 32). While we believe Qihoo 360 and Sogou could
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Alen Lin
gain traffic share in the near term, their ability to fully monetise the service could be
more limited and would take time.
Beyond the top three, search engines such as Tencent’s Soso, Google, Microsoft’s
Bing, and Yahoo have combined market share in China of less than 10%. As we
believe the Internet search market strongly exhibits the characteristics of a
networked industry, market share gains for smaller players could therefore be limited
in the near term.
Sourcing of search traffic
Key suppliers for the Internet search industry are other Internet service providers that
have established user bases, such as Internet portals, navigation sites, social
networking services, e-commerce sites, Internet utilities and entertainment sites.
Baidu has built up a large number of services with a large user base that enables the
company to direct its user base to its own search engine. It also pays search referral
fees to partners for search traffic (Exhibit 31); we believe the recent rise in traffic
acquisition costs could include the effect of the Ad Exchange product.
Other search engine platforms such as Qihoo 360 mostly depend on traffic from their
respective navigation sites. However, as discussed earlier, Qihoo 360 is partnering
with other Internet platforms such as Alibaba to source search traffic along specific
industry verticals. This could imply that the company has exhausted internal
resources. While the partnership terms with Alibaba are undisclosed, we believe that
as Qihoo 360 aims to become a more significant player, it will increasingly need to
source traffic from other platforms in exchange for referral fees. In our view, such an
arrangement could be based on Qihoo 360’s ability to successfully monetise its
Internet search service.
EXHIBIT 31: Baidu's traffic acquisition cost
(RMB m)
Traffic acquisition cost (LHS)
700
Traffic acquisition cost/Revenue (RHS)
14%
600
12%
500
10%
400
8%
300
6%
200
4%
100
2%
0
0%
1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13
Source: Company
Monetisation of search
Once the traffic for a search engine reaches critical mass, search platforms need to
address the monetisation aspect of the business. The value of search increases in
line with the number of Internet search users; this has been shown in empirical data,
as illustrated in Exhibit 33, where search revenue per user rises as the number of
search users increases. A similar relationship is found for Baidu, where revenue per
online advertising customer increases in tandem with the rising number of online
advertising customers. We expect such a pattern to continue for the foreseeable
future as the perceived utility of a search engine increases from a user perspective;
this should continue to drive online advertising revenue in a self-reinforcing cycle.
Empirical data has shown search
revenue per user increases with a
rising number of search users and
number of advertising customers
In terms of monetising Internet search, market leader Baidu shows a consistent link,
with market share by revenue of 78.5% in 2012 vs its page view market share of
77.6%. As the field of search users approaches saturation, we believe the dominant
player, Baidu, will shift its focus to extending its advertising reach to grow its
advertising customer base, leading to a rise in revenue per search user. In addition,
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Alen Lin
its vast amount of user data to which it has access could enable the search engine to
deliver more targeted advertisements, leading to higher advertising fees.
Qihoo 360 also needs to expand its online advertising customer base, which is
currently less than 10,000. Qihoo 360 has partnered with Google, where the former
generates search traffic and the latter provides broad exposure to online advertising
customers; as such, Google’s revenue market share in 2012 was 15.6%, despite its
limited direct exposure to the search users (Exhibit 32). As Qihoo 360 builds up its
own online advertising customer base, it plans to reduce its dependence on Google
and capture a larger proportion of the search revenue generated.
EXHIBIT 32: Search market share by revenue (2012)
SOSO
1.5%
Youdao
0.3%
Others
1.0%
Sogou
3.1%
Qihoo 360 starting to build up
advertising customers to monetise
search services; currently rely on
partnership with Google
EXHIBIT 33: Continuing growth of revenue/search user
(m)
Number of search users (LHS)
500
Revenue/search user (RHS)
(RMB)
70
450
60
400
Google
15.6%
350
50
300
40
250
Baidu
78.5%
200
30
150
20
100
10
50
0
0
2007
2008
2009
2010
2011
2012
Sources: China Internet Watch; CEIC; BNP Paribas
Maximising search advertising revenue through high performance searches
The Internet search industry primarily generates revenue through online advertising.
Given the extensive and dynamic information that exists about Internet users and
advertisers, search platforms can maximise advertising price/revenue through
numerous pricing strategies to improve effectiveness. The pricing mechanism for
such advertising is similar to that for Ad Exchange platforms discussed previously,
where advertisers bid for advertising spots based on CPM, CPC, and CPA.
Industry value can be increased by
optimising search quality – ie, using
user data analytics to improve
relevance of advertising for search
users
The placement of a particular advertisement is generally determined by the
relevance and quality of an advertisement in a particular search query (in Google
terms – Quality Score), and bidding prices from advertisers for the particular search
query; these two factors combined determine the position of the particular
advertisement in the particular search query (Exhibit 7). Advertising prices are
ultimately determined by how effective the advertisement is as measured by the
click-through-rate (CTR); we believe improving the advertising relevance can
improve the CTR, and this is where search platforms can continue to optimise and
differentiate. Exhibit 33 provides a sample for CPC prices for different keywords
related to “Used cars”.
Such industry dynamics should enable search platforms with large amounts of user
data to better monetise Internet search services. Data collected through the various
Internet services can be used to optimise search results for the particular user,
leading to higher a CTR; this would directly lead to higher market prices for
advertising placements. As we discussed in an earlier section, CTRs are generally in
the range of 1-5% for search advertisements.
24
BNP PARIBAS
27 JUNE 2013
Alen Lin
China Internet
EXHIBIT 34: Sample keyword bidding prices
Source: adwords.google.com
Display advertisements – a different type of advertisements
Another type of common advertisement on the Internet is a display advertisement.
These are advertisements placed on various websites. While a less sophisticated
advertisement may be static (like the one shown in Exhibit 7, more intelligence can
be built into the placement of the advertisements by taking into account contextual
information such as the user profile, geographical location, time of day, etc.; this
approach could have the effect of increasing the click-through-rate. As display
advertisements are considered to be “push” advertisements – i.e. pushed to the
users by advertisers – CTR for typical display advertisement is <1%. While the CTR
is lower than for a search advertisement, the frequency of advertising display is
significantly higher for display advertisements.
Techniques for search ads can be
applied to display ads to improve
CTR; Ad Exchange platforms enable
search engines to expand into
display ads
Advertising space inventory can be significantly increased when a search platform
leverages the Ad Exchange platform to include partner Internet websites. According
to Google, it has over 2m partners in its Google Network Members; Baidu also has
partners in its Baidu Union in the range of hundreds of thousands. We believe the
ramping up of Baidu Union is a major step for Baidu to build up an Ad Exchange
platform as efficiency of the platform increases with the increasing number of
participants. We view the Ad Exchange platform as a new product for search engine
platforms that has implications on future growth potential.
Mobile Internet – the next frontier
As the number of mobile Internet users has grown rapidly in recent years with the
rise of smartphones and mobile broadband services in China, Internet companies
are still adapting their business models to tap into this new opportunity. Exhibit 35
shows the number of overall Internet users 5-year CAGR through 2012 was 21.8%
vs. the number of mobile Internet users CAGR of 52.8%. While the rise of mobile
Internet usage presents new opportunities to Internet companies, it also poses
challenges as Internet companies have to adapt to mobile Internet monetisation. The
growth of mobile Internet users has far outpaced Internet companies’ ability to
monetise mobile Internet users’ utility for the services.
Access to mobile Internet more
fragmented than PC Internet; Ad
Exchange platforms can also be
adapted for service mobile ads
Internet companies that have optimised their products for PC Internet advertising are
still adjusting their products for the mobile Internet environment, where a major
limitation is the real estate available on much smaller screens compared to PC
monitors. Taking search engines for example, for each search query a number of
paid-advertisements can be served to the PC user; however, on a mobile device
limited space is available to serve advertisements. Therefore, for mobile Internet
25
BNP PARIBAS
27 JUNE 2013
China Internet
Alen Lin
advertising to be meaningful the frequency of advertisements must be increased; this
would require Internet companies to expand advertising inventory across multiple
applications on mobile devices.
The user behaviour for mobile Internet is very different from PC Internet. On PCs,
users mostly access the Internet through web browsers; this is how most Internet
companies that rely on advertising have developed their products. On a mobile
device, users are more likely to access information using applications for specific
activities; in many cases Internet companies that have succeeded in PC Internet
have limited presence in mobile applications. Based on comScore data for May
2013, browsers only represented 20% of smartphone and tablet usage based on
time spent. A 2012 Google survey of China’s smartphone users indicated that only
34% of users noticed advertisements appearing in an app; users mostly noticed
advertisements on mobile devices while using search engines (49%) and on a
website (54%). In our view, this suggests a significant opportunity for in-app
advertisements. Exhibit 36 is a summary of popular services being used by China’s
mobile users where instant messaging, mobile search, news, Weibo, and music
round out the top 5 applications.
Browser access on mobile Internet
only represents 20% of usage time;
only 34% of users notice ads in
mobile apps – presenting significant
opportunities
In our view, the Ad Exchange could be an effective platform for mobile advertising to
proliferate as mobile applications can become members of the Ad Exchange network
just like other Internet properties and make their mobile applications available
through the Ad Exchange. While the business model for mobile advertising still
needs to be optimised, we believe the potential exists as mobile devices offer
significantly more contextual information about the user that can be used for more
targeted advertising. In our view, this places even more importance on the Ad
Exchange platform we discussed in earlier sections as it has the potential to serve
targeted contextual advertisements to mobile users across multiple applications.
0
2006
Source: CEIC
26
2007
2008
2009
2010
2011
2012
Post & comment
100
Mobile e-mail
200
Network video
300
Social network
400
Network literature
500
Network music
90
80
70
60
50
40
30
20
10
0
Weibo
(%)
Total number of mobile Internet users
News browse
Total number of Internet users
Instant messaging
(m)
600
Mobile search
EXHIBIT 36: China mobile users’ usage of mobile apps (April
2013)
EXHIBIT 35: Number of China Internet users
BNP PARIBAS
27 JUNE 2013
China Internet
Alen Lin
Regulatory control; a significant force in the search engine industry
The Internet is a very effective platform for removing geographical boundaries for
various business models, and also a very efficient medium for the dissemination of
information in real-time. As such, the Internet industry in China is subject to complex
supervision by various regulatory entities of the Chinese government; Exhibit 37
illustrates the full scope of regulatory framework for the industry.
Internet search engines regulated by
13 agencies covering numerous
Internet activities
Industry regulations cover a wide variety of activities including the following:
§
Cultural activities
§
News reporting
§
Payment services
§
Internet publishing, online games, and online game virtual currency
§
Value-added telecommunication services
§
Audio and video broadcasting
§
Internet map services
§
Advertisements
§
Intellectual Property Rights
§
Information security
As these regulatory areas fall under various government agencies, the industry has
to comply with all relevant rules to ensure full compliance. In our view, the area that
most concerns the Chinese government is the dissemination of information, which is
often subject to censorship.
Internet censorship in China
China’s Internet censorship comprises over sixty Internet regulations which have
been executed by provincial branches of state-owned Internet service providers,
companies, and other organisations. These authorities are involved in blocking
website content and monitoring Internet access of individuals in order to eliminate
leakage of illegal information on state security and public interests, and also curb
Internet pornography and other socially disruptive content. In addition to citizens,
foreign individuals and firms are also brought under the purview of these laws. The
three main Internet censorship regulations of China include:
§
Temporary Regulation for the Management of Computer Information Network
International Connection: The regulation mandates that; a) Internet service
providers should be licensed, and b) that Internet traffic should be routed through
ChinaNet, GBNet, CERNET or CSTNET.
§
Ordinance for Security Protection of Computer Information Systems: According to
the ordinance, the Ministry of Public Security will have complete responsibility for
Internet security protection.
§
Security Management Procedures in Internet Accessing: "Harmful information"
and "harmful activities" regarding Internet usage are defined in this regulation.
Internet censorship in China
comprises over 60 regulations that
are executed by state-owned
provincial ISPs
Content restrictions became effective from 2000
In September 2000, content restrictions for Internet content providers were first
created by the State Council, including:
§
China-based websites require separate approvals to link to overseas news
websites or distribution from overseas media.
§
Only “licensed print publishers” are authorised to deliver news online.
27
BNP PARIBAS
27 JUNE 2013
China Internet
Alen Lin
§
Non-licensed websites can only publish/disseminate information already available
in the public.
§
The approvals should be attained from state information offices and the State
Council Information Agency.
After the 2001 APEC summit in Shanghai, overseas news websites including CNN,
NBC, and the Washington Post that were blocked previously were relaxed
permanently except for special occasions.
State Council Information Office established separate authorities to manage
Internet content
In 2011 the State Internet Information Office and the Internet News Coordination
Bureau were established by the State Council Information Office to manage Internet
content more effectively. The authorities enforce restrictions largely through Internet
service providers and impose direct penalties in case of violations. Hence, the
service providers have been entrusted with the responsibility to monitor consumer
content.
State Internet Information Office and
the Internet News Coordination
Bureau were created specifically to
regulate Internet content
Extent of Internet censorship in websites
Search engines
Generally in search engine censorship, search results of certain terms are filtered
leading to little or no results. Some of the examples that can be cited include:
§
Searching for information about “Falun Gong”, “1989 protests in Tiananmen
Square”, “Urumqi riots”, and “Tibetan independence”.
§
Search engine Bing censored search results in mainland China, but not in Hong
Kong, Macau and Taiwan.
Google started blocking websites which the Chinese government considered illegal
in February 2006, in exchange for remaining in mainland China. However, in 2010
Google stopped censorship and closed Google China. Currently, search traffic for
Google is routed to the Google Search Hong Kong site which is uncensored;
however, sensitive keyword searches continue to be blocked for Chinese users.
In support of the Chinese government’s censorship mandate, Baidu search engine
has been the most compliant, given that it has a long list of censored topics and
blocked websites.
Discussion forums
According to British Standpoint magazine, the Chinese government mandated a
shutdown of Internet portals, forums, and discussion boards for maintenance ahead
of the twentieth anniversary of the Tiananmen Square event. Due to the outage,
Chinese Internet users were unable to access popular websites like Twitter, Hotmail
and Flickr, among others.
Social media websites
§
In spite of the government using Sina Weibo (micro blogging service) for
disseminating information, the content is supervised and censored by various
self-censorship policies and methods.
§
According to an article from the Harvard Law School – In Washington Post op-ed,
Berkman Center directors discuss Twitter revolution in Iran on 22 June, 2009 –
social media websites such as Facebook and Twitter have been blocked since
the second half of 2009 due to violations of social or political commentary rules.
§
Generally, messages agitating collective action are blocked. For example,
discussions around Chinese human rights activist Liu Xiaobo, the Nobel Peace
Prize winner, were prohibited. However, discussions around sensitive topics and
controversies such as the Li Gang incident, Wenzhou train collision, and 2010
Shanghai fire incidents on Weibo increased.
28
BNP PARIBAS
27 JUNE 2013
China Internet
Alen Lin
EXHIBIT 37: Regulatory framework for Internet industry
The Ministry of Culture
The State Council News Office
The Ministry of Commerce
The State Food and Drug Administration
People’s Bank of China
General Adminis-tration of Press and
Publication (GAPP)
MIIT
The National
People’s Congress
PRC State Council
The State Administration of Radio Film and
Television
National Administration of Surveying,
Mapping and Geo-information
The State Administration for Industry and
Commerce
• Regulations on Internet Culture Activities
• Regulations on Online Game Virtual Currency
• Regulations on News Display
• Restrictions on Foreign Ownership in ValueAdded Telecommunications Services
• Regulations on Internet Drug Information
Services
• Regulations on Payment Services by Nonfinancial Institutions
• Regulations on Internet Publishing
• Regulations on Online Games
• Regulations on Value-Added
Telecommunications Services and Internet
Content Services
• Regulation on Broadcasting Audio/Video
Programs through the Internet
• Regulations on Internet Map Services
• Regulations on Advertisements
• Regulations on Intellectual Property Rights
The State Intellectual Property Office
The State Secrecy Bureau
• Regulations on Information Security
The Ministry of Public Security
Source: Baidu
29
BNP PARIBAS
27 JUNE 2013
China Internet
Alen Lin
Ad Exchange favours participants with large user bases and
advertisers
While Ad Exchange is a potential new product for many Internet players, we believe
the business model favours players with either large user bases or large online
advertiser bases. The large number of Internet properties available through
partnerships such as the Baidu Union ultimately translates to expansion of the user
base. Within the search engine industry, we believe Baidu has a solid lead in key
measures compared to smaller competitors. In our view, this puts Baidu ahead of the
pack for building a large scale Ad Exchange platform among search engine players
with its Baidu Exchange Service.
Large search engine platforms
leverage existing advertising
customer bases to expand into Ad
Exchange market
We also believe industry vertical specific Ad Exchange platforms can exist as they
cater to specific market segments, both for users and Internet properties. One such
industry vertical could be the e-Commerce segment where Alibaba/Taobao leverages
their respective user base. However, we believe their core strengths in user base
and Internet properties are primarily in the e-tailing space in the early stage as this is
the core segment of their underlying business. In our view, Ad Exchange platforms
that target different market segments can co-exist in the long-run.
We believe Baidu Exchange Service holds significant potential for Baidu as it
leverages its existing core strengths. More importantly, not only does BES expand
Baidu’s inventory of PC Internet properties, it could also enable Baidu to tap into
mobile Internet by including mobile apps in Baidu Union. While it would still take time
to educate the market, and for the platform to adjust for advertising on mobile apps,
we believe the efficiency of the Ad Exchange will self-optimise based on supply and
demand.
EXHIBIT 38: Valuation comparison
BBG
Share
Mkt
------ PE ------
--EV/EBITDA--
---- P/BV ----
code
price
cap
2013
2014
2013
2014
2013
(LC)
(USD m)
(x)
(x)
(x)
(x)
(x)
5.4
----- Yield -----
----- ROE -----
2014
2013
2014
2013
2014
(x)
(x)
(x)
(x)
(x)
4.0
0.0
0.0
28.4
27.2
BAIDU INC - SPON ADR*
BIDU US
113.0
31,435
19.2
14.6
14.7
10.7
QIHOO 360 TECHNOLOGY CO-ADR*
QIHU US
44.2
5,336
125.7
43.2
67.6
26.3
9.2
7.1
0.0
0.0
7.3
16.3
SINA CORP
SINA US
52.6
3,504
75.5
32.0
47.8
20.2
2.6
2.4
0.0
0.0
4.5
9.1
SOHU.COM INC
SOHU US
58.9
2,252
21.4
15.7
5.4
4.3
1.8
1.7
0.0
0.0
8.4
10.4
700 HK
283.4
67,654
25.6
21.0
18.3
15.3
7.5
5.7
0.3
0.4
33.0
30.1
TENCENT HOLDINGS LTD
NETEASE INC-ADR
NTES US
56.2
7,343
10.4
9.2
6.5
5.5
2.3
1.9
0.9
0.9
24.1
21.8
GOOGLE INC-CL A
GOOG US
869.8
288,567
18.8
16.2
11.1
9.4
3.4
2.9
0.0
0.0
17.8
17.7
YAHOO! INC
YHOO US
24.1
26,054
18.2
16.4
13.1
12.5
1.9
1.7
0.0
0.0
10.5
10.1
YOUKU TUDOU INC
YOKU US
18.0
2,961
NA
51.2
NA
23.9
2.0
1.9
0.0
0.0
(3.4)
5.0
RENREN INC-ADR
RENN US
2.8
1,042
Internet service - Mcap Weighted Average (x)
NA
NA
NA
NA
1.0
1.0
0.0
0.0
(5.7)
(2.5)
20.0
17.3
11.3
9.6
4.1
3.3
0.0
0.0
20.8
20.2
As at 25 June 2013
Sources: * BNP Paribas estimates; all others (Not rated) are Bloomberg consensus estimates
30
BNP PARIBAS
27 JUNE 2013
27 JUNE 2013
INITIATION
/ INTERNET
CHINA
BAIDU
BIDU US
BUY
TARGET PRICE
USD113.00
CLOSE
HOW WE DIFFER FROM CONSENSUS
MARKET RECS
TARGET PRICE (%)
7.66
POSITIVE
15
EPS 2013 (%)
(2.8)
NEUTRAL
11
EPS 2014 (%)
2.6
NEGATIVE
4
USD91.09
UP/DOWNSIDE
+24.1%
KEY STOCK DATA
Beyond search advertising
n
n
n
Profit growth to return in 2014: initiate with BUY
We initiate on Baidu, the largest web services company in China,
with a BUY and TP of USD113. Baidu’s Internet search market share
will remain dominant. We expect revenue growth to remain strong at
>30% y-y through 2015, and NP growth to return to +31.6% in 2014.
Growth beyond PC search advertising
We believe Baidu will increasingly tap into display advertising with its
Baidu Exchange Service (BES). Leveraging its Baidu Union and
advertising customers, we believe BES enables Baidu to tap into vast
display ad opportunities and mobile internet monetization.
DCF-based TP of USD113
Our DCF-based USD113 TP implies 2013-15 PE multiples of
23.8x/18.1x/13.5x. Key downside risks include: 1) intensifying
competition in Baidu’s core search segment; 2) new growth drivers
such as mobile Internet and BES fails to gain momentum.
YE Dec (RMB m)
2012A
2013E
2014E
2015E
Revenue
22,306
30,659
40,594
53,851
Rec. net profit
10,456
10,307
13,563
18,144
Recurring EPS (RMB)
299
295
388
519
EPS growth (%)
57.3
(1.5)
31.6
33.8
Recurring P/E (x)
18.7
19.0
14.4
10.8
Dividend yield (%)
EV/EBITDA (x)
0.0
0.0
0.0
0.0
15.6
15.0
11.0
7.5
Price/book (x)
7.5
5.4
3.9
2.9
Net debt/Equity (%)
(8.0)
(37.1)
(57.4)
(70.8)
ROE (%)
50.6
33.1
31.5
30.8
Jun-12
Sep-12
Dec-12
Mar-13
Jun-13
23
142
13
132
3
122
112
(7)
102
(17)
92
(27)
82
(37)
72
n
Ad Exchange – an emerging new product segment
We believe the Ad Exchange platform will complement Baidu’s
existing search advertising business and provide incremental growth
for the company. While a proven business model in mature markets,
the category currently contributes <1% of China’s display ad spend.
(USD)
(47)
BAIDU
Share price performance
Rel to MSCI China
1 Month
Absolute (%)
Relative to country (%)
(%)
3 Month
12 Month
(5.6)
6.8
(18.0)
9.2
21.8
(16.0)
Next results
July, 2013
Mkt cap (USD m)
3m avg daily turnover (USD m)
Key chart: Continuing growth of revenue/search user
(m)
500
31,853
(RMB)
80
400
60
383.7
Free float (%)
Major shareholder
12m high/low (USD)
70
Robin Yanhong Li (16%)
133.98/83.59
3m historic vol. (%)
300
40
ADR ticker
20
ADR closing price (USD; 25 Jun 2013)
200
100
Issued shares (m)
0
0
2007
2008
2009
Sources: Bloomberg consensus; BNP Paribas estimates
Alen Lin
[email protected]
+852 2825 1801
31
2010
2011
2012
35.7
BIDU US
91.09
35
BAIDU
BIDU US
Alen Lin
Investment thesis
Catalyst
We initiate coverage of Baidu with a BUY recommendation
and a DCF-based target price of USD113. We forecast
Baidu’s 2013 net profit will decline 1.3% as it is investing in
new growth areas and net margin will contract on productmix change. However, we forecast profit growth will resume
in 2014. We estimate net profit will increase 31.6% in 2014
and 33.8% in 2015 as new products begin to contribute and
margins reach a stable and sustainable level of about 33%.
We expect revenue growth to remain at over 30% over our
three-year forecast period.
We believe Baidu is in good position to build up its Ad
Exchange platform by leveraging its large base of online
advertisers. This would significantly expand the company’s
reach to non-search online advertising. In addition, we
believe the Ad Exchange platform will enable Baidu to tap
into mobile Internet by including mobile apps in the Baidu
Union. As contributions from these new product offerings
begin to materialize, we believe they will pose upside to the
company’s growth outlook.
Risks to our call
Internet search advertising spending currently represents
37% of total online advertising spending in China. Thus,
there is significant upside potential for Baidu as it builds its
BES platform to tap into non-search online advertising.
Baidu currently generates over 90% of its revenue from
Internet search advertising. In our view, key metrics to track
are the number of online advertising customers and the
number of Baidu Union members; the latter being an
indication of Baidu’s inventory of advertising space.
Company background
Key risks to our BUY recommendation include: 1) more
intense competition in Baidu’s core Internet search
segment, which could slow search advertising revenue and
erode margins; and 2) inability to generate sufficient
revenue growth beyond the core search segment including
its BES platform, online video services and mobile Internet.
Key assumptions
Baidu is the largest web service company in China mainly focus
on search engine for website. On Aug 5, 2005, Baidu was listed
on The NASDAQ National Market with symbol "BIDU".
In addition to its core web search product Baidu.com, the
company powers a broad range of products and services,
including Baidu Postbar (an interactive experience sharing
community), Baidu Encyclopaedia and Baidu Map.
2012
Number of online marketing customers
Average revenue per customer (RMB)
2013E
2014E
2015E
596,000 507,500 609,000
730,800
37,300
16,895
18,585
20,443
50.5
64.5
66.6
66.6
Total operating costs and expenses/
revenue ratio (%)
Sources: Company data; BNP Paribas estimates
Principal activities by revenue (2013E)
Earnings sensitivity
------- Base -------
Other services,
0.6%
2013E
2014E
2013E
2014E
Total revenue
30,659
40,594
33,725
44,653
27,594
36,534
EPS (RMB)
294.74
387.85
321.12
420.80
268.37
354.90
8.9
8.5
(8.9)
(8.5)
Operating expenses/revenue ratio
(%)
EPS (RMB)
64.5
66.6
61.3
63.3
67.7
69.9
294.74
387.85
331.90
437.19
257.59
338.52
12.6
12.7
(12.6)
(12.7)
Change (%)
Key executives
Change in total revenue (%)
0
0
10
10
(10)
(10)
Change in operating expenses
0
0
(5 ppt)
(5 ppt)
5 ppt
5 ppt
Source: BNP Paribas estimates
Age
Since
Title
Robin Yanhong Li
44
2000
Chairman and Chief Executive
Officer
Jennifer Xinzhe Li
45
2008
Chief Financial Officer
http://www.baidu.com
32
------- Worst -------
2014E
Change (%)
Online
marketing
services, 99.4%
------- Best -------
2013E
The key earnings drivers include total revenue and
operating expenses/revenue ratio
A 10% increase in total revenue raises 2013E/2014E EPS
by 8.9%/8.5%; a 10% decrease reduces 2013E/2014E
EPS by 8.9%/8.5%
A 5ppt fall in operating expenses/revenue ratio lifts 2013E/
2014E EPS by 12.6%/12.7%; a 5ppt rise decreases
2013E/2014E EPS by 12.6%/12.7%
BNP PARIBAS
27 JUNE 2013
BAIDU
BIDU US
Alen Lin
Initiate coverage with BUY on emerging new revenue drivers
We initiate coverage of Baidu with a BUY recommendation and a DCF-based target
price of USD113.
Baidu offers traditional Internet search advertising services, but it is now changing its
product mix to tap into new growth opportunities. Internet search advertising
spending currently represents 37% of total online advertising spending. Thus, there
is significant upside potential for Baidu as it builds its BES platform to tap into nonsearch online advertising. Google’s (GOOG US, Not rated) revenue structure could
be a benchmark for Baidu. Google currently generates 28.5% of its advertising
revenue from Google Network Members’ websites, while Baidu generates over 90%
of its revenue from Internet search advertising. We believe Bloomberg consensus
forecasts do not fully factor in the potential from the new product, BES, which could
offer meaningful upside in 2014-15. In our view, key metrics to track are the number
of online advertising customers and the number of Baidu Union members; the latter
being an indication of Baidu’s inventory of advertising space.
Changing product mix to tap into new
growth opportunities
We forecast Baidu’s 2013 net profit will decline 1.3% as it is investing in new growth
areas and net margin will contract on product-mix change. But, profit growth should
resume in 2014. We estimate net profit will increase 31.6% in 2014 and 33.8% in
2015 as new products begin to contribute and as margins reach a sustainable level
of about 33%. We expect revenue growth to remain at over 30% over our three-year
forecast period.
Internet search is the revenue generator
Baidu delivered revenue CAGR of 62.5% over 2008-12. Internet search advertising
remains its core business, contributing over 90% to total revenue during this period.
The company’s revenue base has grown 6x from 2008 to RMB22.3b in 2012, and we
forecast revenue CAGR of 34.2% over 2012-15 (Exhibit 1). We believe online
advertising growth will be driven by an increase in the number of advertising
customers and higher revenue per advertising customer as Internet users are
increasingly dependent on Internet search for information. We estimate the number
of advertising customers will increase from 410,000 in 1Q13 to 507,000 by end-2013
and further to 730,000 by end-2015. In our view, the number of online advertisers will
continue to grow as they become more aware about the effectiveness of this media
channel.
Internet search advertising remains
Baidu’s core business
In addition to Baidu’s traditional Internet search platform for advertising, it is focusing
on the Ad Exchange platform as a new product offering for incremental growth. We
believe this can significantly expand the company’s inventory of advertising space.
Baidu’s increasing emphasis on Baidu Union is setting the stage for the Ad
Exchange platform; Baidu Union members make their Internet properties available
for ad placements. The increasing availability of advertising space should also help
to expand the number of advertising customers. While we do not estimate revenue
contribution from the Ad Exchange platform separately, we believe this would
become an important segment in the future.
33
BNP PARIBAS
27 JUNE 2013
BIDU US
BAIDU
Alen Lin
EXHIBIT 1: Baidu revenue trend
(RMB m)
Total revenue (LHS)
Revenue growth rate (RHS)
(%)
90
60,000
80
50,000
70
40,000
60
50
30,000
40
20,000
30
20
10,000
10
0
0
2009
2010
2011
2012
2013E
2014E
2015E
Significant upside potential for Internet search
As highlighted in our accompanying sector report, Connecting users to advertising,
we believe the Internet search industry will grow strongly. This is because both the
number of Internet search users and online advertising customers will continue to
rise (the latter directly impacting search advertising revenue), thereby forming a
positive feedback loop in driving value for the service. We expect industry revenue
growth to outpace both the number of Internet search users and online advertisers.
In our regression model for projecting search industry revenue, we estimate industry
CAGR of 31.9% over 2012-15, vs 58.8% CAGR over 2007-2012. We assume
revenue/Internet user CAGR of 25.8% for our three-year forecast period, implying
slower Internet user growth. The regression model is based on historical data, thus it
does not take into account fully the potential contribution from new growth drivers
such as mobile Internet and Ad Exchange platform, which could provide incremental
upside for Baidu.
While Baidu has been facing competitive pressure from Qihoo 360 and has lost
market share, we believe incremental gains for Qihoo 360 will moderate as organic
market-share expansion becomes more challenging. Aside from Qihoo 360, we
believe no other viable Internet search platform exists to compete against Baidu’s
large scale given the current industry structure. In spite of the recent market share
shift, we believe Baidu can remain the dominant Internet search service provider as it
has built a strong reputation for its products. In our view, the many popular nonsearch products offered by Baidu can create stickiness for its services. In addition,
we believe there is significant market share inertia as the value created by Baidu
from the positive feedback loop (discussed in details in our sector report) makes
major shifts in market share less likely.
Only one viable competitor:
Qihoo 360
Baidu Exchange Service – a new product offering
While Baidu Union has been around for a few years, we believe it will increasingly
become a more significant part of Baidu’s growth driver as it taps into its Ad
Exchange platform – Baidu Exchange Service (BES). At a high level, online
advertising through BES is similar to Baidu’s traditional Internet search advertising,
but it provides a new product line. Internet properties – advertising space inventories
– offered to advertisers through Baidu were its own properties previously. With BES,
the company is able to offer new inventory from its Baidu Union members to its
advertising customers. This vastly expands the amount of advertising space that can
be sold.
This is a new product and contribution is currently limited, thus we believe the Street
has not fully factored in the upside potential for Baidu. Based on IDC forecast, Ad
Exchange display ad spend could reach RMB2.5b in China by 2015. Baidu’s ability
to capitalize on this opportunity would provide incremental upside. In addition, we
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BIDU US
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believe IDC’s forecast may be conservative as it implies that Ad Exchange ad spend
would represent just 7.8% of total display ad spend.
We view inventories sold through the BES platform as a new product for Baidu, as it
acts as an exchange operator rather than a seller of its own Internet properties.
While the company’s blended margins will be impacted as the product mix changes,
we think this is a natural evolution when offerings are extended (Exhibit 2). A change
in product mix would be reflected in Baidu’s traffic acquisition cost as the BES
platform leverages Baidu Union members to offer more online advertising space.
Because of the product-mix change in 2013, we forecast Baidu’s operating margin
will decline from 37% in 1Q13 to 33.7% in 4Q13 (Exhibit 9). Despite the potential
decline in blended profit margins, the new product is a new source of revenue.
EXHIBIT 2: Baidu product offerings
Internet users
Internet search users
Users of other Baidu
Internet properties
Users of Baidu Union
member Internet
properties
Search Engine
Display Ad Platform
Ad Exchange
Advertising space/product inventory offered
Advertosers
Advertisers
Advertisers
Advertisers
Consumers of advertising service
Source: BNP Paribas
Mobile Internet monetization – potential expansion through Baidu
Union
As discussed in our sector report, access of mobile Internet tends to be more
fragmented than PC Internet where users mostly access it via the browser. This is a
challenge to monetization as no one dominates access of the mobile Internet. Baidu
is making efforts to make its Internet services more relevant on mobile devices
through its mobile apps such as Baidu Search and Baidu Map. The eventual
expansion of Baidu Union to include non-Baidu mobile apps will vastly expand the
company’s advertising presence on mobile platforms and enable it to monetize
mobile Internet, in our view.
Making its services more relevant on
mobile devices
Given the fragmentation of mobile applications, we believe Ad Exchange is an
effective platform to aggregate mobile advertising opportunities to make them
available to a large set of advertisers. More importantly, we believe a common Ad
Exchange platform for PC Internet and mobile Internet will increase the efficiency of
the value chain, including that for advertisers, Internet property owners and
exchange operators. Baidu has a strong presence in PCs, thus a strong Ad
Exchange platform should enable it to leverage its strengths across platforms. We
believe the development of mobile advertising will be gradual as advertisers become
more aware about the value of mobile advertising.
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Normalizing return on equity
We estimate Baidu’s ROAE to approach 30% through our forecast period, from a
peak of 55.8% in 2011. We expect net margin to decline primarily due to a change in
product mix. The expansion of inventories to include its Baidu Union partners
effectively adds a new product offering from its traditional dependence on Internet
search advertising. We forecast Baidu’s asset turnover will remain stable at around
50%. The expansion of Baidu’s equity base will lead to decline in its assets/equity
ratio; this also contributes to the lower ROE in the future. In our view, this can be
enhanced by restructuring its capital structure to lower its equity base.
EXHIBIT 3: Baidu's ROAE decomposition
(%)
2009
2010
2011
2012
2013E
2014E
2015E
NI/Sales
33.4
44.5
45.8
46.9
33.6
33.4
33.7
Sales/Assets
72.2
71.6
62.1
48.8
50.7
51.0
52.2
Assets/Equity
157.0
167.9
196.2
219.7
193.1
184.1
174.8
37.9
53.6
55.8
50.3
32.9
31.4
30.7
ROAE
Strong balance sheet and rising FCF yield
We forecast Baidu will invest in new business platforms in 2013 and that profit
growth will resume in 2014. Thus, the company’s cash position will expand rapidly
from a debt/equity ratio of -0.1% in 2012 to -71.3% in 2015E. During the same
period, we forecast FCF yield will rise from 5.7% in 2012 to 10.1% in 2015. We
assume capex will remain close to 10% of revenue as Baidu continues to expand
PP&E to accommodate more Internet traffic.
EXHIBIT 4: Baidu's balance sheet
(RMB m)
2009
2010
2011
2012
2013E
2014E
2015E
Cash & cash equivalents + Bank deposits
4,180
662
7,782
4,127
11,881
23,584
38,995
58,657
1,000
11,721
22,793
23,490
24,295
25,315
4,843
8,782
15,848
34,674
47,074
63,290
83,972
998
1,622
2,694
3,888
5,578
7,801
10,358
6,157
11,048
23,341
45,669
60,261
79,115
102,701
-
-
172
2,171
2,171
2,171
2,171
Current Liabilities
1,400
2,552
4,235
6,066
10,398
15,702
21,155
Total Current Liabilities
1,400
2,552
4,407
8,237
12,569
17,873
23,325
LT borrowings
4
86
2,278
9,693
9,693
9,693
9,693
Other LT Liabilities
-
5
331
524
524
524
524
Total Liabilities
1,404
2,643
7,015
18,454
22,787
28,090
33,543
Share Capital
1,426
1,557
1,772
2,095
2,095
2,095
2,095
Reserves
3,441
6,966
13,604
24,038
34,309
47,872
66,016
-
-
1,034
1,160
1,160
1,160
1,160
Current Assets
Total Current Assets
Non-Current Assets
Total Assets
ST borrowings / Current portion of LT borrowings
Minority Interest
Total Equity
4,753
8,406
15,292
26,055
36,314
49,865
67,998
Total Equity & Liabilities
6,157
11,048
23,341
45,669
60,261
79,115
102,701
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27 JUNE 2013
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BIDU US
Alen Lin
EXHIBIT 5: Baidu's cash flow
RMB m
2009
2010
2011
2012
2013E
2014E
2015E
Net Profits
1,485
3,525
6,639
10,456
10,307
13,563
18,144
Depreciation & Amortization
317
441
885
1,515
1,740
2,314
3,070
Change in working cap
392
746
592
781
3,636
4,499
4,432
11
58
464
1,279
0
0
0
2,205
4,770
8,580
14,031
15,684
20,375
25,646
33
67
336
759
1,235
2,400
3,360
Other operating cashflow
Operating cash flow
Interest Inc / (Exp)
Taxes paid
(198)
(536)
(1,189)
(1,574)
(1,847)
(2,393)
(3,202)
Capex
(439)
(963)
(1,866)
(2,340)
(3,060)
(4,080)
(5,100)
Free cash flow
1,766
3,807
6,714
11,692
12,624
16,295
20,546
Free cash flow yield (%)
0.9
1.9
3.4
5.9
6.4
8.3
10.4
Dividend yield (%)
0.0
0.0
0.0
0.0
0.0
0.0
0.0
Capex/sales (%)
9.9
12.2
12.9
10.5
10.0
10.1
9.5
(87.9)
(91.6)
(10.6)
(8.0)
(37.1)
(57.4)
(70.8)
Net debt to equity (%)
EXHIBIT 6: Baidu's income statement
RMB m
Revenue
Cost of goods sold
Gross profit
OpEx
2009
2010
2011
2012
2013E
2014E
2015E
4,448
7,915
14,501
22,306
30,659
40,594
53,851
(1,616)
(2,149)
(3,897)
(6,449)
(11,303)
(15,672)
(20,787)
2,832
5,766
10,604
15,857
19,356
24,922
33,065
(1,227)
(1,807)
(3,027)
(4,806)
(8,473)
(11,366)
(15,078)
Operating income
1,605
3,959
7,577
11,051
10,883
13,556
17,986
Profit before tax & minority interest
1,683
4,061
7,809
11,965
12,118
15,956
21,346
Tax
(198)
(536)
(1,189)
(1,574)
(1,847)
(2,393)
(3,202)
Minority interest
Net income
EBITDA
Operating margin (%)
-
-
(18)
(65)
(36)
-
-
1,485
3,525
6,639
10,456
10,307
13,563
18,144
317
441
885
1,515
1,740
2,314
3,070
1,911
4,390
8,396
12,333
12,623
15,870
21,056
36.1
50.0
52.2
49.5
35.5
33.4
33.4
EBITDA margin (%)
43.2
55.6
58.4
56.3
41.2
39.1
39.1
Pre-tax margin (%)
37.8
51.3
53.9
53.6
39.5
39.3
39.6
Net margin (%)
33.4
44.5
45.8
46.9
33.6
33.4
33.7
Strong growth outlook – BUY with a target price of USD113.00
We estimate Baidu’s EPS at RMB294.74 for 2013, RMB387.85 for 2014 and
RMB518.88 for 2015. We set our DCF-based target price at USD113.00 per ADS. At
our target price, the stock would trade at P/E multiples of 23.8x in 2013, 18.1x in
2014 and 13.5x in 2015. The stock is trading at P/E multiples of 19.2x, 14.6x and
10.9x, respectively, over the same period.
We believe Baidu is transitioning from its traditional Internet search business and
expanding into a larger online advertising platform. Within the China market, we view
Baidu as a pioneer for some of the business models that have been proven
successful in more mature markets. Particularly, we believe the Ad Exchange
platform – Baidu Exchange Service – will enable Baidu to expand the scale of its
online advertising operations significantly to include Internet properties that cut
across multiple device platforms, including PC and mobile Internet.
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27 JUNE 2013
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Our DCF model assumes mid-term revenue CAGR of 20.3% and terminal revenue
growth rate of 5%. We assume average mid-term EBIT margin of 30.8% and
terminal EBIT margin of 30%. We use WACC of 11.5%.
Key downside risks to our investment view are:
§
An increase in competition in Baidu’s core Internet search segment, which would
slow search advertising revenue growth and erode margins;
§
Failure to generate sufficient revenue growth beyond the core search segment;
key areas include BES platform, online video services and mobile Internet;
EXHIBIT 7: DCF assumptions and derivation of TP
WACC
Mid-term
Terminal
Revenue growth rate (%)
20.3
5.0
EBIT margin (%)
30.8
25.0
WACC (%)
11.5
EXHIBIT 8: Baidu’s P/E band
EXHIBIT 9: Baidu’s P/BV band
(HKD)
(HKD)
250
350
40x
200
30x
150
300
15.0x
250
12.5x
200
10.0x
150
7.5x
100
5.0x
50
2.5x
20x
100
10x
50
0
Aug-05
Feb-07
Aug-08
Feb-10
Aug-11
0
Aug-05
Feb-13
Sources: Bloomberg; BNP Paribas estimates
Feb-07
Aug-08
Feb-10
Aug-11
Feb-13
EXHIBIT 10: Baidu quarterly P&L
1Q13A
Total revenues
Cost of revenues
2Q13E
3Q13E
4Q13E
2013E
5,969
7,453
8,521
8,718
30,659
(2,099)
(2,661)
(3,170)
(3,374)
(11,303)
Gross profit
3,869
4,792
5,351
5,344
19,356
Selling, general and administrative
(848)
(1,043)
(1,193)
(1,220)
(4,305)
Research and development
(811)
(1,014)
(1,159)
(1,186)
(4,169)
Operating profit
2,210
2,735
2,999
2,938
10,883
Income before income taxes
2,396
3,085
3,349
3,288
12,118
Net income
2,007
2,622
2,847
2,795
10,271
Gross margin (%)
64.8
64.3
62.8
61.3
63.1
Operating margin (%)
37.0
36.7
35.2
33.7
35.5
Net margin (%)
34.2
35.2
33.4
32.1
33.6
Margins (%)
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Company Profile
History and development of the company
Incorporated in January 2000, Baidu Inc is a leading Chinese-language internet
search provider and it conducts operations mainly through Baidu Online and Baidu
Netcom. The company’s ADS have been trading on The NASDAQ Global Select
Market under the symbol “BIDU” since August 2005. The conversion between ADS
and ordinary share is 10 ADS for every 1 Class A ordinary share. In December 2007,
Baidu was included in the NASDAQ-100 index.
The company acquired the domain name hao123.com for its Internet navigation site
in August 2004, online travel search service provider, Qunar (www.qunar.com), in
July 2011 and the online video business of Internet video provider, PPS, in May
2013. In November 2012, Baidu obtained controlling interest in iQIYI.COM, an
online television and movie portal founded by Baidu and Providence Equity Partners
in January 2010.
Business overview
In addition to its core web search product Baidu.com, the company powers a broad
range of products and services. Popular services include:
§
Baidu PostBar (tieba.baidu.com), an interactive experience-sharing community
§
Baidu Knows (zhidao.baidu.com), a query-based searchable platform
§
Baidu Encyclopaedia (baike.baidu.com)
§
Baidu Map
§
Baidu image and video Search and Video Search.
While Baidu provides many popular products, it generated 99.7% of its revenue in
2012 from online marketing services, thanks to its 596,000 active online marketing
customers in 2012. A complete list of Baidu’s product and service offerings is shown
in Exhibit 11.
Industry competition
Baidu faces competition primarily from Google and other Chinese search engines
such as Qihoo 360, Sogou and SOSO. Baidu competes with these entities based on
user traffic, quality and quantity of search results, availability and ease of use of
products and services, the number of online advertising customers, distribution
channels, and the number of associated third-party websites. China search engine
market data released by CNZZ show that Baidu had 71.1% search engine market
share based on usage, Qihoo 360 had 14.1%, Sougou for 8.0%, SOSO for 3.4% and
Google 2.3% as at May 2013.
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EXHIBIT 11: China search engine market share by usage (May 2013)
Soso
3.4%
Google
2.3%
Others
1.1%
Sogou
7.9%
Qihoo
14.1%
Baidu
71.1%
Source: CNZZ
Subsidiaries
Baidu has several wholly owned subsidiaries which offer specific products and
provide support to Baidu’s operations (Exhibit 8). Out of the list of wholly owned
subsidiaries, Qunar and qiyi.com offer Baidu’s travel services and online video
services,. Other entities including Baidu Cloud Computing Technology are
subsidiaries that support Baidu’s operations.
EXHIBIT 12: Baidu's principal subsidiaries and consolidated affiliated entities
Name of entity
Baidu Online Network Technology (Beijing) Co Ltd
Baidu Holdings Ltd
Beijing Baidu Netcom Science Technology Co Ltd
Baidu (China) Co Ltd
Baidu.com Times Technology (Beijing) Co Ltd
Beijing Perusal Technology Co Ltd
Baidu Japan Inc
Baidu (Hong Kong) Ltd
Beijing BaiduPay Science and Technology Co Ltd
Baidu HR Consulting (Shanghai) Co Ltd
Qunar Cayman Islands Ltd
Qiyi.com Inc
B.D. Mobile Telecommunications Ltd
Baidu Cloud Computing Technology (Shanxi) Co Ltd
Baidu Cloud Computing Technology (Beijing) Co Ltd
Source: Company data
Directors and principal Shareholders
Baidu has five directors on its board: one non-independent director and four
independent directors. Baidu’s CEO, Mr Robin Li, serves on the board as chairman.
Mr Robin Li owns 16% of the company’s outstanding shares. Out of the four
independent Directors, Mr William Decker also serves as chairman of the audit
committee. Ms Jennifer Li and the four independent directors have combined share
ownership of 0.8%.
From the principal shareholders, Handsome Reward Ltd is a company wholly owned
and controlled by Mr Robin Li. 15.7% of Baidu’s ordinary shares owned by
Handsome Reward are included in Mr. Robin Li’s individual ownership.
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EXHIBIT 13: Directors and executive officers
Directors and Executive Officers:
Position/Title
Shares Beneficially Owned (%)
Robin Yanhong Li
Chairman and Chief Executive Officer
16.0%
Jennifer Xinzhe Li
Chief Financial Officer
0.8% (combined with
other independent directors)
William Decker
Independent director
James Ding
Nobuyuki Idei
Greg Penner
Source: Company
EXHIBIT 14: Principal shareholders
Principal Shareholders:
Shares Owned (%)
Handsome Reward Limited
15.7
Baillie Gifford & Co (Scottish partnership)
8.1
T. Rowe Price Associates, Inc.
5.4
Source: Company
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EXHIBIT 15: Baidu’s product offerings
Source: Company data
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products
19).
engine industry.
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revenue
(Percentage of individuals using the Internet)
15
200
100
China
10
5
0
0
2007
2008
2009
2010
2011
2012
Korea
20
300
Germany
25
400
France
30
Japan
500
U.S.
35
Hong Kong
600
90
80
70
60
50
40
30
20
10
0
Taiwan
(%)
(RMB b)
Singapore
(m)
Spain
BAIDU
Source: ITU
Internet users.
maximise CTR
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Value Creation
Search Engines
Advertisers
Source: BNP Paribas
Number Internet
users
Number advertisers
Source: BNP Paribas
CAGR of 31.9%
RMB5,800 in 2006, a CAGR of 45.1%.
Internet.
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Alen Lin
(RMB b)
40
(m)
60
35
50
30
40
25
20
30
15
20
10
10
5
2H15E
1H15E
2H14E
1H14E
2H13E
1H13E
2H12
1H12
2H11
1H11
2H10
1H10
2H09
1H09
2H08
0
1H08
0
inventory – search users – are sold
to customers – the advertisers
www.baidu.com
www.so.com
www.sogou.com
www.soso.com
www.google.com
Navigation sites
Web/news portals
www.sina.com.cn
news.sogou.com
news.soso.com
hao.360.cn
www.hao123.com
Social Networking
Internet utilities
Email applications
E-Commerce sites
Web browsers
Etc.
Search Engine
Distribution of
advertising service
Advertisers
Advertisers
Advertisers
Source: BNP Paribas
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BIDU US
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search traffic
Source: hao.360.cn
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BIDU US
Alen Lin
views
100%
Baidu
Qihoo
Soso
Google
Sogou
80%
60%
40%
20%
Source: hao.360.cn
2Q13
1Q13
4Q12
3Q12
2Q12
1Q12
4Q11
3Q11
2Q11
1Q11
4Q10
3Q10
0%
Source: cnzz.com
search traffic
(%)
hao.360.cn
11
hao123.com
8.20
web.sogou.com
6.50
123.duba.net
4.20
2345.com
1.40
hao.uc.cn
0.90
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BIDU US
Alen Lin
Search service
454.0
Online video
452.0
Community friends
439.0
News information
413.0
E-commerce
404.4
Entertainment
403.8
IT digital products
395.0
Media domain
362.1
Financial service
361.5
Email
356.0
footprint
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BAIDU
Alen Lin
Search Engine
(RMB b)
25
Video
Vertical Search
Rich Media
Brand Graphic
(nos)
Other
20
40,000
600,000
35,000
30,000
500,000
15
(RMB)
700,000
25,000
400,000
20,000
300,000
10
15,000
200,000
5
10,000
100,000
5,000
0
0
0
2006 2007 2008 2009 2010 2011 2012
1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13
Source: Baidu
advantage
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Alen Lin
Medium
bargaining power.
Medium
Source: BNP Paribas
services provided by Sohu, such as sohu.com, as sources of search traffic to achieve
a search market share of 7-8%.
2013.
of search usage
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Alen Lin
in the near term.
(RMB m)
700
14%
600
12%
500
10%
400
8%
300
6%
200
4%
100
2%
0
0%
1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13
Source: Company
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SOSO
1.5%
Youdao
0.3%
Others
1.0%
Sogou
3.1%
(m)
500
(RMB)
70
450
60
400
Google
15.6%
350
50
300
40
250
Baidu
78.5%
200
30
150
20
100
10
50
0
0
2007
2008
2009
2010
2011
2012
users
53
BNP PARIBAS
27 JUNE 2013
BAIDU
BIDU US
Alen Lin
display ads
54
BNP PARIBAS
27 JUNE 2013
BIDU US
BAIDU
Alen Lin
opportunities
0
2006
Source: CEIC
55
2007
2008
2009
2010
2011
2012
Post & comment
100
Mobile e-mail
200
Network video
300
Social network
400
Network literature
500
Network music
90
80
70
60
50
40
30
20
10
0
Weibo
(%)
News browse
Instant messaging
(m)
600
Mobile search
2013)
BNP PARIBAS
27 JUNE 2013
BAIDU
BIDU US
Alen Lin
Financial statements
BAIDU
Profit and Loss (RMB m) Year Ending Dec
2011A
2012A
2013E
2014E
2015E
Revenue
14,501
22,306
30,659
40,594
53,851
Cost of sales ex depreciation
(3,078)
(5,167)
(9,563)
(13,358)
(17,717)
Gross profit ex depreciation
11,423
17,139
21,097
27,236
36,134
0
0
0
0
0
(3,027)
(4,806)
(8,473)
(11,366)
(15,078)
Other operating income
Operating costs
Operating EBITDA
8,396
12,333
12,623
15,870
21,056
Depreciation
(819)
(1,281)
(1,740)
(2,314)
(3,070)
Goodwill amortisation
Operating EBIT
Net financing costs
Associates
Recurring non operating income
Non recurring items
0
0
0
0
0
7,577
11,051
10,883
13,556
17,986
3,360
334
754
1,234
2,400
(179)
(294)
(5)
0
0
78
454
6
0
0
0
0
0
0
0
7,809
11,965
12,118
15,956
21,346
(1,189)
(1,574)
(1,847)
(2,393)
(3,202)
6,620
10,391
10,271
13,563
18,144
18
65
36
0
0
Preferred dividends
0
0
0
0
0
Other items
0
0
0
0
0
6,639
10,456
10,307
13,563
18,144
Profit before tax
Tax
Profit after tax
Minority interests
Reported net profit
Non recurring items & goodwill (net)
0
0
0
0
0
6,639
10,456
10,307
13,563
18,144
Recurring EPS *
190
299
295
388
519
Reported EPS
190
299
295
388
519
DPS
0.00
0.00
0.00
0.00
0.00
Revenue (%)
83.2
53.8
37.4
32.4
32.7
Operating EBITDA (%)
91.3
46.9
2.4
25.7
32.7
Operating EBIT (%)
91.4
45.9
(1.5)
24.6
32.7
Recurring EPS (%)
87.9
57.3
(1.5)
31.6
33.8
Reported EPS (%)
87.9
57.3
(1.5)
31.6
33.8
Gross margin inc depreciation (%)
73.1
71.1
63.1
61.4
61.4
Operating EBITDA margin (%)
57.9
55.3
41.2
39.1
39.1
Operating EBIT margin (%)
52.2
49.5
35.5
33.4
33.4
Net margin (%)
45.8
46.9
33.6
33.4
33.7
Effective tax rate (%)
15.2
13.2
15.2
15.0
15.0
0.0
0.0
0.0
0.0
0.0
-
-
-
-
-
0.0
0.0
0.0
0.0
0.0
Recurring net profit
Per share (RMB)
Growth
Operating performance
Dividend payout on recurring profit (%)
Interest cover (x)
Inventory days
Debtor days
11.3
15.2
18.2
19.0
19.1
Creditor days
229.1
224.4
199.7
229.2
245.0
Operating ROIC (%)
148.5
77.3
62.3
88.2
135.4
ROIC (%)
95.6
55.4
43.8
58.5
83.7
ROE (%)
56.0
50.6
33.1
31.5
30.8
ROA (%)
36.6
27.9
17.1
16.0
16.3
*Pre exceptional, pre-goodwill and fully diluted
Revenue By Division (RMB m)
2011A
2012A
2013E
2014E
2015E
Online marketing services
14,490
22,246
30,463
40,201
53,065
11
60
197
393
786
-
-
-
-
-
Other services
Sources: Baidu Inc - ADR; BNP Paribas estimates
56
BNP PARIBAS
27 JUNE 2013
BAIDU
BIDU US
Alen Lin
BAIDU
Cash Flow (RMB m) Year Ending Dec
2011A
2012A
2013E
2014E
2015E
6,639
10,456
10,307
13,563
18,144
3,070
Depreciation
819
1,281
1,740
2,314
Associates & minorities
(18)
(65)
(36)
0
0
Other non-cash items
147
(458)
342
427
498
Recurring cash flow
7,586
11,215
12,353
16,303
21,711
592
781
3,636
4,499
4,432
0
0
0
0
0
(1,866)
(2,340)
(3,060)
(4,080)
(5,100)
Change in working capital
Capex - maintenance
Capex - new investment
Free cash flow to equity
6,313
9,656
12,929
16,722
21,044
(1,946)
(821)
0
0
0
0
0
0
0
0
(10,438)
(10,590)
(872)
(872)
(872)
Net cash flow
(6,072)
(1,754)
12,057
15,849
20,171
Equity finance
67
157
0
0
0
2,359
9,361
0
0
0
(3,646)
7,765
12,057
15,849
20,171
Recurring cash flow per share
217
321
353
466
621
FCF to equity per share
181
276
370
478
602
2011A
2012A
2013E
2014E
2015E
Net acquisitions & disposals
Dividends paid
Non recurring cash flows
Debt finance
Movement in cash
Per share (RMB)
Balance Sheet (RMB m) Year Ending Dec
Working capital assets
11,721
22,793
23,490
24,295
25,315
Working capital liabilities
(4,281)
(8,237)
(12,569)
(17,873)
(23,325)
Net working capital
7,440
14,557
10,921
6,422
1,990
Tangible fixed assets
2,694
3,888
5,578
7,801
10,358
10,134
18,445
16,499
14,223
12,348
2,420
3,878
3,878
3,878
3,878
Other intangible assets
979
1,588
2,089
2,505
2,851
Investments
734
803
803
803
803
Other assets
666
838
838
838
838
Invested capital
14,932
25,552
24,107
22,247
20,718
Cash & equivalents
(4,127)
(11,881)
(23,584)
(38,995)
(58,657)
126
0
0
0
0
2,278
9,693
9,693
9,693
9,693
Operating invested capital
Goodwill
Short term debt
Long term debt *
Net debt
(1,724)
(2,187)
(13,891)
(29,302)
(48,964)
Deferred tax
132
289
289
289
289
Other liabilities
179
44
44
44
44
15,292
26,055
36,314
49,865
67,998
Total equity
Minority interests
1,034
1,160
1,160
1,160
1,160
Invested capital
14,932
25,552
24,107
22,247
20,718
* includes convertibles and preferred stock which is being treated as debt
Per share (RMB)
Book value per share
438
746
1,038
1,426
1,945
Tangible book value per share
341
589
868
1,243
1,752
(10.6)
(8.0)
(37.1)
(57.4)
(70.8)
(7.4)
(4.8)
(23.1)
(37.0)
(47.7)
3.6
4.2
3.7
3.5
3.6
-
-
-
-
-
2011A
2012A
2013E
2014E
2015E
10.8
Financial strength
Net debt/equity (%)
Net debt/total assets (%)
Current ratio (x)
CF interest cover (x)
Valuation
Recurring P/E (x) *
29.4
18.7
19.0
14.4
Recurring P/E @ target price (x) *
36.5
23.2
23.6
17.9
13.4
Reported P/E (x)
29.4
18.7
19.0
14.4
10.8
Dividend yield (%)
0.0
0.0
0.0
0.0
0.0
P/CF (x)
25.7
17.4
15.8
12.0
9.0
P/FCF (x)
30.9
20.3
15.1
11.7
9.3
Price/book (x)
12.8
7.5
5.4
3.9
2.9
Price/tangible book (x)
16.4
9.5
6.4
4.5
3.2
EV/EBITDA (x) **
23.0
15.6
15.0
11.0
7.5
EV/EBITDA @ target price (x) **
28.7
19.3
18.7
14.0
9.7
EV/invested capital (x)
13.0
7.6
7.6
7.5
7.1
* Pre exceptional, pre-goodwill and fully diluted
** EBITDA includes associate income and recurring non-operating income
Sources: Baidu Inc - ADR; BNP Paribas estimates
57
BNP PARIBAS
27 JUNE 2013
27 JUNE 2013
INITIATION
/ INTERNET
CHINA
QIHOO 360 TECHNOLOGY QIHU US
MARKET RECS
HOW WE DIFFER FROM CONSENSUS
HOLD
TARGET PRICE
USD44.20
CLOSE
USD44.14
UP/DOWNSIDE
+0.1%
TARGET PRICE (%)
(11)
POSITIVE
11
EPS 2013 (%)
(47)
NEUTRAL
3
EPS 2014 (%)
(17)
NEGATIVE
0
KEY STOCK DATA
Demanding valuation
n
n
n
n
YE Dec (USD m)
We initiate at HOLD, valuations are stretched
We initiate on Qihoo 360, a provider of PC anti-virus software,
Internet browser, navigation website, and recently added Internet
search, with a HOLD and TP of USD44.20. While we forecast strong
growth in 2014, we believe valuations are stretched.
High expectations for Qihoo 360’s operating leverage
We believe Qihoo 360’s current high valuations reflect high market
expectations for the company’s operating leverage. However, we
think such expectations are vulnerable to marketing and R&D
expenses remaining high, given Qihoo 360’s current growth phase.
DCF-based Target Price of USD44.20
We have a DCF-based TP of USD44.20. While we forecast strong
NP growth in 2014, we believe upside is fully in the price (as seen in
its high valuation). The key upside risk to our call is the company’s
ability to expand market share margins. The key downside risk is
higher operating expenses to grow market share.
Organic growth to become more challenging
We believe, given the company’s current expansion phase, the effect
of operating leverage will be limited. This is particularly true as we
believe organic traffic growth will become more challenging, and
more resources will be required for Qihoo 360 to gain incremental
search market share.
2013E
2014E
2015E
329
592
844
1,046
38
42
121
216
Rec. net profit
0.22
0.23
0.68
1.21
EPS growth (%)
108.0
7.5
191.3
77.7
Recurring P/E (x)
135.2
125.7
43.2
24.3
0.0
0.0
0.0
0.0
EV/EBITDA (x)
69.1
66.8
26.6
15.0
Price/book (x)
10.9
9.2
7.1
5.2
(79.6)
(54.8)
(59.5)
(66.2)
7.9
18.5
24.6
Recurring EPS (USD)
Dividend yield (%)
Net debt/Equity (%)
9.1
ROE (%)
Jun-12
Sep-12
Dec-12
Mar-13
Jun-13
169
49
44
119
39
34
69
29
24
19
19
14
(USD)
(31)
Share price performance
Rel to MSCI China
3 Month
12 Month
2.5
44.7
158.0
17.3
59.8
159.9
Absolute (%)
Relative to country (%)
Next results
August, 2013
5,238
Mkt cap (USD m)
71.9
3m avg daily turnover (USD m)
Major shareholder
Cost of revenues
Selling and marketing
G&A
Product development
40%
(%)
1 Month
40
Free float (%)
Qihoo 360’s expense ratio trends
50%
Revenue
2012A
Hongyi Zhou (0%)
12m high/low (USD)
3m historic vol. (%)
ADR ticker
48.38/14.63
45.7
QIHU US
30%
ADR closing price (USD; 25 Jun 2013)
20%
Issued shares (m)
10%
0%
2010
2011
2012
Alen Lin
[email protected]
+852 2825 1801
58
2013E
2014E
2015E
44.14
178
Alen Lin
Investment thesis
Catalyst
We initiate coverage of Qihoo 360 with HOLD
recommendation and target price of USD44.20. Qihoo 360
shares are trading at 122x our 2013 earnings and 42x our
2014 earnings. We believe these valuations are stretched.
We forecast strong profit growth in 2014-15, but believe
market expectations for Qihoo 360’s operating leverage are
too high and that this presents downside risk to valuations.
We forecast 2013-15 y-y revenue growth of 80%, 42.5% and
24%. We forecast GAAP net profit growth of -10.3%,
+191.2% and +77.7%, and non-GAAP net profit growth
(excluding share-based compensation) of -4.9%, +86.4%
and +54.9%. We expect its net margin to expand from 7% in
2013 to 20.6% in 2015.
With high market expectations for Qihoo 360’s operating
leverage, we believe the downside risks outweigh the
upside risks. We expect rapid revenue growth to be
accompanied by high sales, marketing and R&D expenses.
We expect any disappointment in margins to lead to share
price weakness given such high expectations.
Risks to our call
Key upside risks are: 1) the company managing to grow
its user base (online gaming, navigation site and search)
more than we expect without significant margin
contraction; 2) expansion of online advertising
customers for its search product; and 3) share price
volatility with the shares tracking search market share
changes.
The key downside risk is: weaker-than-expected
margins from the company’s aggressive push to gain
user market share.
Key assumptions
Company background
Qihoo is a software company in China mainly focus on antivirus
software and web browser. On March 30, 2011, Qihoo was
listed on New York Stock Exchange with symbol "QIHU".
The company offers Internet and mobile security products for
free, which has resulted in the company developing a large and
loyal user base. Qihoo 360 monetizes this primarily by offering
different forms of online marketing and Internet value-added
services.
2012
Web game paying users
2013E
2014E
2015E
238,000 404,600 525,980 683,774
Revenue per paying user
485
556
516
516
Security software monthly active users (m)
456
474
493
513
Avg daily UV to 360 navigation page (m)
91
109
126
138
0
95.0
230.0
310.0
Cost of revenues/revenue ratio (%)
10.0
12.7
12.7
12.7
Operating expenses/revenue ratio (%)
76.0
79.8
70.7
63.0
Advertising revenue - search engine
Earnings sensitivity
Principal activities by revenue (2013E)
------ Base ------
Other services
0.6%
Internet valueadded services
37.7%
2013E
2014E
Total revenue
30,659
40,594
33,725
44,653
27,594
36,534
EPS (RMB)
294.74
387.85
321.12
420.80
268.37
354.90
8.9
8.5
(8.9)
(8.5)
64.5
66.6
61.3
63.3
67.7
69.9
294.74
387.85
331.90
437.19
257.59
338.52
12.6
12.7
(12.6)
(12.7)
Change in total revenue (%)
0
0
10
10
(10)
(10)
Change in operating expenses
0
0
(5 ppt)
(5 ppt)
5 ppt
5 ppt
Change (%)
Sources: BNP Paribas estimates
Age
Since
Title
42
2006
Chairman of the board and chief
executive officer
Xiangdong Qi
48
2006
Director and president
Shu Cao
37
2006
Director and chief engineer
Alex Zuoli Xu
44
2011
Co-chief financial officer
Jue Yao
39
2012
59
2014E
EPS (RMB)
Hongyi Zhou
http://www.360.cn
2013E
Operating expenses/revenue ratio
Key executives
------ Worst ------
2014E
Change (%)
Online
advertising
61.7%
------ Best ------
2013E
Key earnings drivers include total revenue and operating
expenses/revenue ratio
A 10% increase in total revenue would raise 2013E/2014E
EPS by 6.8%/10.0%, while a 10% decrease in total revenue
would reduce 2013E and 2014E EPS by 10.3% and 9.1%
A 5ppt decline in operating expenses/revenue ratio would lift
2013E and 2014E EPS by 58.1% and 29.1%, while a 5ppt
rise in operating expenses/revenue ratio would decrease
2013E/2014E EPS by 57.3%/28.1%
BNP PARIBAS
27 JUNE 2013
Alen Lin
Revenue growth driven by online advertising and gaming
Since Qihoo 360 was incorporated in 2005, the company has successfully built up its
user base for its various product offerings and continues to enhance its ability to
monetize services. Key revenue contributors are its online advertising, which is
primarily driven by its Internet navigation site, and Internet value-added services
(VAS), which is primarily driven by PC online games. During 1Q13, online advertising
contributed 57.7% of Qihoo 360’s revenue, and Internet VAS contributed 41.7% (up
from 34.2% in 4Q12 with a number of new online games stimulating user activity).
EXHIBIT 1: Qihoo 360 revenue trends
(%)
Online advertising
Internet value-added services
EXHIBIT 2: Qihoo 360 revenue contribution (1Q13)
Others
Others
0.6%
120
100
80
Internet
value-added
services
41.7%
60
40
Online
advertising
57.7%
20
0
4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13
Source: Company
Source: Company
Organic user growth reaching a plateau
Qihoo 360 has built a strong presence in the China PC market, initially based on its
free-to-download PC antivirus software since 2008 (this software, according to the
company, currently runs on 96% of China’s PCs with 457m active users as of 1Q13).
Through this solid penetration, the company has managed to attract 332m users to
install its 360 Safe Browser. Through these browsers, Qihoo 360 directs traffic to its
own Internet navigation site; the browsers effectively provide users a window into
Qihoo 360 Internet content. Prior to August 2012, the 360 navigation site had Baidu
as the default search engine for Internet users that initiate search queries from the
site. However, in August 2012, Qihoo launched its own search engine and changed
the default search engine to its own, and its search market share (by usage) has
been 15% in the past few quarters (Exhibit 5).
Qihoo 360 has a strong presence in
China through its anti-virus software,
browser, and navigation website;
organic market share gain in Internet
search could be challenging
We believe further organic growth of its search engine market share will become
more difficult. As we follow the user conversion process (Exhibit 3), it starts with
security software users and, as it has already penetrated 96% of PCs in China, we
believe upside potential through this avenue is limited. At the browser level, Qihoo’s
market share by browser usage has remained at around 25% since 4Q11 (Exhibit 4).
We do not see any catalysts to drive usage share significantly higher and believe this
will limit the incremental growth of navigation page users.
As Qihoo’s navigation page is a major source for its search engine traffic, we believe
organic expansion of search market share depends on users being more aware of
the Qihoo 360 search engine and switching from competing search engines. Such a
change in user behaviour could take time. As such, we believe near-term incremental
gain in search market share can only come through partnerships with other Internet
businesses, or through acquisitions of popular Internet businesses. In either case,
the associated costs would disrupt the company’s cost structure.
60
BNP PARIBAS
27 JUNE 2013
Alen Lin
EXHIBIT 3: Qihoo 360 user base
EXHIBIT 4: China web browser market share by usage
Number of security software active users
457m (96% penetration)
90%
IE
Qihoo
Safari
Chrome
Sogou
80%
70%
Number of 360 safe browser users
332m (70% penetration; ~25% usage share)
60%
50%
40%
30%
Number of visitors to 360 navigation
page – 94m
20%
10%
2Q13
1Q13
4Q12
3Q12
2Q12
1Q12
4Q11
3Q11
2Q11
1Q11
4Q10
3Q10
1Q10
2Q10
0%
Search usage market share
15%
Source: CNZZ
EXHIBIT 5: China Internet search engine market share by usage
Baidu
Qihoo
Sogou
Soso
Google
100%
80%
60%
40%
20%
0%
3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13
Source: CNZZ
Monetization of Internet navigation site not easy to scale up
The company’s current ability to monetize its Internet services is primarily through
advertising revenues generated from its 360 navigation website and search engine.
However, as the company’s search engine is a new enterprise, its contribution is still
just <5% of Qihoo 360’s total revenue (as of 1Q13) as it is still building up its
advertising customer base. Given the current deficiency in company’s ability to
monetize its search traffic, it has partnered with Google to leverage Google’s online
advertising customer base. The company has indicated that revenue sharing
between the two partners exists, however details of the arrangement have not been
publicly disclosed. We expect the revenue profile of Qihoo 360’s Internet search
business to change, but for this to be a gradual process. We assume search engine
revenue represents 26% of Qihoo 360’s total online advertising revenue in 2013, and
rises to 43% in 2014.
The company’s Internet services are
monetized primarily through Internet
navigation website ad revenues
Advertising revenue from Qihoo 360’s navigation site has been the company’s key
contributor. However, we believe growth could slow from +80% y-y in 2012 to 22% yy in 2013. Our analysis suggests that, while both the growth in the number of unique
visitors and of daily clicks remained robust at +22.1%/+65.8% y-y in 1Q13 (Exhibit
6), the quality of growth has slowed significantly. Advertising revenue/unique visitor
has slowed y-y since 2Q12, to 5.4% growth in 1Q13. Advertising revenue/click has
also slowed over the same period, to decline 22.4% in 1Q13 (Exhibit 7). In our view,
this suggests that strong advertising revenue growth can only be achieved by the
continued expansion of its navigation site user base, but we expect this to actually
decelerate.
61
BNP PARIBAS
27 JUNE 2013
Alen Lin
EXHIBIT 6: Qihoo 360 navigation site traffic
(m)
Avg daily unique visitors
EXHIBIT 7: Qihoo 360 navigation site revenue metrics
Avg daily clicks
(RMB)
600
Ad revenue/click
Ad revenue/UV
1.0
500
0.8
400
0.6
300
0.4
200
0.2
100
0
0.0
4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13
Source: Company
4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13
Sources: Company; BNP Paribas
Non-organic methods for driving more traffic
We believe Qihoo 360 will explore other methods for driving user traffic, either
through partnerships or acquisitions. In May 2013, the company partnered with
Alibaba (not listed) to create a Qihoo 360 variant of the www.etao.com e-commerce
website, called 360.etao.com. While the merchandise offered for the two locations is
practically the same, the 360.etao.com website includes links to Qihoo 360’s other
Internet properties, including the search engine. In our view, the intent is to both build
awareness of the Qihoo 360 brand name and to direct search traffic from the
etao.com website to Qihoo 360’s search engine.
Exploring partnerships or acquisitions
to drive incremental search traffic
In our view, any partnership or acquisition for Qihoo 360’s search business would be
for the purpose of expanding user traffic, or expanding advertising customer base.
Through either approach, however, the incremental traffic would come at a cost
either in the form of revenue sharing or upfront acquisition cost.
Sohu (SOHU US; NR) has publically disclosed its intention to sell its search engine,
www.sogou.com. We see limited synergies for Qihoo 360 as combining sites does
not necessarily result in more search traffic without securing the referring websites.
However, it may derive some synergies by expanding its advertising customer base
– Qihoo 360 is still building its base up, so Sogou’s base could prove valuable. That
said, separating the customer base between www.sohu.com and www.sogou.com
might prove complicated as both depend on online advertising for revenue
generation.
Gaming – the key revenue growth driver for the near-term
During 1Q13, the gaming segment contributed 33.5% of Qihoo 360’s total revenue,
up from 25.6% in 2012. The gaming segment has registered triple digit revenue
growth since 2011, and we estimate it will grow 112% in 2013. While this growth has
been remarkable, we expect it to gradually decelerate in the coming years. We
assume the company’s gaming revenue grows 34% in 2014 and 30% in 2015, with
its revenue contribution falling from 30.2% in 2013E, to 28.5% in 2014E and 29.8%
in 2015E.
Gaming contributed 33.5% of 1Q13
total revenue
Our analysis suggests that Qihoo 360’s gaming revenue mostly correlates with the
number of games it offers (Exhibit 8); this has a direct impact on the number of
paying users. We see less correlation between the number of games offered and
gaming revenue per user as quarterly gaming revenue per user has fluctuated
between RMB125 and RMB145 from 4Q11 to 1Q13 (Exhibit 9). This implies that in
order for Qihoo 360’s gaming revenue to continue its growth, it needs to expand its
portfolio of games from the 1Q13 level of 150. In our forecasts, we assume the
number of paying users grows by 70% y-y in 4Q13 to 405k, up from 281k in 1Q13.
We estimate growth normalizes at 30% y-y for 2014 and 2015. We assume quarterly
revenue per paying user remains RMB130.
62
BNP PARIBAS
27 JUNE 2013
Alen Lin
EXHIBIT 8: Number of games and paying users
(nos)
Web game paying users (LHS)
300,000
Number of games (RHS)
EXHIBIT 9: Game quarterly revenue per paying user
(nos)
160
140
250,000
120
(RMB m)
145
140
135
130
200,000
100
150,000
80
100,000
50,000
0
4Q11
1Q12
2Q12
3Q12
4Q12
125
120
60
115
40
110
20
105
0
100
4Q11
1Q13
1Q12
2Q12
3Q12
4Q12
1Q13
Sources: Company; BNP Paribas
Source: Company
The market has high expectations of Qihoo 360’s operating leverage
As Qihoo 360 is expanding its monetization capabilities, we forecast its revenue to
grow 80% y-y in 2013, 42.5% y-y in 2014 and 24% y-y in 2015. We expect such
rapid revenue expansion to deliver operating leverage and lower its expense ratios
for sales and marketing, product development, and G&A in 2014. We estimate its
operating profit will decline a modest 2.2% in 2013 as its sales and marketing
expense ratio increases to 24.1% from 17.7% in 2012. We estimate its operating
profit will grow 202.5% y-y in 2014 and 79.3% y-y in 2015. While the growth outlook
is strong, we believe expectations are high as reflected in its shares high valuation.
Rapid revenue expansion to deliver
operating leverage and lower
expense ratios
In our view, the key risks to such high expectations are its sales and marketing
expense ratio and its product development expense ratio both remaining high. For
sales and marketing expenses, this risk is that the company needs to increasingly
depend on external sources for traffic growth. For product development expenses,
the company could need to continue investing in product development to close the
gap with larger competitors; and, given Qihoo 360’s relatively smaller scale, the
expense ratio could remain high in the near term.
While we forecast Qihoo 360’s operating margin will expand from 8% in 2013 to
24.7% in 2015, we believe the downside risks outweigh the upside risks given the
current state of the company. In our view, any disappointment in margins will lead to
share price weakness given the market’s high expectations.
EXHIBIT 10: Qihoo 360 y-y growth rates
450%
EXHIBIT 11: Qihoo 360’s expense ratio trends
Revenue
Operating profit
Cost of revenues
Selling and marketing
Net profit
Non-GAAP NP
G&A
Product development
50%
400%
45%
350%
40%
300%
35%
250%
30%
200%
25%
150%
20%
100%
15%
50%
10%
0%
5%
(50%)
0%
2010
2011
2012
Sources: Company; BNP Paribas estimates
63
2013E
2014E
2015E
2010
2011
2012
2013E
2014E
2015E
BNP PARIBAS
27 JUNE 2013
Alen Lin
Return on equity rising on operating leverage
We forecast Qihoo 360’s ROE to be on an upward trend primarily driven by
expanding net margin; we estimate its net margin will bottom out in 2013E at 7.0%,
and expand to 20.6% in 2015E as operating leverage increases with revenue rising
as the company begins to monetize its services from earlier investments. These
efforts also contribute to our forecast rise in asset turnover. We expect it to rise from
47.7% in 2012 to 81% in 2013E, and to remain at this high level. This would lead to
ROAE rising from 7.9% in 2013E to 24.6% in 2015E.
EXHIBIT 12: Qihoo 360 ROAE decomposition
2011
NI/Sales
2012
2013E
2014E
2015E
(%)
(%)
(%)
(%)
(%)
9.3
14.2
7.0
14.4
20.6
Sales/Assets
39.6
47.7
81.3
85.7
79.5
Assets/Equity
190.8
162.3
139.0
150.0
150.4
7.0
11.0
7.9
18.5
24.6
ROAE
64
BNP PARIBAS
27 JUNE 2013
Alen Lin
Increasing FCF and expanding net cash position
With Qihoo 360’s profitability rising, we forecast its FCF yield will reach 2.5% in 2015,
up from -0.7% in 2013E. This would lead to the strengthening of its balance sheet
with its net debt/equity ratio rising from -55% in 2013E to -66.2% in 2015E. Given the
relatively small scale of Qihoo 360’s operations, this forecast is highly dependent on
how its business model evolves; significantly weaker profitability could have a major
impact on the company’s FCF outlook. We believe its strengthening net cash position
could enable Qihoo 360 to explore expansion strategies through acquisitions.
Strengthening net cash position
could enable expansion strategies
through acquisitions
EXHIBIT 13: Qihoo 360's balance sheet
2010
2011
2012
2013E
2014E
2015E
(USD m) (USD m) (USD m) (USD m) (USD m) (USD m)
Cash & cash equivalents + Bank deposits
60
Current Assets
12
31
Total Current Assets
73
374
Non-Current Assets
15
50
Total Assets
88
424
2
Current Liabilities
Total Current Liabilities
ST borrowings / Current portion of LT borrowings
LT borrowings
Other LT Liabilites
344
381
312
442
667
55
96
148
193
435
409
589
861
254
320
396
456
690
729
985
1,317
0
-
-
-
-
12
46
204
151
235
300
14
47
204
151
235
300
0
-
-
-
-
-
1
6
8
8
8
8
Total Liabilities
15
52
211
158
243
308
Share Capital
0
0
0
0
0
0
Reserves
2
371
478
570
742
1,008
Minority Interest
1
1
0
0
0
0
Total Equity
73
371
478
571
742
1,009
Total Equity & Liabilities
88
424
690
729
985
1,317
Source: Company
EXHIBIT 14: Qihoo 360's cash flow
2010
2011
2012
2013E
2014E
2015E
(USD m)
(USD m)
(USD m)
(USD m)
(USD m)
(USD m)
Net Profits
9
16
47
42
121
216
Depreciation
1
4
16
25
38
53
Change in working cap
(4)
(6)
(15)
(16)
(15)
Other operating
(0)
(3)
17
-
-
-
Operating cash flow
10
13
74
52
144
254
0
3
7
7
7
7
Taxes paid
(0)
(11)
(11)
(9)
(26)
(46)
Capex
(3)
(16)
(69)
(91)
(114)
(114)
7
(3)
6
(39)
30
140
Free cash flow yield (%)
0.3
(0.1)
0.1
(0.7)
0.5
2.5
Dividend yield (%)
0.0
0.0
0.0
0.0
0.0
0.0
Capex/sales (%)
4.9
9.7
20.9
15.4
13.5
10.9
(80.2)
(92.4)
(79.6)
(54.7)
(59.5)
(66.2)
Interest Inc / (Exp)
Free cash flow
Net debt to equity (%)
Source: Company
65
BNP PARIBAS
27 JUNE 2013
Alen Lin
Operating leverage driving margin expansion
We estimate Qihoo 360’s revenue will reach USD1,046m by 2015 (3.2x its 2012
revenue) and its operating margin will rise to 24.7% in 2015, from 14.8% in 2012 and
8% in 2013. We attribute the rapid margin expansion to strong revenue growth in
online gaming (112% y-y in 2013 and 34% in 2014) and online advertising (65% and
48%). While we forecast strong margin expansion, we note this could vary
significantly depending on the company’s implementation of strategies to gain market
share in online gaming and Internet search.
Rapid margin expansion due to
strong revenue growth in online
gaming and advertising
EXHIBIT 15: Qihoo 360's income statement
2010
2011
2012
2013E
2014E
2015E
(USD m)
(USD m)
(USD m)
(USD m)
(USD m)
(USD m)
Revenue
58
168
329
592
844
1,046
Cost Of Goods Sold
(7)
(19)
(33)
(75)
(107)
(133)
Gross Profit
51
149
296
517
737
913
(42)
(131)
(250)
(472)
(597)
(659)
9
18
49
48
144
258
OpEx
Operating Income
Profit before tax & Minority Interest
9
26
63
55
151
265
(0)
(11)
(11)
(9)
(26)
(46)
Minority Interest
0
1
0
(0)
-
-
Net Income
9
16
47
42
121
216
Tax
Share based compensation
4
48
51
51
51
51
12
63
97
92
172
266
1
4
16
25
38
53
10
22
65
73
182
312
15.6
10.8
14.8
8.0
17.1
24.7
EBITDA Margin (%)
18.0
13.3
19.8
12.3
21.6
29.8
Pre-tax Margin (%)
15.6
15.4
19.1
9.3
17.9
25.4
Net Margin (%)
14.8
9.3
14.2
7.0
14.4
20.6
Non-GAAP Net Income
EBITDA
Operating Margin (%)
Source: Company
We initiate at HOLD with a target price of USD44.20
We estimate Qihoo 360’s GAAP EPS at USD0.23 per ordinary share for 2013,
USD0.68 for 2014 and USD1.21 for 2015; we estimate non-GAAP EPS at USD0.52,
USD0.97, USD1.50 for 2013-15. We initiate coverage on the stock with a HOLD
recommendation and DCF-based target price of USD44.2. Our target price implies
2013/14E PE multiples of 125.9x/43.2x. The stock is currently trading at 2013/14E
PE multiples of 125.7.2x/43.2x.
While we forecast Qihoo 360 will see significant earnings growth in 2014 (+191.2%)
and 2015 (+77.7%), we believe this is fully in the price given the high PE multiple.
Also, as the forecast implies significant margin expansion (8% in 2013 to 24.7% in
2015), we see downside risks as the company will increasingly need to expand its
user base through non-organic methods such as partnerships or M&A. Such
approaches are likely to have a material impact on its profitability or balance sheet.
Key upside risks to our call are: the company managing to grow its user base (online
gaming, navigation site and search) more than we expect without significant margin
contraction; and expansion of online advertising customers for its search product.
Key downside risks are: weaker-than-expected margins from its aggressive push to
gain user market share. We also expect share price to be volatile and may respond
to Internet search market share in the short-term.
66
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Alen Lin
In our DCF valuation, we assume a medium-term revenue CAGR of 14.9%, and
terminal revenue growth rate of 5%. We assume an average medium-term EBIT
margin of 27.5%, and terminal EBIT margin of 30%. We use a WACC of 10.5%.
EXHIBIT 16: DCF assumptions and derivation of TP
Mid-term
WACC (%)
Terminal
10.5
Revenue growth rate (%)
14.9
5.0
EBIT margin (%)
27.5
25.0
Source: Company
EXHIBIT 17: Qihoo 360 P/E band
EXHIBIT 18: Qihoo 360 P/B band
(HKD)
80
(HKD)
60
100x
70
60
75x
50
40
50x
50
9.0x
40
7.5x
6.0x
30
4.5x
30
25x
20
3.0x
10
10
0
Mar-11
20
Mar-12
1.5x
0
Mar-11
Mar-13
Mar-12
Mar-13
EXHIBIT 19: Qihoo quarterly P&L
1Q13A
2Q13E
3Q13E
4Q13E
2013E
(USD m)
(USD m)
(USD m)
(USD m)
(USD m)
Total revenues
109.9
142.6
160.3
179.5
592.3
Cost of revenues
(13.9)
(18.1)
(20.4)
(22.8)
(75.2)
96.0
124.5
140.0
156.7
517.1
Selling, general and administrative
(39.0)
(48.5)
(53.7)
(59.2)
(200.4)
Research and development
(50.2)
(64.2)
(72.1)
(80.8)
(267.3)
Operating profit
6.8
11.4
13.5
15.9
47.6
Income before income taxes
8.6
13.2
15.3
17.7
54.8
Gross profit
Net income
5.4
10.2
12.0
14.0
41.7
17.5
10.2
12.0
14.0
92.3
87.3
87.3
87.3
87.3
87.3
Operating margin
6.2
8.0
8.4
8.9
8.0
Net margin
4.9
7.2
7.5
7.8
7.0
Non-GAAP net income (excludes sharebased compensation)
Margins (%)
Gross margin
67
BNP PARIBAS
27 JUNE 2013
Alen Lin
Company Profile
History and development of the company
Qihoo Technology Company Limited, incorporated in June 2005, had its name
changed to Qihoo 360 Technology Co Ltd on 31 December 2010. The company
operates in China through its wholly-owned subsidiaries and affiliated entities
(Exhibit 13). Qihoo 360 listed its ADS on the New York Stock Exchange under the
ticker “QIHU” on 30 March 2011 and soon after, in April 2011, the company
completed its initial public offering of its ADS.
Business overview
The company offers Internet and mobile security products for free, which has
resulted in the company developing a large and loyal user base. Qihoo 360
monetizes this primarily by offering different forms of online marketing and Internet
value-added services.
Qihoo 360’s product offerings can be segmented into three layers of user
applications (Exhibit 16):
§
Core security layer: Qihoo’s many PC and mobile security software products
offered to users for free through which Qihoo 360 has acquired a solid user base
and 96% penetration of China PCs.
§
Access layer: Internet products and services users use to access the Internet.
Its key products are its hao.360.cn Internet navigation site and its 360 Secure
browser. Qihoo 360’s current online advertising revenue is mostly generated
through its navigation page.
§
Service layer: Various Internet services where there is potential for monetization.
Key services include its 360 Search and online gaming. Qihoo 360 is expanding
its search service to enhance its ability to monetize online advertising revenue.
Given Qihoo 360’s smaller scale than large players such as Baidu, the company
leverages partnership relationships to expand its product offerings. Currently, Qihoo
360 is expanding its business through co-operations with well-recognized vertical
websites, such as Alibaba’s etao.com, xiami.com and amap.com, and forming
partnerships with Nokia and Google for the mobile phone and search markets,
respectively.
EXHIBIT 20: Qihoo 360's core Internet and mobile products
Source: Qihoo 360
Competition
Besides Internet security product and service providers, Qihoo competes with PRCbased Internet companies. According to iReseach, Qihoo is the No 1 provider of
Internet and mobile security products in China based on user base. At the end of
1Q13, its PC Internet security product had 457m monthly active users, representing
a penetration rate of 96%, according to the company. Within the China Internet
market, Qihoo’s primary competitors include Tencent (700 HK, NR), the largest
Internet company in China in terms of revenue, which generates most of its revenues
from online gaming. In the China Internet search industry, Baidu (BIDU US, BUY)
and Sohu’s (SOHU US, NR) Sogou.com are the key competitors.
68
BNP PARIBAS
27 JUNE 2013
Alen Lin
Organizational structure and subsidiaries
EXHIBIT 21: Qihoo 360 organizational structure and subsidiaries
Qihoo 360 Technology Co. Ltd
(Cayman Islands)
100%
100%
360 International Development
Co. Limited (Hong Kong)
100%
Qihu 360 Software Co., Limited
(Hong Kong)
Qiji International Development
Limited (Hong Kong)
100%
100%
Qizhi Software (Beijing) Co.,
Ltd)
Tianjin Qisi Technology Co.,
Ltd
30%
100%
Qifei International
Development Co. Limited
(Hong Kong)
100%
Qifei Xiangyi (Beijing)
Software Co., Ltd
70%
Beijing Qichuang Yousheng
Keji Co., Ltd
Beijing Qihu
Technology
Co., Ltd (PRC)
Beijing Star
World
Technology
Co., Ltd.
(PRC)
Eleven Other
VIEs (PRC)
Source: Company
69
BNP PARIBAS
27 JUNE 2013
Alen Lin
Directors and principal shareholders
The company’s board consists of three non-independent directors and six
independent (a total of nine directors). Mr Hongyi Zhou is CEO of Qihoo and
chairman of the board (he owns 17.7% of outstanding shares). Mr Xiangdong Qi and
Mr Shu Cao are the other two non-independent directors (9.5% and 4.9% of shares
respectively). Mr Neil Nanpeng Shen is an independent director and chairman of the
Compensation Committee (5.4% of shares). Mr Xiaohong Shi is vice president of
technology (1.2% of shares). Mr Alex Zuoli Xu, Mr Jue Yao and the other five
independent directors have combined share ownership of 0.6%.
Of the principal shareholders, Global Village Associates Limited is a company
controlled by Mr Hongyi Zhou. The 17.7% of Qihoo’s ordinary shares owned by
Global Village Associates Limited are included in Mr Hongyi Zhou’s individual
ownership. Young Vision Group Limited and Sequoia Capital China I, LP are whollyowned by Mr Xiangdong Qi and Mr Neil Nanpeng Shen, respectively. Mr Shujun Li is
the managing partner of Trustbridge Partners III, LP currently.
EXHIBIT 22: Qihoo 360 Directors and Executive Officers
Directors and Executive Officers:
Position/Title
Shares Beneficially Owned
Hongyi Zhou
Chairman of the board and chief
executive officer
Xiangdong Qi
Director and president
9.5
Shu Cao
Director and chief engineer
4.9
Neil Nanpeng Shen
Independent Director
5.4
Wenjiang Chen
0.6 (combined with
other independent directors and CFOs)
Hong Chuan Thor
Ming Huang
Shujun Li
(%)
William Mark Evans
Alex Zuoli Xu
Jue Yao
Xiaohong Shi
Vice president of technology
17.7
1.2
Source: Company
EXHIBIT 23: Qihoo 360 principal shareholders
Principal Shareholders:
Shares Owned
(%)
Global Village Associates Limited
17.7
Young Vision Group Limited
8.6
Sequoia Capital China I, L.P. and its affiliates
5.4
Trustbridge Partners III, L.P. and its affiliates
5.4
Source: Company
70
BNP PARIBAS
27 JUNE 2013
Alen Lin
products
27).
engine industry.
71
BNP PARIBAS
27 JUNE 2013
Alen Lin
revenue
(Percent of individuals using the Internet)
100
China
10
5
0
0
2007
2008
2009
2010
2011
2012
Korea
15
200
Germany
20
300
France
25
400
Japan
30
U.S.
500
Hong Kong
35
Taiwan
600
90
80
70
60
50
40
30
20
10
0
Singapore
(%)
(RMB b)
Spain
(m)
Source: ITU
Internet users.
maximise CTR
72
BNP PARIBAS
27 JUNE 2013
Alen Lin
Value Creation
Search Engines
Advertisers
Source: BNP Paribas
Number Internet
users
Number advertisers
Source: BNP Paribas
CAGR of 31.9%
RMB5,800 in 2006, a CAGR of 45.1%.
Internet.
73
BNP PARIBAS
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Alen Lin
(RMB b)
40
(m)
60
35
50
30
40
25
20
30
15
20
10
10
5
2H15E
1H15E
2H14E
1H14E
2H13E
1H13E
2H12
1H12
2H11
1H11
2H10
1H10
2H09
1H09
2H08
0
1H08
0
inventory – search users – are sold
to customers – the advertisers
www.baidu.com
www.so.com
www.sogou.com
www.soso.com
www.google.com
Navigation sites
Web/news portals
www.sina.com.cn
news.sogou.com
news.soso.com
hao.360.cn
www.hao123.com
Social Networking
Internet utilities
Email applications
E-Commerce sites
Web browsers
Etc.
Search Engine
Distribution of
advertising service
Advertisers
Advertisers
Advertisers
Source: BNP Paribas
74
BNP PARIBAS
27 JUNE 2013
Alen Lin
en
search traffic
Source: hao.360.cn
75
BNP PARIBAS
27 JUNE 2013
Alen Lin
views
100%
Baidu
Qihoo
Soso
Google
Sogou
80%
60%
40%
20%
Source: hao.360.cn
2Q13
1Q13
4Q12
3Q12
2Q12
1Q12
4Q11
3Q11
2Q11
1Q11
4Q10
3Q10
0%
Source: cnzz.com
search traffic
(%)
hao.360.cn
11
hao123.com
8.20
web.sogou.com
6.50
123.duba.net
4.20
2345.com
1.40
hao.uc.cn
0.90
76
BNP PARIBAS
27 JUNE 2013
Alen Lin
Search service
454.0
Online video
452.0
Community friends
439.0
News information
413.0
E-commerce
404.4
Entertainment
403.8
IT digital products
395.0
Media domain
362.1
Financial service
361.5
Email
356.0
footprint
77
BNP PARIBAS
27 JUNE 2013
Alen Lin
Search Engine
(RMB b)
25
Video
Vertical Search
Rich Media
Brand Graphic
(nos)
Other
20
40,000
600,000
35,000
30,000
500,000
15
(RMB)
700,000
25,000
400,000
20,000
300,000
10
15,000
200,000
5
10,000
100,000
5,000
0
0
0
2006 2007 2008 2009 2010 2011 2012
1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13
Source: Baidu
advantage
78
BNP PARIBAS
27 JUNE 2013
Alen Lin
Medium
bargaining power.
Medium
Source: BNP Paribas
services provided by Sohu, such as sohu.com, as sources of search traffic to achieve
a search market share of 7-8%.
2013.
of search usage
79
BNP PARIBAS
27 JUNE 2013
Alen Lin
in the near term.
(RMB m)
700
14%
600
12%
500
10%
400
8%
300
6%
200
4%
100
2%
0
0%
1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13
Source: Company
80
BNP PARIBAS
27 JUNE 2013
Alen Lin
SOSO
1.5%
Youdao
0.3%
Others
1.0%
Sogou
3.1%
(m)
500
(RMB)
70
450
60
400
Google
15.6%
350
50
300
40
250
Baidu
78.5%
200
30
150
20
100
10
50
0
0
2007
2008
2009
2010
2011
2012
users
81
BNP PARIBAS
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Alen Lin
display ads
82
BNP PARIBAS
27 JUNE 2013
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opportunities
0
2006
Source: CEIC
83
2007
2008
2009
2010
2011
2012
Post & comment
100
Mobile e-mail
200
Network video
300
Social network
400
Network literature
500
Network music
90
80
70
60
50
40
30
20
10
0
Weibo
(%)
News browse
Instant messaging
(m)
600
Mobile search
2013)
BNP PARIBAS
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Alen Lin
Profit and Loss (USD m) Year Ending Dec
2011A
2012A
2013E
2014E
2015E
Revenue
168
329
592
844
1,046
Cost of sales ex depreciation
(19)
(33)
(75)
(107)
(133)
Gross profit ex depreciation
149
296
517
737
913
0
3
3
4
4
(127)
(234)
(447)
(558)
(606)
Other operating income
Operating costs
Operating EBITDA
22
65
73
182
312
Depreciation
(4)
(16)
(25)
(38)
(53)
Goodwill amortisation
0
0
0
0
0
18
49
48
144
258
Net financing costs
9
7
7
7
7
Associates
0
0
0
0
0
(1)
(1)
0
0
0
Operating EBIT
Recurring non operating income
Non recurring items
0
8
0
0
0
26
63
55
151
265
(11)
(11)
(9)
(26)
(46)
15
51
46
125
220
Minority interests
1
0
0
0
0
Preferred dividends
0
0
0
0
0
Other items
0
(5)
(4)
(4)
(4)
16
47
42
121
216
0
(8)
0
0
0
16
38
42
121
216
Recurring EPS *
0.10
0.22
0.23
0.68
1.21
Reported EPS
0.10
0.26
0.23
0.68
1.21
DPS
0.00
0.00
0.00
0.00
0.00
Profit before tax
Tax
Profit after tax
Reported net profit
Non recurring items & goodwill (net)
Per share (USD)
Growth
Revenue (%)
191.1
96.0
80.0
42.5
24.0
Operating EBITDA (%)
115.8
191.3
11.8
150.5
70.9
79.3
Operating EBIT (%)
101.1
168.4
(2.2)
202.5
Recurring EPS (%)
(12.2)
108.0
7.5
191.3
77.7
Reported EPS (%)
(12.2)
153.1
(11.7)
191.3
77.7
Gross margin inc depreciation (%)
86.2
85.0
83.1
82.8
82.2
Operating EBITDA margin (%)
13.3
19.8
12.3
21.6
29.8
Operating EBIT margin (%)
10.8
14.8
8.0
17.1
24.7
9.3
11.7
7.0
14.4
20.6
42.1
18.1
16.7
17.1
17.2
0.0
0.0
0.0
0.0
0.0
-
-
-
-
-
0.0
0.0
0.0
0.0
0.0
Debtor days
27.1
22.4
21.5
25.5
29.0
Creditor days
70.0
72.2
52.6
66.7
78.3
1,633.9
(436.3)
83.2
90.6
128.8
ROIC (%)
72.4
68.6
25.7
50.2
78.6
ROE (%)
7.0
9.1
7.9
18.5
24.6
ROA (%)
2.2
5.6
4.9
13.3
18.1
2011A
2012A
2013E
2014E
2015E
167
329
592
844
1,046
1
0
0
0
0
Operating performance
Net margin (%)
Effective tax rate (%)
Dividend payout on recurring profit (%)
Interest cover (x)
Inventory days
Operating ROIC (%)
*Pre exceptional, pre-goodwill and fully diluted
Revenue By Division (USD m)
Internet services
Sale of third party anti-virus software
Sources: QIHOO 360 TECHNOLOGY; BNP Paribas estimates
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Cash Flow (USD m) Year Ending Dec
2011A
2012A
2013E
2014E
2015E
16
38
42
121
216
4
16
25
38
53
Associates & minorities
(1)
0
0
0
0
Other non-cash items
50
51
51
51
51
Recurring cash flow
68
105
117
210
320
Change in working capital
14
4
(95)
33
20
0
0
0
0
0
(16)
(69)
(91)
(114)
(114)
Depreciation
Capex - maintenance
Capex - new investment
Free cash flow to equity
66
41
(68)
129
226
Net acquisitions & disposals
0
0
0
0
0
Dividends paid
0
0
0
0
0
(18)
(7)
0
0
0
Net cash flow
47
34
(68)
129
226
Equity finance
236
2
0
0
0
(3)
0
0
0
0
281
36
(68)
129
226
Recurring cash flow per share
0.46
0.60
0.66
1.18
1.80
FCF to equity per share
0.44
0.23
(0.38)
0.73
1.27
2011A
2012A
2013E
2014E
2015E
Non recurring cash flows
Debt finance
Movement in cash
Per share (USD)
Balance Sheet (USD m) Year Ending Dec
Working capital assets
31
55
96
148
193
Working capital liabilities
(47)
(204)
(151)
(235)
(300)
Net working capital
(16)
(149)
(54)
(87)
(107)
Tangible fixed assets
17
126
192
267
328
Operating invested capital
1
(23)
138
180
221
Goodwill
5
5
5
5
5
Other intangible assets
8
12
12
12
12
Investments
16
28
28
28
28
Other assets
5
84
84
84
84
34
105
266
308
349
Invested capital
Cash & equivalents
(344)
(381)
(312)
(442)
(667)
Short term debt
0
0
0
0
0
Long term debt *
0
0
0
0
0
(344)
(381)
(312)
(442)
(667)
Deferred tax
1
1
1
1
1
Other liabilities
0
0
0
0
0
371
478
570
742
1,008
Net debt
Total equity
Minority interests
1
0
0
0
0
Invested capital
34
105
266
308
349
* includes convertibles and preferred stock which is being treated as debt
Per share (USD)
Book value per share
2.49
2.71
3.20
4.17
5.67
Tangible book value per share
2.40
2.61
3.11
4.07
5.57
Financial strength
Net debt/equity (%)
(92.6)
(79.6)
(54.8)
(59.5)
(66.2)
Net debt/total assets (%)
(81.1)
(55.2)
(42.9)
(44.8)
(50.7)
8.0
2.1
2.7
2.5
2.9
-
-
-
-
-
2011A
2012A
2013E
2014E
2015E
24.3
Current ratio (x)
CF interest cover (x)
Valuation
Recurring P/E (x) *
281.1
135.2
125.7
43.2
Recurring P/E @ target price (x) *
281.5
135.3
125.9
43.2
24.3
Reported P/E (x)
281.1
111.1
125.7
43.2
24.3
Dividend yield (%)
0.0
0.0
0.0
0.0
0.0
P/CF (x)
64.1
49.4
44.6
24.9
16.4
P/FCF (x)
66.5
127.7
(76.6)
40.5
23.2
Price/book (x)
11.8
10.9
9.2
7.1
5.2
Price/tangible book (x)
12.2
11.3
9.5
7.2
5.3
EV/EBITDA (x) **
143.2
69.1
66.8
26.6
15.0
EV/EBITDA @ target price (x) **
143.4
69.2
66.9
26.7
15.0
EV/invested capital (x)
120.6
45.8
18.5
15.6
13.1
* Pre exceptional, pre-goodwill and fully diluted
** EBITDA includes associate income and recurring non-operating income
Sources: QIHOO 360 TECHNOLOGY; BNP Paribas estimates
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NOTES
NOTES
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NOTES
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NOTES
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Disclaimers and Disclosures
ANALYST(S) CERTIFICATION
Alen Lin, BNP Paribas Securities (Asia) Ltd, +852 2825 1801, [email protected].
The analyst(s) or strategist(s) herein each referred to as analyst(s) named in this report certifies that (i) all views expressed in this report accurately reflect
the personal view of the analyst(s) with regard to any and all of the subject securities, companies or issuers mentioned in this report; (ii) no part of the
compensation of the analyst(s) was, is, or will be, directly or indirectly, relate to the specific recommendation or views expressed herein; and (iii) is not
aware of any other actual or material conflicts of interest concerning any of the subject securities, companies or issuers referenced herein as of the time of
this certification.
Analysts mentioned in this disclaimer are employed by a non-US affiliate of BNP Paribas Securities Corp., and are not registered/ qualified pursuant to NYSE
and/ or FINRA regulations.
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This report was produced by BNP Paribas Securities (Asia) Ltd, a member company of the BNP Paribas Group. "BNP Paribas” is the marketing name for the
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neither all-inclusive nor can they be guaranteed. The analysts’ analysis and models are subject to change based on various other factors. Valuations are
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offer to sell securities described herein, or solicitation of an offer to buy securities described herein, in Canada or any province or territory thereof. Any offer
or sale of the securities described herein in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant
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reproduced in any form by any means or (ii) redistributed or passed on, directly or indirectly, to any other person in whole or in part, for any purpose
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without the prior written consent of BNP Paribas Capital (Malaysia) Sdn Bhd.
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1
No portion of this report was prepared by BNP Paribas Securities Corp (US) personnel and it is considered Third-Party Affiliate research under NASD Rule 2711.
IMPORTANT DISCLOSURES
The disclosure column in the following table lists the important disclosures applicable to each company that has been rated and/or recommended in this
report:
Company
-
Disclosure (as applicable)
-
BNP Paribas represents that:
1. Within the past year, it has managed or co-managed a public offering for this company, for which it received fees.
2. It had an investment banking relationship with this company in the last 12 months.
3. It received compensation for investment banking services from this company in the last 12 months.
4. It beneficially owns 1% or more or the market capitalization of this company.
5. It makes a market in securities in respect of this company.
6. The analyst(s) or an individual who assisted in the preparation of this report (or a member of his/her household) has a financial interest position in
securities issued by this company or derivatives thereof.
7. The analyst (or a member of his/her household) is an officer, director, or advisory board member of this company.
Additional Disclosures
Within the next three months, BNP Paribas may receive or seek compensation in connection with an investment banking relationship with one or more of the
companies referenced herein.
Target price history, stock price charts, valuation and risk details, and equity rating histories applicable to each company rated in this report is available in
our most recently published reports available on our website: http://eqresearch.bnpparibas.com, or you can contact the analyst named on the front of this
note or your BNP Paribas representative.
All share prices are as at market close on 25 June 2013 unless otherwise stated.
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RECOMMENDATION STRUCTURE
Stock Ratings
Stock ratings are based on absolute upside or downside, which we define as (target price* - current price) / current price.
BUY (B). The upside is 10% or more.
HOLD (H). The upside or downside is less than 10%.
REDUCE (R). The downside is 10% or more.
Unless otherwise specified, these recommendations are set with a 12-month horizon. Thus, it is possible that future price volatility may cause a
temporary mismatch between upside/downside for a stock based on market price and the formal recommendation.
* In most cases, the target price will equal the analyst's assessment of the current fair value of the stock. However, if the analyst doesn't think the market will
reassess the stock over the specified time horizon due to a lack of events or catalysts, then the target price may differ from fair value. In most cases, therefore, our
recommendation is an assessment of the mismatch between current market price and our assessment of current fair value.
Industry Recommendations
Improving (é): The analyst expects the fundamental conditions of the sector to be positive over the next 12 months.
Neutral (çè): The analyst expects the fundamental conditions of the sector to be maintained over the next 12 months.
Deteriorating (ê): The analyst expects the fundamental conditions of the sector to be negative over the next 12 months.
Country (Strategy) Recommendations
Overweight (O). Over the next 12 months, the analyst expects the market to score positively on two or more of the criteria used to determine
market recommendations: index returns relative to the regional benchmark, index sharpe ratio relative to the regional benchmark and index
returns relative to the market cost of equity.
Neutral (N). Over the next 12 months, the analyst expects the market to score positively on one of the criteria used to determine market
recommendations: index returns relative to the regional benchmark, index sharpe ratio relative to the regional benchmark and index returns
relative to the market cost of equity.
Underweight (U). Over the next 12 months, the analyst does not expect the market to score positively on any of the criteria used to determine
market recommendations: index returns relative to the regional benchmark, index sharpe ratio relative to the regional benchmark and index
returns relative to the market cost of equity.
RATING DISTRIBUTION (as at 26 June 2013)
Total BNP Paribas coverage universe
657
Investment Banking Relationship
(%)
Buy
354
Buy
8.5
Hold
207
Hold
2.9
96
Reduce
3.1
Reduce
Should you require additional information concerning this report please contact the relevant BNP Paribas research team or the author(s) of this report.
© 2013 BNP Paribas Group
91
BNP PARIBAS
27 JUNE 2013
BANGKOK
JAKARTA
(In cooperation with BNP Paribas)
ACL Securities Co Ltd
990 Abdulrahim Place, 12/F
Rama IV Road, Bangrak
Bangkok 10500
Thailand
Tel (66 2) 611 3500
Fax (66 2) 611 3551
PT BNP Paribas Securities Indonesia
Grand Indonesia, Menara BCA, 35/F
JI. M.H. Thamrin No. 1
Jakarta 10310
Indonesia
Tel (62 21) 2358 6586
Fax (62 21) 2358 7587
SEOUL
SINGAPORE
TAIPEI
BNP Paribas Securities Korea Co Ltd
22/F, Taepyeongno Building
310 Taepyeongno 2-ga
Jung-gu, Seoul 100-767
Korea
Tel (82 2) 2125 0500
Fax (82 2) 2125 0593
BNP Paribas Securities
(Singapore) Pte Ltd
(Co. Reg. No. 199801966C)
10 Collyer Quay
34/F Ocean Financial Centre
Singapore 049315
Tel (65) 6210 1288
Fax (65) 6210 1980
BNP Paribas Securities
(Taiwan) Co Ltd
72/ F, Taipei 101
No. 7 Xin Yi Road, Sec. 5
Taipei, Taiwan
Tel (886 2) 8729 7000
Fax (886 2) 8101 2168
ISTANBUL
NEW YORK
BASEL
TEB Investment
(A JV between TEB Bank and BNP Paribas)
TEB Kampus D7 Saray Mahallesi
Sokullu Sok No 7
Umraniye 34768 Istanbul
Turkey
Tel: (90 216) 636 44 44
Fax: (90 216) 631 44 00
BNP Paribas
The Equitable Tower
787 Seventh Avenue
New York
NY 10019, USA
Tel (1 212) 841 3800
Fax (1 212) 841 3810
BNP Paribas
Aeschengraben 26
CH 4002 Basel
Switzerland
Tel (41 61) 276 5555
Fax (41 61) 276 5514
HONG KONG
BEIJING
BNP Paribas Securities (Asia) Ltd
63/F, Two International Finance Centre
8 Finance Street, Central
Hong Kong SAR
China
Tel (852) 2825 1888
Fax (852) 2845 9411
BNP Paribas (China) Ltd
Beijing Branch
Room 2001, 20/F
China World Tower
1 Jianguomenwai Avenue
Beijing, China
Tel: +86-10-6535 0888
Fax: +86-10-6535 0883
BNP Paribas Equities (Asia) Ltd
Shanghai Representative Office
Room 2630, 26/F
Shanghai World Financial Center
100 Century Avenue
Shanghai 200120, China
Tel (86 21) 6096 9000
Fax (86 21) 6096 9018
KUALA LUMPUR
MUMBAI
BNP Paribas Capital (Malaysia) Sdn Bhd
Vista Tower, Level 48C
The Intermark, 182 Jalan Tun Razak
50400 Kuala Lumpur
Malaysia
Tel (60 3) 2179 6222
Fax (60 3) 2179 6226
BNP Paribas Securities India Pvt Ltd
BNP Paribas House
1 North Avenue, Maker Maxity
Bandra Kurla Complex
Bandra East
Mumbai 400 051
Tel (91 22) 3370 4000
Fax (91 22) 3370 4386
TOKYO
CAPE TOWN
SHANGHAI
BNP Paribas Securities (Japan) Ltd
GranTokyo North Tower
1-9-1 Marunouchi, Chiyoda-Ku
Tokyo 100-6740
Japan
Tel (81 3) 6377 2000
Fax (81 3) 5218 5970
BNP Paribas Cadiz Securities (Pty) Ltd
Ground floor, Fernwood House
The Oval, 1 Oakdale Road, Newlands
Cape Town
South Africa 7700
Tel (27 21) 657 8300
Fax (27 21) 657 8301
FRANKFURT
GENEVA
LONDON
MADRID
BNP Paribas
Mainzer Landstrasse 16
60325 Frankfurt
Germany
Tel (49 69) 7193 6637
Fax (49 69) 7193 2520
BNP Paribas
2 Place de Hollande
1211 Geneva 11
Switzerland
Tel (41 22) 787 7377
Fax (41 22) 787 8020
BNP Paribas
10 Harewood Avenue
London NW1 6AA
UK
Tel (44 20) 7595 2000
Fax (44 20) 7595 2555
MILAN
BNP Paribas SA, sucursal en Espana
Hermanos Becquer 3
PO Box 50784
28006 Madrid
Spain
Tel (34 91) 745 9000
Fax (34 91) 745 8888
BNP Paribas Equities Italia SIM SpA
Piazza San Fedele, 2
20121 Milan
Italy
Tel (39 02) 72 47 1
Fax (39 02) 72 47 6562
PARIS
ZURICH
MANAMA
BNP Paribas Equities France
Société de Bourse
20 boulevard des Italiens
75009 Paris
France
Tel (33 1) 4014 9673
Fax (33 1) 4014 0066
BNP Paribas
Talstrasse 41
8022 Zurich
Switzerland
Tel (41 1) 229 6891
Fax (41 1) 267 6813
BNP Paribas Bahrain
PO Box 5253
Manama
Bahrain
Tel (973) 53 3978
Fax (973) 53 1237
https://eqresearch.bnpparibas.com

China Internet - Splash - BNP Paribas EQresearch

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